UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number: 811-1731
SOURCE CAPITAL, INC.
(Exact name of registrant as specified in charter)
11400 WEST OLYMPIC BLVD., SUITE 1200, LOS ANGELES, CALIFORNIA 90064
(Address of principal executive offices)
J. RICHARD ATWOOD,
11400 WEST OLYMPIC BLVD., SUITE 1200, LOS ANGELES, CALIFORNIA 90064
(Name and address of agent for service)
Registrant's telephone number, including area code: 310-473-0225
Date of fiscal year end: DECEMBER 31
Date of reporting period: JUNE 30, 2004
Item 1. Report to Stockholders
[LOGO]
SOURCE CAPITAL, INC.
SEMIANNUAL REPORT
FOR THE SIX MONTHS ENDED JUNE 30, 2004
SOURCE CAPITAL, INC.
[LOGO]
INVESTMENT ADVISER
First Pacific Advisors, Inc.
11400 West Olympic Blvd., Suite 1200
Los Angeles, California 90064-1550
(800) 982-4372 or (310) 473-0225
CUSTODIAN
State Street Bank and Trust Company
Boston, Massachusetts
LEGAL COUNSEL
O'Melveny & Myers LLP
Los Angeles, California
INDEPENDENT AUDITORS
Deloitte & Touche LLP
Los Angeles, California
TRANSFER AND SHAREHOLDER SERVICE AGENT
Mellon Investor Services LLC
85 Challenger Road
Overpeck Centre
Ridgefield Park, NJ 07660
(800) 279-1241 or (201) 329-8660
www.melloninvestor.com
REGISTRAR
Mellon Investor Services LLC
Ridgefield Park, New Jersey
STOCK EXCHANGE LISTING
New York Stock Exchange:
Symbols: SOR Common Stock
SOR+ Preferred Stock
SUMMARY FINANCIAL INFORMATION
SIX MONTHS ENDED YEAR ENDED
JUNE 30, 2004 DECEMBER 31, 2003
------------------------- -------------------------
TOTAL PER TOTAL PER
NET COMMON NET COMMON
ASSETS SHARE ASSETS SHARE
------------- -------- ------------- --------
Beginning of period $ 521,248,726 $ 56.62 $ 395,175,835 $ 41.90
------------- -------- ------------- --------
Net gain on investments, realized and unrealized $ 44,622,268 $ 5.40 $ 150,721,705 $ 18.36
Net investment income 2,099,774 0.25 3,348,480 0.41
Dividends to Preferred shareholders (2,363,054) (0.29) (4,726,108) (0.57)
Distributions to Common shareholders (16,523,005) (2.00) (28,645,415) (3.50)
Proceeds from shares issued for distributions reinvested
by shareholders 3,087,002 0.03 5,374,229 0.02
------------- -------- ------------- --------
Net changes during period $ 30,922,985 $ 3.39 $ 126,072,891 $ 14.72
------------- -------- ------------- --------
End of period $ 552,171,711 $ 60.01 $ 521,248,726 $ 56.62
============= ======== ============= ========
JUNE 30, 2004 DECEMBER 31, 2003 DECEMBER 31, 2002
------------- ----------------- -----------------
Common market price per share $ 65.02 $ 59.38 $ 52.85
Common market premium to net asset value 8.4% 4.9% 26.1%
Preferred asset coverage 1,020% 963% 730%
Preferred liquidation preference per share $ 27.50 $ 27.50 $ 27.50
Preferred market price per share $ 33.16 $ 33.81 $ 30.81
DESCRIPTION OF THE COMPANY
SOURCE CAPITAL, INC., is a major diversified, publicly traded investment
company with total net assets approximating $552,000,000. Its investment
portfolio includes a wide range of securities with primary emphasis on common
stocks.
Source Capital has Common and Preferred shares outstanding, both of which are
traded on The New York Stock Exchange. Each of the 1,969,212 outstanding
Preferred shares has a prior claim of $27.50 on assets and $2.40 per year on
income. The balance of the Company's assets and income are available to the
8,299,387 shares of Common Stock outstanding.
Source Capital's investment objective is to seek maximum total return for
Common shareholders from both capital appreciation and investment income to the
extent consistent with protection of invested capital and provision of
sufficient income to meet the dividend requirements of Preferred shareholders.
Source Capital is not a mutual fund. Thus, it does not repurchase its own
shares on demand and does not need to structure its portfolio securities to
provide for possible redemptions. As a publicly traded investment company,
Source Capital's Common and Preferred shares are bought and sold on The New York
Stock Exchange, and the Company is not involved in the transaction.
Source Capital's investment approach emphasizes primarily equity and
equity-related investments in seeking to achieve its growth objective for its
Common shareholders. The desirability of equity versus fixed-income investments
has been increasingly debated in recent years. Source Capital's position is that
without assuming undue risk and recognizing the fixed claim of its Preferred
Stock, properly selected stocks offer the better long-term opportunity for
overall investment return as well as long-term protection from the large but
uncertain threat of inflation. Source Capital's equity investments have been
directed toward companies with highly liquid, relatively unleveraged balance
sheets, and a demonstrated long-term ability to earn above-average returns on
invested capital. Source Capital's equity investment portfolio is based on
fundamental judgments of long-term returns attainable from income and
appreciation in the securities of such companies and is not derived from overall
economic forecasts or stock market predictions.
The Company has adopted a flexible distribution policy. This policy is
designed to pay Common shareholders quarterly distributions at a rate that is
substantially in excess of net investment income. The rate will be adjusted
periodically in response to sustained changes in the net asset value, market
conditions and changes to investment company regulations and tax laws. Only a
portion of such distributions is paid from net investment income. The remainder
is paid from any net realized capital gains and/or paid-in capital, as
determined by each year's results. To the extent the Company realizes net
long-term capital gains for any year in excess of the amounts distributed under
the Company's distribution policy, such excess will be distributed to
shareholders. All distributions are taxable to shareholders as dividend income
or capital gain distributions since the Company has accumulated earnings and
profits from prior years.
1
LETTER TO SHAREHOLDERS
TO OUR SHAREHOLDERS:
Source Capital's total net assets increased from $536,928,646 to $552,171,711
during the second quarter. Net asset value per Common share amounted to $60.01
at June 30, 2004, compared with $58.35 at March 31, 2004, and $56.62 at year-end
2003. These changes in net asset value were net of cash distributions of $1.00
paid in both the first and second quarters.
INVESTMENT RESULTS, 2004 FIRST HALF
For the six months ended June 30, 2004, the net asset value per share of
Source Capital's Common Stock increased by 9.7%, as adjusted for reinvestment of
distributions paid during the period, while total net assets rose 9.1%. These
returns compare with a 6.2% increase in the Russell 2500 Index, a measure of
small to medium capitalization stock performance. The foregoing changes were
calculated on the basis of reinvesting all dividends and distributions.
INVESTMENT RESULTS, 2004 SECOND QUARTER
In the most recent quarter, Source Capital's net asset value per share of
Common Stock increased 4.7%, as adjusted for reinvestment of the $1.00
distribution paid during the period, while total net assets rose 4.4%, both on a
reinvestment basis. In comparison, the Russell 2500 Index increased 0.3% during
the quarter, also on a reinvestment basis.
DISTRIBUTIONS TO COMMON SHAREHOLDERS
A regular quarterly distribution of $1.00 per share was paid on June 15,
2004, to shareholders of record on May 28, 2004. In February 2004, the Board of
Directors adopted a flexible distribution policy. This new policy allows the
Board of Directors to continue to consider changes in net asset value when
establishing the quarterly distribution rate, but also provides the flexibility
to consider other factors such as current market conditions and changes to
investment company regulations and tax laws. It is the intention of the Board of
Directors to continue paying quarterly distributions at a rate that is
substantially in excess of net investment income as evidenced by the current
annual distribution rate of $4.00.
PREFERRED DIVIDENDS
The regular Preferred dividend of $0.60 per share was paid on June 15, 2004,
to shareholders of record on May 28, 2004. The changes in the Company's total
net assets since year-end 2003 have resulted in changes in the Preferred shares'
asset coverage from 963% at December 31, 2003, to 992% at March 31, 2004, and
1,020% at June 30, 2004. Net investment income provided Preferred dividend
coverage of 57% for the second quarter and 89% for the six months, compared with
68% and 77% for the corresponding periods of 2003.
MARKET PRICE OF SOURCE CAPITAL SHARES
The market price of Source Capital Common Stock increased from $59.38 to
$65.02 during the first half of 2004. As this $5.64 increase in market price was
more than the $3.39 rise in the underlying net asset value, the market premium
to net asset value of 4.9% at year-end 2003 increased to 8.4% at June 30, 2004.
The market price of Source Capital Preferred Stock decreased to $33.16 at June
30, 2004, from $33.81 at year-end 2003.
COMMENTARY
The stock market has continued to advance in 2004, though at a modest rate
when compared to the big gains of last year. In addition, small-cap stocks
continue to outperform, with the Russell up twice as much as the 3% gain in the
S&P 500 as of June 30.
Source had an especially strong second quarter, with the net asset value up
4.7%, compared to just a nominal gain in the benchmark Russell 2500. For the
year-to-date period, Source is up 9.7%, comfortably ahead of both the Russell
2500 and the larger-cap S&P 500 and Nasdaq. For the longer three- and five-year
periods, Source has significantly outperformed each of these indexes.
PERIODS ENDED JUNE 30, 2004
------------------------------------------------
SECOND ONE THREE FIVE
QUARTER YTD YEAR YEARS* YEARS*
------- ----- ------ ------- ------
Source (NAV) 4.7% 9.7% 35.8% 12.2% 14.0%
Russell 2500 0.3% 6.2% 32.2% 7.4% 8.5%
S&P 500 1.7% 3.4% 19.1% (0.7)% (2.2)%
Nasdaq 2.7% 2.2% 26.2% (1.8)% (5.3)%
* Annualized Returns
SANDISK first entered Source's portfolio in early 2001 and continues to be a
significant holding. It is a leading designer, manufacturer, and distributor of
flash memory products. Flash is used primarily in portable consumer electronic
devices such as digital cameras, multimedia phones, MP3 players and USB flash
drives. Consumers generally encounter flash memory in the form of a removable
card. These are available in a confusing array of different formats, with names
like Memory Stick, Compact Flash, Secure Digital (SD) cards, Smart Media, or xD
cards, all of which perform similar functions. Because the products that use it
are growing so rapidly, flash memory has been a dynamic industry with growth
rates exceeding 50% annually.
Flash has a number of significant advantages over other types of data storage
(like disk drives, CDs, or DRAM). These include:
- Non-volatile--doesn't need continuous power to retain its data
- Can be written and erased many times
- Durable--has no moving parts
- Small size
- Low power requirements
SanDisk is, in many respects, the leading company in the flash memory
industry. It has a number of important competitive strengths that, we believe,
will help it maintain its strong position.
SanDisk manufactures flash memory chips in a joint venture with Toshiba,
which holds the #2 market share position world
2
wide, behind Samsung. The joint venture is currently building a new fab
(tech-speak for a factory which makes semiconductors). The new plant will
greatly expand the joint venture's capacity and ensure its continued low-cost
position.
SanDisk has an extremely strong intellectual property position, holding many
basic flash memory patents. It will receive close to $200 million this year in
royalties and license fees, including a substantial sum from Samsung.
SanDisk has the strongest position at retail, selling all flash memory
formats, with the best recognized brand in an industry with, admittedly,
relatively low brand recognition. The Company has recently started an
advertising campaign to further enhance its brand strength.
SanDisk's competitive position is further reinforced by its financial
strength. It has over $1 billion in net cash (after deducting debt), or $7 per
share.
The SanDisk story is not without some risks, unfortunately. In the short term
these center on margin pressures, mostly the result of price reductions and
extra costs associated with manufacturing transitions. In the longer term, there
are worries about new market entrants, including Micron, Hynix, and Infineon,
and the possibility that they will commoditize the business, making it
impossible for any participant to earn decent returns.
We agree that these concerns, especially the risk of too many competitors
destroying margins, are well worth worrying about. We believe, however, that the
competitive strengths outlined will provide strong defense and protect SanDisk's
position.
- Just as Samsung is paying royalties to SanDisk, we expect that the new
market entrants will have to do the same, though there are no announced
agreements so far, adding to their costs while increasing SanDisk's
profits.
- The traditional flash manufacturers, Samsung, Toshiba, and SanDisk, are
generations ahead in manufacturing technology, and we expect this to enable
them to maintain their low-cost position.
- SanDisk's increasing brand strength, and its unique ability to be a single
source to retailers of all flash memory formats, will serve to maintain its
position as the leading company at the retail end of the business.
As of the end of the quarter, SanDisk was selling at about 15x estimated 2004
earnings of $1.50 per share. This PE would be closer to 11x if we adjusted for
SanDisk's cash position. Its operating margin is about 25% and return on equity
close to 20%, despite the large cash position. These represent quite high
returns and a modest valuation.
During 2003, SanDisk was a major contributor to Source's strong investment
performance, rising from $10 a share at the start of the year to a November high
of $43, as we sold over 70% of Source's position, before backing off to $31 at
year-end.
This price decline has continued during 2004. On June 30, SanDisk was $22,
fifty percent below its high in late 2003. When combined with our continued
enthusiasm for SanDisk's business, this lower price has made the stock more
attractive, and we have increased our position by about 40% over the past few
months. At over 3% of net assets, SanDisk is again one of Source's more
significant positions.
Respectfully submitted,
/s/ Eric S. Ende
Eric S. Ende
President and
Chief Investment Officer
July 27, 2004
3
PORTFOLIO OF INVESTMENTS
June 30, 2004
COMMON STOCKS SHARES VALUE
-------------------------------------------------------------------------------- ------------ ------------
PRODUCER DURABLE GOODS -- 16.4%
Checkpoint Systems, Inc.* 68,462 $ 1,227,524
Cognex Corporation 495,000 19,047,600
Crane Co. 435,000 13,654,650
Graco Inc. 514,500 15,975,225
IDEX Corporation 511,500 17,570,025
Oshkosh Truck Corporation 110,500 6,332,755
Zebra Technologies Corporation (Class A)* 195,000 16,965,000
------------
$ 90,772,779
------------
BUSINESS SERVICES & SUPPLIES -- 14.5%
Bio-Rad Laboratories, Inc.* 95,000 $ 5,591,700
Black Box Corporation 260,800 12,325,408
HNI Corporation 321,400 13,604,862
Manpower Inc. 300,000 15,231,000
Office Depot, Inc.* 900,000 16,119,000
ScanSource, Inc.* 284,000 16,875,280
------------
$ 79,747,250
------------
HEALTHCARE -- 10.7%
Health Management Associates, Inc. 410,000 $ 9,192,200
Landauer, Inc. 14,300 638,638
Lincare Holdings Inc.* 450,000 14,787,000
Ocular Sciences, Inc.* 390,000 14,820,000
Renal Care Group, Inc.* 600,000 19,878,000
------------
$ 59,315,838
------------
ENERGY -- 10.1%
Cal Dive International, Inc.* 725,000 $ 21,982,000
Noble Corporation* 460,000 17,429,400
Tidewater Inc. 540,000 16,092,000
------------
$ 55,503,400
------------
TECHNOLOGY -- 10.0%
Advanced Fibre Communications, Inc.* 710,000 $ 14,342,000
KEMET Corporation* 200,000 2,444,000
Plantronics, Inc.* 380,000 15,998,000
SanDisk Corporation* 740,000 16,050,600
TriQuint Semiconductor, Inc.* 1,143,029 6,240,938
------------
$ 55,075,538
------------
FINANCIAL -- 8.7%
Brown & Brown, Inc. 251,000 $ 10,818,100
Arthur J. Gallagher & Co. 215,000 6,546,750
National Commerce Financial Corporation 415,000 13,487,500
North Fork Bancorporation, Inc. 455,000 17,312,750
------------
$ 48,165,100
------------
4
SHARES OR
FACE
COMMON STOCKS (CONTINUED) AMOUNT VALUE
-------------------------------------------------------------------------------- ------------ -------------
RETAILING -- 7.8%
CarMax, Inc.* 625,006 $ 13,668,881
O'Reilly Automotive, Inc.* 652,500 29,493,000
-------------
$ 43,161,881
-------------
ENTERTAINMENT -- 4.6%
Carnival Corporation 536,600 $ 25,220,200
-------------
MATERIALS -- 2.7%
Engelhard Corporation 465,000 $ 15,024,150
-------------
TRANSPORTATION -- 0.5%
Heartland Express, Inc. 105,000 $ 2,872,800
-------------
TOTAL COMMON STOCKS -- 86.0% (Cost $288,800,191) $ 474,858,936
-------------
PREFERRED STOCKS
REAL ESTATE INVESTMENT TRUST
CBL & Associates Properties, Inc. 100,000 $ 2,529,000
Duke-Weeks Realty Corp. (Series B) 40,000 2,107,500
Pennsylvania Real Estate Investment Trust (Series A) 59,000 3,475,100
ProLogis (Series G) 120,000 2,748,000
-------------
TOTAL PREFERRED STOCKS -- 2.0% (Cost $10,179,446) $ 10,859,600
-------------
CONVERTIBLE BONDS AND DEBENTURES
TECHNOLOGY -- 0.7%
BEA Systems, Inc. -- 4% 2006 $ 2,000,000 $ 1,990,000
LSI Logic Corporation -- 4% 2006 2,000,000 1,950,000
-------------
$ 3,940,000
-------------
PRODUCER DURABLE GOODS -- 0.1%
Checkpoint Systems, Inc. -- 5.25% 2005 $ 781,000 $ 786,858
-------------
TOTAL CONVERTIBLE BONDS
AND DEBENTURES -- 0.8% (Cost $4,355,460) $ 4,726,858
-------------
5
FACE
NON-CONVERTIBLE BONDS AND DEBENTURES AMOUNT VALUE
-------------------------------------------------------------------------------- ------------ -------------
CORPORATE -- 6.8%
Actuant Corporation -- 13% 2009 $ 2,275,000 $ 2,752,750
Avaya Inc. -- 11.125% 2009 1,300,000 1,527,500
Central Garden & Pet Company -- 9.125% 2013 2,000,000 2,170,000
Host Marriott Corporation -- 9.25% 2007 2,000,000 2,223,960
Lear Corporation -- 7.96% 2005 2,000,000 2,115,000
Manitowoc Company, Inc., The -- 10.5% 2012 2,000,000 2,260,000
Metaldyne Corporation -- 11% 2012 2,000,000 1,680,000
OM Group, Inc. -- 9.25% 2011 4,000,000 4,100,000
Orbital Sciences Corporation -- 9% 2011 3,000,000 3,300,000
PolyOne Corporation -- 10.625% 2010 950,000 997,500
Realty Income Corporation -- 8.25% 2008 2,000,000 2,252,000
SpectraSite, Inc. -- 8.25% 2010 2,000,000 2,070,000
Unisys Corporation
-- 7.875% 2008 1,500,000 1,550,625
-- 8.125% 2006 2,000,000 2,137,500
Vicar Operating Inc. -- 9.875% 2009 3,000,000 3,348,750
Windmere Durable Holdings Inc. -- 10% 2008 3,000,000 3,063,750
-------------
$ 37,549,335
-------------
U.S. GOVERNMENT AND AGENCIES -- 0.2%
Federal Home Loan Mortgage Corporation
-- 6.5% 2023 (Interest Only) $ 120,413 $ 12,267
-- 10.15% 2006 (REMIC) 1,044 1,047
Federal National Mortgage Association -- 6% 2029 (Interest Only) 2,225,432 550,794
Government National Mortgage Association (Mobile Home)
-- 9.75% 2010 417,951 450,963
-------------
$ 1,015,071
-------------
TOTAL NON-COVERTIBLE BONDS
AND DEBENTURES -- 7.0% (Cost $37,083,020) $ 38,564,406
-------------
TOTAL INVESTMENT SECURITIES -- 95.8% (Cost $340,418,117) $ 529,009,800
-------------
SHORT TERM INVESTMENTS
Short-term Corporate Notes:
General Electric Capital Corporation
-- 1.30% 7/1/04 $ 8,623,000 $ 8,623,000
General Electric Capital Services, Inc.
-- 1.22% 7/20/04 15,000,000 14,990,342
-------------
TOTAL SHORT-TERM INVESTMENTS -- 4.3% (Cost $23,613,342) $ 23,613,342
-------------
TOTAL INVESTMENTS -- 100.1% (Cost $364,031,459) $ 552,623,142
Other assets and liabilities, net -- (0.1%) (451,431)
-------------
TOTAL NET ASSETS -- 100% $ 552,171,711
=============
* Non-income producing securities
See notes to financial statements.
6
MAJOR PORTFOLIO CHANGES
Quarter Ended June 30, 2004
SHARES OR
FACE AMOUNT
------------
NET PURCHASES
COMMON STOCKS
Bio-Rad Laboratories, Inc. 55,000 shs.
CarMax, Inc. 180,000 shs.
Arthur J. Gallagher & Co.(1) 215,000 shs.
Health Management Associates, Inc. 101,300 shs.
North Fork Bancorporation, Inc. 70,000 shs.
Oshkosh Truck Corporation(1) 110,500 shs.
SanDisk Corporation 140,000 shs.
CONVERTIBLE SECURITY
BEA Systems, Inc. -- 4% 2006(1) $ 2,000,000
NON-CONVERTIBLE SECURITIES
Orbital Sciences Corporation -- 9% 2011 $ 2,000,000
PolyOne Corporation -- 10.625% 2010(1) $ 950,000
SpectraSite, Inc. -- 8.25% 2010(1) $ 2,000,000
NET SALES
COMMON STOCKS
Checkpoint Systems, Inc. 40,000 shs.
National Commerce Financial Corporation 130,000 shs.
Ocular Sciences, Inc. 310,000 shs.
Zebra Technologies Corporation (Class A) 24,000 shs.
CONVERTIBLE SECURITY
IVAX Corporation -- 5.5% 2007(2) $ 3,000,000
(1) Indicates new commitment to portfolio
(2) Indicates elimination from portfolio
7
STATEMENT OF ASSETS AND LIABILITIES
JUNE 30, 2004
-----------------------------
ASSETS
Investments at value:
Investment securities -- at market value
(cost $340,418,117) -- Note A $ 529,009,800
Short-term investments -- at cost plus interest earned
(maturities 60 days or less) -- Note A 23,613,342 $ 552,623,142
-------------
Cash 788
Receivable for:
Investment securities sold $ 3,541,553
Accrued interest and dividends 874,007 4,415,560
------------- -------------
$ 557,039,490
LIABILITIES
Payable for:
Investment securities purchased $ 4,300,510
Advisory fees 317,034
Accrued dividends -- Preferred Stock 196,921
Accrued expenses 53,314 4,867,779
------------- -------------
TOTAL NET ASSETS -- June 30, 2004 $ 552,171,711
=============
Assets applicable to Preferred Stock at a liquidation preference of
$27.50 per share (asset coverage 1,020%) -- Note B $ 54,153,330
=============
Net assets applicable to Common Stock -- $60.01 per share $ 498,018,381
=============
SUMMARY OF SHAREHOLDERS' EQUITY
$2.40 Cumulative Preferred Stock -- par value $3 per share;
authorized 3,000,000 shares; outstanding 1,969,212 shares -- Note B $ 5,907,636
Common Stock -- par value $1 per share; authorized 12,000,000 shares;
outstanding 8,299,387 shares -- Note B 8,299,387
Additional Paid-in Capital 344,291,441
Undistributed net realized gain on investments 5,081,564
Unrealized appreciation of investments 188,591,683
-------------
TOTAL NET ASSETS -- June 30, 2004 $ 552,171,711
=============
See notes to financial statements.
8
STATEMENT OF OPERATIONS
For the six months ended June 30, 2004
INVESTMENT INCOME
Income:
Interest $ 1,823,293
Dividends 2,640,171
-------------
$ 4,463,464
Expenses -- Note C:
Advisory fees $ 1,850,237
Transfer agent fees and expenses 169,352
Reports to shareholders 111,822
Registration and filing fees 53,451
Directors' fees and expenses 50,121
Taxes, other than federal income tax 38,300
Legal and auditing fees 27,704
Insurance 26,506
Custodian fees and expenses 25,937
Other expenses 10,260 2,363,690
------------- -------------
Net investment income -- Note A $ 2,099,774
-------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS
Realized gain on investments:
Proceeds from sale of investment securities
(Excluding short-term investments with maturities of 60 days or less) $ 51,206,976
Cost of investment securities sold 35,466,668
-------------
Net realized gain on investments -- Notes A and D $ 15,740,308
Unrealized appreciation of investments:
Unrealized appreciation at beginning of period $ 159,709,723
Unrealized appreciation at end of period 188,591,683
-------------
Increase in unrealized appreciation of investments 28,881,960
-------------
Net realized and unrealized gain on investments $ 44,622,268
-------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 46,722,042
=============
See notes to financial statements.
9
STATEMENT OF CHANGES IN TOTAL NET ASSETS
FOR THE SIX MONTHS ENDED FOR THE YEAR ENDED
JUNE 30, 2004 DECEMBER 31, 2003
------------------------------ ------------------------------
INCREASE IN TOTAL NET ASSETS
Operations:
Net investment income $ 2,099,774 $ 3,348,480
Net realized gain on investments --
Notes A and D 15,740,308 35,513,181
Increase in unrealized
appreciation of investments 28,881,960 115,208,524
------------- -------------
Increase in total net assets resulting from
operations $ 46,722,042 $ 154,070,185
Distributions to Preferred shareholders:
From net investment income $ (2,099,774) $ (4,171,681)
From net realized capital gains (263,280) (2,363,054) (554,427) (4,726,108)
------------- -------------
Distributions to Common shareholders from net realized
capital gains -- Note A (16,523,005) (28,645,415)
Proceeds from shares issued for distributions
reinvested by shareholders -- Note B 3,087,002 5,374,229
------------- -------------
Increase in total net assets $ 30,922,985 $ 126,072,891
TOTAL NET ASSETS
Beginning of period 521,248,726 395,175,835
------------- -------------
End of period $ 552,171,711 $ 521,248,726
============= =============
See notes to financial statements.
10
FINANCIAL HIGHLIGHTS
Selected data for a share of Common Stock outstanding throughout each period
Six
months
ended Year ended December 31,
June 30, --------------------------------------------------------------------
2004 2003 2002 2001 2000 1999
----------- ------------ ------------ ------------ ------------ -----------
PER SHARE OPERATING PERFORMANCE:
Net asset value at beginning of period $ 56.62 $ 41.90 $ 55.45 $ 48.62 $ 50.70 $ 48.23
----------- ------------ ------------ ------------ ------------ -----------
Income from investment operations:
Net investment income $ 0.25 $ 0.41 $ 0.49 $ 0.54 $ 0.70 $ 0.67
Net realized and unrealized gain (loss)
on investment securities 5.40 18.36 (8.97) 11.40 4.20 10.27
----------- ------------ ------------ ------------ ------------ -----------
Total from investment operations $ 5.65 $ 18.77 $ (8.48) $ 11.94 $ 4.90 $ 10.94
----------- ------------ ------------ ------------ ------------ -----------
Distributions to Preferred shareholders:
From net investment income $ (0.26) $ (0.51) $ (0.49) $ (0.59) $ (0.61) $ (0.62)
From net realized gains (0.03) (0.06) (0.10) -- -- --
Distributions to Common shareholders:
From net investment income -- -- -- (0.30) -- (0.09)
From net realized gains (2.00) (3.50) (4.60) (4.30) (6.41) (7.77)
----------- ------------ ------------ ------------ ------------ -----------
Total distributions $ (2.29) $ (4.07) $ (5.19) $ (5.19) $ (7.02) $ (8.48)
----------- ------------ ------------ ------------ ------------ -----------
Effect of shares issued for distributions
reinvested by shareholders $ 0.03 $ 0.02 $ 0.12 $ 0.08 $ 0.04 $ 0.01
----------- ------------ ------------ ------------ ------------ -----------
Net asset value at end of period $ 60.01 $ 56.62 $ 41.90 $ 55.45 $ 48.62 $ 50.70
=========== ============ ============ ============ ============ ===========
Per share market price at end of period $ 65.02 $ 59.38 $ 52.85 $ 61.02 $ 52.69 $ 48.25
Total investment return(1) 13.1% 20.6% (6.2)% 26.0% 24.1% 15.2%
Net asset value total return(2) 9.7% 45.7% (17.1)% 24.7% 9.6% 23.1%
SUPPLEMENTAL DATA:
Total net assets at end of period
(in thousands) $ 552,172 $ 521,249 $ 395,176 $ 498,726 $ 437,611 $ 444,388
Ratios based on average net assets
applicable to Common Stock:
Expenses 0.98%(3) 0.99% 0.99% 0.97% 1.00% 1.00%
Net income 0.87%(3) 0.85% 0.99% 1.07% 1.46% 1.39%
Ratios based on average total net assets:
Expenses 0.88%(3) 0.87% 0.87% 0.85% 0.87% 0.87%
Net income 0.78%(3) 0.75% 0.87% 0.95% 1.28% 1.21%
Portfolio turnover rate 20.50%(3) 18.43% 16.62% 25.13% 18.55% 23.51%
PREFERRED STOCK:
Total shares outstanding(4) 1,969,212 1,969,212 1,969,212 1,969,212 1,969,212 1,969,212
Asset coverage per share(4) $ 280.40 $ 264.70 $ 200.68 $ 253.26 $ 222.23 $ 225.67
Involuntary liquidation preference per share $ 27.50 $ 27.50 $ 27.50 $ 27.50 $ 27.50 $ 27.50
Average market price per share(5) $ 33.54 $ 31.87 $ 31.15 $ 30.05 $ 27.87 $ 28.54
(1) Based on market value per share, adjusted for reinvestment of distributions
(2) Based on net asset value per share, adjusted for reinvestment of
distributions
(3) Annualized
(4) Information shown as of the end of the period
(5) The average of all month-end market prices during each period
See notes to financial statements.
11
NOTES TO FINANCIAL STATEMENTS
June 30, 2004
NOTE A--SIGNIFICANT ACCOUNTING POLICIES
The Company is registered under the Investment Company Act of 1940 as a
diversified, closed-end management investment company. The investment objective
of the Company is to seek maximum total return for Common shareholders from both
capital appreciation and investment income to the extent consistent with
protection of invested capital and provision of sufficient income to meet the
dividend requirements of Preferred shareholders. The significant accounting
policies followed by the Company in the preparation of its financial statements
include the following:
1. SECURITIES VALUATION--Securities, including any outstanding written
call options, listed or traded on a national securities exchange are valued at
the last sale price. Securities traded on the NASDAQ National Market System are
valued at the NASDAQ Official Closing Price. If there was not a sale that day,
securities are valued at the mean between the most recent bid and asked prices.
Securities that are unlisted and debt and convertible securities listed on a
national securities exchange for which the over-the-counter market more
accurately reflects the securities' value, in the judgment of the Company's
officers, are valued at the mean between the most recent bid and asked prices or
other ascertainable market value. Short-term investments with maturities of 60
days or less are valued at cost plus interest earned, which approximates market
value. Restricted securities and securities for which market quotations are not
readily available are valued at fair value as determined in good faith by, or
under the direction of, the Board of Directors.
2. FEDERAL INCOME TAX--No provision for federal taxes is considered
necessary because the Company has elected to be taxed as a "regulated investment
company" under the Internal Revenue Code and intends to maintain this
qualification and to distribute each year all of its taxable net investment
income and taxable net realized gain on investments to its shareholders in
accordance with the minimum distribution requirements of the Code.
3. USE OF ESTIMATES--The preparation of the financial statements in
accordance with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the amounts
reported. Actual results could differ from those estimates.
4. OTHER--Securities transactions are accounted for on the date
securities are purchased or sold. Dividend income is recorded on the ex-dividend
date. Interest income and expenses are recorded on an accrual basis. Dividends
payable by the Company on the Preferred Stock are recorded on an accrual basis
and distributions payable on the Common Stock are recorded on the ex-dividend
date. The distribution allocation at June 30, 2004, is preliminary and may be
revised based on operating results for the entire year. The ratios of expenses
and net income to average net assets do not reflect the effect of payments to
Preferred shareholders.
NOTE B--CAPITAL STOCK
The Preferred Stock is entitled in liquidation to $27.50 per share plus
accrued dividends and may be called for redemption, at the discretion of the
Company, at $27.50 per share plus accrued dividends. Dividends may not be
declared on the Common Stock if Preferred dividends are in arrears or if the
Preferred Stock would not thereafter have an asset coverage of 200% or more. At
June 30, 2004, the asset coverage of the Preferred Stock was 1,020%.
The Company issued 50,188 shares of Common Stock under its Reinvestment
Plan for Common and Preferred shareholders during the six months ended June 30,
2004.
NOTE C--ADVISORY FEES AND OTHER AFFILIATED TRANSACTIONS
Pursuant to an investment advisory agreement, the Company pays First
Pacific Advisors, Inc. ("Investment Adviser"), monthly investment advisory fees
calculated at an annual rate of 0.725% for the first $100 million of total net
assets, 0.700% for the next $100 million of total net assets, and 0.675% for any
total net assets in excess of $200 million. The Agreement obligates the
Investment Adviser to reduce its fee to the extent necessary to reimburse the
Company for any annual expenses (exclusive of interest, taxes, the cost of any
supplementary statistical and research information, legal expenses related to
portfolio securities, and extraordinary expenses such as litigation) in excess
of 1 1/2% of the first $30 million and 1% of the remaining average total net
assets of the Company for the year.
For the six months ended June 30, 2004, the Company paid aggregate fees
of $50,000 to all Directors who are not affiliated persons of the Investment
Adviser. During the six months ended June 30, 2004, the Company incurred legal
fees of $1,704 payable to O'Melveny & Myers LLP, counsel for the Company. A
Director of the Company is a retired partner and a retired of counsel employee
of that firm. The Officers of the Company are also officers of the Investment
Adviser.
NOTE D--PURCHASES AND SALES OF SECURITIES
Cost of purchases of investment securities (excluding short-term
corporate notes with maturities of 60 days or less) aggregated $58,167,302 for
the six months ended June 30, 2004. Cost of investment securities owned at June
30, 2004, was the same for federal income tax and financial reporting purposes.
Gains and losses are based on the specific certificate identification method.
Gross unrealized appreciation and depreciation for all investments at June 30,
2004, for federal income tax purposes was $203,193,860 and $14,602,177,
respectively.
12
DIRECTORS AND OFFICERS
NUMBER OF
PORTFOLIOS IN
TERM OF OFFICE AND FUND COMPLEX
NAME,AGE & POSITION(S) LENGTH OF PRINCIPAL OCCUPATION(S) OVERSEEN BY OTHER
ADDRESS WITH COMPANY TIME SERVED DURING THE PAST 5 YEARS DIRECTOR DIRECTORSHIPS
---------- ------------ ---------------------- --------------------------- ------------- -------------
Willard H. Altman, Jr. - (68)* Director Term: 1 Year Retired. Formerly, until 6
11400 W. Olympic Blvd. Time Served: 6 Years 1995, Partner of Ernst &
Los Angeles, CA 90064 Young LLP, a public
accounting firm.
Wesley E. Bellwood - (80)* Director Term: 1 Year Retired. Formerly, until 1
11400 W. Olympic Blvd. Time Served: 24 Years 1999, Chairman Emeritus and
Los Angeles, CA 90064 director of Wynn's
International, Inc.
David Rees - (80)* Director Term: 1 Year Private investor. Formerly 1 International
11400 W. Olympic Blvd. Time Served: 36 Years President and Chief Institute of
Los Angeles, CA 90064 Executive Officer of the Los Angeles
International Institute of
Los Angeles. Formerly,
until 1995, the Senior
Editor of Los Angeles
Business Journal.
Paul G. Schloemer - (76)* Director Term: 1 Year Retired. Formerly President 1
11400 W. Olympic Blvd. Time Served: 5 Years and Chief Executive Officer
Los Angeles, CA 90064 (1984-1993) of Parker
Hannifin Corporation.
Lawrence J. Sheehan - (72) Director Term: 1 Year Retired. Formerly partner 5
11400 W. Olympic Blvd. Time Served: 13 Years (1969 to 1994) and of
Los Angeles, CA 90064 counsel employee (1994 to
2002) of the firm of
O'Melveny & Myers LLP,
legal counsel to the
Company.
Eric S. Ende - (59) Director Term: 1 Year Senior Vice President of 3
11400 W. Olympic Blvd. President & Time Served: 4 Years the Adviser.
Los Angeles, CA 90064 Chief
Investment
Officer
Steven R. Geist - (50) Senior Vice Time Served: 8 Years Vice President of the
11400 W. Olympic Blvd. President & Adviser.
Los Angeles, CA 90064 Fixed-Income
Manager
J. Richard Atwood - (44) Treasurer Time Served: 7 Years Principal and Chief First Pacific
11400 W. Olympic Blvd. Operating Officer of the Advisors,
Los Angeles, CA 90064 Adviser. President of Inc., and FPA
FPA Fund Distributors, Fund
Inc. Distributors,
Inc.
Sherry Sasaki - (49) Secretary Time Served: 22 Years Assistant Vice President
11400 W. Olympic Blvd. and Secretary of the
Los Angeles, CA 90064 Adviser and Secretary of
FPA Fund Distributors, Inc.
Christopher H. Thomas - (47) Assistant Time Served: 9 Years Vice President and FPA Fund
11400 W. Olympic Blvd. Treasurer Controller of the Adviser Distributors,
Los Angeles, CA 90064 and of FPA Fund Inc.
Distributors, Inc.
* Audit committee member
RESULTS OF ANNUAL MEETING
Following is a list of matters voted upon and the results of those votes
cast at the annual meeting of shareholders held May 3, 2004:
1. With respect to the election of four directors by the holders of Common
Stock, $1.00 par value, and election of two directors by the holders of
$2.40 Cumulative Preferred Stock, $3.00 par value:
VOTES FOR VOTES WITHHELD
--------------- ---------------
COMMON
Wesley E. Bellwood 6,840,953 77,666
Eric S. Ende 6,863,101 77,666
David Rees 6,850,637 77,666
Lawrence J. Sheehan 6,856,785 77,666
PREFERRED
Willard H. Altman, Jr 1,724,262 17,473
Paul G. Schloemer 1,723,530 17,473
2. With respect to continuation of the Investment Advisory Agreement, a
total of 8,480,473 shares voted for, 63,873 shares voted against, and
127,558 shares abstained.
No broker non-votes were received with respect to any of the matters voted
upon above.
13
SOURCE CAPITAL, INC. PRESORTED
STANDARD
11400 West Olympic Boulevard, Suite 1200 U.S. POSTAGE
Los Angeles, California 90064-1550 PAID
MIS
Item 2. Code of Ethics. N/A.
Item 3. Audit Committee Financial Expert. N/A.
Item 4. Principal Accountant Fees and Services. N/A.
Item 5. Audit Committee of Listed Registrants. N/A.
Item 6. Schedule of Investments. N/A.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies. N/A.
Item 8. Purchases of Equity Securities by Closed-End Management Investment
Company and Affiliated Purchasers. N/A.
Item 9. Submission of Matters to a Vote of Security Holders. There has been
no material changes to the procedures by which shareholders may
recommend nominees to the registrant's board of directors.
Item 10. Controls and Procedures.
(a) The Principal Executive Officer and Principal Financial Officer of
Source Capital, Inc. ("Company") have concluded that the Company's
disclosure controls and procedures (as defined in Rule 30a-3(c) under
the Investment Company Act of 1940) are effective based on their
evaluation of the disclosure controls and procedures as of a date
within 90 days of the filing date of this report.
(b) There have been no significant changes in the Fund's internal controls
over financial reporting (as defined in Rule 30a-3(d) under the
Investment Company Act) that occurred during the registrant's last
fiscal half-year that has materially affected, or is reasonably likely
to materially affect, the registrant's internal controls over
financial reporting.
Item 11. Exhibits.
(a) Code of ethics as applies to the registrant's officers and directors,
as required to be disclosed under Item 2 of Form N-CSR. N/A.
(b) Separate certification for the registrant's principal executive
officer and principal financial officer, as required by Rule 30a-2(a)
under the Investment Company Act of 1940. Attached hereto.
SIGNATURES
Pursuant to the Securities Exchange Act of 1934 and the Investment Company Act
of 1940, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
SOURCE CAPITAL, INC.
By: /s/ ERIC S. ENDE
------------------------------
Eric S. Ende, President
Date: September 3, 2004
Pursuant to the Securities Exchange Act of 1934 and the Investment Company Act
of 1940, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
SOURCE CAPITAL, INC.
By: /s/ J. RICHARD ATWOOD
------------------------------
J. Richard Atwood, Treasurer
Date: September 3, 2004