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, 2005
Item 1. Report to Stockholders
[SOURCE CAPITAL, INC. LOGO]
SOURCE CAPITAL, INC.
SEMIANNUAL REPORT
FOR THE SIX MONTHS ENDED JUNE 30, 2005
SUMMARY FINANCIAL INFORMATION
SIX MONTHS ENDED YEAR ENDED
JUNE 30, 2005 DECEMBER 31, 2004
--------------------------- ---------------------------
TOTAL PER TOTAL PER
NET COMMON NET COMMON
ASSETS SHARE ASSETS SHARE
--------------- -------- --------------- --------
Beginning of period $ 581,728,644 $ 63.20 $ 521,248,726 $ 56.62
--------------- -------- --------------- --------
Net gain on investments, realized and unrealized $ 11,952,821 $ 1.43 $ 88,404,339 $ 10.65
Net investment income 1,870,234 0.22 3,759,389 0.45
Dividends to Preferred shareholders (2,363,054) (0.28) (4,726,109) (0.57)
Distributions to Common shareholders (16,719,301) (2.00) (33,146,891) (4.00)
Proceeds from shares issued for distributions reinvested
by shareholders 3,140,002 0.03 6,189,190 0.05
--------------- -------- --------------- --------
Net changes during period $ (2,119,298) $ (0.60) $ 60,479,918 $ 6.58
--------------- -------- --------------- --------
End of period $ 579,609,346 $ 62.60 $ 581,728,644 $ 63.20
=============== ======== =============== ========
JUNE 30, 2005 DECEMBER 31, 2004 DECEMBER 31, 2003
--------------- ----------------- -----------------
Common market price per share $ 70.00 $ 71.54 $ 59.38
Common market premium to net asset value 11.8% 13.2% 4.9%
Preferred asset coverage 1,070% 1,074% 963%
Preferred liquidation preference per share $ 27.50 $ 27.50 $ 27.50
Preferred market price per share $ 33.85 $ 34.75 $ 33.81
DESCRIPTION OF THE COMPANY
SOURCE CAPITAL, INC., is a major diversified, publicly traded investment
company with total net assets approximating $580,000,000. 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
8,394,437 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 decreased from $581,709,091 to $579,609,346
during the second quarter. Net asset value per Common share amounted to $62.60
at June 30, 2005, compared with $63.02 at March 31, 2005, and $63.20 at year-end
2004. These changes in net asset value were net of cash distributions of $1.00
paid in both the first and second quarters.
INVESTMENT RESULTS, 2005 FIRST HALF
For the six months ended June 30, 2005, the net asset value per share of
Source Capital's Common Stock increased by 2.3%, as adjusted for reinvestment of
distributions paid during the period, while total net assets rose 2.4%. These
returns compare with a 1.2% 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, 2005 SECOND QUARTER
In the most recent quarter, Source Capital's net asset value per share of
Common Stock increased 1.0%, as adjusted for reinvestment of the $1.00
distribution paid during the period, while total net assets rose 1.0%, both on a
reinvestment basis. In comparison, the Russell 2500 Index increased 4.5% 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,
2005, to shareholders of record on May 27, 2005. Source Capital's distribution
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, 2005,
to shareholders of record on May 27, 2005. The changes in the Company's total
net assets since year-end 2004 have resulted in changes in the Preferred shares'
asset coverage from 1,074% at December 31, 2004 and March 31, 2005, and 1,070%
at June 30, 2005. Net investment income provided Preferred dividend coverage of
82% for the second quarter and 79% for the six months, compared with 57% and 89%
for the corresponding periods of 2004.
MARKET PRICE OF SOURCE CAPITAL SHARES
The market price of Source Capital Common Stock decreased from $71.54 to
$70.00 during the first half of 2005. As this $1.54 decrease in market price was
more than the $0.60 decline in the underlying net asset value, the market
premium to net asset value of 13.2% at year-end 2004 decreased to 11.8% at June
30, 2005. The market price of Source Capital Preferred Stock decreased to $33.85
at June 30, 2005, from $34.75 at year-end 2004.
COMMENTARY
In our last shareholder letter, we strongly implied that the First Quarter
2005 market decline was the likely end to the exuberant gains the market had
enjoyed with little pause for the preceding year and three-quarters. Subsequent
events have proven that view to be far off the mark, as the market was up nicely
in the second quarter, with the S&P 500 gaining 1.4% and the small-stock Russell
2000 up over 4% and, at this writing, July is showing yet stronger performance.
After significantly outperforming the weak first-quarter market, Source
under-performed the strong second quarter. For the combined January-to-June
period, Source is modestly ahead of the benchmark Russell 2500, while holding a
larger lead over the big stock indexes. Results for longer periods are generally
quite favorable.
PERIODS ENDED JUNE 30, 2005
------------------------------------------------------------
FIRST SECOND FIRST ONE THREE FIVE
QUARTER QUARTER HALF YEAR YEARS* YEARS*
------- ------- ------ ------ ------ ------
Source 1.3% 1.0% 2.3% 11.5% 16.0% 15.9%
Russell 2500 (3.1)% 4.5% 1.2% 12.7% 14.8% 7.4%
S&P 500 (2.2)% 1.4% (0.8)% 6.3% 8.3% (2.4)%
Nasdaq (8.1)% 2.9% (5.5)% 0.5% 12.0% (12.3)%
* Annualized Returns
O'REILLY AUTOMOTIVE has been in the Source portfolio for over eight
years--only three companies have been there longer--but we have discussed it
with Source shareholders only once, in the Year 2000 letter, and not in much
depth. At that time our emphasis was on how an irrational 65% stock price
decline had given us what we hoped was a great opportunity to double Source's
position at a very attractive valuation. Now, we would like to provide a more
complete description of O'Reilly's business and the reasons for its success.
O'Reilly is one of the leading retailers of auto parts, operating stores
throughout the central and southeastern states. It has grown rapidly over many
years, and it is clear that its management is among the best in the industry. We
believe that its business model, which distinguishes it from nearly all of its
competitors, has been a crucial element of its success.
The typical auto parts retailer does virtually all of its business with one
of two potential groups of customers, the DIY (Do-It-Yourself) individual, or
the professional mechanic.
AutoZone, the nation's largest auto parts retailer, is typical of the DIY
oriented chains, with numerous convenient locations, extensive advertising, and
a low-price-oriented product offering.
Genuine Part's NAPA stores are a representative commercial chain. Known as
jobbers, they must meet the quite different demands of their mechanic customers,
including an extensive inventory of high-quality, branded parts, knowledgeable
and experienced employees, rapid delivery, and credit.
2
O'Reilly is the only major auto parts chain to successfully combine both of
these quite different businesses, with about a 50-50 split between its DIY and
commercial customers. This business model gives O'Reilly several important
competitive advantages, including greater inventory depth, more-skilled
employees, and the ability to operate in small communities.
In addition to successfully executing this "dual market strategy," O'Reilly
has had to take on a number of other challenges during the years we have owned
it.
UNIT GROWTH--O'Reilly has increased its stores by about 15% annually for many
years. This has generally taken one of two forms. O'Reilly has of course opened
new stores from scratch, carefully selecting the location, constructing the
building, hiring new employees, and stocking the store with appropriate
inventory.
An alternative approach has also proved successful especially when entering a
new market, often a smaller one. O'Reilly has bought out an existing auto parts
business, usually a jobber with a mostly commercial business. This has permitted
it to enter new markets without creating excess capacity and acquire an ongoing
business with established commercial relationships, and experienced employees.
The price is often attractive as well, since selling to O'Reilly often is the
only viable exit strategy for an owner ready to retire and with no family member
interested in taking over the business.
In addition to these de novo store openings and small acquisitions, O'Reilly
has made several acquisitions of size. These have enabled it to enter entirely
new geographies, while stepping up the size of the business. In 1998, O'Reilly
acquired Hi-Lo Automotive, about half of O'Reilly's size, making it an important
player in the large Texas market, still O'Reilly's most important state. Hi-Lo
was integrated successfully over several years, with its sales per store and
profitability both increasing to O'Reilly levels.
More recently, O'Reilly has made two somewhat smaller acquisitions. In 2001
it purchased Mid-State Automotive giving it entree to several states in the
Southeast, and in 2005 it bought Midwest Auto Parts as a means of expanding into
the upper Midwest.
MANAGEMENT TRANSITION--O'Reilly was clearly still a family business at the
time of our initial purchase, with several O'Reillys in senior management
positions. Over time, however, this has changed, and now O'Reilly is led by its
CEO, Greg Henslee, and Ted Wise as Chief Operating Officer while Chairman David
O'Reilly continues in an active, though less dominant role than in the past.
USES OF CAPITAL--O'Reilly has been working very hard in recent years to
improve its returns on capital and strengthen its balance sheet. Improving
returns has been approached from two different angles. First, O'Reilly has
installed a sophisticated inventory control system to optimize inventory by
individual store, and to redistribute any excess to stores that need it. In
other words, maintain sales and service levels with lower inventories. Secondly,
O'Reilly has sought to have a larger share of its working capital funded at no
cost by its vendors, increasing accounts payable at a much faster rate than
inventories.
Not only have these efforts improved returns, but they have also made
O'Reilly independent of the whims of the capital markets. In contrast to the
1990s, when O'Reilly had to do several equity offerings, as well as carry a good
deal of debt in order to fund its growth, in recent years O'Reilly has sold no
stock, and has paid off most of its debt, while still maintaining its rapid
growth.
O'Reilly has benefited both from its internal efforts, as described above,
and from a change in the external environment. A few years ago, new leadership
at AutoZone began to manage the company with the single goal of maximizing cash
flow and using the funds to shrink the equity capitalization with massive share
repurchases. It cut costs and raised prices to improve margins, reduced
inventories, dramatically increased the levels of vendor funded accounts
payable, and leveraged its balance sheet with large borrowings. The cash was all
funneled into share repurchase. Over the past seven years, shares outstanding
have shrunk by 50%.
Although it is uncertain whether this policy will benefit the AutoZone
shareholder in the future, there is no question that it has been and will
continue to be positive for O'Reilly and other major chains, as AutoZone's
unaggressive pricing, deteriorating service levels, and minimal unit growth
foster a relatively benign operating environment.
O'Reilly has been one of Source's most successful investments over the past
decade, and is currently its third largest position. We look forward to holding
it for many more years.
Respectfully submitted,
/s/ Eric S. Ende
Eric S. Ende
President and
Chief Investment Officer
July 28, 2005
3
PORTFOLIO OF INVESTMENTS
June 30, 2005
SHARES VALUE
------------- --------------
COMMON STOCKS
ENERGY -- 14.1%
Cal Dive International, Inc.* 629,400 $ 32,961,678
Noble Corporation* 460,000 28,294,600
Tidewater Inc. 540,000 20,584,800
--------------
$ 81,841,078
--------------
PRODUCER DURABLE GOODS -- 13.4%
Crane Co. 40,000 $ 1,052,000
Diebold, Incorporated 70,000 3,157,700
Graco Inc. 495,000 16,864,650
HNI Corporation 270,000 13,810,500
IDEX Corporation 495,000 19,111,950
Oshkosh Truck Corporation 180,000 14,090,400
Zebra Technologies Corporation (Class A)* 220,000 9,633,800
--------------
$ 77,721,000
--------------
BUSINESS SERVICES & SUPPLIES -- 12.6%
CDW Corporation 252,600 $ 14,420,934
Charles River Laboratories International, Inc.* 340,000 16,405,000
Invitrogen Corporation* 170,000 14,159,300
Manpower Inc. 300,000 11,934,000
ScanSource, Inc.* 370,400 15,904,976
--------------
$ 72,824,210
--------------
HEALTHCARE -- 11.1%
Bio-Rad Laboratories, Inc.* 200,300 $ 11,859,763
Health Management Associates, Inc 500,000 13,090,000
Lincare Holdings Inc.* 400,000 16,336,000
Renal Care Group, Inc.* 500,000 23,050,000
--------------
$ 64,335,763
--------------
TECHNOLOGY -- 9.2%
Cognex Corporation 620,000 $ 16,237,800
Plantronics, Inc. 500,000 18,180,000
SanDisk Corporation* 800,000 18,984,000
--------------
$ 53,401,800
--------------
RETAILING -- 8.8%
CarMax, Inc.* 750,006 $ 19,987,660
O'Reilly Automotive, Inc.* 1,050,000 31,300,500
--------------
$ 51,288,160
--------------
FINANCIAL -- 8.4%
Brown & Brown, Inc. 251,000 $ 11,279,940
First American Corporation, The 155,000 6,221,700
Arthur J. Gallagher & Co. 440,000 11,937,200
North Fork Bancorporation, Inc. 682,500 19,171,425
--------------
$ 48,610,265
--------------
4
SHARES OR
FACE
AMOUNT VALUE
------------- --------------
COMMON STOCKS (CONTINUED)
ENTERTAINMENT -- 5.1%
Carnival Corporation 536,600 $ 29,271,530
--------------
MATERIALS -- 2.4%
Engelhard Corporation 480,000 $ 13,704,000
--------------
TRANSPORTATION -- 2.2%
Heartland Express, Inc. 570,000 $ 11,075,100
Knight Transportation, Inc. 75,000 1,824,750
--------------
$ 12,899,850
--------------
CONSUMER DURABLE GOODS -- 2.2%
Briggs & Stratton Corporation 370,000 $ 12,809,400
--------------
TOTAL COMMON STOCKS -- 89.5% (Cost $311,845,262) $ 518,707,056
--------------
PREFERRED STOCKS
REAL ESTATE INVESTMENT TRUST
CBL & Associates Properties, Inc. 100,000 $ 2,745,000
Duke-Weeks Realty Corp. (Series B) 40,000 2,050,000
Pennsylvania Real Estate Investment Trust (Series A) 59,000 3,481,000
ProLogis (Series G) 120,000 3,057,600
--------------
TOTAL PREFERRED STOCKS -- 2.0% (Cost $10,179,446) $ 11,333,600
--------------
CONVERTIBLE BONDS AND DEBENTURES
TECHNOLOGY -- 1.0%
BEA Systems, Inc. -- 4% 2006 $ 2,000,000 $ 1,970,000
International Rectifier Corp. -- 4.25% 2007 2,000,000 1,965,000
LSI Logic Corporation -- 4% 2006 2,000,000 1,980,000
--------------
$ 5,915,000
--------------
BUSINESS SERVICES & SUPPLIES -- 0.3%
Pegasus Solutions, Inc. -- 3.875% 2023 $ 2,000,000 $ 1,750,000
--------------
TOTAL CONVERTIBLE BONDS
AND DEBENTURES -- 1.3% (Cost $7,690,000) $ 7,665,000
--------------
5
FACE
AMOUNT VALUE
------------- --------------
NON-CONVERTIBLE BONDS AND DEBENTURES
CORPORATE -- 4.7%
Central Garden & Pet Company -- 9.125% 2013 $ 2,000,000 $ 2,140,000
HMH Properties, Inc. -- 7.875% 2008 1,338,000 1,373,123
Host Marriott Corporation -- 9.25% 2007 2,000,000 2,180,000
Manitowoc Company, Inc., The -- 10.5% 2012 1,300,000 1,462,500
Metaldyne Corporation -- 11% 2012 2,000,000 1,320,000
OM Group, Inc. -- 9.25% 2011 4,000,000 4,040,000
Orbital Sciences Corporation -- 9% 2011 3,000,000 3,270,000
PolyOne Corporation -- 10.625% 2010 950,000 1,037,875
Realty Income Corporation -- 8.25% 2008 2,000,000 2,204,000
SpectraSite, Inc. -- 8.25% 2010 2,000,000 2,120,000
Unisys Corporation
-- 7.875% 2008 1,500,000 1,526,250
-- 8.125% 2006 2,000,000 2,065,000
Windmere Durable Holdings Inc. -- 10% 2008 3,000,000 2,737,500
--------------
$ 27,476,248
--------------
U.S. GOVERNMENT AND AGENCIES -- 0.1%
Federal Home Loan Mortgage Corporation
-- 6.5% 2023 (Interest Only) $ 73,090 $ 4,629
-- 10.15% 2006 (REMIC) 70 70
Federal National Mortgage Association -- 6% 2029 (Interest Only) 1,614,163 283,236
Government National Mortgage Association (Mobile Home)
-- 9.75% 2010 304,747 309,889
--------------
$ 597,824
--------------
TOTAL NON-COVERTIBLE BONDS
AND DEBENTURES -- 4.8% (Cost $27,985,192) $ 28,074,072
--------------
TOTAL INVESTMENT SECURITIES -- 97.6% (Cost $357,699,900) $ 565,779,728
--------------
SHORT TERM INVESTMENTS
Short-term Corporate Notes:
Rabobank USA Financial Corporation -- 3.37% 7/1/05 $ 6,209,000 $ 6,209,000
General Electric Capital Services Corp. -- 3.03% 7/7/05 10,000,000 9,994,950
--------------
TOTAL SHORT-TERM INVESTMENTS -- 2.8% (Cost $16,203,950) $ 16,203,950
--------------
TOTAL INVESTMENTS -- 100.4% (Cost $373,903,850) $ 581,983,678
Other assets and liabilities, net -- (0.4)% (2,374,332)
--------------
TOTAL NET ASSETS -- 100.0% $ 579,609,346
==============
* Non-income producing securities
See notes to financial statements.
6
PORTFOLIO SUMMARY
June 30, 2005
COMMON STOCKS 89.5%
Energy 14.1%
Producer Durable Goods 13.4%
Business Services & Supplies 12.6%
Healthcare 11.1%
Technology 9.2%
Retailing 8.8%
Financial 8.4%
Entertainment 5.1%
Materials 2.4%
Transportation 2.2%
Consumer Durable Goods 2.2%
PREFERRED STOCKS 2.0%
CONVERTIBLE BONDS AND DEBENTURES 1.3%
NON-CONVERTIBLE BONDS AND DEBENTURES 4.8%
Corporate 4.7%
U.S. Government and Agencies 0.1%
SHORT-TERM INVESTMENTS 2.8%
OTHER (0.4)%
-------
TOTAL NET ASSETS 100.0%
=======
MAJOR PORTFOLIO CHANGES
Quarter Ended June 30, 2005
SHARES OR
FACE AMOUNT
-------------------
NET PURCHASES
COMMON STOCKS
Briggs & Stratton Corporation 55,000 shs.
CDW Corporation 62,600 shs.
Cognex Corporation 20,000 shs.
Heartland Express, Inc. 120,000 shs.
Invitrogen Corporation 17,500 shs.
Knight Transportation, Inc. (1) 75,000 shs.
Plantronics, Inc. 35,000 shs.
ScanSource, Inc. 86,400 shs.
CONVERTIBLE SECURITY
International Rectifier Corp. -- 4.25% 2007 (1) $ 2,000,000
NET SALES
COMMON STOCKS
Crane Co. 350,000 shs.
Engelhard Corporation 25,000 shs.
HNI Corporation 46,200 shs.
Health Management Associates, Inc. 35,000 shs.
Landauer, Inc. (2) 14,300 shs.
Lincare Holdings Inc. 30,000 shs.
Renal Care Group, Inc. 50,000 shs.
NON-CONVERTIBLE SECURITIES
HMH Properties, Inc. -- 7.875% 2008 $ 1,662,000
Lear Corporation -- 7.96% 2005 (2) $ 2,000,000
Vicar Operating Inc. -- 9.875% 2009 (2) $ 3,000,000
(1) Indicates new commitment to portfolio
(2) Indicates elimination from portfolio
7
STATEMENT OF ASSETS AND LIABILITIES
JUNE 30, 2005
---------------------------------
ASSETS
Investments at value:
Investment securities -- at market value
(cost $357,699,900) -- Note A $ 565,779,728
Short-term investments -- at cost plus interest earned
(maturities 60 days or less) -- Note A 16,203,950 $ 581,983,678
--------------
Cash 622
Receivable for accrued interest and dividends 817,138
---------------
$ 582,801,438
LIABILITIES
Payable for:
Investment securities purchased $ 2,621,054
Advisory fees 332,503
Accrued dividends -- Preferred Stock 196,921
Accrued expenses 41,614 3,192,092
-------------- ---------------
TOTAL NET ASSETS -- June 30, 2005 $ 579,609,346
===============
Assets applicable to Preferred Stock at a liquidation preference of
$27.50 per share (asset coverage 1,070%) -- Note B $ 54,153,330
===============
Net assets applicable to Common Stock -- $62.60 per share $ 525,456,016
===============
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 8,394,437 shares -- Note B 8,394,437
Additional Paid-in Capital 350,762,308
Undistributed net realized gain on investments 6,465,137
Unrealized appreciation of investments 208,079,828
---------------
TOTAL NET ASSETS -- June 30, 2005 $ 579,609,346
===============
See notes to financial statements.
8
STATEMENT OF OPERATIONS
For the six months ended June 30, 2005
INVESTMENT INCOME
Income:
Interest $ 1,808,820
Dividends 2,512,179
---------------
$ 4,320,999
Expenses -- Note C:
Advisory fees $ 1,980,099
Transfer agent fees and expenses 153,507
Reports to shareholders 112,987
Directors' fees and expenses 62,541
Legal and auditing fees 39,949
Taxes, other than federal income tax 38,300
Custodian fees and expenses 28,363
Insurance 20,780
Registration and filing fees 11,926
Other expenses 2,313 2,450,765
-------------- ---------------
Net investment income -- Note A $ 1,870,234
---------------
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) $ 65,117,715
Cost of investment securities sold 42,104,501
--------------
Net realized gain on investments -- Notes A and D $ 23,013,214
Unrealized appreciation of investments:
Unrealized appreciation at beginning of period $ 219,140,221
Unrealized appreciation at end of period 208,079,828
--------------
Decrease in unrealized appreciation of investments (11,060,393)
---------------
Net realized and unrealized gain on investments $ 11,952,821
---------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 13,823,055
===============
See notes to financial statements.
9
STATEMENT OF CHANGES IN TOTAL NET ASSETS
FOR THE SIX MONTHS ENDED FOR THE YEAR ENDED
JUNE 30, 2005 DECEMBER 31, 2004
-------------------------------- ------------------------------
INCREASE (DECREASE) IN TOTAL NET ASSETS
Operations:
Net investment income $ 1,870,234 $ 3,759,389
Net realized gain on investments --
Notes A and D 23,013,214 28,973,841
Increase (decrease) in unrealized
appreciation of investments (11,060,393) 59,430,498
-------------- -------------
Increase in total net assets resulting from
operations $ 13,823,055 $ 92,163,728
Distributions to Preferred shareholders:
From net investment income $ (2,085,041) $ (3,544,582)
From net realized capital gains (278,013) (2,363,054) (1,181,527) (4,726,109)
-------------- -------------
Distributions to Common shareholders from net realized
capital gains -- Note A (16,719,301) (33,146,891)
Proceeds from shares issued for distributions
reinvested by shareholders -- Note B 3,140,002 6,189,190
-------------- -------------
Increase (decrease) in total net assets $ (2,119,298) $ 60,479,918
TOTAL NET ASSETS
Beginning of period 581,728,644 521,248,726
-------------- -------------
End of period $ 579,609,346 $ 581,728,644
============== =============
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, -----------------------------------------------------------------------
2005 2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- ----------- -----------
PER SHARE OPERATING PERFORMANCE:
Net asset value at beginning of period $ 63.20 $ 56.62 $ 41.90 $ 55.45 $ 48.62 $ 50.70
----------- ----------- ----------- ----------- ----------- -----------
Income from investment operations:
Net investment income $ 0.22 $ 0.45 $ 0.41 $ 0.49 $ 0.54 $ 0.70
Net realized and unrealized gain (loss)
on investment securities 1.43 10.65 18.36 (8.97) 11.40 4.20
----------- ----------- ----------- ----------- ----------- -----------
Total from investment operations $ 1.65 $ 11.10 $ 18.77 $ (8.48) $ 11.94 $ 4.90
----------- ----------- ----------- ----------- ----------- -----------
Distributions to Preferred shareholders:
From net investment income $ (0.25) $ (0.43) $ (0.51) $ (0.49) $ (0.59) $ (0.61)
From net realized gains (0.03) (0.14) (0.06) (0.10) -- --
Distributions to Common shareholders:
From net investment income -- -- -- -- (0.30) --
From net realized gains (2.00) (4.00) (3.50) (4.60) (4.30) (6.41)
----------- ----------- ----------- ----------- ----------- -----------
Total distributions $ (2.28) $ (4.57) $ (4.07) $ (5.19) $ (5.19) $ (7.02)
----------- ----------- ----------- ----------- ----------- -----------
Effect of shares issued for distributions
reinvested by shareholders $ 0.03 $ 0.05 $ 0.02 $ 0.12 $ 0.08 $ 0.04
----------- ----------- ----------- ----------- ----------- -----------
Net asset value at end of period $ 62.60 $ 63.20 $ 56.62 $ 41.90 $ 55.45 $ 48.62
=========== =========== =========== =========== =========== ===========
Per share market price at end of period $ 70.00 $ 71.54 $ 59.38 $ 52.85 $ 61.02 $ 52.69
Total investment return(1) 0.8% 28.4% 20.6% (6.2)% 26.0% 24.1%
Net asset value total return(2) 2.3% 19.5% 45.7% (17.1)% 24.7% 9.6%
SUPPLEMENTAL DATA:
Total net assets at end of period (in
thousands) $ 579,609 $ 581,729 $ 521,249 $ 395,176 $ 498,726 $ 437,611
Ratios based on average net assets
applicable to Common Stock:
Expenses 0.94%(3) 0.95% 0.99% 0.99% 0.97% 1.00%
Net income 0.72%(3) 0.77% 0.85% 0.99% 1.07% 1.46%
Ratios based on average total net
assets:
Expenses 0.85%(3) 0.85% 0.87% 0.87% 0.85% 0.87%
Net income 0.65%(3) 0.69% 0.75% 0.87% 0.95% 1.28%
Portfolio turnover rate 23.20%(3) 22.86% 18.43% 16.62% 25.13% 18.55%
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) $ 294.34 $ 295.41 $ 264.70 $ 200.68 $ 253.26 $ 222.23
Involuntary liquidation preference per
share $ 27.50 $ 27.50 $ 27.50 $ 27.50 $ 27.50 $ 27.50
Average market price per share(5) $ 34.14 $ 34.04 $ 31.87 $ 31.15 $ 30.05 $ 27.87
(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, 2005
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, 2005, 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, 2005, the asset coverage of the Preferred Stock was 1,070%.
The Company issued 46,439 shares of Common Stock under its Reinvestment
Plan for Common and Preferred shareholders during the six months ended June 30,
2005.
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.
The investment advisory agreement provides that it may be renewed from year
to year by (i) the Board of Directors of the Company or by the vote of a
majority (as defined in the Investment Company Act of 1940) of the outstanding
voting securities of the Company, and (ii) by the vote of a majority of
Directors who are not interested persons (as defined in the 1940 Act) of the
Company or of the Investment Adviser cast in person at a meeting called for the
purpose of voting on such approval. At a meeting of the Board of Directors held
on February 7, 2005, the continuance of the advisory agreement through April 30,
2006, was approved by the Board of Directors and by a majority of the Directors
who are not interested persons of the Company or of the Investment Adviser. At
the annual meeting of shareholders held on May 2, 2005, the shareholders of the
Company approved such continuance.
In determining whether to renew the advisory agreement, those Company
Directors who are not affiliated with the Investment Adviser met separately to
evaluate information provided by the Investment Adviser in accordance with the
1940 Act and to determine their recommendation to the full Board of Directors.
The Directors considered a variety of factors, including the quality of
advisory, management and accounting services provided to the Company, the fees
and expenses borne by the Company, the profitability of the Investment Adviser
and the investment performance of the Company as well as the performance of a
peer group of investment companies. The Company's
12
advisory fee and expense ratio was also considered in light of the advisory fees
and expense ratios of a peer group of investment companies. The Directors noted
the Company's superior investment results and the quality and depth of the
Investment Adviser and its investment and administrative personnel. The
Directors also took into consideration the benefits derived by the Investment
Adviser from arrangements under which it receives research services from brokers
to whom the Company's brokerage transactions are allocated. Based upon its
consideration of these and other relevant factors, the Directors concluded that
the advisory fees and other expenses paid the Company are fair and shareholders
have received reasonable value in return for such fees and expenses. Thus, the
Directors recommended that shareholders approve the continuance of the advisory
agreement.
For the six months ended June 30, 2005, the Company paid aggregate fees of
$62,500 to all Directors who are not affiliated persons of the Investment
Adviser. During the six months ended June 30, 2005, the Company incurred legal
fees of $12,569 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 $71,071,012 for the six
months ended June 30, 2005. Cost of investment securities owned at June 30,
2005, 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,
2005, for federal income tax purposes was $208,988,454 and $908,917,
respectively, with total net unrealized appreciation of $208,079,828.
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 2, 2005:
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 6,952,118 74,106
Eric S. Ende 6,969,317 74,106
David Rees 6,957,918 74,106
Lawrence J. Sheehan 6,960,243 74,106
PREFERRED
Willard H. Altman, Jr. 1,753,384 16,290
Paul G. Schloemer 1,756,020 16,290
2. With respect to continuation of the Investment Advisory Agreement, a
total of 8,655,998 shares voted for, 39,834 shares voted against, and
109,165 shares abstained.
No broker non-votes were received with respect to any of the matters voted
upon above.
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
13
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. - (69)* Director Term: 1 Year Retired. Formerly, until 6
11400 W. Olympic Blvd. Time Served: 7 Years 1995, Partner of Ernst &
Los Angeles, CA 90064 Young LLP, a public
accounting firm.
Wesley E. Bellwood - (81)* Director Term: 1 Year Retired. Formerly, until 1
11400 W. Olympic Blvd. Time Served: 25 Years 1999, Chairman Emeritus
Los Angeles, CA 90064 and director of Wynn's
International, Inc.
David Rees - (81)* Director Term: 1 Year Private investor. 1 International
11400 W. Olympic Blvd. Time Served: 37 Years Formerly President and Institute of
Los Angeles, CA 90064 Chief Executive Officer Los Angeles
of the International
Institute of Los Angeles.
Formerly, until 1995, the
Senior Editor of Los
Angeles Business Journal.
Paul G. Schloemer - (77)* Director Term: 1 Year Retired. Formerly 1
11400 W. Olympic Blvd. Time Served: 6 Years President and Chief
Los Angeles, CA 90064 Executive Officer
(1984-1993) of Parker
Hannifin Corporation.
Lawrence J. Sheehan - (73)* Director Term: 1 Year Retired. Formerly partner 5
11400 W. Olympic Blvd. Time Served: 14 Years (1969 to 1994) and of
Los Angeles, CA 90064 counsel employee (1994 to
2002) of the law firm of
O'Melveny & Myers LLP,
legal counsel to the
Company.
Eric S. Ende - (60) Director Term: 1 Year Senior Vice President of 3
11400 W. Olympic Blvd. President & Time Served: 5 Years the Adviser.
Los Angeles, CA 90064 Chief Investment
Officer
Steven R. Geist - (51) Senior Vice Time Served: 9 Years Vice President of the
11400 W. Olympic Blvd. President & Adviser.
Los Angeles, CA 90064 Fixed-Income
Manager
J. Richard Atwood - (45) Treasurer Time Served: 8 Years Principal and Chief First Pacific
11400 W. Olympic Blvd. Operating Officer of the Advisors, Inc.,
Los Angeles, CA 90064 Adviser. President of FPA and FPA Fund
Fund Distributors, Inc. Distributors,
Inc.
Sherry Sasaki - (50) Secretary Time Served: 23 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 - (48) Chief Compliance Time Served: 10 Years Vice President and FPA Fund
11400 W. Olympic Blvd. Officer and Controller of the Adviser Distributors,
Los Angeles, CA 90064 Assistant Treasurer and of FPA Fund Inc.
Distributors, Inc.
* Audit committee member
Mr. Altman serves as a member of the audit committee of five open-end
investment companies managed by First Pacific Advisors, Inc. ("FPA"), the
Company's investment adviser. Mr. Sheehan serves as a member of the audit
committee of three open-end investment companies managed by FPA. The Company's
Board of Directors has considered the matter of their simultaneous service and
determined that serving simultaneously as a member of these audit committees
does not impair their ability to serve as a member of the Audit Committee of the
Company.
The Company's schedule of portfolio holdings, filed the first and third
quarter on Form N-Q with the SEC, is available on the SEC's website at
www.sec.gov. Form N-Q is available at the SEC's Public Reference Room in
Washington, D.C., and information on the operations of the Public Reference Room
may be obtained by calling 1-202-942-8090. To obtain information on Form N-Q
from the Company, shareholders can call 1-800-982-4372.
The Company's complete proxy voting record for the 12 months ended June 30,
2005, is available without charge, upon request, by calling 1-800-982-4372 and
on the SEC's website at www.sec.gov.
The Company's Audit Committee Charter is available on its website,
www.fpafunds.com, and is available without charge, upon request, by calling
1-800-982-4372. The Company's Annual CEO Certification as required by the NYSE's
Corporate Governance listing standards for the fiscal year ended December 31,
2004 was submitted to the NYSE on May 10, 2005.
14
SOURCE CAPITAL, INC.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064-1550
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. Not Applicable.
Item 3. Audit Committee Financial Expert. Not Applicable.
Item 4. Principal Accountant Fees and Services. Not Applicable.
Item 5. Audit Committee of Listed Registrants. Not Applicable.
Item 6. Schedule of Investments. The schedule of investments is included as
part of the report to shareholders filed under Item 1 of this Form.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies. Not Applicable.
Item 8. Portfolio Managers of Closed-End Management Investment Companies.
Not Applicable.
Item 9. Purchases of Equity Securities by Closed-End Management Investment
Company and Affiliated Purchasers. Not Applicable.
Item 10. Submission of Matters to a Vote of Security Holders. There has
been no material change to the procedures by which shareholders may
recommend nominees to the registrant's board of directors.
Item 11. Controls and Procedures.
(a) The principal executive officer and principal financial officer of the
registrant have concluded that the registrant'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 registrant's internal
controls over financial reporting (as defined in Rule 30a-3(d) under
the Investment Company Act of 1940) that occurred during the
registrant's last fiscal half-year (the registrant's second fiscal
half-year in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal controls over financial reporting.
Item 12. Exhibits.
(a)(1) Code of ethics as applies to the registrant's officers and directors,
as required to be disclosed under Item 2 of Form N-CSR. Not
Applicable.
(a)(2) 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.
(a)(3) Not Applicable.
(b) Separate certification for the registrant's principal executive
officer and principal financial officer, as required by Rule 30a-2(b)
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 2, 2005
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 2, 2005