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: DECEMBER 31, 2004
Item 1. Report to Stockholders
[SOURCE CAPITAL, INC. LOGO]
SOURCE CAPITAL, INC.
2004
ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31
SUMMARY FINANCIAL INFORMATION
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2004 2003
------------------------------- ------------------------------
TOTAL PER TOTAL PER
NET COMMON NET COMMON
ASSETS SHARE ASSETS SHARE
------------- ------------- ------------- -------------
Beginning of year $ 521,248,726 $ 56.62 $ 395,175,835 $ 41.90
------------- ------------- ------------- -------------
Net gain on investments, realized and unrealized $ 88,404,339 $ 10.65 $ 150,721,705 $ 18.36
Net investment income 3,759,389 0.45 3,348,480 0.41
Distributions to Preferred shareholders (4,726,109) (0.57) (4,726,108) (0.57)
Distributions to Common shareholders (33,146,891) (4.00) (28,645,415) (3.50)
Proceeds from shares issued for distributions
reinvested by shareholders 6,189,190 0.05 5,374,229 0.02
------------- ------------- ------------- -------------
Net changes during year $ 60,479,918 $ 6.58 $ 126,072,891 $ 14.72
------------- ------------- ------------- -------------
End of year $ 581,728,644 $ 63.20 $ 521,248,726 $ 56.62
============= ============= ============= =============
Common market price per share $ 71.54 $ 59.38
Common market premium to net asset value 13.2% 4.9%
Preferred asset coverage 1,074% 963%
Preferred liquidation preference per share $ 27.50 $ 27.50
Preferred market price per share $ 34.75 $ 33.81
DESCRIPTION OF THE COMPANY
SOURCE CAPITAL, INC., is a major diversified, publicly traded investment
company with total net assets of approximately $582,000,000. Its investment
portfolio includes a wide range of securities with primary emphasis on common
stock and convertible debentures.
Source Capital has Common and Preferred shares outstanding, both of which
are listed and 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 8,347,998 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 such transactions.
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. For federal income tax purposes, all distributions in excess of
current year earnings will be taxable to shareholders as long as the Company
continues to have accumulated earnings and profits from prior years.
1
LETTER TO SHAREHOLDERS
TO OUR SHAREHOLDERS:
2004 INVESTMENT PORTFOLIO RETURNS
Total net assets of Source Capital amounted to $581,728,644 at December 31,
2004. After providing for Preferred Stock equity, Common equity amounted to
$527,575,314 or $63.20 of net asset value per Common share. This compared with
total net assets of $521,248,726, Common equity of $467,095,396 and net asset
value per Common share of $56.62 one year ago. These changes reflect payments to
Common and Preferred shareholders totaling $37,873,000. As a result, Source
Capital achieved a total investment return during 2004 of 19.5% on its Common
net asset value, and 18.4% on total net assets, with both figures reflecting the
reinvestment of dividends and distributions.
The table at the bottom of this page compares Source Capital's investment
results with the returns of several well-known indices of securities prices.
Each of the last five calendar years is shown, as well as annualized returns for
longer periods. All the percentage changes shown represent total investment
returns from both income and appreciation (depreciation) calculated on the basis
of reinvesting all dividends and distributions.
DISTRIBUTIONS TO COMMON SHAREHOLDERS
In February 2004, the Board of Directors adopted a new flexible
distribution policy. This new policy will allow the Board of Directors to
continue to consider changes in net asset value when establishing the quarterly
distribution rate, but also provides for 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.
Capital gains are the eventual result of successful investments. As in
recent years, changes in relative market valuation as well as changing prospects
of individual companies led us to sell certain holdings in 2004, and these sales
resulted in the realization of significant net capital gains. We believe that we
have been able to replace these securities both by adding to existing
investments at advantageous prices and by making selected new investments
(primarily equity investments) offering potentially better long-term investment
returns.
As a result of these changes, the Company realized $28,973,841 in net
capital gains in 2004. However, distribution of these gains did not require
payment of a special distribution. Detailed tax information is presented on page
9.
MARKET PRICES AND SHAREHOLDER RETURNS
In the long run, the future returns for Source Capital Common shareholders
will depend primarily on how well we manage the firm's investment portfolio. The
longer the period of time involved, the more important portfolio investment
returns will be in determining shareholder returns. However, in the short run,
changes in the market price of Source Capital Common shares can deviate from the
underlying changes in net asset value causing market returns to be either
enhanced or diminished.
In prior years we have commented on the dramatic difference between that
year's market returns for Source shareholders (the change in Source's quoted
price plus
SOURCE CAPITAL STOCK MARKET INDICES FIXED-INCOME INDICES
----------------------- ------------------------------------ --------------------------------
TOTAL COMMON RUSSELL S&P LEHMAN BROTHERS TREASURY
PERIOD NET ASSETS EQUITY 2500 500 DJIA GOVT/CREDIT INDEX BILL YIELDS
---------------------- ---------- ---------- ---------- -------- --------- ----------------- -----------
Annual Rate of Return:
2004 +18.4% +19.5% +18.3% +10.9% + 3.2% + 4.2% +1.2%
2003 +40.5 +45.7 +45.5 +28.7 +25.3 + 4.7 +1.1
2002 -14.6 -17.1 -17.8 -22.1 -15.0 +11.0 +1.7
2001 +22.8 +24.7 + 1.2 -11.9 - 5.4 + 8.5 +4.1
2000 + 9.5 + 9.6 + 4.3 - 9.1 - 4.7 +11.9 +6.0
Annual Compound
Rate of Return:
3 years +12.4 +13.0 +12.3 + 3.6 + 3.2 + 6.6 +1.3
5 years +13.8 +14.6 + 8.4 - 2.3 - 0.2 + 8.0 +2.8
10 years +15.8 +16.8 +13.8 +12.1 +12.6 + 7.8 +4.0
20 years +13.5 +14.4 +13.5 +13.2 +14.4 + 8.8 +4.9
2
dividends received) and the actual investment returns earned by the Source
portfolio. It turns out that five of the past six years have seen similar large
differences, as the premium at which Source has traded over its net asset value
has fluctuated considerably. An increase in the premium (or decrease in the
discount) will, of course, produce a market return greater than that actually
earned on the underlying portfolio, while a decrease in the premium will have
the opposite effect.
YEAR-END
PREMIUM/ MARKET INVESTMENT --------------------------
(DISCOUNT) RETURN RETURN NAV MARKET PRICE
------------ -------- ------------ ----------- ------------
2004 13.2% 27.2% 19.5% $ 63.20 $ 71.54
2003 4.9% 19.0% 45.7% $ 56.62 $ 59.38
2002 26.1% (5.9)% (17.1)% $ 41.90 $ 52.85
2001 10.1% 24.5% 24.7% $ 55.45 $ 61.02
2000 8.4% 22.5% 9.6% $ 48.62 $ 52.69
1999 (4.8)% 14.4% 23.1% $ 50.70 $ 48.25
The following table presents 2004 market returns for both Common and
Preferred shareholders:
COMMON PREFERRED
STOCK STOCK
----------- -----------
Change in Market Value:
NYSE Closing Price
-- 12/31/2004 $ 71.54 $ 34.75
NYSE Closing Price
-- 12/31/2003 59.38 33.81
----------- -----------
Net change in 2004 $ 12.16 $ 0.94
Distributions in 2004 4.00 2.40
----------- -----------
Total return -- Amount $ 16.16 $ 3.34
Total return -- Percent 27.2% 9.9%
Common shareholders who participated in the Company's Automatic
Reinvestment Plan experienced a positive return of 28.4% during 2004. On a
long-term basis, those shareholders who participated in the Automatic
Reinvestment Plan during each of the 28 years since its inception experienced an
annual compound rate of return of 18.0%.
COMMENTARY
As we now approach the fifth anniversary of the stock market's March 2000
peak, it may be instructive to look at how investors have fared in the
subsequent years. Two observations stand out.
First, just as the speculative boom that led up to the market peak was very
uneven, with some stocks participating to a far greater degree than others, the
post-bubble market has also had its winners and losers. Generally, small and
non-tech stocks, which missed much of the 1990s' party, have done well,
especially relative to the negative performance for the market as a whole.
Second, although we are all familiar with long-term studies which show that
equity markets have delivered quite attractive returns over virtually all long
time periods, it turns out that purchasing shares of even the best companies at
bubble highs is unlikely to EVER deliver adequate rates of return. For example,
investors who purchased Microsoft, Intel, and Cisco, each large and highly
successful businesses, in March 2000, have now lost about two thirds of their
funds, or 20% annually over the subsequent five-year period. In other words,
they have suffered a substantial and permanent loss of capital.
Source has approached the market environment of the past five years no
differently than prior periods. We have striven to own high-quality businesses,
but have refused to overpay for them. Though this has produced past periods of
underperformance when overpriced stocks became even more overpriced, on balance
it has served the Source shareholder well.
The following table shows returns for one-, three-, and five-year periods
for the leading large- and small-cap averages, as well as for Source.
VALUE OF $1.00
2004 3 YEARS* 5 YEARS* INVESTED 1/1/2000
----------- ----------- ----------- -----------------
Nasdaq 8.6% 3.7% (11.8)% $ 0.53
S & P 500 10.9% 3.6% (2.3)% $ 0.89
Russell 2000 18.3% 11.5% 6.6% $ 1.38
Source 19.5% 13.0% 14.6% $ 1.97
* Annualized Return
We were frankly surprised at how strongly the market performed in 2004,
especially after the large advance of 2003. Most indexes were up between 10% and
20%, with small-cap stocks repeating their leadership performance of 2003. The
Russell 2000, for example, is up about 75% over the past two years, and has
nearly doubled from its March 2003 lows.
Source's performance in 2004, a gain of 19.5%, was very gratifying. We have
now beaten the benchmark Russell 2500 for each of the past 5 years, though by
only the slimmest of margins for 2002-2004. The Russell 2500 excludes the 500
largest companies in the Russell 3000 Index, which is comprised of the 3,000
largest publicly traded U.S. companies. The table below shows Source's returns
for each year since 2000, as well as those of the Russell 2500.
2000 2001 2002 2003 2004 FIVE YEARS*
------- ------- ------- ------- ------- ----------
Source 9.6% 24.7% (17.1)% 45.7% 19.5% 14.6%
Russell 2500 4.3% 1.2% (17.8)% 45.5% 18.3% 8.4%
* Annualized Return
We would like to discuss a recent addition to Source's portfolio. Founded
in 1917 as a pioneer in the development of all-wheel drive technology, OSHKOSH
TRUCK has spent most of its existence as a builder of military trucks. Under new
management, Oshkosh reinvented itself in the mid-1990s. Starting with a business
that was two thirds defense products,
3
Oshkosh aggressively diversified. With a series of acquisitions, it entered
related specialty truck areas, buying either the market leader, or more often,
the strong number two company in the industry. It improved manufacturing and
invested in product development and technology. Over time, almost all of these
acquired businesses have gained the number one share position as well as
improved profitability. Sales have increased from $400 million in 1996 to over
$2 billion today.
As it expanded the scope of its business, Oshkosh took on large amounts of
debt, but its strong cash flow has enabled it to considerably reduce leverage in
recent years--from debt at 65% of capital five years ago to just 15% today.
Returns on capital have been excellent and trending upwards. Return on equity
over the past five years has averaged 20%.
Oshkosh's largest business is defense, where it supplies medium and heavy
trucks to the U.S. and U.K. military. Though somewhat lumpy, with a small number
of very large contracts, it has the advantage of large backlogs and long-lived
procurements, as well as a continuing demand for parts and reconditioning.
Oshkosh is the market share leader, well ahead of rival Stewart and Stevenson,
with projected Year 2005 sales of about $1 billion, 35% of the corporate total.
Oshkosh's defense operations are currently especially busy because of the severe
wear on vehicles operating in Iraq and Afghanistan.
Oshkosh entered the fire-truck and emergency-vehicle business in 1996,
acquiring Pierce Manufacturing, the number two company in the industry, behind
Federal Signal's E-One. Current Pierce sales are about $700 million, or one
quarter of total Oshkosh revenues. It has grown to the leading market share
spot, with about 30% of the U.S. market, helped both by its own product
innovations and by missteps of E-One.
Oshkosh entered the cement mixer market in 1998 with its purchase of
McNeilus Companies. With a 65% share, McNeilus was already by far the market
leader, however, Oshkosh has further grown its share to about 75%. Current sales
are $550 million, or 20% of Oshkosh's total. It has recently introduced a
revolutionary new product--a cement truck with a plastic composite drum
replacing the usual steel drum. Because the drum is 2,000 pounds lighter, the
new trucks can carry an extra ton of cement, significantly reducing
transportation costs per unit delivered. Oshkosh has recently started to
aggressively market this exciting new product to its cement-mixer customers.
Oshkosh also makes refuse truck bodies, a business it entered by
acquisition in 1998 in the U.S. (McNeilus) and 2001 in Europe (Geesink Norba).
At the time it was a distant number two, with barely half the 32% market share
of leader Heil (owned by Dover). It has now completely closed that gap and is
tied for the number one spot with Heil, at about 25% each, having successfully
executed a strategy of focusing on the Big 3 private haulers. With total sales
of $400 million, refuse trucks represent 15% of Oshkosh revenues.
Oshkosh's most recent business is tow trucks and wreckers, which it entered
in June 2004, with the purchase of Jerr-Dan. With sales of $100 million,
Jerr-Dan is half the size of market leader Miller, but has some innovative
technology that Oshkosh plans to develop further.
We purchased most of our Oshkosh Truck position during the middle of last
year at about $50 per share, 16x year 2004 earnings. We believe that the share
price was under pressure because of some nagging concerns about the business,
including difficulty in recovering steel cost increases, a large U.K. military
truck contract not awarded to Oshkosh, and manufacturing issues at Geesink Norba
and with the new cement-truck drum.
After a recent strong December quarter earnings report, the Street appears
to be feeling better about most of these issues, and the stock is trading at
about $70 per share or 17-18x estimated 2005 earnings. We are comfortable with
our 2.5% position and hope to own Oshkosh Truck for many years.
Respectfully submitted,
/s/ Eric S. Ende
Eric S. Ende
President and
Chief Investment Officer
January 31, 2005
4
PORTFOLIO OF INVESTMENTS
December 31, 2004
COMMON STOCKS SHARES VALUE
----------------------------------------------- ----------- ---------------
PRODUCER DURABLE GOODS -- 15.9%
Crane Co. 435,000 $ 12,545,400
Diebold, Incorporated 50,000 2,786,500
Graco Inc. 514,500 19,216,575
HNI Corporation 321,400 13,836,270
IDEX Corporation 511,500 20,715,750
Oshkosh Truck Corporation 162,500 11,111,750
Zebra Technologies Corporation (Class A)* 220,000 12,381,600
---------------
$ 92,593,845
---------------
ENERGY -- 12.3%
Cal Dive International, Inc.* 725,000 $ 29,543,750
Noble Corporation* 460,000 22,880,400
Tidewater Inc. 540,000 19,229,400
---------------
$ 71,653,550
---------------
BUSINESS SERVICES & SUPPLIES -- 12.1%
Charles River Laboratories International, Inc.* 280,000 $ 12,882,800
Invitrogen Corporation* 140,000 9,398,200
Landauer, Inc. 14,300 653,510
Manpower Inc. 300,000 14,490,000
Office Depot, Inc.* 900,000 15,624,000
ScanSource, Inc.* 284,000 17,653,440
---------------
$ 70,701,950
---------------
HEALTHCARE -- 11.1%
Bio-Rad Laboratories, Inc.* 200,300 $ 11,491,211
Health Management Associates, Inc. 535,000 12,155,200
Lincare Holdings Inc.* 450,000 19,192,500
Renal Care Group, Inc.* 600,000 21,594,000
---------------
$ 64,432,911
---------------
RETAILING -- 9.1%
CarMax, Inc.* 750,006 $ 23,287,686
O'Reilly Automotive, Inc.* 652,500 29,395,125
---------------
$ 52,682,811
---------------
TECHNOLOGY -- 8.8%
Cognex Corporation 575,000 $ 16,042,500
Plantronics, Inc. 380,000 15,758,600
SanDisk Corporation* 790,000 19,726,300
---------------
$ 51,527,400
---------------
5
SHARES OR
FACE
COMMON STOCKS (CONTINUED) AMOUNT VALUE
--------------------------------------------------------------- ----------- ---------------
FINANCIAL -- 7.6%
Brown & Brown, Inc. 251,000 $ 10,931,050
Arthur J. Gallagher & Co. 415,000 13,487,500
North Fork Bancorporation, Inc. 682,500 19,690,125
---------------
$ 44,108,675
---------------
ENTERTAINMENT -- 5.3%
Carnival Corporation 536,600 $ 30,924,258
---------------
MATERIALS -- 2.7%
Engelhard Corporation 505,000 $ 15,488,350
---------------
TRANSPORTATION -- 0.7%
Heartland Express, Inc. 180,300 $ 4,051,341
---------------
TOTAL COMMON STOCKS -- 85.6% (Cost $281,946,646) $ 498,165,091
---------------
PREFERRED STOCKS
REAL ESTATE INVESTMENT TRUST
CBL & Associates Properties, Inc. 100,000 $ 2,628,000
Duke-Weeks Realty Corp. (Series B) 40,000 2,102,000
Pennsylvania Real Estate Investment Trust (Series A) 59,000 3,569,500
ProLogis (Series G) 120,000 3,027,600
---------------
TOTAL PREFERRED STOCKS -- 2.0% (Cost $10,179,446) $ 11,327,100
---------------
CONVERTIBLE BONDS AND DEBENTURES
TECHNOLOGY
BEA Systems, Inc.-- 4% 2006 $ 2,000,000 $ 2,010,000
LSI Logic Corporation -- 4% 2006 2,000,000 1,990,000
---------------
TOTAL CONVERTIBLE BONDS AND DEBENTURES -- 0.7% (Cost $3,840,000) $ 4,000,000
---------------
6
FACE
NON-COVERTIBLE BONDS AND DEBENTURES AMOUNT VALUE
--------------------------------------------------------------- ------------ ----------------
CORPORATE -- 5.8%
Central Garden & Pet Company -- 9.125% 2013 $ 2,000,000 $ 2,210,000
Host Marriott Corporation -- 9.25% 2007 2,000,000 2,245,000
Lear Corporation -- 7.96% 2005 2,000,000 2,055,000
Manitowoc Company, Inc., The -- 10.5% 2012 2,000,000 2,310,000
Metaldyne Corporation -- 11% 2012 2,000,000 1,650,000
OM Group, Inc. -- 9.25% 2011 4,000,000 4,280,000
Orbital Sciences Corporation -- 9% 2011 3,000,000 3,390,000
PolyOne Corporation -- 10.625% 2010 950,000 1,073,500
Realty Income Corporation -- 8.25% 2008 2,000,000 2,248,000
SpectraSite, Inc. -- 8.25% 2010 2,000,000 2,140,000
Unisys Corporation
-- 7.875% 2008 1,500,000 1,545,000
-- 8.125% 2006 2,000,000 2,117,500
Vicar Operating Inc. -- 9.875% 2009 3,000,000 3,345,000
Windmere Durable Holdings Inc. -- 10% 2008 3,000,000 3,007,500
----------------
$ 33,616,500
----------------
U.S. GOVERNMENT AND AGENCIES -- 0.1%
Federal Home Loan Mortgage Corporation
-- 6.5% 2023 (Interest Only) $ 95,032 $ 4,574
-- 10.15% 2006 (REMIC) 430 430
Federal National Mortgage Association -- 6% 2029 (Interest Only) 1,883,784 374,402
Government National Mortgage Association (Mobile Home)
-- 9.75% 2010 359,531 385,513
----------------
$ 764,919
----------------
TOTAL NON-COVERTIBLE BONDS
AND DEBENTURES -- 5.9% (Cost $32,767,297) $ 34,381,419
----------------
TOTAL INVESTMENT SECURITIES -- 94.2% (Cost $328,733,389) $ 547,873,610
----------------
SHORT TERM INVESTMENTS
Short-term Corporate Notes:
General Electric Capital Corporation -- 1.75% 1/3/05 $ 13,694,000 $ 13,692,669
International Lease Finance Corporation -- 2.26% 1/11/05 20,000,000 19,987,444
----------------
TOTAL SHORT-TERM INVESTMENTS -- 5.8% (Cost $33,680,113) $ 33,680,113
----------------
TOTAL INVESTMENTS -- 100.0% (Cost $362,413,502) $ 581,553,723
Other assets and liabilities, net -- 0.0% 174,921
----------------
TOTAL NET ASSETS -- 100% $ 581,728,644
================
* Non-income producing securities
See notes to financial statements.
7
PORTFOLIO SUMMARY
December 31, 2004
COMMON STOCKS 85.6%
Producer Durable Goods 15.9%
Energy 12.3%
Business Services & Supplies 12.1%
Healthcare 11.1%
Retailing 9.1%
Technology 8.8%
Financial 7.6%
Entertainment 5.3%
Materials 2.7%
Transportation 0.7%
PREFERRED STOCKS 2.0%
CONVERTIBLE BONDS AND DEBENTURES 0.7%
NON-CONVERTIBLE BONDS AND DEBENTURES 5.9%
Corporate 5.8%
U.S. Government and Agencies 0.1%
SHORT-TERM INVESTMENTS 5.8%
-------
TOTAL NET ASSETS 100.0%
=======
MAJOR PORTFOLIO CHANGES
(Unaudited)
Quarter Ended December 31, 2004
SHARES OR
FACE AMOUNT
----------------
NET PURCHASES
COMMON STOCKS
Charles River Laboratories International, Inc. 265,000 shs.
Diebold, Incorporated (1) 50,000 shs.
Engelhard Corporation 40,000 shs.
Arthur J. Gallagher & Co. 140,000 shs.
Invitrogen Corporation 45,000 shs.
NET SALES
COMMON STOCKS
Advanced Fibre Communications, Inc. (2) 710,000 shs.
Black Box Corporation (2) 260,800 shs.
Checkpoint Systems, Inc. (2) 68,462 shs.
Inveresk Research Group, Inc. (2) 311,700 shs.
KEMET Corporation (2) 200,000 shs.
Ocular Sciences, Inc. (2) 150,000 shs.
TriQuint Semiconductor, Inc. (2) 943,029 shs.
CONVERTIBLE SECURITY
Checkpoint Systems, Inc. -- 5.25% 2005 (2) $ 781,000
NON-CONVERTIBLE SECURITY
Avaya Inc. -- 11.125% 2009 (2) $ 1,300,000
(1) Indicates new commitment to portfolio
(2) Indicates elimination from portfolio
8
FEDERAL INCOME TAX INFORMATION
CALENDAR 2004
CASH DIVIDENDS AND DISTRIBUTIONS:
(1) (2)
AMOUNT ORDINARY LONG-TERM
PAID INCOME CAPITAL GAIN
DATE PAID PER SHARE DIVIDENDS DISTRIBUTIONS
---------------- ---------- --------- -------------
PREFERRED STOCK:
03/15/2004 $ 0.60 $ 0.60 --
06/15/2004 0.60 0.60 --
09/15/2004 0.60 0.60 --
12/15/2004 0.60 0.60 --
---------- --------- -------------
TOTAL $ 2.40 $ 2.40 --
========== ========= =============
COMMON STOCK:
03/15/2004 $ 1.00 $ 0.5990 $ 0.4010
06/15/2004 1.00 0.0124 0.9876
09/15/2004 1.00 0.0124 0.9876
12/15/2004 1.00 0.0124 0.9876
---------- --------- -------------
TOTAL $ 4.00 $ 0.6362 $ 3.3638
========== ========= =============
(UNAUDITED)
The amount in column (1) is to be included as dividend income on your tax
return and 45.3% of this amount is Qualified Dividend Income and qualifies for
the 5% and 15% capital gains rates.
In accordance with the provisions of the Internal Revenue Code, the amounts
in column (2) are long-term capital gain distributions and qualifies for the 5%
and 15% capital gains rates.
A Form 1099 has been mailed to all shareholders of record on dividend
record dates setting forth the specific amounts to be included in their 2004 tax
returns. For corporate shareholders, 45.3% of the amount in column (1) qualifies
for the 70% corporate dividends received deduction. Source Capital did not elect
to retain any undistributed long-term capital gains for the year ended December
31, 2004. Therefore, Common shareholders will not receive a Form 2439 for 2004.
NOTICE TO DIVIDEND REINVESTMENT PLAN PARTICIPANTS:
The information above shows the cash distributions paid by Source Capital
during 2004. When additional shares are issued by Source Capital under the
Automatic Reinvestment Plan at a discount from the market price, a participant
in the Plan is treated for federal income tax purposes as having received a
taxable distribution equal to the market value of the shares purchased. In
effect, the discount from market price at which shares are purchased is added to
the amount of the cash distribution to determine the total value of the taxable
distribution. Such value also becomes the participant's tax basis for the shares
purchased under the Plan.
The distributions paid during the year were reinvested at a discount from
the market price, and the additional taxable amount of these distributions for
each Common share purchased is as follows: March 15, 2004, $3.2870 per share;
June 15, 2004, $3.1895 per share; September 15, 2004, $3.2500 per share;
December 15, 2004, $3.4750 per share.
STATE TAX INFORMATION:
None of the amounts reported was derived from U.S. Treasury Securities.
Certain states have reduced tax rates for capital gains attributed to
securities that meet certain holding periods. The following percentages should
be applied to the amounts in column (2): 7.8% of these gains was derived from
assets held 1-2 years, 73.5% from assets held 5-6 years, and 18.7% from assets
held more than 6 years.
9
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 2004
-----------------------------------
ASSETS
Investments at value:
Investment securities -- at market value
(cost $328,733,389) -- Note A $ 547,873,610
Short-term investments -- at amortized cost
(maturities 60 days or less) -- Note A 33,680,113 $ 581,553,723
-----------------
Cash 782
Receivable for:
Accrued interest $ 651,095
Dividends 113,433 764,528
----------------- ---------------
$ 582,319,033
LIABILITIES
Payable for:
Advisory fees $ 333,660
Accrued dividends -- Preferred Stock 196,921
Accrued expenses 59,808 590,389
----------------- ---------------
TOTAL NET ASSETS -- December 31, 2004 $ 581,728,644
===============
Assets applicable to Preferred Stock at a liquidation preference of
$27.50 per share (asset coverage 1,074%) -- Note B $ 54,153,330
===============
Net assets applicable to Common Stock -- $63.20 per share $ 527,575,314
===============
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 8,347,998 shares -- Note B 8,347,998
Additional Paid-in Capital 347,668,745
Undistributed net investment income 214,807
Undistributed net realized gain on investments 449,237
Unrealized appreciation of investments 219,140,221
---------------
TOTAL NET ASSETS -- December 31, 2004 $ 581,728,644
===============
See notes to financial statements.
10
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
2004 2003
-------------------------------- --------------------------------
INVESTMENT INCOME
Income:
Interest $ 3,692,457 $ 3,729,915
Dividends 4,674,521 3,517,720
-------------- --------------
$ 8,366,978 $ 7,247,635
Expenses -- Note C:
Advisory fees $ 3,731,644 $ 3,089,995
Transfer agent fees and expenses 314,953 288,755
Reports to shareholders 181,168 175,557
Directors' fees and expenses 115,967 104,472
Taxes, other than federal income tax 75,825 75,825
Custodian fees and expenses 53,685 48,071
Registration and filing fees 53,476 32,432
Legal and auditing fees 37,255 33,822
Other expenses 43,616 4,607,589 50,226 3,899,155
-------------- -------------- ------------- --------------
Net investment income -- Note A $ 3,759,389 $ 3,348,480
-------------- --------------
NET REALIZED AND UNREALIZED GAIN
ON INVESTMENTS
Net realized gain on investments:
Proceeds from sale of investment securities
(excluding short-term corporate notes with
maturities 60 days or less) $ 134,795,151 $ 140,866,163
Cost of investment securities sold 105,821,310 105,352,982
-------------- -------------
Net realized gain on investments --
Notes A and D $ 28,973,841 $ 35,513,181
Unrealized appreciation of investments:
Unrealized appreciation at beginning of year $ 159,709,723 $ 44,501,199
Unrealized appreciation at end of year 219,140,221 159,709,723
-------------- -------------
Increase in unrealized appreciation of
investments 59,430,498 115,208,524
-------------- --------------
Net realized and unrealized gain on
investments $ 88,404,339 $ 150,721,705
-------------- --------------
NET INCREASE IN TOTAL NET ASSETS
RESULTING FROM OPERATIONS $ 92,163,728 $ 154,070,185
============== ==============
See notes to financial statements.
11
STATEMENT OF CHANGES IN TOTAL NET ASSETS
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
2004 2003
-------------------------------- --------------------------------
INCREASE IN TOTAL NET ASSETS
Operations:
Net investment income $ 3,759,389 $ 3,348,480
Net realized gain on investments
-- Notes A and D 28,973,841 35,513,181
Increase in unrealized appreciation of investments 59,430,498 115,208,524
-------------- -------------
Increase in total net assets resulting from operations $ 92,163,728 $ 154,070,185
Distributions to Preferred shareholders:
From net investment income $ (3,544,582) $ (4,171,681)
From net realized capital gains (1,181,527) (4,726,109) (554,427) (4,726,108)
-------------- -------------
Distributions to Common shareholders from net realized
capital gains (33,146,891) (28,645,415)
Proceeds from shares issued for distributions
reinvested by shareholders -- Note B 6,189,190 5,374,229
-------------- --------------
Increase in total net assets $ 60,479,918 $ 126,072,891
TOTAL NET ASSETS
Beginning of year, including
undistributed net investment income of
zero and $823,201 at December 31, 2003
and 2002, respectively 521,248,726 395,175,835
-------------- --------------
End of year, including
undistributed net investment income of
$214,807 and zero at December 31, 2004
and 2003, respectively $ 581,728,644 $ 521,248,726
============== ==============
See notes to financial statements.
NOTICE OF SOURCE OF DISTRIBUTIONS
(Unaudited)
(Common Stock Only)
Since the sources from which distributions are paid cannot be determined
until the end of each fiscal year, the following information amends the
statements forwarded to Common shareholders with each distribution.
SOURCE OF DISTRIBUTIONS
---------------------------
AMOUNT NET
PAID INVESTMENT NET REALIZED
DATE PAID PER SHARE INCOME CAPITAL GAINS
---------- --------- ---------- -------------
3/15/2004 $ 1.00 -- $ 1.00
6/15/2004 1.00 -- 1.00
9/15/2004 1.00 -- 1.00
12/15/2004 1.00 -- 1.00
--------- ---------- -------------
$ 4.00 -- $ 4.00
========= ========== =============
See page 9 for federal income tax information.
12
FINANCIAL HIGHLIGHTS
Selected data for a share of Common Stock outstanding throughout each year
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
Common Stock:
Per share operating performance:
Net asset value at beginning of year $ 56.62 $ 41.90 $ 55.45 $ 48.62 $ 50.70
----------- ----------- ----------- ----------- -----------
Income from investment operations:
Net investment income $ 0.45 $ 0.41 $ 0.49 $ 0.54 $ 0.70
Net realized and unrealized gain (loss)
on investment securities 10.65 18.36 (8.97) 11.40 4.20
----------- ----------- ----------- ----------- -----------
Total from investment operations $ 11.10 $ 18.77 $ (8.48) $ 11.94 $ 4.90
----------- ----------- ----------- ----------- -----------
Distributions to Preferred shareholders:
From net investment income $ (0.43) $ (0.51) $ (0.49) $ (0.59) $ (0.61)
From net realized capital gains (0.14) (0.06) (0.10) -- --
Distributions to Common shareholders:
From net investment income -- -- -- (0.30) --
From net realized gains (4.00) (3.50) (4.60) (4.30) (6.41)
----------- ----------- ----------- ----------- -----------
Total distributions $ (4.57) $ (4.07) $ (5.19) $ (5.19) $ (7.02)
----------- ----------- ----------- ----------- -----------
Effect of shares issued for distributions
reinvested by shareholders $ 0.05 $ 0.02 $ 0.12 $ 0.08 $ 0.04
----------- ----------- ----------- ----------- -----------
Net asset value at end of year $ 63.20 $ 56.62 $ 41.90 $ 55.45 $ 48.62
=========== =========== =========== =========== ===========
Per share market value at end of year $ 71.54 $ 59.38 $ 52.85 $ 61.02 $ 52.69
Total investment return(1) 28.4% 20.6% (6.2)% 26.0% 24.1%
Net asset value total return(2) 19.5% 45.7% (17.1)% 24.7% 9.6%
Ratios/supplemental data:
Net assets at end of year (in thousands) $ 581,729 $ 521,249 $ 395,176 $ 498,726 $ 437,611
Ratios based on average net assets
applicable to Common Stock:
Expenses(3) 0.95% 0.99% 0.99% 0.97% 1.00%
Net Income(3) 0.77% 0.85% 0.99% 1.07% 1.46%
Ratios based on average net assets:
Expenses(3) 0.85% 0.87% 0.87% 0.85% 0.87%
Net Income(3) 0.69% 0.75% 0.87% 0.95% 1.28%
Portfolio turnover rate 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
Asset coverage per share(4) $ 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
Average market value per share(5) $ 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) Does not reflect the effect of dividend payments to Preferred shareholders
(4) Information shown as of the end of the year
(5) The average of all month-end market values during each year
See notes to financial statements.
13
NOTES TO FINANCIAL STATEMENTS
NOTE A--SIGNIFICANT ACCOUNTING POLICIES
Source Capital, Inc. (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 corporate notes with maturities of
60 days or less are valued at amortized cost, which approximates market value.
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 on net investment
income is considered necessary because the Company has elected to be taxed as a
"regulated investment company" under the Internal Revenue Code. The Company
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
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 the
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 ratios of expenses and net income to average net assets do not reflect
the effect of dividend 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.
Preferred asset coverage was 1,074% and 963% at December 31, 2004 and 2003,
respectively.
During the years ended December 31, 2004, and 2003, the Company issued
98,799 and 109,926 shares of Common Stock, respectively, under its Reinvestment
Plan for Common and Preferred shareholders.
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 years ended December 31, 2004, and 2003, the Company paid aggregate
fees of $114,500 and $102,500, respectively, to all Directors who are not
affiliated persons of the Investment Adviser. During the years ended December
31, 2004, and 2003, the Company incurred legal fees of $5,755 and $1,822,
respectively, payable to O'Melveny & Myers LLP, counsel for the Company. A
Director of the Company is a retired partner of that firm.
NOTE D--PURCHASES AND TAX DIFFERENCES
The cost of purchases of investment securities (excluding short-term
corporate notes with maturities of 60 days or less) aggregated $116,837,216 and
$77,307,557 for the years ended December 31, 2004, and 2003, respectively.
Realized gains and losses are based on the specific identification method.
All of the amounts reported in the financial statements at December 31,
2004, were the same for federal income tax and financial reporting purposes. A
permanent difference of $323,727 as of December 31, 2004, was reclassified from
Undistributed Net Realized Gain on Investments to Additional Paid-in Capital.
The permanent difference related to the accounting for market discount on Common
Shares issued under the Dividend Reinvestment Plan, which differs between income
tax regulations and accounting principles generally accepted in the United
States of America. Gross unrealized appreciation and depreciation for all
investments at December 31, 2004, for federal income tax and financial reporting
purposes was $219,920,589 and $780,368 respectively. Refer to page 9 for
detailed information regarding the tax character of distributions paid during
the year ended December 31, 2004.
14
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS AND
BOARD OF DIRECTORS OF SOURCE CAPITAL, INC.
We have audited the accompanying statement of assets and liabilities of
Source Capital, Inc. (the "Company"), including the portfolio of investments, as
of December 31, 2004 and the related statements of operations, changes in total
net assets for each of the two years in the period then ended, and the financial
highlights for each of the three years in the period then ended. These financial
statements and financial highlights are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and financial highlights based on our audits. The financial
highlights of Source Capital, Inc. for each of the two years in the period ended
December 31, 2001 were audited by other auditors whose report, dated February 1,
2002, expressed an unqualified opinion on those financial highlights.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. An audit
includes consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. Our procedures
included confirmation of securities owned as of December 31, 2004, by
correspondence with the custodian. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Source Capital, Inc. as of December 31, 2004, the results of its operations and
changes in net assets for each of the two years in the period then ended, and
the financial highlights for each of the three years in the period then ended,
in conformity with accounting principles generally accepted in the United States
of America.
/s/ Deloitte & Touche LLP
Los Angeles, California
February 4, 2005
15
DIRECTORS AND OFFICERS
(UNAUDITED)
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 SERVICED DURING THE PAST 5 YEARS DIRECTOR DIRECTORSHIPS
------------------------------ ------------ --------------------- ----------------------------------- ------------- -------------
Willard H. Altman, Jr. - (69)* Director Term: 1 Year Retired. Formerly, until 1995, 6
11400 W. Olympic Blvd. Time Served: 7 Years Partner of Ernst & Young LLP a
Suite 1200 public accounting firm.
Los Angeles, CA 90064
Wesley E. Bellwood - (81)* Director Term: 1 Year Retired. Formerly, until 1999, 1
11400 W. Olympic Blvd. Time Served: 25 Years Chairman Emeritus and director of
Suite 1200 Wynn's International, Inc.
Los Angeles, CA 90064
David Rees - (81)* Director Term: 1 Year Private investor. Formerly 1 International
11400 W. Olympic Blvd. Time Served: 37 Years President and Chief Executive Institute of
Suite 1200 Officer of the International Los Angeles
Los Angeles, CA 90064 Institute of Los Angeles. Formerly
until 1995, the Senior Editor of
Los Angeles Business Journal.
Paul G. Schloemer - (76)* Director Term: 1 Year Retired President and Chief 1
11400 W. Olympic Blvd. Time Served: 6 Years Executive Officer (1984-1993) of
Suite 1200 Parker Hannifin Corporation.
Los Angeles, CA 90064
Lawrence J. Sheehan - (72)* Director Term: 1 Year Retired. Formerly Partner (1969 to 5
11400 W. Olympic Blvd. Time Served: 14 Years 1994) and of counsel employee (1994
Suite 1200 to 2002) of the firm of O'Melveny &
Los Angeles, CA 90064 Meyers LLP, legal counsel to the
Company.
Eric S. Ende - (60) Director, Term: 1 Year Senior Vice President of the 3
11400 W. Olympic Blvd. President & Time Served: 5 Years Adviser.
Suite 1200 Chief
Los Angeles, CA 90064 Investment
Officer
Steven R. Geist - (51) Senior Vice Time Served: 9 Years Vice President of the Adviser.
11400 W. Olympic Blvd. President &
Suite 1200 Fixed-Income
Los Angeles, CA 90064 Manager
J. Richard Atwood - (44) Treasurer Time Served: 8 Years Principal and Chief Operating First Pacific
11400 W. Olympic Blvd. Officer of the Adviser. President Advisors,
Suite 1200 of FPA Fund Distributors, Inc. Inc., and
Los Angeles, CA 90064 FPA Fund
Distributors,
Inc.
Sherry Sasaki - (50) Secretary Time Served: 23 Years Assistant Vice President and
11400 W. Olympic Blvd. Secretary of the Adviser and of FPA
Suite 1200 Fund Distributors, Inc.
Los Angeles, CA 90064
Christopher H. Thomas - (47) Assistant Time Served: 10 Years Vice President and Controller of FPA Fund
11400 W. Olympic Blvd. Treasurer the Adviser and of FPA Fund Distributors,
Suite 1200 Distributors, Inc. Inc.
Los Angeles, CA 90064
* Audit committee member
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,
2004, 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,
2003 was submitted to the NYSE on May 28, 2004.
16
SOURCE CAPITAL, INC.
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
COUNSEL
O'Melveny & Myers LLP
Los Angeles, California
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
Los Angeles, California
TRANSFER AND SHAREHOLDER
SERVICE AGENT
Mellon Investor Services LLC
85 Challenger Road
Overpeck Centre
Ridgefield Park, NJ 07660-2108
(800) 279-1241 or (201) 329-8660
http://melloninvestor.com/isd
REGISTRAR
Mellon Investor Services LLC
Ridgefield Park, New Jersey
STOCK EXCHANGE LISTING
New York Stock Exchange:
Symbols: SOR Common Stock
SOR+ Preferred Stock
DIVIDEND REINVESTMENT PLAN
Holders of record (other than brokers or nominees of banks and other
financial institutions) of Common and Preferred Stock are eligible to
participate in the Dividend Reinvestment Plan ("Plan"), pursuant to which
distributions to shareholders are paid in or reinvested in shares of Common
Stock of the Company ("Dividend Shares"). Mellon Bank, N.A. ("Agent") c/o Mellon
Investor Services LLC, Investment Services, P.O. Box 3338, South Hackensack, New
Jersey 07606-1938, acts as agent for participants under the Plan.
A shareholder may join the Plan by signing and returning an authorization
form that may be obtained from the Agent. A shareholder may elect to withdraw
from the Plan at any time by written notice to the Agent and thereby elect to
receive cash in lieu of Dividend Shares. There is no penalty for withdrawal from
the Plan, and shareholders who have previously withdrawn from the Plan may
rejoin at any time. The Company reserves the right to amend or terminate the
Plan.
Purchases of the Company's shares are made by the Agent, on behalf of the
participants in the Plan, promptly after receipt of funds, and in no event later
than 30 days from such receipt except when restricted under applicable federal
securities laws. The Agent purchases outstanding shares in the market when the
price plus estimated commissions of the Company's Common Stock on the NYSE is
lower than the Company's most recently calculated net asset value per share. To
the extent that outstanding shares are not available at a cost of less than per
share net asset value, the Agent, on behalf of the participants in the Plan,
accepts payment of the dividend, or the remaining portion thereof, in authorized
but unissued shares of Common Stock of the Company on the payment date. Such
shares are issued at a per share price equal to the higher of (1) the net asset
value per share on the payment date, or (2) 95% of the closing market price per
share on the payment date. There are no brokerage charges with respect to shares
issued directly by the Company to satisfy the dividend reinvestment
requirements. However, each participant pays a pro rata share of brokerage
commissions incurred with respect to the Agent's open market purchases of
shares. In each case, the cost per share of shares purchased for each
shareholder's account is the average cost, including brokerage commissions, of
any shares purchased in the open market plus the cost of any shares issued by
the Company.
For Federal income tax purposes, shareholders who reinvest distributions
are treated as receiving distributions in an amount equal to the fair market
value, determined as of the payment date, of the shares received if the shares
are purchased from the Company. Such value may exceed the amount of the cash
distribution that would have been paid. If outstanding shares are purchased in
the open market, the taxable distribution equals the cash distribution that
would have been paid. In either event, the cost basis in the shares received
equals the amount recognized as a taxable distribution.
In the case of foreign participants whose dividends are subject to United
States income tax withholding and in the case of any participants subject to 31%
federal backup withholding, the Agent will reinvest dividends after deduction of
the amount required to be withheld.
All record holders of Common Stock are also offered the opportunity, on a
voluntary basis, to send in cash payments of not less than $100 each up to a
total of $7,500 per month to purchase additional shares of the Common Stock of
the Company through participation in the Cash Investment Plan ("Cash Plan").
Under the Cash Plan, shares are purchased in the market and no shares are issued
by the Company. A brochure describing the terms and conditions of the Cash Plan,
including fees and expenses, is available from the Agent.
17
SOURCE CAPITAL, INC.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064-1550
Item 2. Code of Ethics.
(a) The registrant has adopted a code of ethics that
applies to the registrant's senior executive and
financial officers. Upon request, any person may obtain
a copy of this code of ethics, without charge, by
calling (800) 982-4372. A copy of the code of ethics is
filed as an exhibit to this Form N-CSR.
(b) During the period covered by this report, there were
not any amendments to the provisions of the code of
ethics adopted in 2(a) above.
(c) During the period covered by this report, there were
not any implicit or explicit waivers to the provisions
of the code of ethics adopted in 2(a).
Item 3. The registrant's board of directors has determined that
Willard H. Altman, Jr., a member of the registrant's audit
committee and board of directors, is an "audit committee
financial expert" and is "independent," as those terms are
defined in this Item. This designation will not increase the
designee's duties, obligations or liability as compared to his
duties, obligations and liability as a member of the audit
committee and of the board of directors.
Item 4. Principal Accountant Fees and Services.
2003 2004
(a) Audit Fees $ 27,000 $ 27,380
(b) Audit Related Fees -0- -0-
(c) Tax Fees $ 5,000 $ 5,765
(d) All Other Fees -0- -0-
(e)(1) Disclose the audit committee's pre-approval policies
and procedures described in paragraph (c)(7) of Rule
2-01 of Regulation S-X. The audit committee shall
pre-approve all audit and permissible non-audit
services that the committee considers compatible with
maintaining the independent auditors' independence. The
pre-approval requirement will extend to all non-audit
services provided to the registrant, the adviser, and
any entity controlling, controlled by, or under common
control with the adviser that provides ongoing services
to the registrant, if the engagement relates directly
to the operations and financial reporting of the
registrant; provided, however, that an engagement of
the registrant's independent auditors to perform attest
services for the registrant, the adviser or its
affiliates required by generally accepted auditing
standards to complete the examination of the
registrant's financial statements (such as an
examination conducted in accordance with Statement on
Auditing Standards Number 70 issued by the American
Institute of Certified Public Accountants), will be
deem pre-approved if: (i) the registrant's independent
auditors inform the audit committee of the engagement,
(ii) the
registrant's independent auditors advise the audit
committee at least annually that the performance of
this engagement will not impair the independent
auditor's independence with respect to the registrant,
and (iii) the audit committee receives a copy of the
independent auditor's report prepared in connection
with such services. The committee may delegate to one
or more committee members the authority to review and
pre-approve audit and permissible non-audit services.
Actions taken under any such delegation will be
reported to the full committee at its next meeting.
(e)(2) Disclose the percentage of services described in each
of paragraphs (b) - (d) of this Item that were approved
by the audit committee pursuant to paragraph
(c)(7)(i)(C) of Rule 2-01 of Regulation S-X. 100% of
the services provided to the registrant described in
paragraphs (b) - (d) of this Item were pre-approved by
the audit committee pursuant to paragraphs (e)(1) of
this Item. There were no services provided to the
investment adviser or any entity controlling,
controlled by or under common control with the adviser
described in paragraphs (b) - (d) of this Item that
were required to be pre-approved by the audit
committee.
(f) If greater than 50%, disclose the percentage of hours
expended on the principal accountant's engagement to
audit the registrant's financial statements for the
most recent fiscal year that were attributed to work
performed by persons other than the principal
accountant's full-time, permanent employees. All
services performed on the engagement to audit the
registrant's financial statements for the most recent
fiscal year end were performed by the principal
accountant's full-time, permanent employees.
(g) Disclose the aggregate non-audit fees billed by the
registrant's accountant for services rendered to the
registrant, and rendered to the registrant's investment
adviser (not including any sub-adviser whose role is
primarily portfolio management and is subcontracted
with or overseen by another investment adviser), and
any entity controlling, controlled by, or under common
control with the adviser that provides ongoing services
to the registrant for each of the last two fiscal years
of the registrant. None.
(h) Disclose whether the registrant's audit committee of
the board of director has considered whether the
provision of non-audit services that were rendered to
the registrant's investment adviser (not including any
sub-adviser whose role is primarily portfolio
management and is subcontracted with or overseen by
another investment adviser), and any entity
controlling, controlled by, or under common control
with the investment adviser that provides ongoing
services to the registrant that were not pre-approved
pursuant to paragraph (c)(7)(ii) of Rule 2-01 of
Regulation S-X is
compatible with maintaining the principal accountant's
independence. Not Applicable.
Item 5. Audit Committee of Listed Registrants.
(a) The registrant has a standing audit committee. The
members of the audit committee are: David Rees,
chairman; Willard H. Altman, Jr.; Wesley E. Bellwood;
Paul G. Schloemer and Lawrence J. Sheehan.
(b) Not Applicable.
Item 6. Schedule of Investments. Not Applicable. The schedule of
investments is included as part of the report to stockholders
filed under Item 1 of this Form.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
The board of directors has delegated to First Pacific Advisors, Inc.
("Adviser"), the registrant's investment adviser, the responsibility to vote
proxies relating to portfolio securities held by the registrant. The Adviser
is the investment adviser to mutual funds and separately managed accounts. As
such, the Adviser has been delegated the authority to vote proxies with
respect to the investments held in its client accounts, unless the client has
specifically retained such authority in writing. It is the Adviser's duty to
vote proxies in the best interests of clients in a timely and responsive
manner. In deciding to delegate this responsibility to the Adviser, the board
of directors reviewed and approved the policies and procedures that the
Adviser follows and procedures followed if a vote presents a conflict between
the interests of the registrant and its shareholders and the Adviser, and its
other clients.
POLICY
First Pacific Advisors, Inc. ("Adviser") acts as discretionary investment
adviser for various clients, including SEC-registered closed-end and open-end
investment companies ("RIC clients") and separately managed accounts (including
those governed under the laws and provisions of ERISA) (collectively referred to
as client or clients). The Adviser is authorized to vote proxies on behalf of
its clients, unless a client specifically retains or delegates this authority to
another party, in writing. The Adviser will vote all proxies in a timely manner
as part of its full discretionary authority over client assets in accordance
with these Policies and Procedures.
When voting proxies for clients, the Adviser's utmost concern is that all
decisions be made solely in the best interest of the client (and for ERISA
accounts, plan beneficiaries and participants, in accordance with the letter and
spirit of ERISA). The Adviser will act in a prudent and diligent manner intended
to enhance the value of the assets of the client's account.
PURPOSE
The purpose of these Policies and Procedures is to enable the Adviser to comply
with its fiduciary responsibilities to clients and the requirements under the
Investment Advisers Act of 1940, as amended ("Advisers Act"), and the Investment
Company Act of 1940, as amended ("1940 Act"). These Policies and Procedures also
reflect the fiduciary standards and responsibilities set forth by the Department
of Labor for ERISA accounts.
PROCEDURES
The Adviser is ultimately responsible for ensuring that all proxies received by
the Adviser are voted in a timely manner and in a manner consistent with the
Adviser's determination of the client's best interests. Although many proxy
proposals can be voted in accordance with the Adviser's guidelines (see
"Guidelines" below), the Adviser recognizes that some proposals require special
consideration which may dictate that the Adviser make an exception to the
Guidelines.
CONFLICTS OF INTEREST
Where a proxy proposal raises a material conflict between the Adviser's
interests and a client's interest, the Adviser will resolve such a conflict in
the manner described below:
VOTE IN ACCORDANCE WITH THE GUIDELINES. To the extent that the Adviser has
little or no discretion to deviate from the Guidelines with respect to the
proposal in question, the Adviser shall vote in accordance with such
pre-determined voting policy.
OBTAIN CONSENT OF CLIENTS. To the extent that the Adviser has discretion to
deviate from the Guidelines with respect to the proposal in question, the
Adviser will disclose the conflict to the relevant clients and obtain their
consent to the proposed vote prior to voting the securities. The disclosure to
the client will include sufficient detail regarding the matter to be voted on
and the nature of the Adviser's conflict that the client would be able to make
an informed decision
regarding the vote. If a client does not respond to such a conflict disclosure
request or denies the request, the Adviser will abstain from voting the
securities held by that client's account.
CLIENT DIRECTIVE TO USE AN INDEPENDENT THIRD PARTY. Alternatively, a client
may, in writing, specifically direct the Adviser to forward all proxy matters in
which the Adviser has a conflict of interest regarding the client's securities
to an identified independent third party for review and recommendation. Where
such independent third party's recommendations are received on a timely basis,
the Adviser will vote all such proxies in accordance with such third party's
recommendation. If the third party's recommendations are not timely received,
the Adviser will abstain from voting the securities held by that client's
account.
The Adviser will review the proxy proposal for conflicts of interest as part of
the overall vote review process. All material conflicts of interest so
identified by the Adviser will be addressed as above. Matters to be reviewed
include: (i) whether the issuer of the portfolio security to be voted, or an
affiliate or employee group of the issuer, is a client of the Adviser; (ii)
whether the Adviser has made or is actively considering a business proposal to
provide services to the issuer or an affiliate or employee group of the issuer;
(iii) whether the Adviser has any other material business relationship with the
issuer or an affiliate of the issuer; (iv) whether an officer or director of the
Adviser or the portfolio manager responsible for recommending the proxy vote is
a close relative or has a personal or business relationship with an executive,
director or director candidate of the issuer or is a participant in a proxy
contest; and (v) whether there is any other business or personal relationship
where the portfolio manager has a personal interest in the outcome of the matter
to be voted upon.
LIMITATIONS
In certain circumstances where the Adviser has determined that it is in the
client's best interest, the Adviser will not vote proxies received. The
following are some, but not all, circumstances where the Adviser will limit its
role in voting proxies:
CLIENT MAINTAINS PROXY VOTING AUTHORITY. Where the client has instructed
the Adviser in writing, the Adviser will not vote the securities and will direct
the relevant custodian to send the proxy material directly to the client. If any
proxy material is received by the Adviser, it will promptly be forwarded to the
client or a specified third party.
TERMINATED ACCOUNT. Once a client account has been terminated with the
Adviser in accordance with the investment advisory agreement, the Adviser may
refrain from voting any proxies received after the termination. However, the
client may specify in writing who the proxies shall be forwarded to.
SECURITIES NO LONGER HELD. The Adviser may refrain from voting proxies
received for securities which are no longer held by the client's account.
SECURITIES LENDING PROGRAMS. When securities are out on loan, they are
transferred into the borrower's name and are voted by the borrower, in its
discretion. However, where the Adviser determines that a proxy vote is
materially important to the client's account, the Adviser may recall the
security for purposes of voting.
PROCEDURES FOR VOTING
Proxies and annual or other reports received by the Adviser for issuers in
clients' accounts under management are promptly forwarded to the appropriate
portfolio manager, who votes the proxy and returns it to the operations
department to process the votes.
WHEN VOTING TELEPHONICALLY. The telephone number on the proxy is called and
voted, verification of the vote is made after all proposals have been voted, the
date of the telephone call is noted on the proxy and filed in the account's
file. Note of the date of the telephone call is also made on the cross-reference
report and filed alphabetically in a binder by issuer.
WHEN VOTING MANUALLY. Sign and date after manually checking each proposal
being voted and send through the regular postal service. A copy of the proxy is
filed in the account's file. Note of the date of mailing is also made on the
cross reference report and filed alphabetically in a binder by issuer.
WHEN VOTING ELECTRONICALLY. Go online and vote each proxy as designated. A
confirmation is then returned through e-mail. These confirmations are printed
and are then filed with the proxy in the account's file. Note of the date of
voting is also made on the cross reference report and filed alphabetically in a
binder by issuer.
If there is a disagreement as to how a proxy is to be voted, it is the
responsibility of the portfolio managers of the Adviser to discuss and
substantiate their voting. See Guidelines below for further explanation of
standard voting procedures.
RECORD KEEPING
In accordance with the Rules under the Advisers Act, the Adviser will maintain
for the time periods set forth in the Rules the following information:
1. these proxy voting policies and procedures, and all amendments thereto;
2. all proxy statements received regarding client securities (provided
however, that the Adviser may rely on the proxy statement filed on EDGAR as
its records);
3. a record of all votes cast on behalf of clients;
4. records of all client requests for proxy voting information;
5. any documents prepared by the Adviser that were material in making a
decision and/or used as the basis for the decision; and
6. all records relating to requests made to clients regarding conflicts of
interest in voting the proxy. These requests will be kept in the client
proxy file.
The Adviser will disclose its proxy voting policies and procedures and will
inform clients how they may obtain information on how the Adviser voted proxies
with respect to the clients' portfolio securities. Clients may obtain
information on how their securities were voted or a copy of the Adviser's
Policies and Procedures by written request addressed to the Adviser. The Adviser
will prepare all the information required to be filed by its RIC clients on Form
N-PX with the Securities and Exchange Commission.
GUIDELINES
Each proxy issue will be considered individually. The following guidelines are a
partial list to be used in voting proposals contained the proxy statements, but
will not be used as rigid rules.
1. Issues regarding the issuer's Board entrenchment and anti-takeover Oppose
measures such as the following:
1. Proposals to stagger board members' terms;
2. Proposals to limit the ability of shareholders to call special meetings;
3. Proposals to require super majority votes;
4. Proposals requesting excessive increases in authorized common or preferred
shares where management provides no explanation for the use or need of
these additional shares;
5. Proposals regarding "fair price" provisions;
6. Proposals regarding "poison pill" provisions; and
7. Permitting "green mail."
2. Providing cumulative voting rights Oppose
3. "Social issues," unless specific client guidelines supersede Oppose
4. Election of directors recommended by management, except if there is Approve
a proxy fight
5. Election of independent auditors recommended by management, unless Approve
seeking to replace if there exists a dispute over policies
6. Date and place of annual meeting Approve
7. Limitation on charitable contributions or fees paid to lawyers Approve
8. Ratification of directors' actions on routine matters since previous Approve
annual meeting
9. Confidential voting Approve
Confidential voting is most often proposed by shareholders as a means of
eliminating undue management pressure on shareholders regarding their vote on
proxy issues
The Adviser will generally approve these proposals as shareholders can later
divulge their votes to management on a selective basis if a legitimate reason
arises
10. Limiting directors' liability Approve
11. Eliminate preemptive right Approve
Preemptive rights give current shareholders the opportunity to maintain their
current percentage ownership through any subsequent equity offerings. These
provisions are no longer common in the U.S., and can restrict managements'
ability to raise new capital
The Adviser generally approves the elimination of preemptive rights, but will
oppose the elimination of limited preemptive rights, e.g., on proposed issues
representing more than an acceptable level of total dilution
12. Employee Stock Purchase Plan Approve
13. Establish 401(k) Plan Approve
14. Pay director solely in stocks Case-by-case
15. Eliminate director mandatory retirement policy Case-by-case
16. Rotate annual meeting location/date Case-by-case
17. Option and stock grants to management and directors Case-by-case
18. Allowing indemnification of directors and/or officers after reviewing Case-by-case
the applicable laws and extent of protection requested
19. Sale of assets, divisions, product rights, etc. Case-by-case
20. Other business that may arise at the annual meeting Case-by-case
21. Other issues not included on this list Case-by-case
NOTICE TO CLIENTS OF FIRST PACIFIC ADVISORS, INC.
REGARDING PROXY VOTING POLICIES AND PROCEDURES
Unless specifically noted otherwise in writing by the Client, First Pacific
Advisors, Inc. ("Adviser") retains all authority and responsibility to vote
proxies for any stocks held in Accounts under its management.
In accordance with Rule 207.206(4)-6 of the Advisers Act of 1940 with respect to
proxy voting procedures of the Adviser, we are hereby notifying you of your
right to obtain information about our proxy voting policy and procedures,
including how we vote shares held in your Account. If at any time you would like
information on our proxy voting policy and procedures, you may send a request in
writing to J. Richard Atwood, Compliance Officer, First Pacific Advisors, Inc.,
11400 West Olympic Boulevard, Suite 1200, Los Angeles, CA 90064, or fax your
request to (310) 996-5450, or by e-mail to atwood@firstpacad.com
Item 8. Portfolio Managers of Closed-End Management Investment Companies.
Not Applicable. Item is only applicable for annual reports for
the year ending on or after December 31, 2005.
Item 9. Purchases of Equity Securities by Closed-End Management
Investment Companies. 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. Attached hereto as Ex.99.CODE.ETH.
(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: March 7, 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: March 7, 2005