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, 2003
Item 1. Report to Stockholders
[SOURCE CAPITAL, INC. LOGO]
SOURCE CAPITAL, INC.
2003
ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31
SUMMARY FINANCIAL INFORMATION
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
2003 2002
-------------------------------- --------------------------------
TOTAL PER TOTAL PER
NET COMMON NET COMMON
ASSETS SHARE ASSETS SHARE
-------------- -------------- -------------- --------------
Beginning of year $ 395,175,835 $ 41.90 $ 498,725,575 $ 55.45
-------------- -------------- -------------- --------------
Net gain (loss) on investments, realized and unrealized $ 150,721,705 $ 18.36 $ (72,665,931) $ (8.97)
Net investment income 3,348,480 0.41 3,961,461 0.49
Distributions to Preferred shareholders (4,726,108) (0.57) (4,726,109) (0.59)
Distributions to Common shareholders (28,645,415) (3.50) (37,079,161) (4.60)
Proceeds from shares issued for distributions reinvested by
shareholders 5,374,229 0.02 6,960,000 0.12
-------------- -------------- -------------- --------------
Net changes during year $ 126,072,891 $ 14.72 $ (103,549,740) $ (13.55)
-------------- -------------- -------------- --------------
End of year $ 521,248,726 $ 56.62 $ 395,175,835 $ 41.90
============== ============== ============== ==============
Common market price per share $ 59.38 $ 52.85
Common market premium to net asset value 4.9% 26.1%
Preferred asset coverage 963% 730%
Preferred liquidation preference per share $ 27.50 $ 27.50
Preferred market price per share $ 33.81 $ 30.81
DESCRIPTION OF THE COMPANY
SOURCE CAPITAL, INC., is a major diversified, publicly traded investment
company with total net assets of approximately $521,000,000. 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 8,249,199 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:
2003 INVESTMENT PORTFOLIO RETURNS
Total net assets of Source Capital amounted to $521,248,726 at December 31,
2003. After providing for Preferred Stock equity, Common equity amounted to
$467,095,396 or $56.62 of net asset value per Common share. This compared with
total net assets of $395,175,835, Common equity of $341,022,505 and net asset
value per Common share of $41.90 one year ago. These changes reflect payments to
Common and Preferred shareholders totaling $33,371,523. As a result, Source
Capital achieved a total investment return during 2003 of 45.7% on its Common
net asset value, and 40.5% 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
On February 2, 2004, the Board of Directors declared a regular quarterly
distribution on the Common Stock of $1.00 per share payable March 15, 2004. This
action raised the annual distribution rate to $4.00 from the $3.50 rate in place
since February 2003. In addition, 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 latest increase in the
annual distribution rate to $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 2003, 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 $35,513,181 in net capital
gains in 2003. 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.
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:
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
1999 +21.4 +23.1 +24.2 +21.0 +27.3 - 2.2 +4.7
Annual Compound
Rate of Return:
3 years +13.8 +14.6 + 6.6 - 4.1 + 0.3 + 8.0 +2.3
5 years +14.4 +15.2 + 9.4 - 0.6 + 4.1 + 6.7 +3.5
10 years +14.1 +14.8 +11.7 +11.1 +12.8 + 7.0 +4.3
20 years +13.2 +14.0 +12.3 +13.0 +14.3 + 9.4 +5.3
2
In 2000 we commented on the dramatic difference between that year's market
returns for Source shareholders (the change in Source's quoted price plus
dividends received) and the actual investment returns earned by the Source
portfolio. It turns out that four of the past five 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. The effect in 2003 was especially large and was adverse for
Source shareholders, who earned a market return of just 19% despite Source's
investment return of over 45%. The cause--a decline in the premium from 26% to
5% over the year--can be seen on the table below covering the 1999-2003 period.
YEAR-END
PREMIUM/ MARKET INVESTMENT ----------------------
(DISCOUNT) RETURN RETURN NAV MARKET PRICE
---------- ------ ---------- -------- ------------
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 2003 market returns for both Common and
Preferred shareholders:
COMMON PREFERRED
STOCK STOCK
--------- ---------
Change in Market Value:
NYSE Closing Price
-- 12/31/2003 $ 59.38 $ 33.81
NYSE Closing Price
-- 12/31/2002 $ 52.85 $ 30.81
--------- ---------
Net change in 2003 $ 6.53 $ 3.00
Distributions in 2003 3.50 2.40
--------- ---------
Total return -- Amount $ 10.03 $ 5.40
Total return -- Percent 19.0% 17.5%
Common shareholders who participated in the Company's Automatic Reinvestment
Plan experienced a positive return of 20.6% during 2003. On a long-term basis,
those shareholders who participated in the Automatic Reinvestment Plan during
each of the 27 years since its inception experienced an annual compound rate of
return of 17.6%.
COMMENTARY
The year 2003 marked a dramatic reversal of the stock market decline which
began in March 2000, although at year-end most stocks were still well below
their record highs. Clearly, market participants decided that the economy was
rapidly improving, and that foreign affairs and the U.S. dollar were not
concerns either.
The year's advance was uneven, however. Smaller and more speculative stocks
dominated, those with low absolute prices, high beta (a measure of price
volatility), and often no earnings. The Russell 2000 and the Nasdaq, measures of
smaller, more speculative stocks, performed far better than the S&P 500, a
measure of large stock performance. We are concerned that we may be seeing a
re-emergence of the Bubble Market of the 1998-1999 period.
The extreme volatility of the stock market in recent years is clearly seen on
the following table. Massive advances in the late 90s was followed by several
years of dramatic decline. This ended in early 2003, and the market has forged
ahead ever since, with gains of over 70% for the Nasdaq and Russell 2000 from
the March 2003 lows to late January 2004.
The market's performance over the entire 6-year period, however, is less
exciting. After dramatic ups and downs, we ended up only a little higher than we
started, with annualized gains of just 4-5% for the major indexes.
ANNUALIZED
CUMULATIVE RETURNS RETURN
---------------------------- ----------
1998-1999 2000-2002 2003 1998-2003
--------- --------- ---- ---------
Nasdaq 159% (67)% 50% 4%
S&P 500 56% (38)% 29% 4%
Russell 2000 18% (21)% 47% 5%
Source 30% 13% 46% 14%
Source's performance in 2003 represents a dramatic contrast to the prior
year. In 2002, Source had its worst year in its "modern history"--since 1977. In
2003 it had its best year by far--10 points better than 1979's +35%. The table
below shows Source's investment performance for each of the past five years, as
well as that of the benchmark Russell 2500, the index which is the closest match
to the market cap and portfolio weightings of the companies we hold. 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.
1999 2000 2001 2002 2003 FIVE YEARS*
---- ---- ---- ----- ---- -----------
Source 23.1% 9.6% 24.7% (17.1)% 45.7% 15.2%
Russell
2500 24.2% 4.3% 1.2% (17.8)% 45.5% 9.4%
*Annualized Return
We would like to take this opportunity to review significant recent
developments affecting four Source holdings which have been the subject of
discussion in past shareholder letters.
GRACO, a manufacturer of systems for dispensing viscous fluids like paint,
adhesives, and lubricants, has been one of the stars of the Source portfolio
since its purchase in 1996. Its
3
earnings have increased three-fold and its share price six-fold since that date.
It has earned extraordinarily high returns--recently 35% on equity and 50%
pre-tax on operating assets. The negative aspect of these high returns has been
that cash flow has greatly exceeded available investment opportunities. After
prudent reinvestment in its existing business, and a few small acquisitions, its
surplus cash has been mostly spent on several large share repurchases, totaling
about 20% of shares outstanding.
More recently, Graco management has taken a somewhat different tack, perhaps
in response to the stock's historically rich PE ratio, and has decided to pay
out the surplus cash directly to shareholders. Graco's regular dividend has been
increased by 70%, and a special $2.25 per share payment has been declared as
well. The latter will consume most of Graco's $100 million of balance sheet
cash.
DENISON INTERNATIONAL, a manufacturer of hydraulic components for both
stationary and mobile machinery, was added to the portfolio in 1997. At the
time, we were attracted by Denison's high returns on capital and its strong
competitive position in high-end niche hydraulic markets, as well as its
fortress balance sheet.
Although Denison has been able to maintain its strong competitive position,
and has not squandered capital on unwise investments, it has not been able to
achieve meaningful earnings growth, in part burdened by difficult economic
environments as well as adverse currency movements. As a result, we must
describe Denison as one of Source's less successful investments.
In recent months Denison has put itself up for sale, and in December
announced a deal with Parker Hannifin, one of the world's largest hydraulics
companies. The price, $24 per share in cash, is a fair one in our opinion.
Compared to our original purchase price of about $16 per share, it represents a
50% gain, not a bad outcome for an unsuccessful investment.
LINCARE is the leading company providing oxygen to patients in their homes,
mostly people suffering from chronic obstructive pulmonary disease or congestive
heart failure. Because a large percent of Lincare's revenue is paid by Medicare,
it has always been exposed to changes in government reimbursement rates.
Recently, these rates have changed for the worse.
The recently passed Medicare Prescription Drug legislation also contained
some provisions which could significantly reduce the revenue of home oxygen
providers like Lincare. This would involve both the rate paid for asthma drugs,
often provided by oxygen companies, as well as the basic rate for oxygen
equipment. The effects of this legislation on Lincare's 2004 earnings are well
understood, but the year 2005 consequences are highly uncertain and potentially
very adverse.
In response to the impending changes, Lincare's stock price declined from
over $40 to about $30, or almost 30%. Our response to the price decline was to
add to Source's position. We did this for two reasons. First, we believe that
the worst-case reimbursement changes directed by Congress would result in the
exit from the business of many smaller operators, with severe negative effects
on the mostly elderly oxygen-using population. Since the federal agency
overseeing Medicare, or CMS, has considerable discretion in making the changes,
we do not expect the worst case to be implemented. Second, Lincare has
demonstrated in the past that it can take advantage of adverse environments. In
the late 1990s, for example, Medicare rates were reduced by 30% over a two-year
period. Lincare responded by cutting costs and taking market share from weakened
competitors, with the result that its earnings actually went up. While we
certainly do not expect an earnings increase, we do expect Lincare to greatly
outperform its competitors in the coming challenging period.
NORTH FORK BANK, which we wrote about in last quarter's shareholder report,
has recently announced a major acquisition. At the time we first purchased
shares in North Fork, we were impressed by its ability to gain market share as
it steadily expanded west from its original home in New York's Nassau and
Suffolk counties. This was especially true in the very large Manhattan market,
which was poorly served by Citigroup and Morgan Chase, the market share leaders
there.
North Fork's December announcement of its agreement to purchase the Trust
Company of New Jersey represents a continuation of this strategy, and gives it a
substantial presence in the rapidly growing northern New Jersey suburbs. The
stock market seemingly shares our enthusiasm for the acquisition. North Fork's
shares rose on the announcement, unlike the typical bank merger, where only the
acquired bank's shares go up, while the buyer's shares fall.
Respectfully submitted,
/s/ Eric S. Ende
Eric S. Ende
President and
Chief Investment Officer
February 2, 2004
4
PORTFOLIO OF INVESTMENTS
December 31, 2003
COMMON STOCKS SHARES VALUE
---------------------------------------------------------------- -------------- --------------
PRODUCER DURABLE GOODS -- 16.0%
Cognex Corporation 475,400 $ 13,425,296
Crane Co. 435,000 13,371,900
Denison International plc (ADR)*+ 579,500 13,876,127
Graco Inc. 343,000 13,754,300
IDEX Corporation 341,000 14,182,190
Zebra Technologies Corporation (Class A)* 219,000 14,535,030
--------------
$ 83,144,843
--------------
BUSINESS SERVICES & SUPPLIES -- 13.1%
Black Box Corporation 260,800 $ 12,015,056
HON INDUSTRIES Inc. 321,400 13,923,048
Manpower Inc. 300,000 14,124,000
Office Depot, Inc.* 900,000 15,039,000
ScanSource, Inc.* 284,000 12,956,080
--------------
$ 68,057,184
--------------
TECHNOLOGY -- 11.2%
Advanced Fibre Communications, Inc.* 700,000 $ 14,105,000
KEMET Corporation* 449,800 6,157,762
Plantronics, Inc.* 380,000 12,407,000
SanDisk Corporation* 285,000 17,424,900
TriQuint Semiconductor, Inc.* 1,143,029 8,081,215
--------------
$ 58,175,877
--------------
HEALTHCARE -- 10.3%
Health Management Associates, Inc. 195,000 $ 4,680,000
Landauer, Inc. 14,300 583,154
Lincare Holdings Inc.* 380,000 11,411,400
Ocular Sciences, Inc.* 722,900 20,754,459
Renal Care Group, Inc. 400,000 16,480,000
--------------
$ 53,909,013
--------------
ENERGY -- 9.6%
Cal Dive International, Inc.* 725,000 $ 17,479,750
Noble Corporation* 460,000 16,458,800
Tidewater Inc. 540,000 16,135,200
--------------
$ 50,073,750
--------------
RETAILING -- 7.4%
CarMax, Inc.* 445,006 $ 13,764,035
O'Reilly Automotive, Inc.* 652,500 25,029,900
--------------
$ 38,793,935
--------------
5
SHARES OR
FACE
COMMON STOCKS (CONTINUED) AMOUNT VALUE
---------------------------------------------------------------- -------------- --------------
BANKING -- 5.4%
National Commerce Financial Corporation 488,900 $ 13,337,192
North Fork Bancorporation, Inc. 370,000 14,973,900
--------------
$ 28,311,092
--------------
ENTERTAINMENT -- 4.1%
Carnival Corporation 536,600 $ 21,319,118
--------------
MATERIALS -- 2.2%
Engelhard Corporation 390,000 $ 11,680,500
--------------
INSURANCE -- 1.6%
Brown & Brown, Inc. 251,000 $ 8,185,110
--------------
REAL ESTATE INVESTMENT TRUST -- 1.3%
New Plan Excel Realty Trust 279,864 $ 6,904,245
--------------
TOTAL COMMON STOCKS -- 82.2% (Cost $273,428,582) $ 428,554,667
--------------
PREFERRED STOCKS
REAL ESTATE INVESTMENT TRUST
Duke-Weeks Realty Corp. (Series B) 40,000 $ 2,110,000
Pennsylvania Real Estate Investment Trust (Series A) 59,000 3,599,000
ProLogis (Series D) 40,000 1,001,200
ProLogis (Series G) 80,000 2,000,000
--------------
TOTAL PREFERRED STOCKS -- 1.7% (Cost $7,423,971) $ 8,710,200
--------------
CONVERTIBLE BONDS AND DEBENTURES
HEALTHCARE -- 0.6%
IVAX Corporation -- 5.5% 2007 $ 3,000,000 $ 3,090,000
--------------
PRODUCER DURABLE GOODS -- 0.6%
Checkpoint Systems, Inc. -- 5.25% 2005 $ 2,774,000 $ 2,878,025
--------------
TECHNOLOGY -- 0.3%
LSI Logic Corporation -- 4% 2006 $ 2,000,000 $ 1,950,000
--------------
TOTAL CONVERTIBLE BONDS AND DEBENTURES -- 1.5% (Cost $6,307,230) $ 7,918,025
--------------
6
FACE
NON-CONVERTIBLE BONDS AND DEBENTURES AMOUNT VALUE
---------------------------------------------------------------- -------------- --------------
CORPORATE -- 6.0%
Actuant Corporation -- 13% 2009 $ 2,275,000 $ 2,843,750
Central Garden & Pet Company -- 9.125% 2013 2,000,000 2,215,000
Host Marriott Corporation -- 9.25% 2007 2,000,000 2,248,000
Lear Corporation -- 7.96% 2005 2,000,000 2,150,000
Manitowoc Company, Inc., The -- 10.5% 2012 2,000,000 2,260,000
Metaldyne Corporation -- 11% 2012 2,000,000 1,820,000
OM Group, Inc. -- 9.25% 2011 4,000,000 4,180,000
Orbital Sciences Corporation -- 9% 2011 2,000,000 2,150,000
Realty Income Corporation -- 8.25% 2008 2,000,000 2,248,800
Unisys Corporation
-- 7.875% 2008 1,500,000 1,563,735
-- 8.125% 2006 2,000,000 2,184,880
Vicar Operating Inc. -- 9.875% 2009 3,000,000 3,360,000
Windmere Durable Holdings Inc. -- 10% 2008 2,000,000 2,020,000
--------------
$ 31,244,165
--------------
U.S. GOVERNMENT AND AGENCIES -- 0.2%
Federal Home Loan Mortgage Corporation
-- 6.5% 2023 (Interest Only) $ 149,762 $ 7,558
-- 10.15% 2006 (REMIC) 2,017 2,023
Federal National Mortgage Association -- 6% 2029 (Interest Only) 2,915,417 509,289
Government National Mortgage Association (Mobile Home)
-- 9.75% 2010 458,376 481,279
--------------
$ 1,000,149
--------------
TOTAL NON-COVERTIBLE BONDS
AND DEBENTURES -- 6.2% (Cost $30,557,700) $ 32,244,314
--------------
TOTAL INVESTMENT SECURITIES -- 91.6% (Cost $317,717,483) $ 477,427,206
--------------
SHORT TERM INVESTMENTS
Short-term Corporate Notes:
General Electric Capital Corporation -- 0.75% 1/2/04 $ 6,475,000 $ 6,474,865
Toyota Motor Credit Corporation -- 1.03% 1/12/04 22,052,000 22,045,060
Federal National Mortgage Association -- 1% 1/28/04 15,000,000 14,988,750
--------------
TOTAL SHORT-TERM INVESTMENTS -- 8.3% (Cost $43,508,675) $ 43,508,675
--------------
TOTAL INVESTMENTS -- 99.9% (Cost $361,226,158) $ 520,935,881
Other assets and liabilities, net -- 0.1% 312,845
--------------
TOTAL NET ASSETS -- 100% $ 521,248,726
==============
* Non-income producing securities
+ Affiliate as defined in the Investment Company Act of 1940 by reason of
ownership of 5% or more of its outstanding voting securities. There were no
transactions in securities of this affiliate during the year ended December
31, 2003.
See notes to financial statements.
7
MAJOR PORTFOLIO CHANGES
(UNAUDITED)
Quarter Ended December 31, 2003
SHARES OR
FACE AMOUNT
-------------------
NET PURCHASES
COMMON STOCKS
Advanced Fibre Communications, Inc. 220,000 shs.
Cognex Corporation 45,400 shs.
Health Management Associates, Inc. (1) 195,000 shs.
Lincare Holdings Inc. 19,000 shs.
Noble Corporation 20,000 shs.
Renal Care Group, Inc. 50,000 shs.
Tidewater Inc. 83,700 shs.
PREFERRED STOCK
ProLogis Trust (Series G) 80,000 shs.
NON-CONVERTIBLE SECURITIES
Vicar Operating Inc. -- 9.875% 2009 (1) $ 3,000,000
Windmere Durable Holdings Inc. -- 10% 2008 (1) $ 2,000,000
NET SALES
COMMON STOCKS
HON INDUSTRIES Inc. 28,600 shs.
OM Group, Inc. (2) 300,000 shs.
Pathmark Stores, Inc., Warrants (2) 80,898 shs.
SanDisk Corporation 125,000 shs.
PREFERRED STOCK
ProLogis (Series D) 40,000 shs.
CONVERTIBLE SECURITIES
Checkpoint Systems, Inc. -- 5.25% 2005 $ 1,226,000
MascoTech, Inc. -- 4.5% 2003 (2) $ 4,200,000
Reptron Electronics, Inc. -- 6.75% 2004 (2) $ 5,980,000
(1) Indicates new commitment to portfolio
(2) Indicates elimination from portfolio
8
FEDERAL INCOME TAX INFORMATION
(UNAUDITED)
CALENDAR 2003
CASH DIVIDENDS AND DISTRIBUTIONS:
(1) (2)
AMOUNT ORDINARY LONG-TERM
PAID INCOME CAPITAL GAIN
DATE PAID PER SHARE DIVIDENDS DISTRIBUTIONS
--------- --------- --------- -------------
PREFERRED STOCK:
03/15/2003 $ 0.60 $ 0.60 --
06/15/2003 0.60 0.60 --
09/15/2003 0.60 0.60 --
12/15/2003 0.60 0.60 --
---------- ---------- ----------
TOTAL $ 2.40 $ 2.40 --
========== ========== ==========
COMMON STOCK:
03/15/2003 $ 0.875 $ 0.0458 $ 0.8292
06/15/2003 0.875 0.0458 0.8292
09/15/2003 0.875 0.0458 0.8292
12/15/2003 0.875 0.0458 0.8292
---------- ---------- ----------
TOTAL $ 3.500 $ 0.1832 $ 3.3168
========== ========== ==========
The amount in column (1) is to be included as dividend income on your tax
return and 27.7% 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 99.2% resulted from
gains realized after May 5, 2003, 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 2003 tax
returns. For corporate shareholders, 27.7% 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, 2003. Therefore, Common shareholders will not receive a Form 2439 for 2003.
NOTICE TO DIVIDEND REINVESTMENT PLAN PARTICIPANTS:
The information above shows the cash distributions paid by Source Capital
during 2003. 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, 2003, $2.0720 per share; June
15, 2003, $2.6030 per share; September 15, 2003, $2.8315 per share; December 15,
2003, $2.9750 per share.
STATE TAX INFORMATION:
None of the amounts reported were 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): 24.2% of these gains were derived from
assets held 1-2 years, 57.3% 2-3 years, 4.5% 3-4 years, and 14.0% 4-5 years.
None of the gains were derived from assets held more than 5 years.
9
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 2003
-------------------------------
ASSETS
Investments at value:
Investment securities -- at market value
(cost $317,717,483) -- Note A $ 477,427,206
Short-term investments -- at cost plus interest earned
(maturities 60 days or less) -- Note A 43,508,675 $ 520,935,881
--------------
Cash 107
Receivable for:
Accrued interest $ 634,366
Dividends 226,264 860,630
-------------- --------------
$ 521,796,618
LIABILITIES
Payable for:
Advisory fees $ 299,632
Accrued dividends -- Preferred Stock 196,921
Accrued expenses 51,339 547,892
-------------- --------------
TOTAL NET ASSETS -- December 31, 2003 $ 521,248,726
==============
Assets applicable to Preferred Stock at a liquidation
preference of $27.50 per share (asset coverage
963%) -- Note B $ 54,153,330
==============
Net assets applicable to Common Stock -- $56.62 per share $ 467,095,396
==============
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 8,249,199 shares -- Note B 8,249,199
Additional Paid-in Capital 341,254,627
Undistributed net realized gain on investments 6,127,541
Unrealized appreciation of investments 159,709,723
--------------
TOTAL NET ASSETS -- December 31, 2003 $ 521,248,726
==============
See notes to financial statements.
10
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
2003 2002
------------------------------- -------------------------------
INVESTMENT INCOME
Income:
Interest $ 3,729,915 $ 3,916,350
Dividends (including $430,323 from securities of
affiliates during the year ended December 31, 2002) 3,517,720 3,987,321
-------------- --------------
$ 7,247,635 $ 7,903,671
Expenses -- Note C:
Advisory fees $ 3,089,995 $ 3,135,862
Transfer agent fees and expenses 288,755 290,891
Reports to shareholders 175,557 167,874
Directors' fees and expenses 104,472 100,025
Taxes, other than federal income tax 75,825 65,820
Custodian fees and expenses 48,071 48,597
Legal and auditing fees 33,822 42,503
Registration and filing fees 32,432 27,374
Other expenses 50,226 3,899,155 63,264 3,942,210
-------------- -------------- -------------- --------------
Net investment income -- Note A $ 3,348,480 $ 3,961,461
-------------- --------------
NET REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized gain on investments:
Proceeds from sale of investment securities
(excluding short-term corporate notes with
maturities 60 days or less) $ 140,866,163 $ 83,883,772
Cost of investment securities sold 105,352,982 61,837,213
-------------- --------------
Net realized gain on investments -- Notes A and D $ 35,513,181 $ 22,046,559
Unrealized appreciation of investments:
Unrealized appreciation at beginning of year $ 44,501,199 $ 139,213,689
Unrealized appreciation at end of year 159,709,723 44,501,199
-------------- --------------
Increase (decrease) in unrealized appreciation of
investments 115,208,524 (94,712,490)
-------------- --------------
Net realized and unrealized gain (loss) on
investments $ 150,721,705 $ (72,665,931)
-------------- --------------
NET INCREASE (DECREASE) IN TOTAL NET
ASSETS RESULTING FROM OPERATIONS $ 154,070,185 $ (68,704,470)
============== ==============
See notes to financial statements.
11
STATEMENT OF CHANGES IN TOTAL NET ASSETS
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
2003 2002
------------------------------- -------------------------------
INCREASE (DECREASE) IN TOTAL NET
ASSETS
Operations:
Net investment income $ 3,348,480 $ 3,961,461
Net realized gain on investments
-- Notes A and D 35,513,181 22,046,559
Increase (decrease) in unrealized appreciation of
investments 115,208,524 (94,712,490)
-------------- --------------
Increase (decrease) in total net assets resulting
from operations $ 154,070,185 $ (68,704,470)
Distributions to Preferred shareholders:
From net investment income $ (4,171,681) $ (3,915,783)
From net realized capital gains (554,427) (4,726,108) (810,326) (4,726,109)
-------------- --------------
Distributions to Common shareholders from net realized
capital gains (28,645,415) (37,079,161)
Proceeds from shares issued for distributions
reinvested by shareholders -- Note B 5,374,229 6,960,000
-------------- --------------
Increase (decrease) in total net assets $ 126,072,891 $ (103,549,740)
TOTAL NET ASSETS
Beginning of year, including
undistributed net investment income
of $823,201 and $777,523 395,175,835 498,725,575
-------------- --------------
End of year, including
undistributed net investment income
of $823,201 at December 31, 2002 $ 521,248,726 $ 395,175,835
============== ==============
See notes to financial statements.
NOTICE OF SOURCE OF DISTRIBUTIONS
(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
---------------------- --------- ---------- -------------
3/15/2003 $ 0.875 -- $ 0.875
6/15/2003 0.875 -- 0.875
9/15/2003 0.875 -- 0.875
12/15/2003 0.875 -- 0.875
--------- ---------- --------
$ 3.500 -- $ 3.500
========= ========== ========
The source of distributions for financial reporting purposes differs from
federal income tax reporting. 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,
---------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
Common Stock:
Per share operating performance:
Net asset value at beginning of year $ 41.90 $ 55.45 $ 48.62 $ 50.70 $ 48.23
----------- ----------- ----------- ----------- -----------
Income from investment operations:
Net investment income $ 0.41 $ 0.49 $ 0.54 $ 0.70 $ 0.67
Net realized and unrealized gain (loss)
on investment securities 18.36 (8.97) 11.40 4.20 10.27
----------- ----------- ----------- ----------- -----------
Total from investment operations $ 18.77 $ (8.48) $ 11.94 $ 4.90 $ 10.94
----------- ----------- ----------- ----------- -----------
Distributions to Preferred shareholders:
From net investment income $ (0.51) $ (0.49) $ (0.59) $ (0.61) $ (0.62)
From net realized capital gains (0.06) (0.10) -- -- --
Distributions to Common shareholders:
From net investment income -- -- (0.30) -- (0.09)
From net realized gains (3.50) (4.60) (4.30) (6.41) (7.77)
----------- ----------- ----------- ----------- -----------
Total distributions $ (4.07) $ (5.19) $ (5.19) $ (7.02) $ (8.48)
----------- ----------- ----------- ----------- -----------
Effect of shares issued for distributions
reinvested by shareholders $ 0.02 $ 0.12 $ 0.08 $ 0.04 $ 0.01
----------- ----------- ----------- ----------- -----------
Net asset value at end of year $ 56.62 $ 41.90 $ 55.45 $ 48.62 $ 50.70
=========== =========== =========== =========== ===========
Per share market value at end of year $ 59.38 $ 52.85 $ 61.02 $ 52.69 $ 48.25
Total investment return(1) 20.6% (6.2)% 26.0% 24.1% 15.2%
Net asset value total return(2) 45.7% (17.1)% 24.7% 9.6% 23.1%
Ratios/supplemental data:
Net assets at end of year (in thousands) $ 521,249 $ 395,176 $ 498,726 $ 437,611 $ 444,388
Ratios based on average net assets applicable to
Common Stock:
Expenses 0.99% 0.99% 0.97% 1.00% 1.00%
Net Income 0.85% 0.99% 1.07% 1.46% 1.39%
Ratios based on average net assets:
Expenses 0.87% 0.87% 0.85% 0.87% 0.87%
Net Income 0.75% 0.87% 0.95% 1.28% 1.21%
Portfolio turnover rate 18.43% 16.62% 25.13% 18.55% 23.51%
Preferred Stock:
Total shares outstanding(3) 1,969,212 1,969,212 1,969,212 1,969,212 1,969,212
Asset coverage per share(3) $ 264.70 $ 200.68 $ 253.26 $ 222.23 $ 225.67
Involuntary liquidation preference per share $ 27.50 $ 27.50 $ 27.50 $ 27.50 $ 27.50
Average market value per share(4) $ 31.87 $ 31.15 $ 30.05 $ 27.87 $ 28.54
(1) Based on market value per share, adjusted for reinvestment of distributions
(2) Based on net asset value per share, adjusted for reinvestment of
distributions
(3) Information shown as of the end of the year
(4) 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 value 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 cost plus interest earned, 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.
During the years ended December 31, 2003, and 2002, the Company issued
109,926 and 122,085 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, 2003, and 2002, the Company paid aggregate
fees of $102,500 and $99,500, respectively, to all Directors who are not
affiliated persons of the Investment Adviser. During the years ended December
31, 2003, and 2002, the Company incurred legal fees of $1,822 and $9,903,
respectively, payable to O'Melveny & Myers LLP, counsel for the Company. A
Director of the Company is of counsel to, and a retired partner of, that firm.
NOTE D--PURCHASES, SALES AND TAX DIFFERENCES
The cost of purchases of investment securities (excluding short-term
corporate notes with maturities of 60 days or less) aggregated $77,307,557 and
$74,381,488 for the years ended December 31, 2003, and 2002, respectively.
Realized gains and losses are based on the specific-certificate identification
method.
All of the amounts reported in the financial statements at December 31,
2003, were the same for federal income tax and financial reporting purposes. A
permanent difference of $282,854 as of December 31, 2003, 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, 2003, for federal income tax and financial reporting
purposes was $169,949,143 and $10,239,420 respectively.
14
INDEPENDENT AUDITORS' REPORT
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, 2003, and the related statements of operations, changes in total
net assets and financial highlights for each of the two 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 three
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 auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included confirmation of
securities owned as of December 31, 2003, by correspondence with the custodian.
An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Source
Capital, Inc. as of December 31, 2003, the results of its operations, changes in
net assets and financial highlights for each of the two 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
January 30, 2004
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. - (68)* Director Term: 1 Year Retired. Formerly, until 1995, 6
11400 W. Olympic Blvd. Time Served: 6 Years Partner of Ernst & Young LLP a
Suite 1200 public accounting firm.
Los Angeles, CA 90064
Wesley E. Bellwood - (80)* Director Term: 1 Year Retired. Formerly, until 1999, 1
11400 W. Olympic Blvd. Time Served: 24 Years Chairman Emeritus and director
Suite 1200 of Wynn's International, Inc.
Los Angeles, CA 90064
David Rees - (80)* Director Term: 1 Year Private investor. Formerly 1 International
11400 W. Olympic Blvd. Time Served: 36 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 - (75)* Director Term: 1 Year Retired President and Chief 1
11400 W. Olympic Blvd. Time Served: 5 Years Executive Officer (1984-1993)
Suite 1200 of Parker Hannifin
Los Angeles, CA 90064 Corporation.
Lawrence J. Sheehan - (71) Director Term: 1 Year Of counsel to, and partner 5
11400 W. Olympic Blvd. Time Served: 13 Years (1969 to 1994) of, the firm of
Suite 1200 O'Melveny & Myers LLP, legal
Los Angeles, CA 90064 counsel to the Company.
Eric S. Ende - (59) Director, Term: 1 Year Senior Vice President of the 3
11400 W. Olympic Blvd. President & Time Served: 4 Years Adviser.
Suite 1200 Chief
Los Angeles, CA 90064 Investment
Officer
Steven R. Geist - (50) Senior Vice Time Served: 8 Years Vice President of the Adviser.
11400 W. Olympic Blvd. President &
Suite 1200 Fixed-Income
Los Angeles, CA 90064 Manager
J. Richard Atwood - (43) Treasurer Time Served: 7 Years Principal and Chief Operating First Pacific
11400 W. Olympic Blvd. Officer of the Adviser. Advisors, Inc.,
Suite 1200 President of FPA Fund and FPA Fund
Los Angeles, CA 90064 Distributors, Inc. Distributors,
Inc.
Sherry Sasaki - (49) Secretary Time Served: 22 Years Assistant Vice President and
11400 W. Olympic Blvd. Secretary of the Adviser and
Suite 1200 of FPA Fund Distributors, Inc.
Los Angeles, CA 90064
Christopher H. Thomas - (46) Assistant Time Served: 9 Years Vice President and Controller FPA Fund
11400 W. Olympic Blvd. Treasurer of the Adviser and of FPA Fund Distributors,
Suite 1200 Distributors, Inc. Inc.
Los Angeles, CA 90064
* Audit committee member
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 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
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. (a) The registrant has adopted a code of ethics that applies to the
registrant's senior executive and financial officers. 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.
2002 2003
(a) Audit Fees $ 29,400 $ 27,000
(b) Audit Related Fees -0- -0-
(c) Tax Fees $ 3,200 $ 5,000
(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 deemed 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.
(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
directors 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. N/A
Item 5. Audit Committee of Listed Registrants. N/A. Item is only applicable
for annual reports for the year ending on or after January 15, 2004.
Item 6. Reserved.
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. Reserved.
Item 9. Controls and Procedures.
(a) The Principal Executive Officer and Principal Financial Officer of
Source Capital, Inc. ("Company") have concluded that the Company's
Disclosure Controls and Procedures (as defined in Rule 30a-2(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 Company's internal
controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Item 10. Exhibits.
(a) Code of ethics as applies to the registrant's officers and
directors, as required to be disclosed under Item 2 of Form
N-CSR. Attached hereto as Ex. 99.CODE ETH.
(b) Separate certification for the registrant's principal executive
officer and principal financial officer, as required by Rule
30a-2 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 8, 2004
Pursuant to the Securities Exchange Act of 1934 and the Investment Company Act
of 1940, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
SOURCE CAPITAL, INC.
By: /s/ J. RICHARD ATWOOD
--------------------------------
J. Richard Atwood, Treasurer
Date: March 8, 2004