<PAGE> 1
SOURCE CAPITAL, INC.
1996
ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31
<PAGE> 2
<TABLE>
<S> <C>
DIRECTORS COUNSEL
Wesley E. Bellwood O'Melveny & Myers LLP
Julio J. de Puzo, Jr. Los Angeles, California
David Rees
Robert L. Rodriguez INDEPENDENT AUDITORS
Lawrence J. Sheehan Ernst & Young LLP
Charles W. Stanton Los Angeles, California
Kenneth L. Trefftzs
TRANSFER AND SHAREHOLDER
OFFICERS SERVICE AGENT
Julio J. de Puzo, Jr., President ChaseMellon Shareholder Services, L.L.C.
Eric S. Ende, Senior Vice President 85 Challenger Road
Robert L. Rodriguez, Senior Vice President Overpeck Centre
Steven R. Geist, Vice President Ridgefield Park, NJ 07660
Janet M. Pitman, Vice President (800) 279-1241 or (212) 613-7427
Steven T. Romick, Vice President
J. Richard Atwood, Treasurer REGISTRAR
Sherry Sasaki, Secretary ChaseMellon Shareholder Services, L.L.C.
Christopher H. Thomas, Assistant Treasurer Ridgefield Park, New Jersey
INVESTMENT ADVISER STOCK EXCHANGE LISTING
First Pacific Advisors, Inc. New York Stock Exchange:
11400 West Olympic Blvd., Suite 1200 Symbols: SOR Common Stock
Los Angeles, California 90064 SOR+ Preferred Stock
CUSTODIAN
State Street Bank and Trust Company
Boston, Massachusetts
</TABLE>
- --------------------------------------------------------------------------------
SUMMARY FINANCIAL INFORMATION
<TABLE>
<CAPTION>
For the year ended December 31,
------------------------------------------------
1996 1995
---------------------- ----------------------
Total Per Total Per
Net Common Net Common
Assets Share Assets Share
------------ ------ ------------ ------
<S> <C> <C> <C> <C>
Beginning of year....................................... $362,086,804 $42.58 $329,426,748 $38.52
Net gain on investments, realized and unrealized........ 59,669,461 8.25 49,082,213 6.84
Income available to Common shareholders................. 4,722,996 0.65 5,900,899 0.82
Distributions to Common shareholders.................... (44,332,834) (6.13) (25,881,498) (3.60)
Proceeds from shares issued for distributions reinvested
by Common shareholders................................ -- -- 3,558,442 --
------------ ------ ------------ ------
Net changes during year.......................... $ 20,059,623 $2.77 $ 32,660,056 $4.06
------------ ------ ------------ ------
End of year............................................. $382,146,427 $45.35 $362,086,804 $42.58
============ ====== ============ ======
Common market price per share........................... 45 1/2 41 7/8
Common market premium (discount) to net asset value..... 0.3% (1.7)%
Preferred asset coverage................................ 706% 669%
Preferred liquidation preference per share.............. $ 27.50 $27.50
Preferred market price per share........................ 28 5/8 28 1/2
</TABLE>
<PAGE> 3
DESCRIPTION OF THE COMPANY
SOURCE CAPITAL, INC. is a major diversified, publicly traded investment
company with total net assets of approximately $382,000,000. 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
traded on The New York Stock Exchange. The 1,969,212 outstanding Preferred
shares each have 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 7,232,110
shares of Common Stock.
Source Capital's investment objective is to seek maximum total return for
Common shareholders from both capital appreciation and investment income to the
extent consistent with protection of invested capital and provision of
sufficient income to meet the dividend requirements of Preferred shareholders.
Source Capital is not a mutual fund. Thus, it does not repurchase its own
shares on demand and does not need to structure its portfolio securities to
provide for possible redemptions. As a publicly traded investment company,
Source Capital's Common and Preferred shares are bought and sold on The New York
Stock Exchange, and the Company is not involved in the transaction.
Source Capital's investment approach emphasizes primarily equity and
equity-related investments in seeking to achieve its growth objective for its
Common shareholders. The desirability of equity versus fixed-income investments
has been increasingly debated in recent years. Source Capital's position is that
without assuming undue risk and recognizing the fixed claim of its Preferred
Stock, properly selected stocks offer the better long-term opportunity for
overall investment return as well as long-term protection from the large but
uncertain threat of inflation. Source Capital's equity investments have been
directed toward companies with highly liquid, relatively unleveraged balance
sheets and a demonstrated long-term ability to earn above average returns on
invested capital. Source Capital's equity investment portfolio is based on
fundamental judgments of long-term returns attainable from income and
appreciation in the securities of such companies and is not derived from overall
economic forecasts or stock market predictions.
Source Capital has a Common Stock Distribution Policy which provides for cash
distributions of approximately 10% of the ongoing net asset value of its Common
shares. 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 may be
distributed to shareholders or retained by the Company. Distributions to Common
shareholders are paid quarterly in a fixed amount which is periodically adjusted
after sustained changes in net asset value appear to the Board of Directors
reasonably likely to support the new distribution rate on a continuing basis.
This policy is designed to allow Common shareholders to benefit not only from
income, but a portion of the capital appreciation which has resulted to date.
All distributions are taxable to shareholders as dividend income or capital gain
distributions since the Company has accumulated earnings and profits from prior
years.
Since the policy was adopted in June 1976, at an initial annual rate of $1.40
per share, continued increases in net asset value, despite payments from
capital, have permitted 16 subsequent increases to the current rate of $3.70.
Maintenance of the current $3.70 annualized rate is dependent upon achieving a
total return on the Common Stock from both income and appreciation to sustain a
net asset value of approximately $37.00.
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"). ChaseMellon Shareholder Services, L.L.C. ("Agent"), P.O.
Box 590, Ridgefield Park, New Jersey 07660, acts as agent for participants under
the Plan.
A shareholder may join the Plan by signing and returning an authorization form
which 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 dividend 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.
1
<PAGE> 4
LETTER TO SHAREHOLDERS
TO OUR SHAREHOLDERS:
Although not quite as spectacular as the prior year, 1996 proved to be another
year of extremely strong stock market returns. The S&P 500 Stock Index was up
23.3%, following 1995's 37.5% gain. This represented only the second time in the
past 20 years that the S&P has put together back-to-back gains of over 20%. The
prior occasion, 1982-1983 was at the beginning of an economic recovery, while
1995-1996, in contrast, is well into an extended period of prosperity.
The reader may notice that data for the Russell 2500 Index has been included
in the table of returns for the first time. The Russell 2500 is a subset of the
Russell 3000 Index, which is comprised of the 3,000 largest publicly traded U.S.
Companies. The Russell 2500 represents all of the Russell 3000 stocks excluding
the 500 largest. As such, it is an excellent indicator of the performance of
mid-cap and small-cap stocks, covering a market cap range of $150 million to
$2.5 billion, which is much closer to Source Capital's $1.2 billion median
market cap than is the S&P's $5.5 billion median.
There are a number of other issues which make us relatively unenthusiastic
about using the S&P 500 as the primary benchmark for Source Capital's
performance, most of which involve weighting and indexation. Although both the
Russell and S&P are cap-weighted indices, the significance of this is far
greater for the S&P. The largest company in the S&P 500, General Electric, has a
market cap of $165 billion, approximately 400 times that of the S&P's smallest
company, Giddings & Lewis. Thus a 1% price change in GE affects the S&P Index
400 times more than a 1% change in the price of Giddings & Lewis. In contrast,
the biggest-to-smallest market cap range in the Russell 2500 is only about 15
times, so the distortion is far less.
This issue of weighting is significant because in constructing Source's
portfolio we would never choose to own 10 times as much GE as we would a $17
billion company, or 100 times as much as a $1.7 billion company. In fact, both
of these "smaller" market caps are quite adequate for a full-size position in
Source. As a result, the performance of a typical "equal-weighted" portfolio
like Source can diverge significantly from that of the S&P 500. This problem is
reduced if an index like the Russell 2500 is used, or if performance is compared
to the equal weighted S&P -- data which is unfortunately not readily available
to the public.
We believe that the growth of indexation -- the creation of portfolios which
mimic the performance of the S&P 500 -- also serves to reduce its usefulness as
a performance benchmark. With several hundred billion dollars invested in index
funds, and the amount rapidly increasing, the prices of the companies comprising
the S&P 500 are being bid up to higher than "normal" levels, at the same time as
their valuations become less attractive. As a result, we do not own very many
S&P 500 stocks -- currently only 12 companies, comprising just 22% of Source's
portfolio.
1996 INVESTMENT PORTFOLIO RETURNS
Total net assets of Source Capital amounted to $382,146,427 at December 31,
1996. After providing for Preferred Stock equity, Common equity amounted to
$327,993,097 or $45.35 of net asset value per Common share. This compared with
total net assets of $362,086,804, Common equity of $307,933,474 and net asset
value per Common share of $42.58 one year ago. These changes reflect payments to
Common and Preferred shareholders totaling $49,058,943. As a result, Source
Capital achieved a total investment return during 1996 of 21.9% on its Common
net asset value (20.0% 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. 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.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SOURCE CAPITAL STOCK MARKET INDICES FIXED-INCOME INDICES
--------------------- --------------------------- ------------------------------------
TOTAL COMMON RUSSELL S&P LEHMAN BROTHERS TREASURY
PERIOD NET ASSETS EQUITY 2500 500 DJIA GOVT/CORP BOND INDEX BILL YIELDS
- ----------------------- ---------- ------ ------- ----- ----- -------------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
1996 +20.0% +21.9 % +19.0% +23.3% +28.9% + 2.9% + 5.3%
1995 +18.7 +20.7 +31.7 +37.5 +36.9 +19.2 + 5.7
1994 + 2.0 + 0.6 - 1.1 + 1.3 + 5.0 - 3.5 + 4.2
1993 + 6.7 + 6.3 +16.5 +10.0 +17.0 +11.0 + 3.1
1992 +12.5 +13.3 +16.2 + 7.7 + 7.4 + 7.6 + 3.6
1991 +19.7 +22.2 +46.7 +30.6 +24.3 +16.1 + 5.8
1990 - 1.2 - 3.2 -14.9 - 3.1 - 0.5 + 8.3 + 7.8
1989 +21.1 +23.9 +19.4 +31.7 +32.3 +14.2 + 8.2
1988 +15.2 +16.8 +22.7 +16.6 +16.2 + 7.6 + 6.2
1987 + 3.0 + 1.7 - 4.7 + 5.3 + 5.6 + 2.3 + 5.9
1986 +12.8 +13.9 +12.0 +18.7 +27.3 +15.6 + 6.0
1985 +24.2 +28.5 +31.9 +31.8 +33.7 +21.3 + 7.5
1984 +11.9 +12.8 - 4.1 + 6.3 + 1.4 +15.0 + 9.6
1983 +18.4 +21.3 +27.7 +22.6 +26.1 + 8.0 + 8.6
1982 +21.6 +26.1 +26.7 +21.5 +27.2 +31.1 +10.7
1981 +14.2 +16.0 + 3.0 - 5.3 - 3.7 + 7.3 +14.1
1980 +19.2 +23.1 +34.3 +32.4 +22.2 + 3.0 +11.6
1979 +26.6 +35.0 +38.4 +18.7 +10.7 + 2.3 +10.3
1978 +16.1 +19.7 N/A + 6.4 + 2.8 + 1.2 + 7.2
1977 +13.0 +15.1 N/A - 7.2 -12.9 + 3.0 + 5.4
Annual Compound
Rate of Return:
18 years +14.5 +16.3 +16.7 +16.4 +17.0 +10.2 + 7.4
20 years +14.5 +16.4 N/A +14.6 +14.5 + 9.4 + 7.3
</TABLE>
2
<PAGE> 5
NET INVESTMENT INCOME
As has been the case for the past several years, net investment income has
continued to decline. Despite the active management of the bond portfolio, the
current low interest rate environment cannot produce the level of interest
income that was generated in years prior. Most of the decline in net investment
income, however, occurred on the dividend side as we reduced the level of
participation in larger capitalization stocks and moved into the mid-cap arena
for valuation purposes. In a reversal of last year's performance when dividend
income increased, dividends accounted for 35% of gross income compared to 38% in
1995 but still well ahead of the 25% generated in 1991. Specifically, net
investment income amounted to $2,425,030 and $9,449,105 for the fourth quarter
and full year, respectively, compared with $2,853,209 and $10,627,008 in 1995.
After providing for Preferred dividends, net investment income per Common share
totaled $0.17 and $0.65 for the fourth quarter and full year, respectively,
compared with $0.23 and $0.82 earned in the corresponding periods of 1995.
DISTRIBUTIONS TO COMMON SHAREHOLDERS
The distribution rate on Source Capital Common Stock is currently at the $3.70
annual rate which has been in effect since March 1996. Source Capital's
distribution policy, initiated in June 1976, calls for payments to Common
shareholders of approximately 10% of the Common Stock's ongoing net asset value.
Since the adoption of this policy almost 21 years ago, continuing growth in net
asset value has led to 16 increases in the distribution rate totaling 164%. This
growth was achieved despite payments to shareholders in excess of net investment
income of $274,326,770 or $42.88 per Common share, plus payment of federal
income tax on the retained portion of net realized long-term gains of
$36,198,677 or $5.99 per Common share. As we have repeatedly pointed out,
maintenance of the current $3.70 Common distribution rate is dependent on
achieving investment results which will sustain a net asset value of
approximately $37.00.
Capital gains are the eventual result of successful investments. As in recent
years, changes in relative market valuations as well as changing prospects of
individual companies have led us to sell certain holdings in 1996, and these
sales have 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 $44,976,665 in net capital
gains in 1996. Payments to Common shareholders during 1996 were sufficient to
distribute these realized gains. Thus, the Company did not retain any gains in
1996, and IRS Form 2439 will not be required. More detailed tax information is
presented on page 11.
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 which deviate from
the underlying changes in net asset value can cause shareholder returns to be
either enhanced or diminished. The experience of the past year clearly
illustrates the positive side of this phenomenon as the 1.7% market discount
from net asset value at 12/31/95 changed to a 0.3% premium one year later, and
the shareholder returns benefited accordingly. The following table presents 1996
market returns for both Common and Preferred shareholders:
<TABLE>
<CAPTION>
Common Preferred
Stock Stock
------- ---------
<S> <C> <C>
Change in Market Value:
NYSE Closing Price
- 12/31/96.............. $45.500 $28.625
NYSE Closing Price
- 12/31/95.............. 41.875 28.500
------- ---------
Net Change in 1996......... $3.625 $ 0.125
Distributions in 1996........ 6.130 2.400
------- ---------
Total Return - Amount........ $9.755 $ 2.525
Total Return - Percent....... 23.3% 8.9%
</TABLE>
Common shareholders who participated in the Company's Automatic Reinvestment
Plan experienced a positive return of 24.5% during 1996 as they benefited from
appreciation of shares acquired with their distributions. Furthermore, on a
long-term basis those shareholders who participated in the Automatic
Reinvestment Plan during the 20 years since inception experienced an annual
compound rate of return of 18.4%.
COMMENTARY
When reviewing 1996, we were struck by the narrowness of the stock market
advance. The shares of large, well-known companies performed extraordinarily
well, while medium and smaller companies trailed far behind. This difference is
quite apparent in a comparison of
3
<PAGE> 6
several market averages -- from the large stock Dow Jones Industrials to the
small stock Russell 2000.
<TABLE>
<CAPTION>
1996
Returns
-------
<S> <C>
Dow Industrials.......... +28.9%
S&P 500.................. +23.3%
S&P MidCap............... +19.2%
Russell 2000............. +16.5%
</TABLE>
Perhaps even more striking is a comparison of S&P 500 returns by quintile
based on market capitalization, from the largest 20% of the companies to the
smallest 20%:
<TABLE>
<CAPTION>
1996
S&P 500 Returns Market Cap Range
- -------------- ------- -----------------------------
<S> <C> <C>
Largest 20%... +30.1% $14 - 163 billion
Next 20%...... +29.4 7 - 14 billion
Middle 20%.... +19.3 4 - 7 billion
Next 20%...... +18.7 2.3 - 4 billion
Smallest
20%......... + 8.8 290 million - 2.3 billion
</TABLE>
We are particularly pleased with our portfolio's performance in 1996 because
we own virtually none of the really large cap stocks which accounted for so much
of the market's gain, and because our low-beta, high-quality portfolio would
typically have difficulty staying with a market which is up by so much.
We see a number of reasons to be cautious about the outlook for both the
economy and the stock market.
The U.S. economy has continued to perform extraordinarily well, with moderate
growth and virtually no inflation. We are hopeful that this will continue in
1997, but the increasing age of the expansion and hints of labor market
tightness give rise to at least some concern. On balance, we are a bit more
worried about a weakening economy, with resultant profit pressures, than about a
revival of inflation and higher interest rates. Right now neither is imminent,
but we may not be able to make this statement again at the start of 1998.
Corporate profitability has improved dramatically over the past several years,
driven both by cyclical forces and by permanent structural changes in the way
companies are managed. As a result, profit margins are at levels not seen for 30
years, and returns on equity are at post-World War II highs. We believe that
much of this improvement has already occurred, and that future gains will be
more modest. Trends in profit growth of the S&P Industrials support this view as
illustrated below:
<TABLE>
<CAPTION>
S&P Industrials
Year Earnings Growth*
------ ----------------
<S> <C>
1994 +28%
1995 +14
1996 + 6
* Excluding major charges
</TABLE>
The stock market enters 1997 with consecutive annual gains of over 20% for a
two-year total advance of 70%, as measured by the S&P 500. Taking a longer view,
the market's performance of +17% annualized since 1982, a 15-year period, is far
above the trendline equity returns of roughly 10-12%. Much of this surplus
performance was driven by secular declines in interest rates and inflationary
expectations, perfectly valid reasons, but like improvements in corporate
profitability, not something likely to contribute as much to future performance
as past.
Considering the market gains of recent years, it might be useful to spend some
time discussing protection of capital in a down market. We believe that Source
Capital's portfolio is consistently less volatile and less risky than the stock
market as a whole. This is a consequence of the kind of companies we invest in,
our valuation criteria, and the construction of the portfolio. In understanding
the ways in which we reduce risk, it is useful to look at the following four
elements:
Business Risk. Although all businesses have varying degrees of risk, we
strive to minimize it by investing in companies with strong financial and
market positions. Our companies have high operating margins (mid-teens or
better), superior managements, and leading market shares. As a result,
their profitability holds up better than their competitors' in adverse
economic conditions, and they can often gain market share by maintaining
aggressive investments in new capital, product development, and marketing.
In addition, we invest only in companies we thoroughly understand, and we
avoid those where rapidly changing technologies make forecasting the future
especially hazardous.
Financial Risk. Leveraged companies are riskier. Our companies have less
than half the debt levels of the S&P Industrials -- 20% of capital versus
50%. This reduces their earnings volatility and increases their financial
flexibility in difficult environments. They are not dependent on
accommodating capital markets, but are free to reinvest in the business, to
make opportunistic acquisitions, or share repurchases.
Market Risk. Based on trailing twelve-month earnings, the S&P Industrials
are selling at 21x earnings. Our portfolio is valued at 17x earnings, a
valuation advantage which should help our performance if a downturn in the
market occurs.
Portfolio Risk. By limiting our exposure in any company within the
portfolio to less than 5% and by holding approximately 40 companies,
well-diversified across industries, we minimize the risk to our
shareholders, compared to a much more concentrated portfolio, or
excessively large company or industry positions.
We would like to briefly discuss a company recently added to the portfolio. In
August 1996, we initiated a position in CIRCUIT CITY, a successful Source
investment of
4
<PAGE> 7
several years ago, and increased it in December and January, all at prices
between $29 and $31. Our purchases were made in the face of a number of powerful
negatives currently besetting the consumer electronic industry.
- Earnings for all companies, including Circuit City, are declining.
- The environment is intensely competitive.
- There has been a dearth of exciting new consumer electronics product
offerings.
- Consumer PC sales have been weak.
- Many local chains are failing, or tottering on the brink, while even
well-known national chains are shutting stores (Tandy's Incredible
Universe and Computer City, Egghead Software) or sharply reducing
expansion plans (Best Buy).
Despite this challenging environment, Circuit City has managed to preserve
most of its profitability, maintain a rapid expansion rate, and avoid any of the
financial duress affecting its competitors -- Best Buy, for example, has been in
violation of its bank covenants. In addition, Circuit City has developed an
exciting new expansion vehicle -- Car Max. Car Max is a consumer-friendly used
car superstore, featuring an extensive selection of late-model vehicles, a
low-pressure selling environment, no-haggle pricing, and no-strings cash offers
on customer trade-in vehicles. Circuit City has announced an aggressive national
roll-out for Car Max and in early February, 1997, sold about 20% of Car Max in a
public offering. This both raised over $400 million of new capital, and
established a public market value for Circuit City's majority ownership position
in Car Max. This turns out to be about $17 per share, or roughly half of Circuit
City's recent price of $35, despite the fact that Car Max is currently losing
money, while the rest of Circuit City is earning about $1.50 per share.
Our purchase of Circuit City is grounded in the belief that industry
conditions will soon be improving.
- The ranks of competitors will continue to thin and new store growth will
be limited.
- New product is on the way, notably Digital Video Disk (DVD) and high
definition TV (HDTV).
- Margins and returns on capital will improve, driven in part by economic
pressures on industry members.
- Car Max will prove to be a successful and profitable growth vehicle for
Circuit City.
Circuit City is typical of the companies in Source Capital's portfolio, which
have historical growth rates, returns on capital, and balance sheets better than
the average S&P Index Stock, yet sell at lower PE's. They should provide
rewarding long-term returns to shareholders.
Respectfully submitted,
/s/ ERIC S. ENDE
- --------------------------
Eric S. Ende
Senior Vice President
February 15, 1997
5
<PAGE> 8
PORTFOLIO OF INVESTMENTS
December 31, 1996
<TABLE>
<CAPTION>
COMMON STOCKS Shares Cost Value
- ---------------------------------------------------- ---------- ------------ ------------
<S> <C> <C> <C>
PRODUCER DURABLE GOODS -- 17.3%
Belden Inc.......................................... 216,200 $ 6,054,629 $ 7,999,400
Donaldson Company, Inc.............................. 217,200 5,531,072 7,276,200
Dover Corporation................................... 139,900 4,684,766 7,029,975
Federal Signal Corporation.......................... 182,200 4,039,636 4,714,425
Holophane Corporation*.............................. 461,700 7,836,581 8,772,300
Hubbell Incorporated (Class B)...................... 50,264 851,341 2,173,918
IDEX Corporation.................................... 277,200 9,916,855 11,053,350
Kaydon Corporation.................................. 220,400 6,031,962 10,386,350
Leggett & Platt, Incorporated....................... 194,100 4,536,512 6,720,712
------------ ------------
$ 49,483,354 $ 66,126,630
------------ ------------
BUSINESS SERVICES & SUPPLIES -- 9.9%
Arrow Electronics, Inc.*............................ 134,700 $ 5,928,462 $ 7,206,450
Bacou USA, Inc.*.................................... 276,500 4,547,156 4,596,813
Devon Group, Inc.*.................................. 195,300 3,007,100 5,370,750
Expeditors International of Washington, Inc......... 312,200 2,014,417 7,180,600
Franklin Quest Co.*................................. 303,700 6,404,397 6,377,700
Manpower Inc........................................ 225,500 5,862,086 7,328,750
------------ ------------
$ 27,763,618 $ 38,061,063
------------ ------------
MATERIALS -- 9.5%
Bandag, Incorporated................................ 202,500 $ 9,578,696 $ 9,593,438
Bandag, Incorporated (Class A)...................... 40,500 495,856 1,852,875
Caraustar Industries, Inc........................... 332,700 6,604,018 11,062,275
OM Group, Inc....................................... 174,000 4,173,790 4,698,000
Unifi, Inc.......................................... 283,500 6,618,239 9,107,437
------------ ------------
$ 27,470,599 $ 36,314,025
------------ ------------
CONSUMER NON-DURABLE GOODS -- 7.8%
Lancaster Colony Corporation........................ 284,500 $ 9,913,531 $ 13,087,000
Newell Co........................................... 161,600 3,888,146 5,090,400
Tupperware Corporation.............................. 216,000 8,520,981 11,583,000
------------ ------------
$ 22,322,658 $ 29,760,400
------------ ------------
HEALTH CARE -- 7.7%
Allergan, Inc....................................... 279,800 $ 6,660,424 $ 9,967,875
DENTSPLY International Inc.......................... 146,300 5,204,205 6,949,250
Johnson & Johnson................................... 63,500 1,316,048 3,159,125
Landauer, Inc....................................... 188,100 3,771,405 4,608,450
Pfizer Inc.......................................... 55,400 1,631,502 4,591,275
------------ ------------
$ 18,583,584 $ 29,275,975
------------ ------------
RETAILING -- 4.5%
Arbor Drugs, Inc.................................... 482,400 $ 5,584,890 $ 8,381,700
Bob Evans Farms, Inc................................ 292,600 5,838,256 3,950,100
Circuit City Stores, Inc............................ 161,500 4,885,499 4,865,188
------------ ------------
$ 16,308,645 $ 17,196,988
------------ ------------
INSURANCE -- 4.0%
Horace Mann Educators Corporation................... 174,200 $ 4,187,654 $ 7,033,325
Marsh & McLennan Companies, Inc..................... 28,600 1,461,511 2,974,400
Progressive Corporation, The........................ 77,700 3,012,104 5,235,037
------------ ------------
$ 8,661,269 $ 15,242,762
------------ ------------
CONSUMER DURABLE GOODS -- 3.8%
Cooper Tire & Rubber Company........................ 394,000 $ 9,060,854 $ 7,781,500
Genuine Parts Company............................... 100,000 3,507,115 4,450,000
Juno Lighting, Inc.................................. 133,100 1,914,439 2,129,600
------------ ------------
$ 14,482,408 $ 14,361,100
------------ ------------
</TABLE>
6
<PAGE> 9
PORTFOLIO OF INVESTMENTS
(Continued)
<TABLE>
<CAPTION>
Shares or
Face
COMMON STOCKS (Continued) Amount Cost Value
- ---------------------------------------------------- ---------- ------------ ------------
<S> <C> <C> <C>
BANKING -- 3.0%
Norwest Corporation................................. 122,588 $ 3,491,507 $ 5,332,578
Wells Fargo & Company............................... 23,266 5,809,512 6,276,003
------------ ------------
$ 9,301,019 $ 11,608,581
------------ ------------
ENTERTAINMENT -- 2.6%
Carnival Corporation (Class A)...................... 307,400 $ 6,923,610 $ 10,144,200
------------ ------------
OTHER COMMON STOCKS -- 3.0%......................... $ 9,772,130 $ 11,488,425
------------ ------------
TOTAL COMMON STOCKS -- 73.1%........................ $211,072,894 $279,580,149
------------ ------------
PREFERRED STOCK -- 0.5%
Phoenix Duff & Phelps Corporation (Series A)........ 75,000 $ 1,851,805 $ 1,875,000
------------ ------------
CONVERTIBLE BONDS AND DEBENTURES
REAL ESTATE INVESTMENT TRUST -- 2.1%
Alexander Haagen Properties (Series A) -- 7 1/2%
2001.............................................. $1,050,000 $ 916,125 $ 979,125
Alexander Haagen Properties (Series B) -- 7 1/2%
2001.............................................. 1,750,000 1,526,875 1,618,750
Developers Diversified Realty Corporation -- 7%
1999.............................................. 2,500,000 2,430,625 2,725,000
Rockefeller Center Properties, Inc. -- 0% 2000...... 4,455,000 2,913,030 2,762,100
------------ ------------
$ 7,786,655 $ 8,084,975
------------ ------------
RETAILING -- 1.7%
Fabri-Centers of America, Inc. -- 6 1/4% 2002....... $7,000,000 $ 5,758,119 $ 6,580,000
------------ ------------
PRODUCER DURABLE GOODS -- 1.7%
Diagnostic/Retrieval Systems, Inc.
-- 8 1/2% 1998.................................... $ 719,000 $ 627,328 $ 726,190
-- 9% 2003........................................ 2,000,000 2,000,000 2,880,000
TriMas Corporation -- 5% 2003....................... 2,550,000 2,574,852 2,792,250
------------ ------------
$ 5,202,180 $ 6,398,440
------------ ------------
HEALTH CARE -- 1.1%
Healthsource Inc. -- 5% 2003........................ $5,000,000 $ 4,072,500 $ 4,012,500
------------ ------------
TOTAL CONVERTIBLE BONDS
AND DEBENTURES -- 6.6%............................ $ 22,819,454 $ 25,075,915
------------ ------------
NON-CONVERTIBLE BONDS AND
DEBENTURES
CORPORATE -- 8.4%
Busse Broadcasting Corporation -- 11 5/8% 2000...... $2,350,000 $ 2,275,325 $ 2,397,000
Genesco Inc. -- 10 3/8% 2003........................ 1,150,000 1,127,000 1,184,500
GPA Delaware Inc. -- 8 3/4% 1998.................... 2,000,000 2,012,500 2,015,000
Kidder Peabody Mortgage Assets (CMO) -- 8.45% 2018.. 1,226,500 1,220,380 1,227,267
Merrill Lynch Mortgage Investors, Inc.
Series 1988-H -- 9.7% 2008........................ 78,500 81,509 78,745
Series 1992-B -- 8.3% 2012........................ 1,600,000 1,625,750 1,634,500
Pacific Lumber Company, The -- 10 1/2% 2003......... 1,000,000 967,500 997,500
Plantronics, Inc. -- 10% 2001....................... 8,470,000 8,611,244 8,766,450
Primark Corporation -- 8 3/4% 2000.................. 6,472,000 6,303,974 6,654,025
Tenet Healthcare Corporation -- 9 5/8% 2002......... 2,800,000 2,800,000 3,073,000
Trump Atlantic City Associates -- 11 1/4% 2006...... 4,000,000 3,925,000 3,970,000
------------ ------------
$ 30,950,182 $ 31,997,987
------------ ------------
</TABLE>
7
<PAGE> 10
PORTFOLIO OF INVESTMENTS
(Continued)
<TABLE>
<CAPTION>
NON-CONVERTIBLE BONDS AND Face
DEBENTURES (Continued) Amount Cost Value
- ---------------------------------------------------- ---------- ------------ ------------
<S> <C> <C> <C>
U.S. GOVERNMENT AND AGENCIES -- 4.0%
Federal Home Loan Bank
-- 4 1/4% 1998 (Floating Rate Note)............... $ 1,000,000 $ 1,000,000 $ 985,000
Federal Home Loan Mortgage Corporation
-- 6 1/2% 2023 (IO)............................... 5,527,200 774,439 791,080
-- 7% 2023 (CMO).................................. 2,203,400 2,241,995 2,084,279
-- 8 1/2% 2024 (REMIC)............................ 3,000,000 3,018,750 3,018,750
-- 10.15% 2006 (REMIC)............................ 454,600 450,907 460,283
Federal National Mortgage Association
-- 7% 2008 (REMIC)................................ 1,825,400 1,814,015 1,803,153
-- 8% 2011 (REMIC)................................ 1,050,000 1,055,250 1,053,281
Government National Mortgage Association (Mobile Home)
-- 9 3/4% 2006.................................... 309,700 328,714 328,959
-- 9 3/4% 2010.................................... 1,987,600 2,102,014 2,111,204
-- 10 1/4% 2001-2004.............................. 481,000 511,943 514,369
Government National Mortgage Association
-- 7.99125% 2010 (REMIC).......................... 2,256,400 2,256,452 2,264,862
------------ ------------
$ 15,554,479 $ 15,415,220
------------ ------------
TOTAL NON-CONVERTIBLE BONDS AND
DEBENTURES -- 12.4%............................... $ 46,504,661 $ 47,413,207
------------ ------------
TOTAL INVESTMENT SECURITIES -- 92.6%................ $282,248,814 $353,944,271
============ ------------
SHORT-TERM INVESTMENTS -- 7.0%
Short-term Corporate Notes:
Motorola, Inc. -- 5.22% 1/7/97.................... $ 1,000,000 $ 999,130
Ford Motor Credit Company -- 5.35% 1/8/97......... 1,000,000 998,960
Philip Morris Companies Inc. -- 5.26% 1/9/97...... 2,000,000 1,997,662
Disney (Walt) Company, The -- 5.37% 1/17/97....... 2,900,000 2,893,079
Raytheon Company -- 5.40% 1/24/97................. 10,100,000 10,065,155
Kimberly-Clark Corporation -- 5.40% 2/7/97........ 1,500,000 1,491,675
Hershey Foods Corporation -- 5 1/2% 2/13/97....... 6,500,000 6,457,298
State Street Bank Repurchase Agreement (Dated
12/31/96) -- 4 3/4% 1/2/97
(Collateralized by U.S. Treasury Notes -- 6% 1998,
market value $1,901,701).......................... 1,861,000 1,861,246
------------
$ 26,764,205
------------
TOTAL INVESTMENTS -- 99.6%.......................... $380,708,476
Other assets less liabilities -- 0.4%............... 1,437,951
------------
TOTAL NET ASSETS -- 100%............................ $382,146,427
============
</TABLE>
* Non-income producing securities
See notes to financial statements.
8
<PAGE> 11
STATISTICAL PROFILE
(UNAUDITED)
PRINCIPAL COMMON STOCK HOLDINGS
<TABLE>
<CAPTION>
Fundamental Investment Data
------------------------------------------------------
Earnings/Share Valuation Data
-------------- Past 10 Years --------------------------------------------
Last ------------------ Total Return 1995-96 Price/
12 Growth Yrs. EPS Debt % on Beg. Year-End Price P/E Book Div.
1986 Mos. Rate Declined Capital Equity Price Range Ratio Value Yield
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Allergan $0.54 $ 2.00 14% 2 24% 19% $ 36 $26-42 17.8 x 3.1 x 1.5%
Arbor Drugs 0.19 0.75 14 1 10 18 17 9-19 23.2 3.6 1.4
Arrow Electronics (4.82) 4.10 36* 3 28 19 54 35-60 13.0 2.1 0.0
Bacou USA ** 1.02 ** 0 0 20 17 15-19 16.3 2.8 0.0
Bandag 1.43 3.44 9 2 7 22 47 45-66 13.8 2.7 2.1
Bandag (C1. A) 1.43 3.44 9 2 7 22 46 44-61 13.3 2.6 2.2
Belden ** 2.11 15* 1 30 42 37 20-37 17.5 5.9 0.5
Bob Evans Farms 0.52 0.81 5 2 14 8 14 12-22 16.7 1.4 2.4
Caraustar Industries ** 2.17 15* 3 57 45 33 16-37 15.3 5.4 1.7
Carnival (C1. A) 0.44 1.90 13 0 28 23 33 20-33 17.4 3.3 1.3
Circuit City Stores 0.40 1.52 15 1 48 15 30 21-39 19.8 2.6 0.5
Cooper Tire & Rubber 0.29 1.31 17 2 14 15 20 18-30 15.1 2.1 1.7
DENTSPLY International ** 2.51 ** 0 23 21 48 31-49 18.9 3.7 0.8
Devon Group 1.19 2.93 10 3 1 20 28 22-46 9.4 1.6 0.0
Donaldson 0.49 1.73 13 1 10 21 34 23-34 19.4 3.8 1.1
Dover 0.61 2.97 17 1 28 28 50 26-55 16.9 4.0 1.4
Expeditors International 0.18 0.86 17 1 11 19 23 10-23 26.7 4.4 0.3
Federal Signal 0.25 1.30 18 1 50 24 26 20-28 19.9 4.3 2.6
Franklin Quest ** 1.71 15* 1 2 17 21 17-36 12.3 2.0 0.0
Genuine Parts 1.01 2.68 11 0 3 20 45 36-48 16.6 3.2 3.0
Holophane ** 1.24 ** 0 24 30 19 11-24 15.3 3.6 0.0
Horace Mann Educators ** 3.11 15* 1 24 15 40 20-41 13.0 2.0 1.1
Hubbell (C1. B) 0.83 2.10 10 0 14 21 43 25-44 20.6 4.0 2.4
IDEX ** 1.69 17* 1 59 33 40 28-44 15.8 6.1 1.8
Johnson & Johnson 0.23 2.18 25 0 17 31 50 27-54 22.8 6.2 1.5
Juno Lighting 0.41 1.08 10 2 4 14 16 13-21 14.8 2.0 2.0
Kaydon 0.60 3.05 18 1 3 27 47 23-50 15.5 3.3 1.2
Lancaster Colony 0.32 2.77 23 0 9 27 46 29-46 16.6 4.1 1.6
Landauer ** 1.32 11 0 0 47 25 16-25 18.6 8.4 4.9
Leggett & Platt 0.48 1.78 15 3 34 21 35 17-35 19.5 3.8 1.4
Manpower ** 1.76 ** 0 15 45 33 24-43 18.5 4.8 0.5
Marsh & McLennan 3.30 6.30 7 0 33 28 104 76-115 16.5 4.3 3.5
Newell 0.27 1.62 20 0 39 20 32 20-34 19.4 3.5 1.8
Norwest 0.61 3.10 18 1 76 22 44 23-47 14.0 2.7 2.8
OM Group ** 1.56 ** 0 38 19 27 15-29 17.3 2.8 1.1
Pfizer 0.98 2.99 12 1 36 34 83 37-91 27.7 8.1 1.6
Progressive 0.77 4.08 18 3 33 20 67 35-72 16.5 2.9 0.4
Tupperware ** 2.79 ** 0 45 76 54 38-56 19.5 11.1 1.6
Unifi 0.29 1.54 17 2 28 18 32 21-33 20.9 3.7 1.4
Wells Fargo 5.03 20.06 15 3 30 23 270 141-293 13.4 1.7 1.9
- ---------------------------------------------------------------------------------------------------------------------------------
Source Portfolio 14 1 23 23 16.7 3.3 1.4
Dow Jones Industrials 8 2 45 21 6448.27 18.9 4.8 2.1
S&P Industrials 9 3 54 19 869.97 21.2 5.3 1.8
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* 5 to 9-year growth rate
** Comparable data not available
9
<PAGE> 12
MAJOR PORTFOLIO CHANGES
(UNAUDITED)
Quarter Ended December 31, 1996
<TABLE>
<CAPTION>
Shares
-------
<S> <C>
NET PURCHASES
Common Stocks
Allergan, Inc. ........................................................................... 95,000
Bacou USA, Inc. .......................................................................... 169,500
Bandag, Incorporated...................................................................... 155,900
Belden Inc. .............................................................................. 8,300
Caraustar Industries, Inc. ............................................................... 16,200
Circuit City Stores, Inc. ................................................................ 111,700
Cooper Tire & Rubber Company.............................................................. 33,800
Holophane Corporation..................................................................... 13,000
Kaydon Corporation........................................................................ 7,000
Lancaster Colony Corporation.............................................................. 26,800
Manpower Inc. ............................................................................ 24,300
OM Group, Inc. ........................................................................... 52,350
NET SALES
Common Stocks
Bandag, Incorporated (Class A)............................................................ 155,900
Expeditors International of Washington, Inc. ............................................. 54,000
Hubbell Incorporated (Class B)............................................................ 35,000
Loctite Corporation(1).................................................................... 56,700
Marsh & McLennan Companies, Inc. ......................................................... 38,500
Norwest Corporation....................................................................... 39,500
Pfizer Inc................................................................................ 9,100
</TABLE>
(1) Indicates elimination from portfolio
10
<PAGE> 13
FEDERAL INCOME TAX INFORMATION
(UNAUDITED)
CALENDAR 1996
CASH DIVIDENDS AND DISTRIBUTIONS:
<TABLE>
<CAPTION>
(1) (2)
AMOUNT ORDINARY LONG-TERM
PAID INCOME CAPITAL GAIN
DATE PAID PER SHARE DIVIDENDS DISTRIBUTIONS
--------------------------- --------------- --------------- ---------------
<S> <C> <C> <C>
PREFERRED STOCK:
03/15/96 $ 0.60 $0.60 --
06/15/96 0.60 0.60 --
09/15/96 0.60 0.60 --
12/15/96 0.60 0.60 --
------- --------------- ---------------
TOTAL $ 2.40 $2.40 --
=============== =============== ===============
COMMON STOCK:
03/15/96 $ 0.925 $0.27930 $0.64570
06/15/96 0.925 0.08099 0.84401
09/15/96 0.925 0.08099 0.84401
12/15/96 0.925 0.08099 0.84401
12/15/96 (special year-end) 2.430 -- 2.43000
------- --------------- ---------------
TOTAL $ 6.130 $0.52227 $5.60773
=============== =============== ===============
</TABLE>
The amount in column (1) is to be included as dividend income on your tax
return. For corporate shareholders, 29.2% of the amount in column (1) qualifies
for the 70% corporate dividends received deduction.
The amounts in column (2) are long-term capital gain distributions and are
taxable to shareholders as such.
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 1996 tax
returns. Source Capital had no undistributed long-term capital gains at
year-end. Therefore, Common shareholders will not receive a Form 2439 for 1996.
- --------------------------------------------------------------------------------
NOTICE TO DIVIDEND REINVESTMENT PLAN PARTICIPANTS:
The information above shows the cash distributions paid by Source Capital
during 1996. 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.
Only the distributions paid on December 15, 1996 were reinvested at a
discount from the market price and the additional taxable amount of these
distributions is equivalent to $0.08719 per Common share received.
11
<PAGE> 14
STATEMENT OF ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
December 31, 1996
-----------------------------
<S> <C> <C>
ASSETS
Investments at value:
Investment securities -- at market value (cost $282,248,814) --
Note A............................................................. $353,944,271
Short-term corporate notes -- at cost plus interest earned
(maturities 60 days or less) -- Note A............................. 26,764,205 $380,708,476
------------
Cash................................................................... 294
Receivable for:
Investment securities sold.......................................... $ 286,697
Dividends and accrued interest...................................... 1,934,258 2,220,955
------------ ------------
$382,929,725
LIABILITIES
Payable for:
Investment securities purchased..................................... $ 292,188
Advisory fees....................................................... 221,326
Accrued dividends -- Preferred Stock................................ 196,921
Accrued expenses.................................................... 72,863 783,298
------------ ------------
TOTAL NET ASSETS -- December 31, 1996.................................... $382,146,427
===========
Assets applicable to Preferred Stock at a liquidation preference of
$27.50 per share (asset coverage 706%) -- Note B.................... $ 54,153,330
===========
Net assets applicable to Common Stock -- $45.35 per share.............. $327,993,097
===========
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 7,232,110 shares -- Note B.............................. 7,232,110
Additional Paid-in Capital............................................. 289,626,915
Undistributed net investment income.................................... 3,321,891
Undistributed net realized gain on investments......................... 4,362,418
Unrealized appreciation of investments................................. 71,695,457
------------
TOTAL NET ASSETS -- December 31, 1996.................................... $382,146,427
===========
</TABLE>
See notes to financial statements.
12
<PAGE> 15
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the year ended December 31,
-------------------------------------------------------------
1996 1995
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
INVESTMENT INCOME
Income:
Interest................................ $ 8,241,608 $ 8,531,983
Dividends............................... 4,519,900 5,279,736
----------- -----------
$12,761,508 $13,811,719
Expenses -- Note C:
Advisory fees........................... $ 2,602,494 $ 2,437,373
Transfer agent fees and expenses........ 245,734 231,315
Reports to shareholders................. 161,717 207,144
Directors' fees and expenses............ 81,846 75,313
Custodian fees and expenses............. 50,981 52,961
Taxes, other than federal income tax.... 65,820 65,800
Legal and auditing fees................. 52,228 49,473
Registration and filing fees............ 20,408 21,699
Other expenses.......................... 31,175 3,312,403 43,633 3,184,711
------------ ----------- ------------ -----------
Net investment income -- Note A.... $ 9,449,105 $10,627,008
----------- -----------
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)......................... $180,179,950 $175,825,101
Cost of investment securities sold...... 135,203,285 153,390,056
------------ ------------
Net realized gain on investments
-- Notes A and D...................... $44,976,665 $22,435,045
Unrealized appreciation of investments:
Unrealized appreciation at beginning of
year.................................. $ 57,002,661 $ 30,355,493
Unrealized appreciation at end of
year.................................. 71,695,457 57,002,661
------------ ------------
Increase in unrealized
appreciation of investments........ 14,692,796 26,647,168
----------- -----------
Net realized and unrealized gain
on investments................... $59,669,461 $49,082,213
----------- -----------
NET INCREASE IN TOTAL NET
ASSETS RESULTING FROM
OPERATIONS................................. $69,118,566 $59,709,221
========== ==========
</TABLE>
See notes to financial statements.
13
<PAGE> 16
STATEMENT OF CHANGES IN TOTAL NET ASSETS
<TABLE>
<CAPTION>
For the year ended December 31,
---------------------------------------------------------------
1996 1995
----------------------------- -----------------------------
<S> <C> <C> <C> <C>
INCREASE IN TOTAL NET ASSETS
Operations:
Net investment income.................... $ 9,449,105 $ 10,627,008
Net realized gain on investments -- Notes
A and D............................... 44,976,665 22,435,045
Increase in unrealized appreciation of
investments........................... 14,692,796 26,647,168
------------- -------------
Increase in total net assets resulting from
operations............................... $ 69,118,566 $ 59,709,221
Distributions to Preferred shareholders:
From net investment income............... (4,726,109) (4,726,109)
Distributions to Common shareholders:
From net investment income............... $ (3,718,587) $ (3,583,417)
From net realized capital gains.......... (40,614,247) (44,332,834) (22,298,081) (25,881,498)
------------- -------------
Proceeds from shares issued for
distributions reinvested by Common
shareholders -- Note B................... -- 3,558,442
------------- -------------
Increase in total net assets............... $ 20,059,623 $ 32,660,056
TOTAL NET ASSETS
Beginning of year, including undistributed
net investment income of $2,317,482 at
January 1, 1996.......................... 362,086,804 329,426,748
------------- -------------
End of year, including undistributed net
investment income of $3,321,891 and
$2,317,482 at December 31, 1996 and
1995..................................... $382,146,427 $362,086,804
============= =============
</TABLE>
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.
<TABLE>
<CAPTION>
Source of Distributions
---------------------------
Amount Net Net Realized
Paid Investment Capital
Date Paid Per Share Income Gains
- --------- --------- ---------- ------------
<S> <C> <C> <C>
3/15/96 $0.925 $0.482 $0.443
6/15/96 0.925 0.032 0.893
9/15/96 0.925 -- 0.925
12/15/96 0.925 -- 0.925
12/15/96 (special) 2.430 -- 2.430
------ ------ ------
$6.130 $0.514 $5.616
====== ====== ======
</TABLE>
The source of distributions for financial reporting purposes differs from
federal income tax reporting. See page 11 for federal income tax information.
14
<PAGE> 17
FINANCIAL HIGHLIGHTS
Selected data for a share of Common Stock outstanding throughout each year
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Per share operating performance:
Net asset value at beginning of year................ $42.58 $38.52 $41.85 $42.87 $41.23
--------- --------- --------- --------- ---------
Net investment income............................... $ 1.30 $ 1.48 $ 1.62 $ 1.94 $ 1.98
Net realized and unrealized gain
(loss) on investment securities................... 8.25 6.84 (0.67) 1.32 3.96
--------- --------- --------- --------- ---------
Total from investment operations.................... $ 9.55 $ 8.32 $ 0.95 $ 3.26 $ 5.94
--------- --------- --------- --------- ---------
Distributions to Preferred Shareholders:
From net investment income........................ $(0.65) $(0.66) $(0.69) $(0.72) $(0.73)
Distributions to Common Shareholders:
From net investment income........................ (0.51) (0.50) (1.14) (1.39) (1.02)
From net realized gains........................... (5.62) (3.10) (2.03) (2.21) (2.58)
In excess of net realized gains................... -- -- (0.02) -- --
From Additional Paid-in Capital................... -- -- (0.41) -- --
--------- --------- --------- --------- ---------
Total distributions.......................... $(6.78) $(4.26) $(4.29) $(4.32) $(4.33)
--------- --------- --------- --------- ---------
Effect of shares issued for distributions
reinvested by Common shareholders................. -- -- $ 0.01 $ 0.04 $ 0.03
--------- --------- --------- --------- ---------
Net asset value at end of year...................... $45.35 $42.58 $38.52 $41.85 $42.87
======== ======== ======== ======== ========
Per share market value at end of year............... $45.50 $41.88 $37.00 $43.25 $47.75
Total investment return(1).......................... 24.5% 23.4% (6.5%) (1.8%) 17.0%
Net asset value total return(2)..................... 21.9% 20.7% 0.6% 6.3% 13.3%
Ratios/supplemental data:
Net assets at end of year (in thousands).......... $ 382,146 $ 362,087 $ 329,427 $ 330,465 $ 332,574
Ratio of expenses to average net assets........... 0.89% 0.91% 0.96% 0.95% 0.94%
Ratio of net income to average net assets......... 2.52% 3.04% 3.36% 3.86% 3.93%
Portfolio turnover rate........................... 41.04% 51.44% 71.39% 73.91% 69.01%
Average brokerage commission per share............ $0.0589 -- -- -- --
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)....................... $194.06 $183.87 $167.29 $167.82 $168.89
Involuntary liquidation preference per share...... $ 27.50 $ 27.50 $ 27.50 $ 27.50 $ 27.50
Average market value per share(4)................. $ 28.50 $ 28.00 $ 27.89 $ 30.24 $ 29.21
</TABLE>
(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.
- --------------------------------------------------------------------------------
QUARTERLY RESULTS OF INVESTMENT OPERATIONS (unaudited)
<TABLE>
<CAPTION>
Quarter ended
-----------------------------------------------------------------------------
March 31, 1996 June 30, 1996 September 30, 1996 December 31, 1996
-------------- ------------- ------------------ -----------------
<S> <C> <C> <C> <C>
Total investment income................. $ 3,158,438 $ 3,129,307 $ 3,256,062 $ 3,217,701
Net investment income................... $ 2,350,412 $ 2,203,094 $ 2,470,569 $ 2,425,030
Income available to Common.............. $ 1,168,885 $ 1,021,567 $ 1,289,042 $ 1,243,502
Per share Common...................... $0.16 $0.14 $0.18 $0.17
Net realized and unrealized
appreciation.......................... $ 15,225,474 $ 10,043,278 $ 6,680,604 $27,720,105
Per share Common...................... $2.11 $1.39 $0.92 $3.83
</TABLE>
<TABLE>
<CAPTION>
Quarter ended
-----------------------------------------------------------------------------
March 31, 1995 June 30, 1995 September 30, 1995 December 31, 1995
-------------- ------------- ------------------ -----------------
<S> <C> <C> <C> <C>
Total investment income................. $ 3,393,865 $ 3,630,924 $ 3,137,318 $ 3,649,612
Net investment income................... $ 2,625,601 $ 2,777,124 $ 2,371,074 $ 2,853,209
Income available to Common.............. $ 1,444,074 $ 1,595,597 $ 1,189,546 $ 1,671,682
Per share Common...................... $0.20 $0.22 $0.17 $0.23
Net realized and unrealized
appreciation.......................... $ 16,681,675 $ 11,555,740 $ 13,599,125 $ 7,245,673
Per share Common...................... $2.34 $1.61 $1.89 $1.00
</TABLE>
15
<PAGE> 18
NOTES TO FINANCIAL STATEMENTS
NOTE A--SIGNIFICANT ACCOUNTING POLICIES
The Company is registered under the Investment Company Act of 1940 as a
diversified, closed-end management investment company. The investment objective
of the Company is to seek maximum total return for Common shareholders from both
capital appreciation and investment income to the extent consistent with
protection of invested capital and provision of sufficient income to meet the
dividend requirements of Preferred shareholders. The significant accounting
policies followed by the Company in the preparation of its financial statements
include the following:
1. SECURITIES VALUATION--Securities, including any outstanding call
options, listed or traded on a national securities exchange or on the NASDAQ
National Market System are valued at the last sale price on the last business
day of the year, or, if there was not a sale that day, at the mean between the
most recent bid and asked prices. Securities which are unlisted are valued at
the mean between the most recent bid and asked prices. 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, and intends to
maintain this qualification and to distribute each year all of its taxable net
investment income and taxable net realized gain on investments to its
shareholders in accordance with the minimum distribution requirements of the
Code.
3. 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.
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 year ended December 31, 1995, the Company issued 86,640 shares
of Common Stock 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 .725% for the first $100 million of total net
assets, .700% for the next $100 million of total net assets, and .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, 1996 and 1995, the Company paid aggregate
fees of $81,250 and $75,000 respectively, to all Directors who are not
affiliated persons of the Investment Adviser. During the years ended December
31, 1996 and 1995, the Company incurred legal fees of $15,984 and $14,373,
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 AND SALES OF SECURITIES
Cost of purchases of investment securities (excluding short-term corporate
notes with maturities of 60 days or less) aggregated $136,691,674 and
$161,525,237 for the years ended December 31, 1996 and 1995, respectively.
Realized gains and losses are based on the specific-certificate identification
method. Cost of investment securities owned at December 31, 1996 was
$282,659,175 for federal income tax purposes. Gross unrealized appreciation and
depreciation for all securities at December 31, 1996 for federal income tax
purposes was $74,898,855 and $3,613,759, respectively.
NOTE E--QUARTERLY INFORMATION
See page 15 for unaudited quarterly results of investment operations.
16
<PAGE> 19
REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND
SHAREHOLDERS OF SOURCE CAPITAL, INC.
We have audited the accompanying statement of assets and liabilities of
Source Capital, Inc., including the portfolio of investments, as of December 31,
1996, and the related statements of operations and changes in total net assets
for each of the two years in the period then ended, and the financial
highlights, as it relates to selected data for a share of Common Stock, for each
of the five 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.
We conducted our audits in accordance with generally accepted auditing
standards. 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, 1996, 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. at December 31, 1996, the results of its operations and the
changes in its total net assets for each of the two years in the period then
ended, and the financial highlights for each of the five years in the period
then ended in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Los Angeles, California
February 7, 1997
- --------------------------------------------------------------------------------
RESULTS OF ANNUAL MEETING
Following is a list of matters voted upon and the results of those votes
cast at the annual meeting of shareholders held April 29, 1996:
1. With respect to the election of five directors by the holders of Common
Stock, $1.00 par value, and election of two directors by the holders of
$2.40 Cumulative Preferred Stock, $3.00 par value:
<TABLE>
<CAPTION>
VOTES FOR VOTES WITHHELD
---------- --------------
<S> <C> <C>
COMMON
Wesley E. Bellwood...................................... 4,730,162 83,092
Julio J. de Puzo, Jr.................................... 4,702,253 83,092
David Rees.............................................. 4,732,099 83,092
Robert L. Rodriguez..................................... 4,692,392 83,092
Lawrence J. Sheehan..................................... 4,728,909 83,092
PREFERRED
Charles W. Stanton...................................... 1,574,991 28,594
Kenneth L. Trefftzs..................................... 1,579,207 28,594
</TABLE>
2. With respect to continuation of the Investment Advisory Agreement, a
total of 6,122,726 shares voted for, 109,305 shares voted against and
173,915 shares abstained.
3. With respect to the selection of Ernst & Young LLP as independent
auditors for the Company for the fiscal year, a total of 6,235,744
shares voted for, 62,330 shares voted against and 107,874 shares
abstained.
No broker non-votes were received with respect to any of the matters voted
upon above.
<PAGE> 20
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SOURCE CAPITAL, INC.
BULK RATE
11400 West Olympic Boulevard, Suite 1200
U.S. POSTAGE
Los Angeles, California 90064
PAID
CMSS
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