<PAGE>
[LOGO]
SOURCE CAPITAL, INC.
SEMI-ANNUAL REPORT
for the six months ended June 30, 1997
<PAGE>
SUMMARY FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Six months ended Year ended
June 30, 1997 December 31, 1996
--------------------------- ---------------------------
Total Total
Net Per Common Net Per Common
Assets Share Assets Share
-------------- ----------- -------------- -----------
<S> <C> <C> <C> <C>
Beginning of period.................................................... $ 382,146,427 $ 45.35 $ 362,086,804 $ 42.58
Net gain on investments, realized and unrealized....................... 39,871,839 5.46 59,669,461 8.25
Income available to Common shareholders................................ 1,580,911 0.22 4,722,996 0.65
Regular distributions to Common shareholders........................... (13,504,003) (1.85) (44,332,834) (6.13)
Proceeds from shares issued for distributions reinvested
by shareholders...................................................... 3,363,744 -- -- --
-------------- ----------- -------------- -----------
Net changes during period.......................................... $ 31,312,491 $ 3.83 $ 20,059,623 $ 2.77
-------------- ----------- -------------- -----------
End of period.......................................................... $ 413,458,918 $ 49.18 $ 382,146,427 $ 45.35
-------------- ----------- -------------- -----------
-------------- ----------- -------------- -----------
</TABLE>
<TABLE>
<CAPTION>
June 30, 1997 December 31, 1996 December 31, 1995
------------- ----------------- -----------------
<S> <C> <C> <C>
Common market price per share........................................... 47 45 1/2 41 7/8
Common market premium (discount) to net asset value..................... (4.4)% 0.3% (1.7)%
Preferred asset coverage................................................ 763% 706% 669%
Preferred liquidation preference per share.............................. $ 27.50 $ 27.50 $ 27.50
Preferred market price per share........................................ 28 1/2 28 5/8 28 1/2
</TABLE>
- --------------------------------------------------------------------------------
DESCRIPTION OF THE COMPANY
SOURCE CAPITAL, INC. is a major diversified, publicly traded investment
company with total net assets of approximately $413,000,000. Its investment
portfolio includes a wide range of securities with primary emphasis on common
stocks 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 7,306,292
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 17 subsequent increases to the current rate of $4.00
(effective for the distribution payable September 15, 1997). Maintenance of the
current $4.00 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 $40.00.
1
<PAGE>
LETTER TO SHAREHOLDERS
TO OUR SHAREHOLDERS:
Source Capital's total net assets increased from $375,667,984 to $413,458,918
during the second quarter. Net asset value per Common share amounted to $49.18
at June 30, 1997 compared with $44.01 at March 31, 1997 and $45.35 at year-end
1996. These changes in net asset value were net of cash distributions of $0.925
paid in both the first and second quarters.
INVESTMENT RESULTS, 1997 FIRST HALF
For the six months ended June 30, 1997 the net asset value per share of Source
Capital's Common Stock increased by 12.9%, including distributions paid during
the period, while total net assets gained 11.7%. These returns compare with a
11.3% increase in the Russell 2500 Index. The foregoing changes were calculated
on the basis of reinvesting all dividends and distributions.
INVESTMENT RESULTS, 1997 SECOND QUARTER
In the most recent quarter, Source Capital's net asset value per share of
Common Stock increased 14.0%, including the $0.925 distribution paid during the
period, while total net assets gained 12.3%, both on a reinvestment basis. In
comparison, the Russell 2500 Index increased 15.1% during the quarter, also on a
reinvestment basis.
NET INVESTMENT INCOME
Net investment income amounted to $1,967,579 and $3,943,965 for the second
quarter and six months, respectively, as against $2,203,094 and $4,553,506 in
the comparable periods of 1996. After providing for Preferred dividends, net
investment income per Common share was $0.11 and $0.22 for the quarter and
six-month periods, respectively, compared to the $0.14 and $0.30 earned in the
corresponding periods of 1996.
DISTRIBUTIONS TO COMMON SHAREHOLDERS
A regular quarterly distribution of $0.925 per share was paid on June 15, 1997
to shareholders of record on May 23, 1997. This payment marks the 20th
anniversary of Source Capital's 10% Distribution Policy which calls for total
annual payments approximating 10% of the Common Stock's ongoing net asset value.
Since the adoption of this policy, continuing growth in net asset value has led
to 17 increases in the distribution rate totaling 186%. The most recent increase
in the distribution rate was approved by the Board of Directors on August 4,
1997, raising the annualized rate to $4.00 for the distribution payable
September 15, 1997 -- the original rate adopted in June 1976 was $1.40. The
growth in the net asset value which has permitted this continuing expansion in
cash distributions has been achieved despite distributions in excess of net
investment income of $282,927,972 or $44.06 per Common share, and payments of
federal income tax on undistributed realized capital gains amounting to
$36,198,677 or $5.99 per Common share. Maintenance of the current $4.00 rate is
dependent upon achieving long-term investment results which sustain a net asset
value of approximately $40.00.
PREFERRED DIVIDENDS
The regular Preferred dividend of $0.60 per share was paid on June 15, 1997,
to shareholders of record on May 23, 1997. The changes in the Company's total
net assets since year-end 1996 have resulted in changes in the Preferred shares'
asset coverage from 706% at December 31, 1996 to 694% at March 31, 1997, and
763% at June 30, 1997. The decrease in net investment income led to a decline in
Preferred dividend coverage to 167% for both the second quarter and the six
months, compared to 186% and 193% in the corresponding periods of 1996.
MARKET PRICE OF SOURCE CAPITAL SHARES
The market price of Source Capital Common Stock increased from $45 1/2 to $47
during the first half of 1997. As this $1.50 increase in market price was less
than the $3.83 gain in the underlying net asset value, the market premium to net
asset value of 0.3% at year-end 1996 decreased to a discount of 4.4% at June 30,
1997. The market price of Source Capital Preferred Stock decreased to $28 1/2 at
June 30, 1997 from $28 5/8 at year-end 1996.
COMMENTARY
We have noted for some time that the stock market's gains have been led by the
biggest of the big stocks, and this has continued in 1997. The S&P 500 Index as
a whole is up 20.5% year-to-date, while the 50 largest S&P stocks (comprising
about half of the Index's market cap) are up 26.2%. In contrast, the remaining
450 are ahead "only" 15.8%. Over the past twelve months, the difference is even
greater -- a gain of 46% for the top 50 vs. 26% for the rest.
Although the market's valuation level continues to be rich by historical
standards, we can take some comfort in the quality and relative valuations of
the companies in the Source Capital portfolio, compared to the market as a
whole. We continue to attain our objective of owning better companies at lower
valuations. As shown in the table below, the companies Source Capital owns have
achieved faster growth, earned higher returns, and possess superior balance
sheets, yet are priced at lower PE
2
<PAGE>
ratios, compared to the average S&P 500 Index company.
<TABLE>
<CAPTION>
S&P 500
Source* Index*
----------- -----------
<S> <C> <C>
EPS Growth Rate (10Yr.) 17% 11%
Return on Assets 11% 6%
Debt % Capital 24% 54%
PE Ratio 17x 23x
</TABLE>
* Industrial companies only (i.e. excludes banks and insurance)
ARBOR DRUGS, owned by Source Capital since 1995, is a good example of the high
quality companies we strive to own, but also of the increasingly high valuations
which many of our stocks have reached.
Arbor was founded in 1963 by twenty-six year old Eugene Applebaum, who remains
the CEO, with a single store in Dearborn, Michigan. It grew slowly but steadily,
and when it first sold shares to the public in 1986, it had about fifty stores.
Unit growth since then has been at a 13% rate and Arbor now has 200 stores, all
in southeastern Michigan.
Arbor's store growth has resulted in a remarkable increase in its market share
in the Detroit Metropolitan area, from 3% fifteen years ago, to 10-12% at the
time of the initial public offering, to 45% today. Much of this growth came from
the declining role of independent drug stores, but of the drug chains operating
in this market, only Arbor gained share. The number two Detroit chain, Perry
Drugs (now owned by Rite Aid), only held its share constant over the past ten
years, at about 25%, while Arbor's share was quadrupling.
Arbor's rapid sales and unit growth has been achieved in the "right way," --
not just by opening new stores, but by opening profitable ones. About half of
sales growth has come from new units and half from growth in stores already open
for over a year, an impressive achievement. Arbor's growth has been largely
self-funded -- it has raised no new capital since 1991, and balance sheet
leverage has steadily decreased. In fact, cash balances of $40 million exceed
Arbor's $15 million of debt. Return on equity has held steady in the 16-19%
range. Ten year growth in EPS is 14% per year.
Arbor plans to continue to grow its store base, opening about 100 new stores in
the next 4-5 years. It is finding opportunities in other Michigan cities,
notably Flint, as well as in the under-stored city of Detroit -- most of Arbor's
stores are in the suburbs. Arbor also recently expanded its distribution
facility -- its warehouse can now support 400 stores, twice their existing store
base.
Arbor has achieved its high returns by understanding its customers' need for
convenience, courteous and professional service, excellent assortment in clean
and orderly stores, and fair prices. Its state-of-the-art stores achieve
industry leading sales per square foot of $550, and total sales per store of
$4.7 million, while earning the highest operating margins in the business.
There are a few competitive challenges to Arbor which have appeared in recent
years, but we do not believe they currently represent a serious threat to its
future success. As mentioned earlier, Rite Aid purchased Arbor's chief
competitor Perry Drugs in early 1995. Perry was not a well-run chain and Rite
Aid has clearly improved its operations, though any adverse effect on Arbor's
market share or profitability is hard to detect. In addition, in May 1996
Walgreen announced that it planned to enter the Detroit market, and has recently
opened its first few units. Although the entry of these two large and well
capitalized companies will make prime real estate more difficult to obtain,
there is no reason to expect a serious threat to Arbor's market dominance or
profitability. Arbor has the most stores, the best locations, the leading name
in the market, and store level execution as good as anybody in the industry. Its
buying power, compact market area, and great balance sheet give it a highly
competitive cost structure.
Although we are very pleased with Arbor's superior operating performance,
excellent earnings growth and high returns, its increasingly high valuation has
made it difficult to hold, and we have been net sellers over the past year,
though Source Capital continues to own a substantial position. At its June 30,
1997 price of 20 1/8, Arbor was priced at 24.5x trailing 12-month earnings, a
bit higher than the S&P Industrials and "cheap" only if compared to Walgreen,
which, with returns on capital, balance sheet and growth record similar to
Arbor's, was valued at 32x earnings.
Today's fully-priced stock market is not providing many opportunities to buy
companies of Arbor's quality at reasonable prices. As a result, we find
ourselves in a dilemma -- we hold a portfolio of high quality companies, many of
which, like Arbor, are fully priced, yet we are reluctant to reduce positions
further in the absence of replacement ideas. We are confident that this
situation will not continue indefinitely, but until it ends, our position is an
uncomfortable one.
Respectfully submitted,
/s/ ERIC S. ENDE
Eric S. Ende
Senior Vice President and
Chief Investment Officer
August 5, 1997
3
<PAGE>
PORTFOLIO OF INVESTMENTS
June 30, 1997
<TABLE>
<CAPTION>
COMMON STOCKS Shares Cost Value
- ------------------------------------------------------------------------ ----------- -------------- --------------
<S> <C> <C> <C>
PRODUCER DURABLE GOODS -- 17.0%
Donaldson Company, Inc.................................................. 211,200 $ 5,373,037 $ 8,025,600
Federal Signal Corporation.............................................. 178,200 3,948,396 4,477,275
Graco Inc............................................................... 282,000 5,687,177 8,495,250
Holophane Corporation*.................................................. 526,900 9,158,601 10,538,000
IDEX Corporation........................................................ 405,800 9,661,455 13,391,400
Kaydon Corporation...................................................... 213,400 5,736,940 10,589,975
Leggett & Platt, Incorporated........................................... 164,000 3,820,358 7,052,000
TriMas Corporation...................................................... 265,810 6,087,667 7,475,906
-------------- --------------
$ 49,473,631 $ 70,045,406
-------------- --------------
MATERIALS -- 10.3%
Bandag, Incorporated.................................................... 192,000 $ 8,983,060 $ 9,408,000
Caraustar Industries, Inc............................................... 437,500 9,448,417 15,148,438
Nucor Corporation....................................................... 104,500 4,968,043 5,904,250
OM Group, Inc........................................................... 229,800 5,666,441 7,612,125
Unifi, Inc.............................................................. 116,100 2,599,542 4,339,237
-------------- --------------
$ 31,665,503 $ 42,412,050
-------------- --------------
BUSINESS SERVICES & SUPPLIES -- 9.9%
Arrow Electronics, Inc.*................................................ 119,000 $ 5,197,313 $ 6,321,875
Bacou USA, Inc.*........................................................ 276,500 4,547,156 4,493,125
Devon Group, Inc.*...................................................... 195,300 3,007,100 6,981,975
Expeditors International of Washington, Inc............................. 199,500 1,280,824 5,660,813
Franklin Covey Co.*..................................................... 295,700 6,213,005 7,484,906
Kennametal Inc.......................................................... 70,000 2,436,097 3,010,000
Manpower Inc............................................................ 158,100 4,013,866 7,035,450
-------------- --------------
$ 26,695,361 $ 40,988,144
-------------- --------------
RETAILING -- 7.8%
Arbor Drugs, Inc........................................................ 378,900 $ 4,228,560 $ 7,625,363
Bob Evans Farms, Inc.................................................... 292,600 5,838,256 4,955,912
Circuit City Stores, Inc................................................ 163,900 4,946,815 5,828,694
O'Reilly Automotive, Inc.*.............................................. 112,200 3,617,213 4,319,700
Toys "R" Us, Inc.*...................................................... 183,200 4,730,405 6,412,000
Viking Office Products, Inc.*........................................... 163,300 2,298,852 3,102,700
-------------- --------------
$ 25,660,101 $ 32,244,369
-------------- --------------
CONSUMER NON-DURABLE GOODS -- 6.8%
Lancaster Colony Corporation............................................ 260,300 $ 9,018,751 $ 12,592,013
Newell Co............................................................... 141,600 3,402,026 5,610,900
Tupperware Corporation.................................................. 275,000 10,903,667 10,037,500
-------------- --------------
$ 23,324,444 $ 28,240,413
-------------- --------------
HEALTH CARE -- 5.2%
Allergan, Inc........................................................... 306,100 $ 7,457,577 $ 9,737,806
DENTSPLY International Inc.............................................. 143,500 5,130,667 7,031,500
Landauer, Inc........................................................... 199,600 4,005,745 4,628,225
-------------- --------------
$ 16,593,989 $ 21,397,531
-------------- --------------
TECHNOLOGY -- 4.0%
Belden Inc.............................................................. 216,200 $ 6,054,629 $ 7,364,312
Methode Electronics, Inc. (Class A)..................................... 468,000 7,289,635 9,301,500
-------------- --------------
$ 13,344,264 $ 16,665,812
-------------- --------------
INSURANCE -- 4.0%
Horace Mann Educators Corporation....................................... 80,400 $ 1,873,489 $ 3,939,600
Poe & Brown, Inc........................................................ 182,900 4,560,785 6,767,300
Progressive Corporation, The............................................ 67,900 2,631,524 5,907,300
-------------- --------------
$ 9,065,798 $ 16,614,200
-------------- --------------
</TABLE>
4
<PAGE>
PORTFOLIO OF INVESTMENTS
CONTINUED
<TABLE>
<CAPTION>
Shares or
Face
COMMON STOCKS (CONTINUED) Amount Cost Value
- ------------------------------------------------------------------------ ----------- -------------- --------------
<S> <C> <C> <C>
ENTERTAINMENT -- 2.8%
Carnival Corporation (Class A).......................................... 284,400 $ 6,350,631 $ 11,731,500
-------------- --------------
CONSUMER DURABLE GOODS -- 2.7%
Cooper Tire & Rubber Company............................................ 388,000 $ 8,907,338 $ 8,536,000
Juno Lighting, Inc...................................................... 158,100 2,283,189 2,569,125
-------------- --------------
$ 11,190,527 $ 11,105,125
-------------- --------------
BANKING -- 2.6%
Norwest Corporation..................................................... 90,088 $ 2,547,439 $ 5,067,450
Wells Fargo & Company................................................... 20,366 5,085,383 5,488,637
-------------- --------------
$ 7,632,822 $ 10,556,087
-------------- --------------
TOTAL COMMON STOCKS -- 73.1%............................................ $ 220,997,071 $ 302,000,637
-------------- --------------
CONVERTIBLE PREFERRED STOCKS
REAL ESTATE INVESTMENT TRUST -- 1.3%
Excel Realty Trust, Inc................................................. 200,000 $ 5,000,000 $ 5,450,000
-------------- --------------
FINANCIAL SERVICES -- 0.5%
Phoenix Duff & Phelps Corporation (Series A)............................ 75,000 $ 1,851,805 $ 2,053,125
-------------- --------------
CONVERTIBLE BONDS AND DEBENTURES
REAL ESTATE INVESTMENT TRUST -- 2.1%
Alexander Haagen Properties (Series A) -- 7 1/2% 2001................... $ 1,050,000 $ 916,125 $ 1,018,500
Alexander Haagen Properties (Series B) -- 7 1/2% 2001................... 2,750,000 2,459,375 2,667,500
Developers Diversified Realty Corporation -- 7% 1999.................... 2,500,000 2,430,625 2,984,375
Rockefeller Center Properties, Inc. -- 0% 2000.......................... 3,005,000 2,062,516 2,065,938
-------------- --------------
$ 7,868,641 $ 8,736,313
-------------- --------------
HEALTH CARE -- 1.2%
IVAX Corporation -- 6 1/2% 2001......................................... $ 1,500,000 $ 1,256,125 $ 1,359,375
NovaCare, Inc. -- 5 1/2% 2000........................................... 4,000,000 3,625,000 3,760,000
-------------- --------------
$ 4,881,125 $ 5,119,375
-------------- --------------
PRODUCER DURABLE GOODS -- 0.8%
Diagnostic/Retrieval Systems, Inc.
-- 8 1/2% 1998........................................................ $ 719,000 $ 627,328 $ 720,348
-- 9% 2003............................................................ 2,000,000 2,000,000 2,460,000
-------------- --------------
$ 2,627,328 $ 3,180,348
-------------- --------------
TOTAL CONVERTIBLE SECURITIES -- 5.9%.................................... $ 22,228,899 $ 24,539,161
-------------- --------------
<CAPTION>
NON-CONVERTIBLE BONDS AND DEBENTURES
<S> <C> <C> <C>
CORPORATE -- 7.0%
Busse Broadcasting Corporation -- 11 5/8% 2000.......................... $ 2,350,000 $ 2,275,325 $ 2,491,000
Genesco Inc. -- 10 3/8% 2003............................................ 1,150,000 1,127,000 1,191,688
GPA Delaware Inc. -- 8 3/4% 1998........................................ 2,000,000 2,012,500 2,045,000
Kidder Peabody Mortgage Assets (CMO) -- 8.45% 2018...................... 1,226,500 1,220,381 1,227,266
Merrill Lynch Mortgage Investors, Inc.
Series 1992-B -- 8.3% 2012............................................. 1,600,000 1,625,750 1,631,500
Pacific Lumber Company, The -- 10 1/2% 2003............................. 1,000,000 967,500 1,032,500
Plantronics, Inc. -- 10% 2001........................................... 8,470,000 8,611,244 8,724,100
Primark Corporation -- 8 3/4% 2000...................................... 6,472,000 6,303,973 6,601,440
Trump Atlantic City Associates -- 11 1/4% 2006.......................... 4,000,000 3,925,000 3,910,000
-------------- --------------
$ 28,068,673 $ 28,854,494
-------------- --------------
</TABLE>
5
<PAGE>
PORTFOLIO OF INVESTMENTS
CONTINUED
<TABLE>
<CAPTION>
NON-CONVERTIBLE BONDS AND DEBENTURES (CONTINUED) Face Amount Cost Value
- ------------------------------------------------------------------------ ----------- -------------- --------------
<S> <C> <C> <C>
U.S. GOVERNMENT AND AGENCIES -- 3.5%
Federal Home Loan Bank
-- 4.58% 1998 (Floating Rate Note).................................... $ 1,000,000 $ 1,000,000 $ 990,625
Federal Home Loan Mortgage Corporation
-- 6 1/2% 2023 (IO)................................................... 4,810,600 637,303 681,000
-- 7% 2023 (CMO)...................................................... 2,203,400 2,241,995 2,106,313
-- 8 1/2% 2024 (REMIC)................................................ 3,000,000 3,018,750 3,031,875
-- 10.15% 2006 (REMIC)................................................ 352,000 349,097 355,740
Federal National Mortgage Association
-- 7% 2008 (REMIC).................................................... 1,825,400 1,814,015 1,802,582
-- 8% 2011 (REMIC).................................................... 1,050,000 1,055,250 1,058,531
Government National Mortgage Association (Mobile Home)
-- 9 3/4% 2006........................................................ 271,500 288,221 286,772
-- 9 3/4% 2010........................................................ 1,803,700 1,908,919 1,905,158
-- 10 1/4% 2001-2004.................................................. 425,300 452,813 454,274
Government National Mortgage Association
-- 7.99125% 2010 (REMIC).............................................. 1,965,000 1,965,021 1,978,509
-------------- --------------
$ 14,731,384 $ 14,651,379
-------------- --------------
OTHER NON-CONVERTIBLE BONDS
AND DEBENTURES -- 0.5%................................................ $ 2,035,000 $ 2,022,500
-------------- --------------
TOTAL NON-CONVERTIBLE BONDS
AND DEBENTURES -- 11.0%............................................... $ 44,835,057 $ 45,528,373
-------------- --------------
TOTAL INVESTMENT SECURITIES -- 90.0%.................................... $ 288,061,027 $ 372,068,171
-------------- --------------
--------------
SHORT-TERM INVESTMENTS -- 9.5%
Short-term Corporate Notes:
AT&T Corp. -- 5.53% 7/1/97............................................ $ 5,000,000 $ 5,000,000
MetLife Funding, Inc. -- 5.58% 7/8/97................................. 3,000,000 2,996,745
PepsiCo, Inc. -- 5 1/2% 7/14/97....................................... 3,000,000 2,994,042
Sherwin-Williams Company, The -- 5.52% 7/18/97........................ 2,000,000 1,994,787
Sherwin-Williams Company, The -- 5.51% 7/18/97........................ 5,000,000 4,986,990
PepsiCo, Inc. -- 5.52% 7/18/97........................................ 1,200,000 1,196,872
Philip Morris Companies Inc. -- 5.53% 7/21/97......................... 1,000,000 996,928
Philip Morris Companies Inc. -- 5.55% 7/21/97......................... 1,000,000 996,917
Sherwin-Williams Company, The -- 5.53% 7/21/97........................ 3,000,000 2,990,783
MetLife Funding, Inc. -- 5.51% 7/24/97................................ 4,000,000 3,985,919
MetLife Funding, Inc. -- 5.55% 7/29/97................................ 1,000,000 995,683
Philip Morris Companies Inc. -- 5.55% 8/11/97......................... 1,000,000 993,679
Sherwin-Williams Company, The -- 5.57% 8/21/97........................ 5,500,000 5,456,600
MetLife Funding, Inc. -- 5.55% 8/25/97................................ 3,500,000 3,470,323
State Street Bank Repurchase Agreement -- 5 1/2% 07/01/97
(collateralized by U.S. Treasury Notes -- 5 1/2% 2000,
market value $164,023)................................................. 159,000 159,022
--------------
$ 39,215,290
--------------
TOTAL INVESTMENTS -- 99.5%.............................................. $ 411,283,461
Other assets less liabilities -- 0.5%................................... 2,175,457
--------------
TOTAL NET ASSETS -- 100%................................................ $ 413,458,918
--------------
--------------
</TABLE>
* Non-income producing securities
See notes to financial statements.
6
<PAGE>
MAJOR PORTFOLIO CHANGES
Quarter Ended June 30, 1997
<TABLE>
<CAPTION>
Shares or
Face Amount
----------------
<S> <C>
NET PURCHASES
COMMON STOCKS
Graco Inc................................................................................................... 37,200 shs.
Holophane Corporation....................................................................................... 65,200 shs.
Kennametal Inc.............................................................................................. 22,000 shs.
Methode Electronics, Inc. (Class A)......................................................................... 81,800 shs.
Nucor Corporation........................................................................................... 17,000 shs.
OM Group, Inc............................................................................................... 55,800 shs.
O'Reilly Automotive, Inc.................................................................................... 16,700 shs.
Viking Office Products, Inc.(1)............................................................................. 163,300 shs.
CONVERTIBLE SECURITIES
Alexander Haagen Properties (Series B) -- 7 1/2% 2001....................................................... $ 1,000,000
NovaCare, Inc. -- 5 1/2% 2000............................................................................... $ 1,000,000
NET SALES
COMMON STOCKS
Arbor Drugs, Inc............................................................................................ 61,600 shs.
Bandag, Incorporated........................................................................................ 51,000 shs.
Dover Corporation(2)........................................................................................ 139,900 shs.
Expeditors International of Washington, Inc................................................................. 27,000 shs.
Genuine Parts Company(2).................................................................................... 72,400 shs.
Horace Mann Educators Corporation........................................................................... 56,600 shs.
Leggett & Platt, Incorporated............................................................................... 15,100 shs.
Manpower Inc................................................................................................ 67,400 shs.
Norwest Corporation......................................................................................... 14,600 shs.
Progressive Corporation, The................................................................................ 9,800 shs.
Unifi, Inc.................................................................................................. 122,600 shs.
CONVERTIBLE SECURITIES
Fabri-Centers of America Inc. -- 6 1/4% 2002(2)............................................................. $ 7,000,000
Healthsource Inc. -- 5% 2003(2)............................................................................. $ 2,500,000
</TABLE>
(1) Indicates new commitment to portfolio
(2) Indicates elimination from portfolio
7
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
June 30, 1997
------------------------------
<S> <C> <C>
ASSETS
Investments at value:
Investment securities -- at market value
(cost $288,061,027) -- Note A.......................................................... $ 372,068,171
Short-term investments -- at cost plus interest earned
(maturities 60 days or less) -- Note A................................................. 39,215,290 $ 411,283,461
--------------
Cash....................................................................................... 817
Receivable for:
Dividends and accrued interest........................................................... $ 1,738,168
Investment securities sold............................................................... 955,471 2,693,639
-------------- --------------
$ 413,977,917
LIABILITIES
Payable for:
Advisory fees............................................................................ $ 238,964
Accrued dividends -- Preferred Stock..................................................... 196,921
Accrued expenses......................................................................... 83,114 518,999
-------------- --------------
TOTAL NET ASSETS -- June 30, 1997............................................................ $ 413,458,918
--------------
--------------
Assets applicable to Preferred Stock at a liquidation preference of
$27.50 per share (asset coverage 763%) -- Note B......................................... $ 54,153,330
--------------
--------------
Net assets applicable to Common Stock -- $49.18 per share.................................. $ 359,305,588
--------------
--------------
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 7,306,292
shares -- Note B......................................................................... 7,306,292
Additional Paid-in Capital................................................................. 292,916,477
Undistributed net realized gain on investments............................................. 31,922,570
Unrealized appreciation of investments..................................................... 84,007,144
Unallocated distributions -- Note A........................................................ (8,601,201)
--------------
TOTAL NET ASSETS -- June 30, 1997............................................................ $ 413,458,918
--------------
--------------
</TABLE>
See notes to financial statements.
8
<PAGE>
STATEMENT OF OPERATIONS
For the six months ended June 30, 1997
<TABLE>
<S> <C> <C>
INVESTMENT INCOME
Income:
Interest......................................................................... $ 3,588,677
Dividends........................................................................ 2,115,851
-----------
$ 5,704,528
Expenses -- Note C:
Advisory fees.................................................................... $ 1,353,847
Transfer agent fees and expenses................................................. 127,252
Reports to shareholders.......................................................... 119,870
Directors' fees and expenses..................................................... 40,177
Taxes, other than federal income tax............................................. 33,320
Legal and auditing fees.......................................................... 32,566
Custodian fees and expenses...................................................... 24,636
Registration and filing fees..................................................... 16,320
Insurance........................................................................ 12,195
Other expenses................................................................... 380 1,760,563
----------- -----------
Net investment income -- Note A.............................................. $ 3,943,965
-----------
REALIZED AND UNREALIZED GAIN
ON INVESTMENTS
Realized gain on investments:
Proceeds from sale of investment securities
(Excluding short-term investments with maturities of 60 days or less).......... $79,190,893
Cost of investment securities sold............................................... 51,630,741
-----------
Net realized gain on investments -- Notes A and D.............................. $27,560,152
Unrealized appreciation of investments:
Unrealized appreciation at beginning of period................................... $71,695,457
Unrealized appreciation at end of period......................................... 84,007,144
-----------
Increase in unrealized appreciation of investments............................. 12,311,687
-----------
Net realized and unrealized gain on investments.............................. $39,871,839
-----------
NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS.................................................................... $43,815,804
-----------
-----------
</TABLE>
See notes to financial statements.
9
<PAGE>
STATEMENT OF CHANGES IN TOTAL NET ASSETS
<TABLE>
<CAPTION>
For the six months ended For the year ended
June 30, 1997 December 31, 1996
---------------------------- -----------------------------
<S> <C> <C> <C> <C>
INCREASE IN TOTAL NET ASSETS
Operations:
Net investment income.................................... $ 3,943,965 $ 9,449,105
Net realized gain on investments
-- Notes A and D....................................... 27,560,152 44,976,665
Increase in unrealized appreciation of investments....... 12,311,687 14,692,796
------------ -------------
Increase in total net assets resulting
from operations.......................................... $ 43,815,804 $ 69,118,566
Distributions to Preferred shareholders:
From net investment income............................... (2,363,054) (4,726,109)
Distributions to Common shareholders:
From net investment income............................... $ (4,902,802) $ (3,718,587)
From net realized capital gains.......................... -- (40,614,247)
Unallocated -- Note A.................................... (8,601,201) (13,504,003) -- (44,332,834)
------------ -------------
Proceeds from shares issued for distributions reinvested
by shareholders -- Note B.............................. 3,363,744 --
-------------- --------------
Increase in total net assets............................... $ 31,312,491 $ 20,059,623
TOTAL NET ASSETS
Beginning of period, including
undistributed net investment income
of $3,321,891 and $2,317,482............................. 382,146,427 362,086,804
-------------- --------------
End of period, including
undistributed net investment income
of $3,321,891 at December 31, 1996....................... $ 413,458,918 $ 382,146,427
-------------- --------------
-------------- --------------
</TABLE>
See notes to financial statements.
10
<PAGE>
FINANCIAL HIGHLIGHTS
Selected data for a share of Common Stock outstanding throughout each period
<TABLE>
<CAPTION>
Six
Months Year ended December 31,
Ended ------------------------------------------
June 30,
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Per share operating performance:
Net asset value at beginning of period............................. $ 45.35 $ 42.58 $ 38.52 $ 41.85 $ 42.87
--------- --------- --------- --------- ---------
Net investment income.............................................. $ 0.54 $ 1.30 $ 1.48 $ 1.62 $ 1.94
Net realized and unrealized gain (loss)
on investment securities......................................... 5.46 8.25 6.84 (0.67) 1.32
--------- --------- --------- --------- ---------
Total from investment operations................................. $ 6.00 $ 9.55 $ 8.32 $ 0.95 $ 3.26
--------- --------- --------- --------- ---------
Distributions to Preferred shareholders:
From net investment income....................................... $ (0.32) $ (0.65) $ (0.66) $ (0.69) $ (0.72)
Distributions to Common shareholders:
From net investment income....................................... (0.67) (0.51) (0.50) (1.14) (1.39)
From net realized gains.......................................... -- (5.62) (3.10) (2.03) (2.21)
In excess of net realized gains.................................. -- -- -- (0.02) --
From Additional Paid-in Capital.................................. -- -- -- (0.41) --
Unallocated...................................................... (1.18) -- -- -- --
--------- --------- --------- --------- ---------
Total distributions............................................ $ (2.17) $ (6.78) $ (4.26) $ (4.29) $ (4.32)
--------- --------- --------- --------- ---------
Effect of shares issued for distributions
reinvested by Common shareholders................................ -- -- -- $ 0.01 $ 0.04
--------- --------- --------- --------- ---------
Net asset value at end of period................................... $ 49.18 $ 45.35 $ 42.58 $ 38.52 $ 41.85
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Per share market value at end of period............................ $ 47.00 $ 45.50 $ 41.88 $ 37.00 $ 43.25
Total investment return(1)......................................... 7.5% 24.5% 23.4% (6.5)% (1.8)%
Net asset value total return(2).................................... 12.9% 21.9% 20.7% 0.6% 6.3%
Ratios/supplemental data:
Net assets at end of period
(in thousands)................................................. $413,459 $382,146 $362,087 $329,427 $330,465
Ratio of expenses to average
net assets..................................................... 0.90%(3) 0.89% 0.91% 0.96% 0.95%
Ratio of net income to average
net assets..................................................... 2.02%(3) 2.52% 3.04% 3.36% 3.86%
Portfolio turnover rate.......................................... 31.81%(3) 41.04% 51.44% 71.39% 73.91%
Average brokerage commission
per share...................................................... $0.0577 $0.0589 -- -- --
Preferred Stock:
Total shares outstanding(4)........................................ 1,969,212 1,969,212 1,969,212 1,969,212 1,969,212
Asset coverage per Share(4)........................................ $209.96 $194.06 $183.87 $167.29 $167.82
Involuntary liquidation preference per share....................... $27.50 $27.50 $27.50 $27.50 $27.50
Average market value per share(5).................................. $28.50 $28.50 $28.00 $27.89 $30.24
<CAPTION>
1992
---------
<S> <C>
Per share operating performance:
Net asset value at beginning of period............................. $ 41.23
---------
Net investment income.............................................. $ 1.98
Net realized and unrealized gain (loss)
on investment securities......................................... 3.96
---------
Total from investment operations................................. $ 5.94
---------
Distributions to Preferred shareholders:
From net investment income....................................... $ (0.73)
Distributions to Common shareholders:
From net investment income....................................... (1.02)
From net realized gains.......................................... (2.58)
In excess of net realized gains.................................. --
From Additional Paid-in Capital.................................. --
Unallocated...................................................... --
---------
Total distributions............................................ $ (4.33)
---------
Effect of shares issued for distributions
reinvested by Common shareholders................................ $ 0.03
---------
Net asset value at end of period................................... $ 42.87
---------
---------
Per share market value at end of period............................ $ 47.75
Total investment return(1)......................................... 17.0%
Net asset value total return(2).................................... 13.3%
Ratios/supplemental data:
Net assets at end of period
(in thousands)................................................. $332,574
Ratio of expenses to average
net assets..................................................... 0.94%
Ratio of net income to average
net assets..................................................... 3.93%
Portfolio turnover rate.......................................... 69.01%
Average brokerage commission
per share...................................................... --
Preferred Stock:
Total shares outstanding(4)........................................ 1,969,212
Asset coverage per Share(4)........................................ $168.89
Involuntary liquidation preference per share....................... $27.50
Average market value per share(5).................................. $29.21
</TABLE>
(1) Based on market value per share, adjusted for reinvestment of distributions
and taxes
(2) Based on net asset value per share, adjusted for reinvestment of
distributions and taxes
(3) Annualized
(4) Information shown as of the end of the period
(5) The average of all month-end market values during each period
See notes to financial statements.
11
<PAGE>
NOTES TO FINANCIAL STATEMENTS
June 30, 1997
NOTE A--SIGNIFICANT ACCOUNTING POLICIES
The Company is registered under the Investment Company Act of 1940 as a
diversified, closed-end management investment company. The investment objective
of the Company is to seek maximum total return for Common shareholders from both
capital appreciation and investment income to the extent consistent with
protection of invested capital and provision of sufficient income to meet the
dividend requirements of Preferred shareholders. The significant accounting
policies followed by the Company in the preparation of its financial statements
include the following:
1. SECURITIES VALUATION--Securities, including any outstanding written
call options, listed or traded on a national securities exchange or on the NAS-
DAQ National Market System are valued at the last sale price on the last
business day of the period, 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
investments with maturities of 60 days or less are valued at cost plus interest
earned, which approximates market value. Restricted securities and securities
for which market quotations are not readily available are valued at fair value
as determined in good faith by, or under the direction of, the Board of
Directors.
2. FEDERAL INCOME TAX--No provision for federal taxes is considered
necessary because the Company has elected to be taxed as a "regulated investment
company" under the Internal Revenue Code, and intends to maintain this
qualification and to distribute each year all of its taxable net investment
income and taxable net realized gain on investments to its shareholders in
accordance with the minimum distribution requirements of the Code.
3. UNALLOCATED DISTRIBUTIONS--Un-
allocated distributions represent distributions paid to Common shareholders
during the period from source(s) other than net investment income. Such
source(s) will be determined by the results of operations for the entire fiscal
year and will be paid-in capital, except to the extent of any net realized
capital gains for the fiscal year.
4. USE OF ESTIMATES--The preparation of the financial statements in
accordance with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported. Actual results
could differ from those estimates.
5. OTHER--Securities transactions are accounted for on the date
securities are purchased or sold. Dividend income is recorded on the ex-dividend
date. Interest income and expenses are recorded on an accrual basis. Dividends
payable by the Company on the Preferred Stock are recorded on an accrual basis
and distributions payable on the Common Stock are recorded on the ex-dividend
date.
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.
The Company issued 74,182 shares of Common Stock under its Reinvestment
Plan for Common and Preferred shareholders during the six months ended June 30,
1997.
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 six months ended June 30, 1997, the Company paid aggregate fees of
$40,000 to all Directors who are not affiliated persons of the Investment
Adviser. During the six months ended June 30, 1997, the Company incurred legal
fees of $3,491 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.
The Officers of the Company are also officers of the Investment Adviser.
NOTE D--PURCHASES AND SALES OF SECURITIES
Cost of purchases of investment securities (excluding short-term corporate
notes with maturities of 60 days or less) aggregated $57,442,954 for the six
months ended June 30, 1997. Cost of investment securities owned at June 30, 1997
was the same for federal income tax and financial reporting purposes. Gains and
losses are based on the specific certificate identification method.
12
<PAGE>
SOURCE CAPITAL, INC.
[LOGO]
DIRECTORS
Wesley E. Bellwood
Julio J. de Puzo, Jr.
David Rees
Robert L. Rodriguez
Lawrence J. Sheehan
Charles W. Stanton
Kenneth L. Trefftzs
OFFICERS
Julio J. de Puzo, Jr., PRESIDENT
Eric S. Ende, SENIOR VICE PRESIDENT AND
CHIEF INVESTMENT OFFICER
Robert L. Rodriguez, SENIOR VICE PRESIDENT
Steven R. Geist, VICE PRESIDENT
Janet M. Pitman, VICE PRESIDENT
Steven T. Romick, VICE PRESIDENT
J. Richard Atwood, TREASURER
Sherry Sasaki, SECRETARY
Christopher H. Thomas, ASSISTANT TREASURER
INVESTMENT ADVISER
First Pacific Advisors, Inc.
11400 West Olympic Blvd., Suite 1200
Los Angeles, California 90064
CUSTODIAN
State Street Bank and Trust Company
Boston, Massachusetts
COUNSEL
O'Melveny & Myers LLP
Los Angeles, California
TRANSFER AND SHAREHOLDER SERVICE AGENT
ChaseMellon Shareholder Services, L.L.C.
85 Challenger Road
Overpeck Centre
Ridgefield Park, NJ 07660
(800) 279-1241 or (212) 613-7427
REGISTRAR
ChaseMellon Shareholder Services, L.L.C.
Ridgefield Park, New Jersey
STOCK EXCHANGE LISTING
New York Stock Exchange:
Symbols: SOR Common Stock
SOR+ Preferred Stock
13
<PAGE>
<TABLE>
<S> <C>
SOURCE CAPITAL, INC. BULK RATE
11400 West Olympic Boulevard, Suite 1200 U.S. POSTAGE
Los Angeles, California 90064 PAID
CMSS
</TABLE>
