<PAGE>
[LOGO]
SOURCE CAPITAL, INC.
1997
ANNUAL REPORT
for the year ended December 31
<PAGE>
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
INDEPENDENT AUDITORS
Ernst & Young 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
- --------------------------------------------------------------------------------
SUMMARY FINANCIAL INFORMATION
<TABLE>
<CAPTION>
For the year ended December 31,
--------------------------------------------------------
1997 1996
--------------------------- ---------------------------
Total Total
Net Per Common Net Per Common
Assets Share Assets Share
-------------- ----------- -------------- -----------
<S> <C> <C> <C> <C>
Beginning of year...................................................... $382,146,427 $ 45.35 $362,086,804 $ 42.58
Net gain on investments, realized and unrealized....................... 76,662,465 10.50 59,669,461 8.25
Income available to Common shareholders................................ 3,232,410 0.43 4,722,996 0.65
Distributions to Common shareholders................................... (44,409,618) (6.08) (44,332,834) (6.13)
Proceeds from shares issued for distributions reinvested by
shareholders......................................................... 7,858,423 -- -- --
-------------- ----------- -------------- -----------
Net changes during year............................................ $ 43,343,680 $ 4.85 $ 20,059,623 $ 2.77
-------------- ----------- -------------- -----------
End of year............................................................ $425,490,107 $ 50.20 $382,146,427 $ 45.35
-------------- ----------- -------------- -----------
-------------- ----------- -------------- -----------
Common market price per share.......................................... 51 1/16 45 1/2
Common market premium to net asset value............................... 1.7% 0.3%
Preferred asset coverage............................................... 786% 706%
Preferred liquidation preference per share............................. $27.50 $27.50
Preferred market price per share....................................... 29 28 5/8
</TABLE>
<PAGE>
DESCRIPTION OF THE COMPANY
SOURCE CAPITAL, INC. is a major diversified, publicly traded investment
company with total net assets of approximately $425,000,000. 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 7,397,259
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.
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.
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"). Chase Manhattan Bank ("Agent") c/o ChaseMellon Shareholder
Services, L.L.C., Investor Services, P.O. Box 3338, South Hackensack, New Jersey
07660-1938, 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 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>
LETTER TO SHAREHOLDERS
TO OUR SHAREHOLDERS:
1997 INVESTMENT PORTFOLIO RETURNS
Total net assets of Source Capital amounted to $425,490,107 at December 31,
1997. After providing for Preferred Stock equity, Common equity amounted to
$371,336,777 or $50.20 of net asset value per Common share. This compared with
total net assets of $382,146,427, Common equity of $327,993,097 and net asset
value per Common share of $45.35 one year ago. These changes reflect payments to
Common and Preferred shareholders totaling $49,135,727. As a result, Source
Capital achieved a total investment return during 1997 of 25.4% on its Common
net asset value (23.0% 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.
NET INVESTMENT INCOME
As has been the case for the past several years, net investment income has
continued to decline. Most of this decline has occurred on the interest side of
net investment income while the dividend side has remained essentially flat with
1996. Holdings in commercial paper have declined this year as the asset
allocation to equities has increased with a resulting decline in the cash
position. Specifically, net investment income amounted to $1,964,401 and
$7,958,519 for the fourth quarter and full year, respectively, compared with
$2,425,030 and $9,449,105 in 1996. After providing for Preferred dividends, net
investment income per Common share totaled $0.09 and $0.43 for the fourth
quarter and full year, respectively, compared with $0.17 and $0.65 earned in the
corresponding periods of 1996.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SOURCE CAPITAL STOCK MARKET INDICES FIXED-INCOME INDICES
------------------------ --------------------------------- ---------------------
TOTAL COMMON RUSSELL S&P LEHMAN BROTHERS
PERIOD NET ASSETS EQUITY 2500 500 DJIA GOVT/CORP BOND INDEX
- ------------------------------------------------ ----------- ----------- --------- ---------- ---------- ---------------------
<S> <C> <C> <C> <C> <C> <C>
1997 +23.0% +25.4% +24.4% +33.4% +24.9% + 9.8%
1996 +20.0 +21.9 +19.0 +23.3 +28.9 + 2.9
1995 +18.7 +20.7 +31.7 +37.5 +36.9 +19.2
1994 + 2.0 + 0.6 - 1.1 + 1.3 + 5.0 - 3.5
1993 + 6.7 + 6.3 +16.5 +10.0 +17.0 +11.0
1992 +12.5 +13.3 +16.2 + 7.7 + 7.4 + 7.6
1991 +19.7 +22.2 +46.7 +30.6 +24.3 +16.1
1990 - 1.2 - 3.2 -14.9 - 3.1 - 0.5 + 8.3
1989 +21.1 +23.9 +19.4 +31.7 +32.3 +14.2
1988 +15.2 +16.8 +22.7 +16.6 +16.2 + 7.6
1987 + 3.0 + 1.7 - 4.7 + 5.3 + 5.6 + 2.3
1986 +12.8 +13.9 +12.0 +18.7 +27.3 +15.6
1985 +24.2 +28.5 +31.9 +31.8 +33.7 +21.3
1984 +11.9 +12.8 - 4.1 + 6.3 + 1.4 +15.0
1983 +18.4 +21.3 +27.7 +22.6 +26.1 + 8.0
1982 +21.6 +26.1 +26.7 +21.5 +27.2 +31.1
1981 +14.2 +16.0 + 3.0 - 5.3 - 3.7 + 7.3
1980 +19.2 +23.1 +34.3 +32.4 +22.2 + 3.0
1979 +26.6 +35.0 +38.4 +18.7 +10.7 + 2.3
1978 +16.1 +19.7 N/A + 6.4 + 2.8 + 1.2
1977 +13.0 +15.1 N/A - 7.2 -12.9 + 3.0
Annual Compound
Rate of Return:
19 years +15.0 +16.7 +17.1 +17.2 +17.4 +10.2
21 years +14.9 +16.8 N/A +15.4 +15.0 + 9.4
<CAPTION>
TREASURY
PERIOD BILL YIELDS
- ------------------------------------------------ -----------
<S> <C>
1997 + 5.2%
1996 + 5.3
1995 + 5.7
1994 + 4.2
1993 + 3.1
1992 + 3.6
1991 + 5.8
1990 + 7.8
1989 + 8.2
1988 + 6.2
1987 + 5.9
1986 + 6.0
1985 + 7.5
1984 + 9.6
1983 + 8.6
1982 +10.7
1981 +14.1
1980 +11.6
1979 +10.3
1978 + 7.2
1977 + 5.4
Annual Compound
Rate of Return:
19 years + 7.3
21 years + 7.2
</TABLE>
2
<PAGE>
DISTRIBUTIONS TO COMMON SHAREHOLDERS
The distribution rate on Source Capital Common Stock is currently at the $4.00
annual rate which has been in effect since September 1997. 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 22 years ago, continuing growth in net
asset value has led to 17 increases in the distribution rate totaling 186%. This
growth was achieved despite payments to shareholders in excess of net investment
income of $316,406,794 or $48.64 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 $4.00 Common distribution rate is dependent on
achieving investment results which will sustain a net asset value of
approximately $40.00.
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 1997, 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 $42,884,612 in net capital
gains in 1997. Distribution of these gains required payment of a special
distribution of $2.23 per share to Common shareholders on December 15, 1997 in
addition to the $1.00 per share regular quarterly distribution to Common
shareholders. 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 0.3% market premium to
net asset value at 12/31/96 increased to a 1.7% premium one year later, and the
shareholder returns benefited accordingly. The following table presents 1997
market returns for both Common and Preferred shareholders:
<TABLE>
<CAPTION>
Common Preferred
Stock Stock
----------- -----------
<S> <C> <C>
Change in Market Value:
NYSE Closing Price
- 12/31/97.............. $ 51.0625 $ 29.0000
NYSE Closing Price
- 12/31/96.............. $ 45.5000 $ 28.6250
----------- -----------
Net Change in 1997........ $ 5.5625 $ 0.3750
Distributions in 1997....... 6.0800 2.4000
----------- -----------
Total Return -- Amount...... $ 11.6425 $ 2.7750
Total Return -- Percent..... 25.6% 9.7%
</TABLE>
Common shareholders who participated in the Company's Automatic Reinvestment
Plan experienced a positive return of 26.9% during 1997 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 21 years since inception experienced an annual
compound rate of return of 18.8%.
COMMENTARY
The marked outperformance of large market-cap companies, which we discussed in
our letter a year ago, continued throughout most of 1997. As a result, the S&P
500 Index, whose performance is dominated by a relatively few very large
companies, greatly outperformed indexes more representative of most of the
market.
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
S&P 500 +23.25% +33.38%
Russell 2500 +19.03% +24.36%
Russell 2000 +16.49% +22.36%
</TABLE>
Even within the S&P 500, performance disparities were astonishing, and the 300
largest companies (market caps over $5 billion) significantly outperformed the
others.
<TABLE>
<CAPTION>
1997 Market
S&P 500 Performance* Cap Range
- ------------ ------------- ----------------------
<S> <C> <C>
Largest 20% +39.5% $18 - 240 billion
Next 20% +34.5% $9 - 18 billion
Middle 20% +32.0% $5 - 9 billion
Next 20% +14.4% $2.7 - 5 billion
$340 million - 2.7
Smallest 20% +12.5% billion
</TABLE>
* Excludes Dividends
We are very pleased that our portfolio again outperformed the Russell 2500, the
index which is the closest match to the market caps and portfolio weightings of
the companies we hold. This performance is especially gratifying because the
low-beta, high-quality companies in our portfolio would typically find it
difficult to keep up with such a strong market -- as was the case in 1995.
3
<PAGE>
<TABLE>
<CAPTION>
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Source Capital +20.7% +21.9% +25.4%
Russell 2500 +31.7% +19.0% +24.4%
</TABLE>
A year ago we expressed our caution about the prospects for the stock market
and the economy, arguing that the age of the economic recovery and some evidence
of labor market tightness could eventually produce profit pressure and stock
market weakness. Although the stock market's 1997 performance clearly
demonstrated that we were premature, it seems certain that recent events in Asia
have heightened the risks to the profit growth of many U.S. companies. This
clearly could have adverse implications for equity returns in 1998. Also
supporting this point is the following table, which compares S&P profit growth
with stock price growth for 1995-1997. Market valuation levels have increased
significantly over the past three years, driven by an economic environment in
which very little went wrong.
<TABLE>
<CAPTION>
Cumulative
1995 1996 1997 Gain
--------- --------- --------- -------------
<S> <C> <C> <C> <C>
S&P Operating
Earnings +18% +4% +12% +37%
S&P 500 Index +38% +23% +33% +126%
</TABLE>
Our investment approach continues to emphasize the ownership of high-return
companies, purchased and held at relatively attractive valuations. We believe
that this strategy will continue to produce rewarding returns, achieved with
significantly lower risk than the market averages.
Our current portfolio reflects this approach. Its component companies have a
history of outstanding growth, earn high returns, and have relatively
unleveraged balance sheets. Despite these superior characteristics, the
companies are priced at valuation levels well below those of the market as a
whole.
<TABLE>
<CAPTION>
S&P
Portfolio Industrials
----------- -------------
<S> <C> <C>
EPS Growth Rate (10 year) 17% 9%
Return on Assets 10% 5%
Debt % Capital 25% 54%
PE Ratio 18x 24x
</TABLE>
One of the most dynamically growing parts of the U.S. economy over the past
decade has been technology. This has also been an area of the stock market where
we have found it difficult to participate, in part because the rapid changes in
specific products and corporate market shares make historical company
performance a poor guide to future success. Our under-representation in
technology has been a cause of increasing concern, however, as its importance to
the economy, and its contribution to overall stock market returns has increased
over time.
One approach we have developed to deal with this problem is to search out
companies which can fully participate in the growth of the technology sectors of
the economy, yet not take the significant product and company specific risks
which have made many portfolio investments in this area so risky. The companies
we have identified and purchased which fit these requirements manufacture
products like connectors, wire and cable, passive devices, electronics
enclosures, or distribute electronic components. They can be described as
"chicken techs."
ARROW ELECTRONICS is the world-wide leader in distribution of electronics
components. It carries products from most major suppliers and sells to a wide
variety of customers, mostly original equipment manufacturers making electronics
products. Because of this supplier and customer diversification, changes in the
fortunes of individual companies will have little effect on Arrow.
Distributors have become increasingly important in the industry as components
manufacturers have concluded that reaching small and medium-sized customers with
a direct sales force is too expensive. While the manufacturers concentrate on a
small number of very large customers, Arrow and other distributors take care of
servicing the rest. As the result of this industry trend, the dynamic growth in
the use of electronics in society, and key acquisitions, Arrow's revenues have
grown at a 35% rate over the past five years, from $1.6 billion in 1992 to over
$7 billion in 1997.
BELDEN is a leading manufacturer of specialty wire and cable products for a
wide variety of applications. Some typical uses for Belden products are computer
related products (office networks, peripheral interconnections, internal
wiring), audio-video (broadcast TV and radio, music production, sports arenas
and stadiums, cable TV), and industrial (factory automation, fire and security
systems, instrumentation and control). A number of these areas, notably computer
networking and industrial automation and controls have been dynamic growth
areas, enabling Belden to benefit from the rapid pace of innovation in the
electronics and computer industries.
Belden has also been astute in its acquisition program, broadening its product
line and geography, while demonstrating an ability to improve the profitability
of the businesses it has purchased.
KEMET is one of the leading producers of ceramic and tantalum capacitors,
passive devices which store and regulate the flow of electricity. Capacitors are
ubiquitous in electronics applications and products, and KEMET's products are
used in computers, telecommunications equipment, automotive and industrial
electronics, and military and aerospace systems. Not only does KEMET benefit
from the growth of these applications, but the
4
<PAGE>
increasing complexity of electronics products also demands an increased number
of capacitors. As a result, KEMET has grown sales at a 14% annual rate over the
past five years, despite the rapid unit price declines which are common in
electronics components.
METHODE ELECTRONICS is a manufacturer of electronics connectors and automotive
controls, each area representing about half of Methode's sales. Automotive
electronics has grown rapidly in the last two decades, driven by increased use
of remote motors, sensors, controls, music and security systems, and
diagnostics. Methode is an important supplier of many of these devices or
systems, and its business has also grown quickly, both in the U.S. and, more
recently, in Europe.
Electronics connectors are crucial to all electronics, and as these products
have become smaller and more sophisticated, so have their connectors. Though it
shares some of the technological dynamism of its electronics customers, the
connector business has been characterized by much greater stability in
profitability and market share. This has made investment in Methode, and
possibly other connector companies in the future, more comfortable for us.
Operating in its dynamic market place, and helped by some acquisitions,
Methode's sales have grown at an 18% annual rate over the past five years, and
earnings have risen steadily as well.
CHANNELL COMMERCIAL is a manufacturer of thermoplastic enclosures used by cable
TV and telephone companies, most often at curbside. Though clearly not a high
tech product, Channell's enclosures play an important role in protecting its
customers' electronics from water, humidity, vandalism and accidental damage,
while still permitting service and maintenance access. As Channell's customers
expand their product offerings -- cable companies enter the telephone and data
transmission business, and phone companies add cable services -- they are
demanding larger and more sophisticated enclosures from Channell. We expect this
will enable Channell to extend its record of rapid income and sales growth.
The table below compares some financial data for these companies with that of
the S&P Industrials:
<TABLE>
<CAPTION>
Five Year Growth
-------------------- PE
Sales Income Market Cap --
--------- --------- -----------
<S> <C> <C> <C> <C>
$3.1
Arrow 36% 19% billion 15x
$1.0
Belden 15% 16% billion 16x
Channell 25% 45% $75 million 13x
$675
KEMET 14% 19% million 12x
$500
Methode 18% 22% million 13x
S&P
Industrials 4% 13% $6 billion 24x
</TABLE>
These five companies accounted for 9% of Source Capital's equity investments at
the end of 1997. We hope to increase this percent over time as we find other
companies with similarly attractive economic and financial characteristics.
Respectfully submitted,
/s/ ERIC S. ENDE
Eric S. Ende
Senior Vice President and
Chief Investment Officer
February 2, 1998
5
<PAGE>
PORTFOLIO OF INVESTMENTS
December 31, 1997
<TABLE>
<CAPTION>
COMMON STOCKS Shares Cost Value
- ------------------------------------------------------------------------ ----------- -------------- --------------
<S> <C> <C> <C>
PRODUCER DURABLE GOODS -- 19.3%
Denison International plc (ADR)*........................................ 332,300 $ 5,653,091 $ 5,732,175
Donaldson Company, Inc.................................................. 149,400 3,775,799 6,732,338
Federal Signal Corporation.............................................. 178,200 3,948,396 3,853,575
Graco Inc............................................................... 278,400 5,590,836 10,387,800
Holophane Corporation*.................................................. 535,500 9,319,851 13,253,625
IDEX Corporation........................................................ 380,800 9,025,659 13,280,400
Kaydon Corporation...................................................... 426,800 5,736,940 13,924,350
Leggett & Platt, Incorporated........................................... 141,100 3,276,951 5,908,562
TriMas Corporation...................................................... 264,210 6,049,204 9,082,219
-------------- --------------
$ 52,376,727 $ 82,155,044
-------------- --------------
BUSINESS SERVICES & SUPPLIES -- 13.4%
Arrow Electronics, Inc.*................................................ 223,000 $ 4,848,084 $ 7,233,563
Bacou USA, Inc.*........................................................ 276,500 4,547,156 4,838,750
Devon Group, Inc.*...................................................... 195,300 3,007,100 8,983,800
Expeditors International of Washington, Inc............................. 147,400 946,121 5,674,900
Franklin Covey Co.*..................................................... 295,700 6,213,005 6,505,400
Galileo International, Inc.............................................. 366,900 9,514,651 10,135,612
Kennametal Inc.......................................................... 70,000 2,436,097 3,626,875
Manpower Inc............................................................ 288,600 9,045,647 10,173,150
-------------- --------------
$ 40,557,861 $ 57,172,050
-------------- --------------
RETAILING -- 8.2%
Arbor Drugs, Inc........................................................ 404,100 $ 2,928,313 $ 7,475,850
Bob Evans Farms, Inc.................................................... 178,300 3,385,842 3,944,888
Circuit City Stores, Inc................................................ 228,000 7,025,807 8,108,250
O'Reilly Automotive, Inc.*.............................................. 240,600 3,965,918 6,315,750
Toys "R" Us, Inc.*...................................................... 183,200 4,730,405 5,759,350
Viking Office Products, Inc.*........................................... 148,300 2,085,241 3,234,794
-------------- --------------
$ 24,121,526 $ 34,838,882
-------------- --------------
MATERIALS -- 7.3%
Caraustar Industries, Inc............................................... 437,500 $ 9,448,417 $ 14,984,375
Nucor Corporation....................................................... 168,300 8,179,710 8,130,994
OM Group, Inc........................................................... 219,800 5,398,941 8,050,175
-------------- --------------
$ 23,027,068 $ 31,165,544
-------------- --------------
CONSUMER NON-DURABLE GOODS -- 6.3%
Lancaster Colony Corporation............................................ 240,300 $ 8,300,201 $ 13,546,913
Newell Co............................................................... 129,600 3,111,055 5,508,000
Tupperware Corporation.................................................. 275,000 10,903,667 7,665,625
-------------- --------------
$ 22,314,923 $ 26,720,538
-------------- --------------
HEALTH CARE -- 5.5%
Allergan, Inc........................................................... 281,100 $ 6,568,948 $ 9,434,419
DENTSPLY International Inc.............................................. 272,000 4,793,813 8,296,000
Landauer, Inc........................................................... 199,600 4,005,745 5,588,800
-------------- --------------
$ 15,368,506 $ 23,319,219
-------------- --------------
TECHNOLOGY -- 5.4%
Belden Inc.............................................................. 236,900 $ 6,773,206 $ 8,350,725
Channell Commercial Corporation*........................................ 215,000 2,418,750 2,687,500
KEMET Corporation*...................................................... 205,100 3,802,066 3,973,812
Methode Electronics, Inc. (Class A)..................................... 503,400 7,847,185 8,180,250
-------------- --------------
$ 20,841,207 $ 23,192,287
-------------- --------------
ENTERTAINMENT -- 3.3%
Carnival Corporation (Class A).......................................... 254,200 $ 5,653,917 $ 14,076,325
-------------- --------------
</TABLE>
6
<PAGE>
PORTFOLIO OF INVESTMENTS
December 31, 1997
<TABLE>
<CAPTION>
Shares or
Face
COMMON STOCKS (CONTINUED) Amount Cost Value
- ------------------------------------------------------------------------ ----------- -------------- --------------
<S> <C> <C> <C>
CONSUMER DURABLE GOODS -- 3.1%
Cooper Tire & Rubber Company............................................ 445,400 $ 10,174,718 $ 10,856,625
Juno Lighting, Inc...................................................... 144,100 2,057,039 2,521,750
-------------- --------------
$ 12,231,757 $ 13,378,375
-------------- --------------
BANKING -- 3.0%
Norwest Corporation..................................................... 165,176 $ 2,329,752 $ 6,379,923
Wells Fargo & Company................................................... 18,366 4,585,983 6,234,109
-------------- --------------
$ 6,915,735 $ 12,614,032
-------------- --------------
INSURANCE -- 2.9%
Poe & Brown, Inc........................................................ 172,900 $ 4,295,785 $ 7,715,662
Progressive Corporation, The............................................ 37,800 1,463,042 4,531,275
-------------- --------------
$ 5,758,827 $ 12,246,937
-------------- --------------
TOTAL COMMON STOCKS -- 77.7%............................................ $ 229,168,054 $ 330,879,233
-------------- --------------
PREFERRED STOCKS
REAL ESTATE INVESTMENT TRUST -- 1.9%
Crown America Realty Trust.............................................. 39,000 $ 1,951,792 $ 2,037,750
Excel Realty Trust, Inc., Cvt........................................... 200,000 5,000,000 6,068,750
-------------- --------------
$ 6,951,792 $ 8,106,500
-------------- --------------
FINANCIAL SERVICES -- 0.5%
Phoenix Duff & Phelps Corporation (Series A), Cvt....................... 75,000 $ 1,851,805 $ 2,146,875
-------------- --------------
TOTAL PREFERRED STOCKS -- 2.4%.......................................... $ 8,803,597 $ 10,253,375
-------------- --------------
CONVERTIBLE BONDS AND DEBENTURES
REAL ESTATE INVESTMENT TRUST -- 2.1%
Alexander Haagen Properties (Series A) -- 7 1/2% 2001................... $ 1,050,000 $ 916,125 $ 1,064,438
Alexander Haagen Properties (Series B) -- 7 1/2% 2001................... 2,750,000 2,459,375 2,722,500
Developers Diversified Realty Corporation -- 7% 1999.................... 2,500,000 2,430,625 2,837,500
Rockefeller Center Properties, Inc. -- 0% 2000.......................... 3,005,000 2,176,440 2,156,087
-------------- --------------
$ 7,982,565 $ 8,780,525
-------------- --------------
PRODUCER DURABLE GOODS -- 2.0%
DRS Technologies, Inc.
-- 8 1/2% 1998........................................................ $ 719,000 $ 627,328 $ 740,570
-- 9% 2003............................................................ 2,000,000 2,000,000 3,240,000
Reptron Electronics, Inc. -- 6 3/4% 2004................................ 5,980,000 5,798,575 4,664,400
-------------- --------------
$ 8,425,903 $ 8,644,970
-------------- --------------
HEALTH CARE -- 1.5%
IVAX Corporation -- 6 1/2% 2001......................................... $ 1,500,000 $ 1,256,125 $ 1,293,750
NovaCare, Inc. -- 5 1/2% 2000........................................... 5,250,000 4,809,375 4,987,500
-------------- --------------
$ 6,065,500 $ 6,281,250
-------------- --------------
CONSUMER NON-DURABLE GOODS -- 0.4%
Bell Sports Corp. -- 4 1/4% 2000........................................ $ 2,000,000 $ 1,765,724 $ 1,695,000
-------------- --------------
TOTAL CONVERTIBLE BONDS AND DEBENTURES -- 6.0%.......................... $ 24,239,692 $ 25,401,745
-------------- --------------
</TABLE>
7
<PAGE>
PORTFOLIO OF INVESTMENTS
December 31, 1997
<TABLE>
<CAPTION>
NON-CONVERTIBLE BONDS AND DEBENTURES Face Amount Cost Value
- ------------------------------------------------------------------------ ----------- -------------- --------------
<S> <C> <C> <C>
CORPORATE -- 7.2%
Busse Broadcasting Corporation -- 11 5/8% 2000.......................... $ 2,350,000 $ 2,275,325 $ 2,526,250
DLJ Mortgage Acceptance Corp. (Series 1997-E Class B)
-- 7.5481% 2026+....................................................... 997,300 880,130 899,440
Flagstar Corporation -- 10 7/8% 2002.................................... 2,000,000 2,035,000 2,062,500
Genesco Inc. -- 10 3/8% 2003............................................ 1,150,000 1,127,000 1,193,844
GPA Delaware Inc. -- 8 3/4% 1998........................................ 2,000,000 2,012,500 2,035,000
Merrill Lynch Mortgage Investors, Inc. (Series 1992-B)
-- 8.3% 2012........................................................... 1,193,000 1,212,176 1,203,066
Pacific Lumber Company, The -- 10 1/2% 2003............................. 1,000,000 967,500 1,037,500
Plantronics, Inc. -- 10% 2001........................................... 8,470,000 8,611,244 8,904,088
Primark Corporation -- 8 3/4% 2000...................................... 6,472,000 6,303,973 6,686,385
Trump Atlantic City Associates -- 11 1/4% 2006.......................... 4,000,000 3,925,000 3,920,000
-------------- --------------
$ 29,349,848 $ 30,468,073
-------------- --------------
U.S. GOVERNMENT AND AGENCIES -- 3.1%
Federal Home Loan Bank (Floating Rate Note)
-- 4.81% 1998......................................................... $ 1,000,000 $ 1,000,000 $ 998,438
Federal Home Loan Mortgage Corporation
-- 6 1/2% 2023 (IO)................................................... 3,991,100 516,485 548,776
-- 7% 2023 (CMO)...................................................... 2,203,400 2,241,995 2,248,845
-- 8 1/2% 2024 (REMIC)................................................ 3,000,000 3,018,750 3,013,125
-- 10.15% 2006 (REMIC)................................................ 260,600 258,432 264,183
Federal National Mortgage Association (REMIC)
-- 7% 2008............................................................ 1,662,700 1,652,264 1,660,102
-- 8% 2011............................................................ 1,050,000 1,055,250 1,053,281
Government National Mortgage Association (Mobile Home)
-- 9 3/4% 2006........................................................ 255,400 271,090 269,287
-- 9 3/4% 2010........................................................ 1,465,700 1,551,429 1,545,397
-- 10 1/4% 2001-2004.................................................. 354,100 377,215 372,690
Government National Mortgage Association (REMIC)
-- 7.99125% 2010...................................................... 1,299,300 1,299,251 1,300,112
-------------- --------------
$ 13,242,161 $ 13,274,236
-------------- --------------
TOTAL NON-CONVERTIBLE BONDS
AND DEBENTURES -- 10.3%............................................... $ 42,592,009 $ 43,742,309
-------------- --------------
TOTAL INVESTMENT SECURITIES -- 96.4%.................................... $ 304,803,352 $ 410,276,662
-------------- --------------
--------------
SHORT-TERM INVESTMENTS -- 3.1%
Short-term Corporate Notes:
Coca-Cola Company, The -- 5.87% 1/9/98................................ $ 4,000,000 $ 3,994,782
MetLife Funding, Inc. -- 5.74% 2/4/98................................. 8,000,000 7,956,631
State Street Bank Repurchase Agreement -- 5% 1/2/98
(Dated 12/31/97; to be repurchased at $979,272; collateralized by U.S.
Treasury Bonds -- 7 1/4% 2016, market value $1,000,366)................ 979,000 979,136
--------------
$ 12,930,549
--------------
TOTAL INVESTMENTS -- 99.5%.............................................. $ 423,207,211
Other assets less liabilities -- 0.5%................................... 2,282,896
--------------
TOTAL NET ASSETS -- 100%................................................ $ 425,490,107
--------------
--------------
</TABLE>
* Non-income producing securities
+ Restricted security purchased without registration under the Securities Act
of 1933 pursuant to Rule 144A, which generally may be resold only to certain
institutional investors prior to registration.
See notes to financial statements.
8
<PAGE>
STATISTICAL PROFILE
(UNAUDITED)
PRINCIPAL COMMON STOCK HOLDINGS
<TABLE>
<CAPTION>
Fundamental Investment Data
------------------------------------------------------------------------------------
Earnings/Share Past 10 Years
---------------------- ------------------------------
Last 12 Yrs. EPS Total Debt % Ret. on Beg.
1987 Mos. Growth Rate Declined Capital Equity
<S> <C> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------------------
Allergan ** $ 1.57 10% 3 21% 14%
Arbor Drugs $ 0.11 0.60 18 0 7 19
Arrow Electronics (4.60) 1.99 31* 3 39 15
Bacou USA ** 1.11 ** 0 3 18
Belden ** 2.35 14* 1 35 34
Bob Evans Farms 0.68 0.95 6 3 10 10
Caraustar Industries 0.64 2.04 13 3 53 33
Carnival (Cl. A) 0.65 2.24 13 0 22 22
Channell Commercial ** 0.91 * * 0 2 24
Circuit City Stores 0.56 1.24 11 2 33 11
Cooper Tire & Rubber 0.38 1.51 15 3 24 16
Denison Int'l plc (ADR) ** 1.43 * * 0 6 40
DENTSPLY Int'l ** 1.37 * * 0 22 20
Devon Group 1.20 2.97 9 4 2 17
Donaldson 0.18 2.08 19 0 17 23
Expeditors Int'l Wash. 0.25 1.26 20 1 15 24
Federal Signal 0.32 1.29 15 1 49 22
Franklin Covey ** 1.82 14* 1 22 17
Galileo Int'l ** 1.44 * * 0 38 23
Graco 0.68 2.56 14 2 7 34
Holophane ** 1.57 * * 0 15 29
IDEX ** 1.78 15* 1 52 27
Juno Lighting 0.54 1.10 7 2 2 13
Kaydon 0.50 1.86 14 1 0 27
KEMET ** 1.48 28* 1 29 24
Kennametal 0.85 2.81 12 2 16 16
Lancaster Colony 0.50 3.24 20 0 8 27
Landauer 0.49 1.45 11 0 0 49
Leggett & Platt 0.56 2.08 14 3 30 23
Manpower ** 1.96 31* 0 29 29
Methode Electronics 0.16 1.10 22 1 0 21
Newell 0.34 1.82 18 0 46 19
Norwest (0.11) 1.75 17 0 76 22
Nucor 0.60 3.42 20 3 9 20
OM Group ** 1.78 17* 0 37 19
O'Reilly Automotive ** 1.06 * * 0 7 15
Poe & Brown ** 2.22 11* 2 11 29
Progressive 0.99 4.66 16 3 27 19
Toys "R" Us 0.69 1.77 10 1 30 14
TriMas ** 1.77 15* 0 12 17
Tupperware ** 1.83 * * 1 55 38
Viking Office Products ** 0.87 37* 0 0 23
Wells Fargo 0.52 17.95 12 3 46 12
- -------------------------------------------------------------------------------------------------------------------------
Source Portfolio 17 1 25 21
Dow Jones Industrials 9 2 43 25
S&P Industrials 9 2 54 20
- -------------------------------------------------------------------------------------------------------------------------
* 5 to 9-year growth rate
**Comparable data not available
<CAPTION>
----------------------------------------------------------------
1996-97
Year-End Price Price/ Book
Price Range P/E Ratio Value Div. Yield
<S> <C> <C> <C> <C> <C>
- -----------------------------------
Allergan $ 34 $26-42 21.4x 2.6x 1.5%
Arbor Drugs 18 8-20 30.8 5.0 1.3
Arrow Electronics 32 18-36 16.3 2.4 0.0
Bacou USA 17 15-19 15.8 2.5 0.0
Belden 35 24-40 15.0 4.0 0.6
Bob Evans Farms 22 12-23 23.3 2.1 1.4
Caraustar Industries 34 19-38 16.8 4.4 1.9
Carnival (Cl. A) 55 23-56 24.7 4.7 1.1
Channell Commercial 12 9-17 13.7 2.6 0.0
Circuit City Stores 36 25-46 28.7 2.1 0.4
Cooper Tire & Rubber 24 18-28 16.1 2.4 1.6
Denison Int'l plc (ADR) 17 16-21 12.1 3.8 0.0
DENTSPLY Int'l 30 19-32 22.3 4.1 0.7
Devon Group 46 23-49 15.5 2.2 0.0
Donaldson 45 24-55 21.7 4.5 0.4
Expeditors Int'l Wash. 38 11-49 30.6 6.3 0.3
Federal Signal 22 20-28 16.8 3.4 3.3
Franklin Covey 22 17-29 12.1 1.5 0.0
Galileo Int'l 28 22-29 19.2 4.4 0.9
Graco 37 18-40 14.6 4.4 1.8
Holophane 25 14-26 15.8 4.0 0.0
IDEX 35 20-37 19.6 4.4 1.5
Juno Lighting 17 13-20 15.9 1.9 2.1
Kaydon 33 14-35 17.5 3.8 1.1
KEMET 19 15-31 13.1 2.7 0.0
Kennametal 52 28-56 18.4 2.5 1.3
Lancaster Colony 56 33-58 17.4 4.3 1.4
Landauer 28 19-28 19.3 8.9 4.6
Leggett & Platt 42 21-48 20.1 3.8 1.3
Manpower 35 24-50 18.0 4.7 0.5
Methode Electronics 16 12-27 14.8 2.8 1.2
Newell 42 25-44 23.4 4.1 1.5
Norwest 39 15-39 22.1 4.2 1.7
Nucor 48 45-63 14.1 2.5 0.8
OM Group 37 22-42 20.6 2.8 0.9
O'Reilly Automotive 26 14-28 24.8 3.3 0.0
Poe & Brown 45 23-47 20.1 5.1 1.3
Progressive 120 40-121 26.9 4.2 0.2
Toys "R" Us 31 20-38 17.8 2.2 0.0
TriMas 34 17-34 19.4 2.7 0.8
Tupperware 28 22-56 15.2 7.1 3.2
Viking Office Products 22 13-34 25.1 5.1 0.0
Wells Fargo 339 203-350 18.9 2.3 1.5
- -----------------------------------
Source Portfolio 18.2 3.4 1.1
Dow Jones Industrials 7908.25 20.5 5.6 1.7
S&P Industrials 1121.38 23.7 6.7 1.5
- -----------------------------------
* 5 to 9-year growth rate
**Comparable data not available
</TABLE>
9
<PAGE>
MAJOR PORTFOLIO CHANGES
(UNAUDITED)
Quarter Ended December 31, 1997
<TABLE>
<CAPTION>
Shares or
Face Amount
----------------
<S> <C>
NET PURCHASES
COMMON STOCKS
Belden Inc.................................................................................................. 20,700 shs.
Channell Commercial Corporation(1).......................................................................... 215,000 shs.
Circuit City Stores, Inc.................................................................................... 64,100 shs.
Cooper Tire & Rubber Company................................................................................ 57,400 shs.
Galileo International, Inc.................................................................................. 263,100 shs.
KEMET Corporation(1)........................................................................................ 205,100 shs.
Manpower Inc................................................................................................ 80,100 shs.
Methode Electronics, Inc. (Class A)......................................................................... 35,400 shs.
Nucor Corporation........................................................................................... 45,300 shs.
O'Reilly Automotive, Inc.................................................................................... 16,200 shs.
CONVERTIBLE SECURITIES
Bell Sports Corp. -- 4 1/4% 2000............................................................................ $ 1,380,000
Reptron Electronics, Inc. -- 6 3/4% 2004.................................................................... $ 1,695,000
NET SALES
COMMON STOCKS
Allergan, Inc............................................................................................... 25,000 shs.
Arbor Drugs, Inc............................................................................................ 178,400 shs.
Arrow Electronics, Inc...................................................................................... 15,000 shs.
Bandag, Incorporated(2)..................................................................................... 192,000 shs.
Bob Evans Farms, Inc........................................................................................ 114,300 shs.
Carnival Corporation (Class A).............................................................................. 30,200 shs.
DENTSPLY International Inc.................................................................................. 15,000 shs.
Donaldson Company, Inc...................................................................................... 35,600 shs.
IDEX Corporation............................................................................................ 25,000 shs.
Lancaster Colony Corporation................................................................................ 20,000 shs.
Leggett & Platt, Incorporated............................................................................... 10,000 shs.
Newell Co................................................................................................... 12,000 shs.
Norwest Corporation......................................................................................... 15,000 shs.
OM Group, Inc............................................................................................... 10,000 shs.
Poe & Brown, Inc............................................................................................ 10,000 shs.
Progressive Corporation, The................................................................................ 3,000 shs.
Viking Office Products, Inc................................................................................. 15,000 shs.
Wells Fargo & Company....................................................................................... 2,000 shs.
</TABLE>
(1) Indicates new commitment to portfolio
(2) Indicates elimination from portfolio
10
<PAGE>
FEDERAL INCOME TAX INFORMATION
(UNAUDITED)
CALENDAR 1997
CASH DIVIDENDS AND DISTRIBUTIONS:
<TABLE>
<CAPTION>
(1) (2)
ORDINARY LONG-TERM
AMOUNT PAID INCOME CAPITAL GAIN
DATE PAID PER SHARE DIVIDENDS DISTRIBUTIONS
- -------------------------------------------------------- ----------- ----------- -------------
<S> <C> <C> <C>
PREFERRED STOCK:
03/15/97 $ 0.60 $ 0.60 --
06/15/97 0.60 0.60 --
09/15/97 0.60 0.60 --
12/15/97 0.60 0.60 --
----------- ----------- ------
TOTAL $ 2.40 $ 2.40 --
----------- ----------- ------
----------- ----------- ------
COMMON STOCK:
03/15/97 $ 0.925 $ 0.925 --
06/15/97 0.925 -- $ 0.925
09/15/97 1.000 -- 1.000
12/15/97 1.000 -- 1.000
12/15/97 (special year-end) 2.230 -- 2.230
----------- ----------- ------
TOTAL $ 6.080 $ 0.925 $ 5.155
----------- ----------- ------
----------- ----------- ------
</TABLE>
The amount in column (1) is to be included as dividend income on your tax
return. For corporate shareholders, 30.9% 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. In
accordance with the provisions of the Taxpayer Relief Act of 1997, 46.7% of the
amounts in column (2) qualify as 20% rate gain distributions and the remaining
53.3% of the amounts in column (2) qualify as 28% rate gain distributions.
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 1997 tax
returns. Source Capital had no undistributed long-term capital gains at
year-end. Therefore, Common shareholders will not receive a Form 2439 for 1997.
- --------------------------------------------------------------------------------
NOTICE TO DIVIDEND REINVESTMENT PLAN PARTICIPANTS:
The information above shows the cash distributions paid by Source Capital
during 1997. 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 March 15, 1997 and December 15, 1997 were
reinvested at a discount from the market price and the additional taxable amount
of these distributions is equivalent to $0.02483 and $0.59000, respectively, per
Common share received.
11
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
December 31, 1997
------------------------------
<S> <C> <C>
ASSETS
Investments at value:
Investment securities -- at market value
(cost $304,803,352) -- Note A.......................................................... $ 410,276,662
Short-term corporate notes -- at cost plus interest earned
(maturities 60 days or less) -- Note A................................................. 12,930,549 $ 423,207,211
--------------
Cash....................................................................................... 608
Receivable for:
Dividends and accrued interest........................................................... $ 2,067,154
Investment securities sold............................................................... 736,756 2,803,910
-------------- --------------
$ 426,011,729
LIABILITIES
Payable for:
Advisory fees............................................................................ $ 245,726
Accrued dividends -- Preferred Stock..................................................... 196,921
Accrued expenses......................................................................... 78,975 521,622
-------------- --------------
TOTAL NET ASSETS -- December 31, 1997........................................................ $ 425,490,107
--------------
--------------
Assets applicable to Preferred Stock at a liquidation preference of
$27.50 per share (asset coverage 786%) -- Note B......................................... $ 54,153,330
--------------
--------------
Net assets applicable to Common Stock -- $50.20 per share.................................. $ 371,336,777
--------------
--------------
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 7,397,259 shares -- Note B................................................... 7,397,259
Additional Paid-in Capital................................................................. 297,320,189
Undistributed net investment income........................................................ 4,224,707
Undistributed net realized gain on investments............................................. 5,167,006
Unrealized appreciation of investments..................................................... 105,473,310
--------------
TOTAL NET ASSETS -- December 31, 1997........................................................ $ 425,490,107
--------------
--------------
</TABLE>
See notes to financial statements.
12
<PAGE>
STATEMENT OF OPERATIONS
<TABLE>
<S> <C> <C> <C> <C>
For the year ended December 31,
----------------------------------------------------
1997 1996
------------------------- -------------------------
INVESTMENT INCOME
Income:
Interest............................................ $ 7,319,925 $ 8,241,608
Dividends........................................... 4,213,053 4,519,900
----------- -----------
$11,532,978 $12,761,508
Expenses -- Note C:
Advisory fees....................................... $ 2,836,701 $ 2,602,494
Transfer agent fees and expenses.................... 239,812 245,734
Reports to shareholders............................. 218,100 161,717
Directors' fees and expenses........................ 80,320 81,846
Custodian fees and expenses......................... 48,613 50,981
Taxes, other than federal income tax................ 65,840 65,820
Legal and auditing fees............................. 38,285 52,228
Registration and filing fees........................ 16,330 20,408
Other expenses...................................... 30,458 3,574,459 31,175 3,312,403
------------ ----------- ------------ -----------
Net investment income -- Note A................. $ 7,958,519 $ 9,449,105
----------- -----------
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)....................... $124,684,468 $180,179,950
Cost of investment securities sold.................. 81,799,856 135,203,285
------------ ------------
Net realized gain on investments -- Notes A and
D............................................... $42,884,612 $44,976,665
Unrealized appreciation of investments:
Unrealized appreciation at beginning of year........ $ 71,695,457 $ 57,002,661
Unrealized appreciation at end of year.............. 105,473,310 71,695,457
------------ ------------
Increase in unrealized appreciation of
investments..................................... 33,777,853 14,692,796
----------- -----------
Net realized and unrealized gain on
investments................................... $76,662,465 $59,669,461
----------- -----------
NET INCREASE IN TOTAL NET
ASSETS RESULTING FROM OPERATIONS...................... $84,620,984 $69,118,566
----------- -----------
----------- -----------
</TABLE>
See notes to financial statements.
13
<PAGE>
STATEMENT OF CHANGES IN TOTAL NET ASSETS
<TABLE>
<CAPTION>
For the year ended December 31,
------------------------------------------------------
1997 1996
-------------------------- --------------------------
<S> <C> <C> <C> <C>
INCREASE IN TOTAL NET ASSETS
Operations:
Net investment income................. $ 7,958,519 $ 9,449,105
Net realized gain on investments
-- Notes A and D.................... 42,884,612 44,976,665
Increase in unrealized appreciation of
investments......................... 33,777,853 14,692,796
------------ ------------
Increase in total net assets resulting
from operations....................... $ 84,620,984 $ 69,118,566
Distributions to Preferred shareholders:
From net investment income............ (4,726,109) (4,726,109)
Distributions to Common shareholders:
From net investment income............ $ (2,329,594) $ (3,718,587)
From net realized capital gains....... (42,080,024) (44,409,618) (40,614,247) (44,332,834)
------------ ------------
Proceeds from shares issued for
distributions reinvested by
shareholders -- Note B................ 7,858,423 --
------------ ------------
Increase in total net assets............ $ 43,343,680 $ 20,059,623
TOTAL NET ASSETS
Beginning of year, including
undistributed net investment income
of $3,321,891 and $2,317,482.......... 382,146,427 362,086,804
------------ ------------
End of year, including
undistributed net investment income
of $4,224,707 and $3,321,891.......... $425,490,107 $382,146,427
------------ ------------
------------ ------------
</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
--------------------------
<S> <C> <C> <C>
Amount Net
Paid Investment Net Realized
Date Paid Per Share Income Capital Gains
- -------------------------- --------- ---------- -------------
3/15/97 $0.925 $0.319 $0.606
6/15/97 0.925 -- 0.925
9/15/97 1.000 -- 1.000
12/15/97 1.000 -- 1.000
12/15/97(special) 2.230 -- 2.230
--------- ---------- ------
$6.080 $0.319 $5.761
--------- ---------- ------
--------- ---------- ------
</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>
FINANCIAL HIGHLIGHTS
Selected data for a share of Common Stock outstanding throughout each year
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Per share operating performance:
Net asset value at beginning of year..................................... $ 45.35 $ 42.58 $ 38.52 $ 41.85 $ 42.87
--------- --------- --------- --------- ---------
Net investment income.................................................... $ 1.08 $ 1.30 $ 1.48 $ 1.62 $ 1.94
Net realized and unrealized gain (loss)
on investment securities............................................... 10.50 8.25 6.84 (0.67) 1.32
--------- --------- --------- --------- ---------
Total from investment operations....................................... $ 11.58 $ 9.55 $ 8.32 $ 0.95 $ 3.26
--------- --------- --------- --------- ---------
Distributions to Preferred shareholders:
From net investment income............................................. $ (0.65) $ (0.65) $ (0.66) $ (0.69) $ (0.72)
Distributions to Common shareholders:
From net investment income............................................. (0.32) (0.51) (0.50) (1.14) (1.39)
From net realized gains................................................ (5.76) (5.62) (3.10) (2.03) (2.21)
In excess of net realized gains........................................ -- -- -- (0.02) --
From Additional Paid-in Capital........................................ -- -- -- (0.41) --
--------- --------- --------- --------- ---------
Total distributions.................................................. $ (6.73) $ (6.78) $ (4.26) $ (4.29) $ (4.32)
--------- --------- --------- --------- ---------
Effect of shares issued for distributions
reinvested by shareholders............................................. -- -- -- $ 0.01 $ 0.04
--------- --------- --------- --------- ---------
Net asset value at end of year........................................... $ 50.20 $ 45.35 $ 42.58 $ 38.52 $ 41.85
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Per share market value at end of year.................................... $ 51.06 $ 45.50 $ 41.88 $ 37.00 $ 43.25
Total investment return(1)............................................... 26.9% 24.5% 23.4% (6.5)% (1.8)%
Net asset value total return(2).......................................... 25.4% 21.9% 20.7% 0.6% 6.3%
Ratios/supplemental data:
Net assets at end of year (in thousands)............................... $425,490 $382,146 $362,087 $329,427 $330,465
Ratio of expenses to average net assets................................ 0.87% 0.89% 0.91% 0.96% 0.95%
Ratio of net income to average net assets.............................. 1.95% 2.52% 3.04% 3.36% 3.86%
Portfolio turnover rate................................................ 27.46% 41.04% 51.44% 71.39% 73.91%
Average brokerage commission per share................................. $0.0586 $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).............................................. $216.07 $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(4)........................................ $28.72 $28.50 $28.00 $27.89 $30.24
</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, June 30, September December
1997 1997 30, 1997 31, 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Total investment income.......................................... $2,832,137 $2,872,391 $2,974,098 $2,854,352
Net investment income............................................ $1,976,386 $1,967,579 $2,050,153 $1,964,401
Income available to Common....................................... $ 794,859 $ 786,052 $868,625 $782,874
Per share Common............................................... $0.11 $0.11 $0.12 $0.09
Net realized and unrealized
appreciation (depreciation).................................... $(3,801,363) $43,673,202 $34,116,727 $2,673,899
Per share Common............................................... $(0.52) $5.98 $4.67 $0.37
<CAPTION>
Quarter ended
------------------------------------------
March 31, June 30, September December
1996 1996 30, 1996 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>
15
<PAGE>
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 written
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 and
debt and convertible securities listed on a national securities exchange for
which the over-the-counter market more accurately reflects the securities'
value in the judgment of the Company's officers, are valued at the mean between
the most recent bid and asked prices or other ascertainable market value.
Short-term corporate notes with maturities of 60 days or less are valued at
cost plus interest earned, which approximates market value. Securities for
which market quotations are not readily available are valued at fair value as
determined in good faith by, or under the direction of, the Board of Directors.
2. FEDERAL INCOME TAX--No provision for federal taxes on net investment
income is considered necessary because the Company has elected to be taxed as a
"regulated investment company" under the Internal Revenue Code, and intends to
maintain this qualification and to distribute each year all of its taxable net
investment income and taxable net realized gain on investments to its
shareholders in accordance with the minimum distribution requirements of the
Code.
3. USE OF ESTIMATES--The preparation of the financial statements in
accordance with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported. Actual results
could differ from those estimates.
4. OTHER--Securities transactions are accounted for on the date the
securities are purchased or sold. Dividend income is recorded on the ex-dividend
date. Interest income and expenses are recorded on an accrual basis. Dividends
payable by the Company on the Preferred Stock are recorded on an accrual basis
and distributions payable on the Common Stock are recorded on the ex-dividend
date.
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, 1997, the Company issued 165,149 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, 1997 and 1996, the Company paid aggregate
fees of $80,000 and $81,250, respectively, to all Directors who are not
affiliated persons of the Investment Adviser. During the years ended December
31, 1997 and 1996, the Company incurred legal fees of $5,960 and $15,984,
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
The cost of purchases of investment securities (excluding short-term
corporate notes with maturities of 60 days or less) aggregated $104,354,394 and
$136,691,674 for the years ended December 31, 1997 and 1996, respectively.
Realized gains and losses are based on the specific-certificate identification
method. The cost of investment securities owned at December 31, 1997 was the
same for federal income tax and financial reporting purposes.
NOTE E--YEAR 2000 (UNAUDITED)
Like other investment companies, financial and business organizations and
individuals around the world, the Company could be adversely affected if the
computer systems used by the Adviser and other service providers do not properly
process and calculate date-related information and data from and after January
1, 2000. The Adviser is taking steps that it believes are reasonably designed to
address the Year 2000 issue with respect to computer systems that it uses and to
obtain reasonable assurances that comparable steps are being taken by the
Company's other major service providers. At this time, however, there can be no
assurance that these steps will be sufficient to avoid any adverse impact to the
Company.
NOTE F--QUARTERLY INFORMATION
See page 15 for unaudited quarterly results of investment operations.
16
<PAGE>
REPORT OF 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. (the "Company"), including the portfolio of investments, as
of December 31, 1997, 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 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, including confirmation of securities owned as of December 31, 1997,
by correspondence with the custodian and brokers. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Source
Capital, Inc. as of December 31, 1997, 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
January 20, 1998
- --------------------------------------------------------------------------------
RESULTS OF ANNUAL MEETING
Following is a list of matters voted upon and the results of those votes cast
at the annual meeting of shareholders held May 5, 1997:
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......................................................................... 5,320,193 54,455
Julio J. de Puzo, Jr....................................................................... 5,327,423 54,455
David Rees................................................................................. 5,327,052 54,455
Robert L. Rodriguez........................................................................ 5,323,635 54,455
Lawrence J. Sheehan........................................................................ 5,328,802 54,455
PREFERRED
Charles W. Stanton......................................................................... 1,448,922 21,264
Kenneth L. Trefftzs........................................................................ 1,448,630 21,264
</TABLE>
2. With respect to continuation of the Investment Advisory Agreement, a
total of 6,653,148 shares voted for, 61,152 shares voted against and
135,616 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 6,755,553 shares
voted for, 24,996 shares voted against and 69,367 shares abstained.
No broker non-votes were received with respect to any of the matters voted
upon above.
17
<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>
