<PAGE>
FPA New Income, Inc.
ANNUAL REPORT
SEPTEMBER 30, 1997
[LOGO]
DISTRIBUTOR:
FPA FUND DISTRIBUTORS, INC.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
<PAGE>
LETTER TO SHAREHOLDERS
Dear Fellow Shareholders:
This Annual Report covers the fiscal year ended September 30, 1997. Your
Fund's net asset value (NAV) per share closed at $11.24. During the fiscal
year, income dividends totaling $0.68 and a $0.05 short-term capital gains
distribution, were paid.
The following table shows the average annual total return for several
different periods ended on that date for the Fund and several comparative
indices. The data quoted represents past performance, and an investment in the
Fund may fluctuate so that an investor's shares when redeemed may be worth more
or less than their original cost.
AVERAGE ANNUAL TOTAL RETURN
PERIODS ENDED SEPTEMBER 30, 1997
--------------------------------
1 YEAR 5 YEARS 10 YEARS
------ ------- --------
FPA New Income, Inc.
(NAV) . . . . . . . . . . . . . . . 9.54%* 8.27%* 10.37%*
FPA New Income, Inc.
(Net of Sales Charge) . . . . . . . 4.61%++ 7.28%++ 9.86%++
Lipper Corporate Debt
A Rated Fund Average. . . . . . . . 9.60% 6.70% 9.34%
Lehman Brothers Government/
Corporate Bond Index . . . . . . . . 9.60% 6.95% 9.42%
The Fund's total rate of return for the fiscal year, which reflects the
change in NAV combined with the reinvestment of dividends and distributions
paid, was 9.54%* versus 9.60% for both the Lipper Average and Lehman Brothers
Government/Corporate Bond Index, respectively. The second half fiscal year
total returns were: FPA New Income, Inc., 6.08%*; Lipper Average, 7.14%; and
the Lehman Brothers Index, 7.27%. Finally, on a calendar year-to-date basis,
the total returns were: FPA New Income, Inc., 6.67%*; the Lipper Average,
6.28%; and the Lehman Brothers Index, 6.35%.
COMMENTARY
Your Fund has recently underperformed both the Lipper Average and the
Lehman Index. Over the past year its performance has been average. This is
frustrating for us as your Fund is typically among the top performers in its
category. Why has this occurred? The short answer is that we have
positioned your Fund more defensively than the average fund or the
Lehman Index. We have done so because we believe that we are not receiving
sufficient compensation to take on either credit risk or maturity risk. The
following commentary outlines why we are employing this strategy.
The yield curve is very flat today. This means that one does not gain much
additional yield for the risk of investing in longer term bonds. Recently, the
ten-year Treasury bond yield fell to 5.85%. At that level, it provided only 35
basis points (there are 100 basis points in one percentage point) more yield
than we are currently earning on three-month commercial paper. Unless a strong
argument can be made for significantly lower short-term rates, we cannot see
longer term bond yields falling much lower.
For almost four years, we have argued that long-term Treasury bond yields
were likely to remain most of the time within a range of 6.25% to 7.50%. During
this past year, this range narrowed to 6.25% to 7.25%, with yields generally
below 6.625%. Because of the low level of yields, we were unwilling to extend
the portfolio's average maturity. When yields were higher than 7%, we did
purchase longer term securities. The rewards from this strategy have been
minimal, due to the short duration and infrequency of bond market declines and
the rapid growth of your Fund. The Fund's rapid growth diluted the maturity
extension strategy.
This defensive portfolio strategy has been a direct result of our belief
that economic growth was likely to be faster than consensus expectations, as we
discussed in our September 1996 Shareholder Letter. During the past year, real
gross domestic product grew at a rate of approximately 4.0%, a level that was
about 60% faster than the consensus forecast. In light of this, we would have
expected bond yields to have been biased upwards, but this was generally not the
case. We also anticipated that various measures of wage inflation would be
accelerating by now. The national unemployment rate continues to hover around a
twenty-five-year low. We do see pockets of wage pressures, but these have not
yet significantly impacted the total wage inflation numbers. We still believe,
however, that pressures are building in
_______________
* Does not reflect deduction of the sales charge which, if reflected, would
reduce the performance shown
++ Reflects deduction of the current maximum sales charge of 4.50% of the
offering price
1
<PAGE>
this area. Our own direct contacts with companies indicate a growing level of
labor pressures, which show up as either higher compensation demands or, more
commonly, as a difficulty in finding and attracting qualified personnel. More
industries indicate that these are growing challenges. For example, during the
past twelve months, the labor pool grew by approximately 1.6 million, while
annual job creation was at 2.7 million. This trend cannot continue indefinitely
without higher wage demands developing on a much wider scale.
We feel we may have misjudged the environment in terms of comprehensive
measures of inflation. Various indexes of inflation, such as the Consumer Price
Index or the Producer Price Index, remain benign. There has been widespread
speculation as to why this has been the case. Productivity improvement and
foreign competition frequently have been cited as the principal reasons for the
diminished levels of inflation. We believe both of these are rather soft
explanations. There is very little question that there has been a reduced level
of pricing power in broad areas of the economy. The test will come as we reach
high levels of capacity utilization of resource inputs. The September Capacity
Utilization Rate was at 84.4%; the highest level since January 1995, a period
that followed Federal Reserve monetary tightening. Essentially, the inflation
debate boils down to whether longer term it will be at the 2-2.5% or 3-3.5%
level. We seek longer term yields high enough in order to win under either
inflation scenario. This is a typical element of our investment philosophy of
"winning by not losing."
During the last week of October, global financial markets were rocked by
the events emanating from the Asia/Pacific region. Several stock markets
collapsed. Currencies that were previously linked to the dollar have been now
set free to fall to more realistic exchange values. This has resulted in an
upward escalation in interest-rate levels in those countries. A growing number
of analysts expect a slowing in global economic growth, as a result of these
economic dislocations. It is expected that these countries will use their
depreciated currency values to increase their exports; their cheaper exports may
help to contain any inflation tendencies in the system. It is estimated that
non-Japan Asia accounts for 23% of global gross domestic product. If China and
India are excluded, the Asian weight drops to 7.3%. Though significant, it does
not appear to be catastrophic. By way of comparison, Latin America accounts for
9% of world GDP. Unless this economic chaos spreads to other regions, we see
only a limited impact on the world economy.
We do think this economic disruption will likely lead to a period of
somewhat lower yield levels in the near term. During periods of economic
uncertainty, foreigners view the U.S. as a safe haven for their capital.
U.S. bond yields can be temporarily depressed because of this flight capital.
During a later stage, central banks of the troubled regions are likely to
liquidate portions of their Treasury holdings so as to support their own
domestic economies. This process can place upward pressure on the level of
Treasury yields.
In light of the above, we are somewhat torn as to what the appropriate
yield range will be going forward. We think the odds have increased that longer
term Treasury yields will be contained in a new 6% to 7% trading range for
possibly the next year to eighteen months. We think it will be difficult to
sustain longer term yields below the 6% level because of the current level of
short-term rates. We do not think Federal Reserve chairman Alan Greenspan will
lower short-term rates, in response to the international situation in Asia. The
Fed did not do so when Mexico had its problems a few years ago. With a strong
economy experiencing low unemployment rates, we do not think Greenspan would
risk re-igniting a potential demand-pull inflation with an easier monetary
policy. Longer term rates may again be biased slightly upward. A potentially
higher level of rates could occur as a result of renewed foreign economic
growth, challenges from the recently enacted budgetary agreement, and the
before-mentioned tight labor markets. Please note that virtually all of the
major expenditure cuts in the budget agreement do not occur until the final two
years--2001 and 2002. Major changes in entitlement spending are still required
in order to achieve long-term budgetary integrity. Without them, we are in only
a temporary period of budgetary calm.
Despite this long discussion of the macro-economic environment, we continue
to focus on selecting individual securities one at a time. The largest addition
to the Fund, approximately 10% of total assets, was a ten-year Treasury
Inflation Index Bond. This bond has severely underperformed its ten-year
nominal Treasury counterpart, since its introduction last February. During this
period, the ten-year nominal yield bond declined about 50 basis points while the
inflation index bond yield rose 35 basis points. As a result, we believe the
inflation index bond's embedded call option on inflation has become very cheap
and, thus, these securities should provide excellent principal protection, if
fears of renewed inflation return. Furthermore, the combined yield and
inflation accrual will also protect the portfolio from any decline in short-term
interest rates. We also added to some of our existing
less-than-investment-grade holdings. We are being very cautious in this area
because yield spreads are the narrowest they have been since the
2
<PAGE>
beginning of the decade. We did add one new high-yield holding, the senior
debt of restaurant holding company Flagstar. The company is currently in
bankruptcy, but will exit with a dramatically improved balance sheet and
interest coverage ratios some time later this year. At the price paid for them,
we will collect what should be an 11% cash yield and have the opportunity for
capital appreciation.
The portfolio continues to maintain a high-quality asset mix.
Government/Agency securities total 62% with 75% of these being agency
mortgage-backed securities. An additional 4% is invested in AAA mortgage-backed
securities. High-yield and convertible securities represent 6% and 5%,
respectively. Short-term liquidity totals 21%. On September 30, the Fund's
duration was 3.85 years versus 4.87 years at March 31. (The lower the duration
number, the more defensive and less volatile a portfolio is.) By comparison,
the Lehman Index's duration is 5.2 years.
Before closing, I would like to introduce you to a new member of our
management team, Tom Atteberry. He joined us earlier this year from Fifth Third
Bank of Ohio, where he was the head of fixed income investment. He has over
fourteen years of investment experience. We look forward to his future
contributions. Finally, we wish to thank all of our shareholders for their
support and investment in the Fund.
Respectfully submitted,
/s/ Robert L. Rodriguez
Robert L. Rodriguez, C.F.A.
President & Chief Investment Officer, October 31, 1997
- --------------------------------------------------------------------------------
HISTORICAL PERFORMANCE
CHANGE IN VALUE OF A $10,000 INVESTMENT IN FPA NEW INCOME, INC. VS.
LEHMAN BROTHERS GOVERNMENT/CORPORATE BOND INDEX AND LIPPER CORPORATE
DEBT A RATED FUND AVERAGE FROM OCTOBER 1, 1987 TO SEPTEMBER 30, 1997
[GRAPH]
<TABLE>
<CAPTION>
9/30/87 9/30/88 9/30/89 9/30/90 9/30/91 9/30/92 9/30/93 9/30/94 9/30/95 9/30/96 9/30/97
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
FPA New Income, Inc. 9,550 10,866 12,011 12,504 15,091 17,219 19,185 19,492 21,858 23,388 25,619
FPA New Income, Inc.
(NAV) 10,000 11,378 12,577 13,093 15,802 18,030 20,089 20,410 22,888 24,490 26,826
Lehman Brothers
Government/Corporate 10,000 11,280 12,557 13,406 15,528 17,581 19,597 18,784 21,479 22,446 24,602
Lipper Corporate Debt
A Rated Fund Average 10,000 11,315 12,516 13,100 15,254 17,302 19,314 18,339 20,881 21,710 24,412
</TABLE>
Past performance is not indicative of future performance. The Lehman Brothers
Government/Corporate Bond Index is a broad-based unmanaged index of all
government and corporate bonds that are investment grade with at least one year
to maturity. The Lehman Brothers Government/Corporate Bond Index does not
reflect any commissions or fees which would be incurred by an investor
purchasing the securities it represents. The Lipper Corporate Debt A Rated Fund
Average provides an additional comparison of how your Fund performed in relation
to other mutual funds with similar objectives. The Lipper data does not include
sales charges. The performance shown for FPA New Income, Inc., with an ending
value of $25,619, reflects deduction of the current maximum sales charge of 4.5%
of the offering price. In addition, since investors purchase shares of the Fund
with varying sales charges depending primarily on volume purchased, the Fund's
performance at net asset value (NAV) is also shown, as reflected by the ending
value of $26,826. The performance of the Fund and of the Averages is computed
on a total return basis which includes reinvestment of all distributions.
3
<PAGE>
MAJOR PORTFOLIO CHANGES
For the Six Months Ended September 30, 1997
Shares or
Principal
Amount
---------
NET PURCHASES
NON-CONVERTIBLE BONDS
Countrywide Funding Corporation --7% 2014 (1). . . . . . . . . . . $ 2,809,166
DLJ Mortgage Acceptance Corp. (Series 1997-E Class "B")
--7.5481% 2026 (1) . . . . . . . . . . . . . . . . . . . . . . . $ 5,100,000
Federal Home Loan Bank --6% 1999 (1) . . . . . . . . . . . . . . . $11,500,000
Federal Home Loan Mortgage Corporation (CMO) --7 1/2% 2004 (1) . . $ 7,000,000
Federal Home Loan Mortgage Corporation (PAC-REMIC)--7% 2008. . . . $ 3,637,000
Federal Home Loan Mortgage Corporation (PAC-REMIC)--8% 2019 (1). . $ 5,000,000
Federal Home Loan Mortgage Corporation (REMIC)--7 1/2% 2007. . . . $ 1,000,000
Federal Home Loan Mortgage Corporation (REMIC)--7 1/2% 2018. . . . $ 1,386,441
Federal National Mortgage Association (REMIC) --5.62% 2022 (1) . . $18,500,000
Federal National Mortgage Association (15 YR) --8 1/2% 2008 (1). . $ 6,466,000
Federal National Mortgage Association --0/8.62% 2022 (1) . . . . . $ 9,500,000
Flagstar Corporation --10 3/4% 2001 (1). . . . . . . . . . . . . . $ 3,680,000
Flagstar Corporation --10 7/8% 2002 (1). . . . . . . . . . . . . . $ 6,500,000
Trump Atlantic City Associates --11 1/4% 2006. . . . . . . . . . . $ 1,700,000
U.S. Treasury Inflation-Indexed Notes --3 3/8% 2007 (1). . . . . . $51,155,995
CONVERTIBLE DEBENTURE
Alexander Haagen Properties, Inc. (Class "B") --7 1/2% 2001. . . . $ 3,875,000
PREFERRED STOCK
Crown American Realty Trust (1). . . . . . . . . . . 78,500 shs.
NET SALES
NON-CONVERTIBLE BONDS
Federal Home Loan Mortgage Corporation (REMIC) --6 1/2% 2018 (2) . $ 1,500,000
Federal Home Loan Mortgage Corporation (REMIC) --7% 2003 (2) . . . $ 2,600,000
Federal Home Loan Mortgage Corporation (PAC-REMIC) --9 1/2% 2019 . $ 2,706,387
Federal National Mortgage Association (15 YR) --7% 2012 (2). . . . $ 9,914,094
Federal National Mortgage Association (PAC-REMIC) --8 1/2% 2025. . $ 3,035,962
Republic of Turkey Trust Certificates --0% 1998 (2). . . . . . . . $ 3,000,000
State of Israel Trust Certificate --0% 1998 (2). . . . . . . . . . $ 2,785,000
Kidder Peabody Mortgage Assets (CMO) --8.45% 2018 (2). . . . . . . $ 2,162,794
Residential Funding Mortgage Securities (REMIC) --7% 2023. . . . . $ 3,316,365
U.S. Treasury Notes --5 3/4% 1998 (2). . . . . . . . . . . . . . . $ 8,000,000
CONVERTIBLE DEBENTURE
Fabri-Centers of America, Inc. --6 1/4% 2002 (2) . . . . . . . . . $ 3,631,000
(1) Indicates new commitment to portfolio
(2) Indicates elimination from portfolio
4
<PAGE>
PORTFOLIO OF INVESTMENTS
September 30, 1997
<TABLE>
<CAPTION>
Principal
BONDS & DEBENTURES Amount Cost Value
- --------------------------------------------------------- ------------ ------------ ------------
<S> <C> <C> <C>
U.S. GOVERNMENT & AGENCIES
MORTGAGE-BACKED SECURITIES -- 46.9%
Federal Home Loan Bank (Indexed Notes) --6.55% 2003 . $ 6,191,250 $ 6,131,724 $ 6,208,663
Federal Home Loan Mortgage Corporation (CMO)
--7 1/2% 2004 . . . . . . . . . . . . . . . . . . . 7,000,000 7,052,500 7,059,063
--8 1/2% 2024 . . . . . . . . . . . . . . . . . . . 5,000,000 5,031,250 5,043,750
Federal Home Loan Mortgage Corporation (PAC-REMIC)
--7% 2008 . . . . . . . . . . . . . . . . . . . . . 13,027,000 12,846,958 13,079,922
--7 1/2% 2021 . . . . . . . . . . . . . . . . . . . 4,500,000 4,556,953 4,577,344
--7 1/2% 2022 . . . . . . . . . . . . . . . . . . . 1,600,000 1,580,000 1,576,000
--8% 2019 . . . . . . . . . . . . . . . . . . . . . 5,000,000 5,151,758 5,184,375
--9 1/2% 2019 . . . . . . . . . . . . . . . . . . . 5,680,428 5,778,504 5,742,558
Federal Home Loan Mortgage Corporation (PAC-IO-CMO)
--6 1/2% 2020 . . . . . . . . . . . . . . . . . . . 4,171,384 452,170 448,424
--7% 2020 . . . . . . . . . . . . . . . . . . . . . 8,000,000 1,530,607 1,805,000
Federal Home Loan Mortgage Corporation (PAC-IO-REMIC)
--6 1/2% 2007 . . . . . . . . . . . . . . . . . . . 16,722,123 2,071,787 2,142,522
--6 1/2% 2023 . . . . . . . . . . . . . . . . . . . 8,663,617 1,137,912 1,221,029
Federal Home Loan Mortgage Corporation (REMIC)
--7% 2007 . . . . . . . . . . . . . . . . . . . . . 6,248,912 6,174,706 6,278,204
--7% 2008 . . . . . . . . . . . . . . . . . . . . . 7,977,809 7,932,481 8,010,219
--7% 2008 . . . . . . . . . . . . . . . . . . . . . 8,326,015 8,232,347 8,354,636
--7% 2023 . . . . . . . . . . . . . . . . . . . . . 5,000,000 4,487,500 4,787,500
--7 1/2% 2007 . . . . . . . . . . . . . . . . . . . 3,500,000 3,512,813 3,526,250
--7 1/2% 2018 . . . . . . . . . . . . . . . . . . . 6,810,763 6,812,820 6,844,817
--7 1/2% 2026 ("Z") . . . . . . . . . . . . . . . . 8,074,474 7,221,645 7,690,936
--10.15% 2006 . . . . . . . . . . . . . . . . . . . 61,084 157,994 61,962
Federal National Mortgage Association (15 YR)
--8 1/2% 2008 . . . . . . . . . . . . . . . . . . . 6,466,000 6,590,268 6,528,639
Federal National Mortgage Association (PAC-REMIC)
--7% 2007 . . . . . . . . . . . . . . . . . . . . . 1,825,566 1,805,029 1,828,418
--7 3/4% 2023 . . . . . . . . . . . . . . . . . . . 3,500,000 3,215,625 3,515,313
--8% 2023 . . . . . . . . . . . . . . . . . . . . . 6,590,000 6,540,575 6,614,712
--8 1/2% 2024 . . . . . . . . . . . . . . . . . . . 1,687,000 1,708,615 1,697,544
--8 1/2% 2025 . . . . . . . . . . . . . . . . . . . 5,273,150 5,300,115 5,292,924
Federal National Mortgage Association (PAC-IO-REMIC)
--6 1/2% 2009 . . . . . . . . . . . . . . . . . . . 8,465,170 1,219,931 1,317,392
--6 1/2% 2020 . . . . . . . . . . . . . . . . . . . 6,000,000 1,085,388 1,104,375
--7% 2004 . . . . . . . . . . . . . . . . . . . . . 1,467,926 233,967 244,501
--7% 2017 . . . . . . . . . . . . . . . . . . . . . 9,649,105 475,322 814,143
</TABLE>
5
<PAGE>
PORTFOLIO OF INVESTMENTS
<TABLE>
<CAPTION>
Principal
BONDS & DEBENTURES -- CONTINUED Amount Cost Value
- --------------------------------------------------------- ------------ ------------ ------------
<S> <C> <C> <C>
Federal National Mortgage Association (REMIC)
--5.62% 2022. . . . . . . . . . . . . . . . . . . . $ 18,500,000 $ 17,897,656 $ 17,916,140
--7% 2008 . . . . . . . . . . . . . . . . . . . . . 9,534,062 9,425,977 9,548,958
--7% 2023 . . . . . . . . . . . . . . . . . . . . . 6,406,075 6,213,893 6,245,923
--7% 2024 ("Z") . . . . . . . . . . . . . . . . . . 10,027,532 7,947,777 9,184,593
--7 1/2% 2010 . . . . . . . . . . . . . . . . . . . 8,607,091 8,580,194 8,650,126
--7 1/2% 2024 ("Z") . . . . . . . . . . . . . . . . 6,378,105 5,740,294 6,272,468
--7 1/2% 2024 ("Z") . . . . . . . . . . . . . . . . 8,591,196 7,832,820 8,405,948
--7 1/2% 2026 ("Z") . . . . . . . . . . . . . . . . 10,110,731 8,968,460 9,911,676
--8% 2011 . . . . . . . . . . . . . . . . . . . . . 2,000,000 2,010,000 2,020,000
--8% 2022 . . . . . . . . . . . . . . . . . . . . . 5,847,012 5,843,358 5,841,530
Federal National Mortgage Association
--0/8.62% 2022. . . . . . . . . . . . . . . . . . . 9,500,000 9,219,267 9,216,995
Government National Mortgage Association --7 1/2% 2023 773,127 739,303 786,657
Government National Mortgage Association II
--8% 2027 . . . . . . . . . . . . . . . . . . . . . 9,608,591 9,749,717 9,899,851
Government National Mortgage Association (MH)
--8 1/4% 2006-7 . . . . . . . . . . . . . . . . . . 595,782 625,456 619,986
--8 3/4% 2006 . . . . . . . . . . . . . . . . . . . 1,218,529 1,260,209 1,270,316
--8 3/4% 2011 . . . . . . . . . . . . . . . . . . . 1,491,943 1,542,296 1,564,675
--9% 2010-11. . . . . . . . . . . . . . . . . . . . 2,803,199 2,943,624 2,943,359
--9 1/4% 2010-11. . . . . . . . . . . . . . . . . . 1,224,876 1,289,792 1,286,120
--9 3/4% 2005-6 . . . . . . . . . . . . . . . . . . 3,030,653 3,232,859 3,193,551
--9 3/4% 2012-13. . . . . . . . . . . . . . . . . . 1,319,948 1,421,842 1,390,895
Government National Mortgage Association (PL)
--10 1/4% 2017. . . . . . . . . . . . . . . . . . . 931,186 1,010,337 959,122
Government National Mortgage Association (REMIC)
--7.99125% 2010 . . . . . . . . . . . . . . . . . . 2,447,824 2,447,824 2,457,003
------------- -------------
$ 241,972,219 $ 248,187,027
------------- -------------
OTHER U.S. GOVERNMENT & AGENCIES -- 15.5%
Federal Home Loan Bank --6% 1999. . . . . . . . . . . $ 11,500,000 $ 11,472,148 $ 11,491,706
Tennessee Valley Authority --8 3/8% 1999. . . . . . . 3,400,000 3,222,781 3,537,063
U.S. Small Business Administration --9.8% 1998. . . . 266,642 268,216 268,642
U.S. Treasury Inflation-Indexed Notes --3 3/8% 2007 . 51,155,995 50,120,837 50,180,834
U.S. Treasury Notes --8 1/4% 2005 . . . . . . . . . . 1,800,000 1,706,250 1,892,250
U.S. Treasury Notes Strip --0% 2009 . . . . . . . . . 31,000,000 12,116,767 14,623,320
------------- -------------
$ 78,906,999 $ 81,993,815
------------- -------------
TOTAL U.S. GOVERNMENT & AGENCIES -- 62.4% . . . . . . $320,879,218 $ 330,180,842
------------- -------------
U.S. GOVERNMENT & AGENCY RELATED -- 0.6%
Home Mac Mortgage Securities Corporation (CMO) --9.15%
2019 (backed by U.S. Government Agency Bonds) . . . $ 3,375,719 $ 3,349,301 $ 3,350,401
------------- -------------
</TABLE>
6
<PAGE>
PORTFOLIO OF INVESTMENTS
<TABLE>
<CAPTION>
Principal
BONDS & DEBENTURES -- CONTINUED Amount Cost Value
- --------------------------------------------------------- ------------ ------------ ------------
<S> <C> <C> <C>
MORTGAGE BONDS
ASSET BACKED -- 2.6%
DLJ Mortgage Acceptance Corp. (Series 1997-E Class "B")
--7.5481% 2026+ . . . . . . . . . . . . . . . . . . $ 5,100,000 $ 4,500,750 $ 4,523,063
Green Tree Financial Corporation (CMO) --6.9% 2004. . 5,244,212 5,192,167 5,321,236
Merrill Lynch Mortgage Investors, Inc. Class A
(backed by Manufactured Housing First Mortgages)
--8.3% 2012 . . . . . . . . . . . . . . . . . . . . 3,727,612 3,732,627 3,777,702
--9.2% 2011 . . . . . . . . . . . . . . . . . . . . 87,114 86,706 88,421
------------- -------------
$ 13,512,250 $ 13,710,422
------------- -------------
MORTGAGE BACKED -- 1.6%
Countrywide Funding Corporation --7% 2014 . . . . . . $ 2,809,166 $ 2,808,727 $ 2,806,525
Residential Funding Mortgage Securities (REMIC)
--7% 2023 . . . . . . . . . . . . . . . . . . . . . 792,563 792,687 791,077
--7 3/4% 2026 . . . . . . . . . . . . . . . . . . . 5,000,000 5,078,125 5,084,375
------------- -------------
$ 8,679,539 $ 8,681,977
------------- -------------
TOTAL MORTGAGE BONDS -- 4.2%. . . . . . . . . . . . . $ 22,191,789 $ 22,392,399
------------- -------------
CORPORATE BONDS & DEBENTURES
Busse Broadcasting Corporation --11 5/8% 2000 . . . . $ 3,250,000 $ 3,176,600 $ 3,469,375
Flagstar Corporation
--10 3/4% 2001. . . . . . . . . . . . . . . . . . . 3,680,000 3,757,832 3,795,000
--10 7/8% 2002. . . . . . . . . . . . . . . . . . . 6,500,000 6,632,705 6,727,500
Genesco Inc. --10 3/8% 2003 . . . . . . . . . . . . . 1,000,000 980,000 1,042,500
Michaels Stores, Inc. --10 7/8% 2006. . . . . . . . . 5,000,000 4,386,113 5,487,500
Oregon Steel Mills, Inc. --11% 2003 . . . . . . . . . 1,000,000 1,000,000 1,108,750
Plantronics, Inc. --10% 2001. . . . . . . . . . . . . 3,248,000 3,299,575 3,377,920
Trump Atlantic City Associates --11 1/4% 2006 . . . . 9,000,000 8,829,875 8,730,000
------------- -------------
TOTAL CORPORATE BONDS & DEBENTURES -- 6.4%. . . . . . $ 32,062,700 $ 33,738,545
------------- -------------
TOTAL NON-CONVERTIBLE
BONDS & DEBENTURES -- 73.6%. . . . . . . . . . . . . $ 378,483,008 $ 389,662,187
------------- -------------
CONVERTIBLE SECURITIES
CONVERTIBLE BONDS & DEBENTURES -- 4.4%
Alexander Haagen Properties, Inc.
--7 1/2% 2001 (Class "A") . . . . . . . . . . . . . $ 3,600,000 $ 3,256,088 $ 3,604,500
--7 1/2% 2001 (Class "B") . . . . . . . . . . . . . 5,800,000 5,521,688 5,800,000
Charming Shoppes, Inc. --7 1/2% 2006. . . . . . . . . 6,500,000 6,393,250 6,955,000
DRS Technologies, Inc.
--8 1/2% 1998 . . . . . . . . . . . . . . . . . . . 852,000 615,979 869,040
--9% 2003 . . . . . . . . . . . . . . . . . . . . . 2,000,000 2,000,000 3,370,000
</TABLE>
7
<PAGE>
PORTFOLIO OF INVESTMENTS
<TABLE>
<CAPTION>
Shares or
Principal
CONVERTIBLE SECURITIES--CONTINUED Amount Cost Value
- --------------------------------------------------------- ------------ ------------ ------------
<S> <C> <C> <C>
Michaels Stores, Inc.--6 3/4% 2003 . . . . . . . . . . $ 2,000,000 $ 1,630,000 $ 2,020,000
Quantum Health Resources, Inc.--4 3/4% 2000. . . . . . 1,000,000 776,250 940,000
------------- -------------
$ 20,193,255 $ 23,558,540
------------- -------------
CONVERTIBLE PREFERRED STOCKS -- 0.5%
Integon Corporation . . . . . . . . . . . . . . . . . 30,000 $ 1,500,000 $ 2,021,250
Network Imaging Corporation . . . . . . . . . . . . . 75,000 1,400,000 571,875
------------- -------------
$ 2,900,000 $ 2,593,125
------------- -------------
TOTAL CONVERTIBLE SECURITIES -- 4.9%. . . . . . . . . $ 23,093,255 $ 26,151,665
------------- -------------
LIMITED PARTNERSHIP -- 0.0%
Jewel Recovery L.P. . . . . . . . . . . . . . . . . . 18,594 $ 9,297 $ 9,297
------------- -------------
OTHER PREFERRED STOCK -- 0.8%
Crown American Realty Trust . . . . . . . . . . . . . 78,500 $ 3,926,642 $ 4,199,750
------------- -------------
SHORT-TERM INVESTMENTS -- 5.0%
Federal National Mortgage Association (Floating Rate)
-- 5.305% 6/24/98 . . . . . . . . . . . . . . . . . $ 10,000,000 $ 9,987,351 $ 9,990,800
Federal National Mortgage Association (Floating Rate)
-- 5.24% 5/25/99. . . . . . . . . . . . . . . . . . 5,000,000 4,992,500 4,987,500
Private Export Funding Corp. (Floating Rate)
-- 5.34% 2/28/99. . . . . . . . . . . . . . . . . . 11,250,000 11,248,875 11,233,125
------------- -------------
$ 26,228,726 $ 26,211,425
------------- -------------
TOTAL INVESTMENT SECURITIES -- 84.3%. . . . . . . . . $ 431,740,928 $ 446,234,324
------------- -------------
-------------
OTHER SHORT-TERM INVESTMENTS -- 14.7%
Short-term Corporate Notes:
General Electric Capital Corporation --5.54% 10/1/97 .$ 14,000,000 $ 14,000,000
Ford Motor Credit Corporation --5.49% 10/2/97 . . . 5,132,000 5,131,217
Ford Motor Credit Corporation --5.57% 10/3/97 . . . 5,788,000 5,786,209
General Electric Company --5.65% 10/6/97. . . . . . 6,461,000 6,455,930
American General Financial Corporation --5 1/2% 10/8/97 17,709,000 17,690,061
General Electric Capital Services, Inc. --5 1/2% 10/9/97 11,000,000 10,986,556
General Electric Company --5.51% 10/10/97 . . . . . 9,234,000 9,221,280
General Electric Capital Services, Inc. --5.51% 10/17/97 8,740,000 8,718,597
-------------
$ 77,989,850
-------------
TOTAL INVESTMENTS -- 99.0%. . . . . . . . . . . . . . $ 524,224,174
Other assets less liabilities -- 1.0% . . . . . . . . 5,349,643
-------------
TOTAL NET ASSETS -- 100%. . . . . . . . . . . . . . . $ 529,573,817
-------------
-------------
</TABLE>
+ 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>
STATEMENT OF ASSETS AND LIABILITIES
September 30, 1997
<TABLE>
<S> <C> <C>
ASSETS
Investments at value:
Investment securities -- at market value
(identified cost $431,740,928). . . . . . . . . . . . . . $ 446,234,324
Short-term investments -- at cost plus interest earned
(maturities of 60 days or less) . . . . . . . . . . . . . 77,989,850 $ 524,224,174
-------------
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 880
Receivable for:
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,918,947
Capital Stock sold. . . . . . . . . . . . . . . . . . . . . 1,471,248 6,390,195
------------- -------------
$ 530,615,249
LIABILITIES
Payable for:
Capital Stock repurchased . . . . . . . . . . . . . . . . . $ 728,018
Advisory fees . . . . . . . . . . . . . . . . . . . . . . . 213,534
Accrued expenses and other liabilities. . . . . . . . . . . 99,880 1,041,432
------------- -------------
NET ASSETS -- equivalent to $11.24 per share on 47,126,444
shares of Capital Stock outstanding . . . . . . . . . . . . . $ 529,573,817
-------------
-------------
SUMMARY OF SHAREHOLDERS' EQUITY
Capital Stock -- par value $0.01 per share; authorized
100,000,000 shares; outstanding 47,126,444 shares . . . . . $ 471,264
Additional Paid-in Capital. . . . . . . . . . . . . . . . . . 505,285,628
Undistributed net realized gains on investments . . . . . . . 1,026,212
Undistributed net investment income . . . . . . . . . . . . . 8,297,317
Unrealized appreciation of investments. . . . . . . . . . . . 14,493,396
-------------
Net assets at September 30, 1997. . . . . . . . . . . . . . . $ 529,573,817
-------------
-------------
</TABLE>
See notes to financial statements.
9
<PAGE>
STATEMENT OF OPERATIONS
For the Year Ended September 30, 1997
<TABLE>
<S> <C> <C>
INVESTMENT INCOME
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . $ 29,791,165
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . 306,708
------------
$ 30,097,873
EXPENSES
Advisory fees . . . . . . . . . . . . . . . . . . . . . . . $ 2,124,397
Transfer agent fees and expenses. . . . . . . . . . . . . . 126,205
Registration fees . . . . . . . . . . . . . . . . . . . . . 102,597
Custodian fees and expenses . . . . . . . . . . . . . . . . 53,767
Directors' fees and expenses. . . . . . . . . . . . . . . . 28,662
Postage . . . . . . . . . . . . . . . . . . . . . . . . . . 28,133
Audit fees. . . . . . . . . . . . . . . . . . . . . . . . . 22,810
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . 18,031
Reports to shareholders . . . . . . . . . . . . . . . . . . 13,852
Legal fees. . . . . . . . . . . . . . . . . . . . . . . . . 7,272
Other expenses. . . . . . . . . . . . . . . . . . . . . . . 13,751 2,539,477
------------ ------------
Net investment income . . . . . . . . . . . . . . . $ 27,558,396
------------
NET REALIZED AND UNREALIZED GAIN ON
INVESTMENTS
Net realized gain on investments:
Proceeds from sales of investment securities (excluding
short-term investments with maturities of 60 days or less) $99,608,695
Cost of investment securities sold. . . . . . . . . . . . . 98,543,471
------------
Net realized gain on investments. . . . . . . . . . . . $ 1,065,224
Unrealized appreciation of investments:
Unrealized appreciation at beginning of year. . . . . . . . $ 4,250,868
Unrealized appreciation at end of year. . . . . . . . . . . 14,493,396
------------
Increase in unrealized appreciation of investments. . . 10,242,528
------------
Net realized and unrealized gain on investments . . $ 11,307,752
------------
NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . $ 38,866,148
------------
------------
</TABLE>
See notes to financial statements.
10
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Year Ended September 30,
---------------------------------------------
1997 1996
---------------------- ---------------------
<S> <C> <C> <C> <C>
INCREASE IN NET ASSETS
Operations:
Net investment income. . . . . . . . . . . $ 27,558,396 $ 16,907,824
Net realized gain on investments . . . . . 1,065,224 1,950,447
Increase (decrease) in unrealized
appreciation of investments . . . . . . . 10,242,528 (1,156,591)
------------- -------------
Increase in net assets resulting
from operations. . . . . . . . . . . . . . $ 38,866,148 $ 17,701,680
Distributions to shareholders from:
Net investment income. . . . . . . . . . . $ (24,604,952) $ (14,518,692)
Net realized capital gains . . . . . . . . (1,692,535) (26,297,487) (3,355,550) (17,874,242)
------------- -------------
Capital Stock transactions:
Proceeds from Capital Stock sold . . . . . $ 244,845,762 $ 157,921,206
Proceeds from shares issued to
shareholders upon reinvestment
of dividends and distributions . . . . . 18,444,941 12,754,692
Cost of Capital Stock repurchased. . . . . (84,582,474) 178,708,229 (39,224,350) 131,451,548
------------- ------------- ------------- -------------
Total increase in net assets . . . . . . . . $ 191,276,890 $ 131,278,986
NET ASSETS
Beginning of year, including
undistributed net investment income
of $5,343,873 and $2,954,741 . . . . . . . 338,296,927 207,017,941
------------- -------------
End of year, including
undistributed net investment income
of $8,297,317 and $5,343,873 . . . . . . . $ 529,573,817 $ 338,296,927
------------- -------------
------------- -------------
CHANGE IN CAPITAL STOCK
OUTSTANDING
Shares of Capital Stock sold . . . . . . . . 22,283,273 14,518,767
Shares issued to shareholders
upon reinvestment of dividends
and distributions. . . . . . . . . . . . . 1,697,911 1,178,442
Shares of Capital Stock repurchased. . . . . (7,684,688) (3,608,711)
------------- -------------
Increase in Capital Stock
outstanding. . . . . . . . . . . . . . . . 16,296,496 12,088,498
------------- -------------
------------- -------------
</TABLE>
See notes to financial statements.
11
<PAGE>
FINANCIAL HIGHLIGHTS
SELECTED DATA FOR EACH SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
<TABLE>
<CAPTION>
For the Year Ended September 30,
-------------------------------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Per share operating performance:
Net asset value at beginning of year . . . . $ 10.97 $ 11.05 $ 10.52 $ 11.32 $ 10.90
------- ------- ------- ------- -------
Net investment income. . . . . . . . . . . . $ 0.68 $ 0.68 $ 0.67 $ 0.68 $ 0.70
Net realized and unrealized gain (loss)
on investment securities . . . . . . . . . 0.32 0.06 0.55 (0.51) 0.49
------- ------- ------- ------- -------
Total from investment operations . . . . . . $ 1.00 $ 0.74 $ 1.22 $ 0.17 $ 1.19
------- ------- ------- ------- -------
Less distributions:
Dividends from net investment income . . . $ (0.68) $ (0.66) $ (0.69) $ (0.70) $ (0.70)
Distributions from net realized
capital gains. . . . . . . . . . . . . . (0.05) (0.16) -- (0.27) (0.07)
------- ------- ------- ------- -------
Total distributions. . . . . . . . . . . . . $ (0.73) $ (0.82) $ (0.69) $ (0.97) $ (0.77)
------- ------- ------- ------- -------
Net asset value at end of year . . . . . . . $ 11.24 $ 10.97 $ 11.05 $ 10.52 $ 11.32
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Total investment return* . . . . . . . . . 9.54% 7.00% 12.14% 1.60% 11.42%
Ratios/supplemental data:
Net assets at end of year (in $000's). . . . 529,574 338,297 207,018 122,708 115,062
Ratio of expenses to average net assets. . . 0.59% 0.63% 0.68% 0.74% 0.73%
Ratio of net investment income to
average net assets . . . . . . . . . . . . 6.37% 6.44% 6.50% 6.41% 6.48%
Portfolio turnover rate. . . . . . . . . . . 29% 16% 31% 39% 41%
*Return is based on net asset value per share, adjusted for reinvestment of
distributions, and does not reflect deduction of the sales charge.
- --------------------------------------------------------------------------------
FEDERAL TAX STATUS OF FISCAL YEAR DISTRIBUTIONS TO SHAREHOLDERS (UNAUDITED)
Ordinary Income Long-Term
Per Share --------------------------- Capital Gain
Payable Date Amount Qualifying Non-Qualifying Distribution
- -------------------------------------------- --------- ---------- -------------- ------------
October 15, 1996 . . . . . . . . . . . . . . $0.17 1.6% 98.4% -0-
January 6, 1997. . . . . . . . . . . . . . . $0.22+ 0.9% 99.1% -0-
April 15, 1997 . . . . . . . . . . . . . . . $0.17 0.7% 99.3% -0-
July 15, 1997. . . . . . . . . . . . . . . . $0.17 0.7% 99.3% -0-
</TABLE>
+ This amount includes a $0.05 short-term capital gain distribution taxable
as ordinary income. This is in addition to the $0.17 income dividend which
is also taxable as ordinary income. Even though payment was made in 1997,
this distribution was taxable to shareholders in 1996 under provisions of
the Internal Revenue Code.
Qualifying dividends refers to the amount of dividends which are designated as
qualifying for the 70% dividends received deduction applicable to corporate
shareholders.
A form 1099 will be mailed to each shareholder in January 1998 setting forth
specific amounts to be included in their 1997 tax returns.
12
<PAGE>
NOTES TO FINANCIAL STATEMENTS
September 30, 1997
NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES
The Fund is registered under the Investment Company Act of 1940 as a
diversified, open-end, management investment company. The Fund's investment
objective is to seek current income and long-term total return. The following
is a summary of significant accounting policies consistently followed by the
Fund in the preparation of its financial statements.
A. Security Valuation
Securities 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
last bid price. Unlisted securities and 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 Fund's officers, are
valued at the most recent bid price or other ascertainable market value.
Short-term investments with maturities of 60 days or less are valued at
cost plus interest earned which approximates market value.
B. Federal Income Tax
No provision for federal income tax is required because the Fund 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 to its shareholders, in accordance with the minimum distribution
requirements of the Code, all of its taxable net investment income and
taxable net realized gains on investments.
C. Securities Transactions and Related
Investment Income
Securities transactions are accounted for on the date the
securities are purchased or sold. Dividend income and distributions to
shareholders are recorded on the ex-dividend date. Interest income and
expenses are recorded on an accrual basis.
D. Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported. Actual results could differ from
these estimates.
NOTE 2 -- PURCHASES OF INVESTMENT SECURITIES
Cost of purchases of investment securities (excluding short-term
investments with maturities of 60 days or less) aggregated $295,969,087 for the
year ended September 30, 1997. Realized gains or losses are based on the
specific-certificate identification method. Cost of investment securities owned
at September 30, 1997 was the same for federal income tax and financial
reporting purposes.
NOTE 3 -- ADVISORY FEES AND OTHER
AFFILIATED TRANSACTIONS
Pursuant to an Investment Advisory Agreement, advisory fees were paid by
the Fund to First Pacific Advisors, Inc. (the "Adviser"). Under the terms of
this Agreement, the Fund pays the Adviser a monthly fee calculated at the annual
rate of 0.5% of the average daily net assets of the Fund. The Agreement
obligates the Adviser to reduce its fee to the extent necessary to reimburse
the Fund for any annual expenses (exclusive of interest, taxes, the cost of
any supplemental statistical and research information, and extraordinary
expenses such as litigation) in excess of 1 1/2% of the first $15 million and 1%
of the remaining average net assets of the Fund for the year.
For the year ended September 30, 1997, the Fund paid aggregate fees of
$28,000 to all
13
<PAGE>
Directors who are not affiliated persons of the Adviser. Legal fees were for
services rendered by O'Melveny & Myers LLP, counsel for the Fund. A Director of
the Fund is of counsel to, and a retired partner of, that firm. Certain
officers of the Fund are also officers of the Adviser and FPA Fund Distributors,
Inc.
NOTE 4 -- DISTRIBUTOR
For the year ended September 30, 1997, FPA Fund Distributors, Inc.
("Distributor"), a wholly owned subsidiary of the Adviser, received $163,881 in
net Fund share sales commissions after reallowance to other dealers. The
Distributor pays its own overhead and general administrative expenses, the
cost of supplemental sales literature, promotion and advertising.
NOTE 5 -- DISTRIBUTION TO SHAREHOLDERS
On September 30, 1997, the Board of Directors declared a dividend from net
investment income of $0.17 per share payable October 7, 1997 to shareholders of
record on September 30, 1997. For financial statement purposes, this dividend
and distribution was recorded on the ex-dividend date, October 1, 1997.
- --------------------------------------------------------------------------------
REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND
SHAREHOLDERS OF FPA NEW INCOME, INC.
We have audited the accompanying statement of assets and liabilities of FPA
New Income, Inc., including the portfolio of investments, as of September 30,
1997, the related statement of operations for the year then ended, the
statements of changes in 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 Fund'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 September 30, 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 FPA
New Income, Inc. at September 30, 1997, the results of its operations for the
year then ended, the changes in its 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
October 31, 1997
14
<PAGE>
OFFICERS AND DIRECTORS
DIRECTORS DISTRIBUTOR
Donald E. Cantlay FPA Fund Distributors, Inc.
DeWayne W. Moore 11400 West Olympic Boulevard, Suite 1200
Lawrence J. Sheehan Los Angeles, California 90064
Kenneth L. Trefftzs
COUNSEL
O'Melveny & Myers LLP
Los Angeles, California
OFFICERS
INDEPENDENT AUDITORS
Robert L. Rodriguez, PRESIDENT AND
CHIEF INVESTMENT OFFICER Ernst & Young LLP
Julio J. de Puzo, Jr., Los Angeles, California
EXECUTIVE VICE PRESIDENT
Eric S. Ende, VICE PRESIDENT
Janet M. Pitman, VICE PRESIDENT
J. Richard Atwood, TREASURER CUSTODIAN & TRANSFER AGENT
Sherry Sasaki, SECRETARY
Christopher H. Thomas, State Street Bank and Trust Company
ASSISTANT TREASURER Boston, Massachusetts
SHAREHOLDER SERVICE AGENT
INVESTMENT ADVISER Boston Financial Data Services, Inc.
First Pacific Advisors, Inc. P.O. Box 8500
11400 West Olympic Boulevard, Boston, Massachusetts 02266-8500
Suite 1200 (800) 638-3060
Los Angeles, California 90064 (617) 328-5000
This report has been prepared for the information of shareholders of FPA New
Income, Inc., and is not authorized for distribution to prospective investors
unless preceded or accompanied by a prospectus.
