<PAGE>
Semi-Annual Report
FPA New Income, Inc.
Distributor:
FPA Fund Distributors, Inc.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
March 31, 1998
<PAGE>
OFFICERS AND DIRECTORS
DIRECTORS
Donald E. Cantlay
DeWayne W. Moore
Lawrence J. Sheehan
OFFICERS
Robert L. Rodriguez, PRESIDENT AND
CHIEF INVESTMENT OFFICER
Julio J. de Puzo, Jr., EXECUTIVE VICE PRESIDENT
Eric S. Ende, VICE PRESIDENT
Janet M. Pitman, VICE PRESIDENT
J. Richard Atwood, TREASURER
Sherry Sasaki, SECRETARY
Christopher H. Thomas, ASSISTANT TREASURER
INVESTMENT ADVISER
First Pacific Advisors, Inc.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
DISTRIBUTOR
FPA Fund Distributors, Inc.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
COUNSEL
O'Melveny & Myers LLP
Los Angeles, California
CUSTODIAN & TRANSFER AGENT
State Street Bank and Trust Company
Boston, Massachusetts
SHAREHOLDER SERVICE AGENT
Boston Financial Data Services, Inc.
P.O. Box 8500
Boston, Massachusetts 02266-8500
(800) 638-3060
(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. The financial information
included in this report has been taken from the records of the Fund without
examination by independent auditors.
1
<PAGE>
LETTER TO SHAREHOLDERS
DEAR FELLOW SHAREHOLDERS:
This Semi-Annual Report covers the six-month period ended March 31, 1998.
Your Fund's net asset value (NAV) closed at $11.27. Income dividends of $0.17
were paid on October 7, 1997, and January 7, 1998, to holders of record on
September 30 and December 31, 1997, respectively. The January payment also
included a $0.02 long-term capital gains distribution.
The following table shows the average annual total return for several different
periods ended on that date for the Fund and comparative indices of securities
prices. 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
<TABLE>
<CAPTION>
PERIODS ENDED MARCH 31, 1998
1 YEAR 5 YEARS 10 YEARS
<S> <C> <C> <C>
FPA New Income, Inc.
(NAV) . . . . . . . . . . . . . . . . . . . 9.85%* 7.74%* 9.54%*
FPA New Income, Inc.
(Net of Sales Charge) . . . . . . . . . . . 4.91%++ 6.75%++ 9.04%++
Lipper Corporate Debt Fund
"A" Rated Average . . . . . . . . . . . . . 11.63% 6.65% 8.76%
Lehman Brothers Government/
Corporate Bond Index. . . . . . . . . . . . 12.39% 6.96% 8.93%
</TABLE>
The Fund's total rate of return for the six months was 3.55%* versus 4.12%
and 4.78% for the Lipper Average and the Lehman Index, respectively. For the
calendar year ended December 31, 1997, total returns were: FPA New Income, Inc.,
8.31%*; Lipper Average, 9.17%; and the Lehman Index, 9.76%.
COMMENTARY
Your Fund underperformed the Lehman Index and the Lipper Average over the past
six and twelve months, as shown above. The largest magnitude of
underperformance covers the year ended March 31, 1998. This can be explained by
the fact that bond yields fell for most of this period. As we discussed in our
September 30, 1997 shareholder letter, we have been shifting the portfolio to a
more defensive posture, which results in the portfolio participating to a lesser
degree in a rally when rates decline. We describe below why we believe our
strategy is the appropriate one.
During the past year, the yield curve shifted down in an almost parallel
fashion between the three- and thirty-year segments. Approximately 70% of this
shift occurred between March and September of 1997. During the year, we
explained why we believed the economy was likely to grow faster than consensus
expectations. This outcome did occur; however, we missed the mark on inflation
levels that were considerably less than what we were anticipating. In addition,
the Asian crisis began and consensus expectations again moved towards a much
slower economic outlook. The crisis convinced bond managers that the Federal
Reserve would not need to tighten monetary policy and that they might have to
ease rates to keep the "Asian problem" from spreading. We argued that the Asian
problem would be contained with a much smaller impact than that expected at the
time. Since then, the economy's growth rate has been far in excess of consensus
expectations. I guess you can say that we were right, but still wrong.
In the past six months, interest rates have had difficulty extending their
decline. We tried to convey this feeling in our last shareholder letter, when
we lowered our anticipated longer term Treasury yield range to the 6% to 7%
level. For a brief period, long-term Treasury yields fell to 5.65% but could
not stay there very long. Since then, they have been contained in a very narrow
range of 5.75% to 5.95%. With shorter term yields at 5.5%, an investor does not
derive much additional yield through maturity extension. This is one of the
flattest yield curves we have seen in a long time. Typically, flat yield curves
are inherently unstable. Usually, they are a precursor to either an inverted
yield curve (short rates are higher than long-term rates) or a much steeper
yield curve (short rates fall much faster than longer term rates).
We have a difficult time seeing the Federal Reserve lowering short-term
rates in the near future and thus, a steep yield curve, by way of lower
short-term rates, does not seem likely. The economy is already growing far
faster than most economic forecasts. If it were not for the Asian difficulty,
we believe the Fed would have already moved shorter term rates somewhat higher.
Fed policy has been very
- ------------------
* Does not reflect deduction of the sales charge which, if reflected, would
reduce the performance shown
++ Reflects deduction of the maximum sales charge of 4.50% of the offering
price
2
<PAGE>
stable over the past nine months, and the next six to nine months should be very
telling. If Asia does not slow U.S. economic growth materially, the Fed may be
forced to raise short-term rates in order to moderate economic growth. All
signs point to continuing growth. Unemployment rates are hovering at
twenty-five-year lows while consumer confidence levels set new highs. We also
see signs of inflation beginning to return. Wage rates are growing in excess of
4%, while health-care inflation is starting to show renewed strength. Rate
increases from health maintenance organizations are now running between 5% and
10% for the coming year. Unless corporations get significant productivity
improvements, these costs will either have to be passed on or be absorbed. In
the eighth year of an economic recovery, it does not seem likely that we will
get major productivity improvements, especially with a very low unemployment
rate. If this sounds familiar to you, we made these same arguments a year ago.
Our problem was that we were too early. It now seems more likely that these
pressures should start to destabilize the bond market.
We believe that it is more prudent to protect your capital while awaiting
better investment opportunities. Not only is one not being paid sufficiently to
take on maturity risk, credit spreads are also very tight. With a strong
economy, lenders are willing to take on greater credit risk for lower yields.
This typically occurs late in an economic cycle. We again are being very
patient in order to invest at a more opportune time.
Finally, we still believe that we are in a period of temporary fiscal
budgetary calm. One cannot pick up the newspaper without reading about the
budget surplus. We have been surprised by the magnitude of recovery, but we
still question its durability. The Federal government is having a difficult
time estimating its revenue. The surging stock market has created surprisingly
large capital gains tax receipts. We should not take them as sustainable--they
should be viewed more as a positive windfall. Until the Federal government gets
a handle on how it will deal with its growing entitlement liabilities, these
windfall revenues should be used to get a jump-start on them. What is done in
this area over the next one to three years will help determine how U.S. interest
rates shift.
Our defensive portfolio posturing has shown very tangible benefits when
interest rates have risen only a small amount. During these brief periods, your
Fund has gained considerable relative performance versus the bond market and
other high-quality bond funds. This indicates to us that the average bond fund
is either very close to or in excess of its duration benchmark. In the case of
your Fund, its portfolio duration at March 31, 1998 was 2.85 years versus 3.85
years at September 30 and 4.87 years last March 31. (The lower the duration
number, the more defensive and less volatile a portfolio is.) By comparison,
the Lehman Index's duration is approximately 5.2 years. Since September, the
portfolio's duration has dropped dramatically because of the Fund's rapid growth
as well as the changing characteristics of some of the securities held. Our
large exposure to mortgage securities makes it likely that many will prepay at a
faster rate due to the decline in interest rates. This does not come as a
surprise since many of the securities were purchased with the idea that if
interest rates got to these lower levels, we would experience higher prepayment
rates. We view this as a built-in hedge against a portfolio manager getting
more optimistic after an interest-rate decline. To help protect the portfolio
from duration extension risk should interest rates rise, we increased our
holdings of interest only, "I.O.," securities from 1.7% at September 30 to 5.5%
at March 31. These are securities whose value generally increases when interest
rates rise. They are part of the derivatives portion of the portfolio that
totals 12.8% of assets.
We continue to increase our exposure to Treasury Inflation Index Bonds.
They now represent almost 20% of the portfolio versus 10% at September 30. Our
reasons for holding these were discussed in our September shareholder letter.
After these additions, the portfolio continues to maintain its high-quality
asset mix. Government/Agency securities total 65% with 64% of these being in
agency mortgage-backed securities. An additional 2% is invested in AAA
mortgage-backed securities. High-yield and convertible securities represent 7%
and 5%, respectively. Short-term liquidity totals 16%.
In closing, 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
April 21, 1998
3
<PAGE>
MAJOR PORTFOLIO CHANGES
Six Months Ended March 31, 1998
<TABLE>
<CAPTION>
Shares or
Principal
Amount
------------
NET PURCHASES
NON-CONVERTIBLE BONDS & DEBENTURES
<S> <C>
Federal Home Loan Mortgage Corporation (REMIC) --7% 2010 (1). . . . . $ 16,327,009
Federal National Mortgage Association (PAC-IO-REMIC) --6% 2027 (1). . $ 47,434,722
Federal National Mortgage Association (PAC-IO-REMIC) --6% 2028 (1). . $ 30,007,000
Green Tree Financial Corporation (CMO) --6.9% 2004. . . . . . . . . . $ 1,887,596
Green Tree Financial Corporation (CMO) --7 1/2% 2005 (1). . . . . . . $ 13,560,832
Oregon Steel Mills, Inc. --11% 2003 . . . . . . . . . . . . . . . . . $ 2,300,000
Province of Ontario --11 3/4% 2013 (1). . . . . . . . . . . . . . . . $ 9,000,000
U.S. Treasury Inflation-Indexed Notes --3% 2007 . . . . . . . . . . . $ 72,763,070
CONVERTIBLE BONDS & DEBENTURES
Homebase, Inc. --5 1/4% 2004 (144A) (1) . . . . . . . . . . . . . . . $ 2,800,000
Homebase, Inc. --5 1/4% 2004 (1). . . . . . . . . . . . . . . . . . . $ 1,150,000
Read-Rite Corporation --6 1/2% 2004 (1) . . . . . . . . . . . . . . . $ 4,230,000
NET SALES
NON-CONVERTIBLE BONDS & DEBENTURES
Countrywide Funding Corporation --7% 2014 (2) . . . . . . . . . . . . $ 2,809,166
Federal Home Loan Bank (Indexed Notes) --6.55% 2003 . . . . . . . . . $ 2,672,609
Federal Home Loan Bank --6% 1999 (2). . . . . . . . . . . . . . . . . $ 11,500,000
Federal Home Loan Mortgage Corporation (PAC-REMIC) --7% 2008. . . . . $ 1,729,357
Federal Home Loan Mortgage Corporation (PAC-REMIC) --9 1/2 2019 . . . $ 3,906,718
Federal Home Loan Mortgage Corporation (REMIC) --7 1/2% 2018. . . . . $ 3,157,083
Federal National Mortgage Association (15 YR) --8 1/2% 2008 . . . . . $ 4,192,046
Federal National Mortgage Association (PAC-REMIC) --7 3/4% 2023 . . . $ 2,406,767
Federal National Mortgage Association (PAC-REMIC) --8 1/2% 2025 (2) . $ 5,273,150
Federal National Mortgage Association --0/8.62% 2022 (2) . . . . . . $ 9,500,000
Government National Mortgage Association II --8% 2027 . . . . . . . . $ 1,218,185
Government National Mortgage Association (REMIC) --7.99125% 2010. . . $ 1,658,699
Home Mac Mortgage Securities Corporation (CMO) --9.15% 2019 (2) . . . $ 3,375,719
Merrill Lynch Mortgage Investors, Inc. Class A --8.3% 2012. . . . . . $ 1,277,608
CONVERTIBLE DEBENTURE
Michaels Stores, Inc. --6 3/4% 2003 (2) . . . . . . . . . . . . . . . $ 2,000,000
CONVERTIBLE PREFERRED STOCK
Integon Corporation (2) . . . . . . . . . . . . . . . . . . . . . . . 30,000 shs.
</TABLE>
(1) Indicates new commitment to portfolio
(2) Indicates elimination from portfolio
4
<PAGE>
<TABLE>
<CAPTION>
PORTFOLIO OF INVESTMENTS
March 31, 1998
Principal
BONDS & DEBENTURES Amount Cost Value
- ---------------------------------------------------------------------- -------------- ------------- -----------
<S> <C> <C> <C>
U.S. GOVERNMENT & AGENCIES
Mortgage-Backed Securities -- 41.4%
Federal Home Loan Bank (Indexed Notes) --6.55% 2003 . . . . . . . . . $ 3,518,641 $ 3,484,810 $ 3,527,437
Federal Home Loan Mortgage Corporation (CMO)
--7 1/2% 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,000,000 7,052,500 7,026,250
--8 1/2% 2024 . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,358,122 4,385,360 4,379,912
Federal Home Loan Mortgage Corporation (PAC-REMIC)
--7% 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,975,058 10,825,589 10,982,076
--7 1/2% 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,214,888 4,268,233 4,299,270
--7 1/2% 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,600,000 1,580,000 1,602,000
--8% 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000,000 5,151,758 5,123,438
--9 1/2% 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,773,710 1,804,334 1,774,263
Federal Home Loan Mortgage Corporation (PAC-IO-CMO)
--6 1/2% 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,640,181 331,412 332,167
--7% 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000,000 1,307,567 1,570,000
Federal Home Loan Mortgage Corporation (PAC-IO-REMIC)
--6 1/2% 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,779,562 1,588,442 1,671,647
--6 1/2% 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,192,264 913,250 966,460
Federal Home Loan Mortgage Corporation (REMIC)
--7% 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,248,912 6,174,706 6,256,723
--7% 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,681,454 15,546,281 15,686,878
--7% 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,327,009 16,339,764 16,332,111
--7% 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000,000 4,487,500 4,956,250
--7 1/2% 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,500,000 3,512,813 3,504,375
--7 1/2% 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,653,680 3,654,783 3,654,821
--7 1/2% 2026 ("Z") . . . . . . . . . . . . . . . . . . . . . . . . 8,382,037 7,529,209 8,402,992
--10.15% 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,417 45,421 44,931
Federal National Mortgage Association (15 YR) --81/2% 2008. . . . . . 2,273,954 2,317,656 2,274,664
Federal National Mortgage Association (PAC-REMIC)
--7% 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,399,772 1,384,025 1,399,772
--7 3/4% 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,093,233 1,004,408 1,091,183
--8% 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,955,125 5,910,462 5,955,125
--8 1/2% 2024 . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,054,398 1,067,907 1,052,421
Federal National Mortgage Association (PAC-IO-REMIC)
--6% 2027 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,434,722 14,801,922 15,638,635
--6% 2028 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,007,000 9,939,819 10,286,775
--6 1/2% 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,824,384 1,008,759 1,064,177
--6 1/2% 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,000,000 926,311 935,625
--7% 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,308,184 194,854 203,995
--7% 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,512,446 186,788 518,828
</TABLE>
5
<PAGE>
PORTFOLIO OF INVESTMENTS
March 31, 1998
<TABLE>
<CAPTION>
Principal
BONDS & DEBENTURES--CONTINUED Amount Cost Value
- --------------------------------------------------------------------- ------------- -------------- -------------
<S> <C> <C> <C>
Federal National Mortgage Association (REMIC)
--4.85% 2022. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 18,500,000 $ 17,897,656 $ 17,921,875
--7% 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,878,699 8,778,653 8,878,699
--7% 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,406,075 6,213,893 6,386,056
--7% 2024 ("Z") . . . . . . . . . . . . . . . . . . . . . . . . . . 10,383,654 8,303,899 9,939,104
--7 1/2% 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,409,399 8,383,120 8,419,911
--7 1/2% 2024 ("Z") . . . . . . . . . . . . . . . . . . . . . . . . 15,296,547 13,900,360 15,173,499
--7 1/2% 2026 ("Z") . . . . . . . . . . . . . . . . . . . . . . . . 10,495,857 9,353,586 10,450,368
--8% 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,810,066 1,819,116 1,810,066
--8% 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,847,012 5,843,358 5,859,802
Government National Mortgage Association --7 1/2% 2023. . . . . . . . 728,369 696,503 747,489
Government National Mortgage Association II --8% 2027 . . . . . . . . 8,390,406 8,513,640 8,665,716
Government National Mortgage Association (MH)
--8 1/4% 2006-7 . . . . . . . . . . . . . . . . . . . . . . . . . . 524,155 550,246 539,880
--8 3/4% 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,134,695 1,173,510 1,188,593
--8 3/4% 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,257,055 1,299,481 1,303,409
--9% 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 836,257 872,847 878,070
--9% 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,695,160 1,786,485 1,779,918
--9 1/4% 2010-11. . . . . . . . . . . . . . . . . . . . . . . . . . 1,113,155 1,172,704 1,164,638
--9 3/4% 2005-6 . . . . . . . . . . . . . . . . . . . . . . . . . . 2,643,373 2,819,958 2,795,367
--9 3/4% 2012-13. . . . . . . . . . . . . . . . . . . . . . . . . . 1,128,043 1,215,149 1,192,905
Government National Mortgage Association (PL)
--10 1/4% 2017. . . . . . . . . . . . . . . . . . . . . . . . . . . 923,630 1,002,138 946,721
Government National Mortgage Association (REMIC)
--7.99125% 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . 789,125 789,125 789,125
------------ ------------
$241,112,070 $249,346,412
------------ ------------
OTHER U.S. GOVERNMENT & AGENCIES -- 23.6%
Tennessee Valley Authority --8% 1999. . . . . . . . . . . . . . . . . $ 3,400,000 $ 3,222,781 $ 3,530,516
U.S. Small Business Administration --9.8% 1998. . . . . . . . . . . . 266,642 268,216 268,308
U.S. Treasury Inflation-Indexed Notes --3% 2007 . . . . . . . . . . . 123,919,065 121,120,426 120,162,768
U.S. Treasury Notes --8 1/4% 2005 . . . . . . . . . . . . . . . . . . 1,800,000 1,706,250 1,888,875
U.S. Treasury Notes Strip --0% 2009 . . . . . . . . . . . . . . . . . 31,000,000 12,608,815 15,823,330
------------ ------------
$138,926,488 $141,673,797
------------ ------------
TOTAL U.S. GOVERNMENT & AGENCIES -- 65.0% $380,038,558 $391,020,209
------------ ------------
MORTGAGE BONDS
ASSET BACKED -- 4.6%
DLJ Mortgage Acceptance Corp. (Series 1997-E Class "B")
--7.5481% 2026* . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,076,405 $ 4,479,928 $ 4,635,393
Green Tree Financial Corporation (CMO)
--6.9% 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,131,808 7,094,132 7,111,749
--7 1/4% 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,560,832 13,640,290 13,522,692
</TABLE>
6
<PAGE>
PORTFOLIO OF INVESTMENTS
March 31, 1998
<TABLE>
<CAPTION>
Principal
BONDS & DEBENTURES--CONTINUED Amount Cost Value
- ---------------------------------------------------------------------- ------------ -------------- -----------
<S> <C> <C> <C>
Merrill Lynch Mortgage Investors, Inc. Class A
(backed by Manufactured Housing First Mortgages)
--8.3% 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,450,004 $ 2,453,300 $ 2,466,847
--9.2% 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,267 45,054 45,493
------------ -----------
$ 27,712,704 $27,782,174
------------ -----------
MORTGAGE BACKED -- 0.8%
Residential Funding Mortgage Securities (REMIC)
--7 3/4% 2026 . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,000,000 $ 5,078,125 $ 5,018,750
------------ -----------
TOTAL MORTGAGE BONDS -- 5.4%. . . . . . . . . . . . . . . . . . . . . $ 32,790,829 $32,800,924
------------ -----------
FOREIGN GOVERNMENT SECURITY -- 1.6%
Province of Ontario --11 3/4% 2013. . . . . . . . . . . . . . . . . . $ 9,000,000 $ 9,460,800 $ 9,499,212
------------ -----------
CORPORATE BONDS & DEBENTURES -- 6.3%
Advantica Restaurant Group, Inc. --11 1/4% 2008 . . . . . . . . . . . $10,928,038 $ 11,135,538 $ 11,638,360
Busse Broadcasting Corporation --11% 2000 . . . . . . . . . . . . . . 3,250,000 3,176,600 3,501,875
Genesco Inc. --10% 2003 . . . . . . . . . . . . . . . . . . . . . . . 1,000,000 980,000 1,035,000
Michaels Stores, Inc. --10% 2006. . . . . . . . . . . . . . . . . . . 5,000,000 4,386,113 5,575,000
Oregon Steel Mills, Inc. --11% 2003 . . . . . . . . . . . . . . . . . 3,300,000 3,501,375 3,613,500
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 9,247,500
------------ -----------
$ 35,309,076 $ 37,989,155
------------ -----------
TOTAL NON-CONVERTIBLE
BONDS & DEBENTURES -- 78.3%. . . . . . . . . . . . . . . . . . . . . $457,599,263 $471,309,500
------------ ------------
CONVERTIBLE SECURITIES
CONVERTIBLE BONDS & DEBENTURES -- 4.8%
Alexander Haagen Properties, Inc.
--7 1/2% 2001 (Class "A") . . . . . . . . . . . . . . . . . . . . . $ 3,600,000 $ 3,256,088 $ 3,618,000
--7 1/2% 2001 (Class "B") . . . . . . . . . . . . . . . . . . . . . 5,800,000 5,521,688 5,829,000
Charming Shoppes, Inc. --7 1/2% 2006. . . . . . . . . . . . . . . . . 7,000,000 6,853,250 6,702,500
DRS Technologies, Inc.
--8 1/2% 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . 852,000 615,979 861,585
--9% 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000,000 2,000,000 3,180,000
Homebase, Inc.
--5 1/4% 2004*. . . . . . . . . . . . . . . . . . . . . . . . . . . 2,800,000 2,534,000 2,898,000
--5 1/4% 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,150,000 1,037,875 1,190,250
Quantum Health Resources, Inc. --4 3/4% 2000. . . . . . . . . . . . . 1,000,000 776,250 940,000
Read-Rite Corporation --6 1/2% 2004 . . . . . . . . . . . . . . . . . 4,230,000 3,422,637 3,426,300
----------- ------------
$26,017,767 $ 28,645,635
----------- ------------
</TABLE>
7
<PAGE>
PORTFOLIO OF INVESTMENTS
March 31, 1998
<TABLE>
<CAPTION>
Shares or
Principal
CONVERTIBLE SECURITIES--CONTINUED Amount Cost Value
- ---------------------------------------------------------------------- ------------- ------------ -----------
<S> <C> <C> <C>
CONVERTIBLE PREFERRED STOCK -- 0.1%
Network Imaging Corporation . . . . . . . . . . . . . . . . . . . . . 75,000 $ 1,400,000 $ 867,188
------------ ------------
TOTAL CONVERTIBLE SECURITIES -- 4.9%. . . . . . . . . . . . . . . . . $27,417,767 $29,512,823
------------ ------------
OTHER PREFERRED STOCK -- 0.7%
Crown American Realty Trust . . . . . . . . . . . . . . . . . . . . . 78,500 $ 3,926,642 $ 4,214,469
------------ ------------
SHORT-TERM INVESTMENTS -- 7.8%
Federal National Mortgage Association (Floating Rate)
--5.433% 6/24/98. . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,000,000 $ 9,987,351 $ 9,993,000
--5.668% 11/3/98. . . . . . . . . . . . . . . . . . . . . . . . . . 11,000,000 11,000,000 10,995,171
--5.368% 5/25/99. . . . . . . . . . . . . . . . . . . . . . . . . . 5,000,000 4,992,500 4,961,500
--5.713% 6/30/99. . . . . . . . . . . . . . . . . . . . . . . . . . 10,000,000 10,000,000 9,994,000
Private Export Funding Corp. (Floating Rate)
--5.468% 2/28/98. . . . . . . . . . . . . . . . . . . . . . . . . . 11,250,000 11,248,875 11,221,875
------------ ------------
$ 47,228,726 $ 47,165,546
------------ ------------
TOTAL INVESTMENT SECURITIES -- 91.7%. . . . . . . . . . . . . . . . . $536,172,398 $552,202,338
------------ ------------
------------
OTHER SHORT-TERM INVESTMENTS -- 8.8%
Short-term Corporate Notes:
American General Financial Corporation --5.54% 4/1/98 . . . . . . . $ 3,131,000 $ 3,131,000
Ford Motor Credit Corporation --5.54% 4/2/98. . . . . . . . . . . . 20,000,000 19,996,922
American Express Credit Corporation --53/4% 4/3/98. . . . . . . . . 2,474,000 2,473,210
General Electric Financial Assurance Company
--5.54% 4/6/98. . . . . . . . . . . . . . . . . . . . . . . . . . 17,160,000 17,146,796
General Electric Capital Corporation --5.54% 4/7/98 . . . . . . . . 10,000,000 9,990,767
------------
$ 52,738,695
------------
TOTAL INVESTMENTS -- 100.5% . . . . . . . . . . . . . . . . . . . . . $604,941,033
Liabilities less other assets -- (0.5)% . . . . . . . . . . . . . . . (3,039,559)
------------
TOTAL NET ASSETS -- 100%. . . . . . . . . . . . . . . . . . . . . . . $601,901,474
------------
------------
</TABLE>
* Restricted securities 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
March 31, 1998
<TABLE>
<CAPTION>
ASSETS
<S> <C> <C>
Investments at value:
Investment securities -- at market value
(identified cost $536,172,398). . . . . . . . . . . . . . . . . $ 552,202,338
Short-term investments -- at cost plus interest earned
(maturities of 60 days or less) . . . . . . . . . . . . . . . . 52,738,695 $604,941,033
------------- ------------
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 807
Receivable for:
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,854,286
Capital Stock sold. . . . . . . . . . . . . . . . . . . . . . . . 2,518,340 8,372,626
------------- ------------
$613,314,466
LIABILITIES
Payable for:
Investment securities purchased . . . . . . . . . . . . . . . . . $ 9,939,819
Capital Stock repurchased . . . . . . . . . . . . . . . . . . . . 1,094,965
Advisory fees . . . . . . . . . . . . . . . . . . . . . . . . . . 255,120
Accrued expenses and other liabilities. . . . . . . . . . . . . . 123,088 11,412,992
------------- ------------
NET ASSETS -- equivalent to $11.27 per share on 53,431,056
shares of Capital Stock outstanding . . . . . . . . . . . . . . . . $601,901,474
------------
------------
SUMMARY OF SHAREHOLDERS' EQUITY
Capital Stock -- par value $0.01 per share; authorized
100,000,000 shares; outstanding 53,431,056 shares . . . . . . . . $ 534,310
Additional Paid-in Capital. . . . . . . . . . . . . . . . . . . . . 575,479,099
Undistributed net realized gains on investments . . . . . . . . . . 859,735
Undistributed net investment income . . . . . . . . . . . . . . . . 8,998,390
Unrealized appreciation of investments. . . . . . . . . . . . . . . 16,029,940
------------
Net assets at March 31, 1998. . . . . . . . . . . . . . . . . . . . $601,901,474
------------
------------
</TABLE>
See notes to financial statements.
9
<PAGE>
STATEMENT OF OPERATIONS
For the Six Months Ended March 31, 1998
<TABLE>
<CAPTION>
INVESTMENT INCOME
<S> <C> <C>
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 18,613,427
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215,875
------------
$ 18,829,302
EXPENSES
Advisory fees . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,408,088
Transfer agent fees and expenses. . . . . . . . . . . . . . . . . 129,355
Registration fees . . . . . . . . . . . . . . . . . . . . . . . . 83,566
Custodian fees and expenses . . . . . . . . . . . . . . . . . . . 29,734
Directors' fees and expenses. . . . . . . . . . . . . . . . . . . 18,234
Audit fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,463
Reports to shareholders . . . . . . . . . . . . . . . . . . . . . 9,266
Legal fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,758
Postage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,985
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,809
Other expenses. . . . . . . . . . . . . . . . . . . . . . . . . . 15,068 1,719,326
------------ ------------
Net investment income . . . . . . . . . . . . . . . . . . $ 17,109,976
------------
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). . . $ 86,279,662
Cost of investment securities sold. . . . . . . . . . . . . . . . 85,262,194
------------
Net realized gain on investments. . . . . . . . . . . . . . . $ 1,017,468
Unrealized appreciation of investments:
Unrealized appreciation at beginning of period. . . . . . . . . . $ 14,493,396
Unrealized appreciation at end of period. . . . . . . . . . . . . 16,029,940
------------
Increase in unrealized appreciation of investments. . . . . . 1,536,544
------------
Net realized and unrealized gain on investments . . . . . $ 2,554,012
------------
NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . $ 19,663,988
------------
------------
</TABLE>
See notes to financial statements.
10
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Six Months Ended Year Ended
March 31, 1998 September 30, 1997
-------------------------- ---------------------------
INCREASE IN NET ASSETS
<S> <C> <C> <C> <C>
Operations:
Net investment income . . . . . . . . . . . . . . . . . . . . . . . $ 17,109,976 $ 27,558,396
Net realized gain on investments. . . . . . . . . . . . . . . . . . 1,017,468 1,065,224
Increase in unrealized
appreciation of investments . . . . . . . . . . . . . . . . . . . 1,536,544 10,242,528
------------- ------------
Increase in net assets resulting
from operations . . . . . . . . . . . . . . . . . . . . . . . . . . $ 19,663,988 $ 38,866,148
Distributions to shareholders from:
Net investment income . . . . . . . . . . . . . . . . . . . . . . . $(16,408,903) $(24,604,952)
Net realized capital gains. . . . . . . . . . . . . . . . . . . . . (1,183,945) (17,592,848) (1,692,535) (26,297,487)
------------- -------------
Capital Stock transactions:
Proceeds from Capital Stock sold. . . . . . . . . . . . . . . . . . $ 121,640,872 $244,845,762
Proceeds from shares issued to
shareholders upon reinvestment
of dividends and distributions. . . . . . . . . . . . . . . . . . 15,120,278 18,444,941
Cost of Capital Stock repurchased . . . . . . . . . . . . . . . . . (66,504,633) 70,256,517 (84,582,474) 178,708,229
------------- ------------ ------------- ------------
Total increase in net assets. . . . . . . . . . . . . . . . . . . . . $ 72,327,657 $191,276,890
NET ASSETS
Beginning of period, including
undistributed net investment income
of $8,297,317 and $5,343,873. . . . . . . . . . . . . . . . . . . . 529,573,817 338,296,927
------------ ------------
End of period, including
undistributed net investment income
of $8,998,389 and $8,297,317. . . . . . . . . . . . . . . . . . . . $601,901,474 $529,573,817
------------ ------------
------------ ------------
CHANGE IN CAPITAL STOCK
OUTSTANDING
Shares of Capital Stock sold. . . . . . . . . . . . . . . . . . . . . 10,891,927 22,283,273
Shares issued to shareholders
upon reinvestment of dividends
and distributions . . . . . . . . . . . . . . . . . . . . . . . . . 1,366,001 1,697,911
Shares of Capital Stock repurchased . . . . . . . . . . . . . . . . . (5,953,316) (7,684,688)
------------ ------------
Increase in Capital Stock outstanding . . . . . . . . . . . . . . . . 6,304,612 16,296,496
------------ ------------
------------ ------------
</TABLE>
See notes to financial statements.
11
<PAGE>
FINANCIAL HIGHLIGHTS
SELECTED DATA FOR EACH SHARE OF CAPITAL STOCK
OUTSTANDING THROUGHOUT EACH PERIOD
<TABLE>
<CAPTION>
Six
Months
Ended
March Year Ended September 30,
31, -------------------------------------------------------
1998 1997 1996 1995 1994 1993
-------- -------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Per share operating performance:
Net asset value at beginning of period. . . . . . . . . . . $ 11.24 $ 10.97 $ 11.05 $ 10.52 $ 11.32 $ 10.90
------- ------- ------- ------- ------- -------
Net investment income . . . . . . . . . . . . . . . . . . . $ 0.33 $ 0.68 $ 0.68 $ 0.67 $ 0.68 $ 0.70
Net realized and unrealized gain (loss) on
investment securities . . . . . . . . . . . . . . . . . . 0.06 0.32 0.06 0.55 (0.51) 0.49
------- ------- ------- ------- ------- -------
Total from investment operations. . . . . . . . . . . . . . $ 0.39 $ 1.00 $ 0.74 $ 1.22 $ 0.17 1.19
------- ------- ------- ------- ------- -------
Less distributions:
Dividends from net investment income. . . . . . . . . . . $(0.34) $(0.68) $(0.66) $(0.69) $(0.70) $(0.70)
Distributions from net realized
capital gains . . . . . . . . . . . . . . . . . . . . . (0.02) (0.05) (0.16) -- (0.27) (0.07)
------- ------- ------- ------- ------- -------
Total distributions . . . . . . . . . . . . . . . . . . . . $(0.36) $(0.73) $(0.82) $(0.69) $(0.97) $(0.77)
------- ------- ------- ------- ------- -------
Net asset value at end of period. . . . . . . . . . . . . . $ 11.27 $ 11.24 $ 10.97 $ 11.05 $ 10.52 $ 11.32
------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- -------
Total investment return*. . . . . . . . . . . . . . . . . . 3.55% 9.54% 7.00% 12.14% 1.60% 11.42%
Ratios/supplemental data:
Net assets at end of period (in $000's) . . . . . . . . . . 601,901 529,574 338,297 207,018122,708 115,062
Ratio of expenses to average net assets . . . . . . . . . . 0.60%+ 0.59% 0.63% 0.68% 0.74% 0.73%
Ratio of net investment income to
average net assets. . . . . . . . . . . . . . . . . . . . 6.00%+ 6.37% 6.44% 6.50% 6.41% 6.48%
Portfolio turnover rate . . . . . . . . . . . . . . . . . . 39%+ 29% 16% 31% 39% 41%
</TABLE>
* Return is based on net asset value per share, adjusted for reinvestment of
distributions, and does not reflect deduction of the sales charge. The
return for the six months ended March 31, 1998 is not annualized.
+ Annualized
See notes to financial statements.
12
<PAGE>
NOTES TO FINANCIAL STATEMENTS
March 31, 1998
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 period, 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 those 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 $189,693,664 for the
six months ended March 31, 1998. Realized gains or losses are based on the
specific-certificate identification method. Cost of investment securities owned
at March 31, 1998 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
13
<PAGE>
NOTES TO FINANCIAL STATEMENTS
March 31, 1998
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 six months ended March 31, 1998, the Fund paid aggregate fees of
$18,000 to four Directors who were 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 six months ended March 31, 1998, FPA Fund Distributors, Inc.
("Distributor"), a wholly owned subsidiary of the Adviser, received $72,133 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 March 31, 1998, the Board of Directors declared a dividend from net
investment income of $0.16 per share payable April 7, 1998 to shareholders of
record on March 31, 1998. For financial statement purposes, this dividend was
recorded on the ex-dividend date, April 1, 1998.
14
