<Page>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number: 811-1735
FPA NEW INCOME, INC.
(Exact name of registrant as specified in charter)
11400 WEST OLYMPIC BLVD., SUITE 1200, LOS ANGELES, CALIFORNIA 90064
(Address of principal executive offices)
J. RICHARD ATWOOD,
11400 WEST OLYMPIC BLVD., SUITE 1200, LOS ANGELES, CALIFORNIA 90064
(Name and address of agent for service)
Registrant's telephone number, including area code: 310-473-0225
Date of fiscal year end: SEPTEMBER 30
Date of reporting period: September 30, 2004
Item 1. Report to Stockholders.
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FPA NEW INCOME, INC.
ANNUAL REPORT
[FPA NEW INCOME, INC. LOGO]
DISTRIBUTOR:
FPA FUND DISTRIBUTORS, INC.
11400 WEST OLYMPIC BOULEVARD, SUITE 1200
LOS ANGELES, CALIFORNIA 90064
SEPTEMBER 30, 2004
42075
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LETTER TO SHAREHOLDERS
Dear Fellow Shareholders:
This Annual Report covers the fiscal year ended September 30, 2004. Your
Fund's net asset value (NAV) per share closed at $11.30. During the fiscal year,
your Fund distributed four income dividends totaling $0.43. There were no
capital gains distributions.
The following table shows the average annual total return for several
different periods ended September 30 for the Fund and 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.
<Table>
<Caption>
PERIODS ENDED SEPTEMBER 30, 2004
---------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 15 YEARS 20 YEARS
------- ------- -------- -------- --------
FPA New Income, Inc. (NAV) 4.16%* 7.17%* 7.35%* 8.28%* 9.48%*
FPA New Income (Net of Sales Charge) 0.51%** 6.41%** 6.96%** 8.02%** 9.29%**
Lipper Corporate Debt Funds A Rated Average 3.42% 6.66% 7.06% N/A N/A
Lehman Brothers Government/Credit Index 3.33% 7.74% 7.76% 7.97% 9.16%
</Table>
The Fund's total rate of return for the fiscal year was 4.16%* versus 3.42%
and 3.33% for the Lipper Corporate Debt Funds A Rated Average and Lehman
Brothers Government/Credit Index, respectively. For the second half of the
fiscal year, the total returns were: FPA New Income, Inc., 1.16%*; Lipper
Average, 0.33%; and the Lehman Brothers Index, 0.28%. Finally, on a calendar
year-to-date basis, the total returns were: FPA New Income, Inc., 1.96%*; the
Lipper Average 2.93%; and the Lehman Brothers Index, 3.36%.
MANAGEMENT STRUCTURE
Before discussing your Fund's performance and the business and
interest-rate outlooks, I thought it was important to bring to your attention a
change that has been made with this shareholder letter. You will note that Tom
Atteberry's name has been added to the signature page. He is now a Vice
President and Portfolio Manager of FPA New Income. This recognizes the valuable
contributions that Tom has made in the eight years that he has worked on your
Fund. It also formally recognizes his investment responsibilities. Tom has
really taken a large role in overseeing the day-to-day responsibilities of the
Fund. We work very closely together, with my attention more focused on the
strategy while Tom's is on tactics. We have rarely, if ever, disagreed about the
basic strategy. He has written a section of the shareholder letter under his
name and discusses where and how he has been focusing his attention, as well as
introducing you to a new member of the investment team, Julian Mann, who joined
the team earlier this year.
COMMENTARY
Your Fund outperformed the Lehman Index and the Lipper Index for the six-
and twelve-month periods ended September 30. This outperformance is a function
of your Fund's extraordinary defensive portfolio positioning. As of September
30, your Fund's duration, a measure of volatility, was a record low 0.98 years
versus 1.01 years at March 31 and 1.38 years at last year's fiscal year-end. All
of these measures are far shorter than what has been typical for your Fund over
the last five, ten or twenty years. In this letter, we will again discuss our
reasoning for this portfolio posturing.
During the past year, we have witnessed both sharp rises and falls in the
level of long-term interest rates. Over the past six months, we experienced the
initial tightening moves by the Federal Reserve that have led to the rise of
short-term rates (Fed Funds) from an extraordinary low 1% to the current level
of 1.75%. The yield curve (an interest-rate curve that plots yields for
maturities from three months to thirty years) flattened by 64 basis points
(there are one hundred basis points in one percent) over this period. Both
short- and longer-term yields rose, with shorter-term rates rising faster than
longer-term rates. The rise was far more dramatic between March and June,
- ----------
* Does not reflect deduction of the sales charge which, if reflected, would
reduce the performance shown
** Reflects deduction of the maximum sales charge of 3.50% of the offering price
1
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before longer-term interest rates began to decline somewhat. This curve
flattening does not come as a surprise since the slope of the yield curve was
the steepest in over one hundred years. The odds would say that it was more
likely for the yield curve to flatten than become any steeper. Because your
Fund's duration was so short, when interest rates began to rise, this shift had
little, if any, negative impact on the portfolio.
That is the good news. The bad news is that the Fund underperformed our
expectations. We have been deploying short-term liquidity into various types of
alternative agency and mortgage-backed short-term investments. (Tom Atteberry
will be discussing this in his portion of the letter.) Some of these investments
did not provide the incremental return that we had anticipated. In some cases,
they actually underperformed what would have been earned had we just stayed
invested in Treasury bills. This past year our exposure to Interest Only (IO)
securities initially helped and then hurt the Fund's performance.
Higher-than-anticipated prepayment rates essentially offset any of the typical
benefits they provide in a rising-rate environment. Since fiscal year-end,
interest rates have declined further and, therefore, our IO securities have
continued to underperform.
Our exposure to high-yield bonds and inflation-indexed notes (TIPS) helped
performance materially. High-yield bonds were our best-performing sector this
past fiscal year. In light of this, we have reduced our exposure by
approximately 50% to less than 10% of the Fund. We will likely reduce it further
because of their unattractive valuation characteristics. The base level of
yields and their average yield spreads are close to the lowest they have been in
the last twenty years and, therefore, we do not believe one is getting
compensated sufficiently for credit risk. We anticipate our exposure will likely
fall to less than 8% over the next twelve months. In the case of our TIPS
holding, we benefited from the decrease in its maturity as well as from the rise
in inflation expectations. Our holding matures in 2007; therefore, we see
minimal principal risk. In general, we do not find that the TIPS sector presents
much in the way of value. We will likely hold these securities until maturity.
As a result of the changes in the portfolio, we continue to maintain a
highly defensive structure so as to guard against the risks of rising interest
rates. As of September 30, 2004, cash and equivalents were 43.4% of net assets,
Government/Agency securities totaled 36.0%, 10.4% were in AAA- and AA-rated
securities, and securities rated AA and lower totaled 10.2%. Within the last
segment, high-yield and convertible securities equaled 9.4%.
We are again witnessing ten-year Treasury bond yields below 4% (3.97% to be
exact). After having risen to 4.87% on June 14, they have declined subsequently.
As you know, we have been expecting higher interest-rate levels. Last year we
wrote that we thought the ten-year T-bond would rise to more than 5.25% toward
the end of this year. Obviously, this does not appear to be the case. Given that
we appear to be wrong, are we or should we change our defensive portfolio
structure? If we are wrong, why don't we?
Before answering these questions, we would like to remind our shareholders
that we are guided by the principle of ROC squared. By this we mean we focus on
both the return on capital as well as the return of capital. At various times
over an interest-rate cycle, one has to shift priority between these two. We
find that most of the time the discussion revolves around return on capital.
Most fund managers are loath to have their bond portfolios structured in a way
that would be too different from their benchmark index for fear of being accused
of the mortal sins of "tracking error" and quarterly underperformance. We spend
zero time worrying about either of these. We manage your money as if it were our
own. For the past two years, our focus has been on the return of capital
component. We continue to believe that longer-term bonds provide virtually no
value and, therefore, preservation of capital is paramount in our thinking.
We believe the bond market, whether high quality or high yield, exhibits a
bubble mentality. We do not think that most fixed-income securities are
rationally priced -- in essence, we believe "The
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Emperor Has No Clothes." In light of this, we will not change the portfolio's
defensive posture. I will now spend some time explaining why we are of this
opinion.
The present level of long-term Treasury bond yields signals that bond
investors believe that there will be a sizeable reduction in economic growth and
that inflation fears will subside. There are even some who believe that we may
be on the verge of deflation again. We do not agree with any of these
assessments. If the Treasury market were appropriately priced, high-yield bonds
would appear to be inappropriately priced. A significant slowdown in economic
growth would not be good for corporate profitability and, therefore, debt
coverage ratios. High-yield securities are priced for a continued above-average
economic growth scenario. We see a dichotomy here that will have to be resolved.
Much of the fear concerning slower economic growth derives from escalating
energy prices. If one does an overlay of the change in oil prices to that of the
change in Treasury bond prices, there is a direct correlation. The bond market
believes that higher oil prices will lead to slower economic growth without any
major increase in inflation. We do not disagree that there is a partial impact
from rising energy prices. We have anticipated higher energy prices for several
years. FPA Capital Fund, an open-end equity fund that we manage, has its highest
energy exposure in twenty years. We have also written why we believed that
energy prices were likely to rise. We acknowledge that the rise this year is far
more than what we were expecting but it also came as a surprise to most energy
industry professionals. We are of the opinion that it is a short-term spike and
that energy prices will be lower next year and, therefore, if we are correct,
this would be a net benefit to economic growth. Longer-term, we are quite
optimistic that energy prices will be considerably higher than what the
consensus anticipates currently. Our internal guesstimate is nearly 45% higher
than what the commodity market has priced in for five years from now. We do not
believe that long-term bond yields are factoring in this potential inflationary
problem.
We continue to be of the opinion that the U.S. cannot continue indefinitely
with an expanding Current Account Deficit. It is rapidly approaching 6% of gross
domestic product, a record. We have to import approximately $2 billion dollars
every day of the year to keep our economy operating. Over the last three years,
the two principal buyers of our Treasury securities have been the central banks
of China and Japan. Forgive me for saying this, but I do not believe either of
these countries have our long-term best interests at heart. It is currently a
marriage of convenience in that it is in their self-interest to purchase our
bonds while we purchase their goods. Our growing dependence on them places our
economy, currency and interest rates at greater risk than if we were not in this
financially dependent position. This is another risk we feel we do not get
compensated for with the current level of interest rates.
In our March shareholder letter, we had a long discussion about the
shortcomings of how the Consumer Price Index is constructed. We showed how
different components were either underweighted or defined in a way that
understated the measurement of inflation. Our conclusion was that it was
understating inflation by approximately 1 to 1.5%. A recent study by the Federal
Reserve of Atlanta corroborated some of our calculations. My esteemed colleague
at PIMCO, Bill Gross, recently published his analysis of the CPI and came to the
same conclusion using a different methodology. If inflation is being
understated, why aren't fixed-income investors making an adjustment for this in
their valuation of Treasury bonds? We wish we knew. We can only guess that most
bond managers continue to buy longer-term bonds because they believe they cannot
risk being out of the bond market for the reasons mentioned earlier. Their
philosophy is one that revolves around the idea that they believe they are paid
to manage bonds and not cash. They may keep their portfolio durations toward the
shorter end of their benchmark range, but they will not deviate materially for
fear of missing a bond rally or being accused of benchmark tracking error.
Again, our focus is on
3
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optimizing both the return on capital as well as the return of capital over the
entire interest rate cycle.
Given these various risks, we cannot see how one is being sufficiently
compensated to place capital at risk with a 4% Treasury bond yield. If the
Treasury market is overvalued, so are all the other sectors that trade in
relation to this market via spread analysis. We cannot and will not risk your
capital when we are convinced these risks are present. In many ways, this period
reminds us of the blow-off in equities in 1999 and 2000. At that time we were
warning that there were high risks in the equity market. We see similar elements
in the bond market. We do not know when this environment will change but we do
know that when it does, it will catch most bond managers by surprise. They will
then say, "Who could have known?" Because of this, we are placing our focus on
the return of capital -- the second ROC. When bond investors realize that "The
Emperor Has No Clothes," a rapid price adjustment in bonds will occur.
We will continue our search for undervalued securities; however, we will
not compromise our standards because of outside pressures to do something. We
continue to stand by the thoughts and opinions expressed in our "Buyer's Strike"
piece published in June of last year that you may read on our website,
www.fpafunds.com. We urge you to do it. With that final comment, Tom Atteberry
will convey his thoughts to you.
THOMAS H. ATTEBERRY COMMENTARY
Over the last year your Fund has focused heavily on two sectors as
alternatives to money-market investments, callable and step-up coupon agency
notes along with short duration CMOs (Collateralized Mortgage Obligations).
The agency sector of the portfolio has averaged 11% of the portfolio the
past year. The largest component of this sector has been the step-up note
structure, for which the coupon on the bond starts out low at, say, 2% for six
months to one year. At that point the bond's coupon "steps up" either once or
periodically until it reaches levels of 4 to 8%, depending on the final maturity
of the bond. Typically, the bond is callable at those times when the coupon
steps up. The final maturity of our current holdings is between two and five
years.
Our investment thesis is that the higher coupons later in the life of the
bond would protect our principal value during the near-term rise of short-term
interest rates. Your portfolio has had mixed results with these investments.
During the accelerated run-up in interest rates in the second quarter of this
year, we discovered three holdings that, when retested for their defensive
characteristics, did not exhibit the potential for performance that we felt was
acceptable. Those holdings were sold for small losses. The sell decision was
based on the idea that it was better to take a small loss today versus a
potentially larger loss later if all interest-rate maturities continued to rise,
as was expected during the second quarter of 2004.
The other portion of the portfolio with a similar objective is the CMO
sector. Over the past year this segment has averaged 10% of the portfolio. The
bonds consist of securities that should have a weighted average life of less
than 1.75 years. The average coupon on these bonds is a little over 5.4%. Even
while mortgage prepayments have remained at an elevated level, this segment of
your Fund has achieved its goal of outperforming the money-market holdings in
the portfolio.
While we have had better investment success over the past year with the
short CMO holdings versus the agency holdings, going forward there are still
potential opportunities within the agency sector. We have also considered other
short duration instruments but to date have found very few situations that
warrant our committing your Fund's capital. It is our view that the portfolio
will continue to have 20 to 30% of its assets deployed in these short, very
defensive bonds.
At the beginning of 2003, we decided that it was in the best interest of
our shareholders to expand our fixed-income analytical staff. Over the next year
we conducted a national search to find a seasoned fixed-income professional that
would add valuable expertise to complement our current team. We
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reviewed over 200 resumes and interviewed a dozen very qualified individuals.
The result of this project was that in February of 2004 we added Julian
Mann to the research team. Julian has over 14 years of fixed-income analytical
experience and will add depth and knowledge regarding asset-backed and
mortgage-backed securities. In addition, Julian expands our quantitative and
computer analytical skills.
With those closing comments, we thank you for your continued investment and
support.
Respectfully submitted,
/s/ Robert L. Rodriguez
- -----------------------
Robert L. Rodriguez, CFA
President and Chief
Investment Officer
/s/ Thomas H. Atteberry
- -----------------------
Thomas H. Atteberry
Vice President and
Portfolio Manager
October 25, 2004
5
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HISTORICAL PERFORMANCE
[CHART]
CHANGE IN VALUE OF A $10,000 INVESTMENT IN FPA NEW INCOME, INC. VS. LEHMAN
BROTHERS GOVERNMENT/CREDIT INDEX AND LIPPER CORPORATE DEBT FUNDS A RATED AVERAGE
FROM OCTOBER 1, 1994 TO SEPTEMBER 30, 2004
FPA NEW INCOME, INC
<Table>
<Caption>
AVERAGE ANNUAL TOTAL RETURN
YEARS ENDED SEPTEMBER 30, 2004
--------------------------------
1 YEAR 5 YEARS 10 YEARS
------ ------- --------
At Net Asset Value 4.16% 7.17% 7.35%
With Maximum 3.5% Sales Charge 0.51% 6.41% 6.96%
</Table>
<Table>
<Caption>
LEHMAN LIPPER
BROTHERS CORPORATE
GOVERNMENT/ FPA NEW DEBT FUNDS
CREDIT INCOME, INC. A RATED FPA NEW
INDEX (NAV) AVERAGE INCOME, INC.
1994 $ 10,000 $ 10,000 $ 10,000 $ 9,650
1995 $ 11,438 $ 11,214 $ 11,467 $ 10,822
1996 $ 11,954 $ 11,999 $ 11,973 $ 11,579
1997 $ 13,098 $ 13,144 $ 13,178 $ 12,684
1998 $ 14,780 $ 13,832 $ 14,610 $ 13,348
1999 $ 14,540 $ 14,368 $ 14,332 $ 13,865
2000 $ 15,520 $ 15,310 $ 15,124 $ 14,774
2001 $ 17,564 $ 17,389 $ 16,879 $ 16,781
2002 $ 19,182 $ 18,055 $ 17,968 $ 17,423
2003 $ 20,431 $ 19,503 $ 19,134 $ 18,821
2004 $ 21,114 $ 20,316 $ 19,791 $ 19,605
</Table>
Past performance is not indicative of future performance. The Lehman Brothers
Government/Credit 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/Credit Index does not reflect any commissions or
fees which would be incurred by an investor purchasing the securities it
represents. The Lipper Corporate Debt Funds A Rated 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 $19,605
reflects deduction of the current maximum sales charge of 3.5% 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
$20,316. The performance of the Fund and of the Averages is computed on a total
return basis which includes reinvestment of all distributions.
6
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PORTFOLIO SUMMARY
September 30, 2004
<Table>
BONDS & DEBENTURES 69.3%
U.S. Government 16.2%
Mortgage-Backed 12.9%
Corporate 9.3%
U.S. Agencies 8.1%
Mortgage-Backed Pass-Through 2.5%
Convertible 2.3%
Asset Backed 2.3%
Derivatives - Interest Only 1.7%
International 1.0%
Short-Term U.S. Government 13.0%
PREFERRED STOCK 0.3%
SHORT-TERM CORPORATE NOTES 30.8%
OTHER ASSETS AND LIABILITIES, NET -0.4%
-----
TOTAL NET ASSETS 100.0%
=====
</Table>
MAJOR PORTFOLIO CHANGES
For the Six Months Ended September 30, 2004
(Unaudited)
<Table>
NET PURCHASES
NON-CONVERTIBLE BONDS & DEBENTURES
Bayerische Landesbank--2.3% (floating rate) 2007 (1) $ 21,000,000
Federal Home Loan Bank--2% 2007 (step-up) (1) $ 21,900,000
Federal Home Loan Bank--2% 2009 (step-up) (1) $ 22,500,000
Federal Home Loan Bank--2.06% (floating rate) 2007 (1) $ 24,650,000
Federal Home Loan Mortgage Corporation 2510 CL PV--5.25% 2026 (1) $ 22,341,170
Federal National Mortgage Association--2% 2007 (step-up) (1) $ 22,800,000
Landesbank Baden-Wuerttemberg--2.24% 2007 (1) $ 23,500,000
U.S. Treasury Inflation-Indexed Notes--3.375% 2007 $ 73,949,575
CONVERTIBLE DEBENTURE
BEA Systems, Inc.--4% 2006 (1) $ 18,000,000
NET SALES
NON-CONVERTIBLE BONDS & DEBENTURES
Federal Home Loan Bank--1.75% 2007 (step-up) (2) $ 20,000,000
Federal Home Loan Mortgage Corporation--5.75% 2009 (2) $ 30,908,000
Federal National Mortgage Association--1.6% 2007 (step-up) (2) $ 19,450,000
Qwest Capital Funding, Inc.--5.875% 2004 (2) $ 21,750,000
</Table>
(1) Indicates new commitment to portfolio
(2) Indicates elimination from portfolio
7
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PORTFOLIO OF INVESTMENTS
September 30, 2004
<Table>
<Caption>
PRINCIPAL
BONDS & DEBENTURES AMOUNT VALUE
- ------------------------------------------------------------------------------------ ----------------- ----------------
U.S. GOVERNMENT SECURITIES -- 16.2%
U.S. Treasury Inflation-Indexed Notes -- 3.125% 2007 $ 293,674,575 $ 313,864,702
----------------
MORTGAGE-BACKED SECURITIES -- 12.9%
Banc of America Alternative Loan Trust 2003-6 CL 1NC2 -- 8% 2033 $ 3,722,198 $ 3,921,931
Banc of America Mortgage Securities 2004-4 3A2 -- 6.5% 2019 9,104,271 9,559,484
Chase Mortgage Finance Trust 2003-S14 CL 3A6 -- 5.5% 2034 6,589,354 6,882,119
Chase Mortgage Finance Trust 2003-S14 CL 2A4 -- 7.5% 2034 17,475,253 18,742,908
Citicorp Mortgage Securities, Inc. 2003-4 CL A4 -- 5% 2018 7,439,457 7,518,501
Countrywide Alternative Loan Trust 2002-18 CL A2 -- 5.25% 2033 12,956,016 13,004,601
Countrywide Mortgage Securities 2003-HYB2 CL 1A1 -- 3.4% (floating rate) 2033 9,823,830 9,701,032
Countrywide Mortgage Securities 2003-36 CL A20 -- 5% 2033 2,783,197 2,782,327
Federal Home Loan Mortgage Corporation
1534 CL IA -- 3.81% (floating rate) 2023 1,000,000 1,013,125
1552 CL I -- 3.81% (floating rate) 2023 1,700,000 1,734,000
1669 CL HA -- 3.96% (floating rate) 2023 4,000,000 4,040,624
1673 CL HB -- 3.96% (floating rate) 2024 1,000,000 1,020,000
1684 CL HA -- 3.96% (floating rate) 2024 2,000,000 2,033,750
2581 CS PL -- 4% 2016 12,000,000 12,165,450
1634 CL PL -- 4.03% (floating rate) 2023 7,000,000 7,183,750
1671 CL HA -- 4.24% (floating rate) 2024 3,347,711 3,433,496
2766 CL PT -- 5% 2016 19,304,000 19,798,665
2510 CL PV -- 5.25% 2026 22,341,170 22,787,993
2462 CL CA -- 5.5% 2009 828,884 832,780
2619 CL YV -- 5.5% 2011 11,519,438 11,751,628
2525 CL BR -- 5.5% 2023 2,855,390 2,901,790
1804 CL C -- 6% 2008 1,909,849 1,962,847
1591 CL PV -- 6.25% 2023 10,502,237 10,985,445
2543 CL AD -- 8.5% 2016 293,080 312,130
2519 CL ED -- 8.5% 2030 1,005,690 1,103,745
2626 CL QM -- 9% 2018 4,030,443 4,534,877
HM-A1 -- 10.15% 2006 136 136
Federal National Mortgage Association
-- 6% 2016 598,702 615,861
-- 6.5% 2008 312,975 324,711
-- 6.5% 2017 4,201,325 4,489,494
-- 7% 2007 7,573,325 8,008,791
319 CL 18 -- 8% 2032 2,211,580 2,322,159
First Financial Mortgage Trust 9 CL A4 -- 5.8% 2008 71,405 72,119
</Table>
8
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<Table>
<Caption>
PRINCIPAL
BONDS & DEBENTURES - CONTINUED AMOUNT VALUE
- ------------------------------------------------------------------------------------ ----------------- ----------------
Government National Mortgage Association II
2308-8 CL PG -- 4% 2024 13,544,593 13,604,866
1999-47 -- 7.5% 2029 6,297,608 6,607,450
J.P. Morgan Mortgage Trust 2003-A2 -- 4% 2033 10,864,236 10,883,791
Wachovia Asset Securitization, Inc. 2002-1 CL 2A1 -- 6.25% 2033 4,529,099 4,642,326
Wells Fargo Mortgage Backed Securities Trust 2004-1CL A19 -- 5% 2034 16,763,454 16,915,163
----------------
TOTAL MORTGAGE-BACKED SECURITIES $ 250,195,865
----------------
CORPORATE BONDS & DEBENTURES -- 9.3%
Avnet Inc.
-- 7.875% 2005 $ 8,350,000 $ 8,496,125
-- 8% 2006 2,000,000 2,160,000
BE Aerospace, Inc. -- 8% 2008 10,530,000 10,372,050
Bayerische Landesbank -- 2.3% (floating rate) 2009 21,000,000 20,580,000
Collins & Aikman Products
-- 10.75% 2011 12,245,000 12,183,775
-- 12.875% 2012+ 7,245,000 6,629,175
-- 12.875% (Series B) 2012+ 3,325,000 2,975,875
International Wire Group
-- 11.75% 2005* 14,485,000 10,718,900
-- 11.75% (Series B) 2005* 900,000 666,000
Landesbank Baden-Wuerttemberg -- 2.24% 2007 23,500,000 23,218,000
Metaldyne Corporation -- 11% 2012 22,230,000 18,228,600
Michaels Stores Inc. -- 9.25% 2009 16,505,000 17,990,450
Motors & Gears Inc. -- 10.75% 2006 16,694,000 15,441,950
Northland Cable Company -- 10.25% 2007 8,645,000 8,731,450
Qwest Communications International Inc. -- 4.75% (floating rate) 2009+ 24,045,000 22,902,863
----------------
TOTAL CORPORATE BONDS & DEBENTURES $ 181,295,213
----------------
U.S. AGENCIES SECURITIES -- 8.1%
Federal Home Loan Bank
-- 2% 2007 (step-up) $ 21,900,000 $ 21,906,844
-- 2% 2007 (step-up) 10,230,000 10,223,606
-- 2% 2009 (step-up) 21,250,000 21,077,344
-- 2% 2009 (step-up) 22,500,000 22,471,875
-- 2% 2009 (step-up) 18,750,000 18,574,219
-- 2.06% (floating rate) 2007 24,650,000 24,650,000
Federal National Mortgage Association
-- 2% 2007 (step-up) 22,800,000 22,800,000
-- 5% 2007 15,440,000 15,826,000
----------------
TOTAL U.S. AGENCIES SECURITIES $ 157,529,888
----------------
</Table>
9
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<Table>
<Caption>
PRINCIPAL
BONDS & DEBENTURES -- CONTINUED AMOUNT VALUE
- ------------------------------------------------------------------------------------ ----------------- ----------------
MORTGAGE-BACKED PASS-THROUGH SECURITIES -- 2.5%
Federal National Mortgage Association
-- 5.5% 2014 $ 9,734,476 $ 10,087,351
-- 6% 2011 3,868,615 4,059,628
-- 6% 2012 17,205,815 18,055,352
-- 7% 2030 1,508,155 1,606,185
-- 7% 2031 787,109 835,406
-- 7.5% 2016 215,505 230,860
-- 7.5% 2016 114,293 122,436
-- 7.5% 2028 2,480,149 2,656,860
-- 7.5% 2029 850,303 918,786
-- 7.5% 2029 724,105 773,887
-- 8% 2016 127,308 137,493
Government National Mortgage Association
-- 7% 2028 1,628,157 1,754,469
-- 7.5% 2023 44,963 48,387
-- 8% 2030 483,509 523,096
-- 8% 2030 720,637 779,639
-- 8% 2031 601,510 650,759
Government National Mortgage Association II
-- 7% 2024 702,493 750,895
-- 7% 2028 965,665 1,033,773
-- 7% 2028 170,313 180,958
-- 7.5% 2025 30,878 33,155
-- 7.5% 2025 157,107 168,694
-- 7.5% 2027 44,342 47,612
-- 7.5% 2030 300,371 321,772
-- 8% 2027 470,347 508,323
Government National Mortgage Association (MH)
-- 8.25% 2006-7 46,241 48,537
-- 8.75% 2006 127,884 134,278
-- 8.75% 2011 338,159 364,180
-- 9% 2010 148,517 159,626
-- 9% 2011 481,689 517,719
-- 9.25% 2010-11 318,805 343,414
-- 9.75% 2005 119,504 129,069
-- 9.75% 2006 118,841 123,892
-- 9.75% 2012-13 204,690 221,073
Government National Mortgage Association (PL) -- 10.25% 2017 779,280 793,892
----------------
TOTAL MORTGAGE-BACKED PASS-THROUGH SECURITIES $ 49,121,456
----------------
</Table>
10
<Page>
<Table>
<Caption>
SHARES OR
PRINCIPAL
BONDS & DEBENTURES -- CONTINUED AMOUNT VALUE
- ------------------------------------------------------------------------------------ ----------------- ----------------
CONVERTIBLE BONDS & DEBENTURES -- 2.3%
BEA Systems, Inc. -- 4% 2006 $ 18,000,000 $ 18,000,000
i2 Technologies, Inc. -- 5.25% 2006 18,900,000 17,577,000
Standard Motor Products, Inc. -- 6.75% 2009 8,960,000 8,691,200
----------------
TOTAL CONVERTIBLE BONDS & DEBENTURES $ 44,268,200
----------------
ASSET BACKED SECURITIES -- 2.3%
Alliant Master Trust 2000-1A CL A -- 2.20125% (floating rate) 2006+ $ 16,450,000 $ 16,455,264
CIT RV Trust 1999-A CL A4 -- 6.16% 2013 9,290,354 9,469,565
Green Tree Financial Corporation
-- 7.77% 2029* 5,500,000 3,300,000
-- 8% 2028* 2,769,534 2,077,151
INDYMAC Asset-Backed Securities, Inc. 2000-6 CL AF5 -- 7.88% 2031 7,337,133 7,612,862
Truck Engine Receivables Master Trust 2000-1a -- 2.33% (floating rate) 2006 5,000,000 5,000,000
----------------
TOTAL ASSET BACKED SECURITIES $ 43,914,842
----------------
DERIVATIVE SECURITIES -- 1.7%
INTEREST ONLY SECURITIES
Federal Home Loan Mortgage Corporation
2522 CL PI -- 5.5% 2018 $ 4,645,472 $ 188,722
2558 CL JW -- 5.5% 2022 26,989,331 3,171,246
223 -- 5.5% 2032 24,716,050 5,186,515
1694 CL L -- 6.5% 2023 212,919 11,711
217 -- 6.5% 2032 6,312,358 1,187,512
Federal National Mortgage Association
2003-64 CL XI -- 5% 2033 21,409,884 4,656,650
2003-37 CL IM -- 5.5% 2032 18,266,375 3,790,273
323 CL 1 -- 5.5% 2032 6,584,849 1,132,798
333 CL 2 -- 5.5% 2033 25,252,138 5,677,792
302 CL2 -- 6% 2029 14,162,232 2,876,703
332 CL2 -- 6% 2033 21,875,047 4,600,596
2001-33 CL IC -- 6% 2028 1,230,134 18,452
1994-17 CL JB -- 6.5% 2009 880,221 82,521
----------------
TOTAL DERIVATIVE SECURITIES $ 32,581,491
----------------
INTERNATIONAL SECURITY -- 1.0%
France OATei -- 3% 2012 $ 13,961,393 $ 19,231,944
----------------
PREFERRED STOCK -- 0.3%
Pennsylvania Real Estate Investment Trust 93,800 $ 5,581,100
----------------
</Table>
11
<Page>
<Table>
<Caption>
PRINCIPAL
BONDS & DEBENTURES -- CONTINUED AMOUNT VALUE
- ------------------------------------------------------------------------------------ ----------------- ----------------
SHORT-TERM U.S. GOVERNMENT SECURITIES -- 13.0%
U.S. Treasury Notes
-- 1.625% 3/31/05 $ 49,000,000 $ 48,908,125
-- 1.75% 12/31/04 79,000,000 78,987,676
-- 2.125% 10/31/04 123,137,000 123,175,480
----------------
TOTAL SHORT-TERM U.S. GOVERNMENT SECURITIES $ 251,071,281
----------------
TOTAL INVESTMENT SECURITIES -- 69.6% (Cost $1,319,872,398) $ 1,348,655,982
----------------
SHORT-TERM INVESTMENTS -- 30.8% (Cost $596,959,218)
American General Finance Corporation -- 1.84% 10/1/04 $ 28,195,000 $ 28,195,000
Federal National Mortgage Association Discount Note -- 1.53% 10/5/04 47,466,000 47,457,931
Citigroup Inc. -- 1.60% 10/12/04 43,060,000 43,038,949
ChevronTexaco Funding Corporation -- 1.73% 10/13/04 16,779,000 16,769,324
International Lease Finance Corp. -- 1.65% 10/18/04 50,223,000 50,183,868
AIG Funding, Inc. -- 1.68% 10/20/04 34,000,000 33,969,853
ChevronTexaco Funding Corporation -- 1.7% 10/25/04 46,392,000 46,339,422
Federal Home Loan Bank Discount Note -- 1.74% 10/27/04 45,000,000 44,943,450
Federal Home Loan Bank Discount Note -- 1.74% 10/27/04 45,000,000 44,943,450
Toyota Motor Credit Corporation -- 1.74% 10/29/04 22,991,000 22,959,886
Federal National Mortgage Association Discount Note -- 1.7% 11/2/04 30,361,000 30,315,121
Rabobank USA Financial Corporation -- 1.75% 11/4/04 70,000,000 69,884,306
Toyota Motor Credit Corporation -- 1.77% 11/5/04 34,182,000 34,123,178
Barclays U.S. Funding, Inc. -- 1.76% 11/8/04 24,000,000 23,955,413
AIG Funding, Inc. -- 1.75% 11/10/04 30,000,000 29,941,667
General Electric Company -- 1.76% 11/12/04 30,000,000 29,938,400
----------------
$ 596,959,218
----------------
TOTAL INVESTMENTS -- 100.4% (Cost $1,916,831,616) $ 1,945,615,200
Other assets and liabilities, net -- (0.4)% (6,964,010)
----------------
TOTAL NET ASSETS -- 100% $ 1,938,651,190
================
</Table>
* Non-income producing security, in default
+ 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. The Alliant Master Trust
floating rate due 2006 was purchased between July 17 and October 23, 2003 at
$99.43; the Collins & Aikman Products 12.875% note due 2012 was purchased
between September 10 and September 24, 2004 at $97.34 and the Series B of
this note was purchased on August 12, 2004 at $96.42; the Qwest
Communications International 4.75% notes due 2009 were purchased between
January 30 and February 5, 2004 at $99.83. These restricted securities
constituted 2.5% of total net assets at September 30, 2004.
See notes to financial statements.
12
<Page>
STATEMENT OF ASSETS AND LIABILITIES
September 30, 2004
<Table>
ASSETS
Investments at value:
Investments securities -- at market value
(identified cost $1,319,872,398) $ 1,348,655,982
Short-term investments -- at amortized cost
(maturities 60 days or less) 596,959,218 $ 1,945,615,200
-----------------
Cash 753
Receivable for:
Interest $ 10,710,393
Capital Stock sold 6,928,732
Investment securities sold 4,481,183 22,120,308
----------------- ----------------
$ 1,967,736,261
LIABILITIES
Payable for:
Investment securities purchased $ 24,650,000
Capital Stock repurchased 3,445,038
Advisory fees 785,798
Accrued expenses and other liabilities 204,235 29,085,071
----------------- ----------------
NET ASSETS $ 1,938,651,190
================
SUMMARY OF SHAREHOLDERS' EQUITY
Capital Stock -- par value $0.01 per share; authorized
400,000,000 shares; outstanding 171,544,443 shares $ 1,715,444
Additional Paid in Capital 1,910,390,550
Accumulated net realized loss on investments (22,144,216)
Undistributed net investment income 19,905,828
Unrealized appreciation of investments 28,783,584
----------------
Net assets at September 30, 2004 $ 1,938,651,190
================
NET ASSET VALUE, REDEMPTION PRICE AND
MAXIMUM OFFERING PRICE PER SHARE
Net asset value and redemption price per share
(net assets divided by shares outstanding) $ 11.30
================
Maximum offering price per share
(100/96.5 of per share net asset value) $ 11.71
================
</Table>
See notes to financial statements.
13
<Page>
STATEMENT OF OPERATIONS
For the Year Ended September 30, 2004
<Table>
INVESTMENT INCOME
Interest $ 68,557,408
Dividends 569,812
----------------
$ 69,127,220
EXPENSES
Advisory fees $ 7,405,099
Transfer agent fees and expenses 956,772
Reports to shareholders 361,797
Custodian fees and expenses 118,873
Insurance 79,090
Directors' fees and expenses 39,201
Audit fees 29,050
Postage 23,021
Legal fees 15,877
Registration fees 3,754
Other expenses 17,634 9,050,168
----------------- ----------------
Net investment income $ 60,077,052
----------------
NET REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized loss on investments:
Proceeds from sales of investment securities (excluding
short-term investments with maturities of 60 days or less) $ 808,230,783
Cost of investment securities sold 815,586,064
-----------------
Net realized loss on investments $ (7,355,281)
Unrealized appreciation of investments:
Unrealized appreciation at beginning of year $ 28,093,299
Unrealized appreciation at end of year 28,783,584
-----------------
Increase in unrealized appreciation of investments 690,285
----------------
Net realized and unrealized loss on investments $ (6,664,996)
----------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 53,412,056
================
</Table>
See notes to financial statements.
14
<Page>
STATEMENT OF CHANGES IN NET ASSETS
<Table>
<Caption>
FOR THE YEAR ENDED SEPTEMBER 30,
-----------------------------------------------------------------------------------
2004 2003
---------------------------------------- ---------------------------------------
INCREASE IN NET ASSETS
Operations:
Net investment income $ 60,077,052 $ 51,099,503
Net realized loss on investments (7,355,281) (13,101,736)
Unrealized appreciation of investments 690,285 45,143,854
------------------ -----------------
Increase in net assets resulting
from operations $ 53,412,056 $ 83,141,621
Dividends to shareholders from net
investment income (52,090,881) (55,324,015)
Capital Stock transactions:
Proceeds from Capital Stock sold $ 1,090,872,412 $ 425,894,150
Proceeds from shares issued to
shareholders upon reinvestment
of dividends and distributions 38,674,748 41,822,619
Cost of Capital Stock repurchased (317,715,239) 811,831,921 (480,941,232) (13,224,463)
------------------ ------------------ ----------------- ------------------
Total increase in net assets $ 813,153,096 $ 14,593,143
NET ASSETS
Beginning of year, including
undistributed net investment income
of $11,919,657 and $16,144,169 1,125,498,094 1,110,904,951
------------------ ------------------
End of year, including undistributed net
investment income of $19,905,828
and $11,919,657 $ 1,938,651,190 $ 1,125,498,094
================== ==================
CHANGE IN CAPITAL STOCK
OUTSTANDING
Shares of Capital Stock sold 96,300,078 38,617,791
Shares issued to shareholders upon
reinvestment of dividends
and distributions 3,438,666 3,841,400
Shares of Capital Stock repurchased (28,076,489) (43,771,373)
------------------ ------------------
Increase (decrease) Capital
Stock outstanding 71,662,255 (1,312,182)
================== ==================
</Table>
See notes to financial statements.
15
<Page>
FINANCIAL HIGHLIGHTS
SELECTED DATA FOR EACH SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH PERIOD
<Table>
<Caption>
FOR THE YEAR ENDED SEPTEMBER 30,
-----------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- ------------- ------------- ------------- -------------
Per share operating performance:
Net asset value at beginning of year $ 11.27 $ 10.98 $ 11.17 $ 10.61 $ 10.77
------------- ------------- ------------- ------------- -------------
Income from investment operations:
Net investment income $ 0.43 $ 0.52 $ 0.54 $ 0.80 $ 0.77
Net realized and unrealized gain (loss) on
investment securities 0.03 0.33 (0.12) 0.57 (0.11)
------------- ------------- ------------- ------------- -------------
Total from investment operations $ 0.46 $ 0.85 $ 0.42 $ 1.37 $ 0.66
------------- ------------- ------------- ------------- -------------
Less distributions:
Dividends from net investment income $ (0.43) $ (0.56) $ (0.54) $ (0.73) $ (0.73)
Distributions from net realized capital gains -- -- (0.07) (0.08) (0.09)
------------- ------------- ------------- ------------- -------------
Total distributions $ (0.43) $ (0.56) $ (0.61) $ (0.81) $ (0.82)
------------- ------------- ------------- ------------- -------------
Net asset value at end of year $ 11.30 $ 11.27 $ 10.98 $ 11.17 $ 10.61
============= ============= ============= ============= =============
Total investment return* 4.16% 8.02% 3.83% 13.57% 6.56%
Ratios/supplemental data:
Net assets at end of period (in $000's) 1,938,651 1,125,498 1,110,905 697,384 501,083
Ratio of expenses to average net assets 0.60% 0.61% 0.58% 0.59% 0.61%
Ratio of net investment income to average
net assets 3.77% 4.69% 5.06% 6.49% 7.31%
Portfolio turnover rate 62% 52% 28% 22% 21%
</Table>
* 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)
<Table>
<Caption>
LONG-TERM
PER SHARE ORDINARY INCOME CAPITAL GAIN
PAYABLE DATE AMOUNT QUALIFYING NON-QUALIFYING DISTRIBUTION
- ------------------------------------ -------------- ---------- -------------- ------------
October 7, 2003 $ 0.10 1.1% 98.9% --
December 29, 2003 $ 0.13 1.1% 98.9% --
April 6, 2004 $ 0.09 -- 100.0% --
July 7, 2004 $ 0.11 -- 100.0% --
</Table>
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 2005 setting forth
specific amounts to be included in their 2004 tax returns.
See notes to financial statements.
16
<Page>
NOTES TO FINANCIAL STATEMENTS
September 30, 2004
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 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. Securities traded in
the NASDAQ National Market System are valued at the NASDAQ Official Closing
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 amortized cost 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.
B. 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. Market discounts and premiums on fixed income
securities are amortized over the expected life of the securities. Realized
gains or losses are based on the specific identification method.
C. Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 $1,395,940,669 for
the year ended September 30, 2004.
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, 2004, the Fund paid aggregate fees of
$39,000 to all Directors who are not affiliated persons of the Adviser. Legal
fees of $15,877 were for services rendered by O'Melveny & Myers LLP, counsel for
the Fund. A Director of the Fund is a retired partner and a retired of counsel
employee of that firm. Certain officers of the Fund are also officers of the
Adviser and FPA Fund Distributors, Inc.
NOTE 4 -- 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.
Distributions paid to shareholders are based on net investment income and
net realized gains determined on a tax reporting basis, which may differ from
financial reporting. For federal income tax
17
<Page>
purposes, the components of distributable earnings at September 30, 2004, were
as follows:
<Table>
Undistributed net investment income $ 17,496,363
Accumulated net realized losses $ (17,742,031)
</Table>
Accumulated net realized losses can be carried forward to offset future
gains. The ability to carry these losses forward expires as follows: $1,455,619
in 2011 and $16,286,412 in 2012.
The cost of investment securities at September 30, 2004 for federal income
tax purposes was $1,314,201,010. Gross unrealized appreciation and depreciation
for all securities at September 30, 2004 for federal income tax purposes was
$110,795,002 and $76,340,030, respectively.
NOTE 5 -- DISTRIBUTOR
For the year ended September 30, 2004, FPA Fund Distributors, Inc.
("Distributor"), a wholly owned subsidiary of the Adviser, received $130,244 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 6 -- REDEMPTION FEES
A redemption fee of 2% applies to redemptions within 90 days of purchase
for certain purchases made by persons eligible to purchase shares without an
initial sales charge. For the year ended September 30, 2004, the Fund collected
$127,707 in redemption fees.
NOTE 7 -- DISTRIBUTION TO SHAREHOLDERS
On September 30, 2004, the Board of Directors declared a dividend from net
investment income of $0.09 per share payable October 6, 2004 to shareholders of
record on September 30, 2004. For financial statement purposes, this dividend
was recorded on the ex-dividend date, October 1, 2004.
For tax purposes, all of the dividends paid during the fiscal years ended
September 30, 2004 and 2003, were designated as ordinary income.
18
<Page>
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS AND
BOARD OF DIRECTORS OF FPA NEW INCOME, INC.
We have audited the accompanying statement of assets and liabilities of FPA
New Income, Inc., (the "Fund") including the portfolio of investments, as of
September 30, 2004, the related statement of operations for the year then ended,
and the statements of changes in net assets and financial highlights for each of
the two 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. The financial highlights of FPA New Income, Inc., for each
of the three years in the period ended September 30, 2002 were audited by other
auditors whose report, dated November 11, 2002, expressed an unqualified opinion
on those financial highlights.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included confirmation of
securities owned as of September 30, 2004, by correspondence with the custodian
and brokers; where replies were not received from brokers, we performed other
auditing procedures. 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 2003 and 2004 financial statements and financial
highlights referred to above present fairly, in all material respects, the
financial position of FPA New Income, Inc. as of September 30, 2004, and the
results of its operations for the year then ended, and the changes in its net
assets and financial highlights for each of the two years in the period then
ended, in conformity with accounting principles generally accepted in the United
States of America.
/s/ Deloitte & Touche LLP
Los Angeles, California
November 8, 2004
19
<Page>
SHAREHOLDER EXPENSE EXAMPLE
September 30, 2004
(Unaudited)
FUND EXPENSES
As a shareholder of the Fund, you incur two types of costs: (1) transaction
costs, and (2) ongoing costs, including advisory and administrative fees;
shareholder service fees; and other Fund expenses. The Example is intended to
help you understand your ongoing costs (in dollars) of investing in the Fund and
to compare these costs with the ongoing costs of investing in other mutual
funds. The Example is based on an investment of $1,000 invested at the beginning
of the year and held for the entire year.
ACTUAL EXPENSES
The information in the table under the heading "Actual Performance"
provides information about actual account values and actual expenses. You may
use the information in this column, together with the amount you invested, to
estimate the expenses that you paid over the period. Simply divide your account
value by $1,000 (for example, an $8,600 account value divided by $1,000= 8.6),
then multiply the result by the number in the first column in the row entitled
"Expenses Paid During Period" to estimate the expenses you paid on your account
during this period.
HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES
The information in the table under the heading "Hypothetical Performance
(5% return before expenses)" provides information about hypothetical account
values and hypothetical expenses based on the Fund's actual expense ratio and an
assumed rate of return of 5% per year before expenses, which is not the Fund's
actual return. The hypothetical account values and expenses may not be used to
estimate the actual ending account balance or expenses you paid for the period.
You may use this information to compare the ongoing costs of investing in the
Fund and other funds. To do so, compare this 5% hypothetical example with the 5%
hypothetical examples that appear in the shareholder reports of other funds.
Please note that the expenses shown in the table are meant to highlight
your ongoing costs only and do not reflect any transactional costs. Therefore,
the information under the heading "Hypothetical Performance (5% return before
expenses)" is useful in comparing ongoing costs only, and will not help you
determine the relative total costs of owning different funds. In addition, if
these transactional costs were included, your costs would have been higher.
<Table>
<Caption>
HYPOTHETICAL
PERFORMANCE
(5% RETURN
ACTUAL BEFORE
PERFORMANCE EXPENSES)
------------- ---------------
Beginning Account Value
March 31, 2004 $ 1,000.00 $ 1,000.00
Ending Account Value
September 30, 2004 $ 1,011.60 $ 1,021.90
Expenses Paid During
Period* $ 3.08 $ 3.10
</Table>
* Expenses are equal to the Fund's annualized expense ratio of 0.61%,
multiplied by the average account value over the period and prorated for the
six-months ended September 30, 2004 (183/365 days).
RESULTS OF SPECIAL MEETING
Following is a list of matters voted upon and the results of those votes
cast at the special meeting of shareholders held April 14, 2004:
1. With respect to the approval of a proposed amendment to the Fund's
fundamental investment policy regarding lending, a total of
50,186,383.62 shares voted for, 2,947,859.98 shares voted against, and
2,669,351.05 shares abstained.
2. With respect to the approval of a proposed amendment to the Fund's
fundamental investment policy regarding investments in illiquid
securities, a total of 47,676,739.11 shares voted for, 5,469,130.97
shares voted against, and 2,657,724.55 shares abstained.
No broker non-votes were received with respect to the matter voted upon
above.
20
<Page>
DIRECTOR AND OFFICER INFORMATION
<Table>
<Caption>
POSITION(S) PORTFOLIOS IN
WITH FUND/ PRINCIPAL OCCUPATION(S) FUND COMPLEX
NAME, AGE & ADDRESS YEARS SERVED DURING THE PAST 5 YEARS OVERSEEN OTHER DIRECTORSHIPS
------------------- ------------ ----------------------- -------- -------------------
Willard H. Altman, Jr. - (69) Director+ Retired. Formerly, until 6
11400 W. Olympic Blvd., #1200 Years Served: 6 1995, Partner of Ernst &
Los Angeles, CA 90064 Young LLP, a public
accounting firm.
Alfred E. Osborne, Jr. - (59) Director+ Senior Associate Dean at 3 Investment Company
11400 W. Olympic Blvd., #1200 Years Served: 5 The John E. Anderson Institute, K2 Inc.,
Los Angeles, CA 90064 Graduate School of Nordstrom, Inc., E*
Management at UCLA. Capital Corporation,
Equity Marketing Inc.,
and WM Group of Funds.
A. Robert Pisano - (61) Director+ National Executive 3 Coppola Group, State Net,
11400 W. Olympic Blvd., #1200 Years Served: 2 Director and Chief NetFlix.com, Resources
Los Angeles, CA 90064 Executive Officer of the Connection, and The
Screen Actors Guild. Motion Picture and
Formerly, until 1999, Television
Vice Chairman and
Director of Metro-
Goldwyn-Mayer, Inc.
Lawrence J. Sheehan - (72) Director+ Retired. Formerly partner 5
11400 W. Olympic Blvd., #1200 Years Served: 13 (1969 to 1994) and of
Los Angeles, CA 90064 counsel employee
(1994-2002) of the firm
of O'Melveny & Myers LLP,
legal counsel to the
Fund.
Robert L. Rodriguez - (55) Director+ Principal and Chief 2 First Pacific Advisors,
11400 W. Olympic Blvd., #1200 President & Chief Executive Officer of the Inc. and FPA Fund
Los Angeles, CA 90064 Investment Officer Adviser. Distributors, Inc.
Years Served: 4
Thomas H. Atteberry (51) Vice President & Vice President of the
11400 W. Olympic Blvd., #1200 Portfolio Manager Adviser
Los Angeles, CA 90064 Years Served: < 1
Eric S. Ende - (60) Vice President Senior Vice President of 3
11400 W. Olympic Blvd., #1200 Years Served: 19 the Adviser.
Los Angeles, CA 90064
J. Richard Atwood - (44) Treasurer Principal and Chief First Pacific Advisors,
11400 W. Olympic Blvd., #1200 Years Served: 7 Operating Officer of the Inc. and FPA Fund
Los Angeles, CA 90064 Adviser, President and Distributors, Inc.
Chief Executive Officer
of FPA Fund Distributors,
Inc.
Sherry Sasaki - (49) Secretary Assistant Vice President
11400 W. Olympic Blvd., #1200 Years Served: 20 and Secretary of the
Los Angeles, CA 90064 Advisor and Secretary of
FPA Fund Distributors,
Inc.
Christopher H. Thomas - (47) Assistant Vice President and FPA Fund Distributors,
11400 W. Olympic Blvd., #1200 Treasurer Controller of the Adviser Inc.
Los Angeles, CA 90064 Years Served: 9 and of FPA Fund
Distributors, Inc.
</Table>
+ Directors serve until their resignation, removal or retirement.
21
<Page>
FPA NEW INCOME, INC.
<Table>
INVESTMENT ADVISER INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
First Pacific Advisors, Inc.
11400 West Olympic Boulevard, Suite 1200 Deloitte & Touche LLP
Los Angeles, California 90064 Los Angeles, California
DISTRIBUTOR CUSTODIAN & TRANSFER AGENT
FPA Fund Distributors, Inc. State Street Bank and Trust Company
11400 West Olympic Boulevard, Suite 1200 Boston, Massachusetts
Los Angeles, California 90064
SHAREHOLDER SERVICE AGENT
COUNSEL
Boston Financial Data Services, Inc.
O'Melveny & Myers LLP P.O. Box 8500
Los Angeles, California Boston, Massachusetts 02266-8500
(800) 638-3060
(617) 483-5000
TICKER: FPNIX
CUSIP: 302544101
</Table>
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 Fund's complete proxy voting record for the 12 months ended June 30, 2004 is
available without charge, upon request, by calling (800) 982-4372 and on the
SEC's website at www.sec.gov.
<Page>
Item 2. Code of Ethics.
(a) The registrant has adopted a code of ethics that applies to
the registrant's senior executive and financial officers.
Upon request, any person may obtain a copy of this code of
ethics, without charge, by calling (800) 982-4372. A copy
of the code of ethics is filed as an exhibit to this Form
N-CSR.
(b) During the period covered by this report, there were not
any amendments to the provisions of the code of ethics
adopted in 2(a) above.
(c) During the period covered by this report, there were not
any implicit or explicit waivers to the provisions of the
code of ethics adopted in 2(a).
Item 3. The registrant's board of directors has determined that Willard H.
Altman, Jr., a member of the registrant's audit committee and board
of directors, is an "audit committee financial expert" and is
"independent," as those terms are defined in this Item. This
designation will not increase the designee's duties, obligations or
liability as compared to his duties, obligations and liability as a
member of the audit committee and of the board of directors.
Item 4. Principal Accountant Fees and Services.
<Table>
<Caption>
2003 2004
(a) Audit Fees $ 26,000 $ 27,000
(b) Audit Related Fees -0- -0-
(c) Tax Fees $ 5,000 $ 5,250
(d) All Other Fees -0- -0-
</Table>
(e)(1) Disclose the audit committee's pre-approval policies and
procedures described in paragraph (c)(7) of Rule 2-01 of
Regulation S-X. The audit committee shall pre-approve all
audit and permissible non-audit services that the committee
considers compatible with maintaining the independent
auditors' independence. The pre-approval requirement will
extend to all non-audit services provided to the
registrant, the adviser, and any entity controlling,
controlled by, or under common control with the adviser
that provides ongoing services to the registrant, if the
engagement relates directly to the operations and financial
reporting of the registrant; provided, however, that an
engagement of the registrant's independent auditors to
perform attest services for the registrant, the adviser or
its affiliates required by generally accepted auditing
standards to complete the examination of the registrant's
financial statements (such as an examination conducted in
accordance with Statement on Auditing Standards Number 70
issued by the American Institute of Certified Public
Accountants), will be deem pre-approved if: (i) the
registrant's independent auditors inform the audit
committee of the engagement, (ii) the
<Page>
registrant's independent auditors advise the audit
committee at least annually that the performance of this
engagement will not impair the independent auditor's
independence with respect to the registrant, and (iii) the
audit committee receives a copy of the independent
auditor's report prepared in connection with such services.
The committee may delegate to one or more committee members
the authority to review and pre-approve audit and
permissible non-audit services. Actions taken under any
such delegation will be reported to the full committee at
its next meeting.
(e)(2) Disclose the percentage of services described in each of
paragraphs (b) - (d) of this Item that were approved by the
audit committee pursuant to paragraph (c)(7)(i)(C) of Rule
2-01 of Regulation S-X. 100% of the services provided to
the registrant described in paragraphs (b) - (d) of this
Item were pre-approved by the audit committee pursuant to
paragraphs (e)(1) of this Item. There were no services
provided to the investment adviser or any entity
controlling, controlled by or under common control with the
adviser described in paragraphs (b) - (d) of this Item that
were required to be pre-approved by the audit committee.
(f) If greater than 50%, disclose the percentage of hours
expended on the principal accountant's engagement to audit
the registrant's financial statements for the most recent
fiscal year that were attributed to work performed by
persons other than the principal accountant's full-time,
permanent employees. All services performed on the
engagement to audit the registrant's financial statements
for the most recent fiscal year end were performed by the
principal accountant's full-time, permanent employees.
(g) Disclose the aggregate non-audit fees billed by the
registrant's accountant for services rendered to the
registrant, and rendered to the registrant's investment
adviser (not including any sub-adviser whose role is
primarily portfolio management and is subcontracted with or
overseen by another investment adviser), and any entity
controlling, controlled by, or under common control with
the adviser that provides ongoing services to the
registrant for each of the last two fiscal years of the
registrant. None.
(h) Disclose whether the registrant's audit committee of the
board of director has considered whether the provision of
non-audit services that were rendered to the registrant's
investment adviser (not including any sub-adviser whose
role is primarily portfolio management and is subcontracted
with or overseen by another investment adviser), and any
entity controlling, controlled by, or under common control
with the investment adviser that provides ongoing services
to the registrant that were not pre-approved pursuant to
paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is
<Page>
compatible with maintaining the principal accountant's
independence. Not Applicable.
Item 5. Audit Committee of Listed Registrants. Not Applicable.
Item 6. Schedule of Investments. Not Applicable. The schedule of
investments is included as part of the report to stockholders filed
under Item 1 of this Form.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies. Not Applicable.
Item 8. Purchases of Equity Securities by Closed-End Management Investment
Companies. Not Applicable.
Item 9. Submission of Matters to a Vote of Security Holders. There has been
no material change to the procedures by which shareholders may
recommend nominees to the registrant's board of directors.
Item 10. Controls and Procedures.
(a) The Principal Executive Officer and Principal Financial
Officer of the registrant have concluded that the
registrant's disclosure controls and procedures (as defined
in Rule 30a-3(c) under the Investment Company Act of 1940)
are effective based on their evaluation of the disclosure
controls and procedures as of a date within 90 days of the
filing date of this report.
(b) There have been no significant changes in the registrant's
internal controls over financial reporting (as defined in
Rule 30a-3(d) under the Investment Company Act of 1940)
that occurred during the registrant's last fiscal half-year
(the registrant's second fiscal half- year in the case of
an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's
internal controls over financial reporting.
Item 11. Exhibits.
(a)(1) Code of ethics as applies to the registrant's officers and
directors, as required to be disclosed under Item 2 of Form
N-CSR. Attached hereto as Ex.99.CODE.ETH.
(a)(2) Separate certification for the registrant's principal
executive officer and principal financial officer, as
required by Rule 30a-2(a) under the Investment Company Act
of 1940. Attached hereto.
(a)(3) Not Applicable
<Page>
(b) Separate certification for the registrant's principal
executive officer and principal financial officer, as
required by Rule 30a-2(b) under the Investment Company Act
of 1940. Attached hereto.
SIGNATURES
Pursuant to the Securities Exchange Act of 1934 and the Investment Company Act
of 1940, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
FPA NEW INCOME, INC.
By: /s/ ROBERT L. RODRIGUEZ
----------------------------------
Robert L. Rodriguez, President
Date: December 7, 2004
Pursuant to the Securities Exchange Act of 1934 and the Investment Company Act
of 1940, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
FPA NEW INCOME, INC.
By: /s/ J. RICHARD ATWOOD
----------------------------------
J. Richard Atwood, Treasurer
Date: December 7, 2004