FPA Crescent Portfolio

July 24, 2000 Dear Fellow Shareholders: The second quarter ended June 30, 2000 provided positive relative performance in the face of across-theboard negative returns from the major stock indexes. The Crescent Portfolio declined 1.0%, versus declines of 3.8%, 2.7%, and 13.3% for the Russell 2000, S&P 500, and Nasdaq, respectively. More significantly, when compared to the peak level of the various indexes reached in March, Crescent considerably outperformed. For example, from the March 9 high of the Russell 2000, Crescent increased 1.4%, versus the 14.3% decline in the Russell, 15.7 percentage points of relative performance. The comparisons versus the Nasdaq and the S&P 500 were 23% and 2.5% from their respective March peaks. The stock market has sounded a warning bell as technology stocks and other exorbitantly valued companies have exhibited deteriorating pricing and, in some cases, deteriorating fundamentals. Value investors such as we are should provide a relatively safe haven should we encounter continued market volatility. Sanford Bernstein has assembled some interesting data that reflect that, over the last quarter century, the percentage of stocks that decline 25% or more in a given year has averaged 16%. Since 1995 this group of losing stocks has been steadily rising, reflecting an increasingly narrow universe of companies that are driving the stock indexes. 2000 has been the second worst-performing year, with 25% of stocks declining 25% or more. From the market peak in March and after a very long drought, value is finally outperforming growth. A rational investor will recognize that since World War II, value has modestly outperformed growth and, although growth has soundly beaten value over the last decade, this too shall pass. According to Sanford Bernstein, The new economy stocks currently have a total capitalization of $6.6 trillion and a trailing P/E of 81. At the end of 1997, their P/E was 28. A move halfway back to that level, or to 55x, would eliminate $2.1 trillion in capitalization or a third of their value. With the new economy stocks discounting 16% growth and the old economy less than 4%, the market envisions a virtuous cycle will persist for between 10 and 15 years. Old economy stocks returned 9% for the period 1995 to 2000 estimated earnings. In other words, the stock market is suggesting that over the next decade or so, old economy stocks will grow at a rate 55% less than the last five years, while new economy stocks will only see a 13.5% fall-off in their growth rate a wholly unreasonable expectation. Investors looking for the fast buck might get it and then lose it just as quickly. It is like fast food to us. You can get it quick, but it is not good for you. Investment returns will be judged over time. A number of companies had a notable impact on Crescents first-half performance. Of our largest five positions, Michaels Stores, Inc. and Plains Resources Inc. provided the best performance in the first half, increasing 61% and 28% respectively. Michaels has been consistently turning in excellent monthly comparable sale numbers and improving margins, combining to beat analyst expectations. Even after such a price increase (155% from cost), Michaels does not appear to be terribly expensive with their price/earnings ratio (P/E) of 18x 2000s estimated earnings, a 38% discount from the Russell 2500s estimated P/E. We expect them to continue to grow earnings at least in the high teens for the next few years, which is far more than we expect from the broader market. We love to own businesses that grow at rates greater than the broader stock indexes and yet trade at a discounted valuation. We do not believe that a category-dominant retailer with rapidly growing earnings deserves to trade at such a discount. That being said, we had owned as much as a 9% position in both Michaels Stores common and Michaels

Stores convertible bonds. Given the price appreciation of both the stock and the convert, we sold our entire convert position and reduced our stake in the common to its current 4.3% position, still our third largest stake. Plains Resources has benefited from rising oil prices and the dramatic price rebound of its majority held stake in Plains All American, L.P. We believe it likely that Plains Resources will reorganize their corporate structure to the benefit of shareholders later this year. Plains Resources is an E & P (Exploration and Production) company in a world where the average E & P company trades near 5x cash flow. Plains All American is a master limited partnership, which on a stand- alone basis, could receive a valuation of more than 11x cash flow like, e.g., Kinder Morgan Energy Partners, L.P. It makes no sense for a company in an industry that the public market tends to value at 5x cash flow to own a business that is valued at 11x cash flow. Plains Resources management owns a lot of stock in its business and therefore has a vested interest. We expect them to do what is best for them which, in turn, is what is best for us. Midas, Inc. declined 8.5% in the first half as the exhaust market and auto services in general continue to suffer. The companys stock price has fallen a further 13.1% subsequent to June 30, after they announced lower earnings expectations for the current year. This is a function of the continued weakness in the exhaust market and the very aggressive approach they are taking to a new, but related business venture. They are beginning to aggressively distribute automotive parts from more locations to better serve both their existing dealer base and other professional installers. Although they have hired experienced people who have operated in automotive distribution, this is a new business for Midas and somewhat different from what management has operated in the past. That, combined with their aggressive expansion plans, gives us just pause. Through our research, we had some idea that this might be coming and, as a result, began to reduce our position in early July and succeeded in lowering our stake by almost 20% at prices higher than where they ended the quarter. We are not prepared to increase our position, despite the decline, until we have a better understanding of the economics of this new business and some measure of the success of its roll-out. We have added a couple of new positions that we are fairly excited about. We purchased Hutchinson Technology Inc. 6% Convertible Notes, due 3/15/2005. Hutchinson manufactures and supplies suspension assemblies for hard-disk drives. Suspension assemblies hold recording heads in position above the spinning magnetic disks. The company has market share in excess of 50%, a technological advantage over their competition, no net debt, and is currently operating near cash flow break-even and yet, we purchased these notes with an 18% yield-to-maturity. Due to rapid growth in the areal density of the magnetic disks, fewer suspension assemblies have been required per drive in the past year, eroding Hutchinsons profitability. However, laws of physics seem to dictate that growth in areal density cannot continue at the same rate, which will allow the number of suspension assemblies per drive to increase in the future. Meanwhile, more PCs are sold every year, and more uses are being found for magnetic storage, including such television recording devices as TiVo and Replay. Hutchinsons current stock price is $14.25 and the converts have a $28.35 conversion price. We would not be surprised to see Hutchinsons common stock increase significantly in the next cycle as demand for data storage continues to expand and as assemblies per drive increase. We therefore feel that the convertible option we hold is quite valuable and hope to see our final sale of these bonds be well in excess of par ($100). The reason we chose to invest in the converts instead of the common stock is that the company has not historically had a high return-on-equity (ROE) and we prefer not to own such companies. It is entirely possible, though, that given their wider technological lead when compared to past cycles, their ROE will be higher than past peaks in the future. We were willing, however, to give up what we felt might be only 55% of the upside to be assured a 10% cash yield and, at worst, a return of our capital. In other words, we felt it to be a much better risk/reward.

A more complicated and very inexpensive company is Pittston Brinks Group. We believe Pittston has two wonderful businesses: Brinks Inc., their armored car business and the number one global leader, and Brinks Home Security, the fourth largest and most profitable home monitoring company in the United States. They also have two terrible businesses: Pittston Minerals, which includes a tremendous amount of legacy liabilities attached to their coal business, and BAX Global, a provider of freight transportation and supply chain management services that has terrible returns on capital. The poor businesses are the primary contributors to the decline in price from January 1998, when it was an adjusted $54.19, to what is now $13.69. A new Chairman, Mike Dan, was named in January 1999 and has since put the coal businesses up for sale and they are currently reviewing bids. In addition, he has publicly stated that the BAX Global business must achieve a minimum unleveraged return on capital of 12% by the fourth quarter of 2001 with measured progress along the way. At this time, BAX Global has been getting worse, not better, and we would not be surprised to see that business divested if they cannot reach the stated goal. Either way, it will be an improvement from the current drag on earnings. Pittston trades at a small discount to book and only 8.1x trailing earnings, which do not include $.25 or so in non-cash intangible amortization per share. Crescent currently reflects the lowest valuations that it has seen since its inception and is dramatically cheaper than the comparative stock indexes below. It is important to recognize that the companies we hold are not just cheap but, as stated earlier, have been growing their earnings at double-digit rates.
Ratios (Weighted Average) Stocks Price/Earnings TTM Price/Earnings 2000 est. Price/Book Dividend Yield Bonds Duration Maturity Yield Crescent Russell 2500 S&P 500 Lehman Bros. Govt/Corp.

11.0x 10.5x 1.4x 1.1% 2.7 years 4.1 years 17.0%

32.6x 28.8x 3.1x 1.2%

29.9x 26.8x 5.7x 1.1% 5.4 years 9.7 years 7.0%

Our ten largest equity positions represented 36.6% of the portfolio as of June 30, 2000. Listed below are Crescents ten largest holdings, excluding short-term investments, as of June 30, 2000. Common & Preferred Stocks Fritz Companies, Inc. Consolidated Stores Corporation Michaels Stores, Inc. Midas Inc. Crown American Realty Trust 11% Preferred Plains Resources Inc. Coachmen Industries, Inc. Bonds & Notes Centertrust Retail Properties, 7.5% Convertible Notes, due 1/15/01 Charming Shoppes 7.5% Convertible Notes, due 7/15/00 CKE Restaurants, Inc., 4.25% Convertible Notes, due 3/15/04 Crescent had the following net asset composition at June 30, 2000. Common Stocks, Long Preferred Stocks Bonds & Notes Accrued Income Common Stocks, short Cash & Other Total 60.4% 4.8% 21.3% 0.7% -0.4% 13.2% 100.0%

We believe that the sun is setting on the good old days for high-flying growth companies. The stock market indexes driven by such companies (not the broad stock market) have been posting unsustainable rates of return. In a recent New York Times article, Mark Hulbert points out that over the last 50 years the average annual return on equity for corporate America has been 11.9%, nearly three percentage points lower than the stock markets average return over that period. With lower rates of return and greater volatility, we would expect that the phrase margin of safety will once again return to the modern lexicon. Taste seems to be changing from passion and momentum to reason and value. We look forward to a sustained period of strong relative performance. Respectfully,

Steven Romick