<PAGE>
September 25, 1998
Dear Shareholder:
We are pleased to present this report on the Hilliard-Lyons Government Fund,
Inc. ("HLGF" or the "Fund") for the year ended August 31, 1998.
This has been an eventful year for the Fund. Net assets increased dramatically
from $519 million to $945 million, an 82% increase. This is a new record net
asset level. The average seven day yield ranged from a low of 4.92% to a high
of 5.13% during the year. Distributions of $.0499026 were paid, equivalent to
a 4.99% yield. For those shareholders in the dividend reinvestment plan, this
equates to a compound annual yield of 5.11%.
As evidenced by the narrow spread between the low and high yields for the
year, short term interest rates remained relatively stable. The Federal
Reserve has not changed short term rates since March 1997, but a 25 basis
point cut in the federal funds rate is widely expected at their next meeting.
The federal funds rate is what member banks charge each other for overnight
loans and is a determining factor for other rates from credit cards to
mortgages. Federal Reserve Chairman Alan Greenspan has indicated he believes
the U.S. economy has just began to feel the effects of the financial crises in
Asia and Latin America and he is ready to use Federal Reserve control over
interest rates to strengthen the world economy.
The Asian financial crisis has impacted financial markets for more than a year
and the effects continue to spread. Distant economies have been greatly
affected with Russia seemingly in a depression. Other commodity producing
nations such as Canada and Mexico have also been hard hit. With these far
reaching effects, global investors have become wary further weakening the
world economy.
This global turmoil has also impacted the U.S. economy. The equity markets, as
measured by the Dow Jones Industrial Average, have been quite volatile with
several large one day swings including a 513 point drop on August 31, 1998 and
a 257 point increase on September 23, 1998. Such volatility can make even
seasoned investors cautious and makes our Fund an attractive option for
investors wanting to hold cash.
As shown on the attached Schedule of Investments, the Fund was 100% invested
in U.S. government agency obligations on August 31, 1998. These discount notes
of the Federal Home Loan and Federal Farm Credit Banks while offering a high
degree of credit safety, have allowed the Fund to offer a competitive yield
and an added advantage of income which is exempt from state income tax. The
Fund's expense ratio of 0.51% as shown on the attached financial highlights
table, is the lowest in the history of the Fund. This is due in part to the
Fund's increased asset size and management structure.
We are sorry to report that one of the Fund's original directors, General
Dillman A. Rash passed away on September 8, 1998. His wisdom and guidance not
only helped the Fund get started but also have contributed greatly to its
success through the years. We shall miss him.
You are being asked in the enclosed proxy material to vote for a new director,
Marianne R. Rowe as well as for the other directors who are continuing to
serve. The proxy materials also contain information about another important
item you are being asked to vote on.
Each shareholder should have already received information about the proposed
merger of Hilliard-Lyons, Inc. with PNC Bank Corp. As explained in the
enclosed proxy materials, this merger will cause the termination of the
existing investment advisory agreement. All shareholders are being asked to
approve a new investment advisory agreement to become effective on the date of
the merger, expected to be about November 30, 1998. We ask each shareholder to
please read the enclosed proxy materials and vote promptly. Your vote is
greatly appreciated.
/s/ DONALD F. KOHLER /s/ JOSEPH C. CURRY, JR /s/ DIANNA P. WENGLER
DONALD F. KOHLER JOSEPH C. CURRY, JR. DIANNA P. WENGLER
Chairman President Vice President and
Treasurer
<PAGE>
HILLIARD-LYONS GOVERNMENT FUND, INC.
SCHEDULE OF INVESTMENTS
AUGUST 31, 1998
<TABLE>
<CAPTION>
PRINCIPAL PURCHASE MATURITY
AMOUNT YIELD DATE VALUE
----------- -------- -------- -----------
<C> <S> <C> <C> <C>
U.S. GOVERNMENT AGENCY OBLIGATIONS--100.3%
$10,000,000 Federal Farm Credit Bank 5.504% 09/01/98 $10,000,000
9,145,000 Federal Home Loan Bank 5.729 09/01/98 9,145,000
20,000,000 Federal Home Loan Bank 5.520 09/02/98 19,997,017
13,000,000 Federal Farm Credit Bank 5.507 09/03/98 12,996,114
15,000,000 Federal Home Loan Bank 5.502 09/04/98 14,993,325
10,000,000 Federal Home Loan Bank 5.485 09/08/98 9,989,558
20,000,000 Federal Home Loan Bank 5.529 09/09/98 19,976,089
9,000,000 Federal Farm Credit Bank 5.524 09/10/98 8,987,895
8,000,000 Federal Farm Credit Bank 5.541 09/11/98 7,988,000
4,500,000 Federal Home Loan Bank 5.512 09/11/98 4,493,300
15,000,000 Federal Home Loan Bank 5.490 09/14/98 14,970,913
7,000,000 Federal Farm Credit Bank 5.510 09/15/98 6,985,409
20,000,000 Federal Home Loan Bank 5.530 09/16/98 19,955,167
17,000,000 Federal Farm Credit Bank 5.508 09/17/98 16,959,276
13,000,000 Federal Home Loan Bank 5.520 09/18/98 12,967,034
5,000,000 Federal Farm Credit Bank 5.510 09/21/98 4,985,139
6,000,000 Federal Farm Credit Bank 5.520 09/21/98 5,982,133
17,000,000 Federal Farm Credit Bank 5.505 09/22/98 16,946,648
8,000,000 Federal Home Loan Bank 5.528 09/23/98 7,973,796
15,000,000 Federal Farm Credit Bank 5.517 09/24/98 14,948,538
20,000,000 Federal Home Loan Bank 5.540 09/25/98 19,928,133
11,000,000 Federal Farm Credit Bank 5.509 09/28/98 10,955,615
7,000,000 Federal Farm Credit Bank 5.522 09/29/98 6,970,818
5,000,000 Federal Farm Credit Bank 5.515 09/30/98 4,978,371
9,000,000 Federal Home Loan Bank 5.510 09/30/98 8,961,140
6,754,000 Federal Farm Credit Bank 5.531 10/01/98 6,723,776
8,000,000 Federal Farm Credit Bank 5.511 10/01/98 7,963,933
20,000,000 Federal Home Loan Bank 5.510 10/02/98 19,907,689
25,000,000 Federal Home Loan Bank 5.512 10/05/98 24,873,444
18,000,000 Federal Farm Credit Bank 5.533 10/06/98 17,905,325
15,000,000 Federal Home Loan Bank 5.526 10/07/98 14,919,750
15,000,000 Federal Home Loan Bank 5.508 10/08/98 14,917,367
12,000,000 Federal Home Loan Bank 5.524 10/09/98 11,932,107
20,000,000 Federal Home Loan Bank 5.543 10/13/98 19,874,933
8,000,000 Federal Home Loan Bank 5.532 10/14/98 7,948,782
8,000,000 Federal Home Loan Bank 5.530 10/14/98 7,948,591
21,000,000 Federal Home Loan Bank 5.515 10/15/98 20,862,170
20,000,000 Federal Home Loan Bank 5.540 10/16/98 19,865,250
10,000,000 Federal Farm Credit Bank 5.538 10/19/98 9,928,533
18,000,000 Federal Farm Credit Bank 5.522 10/20/98 17,867,700
14,000,000 Federal Home Loan Bank 5.540 10/21/98 13,895,194
</TABLE>
See notes to financial statements.
2
<PAGE>
HILLIARD-LYONS GOVERNMENT FUND, INC.
SCHEDULE OF INVESTMENTS (CONTINUED)
AUGUST 31, 1998
<TABLE>
<CAPTION>
PRINCIPAL PURCHASE MATURITY
AMOUNT YIELD DATE VALUE
----------- -------- -------- ------------
<C> <S> <C> <C> <C>
$12,000,000 Federal Home Loan Bank 5.542% 10/23/98 $ 11,906,400
15,000,000 Federal Farm Credit Bank 5.537 10/26/98 14,876,479
23,000,000 Federal Home Loan Bank 5.540 10/28/98 22,803,714
14,000,000 Federal Home Loan Bank 5.540 10/30/98 13,877,247
19,000,000 Federal Home Loan Bank 5.489 11/02/98 18,824,609
15,000,000 Federal Farm Credit Bank 5.523 11/03/98 14,859,563
12,000,000 Federal Farm Credit Bank 5.520 11/04/98 11,885,440
20,000,000 Federal Farm Credit Bank 5.508 11/05/98 19,806,444
12,000,000 Federal Home Loan Bank 5.510 11/06/98 11,882,080
17,000,000 Federal Home Loan Bank 5.508 11/09/98 16,825,353
18,000,000 Federal Farm Credit Bank 5.518 11/10/98 17,812,050
15,000,000 Federal Home Loan Bank 5.531 11/12/98 14,838,900
13,000,000 Federal Farm Credit Bank 5.510 11/13/98 12,859,495
7,000,000 Federal Farm Credit Bank 5.530 11/17/98 6,919,449
30,000,000 Federal Home Loan Bank 5.556 11/18/98 29,648,675
10,000,000 Federal Farm Credit Bank 5.505 11/20/98 9,881,778
5,000,000 Federal Home Loan Bank 5.530 11/20/98 4,940,222
17,000,000 Federal Home Loan Bank 5.530 11/25/98 16,784,053
16,000,000 Federal Home Loan Bank 5.520 11/27/98 15,792,360
9,090,000 Federal Home Loan Bank 5.540 12/02/98 8,965,720
8,000,000 Federal Home Loan Bank 5.486 12/04/98 7,888,871
6,390,000 Federal Home Loan Bank 5.532 12/14/98 6,291,054
12,000,000 Federal Farm Credit Bank 5.511 12/21/98 11,802,420
20,000,000 Federal Home Loan Bank 5.498 01/04/99 19,633,333
17,000,000 Federal Home Loan Bank 5.551 01/06/99 16,679,149
20,000,000 Federal Home Loan Bank 5.501 01/08/99 19,619,450
14,000,000 Federal Home Loan Bank 5.514 01/14/99 13,720,700
13,000,000 Federal Home Loan Bank 5.548 01/15/99 12,737,747
13,000,000 Federal Home Loan Bank 5.534 01/20/99 12,728,615
------------
TOTAL U.S. GOVERNMENT AGENCY OBLIGATIONS
(amortized cost -- $947,460,342) 947,460,342
------------
TOTAL INVESTMENTS (100.3%) (cost --
$947,460,342*) $947,460,342
============
</TABLE>
* Also represents cost for federal income tax purposes.
The percentage shown for each investment category is the total value of that
category as a percentage of the total net assets of the Fund.
See notes to financial statements.
3
<PAGE>
HILLIARD-LYONS GOVERNMENT FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
AUGUST 31, 1998
<TABLE>
<S> <C>
ASSETS
Investments in money market instruments, at value:
United States Government Agency Obligations, at value (amortized
cost--$947,460,342)............................................ $947,460,342
------------
Total Investments.............................................. 947,460,342
Cash............................................................. 2,583
Prepaid expenses................................................. 3,666
------------
TOTAL ASSETS................................................... 947,466,591
------------
LIABILITIES
Dividends payable................................................ 2,054,324
Due to J.J.B. Hilliard, W.L. Lyons, Inc.--Note B................. 252,165
Miscellaneous accrued expenses................................... 194,279
------------
TOTAL LIABILITIES.............................................. 2,500,768
------------
NET ASSETS (equivalent to $1.00 per share; 1,500,000,000 shares
authorized and 944,965,823 shares issued and outstanding)--Note
C............................................................... $944,965,823
============
HILLIARD-LYONS GOVERNMENT FUND, INC.
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED AUGUST 31, 1998
INVESTMENT INCOME
Interest income.................................................. $ 42,367,727
EXPENSES
Investment Advisory fee--Note B.................................. 2,550,536
Shareholder servicing fees--Note B............................... 772,607
Transfer agent fees.............................................. 221,993
Custodian fees................................................... 123,130
Printing and other expenses...................................... 83,144
Filing fees...................................................... 112,340
Insurance expense................................................ 32,371
Legal and audit fees............................................. 35,107
Directors' fees.................................................. 21,550
------------
Total expenses.................................................. 3,952,778
------------
Net investment income........................................... 38,414,949
------------
Net increase in net assets resulting from operations............ $ 38,414,949
============
</TABLE>
See notes to financial statements.
4
<PAGE>
HILLIARD-LYONS GOVERNMENT FUND, INC.
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED AUGUST
31
1998 1997
------------- -------------
INCREASE IN NET ASSETS:
<S> <C> <C>
FROM OPERATIONS
Net investment income............................ $ 38,414,949 $ 24,409,576
------------- -------------
Net increase in net assets resulting from
operations..................................... 38,414,949 24,409,576
Dividends to shareholders ($.049903 and $.048529
per share, respectively)........................ ( 38,414,949) ( 24,409,576)
------------- -------------
Undistributed net investment income.............. 0 0
------------- -------------
FROM CAPITAL SHARE TRANSACTIONS
Net capital share transactions (at $1.00 per
share)--Note C.................................. 357,885,980 159,585,459
NET ASSETS
Beginning of year................................ 587,079,843 427,494,384
------------- -------------
End of year...................................... $944,965,823 $587,079,843
============= =============
</TABLE>
FINANCIAL HIGHLIGHTS
The following table includes selected data for a share of capital stock
outstanding throughout each year and other performance information derived
from the financial statements. It should be read in conjunction with the
financial statements and notes thereto.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED AUGUST 31,
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of
year........................ $1.00 $1.00 $1.00 $1.00 $1.00
-------- -------- -------- -------- --------
Net investment income........ .05 .05 .05 .05 .03
-------- -------- -------- -------- --------
Total from investment
operations................. .05 .05 .05 .05 .03
Less distributions:
Dividend distributions...... ( .05) ( .05) ( .05) ( .05) ( .03)
-------- -------- -------- -------- --------
Total distributions......... ( .05) ( .05) ( .05) ( .05) ( .03)
-------- -------- -------- -------- --------
Net asset value, end of year. $1.00 $1.00 $1.00 $1.00 $1.00
======== ======== ======== ======== ========
Number of shares outstanding
(000's omitted)............. 944,966 587,080 427,494 335,776 210,652
Total investment return...... 5.11% 4.96% 4.96% 5.04% 2.85%
SIGNIFICANT RATIOS AND
SUPPLEMENTAL DATA
Net assets, end of year
(000's omitted)............ $944,966 $587,080 $427,494 $335,776 $210,652
Operating expenses to
average net assets......... .51% .57% .61% .72% .75%
Net investment income to
average net assets......... 4.99% 4.86% 4.84% 4.97% 2.80%
</TABLE>
See notes to financial statements
5
<PAGE>
HILLIARD-LYONS GOVERNMENT FUND, INC.
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 1998
NOTE A--ACCOUNTING POLICIES
Hilliard-Lyons Government Fund, Inc. (the "Fund") is a diversified open-end
management investment company registered under the Investment Company Act of
1940, as amended. The following is a summary of significant accounting
policies followed by the Fund in the preparation of its financial statements.
SECURITY VALUATION: The Fund employs the amortized cost method of security
valuation for U.S. Government securities which, in the opinion of the Board of
Directors, represents fair value of the particular security. The Board
monitors deviations between net asset value per share as determined by using
available market quotations and the amortized cost method of security
valuation. If the deviation in the aggregate is significant, the Board
considers what action, if any, should be initiated to provide fair valuation.
The Fund values repurchase agreements at cost and accrues interest into
interest receivable. Normally, repurchase agreements are not subject to
trading. Repurchase agreements are fully collateralized by U.S. Treasury and
U.S. Government Agency obligations valued at bid prices plus accrued interest.
U.S. Treasury and U.S. Government Agency obligations pledged as collateral for
repurchase agreements are held by the Fund's custodian bank until maturity of
the repurchase agreements. Provisions of the agreements provide that the
market value of the collateral plus accrued interest on the collateral is
greater than or equal to the repurchase price plus accrued interest at all
times. In the event of default or bankruptcy by the other party to the
agreements, the Fund maintains the right to sell the underlying securities at
market value; however, realization and/or retention of the collateral may be
subject to legal proceedings.
FEDERAL INCOME TAXES: It is the policy of the Fund to continue to qualify
under the Internal Revenue Code as a regulated investment company and to
distribute all of its taxable income to shareholders, thereby relieving the
Fund of federal income tax liability.
DIVIDENDS TO SHAREHOLDERS: The net investment income of the Fund is determined
on each business day and is declared as a dividend payable to shareholders of
record immediately prior to the time of determination of net asset value on
each such day. Dividends declared since the preceding dividend payment date
are distributed monthly.
The Fund's net investment income for dividend purposes includes accrued
interest and accretion of original issue and market discounts earned and
amortization of premiums, plus or minus any net realized gain or loss on
portfolio securities, if any, occurring since the previous dividend
declaration, less the accrued expenses of the Fund for such period.
INVESTMENT TRANSACTIONS: Investment transactions are accounted for on the date
the securities are bought or sold. Net realized gains and losses on sales of
investments, if any, are determined on the basis of identified cost.
The Fund may enter into repurchase agreements with financial institutions,
deemed to be credit worthy by J.J.B. Hilliard, W.L. Lyons, Inc. (the
"Adviser"), subject to the seller's agreement to repurchase and the Fund's
agreement to sell such security at a mutually agreed upon date and price.
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 reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements. Estimates also affect the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
NOTE B--INVESTMENT ADVISORY FEES & OTHER TRANSACTIONS WITH AFFILIATES
On October 23, 1997, the Fund renewed its investment advisory agreement with
the Adviser. Under the investment advisory agreement, the Adviser supervises
investment operations of the Fund and the composition of its portfolio, and
furnishes advice and recommendations with respect to investments and the
purchase and sale of securities in accordance with the Fund's investment
objectives, policies and restrictions; subject, however, to the general
supervision and control of the Fund's Board of Directors. For the services the
Adviser renders, the Fund has agreed to pay the Adviser an annual advisory fee
of 1/2 of 1% of the first $200 million of average daily net assets, 3/8 of 1%
of the next $100 million of average daily net assets, and 1/4 of 1% of the
average daily net assets in excess of $300 million. Such fee is accrued daily
and paid monthly. The Adviser has agreed to reimburse the Fund if total
operating expenses of the Fund, excluding taxes, interest and extraordinary
expenses (as defined), exceed on an annual basis 1 1/2% of the first $30
million of average daily net assets and 1% of average daily net assets over
$30 million. There was no reimbursement required for the year ended August 31,
1998. On August 20, 1998, PNC Bank Corp. entered into an Agreement and Plan of
Merger with Hilliard-Lyons, Inc. (the "Merger") pursuant to which the Adviser
will become a subsidiary of PNC Bank Corp. The Merger is expected to become
effective on or after November 30, 1998. This Merger constitutes an assignment
of the Investment Advisory Agreement (the "Agreement") as defined in the
Investment Company Act of 1940. Shareholders are being asked to approve a new
Agreement at a Special Shareholders Meeting scheduled to be held November 6,
1998.
The Fund contracted with the Adviser to provide shareholder accounting
services. The Adviser is paid a fee of $1.00 per open account each month.
No compensation is paid by the Fund to officers of the Fund and Directors who
are affiliated with the Adviser. The Fund pays each unaffiliated director an
annual retainer of $3,000, a fee of $750 for each Board of Directors or
committee meeting attended, and all expenses the Directors incur in attending
meetings.
NOTE C--CAPITAL STOCK
The Fund was incorporated in June 1980 under the laws of the state of
Maryland. At August 31, 1998, there were 1,500,000,000 shares of $.01 par
value Common Stock authorized, and capital paid in aggregated $935,516,165.
Transactions in Fund shares at $1.00 per share were as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED AUGUST 31,
1998 1997
-------------- --------------
<S> <C> <C>
Shares sold.................................... 2,979,565,610 1,740,443,413
Shares issued to shareholders in reinvestment
of dividends.................................. 36,974,418 23,618,228
-------------- --------------
3,016,540,028 1,764,061,641
Less shares repurchased........................ (2,658,654,048) (1,604,476,182)
-------------- --------------
Net increase in capital shares................. 357,885,980 159,585,459
============== ==============
</TABLE>
6
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Hilliard-Lyons Government Fund, Inc.
We have audited the accompanying statement of assets and liabilities, including
the schedule of portfolio investments, of the Hilliard-Lyons Government Fund,
Inc. (the Fund) as of August 31, 1998, and the related statement of operations
for the year then ended, statement of changes in net assets for each of the two
years in the period then ended and the financial highlights for each of the
five years in the period then ended. These financial statements and financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements and financial highlights. Our procedures included confirmation of
securities owned as of August 31, 1998, by correspondence with the custodian.
An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of the
Fund as of August 31, 1998, the results of its operations for the year then
ended, the changes in its net assets for each of the two years in the period
then ended and its financial highlights for each of the five years in the
period then ended, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Louisville, Kentucky
September 18, 1998
7
<PAGE>
HILLIARD-LYONS GOVERNMENT FUND, INC.
Hilliard Lyons Center
Louisville, Kentucky 40202
(502) 588-8400
INVESTMENT ADVISER AND DISTRIBUTOR
J.J.B. Hilliard, W.L. Lyons, Inc.
Hilliard Lyons Center
Louisville, Kentucky 40202
(502) 588-8400
CUSTODIAN AND TRANSFER AGENT
State Street Bank and Trust Company
225 Franklin Street
P.O. Box 1912
Boston, Massachusetts 02105
LEGAL COUNSEL
Brown, Todd & Heyburn PLLC
3200 Providian Center
Louisville, Kentucky 40202
DIRECTORS AND OFFICERS
BOARD OF DIRECTORS
Joseph C. Curry, Jr.
J. Henning Hilliard
Donald F. Kohler
Samuel G. Miller
Gilbert L. Pamplin
J. Robert Shine
OFFICERS
Donald F. Kohler - Chairman
Joseph C. Curry, Jr. - President
Dianna P. Wengler - Vice President and Treasurer
Penny L. Wellinghurst -Secretary
HILLIARD-LYONS
GOVERNMENT FUND, INC.
ANNUAL REPORT
AUGUST 31, 1998
LOGO
