<PAGE>
<PAGE> 1
HERITAGE U.S. GOVERNMENT INCOME FUND
880 CARILLON PARKWAY
ST. PETERSBURG, FLORIDA 33716
JULY 19, 1999
DEAR FELLOW SHAREHOLDER:
The enclosed Combined Proxy Statement and Prospectus relates to a special
meeting of the shareholders of the Heritage U.S. Government Income Fund (the
"Government Fund") to be held on Monday, September 27, 1999. The purpose of this
meeting is to seek your approval of a proposal to reorganize the Government Fund
by combining it with the Intermediate Government Fund (the "Intermediate Fund"),
a series of Heritage Income Trust, an existing open-end management investment
company (the "Reorganization"). If the proposal is approved, each Government
Fund shareholder will receive Class A shares of the Intermediate Fund in an
amount equal to the total net asset value of the shareholder's ownership in the
Government Fund. In exchange, the Intermediate Fund will receive all of the
assets, and assume all of the liabilities, of the Government Fund, which then
will be liquidated. Subject to shareholder approval, we expect to complete the
Reorganization on October 15, 1999.
The Government Fund's Board of Trustees ("Board") has considered and
unanimously approved the proposal. As discussed more fully in the enclosed proxy
statement, the Board believes that the Reorganization is in the best interests
of the Government Fund shareholders for the following reasons:
- The proposal, if approved, will eliminate the discount to net asset value
at which the Government Fund shares have historically traded on the New
York Stock Exchange.
- The Reorganization would provide shareholders with the benefits of an
open-end investment company form of organization, including the ability
for shareholders to exchange their shares for shares of other Heritage
mutual funds or sell shares at net asset value.
- Both Funds have substantially similar investment objectives and policies
and share the same portfolio manager.
- Heritage Asset Management, Inc., the Funds' manager, has undertaken to
cap for three years the net annual operating expenses of the Intermediate
Fund's Class A shares at 0.95% of its daily net assets, which is lower
than the Government Fund's net operating expenses of 1.07% of its net
assets.
- The Reorganization will be free from federal income taxes to shareholders
and the Funds.
The Board recommends that you vote FOR the proposal.
Please take time to review the enclosed materials and vote your shares
today. Your prompt attention to this matter is appreciated. If you have any
questions or need further assistance, please call 800-421-4184.
Very truly yours,
/s/ STEPHEN G. HILL
------------------------------------
STEPHEN G. HILL
President
Heritage U.S. Government Income Fund
<PAGE> 2
HERITAGE U.S. GOVERNMENT INCOME FUND
880 CARILLON PARKWAY
ST. PETERSBURG, FLORIDA 33716
---------------------
NOTICE OF
SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON SEPTEMBER 27, 1999
---------------------
TO THE SHAREHOLDERS:
A special meeting of the holders of shares of beneficial interest in the
Heritage U.S. Government Income Fund (the "Government Fund") will be held on
September 27, 1999 at 8:30 a.m., Eastern time, or any adjournment(s) thereof, at
100 CARILLON PARKWAY, SUITE 250, ST. PETERSBURG, FL 33716, for the following
purposes:
(1) To approve an Agreement and Plan of Reorganization and Termination
("Reorganization Plan") that provides for the reorganization of the
Government Fund by combining it with the Intermediate Government Fund
(the "Intermediate Fund"), a series of Heritage Income Trust. Pursuant
to the Reorganization Plan, the Government Fund will transfer all its
assets to the Intermediate Fund in exchange solely for Class A shares
of the Intermediate Fund and the assumption by the Intermediate Fund of
all the Government Fund's liabilities. The Government Fund will issue
to each Government Fund shareholder a number of full and fractional
Class A shares of the Intermediate Fund having an aggregate value that,
on the effective date of the Reorganization, is equal to the aggregate
net asset value of the shareholder's shares in the Government Fund; and
(2) To transact such other business that properly comes before the meeting
or any adjournment(s) thereof.
You are entitled to vote at the meeting and any adjournment(s) thereof if
you owned shares of the Government Fund as of the close of business on July 16,
1999. If you attend the meeting, you may vote your shares in person. IF YOU DO
NOT EXPECT TO ATTEND THE MEETING, YOU MAY VOTE YOUR SHARES BY COMPLETING AND
RETURNING THE ENCLOSED PROXY CARD IN THE ENCLOSED POSTAGE-PAID ENVELOPE.
By Order of the Board of Trustees,
CLIFFORD J. ALEXANDER
Secretary
July 19, 1999
880 Carillon Parkway
St. Petersburg, Florida 33716
YOUR VOTE IS IMPORTANT
NO MATTER HOW MANY SHARES YOU OWN
Please indicate your voting instructions on the enclosed proxy card, date
and sign the card, and return the card in the envelope provided. If you sign,
date and return the proxy card but give no voting instructions, your shares will
be voted "FOR" the proposal noticed above. In order to avoid the additional
expense of further solicitation, we ask your cooperation in returning your proxy
card promptly. Unless proxy cards submitted by corporations and partnerships are
signed by the appropriate persons as indicated in the voting instructions on the
proxy card, they will not be voted.
<PAGE> 3
HERITAGE U.S. GOVERNMENT INCOME FUND
HERITAGE INCOME TRUST
INTERMEDIATE GOVERNMENT FUND
880 CARILLON PARKWAY, ST. PETERSBURG, FLORIDA 33716
TOLL FREE: (800) 421-4184
COMBINED PROXY STATEMENT AND PROSPECTUS
July 19, 1999
This Combined Proxy Statement and Prospectus ("Proxy Statement") is being
furnished in connection with a Special Meeting of Shareholders of the Heritage
U.S. Government Income Fund (the "Government Fund") to be held on September 27,
1999, or any adjournment(s) thereof ("Meeting"), at 100 Carillon Parkway, Suite
250, St. Petersburg, FL 33716. At the Meeting, shareholders of the Government
Fund will be asked to approve a proposal ("Proposal") to reorganize the
Government Fund in accordance with an Agreement and Plan of Reorganization and
Termination ("Reorganization Plan"). The Reorganization Plan provides that the
Government Fund will combine with the Intermediate Government Fund (the
"Intermediate Fund"), a series of Heritage Income Trust ("Income Trust"), an
open-end management investment company ("Reorganization"). The Reorganization
Plan is attached as Appendix A to this Proxy Statement. The Board of Trustees of
the Government Fund ("Board") has unanimously approved the Reorganization Plan
as being in the best interests of the Government Fund.
In accordance with the Reorganization Plan, the Government Fund will
transfer all its assets to the Intermediate Fund in exchange solely for the
Intermediate Fund's Class A shares ("Intermediate Fund Shares") and the
assumption by the Intermediate Fund of all the Government Fund's liabilities.
The Government Fund's shareholders will not be assessed any sales charges in
connection with the Reorganization, and there will be no federal income tax
consequences as a result of the Reorganization. The Government Fund will cease
trading on the New York Stock Exchange ("NYSE") upon completion of the
Reorganization and thereafter will be dissolved.
The Intermediate Fund is an open-end, diversified series of Income Trust, a
Massachusetts business trust. Its investment objective is high current income
consistent with the preservation of capital. The Intermediate Fund seeks to
achieve its objective by investing primarily in debt securities issued or
guaranteed by the U.S. government and its agencies or instrumentalities,
including mortgage-related securities.
This Proxy Statement sets forth information that a Government Fund
shareholder should know before voting on the Reorganization Plan. It should be
read and retained for future reference. A Statement of Additional Information
("SAI"), dated July 19, 1999, is incorporated herein by reference into this
Proxy Statement. The SAI is available without charge by contacting Heritage
Asset Management, Inc. ("Heritage") at the telephone number or address listed
above.
A copy of the current prospectus of the Intermediate Fund, dated February
1, 1999, is included with this Proxy Statement. In addition, the management's
discussion of the Intermediate Fund's performance, which is included in the
Annual Report to Shareholders of the Intermediate Fund for the fiscal year ended
September 30, 1998, is attached as Appendix B to this Proxy Statement. The SAI
of the Intermediate Fund, dated February 1, 1999, its Annual Report to
Shareholders for the period ended September 30, 1998 and its Semi-Annual Report
to Shareholders for the period ended March 31, 1999 are on file with the
Securities and
<PAGE> 4
Exchange Commission ("SEC") and are incorporated by reference into this Proxy
Statement. The Annual Report to Shareholders of the Government Fund for the
fiscal period ended October 31, 1998 is on file with the SEC and is incorporated
by reference into this Proxy Statement. These documents are available without
charge by calling or writing Heritage at the telephone number or address listed
above. The SEC maintains a web site at http://www.sec.gov that contains these
documents and other information about the Intermediate Fund and the Government
Fund. Information relating to the Government Fund also is available for
inspection at the NYSE.
THE SEC HAS NOT APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED IF
THIS PROXY STATEMENT IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
2
<PAGE> 5
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
INTRODUCTION................................................ 4
VOTING INFORMATION.......................................... 4
SYNOPSIS.................................................... 5
The Proposed Reorganization............................... 5
Comparison of the Government Fund and the Intermediate
Fund................................................... 5
Forms of Organization.................................. 5
Investment Objectives and Policies..................... 6
Operations of the Intermediate Fund After the
Reorganization........................................ 7
Portfolio Managers..................................... 8
Performance............................................ 8
Fees and Expenses...................................... 9
Expense Example........................................ 10
Supplemental Expense Example -- Giving Effect to the
Reorganization........................................ 10
Purchase Procedures.................................... 10
Exchange and Redemption Procedures..................... 11
Federal Income Tax Consequences........................ 11
COMPARISON OF PRINCIPAL RISK FACTORS........................ 12
Generally................................................. 12
Principal Differences..................................... 12
Common Risks.............................................. 12
INFORMATION ABOUT THE REORGANIZATION........................ 14
Summary of the Reorganization Plan........................ 14
Reasons for the Reorganization............................ 15
Description of Intermediate Fund Shares................... 16
Dividends and Other Distributions......................... 17
Federal Income Tax Considerations......................... 17
Rights of Shareholders.................................... 18
Capitalization............................................ 18
FINANCIAL HIGHLIGHTS OF THE INTERMEDIATE FUND............... 19
SHARE PRICE DATA............................................ 20
INVESTMENT ADVISER AND DISTRIBUTOR.......................... 20
LEGAL MATTERS............................................... 20
EXPERTS..................................................... 21
INFORMATION FILED WITH THE SEC AND NYSE..................... 21
ADDITIONAL INFORMATION ABOUT EACH FUND...................... 21
APPENDIX A -- Agreement and Plan of Reorganization and
Termination............................................... A-1
APPENDIX B -- Management's Discussion of Intermediate Fund
Performance............................................... B-1
</TABLE>
3
<PAGE> 6
INTRODUCTION
This Proxy Statement is being furnished to shareholders of the Government
Fund in connection with the solicitation of proxies by the Board for use at the
Meeting. At the Meeting, you will be asked to approve the Reorganization Plan.
The Reorganization Plan provides that the Government Fund will transfer all of
its assets to the Intermediate Fund in exchange solely for Intermediate Fund
Shares and the assumption by the Intermediate Fund of all the Government Fund's
liabilities. Intermediate Fund Shares will be distributed to shareholders of the
Government Fund in an amount equal to the total net asset value of the
shareholder's ownership in the Government Fund. The Reorganization will occur as
of the close of business on October 15, 1999, or a later date agreed to by
Income Trust and the Government Fund ("Closing Date"). The Government Fund will
be terminated as soon as is reasonably practicable thereafter.
VOTING INFORMATION
This Proxy Statement, along with a Notice of the Meeting and proxy card, is
first being mailed to shareholders of the Government Fund on or about July 29,
1999. Only shareholders of record as of the close of business on July 16, 1999
(the "Record Date") will be entitled to notice of, and to vote at, the Meeting
or any adjournment thereof. As of the Record Date, the Government Fund had
3,115,471 shares outstanding and entitled to vote. Holders of one-half of the
shares of the Government Fund outstanding at the close of business on the Record
Date must be present in person or represented by proxy at the Meeting to
constitute a quorum for the transaction of business at the Meeting. If a quorum
is not present at the Meeting or a quorum is present but sufficient votes to
approve the Proposal are not received, the persons named as proxies may propose
one or more adjournments of the Meeting to permit the further solicitation of
proxies. Any such adjournment will require the affirmative vote of a majority of
those shares represented at the Meeting in person or by proxy. If a quorum is
present, the persons named as proxies will vote those proxies that they are
entitled to vote FOR the Proposal in favor of an adjournment and will vote those
proxies required to be voted AGAINST the Proposal against an adjournment. A
shareholder vote may be taken on the Proposal described in this Proxy Statement
prior to any adjournment if sufficient votes have been received and it is
otherwise appropriate. Approval of the Proposal with respect to the
Reorganization Plan requires the affirmative vote of a majority of the shares of
the Government Fund outstanding and entitled to vote.
An abstention is a proxy that is properly executed, returned and
accompanied by instructions withholding authority to vote. Broker non-votes are
shares held in street name for which the broker indicates that instructions have
not been received from the beneficial owners or persons entitled to vote or with
respect to which the broker does not have discretionary voting authority.
Abstentions and broker non-votes are counted as votes present for purposes of
determining whether the requisite quorum exists. For purposes of the Proposal,
abstentions and broker non-votes will constitute a vote AGAINST the Proposal
because the Proposal requires the affirmative vote of a majority of the
Government Fund's shares outstanding and entitled to vote.
The individuals named as proxies in the proxy card will vote in accordance
with your directions as indicated thereon if your proxy card is timely received
properly executed by you or by your duly appointed agent or attorney-in-fact. If
you sign, date and return the proxy card, but give no voting instructions, your
shares will be voted in favor of the Proposal described in this Proxy Statement.
The duly appointed proxies may, in their discretion, vote upon other matters
that properly come before the Meeting. You may revoke your proxy card by giving
another proxy or by letter or telegram revoking your initial proxy. To be
effective, revocation must be received by the Government Fund prior to the
Meeting, or by appearing in person and voting at the Meeting.
4
<PAGE> 7
As of the Record Date, no shareholder held of record or owned beneficially
more than 5% of the issued and outstanding shares of either the Government Fund
or the Intermediate Fund. The Trustees and officers of the Government Fund and
the Intermediate Fund as a group own less than 1% of the shares of the
Government Fund and Intermediate Fund, respectively. All costs associated with
the Meeting, including the solicitation of proxies, will be borne by Heritage.
Each full share of the Government Fund is entitled to one vote, and each
fractional share thereof is entitled to a proportionate share of one vote.
Solicitations will be made primarily by mail but also may include telephone
communications by regular employees of Heritage, who will not receive any
compensation therefor from the Government Fund. Certain shareholders whose votes
are solicited by ADP Investor Communication Services may be permitted to vote by
telephone or via the Internet.
SYNOPSIS
The following discussion is a summary about the Reorganization, the
Government Fund and the Intermediate Fund. As discussed more fully below, the
Board believes that the Reorganization will benefit the Government Fund's
shareholders. The Intermediate Fund has an investment objective that is
substantially similar to the investment objective of the Government Fund and has
a substantially similar investment strategy.
THE PROPOSED REORGANIZATION
The Board considered and approved the Reorganization Plan at a meeting held
on May 17, 1999. The Reorganization Plan provides that the Government Fund will
combine with the Intermediate Fund by transferring all its assets to the
Intermediate Fund in exchange solely for Intermediate Fund Shares and the
assumption by the Intermediate Fund of all the Government Fund's liabilities.
The Government Fund will then distribute those Intermediate Fund Shares to its
shareholders. Each shareholder of the Government Fund will receive the number of
full and fractional Intermediate Fund Shares that is equal in total value to the
value of the shareholder's holdings in the Government Fund (based on the
Government Fund's net asset value per share) as of the Closing Date. The
Government Fund will be terminated as soon as is reasonably practicable
thereafter.
For the reasons set forth below under "Reasons for the Reorganization," the
Board (including its Trustees who are not "interested persons" ("Independent
Trustees") as that term is defined in the Investment Company Act of 1940 as
amended ("1940 Act") of the Government Fund, Income Trust or Heritage) has
determined that the Reorganization is in the best interests of the Government
Fund, that the terms of the Reorganization are fair and reasonable and that the
interests of the Government Fund's shareholders will not be diluted as a result
of the Reorganization. Accordingly, the Board recommends approval of the
Reorganization Plan. Additionally, the Board of Trustees of Income Trust has
determined that the Reorganization is in the best interests of the Intermediate
Fund, that the terms of the Reorganization are fair and reasonable and that the
interests of the Intermediate Fund's shareholders will not be diluted as a
result of the Reorganization.
COMPARISON OF THE GOVERNMENT FUND AND THE INTERMEDIATE FUND
Forms of Organization
The Intermediate Fund is a series of Income Trust, an open-end investment
company that is organized as a Massachusetts business trust. The Intermediate
Fund offers for sale three classes of shares, including Class A shares. The
Government Fund is a closed-end fund also organized as a Massachusetts business
trust.
5
<PAGE> 8
Its shares are traded on the NYSE. Open-end funds, such as the Intermediate
Fund, continuously offer and redeem their shares, causing their total assets to
fluctuate. In contrast, most closed-end funds like the Government Fund make a
single offering of non-redeemable shares and thus retain a stable pool of
assets, which changes only upon appreciation or depreciation of their portfolio
investments, payment of operating expenses, and payment of dividends to
shareholders.
Investment Objectives and Policies
Summary
The investment objectives and policies of the Intermediate Fund and the
Government Fund (each, a "Fund") are set forth below. The Intermediate Fund's
investment objective is substantially similar to the Government Fund's
investment objective in that each Fund seeks high current income. The
Intermediate Fund attempts to achieve its objective while preserving capital.
The Government Fund, however, has a secondary objective of capital appreciation.
The investment policies of each Fund permit investments in debt securities
issued or guaranteed by the U.S. government, its agencies or instrumentalities,
mortgage-related securities, certain derivative mortgage instruments, corporate
debt obligations and money market securities, among others. Further, the
Government Fund may utilize techniques such as borrowing in a greater amount
than the Intermediate Fund. Since the Government Fund also pursues capital
appreciation, it may invest in a broader range of securities that may exhibit
greater risk than securities held by the Intermediate Fund.
The Intermediate Fund invests substantially all its assets in U.S. Treasury
securities, mortgage-related securities issued by U.S. government agencies and
repurchase agreements. The Government Fund invests not only in these same types
of securities, but also in mortgage dollar rolls, reverse repurchase agreements
and delayed delivery obligations. The Intermediate Fund typically maintains a
weighted average portfolio maturity of between 3 and 10 years. The Government
Fund's weighted average portfolio maturity is about 6.3 years (as of March 31,
1999). There can be no assurance that either Fund will achieve its investment
objective(s).
The Intermediate Fund
The investment objective of the Intermediate Fund is high current income
consistent with the preservation of capital. It seeks to achieve its objective
by investing primarily in debt securities issued or guaranteed by the U.S.
government, its agencies or instrumentalities and related repurchase agreements.
Under normal conditions, the Intermediate Fund invests at least 80% of its
assets in these debt securities, including mortgage-backed securities. Up to 25%
of the Intermediate Fund's assets may be invested in repurchase agreements. The
Intermediate Fund may invest its remaining assets in derivative securities, such
as options, futures contracts and stripped securities, short-term corporate debt
or other money market instruments. No more than 20% of the Intermediate Fund's
net assets, however, may be invested in mortgage-backed securities of private
issuers. Although the Intermediate Fund is permitted to borrow up to 15% of its
assets, it may do so only as a temporary measure for extraordinary or emergency
purposes, including to meet redemption requests.
The portfolio manager selects securities for the Intermediate Fund's
portfolio by considering factors such as maturity, interest rate conditions and
liquidity. The portfolio manager attempts to manage volatility consistent with
the Intermediate Fund's investment objective. In an effort to help reduce the
impact of interest rate changes, the portfolio manager may engage in options
transactions by hedging up to 100% of the Intermediate Fund's net assets. The
Intermediate Fund may write call and put options on up to 15% of its total
assets.
6
<PAGE> 9
The Government Fund
The primary investment objective of the Government Fund is to provide a
high level of current income. Its secondary investment objective is capital
appreciation. The Government Fund seeks to achieve these objectives through the
active management of a portfolio of securities including primarily
mortgage-related securities and mortgages. Under normal conditions, the
Government Fund invests at least 65% of its assets in securities issued or
guaranteed by the U.S. government, its agencies or instrumentalities, including
mortgage-related securities. The Government Fund may invest its remaining assets
in private issuer mortgage-related securities, individual mortgages, non-U.S.
government mortgage derivative securities, unregistered securities and corporate
debt, among others. In addition, the Government Fund may invest in repurchase
agreements. Unlike the Intermediate Fund, the Government Fund may borrow up to
33 1/3% of its assets to increase leverage. It also may loan its respective
portfolio securities to earn additional income. Historically, the Government
Fund has borrowed by entering into reverse repurchase agreements and mortgage
dollar rolls transactions and delayed delivery transactions. The Government Fund
may invest up to 30% of its total assets in derivative mortgage-backed
securities.
The portfolio manager selects mortgage-related securities based on factors
such as income potential, liquidity and general economic conditions. Further,
the portfolio manager may consider potential benefits from changes in interest
rates when selecting mortgage-related securities. With respect to individual
mortgages, the portfolio manager may consider criteria such as interest rates on
the mortgage, the type of mortgage (i.e., fixed or adjustable), payment history
on the mortgage and the size of the mortgage. Historically, however, the
Government Fund has not invested in individual mortgages. In an effort to help
reduce the impact of interest rate changes, the portfolio manager may engage in
options transactions by hedging up to 100% of the Government Fund's net assets.
At any time, the Government Fund may invest up to 100% of its total assets in
U.S. Treasury securities, including U.S. Treasury bonds, bills and notes.
Other Policies
Each Fund may purchase securities on a "when-issued basis," which means
that settlement of the purchase takes place in the future. In addition, each
Fund may purchase or sell securities on a "forward commitment" basis. The
portfolio manager may use a "forward commitment" strategy, which permits
settlement in the future, to hedge against anticipated changes in interest rates
and prices. Each Fund may invest a portion of its respective assets in illiquid
securities -- up to 10% for the Intermediate Fund and up to 15% for the
Government Fund.
Each Fund is actively managed. Securities may be purchased and sold
relatively quickly due to changes in economic or market conditions.
Consequently, each Fund may be subject to a high rate of portfolio turnover. A
high rate of portfolio turnover generally leads to higher transaction costs and
higher short-term capital gains.
Each Fund may invest in high quality commercial paper. Each Fund also may
invest in deposit instruments such as certificates of deposit issued by domestic
banks with at least $1 billion in assets and capital surplus of at least $100
million as of the bank's most recent fiscal year.
OPERATIONS OF THE INTERMEDIATE FUND AFTER THE REORGANIZATION
As noted previously, the investment objectives and policies of each Fund
are substantially similar. The Intermediate Fund does not intend to change any
investment objective or policies as a result of the Reorganization. Heritage,
the Funds' manager, believes that substantially all the assets held by the
7
<PAGE> 10
Government Fund will be consistent with the investment objective and policies of
the Intermediate Fund and thus could be transferred to and held by the
Intermediate Fund if the Reorganization is approved. If any of the assets owned
by the Government Fund, however, are inconsistent with the investment objective
and policies of the Intermediate Fund, those assets will be sold prior to the
Reorganization. The proceeds of those sales will be held in temporary
investments or reinvested in other assets that qualify for inclusion in the
Intermediate Fund's portfolio. The need, if any, for the Government Fund to sell
assets prior to the Reorganization may result in the Government Fund selling
assets at a disadvantageous time and may result in the Government Fund realizing
losses that would not otherwise have been realized, the net proceeds of which
would be included in a distribution to its shareholders before the
Reorganization.
PORTFOLIO MANAGERS
H. Peter Wallace is responsible for the day-to-day management of each
Fund's investment portfolio. Mr. Wallace has served as portfolio manager of each
Fund since 1993. Mr. Wallace has been a Senior Vice President and Director of
Fixed Income Investments for Heritage since January 1993. Mr. Wallace is a
Chartered Financial Analyst.
PERFORMANCE
The following table compares the average annual total returns of each Fund
and two market indices for the periods ended December 31, 1998 and for the
six-month period ended June 30, 1999. The performance of the Intermediate Fund
does not take into account any sales charges applicable to purchases of
Intermediate Fund Shares.
<TABLE>
<CAPTION>
TOTAL
RETURN AVERAGE ANNUAL TOTAL RETURNS
FOR THE (FOR THE PERIODS ENDED DECEMBER 31, 1998)
6 MONTHS -------------------------------------------------
ENDED SINCE SINCE
JUNE 30, INCEPTION ON INCEPTION ON
1999 1 YEAR 5 YEARS 11/19/93 03/01/98
-------- ------ ------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Government Fund (at market value)....... 10.22% 0.20% 1.13% 1.43% N/A
Government Fund (NAV)................... -2.26% 8.20% 5.67% 5.68% N/A
Intermediate Fund (Class A Shares)...... -1.68% 8.19% 5.82% N/A 5.90%
Lehman Brothers 1 to 3 year Government
Index*................................ 1.15% 6.97% 5.95% 5.94% 7.02%
Lehman Brothers Intermediate
Fund/Corporate Index**................ -0.58% 8.43% 6.60% 6.58% 8.24%
</TABLE>
- ---------------
+ The first "Since Inception" figure is based on the period beginning 12/1/93,
which is the closest month-end to the date of completion of the Government
Fund's initial public offering. The second "Since Inception" figure is based
on the period beginning 3/1/90, which is the closest month-end to
Intermediate Fund's inception date.
* The Lehman Brothers 1 to 3 Year Government Index is an unmanaged index
comprised of U.S. government and agency securities rated investment grade or
higher with a maturity of one to three years and a minimum par value of $100
million for U.S. government issues. Its returns do not include the effect of
any sales charges.
** The Lehman Brothers Intermediate Fund/Corporate Index is comprised of the
Intermediate Fund Index, which includes the Intermediate Treasury and
Intermediate Agency indices, and the Intermediate Corporate Index, which
includes bonds issued by corporations. Its returns do not include the effect
of any sales charges.
8
<PAGE> 11
FEES AND EXPENSES
The following tables compare: (1) shareholder fees and annual operating
expenses for Intermediate Fund Shares for the fiscal year ended September 30,
1998; (2) shareholder transaction expenses and annual fund expenses for the
Government Fund for the fiscal year ended October 31, 1998 and (3) estimated pro
forma fees and expenses for Intermediate Fund Shares after the Reorganization.
<TABLE>
<CAPTION>
INTERMEDIATE COMBINED FUND
FUND GOVERNMENT (CLASS A SHARES)
(CLASS A SHARES) FUND PRO FORMA
---------------- ---------- ----------------
<S> <C> <C> <C>
SHAREHOLDER FEES (fees paid directly from your investment):
Maximum Sales Charge Imposed on Purchases (as a % of
offering price)................................................... 3.75%* 6.00%** 3.75%*
Maximum Deferred Sales Charge (as a % of original
purchase price or redemption proceeds, whichever is
lower)............................................................ None None None
Dividend Reinvestment Plan Fees..................................... None None None
Wire Redemption Fee (per transaction)............................... $5.00 None $5.00
</TABLE>
- ---------------
* There will be no sales charge assessed to the Government Fund's shareholders
as a result of the Reorganization.
** This sales charge was applicable at the time of the initial public offering.
<TABLE>
<S> <C> <C> <C>
ANNUAL OPERATING EXPENSES (expenses deducted from fund assets):
Management Fees...................................................... 0.50%* 0.56%** 0.50%*
Distribution and Service (12b-1) Fees................................ 0.32% None 0.27%
Other Expenses....................................................... 1.18%* 0.62%** 0.39%*
---- ---- ----
Total Annual Operating Expenses.................................... 2.00%* 1.18%** 1.16%*
==== ==== ====
Fee Waiver and/or Expense Reimbursement.............................. 1.08% 0.11% 0.29%
Net Expenses......................................................... 0.92% 1.07% 0.87%
==== ==== ====
</TABLE>
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* Heritage has agreed to waive its investment advisory fees and, if necessary,
reimburse the Intermediate Fund to the extent that Intermediate Fund Shares
annual operating expenses exceed 0.95% through its 2002 fiscal year.
** Heritage voluntarily has undertaken to reduce investment advisory and/or
administration fees and, if necessary, reimburse the Government Fund to the
extent that annual expenses, excluding interest payments on borrowed funds
and taxes, exceed 1.00% for the Government Fund's 1999 fiscal year. In
applying, this expense waiver and/or reimbursement, the investment advisory
fee and total annual expenses were reduced to 0.38% and 1.07%, respectively.
9
<PAGE> 12
EXPENSE EXAMPLE
The Example is intended to help you compare the cost of investing in
Intermediate Fund Shares, both before and after the Reorganization, with the
cost of investing in shares of the Government Fund. The Example assumes that you
invest $10,000 in each Fund for the time periods indicated and then redeem all
of your shares at the end of those periods. The Example also assumes that your
investment has a 5% return each year and that each Fund's operating expenses
remain the same in the first year. To the extent fees are waived, the expenses
will be lower. Although your actual costs may be higher or lower, based on these
assumptions your costs would be:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Intermediate Fund (Class A shares)...................... $465 $878 $1,316 $2,531
Combined Fund (Class A shares) Pro Forma................ $460 $702 $ 962 $1,706
Government Fund......................................... $713 $920 $1,155 $1,827
</TABLE>
SUPPLEMENTAL EXPENSE EXAMPLE -- GIVING EFFECT TO THE REORGANIZATION
Government Fund shareholders will not be assessed any front-end sales
charges in connection with the Reorganization. As a result, the cost of
investing in Intermediate Fund Shares is lower than reflected in the above
Expense Example table. The Example table below is based on the same assumptions
as the example above, except that the front-end sales charges are not included
as an expense in the calculations. Although your actual costs may be higher or
lower, based on these assumptions your costs would be:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Intermediate Fund (Class A shares)....................... $ 94 $523 $978 $2,240
Combined Fund (Class A shares) Pro Forma................. $ 89 $340 $610 $1,383
Government Fund.......................................... $109 $340 $590 $1,306
</TABLE>
PURCHASE PROCEDURES
Intermediate Fund Shares may be purchased by mail, bank wire or through a
financial advisor for regular accounts, systematic investment programs and
retirement accounts. Intermediate Fund Shares are sold at their "offering
price" -- a price equal to their net asset value ("NAV"), plus a maximum sales
charge of 3.75% imposed at the time of purchase. However, no sales charges will
be imposed in connection with the receipt of Intermediate Fund Shares by
shareholders of the Government Fund due to the Reorganization. The minimum
initial investment in the Intermediate Fund is $1,000; each additional
investment must be $50 or more. These minimums may be waived or reduced for
investments by employees of Heritage or its affiliates, certain retirement plans
and participants in the systematic investment program. Normally, you must
maintain a minimum account balance. If your account balance falls below $500 as
a result of selling shares (and not because of performance or sales charges),
the Intermediate Fund reserves the right to request that you buy more shares or
close your account. However, the minimum account balance restriction will be
waived for Intermediate Fund Shares distributed to the Government Fund's
shareholders as a result of the Reorganization.
Intermediate Fund Shares are subject to ongoing distribution and service
(Rule 12b-1) fees of up to 0.35% of their average daily net assets. These fees
permit the Intermediate Fund to pay distribution and services fees for the sale
of its shares and for services provided to shareholders. For a more complete
discussion of the purchase procedures for Intermediate Fund Shares, see "Your
Investment" in the Intermediate Fund's prospectus.
10
<PAGE> 13
Shares of the Government Fund were issued initially in a public offering on
November 19, 1993. Unlike Intermediate Fund Shares, shares of the Government
Fund currently are listed and publicly traded on the NYSE under the symbol
"HGA." These shares may be purchased through your broker, financial advisor or
other investment professional, all of whom may charge a commission. The
Government Fund's shareholders also may accumulate additional shares through a
dividend reinvestment plan, as discussed below. While a commission may be
charged in connection with the purchase of the Government Fund's shares, the
Government Fund currently does not impose a front-end sales charge on purchases
of shares and shares are not subject Rule 12b-1 fees. However, upon completion
of the Reorganization, Intermediate Fund Shares distributed to shareholders will
be subject to Rule 12b-1 fees. No sales charges will be imposed in connection
with this distribution. Upon completion of the Reorganization, shares of the
Government Fund will not be available for purchase.
EXCHANGE AND REDEMPTION PROCEDURES
Shareholders who have owned Intermediate Fund Shares for at least 30 days
may exchange those shares for shares of the same class of any other Heritage
mutual fund if the shareholder satisfies minimum investment requirements of that
fund. However, you may exchange Intermediate Fund Shares received in connection
with the Reorganization immediately. Exchanges, in most cases, may be completed
without paying any additional sales charges. Intermediate Fund Shares may be
sold by telephone, mail or through a financial advisor. Intermediate Fund Shares
will be redeemed at NAV per share next determined after a request in proper form
is received at the Intermediate Fund. For additional information, see "How to
Exchange Your Shares" and "How to Sell Your Investment" in the Intermediate
Fund's prospectus.
The Government Fund's shareholders do not have any exchange privileges with
any Heritage mutual fund. However, upon completion of the Reorganization,
shareholders receiving Intermediate Fund Shares may exchange those shares for
any other Heritage mutual fund. Shares of the Government Fund may be sold on the
NYSE at current market value through a broker, financial advisor or other
investment professional, each of whom may charge a commission for their
services.
FEDERAL INCOME TAX CONSEQUENCES
The Income Trust and the Government Fund will receive an opinion from their
legal counsel, Kirkpatrick & Lockhart LLP, to the effect that the Reorganization
will constitute a tax-free reorganization within the meaning of section
368(a)(1)(D) of the Internal Revenue Code 1986, as amended ("Code").
Accordingly, neither Fund will recognize any gain or loss as a result of the
Reorganization. See "Information About the Reorganization -- Federal Income Tax
Considerations" below. If the Government Fund sells securities before the
Reorganization, it may recognize net gains or losses. Any net recognized gains
would increase the amount of any distribution it makes to its shareholders
before the Reorganization.
11
<PAGE> 14
COMPARISON OF PRINCIPAL RISK FACTORS
GENERALLY
An investment in each Fund is subject to substantially the same risks
arising out of investing in U.S. Treasury securities and mortgage-related
securities issued by U.S. government agencies. However, the Government Fund's
investment portfolio is subject to additional risks arising out of its focus on
engaging in reverse repurchase agreements, mortgage dollar rolls and delayed
delivery transactions. Because each Fund primarily invests in debt or
mortgage-related securities, the market value of those securities may fluctuate
with changes in interest rates. When interest rates rise, the market value of
debt securities held by either Fund will decrease. The market value of
mortgage-related securities are subject to additional risks, including
prepayment and extension risk as discussed below. If any of these circumstances
occur, each Fund's NAV, and the Government Fund's market value may decline. Each
Fund is subject to the risk that its returns will fluctuate. Investors could
lose money by investing in either Fund.
PRINCIPAL DIFFERENCES
The Government Fund may invest in individual mortgages, asset-backed
securities and private placements. The use of these securities by the Government
Fund may increase its overall portfolio risk as compared to the Intermediate
Fund. In addition, the Government Fund may borrow a significantly larger
percentage than the Intermediate Fund which, as discussed below, may result in
more risk.
- Mortgages, in addition to the risks associated with mortgage-backed
securities generally, involve additional risks. Typically, mortgages are
not insured or guaranteed by the U.S. government or any of its agencies.
This may present greater credit risk and sensitivity to changes in market
conditions or interest rates. Further, the purchase and sale of mortgages
may involve costs not associated with mortgage-backed securities. Certain
mortgages may lack liquidity making the sale of such mortgages difficult.
In the event of a foreclosure, there is no assurance the Government Fund
would receive sufficient proceeds to cover its investment in the
mortgage.
- Asset backed securities exhibit many of the risks of mortgages and
mortgage-backed securities. The underlying collateral is not insured or
guaranteed by the U.S. government or any of its agencies or otherwise is
unsecured.
- Private placements are securities that are not registered under the
Securities Act of 1933. These securities only may be sold to a limited
number of purchasers, which may restrict the Government Fund's ability to
readily sell the security. As a result of these potential delays, the
Government Fund may receive an unfavorable price at the time of sale.
COMMON RISKS
Debt Securities. The value of debt securities may be affected by the
issuer's credit quality and interest rate conditions. Credit risk refers to an
issuer's ability to make timely payments of interest and principal. Interest
rate risk refers to the effect on the market value of a debt security from
interest rate changes. A change in interest rates usually has an opposite effect
on the market value. Further, the longer the maturity of a security, the more
sensitive it is to changes in interest rates.
Mortgage-Backed Securities. Mortgage-backed securities may be issued by
the U.S. government, government agencies, such as the Government National
Mortgage Association, or by private entities. These
12
<PAGE> 15
securities represent "pools" of related mortgages having similar characteristics
and may have fixed or adjustable interest rates. In addition to the risks of
debt securities as discussed above, mortgage-backed securities are subject to
prepayment and extension risk. Prepayment risk may affect the market value of
mortgage-backed securities during periods of unanticipated or rapid changes in
market conditions or interest rates. For example, if interest rates dropped,
prepayments may increase causing the Government Fund to invest at lower rates.
Further, the volatility of mortgage-backed securities may increase during such
changes in market conditions or interest rates. Conversely, if interest rates
rise, prepayments may slow (extension risk), which may reduce the market value
of mortgage-backed securities.
Borrowing. The use of borrowing (or leverage) exposes a Fund to the
potential for greater loss. Further, borrowing may exaggerate changes in a
Fund's NAV. The greater the ability of a Fund to borrow, then the greater the
potential for changes in NAV and losses.
Futures Contracts and Options. The use of futures contracts and options
present risks different from and in addition to investment in general. When used
in hedging strategies, incorrect forecasts by the portfolio manager may place a
Fund in a worse position than if no hedging occurred. Further, hedging may
reduce the opportunity for gain. Additional risks of futures contracts and
options include possible lack of a liquid market for closing out positions and
the need for additional or unique portfolio management skills and techniques.
Illiquid Securities. Each Fund may invest in securities deemed illiquid
due to the absence of a readily available market or other legal or contractual
restrictions on resale. These securities often trade at a discount relative to
comparable liquid investments. Further, the portfolio manger may be required to
sell these securities at prices unfavorable to a Fund. Transactions in illiquid
securities may involve more time and result in higher expenses for each Fund.
Stripped Securities and Inverse Floaters. Each Fund may invest in stripped
mortgage-backed securities and inverse floaters. The Intermediate Fund also may
invest in stripped U.S. government securities. Stripped securities are
securities where the interest portion and principal portion of a debt security
are traded separately. Stripped securities are especially sensitive to changes
in interest rates and thus may involve considerably more fluctuation than other
debt or mortgage-backed securities. Inverse floaters are securities where the
interest rate varies inversely with rates on similar securities or an index. The
market value of inverse floaters varies inversely with changes in interest rates
and may exhibit greater volatility. The Board of Trustees of Income Trust has
prohibited the use of these types of securities in the Intermediate Fund's
portfolio.
Portfolio Turnover. Securities may be purchased and sold relatively
quickly due to changes in economic or market conditions. Consequently, each fund
may be subject to a high rate of portfolio turnover. A high rate of portfolio
turnover generally leads to higher transaction costs and higher short-term
capital gains.
Year 2000. Each Fund could be affected adversely if the computer systems
used by Heritage, each Fund's other service providers or companies in which each
Fund invests do not properly process and calculate information that relates to
dates beginning on January 1, 2000 and beyond. Heritage has taken steps that it
believes are reasonably designed to address the potential failure of computer
systems used by them and each Fund's service providers to address the Year 2000
issue. However, due to each Fund's reliance on various service providers to
perform essential functions, either Fund could have difficulty calculating its
NAV, processing orders for share sales and delivering account statements and
other information to shareholders. There can be no assurance that these steps
will be sufficient to avoid any adverse impact.
13
<PAGE> 16
INFORMATION ABOUT THE REORGANIZATION
SUMMARY OF THE REORGANIZATION PLAN
The terms and conditions under which the Reorganization will be
consummated, if approved by shareholders of the Government Fund, are set forth
in the Reorganization Plan, which may be found in its entirety at Appendix A.
The following summary provides a description of the significant provisions of
the Reorganization Plan. However, this summary is qualified in its entirety by
reference to the Reorganization Plan.
The Reorganization Plan contemplates (a) the Intermediate Fund's acquiring
on the Closing Date all the assets of the Government Fund in exchange solely for
Intermediate Fund Shares and the Intermediate Fund's assumption of all the
Government Fund's liabilities and (b) the distribution of those Intermediate
Fund Shares to the Government Fund's shareholders. The Government Fund's assets
include all cash, cash equivalents, securities, receivables (including interest
and dividends receivable), claims and rights of action, rights to register
shares under applicable securities laws, books and records, deferred and prepaid
expenses shown as assets on its books, and other property owned by it as of the
close of business on the Closing Date ("Valuation Time") (collectively, the
"Assets"). The Intermediate Fund will assume from the Government Fund all its
liabilities, debts, obligations and duties of whatever kind or nature, whether
absolute, accrued, contingent or otherwise, whether or not arising in the
ordinary course of business, whether or not determinable at the Valuation Time,
and whether or not referred to in the Reorganization Plan (collectively, the
"Liabilities"); provided, however, that the Government Fund will use its best
efforts to discharge all of its known Liabilities prior to the Valuation Time.
The Intermediate Fund will deliver the Intermediate Fund Shares to the
Government Fund, which then will distribute them to its shareholders.
The value of the Assets to be acquired, and the amount of the Liabilities
to be assumed, by the Intermediate Fund and the NAV of a Intermediate Fund Share
will be determined as of the Valuation Time. Where market quotations are readily
available, securities will be valued based upon appraisals received from a
pricing service using a computerized matrix system or appraisals derived from
information concerning the security or similar securities received from
recognized dealers in those securities. The amortized cost method of valuation
generally will be used to value debt instruments with 60 days or less remaining
to maturity, unless a Fund's Board of Trustees determines that this method does
not represent fair value. All other securities and assets will be valued at fair
value as determined in good faith by or under the direction of each Fund's Board
of Trustees.
On, or as soon as practicable after, the Closing Date, the Government Fund
will distribute to its shareholders of record the Intermediate Fund Shares it
receives so that each shareholder of the Government Fund will receive a number
of full and fractional Intermediate Fund Shares in an amount equal to the
shareholder's ownership in the Government Fund (based on the Government Fund's
NAV per share as of the Closing Date). That distribution will be accomplished by
opening accounts on the books of the Intermediate Fund in the names of the
Government Fund's shareholders and crediting those accounts with Intermediate
Fund Shares in an amount equal to the shareholder's ownership in the Government
Fund (based on the Government Fund's NAV per share as of the Closing Date).
Fractional Intermediate Fund Shares will be rounded to the third decimal place.
Because Intermediate Fund Shares will be issued at NAV in exchange for the
Assets, the aggregate value of those shares issued to the Government Fund's
shareholders will equal the aggregate value of the Government Fund's shares
(based on the Government Fund's NAV per share as of the Closing Date). The
14
<PAGE> 17
NAV per Intermediate Fund Share will not be changed as a result of the
Reorganization. Thus, the Reorganization will not result in a dilution of any
shareholder interest.
REASONS FOR THE REORGANIZATION
The Board, including a majority of its Independent Trustees, has determined
that the Reorganization is in the best interests of the Government Fund, that
the terms of the Reorganization are fair and reasonable and that the interests
of the Government Fund's shareholders will not be diluted as a result of the
Reorganization.
At a Board meeting on May 17, 1999, Heritage proposed that the Board
approve the Reorganization. Heritage informed the Board that the investment
portfolios of the Government Fund and the Intermediate Fund were compatible and
that the Reorganization, if approved, offers a number of benefits to the
Government Fund's shareholders. The Board received from Heritage written
materials that described the structure and the anticipated benefits, costs and
tax consequences of the Reorganization. The Board also reviewed other
information, including a comparison between each Fund's performance records,
fees, current and pro forma expenses, investment objectives, policies and risks.
The Board then made inquiry into a number of factors with respect to the
Reorganization, including: (1) the future prospects for growth and performance
of the Government Fund, whether or not it is reorganized; (2) the compatibility
of each Fund's investment objectives, policies and shareholder services; (3) the
current expense ratio of the Government Fund and the likely effect of the
Reorganization on the Government Fund's expense ratio; (4) the alternatives to
the Reorganization; (5) the costs to be incurred by each Fund as a result of the
Reorganization; (6) the potential benefits to the Government Fund's affiliates,
including Heritage; (7) the tax consequences of the Reorganization; and (8)
whether any cost savings can be achieved by combining the Government Fund and
the Intermediate Fund.
In considering whether to continue to operate the Government Fund as a
closed-end fund, the Board compared the benefits of operating as an open-end
fund to those of operating as a closed-end fund. The Board was advised that the
closed-end fund structure offered benefits in terms of portfolio management,
such as the greater flexibility to borrow against fund assets and to manage the
portfolio without concern to inflows and outflows of fund assets. However, the
Board also was advised that continuing to operate the Government Fund as a
closed-end fund would not address the discount to NAV at which its shares have
historically traded.
As compared to the available alternatives, the Board determined that
reorganizing the Government Fund to an open-end fund format by combining the
Funds was the most advantageous to the Government Fund and its shareholders. The
Board considered that the Reorganization would immediately eliminate the
discount and would provide the Government Fund's shareholders with the benefits
of the open-end fund form of organization, such as the option of redeeming their
shares at NAV on any business day and the ability to exchange their shares for
shares of other Heritage mutual funds. Finally, combining the Funds provides
them with the potential to realize economies of scale.
The Board considered the similarity of the two Funds. The Board was advised
that the investment objectives and policies of the Funds are substantially
similar. In addition, the Government Fund and the Intermediate Fund share the
same portfolio manager. The Board also considered the historic performance of
the Government Fund in relation to the performance of the Intermediate Fund.
Heritage advised the Board that, while past performance provides no guarantee of
future results, the Intermediate Fund had experienced comparable investment
performance to the Government Fund.
The Board also considered the impact the Reorganization would have on
expenses. As a closed-end fund, the Government Fund currently pays no Rule 12b-1
distribution or service fees. Intermediate Fund Shares
15
<PAGE> 18
that the Government Fund shareholders would receive in the Reorganization are
subject to an annual Rule 12b-1 fee of up to 0.35% of average net assets
attributable to them. Open-end funds such as the Intermediate Fund also normally
pay higher transfer agency fees than closed-end funds due to the continuous sale
and redemption of their shares. In addition, open-end funds such as the
Intermediate Fund incur expenses associated with maintaining continuous federal
securities registration. Closed-end funds such as the Government Fund typically
do not incur these expenses.
In analyzing these expenses, the Board considered that, overall, the
Reorganization will result in slightly lower total operating expenses for the
Government Fund shareholders, net of expense waivers and/or reimbursements. For
its fiscal year ended October 31, 1998, the Government Fund had total operating
expenses, excluding interest payments on borrowed funds and taxes, of 1.00% of
its average net assets, after waiver and/or reimbursement by Heritage. The
Government Fund's total operating expenses, including interest payments on
borrowed funds and taxes, was 1.07%. Had Heritage not agreed to waive its
investment advisory fees and, if necessary, reimburse the Government Fund to the
extent that annual operating expenses exceed 1.00%, the Government Fund's
operating expenses would have been 1.18%. For its fiscal year ended September
30, 1998, Intermediate Fund Shares had total operating expenses of 0.92% of its
average daily net assets, after waiver and/or reimbursement by Heritage. Had
Heritage not agreed to waive fees and/or reimburse expenses, Intermediate Fund
Shares total operating expenses would have been 2.00%. Heritage has undertaken
to continue a fee waiver and/or reimbursement for Intermediate Fund Shares for
three years to the extent that annual operating expenses exceed 0.95%.
Accordingly, the Reorganization could result in a decrease in total annual
operating expenses for the Government Fund shareholders. The Board also was
advised that no initial sales charges would be imposed on Intermediate Fund
Shares issued to the Government Fund shareholders in connection with the
Reorganization.
The Board also considered the principal terms of the Reorganization Plan
and was advised that the Government Fund would be provided with an opinion of
counsel that the Reorganization would be tax-free to it and its shareholders.
Finally, the Board was advised that Heritage would undertake to pay for the
costs, including professional fees and the solicitation of proxies, in
connection with the Reorganization.
On the basis of the information provided to the Board and on its evaluation
of that information, the Board determined that the proposed Reorganization will
not dilute the interests of shareholders of the Government Fund and is in the
best interest of the Government Fund. Therefore, the Board recommended the
approval of the Reorganization Plan by the shareholders of the Government Fund
at the Meeting.
DESCRIPTION OF INTERMEDIATE FUND SHARES
Income Trust is registered with the SEC as an open-end management
investment company. Pursuant to its Declaration of Trust, Income Trust may issue
an unlimited number of shares with no par value. The Board of Trustees of Income
Trust has established the Intermediate Fund as a series and has authorized the
public offering of Class A, Class B and Class C shares of that Fund. The
Reorganization involves only Intermediate Fund Shares, which are normally
subject to a maximum initial sales charge of 3.75%. However, this sales charge
will be waived in connection with the Reorganization.
Each share of the Intermediate Fund has equal earnings, assets and voting
privileges and is entitled to any dividends and other distributions out of
income earned on assets belonging to the Intermediate Fund as may be declared by
the Board of Trustees of Income Trust. Each share in a class of that Fund
represents an equal proportionate interest in its assets with each other share
in that class. Shares of the Intermediate Fund entitle
16
<PAGE> 19
their holders to one vote per share and fractional votes for fractional shares
held, except that each class has exclusive voting rights on matters pertaining
to its plan of distribution. Shares of the Intermediate Fund, when issued, are
fully paid and nonassessable.
DIVIDENDS AND OTHER DISTRIBUTIONS
The Intermediate Fund distributes to its shareholders dividends from its
net investment income monthly. Net investment income generally consists of
interest income and dividends received less expenses. The Intermediate Fund also
distributes net capital gains to its shareholders normally once a year. These
distributions automatically are reinvested in Intermediate Fund Shares at their
NAV unless the shareholder opts to take distributions in cash, in the form of a
check, or to direct them for purchase of shares in another Heritage mutual fund.
The receipt of dividends and capital gain distributions are events for
shareholders that are not tax-exempt.
The Government Fund distributes to its shareholders dividends from its net
investment income monthly. The Government Fund distributes any net capital gains
annually. Under the Government Fund's Dividend Reinvestment Plan ("Reinvestment
Plan"), a shareholder's dividends and other distributions may be reinvested
automatically in additional shares of the Government Fund or purchased in the
open market. A shareholder pays no fees or charges for reinvestment of dividends
and other distributions. However, a shareholder may opt out of the Reinvestment
Plan and elect to receive his or her dividends in the form of a check. The
receipt of dividends and capital gain distributions are taxable events for
shareholders.
Each Fund may make additional distributions if necessary to avoid a 4%
excise tax on certain undistributed ordinary income and net capital gains. On or
before the Closing Date, the Government Fund will declare as a distribution
substantially all of its net investment income and realized net capital gain, if
any, and distribute that amount plus any previously declared but unpaid
dividends to maintain its tax status as a regulated investment company.
FEDERAL INCOME TAX CONSIDERATIONS
The exchange of the Assets solely for Intermediate Fund Shares and the
Intermediate Fund's assumption of the Liabilities is intended to qualify for
federal income tax purposes as a tax-free reorganization under section
368(a)(1)(D) of the Code. The Government Fund and Income Trust will receive an
opinion from their legal counsel, Kirkpatrick & Lockhart LLP, substantially to
the effect that:
(1) the Intermediate Fund's acquisition of the Assets in exchange
solely for Intermediate Fund Shares and the Intermediate Fund's assumption
of the Liabilities, followed by the Government Fund's distribution of those
shares pro rata to its shareholders constructively in exchange for their
shares of the Government Fund, will qualify as a "reorganization" within
the meaning of section 368(a)(1)(D) of the Code, and each Fund will be "a
party to a reorganization" within the meaning of section 368(b) of the
Code;
(2) the Government Fund will recognize no gain or loss on the transfer
of the Assets to the Intermediate Fund in exchange solely for Intermediate
Fund Shares and the Intermediate Fund's assumption of the Liabilities or on
the subsequent distribution of those shares to the Government Fund's
shareholders in constructive exchange for their Government Fund shares;
(3) the Intermediate Fund will recognize no gain or loss on its
receipt of the Assets in exchange solely for Intermediate Fund Shares and
the Intermediate Fund's assumption of the Liabilities;
17
<PAGE> 20
(4) the Intermediate Fund's basis for the Assets will be the same as
the Government Fund's basis therefor immediately before the Reorganization,
and the Intermediate Fund's holding period for the Assets will include the
Government Fund's holding period therefor;
(5) A Government Fund shareholder will recognize no gain or loss on
the constructive exchange of all its shares of the Government Fund solely
for Intermediate Fund Shares pursuant to the Reorganization; and
(6) A Government Fund shareholder's aggregate basis for the
Intermediate Fund Shares to be received by it in the Reorganization will be
the same as the aggregate basis for its shares of the Government Fund to be
constructively surrendered in exchange for those Intermediate Fund Shares,
and its holding period for those Intermediate Fund Shares will include its
holding period for those shares of the Government Fund, provided they are
held as capital assets by the shareholder on the Closing Date.
The opinion may state that no opinion is expressed as to the effect of the
Reorganization on either Fund or any shareholder of the Government Fund with
respect to any asset as to which any unrealized gain or loss is required to be
recognized for federal income tax purposes at the end of a taxable year (or on
the termination or transfer thereof) under a mark-to-market system of
accounting.
Utilization by the Intermediate Fund after the Reorganization of
pre-Reorganization capital losses realized by the Government Fund would be
subject to limitation in future years under the Code.
Shareholders of the Government Fund should consult their tax advisers
regarding the effect, if any, of the Reorganization in light of their individual
circumstances. Because the foregoing discussion only relates to the federal
income tax consequences of the Reorganization, those shareholders also should
consult their tax advisers as to state and local tax consequences, if any, of
the Reorganization.
RIGHTS OF SHAREHOLDERS
There are no material differences between the rights of shareholders of the
Funds, except that shareholders of the Government Fund have a right to hold
annual meetings for the election of Trustees and for other proper business.
Intermediate Fund may hold special meetings of its shareholders to transact
necessary business.
CAPITALIZATION
The following table shows the capitalization of each Fund as of May 31,
1999 and on a pro forma combined basis (unaudited) as of that date, giving
effect to the Reorganization.
<TABLE>
<CAPTION>
COMBINED FUND
GOVERNMENT FUND INTERMEDIATE FUND (CLASS A) PRO FORMA
--------------- ----------------- -------------------
<S> <C> <C> <C>
Net Assets.................................... $36,356,896 $11,715,033 $48,071,929
Shares Outstanding............................ 3,115,471 1,272,101 5,219,988
NAV Per Share................................. 11.67 9.21 9.21
</TABLE>
18
<PAGE> 21
FINANCIAL HIGHLIGHTS OF THE INTERMEDIATE FUND
The following table is intended to help you understand the performance of
Intermediate Fund Shares for the periods indicated. Certain information reflects
financial results for a single Intermediate Fund Share. The total returns in the
table represent the rate that an investor would have earned or lost on an
investment in Intermediate Fund Shares (assuming reinvestment of all dividends
and distributions). The information in this table for the periods presented has
been audited by PricewaterhouseCoopers LLP, independent accountants, whose
report along with the Intermediate Fund's financial statements, is included in
the statement of additional information, which is available upon request.
INTERMEDIATE FUND SHARES (CLASS A)
<TABLE>
<CAPTION>
FOR THE
SIX MONTH
PERIOD ENDED FOR THE YEARS ENDED SEPTEMBER 30,
MARCH 31, ------------------------------------------
1999* 1998* 1997* 1996* 1995 1994*
------------ ------ ------ ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of the year... $ 9.70 $ 9.20 $ 9.08 $ 9.29 $ 9.10 $ 9.44
------ ------ ------ ------ ------ ------
Income from Investment Operations:
Net investment income(a)............... 0.20 0.48 0.51 0.50 0.62 0.43
Net realized and unrealized gain (loss)
on investments...................... (0.33) 0.51 0.13 (0.21) 0.12 (0.40)
------ ------ ------ ------ ------ ------
Total from Investment
Operations................... (0.13) 0.99 0.64 0.29 0.74 0.03
------ ------ ------ ------ ------ ------
Less Distributions:
Dividends from net investment income... (0.21) (0.49) (0.52) (0.50) (0.55) (0.37)
------ ------ ------ ------ ------ ------
Total Distributions............ (0.21) (0.49) (0.52) (0.50) (0.55) (0.37)
------ ------ ------ ------ ------ ------
Net asset value, end of year............. $ 9.36 $ 9.70 $ 9.20 $ 9.08 $ 9.29 $ 9.10
====== ====== ====== ====== ====== ======
Total Return (%)(b)...................... (1.32)(c) 11.18 7.28 3.24 8.47 0.36
Ratios (%)/Supplemental Data:
Operating expenses net, to average
daily net assets(a)................. 0.92(d) 0.92 0.93 0.94 0.95 0.95
Net investment income to average daily
net assets.......................... 4.30(d) 5.18 5.65 5.42 5.50 4.60
Portfolio turnover rate................ 100(c) 188 69 135 162 214
Net assets, end of year ($ millions)... 12 13 14 18 24 41
</TABLE>
- ---------------
* Per share amounts have been calculated using the monthly average share
method, which more appropriately presents per share data for the year since
use of the undistributed income method does not correspond with results of
operations.
(a) Excludes management fees waived and expenses reimbursed by Heritage in the
amount of $0.04, $0.10, $0.07, $0.06, $0.06 and $0.03 per Class A share,
respectively. The operating expense ratios including such items would have
been 1.84% (annualized), 2.00%, 1.67%, 1.61%, 1.47% and 1.18% per Class A
share, respectively.
(b) Does not reflect the imposition of a sales charge.
(c) Not annualized.
(d) Annualized.
19
<PAGE> 22
SHARE PRICE DATA
The Government Fund's shares are traded on the NYSE and have historically
traded at a discount to its NAV as illustrated in the table below. The Board
recently approved the Reorganization Plan setting forth the combination of the
Government Fund into the Intermediate Fund.
The following table shows the NAV of the Government Fund, the sales price
of the shares on the NYSE and the premium or discount to NAV that these figures
represent for each quarter since November 1, 1996.
<TABLE>
<CAPTION>
PREMIUM/DISCOUNT
NAV ($) SHARE PRICE ($) (%)
------------- --------------- -----------------
HIGH LOW HIGH LOW HIGH LOW
----- ----- ------ ------ ------- -------
<S> <C> <C> <C> <C> <C> <C>
1999:
Feb. 1 to April 30......................... 12.11 11.87 10.313 10.188 -15.36 -13.56
Nov. 1, 1998 to Jan. 31.................... 12.36 12.12 10.750 10.313 -15.24 -12.24
1998:
Aug. 1 to Oct. 31.......................... 12.62 12.03 11.125 10.563 -15.09 -9.04
May 1 to July 31........................... 12.16 11.92 10.688 10.313 -13.99 -11.23
Feb. 1 to April 30......................... 12.11 11.92 11.625 10.625 -11.24 -3.29
Nov. 1, 1997 to Jan. 31.................... 12.23 12.03 11.500 11.125 -7.91 -4.88
1997:
Aug. 1 to Oct. 1........................... 12.06 11.80 11.188 11.000 -9.68 -5.19
May 1 to July 31........................... 12.09 11.68 12.125 10.875 -7.05 +1.55
Feb. 1 to April 30......................... 12.01 11.54 11.625 11.125 -6.33 -0.56
Nov. 1, 1996 to Jan. 31.................... 12.27 11.89 11.750 11.000 -8.03 -3.92
</TABLE>
INVESTMENT ADVISER AND DISTRIBUTOR
Heritage Asset Management, Inc., organized as a Florida corporation in
1985, is located at 100 Carillon Parkway, St. Petersburg, Florida 33716.
Heritage serves as the investment adviser and administrator of both Funds. Under
separate Investment Advisory and Administration Agreements for Income Trust, on
behalf of the Intermediate Fund, and the Government Fund, respectively, Heritage
is responsible for reviewing and establishing investment policies and
administering noninvestment affairs. In addition to each Fund, Heritage manages,
supervises and conducts the business and administrative affairs of other
Heritage mutual funds with net assets totaling approximately $4.5 billion as of
May 31, 1999.
All of the capital stock of Heritage is owned by Raymond James Financial,
Inc. ("RJF"). RJF is a holding company that, through its subsidiaries, is
engaged primarily in providing customers with a wide variety of financial
services in connection with securities, limited partnerships, options,
investment banking and related fields.
Intermediate Fund Shares are offered continuously through its principal
underwriter, Raymond James & Associates, Inc. ("RJA"), and through other
participating dealers or banks that have agreements with RJA.
LEGAL MATTERS
Certain legal matters concerning the Government Fund and Income Trust and
their participation in the Reorganization, the issuance of Intermediate Fund
Shares in connection with the Reorganization and the tax consequences of the
Reorganization will be passed upon by Kirkpatrick & Lockhart LLP, 1800
Massachusetts Avenue, NW, Washington, D.C. 20036-1800, counsel to the Government
Fund and Income Trust.
20
<PAGE> 23
EXPERTS
The audited financial statements of the Intermediate Fund and the
Government Fund, for the fiscal years ended September 30, 1998 and October 31,
1998, respectively, have been audited by PricewaterhouseCoopers LLP, independent
accountants, whose reports thereon are included in each Fund's Annual Report to
Shareholders for the respective year ends. The financial statements audited by
PricewaterhouseCoopers LLP have been incorporated herein by reference in
reliance on their reports given on their authority as experts in auditing and
accounting matters.
INFORMATION FILED WITH THE SEC AND NYSE
The Government Fund and Income Trust are each subject to the information
requirements of the Securities Exchange Act of 1934 and the 1940 Act and in
accordance therewith files reports and other information with the SEC. The SEC
file number for the Government Fund is Registration No. 33-67960. The SEC file
number for Income Trust is Registration No. 33-30361. Reports, proxy statements,
registration statements and other information filed by the Government Fund and
Income Trust (including the Registration Statement of Income Trust relating to
the Intermediate Fund and the Government Fund on Form N-14 of which this Proxy
Statement is a part and which is hereby incorporated reference) may be inspected
without charge and copied at the public reference facilities maintained by the
SEC at Room 1014, Judiciary Plaza, 450 Fifth Street, NW, Washington, D.C. 20549,
and at the following regional offices of the SEC: 1401 Brickell Avenue, Suite
200, Miami, Florida 33131. Copies of such material can also be obtained from the
Public Reference Branch, Office of Consumer Affairs and Information Services,
Securities and Exchange Commission, Washington, D.C. 20549 at the prescribed
rates. The SEC maintains an Internet web site at http://www.sec.gov that
contains information regarding each Fund and the Income Trust.
The Government Fund's shares are listed and publicly traded on the NYSE.
Reports, proxy statements and other information relating to the Government Fund
may be inspected at the NYSE, 20 Broad Street, New York, NY 10005.
ADDITIONAL INFORMATION ABOUT EACH FUND
For more information with respect to the Intermediate Fund concerning the
following topics, please refer to the Intermediate Fund's Prospectus, dated
February 1, 1999, which is included with this Proxy Statement: (i) see
"Intermediate Government Fund" for further information on its objective,
policies and risks; (ii) see discussion in "Intermediate Government Fund" and
"Management of the Funds" for further information regarding management of the
Intermediate Fund; (iii) see "Distribution of Fund Shares" and "Your Investment"
regarding the shares of the Intermediate Fund; and (iv) see "How to Invest",
"How to Sell Your Investment", "How to Exchange Your Shares" and "Account and
Transaction Policies" regarding the purchase, redemption and exchange of shares.
For more information with respect to the Government Fund concerning the
following topics, please refer to the Government Fund's Annual Report to
Shareholders for the period ended October 31, 1998, as indicated: (i) see "Note
1" and "Note 6" to the financial statements for further information on the
Government Fund's investment objectives, policies and risks; (ii) see "Note 2"
to the financial statements for further information on the Government Fund's
manager; and (iii) see "Dividend Reinvestment Plan" for further information
regarding the reinvestment of dividends paid by the Government Fund.
21
<PAGE> 24
APPENDIX A
AGREEMENT AND PLAN OF REORGANIZATION AND TERMINATION
THIS AGREEMENT AND PLAN OF REORGANIZATION AND TERMINATION ("Agreement") is
made as of June 16, 1999, between Heritage Income Trust, a Massachusetts
business trust ("Trust"), on behalf of Intermediate Government Fund, a
segregated portfolio of assets ("series") thereof ("Acquiring Fund"), and
Heritage U.S. Government Income Fund, also a Massachusetts business trust
("Target"). (Acquiring Fund and Target are sometimes referred to herein
individually as a "Fund" and collectively as the "Funds," and Trust and Target
are sometimes referred to herein individually as an "Investment Company" and
collectively as the "Investment Companies.") All agreements, representations,
actions, and obligations described herein made or to be taken or undertaken by
Acquiring Fund are made and shall be taken or undertaken by Trust.
The Investment Companies wish to effect a reorganization described in
section 368(a)(1)(D) of the Internal Revenue Code of 1986, as amended ("Code").
The reorganization will involve the transfer of Target's assets to Acquiring
Fund in exchange solely for voting shares of beneficial interest ("shares") in
Acquiring Fund and the assumption by Acquiring Fund of Target's liabilities,
followed by the constructive distribution of those shares pro rata to the
holders of shares in Target ("Target Shares") in exchange therefor, all on the
terms and conditions set forth in this Agreement (which is intended to be, and
is adopted as, a "plan of reorganization" within the meaning of the regulations
under the Code). The foregoing transactions are referred to herein collectively
as the "Reorganization."
Acquiring Fund is an open-end management investment company. Its shares are
divided into three classes, designated Class A, Class B, and Class C shares;
only Acquiring Fund's Class A shares ("Acquiring Fund Shares") are involved in
the Reorganization. Target is a closed-end management investment company that
has only a single class of shares, which can be purchased and sold on the New
York Stock Exchange ("NYSE").
In consideration of the mutual promises contained herein, the parties agree
as follows:
1. PLAN OF REORGANIZATION AND TERMINATION
1.1 Target agrees to assign, sell, convey, transfer, and deliver all of its
assets described in paragraph 1.2 ("Assets") to Acquiring Fund. Acquiring Fund
agrees in exchange therefor --
(a) to issue and deliver to Target the number of full and fractional
(rounded to the third decimal place) Acquiring Fund Shares, determined by
dividing the net value of Target (computed as set forth in paragraph 2.1)
by the net asset value ("NAV") of an Acquiring Fund Share (computed as set
forth in paragraph 2.2), and
(b) to assume all of Target's liabilities described in paragraph 1.3
("Liabilities"). Such transactions shall take place at the Closing (as
defined in paragraph 3.1).
1.2 The Assets shall include, without limitation, all cash, cash
equivalents, securities, receivables (including interest and dividends
receivable), claims and rights of action, rights to register shares under
applicable securities laws, books and records, deferred and prepaid expenses
shown as assets on Target's books, and other property owned by Target at the
Effective Time (as defined in paragraph 3.1).
A-1
<PAGE> 25
1.3 The Liabilities shall include (except as otherwise provided herein) all
of Target's liabilities, debts, obligations, and duties of whatever kind or
nature, whether absolute, accrued, contingent, or otherwise, whether or not
arising in the ordinary course of business, whether or not determinable at the
Effective Time, and whether or not specifically referred to in this Agreement.
Notwithstanding the foregoing, Target agrees to use its best efforts to
discharge all its known Liabilities before the Effective Time.
1.4 At or immediately before the Effective Time, Target shall declare and
pay to its shareholders a dividend and/or other distribution in an amount large
enough so that it will have distributed substantially all (and in any event not
less than 90%) of its investment company taxable income (computed without regard
to any deduction for dividends paid) and substantially all of its realized net
capital gain, if any, for the current taxable year through the Effective Time.
1.5 At the Effective Time (or as soon thereafter as is reasonably
practicable), Target shall distribute the Acquiring Fund Shares received by it
pursuant to paragraph 1.1 to Target's shareholders of record, determined as of
the Effective Time (each a "Shareholder" and collectively "Shareholders"), in
constructive exchange for their Target Shares. Such distribution shall be
accomplished by Trust's transfer agent's opening accounts on Acquiring Fund's
share transfer books in the Shareholders' names and transferring such Acquiring
Fund Shares thereto. Each Shareholder's account shall be credited with the
respective pro rata number of full and fractional (rounded to the third decimal
place) Acquiring Fund Shares due that Shareholder. All outstanding Target
Shares, including any represented by certificates, shall simultaneously be
canceled on Target's share transfer books. Acquiring Fund shall not issue
certificates representing the Acquiring Fund Shares issued in connection with
the Reorganization.
1.6 As soon as reasonably practicable after distribution of the Acquiring
Fund Shares pursuant to paragraph 1.5, but in all events within six months after
the Effective Time, Target shall be terminated and any further actions shall be
taken in connection therewith as required by applicable law.
1.7 Any reporting responsibility of Target to a public authority is and
shall remain its responsibility up to and including the date on which it is
terminated.
1.8 Any transfer taxes payable upon issuance of Acquiring Fund Shares in a
name other than that of the registered holder on Target's books of the Target
Shares constructively exchanged therefor shall be paid by the person to whom
such Acquiring Fund Shares are to be issued, as a condition of such transfer.
2. VALUATION
2.1 For purposes of paragraph 1.1(a), Target's net value shall be (a) the
value of the Assets computed as of the close of regular trading on the NYSE on
the date of the Closing ("Valuation Time"), using the valuation procedures set
forth in Target's most recent annual report to its shareholders, less (b) the
amount of the Liabilities as of the Valuation Time.
2.2 For purposes of paragraph 1.1(a), the NAV of an Acquiring Fund Share
shall be computed as of the Valuation Time, using the valuation procedures set
forth in Acquiring Fund's then-current prospectus and statement of additional
information ("SAI").
2.3 All computations pursuant to paragraphs 2.1 and 2.2 shall be made by or
under the direction of Heritage Asset Management, Inc. ("Heritage").
A-2
<PAGE> 26
3. CLOSING AND EFFECTIVE TIME
3.1 The Reorganization, together with related acts necessary to consummate
the same ("Closing"), shall occur at the Funds' principal office on October 15,
1999, or at such other place and/or on such other date as to which the parties
may agree. All acts taking place at the Closing shall be deemed to take place
simultaneously as of the close of business on the date thereof or at such other
time as to which the parties may agree ("Effective Time"). If, immediately
before the Valuation Time, (a) the NYSE is closed to trading or trading thereon
is restricted or (b) trading or the reporting of trading on the NYSE or
elsewhere is disrupted, so that accurate appraisal of the net value of Target
and the NAV of an Acquiring Fund Share is impracticable, the Effective Time
shall be postponed until the first business day after the day when such trading
shall have been fully resumed and such reporting shall have been restored.
3.2 Target's fund accounting and pricing agent shall deliver at the Closing
a certificate of an authorized officer verifying that the information (including
adjusted basis and holding period, by lot) concerning the Assets, including all
portfolio securities, transferred by Target to Acquiring Fund, as reflected on
Acquiring Fund's books immediately following the Closing, does or will conform
to such information on Target's books immediately before the Closing. Target's
custodian shall deliver at the Closing a certificate of an authorized officer
stating that (a) the Assets held by the custodian will be transferred to
Acquiring Fund at the Effective Time and (b) all necessary taxes in conjunction
with the delivery of the Assets, including all applicable federal and state
stock transfer stamps, if any, have been paid or provision for payment has been
made.
3.3 Target shall deliver to Trust at the Closing a list of the names and
addresses of the Shareholders and the number of outstanding Target Shares owned
by each Shareholder, all as of the Effective Time, certified by Target's
Secretary or Assistant Secretary. Trust's transfer agent shall deliver at the
Closing a certificate as to the opening on Acquiring Fund's share transfer books
of accounts in the Shareholders' names. Trust shall issue and deliver a
confirmation to Target evidencing the Acquiring Fund Shares to be credited to
Target at the Effective Time or provide evidence satisfactory to Target that
such Acquiring Fund Shares have been credited to Target's account on Acquiring
Fund's books. At the Closing, each party shall deliver to the other such bills
of sale, checks, assignments, stock certificates, receipts, or other documents
as the other party or its counsel may reasonably request.
3.4 Each Investment Company shall deliver to the other at the Closing a
certificate executed in its name by its President or a Vice President in form
and substance satisfactory to the recipient and dated the Effective Time, to the
effect that the representations and warranties it made in this Agreement are
true and correct at the Effective Time except as they may be affected by the
transactions contemplated by this Agreement.
4. REPRESENTATIONS AND WARRANTIES
4.1 Target represents and warrants as follows:
4.1.1 Target is a trust operating under a written declaration of
trust, the beneficial interest in which is divided into transferable shares
("Business Trust"), that is duly organized and validly existing under the
laws of the Commonwealth of Massachusetts; and a copy of its Declaration of
Trust is on file with the Secretary of the Commonwealth of Massachusetts;
4.1.2 Target is duly registered as a closed-end management investment
company under the Investment Company Act of 1940, as amended ("1940 Act"),
and such registration will be in full force and effect at the Effective
Time;
A-3
<PAGE> 27
4.1.3 At the Closing, Target will have good and marketable title to
the Assets and full right, power, and authority to sell, assign, transfer,
and deliver the Assets free of any liens or other encumbrances; and upon
delivery and payment for the Assets, Acquiring Fund will acquire good and
marketable title thereto;
4.1.4 Target is not in violation of, and the execution and delivery of
this Agreement and consummation of the transactions contemplated hereby
will not conflict with or violate, Massachusetts law or any provision of
its Declaration of Trust or By-laws or of any agreement, instrument, lease,
or other undertaking to which Target is a party or by which it is bound or
result in the acceleration of any obligation, or the imposition of any
penalty, under any agreement, judgment, or decree to which Target is a
party or by which it is bound, except as previously disclosed in writing to
and accepted by Trust;
4.1.5 Except as otherwise disclosed in writing to and accepted by
Trust, all material contracts and other commitments of Target (other than
this Agreement and investment contracts, including options, futures, and
forward contracts) will be terminated, or provision for discharge of any
liabilities of Target thereunder will be made, at or prior to the Effective
Time, without either Fund's incurring any liability or penalty with respect
thereto and without diminishing or releasing any rights Target may have had
with respect to actions taken or omitted or to be taken by any other party
thereto prior to the Closing;
4.1.6 Except as otherwise disclosed in writing to and accepted by
Trust, no litigation, administrative proceeding, or investigation of or
before any court or governmental body is presently pending or (to Target's
knowledge) threatened against Target or any of its properties or assets
that, if adversely determined, would materially and adversely affect its
financial condition or the conduct of its business; and Target knows of no
facts that might form the basis for the institution of any such litigation,
proceeding, or investigation and is not a party to or subject to the
provisions of any order, decree, or judgment of any court or governmental
body that materially or adversely affects its business or its ability to
consummate the transactions contemplated hereby;
4.1.7 The execution, delivery, and performance of this Agreement have
been duly authorized as of the date hereof by all necessary action on the
part of Target's board of trustees, which has made the determinations
required by Rule 17a-8(a) under the 1940 Act; and, subject to approval by
Target's shareholders, this Agreement constitutes a valid and legally
binding obligation of Target, enforceable in accordance with its terms,
except as the same may be limited by bankruptcy, insolvency, fraudulent
transfer, reorganization, moratorium, and similar laws relating to or
affecting creditors' rights and by general principles of equity;
4.1.8 At the Effective Time, the performance of this Agreement shall
have been duly authorized by all necessary action by Target's shareholders;
4.1.9 No governmental consents, approvals, authorizations, or filings
are required under the Securities Act of 1933, as amended ("1933 Act"), the
Securities Exchange Act of 1934, as amended ("1934 Act"), or the 1940 Act
for the execution or performance of this Agreement by Target, except for
(a) the filing with the Securities and Exchange Commission ("SEC") of a
registration statement by Trust on Form N-14 relating to the Acquiring Fund
Shares issuable hereunder, and any supplement or amendment thereto
("Registration Statement"), including therein a prospectus/proxy statement
("Proxy Statement"), and (b) such consents, approvals, authorizations, and
filings as have been made or received or as may be required subsequent to
the Effective Time;
4.1.10 On the effective date of the Registration Statement, at the
time of the shareholders' meeting referred to in paragraph 5.2, and at the
Effective Time, the Proxy Statement will (a) comply in all
A-4
<PAGE> 28
material respects with the applicable provisions of the 1933 Act, the 1934
Act, and the 1940 Act and the rules and regulations thereunder and (b) not
contain any untrue statement of a material fact or omit to state a material
fact required to be stated therein or necessary to make the statements
therein, in light of the circumstances under which such statements were
made, not misleading; provided that the foregoing shall not apply to
statements in or omissions from the Proxy Statement made in reliance on and
in conformity with information furnished by Trust for use therein;
4.1.11 The Liabilities were incurred by Target in the ordinary course
of its business; and there are no Liabilities other than liabilities
disclosed or provided for in its financial statements referred to in
paragraph 4.1.17 and liabilities incurred by Target in the ordinary course
of its business subsequent to October 31, 1998, or otherwise previously
disclosed to Trust, none of which has been materially adverse to the
business, assets, or results of Target operations;
4.1.12 Target qualified for treatment as a regulated investment
company under Subchapter M of the Code ("RIC") for each past taxable year
since it commenced operations and will continue to meet all the
requirements for such qualification for its current taxable year; it has no
earnings and profits accumulated in any taxable year in which the
provisions of Subchapter M did not apply to it; and the Assets will be
invested at all times through the Effective Time in a manner that ensures
compliance with the foregoing;
4.1.13 Target is not under the jurisdiction of a court in a proceeding
under Title 11 of the United States Code or similar case within the meaning
of section 368(a)(3)(A) of the Code;
4.1.14 Not more than 25% of the value of Target's total assets
(excluding cash, cash items, and U.S. government securities) is invested in
the stock and securities of any one issuer, and not more than 50% of the
value of such assets is invested in the stock and securities of five or
fewer issuers;
4.1.15 Target will be terminated as soon as reasonably practicable
after the Effective Time, but in all events within six months thereafter;
4.1.16 Target's federal income tax returns, and all applicable state
and local tax returns, for all taxable years through and including the
taxable year ended October 31, 1998, have been timely filed and all taxes
payable pursuant to such returns have been timely paid; and
4.1.17 Target's financial statements for the year ended October 31,
1998, to be delivered to Trust, fairly represent Target's financial
position as of that date and the results of its operations and changes in
its net assets for the year then ended.
4.2 Acquiring Fund represents and warrants as follows:
4.2.1 Trust is a Business Trust that is duly organized and validly
existing under the laws of the Commonwealth of Massachusetts; and a copy of
its Declaration of Trust is on file with the Secretary of the Commonwealth
of Massachusetts;
4.2.2 Trust is duly registered as an open-end management investment
company under the 1940 Act, and such registration will be in full force and
effect at the Effective Time;
4.2.3 Acquiring Fund is a duly established and designated series of
Trust;
4.2.4 No consideration other than Acquiring Fund Shares (and Acquiring
Fund's assumption of the Liabilities) will be issued in exchange for the
Assets in the Reorganization;
A-5
<PAGE> 29
4.2.5 The Acquiring Fund Shares to be issued and delivered to Target
hereunder will, at the Effective Time, have been duly authorized and, when
issued and delivered as provided herein, will be duly and validly issued
and outstanding shares of Acquiring Fund, fully paid and non-assessable;
4.2.6 Acquiring Fund's current prospectus and SAI conform in all
material respects to the applicable requirements of the 1933 Act and the
1940 Act and the rules and regulations thereunder and do not include any
untrue statement of a material fact or omit to state any material fact
required to be stated therein or necessary to make the statements therein,
in light of the circumstances under which they were made, not misleading;
4.2.7 Acquiring Fund is not in violation of, and the execution and
delivery of this Agreement and consummation of the transactions
contemplated hereby will not conflict with or violate, Massachusetts law or
any provision of Trust's Declaration of Trust or By-laws or of any
provision of any agreement, instrument, lease, or other undertaking to
which Acquiring Fund is a party or by which it is bound or result in the
acceleration of any obligation, or the imposition of any penalty, under any
agreement, judgment, or decree to which Acquiring Fund is a party or by
which it is bound, except as previously disclosed in writing to and
accepted by Target;
4.2.8 Except as otherwise disclosed in writing to and accepted by
Target, no litigation, administrative proceeding, or investigation of or
before any court or governmental body is presently pending or (to Acquiring
Fund's knowledge) threatened against Trust with respect to Acquiring Fund
or any of its properties or assets that, if adversely determined, would
materially and adversely affect Acquiring Fund's financial condition or the
conduct of its business; and Acquiring Fund knows of no facts that might
form the basis for the institution of any such litigation, proceeding, or
investigation and is not a party to or subject to the provisions of any
order, decree, or judgment of any court or governmental body that
materially or adversely affects its business or its ability to consummate
the transactions contemplated hereby;
4.2.9 The execution, delivery, and performance of this Agreement have
been duly authorized as of the date hereof by all necessary action on the
part of Trust's board of trustees (together with Target's board of
trustees, the "Boards"), which has made the determinations required by Rule
17a-8(a) under the 1940 Act; and this Agreement constitutes a valid and
legally binding obligation of Acquiring Fund, enforceable in accordance
with its terms, except as the same may be limited by bankruptcy,
insolvency, fraudulent transfer, reorganization, moratorium, and similar
laws relating to or affecting creditors' rights and by general principles
of equity;
4.2.10 No governmental consents, approvals, authorizations, or filings
are required under the 1933 Act, the 1934 Act, or the 1940 Act for the
execution or performance of this Agreement by Trust, except for (a) the
filing with the SEC of the Registration Statement and (b) such consents,
approvals, authorizations, and filings as have been made or received or as
may be required subsequent to the Effective Time;
4.2.11 On the effective date of the Registration Statement, at the
time of the shareholders' meeting referred to in paragraph 5.2, and at the
Effective Time, the Proxy Statement will (a) comply in all material
respects with the applicable provisions of the 1933 Act, the 1934 Act, and
the 1940 Act and the rules and regulations thereunder and (b) not contain
any untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements therein,
in light of the circumstances under which such statements were made, not
misleading; provided that the foregoing
A-6
<PAGE> 30
shall not apply to statements in or omissions from the Proxy Statement made
in reliance on and in conformity with information furnished by Target for
use therein;
4.2.12 Acquiring Fund is a "fund" as defined in section 851(g)(2) of
the Code; it qualified for treatment as a RIC for each past taxable year
since it commenced operations and will continue to meet all the
requirements for such qualification for its current taxable year; Acquiring
Fund intends to continue to meet all such requirements for the next taxable
year; and it has no earnings and profits accumulated in any taxable year in
which the provisions of Subchapter M of the Code did not apply to it;
4.2.13 Acquiring Fund has no plan or intention to issue additional
Acquiring Fund Shares following the Reorganization except for shares issued
in the ordinary course of its business as a series of an open-end
investment company; nor does Acquiring Fund have any plan or intention to
redeem or otherwise reacquire any Acquiring Fund Shares issued to the
Shareholders pursuant to the Reorganization, except to the extent it is
required by the 1940 Act to redeem any of its shares presented for
redemption at NAV in the ordinary course of that business;
4.2.14 Following the Reorganization, Acquiring Fund (a) will continue
Target's "historic business" (within the meaning of section 1.368-1(d)(2)
of the Income Tax Regulations under the Code), (b) use a significant
portion of Target's historic business assets (within the meaning of section
1.368-1(d)(3) of those regulations) in a business, (c) has no plan or
intention to sell or otherwise dispose of any of the Assets, except for
dispositions made in the ordinary course of that business and dispositions
necessary to maintain its status as a RIC, and (d) expects to retain
substantially all the Assets in the same form as it receives them in the
Reorganization, unless and until subsequent investment circumstances
suggest the desirability of change or it becomes necessary to make
dispositions thereof to maintain such status;
4.2.15 There is no plan or intention for Acquiring Fund to be
dissolved or merged into another business trust or a corporation or any
"fund" thereof (within the meaning of section 851(g)(2) of the Code)
following the Reorganization;
4.2.16 Immediately after the Reorganization, (a) not more than 25% of
the value of Acquiring Fund's total assets (excluding cash, cash items, and
U.S. government securities) will be invested in the stock and securities of
any one issuer and (b) not more than 50% of the value of such assets will
be invested in the stock and securities of five or fewer issuers;
4.2.17 Acquiring Fund does not own, directly or indirectly, nor at the
Effective Time will it own, directly or indirectly, nor has it owned,
directly or indirectly, at any time during the past five years, any shares
of Target;
4.2.18 Acquiring Fund's federal income tax returns, and all applicable
state and local tax returns, for all taxable years through and including
the taxable year ended September 30, 1998, have been timely filed and all
taxes payable pursuant to such returns have been timely paid; and
4.2.19 Trust's financial statements for the year ended September 30,
1998, to be delivered to Target, fairly represent Acquiring Fund's
financial position as of that date and the results of its operations and
changes in its net assets for the year then ended.
4.3 Each Fund represents and warrants as follows:
4.3.1 The fair market value of the Acquiring Fund Shares received by
each Shareholder will be approximately equal to the fair market value of
its Target Shares constructively surrendered in exchange therefor;
A-7
<PAGE> 31
4.3.2 Its management is unaware of any plan or intention of
Shareholders to redeem, sell, or otherwise dispose of (a) any portion of
their Target Shares before the Reorganization to any person related (within
the meaning of section 1.368-1(e)(3) of the Income Tax Regulations under
the Code) to either Fund or (b) any portion of the Acquiring Fund Shares to
be received by them in the Reorganization to any person related (within
such meaning) to Acquiring Fund;
4.3.3 The Shareholders will pay their own expenses, if any, incurred
in connection with the Reorganization;
4.3.4 The fair market value of the Assets on a going concern basis
will equal or exceed the Liabilities to be assumed by Acquiring Fund and
those to which the Assets are subject;
4.3.5 There is no intercompany indebtedness between the Funds that was
issued or acquired, or will be settled, at a discount;
4.3.6 Pursuant to the Reorganization, Target will transfer to
Acquiring Fund, and Acquiring Fund will acquire, at least 90% of the fair
market value of the net assets, and at least 70% of the fair market value
of the gross assets, held by Target immediately before the Reorganization.
For the purposes of this representation, any amounts used by Target to pay
its Reorganization expenses and to make redemptions and distributions
immediately before the Reorganization (except (a) redemptions not made as
part of the Reorganization and (b) distributions made to conform to its
policy of distributing all or substantially all of its income and gains to
avoid the obligation to pay federal income tax and/or the excise tax under
section 4982 of the Code) will be included as assets held thereby
immediately before the Reorganization;
4.3.7 None of the compensation received by any Shareholder who is an
employee of or service provider to Target will be separate consideration
for, or allocable to, any of the Target Shares held by such Shareholder;
none of the Acquiring Fund Shares received by any such Shareholder will be
separate consideration for, or allocable to, any employment agreement,
investment advisory agreement, or other service agreement; and the
consideration paid to any such Shareholder will be for services actually
rendered and will be commensurate with amounts paid to third parties
bargaining at arm's-length for similar services;
4.3.8 Immediately after the Reorganization, the Shareholders will own
shares constituting "control" (within the meaning of section 304(c) of the
Code) of Acquiring Fund; and
4.3.9 Neither Fund will be reimbursed for any expenses incurred by it
or on its behalf in connection with the Reorganization unless those
expenses are solely and directly related to the Reorganization (determined
in accordance with the guidelines set forth in Rev. Rul. 73-54, 1973-1 C.B.
187) ("Reorganization Expenses").
5. COVENANTS
5.1 Each Fund covenants to operate its respective business in the ordinary
course between the date hereof and the Closing, it being understood that --
(a) such ordinary course will include declaring and paying customary
dividends and other distributions and changes in operations
contemplated by each Fund's normal business activities, and
(b) each Fund will retain exclusive control of the composition of its
portfolio until the Closing; provided that (1) Target shall not
dispose of more than an insignificant portion of its historic
business assets during such period without Acquiring Fund's prior
consent and (2) if Target's
A-8
<PAGE> 32
shareholders approve this Agreement (and the transactions
contemplated hereby), then between the date of such approval and the
Closing, the Funds shall coordinate their respective portfolios so
that the transfer of the Assets to Acquiring Fund will not cause it
to fail to be in compliance with all of its investment policies and
restrictions immediately after the Closing.
5.2 Target covenants to call a shareholders' meeting to consider and act on
this Agreement and to take all other action necessary to obtain approval of the
transactions contemplated hereby.
5.3 Target covenants that the Acquiring Fund Shares to be delivered
hereunder are not being acquired for the purpose of making any distribution
thereof, other than in accordance with the terms hereof.
5.4 Target covenants that it will assist Trust in obtaining information
Trust reasonably requests concerning the beneficial ownership of Target Shares.
5.5 Target covenants that its books and records (including all books and
records required to be maintained under the 1940 Act and the rules and
regulations thereunder) will be turned over to Trust at the Closing.
5.6 Each Fund covenants to cooperate in preparing the Proxy Statement in
compliance with applicable federal and state securities laws.
5.7 Each Fund covenants that it will, from time to time, as and when
requested by the other Fund, execute and deliver or cause to be executed and
delivered all such assignments and other instruments, and will take or cause to
be taken such further action, as the other Fund may deem necessary or desirable
in order to vest in, and confirm to, (a) Acquiring Fund, title to and possession
of all the Assets, and (b) Target, title to and possession of the Acquiring Fund
Shares to be delivered hereunder, and otherwise to carry out the intent and
purpose hereof.
5.8 Acquiring Fund covenants to use all reasonable efforts to obtain the
approvals and authorizations required by the 1933 Act, the 1940 Act, and such
state securities laws it may deem appropriate to continue its operations after
the Effective Time.
5.9 Subject to this Agreement, each Fund covenants to take or cause to be
taken all actions, and to do or cause to be done all things, reasonably
necessary, proper, or advisable to consummate and effectuate the transactions
contemplated hereby.
6. CONDITIONS PRECEDENT
Each Fund's obligations hereunder shall be subject to (a) performance by
the other Fund of all its obligations to be performed hereunder at or before the
Effective Time, (b) all representations and warranties of the other Fund
contained herein being true and correct in all material respects as of the date
hereof and, except as they may be affected by the transactions contemplated
hereby, as of the Effective Time, with the same force and effect as if made at
and as of the Effective Time, and (c) the following further conditions that, at
or before the Effective Time:
6.1 This Agreement and the transactions contemplated hereby shall have been
duly adopted and approved by the Boards and shall have been approved by Target's
shareholders in accordance with its Declaration of Trust and applicable law.
6.2 All necessary filings shall have been made with the SEC and state
securities authorities, and no order or directive shall have been received that
any other or further action is required to permit the parties to carry
A-9
<PAGE> 33
out the transactions contemplated hereby. The Registration Statement shall have
become effective under the 1933 Act, no stop orders suspending the effectiveness
thereof shall have been issued, and the SEC shall not have issued an unfavorable
report with respect to the Reorganization under section 25(b) of the 1940 Act
nor instituted any proceedings seeking to enjoin consummation of the
transactions contemplated hereby under section 25(c) of the 1940 Act. All
consents, orders, and permits of federal, state, and local regulatory
authorities (including the SEC and state securities authorities) deemed
necessary by either Investment Company to permit consummation, in all material
respects, of the transactions contemplated hereby shall have been obtained,
except where failure to obtain same would not involve a risk of a material
adverse effect on either Fund's assets or properties, provided that either
Investment Company may for itself waive any of such conditions.
6.3 At the Effective Time, no action, suit, or other proceeding shall be
pending before any court or governmental agency in which it is sought to
restrain or prohibit, or to obtain damages or other relief in connection with,
the transactions contemplated hereby.
6.4 Target shall have received an opinion of Kirkpatrick & Lockhart LLP
("Counsel") substantially to the effect that:
6.4.1 Acquiring Fund is a duly established series of Trust, a Business
Trust duly organized and validly existing under the laws of the
Commonwealth of Massachusetts with power under its Declaration of Trust to
own all its properties and assets and, to the knowledge of Counsel, to
carry on its business as presently conducted;
6.4.2 This Agreement (a) has been duly authorized, executed, and
delivered by Trust on behalf of Acquiring Fund and (b) assuming due
authorization, execution, and delivery of this Agreement by Target, is a
valid and legally binding obligation of Trust with respect to Acquiring
Fund, enforceable in accordance with its terms, except as the same may be
limited by bankruptcy, insolvency, fraudulent transfer, reorganization,
moratorium, and similar laws relating to or affecting creditors' rights and
by general principles of equity;
6.4.3 The Acquiring Fund Shares to be issued and distributed to the
Shareholders under this Agreement, assuming their due delivery as
contemplated by this Agreement, will be duly authorized, validly issued and
outstanding, and fully paid and non-assessable;
6.4.4 The execution and delivery of this Agreement did not, and the
consummation of the transactions contemplated hereby will not, materially
violate Trust's Declaration of Trust or By-laws or any provision of any
agreement (known to Counsel, without any independent inquiry or
investigation) to which Trust (with respect to Acquiring Fund) is a party
or by which it is bound or (to the knowledge of Counsel, without any
independent inquiry or investigation) result in the acceleration of any
obligation, or the imposition of any penalty, under any agreement,
judgment, or decree to which Trust (with respect to Acquiring Fund) is a
party or by which it is bound, except as set forth in such opinion or as
previously disclosed in writing to and accepted by Target;
6.4.5 To the knowledge of Counsel (without any independent inquiry or
investigation), no consent, approval, authorization, or order of any court
or governmental authority is required for the consummation by Trust on
behalf of Acquiring Fund of the transactions contemplated herein, except
those obtained under the 1933 Act, the 1934 Act, and the 1940 Act and those
that may be required under state securities laws;
A-10
<PAGE> 34
6.4.6 Trust is registered with the SEC as an investment company, and
to the knowledge of Counsel no order has been issued or proceeding
instituted to suspend such registration; and
6.4.7 To the knowledge of Counsel (without any independent inquiry or
investigation), (a) no litigation, administrative proceeding, or
investigation of or before any court or governmental body is pending or
threatened as to Trust (with respect to Acquiring Fund) or any of its
properties or assets attributable or allocable to Acquiring Fund and (b)
Trust (with respect to Acquiring Fund) is not a party to or subject to the
provisions of any order, decree, or judgment of any court or governmental
body that materially and adversely affects Acquiring Fund's business,
except as set forth in such opinion or as otherwise disclosed in writing to
and accepted by Target.
In rendering such opinion, Counsel may (1) rely, as to matters governed by
the laws of the Commonwealth of Massachusetts, on an opinion of competent
Massachusetts counsel, (2) make assumptions regarding the authenticity,
genuineness, and/or conformity of documents and copies thereof without
independent verification thereof, (3) limit such opinion to applicable federal
and state law, and (4) define the word "knowledge" and related terms to mean the
knowledge of attorneys then with Counsel who have devoted substantive attention
to matters directly related to this Agreement and the Reorganization.
6.5 Trust shall have received an opinion of Counsel substantially to the
effect that:
6.5.1 Target is a Business Trust duly organized and validly existing
under the laws of the Commonwealth of Massachusetts with power under its
Declaration of Trust to own all its properties and assets and, to the
knowledge of Counsel, to carry on its business as presently conducted;
6.5.2 This Agreement (a) has been duly authorized, executed, and
delivered by Target and (b) assuming due authorization, execution, and
delivery of this Agreement by Trust on behalf of Acquiring Fund, is a valid
and legally binding obligation of Target, enforceable in accordance with
its terms, except as the same may be limited by bankruptcy, insolvency,
fraudulent transfer, reorganization, moratorium, and similar laws relating
to or affecting creditors' rights and by general principles of equity;
6.5.3 The execution and delivery of this Agreement did not, and the
consummation of the transactions contemplated hereby will not, materially
violate Target's Declaration of Trust or By-laws or any provision of any
agreement (known to Counsel, without any independent inquiry or
investigation) to which Target is a party or by which it is bound or (to
the knowledge of Counsel, without any independent inquiry or investigation)
result in the acceleration of any obligation, or the imposition of any
penalty, under any agreement, judgment, or decree to which Target is a
party or by which it is bound, except as set forth in such opinion or as
previously disclosed in writing to and accepted by Trust;
6.5.4 To the knowledge of Counsel (without any independent inquiry or
investigation), no consent, approval, authorization, or order of any court
or governmental authority is required for the consummation by Target of the
transactions contemplated herein, except those obtained under the 1933 Act,
the 1934 Act, and the 1940 Act and those that may be required under state
securities laws;
6.5.5 Target is registered with the SEC as an investment company, and
to the knowledge of Counsel no order has been issued or proceeding
instituted to suspend such registration; and
6.5.6 To the knowledge of Counsel (without any independent inquiry or
investigation), (a) no litigation, administrative proceeding, or
investigation of or before any court or governmental body is pending or
threatened as to Target or any of its properties or assets and (b) Target
is not a party to or subject to the provisions of any order, decree, or
judgment of any court or governmental body that
A-11
<PAGE> 35
materially and adversely affects Target's business, except as set forth in
such opinion or as otherwise disclosed in writing to and accepted by Trust.
In rendering such opinion, Counsel may (1) rely, as to matters governed by
the laws of the Commonwealth of Massachusetts, on an opinion of competent
Massachusetts counsel, (2) make assumptions regarding the authenticity,
genuineness, and/or conformity of documents and copies thereof without
independent verification thereof, (3) limit such opinion to applicable federal
and state law, and (4) define the word "knowledge" and related terms to mean the
knowledge of attorneys then with Counsel who have devoted substantive attention
to matters directly related to this Agreement and the Reorganization.
6.6 Each Investment Company shall have received an opinion of Counsel,
addressed to and in form and substance satisfactory to it, as to the federal
income tax consequences mentioned below ("Tax Opinion"). In rendering the Tax
Opinion, Counsel may rely as to factual matters, exclusively and without
independent verification, on the representations made in this Agreement (or in
separate letters addressed to Counsel) and the certificates delivered pursuant
to paragraph 3.4. The Tax Opinion shall be substantially to the effect that,
based on the facts and assumptions stated therein and conditioned on
consummation of the Reorganization in accordance with this Agreement, for
federal income tax purposes:
6.6.1 Acquiring Fund's acquisition of the Assets in exchange solely
for Acquiring Fund Shares and Acquiring Fund's assumption of the
Liabilities, followed by Target's distribution of those shares pro rata to
the Shareholders constructively in exchange for their Target Shares, will
qualify as a reorganization within the meaning of section 368(a)(1)(D) of
the Code, and each Fund will be "a party to a reorganization" within the
meaning of section 368(b) of the Code;
6.6.2 Target will recognize no gain or loss on the transfer of the
Assets to Acquiring Fund in exchange solely for Acquiring Fund Shares and
Acquiring Fund's assumption of the Liabilities or on the subsequent
distribution of those shares to the Shareholders in constructive exchange
for their Target Shares;
6.6.3 Acquiring Fund will recognize no gain or loss on its receipt of
the Assets in exchange solely for Acquiring Fund Shares and its assumption
of the Liabilities;
6.6.4 Acquiring Fund's basis for the Assets will be the same as
Target's basis therefor immediately before the Reorganization, and
Acquiring Fund's holding period for the Assets will include Target's
holding period therefor;
6.6.5 A Shareholder will recognize no gain or loss on the constructive
exchange of all its Target Shares solely for Acquiring Fund Shares pursuant
to the Reorganization; and
6.6.6 A Shareholder's aggregate basis for the Acquiring Fund Shares to
be received by it in the Reorganization will be the same as the aggregate
basis for its Target Shares to be constructively surrendered in exchange
for those Acquiring Fund Shares, and its holding period for those Acquiring
Fund Shares will include its holding period for those Target Shares,
provided they are held as capital assets by the Shareholder at the
Effective Time.
Notwithstanding subparagraphs 6.6.2 and 6.6.4, the Tax Opinion may state
that no opinion is expressed as to the effect of the Reorganization on the Funds
or any Shareholder with respect to any asset as to which any unrealized gain or
loss is required to be recognized for federal income tax purposes at the end of
a taxable year (or on the termination or transfer thereof) under a
mark-to-market system of accounting.
A-12
<PAGE> 36
At any time before the Closing, either Investment Company may waive any of
the foregoing conditions (except that set forth in paragraph 6.1) if, in the
judgment of its Board, such waiver will not have a material adverse effect on
its Fund's shareholders' interests.
7. BROKERAGE FEES AND EXPENSES
7.1 Each Investment Company represents and warrants to the other that there
are no brokers or finders entitled to receive any payments in connection with
the transactions provided for herein.
7.2 Except as otherwise provided herein, the total Reorganization Expenses
will be borne entirely by Heritage.
8. ENTIRE AGREEMENT; NO SURVIVAL
Neither party has made any representation, warranty, or covenant not set
forth herein, and this Agreement constitutes the entire agreement between the
parties. The representations, warranties, and covenants contained herein or in
any document delivered pursuant hereto or in connection herewith shall not
survive the Closing.
9. TERMINATION OF AGREEMENT
This Agreement may be terminated at any time at or prior to the Effective
Time, whether before or after approval by Target's shareholders:
9.1 By either Fund (a) in the event of the other Fund's material breach of
any representation, warranty, or covenant contained herein to be performed at or
prior to the Effective Time, (b) if a condition to its obligations has not been
met and it reasonably appears that such condition will not or cannot be met, or
(c) if the Closing has not occurred on or before December 31, 1999; or
9.2 By the parties' mutual agreement.
In the event of termination under paragraphs 9.1(c) or 9.2, there shall be
no liability for damages on the part of either Fund, or the trustees or officers
of either Investment Company, to the other Fund.
10. AMENDMENT
This Agreement may be amended, modified, or supplemented at any time,
notwithstanding approval thereof by Target's shareholders, in any manner
mutually agreed upon in writing by the parties; provided that following such
approval no such amendment shall have a material adverse effect on the
Shareholders' interests.
11. MISCELLANEOUS
11.1 This Agreement shall be governed by and construed in accordance with
the internal laws of the Commonwealth of Massachusetts; provided that, in the
case of any conflict between such laws and the federal securities laws, the
latter shall govern.
11.2 Nothing expressed or implied herein is intended or shall be construed
to confer upon or give any person, firm, trust, or corporation other than the
parties and their respective successors and assigns any rights or remedies under
or by reason of this Agreement.
A-13
<PAGE> 37
11.3 The parties acknowledge that each Investment Company is a Business
Trust. Each Fund agrees that, in asserting any rights or claims under this
Agreement, it shall look only to the other Fund's assets and property in
settlement of such rights or claims and not to such other Fund's shareholders or
trustees; and neither those shareholders nor those trustees, nor any of their
agents, whether past, present, or future, nor any other series (in the case of
Trust), shall be personally liable therefor.
11.4 This Agreement may be executed in one or more counterparts, all of
which shall be considered one and the same agreement, and shall become effective
when one or more counterparts have been executed by each Investment Company and
delivered to the other party hereto. The headings contained in this Agreement
are for reference purposes only and shall not affect in any way the meaning or
interpretation of this Agreement.
IN WITNESS WHEREOF, each party has caused this Agreement to be executed and
delivered by its duly authorized officers as of the day and year first written
above.
HERITAGE U.S. GOVERNMENT INCOME FUND
By: /s/ STEPHEN G. HILL
---------------------------------------
Stephen G Hill
President
HERITAGE INCOME TRUST,
on behalf of its series,
Intermediate Government Fund
By: /s/ STEPHEN G. HILL
---------------------------------------
Stephen G Hill
President
A-14
<PAGE> 38
APPENDIX B
ANNUAL REPORT-PRESIDENT'S LETTER
HERITAGE INCOME TRUST
November 19, 1998
Dear Fellow Shareholders:
I am pleased to provide you with the annual report for the fiscal year
ended September 30, 1998, for the Intermediate Government Fund and the High
Yield Bond Fund (the "Funds"), each a portfolio of Heritage Income Trust. During
the past year, bonds with higher credit quality generally outperformed those
with lower credit quality as investors demanded higher yields to accept any
credit risk.
The chart below presents total return data for the most recent fiscal year.
As you can see, unlike recent years past, investors were not rewarded for taking
more aggressive strategies during the past year. Both portfolios did outperform
their respective peer group averages for this period while the Intermediate
Government Fund also outperformed the unmanaged Lehman Brothers-Intermediate and
1-3 Year Index returns.
<TABLE>
<CAPTION>
TOTAL RETURN
(10/01/97-9/30/98)
------------------
<S> <C>
INTERMEDIATE GOVERNMENT FUND
A Shares*................................................... +11.18
C Shares*................................................... +10.85
Lehman Brothers 1-3 Year Government Index................... + 7.93
Lehman Brothers Intermediate Government/Corporate Index..... +10.43
Lipper Intermediate U.S. Government Funds Average........... +10.53
HIGH YIELD BOND FUND
A Shares*................................................... - 0.52
C Shares*................................................... - 1.02
Salomon Brothers High Yield Market Index.................... + 2.48
Lipper High Current Yield Funds Average..................... - 1.77
</TABLE>
On February 1, 1998, your Funds introduced Class B shares. From their
inception through September 30, 1998, the Class B shares returned +7.16% and
- -3.58%, for the Intermediate Government Fund and High Yield Bond Fund,
respectively.*
During the past year, the parent company of Salomon Brothers Asset
Management Inc, the subadviser for the High Yield Bond Fund, was involved in two
major corporate combinations resulting in the ultimate parent of Salomon
Brothers Asset Management Inc now being Citigroup, Inc. We have not experienced,
and do not expect, any material change in the way your portfolio is managed as a
result of this new corporate structure.
- ---------------
*These returns are calculated without the imposition of either front- or
back-end sales charges.
B-1
<PAGE> 39
In the pages that follow, you will find commentaries from Peter Wallace of
Heritage Asset Management, Inc. and Peter Wilby of Salomon Brothers Asset
Management Inc, the portfolio managers for your Funds. I hope you find their
comments helpful in understanding the recent performance of your Funds. We
continue to believe that fixed income investments can play an important part in
a well-diversified portfolio. We encourage you to meet with your financial
advisor to discuss how these or other Heritage funds may fit into your own
unique asset allocation strategies.
Thank you for your continuing investment with us. Please call us at (800)
709-3863 if there are ever ways in which you believe we can better serve you. On
behalf of all of us at Heritage, best wishes for a happy and healthy holiday
season.
Sincerely,
/s/ STEPHEN G. HILL
------------------------------------
Stephen G. Hill
President
B-2
<PAGE> 40
ANNUAL REPORT-PORTFOLIO MANAGER'S LETTER
HIT-INTERMEDIATE GOVERNMENT FUND
November 19, 1998
Dear Fellow Shareholders:
For investors in the Intermediate Government Fund (the "Fund"), the fiscal
year ended September 30, 1998 was quite rewarding. The Fund provided a steady
source of income and produced very attractive total returns even though market
volatility remained quite high. After expenses, the Fund returned +11.18%* in A
shares for the fiscal year which compares to the Lehman Intermediate
Government/Corporate Index return of +10.43% and the Lehman 1 to 3 year
Government Index return of +7.93%.
During the year, a number of factors came together that were very positive
for the U.S. Treasury sector of the bond market producing one of the sharpest
drops in bond yields in recent history. The primary factor influencing the move
lower in yields was the lack of inflationary pressure in our economy. After more
than eight years of expansion, the U.S. economy continued to grow at a moderate
rate. Inflation, which traditionally rises during the later stages of an
economic expansion, continued to decline with the Consumer Price Index showing
only a 1.5% year-over-year rate through September. The Producer Price Index
actually declined by 0.9% over the same period. Increased productivity and
companies' lack of ability to increase prices were the main reasons for this
beneficial trend in inflation.
As the year progressed, it became more evident that the problems in Asia,
notably Japan, were mounting. These pressures spread through the developing
nations of the world causing currencies to fall against the dollar. The
strengthening dollar reduced the prices of goods imported into the United States
and also helped contain domestic inflation. The weakening of foreign economies
also aided in the fall of commodity prices such as oil and agricultural
products. These factors also led investors to flee foreign markets, both equity
and debt, and to seek the safety of U.S. Treasury bonds. The "flight to quality"
brought the yield of the benchmark thirty year Treasury bond to below 5.00%
allowing the Treasury market to perform better than other bond market sectors.
In September, just prior to year-end, the Federal Reserve Open Market
Committee reduced the Federal Funds rate from 5.50% to 5.25%. The Federal
Reserve moved rates lower in order to avert a slowdown in the U.S. economy and
to ease credit conditions. This was followed by further 25 basis point
reductions in mid October and early November to add additional liquidity and to
reduce the risk of a "credit crunch".
During the year we reduced our exposure to the mortgage sector of the
markets and concentrated primarily on U.S. Treasuries. This benefited the Fund's
performance. We have maintained one mortgage position to add additional income
over and above that available from comparable Treasury securities. In hindsight,
which we find nearly always perfect, we could have improved our results even
more by selling all of our mortgage positions and investing in the ten year
sector of the yield curve.
- ---------------
*This return is calculated without the imposition of either front- or back-end
sales charges.
B-3
<PAGE> 41
We envision the Fed continuing to lower rates in 1999 as the economy
continues to weaken as the result of the worldwide economic slowdown and
financial pressures domestically. Currently we remain bullish on the Treasury
market over the balance of 1998 and into 1999, but we expect the markets to
continue to display unparalleled volatility of yields and prices. Strategically,
we plan to maintain a higher than normal exposure to the Treasury sector for the
foreseeable future.
Thanks for your continued confidence in the Heritage Income
Trust-Intermediate Government Fund.
Sincerely,
/s/ H. PETER WALLACE
------------------------------------
H. Peter Wallace, CFA
Senior Vice President
Heritage Asset Management, Inc.
Portfolio Manager, Intermediate
Government Fund
B-4
<PAGE> 42
ANNUAL REPORT-PERFORMANCE HISTORY
GROWTH OF A $10,000 INVESTMENT SINCE
INCEPTION OF HERITAGE INCOME TRUST-INTERMEDIATE GOVERNMENT FUND
CLASS A SHARES ON MARCH 1, 1990
<TABLE>
<S> <C>
$21,000 | Average Annual Total Returns* |
$20,000 | 1 Year: 7.01% 5 Year: 5.22% |
$19,000 | Life of Class A Shares: 5.66% |
$18,000
$17,000 The graph depicts the performance of Class A Shares
$16,000 of the Fund relative to two market indices since
$15,000 the Fund's inception.
$14,000
$13,000
$12,000
$11,000
$10,000 Past performance is not predictive of future performance.
$ 9,000
1990 1991 1992 1993 1994 1995 1996 1997 1998
YEARLY PERIODS ENDED SEPTEMBER 30
Return Since Inception
Heritage Income Trust - Intermediate Government Fund $16,047
Lehman Brothers 1 to 3 Year Government Index $18,079
Lehman Brothers Intermediate Government/Corporate Index $20,074
</TABLE>
- ---------------
* Total return for the Intermediate Government Fund Class A Shares are
calculated in conformance with Item 21 of Form N-1A, which assumes
reinvestment of dividends and a sales load of 3.75%. Performance presented
represents historical data. The investment return and principal value of an
investment will fluctuate so that an investor's shares, when redeemed, may be
worth more or less than their original cost. The Fund's past performance is
not indicative of future performance and should be considered in light of the
Fund's investment policy and objectives, the characteristics and quality of
its portfolio securities and the periods selected.
B-5
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
ACQUISITION OF ASSETS OF
HERITAGE U.S. GOVERNMENT INCOME FUND
BY
HERITAGE INCOME TRUST
INTERMEDIATE GOVERNMENT FUND
880 CARILLON PARKWAY, ST. PETERSBURG, FLORIDA 33716
TOLL FREE: (800) 421-4184
July 19, 1999
This Statement of Additional Information, relating specifically to the
proposed transfer of all the assets to, and the assumption of all the
liabilities, if any, of the Heritage U.S. Government Income Fund by, the
Heritage Income Trust - Intermediate Government Fund consists of this cover page
and the following described documents:
1. Pro Forma Financial Statements as of and at March 31, 1999.
2. Statement of Additional Information of the Heritage Income Trust dated
February 1, 1999 (incorporated by reference herein).
3. Semi-Annual Report to Shareholders of the Heritage Income Trust for the
period ended March 31, 1999 (incorporated by reference herein).
4. Annual Report to Shareholders of the Heritage U.S. Government Income
Fund for the fiscal year ended October 31, 1998 (incorporated by
reference herein).
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Prospectus and Proxy Statement dated July 19, 1999
relating to the above referenced matter. A copy of the Prospectus and Proxy
Statement may be obtained from the Intermediate Government Fund without charge
by writing or calling Heritage Asset Management, Inc. at the address or
telephone number above.
<PAGE>
<TABLE>
HERITAGE INCOME TRUST - INTERMEDIATE GOVERNMENT FUND
PRO FORMA FINANCIAL STATEMENT
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1999 (UNAUDITED)
<CAPTION>
Heritage Income Trust- Heritage U. S.
Intermediate Government Government Proforma Proforma
Fund Income Fund Adjustments Combined
----------------------- ----------------- ------------ -----------------
<S> <C> <C> <C> <C>
ASSETS
- ------
Investments $ 13,918,015 $ 43,715,410 $ 57,633,425
Repo 533,000 3,071,000 3,604,000
Cash 90 379 469
Receivables
Investments sold - 25,586 25,586
Fund shares sold 390,367 - 390,367
Dividends and interest 95,511 288,198 383,709
From Manager 30,939 - 30,939
Prepaid Insurance 1,953 6,981 8,934
Prepaid NYSE Filing Fee - 9,433 9,433
Deferred state qualification expenses 20,621 - 20,621
----------------------- ----------------- -----------------
Total Assets $ 14,990,496 $ 47,116,986 $ 62,107,482
----------------------- ----------------- =================
LIABILITIES
- -----------
Payables
Investments purchased $ - $ 9,787,500 $ 9,787,500
Fund shares redeemed 60,533 - 60,533
Accrued distribution fee 4,483 - 4,483
Other accrued expenses 42,545 143,095 185,640
----------------------- ----------------- -----------------
Total Liabilities $ 107,561 $ 9,930,595 $ 10,038,156
----------------------- ----------------- -----------------
Net assets, at market value $ 14,882,935 $ 37,186,391 $ 52,069,326
======================= ================= =================
NET ASSETS
- ----------
Paid in capital $ 21,247,840 $ 43,452,222 $ 64,700,062
Undistributed net investment income 658,089 (58,165) 599,924
Accumulated net realized loss (6,905,437) (6,044,102) (12,949,539)
Net unrealized depreciation on investments (117,557) (163,564) (281,121)
----------------------- ----------------- -----------------
Net assets, at market value $ 14,882,935 $ 37,186,391 $ 52,069,326
======================= ================= =================
Net assets, at market value
Class A Shares $ 12,414,756 $ 37,186,391 $ 49,601,147
Class B Shares 339,211 - 339,211
Class C Shares 2,128,968 - 2,128,968
----------------------- ----------------- -----------------
Total $ 14,882,935 $ 37,186,391 $ 52,069,326
======================= ================= =================
Shares of beneficial Interest outstanding
Class A Shares 1,326,965 3,115,471 859,238 (1) 5,301,674
Class B Shares 36,379 - 36,379
Class C Shares 228,167 - 228,167
----------------------- ----------------- -----------------
Total 1,591,511 3,115,471 4,706,982
======================= ================= =================
Net Asset Value ---
--- offering and redemption price
per share
Class A Shares $ 9.36 $ 11.94 $ 9.36
======================= ================= =================
Maximum offering price $ 9.72 $ 9.72
(100/96.25 of $9.36) ======================= =================
Class B Shares $ 9.32 $ 9.32
======================= =================
Class C Shares $ 9.33 $ 9.33
======================= =================
(1) Represents the difference between total additional shares to be issued (See Note 2) and current Heritage U. S.
Government Income Fund shares outstanding.
See Notes To Pro Forma Financial Statements
</TABLE>
<PAGE>
<TABLE>
Heritage Income Trust - Intermediate Government Fund
Pro Forma Financial Statement
Statement of Operations
For the 12 months ended March 31, 1999 (unaudited)
<CAPTION>
Heritage Income Trust- Heritage U. S.
Intermediate Government Government Proforma Proforma
Fund Income Fund Adjustments Combined
----------------------- --------------- ------------ -----------
<S> <C> <C> <C> <C>
INVESTMENT INCOME
- -----------------
Interest $ 836,803 $ 2,753,744 $ 3,590,547
EXPENSES
- --------
Management fee 75,733 199,503 (10,213) (1) 265,023
Administrative fee - 56,787 (56,787) (2) (0)
Distribution fee (Class A Shares) 40,264 - 94,645 (3) 134,909
Distribution fee (Class B Shares) 915 - 915
Distribution fee (Class C Shares) 13,995 - 13,995
Professional fees 44,182 47,508 (47,508) (4) 44,182
Custodian/Fund acct fees 43,188 43,773 (33,751) (4) 53,210
Shareholder servicing fees 11,108 22,075 33,183
State qualification fees 33,175 - 33,175
Reports to shareholders 16,645 21,962 (17,462) (4) 21,145
Trustees' fees and expenses 9,954 9,696 (9,696) (4) 9,954
Insurance expense 1,983 3,827 5,810
NYSE Fees - 16,170 (16,170) (5) -
Organization expense - 4,881 4,881
Other (435) 1,325 890
----------------------- --------------- -------- -----------
Total expenses before waiver and reimbursement 290,707 427,506 (96,942) 621,272
Fees waived by Manager (75,733) (49,107) (28,585) (6) (153,425)
Reimbursement from Manager (68,964) - 68,964 (6) -
----------------------- --------------- -------- ----------
Total expenses after waiver and reimbursement 146,010 378,399 (56,563) 467,847
----------------------- --------------- -------- -----------
Net investment income 690,793 2,375,345 56,563 3,122,700
----------------------- --------------- -------- -----------
Realized and Unrealized Gain (Loss) on Investments
- --------------------------------------------------
Net realized gain from investment transactions 343,121 110,459 - 453,580
Net (decrease) in unrealized appreciation of (164,697) (176,599) - (341,296)
investments during the period ----------------------- --------------- -------- -----------
Net loss on investments 178,424 (66,139) - 112,285
----------------------- --------------- -------- -----------
- -
======================= =============== ======== ===========
Net increase (decrease) in net assets $ 869,217 $ 2,309,205 $ 56,563 $ 3,234,985
resulting from operations ======================= =============== ======== ===========
<FN>
(1) Adjustment to reflect reduction in management fees
(2) Adjustment to reflect elimination of the administrative fee
(3) Adjustment to reflect the addition of a 12b-1 fee
(4) Adjustment to reflect the elimination of duplicate fees
(5) Adjustment to reflect the elimination of the NYSE fee
(6) Adjustment to reflect the expense cap of 60 basis points on all non-12b-1 expenses
</FN>
</TABLE>
See Notes To Pro Forma Financial Statements
<PAGE>
<TABLE>
Heritage Income Trust - Intermediate Government Fund
Pro Forma Financial Statement
Investment Portfolio
March 31, 1999 (unaudited)
<CAPTION>
Heritage Income Trust Heritage U. S.
Intermediate Government Government Combined
Fund Income Fund
-------------------- -------------------- --------------------
Principal Market Value Principal Market Value Principal Market Value
Amount MV Amount MV Amount MV
------ -- ------ -- ------ --
<S> <C> <C> <C> <C> <C> <C>
U. S. GOVERNMENT AND AGENCY
SECURITIES--110.69%
U. S. TREASURIES--59.1% (a)
USTN 4.50 09/30/00 $ 2,300,000 $2,282,750 $ 1,000,000 $ 992,500 $ 3,300,000 $3,275,250
USTN 5.375% 2/15/01 1,000,000 1,006,250 1,000,000 1,006,250
USTN 5% 02/28/01 2,000,000 1,999,376 2,000,000 1,999,376
USTN 5.625% 5/15/01 1,000,000 1,011,875 1,000,000 1,011,875
USTN 6.25% 1/31/02 1,000,000 1,029,063 1,000,000 1,029,063
USTN 5.875% 9/30/02 1,000,000 1,022,188 1,000,000 1,022,188
USTN 5.75% 11/30/02 1,000,000 1,018,438 1,000,000 1,018,438
USTN 5.5% 02/28/03 1,000,000 1,010,313 2,000,000 2,020,626 3,000,000 3,030,939
USTN 5.25% 08/15/03 2,300,000 2,305,032 1,000,000 1,002,188 3,300,000 3,307,220
USTN 5.375% 6/30/03 2,000,000 2,011,876 2,000,000 2,011,876
USTN 4.25% 11/15/03 2,000,000 1,925,626 2,000,000 1,925,626
USTN 4.75% 2/15/04 2,300,000 2,264,782 3,000,000 2,954,064 5,300,000 5,218,846
USTN 5.625% 5/15/08 1,000,000 1,018,125 1,000,000 1,018,125
USTN 5.5% 02/15/08 1,000,000 1,010,313 1,000,000 1,010,313
USTN 4.75% 11/15/08 3,000,000 2,889,375 3,000,000 2,889,375
--------- ---------
Total U. S. Treasuries
(cost $12,053,734, $18,929,609, ----------
$30,983,343) 11,950,692 18,824,069 30,774,761
---------- ---------- ----------
U. S. GOVERNMENT AGENCIES--51.6% (a)
Federal National Mortgage Association
- -------------------------------------
FNMA #459881 6.5% 1/1/29 988,355 983,952 988,355 983,952
FNMA #481349 6.5% 1/1/29 987,771 983,371 987,771 983,371
FNMA 1990-96-E SEQUENTIAL 150,836 151,842 150,836 151,842
FNMA 92-65 K, 8.5% 5/25/21 (b) 2,000,000 2,044,623 2,000,000 2,044,623
FNMA POOL #394212 7.50% 7/1/27 (b) 1,027,598 1,055,879 1,027,598 1,055,879
FNMA #481635 6.5% 1/1/29 2,016,112 2,007,130 2,016,112 2,007,130
FNMA 6% 30YR TBA ---------- 5,000,000 4,857,810 5,000,000 4,857,810
--------- ---------
Total Federal National Mortgage Association 1,967,323 10,117,284 12,084,607
--------- ---------- ----------
Federal Home Loan Mortgage Association
- --------------------------------------
FHLMC 1378-H 10% 1/15/21 (b) 3,000,000 3,177,766 3,000,000 3,177,766
FHLMC GOLD 6.5% 30 YR TBA 5,000,000 4,979,690 5,000,000 4,979,690
--------- ---------
Total Federal Home Loan Mortgage Association 8,157,456 8,157,456
---------- ---------
Government National Mortgage Association
- ----------------------------------------
GNMA 7.50% 11/15/25 POOL #415688 (b) 3,409,602 3,512,728 3,409,602 3,512,728
GNMA 7.50% 3/15/27 POOL #442741 (b) 1,045,682 1,076,668 1,045,682 1,076,668
GNMA 1996-16-G 7% 4/16/22 2,000,000 2,027,205 2,000,000 2,027,205
--------- ---------
Total Government National Mortgage Association 6,616,601 6,616,601
--------- ---------
Total U. S. Government Agencies
(cost $1,961,838, $24,969,365, ---------- ---------- ----------
$26,931,203) 1,967,323 24,891,341 26,858,664
--------- ---------- ----------
Total U. S. Government and Agency Securities
( cost $14,035,572, $43,878,974, $57,914,546) 13,918,015 43,715,410 57,633,425
---------- ---------------------
<PAGE>
REPURCHASE AGREEMENTS--6.9% (a)
Repurchase Agreement with State Street Bank and
Trust Company Dated 3/31/99 @ 4.78% to be
repurchased at $533,071 on April 1, 1999,
collateralized by $490,000 U.S. Treasury Bonds,
6.5% due 11/15/26 (cost $533,000) 533,000 533,000
------- -------
Repurchase Agreement with State Street Bank and
Trust Company Dated 3/31/99 @ 4.78% to be
repurchased at $3,071,408 on April 1, 1999,
collateralized by $2,825,000 U.S. Treasury Bonds,
6.5% due 11/15/26 (market value $3,133,670
including interest) (cost $3,071,000) 3,071,000 3,071,000
---------- ---------
---------- ---------- ---------
Total Investment Portfolio 14,451,015 46,786,410 61,237,425
(cost $14,568,572, $46,949,974, $61,518,546)(c),
117.6%(a)
Other Assets and Liabilities, net, -17.6% (a) 431,920 (9,600,019) (9,168,099)
----------- ---------- ----------
Net Assets $ 14,882,935 $ 37,186,391 $ 52,069,326
=========== ========== ==========
<FN>
(a) Percentages are based on net assets.
(b) Some or all of these securities are segregated in connection with the reverse
repurchase agreement and / or mortgage dollar rolls.
(c) The aggregate identified cost for federal income tax purposes for both Funds is
substantially the same. Market value for the Intermediate Government Fund includes net
unrealized depreciation of $117,557, which consist of aggregate gross unrealized
appreciation for all securities in which there is an excess of market value over tax cost
of $89,815 and aggregate gross unrealized depreciation for all securities in which there
is an excess of tax cost over market value of $207,372. Market value for the U.S.
Government Income Fund includes net unrealized depreciation of $163,564, which consist of
aggregate gross unrealized appreciation for all securities in which there is an excess of
market value over tax cost of $282,578 and aggregate gross unrealized depreciation for all
securities in which there is an excess of tax cost over market value of $446,142.
</FN>
</TABLE>
See Notes To Pro Forma Financial Statements
<PAGE>
Heritage Income Trust - Intermediate Government Fund
Notes to Pro Forma Financial Statements
(unaudited)
1. Basis of Combination - The Pro Forma Statement of Assets and Liabilities,
including the Portfolio of Investments, at March 31, 1999 and the related
Statement of Operations ("Pro Forma Statements") for the twelve months ended
March 31, 1999, reflect the accounts of Heritage Income Trust - Intermediate
Government Fund and Heritage U.S. Government Income Fund.
The Pro Forma Statements give effect to the proposed transfer of all assets and
liabilities of the Heritage U.S. Government Income Fund in exchange for shares
in the Heritage Income Trust - Intermediate Government Fund. The Pro Forma
Statements should be read in conjunction with the historical financial
statements of each Fund included in its Statement of Additional Information.
2. Shares of beneficial Interest - The pro forma net asset value per share
assumes the issuance of additional shares of the Heritage Income Trust -
Intermediate Government Fund which would have been issued on March 31, 1999 in
connection with the proposed reorganization. Shareholders of the Heritage U.S.
Government Income Fund would become shareholders of the Heritage Income Trust -
Intermediate Government Fund by receiving Class A Shares of the Heritage Income
Trust - Intermediate Government Fund equal to the value of their holdings in the
Heritage U.S. Government Income Fund. The amount of additional shares assumed to
be issued was calculated based on the March 31, 1999 net assets of the Heritage
U.S. Government Income Fund and the net asset value per share of the Heritage
Income Trust - Intermediate Government Fund as follows:
<TABLE>
<CAPTION>
CLASS CLASS A CLASS B CLASS C
- ----- ------- ------- -------
<S> <C> <C> <C>
Additional Shares Issued 3,974,709 - -
Net Assets 03/31/99
Heritage U.S. Government Income Fund $37,186,391 $ - $ -
Net Asset Value Per Share
Heritage Income Trust - Intermediate
Government Fund $ 9.36 $ 9.32 $ 9.33
</TABLE>
3. Pro Forma Operations - The Pro Forma Statement of Operations assumes similar
rates of gross investment income for the investments of each Fund. Accordingly,
the combined gross investment income is equal to the sum of each Funds gross
investment income. Certain expenses have been adjusted to reflect the expected
expenses of the combined entity- The, pro-forma investment management fees of
the combined Fund are based on the fee schedule in effect for Heritage Income
Trust - Intermediate Government Fund at the combined level of average net assets
for the twelve months ended March 31, 1999. The Pro Forma Statement of
Operations does not include the effect of any realized gains or losses, or
transaction fees incurred in connection with the realignment of the portfolio.
In addition, fees in connection with the reorganization are being borne by
Heritage Asset Management, Inc. and are not included in these pro forma
financial statements.
<PAGE>
HERITAGE INCOME TRUST - INTERMEDIATE GOVERNMENT FUND
NOTES TO PRO FORMA FINANCIAL STATEMENTS
(UNAUDITED)
CAPITALIZATION TABLE (UNAUDITED)
The following table sets forth the capitalization of the Heritage Income Trust -
Intermediate Government Fund and the Heritage U.S. Government Income Fund as of
May 31, 1999 and on a pro forma combined basis as if the reorganization occurred
on that date:
<TABLE>
<CAPTION>
NET ASSET
SHARES VALUE
NET ASSETS OUTSTANDING PER SHARE
---------- ----------- ---------
<S> <C> <C> <C>
CLASS A SHARES
Heritage Income Trust - Intermediate Government Fund $11,715,033 1,272,101 $ 9.21
Heritage U.S. Government Income Fund $36,356,896 3,115,471 $11.67
Combined Fund (pro-forma) $48,071,929 5,219,988 $ 9.21
CLASS B SHARES
Heritage Income Trust - Intermediate Government Fund $ 404,468 44,071 $ 9.18
Heritage U.S. Government Income Fund -- -- $ --
Combined Fund (pro-forma) $ 404,468 44,071 $ 9.18
CLASS C SHARES
Heritage Income Trust - Intermediate Government Fund $ 2,046,532 222,826 $ 9.18
Heritage U.S. Government Income Fund -- -- --
Combined Fund (pro-forma) $ 2,046,532 222,826 $ 9.18
</TABLE>
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
HERITAGE INCOME TRUST
HIGH YIELD BOND FUND
INTERMEDIATE GOVERNMENT FUND
This Statement of Additional Information ("SAI") dated February 1, 1999
should be read in conjunction with the Prospectus dated February 1, 1999 of the
High Yield Bond and Intermediate Government Funds of Heritage Income Trust (the
"Trust"). This SAI is not a prospectus itself. To receive a copy of the funds'
Prospectus write to Heritage Asset Management, Inc. at the address below or call
(800) 421-4184.
HERITAGE ASSET MANAGEMENT, INC.
880 Carillon Parkway
St. Petersburg, Florida 33716
TABLE OF CONTENTS
PAGE
GENERAL INFORMATION...........................................................2
INVESTMENT INFORMATION........................................................2
Investment Strategies and Risks.........................................2
Industry Classifications...............................................23
INVESTMENT LIMITATIONS.......................................................24
NET ASSET VALUE..............................................................26
PERFORMANCE INFORMATION......................................................27
INVESTING IN THE FUNDS.......................................................30
Systematic Investment Options..........................................30
Retirement Plans.......................................................30
Class A Combined Purchase Privilege (Right of Accumulation)............31
Class A Statement of Intention.........................................32
REDEEMING SHARES.............................................................33
Systematic Withdrawal Plan.............................................33
Telephone Transactions.................................................34
Redemptions in Kind....................................................34
Receiving Payment......................................................34
EXCHANGE PRIVILEGE...........................................................35
CONVERSION OF CLASS B SHARES.................................................36
TAXES........................................................................37
SHAREHOLDER INFORMATION......................................................40
TRUST INFORMATION............................................................41
Management of the Trust................................................41
Five Percent Shareholders..............................................43
Investment Adviser and Administrator; Subadviser.......................44
Brokerage Practices....................................................46
Distribution of Shares.................................................47
Administration of the Trust............................................49
Potential Liability....................................................50
APPENDIX....................................................................A-1
REPORT OF INDEPENDENT ACCOUNTANTS...........................................A-5
FINANCIAL STATEMENTS........................................................A-5
<PAGE>
GENERAL INFORMATION
- -------------------
The Trust was established as a Massachusetts business trust under a
Declaration of Trust dated August 4, 1989. It is registered as an open-end
diversified management investment company under the Investment Company Act of
1940, as amended (the "1940 Act"), and is composed of the High Yield Bond Fund
(known as the Diversified Portfolio prior to February 1, 1996) ("High Yield")
and the Intermediate Government Fund (known as the Limited Maturity Government
Portfolio prior to January 31, 1996) ("Government") (each a "fund" and,
collectively, the "funds"). Each fund constitutes a separate investment
portfolio with distinct investment objectives, purposes and strategies. Each
fund offers three classes of shares, Class A shares sold subject to a 3.75%
maximum front-end sales charge ("Class A shares"), Class B shares sold subject
to a 5% maximum contingent deferred sales charge ("CDSC"), declining over a
six-year period ("Class B shares"), and Class C shares sold subject to a 1% CDSC
("Class C shares").
INVESTMENT INFORMATION
- ----------------------
INVESTMENT POLICIES, STRATEGIES AND RISKS
-----------------------------------------
BORROWING. Each fund may borrow in certain limited circumstances. See
"Investment Limitations." Borrowing creates an opportunity for increased return,
but, at the same time, creates special risks. For example, borrowing may
exaggerate changes in the net asset value of a fund's shares and in the return
on the fund's investment portfolio. Although the principal of any borrowing will
be fixed, a fund's assets may change in value during the time the borrowing is
outstanding. A fund may be required to liquidate portfolio securities at a time
when it would be disadvantageous to do so in order to make payments with respect
to any borrowing, which could affect the investment manager's strategy.
Furthermore, if a fund were to engage in borrowing, an increase in interest
rates could reduce the value of the fund's shares by increasing the fund's
interest expense.
BRADY BONDS. High Yield may invest in Brady Bonds, which are debt
securities, generally denominated in U.S. dollars, issued under the framework of
the Brady Plan. The Brady Plan is an initiative announced by former U.S.
Treasury Secretary Nicholas F. Brady in 1989 as a mechanism for debtor nations
to restructure their outstanding external commercial bank indebtedness. In
restructuring its external debt under the Brady Plan framework, a debtor nation
negotiates with its existing bank lenders, as well as multilateral institutions,
such as the International Bank for Reconstruction and Development (the "World
Bank") and the International Monetary Fund (the "IMF"). The Brady Plan
framework, as it has developed, contemplates the exchange of external commercial
bank debt for newly issued bonds (Brady Bonds). Brady Bonds also may be issued
in respect of new money being advanced by existing lenders in connection with
the debt restructuring. The World Bank and/or the IMF support the restructuring
by providing funds pursuant to loan agreements or other arrangements, which
enable the debtor nation to collateralize the new Brady Bonds or to repurchase
outstanding bank debt at a discount. These arrangements with the World Bank
and/or the IMF require debtor nations to agree to the implementation of certain
domestic monetary and fiscal reforms. Such reforms have included the
liberalization of trade and foreign investment, the privatization of state-owned
enterprises and the setting of targets for public spending and borrowing. These
policies and programs seek to promote the debtor country's economic growth and
<PAGE>
development. Investors should recognize that the Brady Plan only sets forth
general guiding principles for economic reform and debt reduction, emphasizing
that solutions must be negotiated on a case-by-case basis between debtor nations
and their creditors. Saloman Brothers Asset Management, Inc ("SBAM" or
"Subadviser") believes economic reforms, undertaken by countries in connection
with the issuance of Brady Bonds, make the debt of those countries that have
issued or announced plans to issue Brady Bonds an attractive opportunity for
investment. However, there can be no assurance that SBAM's expectations with
respect to Brady Bonds will be realized.
Brady Bonds have been issued for only a limited period of time, and,
accordingly, do not have a long payment history. Brady Bonds that have been
issued to date are rated in the categories "BB" or "B" by Standard & Poor's
Ratings Services ("S&P") or "Ba" or "B" by Moody's Investors Services, Inc.
("Moody's") or, in cases in which a rating by S&P or Moody's has not been
assigned, generally are considered by the Subadviser to be of comparable
quality.
Agreements implemented under the Brady Plan to date are designed to
achieve debt and debt-service reduction through specific options negotiated by a
debtor nation with its creditors. As a result, the financial packages offered by
each country differ. The types of options have included the exchange of
outstanding commercial bank debt for bonds issued at 100% of face value of such
debt that carry a below-market stated rate of interest (generally known as par
bonds), bonds issued at a discount from the face value of such debt (generally
known as discount bonds), bonds bearing an interest rate which increases over
time, and bonds issued in exchange for the advancement of new money by existing
lenders. Discount bonds issued to date under the framework of the Brady Plan
generally have borne interest computed semiannually at a rate equal to 13/16 of
one percent above the then current six month London Inter-Bank Offered Rate
("LIBOR").
Regardless of the stated face amount and stated interest rate of the
various types of Brady Bonds, High Yield will purchase Brady Bonds in secondary
markets, as described below.
In the secondary markets, the price and yield to the investor reflect
market conditions at the time of purchase. Brady Bonds issued to date have
traded at a deep discount from their face value. Certain sovereign bonds are
entitled to "value recovery payments" in certain circumstances, which in effect
constitute supplemental interest payments but generally are not collateralized.
Certain Brady Bonds have been collateralized as to principal due at maturity
(typically 30 years from the date of issuance) by U.S. Treasury zero coupon
bonds with a maturity equal to the final maturity of such Brady Bonds, although
the collateral is not available to investors until the final maturity of the
Brady Bonds. Collateral purchases are financed by the IMF, the World Bank and
the debtor nations' reserves. In addition, interest payments on certain types of
Brady Bonds may be collateralized by cash or high-grade securities in amounts
that typically represent between 12 and 18 months of interest accruals on these
instruments with the balance of the interest accruals being uncollateralized.
High Yield may purchase Brady Bonds with limited or no collateralization, and
will rely for payment of interest and (except in the case of principal
collateralized Brady Bonds) principal primarily on the willingness and ability
of the foreign government to make payment in accordance with the terms of the
Brady Bonds. Brady Bonds issued to date are purchased and sold in secondary
markets through U.S. securities dealers and other financial institutions and
3
<PAGE>
generally are maintained through European transnational securities depositories.
A substantial portion of the Brady Bonds and other sovereign debt securities in
which High Yield invests are likely to be acquired at a discount, which involves
certain considerations discussed below under "Taxes."
In the event of a default with respect to collateralized Brady Bonds as a
result of which the payment obligations of the issuer are accelerated, the U.S.
Treasury zero coupon obligations held as collateral for the payment of principal
will not be distributed to investors, nor will such obligations be sold and the
proceeds distributed. The collateral will be held by the collateral agent to the
scheduled maturity of the defaulted Brady Bonds, which will continue to be
outstanding, at which time the face amount of the collateral will equal the
principal payments that would have then been due on the Brady Bonds in the
normal course. Based upon current market conditions, High Yield would not intend
to purchase Brady Bonds that, at the time of investment, are in default as to
payments. However, in light of the residual risk of the Brady Bonds and, among
other factors, the history of default with respect to commercial bank loans by
public and private entities of countries issuing Brady Bonds, investments in
Brady Bonds are to be viewed as speculative.
DEBT OBLIGATIONS AND FUND MATURITY. The market value of debt securities
held by each fund will be affected by changes in interest rates. There normally
is an inverse relationship between the market value of such securities and
actual changes in interest rates. Thus, a decline in interest rates generally
produces an increase in market value while an increase in rates generally
produces a decrease in market value. Moreover, the longer the remaining maturity
of a security, the greater will be the effect of interest rate changes on the
market value of such a security. In addition, changes in the ability of an
issuer to make payments of interest and principal and in the market's perception
of an issuer's creditworthiness also will affect the market value of the debt
securities of that issuer. Differing yields on fixed income securities of the
same maturity are a function of several factors, including the relative
financial strength of the issuers.
EQUITY SECURITIES. High Yield may invest up to 20% of its assets in common
stock, convertible securities, preferred stock, warrants or other equity
securities when consistent with the fund's objectives.
CONVERTIBLE SECURITIES. High Yield may invest in convertible
securities. A convertible security is a bond, debenture, note, preferred stock
or other security that may be converted into or exchanged for a prescribed
amount of common stock of the same or a different issuer within a particular
period of time at a specified price or formula. A convertible security entitles
the holder to receive interest paid or accrued on debt or dividends paid on
preferred stock until the convertible security matures or is redeemed, converted
or exchanged. Convertible securities have unique investment characteristics in
that they generally have higher yields than common stocks, but lower yields than
comparable non-convertible securities, are less subject to fluctuation in value
than the underlying stock because they have fixed income characteristics, and
provide the potential for capital appreciation if the market price of the
underlying common stock increases.
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While no securities investment is without some risk, investments in
convertible securities generally entail less risk than the issuer's common
stock. The extent to which such risk is reduced depends in large measure upon
the degree to which the convertible security sells above its value as a
fixed-income security. Convertible securities in which High Yield may invest
include corporate bonds, notes and preferred stock that can be converted into
common stock. As with all debt securities, the market value of convertible
securities tends to decline as interest rates increase and, conversely, to
increase as interest rates decline. While convertible securities generally offer
lower interest or dividend yields than nonconvertible debt securities of similar
quality, they do enable the investor to benefit from increases in the market
price of the underlying common stock.
PREFERRED STOCK. High Yield may invest in preferred stock. A
preferred stock is a blend of the characteristics of a bond and a common stock.
It can offer the higher yield of a bond and has priority over common stock in
equity ownership, but does not have the seniority of a bond and its
participation in the issuer's growth may be limited. Preferred stock has
preference over common stock in the receipt of dividends and in any residual
assets after payment to creditors should the issuer be dissolved. Although the
dividend is set at a fixed annual rate, in some circumstances it can be changed
or omitted by the issuer.
WARRANTS. High Yield may invest in warrants, which are securities
permitting, but not obligating, their holder to subscribe for other securities.
Warrants do not carry the right to dividends or voting rights with respect to
their underlying securities, and they do not represent any rights in assets of
the issuer. An investment in warrants may be considered speculative. In
addition, the value of a warrant does not necessarily change with the value of
the underlying securities and a warrant ceases to have value if it is not
exercised prior to its expiration date.
FIXED AND FLOATING RATE LOANS. High Yield may invest in fixed and floating
rate loans ("Loans") arranged through private negotiations between a corporate
borrower or a foreign sovereign entity and one or more financial institutions
("Lenders"). High Yield may invest in such loans in the form of participations
in Loans ("Participations") and assignments of all or a portion of Loans from
third parties ("Assignments"). High Yield considers these investments to be
investments in debt securities for purposes of this Prospectus. High Yield, in
pursuing its investment policies, may acquire Participations and Assignments
that are high yield, nonconvertible corporate debt securities or short duration
debt securities. Participations typically will result in the fund having a
contractual relationship only with the Lender, not with the borrower. High Yield
will have the right to receive payments of principal, interest and any fees to
which it is entitled only from the Lender selling the Participation and only
upon receipt by the Lender of the payments from the borrower. In connection with
purchasing Participations, High Yield generally will have no right to enforce
compliance by the borrower with the terms of the loan agreement relating to the
Loan, nor any rights of set-off against the borrower, and High Yield may not
benefit directly from any collateral supporting the Loan in which it has
purchased the Participation. As a result, the fund will assume the credit risk
of both the borrower and the Lender that is selling the Participation. In the
event of the insolvency of the Lender selling a Participation, High Yield may be
treated as a general creditor of the Lender and may not benefit from any set-off
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between the Lender and the borrower. High Yield will acquire Participations only
if the Lender interpositioned between High Yield and the borrower is determined
by the investment manager to be creditworthy. When High Yield purchases
Assignments from Lenders the fund will acquire direct rights against the
borrower on the Loan, except that under certain circumstances such rights may be
more limited than those held by the assigning Lender.
High Yield may have difficulty disposing of Assignments and
Participations. Because the market for such instruments is not highly liquid,
the fund anticipates that such instruments could be sold only to a limited
number of institutional investors. The lack of a highly liquid secondary market
may have an adverse impact on the value of such instruments and will have an
adverse impact on the fund's ability to dispose of particular Assignments or
Participations in response to a specific economic event, such as deterioration
in the creditworthiness of the borrower. Thus the fund will treat investments in
Participations and Assignments as illiquid for purposes of its limitation on
investments in illiquid securities. High Yield may revise this policy in the
future.
FOREIGN DEBT SECURITIES. High Yield may invest up to 10% of its total
assets in foreign fixed and floating rate income securities (including emerging
market securities) all or a portion of which may be non-U.S. dollar denominated
and which include: (a) debt obligations issued or guaranteed by foreign
national, provincial, state, municipal or other governments with taxing
authority or by their agencies or instrumentalities, including Brady Bonds; (b)
debt obligations of supranational entities; (c) debt obligations of the U.S.
Government issued in non-dollar securities; (d) debt obligations and other fixed
income securities of foreign corporate issuers (both dollar and non-dollar
denominated); and (e) U.S. corporate issuers (both Eurodollar and non-dollar
denominated). There is no minimum rating criteria for High Yield's investments
in such securities. Investing in the securities of foreign issuers involves
special considerations that are not typically associated with investing in the
securities of U.S issuers. In addition, emerging markets are markets that have
risks that are different and higher than those in more developed markets.
Investments in securities of foreign issuers may involve risks arising from
restrictions on foreign investment and repatriation of capital, from differences
between U.S. and foreign securities markets, including less volume, much greater
price volatility in and relative illiquidity of foreign securities markets,
different trading and settlement practices and less governmental supervision and
regulation, from changes in currency exchange rates, from high and volatile
rates of inflation, from economic, social and political conditions and, as with
domestic multinational corporations, from fluctuating interest rates. Other
investment risks include the possible imposition of foreign withholding taxes on
certain amounts of High Yield's income, the possible seizure or nationalization
of foreign assets and the possible establishment of exchange controls,
expropriation, confiscatory taxation, other foreign governmental laws or
restrictions that might affect adversely payments due on securities held by High
Yield, the lack of extensive operating experience of eligible foreign
subcustodian's and legal limitations on the ability of the High Yield to recover
assets held in custody by a foreign subcustodian in the event of the
subcustodian's bankruptcy. In addition, there may be less publicly available
information about a foreign issuer than about a U.S. issuer, and foreign issuers
may not be subject to the same accounting, auditing and financial recordkeeping
standards and requirements of U.S. issuers. Finally, in the event of a default
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in any such foreign obligations, it may be more difficult for High Yield to
obtain or enforce a judgment against the issuers of such obligations.
RISKS OF HIGH YIELD FOREIGN SOVEREIGN DEBT SECURITIES. Investing in
fixed and floating rate high yield foreign sovereign debt securities will expose
funds investing in such securities to the direct or indirect consequences of
political, social or economic changes in the countries that issue the
securities. The ability and willingness of sovereign obligors in developing and
emerging countries or the governmental authorities that control repayment of
their external debt to pay principal and interest on such debt when due may
depend on general economic and political conditions within the relevant country.
Countries such as those in which a fund may invest have historically
experienced, and may continue to experience, high rates of inflation, high
interest rates, exchange rate trade difficulties and extreme poverty and
unemployment. Many of these countries also are characterized by political
uncertainty or instability.
Additional factors that may influence the ability or willingness to
service debt include, but are not limited to: a country's cash flow situation,
the availability of sufficient foreign exchange on the date a payment is due,
the relative size of its debt service burden to the economy as a whole, and its
government's policy towards the IMF, the World Bank and other international
agencies. The ability of a foreign sovereign obligor to make timely payments on
its external debt obligations also will be strongly influenced by the obligor's
balance of payments, including export performance, its access to international
credits and investments, fluctuations in interest rates and the extent of its
foreign reserves. A country whose exports are concentrated in a few commodities
or whose economy depends on certain strategic imports could be vulnerable to
fluctuations in international prices of these commodities or imports. To the
extent that a country receives payment for its exports in currencies other than
dollars, its ability to make debt payments denominated in dollars could be
affected adversely. If a foreign sovereign obligor cannot generate sufficient
earnings from foreign trade to service its external debt, it may need to depend
on continuing loans and aid from foreign governments, commercial banks and
multilateral organizations, and inflows of foreign investment. The commitment on
the part of these foreign governments, multilateral organizations and others to
make such disbursements may be conditioned on the government's implementation of
economic reforms and/or economic performance and the timely service of its
obligations. Failure to implement such reforms, achieve such levels of economic
performance or repay principal or interest when due may result in the
cancellation of such third parties' commitments to lend funds, which may further
impair the obligor's ability or willingness to timely service its debts.
The cost of servicing external debt also generally will be affected
adversely by rising international interest rates, because many external debt
obligations bear interest at rates that are adjusted based upon international
interest rates. The ability to service external debt also will depend on the
level of the relevant government's international currency reserves and its
access to foreign exchange. Currency devaluations may affect the ability of a
sovereign obligor to obtain sufficient foreign exchange to service its external
debt.
As a result of the foregoing, a governmental obligor may default on
its obligations. If such an event occurs, High Yield may have limited legal
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recourse against the issuer and/or guarantor. Remedies must, in some cases, be
pursued in the courts of the defaulting party itself, and the ability of the
holder of foreign sovereign debt securities to obtain recourse may be subject to
the political climate in the relevant country. In addition, no assurance can be
given that the holders of commercial bank debt will not contest payments to the
holders of other foreign sovereign debt obligations in the event of default
under their commercial bank loan agreements.
Sovereign obligors in developing and emerging countries are among
the world's largest debtors to commercial banks, other governments,
international financial organizations and other financial institutions. These
obligors have in the past experienced substantial difficulties in servicing
their external debt obligations, which led to defaults on certain obligations
and the restructuring of certain indebtedness. Restructuring arrangements have
included, among other things, reducing and rescheduling interest and principal
payments by negotiating new or amended credit agreements or converting
outstanding principal and unpaid interest to Brady Bonds, and obtaining new
credit to finance interest payments. Holders of certain foreign sovereign debt
securities may be requested to participate in the restructuring of such
obligations and to extend further loans to their issuers. There can be no
assurance that the Brady Bonds and other foreign sovereign debt securities in
which High Yield may invest will not be subject to similar restructuring
arrangements or to requests for new credit that may affect adversely High
Yield's holdings. Furthermore, certain participants in the secondary market for
such debt may be involved directly in negotiating the terms of these
arrangements and may therefore have access to information not available to other
market participants.
FORWARD COMMITMENTS. Government may make contracts to purchase securities
for a fixed price at a future date beyond customary settlement time ("forward
commitments"). Government may engage in forward commitments if it either (1)
holds and maintains until the settlement date in a segregated account cash or
high-grade debt obligations in an amount sufficient to meet the purchase price
or (2) enters into an offsetting contract for the forward sale of securities of
equal value that it owns. Forward commitments may be considered securities in
themselves. They involve a risk of loss if the value of the security to be
purchased declines prior to the settlement date, which risk is in addition to
the risk of decline in value of a fund's other assets. When such purchases are
made through dealers, a fund relies on the dealer to consummate the sale. The
dealer's failure to do so may result in the loss to Government of an
advantageous yield or price. Although Government generally will enter into
forward commitments with the intention of acquiring securities for its
investment portfolios, Government may dispose of a commitment prior to
settlement and may realize short-term profits or losses upon such disposition.
ILLIQUID AND RESTRICTED SECURITIES. Government will not purchase or
otherwise acquire any security if, as a result, more than 10% of its net assets
(taken at current value) would be invested in securities that are illiquid by
virtue of the absence of a readily available market or due to legal or
contractual restrictions on resale.
High Yield has a similar 10% limit on illiquid securities, but not all
restricted securities are deemed illiquid for this purpose. In recent years a
large institutional market has developed for certain securities that are not
registered under the Securities Act of 1933, as amended (the "1933 Act"). Rule
144A under the 1933 Act permits certain sales of unregistered securities by
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investors to "qualified institutional buyers" such as High Yield. Institutional
markets for restricted securities have developed as a result of Rule 144A,
providing both readily ascertainable values for restricted securities and the
ability to liquidate an investment to satisfy share redemption orders. High
Yield is permitted to invest in restricted securities that are sold in reliance
on Rule 144A ("Rule 144A Securities"). These securities generally are deemed to
be illiquid and, thus, are subject to High Yield's investment limit that
restricts investments in illiquid securities to no more than 10% of its net
assets. However, pursuant to High Yield's Guidelines for Purchase of Rule 144A
Securities ("Guidelines") adopted by the Board of Trustees ("Board"), High
Yield's investment subadviser may determine that certain Rule 144A Securities
are liquid. The Subadviser takes into account a number of factors in reaching
liquidity decisions, including (1) the total amount of Rule 144A Securities
being offered, (2) the number of potential purchasers of the Rule 144A
Securities, (3) the number of dealers that have undertaken to make a market in
the Rule 144A Securities, (4) the frequency of trading in the 144A Securities,
and (5) the nature of the 144A Securities and how trading is effected (e.g., the
time needed to sell the 144A Securities, how offers are solicited and the
mechanics of transfer.) The continued liquidity of Rule 144A securities depends
upon various factors, including the maintenance of an efficient institutional
market in which such unregistered securities can be readily resold and the
willingness of the issuer to register the securities under the 1933 Act. High
Yield's investments in Rule 144A Securities that are deemed to be liquid cannot
exceed 25% of its net assets at the time of investment, when combined with the
10% limit on the purchase of illiquid securities.
OTC options and their underlying collateral are considered illiquid
securities. Each fund also may sell OTC options and, in connection therewith,
segregate assets or cover its obligations with respect to OTC options written by
that fund. The assets used as cover for OTC options written by a fund will be
considered illiquid unless the OTC options are sold to qualified dealers who
agree that the fund may repurchase any OTC option it writes at a maximum price
to be calculated by a formula set forth in the option agreement. The cover for
an OTC option written subject to this procedure would be considered illiquid
only to the extent that the maximum repurchase price under the formula exceeds
the intrinsic value of the option.
INVERSE FLOATERS. Government may invest in U.S. Government securities,
including mortgage-backed securities, on which the rate of interest varies
inversely with interest rates on similar securities or the value of an index.
These derivative securities commonly are known as inverse floaters. As market
interest rates rise, the interest rate on the inverse floater goes down, and
vice versa. Inverse floaters include components of securities on which interest
is paid in two separate parts -- an auction component, which pays interest at a
rate that is set periodically through an auction process or other method, and a
residual component, the interest on which varies inversely with that on a
similar security or the value of an index. The residual component may be
established by multiplying the rate of interest paid on such security or the
applicable index by a factor (a "multiplier feature") or by adding or
subtracting the factor to or from such interest rate or index. The secondary
market for inverse floaters may be limited. The market value of inverse floaters
is often significantly more volatile than that of a fixed-rate obligation and,
like most debt obligations, will vary inversely with changes in interest rates.
The interest rates on inverse floaters may be significantly reduced, even to
zero, if interest rates rise.
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LOANS OF PORTFOLIO SECURITIES. The funds may loan portfolio securities to
qualified broker-dealers. Each fund may terminate such loans at any time and the
market risk applicable to any security loaned remains a risk to the fund.
Although voting rights, or rights to consent, with respect to the loaned
securities pass to the borrower, a fund retains the right to call the loans at
any time on reasonable notice, and it will do so in order that the securities
may be voted by the fund if the holders of such securities are asked to vote
upon or consent to matters materially affecting the investment. A fund also may
call such loans in order to sell the securities involved. The funds could incur
a loss if the borrower should fail financially at a time when the value of the
loaned securities is greater than the collateral. The primary objective of
securities lending is to supplement a fund's income through investment of the
cash collateral in short-term interest bearing obligations. Securities loans may
not exceed 25% of a fund's total assets and will be fully collateralized at all
times. The collateral for each fund's loans will be "marked to market" daily so
that the collateral at all times exceeds 100% of the value of the loans. The
borrower must add to the collateral whenever the market value of the securities
rises above the level of such collateral. However, securities loans do involve
some risk. If the other party to the securities loan defaults or becomes
involved in bankruptcy proceedings, a fund may incur delays and costs in selling
or recovering the underlying security or may suffer a loss of principal and
interest.
LOWER-RATED SECURITIES -- RISK FACTORS. Lower-rated securities are subject
to certain risks that may not be present with investments in higher-grade
securities. Investors should consider carefully their ability to assume the
risks associated with lower-rated securities before investing in High Yield.
EFFECT OF INTEREST RATE AND ECONOMIC CHANGES. The lower rating of
certain high yielding corporate income securities reflects a greater possibility
that the financial condition of the issuer or adverse changes in general
economic conditions may impair the ability of the issuer to pay income and
principal. Changes by rating agencies in their ratings of a fixed income
security also may affect the value of these investments. However, allocating
investments in the fund among securities of different issuers should reduce the
risks of owning any such securities separately.
The prices of these high yielding securities tend to be less
sensitive to interest rate changes than higher-rated investments, but more
sensitive to adverse economic changes or individual corporate developments.
During economic downturns or periods of rising interest rates, highly leveraged
issuers may experience financial stress that adversely affects their ability to
service principal and interest payment obligations, to meet projected business
goals or to obtain additional financing, and the markets for their securities
may be more volatile. If an issuer defaults, High Yield may incur additional
expenses to seek recovery.
Frequently, the higher yields of high-yielding securities may not
reflect the value of the income stream that holders of such securities may
expect, but rather the risk that such securities may lose a substantial portion
of their value as a result of their issuer's financial restructuring or default.
Additionally, an economic downturn or an increase in interest rates could have a
negative effect on the high yield securities market and on the market value of
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the high yield securities held by High Yield, as well as on the ability of the
issuers of such securities to repay principal and interest on their borrowings.
SECURITIES RATINGS. Securities ratings are based largely on the
issuer's historical financial information and the rating agencies' investment
analysis at the time of rating. Credit ratings evaluate the safety of principal
and interest payments, not market value risk of high yield bonds. Also, credit
rating agencies may fail to timely change the credit ratings to reflect
subsequent events. Consequently, the rating assigned to any particular security
is not necessarily a reflection of the issuer's current financial condition,
which may be better or worse than the rating would indicate.
LIQUIDITY AND VALUATION. High yielding securities may contain
redemption or call provisions. If an issuer exercises these provisions in a
declining interest rate market, High Yield would have to replace the security
with a lower yielding security. To the extent that there is no established
retail secondary market, there may be thin trading of high yielding securities.
This may lessen High Yield's ability to accurately value these securities and
its ability to dispose of these securities. Additionally, adverse publicity and
investor perceptions, whether or not based on fundamental analysis, may decrease
the values and liquidity of high yielding securities, especially in a thinly
traded market. Certain high yielding securities may involve special registration
responsibilities, liabilities and costs and liquidity and valuation
difficulties; thus, the responsibilities of the Board to value high yield
securities in the portfolio becomes more difficult with judgment playing a
greater role.
MONEY MARKET INSTRUMENTS. The funds may invest in (1) certificates of
deposit, demand and time deposits, savings shares and bankers' acceptances of
domestic banks and savings and loans that have assets of at least $1 billion and
capital, surplus, and undivided profits of over $100 million as of the close of
their most recent fiscal year, or instruments that are insured by the Bank
Insurance Fund or the Savings Institution Insurance Fund of the Federal Deposit
Insurance Corporation;
(2) commercial paper rated A-l or A-2 by S&P or Prime-1 or Prime-2 by
Moody's, and in the case of High Yield, other lower quality commercial paper.
For a description of these ratings, see "Commercial Paper Ratings" in the
Appendix; and
(3) high quality, short-term, corporate debt obligations, including
variable rate demand notes, having a maturity of one year or less. Because there
is no secondary trading market in demand notes, the inability of the issuer to
make required payments could impact adversely a fund's ability to resell when it
deems advisable to do so.
MORTGAGE-BACKED SECURITIES. Government may invest in mortgage-backed
securities issued by the U.S. Government or U.S. Government-related entities or
by non-governmental entities such as banks, savings and loan institutions,
private mortgage insurance companies, mortgage bankers and other secondary
market issuers. In general, mortgage-backed securities represent an interest in
a pool of mortgages made by lenders such as commercial banks, savings and loan
institutions, mortgage bankers and others. These securities generally provide
monthly interest and, in most cases, principal payments that are a
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"pass-through" of the monthly payments made by the individual borrowers on their
residential mortgage loans, net of any fees paid to the issuer or guarantor of
such securities. Although mortgage-backed securities are issued with stated
maturities of up to forty years, unscheduled or early payments of principal and
interest on the underlying mortgages may shorten considerably their effective
maturities. This contrasts with U.S. Treasury securities, for instance, which
generally pay all principal at maturity and typically have an effective maturity
equal to the final stated maturity. Thus, for purposes of calculating the fund's
weighted average maturity, the fund applies the standard market consensus with
respect to the effective maturity of mortgage-backed securities rather than
their stated final maturities.
U.S. GOVERNMENT-RELATED MORTGAGE-BACKED SECURITIES. The Government
National Mortgage Association ("GNMA") is a wholly owned U.S. Government
corporation within the Department of Housing and Urban Development and is a
primary issuer of U.S. Government-related mortgage-backed securities. GNMA
pass-through securities are considered to be riskless with respect to default
because the underlying mortgage loan portfolio is comprised entirely of U.S.
Government-backed loans and timely principal and interest payments are
guaranteed by the full faith and credit of the U.S. Government. Residential
mortgage loans also are pooled by the Federal Home Loan Mortgage Corporation
("FHLMC"), a corporate instrumentality of the U.S. Government, and Fannie Mae, a
U.S. Government-sponsored corporation owned entirely by private stockholders,
which guarantee the timely payment of interest and the ultimate collection of
principal on their respective securities.
PRIVATE ISSUER MORTGAGE-BACKED SECURITIES. Mortgage-backed
securities offered by private issuers include pass-through securities comprised
of pools of conventional residential mortgage loans; mortgage-backed bonds which
are considered to be debt obligations of the institution issuing the bonds and
are collateralized by mortgage loans; and bonds and collateralized mortgage
obligations ("CMOs") that are collateralized by mortgage-backed securities
issued by FHLMC, Fannie Mae, GNMA or pools of conventional mortgages. These
securities generally offer a higher interest rate than securities with direct or
indirect U.S. Government guarantees of payments. However, many issuers or
servicers of these securities guarantee timely payment of interest and
principal, which also may be supported by various forms of insurance, including
individual loan, title, pool and hazard policies. There can be no assurance that
the private issuers or insurers will be able to meet their obligations under the
relevant guarantee or insurance policies. Mortgage-backed securities of private
issuers, including CMOs, also have achieved broad market acceptance and,
consequently, an active secondary market has emerged. However, the market for
these securities is smaller and less liquid than the market for U.S. Government
and U.S. Government-related mortgage pools. The maximum permitted investment in
mortgage-backed securities of private issuers is 20% of Government's net assets.
RISKS OF MORTGAGE-BACKED SECURITIES. Investments in mortgage-backed
securities entail both market and prepayment risk. Fixed-rate mortgage-backed
securities are priced to reflect, among other things, current and perceived
interest rate conditions. As conditions change, market values will fluctuate. In
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addition, the mortgages underlying mortgage-backed securities generally may be
prepaid in whole or in part at the option of the individual buyer. Prepayments
of the underlying mortgages can affect the yield to maturity on mortgage-backed
securities and, if interest rates declined, the prepayment only may be invested
by the fund at the then prevailing lower rate. Changes in market conditions,
particularly during periods of rapid or unanticipated changes in market interest
rates, may result in volatility or the market value of certain mortgage-backed
securities. Heritage Asset Management, Inc. ("Heritage" or "Manager") will
attempt to manage the fund so that this volatility, together with the volatility
of other investments in Government, is consistent with its investment objective.
OPTIONS, FUTURES AND OPTIONS ON FUTURES TRADING. Each fund may engage in
transactions in options and futures contracts in an effort to adjust the
risk/return characteristics of its investment portfolios and, in certain
circumstances, may purchase and sell options and futures contracts as a
substitute for the purchase and sale of securities. Each fund may purchase and
sell put and call options on debt securities and indices of debt securities,
purchase and sell futures contracts on debt securities and indices of debt
securities, and purchase and sell options on such futures contracts ("Derivative
Instruments").
LIMITATIONS ON THE USE OF OPTIONS AND FUTURES. To the extent that a
fund enters into futures contracts or options on futures contracts for other
than BONA FIDE hedging purposes (as defined by the Commodity Futures Trading
Commission ("CFTC")), the aggregate initial margin and premiums required to
establish these positions (excluding the amount by which options are
"in-the-money" at the time of purchase) will not exceed 5% of the liquidation
value of the fund's investment portfolio, after taking into account any
unrealized profits and unrealized losses on any such contracts it has entered
into. (In general, a call option on a futures contract is "in-the-money" if the
value of the underlying futures contract exceeds the strike, I.E., exercise,
price of the call; a put option on a futures contract is "in-the-money" if the
value of the underlying futures contract is exceeded by the strike price of the
put.) This limitation does not limit the percentage of a fund's assets at risk
to 5%.
Government may hedge up to 100% of its net assets by such
transactions. Government will not purchase any option, if immediately
thereafter, the aggregate cost of all outstanding options (including options on
futures described above) purchased would exceed 5% of the value of its total
assets. Government may write call options and put options on up to 15% of its
total assets. Government might not use any of the strategies described above,
and there can be no assurance that any strategy used will succeed. High Yield
currently has no intention of engaging in futures and options transactions.
HEDGING STRATEGIES. Hedging strategies can be categorized broadly as
"short hedges" and "long hedges." A short hedge is a purchase or sale of a
Derivative Instrument intended partially or fully to offset potential declines
in the value of one or more investments held in a fund's investment portfolio.
Thus, in a short hedge, a fund takes a position in a Derivative Instrument whose
price is expected to move in the opposite direction of the price of the
investment being hedged.
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Conversely, a long hedge is a purchase or sale of a Derivative
Instrument intended partially or fully to offset potential increases in the
acquisition cost of one or more investments that a fund intends to acquire.
Thus, in a long hedge, a fund takes a position in a Derivative Instrument whose
price is expected to move in the same direction as the price of the prospective
investment being hedged. A long hedge is sometimes referred to as an
anticipatory hedge. In an anticipatory hedge transaction, a fund does not own a
corresponding security and, therefore, the transaction does not relate to a
security the fund owns. Rather, it relates to a security that the fund intends
to acquire. If a fund does not complete the hedge by purchasing the security it
anticipated purchasing, the effect on the fund's investment portfolio is the
same as if the transaction were entered into for speculative purposes.
Derivative Instruments on securities generally are used to hedge
against price movements in one or more particular securities positions that a
fund owns or intends to acquire. Derivative Instruments on indices, in contrast,
generally are used to attempt to hedge against price movements in market sectors
in which a fund has invested or expects to invest. Derivative Instruments on
debt securities may be used to hedge either individual securities or broad debt
market sectors.
Use of these instruments is subject to applicable regulations of the
Securities and Exchange Commission ("SEC"), the several options and futures
exchanges upon which options and futures are traded, and the CFTC. In addition,
the funds' ability to use these instruments will be limited by tax
considerations. See "Taxes."
In addition to the instruments and strategies described above, the
funds expect to discover additional opportunities in connection with options,
futures contracts and other hedging techniques. These new opportunities may
become available as the Manager or SBAM, as applicable, develops new techniques,
as regulatory authorities broaden the range of permitted transactions and as new
options, futures contracts or other techniques are developed. Heritage or SBAM,
as applicable, may utilize these opportunities to the extent that it is
consistent with a fund's investment objective and permitted by the fund's
investment limitations and applicable regulatory authorities.
SPECIAL RISKS. The use of Derivative Instruments involves special
considerations and risks, certain of which are described below.
(1) Successful use of most Derivative Instruments depends upon the
ability of the funds' Manager or, for High Yield, the Subadviser, as the case
may be, to predict movements of the overall securities and interest rate
markets, which requires different skills than predicting changes in the prices
of individual securities. There can be no assurance that any particular strategy
will succeed. For example, if the Manager or Subadviser, as applicable,
anticipates that interest rates will rise, a fund also may sell a debt futures
contract or a call option thereon or purchase a put option on a futures contract
as a hedge against a decrease in the value of that fund's securities. If the
Manager or Subadviser, as applicable, anticipates that interest rates will
decline, a fund may purchase a debt futures contract or a call option thereon or
sell a put option on a futures contract to protect against an increase in the
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price of securities a fund intends to purchase. If the Manager or the
Subadviser, as applicable, incorrectly forecasts interest rates in utilizing a
hedging strategy using futures or options on futures for a fund, the fund would
be in a better position if it had not hedged at all.
For a hedge to be completely effective, the price change of the
hedging instrument should equal the price change of the security being hedged.
Such equal price changes are not always possible because the security underlying
the hedging instrument may not be the same security that is being hedged. The
Manager or the Subadviser, as applicable, will attempt to create a closely
correlated hedge, but hedging activities may not be completely successful in
eliminating market fluctuation. The ordinary spreads between prices in the
futures and options on futures markets, due to the nature of these markets, are
subject to distortion. Due to the possibility of distortion, a correct forecast
of market trends by the Manager or the Subadviser, as applicable, may still not
result in a successful transaction. The Manager or the Subadviser, as
applicable, may be incorrect in its expectation as to the extent of market
movements, or the time span within which the movements take place.
(2) There might be imperfect correlation, or even no correlation,
between price movements of a Derivative Instrument and price movements of the
investments being hedged. For example, if the value of a Derivative Instrument
used in a short hedge increased by less than the decline in value of the hedged
investment, the hedge would not be fully successful. Such a lack of correlation
might occur due to factors unrelated to the value of the investments being
hedged, such as speculative or other pressures on the markets in which
Derivative Instruments are traded. The effectiveness of hedges using Derivative
Instruments on indices will depend on the degree of correlation between price
movements in the index and price movements in the securities being hedged.
Because there are a limited number of types of exchange-traded
options and futures contracts, it is likely that the standardized contracts
available will not match a fund's current or anticipated investments exactly. A
fund may invest in options and futures contracts based on securities with
different issuers, maturities, or other characteristics from the securities in
which it typically invests, which involves a risk that the options or futures
position will not track the performance of the fund's other investments.
Options and futures prices also can diverge from the prices of their
underlying instruments, even if the underlying instruments match a fund's
investments well. Options and futures prices are affected by such factors as
current and anticipated short-term interest rates, changes in volatility of the
underlying instrument, and the time remaining until expiration of the contract,
which may not affect security prices the same way. Imperfect correlation also
may result from differing levels of demand in the options and futures markets
and the securities markets, from structural differences in how options and
futures and securities are traded, or from imposition of daily price fluctuation
limits or trading halts. A fund may purchase or sell options and futures
contracts with a greater or lesser value than the securities it wishes to hedge
or intends to purchase in order to attempt to compensate for differences in
volatility between the contract and the securities, although this may not be
successful in all cases. If price changes in a fund's options or futures
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positions are correlated poorly with its other investments, the positions may
fail to produce anticipated gains or result in losses that are not offset by
gains in other investments.
(3) Derivative Instruments, if successful, can reduce risk of loss
by wholly or partially offsetting the negative effect of unfavorable price
movements. However, such strategies also can reduce opportunity for gain by
offsetting the positive effect of favorable price movements. For example, if a
fund entered into a short hedge because the Manager or the Subadviser, as the
case may be, projected a decline in the price of a security in the fund's
investment portfolio, and the price of that security increased instead, the gain
from that increase might be wholly or partially offset by a decline in the price
of the Derivative Instrument. Moreover, if the price of the Derivative
Instrument declined by more than the increase in the price of the security, the
fund could suffer a loss. In either such case, the fund would have been in a
better position had it not attempted to hedge at all.
(4) As described below, a fund might be required to maintain
assets as "cover," maintain segregated accounts or make margin payments when it
takes positions in Derivative Instruments involving obligations to third parties
(I.E., Derivative Instruments other than purchased options). If a fund were
unable to close out its positions in such Derivative Instruments, it might be
required to continue to maintain such assets or accounts or make such payments
until the position expired or matured. These requirements might impair a fund's
ability to sell a portfolio security or make an investment at a time when it
would otherwise be favorable to do so, or require that a fund sell a portfolio
security at a disadvantageous time. A fund's ability to close out a position in
a Derivative Instrument prior to expiration or maturity depends on the existence
of a liquid secondary market or, in the absence of such a market, the ability
and willingness of the other party to the transaction ("counterparty") to enter
into a transaction closing out the position. Therefore, there is no assurance
that any position can be closed out at a time and price that is favorable to a
fund.
COVER. The funds will not use leverage in their hedging strategies.
A fund will not enter into a Derivative Instruments strategy that exposes it to
an obligation to another party unless its owns either (1) an offsetting
("covered") position in securities or other options or futures contracts or (2)
cash and other liquid assets with a value, marked-to-market daily, sufficient to
cover its potential obligations to the extent not covered as provided in (1)
above. The funds will comply with SEC guidelines regarding cover for such
transactions and will, if the guidelines so require, set aside cash or other
liquid assets in a segregated account with their custodian in the amount
prescribed.
Assets used as cover or held in a segregated account cannot be sold
while the corresponding futures contract or options position is open, unless
they are replaced with similar assets. As a result, the commitment of a large
percentage of a fund's assets to cover or hold in segregated accounts could
impede portfolio management or the fund's ability to meet redemption requests or
other current obligations.
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GUIDELINES, CHARACTERISTICS AND RISKS OF OPTIONS TRADING. The funds
effectively may terminate their right or obligation under an option by entering
into a closing transaction. If a fund wishes to terminate its obligation under a
put or call option it has written, the fund may purchase a put or call option of
the same series (i.e., an option identical in its terms to the option previously
written); this is known as a closing purchase transaction. Conversely, in order
to terminate its right to purchase or sell under a call or put option it has
purchased, the fund may write an option of the same series as the option held.
This is known as a closing sale transaction. Closing transactions essentially
permit a fund to realize profits or limit losses on its options positions prior
to the exercise or expiration of the option. Whether a profit or loss is
realized from a closing transaction depends on the price movement of the
underlying security, index or futures contract, and the market value of the
option.
In considering the use of options to hedge, particular note should
be taken of the following:
(1) The value of an option position will reflect, among other
things, the current market price of the underlying security, index, or futures
contract, the time remaining until expiration, the relationship of the exercise
price to the market price, the historical price volatility of the underlying
investment and general market conditions. For this reason, the successful use of
options depends upon the ability of the Manager or Subadviser, as the case may
be, to forecast the direction of price fluctuations in the underlying
investment.
(2) Prior to its expiration, the exercise price of an option may be
below, equal to, or above the current market value of the underlying investment.
Purchased options that expire unexercised have no value. Unless an option
purchased by a fund is exercised or unless a closing transaction is effected
with respect to that position, a loss will be realized in the amount of the
premium paid.
(3) A position in an exchange-listed option may be closed out only
on an exchange that provides a secondary market for identical options. Most
exchange-listed options relate to futures contracts and stocks. Exchange markets
for options on debt securities exist, and the ability to establish and close out
positions on the exchanges is subject to the maintenance of a liquid secondary
market. Closing transactions may be effected with respect to options traded in
the over-the-counter ("OTC") markets (currently the primary markets of options
on debt securities) only by negotiating directly with the other party to the
option contract or in a secondary market for the option if such market exists.
In the event of the insolvency of a fund's counterparty, the fund might be
unable to close out an OTC option position at any time prior to its expiration.
Although the funds intend to purchase or write only those options for which
there appears to be an active secondary market, there is no assurance that a
liquid secondary market will exist for any particular option at any specific
time. In such event, it may not be possible to effect closing transactions with
respect to certain options, with the result that a fund would have to exercise
those options that it has purchased in order to realize any profit. With respect
to options written by a fund, the inability to enter into a closing transaction
may result in material losses to the fund. For example, because a fund may
maintain a covered position with respect to any call option it writes on a
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security, the fund may not sell the underlying security during the period it is
obligated under such option. This requirement may impair the fund's ability to
sell a portfolio security or make an investment at a time when such a sale or
investment might be advantageous.
(4) Activities in the options market may result in a higher
portfolio turnover rate and additional brokerage costs. However, the funds also
may save on commissions by using options as a hedge rather than buying or
selling individual securities in anticipation of market movements.
(5) The risks of investment in options on indices may be greater
than options on securities. Because index options are settled in cash, when a
fund writes a call on an index it cannot provide in advance for its potential
settlement obligations by acquiring and holding the underlying securities. A
fund can offset some of the risk of writing a call index option by holding a
diversified portfolio of securities similar to those on which the underlying
index is based. However, a fund cannot, as a practical matter, acquire and hold
an investment portfolio containing exactly the same securities as underlie the
index and, as a result, bears the risk that the value of the securities held
will vary from the value of the index.
Even if a fund could assemble a securities portfolio that exactly
reproduced the composition of the underlying index, it still would not be fully
covered from a risk standpoint because of the "timing risk" inherent in writing
index options. When an index option is exercised, the amount of cash that the
holder is entitled to receive is determined by the difference between the
exercise price and the closing index level on the date when the option is
exercised. As with other kinds of options, a fund as the call writer will not
learn that it has been assigned until the next business day at the earliest. The
time lag between exercise and notice of assignment poses no risk for the writer
of a covered call on a specific underlying security, such as common stock,
because there the writer's obligation is to deliver the underlying security, not
to pay its value as of a fixed time in the past. So long as the writer already
owns the underlying security, it can satisfy its settlement obligations by
simply delivering it, and the risk that its value may have declined since the
exercise date is borne by the exercising holder. In contrast, even if the writer
of an index call holds securities that exactly match the composition of the
underlying index, it will not be able to satisfy its assignment obligations by
delivering those securities against payment of the exercise price. Instead, it
will be required to pay cash in an amount based on the closing index value on
the exercise date. By the time it learns that it has been assigned, the index
may have declined, with a corresponding decline in the value of its securities
portfolio. This "timing risk" is an inherent limitation on the ability of index
call writers to cover their risk exposure by holding securities positions.
If a fund has purchased an index option and exercises it before the
closing index value for that day is available, it runs the risk that the level
of the underlying index subsequently may change. If such a change causes the
exercised option to fall out-of-the-money, the fund will be required to pay the
difference between the closing index value and the exercise price of the option
(times the applicable multiplier) to the assigned writer.
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GUIDELINES, CHARACTERISTICS AND RISKS OF FUTURES AND OPTIONS ON
FUTURES TRADING. When a fund purchases or sells a futures contract, the fund
will be required to deposit an amount equal to a varying specified percentage of
the contract amount. This amount is known as initial margin. Cash held in the
margin account is not income producing. Subsequent payments, called variation
margin, to and from the broker through which such fund entered into the futures
contract, will be made on a daily basis as the price of the underlying security
or index fluctuates making the futures contract more or less valuable, a process
known as marking-to-market.
If a fund writes an option on a futures contract, it will be
required to deposit initial and variation margin pursuant to requirements
similar to those applicable to futures contracts. Premiums received from the
writing of an option on a future are included in the initial margin deposit.
Most of the exchanges on which futures contracts and options on
futures contracts are traded limit the amount of fluctuation permitted in
futures contract and option prices during a single trading day. The daily price
limit establishes the maximum amount that the price of a futures contract or
option may vary either up or down from the previous day's settlement price at
the end of a trading session. Once the daily price limit has been reached in a
particular type of contract, no trades may be made on that day at a price beyond
that limit. The daily price limit governs only price movement during a
particular trading day and therefore does not limit potential losses, because
the limit may prevent the liquidation of unfavorable positions. Futures contract
and option prices occasionally have moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of positions and subjecting some traders to substantial losses.
Another risk in employing futures contracts and options on futures
contracts as a hedge is the prospect that futures and options prices will
correlate imperfectly with the behavior of cash prices for the following
reasons. First, rather than meeting additional margin deposit requirements,
investors may close contracts through offsetting transactions. Second, the
liquidity of the futures and options markets depends on participants entering
into offsetting transactions rather than making or taking delivery. To the
extent that participants decide to make or take delivery, liquidity in these
markets could be reduced, thus producing distortion. Third, from the point of
view of speculators, the deposit requirements in the futures and options markets
are less onerous than margin requirements in the securities market. Therefore,
increased participation by speculators in the futures and options market may
cause temporary price distortions. In addition, activities of large traders in
both the futures and securities markets involving arbitrage, "program trading,"
and other investment strategies might result in temporary price distortions. Due
to the possibility of distortion, a correct forecast of general interest rate
trends by the Manager or Subadviser, as applicable, still may not result in a
successful transaction.
In addition to the risks that apply to all options transactions,
there are several special risks relating to options on futures contracts.
Compared to the purchase or sale of futures contracts, the purchase of call or
put options on futures contracts involves less potential risk to the funds
because the maximum amount at risk is the premium paid for the options (plus
transaction costs). However, there may be circumstances when the purchase of a
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call or put option on a futures contract would result in a loss to a fund when
the purchase or sale of a futures contract would not, such as when there is no
movement in the price of the underlying investment.
REAL ESTATE MORTGAGE INVESTMENT CONDUITS (REMICs). Government may invest
in U.S. Government and privately issued REMICs, a common form of CMO. REMICs are
entities that issue multiple-class real estate mortgage-backed securities that
qualify and elect treatment as such under the Internal Revenue Code of 1986, as
amended (the "Code"). REMICs may take several forms, such as trusts,
partnerships, corporations, associations, or segregated pools of mortgages. Once
REMIC status is elected and obtained, the entity is not subject to Federal
income taxation. Instead, income is passed through the entity and is taxed to
the persons who hold interests in the REMIC. A REMIC interest must consist of
one or more classes of "regular interests" and "residual interests." To qualify
as a REMIC, substantially all the assets of the entity must be directly or
indirectly secured principally by real property. The risks inherent in investing
in REMICs are similar to those of CMOs in general, as well as those of other
mortgage-backed securities as described above.
REPURCHASE AGREEMENTS. The funds may enter into repurchase agreements.
Repurchase agreements are transactions in which a fund purchases securities and
simultaneously commits to resell the securities to the original seller (a member
bank of the Federal Reserve System or a securities dealer who is a member of a
national securities exchange or is a market maker in U.S. Government securities)
at an agreed upon date and price reflecting a market rate of interest unrelated
to the coupon rate or the maturity of the purchased securities. Although
repurchase agreements carry certain risks not associated with direct investment
in securities, including possible decline in the market value of the underlying
securities and delays and costs to a fund if the other party to the repurchase
agreement becomes bankrupt, each fund intends to enter into repurchase
agreements only with banks and dealers in transactions believed by the Manager
or Subadviser, as applicable, to present minimal credit risks in accordance with
guidelines established by the Board.
Each fund may invest up to 25% of its total assets in repurchase
agreements. The period of these repurchase agreements usually will be short,
from overnight to one week, and at no time will a fund invest in repurchase
agreements of more than one year. The securities that are subject to repurchase
agreements, however, may have maturity dates in excess of one year from the
effective date of the repurchase agreement. A fund always will receive as
collateral securities whose market value, including accrued interest, will be at
least equal to 100% of the dollar amount invested by the fund in each agreement,
and the fund will make payment for such securities only upon physical delivery
or evidence of book-entry transfer to the account of its custodian bank.
REVERSE REPURCHASE AGREEMENTS. High Yield may borrow by entering into
reverse repurchase agreements. Under a reverse repurchase agreement, High Yield
sells securities and agrees to repurchase them at a mutually agreed to price. At
the time the fund enters into a reverse repurchase agreement, it will establish
and maintain a segregated account with an approved custodian containing liquid
high grade securities, marked-to-market daily, having a value not less than the
repurchase price (including accrued interest). One reason to enter into a
reverse repurchase agreement is to raise cash without liquidating any investment
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portfolio positions. In this case, reverse repurchase agreements involve the
risk that the market value of securities retained in lieu of sale by High Yield
may decline below the price of the securities the fund has sold but is obliged
to repurchase. In the event the buyer of securities under a reverse repurchase
agreement files for bankruptcy or becomes insolvent, such buyer or its trustee
or receiver may receive an extension of time to determine whether to enforce the
fund's obligation to repurchase the securities and the fund's use of the
proceeds of the reverse repurchase agreement effectively may be restricted
pending such decisions. Reverse repurchase agreements create leverage, a
speculative practice, and will be considered borrowings for the purpose of the
fund's limitation on borrowing.
STRIPPED SECURITIES. Government may invest in separately traded interest
and principal components of securities ("Stripped Securities"), including U.S.
Government securities. Stripped Securities are obligations representing an
interest in all or a portion of the income or principal components of an
underlying or related security, a pool of securities or other assets. In the
most extreme case, one class will receive all of the interest (the interest-only
or "IO" class), while the other class will receive all of the principal (the
principal-only or "PO" class). The market values of stripped income securities
tend to be more volatile in response to changes in interest rates than are
conventional debt securities.
Government also may invest in stripped mortgage-backed securities, which
are derivative multi-class mortgage securities. Stripped mortgage-backed
securities in which it may invest will be issued by agencies or
instrumentalities of the U.S. Government. Stripped mortgage-backed securities
are structured with two classes that receive different proportions of the
interest and principal distributions on a pool of assets represented by
mortgages ("Mortgage Assets"). A common type of stripped mortgage-backed
security will have one class receiving a small portion of the interest and a
larger portion of the principal from the Mortgage Assets, while the other
classes will receive primarily interest and only a small portion of the
principal. The yields to maturity on IOs and POs are sensitive to the rate of
principal payments (including prepayments) on the related underlying Mortgage
Assets, and principal payments may have a material effect on yield to maturity.
In addition, the market value of stripped mortgage-backed securities is subject
to greater risk of fluctuation in response to changes in market interest rates
than other mortgage-backed securities. In the case of mortgage-backed IOs, if
the underlying assets experience greater than anticipated prepayments of
principal, there is a greater possibility that Government may not fully recoup
its initial investment. Conversely, if the underlying assets experience slower
than anticipated principal payments, the yield on the PO class will be affected
more severely than would be the case with traditional mortgage-backed
securities.
The SEC staff takes the position that IOs and POs generally are illiquid
securities. The staff also takes the position, however, that the Board (or the
Manager pursuant to delegation by the Board) may determine that U.S.
Government-issued IOs or POs backed by fixed-rate mortgages are liquid, where
the Board determines that such securities can be disposed of promptly in the
ordinary course of business at a value reasonably close to that used in the
calculation of net asset value per share. Accordingly, certain of the IO and PO
securities in which Government invests may be deemed liquid.
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U.S. GOVERNMENT SECURITIES. Each fund may invest in U.S. Government
securities, including a variety of securities that are issued or guaranteed by
the U.S. Government, its agencies or instrumentalities and repurchase agreements
secured thereby. These securities include: securities issued and guaranteed by
the U.S. Government, such as Treasury bills, Treasury notes, and Treasury bonds;
obligations backed by the "full faith and credit" of the United States, such as
Government National Mortgage Association securities; obligations supported by
the right of the issuer to borrow from the U.S. Treasury, such as those of the
Federal Home Loan Banks; and obligations supported only by the credit of the
issuer, such as those of the Federal Intermediate Credit Banks.
WHEN ISSUED SECURITIES. Each fund may purchase securities on a
"when-issued" basis and the Intermediate Government fund may purchase or sell
securities on a forward commitment basis in order to hedge against anticipated
changes in interest rates and prices. In addition, the High Yield Bond Fund may
purchase securities on a firm commitment basis. When such transactions are
negotiated, the price, which generally is expressed in terms of yield, is fixed
at the time of entering into the transaction. Payment and delivery for
securities purchased or sold using these investment techniques, however, takes
place at a later date than is customary for that type of security. At the time a
fund enters into the transaction, the securities purchased thereby are recorded
as an asset of the fund and thereafter are subject to changes in value based
upon changes in the general level of interest rates. Accordingly, purchasing a
security using one of these techniques can involve a risk that the market price
at the time of delivery may be lower than the agreed upon purchase price, in
which case there could be an unrealized loss at the time of delivery.
At the time that a fund purchases a security using one of these
techniques, a segregated account consisting of cash or liquid securities equal
to the value of the when-issued or forward or firm commitment securities will be
established and maintained with the Trust's custodian or on the fund's books and
records and will be marked to market daily. On the delivery date, the fund will
meet its obligations from securities that are then maturing or sales of
securities held in the segregated asset account and/or from available cash flow.
When-issued and forward commitment securities may be sold prior to the
settlement date. The funds will engage in when-issued and forward commitment
transactions only with the intention of actually receiving or delivering the
securities, as the case may be. However, if the fund chooses to dispose of the
right to acquire a security prior to its acquisition or dispose of its right to
deliver or receive against a forward commitment, it can incur a gain or loss. In
addition, there is always the risk that the securities may not be delivered and
that the fund may incur a loss or will have lost the opportunity to invest the
amount set aside for such transaction in the segregated account.
If the fund disposes of the right to acquire a when-issued or forward
commitment security prior to its acquisition or disposes of its right to deliver
against a forward commitment, it can incur a gain or loss due to market
fluctuation. In some instances, the third-party seller of when-issued or forward
commitment securities may determine prior to the settlement date that it will be
unable to meet its existing transaction commitments without borrowing
securities. If advantageous from a yield perspective, the fund may, in that
event, agree to resell its purchase commitment to the third-party seller at the
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current market price on the date of sale and concurrently enter into another
purchase commitment for such securities at a later date. As an inducement for
the fund to "roll over" its purchase commitment, the fund may receive a
negotiated fee.
ZERO COUPON AND PAY-IN-KIND BONDS. High Yield may invest in zero coupon
securities and pay-in-kind bonds, which involve special risk considerations.
Zero coupon securities are debt securities that pay no cash income but are sold
at substantial discounts from their value at maturity. When a zero coupon
security is held to maturity, its entire return, which consists of the
amortization of discount, comes from the difference between its purchase price
and its maturity value. This difference is known at the time of purchase, so
that investors holding zero coupon securities until maturity know at the time of
their investment what the expected return on their investment will be. Certain
zero coupon securities also are sold at substantial discounts from their
maturity value and provide for the commencement of regular interest payments at
a deferred date. Zero coupon securities may have conversion features. High Yield
also may purchase pay-in-kind bonds. Pay-in-kind bonds pay all or a portion of
their interest in the form of debt or equity securities.
Zero coupon securities and pay-in-kind bonds tend to be subject to greater
price fluctuations in response to changes in interest rates than are ordinary
interest-paying debt securities with similar maturities. The value of zero
coupon securities appreciates more during periods of declining interest rates
and depreciates more during periods of rising interest rates than ordinary
interest-paying debt securities with similar maturities. Zero coupon securities
and pay-in-kind bonds may be issued by a wide variety of corporate and
governmental issuers. Although zero coupon securities and pay-in-kind bonds
generally are not traded on a national securities exchange, such securities are
widely traded by brokers and dealers and, to such extent, will not be considered
illiquid for the purposes of High Yield's 10% limitation on investments in
illiquid securities.
Current Federal income tax law requires the holder of a zero coupon
security, certain pay-in-kind bonds and certain other securities acquired at a
discount (such as Brady Bonds) to accrue income with respect to these securities
prior to the receipt of cash payments. Accordingly, to avoid liability for
Federal income and excise taxes, High Yield may be required to distribute income
accrued with respect to these securities and may have to dispose of portfolio
securities under disadvantageous circumstances in order to generate cash to make
the necessary distributions.
INDUSTRY CLASSIFICATIONS
------------------------
For purposes of determining industry classifications, the funds rely upon
classifications established by the Manager that are based upon classifications
contained in the Directory of Companies Filing Annual Reports with the SEC and
in the Standard & Poor's Corporation Industry Classifications.
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INVESTMENT LIMITATIONS
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FUNDAMENTAL POLICIES:
--------------------
The funds are subject to the following investment limitations that are
fundamental policies and may not be changed without the vote of a majority of
the outstanding voting securities of the applicable fund. Under the 1940 Act, a
"vote of a majority of the outstanding voting securities" of a fund means the
affirmative vote of the lesser of (1) more than 50% of the outstanding shares of
the fund or (2) 67% or more of the shares present at a shareholders meeting if
more than 50% of the outstanding shares are represented at the meeting in person
or by proxy.
BORROWING MONEY. Neither fund may borrow money, except from banks as
a temporary measure for extraordinary or emergency purposes including the
meeting of redemption requests that might require the untimely disposition of
securities. The payment of interest on such borrowings will reduce the funds'
net investment income during the period of such borrowing. Borrowing in the
aggregate may not exceed 15% and borrowing for purposes other than meeting
redemptions may not exceed 5% of a fund's total assets at the time the borrowing
is made. A fund will not make additional investments when borrowings exceed 5%
of its total assets.
DIVERSIFICATION. Neither fund will invest more than 5% of its total
assets in securities of any one issuer other than the U.S. Government or its
agencies or instrumentalities or buy more than 10% of the voting securities or
any other class of securities of any issuer.
INDUSTRY CONCENTRATION. Neither fund will purchase securities if, as
a result, more than 25% of its total assets would be invested in any one
industry with the exception of U.S. Government securities.
INVESTING IN COMMODITIES, MINERALS OR REAL ESTATE. Neither fund may
invest in commodities, commodity contracts, oil, gas or other mineral programs,
real estate limited partnerships, or real estate, except that it may (1)
purchase securities secured by real estate, or issued by companies that invest
in or sponsor such interests, (2) futures contracts and options and (3) engage
in transactions in forward commitments.
UNDERWRITING. Neither fund may underwrite the securities of other
issuers, except that a fund may invest in securities that are not readily
marketable without registration under the 1933 Act (restricted securities), as
provided in the fund's Prospectus and this Statement of Additional Information.
LOANS. Neither fund may make loans, except to the extent that the
purchase of a portion of an issue of publicly distributed or privately placed
notes, bonds or other evidences of indebtedness or deposits with banks and other
financial institutions may be considered loans, and further provided that a fund
may enter into repurchase agreements and securities loans as permitted under the
fund's investment policies. Privately placed securities typically are either
restricted as to resale or may not have readily available market quotations, and
therefore may not be as liquid as other securities.
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ISSUING SENIOR SECURITIES. Neither fund may issue senior securities,
except as permitted by the investment objectives and policies and investment
limitations of that fund.
SELLING SHORT AND BUYING ON MARGIN. Neither fund may sell any
securities short, purchase any securities on margin or maintain a short position
in any security, but may obtain such short-term credits as may be necessary for
clearance of purchase and sales of securities; provided, however, the funds may
make margin deposits and may maintain short positions in connection with the use
of options, futures contracts and options on futures contracts as described
previously.
INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND
TRUSTEES OF THE TRUST. Neither fund may purchase or retain the securities of any
issuer if the officers and Trustees of the Trust or the Manager or its
Subadviser, as applicable, own individually more than 1/2 of 1% of the issuer's
securities or together own more than 5% of the issuer's securities.
REPURCHASE AGREEMENTS AND LOANS OF PORTFOLIO SECURITIES. Neither
fund may enter into repurchase agreements with respect to more than 25% of its
total assets or lend portfolio securities amounting to more than 25% of its
total assets.
NONFUNDAMENTAL POLICIES:
-----------------------
Each fund has adopted the following additional restrictions that are
nonfundamental policies and may not be changed by the Board without shareholder
approval in compliance with applicable law, regulation or regulatory policy.
INVESTING IN INVESTMENT COMPANIES. Neither fund may invest in
securities issued by other investment companies, except as permitted by the 1940
Act.
ILLIQUID SECURITIES. Government may not invest more than 10% of its
net assets in the aggregate in repurchase agreements of more than seven days'
duration, in securities without readily available market quotations, and in
restricted securities including privately placed securities. High Yield has a
similar limitation, however, it may invest up to 25% of its net assets in
restricted securities that are sold in reliance on Rule 144A deemed to be liquid
pursuant to Board-approved guidelines, when combined with the 10% limit on the
purchase of illiquid securities.
Except with respect to borrowing money, if a percentage limitation
is adhered to at the time of the investment, a later increase or decrease in the
percentage resulting from any change in value or net assets will not result in a
violation of such restriction. If at any time, a fund's borrowing exceeds its
limitations due to a decline in net assets, such borrowing will be promptly
reduced to the extent necessary to comply with the limitation.
25
<PAGE>
NET ASSET VALUE
- ---------------
The net asset value per share of Class A shares, Class B shares and Class
C shares is determined separately daily as of the close of regular trading on
the New York Stock Exchange (the "Exchange") each day the Exchange is open for
business. The Exchange normally is open for business Monday through Friday
except the following holidays: New Year's Day, Martin Luther King's Birthday,
President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving and Christmas Day.
Each fund values its securities and other assets based on their market
value determined as follows. A security listed or traded on an exchange or on
the Nasdaq Stock Market is valued at its last sales price on the principal
market on which it is traded prior to the time when assets are valued. If no
sale is reported at that time or the security is traded in the OTC market,
market value is based on the most recent quoted bid price. When market
quotations for options and futures positions held by a fund are readily
available, those positions will be valued based upon such quotations. Market
quotations generally will not be available for options traded in the OTC market.
Securities and other assets for which market quotations are not readily
available, or for which market quotes are not deemed to be reliable by the
Manager or Subadviser, are valued at fair value using such methods as the Board.
Securities and other assets in foreign currency will be valued daily in U.S.
dollars at the foreign currency exchange rates prevailing at the time High Yield
calculates the daily net asset value of each class. Short-term investments
having a maturity of 60 days or less are valued at cost with accrued interest or
discount earned included in interest receivable.
Each fund is open for business on days on which the Exchange is open (each
a "Business Day"). Trading in securities on European and Far Eastern securities
exchanges and OTC markets normally is completed well before the funds' close of
business on each Business Day. In addition, European or Far Eastern securities
trading may not take place on all Business Days. Furthermore, trading takes
place in various foreign capital markets on days that are not Business Days and
on which the funds do not calculate net asset value. Calculation of net asset
value Class A shares, Class B shares and Class C shares net asset value does not
take place contemporaneously with the determination of the prices of the
majority of the portfolio securities used in such calculation. The funds
calculate net asset value per share, and therefore, effect sales and redemptions
as of the close of regular trading on the Exchange each Business Day. If events
materially affecting the value of such securities or other assets occur between
the time when their prices are determined and the time when the funds' net asset
value is calculated, such securities and other assets may be valued at fair
value by methods as determined in good faith by or under procedures established
by the Board.
The Board may suspend the right of redemption or postpone payment for
more than seven days at times (1) during which the Exchange is closed other
than for customary weekend and holiday closings, (2) during which trading on
the Exchange is restricted as determined by the SEC, (3) during which an
emergency exists as a result of which disposal by a fund of securities owned
by it is not reasonably practicable or it is not reasonably practicable for
the fund fairly to determine the value of its net assets, or (4) for such
other periods as the SEC may by order permit for the protection of the
holders of fund shares.
26
<PAGE>
PERFORMANCE INFORMATION
- -----------------------
Total return data of each class from time to time may be included in
advertisements about each fund. Performance information is computed separately
for each class. Because Class B shares and Class C shares bear higher Rule 12b-1
fees, the performance of Class B shares and Class C shares of a fund likely will
be lower than that of Class A shares.
The funds' performance data quoted in advertising and other promotional
materials represents past performance and is not intended to indicate future
performance. The investment return and principal value of an investment will
fluctuate so that an investor's shares, when redeemed, may be worth more or less
than their original cost. Average annual total return quotes for each class used
in each fund's advertising and promotional materials are calculated for the one
year, five year and ten year periods (or life of the fund) according to the
following formula:
n
P(1+T) = ERV
where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the period at the end of that
period
In calculating the ending redeemable value for Class A shares, each fund's
current maximum sales charge of 3.75% is deducted from the initial $1,000
payment and, for Class B shares and Class C shares, the applicable CDSC imposed
on a redemption of Class B shares or Class C shares held for the period is
deducted. All dividends and other distributions by each fund are assumed to have
been reinvested at net asset value on the reinvestment dates during the period.
Based on this formula, the total return, or "T" in the formula above, is
computed by finding the average annual compounded rates of return over the
period that would equate the initial amount invested to the ending redeemable
value.
In connection with communicating its average annual total return
cumulative return to current or prospective shareholders, each fund may compare
these figures to the performance of other mutual funds tracked by mutual fund
rating services or to other unmanaged indexes that may assume reinvestment of
dividends but generally do not reflect deductions for administrative and
management costs. Investment performance also often reflects the risks
associated with a fund's investment objective and policies. These factors should
be considered when comparing a fund's investment results to those of other
mutual funds and investment vehicles.
In addition, each fund from time to time may include in advertising and
promotional materials total return or cumulative figures that are not calculated
according to the formula set forth above or for other periods for each class of
shares. For example, in comparing High Yield's or Government's Class A shares,
Class B shares or Class C shares total return with data published by Lipper
Analytical Services, Inc., CDA Investment Technologies, Inc., Morningstar Mutual
27
<PAGE>
Funds or with such market indices as the Lehman Brothers Government Corporate
Composite Index, Lehman Intermediate Government Corporate Index, and the Merrill
Lynch Domestic Master Index, each class of each fund calculates its aggregate
total return for each class for the specified periods of time by assuming an
investment of $10,000 in that class of shares and assuming the reinvestment of
each dividend or other distribution at net asset value on the reinvestment date.
Percentage increases are determined by subtracting the initial value of the
investment from the ending value and by dividing the remainder by the beginning
value. The funds do not, for these purposes, deduct from the initial value
invested any amount representing front-end sales charges charged on Class A
shares or CDSCs charged on Class B shares and Class C shares. By not annualizing
the performance and excluding the effect of the front-end sales charge on Class
A shares and the CDSC on Class B shares and Class C shares, the total return
calculated in this manner simply will reflect the increase in net asset value
per share over a period of time, adjusted for dividends and other distributions.
Calculating total return without taking into account the sales charge or CDSC
results in a higher rate of return than calculating total return net of the
front-end sales charge.
The average annualized total return and cumulative return are as follows for
each period of each fund below. The calculations below reflect the imposition of
the maximum sales charge for Class A shares and the applicable CDSC for Class B
and Class C shares.
AVERAGE
ANNUALIZED CUMULATIVE
TOTAL TOTAL
FUND SHARES PERIOD RETURN RETURN
- ---- ------ ------ ------ ------
High Yield Class A . One-year period ended
September 30, 1998 (.52)% (.52)%
. Five-year period ended
September 30, 1998 6.70% 38.35%
. March 1, 1990 (commencement
of operations) to
September 30, 1998 9.02% 109.99%
Class B . February 2, 1998 (initial
offering of Class B shares)
to September 30, 1998 N/A (3.58)%
Class C . One-year period ended
September 30, 1998 (1.02)% (1.02)%
. April 3, 1995 (initial
offering of shares) to
September 30, 1998 8.34% 32.36%
Intermediate Class A . One-year period ended
Government September 30, 1998 11.18% 11.18%
. Five-year period ended
September 30, 1998 6.04% 34.04%
28
<PAGE>
AVERAGE
ANNUALIZED CUMULATIVE
TOTAL TOTAL
FUND SHARES PERIOD RETURN RETURN
- ---- ------ ------ ------ ------
. March 1, 1990 (commencement
of operations) to
September 30, 1998 6.14% 66.73%
Class B . February 2, 1998 (initial
offering of Class B shares)
to September 30, 1998 N/A 7.16%
Class C . One-year period ended
September 30, 1998 10.85% 10.85%
. April 3, 1995 (initial
offering of shares) to 7.36% 28.22%
September 30, 1998
Each fund may from time to time advertise the yield of Class A shares,
Class B shares and Class C shares and compare these yields to those of other
mutual funds with similar investment objectives. The yield of each class of each
fund is calculated by dividing each fund's interest income for a thirty-day
period ("Period") attributable to that class, net of expenses attributable to
that class, by the average number of shares of that class entitled to receive
dividends during the Period, and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the maximum offering price per
share at the end of the Period. Yield accounting methods differ from the methods
used for other accounting purposes; accordingly, the yield for a class may not
equal the dividend income actually paid to shareholders or the net investment
income per share reported in each fund's financial statements. Yield quotations
are calculated according to the following formula:
6
YIELD = 2x[(a-b+1) -1]
-----
c x d
where: a = interest earned during the Period;
b = expenses accrued for the Period (net of
reimbursements);
c = the average daily number of shares outstanding during
the Period that were entitled to receive a dividend;
and
d = the maximum offering price per share on the last day
of the Period.
Except as noted below, in determining net investment income earned during
the Period (variable "a" in the above formula), each fund calculates interest
earned on each debt obligation held by it during the Period by (1) computing the
obligation's yield to maturity, based on the market value of the obligation
(including actual accrued interest) to determine the interest income on the
obligation for each day of the Period that the obligation is in the fund. Once
interest earned is calculated in this fashion for each debt obligation held by
29
<PAGE>
the fund, interest earned during the Period is then determined by totaling the
interest earned on all debt obligations. For purposes of these calculations, the
maturity of an obligation with one or more call provisions is assumed to be the
next date on which the obligation reasonably can be expected to be called or, if
none, the maturity date. At September 30, 1998, the 30-day yield for High Yield
and Government Class A shares was 8.82% and 4.53%, respectively. At September
30, 1998, the 30-day yield for High Yield and Government Class B shares was
8.63% and 4.42%, respectively. At September 30, 1998, the 30-day yield for High
Yield and Government Class C shares was 8.61% and 4.36%, respectively.
INVESTING IN THE FUNDS
- ----------------------
Class A shares, Class B shares and Class C shares of each fund are sold at
their next determined net asset value on Business Days. The procedures for
purchasing shares of a fund are explained in the Prospectus under "How to
Invest."
SYSTEMATIC INVESTMENT OPTIONS
-----------------------------
The options below allow you to invest continually in one or more funds at
regular intervals.
1. Automatic Investing -- You may authorize the Manager to process a
monthly draft from your personal checking account for investment into the Trust.
The draft is returned by your bank the same way a canceled check is returned.
2. Direct Deposit -- If your employer participates in a direct deposit
program (also known as ACH Deposits) you may have all or a portion of your
payroll directed to the Trust. This will generate a purchase transaction each
time you are paid by your employer. Your employer will report to you the amount
sent from each paycheck.
3. Government Direct Deposit -- If you receive a qualifying periodic
payment from the U.S. Government or other agency that participates in Direct
Deposit, you may have all or a part of each check directed to purchase shares of
the Trust. The U.S. Government or agency will report to you all payments made.
4. Automatic Exchange -- If you own shares of another Heritage mutual fund
advised or administered by the Manager ("Heritage mutual fund"), you may elect
to have a preset amount redeemed from that fund and exchanged into the
corresponding class of shares of the Trust. You will receive a statement from
the other Heritage mutual fund confirming the redemption.
You may change or terminate any of the above options at any time.
RETIREMENT PLANS
----------------
HERITAGE IRA. Individuals who earn compensation and who have not reached
age 70 1/2 before the close of the year generally may establish a Heritage
Individual Retirement Account ("IRA"). An individual may make limited
contributions to a Heritage IRA through the purchase of shares of a fund and/or
other Heritage mutual funds. The Internal Revenue Code of 1986, as amended (the
30
<PAGE>
"Code"), limits the deductibility of IRA contributions to taxpayers who are not
active participants (and, under certain circumstances, whose spouses are not
active participants, unless their combined adjusted gross income does not exceed
$150,000) in employer-provided retirement plans or who have adjusted gross
income below certain levels. Nevertheless, the Code permits other individuals to
make nondeductible IRA contributions up to $2,000 per year (or $4,000, if such
contributions also are made for a nonworking spouse and a joint return is
filed). In addition, individuals whose earnings (together with their spouse's
earnings) do not exceed a certain level may establish an "education IRA" and/or
a "Roth IRA"; although contributions to these new types of IRAs (established by
the Taxpayer Relief Act of 1997 ("Tax Act")) are nondeductible, withdrawals from
them will not be taxable under certain circumstances. A Heritage IRA also may be
used for certain "rollovers" from qualified benefit plans and from Section
403(b) annuity plans. For more detailed information on the Heritage IRA, please
contact the Manager.
Fund shares also may be used as the investment medium for qualified plans
(defined benefit or defined contribution plans established by corporations,
partnerships or sole proprietorships). Contributions to qualified plans may be
made (within certain limits) on behalf of the employees, including
owner-employees, of the sponsoring entity.
OTHER RETIREMENT PLANS. Multiple participant payroll deduction retirement
plans also may purchase Class A shares of any Heritage mutual fund at a reduced
sales charge on a monthly basis during the 13-month period following such a
plan's initial purchase. The sales charge applicable to an initial purchase of
Class A shares will be that normally applicable under the schedule of sales
charges set forth in the Prospectus to an investment 13 times larger than such
initial purchase. The sales charge applicable to each succeeding monthly
purchase of Class A shares will be that normally applicable, under such
schedule, to an investment equal to the sum of (1) the total purchase previously
made during the 13-month period and (2) the current month's purchase multiplied
by the number of months (including the current month) remaining in the 13-month
period. Sales charges previously paid during such period will not be adjusted
retroactively on the basis of later purchases. Multiple participant payroll
deduction retirement plans may purchase Class B shares and Class C shares at any
time.
CLASS A COMBINED PURCHASE PRIVILEGE (RIGHT OF ACCUMULATION)
-----------------------------------------------------------
Certain investors may qualify for the Class A sales charge reductions
indicated in the sales charge schedule in the Prospectus by combining purchases
of Class A shares of a fund into a single "purchase," if the resulting purchase
totals at least $25,000. The term "purchase" refers to a single purchase by an
individual, or to concurrent purchases that, in the aggregate, are at least
equal to the prescribed amounts, by an individual, his spouse and their children
under the age of 21 years purchasing Class A shares of a fund for his or their
own account; a single purchase by a trustee or other fiduciary purchasing Class
A shares for a single trust, estate or single fiduciary account although more
than one beneficiary is involved; or a single purchase for the employee benefit
plans of a single employer. The term "purchase" also includes purchases by a
"company," as the term is defined in the 1940 Act, but does not include
purchases by any such company that has not been in existence for at least six
months or that has no purpose other than the purchase of Class A shares of a
fund or shares of other registered investment companies at a discount; provided,
31
<PAGE>
however, that it shall not include purchases by any group of individuals whose
sole organizational nexus is that the participants therein are credit card
holders of a company, policy holders of an insurance company, customers of
either a bank or broker-dealer, or clients of an investment adviser. A
"purchase" also may include Class A shares purchased at the same time through a
single selected dealer of any other Heritage Mutual Fund that distributes its
shares subject to a sales charge.
The applicable Class A shares initial sales charge will be based on the
total of:
(i) the investor's current purchase;
(ii) the net asset value (at the close of business on the previous
day) of (a) all Class A shares of a fund held by the investor and (b) all
Class A shares of any other Heritage mutual fund held by the investor and
purchased at a time when Class A shares of such other fund were
distributed subject to a sales charge (including Heritage Cash Trust
shares acquired by exchange); and
(iii) the net asset value of all Class A shares described in
paragraph (ii) owned by another shareholder eligible to combine his
purchases with that of the investor into a single "purchase."
Class A shares of Government purchased from February 1, 1992 through July
31, 1992, without payment of a sales charge will be deemed to fall under the
provisions of paragraph (ii) as if they had been distributed without being
subject to a sales charge, unless those shares were acquired through an exchange
of other shares that were subject to a sales charge.
To qualify for the Combined Purchase Privilege on a purchase through a
selected dealer, the investor or selected dealer must provide Raymond James &
Associates, Inc. (the "Distributor") with sufficient information to verify that
each purchase qualifies for the privilege or discount.
CLASS A STATEMENT OF INTENTION
------------------------------
Investors also may obtain the reduced sales charges shown in the
Prospectus by means of a written Statement of Intention, which expresses the
investor's intention to invest not less than $25,000 within a period of 13
months in Class A shares of a fund or any other Heritage mutual fund subject to
a sales charge. Each purchase of Class A shares under a Statement of Intention
will be made at the public offering price or prices applicable at the time of
such purchase to a single transaction of the dollar amount indicated in the
Statement. In addition, if you own Class A shares of any other Heritage mutual
fund subject to a sales charge, you may include those shares in computing the
amount necessary to qualify for a sales charge reduction.
The Statement of Intention is not a binding obligation upon the investor
to purchase the full amount indicated. The minimum initial investment under a
Statement of Intention is 5% of such amount. Class A shares purchased with the
first 5% of such amount will be held in escrow (while remaining registered in
the name of the investor) to secure payment of the higher sales charge
applicable to the shares actually purchased if the full amount indicated is not
32
<PAGE>
purchased, and such escrowed Class A shares will be involuntarily redeemed to
pay the additional sales charge, if necessary. When the full amount indicated
has been purchased, the escrow will be released. To the extent an investor
purchases more than the dollar amount indicated on the Statement of Intention
and qualifies for a further reduced sales charge, the sales charge will be
adjusted for the entire amount purchased at the end of the 13-month period. The
difference in sales charge will be used to purchase additional Class A shares of
a fund, subject to the rate of sales charge applicable to the actual amount of
the aggregate purchases. An investor may amend his/her Statement of Intention to
increase the indicated dollar amount and begin a new 13-month period. In that
case, all investments subsequent to the amendment will be made at the sales
charge in effect for the higher amount. The escrow procedures discussed above
will apply.
REDEEMING SHARES
- ----------------
The methods of redemption are described in the section of the Prospectus
entitled "How to Sell Your Investment."
SYSTEMATIC WITHDRAWAL PLAN
--------------------------
Shareholders may elect to make systematic withdrawals from their fund
account of a minimum of $50 on a periodic basis. The amounts paid each period
are obtained by redeeming sufficient shares from an account to provide the
withdrawal amount specified. The Systematic Withdrawal Plan currently is not
available for shares held in an Individual Retirement Account, Section 403(b)
annuity plan, defined contribution plan, simplified employee pension plan or
other retirement plans, unless the shareholder establishes to the Manager's
satisfaction that withdrawals from such an account may be made without
imposition of a penalty. Shareholders may change the amount to be paid without
charge not more than once a year by written notice to the Distributor or
Heritage.
Redemptions will be made at net asset value determined as of the close of
regular trading on the Exchange on a day of each month chosen by the
shareholders or a day of the last month of each period chosen by the
shareholders, whichever is applicable. Systematic withdrawals of Class C shares,
if made less than one year of the date of purchase, will be charged a CDSC of
1%. Systematic withdrawals of Class B shares, if made in less than six years of
the date of purchase, will be charged the applicable CDSC for the holding
period. If the Exchange is not open for business on that day, the shares will be
redeemed at net asset value determined as of the close of regular trading on the
Exchange on the preceding Business Day, minus any applicable CDSC for Class B
shares and Class C shares. If a shareholder elects to participate in the
Systematic Withdrawal Plan, dividends and other distributions on all shares in
the account must be reinvested automatically in fund shares. A shareholder may
terminate the Systematic Withdrawal Plan at any time without charge or penalty
by giving written notice to Heritage or the Distributor. The funds, their
transfer agent, and Distributor also reserve the right to modify or terminate
the Systematic Withdrawal Plan at any time.
Withdrawal payments are treated as a sale of shares rather than as a
dividend or a capital gain distribution. These payments are taxable to the
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<PAGE>
extent that the total amount of the payments exceeds the tax basis of the shares
sold. If the periodic withdrawals exceed reinvested dividends and other
distributions, the amount of the original investment may be correspondingly
reduced.
Ordinarily, a shareholder should not purchase additional Class A shares of
a fund if maintaining a Systematic Withdrawal Plan of Class A shares because the
shareholder may incur tax liabilities in connection with such purchases and
withdrawals. A fund will not knowingly accept purchase orders from shareholders
for additional Class A shares if they maintain a Systematic Withdrawal Plan
unless the purchase is equal to at least one year's scheduled withdrawals. In
addition, a shareholder who maintains such a Plan may not make periodic
investments under each fund's Automatic Investment Plan.
TELEPHONE TRANSACTIONS
----------------------
Shareholders may redeem shares by placing a telephone request to a fund.
The Trust, Manager, Distributor and their Trustees, directors, officers and
employees are not liable for any loss arising out of telephone instructions they
reasonably believe are authentic. In acting upon telephone instructions, these
parties use procedures that are reasonably designed to ensure that such
instructions are genuine, such as (1) obtaining some or all of the following
information: account number, name(s) and social security number registered to
the account, and personal identification; (2) recording all telephone
transactions; and (3) sending written confirmation of each transaction to the
registered owner. If the Trust, Manager, Distributor and their Trustees,
directors, officers and employees do not follow reasonable procedures, some or
all of them may be liable for any such losses.
REDEMPTIONS IN KIND
-------------------
The Trust is obligated to redeem shares of each fund for any shareholder
for cash during any 90-day period up to $250,000 or 1% of the fund's net asset
value, whichever is less. Any redemption beyond this amount also will be in cash
unless the Board determine that further cash payments will have a material
adverse effect on remaining shareholders. In such a case, the fund will pay all
or a portion of the remainder of the redemption in portfolio instruments, valued
in the same way as the fund determines net asset value. The portfolio
instruments will be selected in a manner that the Board deem fair and equitable.
A redemption in kind is not as liquid as a cash redemption. If a redemption is
made in kind, a shareholder receiving portfolio instruments could receive less
than the redemption value thereof and could incur certain transaction costs.
RECEIVING PAYMENT
-----------------
If shares of a fund are redeemed by a shareholder through the Distributor
or a participating dealer, the redemption is settled with the shareholder as an
ordinary transaction. If a request for redemption is received in good order (as
described below) and before the close of regular trading on the Exchange, shares
will be redeemed at the net asset value per share determined on that day, minus
any applicable CDSC for Class B shares and Class C shares. Requests for
redemption received after the close of regular trading on the Exchange will be
34
<PAGE>
executed on the next trading day. Payment for shares redeemed normally will be
made by a fund to the Distributor or a participating dealer by the third
business day after the day the redemption request was made, provided that
certificates for shares have been delivered in proper form for transfer to the
Trust or, if no certificates have been issued, a written request signed by the
shareholder has been provided to the Distributor or a participating dealer prior
to settlement date.
Other supporting legal documents may be required from corporations or
other organizations, fiduciaries or persons other than the shareholder of record
making the request for redemption. Questions concerning the redemption of fund
shares can be directed to registered representatives of the Distributor or a
participating dealer, or to Heritage.
A redemption request will be considered to be received in "good order" if:
. the number or amount of shares and the class of shares to be redeemed and
shareholder account number have been indicated;
. any written request is signed by a shareholder and by all co-owners of the
account with exactly the same name or names used in establishing the account;
. any written request is accompanied by certificates representing the shares
that have been issued, if any, and the certificates have been endorsed for
transfer exactly as the name or names appear on the certificates or an
accompanying stock power has been attached; and
. the signatures on any written redemption request of $50,000 or more and on
any certificates for shares (or an accompanying stock power) have been
guaranteed by a national bank, a state bank that is insured by the Federal
Deposit Insurance Corporation, a trust company, or by any member firm of the
New York, American, Boston, Chicago, Pacific or Philadelphia Stock Exchanges.
Signature guarantees also will be accepted from savings banks and certain
other financial institutions that are deemed acceptable by Heritage, as
transfer agent, under its current signature guarantee program.
Each fund has the right to suspend redemption or postpone payment at times
when the Exchange is closed (other than customary weekend or holiday closings)
or during periods of emergency or other periods as permitted by the Securities
and Exchange Commission. In the case of any such suspension, you may either
withdraw your request for redemption or receive payment based upon the net asset
value next determined, less any applicable CDSC, after the suspension is lifted.
If a redemption check remains outstanding after six months, Heritage reserves
the right to redeposit those funds into your account.
EXCHANGE PRIVILEGE
- ------------------
An exchange is effected through the redemption of the shares tendered for
exchange and the purchase of shares being acquired at their respective net asset
values as next determined following receipt by the Heritage mutual fund whose
shares are being exchanged of (1) proper instructions and all necessary
supporting documents as described in such fund's prospectus or (2) a telephone
request for such exchange in accordance with the procedures set forth in the
prospectus and below. Telephone or telegram requests for an exchange received by
35
<PAGE>
a fund before the close of regular trading on the Exchange will be effected at
the close of regular trading on that day. Requests for an exchange received
after the close of regular trading will be effected on the Exchange's next
trading day.
In the event that you or your Financial Advisor (a financial advisor of
the distributor, a particpating dealer or participating bank) are unable to
reach Heritage by telephone, an exchange can be effected by sending a telegram
to Heritage. Due to the volume of calls or other unusual circumstances,
telephone exchanges may be difficult to implement during certain time periods.
Class A shares of Government purchased from February 1, 1992 through July
31, 1992, without payment of an initial sales charge may be exchanged into Class
A shares of another Heritage mutual fund without payment of any sales charge.
Class A shares of Government purchased after July 31, 1992 without an initial
sales charge will be subject to a front-end sales charge when exchanged into
Class A shares of another Heritage mutual fund, unless those shares were
acquired through an exchange of other shares that were subject to an initial
sales charge.
Each Heritage mutual fund reserves the right to reject any order to
acquire its shares through exchange or otherwise to restrict or terminate the
exchange privilege at any time. In addition, each Heritage mutual fund may
terminate this exchange privilege upon 60 days' notice.
CONVERSION OF CLASS B SHARES
- ----------------------------
Class B shares of each fund automatically will convert to Class A shares,
based on the relative net asset values per share of the two classes, eight years
after the end of the calendar month in which the shareholder's order to purchase
was accepted. For the purpose of calculating the holding period required for
conversion of Class B shares, the date of initial issuance shall mean (1) the
date on which such Class B shares were issued or (2) for Class B shares obtained
through an exchange, or a series of exchanges, the date on which the original
Class B shares were issued. For purposes of conversion to Class A shares, Class
B shares purchased through the reinvestment of dividends and other distributions
paid in respect of Class B shares will be held in a separate sub-account. Each
time any Class B shares in the shareholder's regular account (other than those
in the sub-account) convert to Class A shares, a pro rata portion of the Class B
shares in the sub-account will also convert to Class A shares. The portion will
be determined by the ratio that the shareholder's Class B shares converting to
Class A shares bears to the shareholder's total Class B shares not acquired
through dividends and other distributions.
The availability of the conversion feature is subject to the continuing
availability of an opinion of counsel to the effect that the dividends and other
distributions paid on Class A shares and Class B shares will not result in
"preferential dividends" under the Code and the conversion of shares does not
constitute a taxable event. If the conversion feature ceased to be available,
the Class B shares would not be converted and would continue to be subject to
the higher ongoing expenses of the Class B shares beyond eight years from the
date of purchase. Heritage has no reason to believe that this condition for the
availability of the conversion feature will not be met.
36
<PAGE>
TAXES
- -----
Each fund is treated as a separate corporation for Federal income tax
purposes and intends to qualify to continue to qualify for the favorable tax
treatment as a regulated investment company ("RIC") under the Code. To do so, a
fund must distribute annually to its shareholders at least 90% of its investment
company taxable income (generally consisting of net investment income and net
short-term capital gain and, in the case of High Yield, net gains from certain
foreign currency transactions) ("Distribution Requirement") and must meet
several additional requirements. With respect to each fund, these requirements
include the following: (1) the fund must derive at least 90% of its gross income
each taxable year from dividends, interest, payments with respect to securities
loans and gains from the sale or other disposition of securities or foreign
currencies, or other income (including gains from options or futures contracts)
derived with respect to its business of investing in securities or those
currencies ("Income Requirement"); (2) at the close of each quarter of the
fund's taxable year, at least 50% of the value of its total assets must be
represented by cash and cash items, U.S. Government securities, securities of
other RICs and other securities, with those other securities limited, in respect
of any one issuer, to an amount that does not exceed 5% of the value of the
fund's total assets and that does not represent more than 10% of the issuer's
outstanding voting securities; and (3) at the close of each quarter of the
fund's taxable year, not more than 25% of the value of its total assets may be
invested in securities (other than U.S. Government securities or the securities
of other RICs) of any one issuer.
By qualifying for treatment as a RIC, a fund (but not its shareholders)
will be relieved of Federal income tax on the part of its investment company
taxable income and net capital gain (the excess of net long-term capital gain
over net short-term capital loss) that it distributes to its shareholders. If a
fund failed to qualify as a RIC for any taxable year, it would be taxed on the
full amount of its taxable income for that year without being able to deduct the
distributions it makes to its shareholders and the shareholders would treat all
those distributions, including distributions of net capital gain, as dividends
(that is, ordinary income) to the extent of the fund's earnings and profits.
Each fund will be subject to a nondeductible 4% excise tax ("Excise Tax")
to the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and its capital gain net
income for the one-year period ending on October 31 of that year, plus certain
other amounts.
A redemption of fund shares will result in a taxable gain or loss to the
redeeming shareholder, depending on whether the redemption proceeds are more or
less than the shareholder's adjusted basis for the redeemed shares (which
normally includes any sales charge paid on Class A shares). An exchange of
shares of either fund for shares of another Heritage mutual fund generally will
have similar tax consequences. However, special rules apply when a shareholder
disposes of shares of a fund through a redemption or exchange within 90 days
after purchase thereof and subsequently reacquires shares of that fund or
acquires shares of another Heritage mutual fund (including another fund) without
paying a sales charge due to the 90-day reinstatement or exchange privilege. In
these cases, any gain on the disposition of the original fund shares will be
37
<PAGE>
increased, or loss decreased, by the amount of the sales charge paid when those
shares were acquired, and that amount will increase the adjusted basis of the
shares subsequently acquired. In addition, if fund shares are purchased (whether
pursuant to the reinstatement privilege or otherwise) within 30 days before or
after redeeming other shares of that fund (regardless of class) at a loss, all
or a portion of that loss will not be deductible and will increase the basis of
the newly purchased shares.
If shares of a fund are sold at a loss after being held for six months or
less, the loss will be treated as long-term, instead of short-term, capital loss
to the extent of any capital gain distributions received on those shares.
Investors also should be aware that if shares are purchased shortly before the
record date for a dividend or other distribution, the shareholder will pay full
price for the shares and receive some portion of the price back as a taxable
distribution.
Dividends and other distributions declared by each fund in December of any
year and payable to shareholders of record on a date in that month will be
deemed to have been paid by that fund and received by its shareholders on
December 31 if they are paid by the fund during the following January.
Shareholders receive Federal income tax information regarding dividends
and other distributions after the end of each year. The information regarding
capital gain distributions designates the portions of those distributions that
are subject to the different maximum rates of tax applicable to non-corporate
taxpayers' net capital gain indicated above.
Each fund is required to withhold 31% of all dividends, capital gain
distributions and redemption proceeds payable to individuals and certain other
noncorporate shareholders who do not provide that fund with a correct taxpayer
identification number. Withholding at that rate also is required from dividends
and capital gain distributions payable to such shareholders who otherwise are
subject to backup withholding. The portion of the dividends paid to the
Intermediate Government Fund attributable to the interest earned on its U.S.
Government securities generally is not subject to state and local income taxes,
although distributions by that fund to its shareholders of net realized gains on
the disposition of those securities are fully subject to those taxes. You should
consult your tax adviser to determine the taxability of dividends and other
distributions by that fund in your state and locality.
High Yield credited undistributed net investment income and charged
accumulated net realized gain of $44,735 in the current year ended September 30,
1998. High Yield utilized $716,301 of net tax basis capital losses during the
current year against net realized gains from investment transactions.
As of September 30, 1998, Government had a net tax basis capital loss
carryforwards of $7,095,646, which may be applied against any net realized
taxable gains until their expiration dates of September 30, 2001 (as to
$237,373), September 30, 2002 (as to $3,838,721), September 30, 2003 (as to
$2,492,779) and September 30, 2004 (as to $526,773). Government utilized
$150,698 of net tax basis capital losses during the current year against net
realized gains from investment transactions.
38
<PAGE>
HEDGING STRATEGIES. The use of hedging strategies, such as purchasing and
selling (writing) options and futures contracts, involves complex rules that
will determine for income tax purposes the amount, character and timing of
recognition of the gains and losses each fund realizes in connection therewith.
Gains realized by High Yield from the disposition of foreign currencies (except
certain gains that may be excluded by future regulations), and gains from
options and futures contracts derived by a fund with respect to its business of
investing in securities or, for High Yield, foreign currencies, will qualify as
permissible income under the Income Requirement.
Certain options and futures in which a fund may invest will be "section
1256 contracts." Section 1256 contracts held by a fund at the end of each
taxable year, other than section 1256 contracts that are part of a "mixed
straddle" with respect to which it has made an election not to have the
following rules apply, must be "marked-to-market" (that is, treated as sold for
their fair market value) for Federal income tax purposes, with the result that
unrealized gains or losses will be treated as though they were realized. Sixty
percent of any net gain or loss recognized on these deemed sales, and 60% of any
net realized gain or loss from any actual sales of section 1256 contracts, will
be treated as long-term capital gain or loss, and the balance will be treated as
short-term capital gain or loss. Section 1256 contracts also may be
marked-to-market for purposes of the Excise Tax.
Code section 1092 (dealing with straddles) also may affect the taxation of
options and futures contracts in which a fund may invest. Section 1092 defines a
"straddle" as offsetting positions with respect to personal property; for these
purposes, options and futures contracts are personal property. Section 1092
generally provides that any loss from the disposition of a position in a
straddle may be deducted only to the extent the loss exceeds the unrealized gain
on the offsetting position(s) of the straddle. Section 1092 also provides
certain "wash sale" rules, which apply to transactions where a position is sold
at a loss and a new offsetting position is acquired within a prescribed period,
and "short sale" rules applicable to straddles. If a fund makes certain
elections, the amount, character and timing of the recognition of gains and
losses from the affected straddle positions would be determined under rules that
vary according to the elections made. Because only a few of the regulations
implementing the straddle rules have been promulgated, the tax consequences to a
fund of straddle transactions are not entirely clear.
If a fund has an "appreciated financial position" -- generally, an
interest (including an interest through an option, futures or forward contract
or short sale) with respect to any stock, debt instrument (other than "straight
debt") or partnership interest the fair market value of which exceeds its
adjusted basis -- and enters into a "constructive sale" of the same or
substantially similar property, the fund will be treated as having made an
actual sale thereof, with the result that gain will be recognized at that time.
A constructive sale generally consists of a short sale, an offsetting notional
principal contract or futures or forward contract entered into by a fund or a
related person with respect to the same or substantially similar property. In
addition, if the appreciated financial position is itself a short sale or such a
contract, acquisition of the underlying property or substantially similar
property will be deemed a constructive sale.
ORIGINAL ISSUE DISCOUNT AND PAY-IN-KIND SECURITIES. High Yield may acquire
zero coupon or other securities issued with original issue discount ("OID"). As
a holder of those securities, High Yield must include in its income the OID that
39
<PAGE>
accrues thereon during the taxable year, even if it receives no corresponding
payment on them during the year. Similarly, High Yield must include in its gross
income securities it receives as "interest" on pay-in-kind securities. Because
High Yield annually must distribute substantially all of its investment company
taxable income, including any OID and other non-cash income, to satisfy the
Distribution Requirement and avoid imposition of the Excise Tax, it may be
required in a particular year to distribute as a dividend an amount that is
greater than the total amount of cash it actually receives. Those distributions
will be made from High Yield's cash assets or from the proceeds of sales of
portfolio securities, if necessary. High Yield may realize capital gains or
losses from those sales, which would increase or decrease its investment company
taxable income and/or net capital gain (the excess of net long-term capital gain
over net short-term capital loss).
High Yield may invest in debt securities that are purchased with "market
discount," including Brady Bonds and other sovereign debt securities. For these
purposes, market discount is the amount by which a security's purchase price is
exceeded by its stated redemption price at maturity or, in the case of a
security that was issued with OID, the sum of its issue price plus accrued OID,
except that market discount less than the product of (1) 0.25% of the redemption
price at maturity times (2) the number of complete years to maturity after the
taxpayer acquired the security is disregarded. Gain on the disposition of such a
security purchased by High Yield (other than a security with a fixed maturity
date within one year from its issuance), generally is treated as ordinary
income, rather than capital gain, to the extent of the security's accrued market
discount at the time of disposition. In lieu of treating the disposition gain as
above, High Yield may elect to include all market discount (for the taxable year
in which it makes the election and all subsequent taxable years) in its gross
income currently, for each taxable year to which the discount is attributable.
Investors are advised to consult their own tax advisers regarding the
status of an investment in the funds under state and local tax laws.
SHAREHOLDER INFORMATION
- -----------------------
Each share of a fund gives the shareholder one vote in matters submitted
to shareholders for a vote. Class A shares, Class B shares and Class C shares of
each fund have equal voting rights except that in matters affecting only a
particular class or series, only shares of that class or series are entitled to
vote. As a Massachusetts business trust, the Trust is not required to hold
annual shareholder meetings. Shareholder approval will be sought only for
certain changes in the Trust's or a fund's operation and for the election of
Trustees under certain circumstances. Trustees may be removed by the other
Trustees or shareholders at a special meeting. A special meeting of shareholders
shall be called by the Trustees upon the written request of shareholders owning
at least 10% of the Trust's outstanding shares.
40
<PAGE>
TRUST INFORMATION
- -----------------
MANAGEMENT OF THE TRUST
-----------------------
BOARD OF TRUSTEES. The business affairs of each fund are managed by or
under the direction of the Board. The Trustees are responsible for managing the
funds' business affairs and for exercising all the funds' powers except those
reserved to the shareholders. A Trustee may be removed by the other Trustees or
by a two-thirds vote of the outstanding Trust shares.
BACKGROUND OF THE TRUSTEES AND OFFICERS. Trustees and officers are listed
below with their addresses, principal occupations and present positions,
including any affiliation with Raymond James Financial, Inc. ("RJF"), Raymond
James and Associates, Inc. ("RJA") and the Manager.
<TABLE>
<CAPTION>
Position with Principal Occupation
Name the Trust During Past Five Years
---- ------------- ----------------------
<S> <C> <C>
Thomas A. James* (56) Trustee Chairman of the Board since 1986 and Chief
880 Carillon Parkway Executive Officer since 1969 of RJF;
St. Petersburg, FL 33716 Chairman of the Board of RJA since 1986;
Chairman of the Board of Eagle Asset
Management, Inc. ("Eagle") since 1984 and
Chief Executive Officer of Eagle, 1994 to
1996.
Richard K. Riess* (49) Trustee Executive Vice President and Managing
880 Carillon Parkway Director for Asset Management of RJF since
St. Petersburg, FL 33716 1998, Chief Executive Officer of Eagle
since 1996, President of Eagle, 1995 to
present, Chief Operating Officer of Eagle,
1988 to 1995, Executive Vice President of
Eagle, 1988 to 1993.
Donald W. Burton* (54) Trustee President of South Atlantic Capital
614 W. Bay Street, Suite 200 Corporation (venture capital) since 1981.
Tampa, FL 33606
C. Andrew Graham (58) Trustee Vice President of Financial Designs Ltd.
Financial Designs, Ltd. since 1992; Executive Vice President of
1775 Sherman Street the Madison Group, Inc., 1991 to 1992;
Suite 1900 Principal of First Denver Financial
Denver, CO 80203 Corporation (investment banking) since
1987.
David M. Phillips (59) Trustee Chairman and Chief Executive Officer of
World Trade Center Chicago CCC Information Services, Inc. since 1994
444 Merchandise Mart and of InfoVest Corporation (information
Chicago, IL 60654 services to the insurance and auto
industries and consumer households) since
1982.
Eric Stattin (65) Trustee Litigation Consultant/Expert Witness and
1975 Evening Star Drive private investor since 1988.
Park City, UT 84060
41
<PAGE>
Position with Principal Occupation
Name the Trust During Past Five Years
---- ------------- ----------------------
James L. Pappas (55) Trustee Lykes Professor of Banking and Finance
University of South Florida since 1986 at University of South Florida;
College of Business Dean of College of Business
Administration Administration, 1987 to 1996.
Tampa, FL 33620
Stephen G. Hill (39) President Chief Executive Officer and President of
880 Carillon Parkway the Manager since 1989 and Director since
St. Petersburg, FL 33716 1994; Director of Eagle since 1995.
Donald H. Glassman (41) Treasurer Treasurer of the Manager since 1989;
880 Carillon Parkway Treasurer of Heritage Mutual Funds since
St. Petersburg, FL 33716 1989.
Clifford J.Alexander (55) Secretary Partner, Kirkpatrick & Lockhart LLP (law
1800 Massachusetts firm).
Ave., N.W.
Washington, DC 20036
Patricia Schneider (57) Assistant Compliance Administrator of the Manager.
880 Carillon Parkway Secretary
St. Petersburg, FL 33716
Robert J. Zutz (45) Assistant Partner, Kirkpatrick & Lockhart LLP (law
1800 Massachusetts Secretary firm).
Ave., N.W.
Washington, DC 20036
</TABLE>
- -----------
* These Trustees are "interested persons" as defined in section 2(a)(19)
of the 1940 Act.
The Trustees and officers of the Trust as a group, own less than 1% of
each class of each fund's shares outstanding. The Trust's Declaration of Trust
provides that the Trustees will not be liable for errors of judgment or mistakes
of fact or law. However, they are not protected against any liability to which
they would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence or reckless disregard of the duties involved in the conduct of
their office.
The Trust currently pays Trustees who are not employees of the Manager or
its affiliates $8,666 annually and $3,250 per meeting of the Board. Trustees
also are reimbursed for any expenses incurred in attending meetings. Because the
Manager performs substantially all of the services necessary for the operation
of the fund, the fund requires no employees. No officer, director or employee of
the Manager receives any compensation from the fund for acting as a director or
officer. The following table shows the compensation earned by each Trustee for
the fiscal year ended September 30, 1998.
42
<PAGE>
COMPENSATION TABLE
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Total Compensation From
Aggregate Pension or Retirement Estimated Annual the Trust and the
Compensation From Benefits Accrued as Part Benefits Upon Heritage Family of Funds
Name of Person, Position the Trust of the Trust's Expenses Retirement Paid to Trustees
- ------------------------ ---------- ----------------------- ---------- ----------------
Donald W. Burton, Trustee $2,435.90 $0 $0 $20,000
C. Andrew Graham, Trustee $2,435.90 $0 $0 $20,000
Thomas A. James, Trustee $0 $0 $0 $0
James L. Pappas, Trustee $2,435.90 $0 $0 $20,000
David M. Phillips, Trustee $1,935.91 $0 $0 $14,000
Richard K. Riess, Trustee $0 $0 $0 $0
Eric Stattin, Trustee $2,435.90 $0 $0 $20,000
</TABLE>
FIVE PERCENT SHAREHOLDERS
-------------------------
As of January 19, 1999, the following shareholders owned of record or were
known by the funds to own beneficially five percent or more of the outstanding
Class of shares of the funds.
Government Class B Shares:
- -------------------------
Raymond James & Assoc., Inc. (5.41%) Raymond James & Assoc., Inc. (8.96%)
Cust. for Martha V. Greenwood Cust. for William Telkamp
2267 E. Whipp Road 535 N. Wayfield Street
Kettering, OH 45440 Orange, CA 92667
Raymond James & Assoc., Inc. (12.02%) Raymond James & Assoc., Inc. (32.87%)*
Cust. for John H. Powell Trstee. Acct. for Alexander H. Bravo
667 Hickory Ridge Road Trust
Smyrna, DE 19977 2681 Alliston Court
Columbus, OH 43220
Winifred W. Bhelley (7.40%) Jack L. Whitton (11.10%)
402 Woodland Drive Est. of Sylvan Whitton
Marion, SC 29571 P.O. Box 61187
Columbia, SC 29260
*As a shareholder owning voting securities in excess of 25%, this person may
determine the outcome of any matter affecting, and voted on by shareholders of,
the Government Class B shares.
43
<PAGE>
Government Class C Shares:
- -------------------------
William Munro (5.88%) Raymond James & Assoc., Inc. (5.92%)
Trstee. for Munro Sales Cust. for Christel M. Bruyneel
G-4136 Holiday Drive 4991 Tanglewilde
Flint, MI 48507 Houston, TX 77063
Ronald J. Bowers (8.58%)
P.O. Box 4407
Salisbury, NE 28145
High Yield Class B Shares:
- -------------------------
Raymond James & Assoc., Inc. (8.01%) Raymond James & Assoc., Inc. (8.28%)
FAO James A. Davis & Nona K. Davis Trstee. for Claudine H. Schork
9285 W. Tarboro Road 1990 Stonecrest Court
Rocky Mount, NC 27803 Vista, CA 92083
INVESTMENT ADVISER AND ADMINISTRATOR; SUBADVISER
- ------------------------------------------------
The Trust's investment adviser and administrator, Heritage Asset
Management, Inc., was organized as a Florida corporation in 1985. All the
capital stock of the Manager is owned by Raymond James Financial. RJF is a
holding company that, through its subsidiaries, is engaged primarily in
providing customers with a wide variety of financial services in connection with
securities, limited partnerships, options, investment banking and related
fields.
Under an Investment Advisory and Administration Agreement ("Advisory
Agreement") dated January 19, 1990, between the Trust, on behalf of the funds,
and the Manager, and subject to the control and direction of the Board, the
Manager is responsible for reviewing and establishing investment policies for
the Trust as well as administering the Trust's noninvestment affairs. Under a
Subadvisory Agreement, dated February 1, 1996, the Subadviser, subject to
direction by the Manager and Board, will provide investment advice and portfolio
management services to High Yield for a fee payable by the Manager.
The Manager also is obligated to furnish the Trust with office space,
administrative, and certain other services as well as executive and other
personnel necessary for the operation of the Trust. The Manager and its
affiliates also pay all the compensation of Trustees of the Trust who are
employees of the Manager and its affiliates. Each fund pays all its other
expenses that are not assumed by the Manager. Each fund also is liable for such
nonrecurring expenses as may arise, including litigation to which the Trust may
be a party. Each fund also may have an obligation to indemnify Trustees and
officers of the Trust with respect to any such litigation.
The Advisory Agreement and the Subadvisory Agreement each were approved by
the Board of the Trust (including all of the Trustees who are not "interested
persons" of the Manager or Subadviser, as defined under the 1940 Act) and the
shareholders of the applicable fund, in compliance with the 1940 Act. Each
Agreement provides that it will be in force for an initial two-year period and
it must be approved each year thereafter by (1) a vote, cast in person at a
meeting called for that purpose, of a majority of those Trustees who are not
44
<PAGE>
"interested persons" of the Manager, Subadviser or the Trust, and by (2) the
majority vote of either the full Board or the vote of a majority of the
outstanding shares of each applicable fund. The Advisory and Subadvisory
Agreements each automatically terminates on assignment, and each is terminable
on not more than 60 days' written notice by the Trust to either party. In
addition, the Advisory Agreement may be terminated on not less than 60 days'
written notice by the Manager to the Trust and the Subadvisory Agreement may be
terminated on not less than 60 days' written notice by the Manager or 90 days'
written notice by the Subadviser. Under the terms of the Advisory Agreement, the
Manager automatically becomes responsible for the obligations of the Subadviser
upon termination of the Subadvisory Agreement. In the event the Manager ceases
to be the manager of the Trust or the Distributor ceases to be principal
distributor of each fund's shares, the right of the Trust to use the identifying
name of "Heritage" may be withdrawn.
The Manager and Subadviser shall not be liable to the Trust or any
shareholder for anything done or omitted by them, except acts or omissions
involving willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties imposed upon them by their agreements with the Trust or for any
losses that may be sustained in the purchase, holding or sale of any security.
All of the officers of the Trust except for Messrs. Alexander and Zutz are
officers or directors of the Manager. These relationships are described under
"Management of the Trust."
ADVISORY AND ADMINISTRATION FEE. The annual investment advisory fee paid
monthly by each fund to the Manager is based on the applicable fund's average
daily net assets as listed in the prospectus. The Manager's fee for the High
Yield is 0.60% on the first $100 million of its average daily net assets and
0.50% on the average daily net assets of over $100 million. The Manager's fee
for Government is 0.50% of its average daily net assets. The Manager has entered
into an agreement with the Subadviser wherein the Subadviser will provide
investment advice and portfolio management services to High Yield for an annual
fee paid by the Manager equal to 50% of the annual investment advisory fee paid
to the Manager, without regard to any reduction in fees actually paid to the
Manager as a result of voluntary fee waivers by the Manager.
For High Yield, the Manager contractually has agreed to waive management
fees to the extent that total annual operating expenses attributable to Class A
shares exceed 1.19% of the average daily net assets or to the extent that total
annual operating expenses attributable to Class B shares and Class C shares each
exceed 1.70% of average daily net assets attributable to that class for this
fiscal year. For the fiscal years ended September 30, 1996, 1997 and 1998
management fees amounted to $200,042, $287,069 and $347,856, respectively. For
the same periods, the Manager waived its fees in the amounts of $94,308, $45,839
and $60,462, respectively. For the period October 1, 1995 through January 31,
1996, the Manager paid subadvisory fees to Eagle Asset Management, Inc., High
Yield's former subadviser, of $15,507, for such fund, and paid subadvisory fees
to Salomon for the period February 1, 1996 through September 30, 1996 and the
fiscal years ended September 30, 1997 and 1998, of $69,007, $143,535 and
$173,928, respectively.
For Government, the Manager contractually has agreed to waive its fees to
the extent that fund expenses attributable to Class A shares exceed .95% of the
45
<PAGE>
average daily net assets or to the extent that fund expenses attributable to
Class B shares and Class C shares each exceed 1.20% of average daily net assets
attributable to that class for this fiscal year. For the fiscal years ended
September 30, 1996, 1997 and 1998, management fees amounted to $105,455, $81,847
and $72,950, respectively. For the same periods, the Manager waived its fees in
the amounts of $105,455, $81,847 and $72,950, respectively. For the fiscal years
ended September 30, 1996, 1997 and 1998, the Manager reimbursed Government for
expenses totaling $35,322, $39,456 and $84,666, respectively.
CLASS-SPECIFIC EXPENSES. Each fund may determine to allocate certain of
its expenses (in addition to distribution fees) to the specific classes of the
fund's shares to which those expenses are attributable.
BROKERAGE PRACTICES
- -------------------
Each fund's portfolio turnover rate is computed by dividing the lesser of
purchases or sales of securities for the period by the average value of
portfolio securities for that period. A 100% turnover rate would occur if all
the securities in a fund's portfolio, with the exception of securities whose
maturities at the time of acquisition were one year or less, were sold and
either repurchased or replaced within one year. A high rate of portfolio
turnover (100% or more) generally leads to transaction costs and may result in a
greater number of taxable transactions. The annualized portfolio turnover for
the fiscal years ended September 30, 1997 and 1998 were 101% and 87%,
respectively, for High Yield, and 69% and 188%, respectively, for Government.
The Manager is responsible for the execution of each fund's investment
portfolio transactions but has delegated that responsibility to the Subadviser
for a portion of the High Yield Fund's portfolio transactions. In executing
portfolio transactions, both the Manager and the Subadviser must seek the most
favorable price and execution for such transactions. Best execution, however,
does not mean that the fund necessarily will be paying the lowest commission or
spread available. Rather, each fund also will take into account such factors as
size of the order, difficulty of execution, efficiency of the executing broker's
or dealer's facilities, and any risk assumed by the executing broker or dealer.
It is a common practice in the investment advisory business for advisers
of investment companies and other institutional investors to receive research,
statistical and quotation services from broker-dealers who execute portfolio
transactions for the clients of such advisers. Consistent with the policy of
most favorable price and execution, both the Manager and the Subadviser may give
consideration to research, statistical and other services furnished by brokers
or dealers. In addition, they may place orders with brokers or dealers who
provide supplemental investment and market research and securities and economic
analysis and may pay to these brokers a higher brokerage commission or spread
than may be charged by other brokers or dealers, provided that the Manager or
Subadviser, as applicable, determines in good faith that such commission is
reasonable in relation to the value of brokerage and research services provided.
Such research and analysis may be useful to the Manager and the Subadviser in
connection with services to clients other than a fund.
Each fund may use the Distributor as broker for agency transactions in
listed and OTC securities at commission rates and under circumstances consistent
with the policy of best execution. Commissions paid to the Distributor will not
exceed "usual and customary brokerage commissions." Rule 17e-1 under the 1940
Act defines "usual and customary" commissions to include amounts that are
46
<PAGE>
"reasonable and fair compared to the commission, fee or other remuneration
received or to be received by other brokers in connection with comparable
transactions involving similar securities being purchased or sold on a
securities exchange during a comparable period of time."
The Manager and Subadviser also may select other brokers to execute
portfolio transactions. In the OTC market, each fund generally deals with
primary market-makers unless a more favorable execution can otherwise be
obtained.
Each fund effects most purchases and sales of its portfolio investments
with bond dealers acting as principal. Generally, bonds are traded on the OTC
market on a "net" basis without a stated commission through dealers acting for
their own account and not as brokers. Thus, the funds do not expect to pay
significant brokerage commissions. Prices paid to dealers in principal
transactions generally include a "spread," which is the difference between the
prices at which the dealer is willing to purchase and sell a specific security
at that time. The spread includes the dealer's normal profit.
The funds may not buy securities from, or sell securities to, the
Distributor as principal. However, the Board has adopted procedures in
conformity with Rule 10f-3 under the 1940 Act whereby the each fund may purchase
securities that are offered in underwritings in which the Distributor is a
participant. The Board will consider the possibilities of seeking to recapture
for the benefit of each fund expenses of certain portfolio transactions, such as
underwriting commissions and tender offer solicitation fees, by conducting such
portfolio transactions through affiliated entities, including the Distributor,
but only to the extent such recapture would be permissible under applicable
regulations, including the rules of the National Association of Securities
Dealers, Inc. and other self-regulatory organizations.
Pursuant to Section 11(a) of the Securities Exchange Act of 1934, as
amended, each fund expressly consented to the Distributor executing transactions
on an exchange on the Trust's behalf.
DISTRIBUTION OF SHARES
- ----------------------
Shares of each fund are offered continuously through the funds' principal
underwriter, Raymond James & Associates, Inc. (the "Distributor"), and through
other participating dealers or banks that have dealer agreements with the
Distributor. The Distributor receives commissions consisting of that portion of
the sales charge remaining after the dealer concession is paid to participating
dealers or banks. Such dealers may be deemed to be underwriters pursuant to the
1933 Act.
The Distributor and Financial Advisors with whom the Distributor has
entered into dealer agreements offer shares of each fund as agents on a best
efforts basis and are not obligated to sell any specific amount of shares. In
this connection, the Distributor makes distribution and servicing payments to
participating dealers in connection with the sale of fund shares. Pursuant to
its Distribution Agreement with the Trust with respect to Class A shares, Class
B shares and Class C shares of each fund, the Distributor bears the cost of
making information about the Trust available through advertising, sales
literature and other means, the cost of printing and mailing prospectuses to
persons other than shareholders, and salaries and other expenses relating to
47
<PAGE>
selling efforts. The Distributor also pays service fees to dealers for providing
personal services to Class A, B and C shareholders and for maintaining
shareholder accounts. Each fund pays the cost of registering and qualifying
their shares under state and federal securities laws and pays its proportionate
share for typesetting of the prospectus and printing and distributing
prospectuses to existing shareholders.
The Trust has adopted a Distribution Plan for each class of shares on
behalf of each fund (each a "Plan" and collectively the "Plans"). These Plans
permit each fund to pay the Distributor the monthly distribution and service fee
out of the fund's net assets to finance activity that is intended to result in
the sale and retention of Class A shares, Class B shares and Class C shares. The
funds used all Class A and Class C 12b-1 fees to pay the Distributor. The
Distributor, on Class C shares, may retain the first 12 months distribution fee
for reimbursement of amounts paid to the broker-dealer at the time of purchase.
Each Plan was approved by the Board, including a majority of the Trustees who
are not interested persons of a fund (as defined in the 1940 Act) and who have
no direct or indirect financial interest in the operation of the Plan or the
Distribution Agreement. In approving such Plans, the Board determined that there
is a reasonable likelihood that each fund and its shareholders will benefit from
each Plan.
As compensation for services rendered and expenses borne by the
Distributor in connection with the distribution of Class A shares and in
connection with personal services rendered to Class A shareholders and the
maintenance of Class A shareholder accounts, each fund may pay the Distributor
distribution and service fees of up to 0.25% of such fund's average daily net
assets attributable to Class A shares of that fund. Each fund may pay the
Distributor a fee of up to 0.35% of that fund's average daily net assets
attributable to Class A shares purchased prior to April 3, 1995. This fee is
computed daily and paid monthly.
As compensation for services rendered and expenses borne by the
Distributor in connection with the distribution of Class B shares and Class C
shares and in connection with personal services rendered to Class B and Class C
shareholders and the maintenance of Class B and Class C shareholder accounts,
High Yield pays the Distributor a fee of 0.80% and Government pays the
Distributor a fee of 0.60% of the applicable fund's average daily net assets
attributable to Class B shares and Class C shares. This fee is computed daily
and paid monthly.
For the fiscal year ended September 30, 1998 the Distributor received
12b-1 fees in the amount of $124,763 and $42,128 for Class A shares of High
Yield and Government, respectively. For the fiscal year ended September 30,
1998, the Distributor received 12b-1 fees in the amount of $6,165 and $219 for
Class B shares of High Yield and Government, respectively. For the fiscal year
ended September 30, 1998, the Distributor received 12b-1 fees in the amount of
$114,646 and $9,413 for Class C shares of High Yield and Government,
respectively.
In reporting amounts expended under the Plans to the Board, the
Distributor will allocate expenses attributable to the sale of Class A shares,
Class B shares and Class C shares to the applicable class based on the ratio of
sales of shares of that class to the sales of all the classes of shares of the
applicable fund. The fees paid by one class of shares will not be used to
subsidize the sale of any other class of shares.
48
<PAGE>
Each Plan may be terminated by vote of a majority of the Independent
Trustees, or by vote of a majority of the outstanding voting securities of a
class of a fund. The Board reviews quarterly a written report of Plan costs and
the purposes for which such costs have been incurred. A Plan may be amended by
vote of the Board, including a majority of the Independent Trustees cast in
person at a meeting called for such purpose. Any change in a Plan that would
materially increase the distribution cost to a class requires shareholder
approval of that class.
The Distribution Agreement may be terminated at any time on 60 days'
written notice without payment of any penalty by either party. The Trust may
effect such termination by vote of a majority of the outstanding voting
securities of the Trust or by vote of a majority of the Independent Trustees.
For so long as a Plan is in effect, selection and nomination of the Independent
Trustees shall be committed to the discretion of such disinterested persons.
The Distribution Agreement and each Plan will continue in effect for
successive one-year periods, provided that each such continuance is specifically
approved (1) by the vote of a majority of the Independent Trustees and (2) by
the vote of a majority of the entire Board cast in person at a meeting called
for that purpose.
For the three fiscal years ended September 30, 1998, the Distributor
received as compensation for the sale of High Yield A shares $159,739, $216,612
and $134,157, respectively, of which it retained $19,066, $28,693 and $21,438,
respectively. For the same periods, the Distributor received as compensation for
the sale of Government A shares $17,353, $8,937 and $12,451, respectively, of
which it retained $2,577, $1,139 and $3,305, respectively. For the period
January 2, 1998 to September 30, 1998, the Distributor received $774 and $0 of
which it retained the entire amounts for the sale of High Yield Class B and
Government Class B, respectively. For the three fiscal years ended September 30,
1998, the Distributor received $1,011, $4,491 and $6,388, respectively, of which
it retained $1,011, $4,491 and $6,388, respectively, for the sale of High Yield
C shares, and $150, $1,057 and $354, respectively, of which it retained $150,
$1,057 and $354, respectively, for the sale of Government C shares.
ADMINISTRATION OF THE TRUST
- ---------------------------
ADMINISTRATIVE, FUND ACCOUNTING AND TRANSFER AGENT SERVICES. The Manager,
subject to the control of the Board, will manage, supervise and conduct the
administrative and business affairs of the Trust and of each fund; furnish
office space and equipment; oversee the activities of the Subadviser and
Custodian; and pay all salaries, fees and expenses of officers and Trustees of
the Trust who are affiliated with the Manager. The Manager also will provide
certain shareholder servicing activities for customers of the Trust.
The Manager also is the fund accountant and transfer and dividend
disbursing agent for the Trust. The Trust pays the Manager the Manager's cost
plus ten percent for its services as fund accountant and transfer and dividend
disbursing agent.
49
<PAGE>
For the three fiscal years ended September 30, 1998 the Manager earned
approximately $29,201, $28,200 and $33,363, respectively, from Government for
its services as fund accountant. For the same periods the Manager earned
$31,311, $32,320 and $50,573, respectively, from High Yield for its services as
fund accountant.
CUSTODIAN. State Street Bank and Trust Company, P.O. Box 1912, Boston,
Massachusetts 02105, serves as custodian of the Trust's assets. The Custodian
provides portfolio accounting and certain other services.
LEGAL COUNSEL. Kirkpatrick & Lockhart LLP, 1800 Massachusetts Avenue,
N.W., Washington, D.C. 20036, serves as counsel to the Trust.
INDEPENDENT ACCOUNTANTS. PricewaterhouseCoopers LLP, 400 North Ashley
Street, Suite 2800, Tampa, Florida 33602, is the independent accountant for the
Trust. The Financial Statements and Financial Highlights of the funds for the
five fiscal years ended September 30, 1998 that appear in this SAI have been
audited by PricewaterhouseCoopers LLP, and are included herein in reliance upon
the report of said firm of accountants, which is given upon their authority as
experts in accounting and auditing.
POTENTIAL LIABILITY
- -------------------
Under certain circumstances, shareholders may be held personally liable as
partners under Massachusetts law for obligations of the Trust. To protect its
shareholders, the Trust has filed legal documents with Massachusetts that
expressly disclaim the liability of its shareholders for acts or obligations of
the Trust. These documents require notice of this disclaimer to be given in each
agreement, obligation or instrument the Trust or its Trustees enter into or
sign. In the unlikely event a shareholder is held personally liable for the
Trust's obligations, the Trust is required to use its property to protect or
compensate the shareholder. On request, the Trust will defend any claim made and
pay any judgment against a shareholder for any act or obligation of the Trust.
Therefore, financial loss resulting from liability as a shareholder will occur
only if the Trust itself cannot meet its obligations to indemnify shareholders
and pay judgments against them.
50
<PAGE>
APPENDIX
COMMERCIAL PAPER RATINGS
The rating services' descriptions of commercial paper ratings in which the fund
may invest are:
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC. COMMERCIAL PAPER DEBT RATINGS
- ----------------------------------------------------------------------------
PRIME-1. Issuers (or supporting institutions) rated PRIME-1 (P-1) have a
superior ability for repayment of senior short-term debt obligations. P-1
repayment ability will often be evidenced by many of the following
characteristics: leading market positions in well-established industries; high
rates of return on funds employed; conservative capitalization structure with
moderate reliance on debt and ample asset protection; broad margins in earnings
coverage of fixed financial charges and high internal cash generation;
well-established access to a range of financial markets and assured sources of
alternate liquidity.
PRIME-2. Issuers (or supporting institutions) rated PRIME-2 (P-2) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above, but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS
- ---------------------------------------------------------
A-1. This designation indicates that the degree of safety regarding timely
payment is very strong. Those issues determined to possess extremely strong
characteristics are denoted with a plus sign (+) designation.
A-2. Capacity for timely payment of issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1".
CORPORATE DEBT RATINGS
The rating services' descriptions of corporate debt ratings in which the fund
may invest are:
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC. CORPORATE DEBT RATINGS
- ---------------------------------------------------------------------
Aaa - Bonds that are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa - Bonds that are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
A-1
<PAGE>
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present that make the
long-term risks appear somewhat larger than the Aaa securities.
A - Bonds that are rated A possess many favorable investment attributes and are
to be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present that
suggest a susceptibility to impairment sometime in the future.
Baa - Bonds that are rated Baa are considered medium grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba - Bonds that are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B - Bonds that are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa - Bonds that are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca - Bonds that are rated Ca represent obligations that are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C - Bonds that are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the company ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking and the modifier 3
indicates that the company ranks in the lower end of its generic rating
category.
DESCRIPTION OF STANDARD & POOR'S CORPORATE DEBT RATINGS
- -------------------------------------------------------
AAA - Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA - Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
A-2
<PAGE>
A - Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB - Debt rated BBB is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than for debt in higher rated categories.
BB, B, CCC, CC, C - Debt rated "BB," "B," "CCC," "CC," and "C" is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. "BB"
indicates the lowest degree of speculation and "C" the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
BB - Debt rated "BB" has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions that could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
B - Debt rated "B" has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The "B" rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied "BB" or "BB-"
rating.
CCC - Debt rated "CCC" has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial, and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial, or economic conditions, it is not likely to have
the capacity to pay interest and repay principal. The "CCC" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "B" or "B-" rating.
CC - The rating "CC" is typically applied to debt subordinated to senior debt
that is assigned an actual or implied "CCC" rating.
C - The rating "C" is typically applied to debt subordinated to senior debt that
is assigned an actual or implied "CCC-" debt rating. The "C" rating may be used
to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
CI - The rating "CI" is reserved for income bonds on which no interest is being
paid.
D - Debt rated "D" is in payment default. The "D" rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
A-3
<PAGE>
will be made during such grace period. The "D" rating also will be used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
categories.
NR - Indicates that no public rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate a
particular type of obligation as a matter of policy.
A-4
<PAGE>
The Report of the Independent Accounts and Financial Statements are
incorporated herein by reference from the Trust's Annual Report to Shareholders
for the fiscal year ended September 30, 1998, filed with the Securities and
Exchange Commission on November 30, 1998, Accession No. 0000950144-98-013421.
A-5
<PAGE>
<PAGE> 1
(HERITAGE
INCOME
TRUST
LOGO)
[pictures of people working and playing]
From Our Family to Yours: The Intelligent Creation of Wealth.
Intermediate Government Fund
High Yield Bond Fund
Semiannual Report
(Unaudited) and Investment Performance
Review for the Six Month Period Ended
March 31, 1999
(HERITAGE LOGO)
-----------------
INCOME TRUST(TM)
-----------------
<PAGE> 2
May 18, 1999
Dear Fellow Shareholders:
I am pleased to provide you with the semiannual report for the Intermediate
Government Fund and the High Yield Bond Fund (the "Funds"), each a portfolio of
Heritage Income Trust for the six month period ended March 31, 1999. For this
period, the Intermediate Government Fund's performance was -1.32%, -1.57% and
- -1.46% for Class A, B and C shares, respectively.* The High Yield Bond Fund's
performance was +4.27%, +4.02%, and +4.02% for Class A, B and C shares,
respectively.*
Over the long-term, investors have been relatively well-rewarded for taking
the credit risk that is inherent in investing in high yield corporate bond
funds. However, over shorter periods such as during calendar 1998, returns have
shown significant volatility. Government bond fund investors also have earned
reasonably attractive real returns (gross returns less inflation) over the past
several years. The table below presents average annualized returns for your
Funds net of operating expenses and maximum front-end or contingent deferred
sales charges.
<TABLE>
<CAPTION>
INTERMEDIATE GOVERNMENT FUND
- ----------------------------
ONE YEAR THREE YEARS FIVE YEARS LIFE OF CLASS
-------- ----------- ---------- -------------
<S> <C> <C> <C> <C>
Class A........................................ +1.99% +4.76% +4.86% +5.19%(1)
Class B........................................ +1.50 -- -- +1.30(2)
Class C........................................ +5.72 +5.85 -- +6.03(3)
</TABLE>
<TABLE>
<CAPTION>
HIGH YIELD BOND FUND
- --------------------
ONE YEAR THREE YEARS FIVE YEARS LIFE OF CLASS
-------- ----------- ---------- -------------
<S> <C> <C> <C> <C>
Class A........................................ -4.25% +6.89% +6.74% +8.55%(1)
Class B........................................ -4.95 -- -- -3.19(2)
Class C........................................ -1.03 +7.73 -- +8.33(3)
</TABLE>
(1) Inception Date March 1, 1990
(2) Inception Date February 2, 1998
(3) Inception Date April 3, 1995
In the letters that follow, Peter Wallace and Peter Wilby, the portfolio
managers for the Intermediate Government and High Yield Bond Funds,
respectively, provide investment commentaries for their portfolios. I hope you
find their comments helpful in better understanding how your portfolios have
performed over the recent reporting period.
On behalf of all of us at Heritage, thank you for your continuing
investments in the portfolios of Heritage Income Trust. If there are ever any
ideas you would like to share with us about how we could better serve you,
please let us know by calling (800) 709-3863.
Sincerely,
/s/ STEPHEN G. HILL
Stephen G. Hill
President
* These returns are calculated without the imposition of either front-end or
contingent deferred sales charges.
<PAGE> 3
April 30, 1999
Dear Fellow Shareholders:
The six month period ended March 31, 1999 was a difficult period for the
U.S. Bond markets. The Heritage Income Trust-Intermediate Government Fund Class
A Shares produced a return of -1.32%*, compared to the Lehman Brothers
Intermediate Government/Corporate Index return of +0.11%. The Fund performed
slightly better than the -1.70% that would have been generated by an investment
in the generic five year Treasury bond.
Over the last twelve months, the Fund's Class A Shares produced a total
return of 5.97%** compared to the Lehman Brothers Intermediate
Government/Corporate Index return of 6.57%. Among its peer group the Fund ranked
29 of 128 Intermediate U.S. Government Income Funds measured by Lipper and
exceeded the objective average return of 5.44%.**
Over the last six months, yields on fixed income securities generally moved
sharply higher as fears of global recession and financial disruptions waned.
This is quite surprising since during this period the Federal Reserve eased
monetary policy by fifty basis points by twice lowering the Federal Funds Rate
and Discount Rate (three times if we count the twenty-five basis point reduction
of Fed Fund's on September 29, 1998).
In fact, many of the factors responsible for driving yields sharply lower
during the third quarter of 1998 were completely reversed during the period. The
global financial crisis appeared to ease as central banks injected liquidity to
calm distressed markets. A financial debacle was avoided as the Federal Reserve
engineered a rescue of a failing hedge fund, Long Term Capital Management, by
the funds creditors.
The Fed added significant liquidity to the financial system to offset
emerging market problems, and the International Monetary Fund was successful at
stemming defaults and near defaults from several developing nations. These
factors, coupled with a strengthening economy and surging stock markets, quickly
restored investor confidence in corporate and international bond markets and the
"flight to quality" of mid-summer was reversed. Investors sold high quality
Treasury and Agency bonds to once again invest in riskier types of securities.
This, along with fears of renewed inflation and a much stronger domestic economy
(fourth quarter 1998 GDP was +6.0%) all added to move interest rates sharply
higher.
The following Table shows the changes in Treasury yields over the last six
months and the returns that were generated by each maturity segment.
US TREASURY YIELDS AND RETURNS
<TABLE>
<CAPTION>
9/30/98 3/31/99 CHANGE RETURNS
------- ------- ------ -------
<S> <C> <C> <C> <C>
3 month................................................. 4.36% 4.47% 0.11% 2.25%
6 month................................................. 4.47 4.52 0.06 2.28
1 year.................................................. 4.39 4.71 0.31 2.00
5 year.................................................. 4.22 5.10 0.88 -1.70
10 year................................................. 4.41 5.23 0.82 -4.09
30 year................................................. 4.97 5.62 0.66 -8.33
</TABLE>
Source: Bloomberg; Lehman Bros.
Fearing a resumption of widening yield spreads on non-Treasury investments,
the Fund maintained a high exposure to Treasury securities and a very light
exposure to mortgage securities. This strategy, which had benefited the Fund in
the prior period, penalized relative performance in the current period as yield
spreads continued to narrow.
We feel the bond market still offers excellent relative value as yields have
moved sharply higher without a comparable rise in inflation. This increases the
"real yield", nominal yield less inflation, to better than its long term
average.
In the near term, we believe the bond market will continue to exhibit high
levels of volatility until we see some signs of a softening economy.
Strategically we plan to remain at or slightly below market sensitivity until we
see some evidence of a slowing in economic activity.
Thanks for your continued confidence in the Intermediate Government Fund.
Sincerely,
/s/ H. PETER WALLACE
H. Peter Wallace, CFA
Senior Vice President
Heritage Asset Management, Inc.
Portfolio Manager, Intermediate
Government Fund
* These returns are calculated without the imposition of either front-end or
contingent deferred sales charges.
**Lipper Analytical Services, Inc. performance rankings for the Heritage Income
Trust Intermediate Government Fund Class A Shares were 29 out of 128
Intermediate U.S. Government Funds, for the one year period ended March 31,
1999. The performance numbers used for the Fund did not take into account any
front- or back-end sales charges. See the previous letter by Steven G. Hill
for a full statement of returns since inception. Past performance is no
guarantee of future results.
2
<PAGE> 4
May 3, 1999
Dear Shareholders:
During the six months ended March 31, 1999, the Heritage Income
Trust -- High Yield Bond Fund Class A, B and C shares rose 4.27%, 4.02%, and
4.02%, respectively.* This compares with the Salomon Smith Barney High Yield
Market Index, which rose 5.05%, and the Lipper High Current Yield Category,
which increased 5.74%, for the same period.
The U.S. high yield market has rebounded strongly from the global credit
crunch experienced last fall, which was brought on by fundamental problems in
Japan, Russia and Southeast Asia. This recovery began with the Federal Reserve
Board's surprise easing of the Funds Rate in mid-October and has continued as
strong U.S. economic growth continues. Except for a brief contraction in
February following Brazil's currency devaluation, the market has consistently
moved higher. This positive momentum has been fueled by a number of fundamental
and technical factors including:
1. A strong US economy;
2. Rumored and announced acquisitions;
3. Equity indices reaching historic highs;
4. Demand for high yield paper from both retail and institutional
investors;
5. A lighter-than-anticipated new issue calendar;
6. A rebound in energy prices; and,
7. More stability in global markets.
According to the Salomon Smith Barney High Yield Market Index, the average
market yield at March 31, 1999 was 10.28%, unchanged from year-end and down from
10.67% at September 30, 1998. The yield premium over Treasuries finished the
period at 5.11%, narrowing from 5.66% at year-end and 6.30% at September 30,
1998.
Both demand for and new supply of high yield products have picked up since
last fall given the market's stabilization and the return of investor appetite
for yield. However, new issue supply has been less than anticipated and investor
demand has been disciplined, with weaker deals being canceled. These trends have
been healthy for the market.
The worst performing industry by far during the six month period was
Healthcare, due to difficulties transitioning to the newly imposed PPS Medicare
reimbursement system. In addition, despite stellar performance during March on
news that OPEC had reached an agreement to cut oil supply, the Energy sector
landed as one of the worst performers on a quarterly basis. Textile/Apparel and
Transportation also under performed with cheaper imports hurting the former and
over capacity hurting the latter.
The Fund trailed the Index during the period. This was partially due to
underweightings in Telecommunications and Paper Products and an overweighting in
Transportation. In addition, several individual holdings in Energy, Healthcare,
and Electronics have dragged down the Fund's performance. The Fund did benefit
from its over-weighting in Broadcasting, Leisure/Amusement and Retail.
During the last six months, the Fund's industry allocations remained
relatively unchanged. The most substantial modifications were to decrease
weightings in Oil and Gas and Telecommunications. Oil and Gas was decreased by
selling bonds of the higher risk exploration & production and services
companies, as depressed oil and gas prices started to have an impact on the
liquidity of more levered companies.
In addition, Telecommunications was reduced as we believe the risks of these
new technologies and build outs exceed the potential fixed-income returns. In
contrast, exposure in the Broadcasting, Leisure/Amusement, and Consumer Products
sectors was increased during the period due to our attraction to stability in
earnings.
Our outlook for the high yield market remains positive given current
valuations. Our focus is to maintain a core portfolio of better quality, more
liquid credits while taking advantage of opportunities in selected companies
where fundamentals are solid but technicals have created compelling risk/return
situations.
Best regards,
/s/ PETER J. WILBY
Peter J. Wilby
Managing Director
Salomon Brothers Asset Management Inc
Portfolio Manager, High Yield Bond
Fund
* These returns are calculated without the imposition of either front-end or
contingent deferred sales charges.
3
<PAGE> 5
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
INTERMEDIATE GOVERNMENT FUND
INVESTMENT PORTFOLIO
MARCH 31, 1999
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL MATURITY MARKET
AMOUNT DATE VALUE
--------- ---------- -----------
<C> <S> <C> <C>
U.S. GOVERNMENT AND AGENCY SECURITIES--93.5%(A)
- ---------------------------------------------------------------------------------
U.S. TREASURIES--80.3%(A)
$2,300,000 U.S. Treasury Notes, 4.5%................................... 09/30/00 $ 2,282,750
1,000,000 U.S. Treasury Notes, 6.25%.................................. 01/31/02 1,029,063
1,000,000 U.S. Treasury Notes, 5.875%................................. 09/30/02 1,022,188
1,000,000 U.S. Treasury Notes, 5.75%.................................. 11/30/02 1,018,438
1,000,000 U.S. Treasury Notes, 5.5%................................... 02/28/03 1,010,313
2,300,000 U.S. Treasury Notes, 5.25%.................................. 08/15/03 2,305,032
2,300,000 U.S. Treasury Notes, 4.75%.................................. 02/15/04 2,264,783
1,000,000 U.S. Treasury Notes, 5.625%................................. 05/15/08 1,018,125
-----------
Total U.S. Treasuries (cost $12,053,734).................... 11,950,692
-----------
U.S. GOVERNMENT AGENCIES--13.2%(A)
- ---------------------------------------------------------------------------------
FEDERAL NATIONAL MORTGAGE ASSOCIATION--13.2%
987,771 Pool #481349, 30 year Pass-Through, 6.5%.................... 01/01/29 983,371
988,355 Pool #459881, 30 year Pass-Through, 6.5%.................... 01/01/29 983,952
-----------
Total U.S. Government Agencies (cost $1,961,838)............ 1,967,323
-----------
Total U.S. Government and Agency Securities (cost
$14,035,572)................................................ 13,918,015
-----------
REPURCHASE AGREEMENT--3.6%(A)
- ---------------------------------------------------------------------------------
Repurchase Agreement with State Street Bank and Trust Company, dated March 31,
1999 @ 4.78% to be repurchased at $533,071 on April 1, 1999, collateralized by
$490,000 United States Treasury Bonds, 6.5% due November 15, 2026, (market value
$543,539 including interest) (cost $533,000)..................................... 533,000
-----------
TOTAL INVESTMENT PORTFOLIO (cost $14,568,572)(b), 97.1%(a)....................... 14,451,015
OTHER ASSETS AND LIABILITIES, net, 2.9%(a)....................................... 431,920
-----------
NET ASSETS, 100.0%............................................................... $14,882,935
===========
</TABLE>
- ---------------
(a) Percentages indicated are based on net assets.
(b) The aggregate identified cost for federal income tax purposes is
substantially the same. Market value includes net unrealized depreciation of
$117,557, which consists of aggregate gross unrealized appreciation for all
securities in which there is an excess of market value over tax cost of
$89,815 and aggregate gross unrealized depreciation for all securities in
which there is an excess of tax cost over market value of $207,372.
The accompanying notes are an integral part of the financial statements.
4
<PAGE> 6
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
HIGH YIELD BOND FUND
INVESTMENT PORTFOLIO
MARCH 31, 1999
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
--------- ------
<C> <S> <C>
DOMESTIC CORPORATE BONDS -- 88.4%(A)
------------------------------------------
AEROSPACE -- 0.8%
------------------------------------------
$500,000 Stellex Industries, Inc.,
9.5%, 11/01/07............... $ 450,000
-----------
AUTO PARTS/EQUIPMENT -- 2.3%
------------------------------------------
500,000 American Axle & Manufacturing
Holdings, Inc., 9.75%,
03/01/09..................... 511,250
250,000 Hayes Lemmerz International,
Inc., 8.25%, 12/15/08........ 250,000
500,000 JH Heafner Company, 10.0%,
05/15/08..................... 511,250
-----------
1,272,500
-----------
AUTO RENTAL/SERVICE -- 0.9%
------------------------------------------
500,000 Apcoa Inc., 9.25%,
03/15/08..................... 470,000
-----------
BEVERAGES -- 1.4%
------------------------------------------
250,000 Delta Beverage Group, Inc.,
9.75%, 12/15/03.............. 260,000
500,000 Stroh Brewery Company, 11.1%,
07/01/06..................... 500,000
-----------
760,000
-----------
BROADCASTING -- 10.8%
------------------------------------------
250,000 Adelphia Communications
Corporation, 10.5%,
07/15/04..................... 277,500
250,000 Adelphia Communications
Corporation, 9.875%,
03/01/07..................... 272,500
500,000 Chancellor Media Corporation,
9.375%, 10/01/04............. 521,250
1,000,000 Charter Communications
Holdings, LLC, 0% to
04/01/04, 9.92% to
maturity(b), 04/01/11........ 645,000
500,000 CSC Holdings Inc., 10.5%,
05/15/16..................... 595,000
500,000 Falcon Holdings Group, L.P.,
8.375%, 04/15/10............. 502,500
500,000 Granite Broadcasting, 8.875%,
05/15/08..................... 500,000
500,000 Jacor Communications, Inc.,
9.75%, 12/15/06.............. 550,000
500,000 LIN Television Corporation,
8.375%, 03/01/08............. 499,375
500,000 Mediacom LLC Capital, 8.5%,
04/15/08..................... 508,750
329,000 SFX Broadcasting, Inc.,
10.75%, 05/15/06............. 363,545
1,100,000 United International
Holdings, 0% to 02/15/03,
10.75% to maturity(b),
02/15/08..................... 746,625
-----------
5,982,045
-----------
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
--------- ------
<C> <S> <C>
BUILDING -- 0.9%
------------------------------------------
500,000 Panolam Industries
International, 11.5%,
02/15/09..................... 512,500
-----------
CHEMICALS -- 1.8%
------------------------------------------
500,000 Equistar Chemicals, L.P.,
8.75%, 02/15/09.............. 508,934
500,000 Philipp Brothers Chemicals,
9.875%, 06/01/08............. 490,000
-----------
998,934
-----------
CONGLOMERATES/DIVERSIFIED -- 1.1%
------------------------------------------
1,000,000 Jordan Industries, 0% to
04/01/02, 11.75% to
maturity(b), 04/01/09........ 610,000
-----------
CONTAINERS -- 1.9%
------------------------------------------
500,000 Plastic Containers, Inc.,
10.0%, 12/15/06.............. 530,000
250,000 Radnor Holdings, Inc., 10.0%,
12/01/03..................... 261,250
250,000 Radnor Holdings, Inc., Series
"B", 10.0%, 12/01/03......... 261,250
-----------
1,052,500
-----------
COSMETICS/TOILETRIES -- 2.1%
------------------------------------------
350,000 French Fragrances, Inc.,
10.375%, 05/15/07............ 353,500
500,000 Jafra Cosmetics
International, Inc., 11.75%,
05/01/08..................... 446,250
600,000 Revlon Worldwide Corporation,
Zero Coupon Bond, 03/15/01... 360,000
-----------
1,159,750
-----------
ELECTRONICS/ELECTRIC -- 2.8%
------------------------------------------
500,000 Amphenol Corporation, 9.875%,
05/15/07..................... 520,000
500,000 Axiohm Transaction Solutions,
Inc., 9.75%, 10/01/07........ 453,750
250,000 DecisionOne Corporation,
9.75%, 08/01/07.............. 17,500
500,000 DecisionOne Holdings
Corporation, 0% to 8/1/02,
11.5% to maturity(b),
08/01/08..................... 15,000
500,000 L-3 Communications
Corporation, 10.375%,
05/01/07..................... 550,000
-----------
1,556,250
-----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
5
<PAGE> 7
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
HIGH YIELD BOND FUND
INVESTMENT PORTFOLIO
MARCH 31, 1999
(UNAUDITED)
(CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
--------- ------
<C> <S> <C>
FINANCE--3.5%
-------------------------------------------------------
$500,000 Airplane Pass Through Trust,
Class "D", 10.875%,
03/15/19..................... $ 497,695
250,000 ContiFinancial Corporation,
7.50%, 03/15/02.............. 192,500
250,000 ContiFinancial Corporation,
8.125%, 04/01/08............. 181,250
125,000 ContiFinancial Corporation,
8.375%, 08/15/03............. 96,250
500,000 DVI, Inc., 9.875%,
02/01/04..................... 486,250
500,000 Morgan Stanley Aircraft
Finance, 8.7%, 03/15/23...... 451,335
-----------
1,905,280
-----------
FOOD--4.9%
------------------------------------------
250,000 B&G Foods, Inc., 9.625%,
08/01/07..................... 242,500
500,000 Carr-Gottstein Foods Company,
12.0%, 11/15/05.............. 575,625
500,000 CFP Holdings, Inc., 11.625%,
01/15/04..................... 417,500
500,000 Imperial Holly Corporation,
9.75%, 12/15/07.............. 503,750
700,000 Nebco Evans Holding
Corporation, 0% to 07/15/02,
12.375% to maturity(b),
07/15/07..................... 245,000
250,000 Purina Mills, Inc., 9.0%,
03/15/10..................... 203,750
500,000 SC International Services,
Inc., 9.25%, 09/01/07........ 540,000
-----------
2,728,125
-----------
GRAPHIC ARTS--0.9%
-------------------------------------------------------
250,000 Mail-Well Corporation, 8.75%,
12/15/08..................... 256,250
250,000 World Color Press, Inc.,
8.375%, 11/15/08............. 256,250
-----------
512,500
-----------
HEALTH CARE CENTERS--0.5%
-------------------------------------------------------
400,000 Graham-Field Health Products,
Inc., 9.75%, 08/15/07........ 228,000
375,000 Vencor, Inc., 9.875%,
05/01/05..................... 60,000
-----------
288,000
-----------
HOTELS/MOTELS/INNS--1.8%
-------------------------------------------------------
500,000 HMH Properties, Inc., Series
"B", 7.875%, 08/01/08........ 481,250
500,000 Prime Hospitality
Corporation, 9.75%,
04/01/07..................... 515,000
-----------
996,250
-----------
HOUSEHOLD PRODUCTS--1.9%
-------------------------------------------------------
500,000 Ekco Group, Inc., 9.25%,
04/01/06..................... 511,250
500,000 Shop Vac Corporation,
10.625%, 09/01/03............ 542,500
-----------
1,053,750
-----------
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
--------- ------
<C> <S> <C>
JEWELRY/SILVERWARE/TIME PIECES/CHINA--0.8%
-------------------------------------------------------
500,000 Finlay Enterprises, Inc.,
9.0%, 05/01/08............... 470,000
-----------
LEISURE/AMUSEMENT--3.7%
------------------------------------------
500,000 Empress Entertainment,
8.125%, 07/01/06............. 497,500
500,000 Hollywood Park Inc., 9.25%,
02/15/07..................... 513,750
500,000 Park Place Entertainment
Corporation, 7.875%,
12/15/05..................... 490,000
500,000 Waterford Gaming, LLC, 9.5%,
03/15/10..................... 511,875
-----------
2,013,125
-----------
MANUFACTURING/DISTRIBUTIONS--9.2%
------------------------------------------
350,000 Alvey Systems, Inc., 11.375%,
01/31/03..................... 353,500
500,000 Breed Technologies Inc.,
9.25%, 04/15/08.............. 215,000
500,000 Foamex, L.P., 9.875%,
06/15/07..................... 475,000
500,000 Furon Company, 8.125%,
03/01/08..................... 490,000
250,000 Hexcel Corporation, 9.75%,
01/15/09..................... 252,813
500,000 High Voltage Engineering
Group, 10.5%, 08/15/04....... 468,375
325,000 Hines Horticulture, Inc.,
11.75%, 10/15/05............. 351,000
500,000 Indesco International, Inc.,
9.75%, 04/15/08.............. 422,500
500,000 International Knife & Saw,
11.375%, 11/15/06............ 506,250
500,000 Polymer Group, Inc., 9.0%,
07/01/07..................... 506,250
500,000 Simmons Company 10.25%,
03/15/09..................... 517,500
500,000 True Temper Sports Inc.,
10.875%, 12/01/08............ 462,500
-----------
5,020,688
-----------
MEDICAL EQUIPMENT/SUPPLY--4.4%
------------------------------------------
500,000 Fresenius Medical Care, 9.0%
12/01/06..................... 515,000
350,000 Kinetic Concepts, Inc,
Series "B", 9.625%,
11/01/07..................... 337,750
500,000 Maxxim Medical, Inc., 10.5%,
08/01/06..................... 532,500
500,000 Packard Bioscience Company,
9.375%, 03/01/07............. 483,750
500,000 Prime Medical Services, Inc.,
8.75%, 04/01/08.............. 487,500
-----------
2,356,500
-----------
METAL--1.9%
------------------------------------------
500,000 Neenah Corporation, Series
"D", 11.125%, 05/01/07....... 526,250
500,000 Renco Metals Inc., 11.5%,
07/01/03..................... 520,000
-----------
1,046,250
-----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
6
<PAGE> 8
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
HIGH YIELD BOND FUND
INVESTMENT PORTFOLIO
MARCH 31, 1999
(UNAUDITED)
(CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
--------- ------
<C> <S> <C>
MINING/DIVERSIFIED--0.9%
------------------------------------------
$500,000 P&L Coal Holdings
Corporation, 8.875%,
05/15/08..................... $ 521,875
-----------
OIL & GAS--2.1%
------------------------------------------
500,000 Benton Oil & Gas Company,
11.625%, 05/01/03............ 330,000
500,000 Clark R&M, Inc., 8.875%,
11/15/07..................... 420,000
250,000 Costilla Energy, Inc.,
10.25%, 10/01/06............. 171,250
500,000 Dailey International, Inc.,
9.5%, 02/15/08............... 160,000
375,000 Transamerican Energy
Corporation, 0% to 06/15/99,
13.0% to maturity(b),
06/15/02..................... 78,750
-----------
1,160,000
-----------
PLASTIC/PRODUCTS--1.0%
------------------------------------------
500,000 Berry Plastics Corporation,
12.25%, 04/15/04............. 527,500
-----------
POLLUTION CONTROL--2.4%
------------------------------------------
500,000 Allied Waste North America,
Inc., 7.875%, 01/01/09....... 489,375
375,000 Envirosource, Inc., 9.75%,
06/15/03..................... 300,000
500,000 Safety Kleen Services, 9.25%,
06/01/08..................... 522,500
-----------
1,311,875
-----------
PUBLISHING--3.8%
------------------------------------------
500,000 Advanstar Communications,
9.25%, 05/01/08.............. 517,500
500,000 American Media Operation,
Inc., 11.625%, 11/15/04...... 540,000
500,000 Big Flower Press Holdings,
Inc., 8.875%, 07/01/07....... 507,500
500,000 Hollinger International
Publishing, 9.25%,
03/15/07..................... 522,500
-----------
2,087,500
-----------
REAL ESTATE/LAND DEVELOPMENT--0.9%
------------------------------------------
500,000 Forest City Enterprises,
Inc., 8.5%, 03/15/08......... 502,500
-----------
RETAIL STORES--4.2%
------------------------------------------
500,000 Cole National Group, 9.875%,
12/31/06..................... 517,500
500,000 Jitney Jungle Stores, 12.0%,
03/01/06..................... 555,000
500,000 Leslie's Poolmart, 10.375%,
07/15/04..................... 521,250
500,000 Musicland Group, 9.0%,
06/15/03..................... 505,000
250,000 Pueblo Xtra International,
9.5%, 08/01/03............... 241,875
-----------
2,340,625
-----------
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
--------- ------
<C> <S> <C>
SERVICES--5.9%
------------------------------------------
500,000 Comforce Operating, Inc.,
12.0%, 12/01/07.............. 492,500
250,000 Federal Data Corporation,
10.125%, 08/01/05............ 245,312
250,000 Iron Mountain, Inc., 10.125%,
10/01/06..................... 268,750
500,000 Kindercare Learning Centers,
Inc., 9.5%, 02/15/04......... 502,500
500,000 Loomis Fargo & Company,
10.0%, 01/15/04.............. 495,000
250,000 Pierce Leahy Corporation,
11.125%, 07/15/09............ 278,125
500,000 Protection One Alarm
Monitoring, Inc., 8.125%,
07/15/09..................... 510,000
500,000 Sitel Corporation, 9.25%,
03/15/06..................... 475,000
-----------
3,267,187
-----------
TELECOMMUNICATIONS--4.7%
------------------------------------------
500,000 Facilicom International,
10.5%, 01/15/08.............. 395,000
250,000 GST Telecommunications, 0% to
10/31/02, 10.5% to
maturity(b) 05/01/08......... 131,250
250,000 Intermedia Communications,
Inc., 8.6%, 06/01/08......... 250,000
1,000,000 International CableTel, Inc.,
0% to 02/01/01, 11.5% to
maturity(b), 02/01/06,....... 870,000
500,000 Jordan Telecom Products, 0%
to 08/01/00, 11.75% to
maturity(b) 08/01/07......... 407,500
750,000 Nextel Communications, Inc.,
0% to 10/31/02, 9.75% to
maturity(b), 10/31/07........ 525,000
-----------
2,578,750
-----------
TOBACCO--0.9%
------------------------------------------
500,000 North Atlantic Trading
Company, 11.0%, 06/15/04..... 502,500
-----------
TRANSPORTATION--1.3%
------------------------------------------
375,000 Coach USA Inc., Series "B",
9.375%, 07/01/07............. 391,875
500,000 Holt Group, 9.75%,
01/15/06..................... 340,625
-----------
732,500
-----------
Total Domestic Corporate Bonds (cost
$51,985,703)............................ 48,747,759
-----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
7
<PAGE> 9
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
HIGH YIELD BOND FUND
INVESTMENT PORTFOLIO
MARCH 31, 1999
(UNAUDITED)
(CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
--------- ------
<C> <S> <C>
FOREIGN CORPORATE BONDS -- 6.4%(A)(C)
-------------------------------------------------------
BROADCASTING -- 1.3%
------------------------------------------
$250,000 Diamond Cable Communications,
PLC, 0% to 12/15/00, 11.75%
to maturity(b), 12/15/05..... $ 220,938
500,000 Rogers Communications, Inc.,
8.875%, 07/15/07............. 521,250
-----------
742,188
-----------
HOTELS/MOTELS/INNS -- 0.9%
------------------------------------------
500,000 Sun International Hotels,
Ltd., 8.625%, 12/15/07....... 512,500
-----------
MANUFACTURING DISTRIBUTIONS -- 0.9%
------------------------------------------
500,000 International Utility
Structures, Inc., 10.75%,
02/01/08..................... 509,375
-----------
MINING/DIVERSIFIED -- 0.8%
------------------------------------------
500,000 Murrin Murrin Holdings
Property, 9.375%, 08/31/07... 455,000
-----------
PAPER/PRODUCTS -- 0.8%
------------------------------------------
500,000 Miller Western Forest,
9.875%, 05/15/08............. 445,000
-----------
SHIPPING/SHIPBUILDING -- 0.6%
------------------------------------------
500,000 Enterprises Shipholding,
8.875%, 05/01/08............. 320,000
-----------
TELECOMMUNICATIONS -- 0.6%
------------------------------------------
350,000 Telewest Communications PLC,
0% to 10/01/00, 11.0% to
maturity(b) 10/01/07......... 308,000
-----------
TRANSPORTATION -- 0.5%
------------------------------------------
250,000 Stena Line AB, 10.5%,
12/15/05 250,000
-----------
Total Foreign Corporate Bonds
(cost $3,817,693)....................... 3,542,063
-----------
52,289,822
Total investment portfolio excluding
repurchase agreement (cost
$55,803,396)(d), 94.8%(a)...............
</TABLE>
<TABLE>
<CAPTION>
MARKET
VALUE
------
<C> <S> <C>
REPURCHASE AGREEMENT -- 3.1%(A)
-------------------------------------------------------
Repurchase Agreement with State Street
Bank and Trust Company, dated March 31,
1999 @ 4.78% to be repurchased at
$1,702,226 on April 1, 1999,
collateralized by $1,565,000 United States
Treasury Bonds, 6.5% due November 15, 2026
(market value $1,735,997 including
interest)(cost $1,702,000)................ 1,702,000
-----------
TOTAL INVESTMENT PORTFOLIO (cost
$57,505,396)(d), 97.9%(a)............... 53,991,822
OTHER ASSETS AND LIABILITIES, net,
2.1%(a)................................. 1,159,396
-----------
NET ASSETS, 100.0%........................ $55,151,218
===========
</TABLE>
- ---------------
(a) Percentages are based on net assets.
(b) Bonds reset to applicable coupon rate at a future date.
(c) Denominated in U.S. dollars.
(d) The aggregate identified cost for federal income tax purposes is
substantially the same. Market value includes net unrealized depreciation of
$3,513,574, which consists of aggregate gross unrealized appreciation for
all securities in which there is an excess of market value over tax cost of
$864,789 and aggregate gross unrealized depreciation for all securities in
which there is an excess of tax cost over market value of $4,378,363.
The accompanying notes are an integral part of the financial statements.
8
<PAGE> 10
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1999
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
INTERMEDIATE HIGH YIELD
GOVERNMENT FUND BOND FUND
--------------- -----------
<S> <C> <C>
Assets
- ------------------------------------------------------------
Investments, at market value (identified cost $14,035,572
and $55,803,396, respectively) (Note 1)................... $13,918,015 $52,289,822
Repurchase agreement (identified cost $533,000 and
$1,702,000, respectively) (Note 1)........................ 533,000 1,702,000
Cash........................................................ 90 381
Receivables:
Investments sold.......................................... -- 55,550
Fund shares sold.......................................... 390,367 126,980
From Manager.............................................. 30,939 --
Dividends and interest.................................... 95,511 1,288,078
Deferred state qualification expenses (Note 1).............. 20,621 21,371
Prepaid insurance........................................... 1,953 3,249
----------- -----------
Total Assets........................................ $14,990,496 $55,487,431
----------- -----------
Liabilities
- ------------------------------------------------------------
Payables (Note 4):
Investments purchased..................................... $ -- $ 54,962
Fund shares redeemed...................................... 60,533 125,101
Accrued management fee.................................... -- 76,578
Accrued distribution fee.................................. 4,483 20,509
Other accrued expenses.................................... 42,545 59,063
----------- -----------
Total Liabilities................................... $ 107,561 $ 336,213
----------- -----------
Net assets, at market value................................. $14,882,935 $55,151,218
=========== ===========
Net Assets
- ------------------------------------------------------------
Net assets consist of:
Paid-in capital........................................... $21,247,840 $58,924,386
Undistributed net investment income (Note 1).............. 658,089 419,639
Accumulated net realized loss (Notes 1 and 5)............. (6,905,437) (679,233)
Net unrealized depreciation on investments................ (117,557) (3,513,574)
----------- -----------
Net assets, at market value................................. $14,882,935 $55,151,218
=========== ===========
Net assets, at market value
Class A Shares............................................ $12,414,756 $38,649,388
Class B Shares............................................ 339,211 2,825,550
Class C Shares............................................ 2,128,968 13,676,280
----------- -----------
Total............................................... $14,882,935 $55,151,218
=========== ===========
Shares of beneficial interest outstanding
Class A Shares............................................ 1,326,965 3,970,528
Class B Shares............................................ 36,379 291,654
Class C Shares............................................ 228,167 1,411,663
----------- -----------
Total............................................... 1,591,511 5,673,845
=========== ===========
Net Asset Value -- offering and redemption price per share
(Notes 1 and 2)
Class A Shares............................................ $9.36 $9.73
=========== ===========
Maximum offering price per share (100/96.25 of $9.36 and
$9.73, respectively)................................... $9.72 $10.11
=========== ===========
Class B Shares............................................ $9.32 $9.69
=========== ===========
Class C Shares............................................ $9.33 $9.69
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
9
<PAGE> 11
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
STATEMENT OF OPERATIONS
FOR THE SIX MONTH PERIOD ENDED MARCH 31, 1999
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
INTERMEDIATE HIGH YIELD
GOVERNMENT FUND BOND FUND
--------------- -----------
<S> <C> <C>
Investment Income
- ------------------------------------------------------------
Income:
Interest.................................................. $ 411,976 $ 2,789,195
Expenses (notes 1 and 4):
Management fee............................................ 39,454 163,010
Distribution fee (Class A Shares)......................... 20,229 55,237
Distribution fee (Class B Shares)......................... 699 8,932
Distribution fee (Class C Shares)......................... 7,987 53,257
Professional fees......................................... 22,093 23,570
Custodian/Fund accounting fees............................ 23,544 36,331
State qualification expenses.............................. 16,157 17,037
Reports to shareholders................................... 6,521 12,133
Shareholder servicing fees................................ 6,109 18,138
Trustees' fees and expenses............................... 5,194 4,905
Insurance................................................. 1,015 1,689
Other..................................................... 89 356
---------- -----------
Total expenses before waiver and reimbursement...... 149,091 394,595
Fees waived by Manager (Note 4)..................... (39,454) (32,617)
Reimbursement from Manager.......................... (32,989) --
---------- -----------
Total expenses after waiver and reimbursement....... 76,648 361,978
---------- -----------
Net investment income....................................... 335,328 2,427,217
---------- -----------
Realized and Unrealized Gain (Loss) on Investments
- ------------------------------------------------------------
Net realized gain (loss) from investment transactions....... 190,209 (679,709)
Net increase (decrease) in unrealized appreciation of
investments during the period............................. (758,057) 490,539
---------- -----------
Net loss on investments............................. (567,848) (189,170)
---------- -----------
Net increase (decrease) in net assets resulting from
operations................................................ $ (232,520) $ 2,238,047
========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
10
<PAGE> 12
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE SIX
MONTH PERIOD
ENDED FOR THE
MARCH 31, 1999 YEAR ENDED
INTERMEDIATE GOVERNMENT FUND (UNAUDITED) SEPTEMBER 30, 1998
- ---------------------------- -------------- ------------------
<S> <C> <C>
Increase (decrease) in net assets:
Operations:
Net investment income..................................... $ 335,328 $ 748,165
Net realized gain on investment transactions.............. 190,209 280,582
Net increase (decrease) in unrealized appreciation of
investments during the period........................... (758,057) 585,698
----------- -----------
Net increase (decrease) in net assets resulting from
operations.............................................. (232,520) 1,614,445
Distributions to shareholders from:
Net investment income Class A Shares, ($0.21 and $0.49 per
share, respectively).................................... (291,077) (694,550)
Net investment income Class B Shares, ($0.20 and $0.26*
per share, respectively)................................ (4,535) (1,541)
Net investment income Class C Shares, ($0.20 and $0.47 per
share, respectively).................................... (64,678) (72,672)
Increase (decrease) in net assets from Fund share
transactions (Note 2)..................................... (2,301,833) 2,061,901
----------- -----------
Increase (decrease) in net assets........................... (2,894,643) 2,907,583
Net assets, beginning of period............................. 17,777,578 14,869,995
----------- -----------
Net assets, end of period (including undistributed net
investment income of $658,089 and $683,051,
respectively)............................................. $14,882,935 $17,777,578
=========== ===========
FOR THE SIX
MONTH PERIOD
ENDED FOR THE
MARCH 31, 1999 YEAR ENDED
High Yield Bond Fund (UNAUDITED) SEPTEMBER 30, 1998
- ------------------------------------------------------------ ----------- -----------
Increase (decrease) in net assets:
Operations:
Net investment income..................................... $ 2,427,217 $ 4,818,000
Net realized gain (loss) on investment transactions....... (679,709) 761,512
Net increase (decrease) in unrealized appreciation of
investments during the period........................... 490,539 (5,944,103)
----------- -----------
Net increase (decrease) in net assets resulting from
operations.............................................. 2,238,047 (364,591)
Distributions to shareholders from:
Net investment income Class A Shares, ($0.45 and $0.89 per
share, respectively).................................... (1,787,403) (3,625,981)
Net investment income Class B Shares, ($0.42 and $0.48*
per share, respectively)................................ (93,516) (55,927)
Net investment income Class C Shares, ($0.42 and $0.84 per
share, respectively).................................... (578,465) (1,143,752)
Increase in net assets from Fund share transactions (Note
2)........................................................ 611,434 5,333,666
----------- -----------
Increase in net assets...................................... 390,097 143,415
Net assets, beginning of period............................. 54,761,121 54,617,706
----------- -----------
Net assets, end of period (including undistributed net
investment income of $419,639 and $451,806,
respectively)............................................. $55,151,218 $54,761,121
=========== ===========
</TABLE>
- ---------------
* For the period February 2, 1998 (commencement of Class B Shares) to September
30, 1998.
The accompanying notes are an integral part of the financial statements.
11
<PAGE> 13
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST-INTERMEDIATE GOVERNMENT FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The following table includes selected data for a share outstanding
throughout each period and other performance information derived from the
financial statements.
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
------------------------------------------------------------ --------------------------------
FOR THE SIX FOR THE SIX
MONTH PERIOD MONTH PERIOD
ENDED FOR THE YEARS ENDED SEPTEMBER 30, ENDED
MARCH 31, 1999* ------------------------------------------ MARCH 31, 1999*
(UNAUDITED) 1998* 1997* 1996* 1995 1994* (UNAUDITED) 1998++*
--------------- ------ ------ ------ ------ ------ --------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD......................... $ 9.70 $ 9.20 $ 9.08 $ 9.29 $ 9.10 $ 9.44 $ 9.67 $ 9.28
------ ------ ------ ------ ------ ------ ------ ------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a)....... 0.20 0.48 0.51 0.50 0.62 0.43 0.17 0.33
Net realized and unrealized
gain (loss) on investments... (0.33) 0.51 0.13 (0.21) 0.12 (0.40) (0.32) 0.32
------ ------ ------ ------ ------ ------ ------ ------
Total from Investment
Operations................... (0.13) 0.99 0.64 0.29 0.74 0.03 (0.15) 0.65
------ ------ ------ ------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends from net investment
income....................... (0.21) (0.49) (0.52) (0.50) (0.55) (0.37) (0.20) (0.26)
------ ------ ------ ------ ------ ------ ------ ------
Total Distributions............ (0.21) (0.49) (0.52) (0.50) (0.55) (0.37) (0.20) (0.26)
------ ------ ------ ------ ------ ------ ------ ------
NET ASSET VALUE, END OF PERIOD... $ 9.36 $ 9.70 $ 9.20 $ 9.08 $ 9.29 $ 9.10 $ 9.32 $ 9.67
====== ====== ====== ====== ====== ====== ====== ======
TOTAL RETURN (%)(B).............. (1.32)(c) 11.18 7.28 3.24 8.47 0.36 (1.57)(c) 7.16(c)
RATIOS (%)/SUPPLEMENTAL DATA:
Operating expenses, net, to
average daily net
assets(a).................... 0.92(d) 0.92 0.93 0.94 0.95 0.95 1.20(d) 1.20(d)
Net investment income to
average daily net assets..... 4.30(d) 5.18 5.65 5.42 5.50 4.60 4.04(d) 4.59(d)
Portfolio turnover rate........ 100(c) 188 69 135 162 214 100(c) 188(c)
Net assets, end of period ($
millions).................... 12 13 14 18 24 41 0.34 0.13
<CAPTION>
CLASS C SHARES
---------------------------------------------------
FOR THE SIX
MONTH PERIOD
ENDED FOR THE YEARS ENDED SEPTEMBER 30,
MARCH 31, 1999* ---------------------------------
(UNAUDITED) 1998* 1997* 1996* 1995+
--------------- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD......................... $ 9.67 $ 9.18 $ 9.06 $ 9.27 $ 9.05
------ ------ ------ ------ ------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a)....... 0.17 0.41 0.49 0.49 0.21
Net realized and unrealized
gain (loss) on investments... (0.31) 0.55 0.13 (0.21) 0.23
------ ------ ------ ------ ------
Total from Investment
Operations................... (0.14) 0.96 0.62 0.28 0.44
------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends from net investment
income....................... (0.20) (0.47) (0.50) (0.49) (0.22)
------ ------ ------ ------ ------
Total Distributions............ (0.20) (0.47) (0.50) (0.49) (0.22)
------ ------ ------ ------ ------
NET ASSET VALUE, END OF PERIOD... $ 9.33 $ 9.67 $ 9.18 $ 9.06 $ 9.27
====== ====== ====== ====== ======
TOTAL RETURN (%)(B).............. (1.46)(c) 10.85 7.02 3.04 4.90(c)
RATIOS (%)/SUPPLEMENTAL DATA:
Operating expenses, net, to
average daily net
assets(a).................... 1.20(d) 1.20 1.20 1.20 1.20(d)
Net investment income to
average daily net assets..... 4.02(d) 4.74 5.38 5.22 5.19(d)
Portfolio turnover rate........ 100(c) 188 69 135 162(c)
Net assets, end of period ($
millions).................... 2 5 1 0.6 0.07
</TABLE>
- ---------------
* Per share amounts have been calculated using the monthly average share
method, which more appropriately presents per share data for the period
since use of the undistributed income method does not correspond with
results of operations.
+ For the period April 3, 1995 (commencement of Class C Shares) to September
30, 1995.
++ For the period February 2, 1998 (commencement of Class B Shares) to
September 30, 1998.
(a) Excludes management fees waived and expenses reimbursed by the Manager in
the amount of $.04, $.10, $.07, $.06, $.06 and $.03 per Class A Share,
respectively. The operating expense ratios including such items would have
been 1.84% (annualized), 2.00%, 1.67%, 1.61%, 1.47% and 1.18% per Class A
Share, respectively. Excludes management fees waived and expenses
reimbursed by the Manager in the amount of $.04 and $.06 per Class B Share,
respectively. The operating expense ratio including such items would have
been 2.12% (annualized) and 2.28% (annualized) per Class B Share,
respectively. Excludes management fees waived and expenses reimbursed by
the Manager in the amount of $.04, $.10, $.07, $.06 and $.06 per Class C
Share, respectively. The operating expense ratios including such items
would have been 2.12% (annualized), 2.28%, 1.94%, 1.87% and 1.72%
(annualized) per Class C Share, respectively.
(b) Does not reflect the imposition of a sales charge.
(c) Not annualized.
(d) Annualized.
The accompanying notes are an integral part of the financial statements.
12
<PAGE> 14
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST-HIGH YIELD BOND FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The following table includes selected data for a share outstanding
throughout each period and other performance information derived from the
financial statements.
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
----------------------------------------------------------- -------------------------------
FOR THE SIX FOR THE SIX
MONTH PERIOD MONTH PERIOD
ENDED FOR THE YEARS ENDED SEPTEMBER 30, ENDED
MARCH 31, 1999 ------------------------------------------ MARCH 31, 1999
(UNAUDITED) 1998 1997 1996 1995 1994 (UNAUDITED) 1998++
-------------- ------ ------ ------ ------ ------ -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD...................... $ 9.77 $10.69 $10.22 $ 9.94 $ 9.65 $10.65 $ 9.73 $10.57
------ ------ ------ ------ ------ ------ ------ ------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a).... 0.44 0.88 0.90 0.84(e) 0.72 0.69 0.42 0.51
Net realized and unrealized
gain (loss) on
investments............... (0.03) (0.91) 0.46 0.24 0.31 (0.84) (0.04) (0.87)
------ ------ ------ ------ ------ ------ ------ ------
Total from Investment
Operations................ 0.41 (0.03) 1.36 1.08 1.03 (0.15) 0.38 (0.36)
------ ------ ------ ------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends from net
investment income......... (0.45) (0.89) (0.89) (0.80) (0.74) (0.71) (0.42) (0.48)
Distributions from net
realized gains............ -- -- -- -- -- (0.07) -- --
Distribution in excess of
net realized gains........ -- -- -- -- -- (0.07) -- --
------ ------ ------ ------ ------ ------ ------ ------
Total Distributions......... (0.45) (0.89) (0.89) (0.80) (0.74) (0.85) (0.42) (0.48)
------ ------ ------ ------ ------ ------ ------ ------
NET ASSET VALUE, END OF
PERIOD...................... $ 9.73 $ 9.77 $10.69 $10.22 $ 9.94 $ 9.65 $ 9.69 $ 9.73
====== ====== ====== ====== ====== ====== ====== ======
TOTAL RETURN (%)(B)........... 4.27(c) (0.52) 14.00 11.44 11.23 (1.59) 4.02(c) (3.58)(c)
RATIOS (%)/SUPPLEMENTAL DATA:
Operating expenses, net, to
average daily net
assets(a)................. 1.19(d) 1.19 1.21 1.23 1.25 1.25 1.70(d) 1.70(d)
Net investment income to
average daily net
assets.................... 9.08(d) 8.44 8.76 8.41 7.35 6.76 8.60(d) 7.90(d)
Portfolio turnover rate..... 24(c) 87 101 143 109 135 24(c) 87(c)
Net assets, end of period($
millions)................. 38 40 42 33 30 36 3 2
<CAPTION>
CLASS C SHARES
---------------------------------------------------
FOR THE SIX
MONTH PERIOD
ENDED FOR THE YEARS ENDED SEPTEMBER 30,
MARCH 31, 1999 ----------------------------------
(UNAUDITED) 1998 1997 1996 1995+
-------------- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD...................... $ 9.73 $10.65 $10.18 $ 9.91 $ 9.62
------ ------ ------ ------ ------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a).... 0.41 0.83 0.85 0.79(e) 0.31
Net realized and unrealized
gain (loss) on
investments............... (0.03) (0.91) 0.46 0.24 0.28
------ ------ ------ ------ ------
Total from Investment
Operations................ 0.38 (0.08) 1.31 1.03 0.59
------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends from net
investment income......... (0.42) (0.84) (0.84) (0.76) (0.30)
Distributions from net
realized gains............ -- -- -- -- --
Distribution in excess of
net realized gains........ -- -- -- -- --
------ ------ ------ ------ ------
Total Distributions......... $(0.42) (0.84) (0.84) (0.76) (0.30)
------ ------ ------ ------ ------
NET ASSET VALUE, END OF
PERIOD...................... $ 9.69 $ 9.73 $10.65 $10.18 $ 9.91
====== ====== ====== ====== ======
TOTAL RETURN (%)(B)........... 4.02(c) (1.02) 13.53 10.93 6.18(c)
RATIOS (%)/SUPPLEMENTAL DATA:
Operating expenses, net, to
average daily net
assets(a)................. 1.70(d) 1.70 1.70 1.70 1.70(d)
Net investment income to
average daily net
assets.................... 8.57(d) 7.93 8.26 8.39 6.67(d)
Portfolio turnover rate..... 24(c) 87 101 143 109(c)
Net assets, end of period($
millions)................. 14 13 13 6 0.6
</TABLE>
- ---------------
+ For the period April 3, 1995 (commencement of Class C Shares) to September
30, 1995.
++ For the period February 2, 1998 (commencement of Class B Shares) to
September 30, 1998.
(a) Excludes management fees waived by the Manager in the amount of $.01, $.01,
$.01, $.03, $.03 and $.02 per Class A Share, respectively. The operating
expense ratios including such items would have been 1.31% (annualized),
1.30%, 1.30%, 1.51%, 1.51% and 1.42% per Class A Share, respectively.
Excludes management fees waived by the manager in the amount of $.01 and
$.01 per Class B Share. The operating expense ratio including such items
would have been 1.82% (annualized) and 1.80% (annualized) per Class B Share,
respectively. Excludes management fees waived by the Manager in the amount
of $.01, $.01, $.01, $0.03 and $0.03 per Class C Share, respectively. The
operating expense ratios including such items would have been 1.82%
(annualized), 1.80%, 1.79%, 1.98% and 1.96% (annualized) per Class C Share,
respectively.
(b) Does not reflect the imposition of a sales charge.
(c) Not annualized.
(d) Annualized.
(e) Amounts calculated prior to reclassification of $16,079. The effect of such
reclassification would have resulted in an increase in net investment income
of $.01 for Class A Shares and $0.01 for Class C Shares.
The accompanying notes are an integral part of the financial statements.
13
<PAGE> 15
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
- --------------------------------------------------------------------------------
Note 1:
SIGNIFICANT ACCOUNTING POLICIES. Heritage Income Trust (the "Trust") is
organized as a Massachusetts business trust and is registered under the
Investment Company Act of 1940, as amended, as a diversified, open-end
management investment company consisting of two separate investment
portfolios, the Intermediate Government Fund (formerly known as the
Limited Maturity Government Portfolio) and the High Yield Bond Fund
(formerly known as the Diversified Portfolio) (each, a "Fund" and
collectively, the "Funds"). The Intermediate Government Fund has an
investment objective of high current income consistent with the
preservation of capital. The High Yield Bond Fund has an investment
objective of high current income. The Funds currently issue Class A, Class
B and Class C Shares. Class A Shares are sold subject to a maximum sales
charge of 3.75% of the amount invested payable at the time of purchase.
Class B Shares, which were offered to shareholders beginning February 2,
1998, are sold subject to a 5% maximum contingent deferred sales load
(based on the lower of purchase price or redemption price) declining to 0%
over a six-year period. Class C Shares, which were offered to shareholders
beginning April 3, 1995, are sold subject to a contingent deferred sales
charge of 1% of the lower of net asset value or purchase price payable
upon any redemptions made in less than one year of purchase. The
preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and
assumptions that affect the reported amounts and disclosures. Actual
results could differ from those estimates. The following is a summary of
significant accounting policies.
Security Valuation: Each Fund values investment securities at market value
based on the last sales price as reported by the principal securities
exchange on which the security is traded. If no sale is reported, market
value is based on the most recent quoted bid price and in the absence of a
market quote, securities are valued using such methods as the Board of
Trustees believes would reflect fair market value. Investments in certain
debt instruments not traded in an organized market, are valued on the
basis of valuations furnished by independent pricing services or
broker/dealers that utilize information with respect to market
transactions in such securities or comparable securities, quotations from
dealers, yields, maturities, ratings and various relationships between
securities. Short term investments having a maturity of 60 days or less
are valued at amortized cost, which approximates market.
Repurchase Agreements: Each Fund enters into repurchase agreements whereby
a Fund, through its custodian, receives delivery of the underlying
securities, the market value of which at the time of purchase is required
to be in an amount equal to at least 100% of the resale price.
Federal Income Taxes: Each Fund is treated as a single corporate taxpayer
as provided for in The Tax Reform Act of 1986, as amended. Each Fund's
policy is to comply with the requirements of the Internal Revenue Code of
1986, as amended which are applicable to regulated investment companies
and to distribute substantially all of its taxable income to its
shareholders. Accordingly, no provision has been made for federal income
and excise taxes.
Distribution of Income and Gains: Distributions of net investment income
are made monthly. Net realized gains from investment transactions for each
Fund during any particular year in excess of available capital loss
carryforwards, which, if not distributed, would be taxable to each Fund,
will be distributed to shareholders in the following fiscal year. Each
Fund uses the identified cost method for determining realized gain or loss
on investments for both financial and federal income tax reporting
purposes.
Expenses: Each Fund is charged for those expenses that are directly
attributable to it, such as management fee, custodian/fund accounting
fees, distribution fee, etc., while other expenses such as professional
fees, insurance expense, etc., are allocated proportionately among all
Heritage funds. Expenses of each Fund are allocated to each class of
shares based upon their relative percentage of current net assets. All
expenses that are directly attributable to a specific class of shares,
such as distribution fees, are charged directly to that class.
State Qualification Expenses: State qualification fees are amortized based
either on the time period covered by the qualification or as related
shares are sold, whichever is appropriate for each state.
Capital Accounts: The Funds report the undistributed net investment income
and accumulated net realized gain (loss) accounts on a basis approximating
amounts available for future tax distributions (or to offset future
taxable realized gains when a capital loss carryforward is available).
Accordingly, the Funds may periodically make reclassifications among
certain capital accounts without impacting the net asset value of the
Fund.
Other: For purposes of these financial statements, investment security
transactions are accounted for on a trade date basis. Dividend income and
distributions to shareholders are recorded on the ex-dividend date.
Interest income is recorded on the accrual basis except when income is not
expected. All original issue discounts are accreted for both federal
income tax and financial reporting purposes.
14
<PAGE> 16
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
(CONTINUED)
- --------------------------------------------------------------------------------
Note 2:
FUND SHARES: At March 31, 1999, there was an unlimited number of shares
of beneficial interest of no par value authorized.
INTERMEDIATE GOVERNMENT FUND
Transactions in Class A, B and C Shares of the Fund during the six month
period ended March 31, 1999, were as follows:
<TABLE>
<CAPTION>
A SHARES B SHARES C SHARES
------------------------ ------------------------ ------------------------
FOR THE PERIOD ENDED SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
MARCH 31, 1999 (UNAUDITED) --------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Shares sold...................... 208,703 $ 2,000,087 37,474 $ 355,103 74,197 $ 702,791
Shares issued on reinvestment of
distributions.................. 27,106 258,017 323 3,050 6,673 63,644
Shares redeemed.................. (212,033) (2,010,866) (14,506) (137,311) (371,287) (3,536,348)
--------- ----------- --------- ----------- --------- -----------
Net increase (decrease).......... 23,776 $ 247,238 23,291 $ 220,842 (290,417) $(2,769,913)
=========== =========== ===========
Shares outstanding:
Beginning of period............ 1,303,189 13,088 518,584
--------- --------- ---------
End of period.................. 1,326,965 36,379 228,167
========= ========= =========
</TABLE>
Transactions in Class A and Class C Shares of the Fund during the year
ended September 30, 1998 and Class B Shares from February 2, 1998
(commencement of Class B Shares) to September 30, 1998, were as follows:
<TABLE>
<CAPTION>
A SHARES B SHARES C SHARES
------------------------ ------------------------ ------------------------
FOR THE YEAR ENDED SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
SEPTEMBER 30, 1998 --------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Shares sold...................... 185,461 $ 1,724,681 13,028 $ 121,126 474,667 $ 4,432,949
Shares issued on reinvestment of
distributions.................. 67,011 619,953 60 561 7,594 70,281
Shares redeemed.................. (476,959) (4,427,313) -- -- (51,875) (480,337)
--------- ----------- --------- ----------- --------- -----------
Net increase (decrease).......... (224,487) $(2,082,679) 13,088 $ 121,687 430,386 $ 4,022,893
=========== =========== ===========
Shares outstanding:
Beginning of year.............. 1,527,676 -- 88,198
--------- --------- ---------
End of year.................... 1,303,189 13,088 518,584
========= ========= =========
</TABLE>
HIGH YIELD BOND FUND
Transactions in Class A, B and C Shares of the Fund during the six month
period ended March 31, 1999, were as follows:
<TABLE>
<CAPTION>
A SHARES B SHARES C SHARES
------------------------ ----------------------- ------------------------
FOR THE PERIOD ENDED SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
MARCH 31, 1999 (UNAUDITED) --------- ----------- --------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Shares sold....................... 288,580 $ 2,790,643 134,042 $1,297,239 207,418 $ 2,005,427
Shares issued on reinvestment of
distributions................... 119,200 1,151,107 3,945 37,969 45,557 438,140
Shares redeemed................... (517,776) (5,006,201) (29,839) (286,540) (187,736) (1,816,350)
--------- ----------- --------- ---------- --------- -----------
Net increase (decrease)........... (109,996) $(1,064,451) 108,148 $1,048,668 65,239 $ 627,217
=========== ========== ===========
Shares outstanding:
Beginning of period............. 4,080,524 183,506 1,346,424
--------- --------- ---------
End of period................... 3,970,528 291,654 1,411,663
========= ========= =========
</TABLE>
Transactions in Class A and Class C Shares of the Fund during the year
ended September 30, 1998 and Class B Shares from February 2, 1998
(commencement of Class B Shares) to September 30, 1998, were as follows:
<TABLE>
<CAPTION>
A SHARES B SHARES C SHARES
------------------------ ------------------------ ------------------------
FOR THE YEAR ENDED SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
SEPTEMBER 30, 1998 --------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Shares sold...................... 787,959 $ 8,314,882 196,020 $ 2,056,707 607,408 $ 6,390,589
Shares issued on reinvestment of
distributions.................. 234,628 2,462,134 2,626 27,135 86,303 901,721
Shares redeemed.................. (854,815) (8,945,724) (15,140) (157,348) (547,574) (5,716,430)
--------- ----------- --------- ----------- --------- -----------
Net increase..................... 167,772 $ 1,831,292 183,506 $ 1,926,494 146,137 $ 1,575,880
=========== =========== ===========
Shares outstanding:
Beginning of year.............. 3,912,752 -- 1,200,287
--------- --------- ---------
End of year.................... 4,080,524 183,506 1,346,424
========= ========= =========
</TABLE>
15
<PAGE> 17
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
(CONTINUED)
- --------------------------------------------------------------------------------
Note 3:
PURCHASES AND SALES OF SECURITIES. For the six month period ended March
31, 1999, purchases, sales and paydowns of investment securities
(excluding repurchase agreements and short-term obligations) were as
follows:
<TABLE>
<CAPTION>
U.S. GOVERNMENT SECURITIES OTHER
---------------------------------------- --------------------------
PURCHASES SALES PAYDOWNS PURCHASES SALES
----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Intermediate Government Fund.............. $14,844,017 $16,340,922 $1,013,873 -- --
High Yield Bond Fund...................... -- -- -- $12,893,255 $12,451,243
</TABLE>
Note 4:
MANAGEMENT, SUBADVISORY, DISTRIBUTION, SHAREHOLDER SERVICING AGENT, FUND
ACCOUNTING AND TRUSTEES' FEES. Under the Fund's Investment Advisory and
Administrative Agreement with Heritage Asset Management, Inc. (the
"Manager"), the Intermediate Government Fund agrees to pay to the Manager
a fee equal to an annual rate of 0.50% of the Fund's average daily net
assets, computed daily and payable monthly. For the High Yield Bond Fund
the management fee is 0.60% on the first $100,000,000 and 0.50% of any
excess over $100,000,000 of net assets. Pursuant to the current
registration statement, the Manager will waive its investment advisory
fees and, if necessary, reimburse each Fund to the extent that Class A,
Class B and Class C annual operating expenses exceed that Fund's average
daily net assets attributable to that class for the 1999 fiscal year as
follows:
<TABLE>
<CAPTION>
CLASS A CLASS B AND CLASS C
------- -------------------
<S> <C> <C>
Intermediate Government Fund................................ 0.95% 1.20%
High Yield Bond Fund........................................ 1.25% 1.70%
</TABLE>
Under this agreement, management fees of $39,454 were waived and $32,989
of expenses were reimbursed for the Intermediate Government Fund and
management fees of $32,617 were waived in the High Yield Bond Fund for the
six month period ended March 31, 1999. If total Fund expenses fall below
the expense limitation agreed to by the Manager before the end of the year
ended September 30, 2001, the Funds may be required to pay the Manager a
portion or all of the waived management fees. In addition, the Funds may
be required to pay the Manager a portion or all of the management fees
waived in fiscal 1997 and 1998 if total Fund expenses fall below the
annual expense limitations before the end of the year ending September 30,
1999 and 2000, respectively.
Effective February 1, 1996 and reaffirmed on February 23, 1998, the
Manager entered into an agreement with Salomon Brothers Asset Management
Inc. (the "Subadviser") for the Subadviser to provide to the Fund
investment advice, portfolio management services (including the placement
of brokerage orders) and certain compliance and other services for a fee
payable by the Manager equal to 50% of the fees payable by the High Yield
Bond Fund to the Manager without regard to any reduction due to the
imposition of expense limitations. For the six month period ended March
31, 1999 the Manager paid $80,897 for subadviser fees.
The Manager also is the Dividend Paying and Shareholder Servicing Agent
for the Intermediate Government Fund and High Yield Bond Fund. The amount
payable to the Manager for such expenses as of March 31, 1999 was $3,150
and $10,200, respectively. In addition, the Manager performs Fund
accounting services and charged $18,150 and $25,790 during the current
period of which $8,400 and $12,645 was payable as of March 31, 1999,
respectively.
Raymond James & Associates, Inc. (the "Distributor") has advised the Trust
that the Intermediate Government Fund received $9,117 in front-end sales
charges for Class A Shares and $519 in contingent deferred sales charges
for Class C Shares for the six month period ended March 31, 1999. The High
Yield Bond Fund received $29,270 in front-end sales charges for Class A
Shares, $789 in contingent deferred sales charges for Class B Shares and
$1,244 in contingent deferred sales charges for Class C Shares for the six
month period ended March 31, 1999. From these fees, the Distributor paid
sales commissions to salespersons and incurred other distribution costs.
Pursuant to the Class A Distribution Plan adopted in accordance with Rule
12b-1 of the Investment Company Act of 1940, as amended, the Trust is
authorized to pay the Distributor a fee up to .35% of the average daily
net assets for Class A Shares. Under the Class B and Class C Distribution
Plan, the Trust may pay the Distributor a fee of up to .60% for the
Intermediate Government Fund and up to .80% for the High Yield Bond Fund
of the average daily net assets for Class B and Class C Shares. Such fees
are accrued daily and payable monthly. Class B Shares will convert to
Class A Shares eight years after the end of the calendar month in which
the shareholder's order to purchase was accepted. The Manager,
Distributor, Fund Accountant and Shareholder Servicing Agent are all
wholly-owned subsidiaries of Raymond James Financial, Inc.
Trustees of the Trust also serve as Trustees for Heritage Cash Trust,
Heritage Income-Growth Trust, Heritage Capital Appreciation Trust,
Heritage Series Trust and Heritage U.S. Government Income Fund, investment
companies that also are advised by the Manager of the Trust (collectively
referred to as the Heritage mutual funds). Each Trustee of the Heritage
mutual funds who is not an employee of the Manager or employee of an
affiliate of the Manager receives an annual fee of $8,666 and an
additional fee of $3,250 for each combined quarterly meeting of the
Heritage mutual funds attended. Trustees' fees and expenses are shared
equally by each of the Heritage mutual funds.
16
<PAGE> 18
- --------------------------------------------------------------------------------
HERITAGE INCOME TRUST
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
(CONTINUED)
- --------------------------------------------------------------------------------
Note 5:
FEDERAL INCOME TAXES. For the year ended September 30, 1998, to reflect
reclassifications arising from permanent book/tax differences primarily
due to paydown losses and market discount, respectively, the Funds made
the following adjustments:
INTERMEDIATE GOVERNMENT FUND
For the year ended September 30, 1998, the Fund had a net tax basis
capital loss carryforwards of $7,095,646, which may be applied against
any realized net taxable gains until their expiration dates of
September 30, 2001 ($237,373), September 30, 2002 ($3,838,721),
September 30, 2003 ($2,492,779) and September 30, 2004 ($526,773). The
Fund utilized $150,698 of net tax basis capital losses during the year
against net realized gains from investment transactions.
HIGH YIELD BOND FUND
The Fund credited undistributed net investment income and charged
accumulated net realized gain $44,735 in the year ended 1998. The Fund
utilized $716,301 of net tax basis capital losses during the year
against net realized gains from investment transactions.
17
<PAGE> 19
HERITAGE FAMILY OF FUNDS (TM)
From Our Family to Yours: The Intelligent Creation of Wealth.
HERITAGE GROWTH FUNDS
Aggressive Growth
Capital Appreciation
Growth Equity
Income-Growth
International
Mid Cap
Small Cap
Value Equity
HERITAGE BOND FUNDS
High Yield
Intermediate Government
HERITAGE MONEY MARKET FUNDS
Money Market
Municipal Money Market
We are pleased that many of you are also investors in these funds. For
information and a prospectus for any of these mutual funds, please contact your
financial advisor. Please read the prospectus carefully before you invest in
any of the funds.
This report is for the information of shareholders of Heritage Income Trust-
Intermediate Government Fund and Heritage Income Trust-High Yield Bond Fund. It
may also be used as sales literature when preceded or accompanied by a
prospectus.
(C)1999 Heritage Asset Management, Inc.
5M AR5321 SINL 3/99 [RECYCLE LOGO]
[HERITAGE LOGO] Heritage Income Trust
P.O. Box 33022
St. Petersburg, FL 33733
- ----------------------------------------------------------------
Address Change Requested
<PAGE>
<PAGE> 1
[U.S.
GOVERNMENT
INCOME FUND LOGO]
[PHOTO]
From Our Family to Yours: The Intelligent Creation of Wealth.
ANNUAL REPORT
and Investment Performance
Review for the Year Ended
October 31, 1998
[HERITAGE LOGO]
---------------
U.S. GOVERNMENT
INCOME FUND(TM)
---------------
[HERITAGE LOGO and ADDRESS]
HERITAGE FAMILY OF FUNDS (TM)
From Our Family to Yours:
The Intelligent Creation of Wealth.
HERITAGE MONEY MARKET FUNDS
Cash Trust Money Market
Cash Trust Municipal Money Market
HERITAGE BOND FUNDS
Intermediate Government
High Yield
HERITAGE STOCK FUNDS
Aggressive Growth
Capital Appreciation
Growth Equity
Income-Growth
International
Mid Cap
Small Cap
Value Equity
This report is for the information of shareholders of Heritage U.S. Government
Income Fund. New York Stock Exchange Symbol: HGA. It is not a prospectus,
circular or representation intended for use in the purchase or sale of shares
of the Fund or of any securities mentioned in the report.
5M 10/98 (Recycle Logo) Printed on recycled paper
AR5314-HG
<PAGE> 2
December 4, 1998
Dear Fellow Shareholders:
For the fiscal year ended October 31, 1998, the Heritage U.S. Government
Income Fund (the "Fund") returned +9.39% on net asset value (NAV) and +2.37% on
market value. This compares to the Lehman Government/Corporate and Intermediate
Government/Corporate Indices which returned +10.28% and +9.12%, respectively for
the same period.
The fiscal year witnessed a significant drop in bond yields. The following
table shows the magnitude of the decline in yields over the fiscal year.
<TABLE>
<CAPTION>
10/31/97 10/31/98 CHANGE
-------- -------- -------
<S> <C> <C> <C>
3 month............................................. 5.194% 4.323% -0.8711%
6 month............................................. 5.305% 4.349% -0.9560%
1 year.............................................. 5.347% 4.176% -1.1709%
2 year.............................................. 5.608% 4.107% -1.5009%
5 year.............................................. 5.717% 4.233% -1.4846%
10 year............................................. 5.833% 4.603% -1.2301%
30 year............................................. 6.154% 5.150% -1.0046%
</TABLE>
Source: Yields and change: Bloomberg
Unfortunately, the point-to-point nature of the table masks some very
significant volatility in terms of both yields and prices.
During the fiscal year a number of factors came together that were very
positive for the U.S. Treasury market. The primary factor influencing the move
toward lower yields was the lack of inflationary pressures in our economy. After
more than eight years of expansion, the U.S. economy continued to grow at a
moderate rate. Inflation, which traditionally rises during the later stages of
an economic expansion, continued to decline with the Consumer Price Index
showing only a 1.5% gain through October. The Producer Price Index (a measure of
wholesale prices) declined by 0.7% for the twelve months ended in October.
Increased productivity, falling import prices, and plunging commodity prices
were the main reasons for this beneficial trend in inflation.
As the year progressed, it became more evident that the problems of Asia,
notably Japan, were mounting, These pressures spread through the developing
nations of the world causing currencies to fall against the U.S. dollar. This
reduced import prices and helped contain domestic inflation. Falling commodity
prices, particularly oil and other energy related products along with
agricultural products also reduced upward pricing pressures. All of these
factors led investors to flee foreign markets, both equity and debt, to seek the
safety of U.S. Government bonds. The flight to quality brought the benchmark
thirty-year Treasury bond yield to below 5.00% for a short period of time.
The flight to quality and the concomitant sell-off of other sectors of the
fixed income markets such as high yield bonds, corporate bonds, mortgage
securities and even U.S. Agency issues, led to a dramatic widening of yield
spreads. The substantially higher yields along with massive losses suffered on
the part of highly levered institutions caused the onset of a credit crisis in
which the cost of financing became prohibitively high for all but the highest
quality institutions. This dangerous situation threatened the longevity of the
economic expansion and caused the Federal Reserve to ease credit a total of 75
basis points on the Federal Funds Rate and 50 basis points on the Discount Rate
in three steps. These moves restored confidence and at least temporarily averted
a major credit disruption. The flight to quality was reversed and U.S. Treasury
yields rose as investors sold these issues in favor of the sectors they had
earlier forsaken. This caused the yield
<PAGE> 3
on the benchmark long Treasury bond to reach a yield of 5.38% before retreating
to 5.04% at the time of this writing.
Treasuries performed better than any other sector of the bond markets over
the year. The Fund maintained a higher than normal Treasury position throughout
most of the year, minimizing exposure to structured mortgage securities
preferring instead to emphasize Government National Mortgage Association,
Federal National Mortgage Association and, Federal Home Loan Mortgage
Corporation Pass-through securities and Treasury issues. This benefited the
Fund's performance over the year. In hindsight, which we find nearly perfect, we
would have enhanced NAV performance had we further reduced our mortgage
positions and even more heavily emphasized Treasury securities.
During the fiscal year, the yield curve continued to flatten substantially.
The yield advantage between the Ten-Year Treasury yield and 1-month reverse
repurchase agreements (a proxy for financing rates) fell from an already narrow
+30 basis points to -35 basis points at the end of the fiscal year. This
dramatic inversion (borrowing rates higher than lending rates) limited the
income production available from leveraged strategies and resulted in reductions
of the Fund's monthly dividend during the year.
Our market outlook continues to be quite positive longer term. Our
portfolio remains slightly longer than our index and we look forward to another
rewarding year.
Thank you for your continued confidence in the Fund. We look forward to
reporting to you again at the end of the Fund's semi-annual period next year.
<TABLE>
<S> <C>
Sincerely, Sincerely,
/s/ STEPHEN G. HILL /s/ H. PETER WALLACE
- ---------------------------- ---------------------------
Stephen G. Hill H. Peter Wallace
President Portfolio Manager
</TABLE>
2
<PAGE> 4
- --------------------------------------------------------------------------------
HERITAGE U.S. GOVERNMENT INCOME FUND
INVESTMENT PORTFOLIO
OCTOBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL MATURITY MARKET
AMOUNT DATE VALUE
--------- -------- ------------
<C> <S> <C> <C>
U.S. GOVERNMENT AND AGENCY SECURITIES--97.7%(A)
U.S. TREASURIES--57.3%(A)
$1,000,000 U.S. Treasury Notes, 4.5%................................... 09/30/00 $ 1,005,000
1,000,000 U.S. Treasury Notes, 5.375%................................. 02/15/01 1,022,500
3,000,000 U.S. Treasury Notes, 5.625%................................. 05/15/01 3,099,375
2,000,000 U.S. Treasury Notes, 5.5%................................... 02/28/03 2,088,750
3,000,000 U.S. Treasury Notes, 5.5%................................... 03/31/03 3,139,689
2,000,000 U.S. Treasury Notes, 5.375%................................. 06/30/03 2,088,750
1,000,000 U.S. Treasury Notes, 5.25%.................................. 08/15/03 1,043,438
2,000,000 U.S. Treasury Notes, 5.5%................................... 02/15/08 2,135,000
2,000,000 U.S. Treasury Bonds 6.125%.................................. 11/15/27 2,249,376
4,000,000 U.S. Treasury Bonds, 5.5%................................... 08/15/28 4,211,252
------------
Total U.S. Treasuries (cost $21,395,078).................... 22,083,130
------------
U.S. GOVERNMENT AGENCIES--40.4%(A)
FEDERAL HOME LOAN MORTGAGE CORPORATION--8.5%
3,000,000 REMIC, 10.0%, 1378 H, PAC(c)................................ 01/15/21 3,264,390
------------
FEDERAL NATIONAL MORTGAGE ASSOCIATION--12.6%
1,000,000 Medium Term Note, 6.21%..................................... 11/07/07 1,059,189
271,199 REMIC, 9.67%, 1990-96 E, SEQ................................ 01/25/17 275,956
2,000,000 REMIC, 8.5%, 1992-65 K, PAC(c).............................. 05/25/21 2,068,344
1,435,276 Pool #394212, 30 year Pass-Through, 7.5%(c)................. 07/01/27 1,471,806
------------
4,875,295
------------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION--19.3%
2,000,000 REMIC, 7.0%, 1996-16 G, SEQ................................. 04/16/22 2,009,380
3,705,721 Pool #415688, 30 year Pass-Through, 7.5%(c)................. 11/15/25 3,818,280
1,554,559 Pool #442741, 30 year Pass-Through, 7.5%(c)................. 03/15/27 1,602,005
------------
7,429,665
------------
Total U.S. Government Agencies (cost $15,487,033)........... 15,569,350
------------
Total U.S. Government and Agency Securities (cost
$36,882,111)............................................. 37,652,480
------------
PRIVATE ISSUE MORTGAGE SECURITIES--0.3%(A)
PRIVATE ISSUE MORTGAGE SECURITIES--0.3%
118,648 Kidder Peabody Mortgage Asset Trust, 8.94%.................. 04/01/19 118,539
------------
Total Private Issue Mortgage Securities (cost $122,578)..... 118,539
------------
REPURCHASE AGREEMENT--1.7%(A)
Repurchase Agreement with State Street Bank and Trust Company, dated October 30,
1998 @ 5.3% to be repurchased on November 2, 1998 at $644,284, collateralized by
$635,000 United States Treasury Note, 5.375% due June 30, 2000, (market value
$658,023 including interest) (cost $644,000)...................................... 644,000
------------
TOTAL INVESTMENT PORTFOLIO (COST $37,648,689)(B), 99.7%(A)........................ 38,415,019
OTHER ASSETS AND LIABILITIES, NET 0.3%, (A)....................................... 96,757
------------
NET ASSETS, 100.0%................................................................ $ 38,511,776
============
</TABLE>
- ---------------
(a) Percentages indicated are based on net assets.
(b) The aggregate identified cost for federal income tax purposes is
substantially the same. Market value includes net unrealized appreciation of
$766,330, which consists of aggregate gross unrealized appreciation for all
securities in which there is an excess of market value over tax cost of
$929,926 and aggregate gross unrealized depreciation for all securities in
which there is an excess of tax cost over market value of $163,596.
(c) Some or all of these securities are segregated in connection with mortgage
dollar rolls.
PAC--Planned Amortization Class
REMIC--Real Estate Mortgage Investment Conduit
SEQ--Sequential Pay Class
The accompanying notes are an integral part of the financial statements.
3
<PAGE> 5
- --------------------------------------------------------------------------------
HERITAGE U.S. GOVERNMENT INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
Assets
Investments, at market value (identified cost $37,648,689)
(Note 1).................................................. $38,415,019
Cash........................................................ 416
Receivables:
Interest.................................................. 426,490
Prepaid insurance........................................... 4,892
Other....................................................... 611
-----------
Total assets........................................ 38,847,428
Liabilities
Payables (Note 4):
Investments purchased, delayed delivery, net (Note 1)..... $ 249,219
Accrued management fee.................................... 23,354
Accrued administrative fee................................ 4,924
Other accrued expenses.................................... 58,155
-----------
Total liabilities................................... 335,652
-----------
Net assets, at market value................................. $38,511,776
===========
Net Assets
Net assets consist of:
Paid-in capital (Note 1).................................. $43,452,222
Accumulated net realized loss on investments (Note 1)..... (5,706,776)
Net unrealized appreciation on investments................ 766,330
-----------
Net assets, at market value................................. $38,511,776
===========
Net asset value per share ($38,511,776 divided by 3,115,471
shares of beneficial interest outstanding, no par value)
(Notes 1 and 2)........................................... $12.36
======
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE> 6
- --------------------------------------------------------------------------------
HERITAGE U.S. GOVERNMENT INCOME FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED
OCTOBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
Investment Income
Income:
Interest (includes mortgage dollar roll income of
$474,218)............................................... $3,008,161
Expenses (Notes 1 and 4):
Management fee............................................ $209,543
Administrative fee........................................ 56,609
Custodian/Fund accounting fees............................ 43,558
Legal fees................................................ 30,563
Interest expense.......................................... 26,827
Reports to shareholders................................... 23,437
Shareholder servicing..................................... 21,758
Auditing fees............................................. 21,685
NYSE fees................................................. 16,170
Trustees' fees and expenses............................... 7,809
Organization costs........................................ 7,322
Insurance expense......................................... 4,036
Other..................................................... 797
--------
Total expenses before waiver........................ 470,114
Fees waived by Manager (Note 4)..................... (65,892) 404,222
-------- ----------
Net investment income....................................... 2,603,939
----------
Realized and Unrealized Gain on Investments
Net realized gain from investment transactions.............. 393,538
Net increase in unrealized appreciation of investments
during the year........................................... 382,990
----------
Net gain on investments............................. 776,528
----------
Net increase in net assets resulting from operations........ $3,380,467
==========
</TABLE>
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
------------------------------------
OCTOBER 31, 1998 OCTOBER 31, 1997
---------------- ----------------
<S> <C> <C>
Increase (decrease) in net assets:
Operations:
Net investment income..................................... $ 2,603,939 $ 3,108,630
Net realized gain (loss) from investment transactions..... 393,538 (379,007)
Net increase in unrealized appreciation of investments and
futures during the year................................. 382,990 264,998
----------- -----------
Net increase in net assets resulting from operations...... 3,380,467 2,994,621
Distribution to shareholders from:
Net investment income ($0.84 and $0.99 per share,
respectively)........................................... (2,616,783) (3,110,485)
Tax return of capital ($0.02 per share)................... -- (48,409)
----------- -----------
Total distribution.................................. (2,616,783) (3,158,894)
----------- -----------
Increase (decrease) in net assets........................... 763,684 (164,273)
Net assets, beginning of year............................... 37,748,092 37,912,365
----------- -----------
Net assets, end of year..................................... $38,511,776 $37,748,092
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
5
<PAGE> 7
- --------------------------------------------------------------------------------
HERITAGE U.S. GOVERNMENT INCOME FUND
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED OCTOBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
CASH PROVIDED (USED) BY FINANCING ACTIVITIES:
Cash used from reverse repurchase transactions, net....... $ (6,415,321)
Dividends and distributions paid in cash.................. (2,616,783)
Proceeds from disposition of mortgage dollar rolls, net... 9,652,344
------------
Cash provided by financing activities................... 620,240
------------
CASH PROVIDED (USED) BY OPERATIONS:
Net investment income..................................... 2,603,939
Increase in accrued expenses.............................. 15,156
Decrease in interest receivable........................... 75,138
Decrease in investments payable/receivable, net........... (9,766,166)
Proceeds from disposition of portfolio securities......... 85,828,808
Sale of short term securities, net........................ 566,000
Purchase of portfolio securities.......................... (79,942,813)
------------
Cash used by operations................................. (619,938)
------------
NET INCREASE IN CASH........................................ 302
CASH AT BEGINNING OF YEAR................................... 114
------------
CASH AT END OF YEAR......................................... $ 416
============
</TABLE>
The accompanying notes are an integral part of the financial statements.
6
<PAGE> 8
- --------------------------------------------------------------------------------
HERITAGE U.S. GOVERNMENT INCOME FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The following table includes selected data for a share outstanding
throughout each period and other performance information derived from the
financial statements.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED OCTOBER 31,
--------------------------------------------------
1998 1997 1996 1995 1994+
------ -------- ------- ------ -------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF THE YEAR...................... $12.12 $ 12.17 $ 12.59 $11.99 $ 14.02*
------ -------- ------- ------ -------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income(a).................................. .84 .99 1.07 1.17 .98
Net realized and unrealized gain (loss) on investments.... .24 (.03) (.43) .59 (2.04)
------ -------- ------- ------ -------
Total income from investment operations................... 1.08 .96 .64 1.76 (1.06)
------ -------- ------- ------ -------
LESS DISTRIBUTIONS:
Dividends from net investment income...................... (.84) (.99) (1.06) (1.15) (0.91)
Distributions in excess of net investment income.......... -- -- -- -- (0.02)
Tax return of capital..................................... -- (.02) -- (.01) (0.04)
------ -------- ------- ------ -------
Total distributions....................................... (.84) (1.01) (1.06) (1.16) (0.97)
------ -------- ------- ------ -------
NET ASSET VALUE, END OF YEAR................................ $12.36 $ 12.12 $ 12.17 $12.59 $ 11.99
====== ======== ======= ====== =======
MARKET VALUE, END OF YEAR................................... $10.50 $11.0625 $11.125 $11.75 $11.375
====== ======== ======= ====== =======
TOTAL RETURN:
Per share market value(c)................................. 2.37% 8.61% 3.94% 13.87% (18.20%)(b)
Per share net asset value(c).............................. 9.39% 8.44% 5.41% 15.78% (7.75%)(b)
RATIOS AND SUPPLEMENTAL DATA:
Ratio of operating expenses, net, to average daily net
assets (excluding interest)(a).......................... 1.00% 1.00% 1.00% 1.00% 1.00%(d)
Ratio of net investment income to average daily net
assets.................................................. 6.90% 8.37% 8.70% 9.57% 7.99%(d)
Portfolio turnover rate................................... 161% 62% 47% 150% 163%(d)
Net assets, end of year ($ millions)...................... 39 38 38 39 37
</TABLE>
- ---------------
+ For the period November 19, 1993 (commencement of operations) to October 31,
1994.
* Beginning per share amount reflects $15.00, initial public offering price,
net of underwriting discounts and offering costs ($.98).
(a) Excludes management fees waived by the Manager of $.02, $.03, $.03, $.04 and
$.02 per share, respectively. The operating expense ratio (excluding
interest expense) including such items would be 1.18%, 1.28%, 1.27%, 1.36%
and 1.21% (annualized), respectively.
(b) Return since inception, does not include offering costs and is not
annualized.
(c) Total return based on per share net asset value reflects the effects of
changes in net asset value on the performance of the Fund during the period
and assumes dividend distributions were reinvested. Per share net asset
value return percentage is not an indication of the performance of a
shareholder's investment in the Fund due to differences between the market
price of the stock and the net asset value of the Fund during the period.
(d) Annualized.
The accompanying notes are an integral part of the financial statements.
7
<PAGE> 9
- --------------------------------------------------------------------------------
HERITAGE U.S. GOVERNMENT INCOME FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1: SIGNIFICANT ACCOUNTING POLICIES. Heritage U.S. Government Income Fund
(the "Fund") is organized as a Massachusetts business trust and is
registered under the Investment Company Act of 1940, as amended, as a
diversified, closed-end management investment company. The Fund's
primary investment objective is to provide a high level of current
income and its secondary investment objective is capital appreciation.
The Fund will seek to achieve these objectives through the active
management of a portfolio composed primarily of mortgage-related
securities and mortgages. The Fund normally will invest a minimum of 65%
of its total assets in securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, including
mortgage-related securities. The preparation of financial statements in
accordance with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts and disclosures. Actual results could differ from those
estimates. The following is a summary of significant accounting
policies.
Security Valuation: The Fund values investment securities at market
value based on the last sales price as reported by the principal
securities exchange on which the security is traded. If no sale is
reported, market value is based on the most recent quoted bid price and
in the absence of a market quote, securities are valued using such
methods as the Board of Trustees believes would reflect fair market
value. Investments in certain debt instruments not traded in an
organized market are valued on the basis of valuations furnished by
independent pricing services or broker/dealers who utilize information
with respect to market transactions in such securities or comparable
securities, quotations from dealers, yields, maturities, ratings and
various relationships between securities. Short-term investments having
a maturity of 60 days or less are valued at cost, which when combined
with accrued interest included in interest receivable or discount
earned, approximates market.
Repurchase Agreements: The Fund enters into repurchase agreements
whereby the Fund, through its custodian, receives delivery of the
underlying securities, the market value of which at the time of purchase
is required to be in an amount equal to at least 100% of the resale
price.
Reverse Repurchase Agreements: The Fund may borrow by entering into
reverse repurchase agreements whereby the Fund sells securities and
agrees to repurchase them at a mutually agreed price. Reverse repurchase
agreements may be used for leverage purposes as permitted by the
prospectus. At the time the Fund enters into a reverse repurchase
agreement, it will establish and maintain a segregated account with an
approved custodian containing liquid high grade securities, marked to
market daily, having a value no less than the repurchase price
(including accrued interest).
Forward Commitments and When-Issued Securities: Delivery and payment for
securities that have been purchased by the Fund on a forward commitment
or when-issued basis can take place a month or more after the
transaction date. During this period, such securities are subject to
market fluctuations and the Fund maintains, in a segregated account with
its custodian, assets with a market value equal to the amount of its
purchase commitments.
Mortgage Dollar Rolls: The Fund may enter into mortgage dollar rolls
principally in to be announced (TBA) securities, in which the Fund sells
mortgage securities for delivery in the current month and simultaneously
contracts to repurchase similar, but not identical, securities at the
same price on a fixed date. The Fund accounts for such dollar rolls as a
financing transaction and receives compensation as consideration for
entering into the commitment to repurchase.
The compensation is recorded and amortized to income over the roll
period. The counterparty receives all principal and interest payments,
including prepayments, made in respect of the security while it is the
holder. Mortgage dollar rolls may be renewed with a new purchase and
repurchase price fixed and a cash settlement made at cash renewal
without physical delivery of the securities subject to the contract. If
the fund enters into closing transactions before the end of the fee roll
period, the Fund will accelerate the unamortized portion of the fee.
Futures Contracts: A futures contract is an agreement between two
parties to buy and sell financial instruments at a set price on a future
date. Upon entering into futures contracts, the Fund is required to
deposit with a broker an amount ("initial margin") equal to a certain
percentage of the purchase price indicated in the futures contract.
Subsequent payments ("variation margin") are made or received by the
Fund each day, dependent on the daily fluctuations in the value of the
underlying security, and are recorded for financial reporting purposes
as unrealized gains or losses by the Fund. Upon closing of the contract,
the Fund will realize for financial reporting purposes, a gain or loss
equal to the difference between the value of the futures contract opened
and the futures contract closed. The Fund may be subject to certain
risks upon entering into futures contracts resulting from the imperfect
correlation of prices between the futures and securities markets.
Federal Income Taxes: The Fund's policy is to comply with the
requirements of the Internal Revenue Code of 1986, as amended, which are
applicable to regulated investment companies and to distribute
substantially all of its taxable income to its shareholders.
Accordingly, no provision has been made for federal income taxes.
Distribution of Income and Gains: Distributions of net investment income
are made monthly. Net realized gains from investment transactions for
the Fund during any particular year in excess of available capital loss
carryforwards, which, if not distributed, would be taxable to the Fund,
will be distributed to shareholders in the following fiscal year. The
Fund uses the identified cost method for determining realized gain or
loss on investments for both financial and federal income tax reporting
purposes.
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<PAGE> 10
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HERITAGE U.S. GOVERNMENT INCOME FUND
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
Organization Expenses: Expenses incurred in connection with the
formation of the Fund were deferred and are being amortized on a
straight-line basis over 60 months from the date of commencement of
operations.
Capital Accounts: The Fund reports the undistributed net investment
income and accumulated net realized gain (loss) accounts on a basis
approximating amounts available for future tax distributions (or to
offset future taxable realized gains when a capital loss carryforward is
available). Accordingly, the Fund may periodically make
reclassifications among certain capital accounts without impacting the
net asset value of the Fund.
Statement of Cash Flows: Information on financial transactions which
have been settled through the receipt and disbursement of cash is
presented in the Statement of Cash Flows. The cash amount shown in the
Statement of Cash Flows is the amount reported as cash in the Fund's
Statement of Assets and Liabilities and represents the cash position in
its custodian bank account at October 31, 1998.
Other: For the purpose of these financial statements, investment
security transactions are accounted for on a trade date basis (date the
order to buy or sell is executed). Distributions to shareholders are
recorded on the ex-dividend date. Interest income is recorded on the
accrual basis. All original issue discounts are accreted for both tax
and financial reporting purposes.
Note 2: FUND SHARES. There was no Fund share activity for the years ended
October 31, 1998 and 1997. Shares outstanding remain at 3,115,471.
Note 3: PURCHASES AND SALES OF SECURITIES. For the year ended October 31, 1998,
purchases, sales and paydowns of U.S. Government securities (excluding
short-term investments and mortgage dollar roll transactions) aggregated
$79,942,813, $82,428,079 and $3,400,729, respectively. Purchases and
sales including mortgage dollar roll transactions aggregated
$763,637,500 and $773,289,844, respectively.
Note 4: MANAGEMENT, ADMINISTRATIVE, AND TRUSTEES' FEES. Under the Fund's
Investment Advisory Agreement with Heritage Asset Management, Inc. (the
"Manager"), the Fund agrees to pay to the Manager a monthly fee of
0.01667% of average weekly net assets for the preceding period
(approximately .20% per annum) plus a fee equal to 4.5% of gross weekly
income, computed daily and payable monthly. Under the Fund's
Administration Agreement, the Fund will pay the Manager a monthly fee of
0.0125% of average weekly net assets for the preceding period
(approximately .15% per annum). The Manager voluntarily reduces such
fees in any year to the extent that operating expenses (excluding
interest and taxes) of the Fund exceed 1.00% on an annual basis of the
Fund's average daily net assets. Under this agreement, management fees
of $65,892 were waived for the year ended October 31, 1998. If total
Fund expenses fall below the expense limitation agreed to by the Manager
before the end of the year ending October 31, 2000, the Fund may be
required to pay the Manager a portion or all of the waived management
fee. In addition, the Fund may be required to pay the Manager a portion
or all of the management fees waived of $102,111 for the year ended
October 31, 1997, if total Fund expenses fall below the annual expense
limitations before the end of the year ending October 31, 1999.
The Manager also performs Fund Accounting services and charged the Fund
$32,548 during the period of which $11,300 was payable as of October 31,
1998.
Trustees of the Fund also serve as Trustees for Heritage Cash Trust,
Heritage Capital Appreciation Trust, Heritage Income-Growth Trust,
Heritage Income Trust and Heritage Series Trust, open-end investment
companies that are also advised by the Manager (collectively referred to
as the Heritage funds). Each Trustee of the Heritage funds who is not an
employee of the Manager or employee of an affiliate of the Manager
receives an annual fee of $8,666, an additional fee of $3,250 for each
combined quarterly meeting of the Heritage mutual funds attended and
$1,000 for each special Trustees meeting attended. Trustees' fees and
expenses are paid equally by each of the Heritage funds.
Note 5: FEDERAL INCOME TAXES. For the year ended October 31, 1998, to reflect
reclassifications arising from permanent book/tax differences primarily
attributable to paydown income and market discount, the Fund credited
accumulated net realized loss on investments $12,843 and undistributed
net investment loss $3,126 and debited paid-in capital $15,969. As of
October 31, 1998, the fund has net tax basis capital loss carryforwards
of $5,632,684 that may be applied against any realized net taxable gains
until the expiration dates of October 31, 2002 ($3,600,470), October 31,
2003 ($1,211,069), October 31, 2004 ($446,153) and October 31, 2005
($374,992). The Fund utilized $467,630 of capital loss carryforwards
during the current year against net realized gains from investment
transactions.
Note 6: PURPOSES OF AND RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS. The
Fund may enter into reverse repurchase agreements to raise cash without
liquidating any portfolio securities. Reverse repurchase agreements
involve the risk that the market value of
9
<PAGE> 11
- --------------------------------------------------------------------------------
HERITAGE U.S. GOVERNMENT INCOME FUND
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
securities retained in lieu of sale by the Fund may decline below the
price of the securities the Fund has sold but is obliged to repurchase.
The Fund may enter into mortgage dollar roll agreements in order to
hedge against anticipated changes in interest rates and prices and to
enhance the Fund's yield. When such transactions are negotiated, the
price is fixed at the time the commitment is made, but delivery and
payment for the securities takes place on a later date. There is always
a risk that securities may not be delivered and that the Fund may incur
a loss or will have lost the opportunity to invest the amount set aside
for such transaction in the segregated asset account.
In the event the buyer of securities under a reverse repurchase
agreement or dollar roll files for bankruptcy or becomes insolvent, the
Fund's use of proceeds may be restricted pending a determination by the
other party, its trustee or receiver, whether to enforce the Fund's
obligation to repurchase the securities.
10
<PAGE> 12
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Board of Trustees and Shareholders of
Heritage U.S. Government Income Fund
In our opinion, the accompanying statement of assets and liabilities, including
the investment portfolio, and the related statements of operations, of changes
in net assets and of cash flows and the financial highlights present fairly, in
all material respects, the financial position of Heritage U.S. Government Income
Fund (the "Fund") at October 31, 1998, the results of each of its operations and
its cash flows for the year then ended, the changes in its net assets for each
of the two years in the period then ended and the financial highlights for each
of the five years in the period then ended, in conformity with generally
accepted accounting principles. These financial statements and financial
highlights (hereafter referred to as "financial statements") are the
responsibility of the Trust's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of securities at October 31, 1998 by
correspondence with the custodian and brokers, provide a reasonable basis for
the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
- ------------------------------
PricewaterhouseCoopers LLP
Tampa, Florida
December 17, 1998
11
<PAGE> 13
HERITAGE U.S. GOVERNMENT
INCOME FUND
DIVIDEND REINVESTMENT PLAN
1. State Street Bank and Trust Company (the "Plan Agent") will act as
agent for each shareholder of Heritage U.S. Government Income Fund (the "Fund")
who has not elected in writing to receive dividends and distributions in cash
(each a "Participant"), will open an account for each Participant under the
Dividend Reinvestment Plan (the "Plan") in the same name in which such
Participant's shares of beneficial interest in the Fund (the "Shares") are
registered, and, beginning with the second distribution, will put into effect
for such Participant the dividend reinvestment option of the Plan as of the
record date for such dividend or capital gains distribution.
2. Whenever the Fund declares an income dividend or a capital gains
distribution with respect to the Shares, each Participant will receive such
dividends and distributions in additional shares, including fractional shares
acquired by the Plan Agent and credited to each Participant's account. The Plan
Agent, as agent for each Participant, will receive the dividend or distribution
on each Participant's Shares and apply the same (net of pro rata brokerage
commissions, if applicable) to each participant's account. Commencing not more
than five business days before the dividend payment date, purchases of the
Shares will be made by the Plan Agent for the Plan to satisfy reinvestments
under the Plan, provided that such purchases on or before the dividend payment
date may be made on the New York Stock Exchange ("NYSE") or elsewhere only at
times when the price of the Shares on the NYSE plus commissions is less than a
5% premium over the Fund's most recently calculated net asset value per Share.
If, at the close of business on the dividend payment date, the Shares purchased
in the open market are insufficient to satisfy the dividend reinvestment
requirement, the Plan Agent, on behalf of the participants in the Plan, will
accept payment in the dividend, or the remaining portion thereof, in authorized
but unissued Shares of the Fund. Such Shares will be issued at a per share price
equal to the higher of (a) the net asset value per Share as of the close of
business on the payment date or (b) 95% of the closing market price per Share on
the payment date. All dividends, distributions and other payments (whether made
in cash or in Shares) shall be made net of any applicable withholding tax.
3. Open market purchases provided for above may be made on any securities
exchange where the Fund's Shares are traded, in the over-the-counter market or
in negotiated transactions and may be on such terms as to price, delivery and
otherwise as the Plan Agent shall determine. Participants' Funds held by the
Plan Agent uninvested will not bear interest, and it is understood that the Plan
Agent shall have no liability in connection with the timing of any purchases
effected. The Plan Agent shall have no responsibility as to the value of the
Shares acquired for a Participant's account. For the purposes of cash
investments, the Plan Agent may commingle Participants' funds, and the average
price (including brokerage commissions) of all Shares purchased by the Plan
Agent as agent shall be the price per share allocable to each Participant in
connection therewith.
4. The Plan Agent may hold Shares acquired pursuant to the Plan in
non-certificated form in the Plan Agent's name or that of the Plan Agent's
nominee. The Plan Agent will forward to each Participant any proxy solicitation
material and will vote any Shares so held for such Participant only in
accordance with the proxy returned by such Participant to the Fund. Upon a
Participant's written request, the Plan Agent will deliver to such Participant,
without charge, a certificate or certificates for some or all of the whole
Shares held in the Participant's account under the Plan.
5. The Plan Agent will confirm to each Participant each acquisition made
for such Participant's account as soon as practicable but not later than 60 days
after the date thereof. Although Participants may from time to time have
undivided fractional interests (computed to three decimal places) in a Share, no
certificates for a
12
<PAGE> 14
fractional Share shall be issued. However, dividends and distributions on
fractional Shares will be credited to a Participant's account. In the event of
termination of a Participant's account under the Plan, the Plan Agent will
adjust for any such undivided fractional interest in cash at the market value
per share of the Shares at the time of termination, less the pro rata expense of
any sale required to make such an adjustment.
6. Any stock dividends or split shares distributed by the Fund on Shares
held by the Plan Agent for a Participant will be credited to such Participant's
account. In the event that the Fund makes available to its Shareholders rights
to purchase additional Shares or other securities, the Shares held for a
participant under the Plan will be added to other such Shares held by such
Participant in calculating the number of rights to be issued to such
Participant.
7. The Plan Agent's service fee for handling capital gains distributions
or income dividends will be paid by the Fund. Participants will be charged a pro
rata share of brokerage commissions on all open market purchases.
8. Participants may terminate their accounts under the Plan by notifying
the Plan Agent in writing. Such termination will be effective immediately if
such Participant's notice is received by the Plan Agent not less than 10 days
prior to any dividend or distribution payment date; otherwise such termination
will be effective on the first trading day after the payment date for such
dividend or distribution with respect to any subsequent dividend or
distribution. The Plan may be terminated by the Plan Agent or the Fund upon
notice in writing mailed to participants at least 30 days prior to any record
date for the payment of any dividend or distribution by the Fund. Upon any
termination, the Plan Agent will cause a certificate or certificates for the
number of Shares held for each Participant under the Plan to be delivered to
such Participant (or if the Shares are not then in certificated form, will cause
such shares to be transferred to Participant) without charge.
9. The terms and conditions of the Plan may be amended or supplemented by
the Plan Agent or the Fund at any time or times but, except when necessary or
appropriate to comply with applicable law or the rules or policies of the
Securities and Exchange Commission or any other regulatory authority, only by
mailing to Participants appropriate written notice at least 30 days prior to the
effective date thereof. The amendment or supplement shall be deemed to be
accepted by a Participant unless, prior to the effective date thereof, the Plan
Agent receives written notice of the termination of such Participant's account
under the Plan. Any such amendment may include an appointment by the Plan Agent
in its place and stead of a successor agent under these terms and conditions,
with full power and authority to perform all or any of the acts to be performed
by the Plan Agent under these terms and conditions. Upon any such appointment of
a successor agent for the purpose of receiving dividends and distributions, the
Fund will be authorized to pay to such successor agent, for each Participant's
account, all dividends and distributions payable on the Common Stock held in
such Participant's name or under the Plan for retention or application by such
successor agent as provided in these terms and conditions.
10. The Plan Agent shall at all times act in good faith and agree to use
its best efforts within reasonable limits to insure the accuracy of all services
performed under the Agreement and to comply with applicable law, but it assumes
no responsibility and shall not be liable for loss or damage due to errors
unless such error is caused by the Plan Agent's negligence, bad faith or willful
misconduct or that of the Plan Agent's employees.
11. The terms and conditions of the Plan shall be governed by the laws of
the State of Massachusetts.
13
<PAGE> 15
HERITAGE U.S. GOVERNMENT INCOME FUND is a member of the Heritage family of
mutual funds. Other investment alternatives available to you from Heritage
include:
[ ] HERITAGE CASH TRUST
MONEY MARKET FUND
MUNICIPAL MONEY MARKET FUND
[ ] HERITAGE CAPITAL APPRECIATION TRUST
[ ] HERITAGE INCOME-GROWTH TRUST
[ ] HERITAGE INCOME TRUST
HIGH YIELD BOND FUND
INTERMEDIATE GOVERNMENT FUND
[ ] HERITAGE SERIES TRUST
AGGRESSIVE GROWTH FUND
EAGLE INTERNATIONAL EQUITY PORTFOLIO
GROWTH EQUITY FUND
MID CAP GROWTH FUND
SMALL CAP STOCK FUND
VALUE EQUITY FUND
We are pleased that many of you are also investors in these funds. For
information and a prospectus for any of these mutual funds, please contact your
financial advisor. Please read the prospectus carefully before you invest in any
of the funds.
