<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, 1997
[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
Income-Growth
Value Equity
Growth Equity
Capital Appreciation
Mid Cap
Small Cap
International
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 10/97 (Recycle Logo) Printed on recycled paper
<PAGE> 2
December 12, 1997
Dear Fellow Shareholders:
We are pleased to provide you with the annual report for the Heritage U.S.
Government Income Fund (the "Fund") for the fiscal year ended October 31, 1997.
During this period, the Fund produced a high level of income despite a
flattening yield curve and produced a respectable total return, despite the
sometimes extreme volatility in the bond market. After expenses, the Fund
produced total returns for the fiscal year of 8.44% on net asset value basis and
8.61% on a market value basis. By comparison, the Lehman Government -- Corporate
Index returned 8.81% for the same period.
Over the last year, the economy continued to expand without significant
inflationary pressures. The Consumer Price Index (CPI) fell from a 3.00%
year-over-year rate in October 1996 to only 2.10% by October 1997. Despite this
favorable inflationary environment, market fears of a reverse in the
inflationary trend have kept real interest rates relatively high. In our
opinion, this offers investors in bond funds a very attractive opportunity.
Should inflation continue to remain well-behaved, we would expect real interest
rates to return to more historical levels, benefiting fixed income investors.
There are several reasons why we believe this is a likely scenario.
The Federal Reserve Open Market Committee took action on interest rates
only once this year. They took a preemptive strike in March 1997 raising
short-term interest rates by 0.25%. Since then, it appears they have been
satisfied with their monetary policy relative to economic growth. Traditional
sources of inflation that were feared at the beginning of the year have not
presented a problem. Low unemployment rates have not led to higher wage
pressures, possibly due to increases in productivity. Increases in personal
incomes have not triggered substantially higher rates of consumption due to the
general reduction of consumer debt. Despite this recent moderation in consumer
debt levels, we believe they still remain high enough to act as a significant
drag on demand growth, and therefore, the economy. This should help prevent
higher rates of economic expansion that could trigger inflation and negatively
impact the fixed income market. We believe that the Federal Reserve Board will
continue to remain inactive well into 1998 unless we experience a significant
spike in the growth rate of the economy and a corresponding increase in the rate
of inflation.
The market's ongoing uncertainty over inflation and the stance of the
Federal Reserve Board, has periodically helped push volatility to very high
levels. While the yield on both the ten-year and thirty-year Treasury Bond fell
by approximately 50 basis points over the course of the fiscal year, the
ten-year Treasury had a range of more than 100 basis points. For the thirty-year
Treasury Bond, movements of 30 basis points per month were not uncommon. Through
this volatility, we maintained an effective duration longer than our index and
benefited from the general downward trend in interest rates. We were somewhat
penalized for holding mortgage securities as the yields on these securities did
not fall as quickly as the yields on Treasury securities in the latter portion
of the fiscal year. Had we maintained a portfolio with an even longer duration
and a greater commitment to longer Treasury issues, our returns would, in
hindsight, have been even better. However, given the extreme volatility of the
market, we did not believe the risk-reward tradeoffs warranted a further
extension of our portfolio duration.
During the fiscal year the yield curve flattened 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 +86 basis
points to +30 basis points at the end of the fiscal year. This dramatic
flattening limited the income production available from leveraged strategies and
resulted in a reduction of the Fund's monthly dividend from 8.7 cents per share
to 7.7 cents per share.
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Our market outlook continues to be quite positive longer term and our
portfolio's duration 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
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HERITAGE U.S. GOVERNMENT INCOME FUND
INVESTMENT PORTFOLIO
OCTOBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL MATURITY MARKET
AMOUNT DATE VALUE
--------- -------- ------------
<C> <S> <C> <C>
U.S. GOVERNMENT AND AGENCY SECURITIES--137.5%(A)
U.S. TREASURIES--46.5%
$2,000,000 U.S. Treasury Notes, 6.625%(d).............................. 06/30/01 $ 2,056,876
2,000,000 U.S. Treasury Notes, 6.25%(d)............................... 10/31/01 2,035,626
3,000,000 U.S. Treasury Notes, 6.25%(d)............................... 01/31/02 3,053,439
5,000,000 U.S. Treasury Bonds, 11.125%(c)............................. 08/15/03 6,285,940
2,000,000 U.S. Treasury Notes, 6.125%................................. 08/15/07 2,043,750
2,000,000 U.S. Treasury Bonds, 6.5%(d)................................ 11/15/26 2,083,750
------------
Total U.S. Treasuries (cost $17,330,625).................... 17,559,381
------------
U.S. GOVERNMENT AGENCIES--91.0%
FEDERAL HOME LOAN MORTGAGE CORPORATION--27.9%
2,000,000 REMIC, 6.0%, 1858 L Support................................. 06/15/11 1,913,180
173,807 REMIC, 9.5%, 175 G PAC...................................... 05/15/20 173,992
3,000,000 REMIC, 10.0%, 1378 H PAC(d)................................. 01/15/21 3,434,151
5,000,000 TBA, 30-Year Pass-Through, 7.0%............................. 11/01/27 5,020,315
------------
10,541,638
------------
FEDERAL NATIONAL MORTGAGE ASSOCIATION--21.3%
1,894,629 Pool #370552, 15 year Pass-Through, 7.5%(d)................. 04/01/12 1,946,030
827,154 REMIC, 9.85%, 1989-34 E PAC(d).............................. 08/25/14 844,977
574,899 REMIC, 9.67%, 1990-96 E SEQ................................. 01/25/17 591,605
267,081 REMIC, 8%, 1991-28 H PAC(d)................................. 02/25/20 268,080
2,000,000 REMIC, 8.5%, 1992-65 K PAC(d)............................... 05/25/21 2,117,500
356,464 REMIC, G93-19 SG, LIBOR Inverse Floater..................... 04/25/23 245,960
1,966,555 Pool #394212, 30 year Pass-Through, 7.5%(d)................. 07/01/27 2,008,954
------------
8,023,106
------------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION--41.8%
4,465,838 Pool #415688, 30 year Pass-Through, 7.5%(d)................. 11/15/25 4,569,892
2,008,769 Pool #442741, 30 year Pass-Through, 7.5%(d)................. 03/15/27 2,054,167
2,010,734 Pool #418431, 30 year Pass-Through, 8.0%(d)................. 09/15/27 2,087,182
988,635 Pool #452480, 30 year Pass-Through, 8.0%(d)................. 09/15/27 1,026,223
989,280 Pool #452481, 30 year Pass-Through, 8.0%(d)................. 09/15/27 1,026,892
5,000,000 TBA, 30 year Pass-Through, 7.0%............................. 11/01/27 5,025,000
------------
15,789,356
------------
Total U.S. Government Agencies (cost $34,189,223)........... 34,354,100
------------
Total U.S. Government and Agency Securities (cost
$51,519,848)................................................ 51,913,481
------------
PRIVATE ISSUE MORTGAGE SECURITIES--1.7%(A)
609,445 Kidder Peabody Mortgage Asset Trust, 8.94%.................. 04/01/19 619,340
------------
Total Private Issue Mortgage Securities (cost $629,633)..... 619,340
------------
REPURCHASE AGREEMENT--3.2%(A)
Repurchase Agreement with State Street Bank and Trust Company, dated October 31,
1997 @ 5.58% to be repurchased at $1,210,563 on November 3, 1997, collateralized
by $1,080,000 United States Treasury Notes, 7.875% due November 15, 2004, (market
value $1,242,433 including interest) (cost $1,210,000)............................ 1,210,000
------------
TOTAL INVESTMENT PORTFOLIO (COST $53,359,481)(B), 142.4%(A)....................... 53,742,821
OTHER ASSETS AND LIABILITIES, NET (42.4%)(A)...................................... (15,994,729)
------------
NET ASSETS, 100.0%................................................................ $ 37,748,092
============
</TABLE>
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(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
$383,340, which consists of aggregate gross unrealized appreciation for all
securities in which there is an excess of market value over tax cost of
$588,966 and aggregate gross unrealized depreciation for all securities in
which there is an excess of tax cost over market value of $205,626.
(c) Collateral for reverse repurchase agreement.
(d) Some or all of these securities are segregated in connection with the
reverse repurchase agreement and/or mortgage dollar rolls.
LIBOR--London Interbank Offered Rate
PAC--Planned Amortization Class
REMIC--Real Estate Mortgage Investment Conduit
SEQ--Sequential Pay Class
TBA--To be announced
The accompanying notes are an integral part of the financial statements.
3
<PAGE> 5
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HERITAGE U.S. GOVERNMENT INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
Assets
Investments, at market value (identified cost $53,359,481)
(Note 1).................................................. $53,742,821
Cash........................................................ 114
Receivables:
Investments sold.......................................... 71,334
Interest.................................................. 501,628
Deferred organization expense............................... 7,933
Prepaid insurance........................................... 1,800
-----------
Total assets........................................ 54,325,630
Liabilities
Payables (Note 4):
Investments purchased, delayed delivery, net (Note 1)..... $10,086,719
Borrowings under reverse repurchase agreement (Notes 1 and
6)...................................................... 6,415,321
Accrued management fee.................................... 17,172
Accrued administrative fee................................ 4,738
Other accrued expenses.................................... 53,588
-----------
Total liabilities................................... 16,577,538
-----------
Net assets, at market value................................. $37,748,092
===========
Net Assets
Net assets consist of:
Paid-in capital (Note 1).................................. $43,465,066
Accumulated net realized loss on investments (Note 1)..... (6,100,314)
Net unrealized depreciation on investments................ 383,340
-----------
Net assets, at market value................................. $37,748,092
===========
Net asset value per share ($37,748,092 divided by 3,115,471
shares of beneficial interest outstanding, no par value)
(Notes 1 and 2)........................................... $12.12
=====
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE> 6
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HERITAGE U.S. GOVERNMENT INCOME FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED
OCTOBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
Investment Income
Income:
Interest (includes mortgage dollar roll income of
$585,523)............................................... $3,925,361
Expenses (Notes 1 and 4):
Interest expense.......................................... $445,516
Management fee............................................ 230,834
Administrative fee........................................ 55,681
Custodian/Fund accounting fees............................ 43,205
Auditing fees............................................. 31,243
Reports to shareholders................................... 30,413
Shareholder servicing..................................... 20,949
Legal fees................................................ 20,321
NYSE fees................................................. 16,170
Trustees' fees and expenses............................... 9,211
Organization costs........................................ 7,322
Insurance expense......................................... 4,961
Other..................................................... 3,016
--------
Total expenses before waiver........................ 918,842
Fees waived by Manager (Note 4)..................... (102,111) 816,731
-------- ----------
Net investment income....................................... 3,108,630
----------
Realized and Unrealized Gain (Loss) on Investments
Net realized loss from investment transactions.............. (379,007)
Net increase in unrealized appreciation of investments
during the year........................................... 264,998
----------
Net loss on investments............................. (114,009)
----------
Net increase in net assets resulting from operations........ $2,994,621
==========
</TABLE>
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STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
------------------------------------
OCTOBER 31, 1997 OCTOBER 31, 1996
---------------- ----------------
<S> <C> <C>
Increase (decrease) in net assets:
Operations:
Net investment income..................................... $ 3,108,630 $ 3,328,563
Net realized loss from investment transactions............ (379,007) (287,482)
Net realized loss from futures transactions............... -- (170,656)
Net increase in unrealized appreciation of investments and
futures during the year................................. 264,998 (855,527)
----------- -----------
Net increase in net assets resulting from operations...... 2,994,621 2,014,898
Distribution to shareholders from:
Net investment income ($0.99 and $1.06 per share,
respectively)........................................... (3,110,485) (3,314,723)
Tax return of capital ($0.02 per share)................... (48,409) --
----------- -----------
Total distribution.................................. (3,158,894) (3,314,723)
----------- -----------
Decrease in net assets...................................... (164,273) (1,299,825)
Net assets, beginning of year............................... 37,912,365 39,212,190
----------- -----------
Net assets, end of year (including undistributed net
investment income of $1,855 at October 31, 1996).......... $37,748,092 $37,912,365
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
5
<PAGE> 7
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HERITAGE U.S. GOVERNMENT INCOME FUND
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED OCTOBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
CASH USED BY FINANCING ACTIVITIES:
Cash used from Reverse Repurchase Transactions, net....... $ (6,472,179)
Dividends and Distributions paid in cash.................. (3,158,894)
Purchases of mortgage dollar rolls, net................... (14,440,086)
------------
Cash used by financing activities....................... (24,071,159)
------------
CASH PROVIDED (USED) BY OPERATIONS:
Net investment income..................................... 3,108,630
Decrease in accrued expenses.............................. (15,746)
Decrease in interest receivable........................... 52,894
Increase in investments payable/receivable, net........... 10,213,121
Proceeds from disposition of portfolio securities......... 41,422,482
Purchase of short term securities, net.................... (325,723)
Purchase of portfolio securities.......................... (30,388,220)
------------
Cash provided by operations............................. 24,067,438
------------
NET DECREASE IN CASH........................................ (3,721)
CASH AT BEGINNING OF YEAR................................... 3,835
------------
CASH AT END OF YEAR......................................... $ 114
============
</TABLE>
The accompanying notes are an integral part of the financial statements.
6
<PAGE> 8
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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,
----------------------------------------------
1997 1996 1995 1994+
-------- ------- ------ -------
<S> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF THE YEAR...................... $ 12.17 $ 12.59 $11.99 $ 14.02*
-------- ------- ------ -------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income(a).................................. 0.99 1.07 1.17 .98
Net realized and unrealized gain (loss) on investments.... (.03) (.43) .59 (2.04)
-------- ------- ------ -------
Total from investment operations.......................... .96 .64 1.76 (1.06)
-------- ------- ------ -------
LESS DISTRIBUTIONS:
Dividends from net investment income...................... (0.99) (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....................................... (1.01) (1.06) (1.16) (0.97)
-------- ------- ------ -------
NET ASSET VALUE, END OF YEAR................................ $ 12.12 $ 12.17 $12.59 $ 11.99
======== ======= ====== =======
MARKET VALUE, END OF YEAR................................... $11.0625 $11.125 $11.75 $11.375
======== ======= ====== =======
TOTAL RETURN:
Per share market value(c)................................. 8.61% 3.94% 13.87% (18.20%)(b)
Per share net asset value(c).............................. 8.44% 5.41% 15.78% (7.75%)(b)
RATIOS AND SUPPLEMENTAL DATA:
Ratio of operating expenses, net, to average daily net
assets (excluding interest and taxes)(a)................ 1.00% 1.00% 1.00% 1.00%(d)
Ratio of net investment income to average daily net
assets.................................................. 8.37% 8.70% 9.57% 7.99%(d)
Portfolio turnover rate................................... 62% 47% 150% 163%(d)
Net assets, end of year ($ millions)...................... 38 38 39 37
</TABLE>
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+ 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 $.03, $.03, $.04 and $.02
per share, respectively. The operating expense ratio (excluding interest
expense) including such items would be 1.28%, 1.27%, 1.36% and 1.21%
(annualized), respectively.
(b) Return since inception, does not include offering costs, 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
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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.
8
<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, 1997.
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, 1996 and 1997. Shares outstanding remain at 3,115,471.
Note 3: PURCHASES AND SALES OF SECURITIES. For the year ended October 31, 1997,
purchases, sales and paydowns of U.S. Government securities (excluding
short-term investments and mortgage dollar roll transactions) aggregated
$30,388,220, $37,609,537 and $4,431,531, respectively. Purchases and
sales included in mortgage dollar roll transactions aggregated
$536,435,042 and $521,994,956, 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 $102,111 were waived for the year ended October 31, 1997. If total
Fund expenses fall below the expense limitation agreed to by the Manager
before the end of the year ending October 31, 1999, 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 $101,447 for the year ended
October 31, 1996, if total Fund expenses fall below the annual expense
limitations before the end of the year ending October 31, 1998.
The Manager also performs Fund Accounting services and charged the Fund
$31,142 during the period of which $10,400 was payable as of October 31,
1997.
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 that is not
an interested person of the Manager received an annual fee of $8,000, an
additional fee of $2,000 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, 1997, 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 $4,015 and undistributed
net investment loss $48,409 and debited paid-in capital $52,424. As of
October 31, 1997, the fund has net tax basis capital loss carryforwards
of $6,100,314 that may be applied against any realized net taxable gains
until the expiration dates of October 31, 2002 ($4,068,100), October 31,
2003 ($1,211,069), October 31, 2004 ($446,153) and October 31, 2005
($374,992).
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 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.
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<PAGE> 11
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HERITAGE U.S. GOVERNMENT INCOME FUND
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
- --------------------------------------------------------------------------------
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.
Reverse repurchase agreements are collateralized by Fund securities with
a market value including accrued interest, in excess of the Fund's
obligation under the contract at the time the parties enter into the
agreement. If the market value of the collateral falls below the Fund's
obligation, the holder may require additional collateral. At October 31,
1997 securities valued at $6,285,940 were pledged as collateral.
At October 31, 1997, the reverse repurchase agreements outstanding were
$6,415,321 with an interest rate of 5.60% maturing in 28 days. The
maximum and average daily amounts outstanding during the period were
$13,087,500 and $7,972,957, respectively. The weighted average interest
rate during the period was 5.53%.*
---------------------
* Computation is based on those days when such agreements were
outstanding.
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<PAGE> 12
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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Shareholders and Board of Trustees 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, 1997, the results of its operations and its
cash flows for the year then ended and the changes in its net assets and the
financial highlights for each of the two 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 Fund'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, 1997 by
correspondence with the custodian and brokers, provide a reasonable basis for
the opinion expressed above. The financial highlights for the year ended October
31, 1995 and for the period November 19, 1993 (commencement of operations) to
October 31, 1994, were audited by other independent accountants whose report
dated December 22, 1995 expressed an unqualified opinion on those financial
highlights.
/s/ Price Waterhouse LLP
- ------------------------
Price Waterhouse LLP
Tampa, Florida
December 17, 1997
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.
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<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
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.
