<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
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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>
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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
$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
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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
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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
- --------------------------------------------------------------------------------
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
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<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.
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<PAGE> 12
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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
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<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
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.
