-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PA0cqhJZKlZu36itO9aHcSt/CISlpn6pKsHy/ItDx5evfuOxobviEOrjPnSNbIsc T4MNjH1kJC+3IiSS8gVhFg== 0000898733-03-000212.txt : 20030428 0000898733-03-000212.hdr.sgml : 20030428 20030428165417 ACCESSION NUMBER: 0000898733-03-000212 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20030228 FILED AS OF DATE: 20030428 EFFECTIVENESS DATE: 20030428 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRUDENTIAL GOVERNMENT INCOME FUND INC CENTRAL INDEX KEY: 0000717819 IRS NUMBER: 133165671 STATE OF INCORPORATION: MD FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: N-30D SEC ACT: 1940 Act SEC FILE NUMBER: 811-03712 FILM NUMBER: 03667221 BUSINESS ADDRESS: STREET 1: ONE SEAPORT PLZ CITY: NEW YORK STATE: NY ZIP: 10292 BUSINESS PHONE: 2122141250 MAIL ADDRESS: STREET 1: ONE SEAPORT PLAZA CITY: NEW YORK STATE: NY ZIP: 10292 FORMER COMPANY: FORMER CONFORMED NAME: PRUDENTIAL BACHE TELECOMMUNICATIONS FUND INC DATE OF NAME CHANGE: 19850127 FORMER COMPANY: FORMER CONFORMED NAME: PRUDENTIAL BACHE GOVERNMENT PLUS FUND INC DATE OF NAME CHANGE: 19920703 N-30D 1 mf15979.txt PRUDENTIAL GOVERNMENT INCOME FUND -- PROSPECTUS -- 2/28/2003 ANNUAL REPORT FEBRUARY 28, 2003 PRUDENTIAL GOVERNMENT INCOME FUND, INC. FUND TYPE Government securities OBJECTIVE High current return This report is not authorized for distribution to prospective investors unless preceded or accompanied by a current prospectus. The views expressed in this report and information about the Fund's portfolio holdings are for the period covered by this report and are subject to change thereafter. Prudential Financial is a service mark of The Prudential Insurance Company of America, Newark, NJ, and its affiliates. Prudential Financial (LOGO) Prudential Government Income Fund, Inc. Performance at a Glance INVESTMENT GOALS AND STYLE The investment objective of the Prudential Government Income Fund, Inc. (the Fund) is high current return. The Fund normally invests in bonds issued or guaranteed by the U.S. government, its agencies, or instrumentalities. The guarantee on U.S. government securities applies only to the underlying securities of the Fund's portfolio, and not to the value of the Fund's shares. At least 80% of the Fund's assets are invested in U.S. government securities. There can be no assurance that the Fund will achieve its investment objective. Portfolio Composition Expressed as a percentage of net assets as of 2/28/03. 50.5% Mortgages 21.4 Government Agency 17.4 Treasuries 7.0 Asset-Backed 2.0 Corporates 1.7 Cash & Equivalents Portfolio composition is subject to change. Ten Largest Issuers Expressed as a percentage of net assets as of 2/28/03. 37.7% Federal National Mortgage Assoc. 20.8 Federal Home Loan Mort. Corp. 17.4 U.S. Treasury Obligations 5.9 Small Business Administration 5.4 Govt National Mortgage Assoc. 3.8 Corporate Asset Funding 3.6 Three Pillars Funding Corp. 2.0 Falcon Asset Securitization Corp. 2.0 New Jersey Economic Dev. Auth. 1.4 First Union Lehman Brothers Comm. Holdings are subject to change. www.prudential.com (800) 225-1852 Annual Report February 28, 2003 Cumulative Total Returns1 As of 2/28/03
One Year Five Years Ten Years Since Inception2 Class A 9.51% 39.94% 88.45% 160.77% Class B 9.11 36.17 76.95 257.28 (254.26) Class C 9.20 36.68 N/A 77.13 Class Z 9.79 41.57 N/A 61.07 Lehman Bros. Govt Bond Index3 11.26 45.61 101.63 *** Lipper General U.S. Govt Funds Avg.4 9.10 37.58 84.02 ****
Average Annual Total Returns1 As of 3/31/03
One Year Five Years Ten Years Since Inception2 Class A 7.07% 5.97% 6.03% 7.17% Class B 6.01 6.10 5.80 7.33 (7.28) Class C 8.99 6.12 N/A 6.64 Class Z 11.82 7.08 N/A 6.90 Lehman Bros. Govt Bond Index3 13.40 7.68 7.20 *** Lipper General U.S. Govt Funds Avg.4 10.87 6.44 6.18 ****
Distributions and Yields As of 2/28/03 Total Distributions 30-Day Paid for 12 Months SEC Yield Class A $0.46 3.50% Class B $0.41 3.07 Class C $0.41 3.11 Class Z $0.48 3.89 Past performance is not indicative of future results. Principal value and investment return will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. 1Source: Prudential Investments LLC, Lehman Brothers, and Lipper Inc. The cumulative total returns do not take into account applicable sales charges. If reflected, the applicable sales charges would reduce the performance quoted. The average annual total returns do take into account applicable sales charges. Without the distribution and service (12b-1) fee waiver of 0.05%, 0.175%, and 0.25% for Class A, B, and C shares respectively, the returns would have been lower. The Fund charges a maximum front-end sales charge of 4% for Class A shares, and a 12b-1 fee of up to 0.30% annually. In some circumstances, Class A shares may not be subject to a front-end sales charge, but may be subject to a 1.00% contingent deferred sales charge (CDSC) for the first year. Class B shares are subject to a declining CDSC of 5%, 4%, 3%, 2%, 1%, and 1% for six years respectively after purchase, and a 12b-1 fee of up to 1.00% annually. Approximately seven years after purchase, Class B shares will automatically convert to Class A shares on a quarterly basis. Class C shares are subject to a front-end sales charge of 1% and a CDSC of 1% for shares redeemed within 18 months of purchase, and a 12b-1 fee of up to 1.00% annually. Class Z shares are not subject to a sales charge or 12b-1 fee. Without waiver of management fees and/or expense subsidization, the Fund's returns would have been lower, as indicated in parentheses. The returns in the tables above do not reflect the deduction of taxes that a shareholder would pay on fund distributions or following the redemption of fund shares. 2Inception dates: Class A, 1/22/90; Class B, 4/22/85; Class C, 8/1/94; and Class Z, 3/4/96. 3The Lehman Brothers (Bros.) Government (Govt) Bond Index is an unmanaged index of securities issued or backed by the U.S. government, its agencies, and instrumentalities with between 1 and 30 years remaining to maturity. Investors cannot invest directly in an index. 4The Lipper Average represents returns based on an average return of all funds in the Lipper General U.S. Government (Govt) Funds category for the periods noted. Funds in the Lipper General U.S. Govt Funds Average invest primarily in U.S. government agency issues. The returns for the Lehman Bros. Govt Bond Index would be lower if they included the effects of sales charges, operating expenses, or taxes. Returns for the Lipper General U.S. Govt Funds Average reflect the deduction of operating expenses but not sales charges or taxes. *** Lehman Bros. Govt Bond Index Since Inception cumulative returns as of 2/28/03 are 186.40% for Class A, 370.38% for Class B, 94.38% for Class C, and 68.41% for Class Z. Lehman Bros. Govt Bond Index Since Inception average annual returns as of 3/31/03 are 8.30% for Class A, 9.01% for Class B, 7.94% for Class C, and 7.59% for Class Z. **** Lipper Since Inception cumulative returns as of 2/28/03 are 155.42% for Class A, 295.49% for Class B, 79.10% for Class C, and 56.64% for Class Z. Lipper Since Inception average annual returns as of 3/31/03 are 7.34% for Class A, 7.94% for Class B, 6.87% for Class C, and 6.46% for Class Z. 1 Prudential Financial (LOGO) April 15, 2003 DEAR SHAREHOLDER, Financial markets were volatile during the fiscal year of the Prudential Government Income Fund Inc. that ended February 28, 2003. As the economic recovery in the United States struggled to stay on track, prices of stocks swung widely. It is not surprising that the period was dominated by a back-to- basics approach to investing in which high- quality debt securities and other conservative assets played an increasingly prominent role in asset allocation strategies. Bond funds benefited accordingly. For the fiscal year, the Fund's Class A shares trailed the Lehman Brothers Government Bond Index (the Index). This occurred because the Fund was invested in such a way that it was less sensitive than the Index to the decline in interest rates that drove bond prices higher. However, the Fund's Class A shares returned more than the average comparable portfolio as measured by the Lipper General U.S. Government Bond Funds Average. In March 2003 I was named president of the Fund. I am pleased to lead an organization aimed at offering a high-quality product based on consistent investment disciplines--a point of stability in today's turbulent markets. At Prudential Financial Inc., we recommend that you work closely with a financial professional if you are considering making changes to your investment strategy. As always, we appreciate your continued confidence in Prudential mutual funds. Sincerely, Judy A. Rice, President Prudential Government Income Fund, Inc. 2 Prudential Government Income Fund, Inc. Annual Report February 28, 2003 A BANNER YEAR FOR the U.S. BOND MARKET High-quality bonds performed well during our fiscal year that began March 1, 2002. An uneven economic recovery in the United States, corporate governance scandals at key U.S. firms, declining stocks, and the threat of war with Iraq sent investors seeking the safety of U.S. Treasury securities, mortgage-backed securities, and other bonds of high credit quality. Strong demand for Treasuries caused the yield on the benchmark 10-year note, which moves in the opposite direction of its price, to briefly tumble to a 44-year low of 3.56% in October 2002. The decline in yields also reflected the effort of the Federal Reserve (the Fed) to stimulate economic growth by cutting the overnight bank lending rate half a percentage point to 1.25% in November 2002, its lowest level in 41 years. The Fed's press release announcing this reduction noted that geopolitical risk, among other factors, hurt spending, production, and employment. The trend toward lower interest rates began early in the spring of 2002. Because we expected it to continue, we began to lengthen the Fund's duration in May 2002 after initially allowing it to shorten early in the reporting period. (Duration measures a portfolio's sensitivity to changes in the level of interest rates and is expressed in years.) At the end of our reporting period, the Fund's duration stood at 4.9 years. Positioning the Fund to be more responsive to rate changes enabled it to derive greater benefit as falling interest rates drove bond prices higher during our fiscal year. Although we extended the Fund's duration, it remained shorter than that of the Index. This difference hurt the Fund's performance relative to the Index. 3 Prudential Government Income Fund, Inc. Annual Report February 28, 2003 LARGE EXPOSURE TO "SPREAD PRODUCT" AIDED FUND Our asset allocation strategy emphasized spread product--bonds that offer higher yields than U.S. Treasuries. Spread product includes traditional mortgage-backed securities, (commonly called mortgage pass-through securities), commercial mortgage-backed securities, and federal agency securities, all of which outperformed Treasuries for the 12 months ended February 28, 2003. The returns were adjusted to take into account the differences between the overall duration of each type of spread product compared with that of the Treasury market. The Fund had a considerable exposure to mortgage pass-through securities, even though market conditions were less than ideal. With 30-year mortgage rates tumbling to their lowest level in 40 years, homeowners saved money by replacing their current mortgages with new lower-rate loans. This wave of mortgage refinancing caused some securities backed by mortgages to be paid off earlier than their expected maturity dates, leaving investors to reinvest their money at lower interest rates. Although prepayments on mortgage pass- through securities increased substantially, these securities continued to add value to the Fund. They performed well because they provided higher yields than Treasuries. They also served as an alternative investment for banks and other institutional investors who wanted to avoid commercial lending or a corporate bond market that was battered for several months by accounting scandals at WorldCom, Adelphia Communications, and other major U.S. companies. Late in our reporting period, we trimmed the Fund's exposure to mortgage pass-through securities and increased its exposure to Treasuries out of concern that rates might reach a new low in 2003 and trigger a fresh round of prepayments. On the other hand, we maintained the Fund's modest position in commercial mortgage-backed securities, which was largely unaffected by prepayments because property owners are prevented from refinancing the 4 www.prudential.com (800) 225-1852 underlying loans. We believe exposure to mortgage pass-through securities with characteristics that caused them to experience a slower pace of prepayments and exposure to commercial mortgage-backed securities helped enhance the Fund's performance relative to its Lipper Average during our fiscal year. SPOTLIGHT ON 5- AND 10-YEAR U.S. TREASURIES Within the Treasury market, we focused on five-year notes in the first half of our fiscal year. After their prices climbed sharply and their yields fell, we shifted our emphasis to 10-year Treasury notes in the second half of our reporting period. By that time, we believed 10-year Treasury notes offered a better balance between risk and reward than five-year Treasury notes. Maintaining this exposure to intermediate- term Treasury notes benefited the Fund as they performed better than other Treasury sectors during our fiscal year when returns were adjusted for differences in duration. LOOKING AHEAD While the U.S. bond market rally has driven yields dramatically lower, it is by no means certain that rates will head higher in the near term. Even though the war in Iraq is over, there are longstanding problems such as oversupplies of fiber optic networks, computer servers, and power generators that could keep a lid on economic growth in the United States by continuing to discourage significant new business investment. If relatively lackluster economic conditions persist, interest rates are unlikely to move higher in earnest. Nevertheless, we are considering positioning the Fund's duration slightly shorter than that of its benchmark Index to help protect the Fund should interest rates begin to rise and put downward pressure on bond prices. Prudential Government Income Fund, Inc. Management Team 5 ANNUAL REPORT FEBRUARY 28, 2003 PRUDENTIAL GOVERNMENT INCOME FUND, INC. FINANCIAL STATEMENTS Prudential Government Income Fund, Inc. Portfolio of Investments as of February 28, 2003
Principal Amount (000) Description Value (Note 1) - ---------------------------------------------------------------------------------------- LONG-TERM INVESTMENTS 98.4% - ------------------------------------------------------------------------------------- U.S. Government Agency Mortgage Pass-Throughs 44.1% Federal Home Loan Mortgage Corp., $ 8,880 6.50%, 8/01/10 - 9/01/32 $ 9,367,663 26,314 7.00%, 2/01/09 - 9/01/32 28,112,260 9(f) 7.375%, 3/01/06 8,511 50(c) 7.50%, 6/01/24 54 2,168 8.00%, 1/01/22 - 5/01/23 2,370,682 886 8.50%, 6/01/07 - 3/01/20 967,525 1,358 9.00%, 9/01/05 - 1/01/20 1,506,399 335 11.50%, 10/01/19 388,085 Federal National Mortgage Assoc., 29,600(a) 5.00%, 4/01/18 30,303,000 79,634(a)(b) 5.50%, 7/18/12 - 4/01/33 82,767,912 43,407(a) 6.00%, 11/01/14 - 3/01/18 45,590,470 175,313(a) 6.50%, 6/01/08 - 4/01/33 183,937,733 8,766 6.51%, 3/01/11 9,873,208 114,950(a) 7.00%, 7/01/03 - 3/01/33 121,716,898 22,102 7.50%, 12/01/06 - 10/01/26 23,608,841 2 8.00%, 10/01/24 2,640 858 8.50%, 6/01/17 - 3/01/25 935,158 760 9.00%, 8/01/24 - 4/01/25 843,466 216 9.50%, 10/01/19 - 2/01/25 240,246 Government National Mortgage Assoc., 52,207 7.00%, 2/015/09 - 2/15/29 55,894,095 8,774 7.50%, 1/15/04 - 11/15/24 9,452,394 5,137 8.50%, 4/15/25 5,644,936 3,011 9.50%, 10/15/09 - 12/15/17 3,398,808 Government National Mortgage Assoc. II, 409 9.50%, 5/20/18 - 8/20/21 460,460 -------------- Total U.S. government agency mortgage pass-throughs 617,391,444 -------------- - ------------------------------------------------------------------------------------- U.S. Government Obligations 17.5% United States Treasury Bonds, 4,000 5.375%, 2/15/31 4,434,844
See Notes to Financial Statements 7 Prudential Government Income Fund, Inc. Portfolio of Investments as of February 28, 2003 Cont'd.
Principal Amount (000) Description Value (Note 1) - ---------------------------------------------------------------------------------------- $ 51,250 6.50%, 11/15/26 $ 63,664,134 9,900 8.125%, 8/15/21 14,196,827 United States Treasury Notes, 57,000(d) 1.625%, 1/31/05 57,140,277 355(d) 3.00%, 2/15/08 360,408 33,195 3.00%, 7/15/12 36,830,369 41,368 3.875%, 1/15/09 47,605,221 19,210(d) 4.00%, 11/15/12 19,704,504 -------------- Total U.S. government obligations 243,936,584 -------------- - ------------------------------------------------------------------------------------- U.S. Government Agency Securities 21.4% Federal Home Loan Bank, 8,000 2.297%, 2/20/07 8,573,680 Federal Home Loan Mortgage Corp., 131,260 4.375%, 2/04/10 133,732,413 53,210(d) 4.50%, 1/15/13 54,785,921 18,750 5.25%, 11/05/12 19,520,006 Small Business Administration, 9,347 Ser. 1995-20B, 8.15%, 2/01/15 10,555,885 14,593 Ser. 1995-20L, 6.45%, 12/01/15 15,984,802 20,191 Ser. 1996-20H, 7.25%, 8/01/16 22,720,683 12,800 Ser. 1996-20K, 6.95%, 11/01/16 14,306,886 6,258 Ser. 1997-20A, 7.15%, 1/01/17 7,048,106 11,139 Ser. 1998-20I, 6.00%, 9/01/18 12,181,881 -------------- Total U.S. government agency securities 299,410,263 -------------- - ------------------------------------------------------------------------------------- Corporate Bond 2.0% New Jersey Economic Development Authority, 22,000 Ser. A, 7.425%, 2/15/29 27,626,940 - ------------------------------------------------------------------------------------- Collateralized Mortgage Obligations 6.4% Federal Home Loan Mortgage Corp., 5,257 Ser. 1921, Class J, 6.50%, 9/15/24 5,303,649 5,187 Ser. 2100, Class GH, 5.75%, 4/15/10 5,230,843 9,000 Ser. 2496, Class PM, 5.50%, 9/15/17 9,405,107 7,000 Ser. 2501, Class MC, 5.50%, 9/15/17 7,431,003 6,650 Ser. 2513, Class HC, 5.00%, 10/15/17 6,841,556 5,500 Ser. 2518, Class PV, 5.50%, 6/15/19 5,695,125
8 See Notes to Financial Statements Prudential Government Income Fund, Inc. Portfolio of Investments as of February 28, 2003 Cont'd.
Principal Amount (000) Description Value (Note 1) - ---------------------------------------------------------------------------------------- Federal National Mortgage Assoc., $ 10,000 5.50%, 4/25/17 $ 10,786,792 7,400 Ser. 2002-57, Class ND, 5.50%, 9/25/17 7,834,674 18,000 Ser. 2002-94, Class HQ, 4.50%, 1/25/18 17,722,488 Federal National Mortgage Assoc., R.E.M.I.C. Trust, 7,019 Ser.1993- 76, Class B, 6.00%, 6/25/08 7,151,938 Washington Mutual Mortgage Securities Corp., 6,000 Ser. 2002-AR4, Class A7, 5.57%, 4/26/32 6,160,278 -------------- Total collateralized mortgage obligations 89,563,453 -------------- - ------------------------------------------------------------------------------------- Asset Backed Securities 7.0% Bear Stearns Commercial Mortgage Securities, Inc., 1,428 Ser. 2000-WF1, Class A1, 7.64%, 2/15/32 1,609,467 Capital One Master Trust, 3,700 Ser. 1998-4, Class A, 5.43%, 1/15/07 3,795,682 First Union Lehman Brothers Commercial Trust, 17,000 Ser. 1997-C1, Class A3, 7.38%, 4/18/29 19,430,487 First Union National Bank Commercial Mortgage Trust, 6,026 Ser. 2000-C1, Class A1, 7.739%, 5/17/32 6,827,318 9,569 Ser. 2000-C2, Class A1, 6.94%, 10/15/32 10,624,982 GMAC Commercial Mortgage Security, Inc., 11,500 Ser. 2000-C2, Class A2, 7.455%, 8/16/33 13,626,588 Keycorp, 10,000 Ser. 2000-C1, Class A2, 7.727%, 5/17/32 11,978,398 MBNA Master Credit Card Trust, 9,800 Ser. 1999-J, Class A, 7.00%, 2/15/12 11,390,825 Merrill Lynch Mortgage Investors, Inc., 2,814 Ser. 1996-C1, Class A3, 7.42%, 4/25/28 3,085,787 Morgan Stanley Dean Witter Capital, 9,350 Ser. 2001-TOP1, Class A2, 6.32%, 2/15/33 10,282,395 Mortgage Capital Funding, Inc., 4,665 Ser. 1998-MC2, Class A1, 6.325%, 6/18/30 4,997,244 -------------- Total asset backed securities 97,649,173 -------------- Total long-term investments (cost $1,313,848,557) 1,375,577,857 --------------
See Notes to Financial Statements 9 Prudential Government Income Fund, Inc. Portfolio of Investments as of February 28, 2003 Cont'd.
Principal Amount (000) Description Value (Note 1) - ---------------------------------------------------------------------------------------- SHORT-TERM INVESTMENTS 27.2% - ------------------------------------------------------------------------------------- Repurchase Agreement 8.2% Joint Repurchase Agreement Account, $ 115,524 1.37%, 3/03/03 (Note 6) $ 115,524,000 - ------------------------------------------------------------------------------------- Commercial Paper 10.3% Corporate Asset Funding Co., Inc., 53,000 1.27%, 3/13/03 52,977,563 Falcon Asset Securitization Corp., 27,755 1.27%, 3/12/03 27,744,230 Reed Elsevier Inc., 10,000(e) 1.43%, 3/12/03 9,995,631 3,510(e) 1.45%, 3/24/03 3,506,748 Three Pillars Funding Corp., 50,000 1.27%, 3/13/03 49,978,833 -------------- Total commercial paper 144,203,005 -------------- Shares - ---------------------------------------------------------------------------------- Mutual Fund 8.7% 121,223,454(e) Prudential Core Investment Fund-Taxable Money Market Series, (Note 3), 121,223,454 -------------- Total short-term investments (cost $380,950,459) 380,950,459 -------------- Total Investments 125.6% (cost $1,694,799,016; Note 5) 1,756,528,316 Liabilities in excess of other assets (25.6%) (357,699,720) -------------- Net Assets 100% $1,398,828,596 -------------- --------------
- ------------------------------ R.E.M.I.C.--Real Estate Mortgage Investment Conduit. (a) Partial principal amount of $144,500,000 represents a to-be-announced ('TBA') mortgage dollar roll, see Notes 1 and 4. (b) Partial principal amount pledged as collateral for financial future contracts. (c) Represents actual principal amount (not rounded to nearest thousand). (d) Securities, or portion thereof, on loan, see Note 4. (e) Represents security, or portion thereof, purchased with cash collateral received for securities on loan. (f) Fair-valued security-value is determined by the Valuation Committee or Board of Directors in consultation with the investment adviser. 10 See Notes to Financial Statements This page intentionally left blank Prudential Government Income Fund, Inc. Statement of Assets and Liabilities
February 28, 2003 - ---------------------------------------------------------------------------------------- ASSETS Investments, at value, including collateral for securities on loan of $134,725,833 (cost $1,694,799,016) $ 1,756,528,316 Cash 3,494,543 Receivable for investments sold 190,655,461 Interest receivable 7,166,430 Receivable for Fund shares sold 3,241,554 Due from broker--variation margin 912,547 Receivable for security lending 234,069 Prepaid expenses 34,571 ----------------- Total assets 1,962,267,491 ----------------- LIABILITIES Payable for investments purchased 421,641,808 Payable to broker for collateral for securities on loan 134,725,833 Payable for Fund shares repurchased 4,584,645 Accrued expenses 879,317 Management fee payable 526,938 Dividends payable 467,965 Distribution fee payable 349,245 Securities lending rebate payable 187,049 Deferred directors' fees 76,095 ----------------- Total liabilities 563,438,895 ----------------- NET ASSETS $ 1,398,828,596 ----------------- ----------------- Net assets were comprised of: Shares of beneficial interest at par $ 1,476,495 Paid-in capital in excess of par 1,416,351,964 ----------------- 1,417,828,459 Accumulated net realized loss on investments (83,625,406) Net unrealized appreciation on investments 64,625,543 ----------------- Net assets, February 28, 2003 $ 1,398,828,596 ----------------- -----------------
12 See Notes to Financial Statements Prudential Government Income Fund, Inc. Statement of Assets and Liabilities Cont'd.
February 28, 2003 - ---------------------------------------------------------------------------------------- Class A: Net asset value and redemption price per share ($1,046,220,236 / 110,450,378 shares of common stock issued and outstanding) $9.47 Maximum sales charge (4% of offering price) .39 ----------------- Maximum offering price to public $9.86 ----------------- ----------------- Class B: Net asset value, offering price and redemption price per share ($218,806,101 / 23,059,098 shares of common stock issued and outstanding) $9.49 ----------------- ----------------- Class C: Net asset value and redemption price per share ($29,986,433 / 3,160,575 shares of common stock issued and outstanding) $9.49 Sales charge (1% of offering price) .10 ----------------- Offering price to public $9.59 ----------------- ----------------- Class Z: Net asset value, offering price and redemption price per share ($103,815,826 / 10,979,460 shares of common stock issued and outstanding) $9.46 ----------------- -----------------
See Notes to Financial Statements 13 Prudential Government Income Fund, Inc. Statement of Operations
Year Ended February 28, 2003 - ---------------------------------------------------------------------------------------- NET INVESTMENT INCOME Income Interest $ 72,313,265 Income from securities lending (net) 423,601 ----------------- Total net income 72,736,866 ----------------- Expenses Management fee 6,426,296 Distribution fee--Class A 2,475,045 Distribution fee--Class B 1,514,867 Distribution fee--Class C 188,757 Transfer agent's fees and expenses 1,657,000 Custodian's fees and expenses 308,000 Reports to shareholders 234,000 Registration fees 115,000 Legal fees and expenses 45,000 Audit fee 35,000 Directors' fees 30,000 Miscellaneous 31,943 ----------------- Total expenses 13,060,908 ----------------- Net investment income 59,675,958 ----------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain (loss) on: Investment transactions 23,861,881 Financial futures contracts (204,801) Options written 427,734 ----------------- 24,084,814 ----------------- Net change in unrealized appreciation on: Investment transactions 31,580,909 Financial futures contracts 2,232,079 ----------------- 33,812,988 ----------------- Net gain on investments 57,897,802 ----------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 117,573,760 ----------------- -----------------
14 See Notes to Financial Statements Prudential Government Income Fund, Inc. Statement of Changes in Net Assets
Year Ended February 28, -------------------------------- 2003 2002 - --------------------------------------------------------------------------------- INCREASE IN NET ASSETS Operations Net investment income $ 59,675,958 $ 61,345,769 Net realized gain on investment transactions 24,084,814 26,824,925 Net change in unrealized appreciation (depreciation) on investments 33,812,988 (3,401,423) -------------- -------------- Net increase in net assets resulting from operations 117,573,760 84,769,271 -------------- -------------- Dividends from net investment income (Note 1) Class A (49,282,125) (51,879,376) Class B (8,018,372) (6,535,288) Class C (1,113,221) (669,125) Class Z (4,498,042) (5,373,697) -------------- -------------- (62,911,760) (64,457,486) -------------- -------------- Fund share transactions (net of share conversions) (Note 6): Net proceeds from shares subscribed(a) 468,972,304 497,921,440 Net asset value of shares issued to shareholders in reinvestment of dividends 44,995,727 44,681,743 Cost of shares reacquired (372,999,015) (449,207,487) -------------- -------------- Net increase in net assets from Fund share transactions 140,969,016 93,395,696 -------------- -------------- Total increase 195,631,016 113,707,481 NET ASSETS Beginning of year 1,203,197,580 1,089,490,099 -------------- -------------- End of year $1,398,828,596 $1,203,197,580 -------------- -------------- -------------- -------------- - ------------------------------ (a) For the year ended February 28, 2002 includes $113,615,790 for shares issued in connection with the acquisition of Prudential Government Securities Trust Short-Intermediate Term Series.
See Notes to Financial Statements 15 Prudential Government Income Fund, Inc. Notes to Financial Statements Prudential Government Income Fund, Inc., (the 'Fund') is registered under the Investment Company Act of 1940 as a diversified, open-end management investment company. Investment operations commenced on April 22, 1985. The Fund's investment objective is to seek high current return. The Fund will seek to achieve this objective by investing primarily in U.S. Government Securities, including U.S. Treasury bills, notes, bonds, strips and other debt securities issued by the U.S. Treasury, and obligations, including mortgage-related securities, issued or guaranteed by U.S. Government agencies or instrumentalities. Note 1. Accounting Policies The following is a summary of significant accounting policies followed by the Fund in the preparation of its financial statements. Securities Valuation: Securities listed on a securities exchange or NASDAQ (other than options on securities and indices) are valued at the last reported sale price on such exchange or system on the day of valuation or, if there was no sale reported on such day, at the mean between the last reported bid and asked price on such day or at the last bid price on such day in the absence of an asked price. Securities that are actively traded in the over-the-counter market, including listed securities for which the primary market is believed by Prudential Investments LLC ('PI' or 'Manager'), in consultation with the subadvisers to be over-the-counter, are valued at market value using prices provided by an independent pricing agent or more than one principal market maker (if available, otherwise a principal market maker or a primary market dealer). Futures contracts and options thereon traded on a commodities exchange or board of trade are valued at the last sale price at the close of trading on such exchange or board of trade or, if there was no sale on the applicable commodities exchange or board of trade on such day, at the mean between the most recently quoted bid and asked prices on such exchange or board of trade or at the last bid price in the absence of an asked price. Securities for which market quotations are not readily available or for which the pricing agent or market maker does not provide a valuation or methodology, or provides a valuation or methodology that, in the judgment of the Manager or subadviser does not represent fair value, are valued by a Valuation Committee appointed by the Board of Directors, in consultation with the Manager or applicable subadviser. Investments in mutual funds are valued at their net asset value as of the close of the New York Stock Exchange on the date of valuation. Short-term securities which mature in more than 60 days are valued at current market quotations. Short-term securities which mature in 60 days or less are valued at amortized cost, which approximates market value. 16 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. Repurchase Agreements: In connection with transactions in repurchase agreements with United States financial institutions, it is the Fund's policy that its custodian, or designated subcustodians under triparty repurchase agreements, as the case may be, take possession of the underlying collateral securities, the value of which exceeds the principal amount of the repurchase transaction, including accrued interest. To the extent that any repurchase transaction exceeds one business day, the value of the collateral is marked-to-market on a daily basis to ensure the adequacy of the collateral. If the seller defaults and the value of the collateral declines or if bankruptcy proceedings are commenced with respect to the seller of the security, realization of the collateral by the Fund may be delayed or limited. Financial Futures Contracts: A financial futures contract is an agreement to purchase (long) or sell (short) an agreed amount of securities at a set price for delivery on a future date. Upon entering into a financial futures contract, the Fund is required to pledge to the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount. This amount is known as the 'initial margin.' Subsequent payments, known as 'variation margin,' are made or received by the Fund each day, depending on the daily fluctuations in the value of the underlying security. Such variation margin is recorded for financial statement purposes on a daily basis as unrealized gain or loss. When the contract expires or is closed, the gain or loss is realized and is presented in the Statement of Operations as net realized gain (loss) on financial futures contracts. The Fund invests in financial futures contracts in order to hedge existing portfolio securities, or securities the Fund intends to purchase, against fluctuations in value caused by changes in prevailing interest rates or market conditions. Should interest rates move unexpectedly, the Fund may not achieve the anticipated benefits of the financial futures contracts and may realize a loss. The use of futures transactions involves the risk of imperfect correlation in movements in the price of futures contracts, interest rates and the underlying hedged assets. Options: The Fund may either purchase or write options in order to hedge against adverse market movements or fluctuations in value caused by changes in prevailing interest rates with respect to securities which the Fund currently owns or intends to purchase. The Fund's principal reason for writing options is to realize, through receipt of premiums, a greater current return than would be realized on the underlying security alone. When the Fund purchases an option, it pays a premium and an amount equal to that premium is recorded as an asset. When the Fund writes an option, it receives a premium and an amount equal to that premium is recorded as a liability. The asset or liability is adjusted daily to reflect the current market value of the option. 17 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. If an option expires unexercised, the Fund realizes a gain (loss) to the extent of the premium received or paid. If an option is exercised, the premium received or paid is recorded as an adjustment to the proceeds from the sale or the cost of the purchase in determining whether the Fund has realized a gain (loss). The difference between the premium and the amount received or paid on effecting a closing purchase or sale transaction is also treated as a realized gain (loss). Gain (loss) on purchased options is included in net realized gain (loss) on investment transactions. Gain (loss) on written options is presented separately as net realized gain (loss) on options written. The Fund, as writer of an option, may have no control over whether the underlying securities may be sold (called) or purchased (put). As a result, the Fund bears the market risk of an unfavorable change in the price of the security underlying the written option. The Fund, as purchaser of an option, bears the risk of the potential inability of the counterparties to meet the terms of their contracts. The use of derivative transactions, such as written options and futures contracts, may involve elements of both market and credit risk in excess of the amounts reflected on the Statement of Assets and Liabilities. Dollar Rolls: The Fund may enter into mortgage dollar rolls in which the Fund sells mortgage-backed securities for delivery in the current month and simultaneously contracts to repurchase substantially similar (same type, coupon and maturity) securities on a specified future date. During the roll period, the Fund forgoes principal and interest paid on the securities. The Fund's policy is to record the components of the dollar rolls as purchase and sale transactions. The Fund is compensated by the interest earned on the cash proceeds of the initial sale and by the lower repurchase price at the future date. The difference between the sales proceeds and the lower repurchase price is recorded as interest income. The Fund had dollar rolls outstanding as of February 28, 2003, which are included in Receivable for Investments Sold and Payable for Investments Purchased on the Statement of Assets and Liabilities. The Fund maintains a segregated account of U.S. government securities or other liquid assets, the dollar value of which is at least equal to its obligation with respect to dollar rolls. The Fund is subject to the risk that the market value of the securities is obligated to repurchase under the agreement decline below the repurchase price. Securities Lending: The Fund may lend its securities to qualified institutions. The loans are secured by collateral at least equal, at all times, to the market value of the securities loaned. The Fund may bear the risk of delay in recovery of, or even loss of rights in, the securities loaned should the borrower of the securities fail financially. The Fund receives compensation, net of any rebate and securities lending agent fees, for lending its securities in the form of interest or dividends on the collateral received 18 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. for the securities loaned. The Fund is entitled to any gain or loss in the market price of the securities loaned that may occur during the term of the loan. Securities Transactions and Net Investment Income: Securities transactions are recorded on the trade date. Realized and unrealized gains (losses) on sales of securities are calculated on the identified cost basis. Interest income is recorded on the accrual basis. The Fund amortizes premiums and accretes original issue discount on portfolio securities as adjustments to interest income. Expenses are recorded on the accrual basis which may require the use of certain estimates by management. Net investment income (loss) (other than distribution fees) and unrealized and realized gains (losses) are allocated daily to each class of shares based upon the relative proportion of net assets of each class at the beginning of the day. Dividends and Distributions: The Fund declares daily and pays monthly, dividends from net investment income. The Fund will distribute at least annually any net capital gains in excess of loss carryforwards, if any. Dividends and distributions are recorded on the ex-dividend date. Taxes: It is the Fund's policy to continue to meet the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its taxable net income and capital gains, if any, to its shareholders. Therefore, no federal income tax provision is required. Note 2. Agreements The Fund has a management agreement with Prudential Investments LLC ('PI'). Pursuant to this agreement, PI has responsibility for all investment advisory services and supervises the subadviser's performance of such services. PI has entered into a subadvisory agreement with Prudential Investment Management, Inc. ('PIM'). The subadvisory agreement provides that PIM will furnish investment advisory services in connection with the management of the Fund. In connection therewith, PIM is obligated to keep certain books and records of the Fund. PI continues to have responsibility for all investment advisory services pursuant to the management agreement and supervises PIM's performance of such services. PI pays for the services of PIM, the cost of compensation of officers and employees of the Fund, occupancy and certain clerical and bookkeeping costs of the Fund. The Fund bears all other costs and expenses. The management fee paid to PI is computed daily and payable monthly at an annual rate of .50% of the Fund's average daily net assets up to and including $3 billion and .35% of 1% of the average daily net assets of the Fund in excess of $3 billion. 19 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. The Fund has a distribution agreement with Prudential Investment Management Services LLC ('PIMS'), which acts as the distributor of the Class A, Class B, Class C and Class Z shares of the Fund. The Fund compensates PIMS for distributing and servicing the Fund's Class A, Class B and Class C shares pursuant to plans of distribution (the 'Class A, B and C Plans') regardless of expenses actually incurred by them. The distribution fees for Class A, B and C shares are accrued daily and payable monthly. No distribution or service fees were paid to PIMS as distributor of the Class Z shares of the Fund. Pursuant to the Class A Plan, the Fund compensates PIMS for its distribution-related expenses with respect to Class A shares at an annual rate of up to .30 of 1% of the average daily net assets of the Class A shares. Such expenses under the Class A Plan were .25 of 1% of the average daily net assets of the Class A shares for the year ended February 28, 2003. Pursuant to the Class B Plan, the Fund compensates PIMS for its distribution-related activities at an annual rate of up to 1% of the average daily net assets up to $3 billion, .80 of 1% of the next $1 billion of such net assets and .50 of 1% over $4 billion of the average daily net assets of the Class B shares. Such expenses under the Class B Plan were .825 of 1% of the average daily net assets of the Class B shares for the year ended February 28, 2003. Pursuant to the Class C Plan, the Fund compensates PIMS for its distribution-related activities at an annual rate of up to 1% of the average daily net assets of the Class C shares. Such expenses under the Class C Plan were .75 of 1% of the average daily net assets of the Class C shares for the year ended February 28, 2003. PIMS has advised the Fund that it received approximately $534,100 and $108,700 in front-end sales charges resulting from sales of Class A and Class C shares, respectively, during the year ended February 28, 2003. From these fees, PIMS paid such sales charges to affiliated broker-dealers, which in turn paid commissions to salespersons and incurred other distribution costs. PIMS has advised the Fund that for the year ended February 28, 2003 it received approximately $416,200 and $46,000 in contingent deferred sales charges imposed upon redemptions by certain Class B and Class C shareholders, respectively. PI, PIM and PIMS are indirect, wholly-owned subsidiaries of Prudential Financial, Inc. ('Prudential'). The Fund, along with other affiliated registered investment companies (the 'Funds'), entered into a syndicated credit agreement ('SCA') with a group of banks. For the year ended February 28, 2003 the amount of the commitment was $500 20 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. million from February 28, 2002 through May 3, 2002. On May 3, 2002, the Funds renewed and amended the SCA, which increased the banks' commitment to $800 million and allows the Funds to increase the commitment to $1 billion, if necessary. Interest on any borrowings under the SCA will be incurred at market rates. The Funds pay a commitment fee of .08 of 1% of the unused portion of the SCA. The commitment fee is accrued and paid quarterly on a pro rata basis by the Funds. The purpose of the SCA is to serve as an alternative source of funding for capital share redemptions. The expiration date of the SCA is May 2, 2003. The Fund did not borrow any amounts pursuant to the SCA during the year ended February 28, 2003. Note 3. Other Transactions With Affiliates Prudential Mutual Fund Services LLC ('PMFS'), an affiliate of PI and an indirect, wholly-owned subsidiary of Prudential, serves as the Fund's transfer agent. During the year ended February 28, 2003, the Fund incurred fees of approximately $1,451,600 for the services of PMFS. As of February 28, 2003, approximately $246,900 of such fees were due to PMFS. Transfer agent fees and expenses in the Statement of Operations include certain out-of-pocket expenses paid to nonaffiliates. Prudential Securities Inc. ('PSI'), an affiliate of PI and an indirect, wholly-owned subsidiary of Prudential, is the securities lending agent for the Fund. For the year ended February 28, 2003, PSI has been compensated by the Fund approximately $135,300 for these services of which $11,800 is payable at February 28, 2003. The Fund invests in the Taxable Money Market Series (the 'Series'), a portfolio of Prudential Core Investment Fund, pursuant to an exemptive order received from the Securities and Exchange Commission. The Series is a money market mutual fund registered under the Investment Company Act of 1940, as amended, and managed by PI. During the fiscal year ended February 28, 2003, the Fund earned income of approximately $423,601 from the Series by investing their collateral from securities lending. The Fund pays networking fees to affiliated and unaffiliated broker/dealers. These networking fees are payments made to broker/dealers that clear mutual fund transactions through a national clearing system. The Fund paid approximately $192,000 in total networking fees, of which the amount paid to PSI was approximately $101,500 for the year ended February 28, 2003. As of February 28, 2003, approximately $7,800 of such fees were due to PSI. These amounts are included in transfer agent's fees and expenses in the Statement of Operations. 21 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. Note 4. Portfolio Securities Purchases and sales of investment securities, excluding short-term investments, for the year ended February 28, 2003, were $6,373,434,869 and $6,041,552,914 respectively. During the year ended February 28, 2003, the Fund entered into financial futures contracts. Details of open contracts at February 28, 2003 are as follows:
Value at Value at Unrealized Number of Expiration Trade February 28, Appreciation Contracts Type Date Date 2003 (Depreciation) - --------- -------------------- ----------- ------------ ------------ --------------- Long Positions: 442 5 yr. U.S. T-Note June 2003 $ 49,748,214 $ 50,256,781 $ 508,567 1,545 U.S. T-Bond June 2003 172,109,765 176,854,219 4,744,454 Short Position: (1,189) 10 yr. U.S> T-Note June 2003 134,824,097 137,180,875 (2,356,778) --------------- $ 2,896,243 --------------- ---------------
Transactions in options written during the year ended February 28, 2003, were as follows:
Contracts Premium --------- --------- Balance as of February 28, 2002 -- $ -- Options written 37,500 451,172 Options closed (37,500) (451,172) --------- --------- Balance as of February 28, 2003 -- $ -- --------- --------- --------- ---------
As of February 28, 2003, the Fund had securities on loan with an aggregate market value of $131,955,152 The Fund received $134,725,833 in cash as collateral for securities on loan which was used to purchase highly liquid short-term investments in accordance with the Fund's securities lending procedures. Note 5. Distributions and Tax Information Distributions to shareholders, which are determined in accordance with federal income tax regulations, which may differ from generally accepted accounting principles, are recorded on the ex-dividend date. In order to present undistributed net investment income and accumulated net realized gains (losses) on the statement of assets and liabilities that more closely represent their tax character, certain adjustments have been made to paid-in-capital in excess of par, undistributed net investment income and accumulated net realized gain (loss) on investments. For the year ended 22 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. February 28, 2003, the adjustments were to decrease distributions in excess of net investment income by $3,235,802, decrease accumulated realized loss on investments by $23,068,277 and decrease paid-in-capital in excess of par by $26,304,079 due to differences between financial reporting and tax accounting and the expiration of some of the Fund's capital loss carryforward. Net investment income, net realized losses and net assets were not affected by this change. For the years ended February 28, 2003 and February 28, 2002, the tax character of distributions paid by the Fund of $62,911,760 and $64,457,486, respectively, was ordinary income. As of February 28, 2003, the Fund had a capital loss carryforward for tax purposes of approximately $80,085,000 of which $718,000 expires in 2004, $17,950,000 expires in 2005, $18,673,000 expires in 2008 and $42,744,000 expires in 2009. Accordingly, no capital gains distribution is expected to be paid to shareholders until net gains have been realized in excess of such carryforward. The United States federal income tax basis of the Fund's investments and the net unrealized appreciation as of February 28, 2003 were as follows:
Tax Basis Net Unrealized of Investments Appreciation Depreciation Appreciation - ---------------- ---------------- ---------------- ---------------- $1,695,443,164 $61,206,956 $(121,804) $61,085,152
The difference between book basis and tax basis was primarily attributable to deferred losses on wash sales and differences in the treatment of premium amortization for book and tax purposes. Note 6. Joint Repurchase Agreement Account The Fund, along with other affiliated registered investment companies, transfers uninvested cash balances into a single joint account, the daily aggregate balance of which is invested in one or more repurchase agreements collateralized by U.S. Treasury or federal agency obligations. As of February 28, 2003, the Fund had a 56.1% undivided interest in the repurchase agreements in the joint account. This undivided interest for the Fund represented $115,524,000. in principal amount. As of such date, each repurchase agreement in the joint account and the value of the collateral therefore were as follows: Bank of America, 1.37%, in the principal amount of $68,619,000, repurchase price $68,626,834, due 3/3/03. The value of the collateral including accrued interest was $69,991,380. 23 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. Greenwich Capital Markets, 1.38%, in the principal amount of $68,620,000, repurchase price $68,627,891, due 3/3/03. The value of the collateral including accrued interest was $69,992,864. UBS Warburg, 1.37%, in the principal amount of $68,619,000, repurchase price $68,626,834, due 3/3/03. The value of the collateral including accrued interest was $69,996,194. Note 7. Capital The Fund offers Class A, Class B, Class C and Class Z shares. Class A shares are sold with a front-end sales charge of up to 4%. Class B shares are sold with a contingent deferred sales charge which declines from 5% to zero depending on the period of time the shares are held. Class C shares are sold with a front-end sales charge of 1% and a contingent deferred sales charge of 1% during the first 18 months. Class B shares will automatically convert to Class A shares on a quarterly basis approximately seven years after purchase. Class Z shares are not subject to any sales charge and are offered exclusively for sale to a limited group of investors. There are 2 billion shares of common stock, $.01 par value per share, divided into four classes, designated Class A, B, C and Class Z common stock, each of which consists of 500,000,000 authorized shares. Transactions in shares of common stock were as follows:
Class A Shares Amount - ---------------------------------------------------------- ----------- ------------- Year ended February 28, 2003: Shares sold 24,051,136 $ 222,090,771 Shares issued in reinvestment of dividends 3,703,030 34,051,477 Shares reacquired (23,653,420) (218,203,483) ----------- ------------- Net increase (decrease) in shares outstanding before conversion 4,100,746 37,938,765 Shares issued upon conversion from Class B 1,538,272 14,107,728 ----------- ------------- Net increase (decrease) in shares outstanding 5,639,018 $ 52,046,493 ----------- ------------- ----------- ------------- Year ended February 28, 2002: Shares sold 24,420,841 $ 219,010,862 Shares issued in connection with reorganization (Note 8) 11,926,739 106,126,379 Shares issued in reinvestment of dividends 3,836,548 34,394,158 Shares reacquired (32,666,854) (293,157,853) ----------- ------------- Net increase (decrease) in shares outstanding before conversion 7,517,274 66,373,546 Shares issued upon conversion from Class B 2,726,780 24,326,529 ----------- ------------- Net increase (decrease) in shares outstanding 10,244,054 $ 90,700,075 ----------- ------------- ----------- -------------
24 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd.
Class B Shares Amount - ---------------------------------------------------------- ----------- ------------- Year ended February 28, 2003: Shares sold 12,711,686 $ 117,268,468 Shares issued in reinvestment of dividends 625,550 5,771,748 Shares reacquired (5,640,922) (52,030,016) ----------- ------------- Net increase (decrease) in shares outstanding before conversion 7,696,314 71,010,200 Shares reacquired upon conversion into Class A (1,536,994) (14,107,728) ----------- ------------- Net increase (decrease) in shares outstanding 6,159,320 $ 56,902,472 ----------- ------------- ----------- ------------- Year ended February 28, 2002: Shares sold 8,000,061 $ 72,111,222 Shares issued in reinvestment of dividends 499,191 4,478,599 Shares reacquired (3,484,815) (31,331,641) ----------- ------------- Net increase (decrease) in shares outstanding before conversion 5,014,437 45,258,180 Shares reacquired upon conversion into Class A (2,725,000) (24,326,529) ----------- ------------- Net increase (decrease) in shares outstanding 2,289,437 $ 20,931,651 ----------- ------------- ----------- ------------- Class C - ---------------------------------------------------------- Year ended February 28, 2003: Shares sold 2,987,772 $ 27,607,474 Shares issued in reinvestment of dividends 88,904 820,651 Shares reacquired (1,939,960) (17,963,007) ----------- ------------- Net increase (decrease) in shares outstanding 1,136,716 $ 10,465,118 ----------- ------------- ----------- ------------- Year ended February 28, 2002: Shares sold 1,686,719 $ 15,236,121 Shares issued in reinvestment of dividends 58,599 526,340 Shares reacquired (806,731) (7,249,473) ----------- ------------- Net increase (decrease) in shares outstanding 938,587 $ 8,512,988 ----------- ------------- ----------- ------------- Class Z - ---------------------------------------------------------- Year ended February 28, 2003: Shares sold 11,083,042 $ 102,005,591 Shares issued in reinvestment of dividends 473,597 4,351,851 Shares reacquired (9,243,087) (84,802,509) ----------- ------------- Net increase (decrease) in shares outstanding 2,313,552 $ 21,554,933 ----------- ------------- ----------- ------------- Year ended February 28, 2002: Shares sold 8,686,963 $ 77,947,445 Shares issued in connection with reorganization (Note 8) 842,665 7,489,411 Shares issued in reinvestment of dividends 591,475 5,282,646 Shares reacquired (13,046,507) (117,468,520) ----------- ------------- Net increase (decrease) in shares outstanding (2,925,404) $ (26,749,018) ----------- ------------- ----------- -------------
25 Prudential Government Income Fund, Inc. Financial Highlights
Class A ----------------- Year Ended February 28, 2003 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 9.09 ----------------- Income from investment operations Net investment income 0.46 Net realized and unrealized gain (loss) on investment transactions 0.38 ----------------- Total from investment operations 0.84 ----------------- Less distributions Dividends from net investment income (0.46) ----------------- Net asset value, end of year $ 9.47 ----------------- ----------------- TOTAL INVESTMENT RETURN(a): 9.51% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 1,046,220 Average net assets (000) $ 990,018 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 0.94% Expenses, excluding distribution and service (12b-1) fees 0.69% Net investment income 4.73% For Class A, B, C and Z shares: Portfolio turnover rate 479%
- ------------------------------ (a) Total investment return does not consider the effects of sales loads. Total investment return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. 26 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class A - ------------------------------------------------------------------------------------- Year Ended February 28/29, - ------------------------------------------------------------------------------------- 2002 2001 2000 1999 - ------------------------------------------------------------------------------------- $ 8.94 $ 8.41 $ 8.98 $ 9.05 - ---------------- ---------------- ---------------- ---------------- 0.46 0.54 0.55 0.55 0.17 0.53 (0.57) (0.07) - ---------------- ---------------- ---------------- ---------------- 0.63 1.07 (0.02) 0.48 - ---------------- ---------------- ---------------- ---------------- (0.48) (0.54) (0.55) (0.55) - ---------------- ---------------- ---------------- ---------------- $ 9.09 $ 8.94 $ 8.41 $ 8.98 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 7.36% 13.10% (0.15)% 5.40% $952,466 $845,525 $806,620 $895,039 $954,797 $810,113 $857,586 $836,143 0.98% 1.00% 0.94% 0.84% 0.73% 0.75% 0.69% 0.68% 5.43% 6.25% 6.39% 6.05% 440% 337% 68% 106%
See Notes to Financial Statements 27 Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class B ----------------- Year Ended February 28, 2003 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 9.09 ----------------- Income from investment operations Net investment income 0.41 Net realized and unrealized gain (loss) on investment transactions 0.40 ----------------- Total from investment operations 0.81 ----------------- Less distributions Dividends from net investment income (0.41) ----------------- Net asset value, end of year $ 9.49 ----------------- ----------------- TOTAL INVESTMENT RETURN(a): 9.11% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 218,806 Average net assets (000) $ 183,620 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 1.52% Expenses, excluding distribution and service (12b-1) fees 0.69% Net investment income 4.12%
- ------------------------------ (a) Total investment return does not consider the effects of sales loads. Total investment return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. 28 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class B - ------------------------------------------------------------------------------------- Year Ended February 28/29, - ------------------------------------------------------------------------------------- 2002 2001 2000 1999 - ------------------------------------------------------------------------------------- $ 8.95 $ 8.41 $ 8.99 $ 9.05 - ---------------- ---------------- ---------------- ---------------- 0.41 0.49 0.50 0.49 0.16 0.54 (0.58) (0.06) - ---------------- ---------------- ---------------- ---------------- 0.57 1.03 (0.08) 0.43 - ---------------- ---------------- ---------------- ---------------- (0.43) (0.49) (0.50) (0.49) - ---------------- ---------------- ---------------- ---------------- $ 9.09 $ 8.95 $ 8.41 $ 8.99 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 6.62% 12.58% (0.83)% 4.83% $153,685 $130,732 $193,394 $343,425 $134,237 $146,034 $262,863 $322,626 1.55% 1.58% 1.52% 1.50% 0.73% 0.75% 0.69% 0.68% 4.87% 5.68% 5.77% 5.39%
See Notes to Financial Statements 29 Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class C ----------------- Year Ended February 28, 2003 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 9.09 -------- Income from investment operations Net investment income 0.41 Net realized and unrealized gain (loss) on investment transactions 0.40 -------- Total from investment operations 0.81 -------- Less distributions Dividends from net investment income (0.41) -------- Net asset value, end of year $ 9.49 -------- -------- TOTAL INVESTMENT RETURN(a): 9.20% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $29,986 Average net assets (000) $25,168 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 1.44% Expenses, excluding distribution and service (12b-1) fees 0.69% Net investment income 4.17%
- ------------------------------ (a) Total investment return does not consider the effects of sales loads. Total investment return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. 30 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class C - ------------------------------------------------------------------------------------- Year Ended February 28/29, - ------------------------------------------------------------------------------------- 2002 2001 2000 1999 - ------------------------------------------------------------------------------------- $ 8.95 $ 8.41 $ 8.99 $ 9.05 -------- -------- -------- -------- 0.42 0.50 0.51 0.50 0.16 0.54 (0.58) (0.06) -------- -------- -------- -------- 0.58 1.04 (0.07) 0.44 -------- -------- -------- -------- (0.44) (0.50) (0.51) (0.50) -------- -------- -------- -------- $ 9.09 $ 8.95 $ 8.41 $ 8.99 -------- -------- -------- -------- -------- -------- -------- -------- 6.71% 12.67% (0.76)% 4.91% $ 18,405 $ 9,711 $ 8,508 $ 8,236 $ 13,454 $ 7,904 $ 9,014 $ 4,878 1.48% 1.50% 1.44% 1.43% 0.73% 0.75% 0.69% 0.68% 4.97% 5.75% 5.90% 5.50%
See Notes to Financial Statements 31 Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class Z ----------------- Year Ended February 28, 2003 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 9.07 ----------------- Income from investment operations Net investment income 0.48 Net realized and unrealized gain (loss) on investment transactions 0.39 ----------------- Total from investment operations 0.87 ----------------- Less distributions Dividends from net investment income (0.48) ----------------- Net asset value, end of year $ 9.46 ----------------- ----------------- TOTAL INVESTMENT RETURN(a): 9.79% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 103,816 Average net assets (000) $ 86,453 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 0.69% Expenses, excluding distribution and service (12b-1) fees 0.69% Net investment income 4.95%
- ------------------------------ (a) Total investment return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. 32 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class Z - ------------------------------------------------------------------------------------- Year Ended February 28/29, - ------------------------------------------------------------------------------------- 2002 2001 2000 1999 - ------------------------------------------------------------------------------------- $ 8.93 $ 8.40 $ 8.97 $ 9.04 -------- ---------------- -------- -------- 0.49 0.56 0.57 0.57 0.16 0.53 (0.57) (0.07) -------- ---------------- -------- -------- 0.65 1.09 -- 0.50 -------- ---------------- -------- -------- (0.51) (0.56) (0.57) (0.57) -------- ---------------- -------- -------- $ 9.07 $ 8.93 $ 8.40 $ 8.97 -------- ---------------- -------- -------- -------- ---------------- -------- -------- 7.61% 13.39% 0.09% 5.58% $ 78,642 $103,523 $ 93,390 $ 97,629 $ 94,143 $ 94,635 $ 97,811 $ 86,892 0.73% 0.75% 0.69% 0.68% 0.73% 0.75% 0.69% 0.68% 5.71% 6.50% 6.64% 6.22%
See Notes to Financial Statements 33 Prudential Government Income Fund, Inc. Report of Independent Accountants To the Shareholders and Board of Directors of Prudential Government Income Fund, Inc. In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Prudential Government Income Fund, Inc. (the 'Fund') at February 28, 2003, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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 February 28, 2003 by correspondence with the custodian and brokers, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP New York, New York April 21, 2003 34 See Notes to Financial Statements Prudential Government Income Fund, Inc. Important Notice for Certain Shareholders (Unaudited) We are required by Massachusetts, Missouri and Oregon to inform you that dividends which have been derived from interest on federal obligations are not taxable to shareholders providing the mutual fund meets certain requirements mandated by the respective state's taxing authorities. We are pleased to report that 12.22% of the dividends paid by Prudential Government Income Fund qualify for such deduction. For more detailed information regarding your state and local taxes, you should contact your tax adviser or the state/local taxing authorities. See Notes to Financial Statements 35 Prudential Government Income Fund, Inc. www.prudential.com (800) 225-1852 Management of the Fund (Unaudited) Information pertaining to the Directors of the Fund is set forth below. Directors who are not deemed to be 'interested persons' of the Fund, as defined in the 1940 Act are referred to as 'Independent Directors.' Directors who are deemed to be 'interested persons' of the Fund are referred to as 'Interested Directors.' 'Fund Complex' consists of the Fund and any other investment companies managed by Prudential Investments LLC (PI). Independent Directors
Term of Office and Length Position of Time Name, Address** and Age With Fund Served*** -------------------------------------------------------------------------- Delayne Dedrick Gold (64) Director Since 1983 Thomas T. Mooney (61) Director Since 1985 Stephen P. Munn (60) Director Since 1999 Richard A. Redeker (59) Director Since 1993 Number of Fund Complex Principal Occupations Overseen by Name, Address** and Age During Past 5 Years Director ----------------------------------------------------------------------------------------- Delayne Dedrick Gold (64) Marketing Consultant (1982-present); 88 formerly Senior Vice President and member of the Board of Directors, Prudential Bache Securities, Inc. Thomas T. Mooney (61) Chief Executive Officer, the 97 Rochester Business Alliance, formerly President of the Greater Rochester Metro Chamber of Commerce; Rochester City Manager; formerly Deputy Monroe County Executive; Trustee of Center for Governmental Research, Inc.; Director of Blue Cross of Rochester, and Executive Service Corps of Rochester; Director of the Rochester Individual Practice Association. Stephen P. Munn (60) Chairman of the Board (since 1994) 73 and formerly Chief Executive Officer (1988-2001) and President of Carlisle Companies Incorporated. Richard A. Redeker (59) Formerly Management Consultant of 72 Invesmart, Inc. (August 2001-October 2001); formerly employee of Prudential Investments (October 1996-December 1998). Other Directorships Held Name, Address** and Age by the Director**** ------------------------------------------------------------- Delayne Dedrick Gold (64) Thomas T. Mooney (61) Director, President and Treasurer (since 1986) of First Financial Fund, Inc. and Director (since 1988) of The High Yield Plus Fund, Inc. Stephen P. Munn (60) Chairman of the Board (since January 1994) and Director (since 1988) of Carlisle Companies Incorporated (manufacturer of industrial products); Director of Gannett Co. Inc. (publishing and media). Richard A. Redeker (59)
36 37 Prudential Government Income Fund, Inc. www.prudential.com (800) 225-1852 Management of the Fund (Unaudited) Cont'd.
Term of Office and Length Position of Time Name, Address** and Age With Fund Served*** -------------------------------------------------------------------------- Nancy H. Teeters (72) Director Since 1996 Louis A. Weil, III (62) Director Since 1996 Number of Portfolios in Fund Complex Principal Occupations Overseen by Name, Address** and Age During Past 5 Years Director ------------------------------------------------------------------------------------------- Nancy H. Teeters (72) Economist; formerly Vice President 71 and Chief Economist of International Business Machines Corporation; formerly Director of Inland Steel Industries (July 1984-1999), formerly Governor of The Federal Reserve (September 1978-June 1984). Louis A. Weil, III (62) Formerly Chairman (January 1999-July 72 2000), President and Chief Executive Officer (January 1996-July 2000) and Director (since September 1991) of Central Newspapers, Inc.; formerly Chairman of the Board (January 1996-July 2000), Publisher and Chief Executive Officer (August 1991-December 1995) of Phoenix Newspapers, Inc.
Interested Directors
Term of Office and Length Position of Time Name, Address** and Age With Fund Served*** -------------------------------------------------------------------------- Robert F. Gunia (56)* Vice President Since 1996 and Director Number of Fund Complex Principal Occupations Overseen by Name, Address** and Age During Past 5 Years Director ------------------------------------------------------------------------------------------ Robert F. Gunia (56)* Executive Vice President and Chief 116 Administrative Officer (since June 1999) of PI; Executive Vice President and Treasurer (since January 1996) of PI; President (since April 1999) of Prudential Investment Management Services LLC (PIMS); Corporate Vice President (since September 1997) of The Prudential Insurance Company of America (Prudential); formerly Senior Vice President (March 1987-May 1999) of Prudential Securities Incorporated (Prudential Securities); formerly Chief Administrative Officer (July 1989-September 1996), Director (January 1989-September 1996) and Executive Vice President, Treasurer and Chief Financial Officer (June 1987-December 1996) of PMF. Other Directorships Held Name, Address** and Age by the Director**** ---------------------------------------------------------------- Robert F. Gunia (56)* Vice President and Director (since May 1989) and Treasurer (since 1999) of The Asia Pacific Fund, Inc.
38 39 Prudential Government Income Fund, Inc. www.prudential.com (800) 225-1852 Management of the Fund (Unaudited) Cont'd.
Term of Office and Length Position of Time Name, Address** and Age With Fund Served*** -------------------------------------------------------------------------- David R. Odenath, Jr. (46)*D Director Since 1999 Judy A. Rice (55)*D President and Since 2000 Director (Director) and since 2003 (President) Number of Portfolios in Fund Complex Principal Occupations Overseen by Name, Address** and Age During Past 5 Years Director ------------------------------------------------------------------------------------------ David R. Odenath, Jr. (46)*D Formerly President, Chief Executive 120 Officer, Chief Operating Officer and Officer-In-Charge (1999-2003) of PI; Senior Vice President (since June 1999) of Prudential; formerly Senior Vice President (August 1993-May 1999) of PaineWebber Group, Inc. Judy A. Rice (55)*D President, Chief Executive Officer, 98 Chief Operating Officer and Officer-In-Charge (since 2003) of PI; formerly various positions to Senior Vice President (1992-1999) of Prudential Securities; and various positions to Managing Director (1975-1992) of Salomon Smith Barney; Member of Board of Governors of the Money Management Institute.
Information pertaining to the Officers of the Fund who are not also Directors is set forth below. Officers
Term of Office and Length Position of Time Name, Address** and Age With Fund Served*** -------------------------------------------------------------------------- Grace C. Torres (43) Treasurer and Since 1996 Principal Financial and Accounting Officer Deborah A. Docs (45) Secretary Since 1996 Principal Occupations Name, Address** and Age During Past 5 Years ------------------------------------------------------------------------ Grace C. Torres (43) Senior Vice President (since January 2000) of PI; formerly First Vice President (December 1996-January 2000) of PI and First Vice President (March 1993-1999) of Prudential Securities. Deborah A. Docs (45) Vice President and Corporate Counsel (since January 2001) of Prudential; Vice President and Assistant Secretary (since December 1996) of PI.
40 41 Prudential Government Income Fund, Inc. www.prudential.com (800) 225-1852 Management of the Fund (Unaudited) Cont'd.
Term of Office and Length Position of Time Name, Address** and Age With Fund Served*** -------------------------------------------------------------------------- Marguerite E.H. Morrison (46) Assistant Since 2002 Secretary Maryanne Ryan (38) Anti-Money Since 2002 Laundering Compliance Officer Principal Occupations Name, Address** and Age During Past 5 Years ---------------------------------------------------------------------- Marguerite E.H. Morrison (46) Vice President and Chief Legal Officer--Mutual Funds and Unit Investment Trusts (since August 2000) of Prudential; Senior Vice President and Assistant Secretary (since February 2001) of PI; Vice President and Assistant Secretary of PIMS (since October 2001), previously Vice President and Associate General Counsel (December 1996-February 2001) of PI and Vice President and Associate General Counsel (September 1987-September 1996) of Prudential Securities. Maryanne Ryan (38) Vice President, Prudential (since November 1998), First Vice President, Prudential Securities (March 1997-May 1998).
- ------------------ * 'Interested' Director, as defined in the 1940 Act, by reason of employment with the Manager (Prudential Investments LLC), the Subadviser (Prudential Investment Management, Inc.) or the Distributor (Prudential Investment Management Services LLC). ** Unless otherwise noted, the address of the Directors and Officers is c/o: Prudential Investments LLC, Gateway Center Three, 100 Mulberry Street, Newark, NJ 07102. *** There is no set term of office for Directors and Officers. The Independent Directors have adopted a retirement policy, which calls for the retirement of Directors on December 31 of the year in which they reach the age of 75. The table shows the number of years for which they have served as Director and/or Officer. **** This column includes only directorships of companies required to register, or file reports with the SEC under the Securities and Exchange Act of 1934 (i.e., 'public companies') or other investment companies registered under the 1940 Act. D On March 4, 2003, Ms. Rice was elected to serve as the President of the Fund. Mr. Odenath continues to serve as Director.
Additional information about the Fund's Directors is included in the Fund's Statement of Additional Information which is available without charge, upon request, by calling (800) 225-1852 or (732) 482-7555 (Calling from outside the U.S.) 42 43 Prudential Government Income Fund, Inc. Getting the Most from Your Prudential Mutual Fund Some mutual fund shareholders won't ever read this--they don't read annual and semiannual reports. It's quite understandable. These annual and semiannual reports are prepared to comply with federal regulations, and are often written in language that is difficult to understand. So when most people run into those particularly daunting sections of these reports, they don't read them. WE THINK THAT'S A MISTAKE At Prudential, we've made some changes to our mutual funds report to make it easier to understand and more pleasant to read. We hope you'll find it profitable to spend a few minutes familiarizing yourself with your investment. Here's what you'll find in the report: PERFORMANCE AT A GLANCE Since an investment's performance is often a shareholder's primary concern, we present performance information in two different formats. You'll find it first on the "Performance at a Glance" page where we compare the Fund and the comparable average calculated by Lipper, Inc., a nationally recognized mutual fund rating agency. We report both the cumulative total returns and the average annual total returns. The cumulative total return is the total amount of income and appreciation the Fund has achieved in various time periods. The average annual total return is an annualized representation of the Fund's performance. It gives you an idea of how much the Fund has earned in an average year for a given time period. Under the performance box, you'll see legends that explain the performance information, whether fees and sales charges have been included in the returns, and the inception dates for the Fund's share classes. See the performance comparison charts at the back of the report for more performance information. Please keep in mind that past performance is not indicative of future results. www.prudential.com (800) 225-1852 Getting the Most from Your Prudential Mutual Fund INVESTMENT ADVISER'S REPORT The portfolio manager, who invests your money for you, reports on successful-- and not-so-successful--strategies in this section of your report. Look for recent purchases and sales here, as well as information about the sectors the portfolio manager favors, and any changes that are on the drawing board. PORTFOLIO OF INVESTMENTS This is where the report begins to appear technical, but it's really just a listing of each security held at the end of the reporting period, along with valuations and other information. Please note that sometimes we discuss a security in the "Investment Adviser's Report" section that doesn't appear in this listing, because it was sold before the close of the reporting period. STATEMENT OF ASSETS AND LIABILITIES The balance sheet shows the assets (the value of the Fund's holdings), liabilities (how much the Fund owes), and net assets (the Fund's equity or holdings after the Fund pays its debts) as of the end of the reporting period. It also shows how we calculate the net asset value per share for each class of shares. The net asset value is reduced by payment of your dividend, capital gain, or other distribution--but remember that the money or new shares are being paid or issued to you. The net asset value fluctuates daily, along with the value of every security in the portfolio. STATEMENT OF OPERATIONS This is the income statement, which details income (mostly interest and dividends earned) and expenses (including what you pay us to manage your money). You'll also see capital gains here--both realized and unrealized. Prudential Government Income Fund, Inc. Getting the Most from Your Prudential Mutual Fund STATEMENT OF CHANGES IN NET ASSETS This schedule shows how income and expenses translate into changes in net assets. The Fund is required to pay out the bulk of its income to shareholders every year, and this statement shows you how we do it (through dividends and distributions) and how that affects the net assets. This statement also shows how money from investors flowed into and out of the Fund. NOTES TO FINANCIAL STATEMENTS This is the kind of technical material that can intimidate readers, but it does contain useful information. The notes provide a brief history and explanation of your Fund's objectives. In addition, they outline how Prudential mutual funds prices securities. The notes also explain who manages and distributes the Fund's shares and, more important, how much they are paid for doing so. Finally, the notes explain how many shares are outstanding and the number issued and redeemed over the period. FINANCIAL HIGHLIGHTS This information contains many elements from prior pages, but on a per-share basis. It is designed to help you understand how the Fund performed, and to compare this year's performance and expenses to those of prior years. INDEPENDENT ACCOUNTANT'S REPORT Once a year, an independent accountant looks over our books and certifies that the financial statements are fairly presented in accordance with generally accepted accounting principles. TAX INFORMATION This is information that we report annually about how much of your total return is taxable. Should you have any questions, you may want to consult a tax adviser. www.prudential.com (800) 225-1852 Getting the Most from Your Prudential Mutual Fund PERFORMANCE COMPARISON These charts are included in the annual report and are required by the Securities Exchange Commission. Performance is presented here as the return on a hypothetical $10,000 investment in the Fund since its inception or for 10 years (whichever is shorter). To help you put that return in context, we are required to include the performance of an unmanaged, broad-based securities index as well. The index does not reflect the cost of buying the securities it contains or the cost of managing a mutual fund. Of course, the index holdings do not mirror those of the Fund--the index is a broad-based reference point commonly used by investors to measure how well they are doing. A definition of the selected index is also provided. Investors cannot invest directly in an index. Prudential Government Income Fund, Inc. Getting the Most from Your Prudential Mutual Fund How many times have you read these reports-- or other financial materials--and stumbled across a word that you don't understand? Many shareholders have run into the same problem. We'd like to help. So we'll use this space from time to time to explain some of the words you might have read, but not understood. And if you have a favorite word that no one can explain to your satisfaction, please write to us. Basis Point: 1/100th of 1%. For example, one-half of one percent is 50 basis points. Collateralized Mortgage Obligations (CMOs): Mortgage-backed bonds that separate mortgage pools into different maturity classes called tranches. These instruments are sensitive to changes in interest rates and homeowner refinancing activity. They are subject to prepayment and maturity extension risk. Derivatives: Securities that derive their value from other securities. The rate of return of these financial instruments rises and falls--sometimes very suddenly--in response to changes in some specific interest rate, currency, stock, or other variable. Discount Rate: The interest rate charged by the Federal Reserve on loans to member banks. Federal Funds Rate: The interest rate charged by one bank to another on overnight loans. Futures Contract: An agreement to purchase or sell a specific amount of a commodity or financial instrument at a set price at a specified date in the future. www.prudential.com (800) 225-1852 Getting the Most from Your Prudential Mutual Fund Leverage: The use of borrowed assets to enhance return. The expectation is that the interest rate charged on borrowed funds will be lower than the return on the investment. While leverage can increase profits, it can also magnify losses. Liquidity: The ease with which a financial instrument (or product) can be bought or sold (converted into cash) in the financial markets. Price/Earnings Ratio: The price of a share of stock divided by the earnings per share for a 12-month period. Option: An agreement to purchase or sell something, such as shares of stock, by a certain time for a specified price. An option need not be exercised. Spread: The difference between two values; often used to describe the difference between "bid" and "asked" prices of a security, or between the yields of two similar maturity bonds. Yankee Bond: A bond sold by a foreign company or government on the U.S. market and denominated in U.S. dollars. Prudential Government Income Fund, Inc. Class A Growth of a $10,000 Investment (CHART) Average Annual Total Returns as of 2/28/03 One Year Five Years Ten Years Since Inception With Sales Charge 5.13% 6.08% 6.11% 7.25% Without Sales Charge 9.51% 6.95% 6.54% 7.59% Past performance is not indicative of future results. Principal value and investment return will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. The graph compares a $10,000 investment in the Prudential Government Income Fund, Inc. (Class A shares) with a similar investment in the Lehman Brothers Government Bond Index (the Index) by portraying the initial account values at the beginning of the 10- year period (February 28, 1993) and the account values at the end of the current fiscal year (February 28, 2003), as measured on a quarterly basis. For purposes of the graph, and unless otherwise indicated, it has been assumed that (a) the maximum applicable front-end sales charge was deducted from the initial $10,000 investment in Class A shares; (b) all recurring fees (including management fees) were deducted; and (c) all dividends and distributions were reinvested. Without the distribution and service (12b-1) fee waiver of 0.05% for Class A shares annually, the returns would have been lower. The returns on investment in the graph and the returns in the table do not reflect the deduction of taxes that a shareholder would pay on fund distributions or following the redemption of fund shares. The Index is an unmanaged, weighted index comprising securities issued or backed by the U.S. government, its agencies, and instrumentalities with a remaining maturity of 1 to 30 years. It gives a broad look at how U.S. Government bonds with such maturities have performed. The Index's returns include the reinvestment of all dividends, but do not reflect sales charges, operating expenses, or taxes. These returns would be lower if they reflected the effects of sales charges, operating expenses, or taxes. The securities that comprise the Index may differ substantially from the securities in the Fund. The Index is not the only one that may be used to characterize performance of government bond funds. Other indexes may portray different comparative performance. Investors cannot invest directly in an index. This graph is furnished to you in accordance with Securities and Exchange Commission (SEC) regulations. www.prudential.com (800) 225-1852 Class B Growth of a $10,000 Investment (CHART) Average Annual Total Returns as of 2/28/03 One Year Five Years Ten Years Since Inception With Sales Charge 4.11% 6.21% 5.87% 7.39% Without Sales Charge 9.11% 6.37% 5.87% 7.39% Past performance is not indicative of future results. Principal value and investment return will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. The graph compares a $10,000 investment in the Prudential Government Income Fund, Inc. (Class B shares) with a similar investment in the Index by portraying the initial account values at the beginning of the 10- year period (February 28, 1993) and the account values at the end of the current fiscal year (February 28, 2003), as measured on a quarterly basis. For purposes of the graph, and unless otherwise indicated, it has been assumed that (a) the maximum applicable contingent deferred sales charge (CDSC) was deducted from the value of the investment in Class B shares, assuming full redemption on February 28, 2003; (b) all recurring fees (including management fees) were deducted; and (c) all dividends and distributions were reinvested. Approximately seven years after purchase, Class B shares will automatically convert to Class A shares on a quarterly basis. Without the 12b-1 fee waiver of 0.175% for Class B shares annually, the returns would have been lower. Without waiver of management fees and/or expense subsidization, the Fund's returns would have been lower, as indicated in parentheses. The returns on investment in the graph and the returns in the table do not reflect the deduction of taxes that a shareholder would pay on fund distributions or following the redemption of fund shares. The Index is an unmanaged, weighted index comprising securities issued or backed by the U.S. government, its agencies, and instrumentalities with a remaining maturity of 1 to 30 years. It gives a broad look at how U.S. Government bonds with such maturities have performed. The Index's returns include the reinvestment of all dividends, but do not reflect sales charges, operating expenses, or taxes. These returns would be lower if they reflected the effects of sales charges, operating expenses, or taxes. The securities that comprise the Index may differ substantially from the securities in the Fund. The Index is not the only one that may be used to characterize performance of government bond funds. Other indexes may portray different comparative performance. Investors cannot invest directly in an index. This graph is furnished to you in accordance with SEC regulations. Prudential Government Income Fund, Inc. Class C Growth of a $10,000 Investment (CHART) Average Annual Total Returns as of 2/28/03 One Year Five Years Ten Years Since Inception With Sales Charge 7.11% 6.24% N/A 6.76% Without Sales Charge 9.20% 6.45% N/A 6.89% Past performance is not indicative of future results. Principal value and investment return will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. The graph compares a $10,000 investment in the Prudential Government Income Fund, Inc. (Class C shares) with a similar investment in the Index by portraying the initial account values at the commencement of operations of Class C shares (August 1, 1994) and the account values at the end of the current fiscal year (February 28, 2003), as measured on a quarterly basis. For purposes of the graph, and unless otherwise indicated, it has been assumed that (a) the maximum applicable front-end sales charge was deducted from the initial $10,000 investment in Class C shares; (b) the maximum applicable CDSC was deducted from the value of the investment in Class C shares, assuming full redemption on February 28, 2003; (c) all recurring fees (including management fees) were deducted; and (d) all dividends and distributions were reinvested. Without the 12b-1 fee waiver of 0.25% for Class C shares annually, the returns would have been lower. The returns on investment in the graph and the returns in the table do not reflect the deduction of taxes that a shareholder would pay on fund distributions or following the redemption of fund shares. The Index is an unmanaged, weighted index comprising securities issued or backed by the U.S. government, its agencies, and instrumentalities with a remaining maturity of 1 to 30 years. It gives a broad look at how U.S. Government bonds with such maturities have performed. The Index's returns include the reinvestment of all dividends, but do not reflect sales charges, operating expenses, or taxes. These returns would be lower if they reflected the effects of sales charges, operating expenses, or taxes. The securities that comprise the Index may differ substantially from the securities in the Fund. The Index is not the only one that may be used to characterize performance of government bond funds. Other indexes may portray different comparative performance. Investors cannot invest directly in an index. This graph is furnished to you in accordance with SEC regulations. www.prudential.com (800) 225-1852 Class Z Growth of a $10,000 Investment (CHART) Average Annual Total Returns as of 2/28/03 One Year Five Years Ten Years Since Inception 9.79% 7.20% N/A 7.05% Past performance is not indicative of future results. Principal value and investment return will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. The graph compares a $10,000 investment in the Prudential Government Income Fund, Inc. (Class Z shares) with a similar investment in the Index by portraying the initial account values at the commencement of operations of Class Z shares (March 4, 1996) and the account values at the end of the current fiscal year (February 28, 2003), as measured on a quarterly basis. For purposes of the graph, and unless otherwise indicated, it has been assumed that (a) all recurring fees (including management fees) were deducted, and (b) all dividends and distributions were reinvested. Class Z shares are not subject to a sales charge or 12b-1 fee. The returns on investment in the graph and the returns in the table do not reflect the deduction of taxes that a shareholder would pay on fund distributions or following the redemption of fund shares. The Index is an unmanaged, weighted index comprising securities issued or backed by the U.S. government, its agencies, and instrumentalities with a remaining maturity of 1 to 30 years. It gives a broad look at how U.S. Government bonds with such maturities have performed. The Index's returns include the reinvestment of all dividends, but do not reflect sales charges, operating expenses, or taxes. These returns would be lower if they reflected the effects of sales charges, operating expenses, or taxes. The securities that comprise the Index may differ substantially from the securities in the Fund. The Index is not the only one that may be used to characterize performance of government bond funds. Other indexes may portray different comparative performance. Investors cannot invest directly in an index. This graph is furnished to you in accordance with SEC regulations. FOR MORE INFORMATION Prudential Mutual Funds Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 (800) 225-1852 Visit Prudential's website at: www.prudential.com DIRECTORS Delayne Dedrick Gold Robert F. Gunia Thomas T. Mooney Stephen P. Munn David R. Odenath, Jr. Richard A. Redeker Judy A. Rice Nancy H. Teeters Louis A. Weil, III OFFICERS Judy A. Rice, President Robert F. Gunia, Vice President Grace C. Torres, Treasurer Deborah A. Docs, Secretary Marguerite E.H. Morrison, Assistant Secretary Maryanne Ryan, Anti-Money Laundering Compliance Officer MANAGER Prudential Investments LLC Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 INVESTMENT ADVISER Prudential Investment Management, Inc. Gateway Center Two Newark, NJ 07102 DISTRIBUTOR Prudential Investment Management Services LLC Gateway Center Three, 14th Floor 100 Mulberry Street Newark, NJ 07102-4077 CUSTODIAN State Street Bank and Trust Company One Heritage Drive North Quincy, MA 02171 TRANSFER AGENT Prudential Mutual Fund Services LLC PO Box 8098 Philadelphia, PA 19101 INDEPENDENT ACCOUNTANTS PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, NY 10036 LEGAL COUNSEL Shearman & Sterling 599 Lexington Avenue New York, NY 10022 Mutual funds are not insured by the FDIC or any federal government agency, are not a deposit of or guaranteed by any bank or any bank affiliate, and may lose value. Fund Symbols Nasdaq CUSIP - ------------ ------ ----- Class A PGVAX 744339102 Class B PBGPX 744339201 Class C PRICX 744339300 Class Z PGVZX 744339409 MF128E IFS-A079288 -----END PRIVACY-ENHANCED MESSAGE-----