N-CSRS 1 govtinc-nscrs.txt AXP GOVERNMENT INCOME SERIES, INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM N-CSR CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number 811-4260 ------------ AXP GOVERNMENT INCOME SERIES, INC. -------------------------------------------------------------------------------- (Exact name of registrant as specified in charter) 50606 AXP Financial Center, Minneapolis, Minnesota 55474 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip code) Leslie L. Ogg - 901 S. Marquette Avenue, Suite 2810, Minneapolis, MN 55402-3268 -------------------------------------------------------------------------------- (Name and address of agent for service) Registrant's telephone number, including area code: (612) 330-9283 ----------------- Date of fiscal year end: 5/31 -------------- Date of reporting period: 11/30 -------------- AXP(R) Short Duration U.S. Government Fund Semiannual Report for the Period Ended Nov. 30, 2003 AXP Short Duration U.S. Government Fund seeks to provide shareholders with a high level of current income and safety of principal consistent with investment in U.S. government and government agency securities. -------------------------------------------------------------------------------- (logo) (logo) American AMERICAN Express(R) EXPRESS(R) Funds -------------------------------------------------------------------------------- Table of Contents Fund Snapshot 3 Questions & Answers with Portfolio Management 4 Investments in Securities 7 Financial Statements (Portfolio) 12 Notes to Financial Statements (Portfolio) 15 Financial Statements (Fund) 19 Notes to Financial Statements (Fund) 22 Proxy Voting 28 (Dalbar logo) American Express(R) Funds' reports to shareholders have been awarded the Communications Seal from Dalbar Inc., an independent financial services research firm. The Seal recognizes communications demonstrating a level of excellence in the industry. -------------------------------------------------------------------------------- 2 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Fund Snapshot AS OF NOV. 30, 2003 PORTFOLIO MANAGER Portfolio manager Scott Kirby* Since 6/01 Years in industry 24 * The Fund is managed by a team of portfolio managers led by Scott Kirby. FUND OBJECTIVE For investors seeking a high level of current income and safety of principal consistent with investment in U.S. government and government agency securities. Inception dates A: 8/19/85 B: 3/20/95 C: 6/26/00 Y: 3/20/95 Ticker symbols A: IFINX B: ISHOX C: AXFCX Y: IDFYX Total net assets $2.875 billion Number of holdings 200 STYLE MATRIX Shading within the style matrix indicates areas in which the Fund generally invests. DURATION SHORT INT LONG X HIGH MEDIUM QUALITY LOW SECTOR COMPOSITION Percentage of portfolio assets (pie chart) Mortgage-backed securities 45.4% U.S. government obligations & agencies 41.1% Short-term securities 10.0% Financials 3.3% Consumer discretionary 0.2% CREDIT QUALITY SUMMARY Percentage of portfolio assets excluding cash equivalents AAA bonds 100% Individual security ratings are based on information from Standard & Poor's Corp. and Moody's Investors Service. If a rating is unavailable, the rating is determined through an internal analysis, if appropriate. For further detail about these holdings, please refer to the section entitled "Investments in Securities." Shares of the Fund are not insured or guaranteed by the U.S. government. Fund holdings are subject to change. -------------------------------------------------------------------------------- 3 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Questions & Answers WITH PORTFOLIO MANAGEMENT Below, Portfolio Manager Scott Kirby details AXP Short Duration U.S. Government Fund's positioning and results for the six months ended Nov. 30, 2003. Q: How did AXP Short Duration U.S. Government Fund perform for the six months ended Nov. 30, 2003? A: AXP Short Duration U.S. Government Fund's Class A shares (excluding sales charge) fell 0.39% for the six months ended Nov. 30, 2003. The Fund underperformed the Lipper Short U.S. Government Funds Index, representing the Fund's peer group, which fell 0.18% over the same period. The Fund's benchmark, the Lehman Brothers 1-3 Year Government Index, rose 0.13% for the period. Q: What factors most significantly affected Fund performance? A: During the first four months of the period we saw significant and severe volatility. Since the Fund was positioned to do well in a low volatility environment, it struggled during the volatile months of May through September. The fixed income market rallied in June fueled by the belief that interest rates would remain low until the economy showed sustained signs of a recovery. Then, on June 25, 2003, the Federal Reserve Board moderated their stance on deflation and cut the targeted federal funds rate by only 0.25% (a quarter of a (bar graph) PERFORMANCE COMPARISON For the six-month period ended Nov. 30, 2003 0.50% 0.25% (bar 2) 0.00% +0.13% (bar 3) -0.25% (bar 1) -0.18% -0.50% -0.39% (bar 1) AXP Short Duration U.S. Government Fund Class A (excluding sales charge) (bar 2) Lehman Brothers 1-3 Year Government Index(1) (unmanaged) (bar 3) Lipper Short U.S. Government Funds Index(2) (1) Lehman Brothers 1-3 Year Government Index, an unmanaged index, is made up of all publicly issued, non-convertible domestic debt of the U.S. government, or agency thereof, or any quasi-federal corporation. The index also includes corporate debt guaranteed by the U.S. government. Only notes and bonds with a minimum maturity of one year up to a maximum maturity of 2.9 years are included. (2) The Lipper Short U.S. Government Funds Index, published by Lipper Inc., includes the 30 largest funds that are generally similar to the Fund, although some funds in the index may have somewhat different investment policies or objectives. Past performance is no guarantee of future results. The 4.75% sales charge applicable to Class A shares of the Fund is not reflected in the bar chart; if reflected, returns would be lower than those shown. The performance of Class B, Class C and Class Y may vary from that shown above because of differences in expenses. The indices do not reflect the effects of sales charges, expenses (excluding Lipper) and taxes. -------------------------------------------------------------------------------- 4 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Questions & Answers (begin callout quote)> We have seen the fixed-income market settle into a trading range environment where mortgage-backed securities, which make up almost half of the Fund, have done well. (end callout quote) percentage point) to 1.00%, to "add further support for an economy which it expects to improve over time." The Federal Reserve Board's conservative move led to a market sell-off, and U.S. Treasury yields rose dramatically by July. July was also the worst month for mortgage securities in history based on duration-adjusted excess returns over U.S. Treasuries. Therefore, we adjusted
AVERAGE ANNUAL TOTAL RETURNS Class A Class B Class C Class Y (Inception dates) (8/19/85) (3/20/95) (6/26/00) (3/20/95) NAV(1) POP(2) NAV(1) After CDSC(3) NAV(1) After CDSC(4) NAV(5) POP(5) as of Nov. 30, 2003 6 month* -0.39% -5.12% -0.77% -5.70% -0.77% -1.76% -0.31% -0.31% 1 year +1.57% -3.24% +0.81% -3.16% +0.81% +0.81% +1.75% +1.75% 5 years +4.15% +3.14% +3.37% +3.20% N/A N/A +4.31% +4.31% 10 years +5.31% +4.80% N/A N/A N/A N/A N/A N/A Since inception N/A N/A +4.89% +4.89% +4.74% +4.74% +5.85% +5.85% as of Dec. 31, 2003 6 months* +0.17% -4.59% -0.21% -5.16% -0.22% -1.21% +0.25% +0.25% 1 year +1.03% -3.76% +0.27% -3.68% +0.27% +0.27% +1.20% +1.20% 5 years +4.12% +3.11% +3.34% +3.17% N/A N/A +4.28 +4.28% 10 years +5.28% +4.77% N/A N/A N/A N/A N/A N/A Since inception N/A N/A +4.90% +4.90% +4.76% +4.76% +5.85% +5.85%
* Not annualized. (1) Excluding sales charge. (2) Returns at public offering price (POP) reflect a sales charge of 4.75%. (3) Returns at maximum contingent deferred sales charge (CDSC). CDSC applies as follows: first year 5%; second and third year 4%; fourth year 3%; fifth year 2%; sixth year 1%; no sales charge thereafter. (4) 1% CDSC applies to redemptions made within the first year of purchase. (5) Sales charge is not applicable to these shares. Shares available to institutional investors only. Past performance is no guarantee of future results. Investment return and principal value will fluctuate, so that your shares, when redeemed, may be worth more or less than the original cost. The performance shown for each class of shares will vary due to differences in sales charges and fees. Short term performance may be higher or lower than the figures shown. Visit americanexpress.com/funds for current information. -------------------------------------------------------------------------------- 5 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Questions & Answers the Fund's duration to a neutral position. Compounding matters was news of a stabilizing U.S. economy. After peaking in mid-August, U.S. Treasury yields declined somewhat by the end of the period. Mortgage securities also recovered. During September we saw a significant sell-off, but the market began to see an end to high volatility in October and November. In the latter part of the period we have seen the fixed-income market settle into a trading range environment where mortgage-backed securities, which make up almost half of the Fund, have done well. The Fund is currently positioned slightly shorter in duration than its benchmark because we believe that will benefit the Fund during the economic recovery. The Fund underperformed its competitors due to its positioning for lower volatility. The Fund underperformed its benchmark and peer group due its allocation to mortgages. Within the mortgage sector, we were able to add relative value by focusing on pools that historically have had lower-than-average prepayment risks. To help manage risk, the Fund also used a significant number of futures this period, resulting in a gain. For much of the period, we maintained a portfolio asset allocation to mortgage-backed securities near our 50% target. The remaining portion of the Fund is invested in Treasury and Agency securities with a small position in cash. Q: What changes did you make to the Fund and how is it currently positioned? A: Aside from shifting 10% of the Fund's weighting from Treasuries to agency securities, we did not make changes to the Fund's mix of securities. Overall, we have reduced exposure to volatility. We continue to hold the same allocation to mortgage-backed securities, however we hold more conservative positions. Q: How do you intend to manage the Fund in the coming months? A: As the economy continues to recover, we expect rates to move higher and the yield curve could steepen slightly futher. Going forward, we believe there will be good buying opportunities in Treasuries and agency securities as spreads widen. We will hold a rather defensive position in mortgage-backed securities as these changes occur because we anticipate a short time period in which mortgages may struggle. However, after we pass that period, we anticipate a positive environment for mortgages because there will be less call risk in the market. We believe volatility may be reduced as well going forward. However, we intend to keep the Fund's duration shorter than its benchmark. We may seek opportunities to reduce duration even further over the coming months. Quality issues and security selection will remain a priority. -------------------------------------------------------------------------------- 6 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Investments in Securities Government Income Portfolio Nov. 30, 2003 (Unaudited) (Percentages represent value of investments compared to net assets) Bonds (100.9%) Issuer Coupon Principal Value(a) rate amount U.S. government obligations & agencies (46.1%) Federal Home Loan Bank 11-25-05 2.00% $14,700,000 $14,589,371 09-15-06 2.88 17,400,000 17,461,770 Federal Home Loan Mtge Corp 04-15-06 2.38 133,000,000 132,686,918 06-16-06 1.52 54,000,000 53,990,172 08-15-06 2.75 47,750,000 47,841,632 02-15-16 5.00 19,511,488 20,384,770 Federal Natl Mtge Assn 05-15-06 2.25 20,000,000 19,904,100 07-15-07 4.25 46,228,000 47,937,049 12-15-16 4.00 12,351,720 12,267,065 Student Loan Mtge Assn 03-15-06 5.25 13,200,000 14,009,252 12-15-22 2.99 15,000,000 14,974,215 12-15-32 2.25 15,775,000 15,716,948 03-15-33 2.16 14,800,000 14,804,632 U.S. Treasury 12-31-04 1.75 72,000,000(l) 72,227,808 02-15-05 7.50 92,500,000(c) 99,094,233 05-15-05 6.75 65,650,000(c,l) 70,424,987 05-31-05 1.25 38,500,000(c,l) 38,247,440 08-15-05 10.75 85,590,000 98,338,203 08-31-05 2.00 30,000,000 30,064,440 11-15-05 5.75 76,400,000(c) 81,882,311 02-15-06 5.63 85,500,000(c) 91,952,600 11-15-06 2.63 112,379,000(c,l) 112,664,330 11-15-06 3.50 147,700,000(c,l) 151,807,832 11-15-09 10.38 48,000,000(l) 51,991,872 Total 1,325,263,950 Mortgage-backed securities (50.9%)(f) Federal Home Loan Mtge Corp 08-25-06 3.13 42,000,000 42,229,963 10-27-06 3.00 15,000,000 15,026,748 09-01-09 6.50 547,081 575,838 10-01-10 7.00 1,938,357 2,059,547 03-01-12 7.50 7,367,731 7,850,675 07-01-12 5.50 839,318 867,645 09-27-12 3.61 13,979,000 13,975,005 02-01-13 5.00 5,049,803 5,177,626 04-01-13 4.50 3,134,189 3,165,898 04-01-13 5.00 4,322,290 4,431,698 05-01-13 4.50 28,328,444 28,615,567 06-01-15 7.50 14,151,672 15,080,148 04-01-17 6.50 40,712,338 43,116,375 07-01-17 6.50 24,134,801 25,400,475 11-01-17 5.50 12,640,374 13,034,842 02-15-20 4.50 15,450,000 15,377,709 07-01-24 8.00 831,984(l) 905,461 07-01-24 8.00 304,629 331,532 01-01-25 9.00 1,237,090 1,374,749 06-01-25 8.00 1,201,815 1,306,174 08-01-25 8.00 326,380 354,720 05-01-26 9.00 2,202,749 2,449,986 Collateralized Mtge Obligation 12-15-08 2.00 15,403,498 15,337,261 12-15-08 6.00 14,770,711 15,527,691 03-15-12 5.00 20,354,433 20,697,092 04-15-12 5.00 23,418,464 24,051,465 03-15-15 5.50 40,888,673 42,029,201 10-15-15 5.00 29,046,000 30,073,938 01-15-16 5.00 9,125,000 9,536,021 02-15-16 5.00 9,125,000 9,536,194 06-15-16 7.00 16,185,942 17,365,408 07-15-16 4.00 11,000,000 10,903,278 08-15-16 4.00 14,617,385 14,561,380 10-15-16 4.00 9,705,546 9,645,911 01-17-21 6.00 5,638,663 5,714,678 04-15-22 5.50 15,828,024 16,319,042 Interest Only 12-15-12 27.33 18,576,480(i) 1,509,450 02-15-14 10.21 14,466,347(i) 1,475,567 01-01-20 4.71 28,625(i) 6,572 Interest Only/Inverse Floater 06-15-18 4.84 12,910,737(i,j) 859,478 03-15-32 6.83 7,621,638(i,j) 693,456 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 7 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn 09-01-07 8.50% $325,183 $340,098 10-01-07 7.50 953,159 1,018,839 12-01-08 7.50 1,578,448 1,679,279 01-01-09 5.74 3,280,843 3,500,358 05-01-09 7.50 3,245,411 3,469,043 10-01-09 7.11 4,339,670 4,962,316 01-01-10 5.00 1,322,059 1,347,361 07-01-11 7.50 1,391,347 1,487,425 11-01-12 5.00 944,855 968,772 12-01-12 5.00 1,690,934 1,734,634 04-01-13 5.50 20,777,768 21,479,018 05-01-13 5.00 24,929,430 25,560,456 05-01-13 5.50 6,491,082 6,754,101 05-01-13 6.00 1,486,786 1,556,235 06-01-13 5.00 4,153,713 4,258,854 08-01-13 4.50 11,449,483 11,565,320 10-01-13 6.00 4,447,282 4,655,019 12-01-13 4.50 46,600,000(b) 47,004,112 12-01-13 5.50 2,021,685 2,093,758 12-25-13 4.50 21,428,571 22,047,991 01-01-14 5.50 1,243,872 1,288,216 01-01-14 6.00 811,368 849,268 03-01-14 6.00 1,468,585 1,537,184 06-01-14 6.50 15,104,573 15,951,622 08-01-14 6.50 941,906 994,484 05-01-17 7.00 1,732,628 1,845,727 06-01-17 6.00 21,971,852 22,952,503 06-01-17 6.50 5,705,679 6,020,284 06-01-17 7.00 1,364,019 1,453,057 07-01-17 6.00 43,201,315 45,361,038 08-01-17 5.50 29,405,464 30,431,912 08-01-17 6.00 19,225,956 20,123,204 08-01-17 7.00 2,352,742 2,506,321 09-01-17 6.00 633,584 661,862 11-01-17 5.50 28,907,641 29,878,569 11-01-17 6.00 2,432,243 2,567,630 01-01-18 5.50 2,588,674 2,678,381 02-01-18 5.50 18,417,850 19,027,183 03-01-18 5.50 2,086,779 2,150,966 04-01-18 5.50 15,810,862 16,297,187 05-01-18 5.50 5,313,755 5,480,873 06-01-18 5.50 1,122,719 1,157,252 08-25-18 4.50 14,521,523 14,548,687 11-01-21 8.00 432,377 472,391 03-01-23 9.00 261,158 290,855 11-01-23 6.00 2,893,366 2,989,565 11-25-23 4.50 14,800,000 14,763,456 06-01-24 9.00 990,709 1,102,449 02-01-26 6.00 148,670 153,334 02-01-26 8.00 362,267 394,292 05-01-26 7.50 1,967,582 2,109,322 12-01-28 7.00 4,510,349 4,770,599 04-01-31 6.50 7,777,027 8,163,807 09-01-31 7.50 4,511,933 4,823,709 11-01-31 6.50 3,365,775 3,509,908 09-01-32 6.00 8,261,511 8,495,155 09-01-32 6.50 3,758,910 3,919,732 09-01-32 7.00 1,762,822 1,861,166 10-01-32 7.00 3,070,050 3,241,323 11-01-32 7.00 2,418,924 2,553,871 01-01-33 4.87 4,621,696 4,727,666 01-01-33 7.00 948,429 1,001,340 02-01-33 4.75 8,752,411(g) 8,933,500 02-01-33 4.87 24,695,650 25,189,208 03-01-33 4.93 8,185,117(g) 8,411,830 04-01-33 4.38 17,269,607(g) 17,421,925 04-01-33 4.59 12,575,198 12,818,199 04-01-33 4.87 14,348,616(g) 14,743,325 05-01-33 4.60 9,920,600(g) 10,112,304 06-01-33 3.75 4,890,993(g) 4,894,218 07-01-33 4.43 6,275,743(g) 6,382,880 07-01-33 4.46 14,635,541 14,682,898 07-01-33 4.97 7,631,179(g) 7,785,750 08-01-33 3.08 1,891,604(g) 1,866,812 08-01-33 3.63 4,908,471(g) 4,856,957 08-01-33 4.12 4,121,746(g) 4,082,346 09-01-33 4.20 4,191,818(g) 4,159,708 Collateralized Mtge Obligation 03-25-13 4.50 8,690,330 8,824,960 10-25-13 5.00 24,793,451 25,648,282 07-25-16 4.00 11,000,000 10,884,176 08-30-18 4.00 22,832,247 22,855,438 08-25-22 5.00 44,000,000 45,525,260 07-25-23 5.50 21,000,000 22,042,896 01-25-29 2.91 13,202,000 13,045,226 06-25-33 5.35 8,522,896(g) 8,718,543 05-25-42 5.30 11,500,000 11,934,901 07-25-42 5.50 31,500,000 32,440,697 08-25-42 4.70 16,000,000 16,235,011 09-25-42 5.00 17,857,544 18,268,580 10-25-42 7.50 7,773,108 8,458,113 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 8 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn (cont.) Interest Only 05-25-12 116.36% $4,813,140(i) $78,468 12-25-12 25.80 14,700,000(i) 1,114,445 11-25-13 7.14 10,950,000(i) 1,567,518 08-01-18 9.01 14,150(i) 2,873 01-15-20 9.36 580,152(i) 145,379 07-25-22 14.16 1,976,093(i) 389,515 Interest Only/Inverse Floater 02-25-32 6.68 13,432,029(i,j) 1,300,985 Principal Only 06-25-21 3.13 87,298(h) 79,049 Govt Natl Mtge Assn 08-15-13 6.00 2,199,828 2,312,308 09-15-14 6.00 14,668,093 15,418,688 10-16-17 2.21 14,510,400 14,031,536 08-20-19 11.00 33,604 37,947 09-16-21 3.23 14,000,000(b) 13,930,000 03-15-33 7.00 6,440,609 6,851,124 06-15-33 7.00 6,125,733 6,529,409 Collateralized Mtge Obligation 11-20-13 5.50 8,428,563 8,647,335 10-16-20 2.93 14,728,940 14,562,377 06-16-21 2.75 14,412,874 14,265,864 Interest Only 03-20-29 5.60 6,900,000(i) 976,595 Total 1,464,607,161 Banks and savings & loans (0.5%) Washington Mutual Series 2002-AR15 Cl A5 12-25-32 4.38 14,905,000 14,984,274 Financial services (2.8%) Centex Home Equity Series 2001-A Cl A4 07-25-29 6.47 10,000,000 10,447,762 First Franklin Mtge Loan Series 2002-FF4 Cl 2A2 02-25-33 2.80 11,600,000(k) 11,762,205 LB-UBS Commercial Mtge Trust Series 2003-C3 Cl A1 05-15-27 2.60 8,566,615 8,401,548 Series 2002 C2 Cl A2 06-15-26 4.90 9,600,000 10,044,217 Residential Asset Securities Series 2002-KS1 Cl AI4 11-25-29 5.86 23,400,000 24,140,142 Series 2003-QS17 09-25-33 5.50 7,778,343 7,927,441 Series 2003-KS9 Cl A13 01-25-29 3.25 9,000,000 8,983,125 Total 81,706,440 Insurance (0.3%) Conseco Finance Series 2000-D Cl A4 12-15-25 8.17 8,561,140 8,846,789 Leisure time & entertainment (0.3%) KSL Resorts Series 2003-1A Cl A 05-15-13 1.71 7,400,000(d) 7,399,822 Total bonds (Cost: $2,905,902,764) $2,902,808,436 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 9 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Short-term securities (11.2%)(m) Issuer Annualized Amount Value(a) yield on date payable at of purchase maturity U.S. government agencies (7.8%) Federal Home Loan Bank Disc Nt 01-02-04 1.08% $50,000,000 $49,952,179 Federal Home Loan Mtge Corp Disc Nts 12-05-03 1.06 4,900,000 4,899,035 01-08-04 1.08 8,400,000 8,390,379 01-15-04 1.05 2,200,000 2,197,050 02-04-04 1.06 11,000,000 10,979,144 Federal Natl Mtge Assn Disc Nts 12-03-03 1.07 20,900,000 20,897,158 12-24-03 1.00 17,100,000 17,087,909 12-24-03 1.03 9,100,000 9,093,566 01-28-04 1.07 50,000,000 49,916,200 02-04-04 1.07 25,000,000 24,952,600 02-04-04 1.08 25,000,000 24,952,600 Total 223,317,820 Commercial paper (3.4%) CRC Funding LLC 12-16-03 1.05 15,000,000(e) 14,992,125 Greyhawk Funding 12-09-03 1.04 30,000,000(e) 29,990,467 Lehman Brothers Holdings 12-01-03 1.05 12,900,000 12,898,871 Morgan Stanley 12-16-03 1.04 20,000,000 19,989,600 Park Avenue Receivables 12-01-03 1.05 21,000,000(e) 20,998,164 Total 98,869,227 Total short-term securities (Cost: $322,175,412) $322,187,047 Total investments in securities (Cost: $3,228,078,176)(n) $3,224,995,483 Notes to investments in securities (a) Securities are valued by procedures described in Note 1 to the financial statements. (b) At Nov. 30, 2003, the cost of securities purchased, including interest purchased, on a when-issued and/or other forward-commitment basis was $61,316,375. (c) Security is partially or fully on loan. See Note 5 to the financial statements. (d) Represents a security sold under Rule 144A, which is exempt from registration under the Securities Act of 1933, as amended. This security has been determined to be liquid under guidelines established by the board. (e) Commercial paper sold within terms of a private placement memorandum, exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, and may be sold only to dealers in that program or other "accredited investors." This security has been determined to be liquid under guidelines established by the board. (f) Mortgage-backed securities represent direct or indirect participations in, or are secured by and payable from, mortgage loans secured by real property, and include single- and multi-class pass-through securities and Collateralized Mortgage Obligations. These securities may be issued or guaranteed by U.S. government agencies or instrumentalities, or by private issuers, generally originators and investors in mortgage loans, including savings associations, mortgage bankers, commercial banks, investment bankers and special purpose entities. The maturity dates shown represent the original maturity of the underlying obligation. Actual maturity may vary based upon prepayment activity on these obligations. Unless otherwise noted, the coupon rates presented are fixed rates. (g) Adjustable rate mortgage; interest rate varies to reflect current market conditions; rate shown is the effective rate on Nov. 30, 2003. (h) Principal only represents securities that entitle holders to receive only principal payments on the underlying mortgages. The yield to maturity of a principal only is sensitive to the rate of principal payments on the underlying mortgage assets. A slow (rapid) rate of principal repayments may have an adverse (positive) effect on yield to maturity. Interest rate disclosed represents yield based upon the estimated timing of future cash flows as of Nov. 30, 2003. -------------------------------------------------------------------------------- 10 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Notes to investments in securities (continued) (i) Interest only represents securities that entitle holders to receive only interest payments on the underlying mortgages. The yield to maturity of an interest only is extremely sensitive to the rate of principal payments on the underlying mortgage assets. A rapid (slow) rate of principal repayments may have an adverse (positive) effect on yield to maturity. The principal amount shown is the notional amount of the underlying mortgages. Interest rate disclosed represents yield based upon the estimated timing of future cash flows as of Nov. 30, 2003. (j) Inverse floaters represent securities that pay interest at a rate that increases (decreases) in the same magnitude as, or in a multiple of, a decline (increase) in market short-term rates. Interest rate disclosed is the rate in effect on Nov. 30, 2003. (k) Interest rate varies either based on a predetermined schedule or to reflect current market conditions; rate shown is the effective rate on Nov. 30, 2003. (l) Partially pledged as initial deposit on the following open interest rate futures contracts (see Note 4 to the financial statements): Type of security Notional amount Purchase contracts Eurodollar, Sept 2004, 90-day $ 3,000,000 Eurodollar, Dec. 2004, 90-day 81,250,000 Eurodollar, March 2005, 90-day 81,250,000 Eurodollar, June 2005, 90-day 81,250,000 Eurodollar, Sept 2005, 90-day 84,500,000 Eurodollar, Dec. 2005, 90-day 67,500,000 Eurodollar, March 2006, 90-day 6,250,000 Eurodollar, June 2006, 90-day 6,250,000 U.S. Treasury Bonds, March 2004, 30-year 36,900,000 U.S. Treasury Notes, March 2004, 2-year 279,200,000 Sale contracts U.S. Treasury Notes, Dec. 2003, 5-year 412,700,000 U.S. Treasury Notes, Dec. 2003, 10-year 44,700,000 U.S. Treasury Notes, March 2004, 5-year 35,800,000 U.S. Treasury Notes, March 2004, 10-year 19,200,000 (m) At Nov. 30, 2003, cash or short-term securities were designated to cover open call options written as follows (see Note 6 to the financial statements):
Issuer Notional Exercise Expiration Value(a) amount price date U.S. Treasury Notes March 2004, 10 year $37,500,000 $112 Feb. 2004 $515,625
(n) At Nov. 30, 2003, the cost of securities for federal income tax purposes was approximately $3,228,078,000 and the approximate aggregate gross unrealized appreciation and depreciation based on that cost was: Unrealized appreciation $ 15,450,000 Unrealized depreciation (18,533,000) ----------- Net unrealized depreciation $ (3,083,000) ------------ -------------------------------------------------------------------------------- 11 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Financial Statements
Statement of assets and liabilities Government Income Portfolio Nov. 30, 2003 (Unaudited) Assets Investments in securities, at value (Note 1)* (identified cost $3,228,078,176) $3,224,995,483 Accrued interest receivable 16,316,036 Receivable for investment securities sold 2,553,874 U.S. government securities held as collateral (Note 5) 152,210,495 ----------- Total assets 3,396,075,888 ------------- Liabilities Disbursements in excess of cash on demand deposit 1,670,135 Payable for investment securities purchased 76,852,343 Payable upon return of securities loaned (Note 5) 439,939,495 Accrued investment management services fee 78,483 Other accrued expenses 71,044 Options contracts written, at value (premiums received $763,736) (Note 6) 515,625 ------- Total liabilities 519,127,125 ----------- Net assets $2,876,948,763 ============== *Including securities on loan, at value (Note 5) $ 428,275,456 --------------
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 12 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT
Statement of operations Government Income Portfolio Six months ended Nov. 30, 2003 (Unaudited) Investment income Income: Interest $ 49,210,423 Fee income from securities lending (Note 5) 569,005 ------- Total income 49,779,428 ---------- Expenses (Note 2): Investment management services fee 7,890,111 Compensation of board members 9,250 Custodian fees 148,649 Audit fees 18,563 Other 42,227 ------ Total expenses 8,108,800 --------- Investment income (loss) -- net 41,670,628 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (Note 3) (4,334,174) Futures contracts 9,002,127 Options contracts written (Note 6) 174,382 ------- Net realized gain (loss) on investments 4,842,335 Net change in unrealized appreciation (depreciation) on investments (55,725,921) ----------- Net gain (loss) on investments (50,883,586) ----------- Net increase (decrease) in net assets resulting from operations $ (9,212,958) ============
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 13 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT
Statements of changes in net assets Government Income Portfolio Nov. 30, 2003 May 31, 2003 Six months ended Year ended (Unaudited) Operations Investment income (loss) -- net $ 41,670,628 $ 108,160,481 Net realized gain (loss) on investments 4,842,335 44,169,376 Net change in unrealized appreciation (depreciation) on investments (55,725,921) 9,722,424 ----------- --------- Net increase (decrease) in net assets resulting from operations (9,212,958) 162,052,281 ---------- ----------- Proceeds from contributions 3,052,822 1,115,892,070 Fair value of withdrawals (645,323,807) (257,074,099) ------------ ------------ Net contributions (withdrawals) from partners (642,270,985) 858,817,971 ------------ ----------- Total increase (decrease) in net assets (651,483,943) 1,020,870,252 Net assets at beginning of period 3,528,432,706 2,507,562,454 ------------- ------------- Net assets at end of period $2,876,948,763 $3,528,432,706 ============== ==============
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 14 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Notes to Financial Statements Government Income Portfolio (Unaudited as to Nov. 30, 2003) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Government Income Portfolio (the Portfolio) is a series of Income Trust (the Trust) and is registered under the Investment Company Act of 1940 (as amended) as a diversified, open-end management investment company. The Portfolio seeks to provide a high level of current income and safety of principal consistent with investment in U.S. government and government agency securities. The Declaration of Trust permits the Trustees to issue non-transferable interests in the Portfolio. The Portfolio's significant accounting policies are summarized below: Use of estimates Preparing financial statements that conform to accounting principles generally accepted in the United States of America requires management to make estimates (e.g., on assets, liabilities and contingent assets and liabilities) that could differ from actual results. Valuation of securities All securities are valued at the close of each business day. Securities traded on national securities exchanges or included in national market systems are valued at the last quoted sales price. Debt securities are generally traded in the over-the-counter market and are valued at a price that reflects fair value as quoted by dealers in these securities or by an independent pricing service. Securities for which market quotations are not readily available are valued at fair value according to methods selected in good faith by the board. Short-term securities maturing in more than 60 days from the valuation date are valued at the market price or approximate market value based on current interest rates; those maturing in 60 days or less are valued at amortized cost. Option transactions To produce incremental earnings, protect gains and facilitate buying and selling of securities for investments, the Portfolio may buy and sell put and call options and write put and call options. This may include purchasing mortgage-backed security (MBS) put spread options and writing covered MBS call spread options. MBS spread options are based upon the changes in the price spread between a specified mortgage-backed security and a like-duration Treasury security. The risk in writing a call option is that the Portfolio gives up the opportunity for profit if the market price of the security increases. The risk in writing a put option is that the Portfolio may incur a loss if the market price of the security decreases and the option is exercised. The risk in buying an option is that the Portfolio pays a premium whether or not the option is exercised. The Portfolio also has the additional risk of being unable to enter into a closing transaction if a liquid secondary market does not exist. The Portfolio also may write over-the-counter options where completing the obligation depends upon the credit standing of the other party. -------------------------------------------------------------------------------- 15 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Option contracts are valued daily at the closing prices on their primary exchanges and unrealized appreciation or depreciation is recorded. The Portfolio will realize a gain or loss when the option transaction expires or closes. When options on debt securities or futures are exercised, the Portfolio will realize a gain or loss. When other options are exercised, the proceeds on sales for a written call option, the purchase cost for a written put option or the cost of a security for a purchased put or call option is adjusted by the amount of premium received or paid. Futures transactions To gain exposure to or protect itself from market changes, the Portfolio may buy and sell financial futures contracts. Risks of entering into futures contracts and related options include the possibility of an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. Upon entering into a futures contract, the Portfolio is required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract value. Subsequent payments (variation margin) are made or received by the Portfolio each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. The Portfolio recognizes a realized gain or loss when the contract is closed or expires. Short sales The Portfolio may engage in short sales. In these transactions, the Portfolio sells a security that it does not own. The Portfolio is obligated to replace the security that was short by purchasing it at the market price at the time of replacement or entering into an offsetting transaction with the broker. The price at such time may be more or less than the price at which the Portfolio sold the security. Securities purchased on a forward-commitment basis Delivery and payment for securities that have been purchased by the Portfolio on a forward-commitment basis, including when-issued securities and other forward-commitments, can take place one month or more after the transaction date. During this period, such securities are subject to market fluctuations, and they may affect the Portfolio's net assets the same as owned securities. The Portfolio designates cash or liquid securities at least equal to the amount of its forward-commitments. As of Nov. 30, 2003, the Portfolio has entered into outstanding when-issued securities of $61,316,375. The Portfolio also enters into transactions to sell purchase commitments to third parties at current market values and concurrently acquires other purchase commitments for similar securities at later dates. As an inducement for the Portfolio to "roll-over" its purchase commitments, the Portfolio receives negotiated amounts in the form of reductions of the purchase price of the commitment. -------------------------------------------------------------------------------- 16 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Federal taxes For federal income tax purposes the Portfolio qualifies as a partnership and each investor in the Portfolio is treated as the owner of its proportionate share of the net assets, income, expenses and realized and unrealized gains and losses of the Portfolio. As a "pass-through" entity, the Portfolio therefore does not pay any income dividends or capital gain distributions. Other Security transactions are accounted for on the date securities are purchased or sold. Interest income, including amortization of premium, market discount and original issue discount using the effective interest method, is accrued daily. 2. FEES AND EXPENSES The Trust, on behalf of the Portfolio, has an Investment Management Services Agreement with American Express Financial Corporation (AEFC) to manage its portfolio. Under this agreement AEFC determines which securities will be purchased, held or sold. The management fee is a percentage of the Portfolio's average daily net assets in reducing percentages from 0.52% to 0.395% annually. Under the agreement, the Trust also pays taxes, brokerage commissions and nonadvisory expenses, which include custodian fees, audit and certain legal fees, fidelity bond premiums, registration fees for units, office expenses, consultants' fees, compensation of trustees, corporate filing fees, expenses incurred in connection with lending securities of the Portfolio and any other expenses properly payable by the Trust or Portfolio and approved by the board. Under a Deferred Compensation Plan (the Plan), non-interested trustees may defer receipt of their compensation. Deferred amounts are treated as though equivalent dollar amounts had been invested in shares of the underlying Fund or other American Express mutual funds. The Portfolio's liability for these amounts is adjusted for market value changes and remains in the Portfolio until distributed in accordance with the Plan. The Portfolio pays custodian fees to American Express Trust Company, an affiliate of AEFC. According to a Placement Agency Agreement, American Express Financial Advisors Inc. acts as placement agent of the Trust's units. 3. SECURITIES TRANSACTIONS Cost of purchases and proceeds from sales of securities (other than short-term obligations) aggregated $2,453,323,061 and $3,008,285,236, respectively, for the six months ended Nov. 30, 2003. Realized gains and losses are determined on an identified cost basis. 4. INTEREST RATE FUTURES CONTRACTS As of Nov. 30, 2003, investments in securities included securities valued at $11,188,170 that were pledged as collateral to cover initial margin deposits on 3,410 open purchase contracts and 5,142 open sale contracts. The notional market value of the open purchase contracts as of Nov. 30, 2003 was $734,370,858 with a net unrealized loss of $1,139,046. The notional market value of the open sale contracts as of Nov. 30, 2003 was $571,856,188 with a net unrealized loss of $8,730,857. See "Summary of significant accounting policies" and "Notes to investments in securities." -------------------------------------------------------------------------------- 17 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT 5. LENDING OF PORTFOLIO SECURITIES As of Nov. 30, 2003, securities valued at $428,275,456 were on loan to brokers. For collateral, the Portfolio received $287,729,000 in cash and U.S. government securities valued at $152,210,495. Income from securities lending amounted to $569,005 for the six months ended Nov. 30, 2003. The risks to the Portfolio of securities lending are that the borrower may not provide additional collateral when required or return the securities when due. 6. OPTIONS CONTRACTS WRITTEN Contracts and premiums associated with options contracts written are as follows: Six months ended Nov. 30, 2003 Puts Calls Contracts Premiums Contracts Premiums Balance May 31, 2003 -- $ -- -- $ -- Opened 3,127 2,447,175 5,897 4,922,065 Closed (2,138) (1,927,050) (5,522) (4,158,329) Exercised (188) (66,811) -- -- Expired (801) (453,314) -- -- ------ ---------- ------ ---------- Balance Nov. 30, 2003 -- $ -- 375 $ 763,736 ------ ---------- ------ ---------- See "Summary of significant accounting policies." 7. FINANCIAL HIGHLIGHTS The table below shows certain important financial information for evaluating the Portfolio's results.
Ratios/supplemental data Fiscal period ended May 31, 2003(e) 2003 2002 2001 2000 Ratio of expenses to average daily net assets(a) .51%(c) .50% .52% .54% .51% Ratio of net investment income (loss) to average daily net assets 2.60%(c) 3.35% 4.43% 6.13% 6.11% Portfolio turnover rate (excluding short-term securities) 77% 218% 267% 366% 674% Total return(b) (.27%)(d) 5.48% 6.27% 10.56% .50%
Notes to financial highlights (a) Expense ratio is based on total expenses of the Portfolio before reduction of earnings credits on cash balances. The ratio does not include feeder fund expenses. (b) Total return is based on a calculated Portfolio NAV and does not reflect payment of a sales charge. (c) Adjusted to an annual basis. (d) Not annualized. (e) Six months ended Nov. 30, 2003 (Unaudited). -------------------------------------------------------------------------------- 18 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Financial Statements
Statement of assets and liabilities AXP Short Duration U.S. Government Fund Nov. 30, 2003 (Unaudited) Assets Investment in Portfolio (Note 1) $2,876,827,782 Capital shares receivable 1,341,659 --------- Total assets 2,878,169,441 ------------- Liabilities Dividends payable to shareholders 1,077,488 Capital shares payable 1,116,136 Accrued distribution fee 90,154 Accrued service fee 851 Accrued transfer agency fee 18,785 Accrued administrative services fee 7,145 Other accrued expenses 514,994 ------- Total liabilities 2,825,553 --------- Net assets applicable to outstanding capital stock $2,875,343,888 ============== Represented by Capital stock -- $.01 par value (Note 1) $ 5,906,164 Additional paid-in capital 3,047,790,610 Undistributed net investment income 927,312 Accumulated net realized gain (loss) (Note 5) (166,576,229) Unrealized appreciation (depreciation) on investments (12,703,969) ----------- Total -- representing net assets applicable to outstanding capital stock $2,875,343,888 ============== Net assets applicable to outstanding shares: Class A $1,441,138,756 Class B $1,230,583,354 Class C $ 48,807,443 Class Y $ 154,814,335 Net asset value per share of outstanding capital stock: Class A shares 296,048,950 $ 4.87 Class B shares 252,744,178 $ 4.87 Class C shares 10,025,869 $ 4.87 Class Y shares 31,797,450 $ 4.87 ---------- --------------
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 19 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT
Statement of operations AXP Short Duration U.S. Government Fund Six months ended Nov. 30, 2003 (Unaudited) Investment income Income: Interest $ 49,207,372 Fee income from securities lending 568,981 ------- Total income 49,776,353 ---------- Expenses (Note 2): Expenses allocated from Portfolio 8,108,495 Distribution fee Class A 2,004,269 Class B 6,921,087 Class C 271,281 Transfer agency fee 2,076,813 Incremental transfer agency fee Class A 96,508 Class B 130,967 Class C 7,017 Service fee -- Class Y 82,326 Administrative services fees and expenses 724,106 Compensation of board members 6,508 Printing and postage 311,838 Registration fees 27,884 Audit fees 6,188 Other 21,631 ------ Total expenses 20,796,918 Earnings credits on cash balances (Note 2) (27,483) ------- Total net expenses 20,769,435 ---------- Investment income (loss) -- net 29,006,918 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (4,334,417) Futures contracts 9,002,127 Options contracts written 174,382 ------- Net realized gain (loss) on investments 4,842,092 Net change in unrealized appreciation (depreciation) on investments (55,723,812) ----------- Net gain (loss) on investments (50,881,720) ----------- Net increase (decrease) in net assets resulting from operations $(21,874,802) ============
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 20 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT
Statements of changes in net assets AXP Short Duration U.S. Government Fund Nov. 30, 2003 May 31, 2003 Six months ended Year ended (Unaudited) Operations and distributions Investment income (loss) -- net $ 29,006,918 $ 82,662,013 Net realized gain (loss) on investments 4,842,092 44,167,207 Net change in unrealized appreciation (depreciation) on investments (55,723,812) 9,722,377 ----------- --------- Net increase (decrease) in net assets resulting from operations (21,874,802) 136,551,597 ----------- ----------- Distributions to shareholders from: Net investment income Class A (16,553,146) (45,444,253) Class B (9,021,599) (30,935,951) Class C (353,047) (946,842) Class Y (1,837,390) (5,490,847) ---------- ---------- Total distributions (27,765,182) (82,817,893) ----------- ----------- Capital share transactions (Note 3) Proceeds from sales Class A shares (Note 2) 278,988,025 1,178,062,138 Class B shares 136,818,687 998,456,600 Class C shares 11,110,042 46,085,175 Class Y shares 34,575,655 92,327,556 Reinvestment of distributions at net asset value Class A shares 15,028,138 40,761,864 Class B shares 8,492,565 29,157,324 Class C shares 318,646 844,242 Class Y shares 1,503,709 4,979,945 Payments for redemptions Class A shares (555,517,354) (701,715,252) Class B shares (Note 2) (471,267,850) (577,985,093) Class C shares (Note 2) (19,880,892) (18,398,418) Class Y shares (42,445,259) (125,038,635) ----------- ------------ Increase (decrease) in net assets from capital share transactions (602,275,888) 967,537,446 ------------ ----------- Total increase (decrease) in net assets (651,915,872) 1,021,271,150 Net assets at beginning of period 3,527,259,760 2,505,988,610 ------------- ------------- Net assets at end of period $2,875,343,888 $3,527,259,760 ============== ============== Undistributed (excess of distributions over) net investment income $ 927,312 $ (314,424) -------------- --------------
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 21 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Notes to Financial Statements AXP Short Duration U.S. Government Fund (Unaudited as to Nov. 30, 2003) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Fund is a series of AXP Government Income Series, Inc and is registered under the Investment Company Act of 1940 (as amended) as a diversified, open-end management investment company. AXP Government Income Series, Inc. has 10 billion authorized shares of capital stock that can be allocated among the separate series as designated by the board. The Fund offers Class A, Class B, Class C and Class Y shares. o Class A shares are sold with a front-end sales charge. o Class B shares may be subject to a contingent deferred sales charge (CDSC) and automatically convert to Class A shares during the ninth calendar year of ownership. o Class C shares may be subject to a CDSC. o Class Y shares have no sales charge and are offered only to qualifying institutional investors. All classes of shares have identical voting, dividend and liquidation rights. The distribution fee, incremental transfer agency fee and service fee (class specific expenses) differ among classes. Income, expenses (other than class specific expenses) and realized and unrealized gains or losses on investments are allocated to each class of shares based upon its relative net assets. Investment in Government Income Portfolio The Fund invests all of its assets in Government Income Portfolio (the Portfolio), a series of Income Trust (the Trust), an open-end investment company that has the same objectives as the Fund. The Portfolio invests primarily in U.S. government and government agency securities. The Fund records daily its share of the Portfolio's income, expenses and realized and unrealized gains and losses. The financial statements of the Portfolio are included elsewhere in this report and should be read in conjunction with the Fund's financial statements. The Fund records its investment in the Portfolio at the value that is equal to the Fund's proportionate ownership interest in the Portfolio's net assets. The percentage of the Portfolio owned by the Fund as of Nov. 30, 2003 was 99.99%. Valuation of securities held by the Portfolio is discussed in Note 1 of the Portfolio's "Notes to financial statements" (included elsewhere in this report). Use of estimates Preparing financial statements that conform to accounting principles generally accepted in the United States of America requires management to make estimates (e.g., on assets, liabilities and contingent assets and liabilities) that could differ from actual results. -------------------------------------------------------------------------------- 22 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Federal taxes The Fund's policy is to comply with all sections of the Internal Revenue Code that apply to regulated investment companies and to distribute substantially all of its taxable income to the shareholders. No provision for income or excise taxes is thus required. Net investment income (loss) and net realized gains (losses) may differ for financial statement and tax purposes primarily because of deferred losses on certain futures contracts and losses deferred due to "wash sale" transactions. The character of distributions made during the year from net investment income or net realized gains may differ from their ultimate characterization for federal income tax purposes. Also, due to the timing of dividend distributions, the fiscal year in which amounts are distributed may differ from the year that the income or realized gains (losses) were recorded by the Fund. Dividends to shareholders Dividends from net investment income, declared daily and payable monthly, when available, are reinvested in additional shares of the Fund at net asset value or payable in cash. Capital gains, when available, are distributed along with the last income dividend of the calendar year. 2. EXPENSES AND SALES CHARGES In addition to the expenses allocated from the Portfolio, the Fund accrues its own expenses as follows: The Fund has an agreement with AEFC to provide administrative services. Under an Administrative Services Agreement, the Fund pays AEFC a fee for administration and accounting services at a percentage of the Fund's average daily net assets in reducing percentages from 0.05% to 0.025% annually. A minor portion of additional administrative service expenses paid by the Fund are consultants' fees and fund office expenses. Under this agreement, the Fund also pays taxes, audit and certain legal fees, registration fees for shares, compensation of board members, corporate filing fees and any other expenses properly payable by the Fund and approved by the board. Under a Deferred Compensation Plan (the Plan), non-interested board members may defer receipt of their compensation. Deferred amounts are treated as though equivalent dollar amounts had been invested in shares of the Fund or other American Express mutual funds. The Fund's liability for these amounts is adjusted for market value changes and remains in the Fund until distributed in accordance with the Plan. Under a separate Transfer Agency Agreement, American Express Client Service Corporation (AECSC) maintains shareholder accounts and records. The Fund pays AECSC an annual fee per shareholder account for this service as follows: o Class A $20.50 o Class B $21.50 o Class C $21.00 o Class Y $18.50 The incremental transfer agency fee is the amount charged to the specific classes for the additional expense above the fee for Class Y. -------------------------------------------------------------------------------- 23 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT In addition, AECSC is entitled to charge an annual closed-account fee of $5 per inactive account, charged on a pro rata basis from the date the account becomes inactive until the date the account is purged from the transfer agent system generally within one year. However, the closed account fee is currently not effective. The Fund has agreements with American Express Financial Advisors Inc. (the Distributor) for distribution and shareholder services. Under a Plan and Agreement of Distribution, the Fund pays a fee at an annual rate up to 0.25% of the Fund's average daily net assets attributable to Class A shares and up to 1.00% for Class B and Class C shares. Under a Shareholder Service Agreement, the Fund pays the Distributor a fee for service provided to shareholders by financial advisors and other servicing agents. The fee is calculated at a rate of 0.10% of the Fund's average daily net assets attributable to Class Y shares. Sales charges received by the Distributor for distributing Fund shares were $3,569,350 for Class A, $1,314,864 for Class B and $21,565 for Class C for the six months ended Nov. 30, 2003. During the six months ended Nov. 30, 2003, the Fund's transfer agency fees were reduced by $27,483 as a result of earnings credits from overnight cash balances. 3. CAPITAL SHARE TRANSACTIONS Transactions in shares of capital stock for the periods indicated are as follows:
Six months ended Nov. 30, 2003 Class A Class B Class C Class Y Sold 56,829,711 27,896,942 2,265,686 7,047,843 Issued for reinvested distributions 3,069,704 1,734,651 65,096 307,177 Redeemed (113,405,925) (96,104,234) (4,061,663) (8,674,099) ------------ ----------- ---------- ---------- Net increase (decrease) (53,506,510) (66,472,641) (1,730,881) (1,319,079) ----------- ----------- ---------- ---------- Year ended May 31, 2003 Class A Class B Class C Class Y Sold 239,714,272 203,191,315 9,371,202 18,774,998 Issued for reinvested distributions 8,291,730 5,931,794 171,739 1,013,609 Redeemed (142,692,553) (117,558,389) (3,737,168) (25,473,839) ------------ ------------ ---------- ----------- Net increase (decrease) 105,313,449 91,564,720 5,805,773 (5,685,232) ----------- ---------- --------- ----------
-------------------------------------------------------------------------------- 24 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT 4. BANK BORROWINGS The Fund has a revolving credit agreement with a syndicate of banks headed by Deutsche Bank, whereby the Fund is permitted to have bank borrowings for temporary or emergency purposes to fund shareholder redemptions. The Fund must maintain asset coverage for borrowings of at least 300%. The agreement, which enables the Fund to participate with other American Express mutual funds, permits borrowings up to $500 million, collectively. Interest is charged to each Fund based on its borrowings at a rate equal to either the LIBOR plus 0.50%, the IBOR plus 0.50% or the higher of the Federal Funds Rate plus 0.25% and the Prime Lending Rate. Borrowings are payable within 60 days after such loan is executed. The Fund also pays a commitment fee equal to its pro rata share of the amount of the credit facility at a rate of 0.09% per annum. The Fund had no borrowings outstanding during the six months ended Nov. 30, 2003. 5. CAPITAL LOSS CARRY-OVER For federal income tax purposes, the Fund has a capital loss carry-over of $156,987,506 as of May 31, 2003 that will expire in 2007 through 2009 if not offset by capital gains. It is unlikely the board will authorize a distribution of any net realized capital gains until the available capital loss carry-over has been offset or expires. 6. FINANCIAL HIGHLIGHTS The tables below show certain important financial information for evaluating the Fund's results.
Class A Per share income and capital changes(a) Fiscal period ended May 31, 2003(g) 2003 2002 2001 2000 Net asset value, beginning of period $4.94 $4.85 $4.78 $4.59 $4.94 Income from investment operations: Net investment income (loss) .05 .15 .19 .27 .27 Net gains (losses) (both realized and unrealized) (.07) .09 .08 .19 (.27) Total from investment operations (.02) .24 .27 .46 -- Less distributions: Dividends from net investment income (.05) (.15) (.20) (.27) (.28) Distributions from realized gains -- -- -- -- (.07) Total distributions (.05) (.15) (.20) (.27) (.35) Net asset value, end of period $4.87 $4.94 $4.85 $4.78 $4.59 Ratios/supplemental data Net assets, end of period (in millions) $1,441 $1,728 $1,185 $1,047 $1,139 Ratio of expenses to average daily net assets(c) .97%(d) .95% .95% .98% .92% Ratio of net investment income (loss) to average daily net assets 2.14%(d) 2.90% 4.01% 5.72% 5.71% Portfolio turnover rate (excluding short-term securities) 77% 218% 267% 366% 674% Total return(e) (.39%)(f) 4.90% 5.77% 10.19% (.01%)
See accompanying notes to financial highlights. -------------------------------------------------------------------------------- 25 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT
Class B Per share income and capital changes(a) Fiscal period ended May 31, 2003(g) 2003 2002 2001 2000 Net asset value, beginning of period $4.94 $4.85 $4.78 $4.59 $4.94 Income from investment operations: Net investment income (loss) .03 .11 .16 .24 .24 Net gains (losses) (both realized and unrealized) (.07) .09 .08 .18 (.28) Total from investment operations (.04) .20 .24 .42 (.04) Less distributions: Dividends from net investment income (.03) (.11) (.17) (.23) (.24) Distributions from realized gains -- -- -- -- (.07) Total distributions (.03) (.11) (.17) (.23) (.31) Net asset value, end of period $4.87 $4.94 $4.85 $4.78 $4.59 Ratios/supplemental data Net assets, end of period (in millions) $1,231 $1,578 $1,104 $912 $981 Ratio of expenses to average daily net assets(c) 1.72%(d) 1.71% 1.71% 1.73% 1.68% Ratio of net investment income (loss) to average daily net assets 1.38%(d) 2.15% 3.25% 4.96% 4.95% Portfolio turnover rate (excluding short-term securities) 77% 218% 267% 366% 674% Total return(e) (.77%)(f) 4.11% 4.98% 9.36% (.77%)
Class C Per share income and capital changes(a) Fiscal period ended May 31, 2003(g) 2003 2002 2001(b) Net asset value, beginning of period $4.94 $4.85 $4.78 $4.63 Income from investment operations: Net investment income (loss) .03 .11 .16 .22 Net gains (losses) (both realized and unrealized) (.07) .09 .08 .14 Total from investment operations (.04) .20 .24 .36 Less distributions: Dividends from net investment income (.03) (.11) (.17) (.21) Net asset value, end of period $4.87 $4.94 $4.85 $4.78 Ratios/supplemental data Net assets, end of period (in millions) $49 $58 $29 $7 Ratio of expenses to average daily net assets(c) 1.73%(d) 1.72% 1.72% 1.73%(d) Ratio of net investment income (loss) to average daily net assets 1.38%(d) 2.10% 3.09% 4.93%(d) Portfolio turnover rate (excluding short-term securities) 77% 218% 267% 366% Total return(e) (.77%)(f) 4.11% 4.98% 8.08%(f)
See accompanying notes to financial highlights. -------------------------------------------------------------------------------- 26 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT
Class Y Per share income and capital changes(a) Fiscal period ended May 31, 2003(g) 2003 2002 2001 2000 Net asset value, beginning of period $4.94 $4.85 $4.78 $4.59 $4.94 Income from investment operations: Net investment income (loss) .05 .15 .20 .28 .28 Net gains (losses) (both realized and unrealized) (.07) .09 .08 .19 (.28) Total from investment operations (.02) .24 .28 .47 -- Less distributions: Dividends from net investment income (.05) (.15) (.21) (.28) (.28) Distributions from realized gains -- -- -- -- (.07) Total distributions (.05) (.15) (.21) (.28) (.35) Net asset value, end of period $4.87 $4.94 $4.85 $4.78 $4.59 Ratios/supplemental data Net assets, end of period (in millions) $155 $164 $188 $161 $175 Ratio of expenses to average daily net assets(c) .81%(d) .79% .79% .82% .78% Ratio of net investment income (loss) to average daily net assets 2.31%(d) 3.12% 4.17% 5.89% 5.92% Portfolio turnover rate (excluding short-term securities) 77% 218% 267% 366% 674% Total return(e) (.31%)(f) 5.07% 5.93% 10.36% .15%
Notes to financial highlights (a) For a share outstanding throughout the period. Rounded to the nearest cent. (b) Inception date was June 26, 2000. (c) Expense ratio is based on total expenses of the Fund before reduction of earnings credits on cash balances. (d) Adjusted to an annual basis. (e) Total return does not reflect payment of a sales charge. (f) Not annualized. (g) Six months ended Nov. 30, 2003 (Unaudited). -------------------------------------------------------------------------------- 27 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT Proxy Voting The policy of the Board is to vote all proxies of the companies in which the Fund holds investments. The procedures are stated in the Statement of Additional Information (SAI). You may obtain a copy of the SAI without charge by calling (800) 862-7919; by looking at the Web site americanexpress.com/funds; or by searching the Web site of the Securities and Exchange Commission http://www.sec.gov. You may view the Fund's voting record for all portfolio companies whose shareholders meetings were completed the previous quarter on americanexpress.com/funds or obtain a copy by calling the Fund's administrator, Board Services Corporation, collect at (612) 330-9283. In addition, after Aug. 1, 2004, information regarding how the Fund voted proxies relating to portfolio securities during the most recent 12-month period ended June 30 will be available at http://www.sec.gov. -------------------------------------------------------------------------------- 28 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2003 SEMIANNUAL REPORT -------------------------------------------------------------------------------- (logo) AMERICAN EXPRESS (R) -------------------------------------------------------------------------------- American Express Funds 70100 AXP Financial Center Minneapolis, MN 55474 This report must be accompanied or preceded by the Fund's current prospectus. Distributed by American Express Financial Advisors Inc. Member NASD. American Express Company is separate from American Express Financial Advisors Inc. and is not a broker-dealer. AXP(R) U.S. Government Mortgage Fund Semiannual Report for the Period Ended Nov. 30, 2003 AXP U.S. Government Mortgage Fund seeks to provide shareholders with current income as its primary goal and, as its secondary goal, preservation of capital. -------------------------------------------------------------------------------- (logo) (logo) American AMERICAN Express(R) EXPRESS(R) Funds -------------------------------------------------------------------------------- Table of Contents Fund Snapshot 3 Questions & Answers with Portfolio Management 4 Investments in Securities 8 Financial Statements 12 Notes to Financial Statements 15 Proxy Voting 23 (logo) Dalbar American Express(R) Funds' reports to shareholders have been awarded the Communications Seal from Dalbar Inc., an independent financial services research firm. The Seal recognizes communications demonstrating a level of excellence in the industry. -------------------------------------------------------------------------------- 2 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Fund Snapshot AS OF NOV. 30, 2003 PORTFOLIO MANAGER Portfolio manager Scott Kirby* Since 2/02 Years in industry 24 * The Fund is managed by a team of portfolio managers led by Scott Kirby. FUND OBJECTIVE The Fund seeks to provide shareholders with current income as its primary goal and, as its secondary goal, preservation of capital. Inception dates A: 2/14/02 B: 2/14/02 C: 2/14/02 Y: 2/14/02 Ticker symbols A: AUGAX B: AUGBX C: AUGCX Y: -- Total net assets $390.5 million Number of holdings 147 STYLE MATRIX Shading within the style matrix indicates areas in which the Fund generally invests. DURATION SHORT INT LONG X HIGH MEDIUM QUALITY LOW SECTOR COMPOSITION Percentage of portfolio assets (pie chart) Mortgage-backed securities 92.3% Short-term securities 5.9% U.S. government obligation & agency 1.2% Financials 0.6% CREDIT QUALITY SUMMARY Percentage of portfolio assets excluding cash equivalents AAA bonds 100% Individual security ratings are based on information from Standard & Poor's Corp. and Moody's Investors Service. If a rating is unavailable, the rating is determined through an internal analysis, if appropriate. Individual securities owned by the Fund, but not shares of the Fund, are guaranteed by the U.S. government, its agencies or instrumentalities as to timely payments of principal and interest. The Fund's yield and share price are not guaranteed, and may vary with market conditions. Fund holdings are subject to change. -------------------------------------------------------------------------------- 3 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Questions & Answers WITH PORTFOLIO MANAGEMENT Below, Portfolio Manager Scott Kirby discusses the Fund's positioning and results for the six months ended Nov. 30, 2003. Q: How did the AXP U.S. Government Mortgage Fund perform for the first half of the current fiscal year? A: AXP U.S. Government Mortgage Fund's Class A shares (excluding sales charge) rose 0.40% for the six month period ended Nov. 30, 2003. Its benchmark, the Lehman Brothers Mortgage-Backed Securities Index, and its peer group, as represented by the Lipper U.S. Mortgage Funds Index both rose 0.53%. Q: What factors most affected Fund performance during the period? A: During the first four months of the period we saw significant and severe volatility, therefore mortgage-backed securities struggled during this time. In the latter part of the period we have seen the fixed income market settle into a trading range environment where mortgage-backed securities have done well. The fixed income market rallied in June fueled by the belief that interest rates would remain low until the economy showed sustained signs of a recovery. Then, on June 25, 2003, the Federal Reserve Board moderated their stance on deflation and cut the targeted federal funds rate by only 0.25% (one-quarter of a percentage point) to 1.00%, to "add further support for an economy which it (bar graph) PERFORMANCE COMPARISON For the six-month period ended Nov. 30, 2003 1.00% 0.75% (bar 2) (bar 2) 0.50% (bar 1) +0.53% +0.53% +0.40% 0.25% 0.00% (bar 1) AXP U.S. Government Mortgage Fund Class A (excluding sales charge) (bar 2) Lehman Brothers Mortgage-Backed Securities Index(1) (unmanaged) (bar 3) Lipper U.S. Mortgage Funds Index(2) (1) The Lehman Brothers Mortgage-Backed Securities Index, an unmanaged index, includes 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), and Federal National Mortgage Association (FNMA). (2) The Lipper U.S. Mortgage Funds Index, published by Lipper Inc., includes the 10 largest funds that are generally similar to the Fund, although some funds in the index may have somewhat different investment policies or objectives. Past performance is no guarantee of future results. The 4.75% sales charge applicable to Class A shares of the Fund is not reflected in the bar chart; if reflected, returns would be lower than those shown. The performance of Class B, Class C and Class Y may vary from that shown above because of differences in expenses. The indices do not reflect the effects of sales charges, expenses (excluding Lipper) and taxes. -------------------------------------------------------------------------------- 4 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Questions & Answers (begin callout quote)> In the latter part of the period we have seen the fixed income market settle into a trading range environment where mortgage-backed securities have done well.(end callout quote) expects to improve over time." The Federal Reserve Board's conservative move led to a market sell-off, and U.S. Treasury yields rose dramatically by July. July was also the worst month for mortgage securities in history based on duration-adjusted excess returns over U.S. Treasuries. Compounding matters was news of a stabilizing U.S. economy. After peaking in mid-August, U.S. Treasury yields declined somewhat by the end of the period.
AVERAGE ANNUAL TOTAL RETURNS Class A Class B Class C Class Y (Inception dates) (2/14/02) (2/14/02) (2/14/02) (2/14/02) NAV(1) POP(2) NAV(1) After CDSC(3) NAV(1) After CDSC(4) NAV(5) POP(5) as of Nov. 30, 2003 6 month* +0.40% -4.37% -0.17% -5.11% -0.17% -1.16% +0.50% +0.50% 1 year +3.23% -1.68% +2.45% -1.55% +2.45% +2.45% +3.41% +3.41% Since inception +5.05% +2.24% +4.29% +2.11% +4.27% +4.27% +5.23% +5.23% as of Dec. 31, 2003 6 months* +1.11% -3.70% +0.72% -4.20% +0.72% -0.26% +1.21% +1.21% 1 year +3.04% -1.86% +2.25% -1.70% +2.25% +2.25% +3.22% +3.22% Since inception +5.36% +2.66% +4.59% +2.52% +4.57% +4.57% +5.54% +5.54%
* Not annualized. (1) Excluding sales charge. (2) Returns at public offering price (POP) reflect a sales charge of 4.75%. (3) Returns at maximum contingent deferred sales charge (CDSC). CDSC applies as follows: first year 5%; second and third year 4%; fourth year 3%; fifth year 2%; sixth year 1%; no sales charge thereafter. (4) 1% CDSC applies to redemptions made within the first year of purchase. (5) Sales charge is not applicable to these shares. Shares available to institutional investors only. Past performance is no guarantee of future results. Investment return and principal value will fluctuate, so that your shares, when redeemed, may be worth more or less than the original cost. The performance shown for each class of shares will vary due to differences in sales charges and fees. Short term performance may be higher or lower than the figures shown. Visit americanexpress.com/funds for current information. -------------------------------------------------------------------------------- 5 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Questions & Answers Mortgage securities also gained back a portion of their underperformance. During September we saw a significant sell-off, but the market began to see an end to high volatility in October and November. In June, as mortgage securities began to underperform, we adjusted duration to a neutral position, maintaining that strategy through July. By the end of August, the Fund was slightly shorter in duration than its benchmark and is currently positioned in this fashion because we believe that will benefit the Fund during the economic recovery. Q: What changes have you made to the Fund? A: We repositioned the Fund by adding 30-year mortgages and selling securities with 15-year maturities. We felt there was better value in 30-year mortgages in anticipation of a flattening yield curve. The Fund continued to focus on high-quality agency mortgages such as Ginnie Mae, Freddie Mac and Fannie Mae, with a focus on those offering call protection from early repayment. However, the Fund has a lower-than-index position in Ginnie Mae securities because these securities tend to underperform in an economic recovery. We also integrated two strategies within the Fund to add relative value. One is what we call a "specified pool" strategy. We focused on pools of mortgages that historically have had lower-than-average prepayment risks, such as low-balance mortgages, mortgages in states with less refinancing activity, newer mortgages that would likely not be seeking to refinance too quickly and servicing organizations that have historically been less aggressive in getting customers to refinance. We believe many of the pools we purchased will add value during a period of rising interest rates and declining refinancing. The other driving force of the Fund's performance was what we call our "dollar roll" strategy. This strategy involved selling a pool of mortgage-backed securities that would have delivered in the current month and simultaneously agreeing to purchase a similar pool of securities at a future date. The dealer, in effect, offers a discount, providing an incentive to buy the bonds forward. This strategy added to the Fund's return during the period without notably increasing its risk profile. However, we have recently removed several of these positions to shift the Fund's stance to more conservative mortgage products. We continued to emphasize those securities issued by government mortgage agencies, including Ginnie Mae, Fannie Mae and Freddie Mac. Remaining assets were invested in bonds and notes issued -------------------------------------------------------------------------------- 6 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Questions & Answers by the U.S. Treasury. Our focus was on generating a competitive level of current income while maintaining an extremely high level of credit quality. Q: How do you intend to manage the Fund in the coming months? A: As economic growth accelerates, we expect rates to move higher. We will hold a rather defensive position in mortgage-backed securities as these changes occur because we anticipate a short time period in which mortgages may struggle. However, after we pass that period, we anticipate a very positive environment for mortgages because there will be less call risk in the market. We believe volatility will be reduced as well going forward. We intend to keep the Fund's duration shorter than the benchmark and to seek opportunities to reduce duration further over the coming months. We believe that mortgages continue to offer good relative value and good risk-adjusted returns over longer periods of time. Quality issues and security selection will remain a priority. -------------------------------------------------------------------------------- 7 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Investments in Securities AXP U.S. Government Mortgage Fund Nov. 30, 2003 (Unaudited) (Percentages represent value of investments compared to net assets) Bonds (100.1%) Issuer Coupon Principal Value(a) rate amount U.S. government obligation & agency (1.3%) Federal Natl Mtge Assn 11-17-08 3.88% $5,000,000 $4,980,900 Mortgage-backed securities (98.1%)(f) Federal Home Loan Mtge Corp 01-01-09 7.00 475,764 506,122 03-01-10 8.00 873,109 945,421 06-01-15 7.50 2,802,108 2,985,951 12-01-16 6.50 737,128 779,929 02-01-17 6.50 3,058,661 3,239,343 04-01-17 7.00 1,730,921 1,852,839 10-01-17 8.00 1,125,402 1,223,479 01-01-18 5.50 1,797,511 1,853,606 02-01-18 5.50 1,127,185 1,162,361 05-01-18 5.00 2,827,352 2,877,396 08-01-18 5.00 2,955,161 3,002,301 10-01-18 5.00 691,787 700,836 12-01-18 5.00 3,000,000(b) 3,037,500 03-01-22 6.50 1,368,676 1,431,004 04-01-22 6.50 1,548,143 1,627,939 03-01-30 7.50 594,667 636,391 12-01-30 5.50 2,426,933 2,452,021 06-01-31 8.00 950,010 1,023,073 03-01-32 7.00 414,045 440,868 07-01-32 7.00 820,828 866,094 08-01-32 6.50 5,578,240 5,821,934 09-01-32 6.50 2,315,287 2,416,433 04-01-33 6.00 3,735,102 3,858,839 06-01-33 5.50 2,897,124 2,915,198 07-01-33 6.00 1,475,022 1,516,490 09-01-33 4.56 1,478,584(g) 1,473,853 12-01-33 5.00 11,573,000(b) 11,334,308 Collateralized Mtge Obligation 07-15-16 4.00 2,700,000 2,676,259 09-15-18 4.00 3,500,000 3,188,348 10-15-18 5.00 2,700,000 2,779,627 11-15-18 5.00 5,200,000 5,358,338 02-15-27 5.00 3,200,000 3,266,343 02-15-33 5.50 3,802,067 3,970,689 02-25-42 6.50 4,730,118 5,015,405 Interest Only 02-15-14 10.21 1,800,000(e) 183,600 Interest Only/Inverse Floater 03-15-32 6.83 1,465,627(d,e) 133,350 06-15-18 4.84 1,470,844(d,e) 97,915 Federal Natl Mtge Assn 05-01-08 7.75 585,622 631,997 10-01-09 8.50 294,436 312,985 08-01-10 7.50 1,133,688 1,212,905 04-01-11 6.50 294,386 311,591 11-01-12 4.79 325,000 325,467 08-01-13 4.37 3,990,548 3,847,629 10-01-13 5.11 999,091 1,024,380 08-01-16 6.50 425,930 452,231 11-01-16 7.00 1,059,974 1,138,077 02-01-17 7.00 1,336,067 1,434,714 03-01-17 6.00 1,449,440 1,522,552 03-01-17 6.50 1,035,011 1,098,881 03-01-17 7.00 50,393 53,826 04-01-17 7.50 132,243 141,364 05-01-17 6.00 512,593 535,472 06-01-17 6.50 2,515,484 2,654,185 07-01-17 6.00 7,077,985 7,435,501 07-01-17 7.50 853,867 912,704 08-01-17 5.50 3,628,801 3,755,470 09-01-17 6.50 3,150,507 3,345,759 10-01-17 5.50 938,125 970,793 11-01-17 5.50 3,430,710 3,550,230 12-01-17 5.50 2,715,798 2,810,367 12-01-17 6.00 3,829,478 4,000,396 02-01-18 5.50 3,857,021 3,990,442 04-01-18 5.50 4,583,211(h) 4,741,713 05-01-18 5.00 2,156,935 2,186,496 07-01-18 4.50 454,812 451,645 08-01-18 4.50 7,719,668 7,677,011 10-15-18 4.00 5,000,000 4,432,100 12-01-18 5.00 2,200,000 2,230,152 12-01-18 5.00 11,700,000(b) 11,849,878 09-01-22 6.50 940,384 982,363 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 8 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn (cont.) 11-01-22 6.00% $1,181,824 $1,218,962 03-01-23 5.50 2,193,439 2,244,904 07-01-23 5.00 1,178,210 1,173,045 08-01-23 5.50 4,463,981 4,528,771 09-01-23 5.50 3,910,904 3,967,667 10-01-23 5.50 1,955,768 1,984,154 04-01-25 8.00 1,508,766 1,668,757 07-01-28 5.50 2,343,791 2,372,507 08-01-28 5.50 1,379,050 1,395,946 09-01-28 7.50 2,014,313 2,159,385 12-01-28 7.00 2,014,528 2,151,139 01-01-29 6.00 1,798,713 1,851,930 03-01-29 6.50 5,067,674 5,355,350 06-01-29 6.00 6,208,684 6,427,994 06-01-29 7.50 1,832,559 1,955,922 06-25-30 7.50 558,203 607,395 06-01-31 7.00 4,350,458 4,623,320 09-01-31 7.00 3,190,326 3,406,431 09-01-31 7.50 3,502,835 3,744,883 10-01-31 9.50 257,786 286,357 11-01-31 6.50 2,026,979 2,119,098 01-01-32 6.00 2,034,153 2,095,993 01-01-32 6.50 1,220,809 1,282,151 03-01-32 7.00 2,526,030 2,686,770 04-01-32 6.50 3,683,039 3,868,079 04-01-32 7.00 2,950,972 3,131,697 05-01-32 6.50 4,207,410(h) 4,418,912 05-01-32 6.50 1,052,719 1,097,758 05-01-32 7.00 4,220,945 4,478,013 06-01-32 6.50 1,453,321 1,523,403 07-01-32 6.50 681,350 710,501 08-01-32 6.50 2,126,538 2,230,109 09-01-32 6.00 7,007,789 7,204,263 09-01-32 6.50 3,519,604 3,670,187 11-01-32 6.00 5,132,369 5,300,136 12-01-32 6.00 2,510,839 2,580,352 12-01-32 6.50 3,595,656 3,749,493 12-01-32 7.00 810,159 855,356 12-01-32 7.50 974,559 1,039,806 01-01-33 6.00 6,259,401 6,432,692 01-01-33 7.00 1,779,477 1,892,060 02-01-33 4.74 1,750,482(g) 1,786,700 02-01-33 5.50 2,932,031 2,955,229 03-01-33 5.50 2,900,538 2,925,934 03-01-33 6.00 5,847,456(h) 6,023,931 03-01-33 6.50 705,250 735,423 04-01-33 5.50 18,076,437 18,207,725 04-01-33 6.00 6,132,488 6,304,822 05-01-33 5.50 11,206,903 11,290,300 05-01-33 6.00 2,435,199 2,507,839 06-01-33 6.00 2,262,129 2,324,742 07-01-33 5.50 8,678,920 8,740,928 07-01-33 6.00 1,508,239 1,549,985 08-01-33 5.50 1,494,895 1,505,156 08-01-33 6.00 4,649,596 4,778,290 08-30-33 4.82 2,000,000 2,020,000 12-01-33 5.50 4,000,000(b) 4,025,000 Collateralized Mtge Obligation 07-25-16 4.00 2,700,000 2,671,570 08-25-41 7.50 2,663,857 2,898,609 10-25-42 7.50 2,534,709 2,758,080 Interest Only 10-25-09 5.00 9,357,793(e) 138,926 12-25-12 25.80 1,800,000(e) 136,463 Govt Natl Mtge Assn 04-15-29 6.50 577,330 607,420 02-15-30 7.00 550,840 586,111 03-15-30 7.00 633,315 673,866 12-15-31 6.50 863,000 907,783 02-15-32 6.50 1,046,377 1,100,099 12-15-32 6.00 888,078 919,614 05-15-33 6.00 1,334,315 1,381,476 10-15-33 5.50 4,683,855 4,738,164 Total 383,364,512 Banks and savings & loans (0.4%) Washington Mutual Series 2003-AR10 Cl A6 10-25-33 4.11 1,500,000 1,493,734 Financial services (0.3%) Residential Asset Securities Series 2002-KS1 Cl AI4 11-25-29 5.86 1,000,000 1,031,630 Total bonds (Cost: $391,046,447) $390,870,776 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 9 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Short-term securities (6.2%) Issuer Annualized Amount Value(a) yield on date payable at of purchase maturity U.S. government agencies (3.8%) Federal Home Loan Bank Disc Nt 01-02-04 1.08% $10,000,000 $9,990,435 Federal Natl Mtge Assn Disc Nt 01-14-04 1.07 4,900,000 4,893,673 Total 14,884,108 Commercial paper (2.4%) Park Avenue Receivables 12-01-03 1.05% $5,000,000(c) $4,999,563 Sigma Finance 12-01-03 1.05 4,400,000(c) 4,399,615 Total 9,399,178 Total short-term securities (Cost: $24,282,584) $24,283,286 Total investments in securities (Cost: $415,329,031)(i,j) $415,154,062 Notes to investments in securities (a) Securities are valued by procedures described in Note 1 to the financial statements. (b) At Nov. 30, 2003, the cost of securities purchased, including interest purchased, on a when-issued and/or other forward-commitment basis was $30,241,849. (c) Commercial paper sold within terms of a private placement memorandum, exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, and may be sold only to dealers in that program or other "accredited investors." This security has been determined to be liquid under guidelines established by the board. (d) Inverse floaters represent securities that pay interest at a rate that increases (decreases) in the same magnitude as, or in a multiple of, a decline (increase) in the LIBOR (London InterBank Offering Rate) Index. Interest rate disclosed is the rate in effect on Nov. 30, 2003. (e) Interest only represents securities that entitle holders to receive only interest payments on the underlying mortgages. The yield to maturity of an interest only is extremely sensitive to the rate of principal payments on the underlying mortgage assets. A rapid (slow) rate of principal repayments may have an adverse (positive) effect on yield to maturity. The principal amount shown is the notional amount of the underlying mortgages. Interest rate disclosed represents yield based upon the estimated timing and amount of future cash flows as of Nov. 30, 2003. (f) Mortgage-backed securities represent direct or indirect participations in, or are secured by and payable from, mortgage loans secured by real property, and include single- and multi-class pass-through securities and Collateralized Mortgage Obligations. These securities may be issued or guaranteed by U.S. government agencies or instrumentalities, or by private issuers, generally originators and investors in mortgage loans, including savings associations, mortgage bankers, commercial banks, investment bankers and special purpose entities. The maturity dates shown represent the original maturity of the underlying obligation. Actual maturity may vary based upon prepayment activity on these obligations. Unless otherwise noted, the coupon rates presented are fixed rates. (g) Adjustable rate mortgage; interest rate varies to reflect current market conditions; rate shown is the effective rate on Nov. 30, 2003. (h) Partially pledged as initial deposit on the following open interest rate futures contracts (see Note 5 to the financial statements): Type of security Notional amount Purchase contracts U.S. Treasury Bonds, March 2003, 30-year $ 6,000,000 U.S. Treasury Notes, March 2004, 10-year 7,000,000 Sale contracts U.S. Treasury Notes, Dec. 2003, 2-year 26,400,000 -------------------------------------------------------------------------------- 10 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Notes to investments in securities (continued) (i) At Nov. 30, 2003, cash or short-term securities were designated to cover open call options written as follows (see Note 6 to the financial statements):
Issuer Notional Exercise Expiration Value(a) amount price date U.S. Treasury Notes March 2004, 10-year $10,600,000 $112 Feb. 2004 $145,750
(j) At Nov. 30, 2003, the cost of securities for federal income tax purposes was approximately $415,329,000 and the approximate aggregate gross unrealized appreciation and depreciation based on that cost was: Unrealized appreciation $ 2,716,000 Unrealized depreciation (2,891,000) ---------- Net unrealized depreciation $ (175,000) ----------- -------------------------------------------------------------------------------- 11 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Financial Statements
Statement of assets and liabilities AXP U.S. Government Mortgage Fund Nov. 30, 2003 (Unaudited) Assets Investments in securities, at value (Note 1) (identified cost $415,329,031) $415,154,062 Cash in bank on demand deposit 16,087 Capital shares receivable 476,989 Accrued interest receivable 1,732,915 Receivable for investment securities sold 4,084,053 --------- Total assets 421,464,106 ----------- Liabilities Dividends payable to shareholders 177,106 Capital shares payable 244,942 Payable for investment securities purchased 111,718 Payable for securities purchased on a forward-commitment basis (Note 1) 30,241,849 Accrued investment management services fee 11,155 Accrued distribution fee 12,741 Accrued transfer agency fee 3,427 Accrued administrative services fee 1,073 Other accrued expenses 52,077 Options contracts written, at value (premiums received $218,201) (Note 6) 145,750 ------- Total liabilities 31,001,838 ---------- Net assets applicable to outstanding capital stock $390,462,268 ============ Represented by Capital stock -- $.01 par value (Note 1) $ 759,552 Additional paid-in capital 387,759,922 Undistributed net investment income 242,604 Accumulated net realized gain (loss) 2,075,958 Unrealized appreciation (depreciation) on investments (375,768) -------- Total -- representing net assets applicable to outstanding capital stock $390,462,268 ============ Net assets applicable to outstanding shares: Class A $211,681,732 Class B $160,342,636 Class C $ 18,425,098 Class Y $ 12,802 Net asset value per share of outstanding capital stock: Class A shares 41,185,392 $ 5.14 Class B shares 31,184,547 $ 5.14 Class C shares 3,582,743 $ 5.14 Class Y shares 2,491 $ 5.14 ----- ------------
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 12 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT
Statement of operations AXP U.S. Government Mortgage Fund Six months ended Nov. 30, 2003 (Unaudited) Investment income Income: Interest $ 8,655,976 ----------- Expenses (Note 2): Investment management services fee 1,136,819 Distribution fee Class A 297,307 Class B 897,894 Class C 99,006 Transfer agency fee 343,005 Incremental transfer agency fee Class A 18,606 Class B 24,356 Class C 2,793 Service fee -- Class Y 6 Administrative services fees and expenses 114,078 Compensation of board members 4,875 Custodian fees 42,360 Printing and postage 40,639 Registration fees 52,397 Audit fees 9,500 Other 1,663 ----- Total expenses 3,085,304 Expenses waived/reimbursed by AEFC (Note 2) (180,500) -------- 2,904,804 Earnings credits on cash balances (Note 2) (2,976) ------ Total net expenses 2,901,828 --------- Investment income (loss) -- net 5,754,148 --------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (Note 3) (1,974,643) Futures contracts 83,811 Options contracts written (Note 6) 95,673 ------ Net realized gain (loss) on investments (1,795,159) Net change in unrealized appreciation (depreciation) on investments (3,875,636) ---------- Net gain (loss) on investments (5,670,795) ---------- Net increase (decrease) in net assets resulting from operations $ 83,353 ===========
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 13 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT
Statements of changes in net assets AXP U.S. Government Mortgage Fund Nov. 30, 2003 May 31, 2003 Six months ended Year ended (Unaudited) Operations and distributions Investment income (loss) -- net $ 5,754,148 $ 9,686,929 Net realized gain (loss) on investments (1,795,159) 5,763,024 Net change in unrealized appreciation (depreciation) on investments (3,875,636) 2,819,705 ---------- --------- Net increase (decrease) in net assets resulting from operations 83,353 18,269,658 ------ ---------- Distributions to shareholders from: Net investment income Class A (3,283,845) (6,365,488) Class B (1,793,644) (3,718,149) Class C (197,974) (383,803) Class Y (182) (475) Net realized gain Class A -- (878,837) Class B -- (703,993) Class C -- (67,316) Class Y -- (57) ---------- ----------- Total distributions (5,275,645) (12,118,118) ---------- ----------- Capital share transactions (Note 4) Proceeds from sales Class A shares (Note 2) 51,807,908 277,134,067 Class B shares 27,793,520 210,911,273 Class C shares 3,887,364 19,636,847 Class Y shares 500 502 Reinvestment of distributions at net asset value Class A shares 3,101,754 6,382,377 Class B shares 1,717,336 4,108,191 Class C shares 183,209 404,490 Class Y shares 31 85 Payments for redemptions Class A shares (91,503,473) (93,565,033) Class B shares (Note 2) (66,981,644) (45,757,524) Class C shares (Note 2) (6,941,011) (3,415,045) Class Y shares -- (132) ---------- ----------- Increase (decrease) in net assets from capital share transactions (76,934,506) 375,840,098 ----------- ----------- Total increase (decrease) in net assets (82,126,798) 381,991,638 Net assets at beginning of period 472,589,066 90,597,428 ----------- ---------- Net assets at end of period $390,462,268 $472,589,066 ============ ============ Undistributed (excess of distributions over) net investment income $ 242,604 $ (235,899) ------------ ------------
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 14 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Notes to Financial Statements AXP U.S. Government Mortgage Fund (Unaudited as to Nov. 30, 2003) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Fund is a series of AXP Government Income Series, Inc. and is registered under the Investment Company Act of 1940 (as amended) as a diversified, open-end management investment company. AXP Government Income Series, Inc. has 10 billion authorized shares of capital stock that can be allocated among the separate series as designated by the board. The Fund invests primarily in debt obligations guaranteed as to principal and interest by the U.S. government, its agencies or instrumentalities. Although the Fund may invest in any U.S. government securities, it is anticipated that U.S. government securities representing part ownership in pools of mortgage loans (mortgage-backed securities) will comprise a large percentage of the Fund's investments. The Fund offers Class A, Class B, Class C and Class Y shares. o Class A shares are sold with a front-end sales charge. o Class B shares may be subject to a contingent deferred sales charge (CDSC) and automatically convert to Class A shares during the ninth calendar year of ownership. o Class C shares may be subject to a CDSC. o Class Y shares have no sales charge and are offered only to qualifying institutional investors. All classes of shares have identical voting, dividend and liquidation rights. The distribution fee, incremental transfer agency fee and service fee (class specific expenses) differ among classes. Income, expenses (other than class specific expenses) and realized and unrealized gains or losses on investments are allocated to each class of shares based upon its relative net assets. The Fund's significant accounting policies are summarized below: Use of estimates Preparing financial statements that conform to accounting principles generally accepted in the United States of America requires management to make estimates (e.g., on assets, liabilities and contingent assets and liabilities) that could differ from actual results. Valuation of securities All securities are valued at the close of each business day. Securities traded on national securities exchanges or included in national market systems are valued at the last quoted sales price. Debt securities are generally traded in the over-the-counter market and are valued at a price that reflects fair value as quoted by dealers in these securities or by an independent pricing service. Securities for which market quotations are not readily available are valued at fair value according to methods selected in good faith by the board. Short-term securities maturing in more than 60 days from the valuation date are valued at the market price or approximate market value based on current interest rates; those maturing in 60 days or less are valued at amortized cost. -------------------------------------------------------------------------------- 15 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Option transactions To produce incremental earnings, protect gains and facilitate buying and selling of securities for investments, the Fund may buy and sell put and call options and write put and call options. This may include purchasing mortgage-backed security (MBS) put spread options and writing covered MBS call spread options. MBS spread options are based upon the changes in the price spread between a specified mortgage-backed security and a like-duration Treasury security. The risk in writing a call option is that the Fund gives up the opportunity for profit if the market price of the security increases. The risk in writing a put option is that the Fund may incur a loss if the market price of the security decreases and the option is exercised. The risk in buying an option is that the Fund pays a premium whether or not the option is exercised. The Fund also has the additional risk of being unable to enter into a closing transaction if a liquid secondary market does not exist. The Fund also may write over-the-counter options where completing the obligation depends upon the credit standing of the other party. Option contracts are valued daily at the closing prices on their primary exchanges and unrealized appreciation or depreciation is recorded. The Fund will realize a gain or loss when the option transaction expires or closes. When options on debt securities or futures are exercised, the Fund will realize a gain or loss. When other options are exercised, the proceeds on sales for a written call option, the purchase cost for a written put option or the cost of a security for a purchased put or call option is adjusted by the amount of premium received or paid. Futures transactions To gain exposure to or protect itself from market changes, the Fund may buy and sell financial futures contracts. Risks of entering into futures contracts and related options include the possibility of an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. Upon entering into a futures contract, the Fund is required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract value. Subsequent payments (variation margin) are made or received by the Fund each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. The Fund recognizes a realized gain or loss when the contract is closed or expires. Short sales The Fund may engage in short sales. In these transactions, the Fund sells a security that it does not own. The Fund is obligated to replace the security that was short by purchasing it at the market price at the time of replacement or entering into an offsetting transaction with the broker. The price at such time may be more or less than the price at which the Fund sold the security. Securities purchased on a forward-commitment basis Delivery and payment for securities that have been purchased by the Fund on a forward-commitment basis, including when-issued securities and other forward-commitments, can take place one month or more after the transaction date. During this period, such securities are subject to market fluctuations, and they may affect the Fund's net assets the same as owned securities. The Fund designates cash or liquid securities at least equal to the amount of its forward-commitments. As of Nov. 30, 2003, the Fund has entered into outstanding when-issued securities of $30,241,849. -------------------------------------------------------------------------------- 16 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT The Fund also enters into transactions to sell purchase commitments to third parties at current market values and concurrently acquires other purchase commitments for similar securities at later dates. As an inducement for the Fund to "roll over" its purchase commitments, the Fund receives negotiated amounts in the form of reductions of the purchase price of the commitment. Federal taxes The Fund's policy is to comply with all sections of the Internal Revenue Code that apply to regulated investment companies and to distribute substantially all of its taxable income to shareholders. No provision for income or excise taxes is thus required. Net investment income (loss) and net realized gains (losses) may differ for financial statement and tax purposes primarily because of deferred losses on certain futures contracts and losses deferred due to "wash sale" transactions. The character of distributions made during the year from net investment income or net realized gains may differ from their ultimate characterization for federal income tax purposes. Also, due to the timing of dividend distributions, the fiscal year in which amounts are distributed may differ from the year that the income or realized gains (losses) were recorded by the Fund. Dividends to shareholders Dividends from net investment income, declared daily and payable monthly, when available, are reinvested in additional shares of the Fund at net asset value or payable in cash. Capital gains, when available, are distributed along with the last income dividend of the calendar year. Other Security transactions are accounted for on the date securities are purchased or sold. Interest income, including amortization of premium, market discount and original issue discount using the effective interest method, is accrued daily. 2. EXPENSES AND SALES CHARGES The Fund has agreements with American Express Financial Corporation (AEFC) to manage its portfolio and provide administrative services. Under an Investment Management Services Agreement, AEFC determines which securities will be purchased, held or sold. The management fee is a percentage of the Fund's average daily net assets in reducing percentages from 0.52% to 0.395% annually. Under an Administrative Services Agreement, the Fund pays AEFC a fee for administration and accounting services at a percentage of the Fund's average daily net assets in reducing percentages from 0.05% to 0.025% annually. A minor portion of additional administrative service expenses paid by the Fund are consultants' fees and fund office expenses. Under this agreement, the Fund also pays taxes, audit and certain legal fees, registration fees for shares, compensation of board members, corporate filing fees and any other expenses properly payable by the Fund and approved by the board. Under a Deferred Compensation Plan (the Plan), non-interested board members may defer receipt of their compensation. Deferred amounts are treated as though equivalent dollar amounts had been invested in shares of the Fund or other American Express mutual funds. The Fund's liability for these amounts is adjusted for market value changes and remains in the Fund until distributed in accordance with the Plan. -------------------------------------------------------------------------------- 17 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Under a separate Transfer Agency Agreement, American Express Client Service Corporation (AECSC) maintains shareholder accounts and records. The Fund pays AECSC an annual fee per shareholder account for this service as follows: o Class A $20.50 o Class B $21.50 o Class C $21.00 o Class Y $18.50 The incremental transfer agency fee is the amount charged to the specific classes for the additional expense above the fee for Class Y. In addition, AECSC is entitled to charge an annual closed-account fee of $5 per inactive account, charged on a pro rata basis from the date the account becomes inactive until the date the account is purged from the transfer agent system generally within one year. However, the closed account fee is currently not effective. The Fund has agreements with American Express Financial Advisors Inc. (the Distributor) for distribution and shareholder services. Under a Plan and Agreement of Distribution, the Fund pays a fee at an annual rate up to 0.25% of the Fund's average daily net assets attributable to Class A shares and up to 1.00% for Class B and Class C shares. Under a Shareholder Service Agreement, the Fund pays the Distributor a fee for service provided to shareholders by financial advisors and other servicing agents. The fee is calculated at a rate of 0.10% of the Fund's average daily net assets attributable to Class Y shares. Sales charges received by the Distributor for distributing Fund shares were $659,224 for Class A, $163,620 for Class B and $13,974 for Class C for the six months ended Nov. 30, 2003. For the six months ended Nov. 30, 2003, AEFC and its affiliates waived certain fees and expenses to 0.98% for Class A, 1.74% for Class B, 1.74% for Class C and 0.80% for Class Y. In addition, AEFC and its affiliates have agreed to waive certain fees and expenses until May 31, 2004. Under this agreement, total expenses will not exceed 0.99% for Class A, 1.75% for Class B, 1.75% for Class C and 0.81% for Class Y of the Fund's average daily net assets. During the six months ended Nov. 30, 2003, the Fund's custodian and transfer agency fees were reduced by $2,976 as a result of earnings credits from overnight cash balances. The Fund also pays custodian fees to American Express Trust Company, an affiliate of AEFC. -------------------------------------------------------------------------------- 18 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT 3. SECURITIES TRANSACTIONS Cost of purchases and proceeds from sales of securities (other than short-term obligations) aggregated $368,266,116 and $430,639,471, respectively, for the six months ended Nov. 30, 2003. Realized gains and losses are determined on an identified cost basis. 4. CAPITAL SHARE TRANSACTIONS Transactions in shares of capital stock for the periods are as follows:
Six months ended Nov. 30, 2003 Class A Class B Class C Class Y Sold 10,047,000 5,395,154 754,895 97 Issued for reinvested distributions 603,134 333,725 35,588 6 Redeemed (17,808,939) (13,017,678) (1,350,351) -- ----------- ----------- ---------- --- Net increase (decrease) (7,158,805) (7,288,799) (559,868) 103 ---------- ---------- -------- --- Year ended May 31, 2003 Class A Class B Class C Class Y Sold 53,840,581 40,951,953 3,809,031 98 Issued for reinvested distributions 1,236,256 795,646 78,342 16 Redeemed (18,129,387) (8,851,021) (659,979) (25) ----------- ---------- -------- ---- Net increase (decrease) 36,947,450 32,896,578 3,227,394 89 ---------- ---------- --------- ----
5. INTEREST RATE FUTURES CONTRACTS As of Nov. 30, 2003, investments in securities included securities valued at $525,995 that were pledged as collateral to cover initial margin deposits on 130 open purchase contracts and 132 open sale contracts. The notional market value of the open purchase contracts as of Nov. 30, 2003 was $14,232,969 with a net unrealized loss of $227,348. The notional market value of the open sale contracts as of Nov. 30, 2003 was $28,274,813 with a net unrealized loss of $45,902. See "Summary of significant accounting policies." 6. OPTIONS CONTRACTS WRITTEN Contracts and premiums associated with options contracts written are as follows: Six months ended Nov. 30, 2003 Puts Calls Contracts Premiums Contracts Premiums Balance May 31, 2003 -- $ -- -- $ -- Opened 211 152,923 1,262 1,247,923 Closed (211) (152,923) (1,156) (1,029,722) ---- -------- ------ ---------- Balance Nov. 30, 2003 -- $ -- 106 $ 218,201 ---- --------- ------ ----------- See "Summary of significant accounting policies." -------------------------------------------------------------------------------- 19 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT 7. BANK BORROWINGS The Fund has a revolving credit agreement with a syndicate of banks headed by Deutsche Bank, whereby the Fund is permitted to have bank borrowings for temporary or emergency purposes to fund shareholder redemptions. The Fund must maintain asset coverage for borrowings of at least 300%. The agreement, which enables the Fund to participate with other American Express mutual funds, permits borrowings up to $500 million, collectively. Interest is charged to each Fund based on its borrowings at a rate equal to either the LIBOR plus 0.50%, the IBOR plus 0.50% or the higher of the Federal Funds Rate plus 0.25% and the Prime Lending Rate. Borrowings are payable within 60 days after such loan is executed. The Fund also pays a commitment fee equal to its pro rata share of the amount of the credit facility at a rate of 0.09% per annum. The Fund had no borrowings outstanding during the six months ended Nov. 30, 2003. 8. FINANCIAL HIGHLIGHTS The tables below show certain important financial information for evaluating the Fund's results.
Class A Per share income and capital changes(a) Fiscal period ended May 31, 2003(k) 2003 2002(b) Net asset value, beginning of period $5.19 $5.06 $5.01 Income from investment operations: Net investment income (loss) .08 .19 .04 Net gains (losses) (both realized and unrealized) (.06) .16 .04 Total from investment operations .02 .35 .08 Less distributions: Dividends from net investment income (.07) (.20) (.03) Distributions from realized gains -- (.02) -- Total distributions (.07) (.22) (.03) Net asset value, end of period $5.14 $5.19 $5.06 Ratios/supplemental data Net assets, end of period (in millions) $212 $251 $58 Ratio of expenses to average daily net assets(c),(e) .98%(d) .99% .95%(d) Ratio of net investment income (loss) to average daily net assets 2.98%(d) 3.31% 2.98%(d) Portfolio turnover rate (excluding short-term securities) 85% 227% 200% Total return(i) .40%(j) 6.93% 1.75%(j)
See accompanying notes to financial highlights. -------------------------------------------------------------------------------- 20 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT
Class B Per share income and capital changes(a) Fiscal period ended May 31, 2003(k) 2003 2002(b) Net asset value, beginning of period $5.20 $5.07 $5.01 Income from investment operations: Net investment income (loss) .06 .15 .03 Net gains (losses) (both realized and unrealized) (.07) .16 .05 Total from investment operations (.01) .31 .08 Less distributions: Dividends from net investment income (.05) (.16) (.02) Distributions from realized gains -- (.02) -- Total distributions (.05) (.18) (.02) Net asset value, end of period $5.14 $5.20 $5.07 Ratios/supplemental data Net assets, end of period (in millions) $160 $200 $28 Ratio of expenses to average daily net assets(c),(f) 1.74%(d) 1.75% 1.74%(d) Ratio of net investment income (loss) to average daily net assets 2.21%(d) 2.49% 2.68%(d) Portfolio turnover rate (excluding short-term securities) 85% 227% 200% Total return(i) (.17%)(j) 6.12% 1.76%(j) Class C Per share income and capital changes(a) Fiscal period ended May 31, 2003(k) 2003 2002(b) Net asset value, beginning of period $5.20 $5.07 $5.01 Income from investment operations: Net investment income (loss) .06 .15 .03 Net gains (losses) (both realized and unrealized) (.07) .16 .05 Total from investment operations (.01) .31 .08 Less distributions: Dividends from net investment income (.05) (.16) (.02) Distributions from realized gains -- (.02) -- Total distributions (.05) (.18) (.02) Net asset value, end of period $5.14 $5.20 $5.07 Ratios/supplemental data Net assets, end of period (in millions) $18 $22 $5 Ratio of expenses to average daily net assets(c),(g) 1.74%(d) 1.75% 1.73%(d) Ratio of net investment income (loss) to average daily net assets 2.23%(d) 2.50% 2.60%(d) Portfolio turnover rate (excluding short-term securities) 85% 227% 200% Total return(i) (.17%)(j) 6.12% 1.74%(j)
See accompanying notes to financial highlights. -------------------------------------------------------------------------------- 21 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT
Class Y Per share income and capital changes(a) Fiscal period ended May 31, 2003(k) 2003 2002(b) Net asset value, beginning of period $5.19 $5.06 $5.01 Income from investment operations: Net investment income (loss) .09 .19 .04 Net gains (losses) (both realized and unrealized) (.06) .16 .04 Total from investment operations .03 .35 .08 Less distributions: Dividends from net investment income (.08) (.20) (.03) Distributions from realized gains -- (.02) -- Total distributions (.08) (.22) (.03) Net asset value, end of period $5.14 $5.19 $5.06 Ratios/supplemental data Net assets, end of period (in millions) $-- $-- $-- Ratio of expenses to average daily net assets(c),(h) .80%(d) .80% .78%(d) Ratio of net investment income (loss) to average daily net assets 3.19%(d) 3.68% 2.95%(d) Portfolio turnover rate (excluding short-term securities) 85% 227% 200% Total return(i) .50%(j) 7.10% 1.80%(j)
Notes to financial highlights (a) For a share outstanding throughout the period. Rounded to the nearest cent. (b) For the period from Feb. 14, 2002 (when shares became publicly available) to May 31, 2002. (c) Expense ratio is based on total expenses of the Fund before reduction of earnings credits on cash balances. (d) Adjusted to an annual basis. (e) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratios of expenses for Class A would have been 1.06% for the six months ended Nov. 30, 2003 and 1.06% and 1.58% for the periods ended May 31, 2003 and 2002, respectively. (f) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratios of expenses for Class B would have been 1.82% for the six months ended Nov. 30, 2003 and 1.82% and 2.34% for the periods ended May 31, 2003 and 2002, respectively. (g) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratios of expenses for Class C would have been 1.83% for the six months ended Nov. 30, 2003 and 1.82% and 2.34% for the periods ended May 31, 2003 and 2002, respectively. (h) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratios of expenses for Class Y would have been 0.90% for the six months ended Nov. 30, 2003, and 0.88% and 1.40% for the periods ended May 31, 2003 and 2002, respectively. (i) Total return does not reflect payment of a sales charge. (j) Not annualized. (k) Six months ended Nov. 30, 2003 (Unaudited). -------------------------------------------------------------------------------- 22 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT Proxy Voting The policy of the Board is to vote all proxies of the companies in which the Fund holds investments. The procedures are stated in the Statement of Additional Information (SAI). You may obtain a copy of the SAI without charge by calling (800) 862-7919; by looking at the Web site americanexpress.com/funds; or by searching the Web site of the Securities and Exchange Commission http://www.sec.gov. You may view the Fund's voting record for all portfolio companies whose shareholders meetings were completed the previous quarter on americanexpress.com/funds or obtain a copy by calling the Fund's administrator, Board Services Corporation, collect at (612) 330-9283. In addition, after Aug. 1, 2004, information regarding how the Fund voted proxies relating to portfolio securities during the most recent 12-month period ended June 30 will be available at http://www.sec.gov. -------------------------------------------------------------------------------- 23 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2003 SEMIANNUAL REPORT -------------------------------------------------------------------------------- (logo) AMERICAN EXPRESS (R) -------------------------------------------------------------------------------- American Express Funds 70100 AXP Financial Center Minneapolis, MN 55474 This report must be accompanied or preceded by the Fund's current prospectus. Distributed by American Express Financial Advisors Inc. Member NASD. American Express Company is separate from American Express Financial Advisors Inc. and is not a broker-dealer. Item 2. Code of Ethics. Not applicable for semi-annual reports. Item 3. Audit Committee Financial Expert. Not applicable for semi-annual reports. Item 4. Principal Accountant Fees and Services. Not applicable at this time. Item 5. Audit Committee of Listed Registrants. Not applicable. Item 6. [Reserved] Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies. Not applicable. Item 8. Purchase of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers. Not applicable. Item 9. Submission of matters to a vote of security holders. Not applicable at this time. Item 10. Controls and Procedures. (a) The registrant's Principal Executive Officer and Principal Financial Officer have evaluated the registrant's disclosure controls and procedures within 90 days of this filing and have concluded that the registrant's disclosure controls and procedures by the registrant in this Form N-CSR was recorded, processed, summarized, and reported timely. (b) At the date of filing this Form N-CSR, the registrant's Principal Executive Officer and Principal Financial Officer are aware of no significant changes in the registrant's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Item 11. Exhibits. (a)(1) Not applicable for semi-annual reports. (a)(2) Separate certification for the Registrant's principal executive officer and principal financial officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002 and Rule 30a-2(a) under the Investment Company Act of 1940, are attached as EX.99.CERT. (a)(3) Not applicable. (b) A certification by the Registrant's principal executive officer and principal financial officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and Rule 30a-2(b) under the Investment Company Act of 1940, is attached as EX.99.906 CERT. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. (Registrant) AXP Government Income Series, Inc. By /s/ Paula R. Meyer ------------------ Paula R. Meyer President and Principal Executive Officer Date February 3, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By /s/ Paula R. Meyer ------------------ Paula R. Meyer President and Principal Executive Officer Date February 3, 2004 By /s/ Jeffrey P. Fox ------------------ Jeffrey P. Fox Treasurer and Principal Financial Officer Date February 3, 2004