-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CEYHa8b9DlQadfOoQypY06w5NLd/YDQsq/uEoISotpH7/GDPpSd3OVCOkWPlb8HI YlAn+Y7Sa/qhtH4msR56ZA== 0000820027-04-000648.txt : 20040803 0000820027-04-000648.hdr.sgml : 20040803 20040803123614 ACCESSION NUMBER: 0000820027-04-000648 CONFORMED SUBMISSION TYPE: N-CSR PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20040531 FILED AS OF DATE: 20040803 EFFECTIVENESS DATE: 20040803 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AXP GOVERNMENT INCOME SERIES INC CENTRAL INDEX KEY: 0000764802 IRS NUMBER: 412021315 STATE OF INCORPORATION: MN FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: N-CSR SEC ACT: 1940 Act SEC FILE NUMBER: 811-04260 FILM NUMBER: 04947418 BUSINESS ADDRESS: STREET 1: 50606 AXP FINANCIAL CENTER STREET 2: H27/52 CITY: MINNEAPOLIS STATE: MN ZIP: 55474 BUSINESS PHONE: 6123722772 MAIL ADDRESS: STREET 1: 50606 AXP FINANCIAL CENTER STREET 2: H27/52 CITY: MINNEAPOLIS STATE: MN ZIP: 55474 FORMER COMPANY: FORMER CONFORMED NAME: AXP FEDERAL INCOME FUND INC /MN/ DATE OF NAME CHANGE: 20000829 FORMER COMPANY: FORMER CONFORMED NAME: IDS FEDERAL INCOME FUND INC DATE OF NAME CHANGE: 19920703 N-CSR 1 govtinc-nscr.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: 5/31 -------------- AXP(R) Short Duration U.S. Government Fund Annual Report for the Period Ended May 31, 2004 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 Funds (R) Table of Contents Fund Snapshot 3 Questions & Answers with Portfolio Management 4 The Fund's Long-term Performance 9 Investments in Securities 10 Financial Statements (Portfolio) 15 Notes to Financial Statements (Portfolio) 18 Report of Independent Registered Public Accounting Firm (Portfolio) 22 Financial Statements (Fund) 23 Notes to Financial Statements (Fund) 26 Report of Independent Registered Public Accounting Firm (Fund) 36 Federal Income Tax Information 37 Board Members and Officers 39 Proxy Voting 41 (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 SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Fund Snapshot AS OF MAY 31, 2004 PORTFOLIO MANAGER Portfolio manager Scott Kirby* Since 6/01 Years in industry 25 * 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 $2.308 billion Number of holdings 173 Average weighted life** 2.3 years Effective duration*** 1.3 years Weighted average bond rating AAA 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 graph) U.S. government obligations & agencies 45.3% Mortgage-backed securities 44.6% Short-term securities* 7.2% CMBS/ABS** 2.1% Corporate bonds*** 0.8% * 6.8% of the securities in this category is due to security lending activity. 0.4% of the short-term securities is the Fund's cash equivalent position. ** Commercial mortgage-backed securities/Asset-backed securities. *** Includes 0.5% Banks & brokers and 0.3% Other financial. CREDIT QUALITY SUMMARY Percentage of portfolio assets excluding cash equivalents AAA bonds 100.0% 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." ** Average weighted life is the average number of years that each dollar of unpaid principal due on a security remains outstanding. *** Effective duration measures the sensitivity of a security's price to parallel shifts in the yield curve (the graphical depiction of the levels of interest rates from two years to 30 years). Positive duration means that as rates rise, the price decreases, and negative duration means that as rates rise, the price increases. 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 --- 2004 ANNUAL 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 12 months ended May 31, 2004. Q: How did AXP Short Duration U.S. Government Fund perform for the 12 months ended May 31, 2004? A: AXP Short Duration U.S. Government Fund's Class A shares (excluding sales charge) fell 0.24% for the 12 months ended May 31, 2004. The Fund's benchmark, the Lehman Brothers 1-3 Year Government Index, rose 0.66% for the period. The Fund also underperformed the Lipper Short U.S. Government Funds Index, the Fund's peer group, which rose 0.07% over the same time frame. To help keep the Fund competitive with its peers, we implemented a new expense cap effective June 1, 2004, reducing the maximum level of expenses borne by Class A shareholders from 0.97% of net assets per fiscal year to a maximum 0.93% of net assets per year. Q: What factors most significantly affected Fund performance? A: The fiscal period was marked by substantial volatility. Uncertainty regarding the scope of U.S. economic recovery, the potential for rising interest rates, geopolitical events and the continued threat of terrorism influenced the fixed income market throughout the 12 months ended May 31, 2004. The Fund was positioned to do well in a low volatility environment, so it struggled through some turbulent periods during this past fiscal year. The Fund's allocation to mortgages also contributed to its underperformance of the benchmark and peer group for the period. Our security selection within the mortgage sector of buying pools that historically have had lower-than-average prepayment risk worked well, however, not well enough to offset the impact of (bar graph) PERFORMANCE COMPARISON For the year ended May 31, 2004 0.75% (bar 2) 0.50% +0.66% 0.25% (bar 3) 0.00% (bar 1) +0.07% - -0.25% -0.24% - -0.50% (bar 1) AXP Short Duration U.S. Government Fund Class A (excluding sales charge) (bar 2) Lehman Brothers 1-3 Year Government Index (unmanaged) (bar 3) Lipper Short U.S. Government Funds Index (see "The Fund's Long-term Performance" for Index descriptions) 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 --- 2004 ANNUAL REPORT Questions & Answers (begin callout quote)> The period was marked by significant volatility as the market tried to determine what action the Federal Reserve Board (the Fed) would take with interest rates. (end callout quote) the volatile environment. The volatility experienced was primarily due to the market trying to determine what action the Federal Reserve Board (the Fed) would take with interest rates. Shortly before the start of the new fiscal year, a Federal Reserve Board meeting took place in which the Fed introduced the idea
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 May 31, 2004 1 year -0.24% -4.97% -0.99% -4.89% -0.99% -0.99% -0.08% -0.08% 3 years +3.44% +1.78% +2.67% +1.71% +2.67% +2.67% +3.61% +3.61% 5 years +4.05% +3.04% +3.27% +3.09% N/A N/A +4.21% +4.21% 10 years +5.45% +4.94% N/A N/A N/A N/A N/A N/A Since inception N/A N/A +4.60% +4.60% +4.07% +4.07% +5.55% +5.55% as of June 30, 2004 1 year -0.20% -4.94% -0.95% -4.85% -0.95% -0.95% -0.04% -0.04% 3 years +3.38% +1.72% +2.60% +1.64% +2.60% +2.60% +3.55% +3.55% 5 years +4.09% +3.08% +3.30% +3.13% N/A N/A +4.25% +4.25% 10 years +5.43% +4.92% N/A N/A N/A N/A N/A N/A Since inception N/A N/A +4.55% +4.55% +3.97% +3.97% +5.50% +5.50%
The performance information shown represents the past performance and is not a guarantee of future results. The investment return and principal value of your investment and returns will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance information shown. You may obtain performance information current to the most recent month-end by calling (888) 723-8476 or visiting www.americanexpress.com/funds. You should consider the investment objectives, risks, and charges and expenses of the Fund carefully before investing. (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. - -------------------------------------------------------------------------------- 5 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Questions & Answers that the probability of deflation exceeded that of inflation over the next few calendar quarters. The fixed income market rallied, fueled by the belief that interest rates would remain low and that the Fed would do whatever was necessary to fight deflation. Two-year U.S. Treasury yields rallied slightly at the start of fiscal year in June 2003. Then, on June 25, 2003, the Fed disappointed the market by cutting the targeted federal funds rate by only 0.25% to 1.00%. The Fed's move led to a market sell-off, and U.S. Treasury yields rose dramatically. The market perceived that deflation was not as big of a threat as the Fed had led it to believe. Given the Fed's conservative action, coupled with signs that the economy may start to recover, the two-year U.S. Treasury yield rose from 1.08% in June to over 2% by the end of August. During this period, mortgage securities underperformed dramatically. The performance of the mortgage securities held in the Fund hurt overall performance. The duration of the Fund during the back up in rates was not short enough to offset the mortgage impact. From September 2003 until the beginning of March 2004, two-year U.S. Treasury yields generally stayed in a relatively tight range of 1.60% to 1.90% breaking out briefly both higher and lower in rates. Mortgages performed well during this period. During this period we also set the Fund's duration slightly short of its benchmark due to the uncertainty of how and when the economy would recover. This strategy was designed to produce principal preservation, but it did slightly detract from performance. Early in 2004, U.S. fixed income markets (as measured by the Lehman Brothers Aggregate Bond Index) outperformed most stock market indices. Geopolitical tensions, global terrorist attacks and problems in the war with Iraq shook investors' confidence in the stock market and increased investors' interest in the fixed income market. Disappointing employment reports continued, which caused investors to question whether the U.S. economic recovery was really back on track. Although signs of an economic recovery were evident, it began to appear as if the jobs necessary to sustain the recovery were not developing. Fixed income investors grew concerned as weak employment reports continued in February (published in March), even though other data suggested that the jobs would eventually come through. During this period, the Fund performed well as the mortage securities in the Fund outperformed Treasury bonds. During this period, we reduced the duration as we expected the recovery may develop slower than expected. A long-awaited strong employment report came through in early April to show that - -------------------------------------------------------------------------------- 6 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Questions & Answers non-farm payrolls increased by 308,000 in March. Also, the previous two months payroll numbers were revised upward. Another strong employment report in April (published in early May) was further evidence that the recovery picture was in sharper focus. As the economic recovery developed, we reduced the Fund's duration and reduced its exposure to mortgage backed securities. To add income, we increased the weighting in short-term agency securities. We continue to hold a defensive position as the economic recovery gains strength. Throughout the period, the Fund participated in the use of derivative instruments. The use of derivative instruments, such as listed futures, is primarily for hedging either duration or the yield curve. The Fund will also use listed contracts, such as eurodollar and swap contracts, to manage spread product exposure in the portfolio. Q: What changes did you make to the Fund and how is it currently positioned? A: Over the fiscal year, we improved the structure of the Fund in an effort to reduce the effects of market volatility on Fund performance. We continued to balance the Fund's weightings in U.S. government Treasury, agency and mortgage-backed securities to provide adequate income within a lower-risk framework. Mortgage-backed securities comprise approximately half of the Fund's portfolio. The mortgage securities we held at the beginning of the fiscal year had characteristics that helped protect these securities from prepayments. As we approached the end of the fiscal year, the environment shifted from prepayment risk to duration extension risk. We changed the mortgage strategy to focus on higher coupons and more seasoned bonds, which we expect to outperform when the Fed increases rates. We also reduced the Fund's allocation to U.S. government agencies from overweight to neutral as agency spreads widened. We have recently added back exposure to agencies to capture some of the recent spread widening. Throughout the year we continued to position the Fund with securities that roll down the yield curve. As we got closer to a rate increase by the Fed, we have started to move the Fund toward a barbell strategy. In a barbell strategy, the Fund owns positions at the short and longer end of the yield curve. We favor this strategy when we believe the yield curve will flatten. We also used a mortgage forward purchase or roll strategy, which contributed to a portfolio turnover rate of 125% for the period. We have reduced the use of this strategy over the course of the year. Through this reporting period, we believed signs were leading toward a pickup in the economic recovery. - -------------------------------------------------------------------------------- 7 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Questions & Answers Therefore, our outlook called for the Federal Reserve Board to raise the target federal funds rate sooner than the view that was priced into the market. Based on this outlook, we shortened the duration of the Fund and improved the structure in its mortgage holdings. When job creation did not materialize as quickly as we expected, the Fund gave up some performance versus its broad-based benchmark due to its shorter duration. We took defensive measures to reduce the Fund's exposure to volatility whenever possible. For example, we maintained approximately the same allocation in mortgage-backed securities, but improved the characteristics of these securities to reduce their exposure to volatility. Toward the end of the period, we started to reduce the Fund's overall exposure to mortage-backed securities due to valuations. Q: How do you intend to manage the Fund in the coming months? A: Looking ahead, we believe the Fed will raise interest rates some time this summer. The key question is by how much? The fixed income futures market was already pricing in a total of 100 basis points (1%) in a series of interest rate increases by the end of December 2004. We have positioned the Fund for ongoing economic recovery and a moderately higher interest rate environment. Our continued strategy is to provide added portfolio value with a moderate amount of risk. We like the balance of risk and performance of the securities we currently hold. We intend to keep the Fund's duration shorter than the benchmark until we believe the market has finished pricing in any Fed increases. We also intend to maintain a defensive, lower allocation to mortgage-backed securities until their valuations become more attractive. Finally, we intend to favor a barbell strategy, owning positions at the short and longer ends of the curve, for the near term, given our view that the yield curve will flatten once the Fed begins to raise interest rates over the coming months. As always, we continue to seek attractive buying opportunities. Quality issues and security selection remain a priority. - -------------------------------------------------------------------------------- 8 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT The Fund's Long-term Performance This chart illustrates the total value of an assumed $10,000 investment in AXP Short Duration U.S. Government Fund Class A shares (from 6/1/94 to 5/31/04) as compared to the performance of two widely cited performance indices, the Lehman Brothers 1-3 Year Government Index and the Lipper Short U.S. Government Funds Index. In comparing the Fund's Class A shares to these indices, you should take into account the fact that the Fund's performance reflects the maximum sales charge of 4.75%, while such charges are not reflected in the performance of the indices. Returns for the Fund include the reinvestment of any distribution paid during each period. The performance information shown represents the past performance and is not a guarantee of future results. The value of your investment and returns will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Returns do not reflect taxes payable on distributions and redemptions. Current performance may be lower or higher than the performance information shown. You may obtain performance information current to the most recent month-end by calling (888) 723-8476 or visiting www.americanexpress.com/funds. Also see "Past Performance" in the Fund's current prospectus. You should consider the investment objectives, risks, and charges and expenses of the Fund carefully before investing. (line graph)
VALUE OF A HYPOTHETICAL $10,000 INVESTMENT IN AXP SHORT TERM U.S. GOVERNMENT FUND AXP Short Duration U.S. Government Fund Class A $ 9,525 $10,348 $10,952 $11,799 $12,761 $13,282 $13,281 $14,634 $15,479 $16,237 $16,198 Lehman Brothers 1-3 Year Government Index(1) $10,000 $10,736 $11,303 $12,050 $12,890 $13,570 $14,117 $15,538 $16,532 $17,466 $17,581 Lipper Short U.S. Government Funds Index(2) $10,000 $10,711 $11,219 $11,948 $12,741 $13,354 $13,847 $15,202 $15,999 $16,735 $16,747 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04
(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 and objectives. Average Annual Total Returns Class A with Sales Charge as of May 31, 2004 1 year -4.97% 5 years +3.04% 10 years +4.94% Results for other share classes can be found on page 5. - -------------------------------------------------------------------------------- 9 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Investments in Securities Government Income Portfolio May 31, 2004 (Percentages represent value of investments compared to net assets) Bonds (98.9%) Issuer Coupon Principal Value(a) rate amount U.S. government obligations & agencies (48.3%) Federal Farm Credit Bank 07-17-06 2.13% $15,100,000 $14,853,870 10-02-06 2.38 14,600,000 14,367,130 Federal Home Loan Bank 09-15-06 2.88 17,400,000 17,336,316 Federal Home Loan Mtge Corp 01-15-06 5.25 43,500,000 45,373,197 08-15-06 2.75 92,650,000 92,262,445 08-25-06 3.13 42,000,000 41,855,071 10-27-06 3.00 15,000,000 14,939,214 02-15-07 2.38 43,625,000 42,583,715 09-15-08 3.63 11,543,000 11,362,583 Federal Natl Mtge Assn 02-28-06 2.25 6,770,000 6,726,279 02-15-07 2.38 36,985,000 36,107,420 05-15-08 6.00 17,850,000 19,223,433 Student Loan Mtge Assn 03-15-06 5.25 13,200,000 13,780,510 12-15-32 2.25 16,325,000 16,296,921 03-15-33 2.16 14,800,000 14,785,644 U.S. Treasury 02-15-05 7.50 27,500,000(j) 28,631,158 08-15-05 10.75 85,590,000 94,459,948 11-15-05 5.75 154,125,000 161,951,621 12-31-05 1.88 142,920,000 141,993,307 01-31-06 1.88 46,320,000 45,965,374 11-15-06 3.50 147,700,000(j) 149,996,291 08-15-07 3.25 40,250,000(j) 40,347,486 11-15-09 10.38 48,000,000(j) 49,936,896 Total 1,115,135,829 Commercial mortgage-backed/ Asset-backed securities (2.3%)(f) Centex Home Equity Series 2001-A Cl A4 07-25-29 6.47 7,516,421 7,741,269 Conseco Finance Series 2000-D Cl A4 12-15-25 8.17 3,838,962 3,927,061 KSL Resorts Series 2003-1A Cl A 05-15-13 1.65 7,400,000(h) 7,403,278 LB-UBS Commercial Mtge Trust Series 2002 C2 Cl A2 06-15-26 4.90 9,600,000 9,887,829 Residential Asset Securities Series 2002-KS1 Cl AI4 11-25-29 5.86 23,400,000 23,841,792 Total 52,801,229 Mortgage-backed securities (47.5%)(f,g) Federal Home Loan Mtge Corp 09-01-09 6.50 496,207 528,658 10-01-10 7.00 1,539,392 1,637,598 03-01-12 7.50 5,900,700 6,336,073 07-01-12 5.50 650,377 669,812 02-01-13 5.00 4,387,044 4,455,420 04-01-13 4.50 2,985,581 2,992,812 04-01-13 5.00 3,945,587 4,007,082 05-01-13 4.50 25,773,152 25,835,991 01-01-14 4.00 13,542,059 13,304,853 05-01-14 4.00 10,065,000 9,644,496 06-01-15 7.50 11,780,508 12,708,135 04-01-17 6.50 34,091,854 36,286,610 07-01-17 6.50 18,661,292 19,721,616 11-01-17 5.50 11,168,015 11,413,923 07-01-24 8.00 888,651 967,673 01-01-25 9.00 1,077,426 1,202,853 06-01-25 8.00 965,816 1,052,595 08-01-25 8.00 247,314 269,535 05-01-26 9.00 1,813,483 2,026,727 See accompanying notes to investments in securities. - -------------------------------------------------------------------------------- 10 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Home Loan Mtge Corp (cont.) Collateralized Mtge Obligation 12-15-08 6.00% $11,749,234 $12,248,921 03-15-12 5.00 18,880,507 19,319,730 04-15-12 5.00 21,862,191 22,483,733 03-15-15 5.50 40,888,673 41,963,155 10-15-15 5.00 29,046,000 29,835,113 01-15-16 5.00 9,125,000 9,394,964 02-15-16 5.00 28,636,488 29,478,627 06-15-16 7.00 14,961,944 15,918,029 08-15-16 4.00 13,754,798 13,526,240 02-15-20 4.50 15,450,000 15,264,538 Interest Only 12-15-12 12.70 17,890,997(b) 1,408,916 02-15-14 7.40 13,987,282(b) 1,240,112 06-15-18 7.59 11,175,360(b) 702,735 01-01-20 0.00 20,793(b) 3,925 Interest Only/Inverse Floater 03-15-32 0.00 5,359,289(b,e) 505,920 Federal Natl Mtge Assn 09-01-07 8.50 226,651 233,007 10-01-07 7.50 727,283 776,894 12-01-08 7.50 1,176,831 1,249,987 01-01-09 5.74 3,254,080 3,438,083 05-01-09 7.50 2,541,680 2,715,058 10-01-09 7.11 4,315,659 4,797,616 01-01-10 5.00 1,312,175 1,335,051 07-01-11 7.50 1,134,315 1,211,553 11-01-12 5.00 899,512 913,532 12-01-12 5.00 1,420,641 1,446,719 04-01-13 5.50 17,919,691 18,455,181 05-01-13 5.00 22,073,449 22,417,484 05-01-13 5.50 5,566,955 5,728,397 05-01-13 6.00 1,277,018 1,330,271 06-01-13 5.00 3,725,591 3,783,658 08-01-13 4.50 10,430,332 10,455,593 10-01-13 6.00 3,626,135 3,777,352 12-01-13 5.50 1,812,771 1,862,487 01-01-14 5.50 1,080,553 1,110,188 01-01-14 6.00 638,963 665,609 03-01-14 6.00 1,297,022 1,351,110 06-01-14 6.50 11,915,144 12,604,570 08-01-14 6.50 705,240 745,445 08-01-15 5.50 24,300,972 24,967,434 05-01-17 7.00 1,196,253 1,272,963 06-01-17 6.00 18,298,700 19,130,714 06-01-17 6.50 4,644,583 4,904,610 06-01-17 7.00 1,090,010 1,159,906 07-01-17 6.00 37,901,340 39,615,591 08-01-17 5.50 26,166,387 26,854,405 08-01-17 6.00 16,196,902 16,865,515 08-01-17 7.00 1,808,604 1,924,581 09-01-17 6.00 618,876 643,072 11-01-17 5.50 25,587,084 26,220,783 11-01-17 6.00 2,375,460 2,492,313 01-01-18 5.50 2,327,245 2,390,896 02-01-18 5.50 16,712,298 17,166,728 03-01-18 5.50 1,802,041 1,841,407 04-01-18 5.50 14,767,429 15,171,452 05-01-18 5.50 4,683,967 4,791,574 06-01-18 5.50 1,094,106 1,121,972 11-01-21 8.00 352,622 384,977 11-01-23 6.00 2,389,378 2,444,586 06-01-24 9.00 814,178 905,799 02-01-26 6.00 130,704 133,501 05-01-26 7.50 1,428,993 1,532,274 12-01-28 7.00 3,392,232 3,584,642 04-01-31 6.50 5,706,526 5,963,227 09-01-31 7.50 3,749,923 4,014,637 11-01-31 6.50 2,502,279 2,614,808 09-01-32 6.50 3,039,672 3,149,527 10-01-32 7.00 1,893,342 1,990,853 11-01-32 7.00 1,670,609 1,756,649 01-01-33 4.85 3,814,532(i) 3,855,455 02-01-33 4.87 20,518,894(i) 20,783,848 04-01-33 4.37 15,085,012(i) 15,092,403 04-01-33 4.60 11,465,843(i) 11,421,894 04-01-33 4.88 12,410,571(i) 12,859,054 05-01-33 4.60 9,348,516(i) 9,606,474 07-01-33 4.45 5,759,366(i) 5,785,393 07-01-33 4.46 13,972,841(i) 13,912,720 07-01-33 4.97 7,573,289(i) 7,490,106 08-01-33 3.06 1,361,102(i) 1,329,976 08-01-33 4.12 3,764,661(i) 3,708,848 09-01-33 4.20 3,560,857(i) 3,504,697 Collateralized Mtge Obligation 03-25-13 4.50 8,134,093 8,258,551 10-25-13 5.00 23,148,264 23,679,299 12-25-13 4.50 21,428,571 21,842,245 05-25-16 4.00 11,160,000 10,956,191 07-25-16 4.00 11,000,000 10,733,723 10-25-19 4.50 14,800,000 14,723,616 07-25-23 5.50 21,000,000 21,770,750 12-25-26 8.00 5,421,821 5,801,932 06-25-33 5.32 7,120,488(i) 7,225,903 See accompanying notes to investments in securities. - -------------------------------------------------------------------------------- 11 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn (cont.) Collateralized Mtge Obligation (cont.) 11-25-33 2.91% $13,202,000 $12,987,468 05-25-34 3.75 10,100,000 10,057,391 06-25-34 5.00 12,750,000 12,895,179 05-25-42 5.30 11,500,000 11,833,900 07-25-42 5.50 28,960,774 29,430,938 10-25-42 7.50 6,432,793 6,870,923 Interest Only 05-25-12 0.00 1,566,840(b) 10,880 12-25-12 13.29 13,483,827(b) 1,022,769 11-25-13 10.08 10,950,000(b) 1,314,963 08-01-18 0.00 11,638(b) 2,128 01-15-20 0.00 479,593(b) 94,920 07-25-22 0.00 1,615,881(b) 273,136 03-25-23 7.94 3,576,566(b) 760,814 Interest Only/Inverse Floater 02-25-32 0.00 9,635,053(b,e) 995,738 Principal Only 06-25-21 2.00 72,884(c) 67,573 Govt Natl Mtge Assn 08-15-13 6.00 1,979,348 2,068,275 09-15-14 6.00 12,338,701 12,895,450 06-15-33 7.00 5,138,588 5,451,721 Collateralized Mtge Obligation 11-20-13 5.50 8,104,540 8,170,702 03-16-19 2.95 11,300,000 10,882,648 07-16-21 3.41 13,500,000 13,238,438 09-16-21 3.23 14,000,000 13,643,756 Interest Only 03-20-29 7.17 6,900,000(b) 834,560 Total 1,097,920,709 Banks and savings & loans (0.5%) Washington Mutual Series 2002-AR15 Cl A5 12-25-32 4.38 11,723,375 11,761,142 Financial services (0.3%) Residential Accredit Loans Series 2003-QS17 Cl CB7 09-25-33 5.50 6,494,742 6,594,185 Total bonds (Cost: $2,300,763,328) $2,284,213,094 Option purchased (--%) Issuer Notional Exercise Expiration Value(a) amount price date Put Sept. U.S. Treasury Nts Futures 10-year $53,800,000 $107 Aug. 2004 $622,063 Total option purchased (Cost: $1,001,278) $622,063 Short-term securities (7.7%)(k,l) Issuer Annualized Amount Value(a) yield on date payable at of purchase maturity U.S. government agencies (4.8%) Federal Home Loan Mtge Corp Disc Nts 07-27-04 1.04% $20,000,000 $19,965,239 08-10-04 1.13 29,400,000 29,338,260 08-16-04 1.06 4,900,000 4,888,828 Federal Natl Mtge Assn Disc Nts 06-09-04 0.99 3,500,000 3,498,891 07-01-04 1.01 21,000,000 20,981,015 07-21-04 1.03 20,000,000 19,970,327 08-11-04 1.13 11,200,000 11,176,144 Total 109,818,704 Commercial paper (3.0%) Barton Capital 06-03-04 1.02 1,700,000(d) 1,699,711 Fairway Finance 06-01-04 1.03 10,900,000(d) 10,898,753 HBOS Treasury Services 07-23-04 1.08 6,200,000 6,189,315 Variable Funding Capital 06-01-04 1.03 49,600,000(d) 49,594,323 Total 68,382,102 Total short-term securities (Cost: $178,194,933) $178,200,806 Total investments in securities (Cost: $2,479,959,539)(m) $2,463,035,963 See accompanying notes to investments in securities. - -------------------------------------------------------------------------------- 12 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Notes to investments in securities (a) Securities are valued by procedures described in Note 1 to the financial statements. (b) 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 May 31, 2004. (c) 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 May 31, 2004. (d) 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. These securities may be resold in transactions exempt from registration, normally to qualified institutional buyers. As of May 31, 2004, the value of these securities amounted to $62,192,787 or 2.7% of net assets. (e) 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 May 31, 2004. (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) Comparable securities are held to satisfy future delivery requirements of the following open forward sale commitments as of May 31, 2004: Security Principal Settlement Proceeds Value amount date receivable Federal Natl Mtge Assn 06-01-19 5.50% $75,000,000 6-17-04 $76,022,813 $76,476,600 06-01-19 6.00 26,000,000 6-17-04 26,820,625 26,966,888 (h) Interest rate varies either based on a predetermined schedule or to reflect current market conditions; rate shown is the effective rate on May 31, 2004. (i) Adjustable rate mortgage; interest rate varies to reflect current market conditions; rate shown is the effective rate on May 31, 2004. - -------------------------------------------------------------------------------- 13 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Notes to investments in securities (continued) (j) 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 43,750,000 Eurodollar, March 2005, 90-day 43,750,000 Eurodollar, June 2005, 90-day 43,750,000 Eurodollar, Sept. 2005, 90-day 43,750,000 Eurodollar, Dec. 2005, 90-day 43,750,000 U.S. Long Bonds, Sept. 2004, 20-year 16,800,000 U.S. Treasury Notes, Sept. 2004, 2-year 88,800,000 U.S. Treasury Notes, Sept. 2004, 10-year 3,500,000 Sale contracts U.S. Treasury Notes, June 2004, 5-year 152,700,000 U.S. Treasury Notes, Sept. 2004, 5-year 134,300,000 (k) At May 31, 2004, cash or short-term securities were designated to cover open put options on futures written as follows (see Note 6 to the financial statements):
Issuer Notional Exercise Expiration Value(a) amount price date U.S. Treasury Notes Sept. 2004, 10 year $53,800,000 $105 Aug. 2004 $319,438
(l) Cash collateral received from security lending activity is invested in short-term securities and represents 7.2% of this category (see Note 5 to the financial statements). 0.5% of the short-term securities is the Fund's cash equivalent position. (m) At May 31, 2004, the cost of securities for federal income tax purposes was $2,479,967,726 and the aggregate gross unrealized appreciation and depreciation based on that cost was: Unrealized appreciation $ 10,615,544 Unrealized depreciation (27,547,307) ----------- Net unrealized depreciation $(16,931,763) ------------ - -------------------------------------------------------------------------------- 14 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Financial Statements
Statement of assets and liabilities Government Income Portfolio May 31, 2004 Assets Investments in securities, at value (Note 1)* (identified cost $2,479,959,539) $2,463,035,963 Accrued interest receivable 13,519,113 Receivable for investment securities sold 104,079,793 U.S. government securities held as collateral (Note 5) 27,785,055 ---------- Total assets 2,608,419,924 ------------- Liabilities Disbursements in excess of cash on demand deposit 354,809 Payable for investment securities purchased 588,984 Payable upon return of securities loaned (Note 5) 194,495,930 Accrued investment management services fee 31,817 Other accrued expenses 76,693 Options contracts written, at value (premiums received $579,598) (Note 6) 319,438 Forward sale commitments, at value (proceeds receivable $102,843,438) (Note 1) 103,443,488 ----------- Total liabilities 299,311,159 ----------- Net assets $2,309,108,765 ============== * Including securities on loan, at value (Note 5) $ 189,616,043 --------------
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- 15 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT
Statement of operations Government Income Portfolio Year ended May 31, 2004 Investment income Income: Interest $ 90,569,238 Fee income from securities lending (Note 5) 791,841 ------- Total income 91,361,079 ---------- Expenses (Note 2): Investment management services fee 14,303,395 Compensation of board members 18,225 Custodian fees 271,153 Audit fees 37,125 Other 77,690 ------ Total expenses 14,707,588 ---------- Investment income (loss) -- net 76,653,491 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (Note 3) (3,751,368) Futures contracts (11,185,027) Options contracts written (Note 6) 992,519 ------- Net realized gain (loss) on investments (13,943,876) Net change in unrealized appreciation (depreciation) on investments (56,711,856) ----------- Net gain (loss) on investments (70,655,732) ----------- Net increase (decrease) in net assets resulting from operations $ 5,997,759 ============
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- 16 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT
Statements of changes in net assets Government Income Portfolio Year ended May 31, 2004 2003 Operations Investment income (loss) -- net $ 76,653,491 $ 108,160,481 Net realized gain (loss) on investments (13,943,876) 44,169,376 Net change in unrealized appreciation (depreciation) on investments (56,711,856) 9,722,424 ----------- --------- Net increase (decrease) in net assets resulting from operations 5,997,759 162,052,281 --------- ----------- Proceeds from contributions 7,986,457 1,115,892,070 Fair value of withdrawals (1,233,308,157) (257,074,099) -------------- ------------ Net contributions (withdrawals) from partners (1,225,321,700) 858,817,971 -------------- ----------- Total increase (decrease) in net assets (1,219,323,941) 1,020,870,252 Net assets at beginning of year 3,528,432,706 2,507,562,454 ------------- ------------- Net assets at end of year $ 2,309,108,765 $3,528,432,706 =============== ==============
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- 17 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Notes to Financial Statements Government Income Portfolio 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. - -------------------------------------------------------------------------------- 18 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL 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. Forward sale commitments The Portfolio may enter into forward sale commitments to hedge its portfolio positions or to sell mortgage-backed securities it owns under delayed delivery arrangements. Proceeds of forward sale commitments are not received until the contractual settlement date. During the time a forward sale commitment is outstanding, equivalent deliverable securities, or an offsetting forward purchase commitment deliverable on or before the sale commitment date, are used to satisfy the commitment. Unsettled forward sale commitments are valued at the current market value of the underlying securities, generally according to the procedures described under "Valuation of securities" above. The forward sale commitment is "marked-to-market" daily and the change in market value is recorded by the Portfolio as an unrealized gain or loss. If the forward sale commitment is closed through the acquisition of an offsetting purchase commitment, the Portfolio realizes a gain or loss. If the Portfolio delivers securities under the commitment, the Portfolio realizes a gain or a loss from the sale of the securities based upon the market price established at the date the commitment was entered into. Forward sale commitments outstanding at period end are listed in the "Notes to investments in securities." - -------------------------------------------------------------------------------- 19 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL 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 $3,547,255,294 and $4,809,571,356, respectively, for the year ended May 31, 2004. Realized gains and losses are determined on an identified cost basis. 4. INTEREST RATE FUTURES CONTRACTS As of May 31, 2004, investments in securities included securities valued at $4,335,700 that were pledged as collateral to cover initial margin deposits on 1,534 open purchase contracts and 2,870 open sale contracts. The notional market value of the open purchase contracts as of May 31, 2004 was $329,539,938 with a net unrealized loss of $118,430. The notional market value of the open sale contracts as of May 31, 2004 was $312,576,772 with a net unrealized gain of $3,691,475. See "Summary of significant accounting policies" and "Notes to investments in securities." - -------------------------------------------------------------------------------- 20 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT 5. LENDING OF PORTFOLIO SECURITIES As of May 31, 2004, securities valued at $189,616,043 were on loan to brokers. For collateral, the Portfolio received $166,710,875 in cash and U.S. government securities valued at $27,785,055. Cash collateral received is invested in short-term securities, which are included in the short-term section of the "Investments in securities." Income from securities lending amounted to $791,841 for the year ended May 31, 2004. 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: Year ended May 31, 2004 Puts Calls Contracts Premiums Contracts Premiums Balance May 31, 2003 -- $ -- -- $ -- Opened 4,415 3,415,181 7,787 7,020,991 Closed (2,488) (2,220,963) (7,387) (6,960,091) Exercised (188) (66,811) -- -- Expired (1,201) (547,809) (400) (60,900) ------- ----------- ------ ----------- Balance May 31, 2004 538 $ 579,598 -- $ -- ------- ----------- ------ ----------- 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, 2004 2003 2002 2001 2000 Ratio of expenses to average daily net assets(a) .51% .50% .52% .54% .51% Ratio of net investment income (loss) to average daily net assets 2.65% 3.35% 4.43% 6.13% 6.11% Portfolio turnover rate (excluding short-term securities) 125% 218% 267% 366% 674% Total return(b) .13% 5.48% 6.27% 10.56% .50%
(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. - -------------------------------------------------------------------------------- 21 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Report of Independent Registered Public Accounting Firm THE BOARD OF TRUSTEES AND UNITHOLDERS INCOME TRUST We have audited the accompanying statement of assets and liabilities, including the schedule of investments in securities, of Government Income Portfolio (a series of Income Trust) as of May 31, 2004, the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period ended May 31, 2004, and the financial highlights for each of the years in the five-year period ended May 31, 2004. These financial statements and financial highlights are the responsibility of portfolio management. Our responsibility is to express an opinion on these financial statements and the financial highlights based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and the financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of May 31, 2004, by correspondence with the custodian and brokers or by other appropriate auditing procedures. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Government Income Portfolio as of May 31, 2004, and the results of its operations, changes in its net assets and the financial highlights for each of the periods stated in the first paragraph above, in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Minneapolis, Minnesota July 20, 2004 - -------------------------------------------------------------------------------- 22 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Financial Statements
Statement of assets and liabilities AXP Short Duration U.S. Government Fund May 31, 2004 Assets Investment in Portfolio (Note 1) $2,308,987,264 Capital shares receivable 857,044 ------- Total assets 2,309,844,308 ------------- Liabilities Dividends payable to shareholders 263,852 Capital shares payable 656,391 Accrued distribution fee 35,607 Accrued service fee 314 Accrued transfer agency fee 9,354 Accrued administrative services fee 2,940 Other accrued expenses 607,064 ------- Total liabilities 1,575,522 --------- Net assets applicable to outstanding capital stock $2,308,268,786 ============== Represented by Capital stock -- $.01 par value (Note 1) $ 4,788,324 Additional paid-in capital 2,503,316,833 Excess of distributions over net investment income (154,011) Accumulated net realized gain (loss) (Note 5) (185,992,649) Unrealized appreciation (depreciation) on investments (13,689,711) ----------- Total -- representing net assets applicable to outstanding capital stock $2,308,268,786 ============== Net assets applicable to outstanding shares: Class A $1,187,755,557 Class B $ 963,349,248 Class C $ 37,978,432 Class I $ 4,080,900 Class Y $ 115,104,649 Net asset value per share of outstanding capital stock: Class A shares 246,410,623 $ 4.82 Class B shares 199,820,074 $ 4.82 Class C shares 7,878,416 $ 4.82 Class I shares 845,632 $ 4.83 Class Y shares 23,877,655 $ 4.82 ---------- --------------
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- 23 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT
Statement of operations AXP Short Duration U.S. Government Fund Year ended May 31, 2004 Investment income Income: Interest $ 90,563,413 Fee income from securities lending 791,799 ------- Total income 91,355,212 ---------- Expenses (Note 2): Expenses allocated from Portfolio 14,706,970 Distribution fee Class A 3,630,705 Class B 12,364,597 Class C 486,007 Transfer agency fee 3,618,082 Incremental transfer agency fee Class A 170,456 Class B 215,639 Class C 10,296 Service fee -- Class Y 148,878 Administrative services fees and expenses 1,317,413 Compensation of board members 13,125 Printing and postage 656,838 Registration fees 103,534 Audit fees 12,375 Other 32,318 ------ Total expenses 37,487,233 Earnings credits on cash balances (Note 2) (50,378) ------- Total net expenses 37,436,855 ---------- Investment income (loss) -- net 53,918,357 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (3,751,220) Futures contracts (11,184,415) Options contracts written 992,462 ------- Net realized gain (loss) on investments (13,943,173) Net change in unrealized appreciation (depreciation) on investments (56,709,554) ----------- Net gain (loss) on investments (70,652,727) ----------- Net increase (decrease) in net assets resulting from operations $(16,734,370) ============
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- 24 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT
Statements of changes in net assets AXP Short Duration U.S. Government Fund Year ended May 31, 2004 2003 Operations and distributions Investment income (loss) -- net $ 53,918,357 $ 82,662,013 Net realized gain (loss) on investments (13,943,173) 44,167,207 Net change in unrealized appreciation (depreciation) on investments (56,709,554) 9,722,377 ----------- --------- Net increase (decrease) in net assets resulting from operations (16,734,370) 136,551,597 ----------- ----------- Distributions to shareholders from: Net investment income Class A (32,141,993) (45,444,253) Class B (17,983,822) (30,935,951) Class C (706,906) (946,842) Class I (10,055) -- Class Y (3,546,323) (5,490,847) ---------- ---------- Total distributions (54,389,099) (82,817,893) ----------- ----------- Capital share transactions (Note 3) Proceeds from sales Class A shares (Note 2) 429,411,653 1,178,062,138 Class B shares 218,218,185 998,456,600 Class C shares 15,463,649 46,085,175 Class I shares 4,117,088 -- Class Y shares 58,935,229 92,327,556 Reinvestment of distributions at net asset value Class A shares 29,532,472 40,761,864 Class B shares 17,136,580 29,157,324 Class C shares 654,048 844,242 Class I shares 9,402 -- Class Y shares 2,825,788 4,979,945 Payments for redemptions Class A shares (962,651,760) (701,715,252) Class B shares (Note 2) (819,584,452) (577,985,093) Class C shares (Note 2) (35,046,321) (18,398,418) Class I shares (15,452) -- Class Y shares (106,873,614) (125,038,635) ------------ ------------ Increase (decrease) in net assets from capital share transactions (1,147,867,505) 967,537,446 -------------- ----------- Total increase (decrease) in net assets (1,218,990,974) 1,021,271,150 Net assets at beginning of year 3,527,259,760 2,505,988,610 ------------- ------------- Net assets at end of year $ 2,308,268,786 $3,527,259,760 =============== ==============
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- 25 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Notes to Financial Statements AXP Short Duration U.S. Government Fund 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. Effective March 4, 2004, the Fund offers an additional class of shares, Class I, exclusively to certain institutional investors. Class I shares have no sales charge and are made available through a separate prospectus supplement provided to investors eligible to purchase the shares. As of May 31, 2004, AEFC and the AXP Portfolio Builder Funds owned 100% of Class I shares, which represents 0.18% of the Fund's net assets. 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 May 31, 2004 was 99.99%. - -------------------------------------------------------------------------------- 26 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT All securities held by the Portfolio 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. 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. 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. On the statement of assets and liabilities, as a result of permanent book-to-tax differences, undistributed net investment income has been increased by $631,155 and accumulated net realized loss has been increased by $631,155. - -------------------------------------------------------------------------------- 27 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT The tax character of distributions paid for the years indicated is as follows: Year ended May 31, 2004 2003 Class A Distributions paid from: Ordinary income $32,141,993 $45,444,253 Long-term capital gain -- -- Class B Distributions paid from: Ordinary income 17,983,822 30,935,951 Long-term capital gain -- -- Class C Distributions paid from: Ordinary income 706,906 946,842 Long-term capital gain -- -- Class I* Distributions paid from: Ordinary income 10,055 N/A Long-term capital gain -- N/A Class Y Distributions paid from: Ordinary income 3,546,323 5,490,847 Long-term capital gain -- -- * Inception date was March 4, 2004. As of May 31, 2004, the components of distributable earnings on a tax basis are as follows: Undistributed ordinary income $ 983,792 Accumulated long-term gain (loss) $(274,375,673) Unrealized appreciation (depreciation) $ 73,819,362 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. - -------------------------------------------------------------------------------- 28 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT 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. Class I pays a transfer agency fee at an annual rate per shareholder account of $1. This amount is included in the transfer agency fee on the statement of operations. 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 $5,744,897 for Class A, $2,275,430 for Class B and $34,803 for Class C for the year ended May 31, 2004. Beginning June 1, 2004, AEFC and its affiliates have agreed to waive certain fees and expenses until May 31, 2005. Under this agreement, net expenses will not exceed 0.93% for Class A, 1.68% for Class B, 1.68% for Class C, 0.74% for Class I and 0.76% for Class Y of the Fund's average daily net assets. During the year ended May 31, 2004, the Fund's transfer agency fees were reduced by $50,378 as a result of earnings credits from overnight cash balances. - -------------------------------------------------------------------------------- 29 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT 3. CAPITAL SHARE TRANSACTIONS Transactions in shares of capital stock for the years indicated are as follows:
Year ended May 31, 2004 Class A Class B Class C Class I* Class Y Sold 87,696,692 44,598,088 3,158,063 846,839 12,038,535 Issued for reinvested distributions 6,044,611 3,507,313 133,878 1,941 578,270 Redeemed (196,886,140) (167,502,146) (7,170,275) (3,148) (21,855,679) ------------ ------------ ---------- ------- ---------- Net increase (decrease) (103,144,837) (119,396,745) (3,878,334) 845,632 (9,238,874) ------------ ------------ ---------- ------- ---------- *Inception date was March 4, 2004. Year ended May 31, 2003 Class A Class B Class C Class I Class Y Sold 239,714,272 203,191,315 9,371,202 N/A 18,774,998 Issued for reinvested distributions 8,291,730 5,931,794 171,739 N/A 1,013,609 Redeemed (142,692,553) (117,558,389) (3,737,168) N/A (25,473,839) ------------ ------------ ---------- ------- ---------- Net increase (decrease) 105,313,449 91,564,720 5,805,773 N/A (5,685,232) ------------ ------------ ---------- ------- ----------
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 year ended May 31, 2004. 5. CAPITAL LOSS CARRY-OVER For federal income tax purposes, the Fund has a capital loss carry-over of $274,375,673 as of May 31, 2004 that will expire in 2007 through 2012 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. - -------------------------------------------------------------------------------- 30 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT 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, 2004 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) .11 .15 .19 .27 .27 Net gains (losses) (both realized and unrealized) (.12) .09 .08 .19 (.27) Total from investment operations (.01) .24 .27 .46 -- Less distributions: Dividends from net investment income (.11) (.15) (.20) (.27) (.28) Distributions from realized gains -- -- -- -- (.07) Total distributions (.11) (.15) (.20) (.27) (.35) Net asset value, end of period $4.82 $4.94 $4.85 $4.78 $4.59 Ratios/supplemental data Net assets, end of period (in millions) $1,188 $1,728 $1,185 $1,047 $1,139 Ratio of expenses to average daily net assets(b) .97% .95% .95% .98% .92% Ratio of net investment income (loss) to average daily net assets 2.19% 2.90% 4.01% 5.72% 5.71% Portfolio turnover rate (excluding short-term securities) 125% 218% 267% 366% 674% Total return(c) (.24%) 4.90% 5.77% 10.19% (.01%)
(a) For a share outstanding throughout the period. Rounded to the nearest cent. (b) Expense ratio is based on total expenses of the Fund before reduction of earnings credits on cash balances. (c) Total return does not reflect payment of a sales charge. - -------------------------------------------------------------------------------- 31 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT
Class B Per share income and capital changes(a) Fiscal period ended May 31, 2004 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) .07 .11 .16 .24 .24 Net gains (losses) (both realized and unrealized) (.12) .09 .08 .18 (.28) Total from investment operations (.05) .20 .24 .42 (.04) Less distributions: Dividends from net investment income (.07) (.11) (.17) (.23) (.24) Distributions from realized gains -- -- -- -- (.07) Total distributions (.07) (.11) (.17) (.23) (.31) Net asset value, end of period $4.82 $4.94 $4.85 $4.78 $4.59 Ratios/supplemental data Net assets, end of period (in millions) $963 $1,578 $1,104 $912 $981 Ratio of expenses to average daily net assets(b) 1.72% 1.71% 1.71% 1.73% 1.68% Ratio of net investment income (loss) to average daily net assets 1.44% 2.15% 3.25% 4.96% 4.95% Portfolio turnover rate (excluding short-term securities) 125% 218% 267% 366% 674% Total return(c) (.99%) 4.11% 4.98% 9.36% (.77%)
(a) For a share outstanding throughout the period. Rounded to the nearest cent. (b) Expense ratio is based on total expenses of the Fund before reduction of earnings credits on cash balances. (c) Total return does not reflect payment of a sales charge. - -------------------------------------------------------------------------------- 32 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT
Class C Per share income and capital changes(a) Fiscal period ended May 31, 2004 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) .07 .11 .16 .22 Net gains (losses) (both realized and unrealized) (.12) .09 .08 .14 Total from investment operations (.05) .20 .24 .36 Less distributions: Dividends from net investment income (.07) (.11) (.17) (.21) Net asset value, end of period $4.82 $4.94 $4.85 $4.78 Ratios/supplemental data Net assets, end of period (in millions) $38 $58 $29 $7 Ratio of expenses to average daily net assets(c) 1.73% 1.72% 1.72% 1.73%(d) Ratio of net investment income (loss) to average daily net assets 1.44% 2.10% 3.09% 4.93%(d) Portfolio turnover rate (excluding short-term securities) 125% 218% 267% 366% Total return(e) (.99%) 4.11% 4.98% 8.08%(f)
(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. - -------------------------------------------------------------------------------- 33 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Class I Per share income and capital changes(a) Fiscal period ended May 31, 2004(b) Net asset value, beginning of period $4.90 Income from investment operations: Net investment income (loss) .03 Net gains (losses) (both realized and unrealized) (.07) Total from investment operations (.04) Less distributions: Dividends from net investment income (.03) Net asset value, end of period $4.83 Ratios/supplemental data Net assets, end of period (in millions) $4 Ratio of expenses to average daily net assets(c) .63%(d) Ratio of net investment income (loss) to average daily net assets 2.74%(d) Portfolio turnover rate (excluding short-term securities) 125% Total return(e) (.87%)(f) (a) For a share outstanding throughout the period. Rounded to the nearest cent. (b) Inception date was March 4, 2004. (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. - -------------------------------------------------------------------------------- 34 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT
Class Y Per share income and capital changes(a) Fiscal period ended May 31, 2004 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) .12 .15 .20 .28 .28 Net gains (losses) (both realized and unrealized) (.12) .09 .08 .19 (.28) Total from investment operations -- .24 .28 .47 -- Less distributions: Dividends from net investment income (.12) (.15) (.21) (.28) (.28) Distributions from realized gains -- -- -- -- (.07) Total distributions (.12) (.15) (.21) (.28) (.35) Net asset value, end of period $4.82 $4.94 $4.85 $4.78 $4.59 Ratios/supplemental data Net assets, end of period (in millions) $115 $164 $188 $161 $175 Ratio of expenses to average daily net assets(b) .81% .79% .79% .82% .78% Ratio of net investment income (loss) to average daily net assets 2.35% 3.12% 4.17% 5.89% 5.92% Portfolio turnover rate (excluding short-term securities) 125% 218% 267% 366% 674% Total return(c) (.08%) 5.07% 5.93% 10.36% .15%
(a) For a share outstanding throughout the period. Rounded to the nearest cent. (b) Expense ratio is based on total expenses of the Fund before reduction of earnings credits on cash balances. (c) Total return does not reflect payment of a sales charge. - -------------------------------------------------------------------------------- 35 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Report of Independent Registered Public Accounting Firm The board and shareholders AXP GOVERNMENT Income SERIES, Inc. We have audited the accompanying statement of assets and liabilities of AXP Short Duration U.S. Government Fund (a series of AXP Government Income Series, Inc.) as of May 31, 2004, the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period ended May 31, 2004, and the financial highlights for each of the years in the five-year period ended May 31, 2004. These financial statements and the financial highlights are the responsibility of fund management. Our responsibility is to express an opinion on these financial statements and the financial highlights based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and the financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of AXP Short Duration U.S. Government Fund as of May 31, 2004, and the results of its operations, changes in its net assets and the financial highlights for each of the periods stated in the first paragraph above, in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Minneapolis, Minnesota July 20, 2004 - -------------------------------------------------------------------------------- 36 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Federal Income Tax Information (UNAUDITED) The Fund is required by the Internal Revenue Code of 1986 to tell its shareholders about the tax treatment of the dividends it pays during its fiscal year. The dividends listed below are reported to you on Form 1099-DIV, Dividends and Distributions. Shareholders should consult a tax advisor on how to report distributions for state and local tax purposes. AXP Short Duration U.S. Government Fund Fiscal year ended May 31, 2004 Class A Income distributions -- taxable as dividend income: Qualified Dividend Income for individuals 0.00% Dividends Received Deduction for corporations 0.00% Payable date Per share June 23, 2003 $0.00850 July 24, 2003 0.00805 Aug. 22, 2003 0.00800 Sept. 22, 2003 0.00800 Oct. 23, 2003 0.00887 Nov. 21, 2003 0.00900 Dec. 22, 2003 0.01535 Jan. 26, 2004 0.00920 Feb. 25, 2004 0.00883 March 26, 2004 0.00900 April 26, 2004 0.00850 May 26, 2004 0.00838 Total distributions $0.10968 Class B Income distributions -- taxable as dividend income: Qualified Dividend Income for individuals 0.00% Dividends Received Deduction for corporations 0.00% Payable date Per share June 23, 2003 $0.00530 July 24, 2003 0.00488 Aug. 22, 2003 0.00506 Sept. 22, 2003 0.00486 Oct. 23, 2003 0.00572 Nov. 21, 2003 0.00606 Dec. 22, 2003 0.01221 Jan. 26, 2004 0.00565 Feb. 25, 2004 0.00586 March 26, 2004 0.00595 April 26, 2004 0.00537 May 26, 2004 0.00538 Total distributions $0.07230 - -------------------------------------------------------------------------------- 37 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Class C Income distributions -- taxable as dividend income: Qualified Dividend Income for individuals 0.00% Dividends Received Deduction for corporations 0.00% Payable date Per share June 23, 2003 $0.00529 July 24, 2003 0.00486 Aug. 22, 2003 0.00503 Sept. 22, 2003 0.00482 Oct. 23, 2003 0.00570 Nov. 21, 2003 0.00604 Dec. 22, 2003 0.01218 Jan. 26, 2004 0.00563 Feb. 25, 2004 0.00598 March 26, 2004 0.00593 April 26, 2004 0.00535 May 26, 2004 0.00535 Total distributions $0.07216 Class I Income distributions -- taxable as dividend income: Qualified Dividend Income for individuals 0.00% Dividends Received Deduction for corporations 0.00% Payable date Per share March 26, 2004 0.01165 April 26, 2004 0.00960 May 26, 2004 0.00943 Total distributions $0.03068 Class Y Income distributions -- taxable as dividend income: Qualified Dividend Income for individuals 0.00% Dividends Received Deduction for corporations 0.00% Payable date Per share June 23, 2003 $0.00918 July 24, 2003 0.00873 Aug. 22, 2003 0.00863 Sept. 22, 2003 0.00868 Oct. 23, 2003 0.00955 Nov. 21, 2003 0.00963 Dec. 22, 2003 0.01603 Jan. 26, 2004 0.00996 Feb. 25, 2004 0.00945 March 26, 2004 0.00965 April 26, 2004 0.00918 May 26, 2004 0.00902 Total distributions $0.11769 - -------------------------------------------------------------------------------- 38 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT Board Members and Officers Shareholders elect a board that oversees the Fund's operations. The board appoints officers who are responsible for day-to-day business decisions based on policies set by the board. The following is a list of the Fund's board members. Each member oversees 15 Master Trust portfolios and 86 American Express mutual funds. Board members serve until the next regular shareholders' meeting or until he or she reaches the mandatory retirement age established by the board.
Independent Board Members Name, address, age Position held Principal occupation during past five Other directorships with Fund and years length of service - ---------------------------------- ------------------- ----------------------------------------- ----------------------------- Arne H. Carlson Board member Chair, Board Services Corporation 901 S. Marquette Ave. since 1999 (provides administrative services to Minneapolis, MN 55402 boards). Former Governor of Minnesota Age 69 - ---------------------------------- ------------------- ----------------------------------------- ----------------------------- Philip J. Carroll, Jr. Board member Retired Chairman and CEO, Fluor Scottish Power PLC, Vulcan 901 S. Marquette Ave. since 2002 Corporation (engineering and Materials Company, Inc. Minneapolis, MN 55402 construction) since 1998 (construction Age 66 materials/chemicals) - ---------------------------------- ------------------- ----------------------------------------- ----------------------------- Livio D. DeSimone Board member Retired Chair of the Board and Chief Cargill, Incorporated 30 Seventh Street East since 2001 Executive Officer, Minnesota Mining and (commodity merchants and Suite 3050 Manufacturing (3M) processors), General Mills, St. Paul, MN 55101-4901 Inc. (consumer foods), Age 70 Vulcan Materials Company (construction materials/ chemicals), Milliken & Company (textiles and chemicals), and Nexia Biotechnologies, Inc. - ---------------------------------- ------------------- ----------------------------------------- ----------------------------- Anne P. Jones Board member Attorney and Consultant 901 S. Marquette Ave. since 1985 Minneapolis, MN 55402 Age 69 - ---------------------------------- ------------------- ----------------------------------------- ----------------------------- Stephen R. Lewis, Jr.* Board member Retired President and Professor of Valmont Industries, Inc. 901 S. Marquette Ave. since 2002 Economics, Carleton College (manufactures irrigation Minneapolis, MN 55402 systems) Age 65 - ---------------------------------- ------------------- ----------------------------------------- -----------------------------
* Interested person of AXP Partners International Aggressive Growth Fund by reason of being a security holder of FleetBoston Financial Corporation, parent company of Columbia Wanger Asset Management, L.P., one of the fund's subadvisers. - -------------------------------------------------------------------------------- 39 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT
Independent Board Members (continued) Name, address, age Position held Principal occupation during past five Other directorships with Fund and years length of service - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Alan K. Simpson Board member Former three-term United States Senator 1201 Sunshine Ave. since 1997 for Wyoming Cody, WY 82414 Age 72 - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Alison Taunton-Rigby Board member since Founder and Chief Executive Officer, 901 S. Marquette Ave. 2002 RiboNovix, Inc. since 2004; President, Minneapolis, MN 55402 Forester Biotech since 2000; prior to Age 60 that, President and CEO, Aquila Biopharmaceuticals, Inc. - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Board Member Affiliated with AEFC** Name, address, age Position held Principal occupation during past five Other directorships with Fund and years length of service - --------------------------------- -------------------- ----------------------------------------- ----------------------------- William F. Truscott Board member Senior Vice President - Chief 53600 AXP Financial Center since 2001, Vice Investment Officer of AEFC since 2001. Minneapolis, MN 55474 President since Former Chief Investment Officer and Age 43 2002 Managing Director, Zurich Scudder Investments - --------------------------------- -------------------- ----------------------------------------- -----------------------------
** Interested person by reason of being an officer, director and/or employee of AEFC. - -------------------------------------------------------------------------------- 40 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL REPORT The board has appointed officers who are responsible for day-to-day business decisions based on policies it has established. The officers serve at the pleasure of the board. In addition to Mr. Truscott, who is vice president, the Fund's other officers are:
Other Officers Name, address, age Position held Principal occupation during past five Other directorships with Fund and years length of service - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Jeffrey P. Fox Treasurer since Vice President - Investment Accounting, 50005 AXP Financial Center 2002 AEFC, since 2002; Vice President - Minneapolis, MN 55474 Finance, American Express Company, Age 49 2000-2002; Vice President - Corporate Controller, AEFC, 1996-2000 - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Paula R. Meyer President since Senior Vice President and General 596 AXP Financial Center 2002 Manager - Mutual Funds, AEFC, since Minneapolis, MN 55474 2002; Vice President and Managing Age 50 Director - American Express Funds, AEFC, 2000-2002; Vice President, AEFC, 1998-2000 - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Leslie L. Ogg Vice President, President of Board Services Corporation 901 S. Marquette Ave. General Counsel, Minneapolis, MN 55402 and Secretary Age 65 since 1978 - --------------------------------- -------------------- ----------------------------------------- -----------------------------
The SAI has additional information about the Fund's directors and is available, without charge, upon request by calling (800) 862-7919. 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 August 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. - -------------------------------------------------------------------------------- 41 --- AXP SHORT DURATION U.S. GOVERNMENT FUND --- 2004 ANNUAL 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.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 Annual Report for the Period Ended May 31, 2004 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 Funds (R) Table of Contents Fund Snapshot 3 Questions & Answers with Portfolio Management 4 The Fund's Long-term Performance 9 Investments in Securities 10 Financial Statements 14 Notes to Financial Statements 17 Report of Independent Registered Public Accounting Firm 29 Federal Income Tax Information 30 Board Members and Officers 33 Proxy Voting 35 (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 -- 2004 ANNUAL REPORT Fund Snapshot AS OF MAY31, 2004 PORTFOLIO MANAGER Portfolio manager Scott Kirby* Since 2/02 Years in industry 25 * 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 $320.6 million Number of holdings 152 Average weighted life** 4.8 years Effective duration*** 3.4 years Weighted average bond rating AAA 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 88.0% Short-term securities 5.6% U.S. government obligations & agencies 5.1% CMBS/ABS* 1.3% * Commercial mortgage-backed securities/Asset-backed securities Credit Quality Summary Percentage of portfolio assets excluding cash equivalents AAA bonds 100.0% 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." ** Average weighted life is the average number of years that each dollar of unpaid principal due on a security remains outstanding. *** Effective duration measures the sensitivity of a security's price to parallel shifts in the yield curve (the graphical depiction of the levels of interest rates from two years out to 30 years). Positive duration means that as rates rise, the price decreases, and negative duration means that as rates rise, the price increases. 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 -- 2004 ANNUAL REPORT Questions & Answers WITH PORTFOLIO MANAGEMENT Below, Portfolio Manager Scott Kirby discusses the Fund's positioning and results for the 12 months ended May 31, 2004. Q: How did the AXP U.S. Government Mortgage Fund perform for the current fiscal year? A: AXP U.S. Government Mortgage Fund's Class A shares (excluding sales charge) rose 1.27% for the 12-month period ended May 31, 2004. In comparison, the Lehman Brothers Mortgage-Backed Securities Index advanced 1.50%. The Fund's performance was slightly less than that of its peer group, represented by the Lipper U.S. Mortgage Funds Index, which rose 1.33% over the same time frame. To help keep the Fund competitive with its peers, we revised the Fund's expense cap effective June 1, 2004, reducing the maximum level of expenses borne by Class A shareholders from 0.99% of net assets per fiscal year to a maximum 0.945% per year. Q: What factors most affected Fund performance during the period? A: The hallmark of this fiscal year was volatility. Significant and severe volatility cast a shadow over the fixed income market, which tends to hurt the performance of mortgage-backed securities. The Fund, however, was well positioned through its security selection to offset much of the impact of the environment. The fixed income market rallied in June fueled by the expectation that interest rates would remain low -- and move even lower -- until the economy showed sustained signs of a recovery. Then on June 25, 2003, at the Federal Open Market Committee meeting, the Federal Reserve Board (the Fed) modified its stance on deflation and cut the targeted federal funds rate by only 0.25% (one-quarter of a percentage point) to 1.00%. The market's expectation was (bar chart) PERFORMANCE COMPARISON For the year ended May 31, 2004 (bar 2) 1.5% (bar 1) +1.50% (bar 3) +1.27% +1.33% 1.2% 0.9% 0.6% 0.3% 0.0% (bar 1) AXP U.S. Government Mortgage Fund A (excluding sales charge) (bar 2) Lehman Brothers Mortgage-Backed Securities Index (unmanaged) (bar 3) Lipper U.S. Mortgage Funds Index (see "The Fund's Long-term Performance" for Index descriptions) 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 -- 2004 ANNUAL REPORT Questions & Answers (begin callout quote)> We have positioned the Fund for an ongoing U.S. economic recovery and a higher interest rate environment. (end callout quote) for a deeper cut, and the market's perception was now that deflation was not as big a threat as the Fed had led us to believe. This led to a market sell-off. Given the Fed's conservative action, together with signs that the economy may start to recover, 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. The fourth calendar quarter of 2003 was a period of relative stability in the fixed income markets. During periods like this, mortgages tend to do well as was the case during this 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 May 31, 2004 1 year +1.27% -3.54% +0.52% -3.35% +0.52% +0.52% +1.45% +1.45% Since inception +4.32% +2.13% +3.65% +1.96% +3.64% +3.64% +4.50% +4.50% as of June 30, 2004 1 year +1.70% -3.14% +1.14% -2.76% +1.14% +1.14% +1.88% +1.88% Since inception +4.47% +2.35% +3.79% +2.17% +3.78% +3.78% +4.65% +4.65%
The performance information shown represents the past performance and is not a guarantee of future results. The investment return and principal value of your investment and returns will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance information shown. You may obtain performance information current to the most recent month-end by calling (888) 723-8476 or visiting www.americanexpress.com/funds. You should consider the investment objectives, risks, and charges and expenses of the Fund carefully before investing. (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. - -------------------------------------------------------------------------------- 5 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Questions & Answers We adjusted the Fund's duration to a neutral position in June, as mortgage securities began to underperform, and maintained that strategy through July. By the end of August, the Fund was slightly shorter in duration than its benchmark. We believed that the shorter duration, a somewhat defensive positioning, would benefit performance during the economic recovery, and we held on to the Fund's shorter duration and conservative positioning going into January. We continued to believe signs were leading toward a pickup in the economic recovery. Therefore, our outlook called for the Fed to raise the target federal funds rate sooner than the view that was priced into the market. Based on this outlook, we shortened the duration of the Fund and improved the structure in its mortgage holdings. When job creation did not materialize as quickly as we expected, the Fund gave up some performance versus the broad-based benchmarks due to its shorter duration. Early in 2004, the U.S. fixed income markets (as measured by the Lehman Brothers Aggregate Bond Index) outperformed most stock market indices. Geopolitical tensions, global terrorist attacks and problems in the war with Iraq shook investors' confidence in the stock market and increased investors' interest in the fixed income market. Disappointing employment reports continued in the early months of 2004, which caused investors to question whether the U.S. economic recovery was really back on track. Although signs of an economic recovery were evident, it began to appear as if the jobs necessary to sustain the recovery were not developing. Fixed income investors grew concerned as weak employment reports continued in February (published in March), even though other data suggested that the jobs would eventually come through. A long-awaited strong employment report came through in March (published in early April) to show that non-farm payrolls increased by 308,000. Also, the previous two months payroll numbers were revised upward. Another strong employment report in April (published in early May) - -------------------------------------------------------------------------------- 6 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Questions & Answers was further evidence that the recovery picture was now in sharper focus. This, along with an unexpectedly high reading on the Consumer Price Index (CPI), contributed to bond yields rising sharply at the end of the reporting period. Throughout the period, the Fund focused on higher coupon mortgage-backed securities that would outperform if there were an increase in interest rates. However, the securities were carefully selected to also reduce the risk of prepayments if the increase in interest rates did not materialize. The Fund also participated in the use of derivative instruments this period. The use of derivative instruments, such as listed futures, is primarily for hedging either duration or the yield curve. The Fund will also use listed contracts, such as eurodollar and swap contracts, to manage spread product exposure in the portfolio. Q: What changes have you made to the Fund? A: Early in the period, 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. We continued to emphasize those securities issued by government mortgage agencies, including Ginnie Mae, Fannie Mae and Freddie Mac. However, the Fund has a lower-than-index position in Ginnie Mae securities because we believe other sectors within the mortgage-backed sucurities market offer better relative value. Throughout the year, we positioned the Fund to use both specified securities as well as forward purchases also known as mortgage rolls. Our effective use of this roll strategy contributed to a portfolio turnover rate of 163% for the fiscal period. We reduced the duration of the Fund early in 2004 and continued to hold its duration short of the index. There have been no major shifts in asset allocation. We continue to remain slightly defensive by reducing the Fund's exposure to volatility, when possible. - -------------------------------------------------------------------------------- 7 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Questions & Answers Q: How do you intend to manage the Fund in the coming months? A: Looking ahead, we believe the Fed will raise interest rates some time this summer. The key question is: by how much? The fixed income futures market was already pricing in a total of 100 basis points (1%) in a series of interest rate increases by the end of December 2004. We have positioned the Fund for an ongoing U.S. economic recovery and a higher interest rate environment. We intend to keep the Fund's duration shorter than its benchmark until we believe the market has finished pricing in any Fed increases. As always, we continue to seek attractive buying opportunities, quality issues and security selection remain a priority. - -------------------------------------------------------------------------------- 8 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT The Fund's Long-term Performance This chart illustrates the total value of an assumed $10,000 investment in AXP U.S. Government Mortgage Fund Class A shares (from 3/1/02 to 5/31/04) as compared to the performance of two widely cited performance indices, Lehman Brothers Mortgage-Backed Securities Index and the Lipper U.S. Mortgage Funds Index. In comparing the Fund's Class A shares to these indices, you should take into account the fact that the Fund's performance reflects the maximum sales charge of 4.75%, while such charges are not reflected in the performance of the indices. Returns for the Fund include the reinvestment of any distribution paid during each period. The performance information shown represents the past performance and is not a guarantee of future results. The value of your investment and returns will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Returns do not reflect taxes payable on distributions and redemptions. Current performance may be lower or higher than the performance information shown. You may obtain performance information current to the most recent month-end by calling (888) 723-8476 or visiting www.americanexpress.com/funds. Also see "Past Performance" in the Fund's current prospectus. You should consider the investment objectives, risks, and charges and expenses of the Fund carefully before investing.
VALUE OF A HYPOTHETICAL $10,000 INVESTMENT IN AXP U.S. GOVERNMENT MORTGAGE FUND AXP U.S. Government Mortgage Fund Class A $ 9,525 $ 9,692 $10,363 $10,495 Lehman Brothers Mortgage- Backed Securities Index(1) $10,000 $10,169 $10,822 $10,984 Lipper U.S. Mortgage Funds Index $10,000 $10,128 $10,744 $10,887 3/1/02 5/31/02 5/31/03 5/31/04
(1) 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 invesmtent policies or objectives. Average Annual Total Returns Class A with Sales Charge as of May 31, 2004 1 year -3.54% Since inception (2/14/02) +2.13 Results for other share classes can be found on page 5. - -------------------------------------------------------------------------------- 9 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Investments in Securities AXP U.S. Government Mortgage Fund May 31, 2004 (Percentages represent value of investments compared to net assets) Bonds (99.9%) Issuer Coupon Principal Value(a) rate amount U.S. government obligations & agencies (5.4%) Federal Home Loan Mtge Corp 06-01-19 4.50% $10,400,000(b) $10,153,000 Federal Natl Mtge Assn 06-01-19 4.50 1,000,000(b) 976,250 U.S. Treasury 05-15-09 3.88 4,000,000 4,014,360 05-15-14 4.75 2,075,000 2,090,563 Total 17,234,173 Commercial mortgage-backed/Asset-backed securities (1.4%)(f) Bank of America Alternative Loan Trust Series 2003-11 Cl 1A1 01-25-34 6.00 1,044,677 1,052,439 CS First Boston Mtge Securities Series 2003-8 Cl 5A1 04-25-33 6.50 1,184,436(h) 1,207,532 Structured Asset Securities Series 2003-33H Cl 1A1 10-25-33 5.50 2,419,876 2,373,896 Total 4,633,867 Mortgage-backed securities (93.1%)(f) Federal Home Loan Mtge Corp 01-01-09 7.00 369,606 393,632 03-01-10 8.00 634,646 683,024 06-01-15 7.50 2,332,605 2,516,280 12-01-16 6.50 624,301 663,255 02-01-17 6.50 2,503,351 2,664,630 04-01-17 7.00 1,306,734 1,401,670 10-01-17 8.00 833,887 906,082 01-01-18 5.50 1,709,252 1,746,887 02-01-18 5.50 1,050,535 1,073,667 05-01-18 5.00 2,642,345 2,661,438 08-01-18 5.00 2,750,292 2,763,340 10-01-18 5.00 3,471,176 3,477,298 06-01-19 5.00 3,000,000(b) 2,995,314 03-01-22 6.50 812,921 846,267 04-01-22 6.50 1,286,200 1,349,111 03-01-30 7.50 496,196 533,324 12-01-30 5.50 2,074,593 2,066,948 06-01-31 8.00 826,614 892,821 03-01-32 7.00 328,649 349,054 07-01-32 7.00 589,593 619,393 08-01-32 6.50 4,192,497 4,343,409 09-01-32 6.50 1,769,491 1,833,185 04-01-33 6.00 3,443,398 3,523,968 06-01-33 5.50 2,710,902 2,691,350 07-01-33 6.00 1,272,442 1,302,518 08-01-33 5.00 1,870,601 1,799,850 09-01-33 4.56 1,428,993(e) 1,423,805 09-01-33 5.00 2,893,578 2,784,134 Collateralized Mtge Obligation 10-15-18 5.00 2,700,000 2,727,859 11-15-18 5.00 5,200,000 5,253,400 11-15-21 5.00 1,000,000 1,021,885 02-15-27 5.00 3,200,000 3,217,724 11-15-28 4.50 1,663,442 1,655,647 02-15-33 5.50 3,665,785 3,778,068 Interest Only 02-15-14 7.40 1,740,392(g) 154,303 06-15-18 7.59 1,273,142(g) 80,058 10-15-22 14.56 1,733,193(g) 192,800 Interest Only/Inverse Floater 03-15-32 0.00 1,030,582(d,g) 97,288 Federal Natl Mtge Assn 05-01-08 7.75 453,317 486,293 10-01-09 8.50 211,517 221,962 08-01-10 7.50 909,398 971,972 04-01-11 6.50 263,441 278,832 08-01-16 6.50 384,163 408,630 11-01-16 7.00 953,757 1,023,928 02-01-17 7.00 1,306,203 1,402,348 03-01-17 6.00 1,264,591 1,321,839 03-01-17 6.50 982,512 1,045,074 03-01-17 7.00 49,249 52,438 See accompanying notes to investments in securities. - -------------------------------------------------------------------------------- 10 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn (cont.) 04-01-17 7.50% $107,624 $114,691 05-01-17 6.00 426,161 443,923 07-01-17 6.00 6,195,655 6,475,676 08-01-17 5.50 3,229,080 3,313,985 09-01-17 6.50 2,907,001 3,090,471 10-01-17 5.50 849,724 871,731 11-01-17 5.50 3,134,516 3,215,770 12-01-17 5.50 2,525,073 2,590,778 12-01-17 6.00 3,137,635 3,260,304 02-01-18 5.50 3,449,156 3,541,456 04-01-18 5.50 4,092,543 4,201,765 05-01-18 5.00 2,034,349 2,036,468 06-01-18 5.00 1,970,040 1,981,887 07-01-18 4.50 435,169 426,294 08-01-18 4.50 6,327,011(h) 6,196,517 08-01-18 4.50 992,215 972,050 10-01-18 5.00 2,846,759 2,849,723 12-01-18 5.00 2,105,754 2,113,178 02-01-19 5.00 1,685,394 1,687,149 09-01-22 6.50 917,202 954,968 11-01-22 6.00 1,060,287 1,089,385 03-01-23 5.50 2,070,199 2,100,812 07-01-23 5.00 1,128,770 1,109,704 08-01-23 5.50 4,291,964 4,327,383 09-01-23 5.50 3,582,582 3,609,914 10-01-23 5.50 1,912,302 1,927,570 04-01-25 8.00 1,342,578 1,484,001 07-01-28 5.50 1,950,926 1,943,346 08-01-28 5.50 1,365,676 1,360,370 09-01-28 7.50 1,802,880 1,934,322 12-01-28 7.00 1,672,709 1,784,387 01-01-29 6.00 1,495,165 1,523,635 03-01-29 6.50 3,961,641 4,129,593 04-01-29 5.00 1,996,805 1,926,575 05-01-29 6.00 1,149,421(b) 1,171,308 06-01-29 6.00 5,526,957 5,667,975 06-01-29 7.50 1,461,580 1,562,842 06-01-31 7.00 3,560,705 3,783,474 09-01-31 7.00 2,878,950 3,064,070 09-01-31 7.50 2,911,249 3,116,760 10-01-31 9.50 206,689 229,274 11-01-31 6.50 1,562,479 1,632,612 01-01-32 6.00 1,705,086 1,743,530 01-01-32 6.50 1,060,940 1,112,234 03-01-32 7.00 2,050,396 2,180,304 04-01-32 6.50 3,019,728 3,165,698 04-01-32 7.00 2,506,359 2,661,340 05-01-32 6.50 4,732,438 4,951,045 05-01-32 7.00 3,657,441 3,873,764 06-01-32 6.50 1,442,396 1,505,382 07-01-32 6.50 569,885 590,481 08-01-32 6.50 1,836,333 1,915,947 09-01-32 6.00 2,533,394 2,577,471 09-01-32 6.50 2,846,155 2,949,017 10-01-32 5.50 957,976 951,027 11-01-32 6.00 4,723,887 4,832,851 12-01-32 6.00 1,996,252 2,030,983 12-01-32 6.50 2,940,930 3,047,217 12-01-32 7.50 484,770 517,543 01-01-33 6.00 2,887,872 2,938,115 01-01-33 7.00 1,604,840 1,701,092 02-01-33 5.50 2,708,962 2,695,021 03-01-33 5.50 1,009,477(b) 1,003,770 03-01-33 5.50 2,734,160 2,721,713 03-01-33 6.00 5,430,134 5,537,171 03-01-33 6.50 653,430 679,286 04-01-33 5.50 13,564,721 13,504,211 04-01-33 6.00 5,010,879 5,100,003 05-01-33 5.50 10,386,926 10,313,201 05-01-33 6.00 2,243,816 2,289,242 07-01-33 5.50 6,767,266 6,716,680 07-01-33 6.00 1,499,224 1,531,510 08-01-33 5.50 1,454,055 1,442,633 08-01-33 6.00 4,179,190 4,250,904 01-01-34 6.50 972,895 1,016,565 04-01-34 5.00 3,487,616 3,361,434 06-01-34 5.50 3,700,000(b) 3,661,846 Collateralized Mtge Obligation 05-25-16 4.00 2,000,000 1,963,475 12-25-26 8.00 774,546 828,847 02-25-44 7.00 2,000,000 2,115,938 Interest Only 10-25-09 0.00 2,714,817(g) 15,983 12-25-12 13.29 1,651,081(g) 125,237 See accompanying notes to investments in securities. - -------------------------------------------------------------------------------- 11 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Govt Natl Mtge Assn 04-15-29 6.50% $511,968 $532,842 02-15-30 7.00 466,902 494,135 03-15-30 7.00 551,620 583,795 12-15-31 6.50 801,965 834,370 02-15-32 6.50 952,957 991,414 12-15-32 6.00 798,133 814,111 05-15-33 6.00 1,101,734 1,123,493 03-20-34 6.50 451,862 466,415 Total 298,476,384 Total bonds (Cost: $322,571,363) $320,344,424 Option purchased (--%) Issuer Notional Exercise Expiration Value(a) amount price date Call Sept. U.S. Treasury Nt Futures 5-year $10,000,000 $110.50 June 2004 $4,688 Total option purchased (Cost: $30,088) $4,688 Short-term securities (5.9%) Issuer Annualized Amount Value(a) yield on date payable at of purchase maturity U.S. government agencies (3.3%) Federal Home Loan Mtge Corp Disc Nt 08-17-04 1.14% $10,000,000 $9,976,900 Federal Natl Mtge Assn Disc Nt 07-14-04 1.04 700,000 699,114 Total 10,676,014 Commercial paper (2.6%) Park Avenue Receivables 06-01-04 1.03 4,300,000(c) 4,299,508 Variable Funding Capital 06-14-04 1.03 3,900,000(c) 3,898,103 Total 8,197,611 Total short-term securities (Cost: $18,871,693) $18,873,625 Total investments in securities (Cost: $341,473,144)(i) $339,222,737 See accompanying notes to investments in securities. - -------------------------------------------------------------------------------- 12 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Notes to investments in securities (a) Securities are valued by procedures described in Note 1 to the financial statements. (b) At May 31, 2004, the cost of securities purchased, including interest purchased, on a when-issued and/or other forward-commitment basis was $19,854,310. (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. These securities may be resold in transactions exempt from registration, normally to qualified institutional buyers. As of May 31, 2004, the value of these securities amounted to $8,197,611 or 2.6% of net assets. (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 May 31, 2004. (e) Adjustable rate mortgage; interest rate varies to reflect current market conditions; rate shown is the effective rate on May 31, 2004. (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) 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 May 31, 2004. (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. Long Bond, Sept. 2004, 20-year $10,700,000 Sale contracts U.S. Treasury Notes, June 2004, 5-year 2,500,000 U.S. Treasury Notes, Sept. 2004, 2-year 20,000,000 U.S. Treasury Notes, Sept. 2004, 5-year 2,200,000 (i) At May 31, 2004, the cost of securities for federal income tax purposes was $341,495,787 and the aggregate gross unrealized appreciation and depreciation based on that cost was: Unrealized appreciation $ 1,850,708 Unrealized depreciation (4,123,758) ---------- Net unrealized depreciation $(2,273,050) ----------- - -------------------------------------------------------------------------------- 13 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Financial Statements
Statement of assets and liabilities AXP U.S. Government Mortgage Fund May 31, 2004 Assets Investments in securities, at value (Note 1) (identified cost $341,473,144) $339,222,737 Cash in bank on demand deposit 23,242 Capital shares receivable 108,011 Accrued interest receivable 1,377,077 Receivable for investment securities sold 1,123,996 --------- Total assets 341,855,063 ----------- Liabilities Dividends payable to shareholders 54,994 Capital shares payable 177,644 Payable for investment securities purchased 1,053,330 Payable for securities purchased on a forward-commitment basis (Note 1) 19,854,310 Accrued investment management services fee 4,575 Accrued distribution fee 5,152 Accrued transfer agency fee 1,563 Accrued administrative services fee 440 Other accrued expenses 58,382 ------ Total liabilities 21,210,390 ---------- Net assets applicable to outstanding capital stock $320,644,673 ============ Represented by Capital stock -- $.01 par value (Note 1) $ 636,828 Additional paid-in capital 324,497,854 Excess of distributions over net investment income (169,582) Accumulated net realized gain (loss) (2,137,388) Unrealized appreciation (depreciation) on investments (2,183,039) ---------- Total -- representing net assets applicable to outstanding capital stock $320,644,673 ============ Net assets applicable to outstanding shares: Class A $177,289,900 Class B $128,608,354 Class C $ 14,724,034 Class I $ 9,767 Class Y $ 12,618 Net asset value per share of outstanding capital stock: Class A shares 35,218,317 $ 5.03 Class B shares 25,536,915 $ 5.04 Class C shares 2,923,120 $ 5.04 Class I shares 1,942 $ 5.03 Class Y shares 2,507 $ 5.03 ----- ------------
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- 14 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT
Statement of operations AXP U.S. Government Mortgage Fund Year ended May 31, 2004 Investment income Income: Interest $16,242,923 ----------- Expenses (Note 2): Investment management services fee 2,063,726 Distribution fee Class A 540,930 Class B 1,621,705 Class C 183,111 Transfer agency fee 564,542 Incremental transfer agency fee Class A 31,990 Class B 38,589 Class C 3,954 Service fee -- Class Y 12 Administrative services fees and expenses 204,741 Compensation of board members 9,925 Custodian fees 76,690 Printing and postage 82,731 Registration fees 103,609 Audit fees 19,000 Other 727 --- Total expenses 5,545,982 Expenses waived/reimbursed by AEFC (Note 2) (268,608) -------- 5,277,374 Earnings credits on cash balances (Note 2) (5,775) ------ Total net expenses 5,271,599 --------- Investment income (loss) -- net 10,971,324 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (Note 3) (1,934,596) Futures contracts (79,025) Options contracts written (Note 6) 252,128 ------- Net realized gain (loss) on investments (1,761,493) Net change in unrealized appreciation (depreciation) on investments (5,682,907) ---------- Net gain (loss) on investments (7,444,400) ---------- Net increase (decrease) in net assets resulting from operations $ 3,526,924 ===========
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- 15 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT
Statements of changes in net assets AXP U.S. Government Mortgage Fund Year ended May 31, 2004 2003 Operations and distributions Investment income (loss) -- net $ 10,971,324 $ 9,686,929 Net realized gain (loss) on investments (1,761,493) 5,763,024 Net change in unrealized appreciation (depreciation) on investments (5,682,907) 2,819,705 ---------- --------- Net increase (decrease) in net assets resulting from operations 3,526,924 18,269,658 --------- ---------- Distributions to shareholders from: Net investment income Class A (6,673,492) (6,365,488) Class B (3,833,418) (3,718,149) Class C (435,554) (383,803) Class I (167) -- Class Y (414) (475) Tax return of capital Class A (379,306) -- Class B (217,882) -- Class C (24,756) -- Class I (9) -- Class Y (24) -- Net realized gain Class A (2,276,411) (878,837) Class B (1,733,487) (703,993) Class C (199,554) (67,316) Class Y (142) (57) ----------- ----------- Total distributions (15,774,616) (12,118,118) ----------- ----------- Capital share transactions (Note 4) Proceeds from sales Class A shares (Note 2) 80,517,965 277,134,067 Class B shares 42,305,093 210,911,273 Class C shares 5,501,269 19,636,847 Class I shares 44,454 -- Class Y shares 500 502 Reinvestment of distributions at net asset value Class A shares 8,808,051 6,382,377 Class B shares 5,526,710 4,108,191 Class C shares 615,962 404,490 Class I shares 66 -- Class Y shares 111 85 Payments for redemptions Class A shares (156,430,470) (93,565,033) Class B shares (Note 2) (114,195,539) (45,757,524) Class C shares (Note 2) (12,356,331) (3,415,045) Class I shares (34,542) -- Class Y shares -- (132) ----------- ----------- Increase (decrease) in net assets from capital share transactions (139,696,701) 375,840,098 ------------ ----------- Total increase (decrease) in net assets (151,944,393) 381,991,638 Net assets at beginning of year 472,589,066 90,597,428 ----------- ---------- Net assets at end of year $ 320,644,673 $472,589,066 ============= ============
See accompanying notes to financial statements. - -------------------------------------------------------------------------------- 16 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Notes to Financial Statements AXP U.S. Government Mortgage Fund 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. Effective March 4, 2004, the Fund offers an additional class of shares, Class I, exclusively to certain institutional investors. Class I shares have no sales charge and are made available through a separate prospectus supplement provided to investors eligible to purchase the shares. As of May 31, 2004, American Express Financial Corporation (AEFC) and the AXP Portfolio Builder Funds owned 100% of Class I shares. 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. - -------------------------------------------------------------------------------- 17 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT 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 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. - -------------------------------------------------------------------------------- 18 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT 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 May 31, 2004, the Fund has entered into outstanding when-issued securities of $17,685,018 and other forward-commitments of $2,169,292. 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. On the statement of assets and liabilities, as a result of permanent book-to-tax differences, undistributed net investment income has been increased by $38,038 and accumulated net realized loss has been increased by $37,418 resulting in a net reclassification adjustment to decrease paid-in capital by $620. - -------------------------------------------------------------------------------- 19 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT The tax character of distributions paid for the years indicated is as follows: Year ended May 31, 2004 2003 Class A Distributions paid from: Ordinary income $8,814,309 $7,244,325 Long-term capital gain 135,594 -- Tax return of capital 379,306 -- Class B Distributions paid from: Ordinary income 5,463,649 4,422,142 Long-term capital gain 103,256 -- Tax return of capital 217,882 -- Class C Distributions paid from: Ordinary income 623,221 451,119 Long-term capital gain 11,887 -- Tax return of capital 24,756 -- Class I* Distributions paid from: Ordinary income 167 N/A Long-term capital gain -- N/A Tax return of capital 9 -- Class Y Distributions paid from: Ordinary income 548 532 Long-term capital gain 8 -- Tax return of capital 24 -- * Inception date was March 4, 2004. As of May 31, 2004, the components of distributable earnings on a tax basis are as follows: Undistributed ordinary income $ -- Accumulated long-term gain (loss) $(1,882,303) Unrealized appreciation (depreciation) $(2,552,712) 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. - -------------------------------------------------------------------------------- 20 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT 2. EXPENSES AND SALES CHARGES The Fund has agreements with 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. 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. Class I pays a transfer agency fee at an annual rate per shareholder account of $1. This amount is included in the transfer agency fee on the statement of operations. 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 $1,117,521 for Class A, $279,925 for Class B and $16,963 for Class C for the year ended May 31, 2004. - -------------------------------------------------------------------------------- 21 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT For the year ended May 31, 2004, 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, 0.64% for Class I and 0.81% for Class Y. Beginning June 1, 2004, AEFC and its affiliates have agreed to waive certain fees and expenses until May 31, 2005. Under this agreement, net expenses will not exceed 0.945% for Class A, 1.695% for Class B, 1.695% for Class C, 0.645% for Class I and 0.765% for Class Y of the Fund's average daily net assets. During the year ended May 31, 2004, the Fund's custodian and transfer agency fees were reduced by $5,775 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. 3. SECURITIES TRANSACTIONS Cost of purchases and proceeds from sales of securities (other than short-term obligations) aggregated $642,311,752 and $773,253,852, respectively, for the year ended May 31, 2004. Realized gains and losses are determined on an identified cost basis. 4. CAPITAL SHARE TRANSACTIONS Transactions in shares of capital stock for the years indicated are as follows:
Year ended May 31, 2004 Class A Class B Class C Class I* Class Y Sold 15,645,306 8,226,489 1,069,281 8,629 97 Issued for reinvested distributions 1,719,729 1,078,130 120,137 13 22 Redeemed (30,490,915) (22,241,050) (2,408,909) (6,700) -- ----------- ----------- ---------- ------ --- Net increase (decrease) (13,125,880) (12,936,431) (1,219,491) 1,942 119 ----------- ----------- ---------- ----- --- * Inception date was March 4, 2004. Year ended May 31, 2003 Class A Class B Class C Class I Class Y Sold 53,840,581 40,951,953 3,809,031 N/A 98 Issued for reinvested distributions 1,236,256 795,646 78,342 N/A 16 Redeemed (18,129,387) (8,851,021) (659,979) N/A (25) ----------- ----------- ---------- ----- --- Net increase (decrease) 36,947,450 32,896,578 3,227,394 N/A 89 ----------- ----------- ---------- ----- ---
5. INTEREST RATE FUTURES CONTRACTS As of May 31, 2004, investments in securities included securities valued at $601,669 that were pledged as collateral to cover initial margin deposits on 107 open purchase contracts and 147 open sale contracts. The notional market value of the open purchase contracts as of May 31, 2004 was $11,258,406 with a net unrealized loss of $48,592. The notional market value of the open sale contracts as of May 31, 2004 was $26,173,531 with a net unrealized gain of $115,960. See "Summary of significant accounting policies" and "Notes to investments in securities." - -------------------------------------------------------------------------------- 22 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT 6. OPTIONS CONTRACTS WRITTEN Contracts and premiums associated with options contracts written are as follows: Year ended May 31, 2004 Puts Calls Contracts Premiums Contracts Premiums Balance May 31, 2003 -- $ -- -- $ -- Opened 211 152,923 1,474 1,743,950 Closed (211) (152,923) (1,474) (1,743,950) ---- -------- ------ ---------- Balance May 31, 2004 -- $ -- -- $ -- ---- --------- ------ ----------- See "Summary of significant accounting policies." 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 year ended May 31, 2004. 8. CAPITAL LOSS CARRY-OVER For federal income tax purposes, the Fund has a capital loss carry-over of $1,882,303 as of May 31, 2004 that will expire in 2012 and 2013 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. - -------------------------------------------------------------------------------- 23 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT 9. 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, 2004 2003 2002(b) Net asset value, beginning of period $5.19 $5.06 $5.01 Income from investment operations: Net investment income (loss) .16 .19 .04 Net gains (losses) (both realized and unrealized) (.09) .16 .04 Total from investment operations .07 .35 .08 Less distributions: Dividends from net investment income (.16) (.20) (.03) Tax return of capital (.01) -- -- Distributions from realized gains (.06) (.02) -- Total distributions (.23) (.22) (.03) Net asset value, end of period $5.03 $5.19 $5.06 Ratios/supplemental data Net assets, end of period (in millions) $177 $251 $58 Ratio of expenses to average daily net assets(c),(e) .98% .99% .95%(d) Ratio of net investment income (loss) to average daily net assets 3.11% 3.31% 2.98%(d) Portfolio turnover rate (excluding short-term securities) 163% 227% 200% Total return(f) 1.27% 6.93% 1.75%(g)
(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 1.05%, 1.06% and 1.58% for the periods ended May 31, 2004, 2003 and 2002, respectively. (f) Total return does not reflect payment of a sales charge. (g) Not annualized. - -------------------------------------------------------------------------------- 24 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT
Class B Per share income and capital changes(a) Fiscal period ended May 31, 2004 2003 2002(b) Net asset value, beginning of period $5.20 $5.07 $5.01 Income from investment operations: Net investment income (loss) .12 .15 .03 Net gains (losses) (both realized and unrealized) (.09) .16 .05 Total from investment operations .03 .31 .08 Less distributions: Dividends from net investment income (.12) (.16) (.02) Tax return of capital (.01) -- -- Distributions from realized gains (.06) (.02) -- Total distributions (.19) (.18) (.02) Net asset value, end of period $5.04 $5.20 $5.07 Ratios/supplemental data Net assets, end of period (in millions) $129 $200 $28 Ratio of expenses to average daily net assets(c),(e) 1.74% 1.75% 1.74%(d) Ratio of net investment income (loss) to average daily net assets 2.35% 2.49% 2.68%(d) Portfolio turnover rate (excluding short-term securities) 163% 227% 200% Total return(f) .52% 6.12% 1.76%(g)
(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 B would have been 1.80%, 1.82% and 2.34% for the periods ended May 31, 2004, 2003 and 2002, respectively. (f) Total return does not reflect payment of a sales charge. (g) Not annualized. - -------------------------------------------------------------------------------- 25 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT
Class C Per share income and capital changes(a) Fiscal period ended May 31, 2004 2003 2002(b) Net asset value, beginning of period $5.20 $5.07 $5.01 Income from investment operations: Net investment income (loss) .12 .15 .03 Net gains (losses) (both realized and unrealized) (.09) .16 .05 Total from investment operations .03 .31 .08 Less distributions: Dividends from net investment income (.12) (.16) (.02) Tax return of capital (.01) -- -- Distributions from realized gains (.06) (.02) -- Total distributions (.19) (.18) (.02) Net asset value, end of period $5.04 $5.20 $5.07 Ratios/supplemental data Net assets, end of period (in millions) $15 $22 $5 Ratio of expenses to average daily net assets(c),(e) 1.74% 1.75% 1.73%(d) Ratio of net investment income (loss) to average daily net assets 2.36% 2.50% 2.60%(d) Portfolio turnover rate (excluding short-term securities) 163% 227% 200% Total return(f) .52% 6.12% 1.74%(g)
(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 C would have been 1.80%, 1.82% and 2.34% for the periods ended May 31, 2004, 2003 and 2002, respectively. (f) Total return does not reflect payment of a sales charge. (g) Not annualized. - -------------------------------------------------------------------------------- 26 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Class I Per share income and capital changes(a) Fiscal period ended May 31, 2004(b) Net asset value, beginning of period $5.15 Income from investment operations: Net investment income (loss) .05 Net gains (losses) (both realized and unrealized) (.11) Total from investment operations (.06) Less distributions: Dividends from net investment income (.06) Net asset value, end of period $5.03 Ratios/supplemental data Net assets, end of period (in millions) $-- Ratio of expenses to average daily net assets(c) .64%(d) Ratio of net investment income (loss) to average daily net assets 3.39%(d) Portfolio turnover rate (excluding short-term securities) 163% Total return(e) (1.38%)(f) (a) For a share outstanding throughout the period. Rounded to the nearest cent. (b) Inception date was March 4, 2004. (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. - -------------------------------------------------------------------------------- 27 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT
Class Y Per share income and capital changes(a) Fiscal period ended May 31, 2004 2003 2002(b) Net asset value, beginning of period $5.19 $5.06 $5.01 Income from investment operations: Net investment income (loss) .17 .19 .04 Net gains (losses) (both realized and unrealized) (.09) .16 .04 Total from investment operations .08 .35 .08 Less distributions: Dividends from net investment income (.17) (.20) (.03) Tax return of capital (.01) -- -- Distributions from realized gains (.06) (.02) -- Total distributions (.24) (.22) (.03) Net asset value, end of period $5.03 $5.19 $5.06 Ratios/supplemental data Net assets, end of period (in millions) $-- $-- $-- Ratio of expenses to average daily net assets(c),(e) .81% .80% .78%(d) Ratio of net investment income (loss) to average daily net assets 3.29% 3.68% 2.95%(d) Portfolio turnover rate (excluding short-term securities) 163% 227% 200% Total return(f) 1.45% 7.10% 1.80%(g)
(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 Y would have been 0.87%, 0.88% and 1.40% for the periods ended May 31, 2004, 2003 and 2002, respectively. (f) Total return does not reflect payment of a sales charge. (g) Not annualized. - -------------------------------------------------------------------------------- 28 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Report of Independent Registered Public Accounting Firm THE BOARD AND SHAREHOLDERS AXP GOVERNMENT INCOME SERIES, INC. We have audited the accompanying statement of assets and liabilities, including the schedule of investments in securities, of AXP U.S. Government Mortgage Fund (a series of AXP Government Income Series, Inc.) as of May 31, 2004, the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period ended May 31, 2004, and the financial highlights for each of the years in the two-year period ended May 31, 2004 and for the period from Feb. 14, 2002 (when shares became publicly available) to May 31, 2002. These financial statements and the financial highlights are the responsibility of fund management. Our responsibility is to express an opinion on these financial statements and the financial highlights based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and the financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of May 31, 2004, by correspondence with the custodian and brokers or by other appropriate auditing procedures. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of AXP U.S. Government Mortgage Fund as of May 31, 2004, and the results of its operations, changes in its net assets and the financial highlights for each of the periods stated in the first paragraph above, in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Minneapolis, Minnesota July 20, 2004 - -------------------------------------------------------------------------------- 29 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Federal Income Tax Information (UNAUDITED) The Fund is required by the Internal Revenue Code of 1986 to tell its shareholders about the tax treatment of the dividends it pays during its fiscal year. The dividends listed below are reported to you on Form 1099-DIV, Dividends and Distributions. Shareholders should consult a tax advisor on how to report distributions for state and local tax purposes. AXP U.S. Government Mortgage Fund Fiscal year ended May 31, 2004 Class A Income distributions -- taxable as dividend income: Qualified Dividend Income for individuals 0.00% Dividends Received Deduction for corporations 0.00% Payable date Per share June 23, 2003 $0.01413 July 24, 2003 0.01310 Aug. 22, 2003 0.01107 Sept. 22, 2003 0.01100 Oct. 23, 2003 0.01100 Nov. 21, 2003 0.01100 Dec. 22, 2003 0.07590 Jan. 26, 2004 0.01380 Feb. 25, 2004 0.01600 March 26, 2004 0.01750 April 26, 2004 0.01666 May 26, 2004 0.01402 Total $0.22518 Capital gain distributions -- taxable as long-term capital gain. Payable date Per share Dec. 22, 2003 $0.00340 Total distributions* $0.22858 - -------------------------------------------------------------------------------- 30 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Class B Income distributions -- taxable as dividend income: Qualified Dividend Income for individuals 0.00% Dividends Received Deduction for corporations 0.00% Payable date Per share June 23, 2003 $0.01076 July 24, 2003 0.00975 Aug. 22, 2003 0.00798 Sept. 22, 2003 0.00768 Oct. 23, 2003 0.00767 Nov. 21, 2003 0.00788 Dec. 22, 2003 0.07255 Jan. 26, 2004 0.01006 Feb. 25, 2004 0.01292 March 26, 2004 0.01428 April 26, 2004 0.01337 May 26, 2004 0.01088 Total $0.18578 Capital gain distribution -- taxable as long-term capital gain. Payable date Per share Dec. 22, 2003 $0.00340 Total distributions* $0.18918 Class C Income distributions -- taxable as dividend income: Qualified Dividend Income for individuals 0.00% Dividends Received Deduction for corporations 0.00% Payable date Per share June 23, 2003 $0.01078 July 24, 2003 0.00976 Aug. 22, 2003 0.00797 Sept. 22, 2003 0.00771 Oct. 23, 2003 0.00767 Nov. 21, 2003 0.00789 Dec. 22, 2003 0.07256 Jan. 26, 2004 0.01008 Feb. 25, 2004 0.01305 March 26, 2004 0.01429 April 26, 2004 0.01338 May 26, 2004 0.01088 Total $0.18602 Capital gain distribution -- taxable as long-term capital gain. Payable date Per share Dec. 22, 2003 $0.00340 Total distributions* $0.18942 - -------------------------------------------------------------------------------- 31 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Class I Income distributions -- taxable as dividend income: Qualified Dividend Income for individuals 0.00% Dividends Received Deduction for corporations 0.00% Payable date Per share March 26, 2004 $0.02217 April 26, 2004 0.01851 May 26, 2004 0.01578 Total distributions $0.05646 Class Y Income distributions -- taxable as dividend income: Qualified Dividend Income for individuals 0.00% Dividends Received Deduction for corporations 0.00% Payable date Per share June 23, 2003 $0.01489 July 24, 2003 0.01384 Aug. 22, 2003 0.01178 Sept. 22, 2003 0.01218 Oct. 23, 2003 0.01177 Nov. 21, 2003 0.01168 Dec. 22, 2003 0.07660 Jan. 26, 2004 0.01460 Feb. 25, 2004 0.01664 March 26, 2004 0.01808 April 26, 2004 0.01777 May 26, 2004 0.01469 Total $0.23452 Capital gain distribution -- taxable as long-term capital gain. Payable date Per share Dec. 22, 2003 $0.00340 Total distributions* $0.23792 * $0.01 per share represents a tax return of capital. - -------------------------------------------------------------------------------- 32 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT Board Members and Officers Shareholders elect a board that oversees the Fund's operations. The board appoints officers who are responsible for day-to-day business decisions based on policies set by the board. The following is a list of the Fund's board members. Each member oversees 15 Master Trust portfolios and 86 American Express mutual funds. Board members serve until the next regular shareholders' meeting or until he or she reaches the mandatory retirement age established by the board.
Independent Board Members Name, address, age Position held Principal occupation during past five Other directorships with Fund and years length of service - ---------------------------------- ------------------- ----------------------------------------- ----------------------------- Arne H. Carlson Board member Chair, Board Services Corporation 901 S. Marquette Ave. since 1999 (provides administrative services to Minneapolis, MN 55402 boards). Former Governor of Minnesota Age 69 - ---------------------------------- ------------------- ----------------------------------------- ----------------------------- Philip J. Carroll, Jr. Board member Retired Chairman and CEO, Fluor Scottish Power PLC, Vulcan 901 S. Marquette Ave. since 2002 Corporation (engineering and Materials Company, Inc. Minneapolis, MN 55402 construction) since 1998 (construction Age 66 materials/chemicals) - ---------------------------------- ------------------- ----------------------------------------- ----------------------------- Livio D. DeSimone Board member Retired Chair of the Board and Chief Cargill, Incorporated 30 Seventh Street East since 2001 Executive Officer, Minnesota Mining and (commodity merchants and Suite 3050 Manufacturing (3M) processors), General Mills, St. Paul, MN 55101-4901 Inc. (consumer foods), Age 70 Vulcan Materials Company (construction materials/ chemicals), Milliken & Company (textiles and chemicals), and Nexia Biotechnologies, Inc. - ---------------------------------- ------------------- ----------------------------------------- ----------------------------- Anne P. Jones Board member Attorney and Consultant 901 S. Marquette Ave. since 1985 Minneapolis, MN 55402 Age 69 - ---------------------------------- ------------------- ----------------------------------------- ----------------------------- Stephen R. Lewis, Jr.* Board member Retired President and Professor of Valmont Industries, Inc. 901 S. Marquette Ave. since 2002 Economics, Carleton College (manufactures irrigation Minneapolis, MN 55402 systems) Age 65 - ---------------------------------- ------------------- ----------------------------------------- -----------------------------
* Interested person of AXP Partners International Aggressive Growth Fund by reason of being a security holder of FleetBoston Financial Corporation, parent company of Columbia Wanger Asset Management, L.P., one of the fund's subadvisers. - -------------------------------------------------------------------------------- 33 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT
Independent Board Members (continued) Name, address, age Position held Principal occupation during past five Other directorships with Fund and years length of service - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Alan K. Simpson Board member Former three-term United States Senator 1201 Sunshine Ave. since 1997 for Wyoming Cody, WY 82414 Age 72 - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Alison Taunton-Rigby Board member since Founder and Chief Executive Officer, 901 S. Marquette Ave. 2002 RiboNovix, Inc. since 2004; President, Minneapolis, MN 55402 Forester Biotech since 2000; prior to Age 60 that, President and CEO, Aquila Biopharmaceuticals, Inc. - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Board Member Affiliated with AEFC** Name, address, age Position held Principal occupation during past five Other directorships with Fund and years length of service - --------------------------------- -------------------- ----------------------------------------- ----------------------------- William F. Truscott Board member Senior Vice President - Chief 53600 AXP Financial Center since 2001, Vice Investment Officer of AEFC since 2001. Minneapolis, MN 55474 President since Former Chief Investment Officer and Age 43 2002 Managing Director, Zurich Scudder Investments - --------------------------------- -------------------- ----------------------------------------- -----------------------------
** Interested person by reason of being an officer, director and/or employee of AEFC. - -------------------------------------------------------------------------------- 34 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL REPORT The board has appointed officers who are responsible for day-to-day business decisions based on policies it has established. The officers serve at the pleasure of the board. In addition to Mr. Truscott, who is vice president, the Fund's other officers are:
Other Officers Name, address, age Position held Principal occupation during past five Other directorships with Fund and years length of service - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Jeffrey P. Fox Treasurer since Vice President - Investment Accounting, 50005 AXP Financial Center 2002 AEFC, since 2002; Vice President - Minneapolis, MN 55474 Finance, American Express Company, Age 49 2000-2002; Vice President - Corporate Controller, AEFC, 1996-2000 - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Paula R. Meyer President since Senior Vice President and General 596 AXP Financial Center 2002 Manager - Mutual Funds, AEFC, since Minneapolis, MN 55474 2002; Vice President and Managing Age 50 Director - American Express Funds, AEFC, 2000-2002; Vice President, AEFC, 1998-2000 - --------------------------------- -------------------- ----------------------------------------- ----------------------------- Leslie L. Ogg Vice President, President of Board Services Corporation 901 S. Marquette Ave. General Counsel, Minneapolis, MN 55402 and Secretary Age 65 since 1978 - --------------------------------- -------------------- ----------------------------------------- -----------------------------
The SAI has additional information about the Fund's directors and is available, without charge, upon request by calling (800) 862-7919. 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 August 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. - -------------------------------------------------------------------------------- 35 -- AXP U.S. GOVERNMENT MORTGAGE FUND -- 2004 ANNUAL 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. (a) The Registrant has adopted a code of ethics that applies to the Registrant's principal executive officer and principal financial officer. A copy of the code of ethics is filed as an exhibit to this form N-CSR. (b) During the period covered by this report, there were not any amendments to the provisions of the code of ethics adopted in 2(a) above. (c) During the period covered by this report, there were not any implicit or explicit waivers to the provisions of the code of ethics adopted in 2(a). Item 3. The Registrant's board of directors has determined that independent directors Livio D. DeSimone, Anne P. Jones, and Alan G. Quasha, each qualify as audit committee financial experts. Item 4. Principal Accountant Fees and Services Fund - Related Fees (a) Audit Fees. The fees paid for the years ended May 31, to KPMG LLP for professional services rendered for the audits of the annual financial statements for AXP Government Income Series, Inc. were as follows: 2003 - $28,773; 2002 - $30,588 (b) Audit - Related Fees. The fees paid for the years ended May 31, to KPMG LLP for additional professional services rendered in connection with the registrant's security count pursuant to Rule 17f-2 for AXP Government Income Series, Inc. were as follows: 2003 - $579; 2002 - $771 (c) Tax Fees. The fees paid for the years ended May 31, to KPMG LLP for tax compliance related services for AXP Government Income Series, Inc. were as follows: 2003 - $5,450; 2002 - $5,150 (d) All Other Fees. The fees paid for the years ended May 31, to KPMG LLP for additional professional services rendered in connection to proxy filing for AXP Government Income Series, Inc. were as follows: 2003 - None; 2002 - $45 (e) (1) Audit Committee Pre-Approval Policy. Pursuant to Sarbanes-Oxley pre-approval requirements, all services to be performed by KPMG LLP for the registrant and to the registrant's investment adviser and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the registrant must be pre-approved by the audit committee. (e) (2) 100% of the services performed for items (b) through (d) above during 2003 and 2002 were pre-approved by the audit committee with the exception of the 2002 tax fees. (f) Not applicable. (g) Non-Audit Fees. The fees paid for the years ended May 31, by the registrant for non-audit services to KPMG LLP were as follows: 2003 - None; 2002 - None The fees paid for the years ended May 31, to KPMG LLP by the registrant's investment adviser, and any entity controlling, controlled by, or under common control with the adviser that provides ongoing services to the registrant were as follows: 2003 - $71,000; 2002 - $164,000 (h) For the fees disclosed in item (g) above, 100% and 97% of the fees for services performed during 2003 and 2002, respectively, were pre-approved by the audit committee. The exception was a 2002 tax research request by the adviser on defaulted securities for $5,000. The amounts not pre-approved are compatible with maintaining KPMG LLP's independence. 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. 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) Code of ethics as applies to the Registrant's principal executive officer and principal financial officer, as required to be disclosed under Item 2 of Form N-CSR, is attached as Ex. 99.CODE ETH. (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 August 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 August 3, 2004 By /s/ Jeffrey P. Fox ------------------ Jeffrey P. Fox Treasurer and Principal Financial Officer Date August 3, 2004 EX-99.CODE ETH 2 code-ethics.txt CODE OF ETHICS AMERICAN EXPRESS FUNDS PREFERRED MASTER TRUST GROUP (THE AXP FUNDS) CODE OF ETHICS FOR PRINCIPAL EXECUTIVE AND SENIOR FINANCIAL OFFICERS I. Purpose of the Code; Covered Officers This code of ethics ("Code") for the AXP Funds (collectively, "Funds," and each, "Fund") applies to the Funds' Principal Executive Officer and Principal Financial Officer (the "Covered Officers," each of whom is identified in Exhibit A) for the purpose of promoting, in connection with his or her duties: o honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; o full, fair, accurate, timely, and understandable disclosure in reports and documents that a Fund files with, or submits to, the Securities and Exchange Commission ("SEC") and in other public communications made by the Funds; o compliance with laws and governmental rules and regulations applicable to the conduct of the Funds' business and their financial reporting; o the prompt internal reporting of violations of the Code to an appropriate person or persons identified in the Code; and o accountability for adherence to the Code. Each Covered Officer should adhere to a high standard of business ethics and should be sensitive to situations that may give rise to actual as well as apparent conflicts of interest. II. Covered Officers Should Handle Ethically Actual and Apparent Conflicts of Interest A "conflict of interest" occurs when a Covered Officer's private interest interferes with the interests of, or his or her service to, the Funds. For example, a conflict of interest would arise if a Covered Officer, or a member of his or her family, receives improper personal benefits as a result of his or her position with the Funds. Certain conflicts of interest arise out of the relationships between Covered Officers and the Funds and already are subject to conflict of interest provisions in the Investment Company Act of 1940 ("Investment Company Act") and the Investment Advisers Act of 1940 ("Investment Advisers Act"). For example, Covered Officers may not individually engage in certain transactions, such as the purchase or sale of securities or other property, with the Funds because of their status as "affiliated persons" of the Funds. The compliance programs and -1- procedures of the Funds and of American Express Financial Corporation ("AEFC"), the investment adviser to the Funds, are designed to prevent, or identify and correct, violations of these provisions. This Code does not, and is not intended to, repeat or replace these programs and procedures, and such conflicts fall outside of the parameters of this Code. Although typically not presenting an opportunity for improper personal benefit, conflicts arise from, or as a result of, the contractual relationship between the Funds and AEFC, of which the Covered Officers are also officers or employees. As a result, this Code recognizes that the Covered Officers will, in the normal course of their duties, whether formally for the Funds or for AEFC, or for both, be involved in establishing policies and implementing decisions that will have different effects on AEFC and the Funds. The participation of the Covered Officers in such activities is inherent in the contractual relationship between the Funds and AEFC and is consistent with the performance by the Covered Officers of their duties as officers of the Funds. Thus, if performed in conformity with the provisions of the Investment Company Act and the Investment Advisers Act, such activities will be deemed to have been handled ethically. Other conflicts of interest are covered by the Code, even if such conflicts of interest are not subject to provisions in the Investment Company Act and the Investment Advisers Act. The following list provides examples of conflicts of interest under the Code, but Covered Officers should keep in mind that these examples are not exhaustive. The overarching principle is that the personal interest of a Covered Officer should not be placed improperly before the interest of the Funds. Each Covered Officer must: o not use his or her personal influence or personal relationships improperly to influence investment decisions or financial reporting by the Funds whereby the Covered Officer would benefit personally to the detriment of the Funds; o not cause the Funds to take action, or fail to take action, for the individual personal benefit of the Covered Officer rather than the benefit of the Funds; o not use material non-public knowledge of portfolio transactions made or contemplated for the Company to trade personally or cause others to trade personally in contemplation of the market effect of such transactions; III. Disclosure and Compliance o Each Covered Officer should familiarize himself or herself with the disclosure requirements generally applicable to the Funds; o Each Covered Officer should not knowingly misrepresent, or cause others to misrepresent, facts about the Funds to others, whether within or outside the Funds, including to the Funds' directors and auditors, and to governmental regulators and self-regulatory organizations; o Each Covered Officer should, to the extent appropriate within his or her area of responsibility, consult with other officers and employees of the Funds and AEFC with the goal of promoting full, fair, accurate, timely, and understandable disclosure in the reports -2- and documents the Funds file with, or submit to, the SEC and in other public communications made by the Funds; and o It is the responsibility of each Covered Officer to promote compliance with the standards and restrictions imposed by applicable laws, rules, and regulations. IV. Reporting and Accountability Each Covered Officer must: o upon adoption of the Code (or thereafter as applicable, upon becoming a Covered Officer), affirm in writing to the Board that he or she has received, read, and understands the Code; o annually thereafter affirm to the Board that he or she has complied with the requirements of the Code; o not retaliate against any other Covered Officer or any employee of AEFC or its affiliated persons for reports of potential violations that are made in good faith; and o notify the general counsel of the Funds ("Funds General Counsel") promptly if he or she knows of any violation of this Code. Failure to do so is itself a violation of this Code. The Funds General Counsel is responsible for applying this Code to specific situations in which questions are presented under it and has the authority to interpret this Code in any particular situation. However, any approvals or waivers sought by a Covered Officers will be considered by the Board Effectiveness Committees (the "Committees"). The Funds will follow these procedures in investigating and enforcing this Code: o The Funds General Counsel will take all appropriate action to investigate any potential violations reported to him; o If, after such investigation, the Funds General Counsel believes that no violation has occurred, he or she is not required to take any further action; o Any matter that the Funds General Counsel believes is a violation will be reported to the Committees; o If the Committees concur that a violation has occurred, they will inform the Board, and the Board will consider appropriate action, which may include review of, and appropriate modifications to, applicable policies and procedures; notification to appropriate personnel of the investment adviser or its board; or a recommendation to dismiss the Covered Officer; o The Committees will be responsible for granting waivers, as appropriate; and o Any changes to or waivers of this Code will, to the extent required, be disclosed as provided by SEC rules. V. Other Policies and Procedures This Code shall be the sole code of ethics adopted by the Funds for purposes of Section 406 of the Sarbanes-Oxley Act and the rules and forms applicable to registered investment companies thereunder. Insofar as other policies or procedures of the Funds, AEFC, or any -3- affiliate of AEFC govern or purport to govern the activities of the Covered Officers, they are superseded by this Code to the extent that they overlap or conflict with the provisions of this Code. AEFC's code of ethics under Rule 17j-1 under the Investment Company Act is a separate requirement applying to the Covered Officers and others, and is not part of this Code. VI. Amendments Any amendments to this Code, other than amendments to Exhibit A, must be approved or ratified by a majority vote of each Fund's Board, including a majority of its independent directors. Date: July, 2003 -4- Exhibit A Persons Covered by this Code of Ethics Paula R. Meyer President Jeffrey P. Fox Treasurer -5- EX-99.CERT 3 ex99-cert.txt CERTIFICATION PURSUANT TO 270.30A-2 OF THE INVESTMENT COMPANY ACT OF 1940 Certification Pursuant to 270.30a-2 of the Investment Company Act of 1940 I, Paula Meyer, certify that: 1. I have reviewed this report on Form N-CSR of AXP Government Income Series, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-2(c) under the Investment Company Act of 1940) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of a date within 90 days prior to the filing date of this report based on such evaluation and disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal half-year (the registrant's second fiscal half-year in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: July 30, 2004 /s/ Paula R. Meyer -------------------------------- Name: Paula R. Meyer Title: President and Chief Executive Officer Certification Pursuant to 270.30a-2 of the Investment Company Act of 1940 I, Jeffrey Fox, certify that: 1. I have reviewed this report on Form N-CSR of AXP Government Income Series, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-2(c) under the Investment Company Act of 1940) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of a date within 90 days prior to the filing date of this report based on such evaluation and disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal half-year (the registrant's second fiscal half-year in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: July 30, 2004 /s/ Jeffrey P. Fox -------------------------------- Name: Jeffrey P. Fox Title: Treasurer and Chief Financial Officer EX-99.906 CERT 4 ex99-906cert.txt CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION AXP Government Income Series, Inc. (the Registrant) Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Each of the undersigned below certifies that 1. This report on Form N-CSR of the Registrant (the Report) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Date: July 30, 2004 /s/ Paula R. Meyer ------------------ Paula R. Meyer President and Chief Executive Officer Date: July 30, 2004 /s/ Jeffrey P. Fox ------------------ Jeffrey P. Fox Treasurer and Chief Financial Officer A SIGNED ORIGINAL OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906, OR OTHER DOCUMENT AUTHENTICATING, ACKNOWLEDGING, OR OTHERWISE ADOPTING THE SIGNATURE THAT APPEARS IN TYPED FORM WITHIN ELECTRONIC VERSION OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906, HAS BEEN PROVIDED TO THE REGISTRANT AND WILL BE RETAINED BY THE REGISTRANT AND FURNISHED TO THE SECURITIES AND EXCHANGE COMMISSION OR ITS STAFF UPON REQUEST. This certification is being furnished to the Commission solely pursuant to 18 U.S.C. Section 1350 and is not being filed as part of the Form N-CSR filed with the Commission. -----END PRIVACY-ENHANCED MESSAGE-----