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, 2005 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 Performance Summary 4 Questions & Answers with Portfolio Management 5 The Fund's Long-term Performance 8 Investments in Securities 10 Financial Statements (Portfolio) 15 Notes to Financial Statements (Portfolio) 18 Report of Independent Registered Public Accounting Firm (Portfolio) 23 Financial Statements (Fund) 24 Notes to Financial Statements (Fund) 27 Report of Independent Registered Public Accounting Firm (Fund) 37 Federal Income Tax Information 38 Fund Expenses Example 41 Board Members and Officers 43 Approval of Investment Management Services Agreement 46 Proxy Voting 47 [DALBAR LOGO] American Express(R) Funds' reports to shareholders have been awarded the Communications Seal from Dalbar Inc., an independent financial services research firm. The Seal recognizes communications demonstrating a level of excellence in the industry. -------------------------------------------------------------------------------- 2 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Fund Snapshot AT MAY 31, 2005 PORTFOLIO MANAGERS Portfolio managers Since Years in industry Jamie Jackson* 6/03 17 Scott Kirby* 6/01 24 * The Fund is managed by a team of portfolio managers led by Jamie Jackson and 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 by class A: 8/19/85 B: 3/20/95 C: 6/26/00 I: 3/4/04 Y: 3/20/95 Ticker symbols by class A: IFINX B: ISHOX C: AXFCX I: -- Y: IDFYX Total net assets $1.638 billion Number of holdings 176 Weighted average life(1) 2.3 years Effective duration(2) 1.6 years Weighted average bond rating(3) AAA (1) Weighted average life measures a bond's maturity, which takes into consideration the possibility that the issuer may call the bond before its maturity date. (2) 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. (3) Weighted average bond rating represents the average credit quality of the underlying bonds in the portfolio. SECTOR COMPOSITION Percentage of portfolio assets [PIE CHART] U.S. government obligations & agencies 46.8% Mortgage-backed securities 42.5% CMBS/ABS* 5.7% Short-term securities** 5.0% * Commercial mortgage-backed securities/Asset-backed securities ** Of the 5.0%, 4.5% is due to security lending activity and 0.5% is the Portfolio's cash equivalent position. CREDIT QUALITY SUMMARY Percentage of bond portfolio assets 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. STYLE MATRIX Shading within the style matrix indicates areas in which the Fund generally invests. DURATION SHORT INT. LONG X HIGH MEDIUM QUALITY LOW 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 -- 2005 ANNUAL REPORT Performance Summary [BAR CHART] PERFORMANCE COMPARISON For the year ended May 31, 2005 +1.92% +1.88% +2.03% +1.92% = AXP Short Duration U.S. Government Fund Class A (excluding sales charge) +1.88% = Lehman Brothers 1-3 Year Government Index (unmanaged) +2.03% = Lipper Short U.S. Government Funds Index (see "The Fund`s Long-term Performance" for Index descriptions)The performance information shown represents past performance and is not a guarantee of future results. The investment return and principal value of your investment 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 (800) 862-7919 or visiting www.americanexpress.com/funds. 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 other classes may vary from that shown because of differences in expenses. The indices do not reflect the effects of sales charges, expenses (excluding Lipper) and taxes.
AVERAGE ANNUAL TOTAL RETURNS Class A Class B Class C Class I Class Y (Inception dates) (8/19/85) (3/20/95) (6/26/00) (3/4/04) (3/20/95) After After NAV(1) POP(2) NAV(1) CDSC(3) NAV(1) CDSC(4) NAV(5) NAV(6) at May 31, 2005 1 year +1.92% -2.91% +1.16% -3.81% +1.16% +0.16% +2.06% +2.10% 3 years +2.17% +0.52% +1.41% +0.11% +1.40% +1.40% N/A +2.34% 5 years +4.45% +3.43% +3.66% +3.31% N/A N/A N/A +4.62% 10 years +4.78% +4.27% +3.98% +3.98% N/A N/A N/A +4.93% Since inception +6.44% +6.18% +4.25% +4.25% +3.47% +3.47% +0.94% +5.21% at June 30, 2005 1 year +2.08% -2.77% +1.32% -3.66% +1.32% +0.33% +2.22% +2.26% 3 years +2.06% +0.42% +1.30% +0.00% +1.29% +1.29% N/A +2.23% 5 years +4.20% +3.19% +3.42% +3.06% +3.38% +3.38% N/A +4.37% 10 years +4.72% +4.21% +3.92% +3.92% N/A N/A N/A +4.87% Since inception +6.42% +6.16% +4.23% +4.23% +3.43% +3.43% +1.03% +5.18%
(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 eligible investors only, currently limited to AXP Portfolio Builder Series funds, six affiliated funds-of-funds. (6) Sales charge is not applicable to these shares. Shares available to institutional investors only. -------------------------------------------------------------------------------- 4 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Questions & Answers WITH PORTFOLIO MANAGEMENT Below, Portfolio Managers Jamie Jackson and Scott Kirby discuss the Fund's positioning and results for the annual period ended May 31, 2005. Q: How did AXP Short Duration U.S. Government Fund perform for the fiscal year? A: AXP Short Duration U.S. Government Fund's Class A shares (excluding sales charge) rose 1.92% for the 12 months ended May 31, 2005. The Fund outperformed the Lehman Brothers 1-3 Year Government Index (Lehman Index), which gained 1.88%. The Lipper Short U.S. Government Funds Index, representing the Fund's peer group, rose 2.03% over the same time frame. To help keep the Fund competitive with its peers, American Express Financial Corporation implemented a new expense cap on June 1, 2005, reducing the maximum level of expenses borne by Class A shareholders from 0.93% of net assets per fiscal year to a maximum 0.89% of net assets per year. Q: What factors most significantly affected Fund performance during the annual period? A: The Fund's returns were helped primarily by effective yield curve positioning, duration positioning and sector allocation, despite a challenging environment for short-term fixed income investors. As the Federal Reserve Board (the Fed) raised interest rates eight times during the annual period, bringing the targeted federal funds rate to 3%, the difference in yields between short- and long-term maturities narrowed or flattened dramatically. Indeed, the two-year Treasury yield rose 98 basis points over the 12 months to a level of 3.60%. The five-year and 10-year Treasury yields actually fell 10 basis points and 72 basis points to levels of 3.76% and 4%, respectively. We had prudently positioned the portfolio early in the reporting period for just such a yield curve flattening scenario, and thus the Fund outperformed the Lehman Index even with this significant increase in short-term yields. We kept the Fund's duration shorter than the Lehman Index. SEC YIELDS At May 31, 2005 by class A: 2.87% B: 2.27% C: 2.27% I: 3.40% Y: 3.19% At June 30, 2005 by class A: 3.05% B: 2.45% C: 2.45% I: 3.52% Y: 3.34% The Securities and Exchange Commission (SEC) yield is calculated by dividing anticipated net investment income during a 31-day period by the public offering price (POP) per share on the last day of the period, and converting the results to yearly figures. See Average Annual Total Returns on page 4 for additional performance information. -------------------------------------------------------------------------------- 5 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Questions & Answers [BEGIN CALLOUT QUOTE]> We had prudently positioned the portfolio for a yield curve flattening scenario, and thus the Fund outperformed the Lehman Index even with a significant increase in short-term yields. [END CALLOUT QUOTE] The spread sectors -- agencies, asset-backed securities and mortgage-backed securities -- outperformed U.S. Treasuries for the annual period. As the Fund had greater exposure to these spread sectors compared to the Lehman Index, such allocation further boosted its relative results. Mortgages, where the Fund had its greatest allocation, performed particularly well, supported by a contained interest rate change that muted overall volatility. Exposure to asset-backed securities and AAA-rated commercial mortgage-backed securities (CMBS) also was a positive contributor to the Fund's annual performance. Detracting modestly from Fund performance was the Fund's focus within the mortgage sector on higher coupon bonds. While these bonds offered both attractive yields and potential protection from higher rates, lower coupon bonds outperformed for the 12 months. The Fund modestly lagged its Lipper peer group due to its comparatively defensive positioning, generally maintaining a more conservative risk profile than many of its peers. Q: What changes did you make to the portfolio and how is it currently positioned? A: During the annual period, we increased the Fund's allocation to asset-backed securities, CMBS and agencies, and we reduced its allocation to mortgages, taking profits from several securities that had performed well. Within the mortgage sector, we added some lower coupons and some longer-maturity securities. Still, we continued to focus within the sector on higher coupons and more seasoned bonds, as we expect these securities to outperform in a rising rate environment. We also continued to hold those pools of mortgages with historically lower-than-average prepayment risks, which we have owned for some time now. Not only do these pools continue to offer attractive yields, but also, as they age, are transitioning well into the benefits of seasoning that the market is increasingly favoring. During the second half of the fiscal year, we sold some of the Fund's positions in collateralized mortgage obligations and focused on holding those that we believe will perform better as rates rise. -------------------------------------------------------------------------------- 6 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Questions & Answers [BEGIN CALLOUT QUOTE]> We intend to continue to position the Fund for ongoing economic recovery and a higher interest rate environment. [END CALLOUT QUOTE] Collateralized mortgage obligations are attractively structured mortgage-backed securities in that they separate mortgage pools into short-, medium- and long-term cash flows. As the yield curve flattened dramatically, we also removed some of the Fund's yield curve flattening bias and reduced the portfolio's sensitivity to changes in interest rates. While we kept duration shorter than the Lehman Index throughout the annual period, we made minor adjustments to portfolio duration and yield curve positioning as market conditions changed. Overall, the opportunistic changes we made in response to valuations or market developments resulted in an annual portfolio turnover rate of 169%. Q: How do you intend to manage the Fund in the coming months? A We believe the U.S. economic recovery will continue and interest rates will move higher. We further believe these themes are likely to continue to weigh on the fixed income markets through the summer. We believe there may be cause for the Fed to deviate from its measured pace and increase interest rates more vigorously than the market currently anticipates. Indeed, we will continue to monitor inflation numbers, as they remain the key indicator for the economy in the coming months. In addition, we anticipate that the yield curve may flatten a bit more in the near term but that after an extended period of yield curve flattening, the yield spread between short- and long-term maturities may stabilize somewhat in the months ahead with more parallel shifts across the yield curve. Based on this view, we intend to maintain the Fund's duration shorter than the Lehman Index for the near term. Within mortgage-backed securities, we expect to maintain a conservative risk posture. Should rates move higher, we would seek select opportunities to remove some of the Fund's defensive overall positioning. As always, however, our strategy is to provide added portfolio value with a moderate amount of risk. Quality issues and security selection remain a priority as we continue to seek attractive buying opportunities. -------------------------------------------------------------------------------- 7 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT The Fund's Long-term Performance The chart on the facing page illustrates the total value of an assumed $10,000 investment in AXP Short Duration U.S. Government Fund Class A shares (from 6/1/95 to 5/31/05) 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 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 (800) 862-7919 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. DISTRIBUTION SUMMARY The table below details the Fund's income and capital gain distributions for the fiscal years shown. More information on the other classes can be found in the Financial Highlights section of this report's Notes to Financial Statements. Class A Short-term Long-term Fiscal year ended Income capital gains capital gains Total May 31, 2005 $0.12 $-- $-- $0.12 May 31, 2004 0.11 -- -- 0.11 May 31, 2003 0.15 -- -- 0.15 May 31, 2002 0.20 -- -- 0.20 May 31, 2001 0.27 -- -- 0.27 -------------------------------------------------------------------------------- 8 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT [LINE CHART]
VALUE OF A HYPOTHETICAL $10,000 INVESTMENT IN AXP SHORT DURATION U.S. GOVERNMENT FUND AXP Short Duration U.S. Government Fund Class A (includes sales charge) $ 9,525 $10,081 $10,861 $11,746 $12,226 $12,225 $13,471 $14,248 $14,946 $14,910 $15,196 Lehman Brothers 1-3 Year Government Index(1) $10,000 $10,528 $11,224 $12,006 $12,640 $13,150 $14,472 $15,399 $16,269 $16,376 $16,684 Lipper Short U.S. Government Funds Index(2) $10,000 $10,474 $11,155 $11,895 $12,468 $12,928 $14,193 $14,937 $15,624 $15,635 $15,953 `95 `96 `97 `98 `99 `00 `01 `02 `03 `04 `05
COMPARATIVE RESULTS Results at May 31, 2005 Since 1 year 3 years 5 years 10 years inception(3) AXP Short Duration U.S Government Fund (includes sales charge) Class A Cumulative value of $10,000 $9,709 $10,157 $11,837 $15,196 $32,745 Average annual total return -2.91% +0.52% +3.43% +4.27% +6.18% The Lehman Brothers 1-3 Year Government Index(1) Cumulative value of $10,000 $10,188 $10,835 $12,690 $16,684 $35,005 Average annual total return +1.88% +2.71% +4.88% +5.25% +6.55% The Lipper Short U.S. Government Funds Index(2) Cumulative value of $10,000 $10,203 $10,681 $12,337 $15,953 N/A Average annual total return +2.03% +2.22% +4.29% +4.78% N/A
Results for other share classes can be found on page 4. (1) The 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 includes the 30 largest short U.S. government funds tracked by Lipper Inc. The index's returns include net reinvested dividends (3) Fund data is from Aug. 19, 1985. Lehman Brothers 1-3 Government Index data is from Sept. 1, 1985. The Fund began operating before the inception of the Lipper peer group. -------------------------------------------------------------------------------- 9 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Investments in Securities Government Income Portfolio May 31, 2005 (Percentages represent value of investments compared to net assets) Bonds (100.3%) Issuer Coupon Principal Value(a) rate amount U.S. government obligations & agencies (49.4%) Federal Farm Credit Bank 07-17-06 2.13% $15,100,000 $14,847,830 10-02-06 2.38 14,600,000 14,345,201 Federal Home Loan Bank 03-13-06 2.50 24,785,000 24,580,152 05-15-06 3.00 25,570,000 25,415,353 05-22-06 2.88 90,080,000 89,409,984 09-15-06 3.50 43,500,000 43,379,766 04-18-08 4.13 22,660,000 22,819,051 Federal Home Loan Mtge Corp 09-15-06 3.63 54,500,000 54,447,026 01-30-07 3.00 10,950,000 10,794,083 10-15-08 5.13 17,485,000 18,154,868 Federal Natl Mtge Assn 02-15-06 5.50 15,500,000 15,695,254 02-28-06 2.25 6,770,000 6,706,504 04-13-06 2.15 4,500,000 4,444,259 03-02-07 3.00 16,000,000 15,785,040 05-15-08 6.00 17,850,000 18,877,607 U.S. Treasury 11-30-06 2.88 59,585,000 59,007,741 01-31-07 3.13 28,790,000 28,584,209 02-15-07 2.25 20,683,000(l) 20,240,260 02-28-07 3.38 61,600,000(b) 61,395,488 08-15-07 2.75 28,775,000(b) 28,254,575 08-15-07 3.25 70,585,000 70,072,128 02-15-08 3.38 107,400,000 106,665,813 04-15-10 4.00 3,720,000 3,758,361 05-15-10 3.88 3,325,000 3,343,184 08-15-14 4.25 10,000,000 10,189,450 02-15-15 4.00 17,500,000(b) 17,458,980 05-15-15 4.13 20,000,000 20,193,760 Total 808,865,927 Bonds (continued) Issuer Coupon Principal Value(a) rate amount Commercial mortgage-backed(f)/ Asset-backed securities (6.0%) AmeriCredit Automobile Receivables Trust Series 2004-CA Cl A3 (AMBAC) 03-06-09 3.00% $12,000,000(m) $11,893,128 Centex Home Equity Series 2001-A Cl A4 (MBIA) 07-25-29 6.47 2,069,024(m) 2,083,474 Federal Natl Mtge Assn 01-01-09 5.74 3,197,929 3,342,876 10-01-09 7.11 4,265,766 4,712,926 11-25-33 2.91 8,121,764 8,096,384 Honda Auto Receivables Owner Trust Series 2005-1 Cl A3 10-21-08 3.53 5,200,000 5,174,468 LB-UBS Commercial Mtge Trust Series 2004-C6 Cl A2 08-15-29 4.19 6,165,000 6,128,195 Morgan Stanley Capital I Series 2004-IQ8 Cl A2 06-15-40 3.96 12,170,000 12,092,686 Nissan Auto Receivables Owner Trust Series 2005-A Cl A3 10-15-08 3.54 6,500,000 6,461,065 Residential Asset Securities Series 2002-KS1 Cl AI4 (AMBAC) 11-25-29 5.86 7,051,765(m) 7,054,374 Student Loan Mtge Assn 06-25-05 2.25 16,325,000(d,n) 16,293,422 03-15-33 2.16 14,800,000(d) 14,721,856 Total 98,054,854 Mortgage-backed securities (44.9%)(f,g) Bear Stearns Alternative Trust Series 2005-5 Cl 1A1 10-25-34 3.31 8,575,000(n) 8,575,000 Chaseflex Trust Series 2005-2 Cl 2A1 05-25-35 6.00 18,000,000 18,407,880 Countrywide Alternative Loan Trust Series 2005-6CB Cl 1A1 04-25-35 7.50 2,698,743 2,837,591 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 10 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Home Loan Mtge Corp 09-01-09 6.50% $348,954 $365,523 10-01-10 7.00 1,068,969 1,122,405 03-01-12 7.50 4,100,184 4,372,063 07-01-12 5.50 495,802 508,682 02-01-13 5.00 3,536,956 3,594,310 04-01-13 4.50 2,257,106 2,265,638 04-01-13 5.00 3,298,959 3,353,720 05-01-13 4.50 20,698,511 20,777,186 06-01-15 7.50 7,938,208 8,512,697 04-01-17 6.50 25,641,986 26,819,507 11-01-17 5.00 5,180,554 5,247,409 11-01-17 5.50 9,216,428 9,472,803 09-01-19 5.50 4,371,677 4,492,221 07-01-24 8.00 556,987 603,690 01-01-25 9.00 783,779 866,681 06-01-25 8.00 600,494 650,554 08-01-25 8.00 154,039 166,880 05-01-26 9.00 1,204,918 1,329,911 01-01-34 5.50 4,190,036 4,255,140 09-01-34 6.50 17,812,928 18,496,292 10-01-34 4.99 7,126,160(k) 7,249,514 Collateralized Mtge Obligation 06-15-16 7.00 12,330,453 13,131,099 12-15-28 5.50 2,500,000 2,574,854 Interest Only 12-15-12 12.70 11,685,265(i) 633,622 02-15-14 7.40 10,663,503(i) 789,739 01-01-20 0.00 15,747(i) 2,997 03-15-25 0.00 11,474,020(i) 814,832 Interest Only/Inverse Floater 11-15-19 0.00 10,457,955(h,i) 1,020,107 03-15-32 0.00 3,132,661(h,i) 245,300 Federal Natl Mtge Assn 09-01-07 8.50 96,920 97,902 10-01-07 7.50 391,749 404,236 12-01-08 7.50 640,396 660,809 05-01-09 7.50 1,460,733 1,507,294 01-01-10 5.00 1,195,123 1,207,786 07-01-11 7.50 717,868 760,238 11-01-12 5.00 738,258 749,372 12-01-12 5.00 1,182,985 1,207,452 04-01-13 5.50 13,406,118 13,754,364 05-01-13 5.00 17,122,610 17,384,514 05-01-13 5.50 4,134,539 4,261,387 05-01-13 6.00 897,745 931,270 06-01-13 5.00 2,701,912 2,743,251 Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn (cont.) 08-01-13 4.50% $8,472,112 $8,493,494 10-01-13 6.00 2,535,385 2,630,068 12-01-13 5.50 1,531,099 1,575,614 01-01-14 5.50 795,923 819,064 01-01-14 6.00 502,316 521,075 03-01-14 6.00 992,198 1,029,251 06-01-14 6.50 8,167,605 8,526,084 08-01-14 6.50 419,014 437,416 09-01-14 6.00 1,811,252 1,889,439 08-01-15 5.50 17,580,499 18,091,633 06-01-17 6.00 13,398,352 13,921,488 06-01-17 6.50 3,280,793 3,424,583 06-01-17 7.00 728,152 765,062 07-01-17 6.00 29,575,931 30,753,914 08-01-17 5.50 20,003,895 20,595,159 08-01-17 6.00 12,263,066 12,728,076 08-01-17 7.00 1,339,976 1,407,897 09-01-17 6.00 268,582 278,438 11-01-17 5.50 14,381,350 14,803,754 11-01-17 6.00 1,438,687 1,505,922 01-01-18 5.50 1,794,336 1,846,475 02-01-18 5.50 13,472,643 13,866,808 04-01-18 5.50 12,067,152 12,421,069 05-01-18 5.50 1,248,095 1,283,031 06-01-18 5.50 844,439 868,145 11-01-21 8.00 224,752 243,212 05-01-23 5.50 14,818,874 15,134,566 11-01-23 6.00 1,740,669 1,799,493 06-01-24 9.00 550,225 596,120 02-01-26 6.00 112,068 115,735 05-01-26 7.50 854,686 918,774 12-01-28 7.00 2,492,531 2,640,986 04-01-31 6.50 4,120,581 4,317,183 09-01-31 7.50 3,197,218 3,433,956 11-01-31 6.50 1,556,965 1,628,553 06-01-32 6.50 4,086,221 4,251,286 09-01-32 6.50 2,234,683 2,324,954 11-01-32 7.00 187,302 197,794 03-01-33 6.00 17,044,445 17,549,233 04-01-33 4.58 9,605,193(k) 9,623,868 05-01-33 4.59 8,400,378(k) 8,419,305 06-01-33 5.50 17,264,703 17,525,238 07-01-33 4.97 6,690,629(k) 6,690,737 08-01-33 3.20 863,398(k) 872,523 08-01-33 4.11 3,300,972(k) 3,275,946 09-01-33 6.00 7,218,488 7,425,943 11-01-33 7.00 11,292,850 11,923,556 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 11 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn (cont.) 02-01-34 5.50% $19,658,285 $19,954,941 03-01-34 5.00 16,327,682 16,344,470 06-01-34 5.50 5,039,768 5,112,222 07-01-34 5.50 4,390,129 4,453,243 08-01-34 4.53 5,133,393(k) 5,144,327 09-01-34 4.86 6,617,038(k) 6,692,600 09-01-34 5.00 7,357,432 7,360,921 10-01-34 5.07 7,206,755(k) 7,346,278 10-01-34 6.00 8,028,761(e) 8,256,259 11-01-34 5.07 6,916,741(k) 7,006,936 02-01-35 4.65 8,289,502(k) 8,354,922 02-01-35 5.50 4,873,710 4,943,777 04-01-35 5.50 5,693,075 5,777,551 06-01-35 6.00 4,000,000(e) 4,110,000 Collateralized Mtge Obligation 07-25-23 5.50 21,000,000 21,413,995 12-25-26 8.00 3,977,860 4,217,088 06-25-33 5.34 2,470,772(k) 2,521,509 04-25-34 5.50 4,753,593 4,862,084 Interest Only 12-25-12 13.29 9,669,866(i) 504,161 11-25-13 10.08 10,950,000(i) 912,566 08-01-18 0.00 9,485(i) 2,200 01-15-20 0.00 359,986(i) 72,773 07-25-22 22.30 1,124,339(i) 189,136 03-25-23 7.94 2,831,605(i) 442,083 12-25-31 1.19 3,530,412(i) 569,240 02-25-32 0.00 5,925,403(i) 482,278 Principal Only 06-25-21 2.08 54,295(j) 50,967 First Horizon Alternative Mtge Securities Series 2004-AA4 Cl A1 10-25-34 5.43 4,582,404 4,677,534 GMAC Mtge Corporation Loan Trust Series 2004-AR2 Cl 3A 08-19-34 4.44 7,161,956(k) 7,159,314 Govt Natl Mtge Assn 08-15-13 6.00 1,651,900 1,719,618 09-15-14 6.00 8,770,230 9,129,903 Collateralized Mtge Obligation Interest Only 03-20-29 7.17 6,198,499(i) 504,369 GSR Mtge Loan Trust Series 2005-AR2 Cl 2A1 04-25-35 4.89 5,884,667(k) 5,927,625 Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Harborview Mtge Loan Trust Series 2004-4 Cl 3A 06-19-34 2.98% $9,063,098(k) $8,863,351 Morgan Stanley Mtge Loan Trust Series 2004-10AR Cl 2A1 11-25-34 5.14 3,496,461(k) 3,549,817 Structured Asset Securities Series 2004-12H Cl 2A 04-25-34 5.56 6,542,653(k) 6,597,164 Washington Mutual Series 2002-AR15 Cl A5 12-25-32 4.38 6,964,171(k) 6,947,043 Series 2005-AR3 Cl A2 03-25-35 4.66 8,603,692(k) 8,743,416 Wells Fargo Mtge Backed Securities Trust Series 2005-5 Cl 2A1 05-25-35 5.50 5,990,888 6,095,863 Series 2005-AR2 03-25-35 4.56 4,593,901(k) 4,660,283 Total 736,291,469 Total bonds (Cost: $1,644,533,563) $1,643,212,250 Short-term securities (5.3%)(c) Issuer Effective Amount Value(a) yield payable at maturity U.S. government agencies (3.6%) Federal Home Loan Mtge Corp Disc Nt 06-13-05 2.79% $5,300,000 $5,294,672 Federal Natl Mtge Assn Disc Nts 06-02-05 2.76 2,400,000 2,399,632 06-13-05 2.79 28,500,000 28,471,352 06-14-05 2.79 23,100,000 23,074,993 Total 59,240,649 Commercial paper (1.7%) Deutsche Bank Financial LLC 06-01-05 3.07 27,300,000 27,297,672 Total short-term securities (Cost: $86,543,736) $86,538,321 Total investments in securities (Cost: $1,731,077,299)(o) $1,729,750,571 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 12 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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, 2005, security was partially or fully on loan. See Note 5 to the financial statements. (c) Cash collateral received from security lending activity is invested in short-term securities and represents 4.8% of net assets. See Note 5 to the financial statements. 0.5% of net assets is the Portfolio's cash equivalent position (d) Represents a security sold under Rule 144A, which is exempt from registration under the Securities Act of 1933, as amended. This security has been determined to be liquid under guidelines established by the Fund's Board of Directors. These securities may be resold in transactions exempt from registration, normally to qualified institutional buyers. At May 31, 2005, the value of these securities amounted to $31,015,278 or 1.9% of net assets. (e) At May 31, 2005, the cost of securities purchased, including interest purchased, on a when-issued and/or other forward-commitment basis was $12,381,219. (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 at May 31, 2005: Security Principal Settlement Proceeds Value amount date receivable Federal Natl Mtge Assn 06-01-20 5.50% $39,000,000 6-16-05 $39,871,406 $40,035,918 06-01-35 5.50 36,000,000 6-13-05 36,232,344 36,483,768 06-01-35 6.50 12,000,000 6-13-05 12,481,875 12,465,000 (h) 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, 2005. At May 31, 2005, the value of inverse floaters represented 0.1% of net assets. (i) Interest only represents securities that entitle holders to receive only interest payments on the underlying mortgages. The yield to maturity of an interest only is extremely sensitive to the rate of principal payments on the underlying mortgage assets. A rapid (slow) rate of principal repayments may have an adverse (positive) effect on yield to maturity. The principal amount shown is the notional amount of the underlying mortgages. Interest rate disclosed represents yield based upon the estimated timing and amount of future cash flows at May 31, 2005. (j) 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 at May 31, 2005. (k) Adjustable rate mortgage; interest rate varies to reflect current market conditions; rate shown is the effective rate on May 31, 2005. -------------------------------------------------------------------------------- 13 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Notes to investments in securities (continued) (l) Partially pledged as initial deposit on the following open interest rate futures contracts (see Note 4 to the financial statements): Type of security Notional amount Purchase contracts U.S. Treasury Note, Sept. 2005, 2-year $58,800,000 U.S. Long Bond, Sept. 2005, 20-year 8,600,000 Sale contracts U.S. Treasury Note, Sept. 2005, 5-year 61,000,000 (m) The following abbreviations are used in the portfolio security descriptions to identify the insurer of the issue: AMBAC -- Ambac Assurance Corporation MBIA -- MBIA Insurance Corporation (n) Interest rate varies either based on a predetermined schedule or to reflect current market conditions; rate shown is the effective rate on May 31, 2005 (o) At May 31, 2005, the cost of securities for federal income tax purposes was $1,732,630,510 and the aggregate gross unrealized appreciation and depreciation based on that cost was: Unrealized appreciation $ 7,913,785 Unrealized depreciation (10,793,724) ----------- Net unrealized depreciation $ (2,879,939) ------------ How to find information about the Fund's portfolio holdings (i) The Fund files its complete schedule of portfolio holdings with the Securities and Exchange Commission (Commission) for the first and third quarters of each fiscal year on Form N-Q; (ii) The Fund's Forms N-Q are available on the Commission's website at http://www.sec.gov; (iii) The Fund's Forms N-Q may be reviewed and copied at the Commission's Public Reference Room in Washington, DC (information on the operations of the Public Reference Room may be obtained by calling 1-800-SEC-0330); and (iv) The Fund's complete schedule of portfolio holdings, as disclosed in its annual and semiannual shareholder reports and in its filings on Form N-Q, can be found at www.americanexpress.com/funds. -------------------------------------------------------------------------------- 14 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Financial Statements
Statement of assets and liabilities Government Income Portfolio May 31, 2005 Assets Investments in securities, at value (Note 1)* (identified cost $1,731,077,299) $1,729,750,571 Cash in bank on demand deposit 1,938,048 Accrued interest receivable 9,098,027 Receivable for investment securities sold 108,310,243 ----------- Total assets 1,849,096,889 ------------- Liabilities Payable for investment securities purchased 43,567,807 Payable upon return of securities loaned (Note 5) 77,966,250 Accrued investment management services fee 91,741 Other accrued expenses 164,588 Forward sale commitments, at value (proceeds receivable $88,585,625) (Note 1) 88,984,686 ---------- Total liabilities 210,775,072 ----------- Net assets $1,638,321,817 ============== * Including securities on loan, at value (Note 5) $ 76,421,140 --------------
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 15 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT
Statement of operations Government Income Portfolio Year ended May 31, 2005 Investment income Income: Interest $ 68,054,988 Fee income from securities lending (Note 5) 264,864 ------- Total income 68,319,852 ---------- Expenses (Note 2): Investment management services fee 10,141,504 Compensation of board members 15,431 Custodian fees 168,781 Audit fees 37,125 Other 91,457 ------ Total expenses 10,454,298 Earnings credits on cash balances (Note 2) (893) ---- Total net expenses 10,453,405 ---------- Investment income (loss) -- net 57,866,447 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (Note 3) (22,938,447) Futures contracts (3,327,750) Options contracts written (Note 6) 880,071 ------- Net realized gain (loss) on investments (25,386,126) Net change in unrealized appreciation (depreciation) on investments 12,004,966 ---------- Net gain (loss) on investments (13,381,160) ----------- Net increase (decrease) in net assets resulting from operations $ 44,485,287 ============
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 16 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT
Statements of changes in net assets Government Income Portfolio Year ended May 31, 2005 2004 Operations Investment income (loss) -- net $ 57,866,447 $ 76,653,491 Net realized gain (loss) on investments (25,386,126) (13,943,876) Net change in unrealized appreciation (depreciation) on investments 12,004,966 (56,711,856) ---------- ----------- Net increase (decrease) in net assets resulting from operations 44,485,287 5,997,759 ---------- --------- Proceeds from contributions 10,609,078 7,986,457 Fair value of withdrawals (725,881,313) (1,233,308,157) ------------ -------------- Net contributions (withdrawals) from partners (715,272,235) (1,225,321,700) ------------ -------------- Total increase (decrease) in net assets (670,786,948) (1,219,323,941) Net assets at beginning of year 2,309,108,765 3,528,432,706 ------------- ------------- Net assets at end of year $1,638,321,817 $ 2,309,108,765 ============== ===============
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 17 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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 invests in direct obligations of the U.S. government, such as Treasury bonds, bills, and notes, and of its agencies and instrumentalities. 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 U.S. generally accepted accounting principles 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. Securities purchased on a forward-commitment basis Delivery and payment for securities that have been purchased by the Portfolio on a forward-commitment basis, including when-issued securities and other forward-commitments, can take place one month or more after the transaction date. During this period, such securities are subject to market fluctuations, and they may affect the Portfolio's net assets the same as owned securities. The Portfolio designates cash or liquid securities at least equal to the amount of its forward-commitments. At May 31, 2005, the Portfolio has entered into outstanding when-issued securities of $4,084,875 and other forward-commitments of $8,296,344. The Portfolio also enters into transactions to sell purchase commitments to third parties at current market values and concurrently acquires other purchase commitments for similar securities at later dates. As an inducement for the Portfolio to "roll over" its purchase commitments, the Portfolio receives negotiated amounts in the form of reductions of the purchase price of the commitment. -------------------------------------------------------------------------------- 18 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT 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. 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. -------------------------------------------------------------------------------- 19 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT 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." Guarantees and indemnifications Under the Portfolio's organizational documents, its officers and trustees are indemnified against certain liabilities arising out of the performance of their duties to the Portfolio. In addition, certain of the Portfolio's contracts with its service providers contain general indemnification clauses. The Portfolio's maximum exposure under these arrangements is unknown since the amount of any future claims that may be made against the Portfolio cannot be determined and the Portfolio has no historical basis for predicting the likelihood of any such claims. 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. -------------------------------------------------------------------------------- 20 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT 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 that declines from 0.52% to 0.395% annually as the Portfolio's assets increase. 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. During the year ended May 31, 2005, the Portfolio's custodian fees were reduced by $893 as a result of earnings credits from overnight cash balances. The Portfolio also 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 $3,223,513,728 and $3,844,194,713, respectively, for the year ended May 31, 2005. Realized gains and losses are determined on an identified cost basis. 4. INTEREST RATE FUTURES CONTRACTS At May 31, 2005, investments in securities included securities valued at $636,086 that were pledged as collateral to cover initial margin deposits on 380 open purchase contracts and 610 open sale contracts. The notional market value of the open purchase contracts at May 31, 2005 was $71,168,938 with a net unrealized gain of $113,152. The notional market value of the open sale contracts at May 31, 2005 was $66,347,034 with a net unrealized loss of $72,817. See "Summary of significant accounting policies" and "Notes to investments in securities." 5. LENDING OF PORTFOLIO SECURITIES At May 31, 2005, securities valued at $76,421,140 were on loan to brokers. For collateral, the Portfolio received $77,966,250 in cash. 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 $264,864 for the year ended May 31, 2005. 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. -------------------------------------------------------------------------------- 21 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT 6. OPTIONS CONTRACTS WRITTEN Contracts and premiums associated with options contracts written are as follows: Year ended May 31, 2005 Puts Contracts Premiums Balance May 31, 2004 538 $ 579,598 Opened 717 386,461 Closed (179) (85,988) Expired (1,076) (880,071) ------ --------- Balance May 31, 2005 -- $ -- ------ --------- 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, 2005 2004 2003 2002 2001 Ratio of expenses to average daily net assets(a) .52% .51% .50% .52% .54% Ratio of net investment income (loss) to average daily net assets 2.89% 2.65% 3.35% 4.43% 6.13% Portfolio turnover rate (excluding short-term securities) 169% 125% 218% 267% 366% Total return(b) 2.26% .13% 5.48% 6.27% 10.56%
(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 net asset value and does not reflect payment of a sales charge. -------------------------------------------------------------------------------- 22 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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, 2005, 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, 2005, and the financial highlights for each of the years in the five-year period ended May 31, 2005. 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, 2005, 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, 2005, 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 U.S. generally accepted accounting principles. KPMG LLP Minneapolis, Minnesota July 20, 2005 -------------------------------------------------------------------------------- 23 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Financial Statements
Statement of assets and liabilities AXP Short Duration U.S. Government Fund May 31, 2005 Assets Investment in Portfolio (Note 1) $1,638,197,540 Capital shares receivable 408,003 ------- Total assets 1,638,605,543 ------------- Liabilities Dividends payable to shareholders 393,422 Capital shares payable 750,897 Accrued distribution fee 91,692 Accrued service fee 1,090 Accrued transfer agency fee 26,261 Accrued administrative services fee 8,627 Other accrued expenses 526,720 ------- Total liabilities 1,798,709 --------- Net assets applicable to outstanding capital stock $1,636,806,834 ============== Represented by Capital stock -- $.01 par value (Note 1) $ 3,418,248 Additional paid-in capital 1,847,201,955 Excess of distributions over net investment income (612,834) Accumulated net realized gain (loss) (Note 5) (211,515,171) Unrealized appreciation (depreciation) on investments (1,685,364) ---------- Total -- representing net assets applicable to outstanding capital stock $1,636,806,834 ============== Net assets applicable to outstanding shares: Class A $ 894,085,093 Class B $ 588,209,128 Class C $ 23,606,429 Class I $ 31,332,182 Class Y $ 99,574,002 Net asset value per share of outstanding capital stock: Class A shares 186,727,963 $ 4.79 Class B shares 122,837,566 $ 4.79 Class C shares 4,929,965 $ 4.79 Class I shares 6,535,370 $ 4.79 Class Y shares 20,793,917 $ 4.79 ---------- --------------
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 24 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT
Statement of operations AXP Short Duration U.S. Government Fund Year ended May 31, 2005 Investment income Income: Interest $ 68,040,947 Fee income from securities lending 264,844 ------- Total income 68,305,791 ---------- Expenses (Note 2): Expenses allocated from Portfolio 10,452,758 Distribution fee Class A 2,696,008 Class B 7,653,428 Class C 311,601 Transfer agency fee 3,043,500 Incremental transfer agency fee Class A 146,920 Class B 169,955 Class C 8,754 Service fee -- Class Y 110,896 Administrative services fees and expenses 960,018 Compensation of board members 11,472 Printing and postage 263,342 Registration fees 66,759 Audit fees 12,375 Other 35,333 ------ Total expenses 25,943,119 Expenses waived/reimbursed by AEFC (Note 2) (1,575,256) ---------- 24,367,863 Earnings credits on cash balances (Note 2) (84,069) ------- Total net expenses 24,283,794 ---------- Investment income (loss) -- net 44,021,997 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (22,937,088) Futures contracts (3,327,618) Options contracts written 880,020 ------- Net realized gain (loss) on investments (25,384,686) Net change in unrealized appreciation (depreciation) on investments 12,004,347 ---------- Net gain (loss) on investments (13,380,339) ----------- Net increase (decrease) in net assets resulting from operations $ 30,641,658 ============
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 25 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT
Statements of changes in net assets AXP Short Duration U.S. Government Fund Year ended May 31, 2005 2004 Operations and distributions Investment income (loss) -- net $ 44,021,997 $ 53,918,357 Net realized gain (loss) on investments (25,384,686) (13,943,173) Net change in unrealized appreciation (depreciation) on investments 12,004,347 (56,709,554) ---------- ----------- Net increase (decrease) in net assets resulting from operations 30,641,658 (16,734,370) ---------- ----------- Distributions to shareholders from: Net investment income Class A (27,188,188) (32,141,993) Class B (13,508,603) (17,983,822) Class C (552,010) (706,906) Class I (370,986) (10,055) Class Y (2,998,869) (3,546,323) ---------- ---------- Total distributions (44,618,656) (54,389,099) ----------- ----------- Capital share transactions (Note 3) Proceeds from sales Class A shares (Note 2) 238,048,631 429,411,653 Class B shares 101,336,355 218,218,185 Class C shares 5,860,931 15,463,649 Class I shares 32,075,351 4,117,088 Class Y shares 22,393,741 58,935,229 Reinvestment of distributions at net asset value Class A shares 24,424,025 29,532,472 Class B shares 12,662,464 17,136,580 Class C shares 516,851 654,048 Class I shares 361,220 9,402 Class Y shares 2,010,628 2,825,788 Payments for redemptions Class A shares (548,605,037) (962,651,760) Class B shares (Note 2) (483,681,823) (819,584,452) Class C shares (Note 2) (20,526,865) (35,046,321) Class I shares (5,183,945) (15,452) Class Y shares (39,177,481) (106,873,614) ----------- ------------ Increase (decrease) in net assets from capital share transactions (657,484,954) (1,147,867,505) ------------ -------------- Total increase (decrease) in net assets (671,461,952) (1,218,990,974) Net assets at beginning of year 2,308,268,786 3,527,259,760 ------------- ------------- Net assets at end of year $1,636,806,834 $ 2,308,268,786 ============== ===============
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 26 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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 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. 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. At May 31, 2005, AEFC and the AXP Portfolio Builder Series funds owned 100% of Class I shares, which represents 1.91% of the Fund's net assets. All classes of shares have identical voting, dividend and liquidation rights. The distribution fee, transfer agency fees 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 direct obligations of the U.S. government, such as Treasury bonds, bills and notes and of its agencies and instrumentalities. 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 at May 31, 2005 was 99.99%. -------------------------------------------------------------------------------- 27 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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 U.S. generally accepted accounting principles requires management to make estimates (e.g., on assets, liabilities and contingent assets and liabilities) that could differ from actual results. Guarantees and indemnifications Under the Fund's organizational documents, its officers and directors are indemnified against certain liabilities arising out of the performance of their duties to the Fund. In addition, certain of the Fund's contracts with its service providers contain general indemnification clauses. The Fund's maximum exposure under these arrangements is unknown since the amount of any future claims that may be made against the Fund cannot be determined and the Fund has no historical basis for predicting the likelihood of any such claims. 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 $137,836 and accumulated net realized loss has been increased by $137,836. -------------------------------------------------------------------------------- 28 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT The tax character of distributions paid for the years indicated is as follows: Year ended May 31, 2005 2004 Class A Distributions paid from: Ordinary income $27,188,188 $32,141,993 Long-term capital gain -- -- Class B Distributions paid from: Ordinary income 13,508,603 17,983,822 Long-term capital gain -- -- Class C Distributions paid from: Ordinary income 552,010 706,906 Long-term capital gain -- -- Class I* Distributions paid from: Ordinary income 370,986 10,055 Long-term capital gain -- -- Class Y Distributions paid from: Ordinary income 2,998,869 3,546,323 Long-term capital gain -- -- * Inception date was March 4, 2004. At May 31, 2005, the components of distributable earnings on a tax basis are as follows: Undistributed ordinary income $ 611,903 Accumulated long-term gain (loss) $(205,645,039) Unrealized appreciation (depreciation) $ (8,386,811) 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 that declines from 0.05% to 0.025% annually as the Fund's assets increase. 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. -------------------------------------------------------------------------------- 29 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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 pursuant to Rule 12b-1, 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 $2,426,288 Class A, $1,324,762 for Class B and $10,654 for Class C for the year ended May 31, 2005. For the year ended May 31, 2005, AEFC and its affiliates waived certain fees and expenses to 0.93% for Class A, 1.68% for Class B, 1.68% for Class C and 0.76% for Class Y. Of these waived fees and expenses, the transfer agency fees waived for Class A, Class B, Class C and Class Y were $821,283, $633,909, $28,044 and $92,020, respectively. Begining June 1, 2005, AEFC and its affiliates have agreed to waive certain fees and expenses until May 31, 2006. Under this agreement, net expenses will not exceed 0.89% for Class A, 1.64% for Class B, 1.64% for Class C, 0.59% for Class I and 0.72% for Class Y of the Fund's average daily net assets. During the year ended May 31, 2005, the Fund's transfer agency fees were reduced by $84,069 as a result of earnings credits from overnight cash balances. -------------------------------------------------------------------------------- 30 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT 3. CAPITAL SHARE TRANSACTIONS Transactions in shares of capital stock for the years indicated are as follows:
Year ended May 31, 2005 Class A Class B Class C Class I Class Y Sold 49,509,431 21,094,221 1,219,375 6,690,057 4,661,213 Issued for reinvested distributions 5,087,150 2,636,716 107,621 75,207 418,767 Redeemed (114,279,241) (100,713,445) (4,275,447) (1,075,526) (8,163,718) ------------ ------------ ---------- ---------- ---------- Net increase (decrease) (59,682,660) (76,982,508) (2,948,451) 5,689,738 (3,083,738) ----------- ----------- ---------- --------- ---------- 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. 4. BANK BORROWINGS The Fund has a revolving credit agreement with a syndicate of banks headed by The Bank of New York, whereby the Fund may borrow for the temporary funding of shareholder redemptions or for other temporary or emergency purposes. The agreement went into effect Sept. 21, 2004. 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 higher of the Federal Funds Effective Rate plus 0.50% or 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. Prior to this agreement, the Fund had a revolving credit agreement that permitted borrowings up to $500 million with Deutsche Bank. The Fund had no borrowings outstanding during the year ended May 31, 2005. 5. CAPITAL LOSS CARRY-OVER For federal income tax purposes, the Fund had a capital loss carry-over of $205,645,039 at May 31, 2005, that if not offset by capital gains will expire as follows: 2008 2009 2013 2014 $35,174,077 $117,356,906 $36,267,962 $16,846,094 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. -------------------------------------------------------------------------------- 31 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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, 2005 2004 2003 2002 2001 Net asset value, beginning of period $4.82 $4.94 $4.85 $4.78 $4.59 ----- ----- ----- ----- ----- Income from investment operations: Net investment income (loss) .12 .11 .15 .19 .27 Net gains (losses) (both realized and unrealized) (.03) (.12) .09 .08 .19 ----- ----- ----- ----- ----- Total from investment operations .09 (.01) .24 .27 .46 ----- ----- ----- ----- ----- Less distributions: Dividends from net investment income (.12) (.11) (.15) (.20) (.27) ----- ----- ----- ----- ----- Net asset value, end of period $4.79 $4.82 $4.94 $4.85 $4.78 ----- ----- ----- ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $894 $1,188 $1,728 $1,185 $1,047 Ratio of expenses to average daily net assets(b) .93%(c) .97% .95% .95% .98% Ratio of net investment income (loss) to average daily net assets 2.49% 2.19% 2.90% 4.01% 5.72% Portfolio turnover rate (excluding short-term securities) 169% 125% 218% 267% 366% Total return(d) 1.92% (.24%) 4.90% 5.77% 10.19%
(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) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratio of expenses for Class A would have been 1.01% for the year ended May 31, 2005. (d) Total return does not reflect payment of a sales charge. -------------------------------------------------------------------------------- 32 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT
Class B Per share income and capital changes(a) Fiscal period ended May 31, 2005 2004 2003 2002 2001 Net asset value, beginning of period $4.82 $4.94 $4.85 $4.78 $4.59 ----- ----- ----- ----- ----- Income from investment operations: Net investment income (loss) .08 .07 .11 .16 .24 Net gains (losses) (both realized and unrealized) (.03) (.12) .09 .08 .18 ----- ----- ----- ----- ----- Total from investment operations .05 (.05) .20 .24 .42 ----- ----- ----- ----- ----- Less distributions: Dividends from net investment income (.08) (.07) (.11) (.17) (.23) ----- ----- ----- ----- ----- Net asset value, end of period $4.79 $4.82 $4.94 $4.85 $4.78 ----- ----- ----- ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $588 $963 $1,578 $1,104 $912 Ratio of expenses to average daily net assets(b) 1.68%(c) 1.72% 1.71% 1.71% 1.73% Ratio of net investment income (loss) to average daily net assets 1.73% 1.44% 2.15% 3.25% 4.96% Portfolio turnover rate (excluding short-term securities) 169% 125% 218% 267% 366% Total return(d) 1.16% (.99%) 4.11% 4.98% 9.36%
(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) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratio of expenses for Class B would have been 1.76% for the year ended May 31, 2005. (d) Total return does not reflect payment of a sales charge. -------------------------------------------------------------------------------- 33 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT
Class C Per share income and capital changes(a) Fiscal period ended May 31, 2005 2004 2003 2002 2001(b) Net asset value, beginning of period $4.82 $4.94 $4.85 $4.78 $4.63 ----- ----- ----- ----- ----- Income from investment operations: Net investment income (loss) .08 .07 .11 .16 .22 Net gains (losses) (both realized and unrealized) (.03) (.12) .09 .08 .14 ----- ----- ----- ----- ----- Total from investment operations .05 (.05) .20 .24 .36 ----- ----- ----- ----- ----- Less distributions: Dividends from net investment income (.08) (.07) (.11) (.17) (.21) ----- ----- ----- ----- ----- Net asset value, end of period $4.79 $4.82 $4.94 $4.85 $4.78 ----- ----- ----- ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $24 $38 $58 $29 $7 Ratio of expenses to average daily net assets(c) 1.68%(d) 1.73% 1.72% 1.72% 1.73%(e) Ratio of net investment income (loss) to average daily net assets 1.73% 1.44% 2.10% 3.09% 4.93%(e) Portfolio turnover rate (excluding short-term securities) 169% 125% 218% 267% 366% Total return(f) 1.16% (.99%) 4.11% 4.98% 8.08%(g)
(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) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratio of expenses for Class C would have been 1.77% for the year ended May 31, 2005. (e) Adjusted to an annual basis. (f) Total return does not reflect payment of a sales charge. (g) Not annualized. -------------------------------------------------------------------------------- 34 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT
Class I Per share income and capital changes(a) Fiscal period ended May 31, 2005 2004(b) Net asset value, beginning of period $4.83 $4.90 ----- ----- Income from investment operations: Net investment income (loss) .14 .03 Net gains (losses) (both realized and unrealized) (.04) (.07) ----- ----- Total from investment operations .10 (.04) ----- ----- Less distributions: Dividends from net investment income (.14) (.03) ----- ----- Net asset value, end of period $4.79 $4.83 ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $31 $4 Ratio of expenses to average daily net assets(c) .57% .63%(d) Ratio of net investment income (loss) to average daily net assets 2.98% 2.74%(d) Portfolio turnover rate (excluding short-term securities) 169% 125% Total return(e) 2.06% (.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. -------------------------------------------------------------------------------- 35 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT
Class Y Per share income and capital changes(a) Fiscal period ended May 31, 2005 2004 2003 2002 2001 Net asset value, beginning of period $4.82 $4.94 $4.85 $4.78 $4.59 ----- ----- ----- ----- ----- Income from investment operations: Net investment income (loss) .13 .12 .15 .20 .28 Net gains (losses) (both realized and unrealized) (.03) (.12) .09 .08 .19 ----- ----- ----- ----- ----- Total from investment operations .10 -- .24 .28 .47 ----- ----- ----- ----- ----- Less distributions: Dividends from net investment income (.13) (.12) (.15) (.21) (.28) ----- ----- ----- ----- ----- Net asset value, end of period $4.79 $4.82 $4.94 $4.85 $4.78 ----- ----- ----- ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $100 $115 $164 $188 $161 Ratio of expenses to average daily net assets(b) .76%(c) .81% .79% .79% .82% Ratio of net investment income (loss) to average daily net assets 2.66% 2.35% 3.12% 4.17% 5.89% Portfolio turnover rate (excluding short-term securities) 169% 125% 218% 267% 366% Total return(d) 2.10% (.08%) 5.07% 5.93% 10.36%
(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) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratio of expenses for Class Y would have been 0.84% for the year ended May 31, 2005. (d) Total return does not reflect payment of a sales charge. -------------------------------------------------------------------------------- 36 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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, 2005, 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, 2005, and the financial highlights for each of the years in the five-year period ended May 31, 2005. 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, 2005, 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 U.S. generally accepted accounting principles. KPMG LLP Minneapolis, Minnesota July 20, 2005 -------------------------------------------------------------------------------- 37 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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, 2005 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 25, 2004 $0.00950 July 26, 2004 0.00950 Aug. 25, 2004 0.00998 Sept. 24, 2004 0.01093 Oct. 25, 2004 0.01104 Nov. 24, 2004 0.00905 Dec. 22, 2004 0.01590 Jan. 27, 2005 0.00902 Feb. 24, 2005 0.00900 March 30, 2005 0.00900 April 28, 2005 0.00900 May 26, 2005 0.00900 Total distributions $0.12092 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 25, 2004 $0.00651 July 26, 2004 0.00641 Aug. 25, 2004 0.00698 Sept. 24, 2004 0.00796 Oct. 25, 2004 0.00797 Nov. 24, 2004 0.00609 Dec. 22, 2004 0.01314 Jan. 27, 2005 0.00540 Feb. 24, 2005 0.00624 March 30, 2005 0.00567 April 28, 2005 0.00615 May 26, 2005 0.00625 Total distributions $0.08477 -------------------------------------------------------------------------------- 38 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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 25, 2004 $0.00650 July 26, 2004 0.00644 Aug. 25, 2004 0.00700 Sept. 24, 2004 0.00797 Oct. 25, 2004 0.00797 Nov. 24, 2004 0.00608 Dec. 22, 2004 0.01314 Jan. 27, 2005 0.00541 Feb. 24, 2005 0.00624 March 30, 2005 0.00567 April 28, 2005 0.00616 May 26, 2005 0.00624 Total distributions $0.08482 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 June 25, 2004 $0.01057 July 26, 2004 0.01093 Aug. 25, 2004 0.01126 Sept. 24, 2004 0.01228 Oct. 25, 2004 0.01235 Nov. 24, 2004 0.01032 Dec. 22, 2004 0.01683 Jan. 27, 2005 0.01052 Feb. 24, 2005 0.01019 March 30, 2005 0.01044 April 28, 2005 0.01109 May 26, 2005 0.01047 Total distributions $0.13725 -------------------------------------------------------------------------------- 39 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT 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 25, 2004 $0.01015 July 26, 2004 0.01020 Aug. 25, 2004 0.01064 Sept. 24, 2004 0.01161 Oct. 25, 2004 0.01174 Nov. 24, 2004 0.00973 Dec. 22, 2004 0.01653 Jan. 27, 2005 0.00981 Feb. 24, 2005 0.00963 March 30, 2005 0.00976 April 28, 2005 0.00965 May 26, 2005 0.00963 Total distributions $0.12908 -------------------------------------------------------------------------------- 40 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Fund ExpensesExample (UNAUDITED) As a shareholder of the Fund, you incur two types of costs: (1) transaction costs, including sales charges (loads) on purchase payments; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Fund expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other mutual funds. The example is based on an investment of $1,000 invested at the beginning of the period and held for the six months ended May 31, 2005. Actual Expenses The first line of the table provides information about actual account values and actual expenses. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading titled "Expenses paid during the period" to estimate the expenses you paid on your account during this period. Hypothetical Example for Comparison Purposes The second line of the table provides information about hypothetical account values and hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in the Fund and other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the other funds. Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect any transactional costs, such as sales charges (loads). Therefore, the second line of the table is useful in comparing ongoing costs only, and will not help you determine the relative total costs of owning different funds. In addition, if these transactional costs were included, your costs would have been higher. -------------------------------------------------------------------------------- 41 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT
Beginning Ending Expenses account value account value paid during Annualized Dec. 1, 2004 May 31, 2005 the period(a) expense ratio Class A Actual(b) $1,000 $1,010.50 $4.66(c) .93% Hypothetical (5% return before expenses) $1,000 $1,020.29 $4.68(c) .93% Class B Actual(b) $1,000 $1,006.80 $8.41(c) 1.68% Hypothetical (5% return before expenses) $1,000 $1,016.55 $8.45(c) 1.68% Class C Actual(b) $1,000 $1,006.80 $8.41(c) 1.68% Hypothetical (5% return before expenses) $1,000 $1,016.55 $8.45(c) 1.68% Class I Actual(b) $1,000 $1,010.30 $2.71 .54% Hypothetical (5% return before expenses) $1,000 $1,022.24 $2.72 .54% Class Y Actual(b) $1,000 $1,011.40 $3.81(c) .76% Hypothetical (5% return before expenses) $1,000 $1,021.14 $3.83(c) .76%
(a) Expenses are equal to the Fund's annualized expense ratio as indicated above, multiplied by the average account value over the period, multiplied by 182/365 (to reflect the one-half year period). (b) Based on the actual return for the six months ended May 31, 2005: +1.05% for Class A, +0.68% for Class B, +0.68% for Class C, +1.03% for Class I and +1.14% for Class Y. (c) Beginning June 1, 2005, AEFC and its affiliates have contractually agreed to waive certain fees and to absorb certain expenses until May 31, 2006, unless sooner terminated at the discretion of the Fund's Board of Directors. Under this agreement, net expenses will not exceed 0.89% for Class A; 1,64% for Class B; 1.64% for Class C; and 0.72% for Class Y. If this agreement had been in place for the entire six-month period ended May 31, 2005, the actual expenses paid would have been: $4.46 for Class A, $8.21 for Class B, $8.21 for Class C and $3.61 for Class Y; the hypothetical expenses paid would have been: $4.48 for Class A, $8.25 for Class B, $8.25 for Class C and $3.63 for Class Y. -------------------------------------------------------------------------------- 42 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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 14 Master Trust portfolios and 90 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 Other directorships with Fund and past five years length of service -------------------------------------- --------------- ------------------------------ ----------------------------- Arne H. Carlson Board member Chair, Board Services 901 S. Marquette Ave. since 1999 Corporation (provides Minneapolis, MN 55402 administrative services to Age 70 boards). Former Governor of Minnesota -------------------------------------- --------------- ------------------------------ ----------------------------- Philip J. Carroll, Jr. Board member Retired Chairman and CEO, Scottish Power PLC, Vulcan 901 S. Marquette Ave. since 2002 Fluor Corporation Materials Company, Inc. Minneapolis, MN 55402 (engineering and (construction Age 67 construction) since 1998 materials/chemicals) -------------------------------------- --------------- ------------------------------ ----------------------------- Livio D. DeSimone Board member Retired Chair of the Board Cargill, Incorporated 30 Seventh Street East since 2001 and Chief Executive Officer, (commodity merchants and Suite 3050 Minnesota Mining and processors), General Mills, St. Paul, MN 55101-4901 Manufacturing (3M) Inc. (consumer foods), Age 71 Vulcan Materials Company (construction materials/ chemicals), Milliken & Company (textiles and chemicals), and Nexia Biotechnologies, Inc. -------------------------------------- --------------- ------------------------------ ----------------------------- Patricia M. Flynn Board member Trustee Professor of BostonFed Bancorp, Inc. 901 S. Marquette Ave. since 2004 Economics and Management, (holding company) and its Minneapolis, MN 55402 Bentley College since 2002; subsidiary Boston Federal Age 54 former Dean, McCallum Savings Bank Graduate School of Business, Bentley College from 1999 to 2002 -------------------------------------- --------------- ------------------------------ ----------------------------- Anne P. Jones Board member Attorney and Consultant 901 S. Marquette Ave. since 1985 Minneapolis, MN 55402 Age 70 -------------------------------------- --------------- ------------------------------ ----------------------------- Stephen R. Lewis, Jr. Board member Retired President and Valmont Industries, Inc. 901 S. Marquette Ave. since 2002 Professor of Economics, (manufactures irrigation Minneapolis, MN 55402 Carleton College systems) Age 66 -------------------------------------- --------------- ------------------------------ -----------------------------
-------------------------------------------------------------------------------- 43 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT
Independent Board Members (continued) Name, address, age Position Principal occupation during Other directorships held with past five years Fund and length of service -------------------------------------- --------------- ------------------------------- ---------------------------- Catherine James Paglia Board member Director, Enterprise Asset Strategic Distribution, 901 S. Marquette Ave. since 2004 Management, Inc. (private Inc. (transportation, Minneapolis, MN 55402 real estate and asset distribution and logistics Age 52 management company) since 1999 consultants) -------------------------------------- --------------- ------------------------------- ---------------------------- Alan K. Simpson Board member Former three-term United 1201 Sunshine Ave. since 1997 States Senator for Wyoming Cody, WY 82414 Age 73 -------------------------------------- --------------- ------------------------------- ---------------------------- Alison Taunton-Rigby Board member Founder and Chief Executive Hybridon, Inc. 901 S. Marquette Ave. since 2002 Officer, RiboNovix, Inc. (biotechnology) Minneapolis, MN 55402 since 2004; President, Age 61 Forester Biotech since 2000; prior to that, President and CEO, Aquila Biopharmaceuticals, Inc. -------------------------------------- --------------- ------------------------------- ---------------------------- Board Member Affiliated with AEFC* Name, address, age Position held Principal occupation during Other directorships with Fund and past five years length of service -------------------------------------- --------------- ------------------------------- ---------------------------- William F. Truscott Board member Senior Vice President - Chief 53600 AXP Financial Center since 2001, Investment Officer of AEFC Minneapolis, MN 55474 Vice President since 2001. Former Chief Age 44 since 2002 Investment Officer and Managing Director, Zurich Scudder Investments -------------------------------------- --------------- ------------------------------- ----------------------------
* Interested person by reason of being an officer, director and/or employee of AEFC. -------------------------------------------------------------------------------- 44 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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 Other directorships with Fund and past five years length of service -------------------------------------- --------------- ------------------------------- ---------------------------- Jeffrey P. Fox Treasurer Vice President - Investment 105 AXP Financial Center since 2002 Accounting, AEFC, since Minneapolis, MN 55474 2002; Vice President - Age 50 Finance, American Express Company, 2000-2002; Vice President - Corporate Controller, AEFC, 1996-2000 -------------------------------------- --------------- ------------------------------- ---------------------------- Paula R. Meyer President Senior Vice President and 596 AXP Financial Center since 2002 General Manager - Mutual Minneapolis, MN 55474 Funds, AEFC, since 2002; Vice Age 51 President and Managing Director - American Express Funds, AEFC, 2000-2002; Vice President, AEFC, 1998-2000 -------------------------------------- --------------- ------------------------------- ---------------------------- Leslie L. Ogg Vice President of Board Services 901 S. Marquette Ave. President, Corporation Minneapolis, MN 55402 Age 66 General Counsel, and Secretary since 1978 -------------------------------------- --------------- ------------------------------- ---------------------------- Beth E. Weimer Chief Vice President and Chief 172 AXP Financial Center Compliance Compliance Officer, AEFC, Minneapolis, MN 55474 Officer since since 2001; Vice President Age 52 2004 and Chief Compliance Officer, AEFA, 2001-2005; Partner, Arthur Andersen Regulatory Risk Services, 1998-2001 -------------------------------------- --------------- ------------------------------- ----------------------------
The SAI has additional information about the Fund's directors and is available, without charge, upon request by calling (800) 862-7919. -------------------------------------------------------------------------------- 45 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT Approval of Investment Management Services Agreement American Express Financial Corporation (AEFC), a wholly-owned subsidiary of American Express Company, serves as the investment manager to the Fund. Under an Investment Management Services Agreement (the Agreement), AEFC provides investment advice and other services to the Fund. Throughout the year, the Funds' Board of Directors and the Board's Investment Review Committee monitor these services. Each year the Board determines whether to continue the Agreement by evaluating the quality and level of service received and the costs associated with those services. AEFC prepares detailed reports for the Board and its Contracts Committee in March and April and provides data prepared by independent organizations to assist the Board in making this determination. The Board gives considerable weight to the work, deliberations and conclusions of the Contracts and Investment Review Committees in determining whether to continue the Agreement. On February 1, 2005, American Express Company announced its intention to pursue a spin-off of AEFC by distributing shares of the common stock of AEFC to shareholders of American Express Company. At a meeting held in person on April 14, 2005, the Board, including a majority of the independent members, approved the continuation of the Agreement for an interim period, not to exceed one year, ending on the later of (i) the effective date of the spin-off or (ii) the approval by the Fund's shareholders of a new investment management services agreement with AEFC (the Interim Period). The spin-off will not result in an "assignment" of the Agreement under the Investment Company Act of 1940 and, therefore, will not cause the termination of the Agreement according to its terms. In connection with the spin-off AEFC has proposed that going forward, services under the Agreement be provided by an affiliate, RiverSource Investments, LLC (RiverSource). Independent counsel advised the Board that it would be prudent, in connection with the spin-off, to consider a new agreement with RiverSource and to seek shareholder approval of that agreement as soon as practical thereafter. Investment performance is a major factor in the evaluation process, and the Board reviewed the Fund's performance over a range of different periods by comparing its performance to relevant Lipper and broader market indices. The Board considered that over time the Fund's investment performance should be above the median for a peer group of funds with similar investment goals and noted that the Fund's investment performance, although below median, was consistent with the management style of the Fund in light of market conditions in 2004. The Board noted that, in addition to portfolio management and investment research, AEFC provides portfolio trading, daily net asset value calculation, management of cash flow, product development, administration of its compliance and legal departments, access to distribution, accounting and recordkeeping, and reporting to the Board and shareholders. To evaluate these services, the Board referred to surveys and benchmarks established by commercial providers, trade associations and AEFC's internal processes. The Board concluded that the services provided were consistent with services provided by investment managers to comparable mutual funds. -------------------------------------------------------------------------------- 46 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 ANNUAL REPORT The Board also evaluated the price paid for the services provided by AEFC, noting the existence of a pricing philosophy, established by the Board and AEFC, that seeks to maintain total Fund expenses within a range of the median expenses charged to comparable funds sold through financial advisors. The Board considered detailed information set forth in an annual report on fees and expenses, including, among other things, data showing a comparison of the Fund's expenses with median expenses paid by funds in its comparison group and data showing the Fund's contribution to AEFC's profitability. The Board determined that while the Fund's expenses are relatively high for its comparison group, the existing fee waiver has been increased to reduce further the expenses the Fund will pay. The Board considered the economies of scale that might be realized by AEFC as the Fund grew and took note of the extent to which Fund shareholders also might benefit from such growth. The Board considered that the Agreement provided for lower fees as assets increase at pre-established breakpoints and concluded that the Agreement satisfactorily provided for sharing these economies of scale. The Board took into account the Contracts Committee's discussion comparing the fees AEFC charges to the Fund with those it charges to institutional clients, noting that the relatively higher fees paid by the Fund were principally attributable to the additional services required to manage a regulated mutual fund, like the Fund, and the operation of a large mutual fund family. The Board also considered the profitability realized by AEFC and its affiliates from its relationship with the Fund. The Board took into account the services acquired by AEFC through the use of commission dollars paid by the Fund on portfolio transactions. The Board concluded that AEFC's overall costs and profitability were appropriate, although profitability may be too low on an ongoing basis. The Board noted that the fees paid by the Fund should permit AEFC to offer competitive compensation to its personnel, make necessary investments in its business and earn an appropriate profit. Based on the foregoing, the Board concluded that the fees paid to AEFC under the Agreement were fair and reasonable and determined to approve renewal of the Agreement for the Interim Period. 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 website americanexpress.com/funds; or by searching the website 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, information regarding how the Fund voted proxies relating to portfolio securities during the most recent 12-month period ended June 30 is available at http://www.sec.gov. -------------------------------------------------------------------------------- 47 -- AXP SHORT DURATION U.S. GOVERNMENT FUND -- 2005 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. AXP(R) U.S. Government Mortgage Fund Annual Report for the Period Ended May 31, 2005 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 Performance Summary 4 Questions & Answers with Portfolio Management 5 The Fund's Long-term Performance 8 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 Fund Expenses Example 33 Board Members and Officers 35 Approval of Investment Management Services Agreement 38 Proxy Voting 39 [DALBAR LOGO] American Express(R) Funds' reports to shareholders have been awarded the Communications Seal from Dalbar Inc., an independent financial services research firm. The Seal recognizes communications demonstrating a level of excellence in the industry. -------------------------------------------------------------------------------- 2 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Fund Snapshot AT MAY 31, 2005 PORTFOLIO MANAGER Portfolio manager Since Years in industry Scott Kirby* 2/02 24 * The Fund is managed by a team 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 by class A: 2/14/02 B: 2/14/02 C: 2/14/02 I: 3/4/04 Y: 2/14/02 Ticker symbols by class A: AUGAX B: AUGBX C: AUGCX I: -- Y: -- Total net assets $267.7 million Number of holdings 170 Weighted average life(1) 3.4 years Effective duration(2) 2.1 years Weighted average bond rating(3) 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* 98.3% Short-term securities* 1.0% CMBS/ABS** 0.7% * Of the 98.3%, 4.8% is due to forward commitment mortgage-backed securities activity. Short-term securities are held as collateral for these commitments. ** Commercial mortgage-backed/Asset-backed securities CREDIT QUALITY SUMMARY Percentage of bond portfolio assets AAA bonds 99.2% AA bonds 0.8% 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. (1) Weighted average life measures a bond's maturity, which takes into consideration the possibility that the issuer may call the bond before its maturity date. (2) 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. (3) Weighted average bond rating represents the average credit quality of the underlying bonds in the portfolio. 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 --- 2005 ANNUAL REPORT Performance Summary [BAR CHART] PERFORMANCE COMPARISON For the year ended May 31, 2005 +5.78% +6.69% +5.29% +5.78% = AXP U.S. Government Mortgage Fund Class A (excluding sales charge) +6.69% = Lehman Brothers Mortgage-Backed Securities Index (unmanaged) +5.29% = Lipper U.S. Mortgage Funds Index (see "The Fund`s Long-term Performance" for Index descriptions) The performance information shown represents past performance and is not a guarantee of future results. The investment return and principal value of your investment 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 (800) 862-7919 or visiting www.americanexpress.com/funds. 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 other classes may vary from that shown because of differences in expenses. The indices do not reflect the effects of sales charges, expenses (excluding Lipper) and taxes.
AVERAGE ANNUAL TOTAL RETURNS Class A Class B Class C Class I Class Y (Inception dates) (2/14/02) (2/14/02) (2/14/02) (3/4/04) (2/14/02) After After NAV(1) POP(2) NAV(1) CDSC(3) NAV(1) CDSC(4) NAV(5) NAV(6) at May 31, 2005 1 year +5.78% +0.75% +4.78% -0.22% +4.79% +3.79% +5.92% +5.75% 3 years +4.63% +2.95% +3.78% +2.53% +3.78% +3.78% N/A +4.74% Since inception +4.76% +3.22% +3.99% +3.15% +3.98% +3.98% +3.58% +4.88% at June 30, 2005 1 year +5.17% +0.18% +4.19% -0.81% +4.40% +3.40% +5.52% +5.36% 3 years +4.40% +2.72% +3.62% +2.36% +3.68% +3.68% N/A +4.58% Since inception +4.68% +3.18% +3.91% +3.09% +3.96% +3.96% +3.62% +4.86%
(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 eligible investors only, currently limited to AXP Portfolio Builder Series funds, six affiliated funds-of-funds. (6) Sales charge is not applicable to these shares. Shares available to institutional investors only. -------------------------------------------------------------------------------- 4 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Questions & Answers WITH PORTFOLIO MANAGEMENT Below, Portfolio Manager Scott Kirby discusses the Fund's positioning and results for the annual period ended May 31, 2005. Q: How did AXP U.S. Government Mortgage Fund perform for the fiscal year? A: AXP U.S. Government Mortgage Fund's Class A shares (excluding sales charge) rose 5.78% for the 12 months ended May 31, 2005. In comparison, the Lehman Brothers Mortgage-Backed Securities Index (Lehman Index) advanced 6.69%. The Fund outperformed the Lipper U.S. Mortgage Funds Index, representing the Fund's peer group, which gained 5.29% over the same time frame. To help keep the Fund competitive with its peers, American Express Financial Corporation and its affiliates revised the Fund's expense cap on June 1, 2005, reducing the maximum level of expenses borne by Class A shareholders from 0.945% of net assets per fiscal year to a maximum 0.89% of net assets per year. Q: What factors most significantly affected the Fund's performance during the annual period? A: The Fund outperformed its peer group due primarily to effective individual security selection. We focused on issues with reduced sensitivity to changes in interest rates. The Fund was also helped by its duration positioning relative to the Lehman Index during the fiscal year. As the Federal Reserve Board (the Fed) raised interest rates eight times during the annual period, bringing the targeted federal funds rate to 3%, the difference in yields between short- and long-term maturities has narrowed or flattened dramatically. Indeed, the two-year Treasury yield rose 98 basis points over the 12 months to a level of 3.60%, while 10-year Treasury yields actually fell 72 basis points to a level of 4%. We had prudently positioned the portfolio early in the reporting period for just such a yield curve flattening scenario. On the other hand, the Fund's positioning in commercial mortgage-backed securities (CMBS) detracted from performance, as these securities, which are not included in the Lehman Index, modestly underperformed mortgages. Thus, this non-index position contributed to underperformance relative to the Lehman Index. Also detracting from the Fund's relative returns were its SEC YIELDS At May 31, 2005 by class A: 3.55% B: 2.98% C: 2.98% I: 4.04% Y: 3.89% At June 30, 2005 by class A: 3.78% B: 3.21% C: 3.21% I: 4.27% Y: 4.14% The Securities and Exchange Commission (SEC) yield is calculated by dividing anticipated net investment income during a 31-day period by the public offering price (POP) per share on the last day of the period, and converting the results to yearly figures. See Average Annual Total Returns on page 4 for additional performance information. -------------------------------------------------------------------------------- 5 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Questions & Answers [BEGIN CALLOUT QUOTE]> The Fund outperformed its peer group due primarily to effective individual security selection. [END CALLOUT QUOTE] investments in hybrid adjustable rate mortgages (ARMs) and collateralized mortgage obligations (CMOs). While these securities historically outperform in a rising interest rate environment, they underperformed this period due to the market's response to the "measured" pace of interest rate increases. Further detracting modestly from Fund performance was its focus within the mortgage sector on higher coupon bonds. While these bonds offered both attractive yields and potential protection from higher rates, lower coupon bonds outperformed for the 12 months. Finally, the Fund was defensively positioned with significant exposure to 15-year mortgages, which underperformed 30-year mortgages during the annual period. Still, we maintained this conservative strategy, as we believe 15-year mortgage securities will generally perform better as interest rates rise. Overall, the Fund's conservative risk profile hurt Fund returns at a time when shorter-term securities underperformed and long-term bonds rallied. We believed rates would move more aggressively than they did and sought to reduce the Fund's exposure to volatility when possible. Q: What changes did you make to the portfolio and how is it currently positioned? A: Over the annual period, we incrementally enhanced the Fund's risk profile, making it even more defensive, given tighter mortgage spreads, less attractive mortgage valuations and lower levels of volatility in the mortgage market at the end of May than one year prior. We also removed some of the yield curve flattening bias, while making minor adjustments to portfolio duration throughout the fiscal year as market conditions changed. In addition, we increased the Fund's cash position, patiently seeking opportunities to invest in the market at higher yield levels. We continued to emphasize those securities issued by government mortgage agencies, including Ginnie Mae, Fannie Mae and Freddie Mac. We maintained our focus on higher coupon mortgage securities and emphasized investment in more seasoned pools of mortgages, which we expect to outperform with increased interest rates. Throughout, securities were carefully selected to reduce the risk of prepayments if significantly higher interest rates do not materialize. Overall, -------------------------------------------------------------------------------- 6 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Questions & Answers [BEGIN CALLOUT QUOTE]> We intend to continue to position the Fund for ongoing economic recovery and a higher interest rate environment. [END CALLOUT QUOTE] the opportunistic adjustments we made in response to valuations or market developments resulted in an annual portfolio turnover rate of 137%. Q: How do you intend to manage the Fund in the coming months? A: We believe the U.S. economic recovery will continue and interest rates will move higher. We further believe these themes are likely to continue to weigh on the fixed income markets through the summer. Even with the Fed's May 2005 comments that inflation pressures have risen, we believe there may be cause for it to deviate from its measured pace and increase interest rates more vigorously than the market currently anticipates. Indeed, we will continue to monitor inflation numbers, as they remain the key indicator for the economy in the coming months. In addition, we anticipate that the yield curve may flatten a bit more in the near term but that after an extended period of yield curve flattening, the yield spread between short- and long-term maturities may stabilize somewhat in the months ahead with more parallel shifts across the yield curve. Based on this view, we intend to maintain the Fund's duration shorter than the Lehman Index for the near term. Within mortgage-backed securities, we expect to maintain a conservative risk posture. Should rates move higher, we would seek to select opportunities to remove some of the Fund's defensive overall positioning. As always, however, our strategy is to provide added portfolio value with a moderate amount of risk. Quality issues and security selection remain a priority as we continue to seek attractive buying opportunities. -------------------------------------------------------------------------------- 7 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT The Fund's Long-term Performance The chart on the facing page 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 5/31/05) as compared to the performance of two widely cited performance indices, the 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 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 (800) 862-7919 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. DISTRIBUTION SUMMARY The table below details the Fund's income and capital gain distributions for the fiscal years shown. More information on the other classes can be found in the Financial Highlights section of this report's Notes to Financial Statements. Class A Short-term Long-term Fiscal year ended Income capital gains capital gains Total May 31, 2005 $0.20 $ -- $-- $0.20 May 31, 2004 0.17 0.06 -- 0.23(1) May 31, 2003 0.20 0.02 -- 0.22 May 31, 2002(2) 0.03 -- -- 0.03 (1) $0.01 per share represents a tax return of capital. (2) For the period from Feb. 14, 2002 (when shares became publicly available) to May 31, 2002. -------------------------------------------------------------------------------- 8 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT [LINE CHART]
VALUE OF A HYPOTHETICAL $10,000 INVESTMENT IN AXP U.S. GOVERNMENT MORTGAGE FUND AXP U.S. Government Mortgage Fund Class A (includes sales charge) $ 9,525 $ 9,692 $10,363 $10,495 $11,102 Lehman Brothers Mortgage-Backed Securities Index(1) $10,000 $10,169 $10,822 $10,984 $11,719 Lipper U.S. Mortgage Funds Index(2) $10,000 $10,128 $10,744 $10,887 $11,463 3/1/02 5/31/02 5/31/03 5/31/04 5/31/05
COMPARATIVE RESULTS Results at May 31, 2005 Since 1 year 3 years inception(3) AXP U.S. Government Mortgage Fund (includes sales charge) Class A Cumulative value of $10,000 $10,075 $10,911 $11,102 Average annual total return +0.75% +2.95% +3.22% Lehman Brothers Mortgage-Backed Securities Index(1) Cumulative value of $10,000 $10,669 $11,523 $11,719 Average annual total return +6.69% +4.84% +4.95% Lipper U.S. Mortgage Funds Index(2) Cumulative value of $10,000 $10,529 $11,317 $11,463 Average annual total return +5.29% +4.21% +4.29%
Results for other share classes can be found on page 4. (1) The Lehman Brothers Mortgage-Backed Securities Index, an unmanaged index, includes 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), and Federal National Mortgage Association (FNMA). (2) The Lipper U.S. Mortgage Funds Index includes the 10 largest U.S. mortgage funds tracked by Lipper Inc. The index's returns include net reinvested dividends. (3) Fund data is from Feb. 14, 2002. Lehman Brothers Mortgage-Backed Securities Index and Lipper peer group data is from March 1, 2002. -------------------------------------------------------------------------------- 9 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Investments in Securities AXP U.S. Government Mortgage Fund May 31, 2005 (Percentages represent value of investments compared to net assets) Bonds (99.1%) Issuer Coupon Principal Value(a) rate amount Commercial mortgage-backed/(f) Asset-backed securities (0.8%) Federal Natl Mtge Assn 12-01-11 4.27% $993,870 $991,931 02-01-13 4.87 24,261 24,886 07-01-13 4.48 487,500 489,667 12-01-13 5.01 540,749 559,438 Total 2,065,922 Mortgage-backed securities (98.3%)(f,i) Adjustable Rate Mtge Trust Series 2004-2 Cl 6A1 02-25-35 5.28 619,185(c) 628,476 Banc of America Mtge Securities Series 2004-F Cl B1 07-25-34 4.14 545,614(c) 552,424 Bank of America Alternative Loan Trust Series 2003-11 Cl 1A1 01-25-34 6.00 851,313 867,139 Series 2003-11 Cl 4A1 01-25-19 4.75 424,655 424,701 Chaseflex Trust Series 2005-2 Cl 2A1 06-25-35 6.00 2,500,000 2,556,650 Series 2005-2 Cl 2A2 06-25-35 6.50 1,000,000 1,035,000 Countrywide Alternative Loan Trust Series 2004-28CB Cl 6A1 01-25-35 6.00 2,673,006 2,754,916 Series 2005-6CB Cl 1A1 04-25-35 7.50 666,115 700,386 Countrywide Home Loans Series 2004-12 Cl 1M 08-25-34 4.65 374,582(c) 375,660 CS First Boston Mtge Securities Series 2004-AR5 Cl CB1 06-25-34 4.43 372,410(c) 367,506 Federal Home Loan Mtge Corp 01-01-09 7.00 229,623 238,925 03-01-10 8.00 394,429 412,486 06-01-15 7.50 1,571,808 1,685,560 Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Home Loan Mtge Corp (cont.) 12-01-16 6.50% $441,356 $462,261 02-01-17 6.50 2,053,198 2,147,484 04-01-17 7.00 1,188,266 1,252,826 10-01-17 8.00 553,131 593,302 11-01-17 5.00 2,626,278 2,660,170 01-01-18 5.50 1,578,281 1,622,185 05-01-18 5.00 2,230,123 2,260,125 08-01-18 5.00 2,537,044 2,575,434 10-01-18 5.00 3,022,074 3,059,718 03-01-22 6.50 505,969 527,355 04-01-22 6.50 901,069 945,950 01-01-30 5.50 2,252,940 2,298,625 12-01-30 5.50 1,494,432 1,523,196 06-01-31 8.00 410,464 442,936 07-01-32 7.00 235,126 247,909 08-01-32 6.50 3,320,420 3,451,250 04-01-33 6.00 2,894,439 3,001,799 06-01-33 5.50 2,337,803 2,375,529 07-01-33 6.00 1,015,572 1,054,842 08-01-33 5.00 1,641,588 1,641,844 09-01-33 5.00 2,577,923 2,578,326 10-01-33 6.00 1,413,032 1,452,371 04-01-34 6.50 750,193 778,973 08-01-34 6.50 2,881,867 2,992,424 Collateralized Mtge Obligation 02-15-27 5.00 3,200,000 3,239,883 10-15-27 5.00 2,225,000 2,270,849 06-15-28 5.00 2,200,000 2,247,639 12-15-28 5.50 635,000 654,013 02-15-33 5.50 3,382,015 3,488,277 Interest Only 02-15-14 7.40 1,326,825(g) 98,265 07-15-17 3.00 894,560(g) 98,728 10-15-22 14.56 1,450,854(g) 93,711 Interest Only/Inverse Floater 11-15-19 0.00 1,568,693(d,g) 153,016 03-15-32 0.00 602,405(d,g) 47,171 Federal Natl Mtge Assn 05-01-08 7.75 237,106 247,061 10-01-09 8.50 107,926 110,356 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 10 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn (cont.) 08-01-10 7.50% $612,245 $646,128 04-01-11 6.50 200,939 209,696 08-01-16 6.50 309,126 323,896 03-01-17 6.00 876,474 910,686 03-01-17 6.50 728,812 761,478 03-01-17 7.00 46,834 49,145 04-01-17 7.50 90,129 95,300 05-01-17 6.00 401,903 417,667 07-01-17 6.00 4,822,619 5,014,699 08-01-17 5.50 2,468,594 2,541,559 09-01-17 6.50 2,133,979 2,233,986 10-01-17 5.50 787,197 810,334 11-01-17 5.50 2,627,026 2,704,175 12-01-17 5.50 2,009,128 2,066,650 02-01-18 5.50 2,754,350 2,834,176 04-01-18 5.50 3,416,680 3,516,934 05-01-18 5.00 1,727,787 1,749,088 05-01-18 6.00 1,358,494 1,408,483 06-01-18 4.50 2,299,291 2,293,810 06-01-18 5.00 1,728,861 1,753,403 08-01-18 4.50 5,459,371 5,441,883 12-01-18 5.00 1,769,589 1,792,013 02-01-19 5.00 1,549,603 1,568,707 09-01-19 6.00 1,136,785 1,178,602 06-01-20 5.00 3,250,000(b) 3,286,563 06-01-20 5.50 350,000(b) 359,297 06-01-20 6.00 2,500,000(b) 2,589,845 09-01-22 6.50 773,210 806,667 11-01-22 6.00 894,829 925,454 03-01-23 5.50 2,005,475 2,054,077 07-01-23 5.00 991,194 998,604 08-01-23 5.50 3,629,714 3,697,806 09-01-23 5.50 2,896,952 2,958,667 10-01-23 5.50 1,697,997 1,729,884 04-01-25 8.00 1,149,372 1,250,847 07-01-28 5.50 1,550,329 1,579,376 08-01-28 5.50 1,336,718 1,361,764 09-01-28 7.50 1,301,865 1,399,785 12-01-28 7.00 1,507,205 1,612,244 01-01-29 6.00 1,165,164 1,201,609 03-01-29 6.50 2,668,357 2,802,272 04-01-29 5.00 1,816,445 1,816,394 05-01-29 6.00 808,570 833,861 06-01-29 6.00 4,127,222 4,276,834 06-01-31 7.00 2,417,727 2,567,365 09-01-31 7.00 2,489,336 2,657,595 09-01-31 7.50 2,482,157 2,665,949 Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn (cont.) 10-01-31 9.50% $105,937 $117,187 11-01-31 6.50 1,025,860 1,073,037 01-01-32 6.00 1,297,077 1,339,103 01-01-32 6.50 881,257 923,241 03-01-32 7.00 746,267 795,619 04-01-32 6.50 2,463,612 2,576,948 04-01-32 7.00 805,007 852,724 05-01-32 6.50 3,888,536 4,066,679 05-01-32 7.00 2,871,267 3,042,741 06-01-32 6.50 1,157,942 1,214,336 08-01-32 6.50 1,349,990 1,412,040 09-01-32 6.00 1,959,641 2,017,678 09-01-32 6.50 2,092,415 2,176,939 10-01-32 5.50 774,399 786,553 11-01-32 6.00 3,694,053 3,820,390 12-01-32 6.00 1,700,839 1,751,211 01-01-33 5.50 1,008,124 1,023,946 01-01-33 6.00 2,487,416 2,561,084 01-01-33 7.00 1,118,949 1,184,761 02-01-33 5.50 2,283,086 2,323,086 03-01-33 5.50 2,405,944 2,449,587 03-01-33 6.50 364,524 380,841 04-01-33 5.50 11,388,269 11,588,934 05-01-33 5.50 5,966,382 6,064,250 05-01-33 6.00 1,785,748 1,847,224 06-01-33 5.50 3,333,978 3,384,290 07-01-33 4.85 724,685(c) 725,193 07-01-33 5.00 1,451,619 1,453,112 07-01-33 5.50 3,178,515(h) 3,226,481 07-01-33 5.50 937,624 951,774 08-01-33 5.50 1,222,598 1,241,048 11-01-33 5.50 2,566,102 2,604,826 11-01-33 7.00 816,529 862,132 01-01-34 6.50 757,248 790,791 03-01-34 5.00 1,456,212 1,457,710 04-01-34 5.00 3,015,836 3,018,158 09-01-34 4.84 1,876,589(c) 1,893,674 12-01-34 4.40 980,308(c) 978,005 06-01-35 6.00 2,400,000(b) 2,466,000 07-01-35 5.00 5,000,000(b) 4,979,700 Collateralized Mtge Obligation 12-25-26 8.00 568,266 602,441 Interest Only 12-25-12 13.29 1,184,065(g) 61,734 12-25-22 3.19 340,006(g) 46,854 12-25-31 1.19 784,536(g) 126,498 12-25-33 6.09 645,778(g) 155,648 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 11 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn (cont.) Principal Only 08-25-44 8.28% $1,125,099(e) $900,056 First Horizon Alternative Mtge Securities Series 2004-AA4 Cl A1 10-25-34 5.43 660,527 674,239 Series 2005-AA3 Cl 3A1 05-25-35 5.44 1,275,897 1,297,983 Series 2005-AA4 Cl B1 06-25-35 5.40 349,956 355,151 Govt Natl Mtge Assn 02-15-30 7.00 265,401 281,395 03-15-30 7.00 540,819 573,411 12-15-31 6.50 594,523 623,370 02-15-32 6.50 693,332 726,884 12-15-32 6.00 560,298 579,391 07-15-33 5.00 792,273 799,340 10-15-33 5.00 1,450,570 1,463,268 IndyMac Index Mtge Loan Trust Series 2005-AR3 Cl 3A1 04-25-35 5.34 408,462(c) 414,617 Series 2005-AR8 Cl AX1 Interest Only 04-25-35 4.50 23,840,000(c,g) 312,900 Master Alternative Loans Trust Series 2004-7 Cl 8A1 08-25-19 5.00 558,848 561,804 Series 2004-8 Cl 7A1 09-25-19 5.00 791,753 796,203 Series 2005-1 Cl 2A1 02-25-35 6.00 1,586,723 1,632,601 Structured Adjustable Rate Mtge Loan Series 2004-5 Cl B1 05-25-34 4.62 423,872(c) 419,294 Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Structured Asset Securities Series 2003-33H Cl 1A1 10-25-33 5.50% $1,846,561 $1,855,725 Washington Mutual Series 2004-CB2 Cl 6A 07-25-19 4.50 886,795 869,387 Series 2004-CB4 Cl 22A 12-25-19 6.00 2,312,379 2,387,938 Wells Fargo Mtge Backed Securities Trust Series 2005-5 Cl 2A1 05-25-35 5.50 998,481 1,015,977 Series 2005-AR1 Cl 1A1 02-25-35 4.57 1,107,812(c) 1,107,878 Total 263,115,909 Total bonds (Cost: $264,264,572) $265,181,831 Short-term securities (6.0%) Issuer Effective Amount Value(a) yield payable at maturity Commercial paper BNP Paribas North America 06-01-05 3.06% $6,200,000 $6,199,473 National Australia Funding 06-16-05 3.01 5,000,000 4,993,311 Variable Funding Capital 06-16-05 3.02 5,000,000 4,993,289 Total short-term securities (Cost: $16,187,438) $16,186,073 Total investments in securities (Cost: $280,452,010)(j) $281,367,904 Notes to investments in securities (a) Securities are valued by procedures described in Note 1 to the financial statements. (b) At May 31, 2005, the cost of securities purchased, including interest purchased, on a when-issued and/or other forward-commitment basis was $13,649,112. (c) Adjustable rate mortgage; interest rate varies to reflect current market conditions; rate shown is the effective rate on May 31, 2005. (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, 2005. At May 31, 2005, the value of inverse floaters represented 0.1% of net assets. -------------------------------------------------------------------------------- 12 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Notes to investments in securities (continued) (e) 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 at May 31, 2005. (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 at May 31, 2005. (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. 2005, 20-year $12,000,000 Sale contracts U.S. Treasury Note, Sept. 2005, 2-year 3,500,000 U.S. Treasury Note, Sept. 2005, 5-year 9,300,000 U.S. Treasury Note, Sept. 2005, 10-year 2,100,000 (i) Comparable securities are held to satisfy future delivery requirements of the following open forward sale commitments at May 31, 2005: Security Principal Settlement Proceeds Value amount date receivable Federal Natl Mtge Assn 06-01-20 4.50% $ 400,000 6-16-05 $ 394,500 $ 398,125 06-01-35 6.50 2,500,000 6-13-05 2,600,391 2,596,875 (j) At May 31, 2005, the cost of securities for federal income tax purposes was $280,684,949 and the aggregate gross unrealized appreciation and depreciation based on that cost was: Unrealized appreciation $ 1,749,090 Unrealized depreciation (1,066,135) ---------- Net unrealized appreciation $ 682,955 ----------- How to find information about the Fund's portfolio holdings (i) The Fund files its complete schedule of portfolio holdings with the Securities and Exchange Commission (Commission) for the first and third quarters of each fiscal year on Form N-Q; (ii) The Fund's Forms N-Q are available on the Commission's website at http://www.sec.gov; (iii) The Fund's Forms N-Q may be reviewed and copied at the Commission's Public Reference Room in Washington, DC (information on the operations of the Public Reference Room may be obtained by calling 1-800-SEC-0330); and (iv) The Fund's complete schedule of portfolio holdings, as disclosed in its annual and semiannual shareholder reports and in its filings on Form N-Q, can be found at www.americanexpress.com/funds. -------------------------------------------------------------------------------- 13 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Financial Statements
Statement of assets and liabilities AXP U.S. Government Mortgage Fund May 31, 2005 Assets Investments in securities, at value (Note 1) (identified cost $280,452,010) $281,367,904 Cash in bank on demand deposit 25,120 Capital shares receivable 63,467 Dividends and accrued interest receivable 1,236,570 Receivable for investment securities sold 9,330,655 --------- Total assets 292,023,716 ----------- Liabilities Dividends payable to shareholders 127,795 Capital shares payable 209,772 Payable for investment securities purchased 7,242,746 Payable for securities purchased on a forward-commitment basis (Note 1) 13,649,112 Accrued investment management services fee 15,255 Accrued distribution fee 16,250 Accrued transfer agency fee 4,638 Accrued administrative services fee 1,467 Other accrued expenses 72,589 Forward sale commitments, at value (proceeds receivable $2,994,891) (Note 1) 2,995,000 --------- Total liabilities 24,334,624 ---------- Net assets applicable to outstanding capital stock $267,689,092 ============ Represented by Capital stock -- $.01 par value (Note 1) $ 523,242 Additional paid-in capital 266,461,422 Excess of distributions over net investment income (186,452) Accumulated net realized gain (loss) (147,719) Unrealized appreciation (depreciation) on investments 1,038,599 --------- Total -- representing net assets applicable to outstanding capital stock $267,689,092 ============ Net assets applicable to outstanding shares: Class A $159,223,769 Class B $ 97,863,453 Class C $ 10,556,978 Class I $ 9,924 Class Y $ 34,968 Net asset value per share of outstanding capital stock: Class A shares 31,128,293 $ 5.12 Class B shares 19,124,334 $ 5.12 Class C shares 2,062,750 $ 5.12 Class I shares 1,942 $ 5.11 Class Y shares 6,838 $ 5.11 ----- ------------
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 14 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT
Statement of operations AXP U.S. Government Mortgage Fund Year ended May 31, 2005 Investment income Income: Interest $13,576,333 ----------- Expenses (Note 2): Investment management services fee 1,532,464 Distribution fee Class A 427,918 Class B 1,109,871 Class C 125,193 Transfer agency fee 484,311 Incremental transfer agency fee Class A 28,225 Class B 31,603 Class C 3,447 Service fee -- Class Y 22 Administrative services fees and expenses 152,145 Compensation of board members 9,573 Custodian fees 72,460 Printing and postage 97,713 Registration fees 46,824 Audit fees 21,000 Other 15,069 ------ Total expenses 4,157,838 Expenses waived/reimbursed by AEFC (Note 2) (440,728) -------- 3,717,110 Earnings credits on cash balances (Note 2) (10,045) ------- Total net expenses 3,707,065 --------- Investment income (loss) -- net 9,869,268 --------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (Note 3) 383,056 Futures contracts 1,676,423 --------- Net realized gain (loss) on investments 2,059,479 Net change in unrealized appreciation (depreciation) on investments 3,221,638 --------- Net gain (loss) on investments 5,281,117 --------- Net increase (decrease) in net assets resulting from operations $15,150,385 ===========
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 15 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT
Statements of changes in net assets AXP U.S. Government Mortgage Fund Year ended May 31, 2005 2004 Operations and distributions Investment income (loss) -- net $ 9,869,268 $ 10,971,324 Net realized gain (loss) on investments 2,059,479 (1,761,493) Net change in unrealized appreciation (depreciation) on investments 3,221,638 (5,682,907) --------- ---------- Net increase (decrease) in net assets resulting from operations 15,150,385 3,526,924 ---------- --------- Distributions to shareholders from: Net investment income Class A (6,521,365) (6,673,492) Class B (3,367,254) (3,833,418) Class C (379,894) (435,554) Class I (414) (167) Class Y (890) (414) 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) Class B -- (1,733,487) Class C -- (199,554) Class Y -- (142) ----------- ----------- Total distributions (10,269,817) (15,774,616) ----------- ----------- Capital share transactions (Note 4) Proceeds from sales Class A shares (Note 2) 49,147,666 80,517,965 Class B shares 19,159,654 42,305,093 Class C shares 1,916,466 5,501,269 Class I shares -- 44,454 Class Y shares 21,761 500 Reinvestment of distributions at net asset value Class A shares 5,863,503 8,808,051 Class B shares 3,139,154 5,526,710 Class C shares 344,732 615,962 Class I shares -- 66 Class Y shares 464 111 Payments for redemptions Class A shares (75,829,038) (156,430,470) Class B shares (Note 2) (54,952,040) (114,195,539) Class C shares (Note 2) (6,648,471) (12,356,331) Class I shares -- (34,542) ----------- ----------- Increase (decrease) in net assets from capital share transactions (57,836,149) (139,696,701) ----------- ------------ Total increase (decrease) in net assets (52,955,581) (151,944,393) Net assets at beginning of year 320,644,673 472,589,066 ----------- ----------- Net assets at end of year $267,689,092 $ 320,644,673 ============ =============
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 16 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 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 mortgage-backed securities that either are issued or guaranteed as to principal and interest by the U.S. government, its agencies, authorities or instrumentalities. 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 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. 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. At May 31, 2005, American Express Financial Corporation (AEFC) owned 100% of Class I shares, which represents 0.004% of the Fund's net assets. All classes of shares have identical voting, dividend and liquidation rights. The distribution fee, transfer agency fees 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 U.S. generally accepted accounting principles 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 --- 2005 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. 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. At May 31, 2005, the Fund has entered into outstanding when-issued securities of $13,649,112. 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. 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. -------------------------------------------------------------------------------- 18 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Futures transactions To gain exposure to or protect itself from market changes, the Fund may buy and sell financial futures contracts. Risks of entering into futures contracts and related options include the possibility of an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. Upon entering into a futures contract, the Fund is required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract value. Subsequent payments (variation margin) are made or received by the Fund each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. The Fund recognizes a realized gain or loss when the contract is closed or expires. Short sales The Fund may engage in short sales. In these transactions, the Fund sells a security that it does not own. The Fund is obligated to replace the security that was short by purchasing it at the market price at the time of replacement or entering into an offsetting transaction with the broker. The price at such time may be more or less than the price at which the Fund sold the security. Forward sale commitments The Fund 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 Fund as an unrealized gain or loss. If the forward sale commitment is closed through the acquisition of an offsetting purchase commitment, the Fund realizes a gain or loss. If the Fund delivers securities under the commitment, the Fund 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." Guarantees and indemnifications Under the Fund's organizational documents, its officers and directors are indemnified against certain liabilities arising out of the performance of their duties to the Fund. In addition, certain of the Fund's contracts with its service providers contain general indemnification clauses. The Fund's maximum exposure under these arrangements is unknown since the amount of any future claims that may be made against the Fund cannot be determined and the Fund has no historical basis for predicting the likelihood of any such claims. -------------------------------------------------------------------------------- 19 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Federal taxes The Fund's policy is to comply with all sections of the Internal Revenue Code that apply to regulated investment companies and to distribute substantially all of its taxable income to 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 $383,679 and accumulated net realized loss has been increased by $69,810 resulting in a net reclassification adjustment to decrease paid-in capital by $313,869. The tax character of distributions paid for the years indicated is as follows: Year ended May 31, 2005 2004 Class A Distributions paid from: Ordinary income $6,521,365 $8,814,309 Long-term capital gain -- 135,594 Tax return of capital -- 379,306 Class B Distributions paid from: Ordinary income 3,367,254 5,463,649 Long-term capital gain -- 103,256 Tax return of capital -- 217,882 Class C Distributions paid from: Ordinary income 379,894 623,221 Long-term capital gain -- 11,887 Tax return of capital -- 24,756 Class I* Distributions paid from: Ordinary income 414 167 Long-term capital gain -- -- Tax return of capital -- 9 Class Y Distributions paid from: Ordinary income 890 548 Long-term capital gain -- 8 Tax return of capital -- 24 * Inception date was March 4, 2004. At May 31, 2005, the components of distributable earnings on a tax basis are as follows: Undistributed ordinary income $325,769 Accumulated long-term gain (loss) $113,414 Unrealized appreciation (depreciation) $393,040 -------------------------------------------------------------------------------- 20 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Dividends to shareholders Dividends from net investment income, declared daily and payable monthly, when available, are reinvested in additional shares of the Fund at net asset value or payable in cash. Capital gains, when available, are distributed along with the last income dividend of the calendar year. Other Security transactions are accounted for on the date securities are purchased or sold. Interest income, including amortization of premium, market discount and original issue discount using the effective interest method, is accrued daily. 2. EXPENSES AND SALES CHARGES The Fund has agreements with 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 that declines from 0.52% to 0.395% annually as the Fund's assets increase. 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 that declines from 0.05% to 0.025% annually as the Fund's assets increase. 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. -------------------------------------------------------------------------------- 21 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT The Fund has agreements with American Express Financial Advisors Inc. (the Distributor) for distribution and shareholder services. Under a Plan and Agreement of Distribution pursuant to Rule 12b-1, 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 $441,264 for Class A, $177,017 for Class B and $3,125 for Class C for the year ended May 31, 2005. For the year ended May 31, 2005, AEFC and its affiliates waived certain fees and expenses to 0.95% for Class A, 1.69% for Class B, 1.70% for Class C, 0.62% for Class I and 0.77% for Class Y. Of these waived fees and expenses, the transfer agency fees waived for Class A, Class B, Class C and Class Y were $171,675, $123,480, $13,768 and $25, respectively, and the management fees waived at the Fund level were $131,780. Beginning June 1, 2005, AEFC and its affiliates have agreed to waive certain fees and expenses until May 31, 2006. Under this agreement, net expenses will not exceed 0.89% for Class A, 1.64% for Class B, 1.64% for Class C, 0.59% for Class I and 0.71% for Class Y of the Fund's average daily net assets. During the year ended May 31, 2005, the Fund's custodian and transfer agency fees were reduced by $10,045 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 $399,037,334 and $460,230,683, respectively, for the year ended May 31, 2005. 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, 2005 Class A Class B Class C Class I Class Y Sold 9,625,103 3,748,262 374,927 -- 4,240 Issued for reinvested distributions 1,147,161 613,952 67,418 -- 91 Redeemed (14,862,288) (10,774,795) (1,302,715) -- -- ----------- ----------- ---------- ------ ----- Net increase (decrease) (4,090,024) (6,412,581) (860,370) -- 4,331 ----------- ----------- ---------- ------ ----- 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. -------------------------------------------------------------------------------- 22 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT 5. INTEREST RATE FUTURES CONTRACTS At May 31, 2005, investments in securities included securities valued at $355,282 that were pledged as collateral to cover initial margin deposits on 120 open purchase contracts and 149 open sale contracts. The notional market value of the open purchase contracts at May 31, 2005 was $14,092,500 with a net unrealized gain of $146,707. The notional market value of the open sale contracts at May 31, 2005 was $19,763,938 with a net unrealized loss of $23,893. See "Summary of significant accounting policies" and "Notes to investments in securities." 6. BANK BORROWINGS The Fund has a revolving credit agreement with a syndicate of banks headed by The Bank of New York, whereby the Fund may borrow for the temporary funding of shareholder redemptions or for other temporary or emergency purposes. The agreement went into effect Sept. 21, 2004. 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 higher of the Federal Funds Effective Rate plus 0.50% or 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. Prior to this agreement, the Fund had a revolving credit agreement that permitted borrowings up to $500 million with Deutsche Bank. The Fund had no borrowings outstanding during the year ended May 31, 2005. -------------------------------------------------------------------------------- 23 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT 7. 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, 2005 2004 2003 2002(b) Net asset value, beginning of period $5.03 $5.19 $5.06 $5.01 ----- ----- ----- ----- Income from investment operations: Net investment income (loss) .19 .16 .19 .04 Net gains (losses) (both realized and unrealized) .10 (.09) .16 .04 ----- ----- ----- ----- Total from investment operations .29 .07 .35 .08 ----- ----- ----- ----- Less distributions: Dividends from net investment income (.20) (.16) (.20) (.03) Tax return of capital -- (.01) -- -- Distributions from realized gains -- (.06) (.02) -- ----- ----- ----- ----- Total distributions (.20) (.23) (.22) (.03) ----- ----- ----- ----- Net asset value, end of period $5.12 $5.03 $5.19 $5.06 ----- ----- ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $159 $177 $251 $58 Ratio of expenses to average daily net assets(c),(d) .95% .98% .99% .95%(e) Ratio of net investment income (loss) to average daily net assets 3.67% 3.11% 3.31% 2.98%(e) Portfolio turnover rate (excluding short-term securities) 137% 163% 227% 200% Total return(f) 5.78% 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) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratios of expenses for Class A would have been 1.10%, 1.05%, 1.06% and 1.58% for the periods ended May 31, 2005, 2004, 2003 and 2002, respectively. (e) Adjusted to an annual basis. (f) Total return does not reflect payment of a sales charge. (g) Not annualized. -------------------------------------------------------------------------------- 24 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT
Class B Per share income and capital changes(a) Fiscal period ended May 31, 2005 2004 2003 2002(b) Net asset value, beginning of period $5.04 $5.20 $5.07 $5.01 ----- ----- ----- ----- Income from investment operations: Net investment income (loss) .15 .12 .15 .03 Net gains (losses) (both realized and unrealized) .09 (.09) .16 .05 ----- ----- ----- ----- Total from investment operations .24 .03 .31 .08 ----- ----- ----- ----- Less distributions: Dividends from net investment income (.16) (.12) (.16) (.02) Tax return of capital -- (.01) -- -- Distributions from realized gains -- (.06) (.02) -- ----- ----- ----- ----- Total distributions (.16) (.19) (.18) (.02) ----- ----- ----- ----- Net asset value, end of period $5.12 $5.04 $5.20 $5.07 ----- ----- ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $98 $129 $200 $28 Ratio of expenses to average daily net assets(c),(d) 1.69% 1.74% 1.75% 1.74%(e) Ratio of net investment income (loss) to average daily net assets 2.90% 2.35% 2.49% 2.68%(e) Portfolio turnover rate (excluding short-term securities) 137% 163% 227% 200% Total return(f) 4.78% .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) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratios of expenses for Class B would have been 1.86%, 1.80%, 1.82% and 2.34% for the periods ended May 31, 2005, 2004, 2003 and 2002, respectively. (e) Adjusted to an annual basis. (f) Total return does not reflect payment of a sales charge. (g) Not annualized. -------------------------------------------------------------------------------- 25 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT
Class C Per share income and capital changes(a) Fiscal period ended May 31, 2005 2004 2003 2002(b) Net asset value, beginning of period $5.04 $5.20 $5.07 $5.01 ----- ----- ----- ----- Income from investment operations: Net investment income (loss) .15 .12 .15 .03 Net gains (losses) (both realized and unrealized) .09 (.09) .16 .05 ----- ----- ----- ----- Total from investment operations .24 .03 .31 .08 ----- ----- ----- ----- Less distributions: Dividends from net investment income (.16) (.12) (.16) (.02) Tax return of capital -- (.01) -- -- Distributions from realized gains -- (.06) (.02) -- ----- ----- ----- ----- Total distributions (.16) (.19) (.18) (.02) ----- ----- ----- ----- Net asset value, end of period $5.12 $5.04 $5.20 $5.07 ----- ----- ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $11 $15 $22 $5 Ratio of expenses to average daily net assets(c),(d) 1.70% 1.74% 1.75% 1.73%(e) Ratio of net investment income (loss) to average daily net assets 2.90% 2.36% 2.50% 2.60%(e) Portfolio turnover rate (excluding short-term securities) 137% 163% 227% 200% Total return(f) 4.79% .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) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratios of expenses for Class C would have been 1.85%, 1.80%, 1.82% and 2.34% for the periods ended May 31, 2005, 2004, 2003 and 2002, respectively. (e) Adjusted to an annual basis. (f) Total return does not reflect payment of a sales charge. (g) Not annualized. -------------------------------------------------------------------------------- 26 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT
Class I Per share income and capital changes(a) Fiscal period ended May 31, 2005 2004(b) Net asset value, beginning of period $5.03 $5.15 ----- ----- Income from investment operations: Net investment income (loss) .20 .05 Net gains (losses) (both realized and unrealized) .09 (.11) ----- ----- Total from investment operations .29 (.06) ----- ----- Less distributions: Dividends from net investment income (.21) (.06) ----- ----- Net asset value, end of period $5.11 $5.03 ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $-- $-- Ratio of expenses to average daily net assets(c) .62%(d) .64%(e) Ratio of net investment income (loss) to average daily net assets 3.99% 3.39%(e) Portfolio turnover rate (excluding short-term securities) 137% 163% Total return(f) 5.92% (1.38%)(g)
(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) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratio of expenses for Class I would have been 0.66% for the year ended May 31, 2005. (e) Adjusted to an annual basis. (f) Total return does not reflect payment of a sales charge. (g) Not annualized. -------------------------------------------------------------------------------- 27 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT
Class Y Per share income and capital changes(a) Fiscal period ended May 31, 2005 2004 2003 2002(b) Net asset value, beginning of period $5.03 $5.19 $5.06 $5.01 ----- ----- ----- ----- Income from investment operations: Net investment income (loss) .20 .17 .19 .04 Net gains (losses) (both realized and unrealized) .08 (.09) .16 .04 ----- ----- ----- ----- Total from investment operations .28 .08 .35 .08 ----- ----- ----- ----- Less distributions: Dividends from net investment income (.20) (.17) (.20) (.03) Tax return of capital -- (.01) -- -- Distributions from realized gains -- (.06) (.02) -- ----- ----- ----- ----- Total distributions (.20) (.24) (.22) (.03) ----- ----- ----- ----- Net asset value, end of period $5.11 $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),(d) .77% .81% .80% .78%(e) Ratio of net investment income (loss) to average daily net assets 3.99% 3.29% 3.68% 2.95%(e) Portfolio turnover rate (excluding short-term securities) 137% 163% 227% 200% Total return(f) 5.75% 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) AEFC waived/reimbursed the Fund for certain expenses. Had AEFC not done so, the annual ratios of expenses for Class Y would have been 0.94%, 0.87%, 0.88% and 1.40% for the periods ended May 31, 2005, 2004, 2003 and 2002, respectively. (e) Adjusted to an annual basis. (f) Total return does not reflect payment of a sales charge. (g) Not annualized. -------------------------------------------------------------------------------- 28 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 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, 2005, 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, 2005, and the financial highlights for each of the years in the three-year period ended May 31, 2005 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, 2005, 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, 2005, 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 U.S. generally accepted accounting principles. KPMG LLP Minneapolis, Minnesota July 20, 2005 -------------------------------------------------------------------------------- 29 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 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, 2005 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 25, 2004 $0.01350 July 26, 2004 0.01300 Aug. 25, 2004 0.01300 Sept. 24, 2004 0.01397 Oct. 25, 2004 0.01500 Nov. 24, 2004 0.01692 Dec. 22, 2004 0.01954 Jan. 27, 2005 0.01617 Feb. 24, 2005 0.01600 March 30, 2005 0.01800 April 28, 2005 0.02000 May 26, 2005 0.02000 Total distributions $0.19510 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 25, 2004 $0.01055 July 26, 2004 0.00975 Aug. 25, 2004 0.00986 Sept. 24, 2004 0.01078 Oct. 25, 2004 0.01174 Nov. 24, 2004 0.01376 Dec. 22, 2004 0.01660 Jan. 27, 2005 0.01231 Feb. 24, 2005 0.01305 March 30, 2005 0.01445 April 28, 2005 0.01697 May 26, 2005 0.01718 Total distributions $0.15700 -------------------------------------------------------------------------------- 30 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 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 25, 2004 $0.01044 July 26, 2004 0.00978 Aug. 25, 2004 0.00987 Sept. 24, 2004 0.01080 Oct. 25, 2004 0.01174 Nov. 24, 2004 0.01377 Dec. 22, 2004 0.01661 Jan. 27, 2005 0.01232 Feb. 24, 2005 0.01306 March 30, 2005 0.01445 April 28, 2005 0.01698 May 26, 2005 0.01722 Total distributions $0.15704 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 June 25, 2004 $0.01423 July 26, 2004 0.01428 Aug. 25, 2004 0.01423 Sept. 24, 2004 0.01575 Oct. 25, 2004 0.01644 Nov. 24, 2004 0.01830 Dec. 22, 2004 0.02083 Jan. 27, 2005 0.01735 Feb. 24, 2005 0.01730 March 30, 2005 0.01958 April 28, 2005 0.02134 May 26, 2005 0.02132 Total distributions $0.21095 -------------------------------------------------------------------------------- 31 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT 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 25, 2004 $0.01376 July 26, 2004 0.01389 Aug. 25, 2004 0.01373 Sept. 24, 2004 0.01471 Oct. 25, 2004 0.01577 Nov. 24, 2004 0.01766 Dec. 22, 2004 0.02024 Jan. 27, 2005 0.01709 Feb. 24, 2005 0.01671 March 30, 2005 0.01885 April 28, 2005 0.02072 May 26, 2005 0.02043 Total distributions $0.20356 -------------------------------------------------------------------------------- 32 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Fund Expenses Example (UNAUDITED) As a shareholder of the Fund, you incur two types of costs: (1) transaction costs, including sales charges (loads) on purchase payments; and (2) ongoing costs, including management fees; distribution and service (12b-1) fees; and other Fund expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other mutual funds. The example is based on an investment of $1,000 invested at the beginning of the period and held for the six months ended May 31, 2005. Actual Expenses The first line of the table provides information about actual account values and actual expenses. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading titled "Expenses paid during the period" to estimate the expenses you paid on your account during this period. Hypothetical Example for Comparison Purposes The second line of the table provides information about hypothetical account values and hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in the Fund and other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the other funds. Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect any transactional costs, such as sales charges (loads). Therefore, the second line of the table is useful in comparing ongoing costs only, and will not help you determine the relative total costs of owning different funds. In addition, if these transactional costs were included, your costs would have been higher. -------------------------------------------------------------------------------- 33 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT
Beginning Ending Expenses Annualized account value account value paid during expense Dec. 1, 2004 May 31, 2005 the period(a) ratio Class A Actual(b) $1,000 $1,021.40 $4.79(c) .95% Hypothetical (5% return before expenses) $1,000 $1,020.19 $4.78(c) .95% Class B Actual(b) $1,000 $1,017.70 $8.55(c) 1.70% Hypothetical (5% return before expenses) $1,000 $1,016.45 $8.55(c) 1.70% Class C Actual(b) $1,000 $1,017.70 $8.55(c) 1.70% Hypothetical (5% return before expenses) $1,000 $1,016.45 $8.55(c) 1.70% Class I Actual(b) $1,000 $1,023.10 $3.13(c) .62% Hypothetical (5% return before expenses) $1,000 $1,021.84 $3.13(c) .62% Class Y Actual(b) $1,000 $1,020.30 $3.88(c) .77% Hypothetical (5% return before expenses) $1,000 $1,021.09 $3.88(c) .77%
(a) Expenses are equal to the Fund's annualized expense ratio as indicated above, multiplied by the average account value over the period, multiplied by 182/365 (to reflect the one-half year period). (b) Based on the actual return for the six months ended May 31, 2005: +2.14% for Class A, +1.77% for Class B, +1.77% for Class C, +2.31% for Class I and +2.03% for Class Y. (c) Beginning June 1, 2005, AEFC and its affiliates have contractually agreed to waive certain fees and to absorb certain expenses until May 31, 2006, unless sooner terminated at the discretion of the Fund's Board of Directors. Under this agreement, net expenses will not exceed 0.89% for Class A; 1.64% for Class B; 1.64% for Class C; 0.59% for Class I and 0.71% for Class Y. If this agreement had been in place for the entire six-month period ended May 31, 2005, the actual expenses paid would have been: $4.49 for Class A, $8.25 for Class B, $8.25 for Class C, $2.98 for Class I and $3.58 for Class Y; the hypothetical expenses paid would have been: $4.48 for Class A, $8.25 for Class B, $8.25 for Class C, $2.97 for Class I and $3.58 for Class Y. -------------------------------------------------------------------------------- 34 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 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 14 Master Trust portfolios and 90 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 Other directorships with Fund and past five years length of service -------------------------------------- --------------- ------------------------------ ----------------------------- Arne H. Carlson Board member Chair, Board Services 901 S. Marquette Ave. since 1999 Corporation (provides Minneapolis, MN 55402 administrative services to Age 70 boards). Former Governor of Minnesota -------------------------------------- --------------- ------------------------------ ----------------------------- Philip J. Carroll, Jr. Board member Retired Chairman and CEO, Scottish Power PLC, Vulcan 901 S. Marquette Ave. since 2002 Fluor Corporation Materials Company, Inc. Minneapolis, MN 55402 (engineering and (construction Age 67 construction) since 1998 materials/chemicals) -------------------------------------- --------------- ------------------------------ ----------------------------- Livio D. DeSimone Board member Retired Chair of the Board Cargill, Incorporated 30 Seventh Street East since 2001 and Chief Executive Officer, (commodity merchants and Suite 3050 Minnesota Mining and processors), General Mills, St. Paul, MN 55101-4901 Manufacturing (3M) Inc. (consumer foods), Age 71 Vulcan Materials Company (construction materials/ chemicals), Milliken & Company (textiles and chemicals), and Nexia Biotechnologies, Inc. -------------------------------------- --------------- ------------------------------ ----------------------------- Patricia M. Flynn Board member Trustee Professor of BostonFed Bancorp, Inc. 901 S. Marquette Ave. since 2004 Economics and Management, (holding company) and its Minneapolis, MN 55402 Bentley College since 2002; subsidiary Boston Federal Age 54 former Dean, McCallum Savings Bank Graduate School of Business, Bentley College from 1999 to 2002 -------------------------------------- --------------- ------------------------------ ----------------------------- Anne P. Jones Board member Attorney and Consultant 901 S. Marquette Ave. since 1985 Minneapolis, MN 55402 Age 70 -------------------------------------- --------------- ------------------------------ ----------------------------- Stephen R. Lewis, Jr. Board member Retired President and Valmont Industries, Inc. 901 S. Marquette Ave. since 2002 Professor of Economics, (manufactures irrigation Minneapolis, MN 55402 Carleton College systems) Age 66 -------------------------------------- --------------- ------------------------------ -----------------------------
-------------------------------------------------------------------------------- 35 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT
Independent Board Members (continued) Name, address, age Position Principal occupation during Other directorships held with past five years Fund and length of service -------------------------------------- --------------- ------------------------------- ---------------------------- Catherine James Paglia Board member Director, Enterprise Asset Strategic Distribution, 901 S. Marquette Ave. since 2004 Management, Inc. (private Inc. (transportation, Minneapolis, MN 55402 real estate and asset distribution and logistics Age 52 management company) since 1999 consultants) -------------------------------------- --------------- ------------------------------- ---------------------------- Alan K. Simpson Board member Former three-term United 1201 Sunshine Ave. since 1997 States Senator for Wyoming Cody, WY 82414 Age 73 -------------------------------------- --------------- ------------------------------- ---------------------------- Alison Taunton-Rigby Board member Founder and Chief Executive Hybridon, Inc. 901 S. Marquette Ave. since 2002 Officer, RiboNovix, Inc. (biotechnology) Minneapolis, MN 55402 since 2004; President, Age 61 Forester Biotech since 2000; prior to that, President and CEO, Aquila Biopharmaceuticals, Inc. -------------------------------------- --------------- ------------------------------- ---------------------------- Board Member Affiliated with AEFC* Name, address, age Position held Principal occupation during Other directorships with Fund and past five years length of service -------------------------------------- --------------- ------------------------------- ---------------------------- William F. Truscott Board member Senior Vice President - Chief 53600 AXP Financial Center since 2001, Investment Officer of AEFC Minneapolis, MN 55474 Vice President since 2001. Former Chief Age 44 since 2002 Investment Officer and Managing Director, Zurich Scudder Investments -------------------------------------- --------------- ------------------------------- ----------------------------
* Interested person by reason of being an officer, director and/or employee of AEFC. -------------------------------------------------------------------------------- 36 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 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 Other directorships with Fund and past five years length of service -------------------------------------- --------------- ------------------------------- ---------------------------- Jeffrey P. Fox Treasurer Vice President - Investment 105 AXP Financial Center since 2002 Accounting, AEFC, since Minneapolis, MN 55474 2002; Vice President - Age 50 Finance, American Express Company, 2000-2002; Vice President - Corporate Controller, AEFC, 1996-2000 -------------------------------------- --------------- ------------------------------- ---------------------------- Paula R. Meyer President Senior Vice President and 596 AXP Financial Center since 2002 General Manager - Mutual Minneapolis, MN 55474 Funds, AEFC, since 2002; Vice Age 51 President and Managing Director - American Express Funds, AEFC, 2000-2002; Vice President, AEFC, 1998-2000 -------------------------------------- --------------- ------------------------------- ---------------------------- Leslie L. Ogg Vice President of Board Services 901 S. Marquette Ave. President, Corporation Minneapolis, MN 55402 Age 66 General Counsel, and Secretary since 1978 -------------------------------------- --------------- ------------------------------- ---------------------------- Beth E. Weimer Chief Vice President and Chief 172 AXP Financial Center Compliance Compliance Officer, AEFC, Minneapolis, MN 55474 Officer since since 2001; Vice President Age 52 2004 and Chief Compliance Officer, AEFA, 2001-2005; Partner, Arthur Andersen Regulatory Risk Services, 1998-2001 -------------------------------------- --------------- ------------------------------- ----------------------------
The SAI has additional information about the Fund's directors and is available, without charge, upon request by calling (800) 862-7919. -------------------------------------------------------------------------------- 37 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT Approval of Investment Management Services Agreement American Express Financial Corporation (AEFC), a wholly-owned subsidiary of American Express Company, serves as the investment manager to the Fund. Under an Investment Management Services Agreement (the Agreement), AEFC provides investment advice and other services to the Fund. Throughout the year, the Funds' Board of Directors and the Board's Investment Review Committee monitor these services. Each year the Board determines whether to continue the Agreement by evaluating the quality and level of service received and the costs associated with those services. AEFC prepares detailed reports for the Board and its Contracts Committee in March and April and provides data prepared by independent organizations to assist the Board in making this determination. The Board gives considerable weight to the work, deliberations and conclusions of the Contracts and Investment Review Committees in determining whether to continue the Agreement. On February 1, 2005, American Express Company announced its intention to pursue a spin-off of AEFC by distributing shares of the common stock of AEFC to shareholders of American Express Company. At a meeting held in person on April 14, 2005, the Board, including a majority of the independent members, approved the continuation of the Agreement for an interim period, not to exceed one year, ending on the later of (i) the effective date of the spin-off or (ii) the approval by the Fund's shareholders of a new investment management services agreement with AEFC (the Interim Period). The spin-off will not result in an "assignment" of the Agreement under the Investment Company Act of 1940 and, therefore, will not cause the termination of the Agreement according to its terms. In connection with the spin-off AEFC has proposed that going forward, services under the Agreement be provided by an affiliate, RiverSource Investments, LLC (RiverSource). Independent counsel advised the Board that it would be prudent, in connection with the spin-off, to consider a new agreement with RiverSource and to seek shareholder approval of that agreement as soon as practical thereafter. Investment performance is a major factor in the evaluation process, and the Board reviewed the Fund's performance over a range of different periods by comparing its performance to relevant Lipper and broader market indices. The Board considered that over time the Fund's investment performance should be above the median for a peer group of funds with similar investment goals and noted that the Fund's investment performance in 2004 exceeded the median. The Board noted that, in addition to portfolio management and investment research, AEFC provides portfolio trading, daily net asset value calculation, management of cash flow, product development, administration of its compliance and legal departments, access to distribution, accounting and recordkeeping, and reporting to the Board and shareholders. To evaluate these services, the Board referred to surveys and benchmarks established by commercial providers, trade associations and AEFC's internal processes. The Board concluded that the services provided were consistent with services provided by investment managers to comparable mutual funds. -------------------------------------------------------------------------------- 38 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 ANNUAL REPORT The Board also evaluated the price paid for the services provided by AEFC, noting the existence of a pricing philosophy, established by the Board and AEFC, that seeks to maintain total Fund expenses within a range of the median expenses charged to comparable funds sold through financial advisors. The Board considered detailed information set forth in an annual report on fees and expenses, including, among other things, data showing a comparison of the Fund's expenses with median expenses paid by funds in its comparison group and data showing the Fund's contribution to AEFC's profitability. The Board determined that while the Fund's expenses are slightly higher than the median for its comparison group, the existing fee waiver has been increased to reduce further the expenses the Fund will pay. The Board considered the economies of scale that might be realized by AEFC as the Fund grew and took note of the extent to which Fund shareholders also might benefit from such growth. The Board considered that the Agreement provided for lower fees as assets increase at pre-established breakpoints and concluded that the Agreement satisfactorily provided for sharing these economies of scale. The Board took into account the Contracts Committee's discussion comparing the fees AEFC charges to the Fund with those it charges to institutional clients, noting that the relatively higher fees paid by the Fund were principally attributable to the additional services required to manage a regulated mutual fund, like the Fund, and the operation of a large mutual fund family. The Board also considered the profitability realized by AEFC and its affiliates from its relationship with the Fund. The Board took into account the services acquired by AEFC through the use of commission dollars paid by the Fund on portfolio transactions. The Board concluded that AEFC's overall costs and profitability were appropriate, although profitability may be too low on an ongoing basis. The Board noted that the fees paid by the Fund should permit AEFC to offer competitive compensation to its personnel, make necessary investments in its business and earn an appropriate profit. Based on the foregoing, the Board concluded that the fees paid to AEFC under the Agreement were fair and reasonable and determined to approve renewal of the Agreement for the Interim Period. 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 website americanexpress.com/funds; or by searching the website 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, information regarding how the Fund voted proxies relating to portfolio securities during the most recent 12-month period ended June 30 is available at http://www.sec.gov. -------------------------------------------------------------------------------- 39 --- AXP U.S. GOVERNMENT MORTGAGE FUND --- 2005 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 and Anne P. Jones, 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: 2005 - $31,875; 2004 - $28,773 (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: 2005 - $454; 2004 - $579 (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: 2005 - $5,278; 2004 - $5,450 (d) All Other Fees. The fees paid for the years ended May 31, to KPMG LLP for additional professional services rendered for AXP Government Income Series, Inc. were as follows: 2005 - $949; 2004 - None (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 2005 and 2004 were pre-approved by the audit committee. (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: 2005 - None; 2004 - 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: 2005 - $75,900; 2004 - $71,000 (h) 100% of the services performed for item (g) above during 2005 and 2004 were pre-approved by the audit committee. * 2004 represents bills paid 6/1/03 - 5/31/04 2005 represents bills paid 6/1/04 - 5/31/05 Item 5. Audit Committee of Listed Registrants. Not applicable. Item 6. The complete schedule of investments is included in Item 1 of this Form N-CSR. Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies. Not applicable. Item 8. Portfolio Managers of Closed-End Management Investment Companies. Not applicable. Item 9. Purchase of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers. Not applicable. Item 10. Submission of matters to a vote of security holders. Not applicable. Item 11. Controls and Procedures. (a) Based upon their evaluation of the registrant's disclosure controls and procedures as conducted within 90 days of the filing date of this Form N-CSR, the registrant's Principal Financial Officer and Principal Executive Officer have concluded that those disclosure controls and procedures provide reasonable assurance that the material information required to be disclosed by the registrant on this report is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. (b) There were no changes in the registrant's internal controls over financial reporting that occurred during the registrant's last 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. Item 12. 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, 2005 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, 2005 By /s/ Jeffrey P. Fox ------------------ Jeffrey P. Fox Treasurer and Principal Financial Officer Date August 3, 2005