N-30D 1 ctft1202anl.txt CHURCHILL TAX-FREE TRUST 12/31/2002 ANNUAL REPORT MANAGER AND FOUNDER AQUILA MANAGEMENT CORPORATION 380 Madison Avenue, Suite 2300 New York, New York 10017 BOARD OF TRUSTEES Lacy B. Herrmann, Chairman Thomas A. Christopher Douglas Dean Diana P. Herrmann Carroll F. Knicely Theodore T. Mason Anne J. Mills William J. Nightingale James R. Ramsey OFFICERS Diana P. Herrmann, President Thomas S. Albright, Senior Vice President and Portfolio Manager Jerry G. McGrew, Senior Vice President Jason T. McGrew, Vice President Rose F. Marotta, Chief Financial Officer Joseph P. DiMaggio, Treasurer Edward M.W. Hines, Secretary DISTRIBUTOR AQUILA DISTRIBUTORS, INC. 380 Madison Avenue, Suite 2300 New York, New York 10017 CUSTODIAN BANK ONE TRUST COMPANY, N.A. 1111 Polaris Parkway Columbus, Ohio 43240 TRANSFER AND SHAREHOLDER SERVICING AGENT PFPC INC. 400 Bellevue Parkway Wilmington, Delaware 19809 INDEPENDENT AUDITORS KPMG LLP 757 Third Avenue New York, New York 10017 Further information is contained in the Prospectus, which must precede or accompany this report. ANNUAL REPORT DECEMBER 31, 2002 CHURCHILL TAX-FREE FUND OF KENTUCKY A TAX-FREE INCOME INVESTMENT [Logo of the Churchill Tax-Free Fund of Kentucky: a standing pegasus in a circle] [Logo of the Aquila Group of Funds: an eagle's head] ONE OF THE AQUILASM GROUP OF FUNDS [Logo of the Churchill Tax-Free Fund of Kentucky: a standing pegasus in a circle] SERVING KENTUCKY INVESTORS FOR 15 YEARS CHURCHILL TAX-FREE FUND OF KENTUCKY ANNUAL REPORT "CONSISTENT TAX-FREE DIVIDENDS" February 14, 2003 Dear Fellow Shareholder: If you happen to have read the January "Thought For The Month," you will remember that it, too, talked about consistent tax-free* dividends. We feel it is important to highlight this concept again since it is the very basis of the Fund. MEETING THE NEEDS OF SHAREHOLDERS You probably won't be surprised to learn that a large percentage of shareholders in Churchill Tax-Free Fund of Kentucky are pre-retirees or retirees who depend on monthly income to meet their living expenses. Thus, Churchill Tax-Free Fund of Kentucky's objective of providing "as high a level of current income exempt from Kentucky state and regular Federal income taxes as is consistent with preservation of capital" is "just what the doctor ordered" for many of our shareholders. Since Churchill Tax-Free Fund of Kentucky's inception in May, 1987, shareholders have been the beneficiaries of dividends that have been paid each and every month. And, since we fully recognize that our shareholders depend on this income, we purposefully arrange to have the number of days for each dividend payment fluctuate only slightly from month to month. In this way, we provide you with as consistent a level of income as possible. And, since these dividends are not only consistent, but also tax-free, you and our other shareholders get to utilize the full purchasing power of every dollar earned. (As you know, with a taxable investment, 20% or more of each dividend dollar could be eaten away by state and Federal taxes.) For those shareholders who are on a fixed income, these additional dollars which stay in your own pocket - instead of going toward taxes - could prove to be extremely beneficial to you. STABILITY OF YOUR CAPITAL The other significant need of our shareholders that we meet besides providing consistent tax-free dividends, is managing the Fund so that its share price remains relatively stable.** Following is the year-end Class A share price of Churchill Tax-Free Fund of Kentucky for the past three years. As you will note, the share price of the Fund did fluctuate somewhat as interest rates changed over the period. However, the total fluctuation over this period was only $0.35, or approximately 3 1/2% - a slight variance when compared to other investments you might have made over this same time period. December 31, 2002 $10.66 December 31, 2001 $10.31 December 31, 2000 $10.40 PORTFOLIO CHARACTERISTICS In order to ensure that Churchill Tax-Free Fund of Kentucky's objective of capital preservation and steady tax-free income is accomplished, the Fund employs very distinct techniques in the construction of the Fund's portfolio. To the maximum extent possible, we strive to make certain that there are no "surprises" with any of the securities in the Fund's portfolio. To help limit the degree of uncertainty, our knowledgeable Kentucky-based portfolio manager constructs the Fund's portfolio with high quality, intermediate maturity and geographic diversification in mind. As we have pointed out before, municipal securities have various credit ratings which attempt to measure the safety that the securities represent. With Churchill Tax-Free Fund of Kentucky, we specifically limit the credit ratings to those within the TOP FOUR categories - AAA, AA, A, AND Baa. We further ensure that, in general, the majority of securities in the Fund's portfolio are within the top TWO credit grades - AAA AND AA. And, we very carefully monitor the quality characteristics of each investment once it is in the portfolio. Another technique we use in the construction of the overall portfolio to help keep a stable share price is a laddering of maturity levels with the various municipal securities that we purchase. As you know, long-term bonds tend to produce a higher return than short-term bonds. However, such longer maturity bonds also experience a higher degree of volatility in their price. Therefore, for Churchill Tax-Free Fund of Kentucky's portfolio, we include both short-term and long-term bonds, so that the overall average of these maturities run at an intermediate level. In this way, we can capture a substantial amount of income available from the bonds, but avoid any undue level of price volatility. DIVERSIFICATION OF THE PORTFOLIO We also employ diversification in the construction of the Fund's portfolio - both in terms of project type as well as geographic characteristics. We strive to include in the portfolio securities representing locations throughout Kentucky and all types of public purpose projects. In this way, we can assure ourselves that no one project or area of the Commonwealth can have any significant adverse influence upon your investment in the Fund. APPRECIATION With the stock market being so tumultuous over the past several years, we hope that you and our other shareholders are comforted by the fact that Churchill Tax-Free Fund of Kentucky is still meeting its objective - just as it has from day one. Your continued confidence in the Fund through your investment is greatly appreciated. We will continually strive to do what is necessary to merit the confidence you have placed in us. Sincerely, /s/ Diana P. Herrmann ---------------------- Diana P. Herrmann President /s/ Lacy B. Herrmann --------------------- Lacy B. Herrmann Chairman of the Board of Trustees * For certain investors, some dividends may be subject to Federal and state taxes, including the Alternative Minimum Tax (AMT). ** Past performance does not guarantee future stability. Investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. PERFORMANCE REPORT The following graph illustrates the value of $10,000 invested in the Class A shares of Churchill Tax-Free Fund of Kentucky for the 10-year period ended December 31, 2002 as compared with the Lehman Brothers Quality Intermediate Municipal Bond Index and the Consumer Price Index (a cost of living index). The performance of each of the other classes is not shown in the graph but is included in the table below. It should be noted that the Lehman Index does not include any operating expenses nor sales charges and being nationally oriented, does not reflect state specific bond market performance. [Graphic of a line chart with the following information:]
Lehman Brothers Quality Intermediate Fund's Class A Shares Municipal Bond Index With Sales Charge Without Sales Charge Cost of Living Index $10,000 $9,600 $10,000 $10,000 $10,990 $10,590 $11,034 $10,275 $10,690 $10,250 $10,679 $10,550 $12,164 $11,636 $12,124 $10,817 $12,683 $12,165 $12,675 $11,177 $13,612 $13,122 $13,672 $11,367 $14,428 $13,787 $14,365 $11,550 $14,471 $13,580 $14,149 $11,860 $15,719 $14,713 $15,329 $12,262 $16,586 $15,307 $15,949 $12,452 $18,118 $16,588 $17,282 $12,748
AVERAGE ANNUAL TOTAL RETURN FOR PERIODS ENDED DECEMBER 31, 2002 -------------------------------------------- SINCE 1 YEAR 5 YEARS 10 YEARS INCEPTION ------ ------- -------- --------- Class A (5/21/87) With Sales Charge............................. 3.82% 3.92% 5.19% 6.43% Without Sales Charge.......................... 8.15% 4.78% 5.62% 6.71% Class C (4/1/96) With CDSC..................................... 6.19% 3.90% n/a 4.64% Without CDSC.................................. 7.23% 3.90% n/a 4.64% Class Y (4/1/96) No Sales Charge............................... 8.30% 4.94% n/a 5.66% Class I (8/6/01) No Sales Charge............................... 7.98% n/a n/a 6.07%* Lehman Index..................................... 9.23% 5.88% 6.11% 6.71% (Class A) 9.23% 5.88% n/a 6.11% (Class C&Y) 9.23% n/a n/a 7.28%* (Class I)
* Not annualized Total return figures shown for the Fund reflect any change in price and assume all distributions within the period were invested in additional shares. Returns for Class A shares are calculated with and without the effect of the initial 4% maximum sales charge. Returns for Class C shares are calculated with and without the effect of the 1% contingent deferred sales charge (CDSC), imposed on redemptions made within the first 12 months after purchase. Class Y shares are sold without any sales charge. The rates of return will vary and the principal value of an investment will fluctuate with market conditions. Shares, if redeemed, may be worth more or less than their original cost. A portion of each classes' income may be subject to federal and state income taxes. Past performance is not predictive of future investment results. MANAGEMENT DISCUSSION OF FUND PERFORMANCE 2002 was another in a series of profitable years as it relates to interest rates and the bond market. Unfortunately, we saw the equity market continue its unprecedented three-year slide from historical high levels posted in early 2000. The Federal Reserve maintained historically low short-term interest rates at levels not seen for decades. And, as we begin 2003, it too promises to be just as eventful: the United States is preparing to take decisive action in Iraq, we are considering the course to take in response to the threat of "nuclear blackmail" from Communist North Korea, and, sadly, we mourn the deaths of the brave crew of the Columbia space shuttle who perished on their return from space. Last year, inflation, by and large, remained in check. As measured by the Producer Price Index (PPI), inflation edged up a modest 1.2% versus a 1.8% decline in 2001. The Consumer Price Index (CPI) rose 2.4% versus a rise of 1.6% in 2001. The best overall measure of the nation's economic health - the Gross Domestic Product (GDP) rebounded to a 2.4% growth rate versus a slight rise of 0.3% in recession-plagued 2001. In a concerted effort to get our lethargic economy "pumping" once again, the Federal Reserve kept interest rates at historical lows, hoping to spur an economic recovery. The national unemployment rate, unfortunately, remains disturbingly high at 6.0%. With the overhanging situation of the outcome of military action in the Middle East, the price of a barrel of oil has shot back up from the lows we saw last year. The combination of low inflation and low interest rates, as well as the Fed's accommodative credit policy led to this third straight banner year for bonds versus stocks. 2002 was the third consecutive down year for stocks and most stock funds. The Dow Jones Industrial Average fell 15.01% last year. Other measures of equity performance fared even worse: the S & P 500 closed down 22.10%; and the NASDAQ Composite Index was off 31.26%. According to Lipper Inc., the average U. S. equity fund produced a loss of 22.43%. We are proud to report that Churchill Tax-Free Fund of Kentucky provided its shareholders a positive total rate of return through dividends and market action of 8.15% in 2002. Individual states - Kentucky included - have not been able to avoid the effects of the slowdown in the national economy. The budget surpluses that had accumulated in the Commonwealth's "rainy day fund" are gone. Budget deficits are being forecasted in nearly all fifty states for 2003 and 2004. To make matters worse, the Commonwealth of Kentucky begins 2003 operating without an approved budget. Without a budget, the Commonwealth has been unable to bring municipal bond financings to market since the middle of 2002. During this time, individual cities, counties, and local municipalities have come to market. Meanwhile, the demand for quality Kentucky tax-free bonds has far outpaced the supply of available bonds. This shortage of Commonwealth of Kentucky bonds contributed to your Fund's excellent performance in 2002. The investment objective of the Churchill Tax-Free Fund of Kentucky is to provide as high a level of triple tax-exempt current income as is consistent with the preservation of capital. This objective continues to be successfully addressed by adhering to a discipline of solid fundamental, conservative portfolio management ideals. The Fund continues to maintain an average credit quality of "AA". Our "laddered" maturity structure helps us manage price volatility. The Fund has an average life of approximately 15.0 years and a duration of 5.50 years. We maintain a well-diversified portfolio of over 170 different Kentucky issues. We are cautiously optimistic about the prospects for the U. S. economy in 2003, but will continue to watch for any signs of rising inflation. It is going to take continued vigilance by the Federal Reserve to revive and re-energize our economy without driving up interest rates over the course of 2003. To address these concerns, we will "stay the course" and manage the portfolio by taking advantage of opportunities in the Kentucky marketplace that are consistent with the investment objectives of the Fund. PRIVACY NOTICE (UNAUDITED) OUR PRIVACY POLICY. In providing services to you as an individual who owns or is considering investing in shares of a fund of the Aquila(SM) Group of Funds, we collect certain nonpublic personal information about you. Our policy is to keep this information strictly safeguarded and confidential, and to use or disclose it only as necessary to provide services to you or as otherwise permitted by law. Our privacy policy applies equally to former shareholders and persons who inquire about a fund. INFORMATION WE COLLECT. "Nonpublic personal information" is personally identifiable financial information about you as an individual or your family. The kinds of nonpublic personal information we have about you may include the information you provide us on your share purchase application or in telephone calls or correspondence with us, and information about your fund transactions and holdings, how you voted your shares and the account where your shares are held. INFORMATION WE DISCLOSE. We disclose nonpublic personal information about you to companies that provide necessary services to your fund, such as the fund's transfer agent, distributor, investment adviser or sub-adviser and to our affiliates, as permitted or required by law, or as authorized by you. We also may disclose this information to another fund of the Aquila(SM) Group of Funds or its distributor, or to the broker-dealer that holds your fund shares, under agreements that permit them to use the information only to provide you information about your fund, other funds in the Aquila(SM) Group of Funds or new services we are offering which may be of interest to you. Any other use is strictly prohibited. We do not sell information about you or any of our fund shareholders to anyone. HOW WE SAFEGUARD YOUR INFORMATION. We restrict access to nonpublic personal information about you to only those persons who need it to provide services to you or who are permitted by law to receive it. We maintain physical, electronic and procedural safeguards to protect the confidentiality of all nonpublic personal information we have about you. If you have any questions regarding our Privacy Policy, please contact us at 1-800-437-1020. [Logo of KPMG LLP: four solid rectangles with the letters KPMG in front of them] INDEPENDENT AUDITORS' REPORT To the Board of Trustees and Shareholders of Churchill Tax-Free Fund of Kentucky: We have audited the accompanying statement of assets and liabilities of Churchill Tax-Free Fund of Kentucky, including the statement of investments, as of December 31, 2002, and the related statement of operations for the year then ended, the statements of changes in net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and 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 and financial highlights. Our procedures included confirmation of securities owned as of December 31, 2002, by correspondence with the custodian. As to securities purchased or sold but not yet received or delivered, we performed 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 Churchill Tax-Free Fund of Kentucky as of December 31, 2002, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ KPMG LLP -------------- New York, New York February 7, 2003 CHURCHILL TAX-FREE FUND OF KENTUCKY STATEMENT OF INVESTMENTS DECEMBER 31, 2002
RATING FACE MOODY'S/ AMOUNT GENERAL OBLIGATION BONDS (1.4%) S&P VALUE --------------- ------------------------------------------------------- --------- ------------- Bowling Green Kentucky $ 200,000 5.300%, 06/01/18.................................... Aa3/NR $ 214,000 Lexington-Fayette Urban County Government Project Unlimited Tax 125,000 5.000%, 12/01/15.................................... Aa2/AA+ 134,219 340,000 5.150%, 12/01/17.................................... Aa2/AA+ 363,800 Louisville Kentucky Unlimited Tax 2,205,000 5.000%, 10/01/21 FGIC Insured....................... Aaa/AAA 2,276,662 Warren County Kentucky Judicial Unlimited Tax 345,000 5.100%, 09/01/17 AMBAC Insured...................... Aaa/NR 369,150 365,000 5.150%, 09/01/18 AMBAC Insured...................... Aaa/NR 389,638 ------------- Total General Obligation Bonds.................... 3,747,469 ------------- REVENUE BONDS (99.1%) ------------------------------------------------------- STATE AGENCIES (31.2%) ------------------------------------------------------- Kentucky Area Development District Financing 500,000 5.000%, 12/01/23 LOC Wachovia Bank.................. NR/AA 510,625 Kentucky Higher Education Student Loan Corporation Insured Student Loan 220,000 6.800%, 06/01/03 AMT................................ Aaa/AA- 223,623 1,915,000 7.100%, 12/01/11 AMT................................ Aaa/AA- 1,945,697 Kentucky Infrastructure Authority 1,000,000 5.250%, 06/01/12.................................... Aa3/A+ 1,118,750 635,000 5.250%, 06/01/12.................................... Aa3/A+ 683,419 2,740,000 5.250%, 06/01/14.................................... Aa3/A+ 3,010,575 1,110,000 6.375%, 06/01/14 Pre-Refunded....................... Aaa/AAA 1,259,850 1,500,000 5.375%, 02/01/18.................................... NR/A- 1,531,290 Kentucky Local Correctional Facilities Construction Authority 6,355,000 5.500%, 11/01/14 FSA Insured........................ Aaa/AAA 6,855,456 Kentucky Rural Economic Development Authority 3,110,000 7.250%, 06/01/17 LOC Bank One AMT................... NR/A+ 3,194,499 Kentucky State Property and Buildings Commission $ 3,000,000 6.250%, 09/01/07 MBIA Insured....................... Aaa/AAA $ 3,506,250 220,000 6.000%, 09/01/08.................................... Aa3/A+ 255,750 500,000 5.500%, 11/01/09 AMBAC Insured...................... Aaa/AAA 553,125 400,000 5.000%, 09/01/13.................................... Aa3/A+ 413,280 4,000,000 5.375%, 02/01/14 FSA Insured........................ Aaa/AAA 4,480,000 400,000 5.250%, 10/01/14.................................... Aa3/A+ 436,500 460,000 5.125%, 09/01/15.................................... Aa3/A+ 495,650 3,250,000 5.625%, 09/01/15.................................... Aa3/A+ 3,656,250 100,000 5.375%, 05/01/16 MBIA Insured....................... Aaa/AAA 108,375 6,500,000 5.375%, 08/01/16 FSA Insured........................ Aaa/AAA 7,166,250 3,905,000 5.125%, 09/01/16.................................... Aa3/A+ 4,178,350 5,000,000 5.250%, 10/01/16.................................... Aa3/A+ 5,412,500 1,140,000 5.000%, 08/01/17 FSA Insured........................ Aaa/AAA 1,204,125 8,155,000 5.125%, 09/01/17.................................... Aa3/A+ 8,685,075 1,735,000 5.250%, 10/01/17.................................... Aa3/A+ 1,875,969 800,000 5.500%, 11/01/17 FSA Insured........................ Aaa/AAA 892,000 165,000 5.375%, 02/01/18 FSA Insured........................ Aaa/AAA 180,263 1,105,000 5.000%, 08/01/18.................................... Aaa/AAA 1,160,250 2,950,000 5.125%, 09/01/18.................................... Aa3/A+ 3,123,313 6,000,000 5.250%, 10/01/18.................................... Aa3/A+ 6,450,000 145,000 5.100%, 11/01/18.................................... Aa3/A+ 151,887 1,040,000 5.000%, 08/01/19 FSA Insured........................ Aaa/AAA 1,085,500 1,000,000 5.375%, 10/01/19 MBIA Insured....................... Aaa/AAA 1,080,000 1,925,000 5.000%, 10/01/19.................................... Aa3/A+ 2,004,406 360,000 5.000%, 10/01/19 MBIA Insured....................... Aaa/AAA 375,750 3,000,000 5.000%, 11/01/19 FSA Insured........................ Aaa/AAA 3,146,250 705,000 5.150%, 11/01/19 FSA Insured........................ Aaa/AAA 747,300 2,000,000 5.750%, 05/01/20 MBIA Insured....................... Aaa/AAA 2,212,500 160,000 5.000%, 10/01/20 MBIA Insured....................... Aaa/AAA 166,000 205,000 5.150%, 02/01/22 FSA Insured........................ Aaa/AAA 212,431 ------------- 85,749,083 ------------- COUNTY AGENCIES (10.2%) ------------------------------------------------------- Floyd County Public Property Courthouse 510,000 5.500%, 09/01/14 Pre-Refunded....................... NR/A+ 576,300 Jefferson County Kentucky Capital Projects $ 1,000,000 5.200%, 06/01/08 MBIA Insured....................... Aaa/AAA $ 1,122,500 430,000 5.200%, 06/01/12 MBIA Insured....................... Aaa/AAA 466,550 570,000 5.250%, 06/01/13 MBIA Insured....................... Aaa/AAA 618,450 520,000 5.250%, 06/01/14 MBIA Insured....................... Aaa/AAA 560,950 3,370,000 5.375%, 06/01/18 MBIA Insured....................... Aaa/AAA 3,605,900 1,640,000 5.375%, 06/01/22 MBIA Insured....................... Aaa/AAA 1,709,700 5,900,000 5.500%, 06/01/28 MBIA Insured....................... Aaa/AAA 6,231,875 Pendleton County Kentucky Multi-County Lease Revenue 4,500,000 6.500%, 03/01/19.................................... NR/A 4,608,990 3,000,000 6.400%, 03/01/19.................................... NR/A 3,701,250 Warren County Kentucky Justice Center 1,580,000 5.250%, 09/01/17 MBIA Insured....................... Aaa/AAA 1,684,675 2,875,000 5.350%, 09/01/29 MBIA Insured....................... Aaa/AAA 3,004,375 ------------- 27,891,515 ------------- CITY/MUNICIPAL OBLIGATIONS (6.1%) ------------------------------------------------------- Jeffersontown Kentucky Public Project Corp. 500,000 5.750%, 11/01/15.................................... A3/NR 539,375 Kentucky League Cities Funding Trust Certificates of Participation (Covington) 1,715,000 6.200%, 08/01/17.................................... NR/A+ 1,802,894 Kentucky League Cities Funding Trust Certificates of Participation (Owensboro) 700,000 5.900%, 08/01/16.................................... NR/A 734,125 Louisville Kentucky Parking Authority 1,140,000 5.000%, 12/01/14 MBIA Insured....................... Aaa/AAA 1,211,250 Mount Sterling Kentucky Lease Revenue 2,020,000 6.150%, 03/01/13.................................... Aa3/NR 2,073,732 7,000,000 6.200%, 03/01/18.................................... Aa3/NR 7,186,690 Munfordville Kentucky Industrial Development 2,500,000 7.000%, 06/01/19 LOC Bank One AMT................... NR/A+ 2,615,625 Shelbyville Kentucky Certificates of Participation $ 625,000 5.000%, 10/01/22.................................... A2/NR $ 661,719 ------------- 16,825,410 ------------- HOSPITALS (5.4%) ------------------------------------------------------- Jefferson County Kentucky Health Facilities Revenue 240,000 5.000%, 10/01/12 MBIA Insured....................... Aaa/AAA 255,600 1,500,000 5.650%, 01/01/17 AMBAC Insured...................... Aaa/AAA 1,635,000 2,200,000 5.250%, 05/01/17.................................... NR/A 2,249,500 2,765,000 5.125%, 10/01/17 AMBAC Insured ETM.................. Aaa/AAA 2,941,269 250,000 5.125%, 10/01/18 MBIA Insured ETM................... Aaa/AAA 270,000 Kentucky Development Finance Authority Hospital Revenue 1,375,000 6.125%, 02/01/12 FSA Insured........................ Aaa/AAA 1,406,721 2,790,000 5.000%, 08/15/15 MBIA Insured....................... Aaa/AAA 2,884,162 3,000,000 5.900%, 12/01/15 FGIC Insured....................... Aaa/AAA 3,165,540 ------------- 14,807,792 ------------- HOUSING (11.8%) ------------------------------------------------------- Greater Kentucky Housing Assistance Corp. Multi-Family Housing Revenue 320,000 6.300%, 07/01/15 MBIA Insured....................... Aaa/AAA 328,701 275,000 6.400%, 07/01/23 MBIA Insured....................... Aaa/AAA 282,299 Kentucky Housing Corp. Housing Revenue 1,660,000 5.400%, 07/01/14.................................... Aaa/AAA 1,722,516 1,150,000 6.250%, 07/01/15 AMT................................ Aaa/AAA 1,200,312 315,000 6.100%, 07/01/16 AMT................................ Aaa/AAA 329,962 715,000 6.400%, 01/01/17.................................... Aaa/AAA 741,813 260,000 5.550%, 07/01/18 AMT................................ Aaa/AAA 266,500 1,565,000 5.800%, 01/01/19.................................... Aaa/AAA 1,596,300 2,000,000 5.600%, 07/01/20 AMT................................ Aaa/AAA 2,050,000 1,000,000 5.350%, 01/01/21 AMT................................ Aaa/AAA 1,013,750 285,000 4.900%, 07/01/21 AMT................................ Aaa/AAA 276,450 6,075,000 5.450%, 07/01/22 AMT +.............................. Aaa/AAA 6,234,469 245,000 5.200%, 07/01/22.................................... Aaa/AAA 251,738 $ 300,000 5.100%, 07/01/22 AMT ++............................. Aaa/AAA $ 301,125 4,040,000 5.250%, 07/01/22 AMT................................ Aaa/AAA 4,125,850 4,140,000 5.200%, 07/01/25 AMT ++............................. Aaa/AAA 4,171,050 275,000 5.375%, 07/01/27.................................... Aaa/AAA 281,188 4,175,000 6.300%, 01/01/28 AMT................................ Aaa/AAA 4,326,344 355,000 6.375%, 07/01/28 AMT................................ Aaa/AAA 368,312 1,910,000 6.250%, 07/01/28 AMT................................ Aaa/AAA 1,979,238 570,000 5.550%, 07/01/33.................................... Aaa/AAA 583,537 ------------- 32,431,454 ------------- POLLUTION CONTROL REVENUE (2.9%) ------------------------------------------------------- Boone County Kentucky Pollution Control (Dayton Power & Light) 4,000,000 6.500%, 11/15/22.................................... A2/BBB+ 4,099,360 Jefferson County Kentucky Pollution Control (E.ON AG -LGE Energy) 3,800,000 5.900%, 04/15/23.................................... A1/A- 3,899,750 ------------- 7,999,110 ------------- SCHOOLS (13.8%) ------------------------------------------------------- Beechwood, Kentucky Independent School District Finance Corp. 180,000 5.650%, 03/01/20.................................... Aa3/NR 195,750 Boone County Kentucky School District Finance Corp. School Building 660,000 5.000%, 06/01/15.................................... Aa3/NR 700,425 225,000 5.250%, 08/01/15.................................... Aa3/NR 245,531 285,000 5.700%, 02/01/16.................................... Aa3/NR 319,200 2,295,000 5.700%, 05/01/18 Pre-Refunded....................... Aa3/NR 2,374,637 1,000,000 5.375%, 08/01/20 FSA Insured........................ Aaa/NR 1,072,500 Boyd County Kentucky School District Finance Corp. 1,025,000 5.000%, 10/01/15.................................... AA3/NR 1,087,781 575,000 5.375%, 10/01/17.................................... Aa3/NR 620,281 Campbell County Kentucky School District Finance Corp. 350,000 5.100%, 02/01/12.................................... Aa3/NR 362,225 Christian County Kentucky School District Finance Corp. $ 500,000 5.000%, 06/01/09.................................... Aa3/NR $ 549,375 Fayette County School Building 1,780,000 5.700%, 12/01/16.................................... Aa3/AA- 1,973,575 Floyd County Kentucky School Building 250,000 5.000%, 12/01/09.................................... Aa3/NR 278,438 Grayson County Kentucky School Building Revenue 1,940,000 6.000%, 01/01/15.................................... Aa3/NR 2,150,975 Hardin County School District Finance Corp. 100,000 5.500%, 02/01/17.................................... Aa3/NR 109,250 Jefferson County Kentucky School District Finance Corp. School Building 1,295,000 5.300%, 07/01/12 MBIA Insured....................... Aaa/AAA 1,406,694 750,000 5.300%, 01/01/13 FSA Insured........................ Aaa/AAA 849,375 695,000 5.125%, 11/01/14 FSA Insured........................ Aaa/AAA 741,044 465,000 5.300%, 07/01/15 MBIA Insured....................... Aaa/AAA 498,712 3,195,000 5.125%, 02/01/16 MBIA Insured....................... Aaa/AAA 3,354,750 250,000 5.250%, 07/01/16 FSA Insured........................ Aaa/AAA 270,312 Kenton County, Kentucky School District 1,760,000 5.375%, 03/01/15.................................... NR/A+ 1,909,600 920,000 5.000%, 04/01/16.................................... Aa3/NR 982,100 1,055,000 5.000%, 04/01/17.................................... Aa3/NR 1,118,300 605,000 5.000%, 04/01/19.................................... Aa3/NR 632,981 Kentucky Econ. Dev. Fin. Auth. College Rev. Centre College 1,230,000 5.000%, 04/01/17 FSA Insured........................ Aaa/AAA 1,306,875 1,675,000 5.000%, 04/01/19 FSA Insured........................ Aaa/AAA 1,754,563 Larue County Kentucky School District Finance Corp. 350,000 5.000%, 08/01/26.................................... Aa3/NR 355,687 Lexington-Fayette Urban County Government Project Transylvania University 1,250,000 5.125%, 08/01/18 MBIA Insured....................... Aaa/AAA 1,317,188 Lexington-Fayette Urban County Government Project U.K. Library $ 725,000 5.000%, 11/01/15 MBIA Insured....................... Aaa/AAA $ 773,031 205,000 5.000%, 11/01/18 MBIA Insured....................... Aaa/AAA 213,969 Meade County Kentucky School District Finance Corp. 400,000 5.700%, 07/01/15.................................... Aa3/NR 441,000 500,000 6.000%, 07/01/16.................................... Aa3/NR 556,250 Middlesboro Kentucky Independent School District Finance Corp. 100,000 6.100%, 08/01/16.................................... Aa3/NR 111,875 Nelson County Kentucky School Building 1,820,000 5.750%, 04/01/15.................................... Aa3/NR 1,990,625 Scott County Kentucky School Building 2,750,000 5.900%, 06/01/18 Pre-Refunded....................... Aaa/AAA 3,090,312 Taylor County Kentucky School Building 280,000 6.000%, 08/01/16.................................... Aa3/NR 312,200 175,000 5.250%, 06/01/19.................................... Aa3/NR 186,812 University of Kentucky Revenue 1,335,000 5.000%, 05/01/16 FGIC Insured....................... Aaa/AAA 1,410,094 385,000 5.000%, 06/01/18 FSA insured........................ Aaa/AAA 402,325 ------------- 38,026,617 ------------- TRANSPORTATION (5.6%) ------------------------------------------------------- Kenton Kentucky Airport Board 800,000 5.000%, 03/01/08 MBIA Insured AMT................... Aaa/AAA 866,000 500,000 5.625%, 03/01/13 MBIA Insured AMT................... Aaa/AAA 553,750 750,000 5.625%, 03/01/14 MBIA Insured AMT................... Aaa/AAA 825,938 Kentucky Interlocal School Transportation Authority 150,000 5.100%, 03/01/05.................................... Aa3/A+ 161,250 145,000 5.400%, 06/01/17.................................... NR/A+ 146,894 600,000 6.000%, 12/01/20.................................... NR/A+ 610,536 300,000 5.800%, 12/01/20.................................... NR/A+ 305,286 400,000 5.650%, 12/01/20.................................... NR/A+ 406,436 350,000 5.600%, 12/01/20.................................... NR/A+ 355,593 Kentucky State Turnpike Auth. Econ. Dev. & Resource Recovery Road Revenue $ 120,000 8.500%, 07/01/06.................................... Aa3/A+ $ 145,650 1,000,000 6.500%, 07/01/08 AMBAC Insured...................... Aaa/AAA 1,188,750 1,010,000 5.500%, 07/01/11 AMBAC Insured...................... Aaa/AAA 1,049,037 1,000,000 5.625%, 07/01/12 FSA Insured........................ Aaa/AAA 1,141,250 200,000 5.625%, 07/01/13 FSA Insured........................ Aaa/AAA 225,750 250,000 5.200%, 07/01/14 FSA Insured........................ Aaa/AAA 273,125 500,000 5.625%, 07/01/14 FSA Insured........................ Aaa/AAA 563,750 2,760,000 5.625%, 07/01/15 AMBAC Insured, Pre-Refunded........ Aaa/AAA 3,094,650 940,000 5.625%, 07/01/15 AMBAC Insured...................... Aaa/AAA 1,017,550 450,000 5.250%, 07/01/15 FSA Insured........................ Aaa/AAA 490,500 440,000 5.100%, 07/01/18 FSA Insured........................ Aaa/AAA 465,300 Louisville-Jefferson Co. Regional Airport 1,000,000 5.750%, 07/01/15 FSA Insured AMT.................... Aaa/AAA 1,103,750 275,000 5.375%, 07/01/23 FSA Insured AMT.................... Aaa/AAA 282,562 ------------- 15,273,307 ------------- UTILITIES (12.1%) ------------------------------------------------------- Campbell & Kenton Counties 100,000 5.000%, 08/01/18 FGIC Insured AMT................... Aaa/AAA 104,875 Hardin County, Kentucky Water District 1,000,000 5.900%, 01/01/25 MBIA Insured....................... Aaa/AAA 1,092,500 Kenton County Kentucky Water District Water/Sewer 1,000,000 6.000%, 02/01/17 FGIC Insured Pre-Refunded.......... Aaa/AAA 1,033,390 Lexington-Fayette Urban County Government Sewer System 1,000,000 5.000%, 07/01/19.................................... Aa3/AA 1,050,000 Louisville and Jefferson County Kentucky Metropolitan Sewer District 1,000,000 5.000%, 05/15/12 FGIC Insured....................... Aaa/AAA 1,080,000 2,565,000 5.375%, 05/15/17 MBIA Insured....................... Aaa/AAA 2,824,706 3,325,000 5.300%, 05/15/19 MBIA Insured....................... Aaa/AAA 3,403,769 1,410,000 5.400%, 05/15/22 FGIC Insured....................... Aaa/AAA 1,473,450 4,095,000 5.500%, 05/15/23 MBIA Insured....................... Aaa/AAA 4,205,360 120,000 6.250%, 05/15/26 MBIA Insured....................... Aaa/AAA 137,700 Louisville Kentucky Waterworks Board Water $ 1,000,000 5.250%, 11/15/16 FSA Insured........................ Aaa/AAA $ 1,081,250 1,000,000 5.250%, 11/15/17 FSA Insured........................ Aaa/AAA 1,075,000 2,335,000 5.250%, 11/15/18 FSA Insured........................ Aaa/AAA 2,498,450 6,600,000 5.250%, 11/15/22 FSA Insured........................ Aaa/AAA 6,872,250 2,415,000 5.250%, 11/15/24 FSA Insured........................ Aaa/AAA 2,502,544 Northern Kentucky Water District 1,015,000 5.000%, 02/01/27 FGIC Insured....................... Aaa/NR 1,032,762 Owensboro-Davies County Water District 600,000 5.000%, 01/01/13 AMBAC Insured...................... Aaa/AAA 642,000 Owensboro, Kentucky Electric and Power 1,000,000 5.000%, 01/01/20 FSA Insured........................ Aaa/AAA 1,035,000 ------------- 33,145,006 ------------- Total Revenue Bonds............................... 272,149,294 ------------- Total Investments (cost $262,973,765*)................. 100.5% 275,896,763 Other assets less liabilities.......................... (0.5) (1,449,804) ------ ------------- Net Assets............................................. 100.0% $ 274,446,959 ====== =============
* See notes 2f and 4. + A portion of this security is pledged as collateral for the Fund's when-issued commitment. ++ Security traded on a "when-issued" basis (see note 9). PORTFOLIO ABBREVIATIONS: AMBAC - American Municipal Bond Assurance Corp. AMT - Alternative Minimum Tax ETM - Escrowed To Maturity FGIC - Financial Guaranty Insurance Co. FSA - Financial Security Assurance LOC - Letter of Credit MBIA - Municipal Bond Investors Assurance Corp. See accompanying notes to financial statements. CHURCHILL TAX-FREE FUND OF KENTUCKY STATEMENT OF ASSETS AND LIABILITIES DECEMBER 31, 2002 ASSETS Investments at value (cost $262,973,765 ) ................ $ 275,896,763 Cash ..................................................... 181,330 Interest receivable ...................................... 4,057,936 Receivable for investment securities sold ................ 965,000 Receivable for Fund shares sold .......................... 108,012 Other assets ............................................. 251 ------------- Total assets ............................................. 281,209,292 ------------- LIABILITIES Payable for investment securities purchased .............. 6,030,081 Dividends payable ........................................ 293,369 Payable for Fund shares redeemed ......................... 241,387 Distribution fees payable ................................ 89,902 Management fee payable ................................... 27,237 Accrued expenses ......................................... 80,357 ------------- Total liabilities ........................................ 6,762,333 ------------- NET ASSETS .................................................. $ 274,446,959 ============= Net Assets consist of: Capital Stock - Authorized an unlimited number of shares, par value $.01 per share ............. $ 257,362 Additional paid-in capital ............................... 262,332,595 Net unrealized appreciation on investments (note 4) ...... 12,922,998 Undistributed net investment income ...................... 333,920 Accumulated net realized loss on investments ............. (1,399,916) ------------- $ 274,446,959 ============= CLASS A Net Assets ............................................... $ 226,013,887 ============= Capital shares outstanding ............................... 21,196,101 ============= Net asset value and redemption price per share ........... $ 10.66 ============= Offering price per share (100/96 of $10.66 adjusted to nearest cent) .............................. $ 11.10 ============= CLASS C Net Assets ............................................... $ 4,803,571 ============= Capital shares outstanding ............................... 450,697 ============= Net asset value and offering price per share ............. $ 10.66 ============= Redemption price per share (*a charge of 1% is imposed on the redemption proceeds of the shares, or on the original price, whichever is lower, if redeemed during the first 12 months after purchase) .... $ 10.66* ============= CLASS I Net Assets ............................................... $ 2,406,548 ============= Capital shares outstanding ............................... 225,751 ============= Net asset value offering and redemption price per share .. $ 10.66 ============= CLASS Y Net Assets ............................................... $ 41,222,953 ============= Capital shares outstanding ............................... 3,863,627 ============= Net asset value and redemption price per share ........... $ 10.67 ============= See accompanying notes to financial statements. CHURCHILL TAX-FREE FUND OF KENTUCKY STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2002 INVESTMENT INCOME: Interest income .......................................... $ 13,184,613 Expenses: Management fee (note 3) .................................. $ 1,010,893 Distribution and service fees (note 3) ................... 364,758 Transfer and shareholder servicing agent fees ............ 120,669 Trustees' fees and expenses (note 8) ..................... 93,960 Legal fees ............................................... 54,546 Shareholders' reports and proxy statements ............... 51,869 Audit and accounting fees ................................ 31,050 Custodian fees ........................................... 23,477 Registration fees and dues ............................... 18,829 Insurance ................................................ 7,861 Miscellaneous ............................................ 19,828 ------------ Total expenses ........................................... 1,797,740 Expenses paid indirectly (note 6) ........................ (23,144) ------------ Net expenses ............................................. 1,774,596 ------------- Net investment income .................................... 11,410,017 REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Net realized gain (loss) from securities transactions .... 773,552 Change in unrealized appreciation on investments ......... 7,631,648 ------------ Net realized and unrealized gain (loss) on investments ... 8,405,200 ------------- Net change in net assets resulting from operations ....... $ 19,815,217 =============
See accompanying notes to financial statements. CHURCHILL TAX-FREE FUND OF KENTUCKY STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED DECEMBER 31, 2002 DECEMBER 31, 2001 ----------------- ----------------- OPERATIONS: Net investment income ................................... $ 11,410,017 $ 10,828,727 Net realized gain (loss) from securities transactions ... 773,552 685,773 Change in unrealized appreciation on investments ........ 7,631,648 (2,726,957) ------------- ------------- Change in net assets from operations ................. 19,815,217 8,787,543 ------------- ------------- DISTRIBUTIONS TO SHAREHOLDERS (NOTE 10): Class A Shares: Net investment income ................................... (9,598,236) (9,652,185) Class C Shares: Net investment income ................................... (146,784) (102,324) Class I Shares: Net investment income ................................... (86,355) (19,875) Class Y Shares: Net investment income ................................... (1,537,493) (1,006,963) ------------- ------------- Change in net assets from distributions .............. (11,368,868) (10,781,347) ------------- ------------- CAPITAL SHARE TRANSACTIONS (NOTE 7): Proceeds from shares sold ............................... 52,239,557 32,406,399 Reinvested dividends and distributions .................. 5,609,442 5,076,827 Cost of shares redeemed ................................. (23,818,330) (18,015,538) ------------- ------------- Change in net assets from capital share transactions .... 34,030,669 19,467,688 ------------- ------------- Change in net assets .................................... 42,477,018 17,473,884 NET ASSETS: Beginning of period ..................................... 231,969,941 214,496,057 ------------- ------------- End of period* .......................................... $ 274,446,959 $ 231,969,941 ============= ============= * Includes undistributed net investment income of: $ 333,920 $ 292,771 ============= =============
See accompanying notes to financial statements. CHURCHILL TAX-FREE FUND OF KENTUCKY NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION Churchill Tax-Free Fund of Kentucky (the "Fund"), a non-diversified, open-end investment company, was organized in March, 1987 as a Massachusetts business trust and commenced operations on May 21, 1987. The Fund is authorized to issue an unlimited number of shares and, since its inception to April 1, 1996, offered only one class of shares. On that date, the Fund began offering two additional classes of shares, Class C and Class Y shares. All shares outstanding prior to that date were designated as Class A shares and are sold with a front-payment sales charge and bear an annual distribution fee. Class C shares are sold with a level-payment sales charge with no payment at time of purchase but level service and distribution fees from date of purchase through a period of six years thereafter. A contingent deferred sales charge of 1% is assessed to any Class C shareholder who redeems shares of this Class within one year from the date of purchase. Class C Shares together with a pro-rata portion of all Class C Shares acquired through reinvestment of dividends and other distributions paid in additional Class C Shares, automatically convert to Class A Shares after 6 years. The Class Y shares are only offered to institutions acting for an investor in a fiduciary, advisory, agency, custodian or similar capacity and are not offered directly to retail investors. Class Y shares are sold at net asset value without any sales charge, redemption fees, contingent deferred sales charge or distribution or service fees. On April 30, 1998, the Fund established Class I shares, which are offered and sold only through financial intermediaries and are not offered directly to retail investors. Class I shares carry a distribution fee and a service fee. All classes of shares represent interests in the same portfolio of investments and are identical as to rights and privileges but differ with respect to the effect of sales charges, the distribution and/or service fees borne by each class, expenses specific to each class, voting rights on matters affecting a single class and the exchange privileges of each class. 2. SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies followed by the Fund in the preparation of its financial statements. The policies are in conformity with accounting principles generally accepted in the United States of America for investment companies. a) PORTFOLIO VALUATION: Municipal securities which have remaining maturities of more than 60 days are valued at fair value each business day based upon information provided by a nationally prominent independent pricing service and periodically verified through other pricing services. In the case of securities for which market quotations are readily available, securities are valued at the mean of bid and asked quotations and, in the case of other securities, at fair value determined under procedures established by and under the general supervision of the Board of Trustees. Securities which mature in 60 days or less are valued at amortized cost if their term to maturity at purchase was 60 days or less, or by amortizing their unrealized appreciation or depreciation on the 61st day prior to maturity, if their term to maturity at purchase exceeded 60 days. b) SECURITIES TRANSACTIONS AND RELATED INVESTMENT INCOME: Securities transactions are recorded on the trade date. Realized gains and losses from securities transactions are reported on the identified cost basis. Interest income is recorded daily on the accrual basis and is adjusted for amortization of premium and accretion of original issue and market discount. c) FEDERAL INCOME TAXES: It is the policy of the Fund to qualify as a regulated investment company by complying with the provisions of the Internal Revenue Code applicable to certain investment companies. The Fund intends to make distributions of income and securities profits sufficient to relieve it from all, or substantially all, Federal income and excise taxes. d) ALLOCATION OF EXPENSES: Expenses, other than class-specific expenses, are allocated daily to each class of shares based on the relative net assets of each class. Class-specific expenses, which include distribution and service fees and any other items that are specifically attributed to a particular class, are charged directly to such class. e) USE OF ESTIMATES: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of increases and decreases in net assets from operations during the reporting period. Actual results could differ from those estimates. f) NEW ACCOUNTING PRONOUNCEMENT: In November 2000, the AICPA issued a revised audit and accounting guide, AUDITS OF INVESTMENT COMPANIES, which is effective for fiscal years beginning after December 15, 2000. The revised Guide requires the Fund to amortize premium and discounts on all fixed-income securities. The Fund elected to adopt this requirement effective January 1, 2001. This change does not affect the Fund's net asset value, but does change the classification of certain amounts in the statement of operations. The Fund recorded an adjustment to increase the cost of securities and increase accumulated undistributed net investment income by $245,182 to reflect the cumulative effect of this change up to the date of adoption. 3. FEES AND RELATED PARTY TRANSACTIONS a) MANAGEMENT ARRANGEMENTS: Aquila Management Corporation (the "Manager"), the Fund's founder and sponsor, serves as the Manager for the Fund under an Advisory and Administration Agreement with the Fund. Under the Advisory and Administration Agreement, the Manager provides all administrative services to the Fund. The Manager's services include providing the office of the Fund and all related services as well as overseeing the activities of all the various support organizations to the Fund such as the shareholder servicing agent, custodian, legal counsel, auditors and distributor and additionally maintaining the Fund's accounting books and records. For its services, the Manager is entitled to receive a fee which is payable monthly and computed as of the close of business each day at the annual rate of 0.40 of 1% on the Fund's average net assets. Specific details as to the nature and extent of the services provided by the Manager are more fully defined in the Fund's Prospectus and Statement of Additional Information. b) DISTRIBUTION AND SERVICE FEES: The Fund has adopted a Distribution Plan (the "Plan") pursuant to Rule 12b-1 (the "Rule") under the Investment Company Act of 1940. Under one part of the Plan, with respect to Class A Shares, the Fund is authorized to make service fee payments to broker-dealers ("Qualified Recipients") or others selected by Aquila Distributors, Inc. (the "Distributor") including, but not limited to, any principal underwriter of the Fund, with which the Distributor has entered into written agreements contemplated by the Rule and which have rendered assistance in the distribution and/or retention of the Fund's shares or servicing of shareholder accounts. The Fund makes payment of this service fee at the annual rate of 0.15% of the Fund's average net assets represented by Class A Shares. For the year ended December 31, 2002, service fees on Class A Shares amounted to $320,209 of which the Distributor retained $9,081. Under another part of the Plan, the Fund is authorized to make payments with respect to Class C Shares to Qualified Recipients which have rendered assistance in the distribution and/or retention of the Fund's Class C shares or servicing of shareholder accounts. These payments are made at the annual rate of 0.75% of the Fund's average net assets represented by Class C Shares and for year ended December 31, 2002, amounted to $30,419. In addition, under a Shareholder Services Plan, the Fund is authorized to make service fee payments with respect to Class C Shares to Qualified Recipients for providing personal services and/or maintenance of shareholder accounts. These payments are made at the annual rate of 0.25% of the Fund's average net assets represented by Class C Shares and for the year ended December 31, 2002, amounted to $10,139. The total of these payments with respect to Class C Shares amounted to $40,558 of which the Distributor retained $6,387. Under another part of the Plan, the Fund is authorized to make payments with respect to Class I Shares to Qualified Recipients. Class I payments, under the Plan, may not exceed for any fiscal year of the Fund a rate (currently 0.20%), set from time to time by the Board of Trustees, of not more than 0.25% of the average annual net assets represented by the Class I Shares. In addition, Class I has a Shareholder Services Plan under which it may pay service fees (currently 0.15%) of not more than 0.25% of the average annual net assets represented by Class I Shares. That is, the total payments under both plans will not exceed 0.50% of such net assets. For the year ended December 31, 2002, these payments were made at the average annual rate of 0.35% of such net assets and amounted to $6,984 of which $3,991 related to the Plan and $2,993 related to the Shareholder Services Plan. Specific details about the Plans are more fully defined in the Fund's Prospectus and Statement of Additional Information. Under a Distribution Agreement, the Distributor serves as the exclusive distributor of the Fund's shares. Through agreements between the Distributor and various broker-dealer firms ("dealers"), the Fund's shares are sold primarily through the facilities of these dealers having offices within Kentucky, with the bulk of sales commissions inuring to such dealers. For the year ended December 31, 2002, total commissions on sales of Class A Shares amounted to $485,352 of which the Distributor received $35,202. c) OTHER RELATED PARTY TRANSACTIONS: For the year ended December 31, 2002, the Fund incurred $53,971 of legal fees allocable to Hollyer Brady Smith & Hines LLP, counsel to the Fund for legal services in conjunction with the Fund's ongoing operations. The Secretary of the Fund is a Partner of Hollyer Brady Smith & Hines LLP. 4. PURCHASES AND SALES OF SECURITIES During the year ended December 31, 2002, purchases of securities and proceeds from the sales of securities aggregated $83,933,713 and $45,766,366, respectively. At December 31, 2002, aggregate gross unrealized appreciation for all securities in which there is an excess of market value over tax cost of $262,658,684 amounted to $13,314,786 and aggregate gross unrealized depreciation for all securities in which there is an excess of tax cost over market value amounted to $76,707 for a net unrealized appreciation of $13,238,079. 5. PORTFOLIO ORIENTATION Since the Fund invests principally and may invest entirely in triple tax-free municipal obligations of issuers within Kentucky, it is subject to possible risks associated with economic, political, or legal developments or industrial or regional matters specifically affecting Kentucky and whatever effects these may have upon Kentucky issuers' ability to meet their obligations. 6. EXPENSES The Fund has negotiated an expense offset arrangement with its custodian wherein it receives credit toward the reduction of custodian fees and other Fund expenses whenever there are uninvested cash balances. The Statement of Operations reflects the total expenses before any offset, the amount of offset and the net expenses. It is the general intention of the Fund to invest, to the extent practicable, some or all of cash balances in income-producing assets rather than leave cash on deposit. 7. CAPITAL SHARE TRANSACTIONS Transactions in Capital Shares of the Fund were as follows:
YEAR ENDED YEAR ENDED DECEMBER 31, 2002 DECEMBER 31, 2001 ----------------------------- ------------------------------ SHARES AMOUNT SHARES AMOUNT ---------- ------------ ---------- ------------ CLASS A SHARES: Proceeds from shares sold 2,800,411 $ 29,436,982 1,607,327 $ 16,756,957 Reinvested distributions 454,110 4,764,701 454,646 4,732,061 Cost of shares redeemed . (1,611,194) (16,933,028) (1,448,690) (15,081,445) ---------- ------------ ---------- ------------ Net change ........... 1,643,327 17,268,655 613,283 6,407,573 ---------- ------------ ---------- ------------ CLASS C SHARES: Proceeds from shares sold 166,058 1,743,988 214,928 2,244,008 Reinvested distributions 9,211 96,673 6,792 70,675 Cost of shares redeemed . (50,063) (523,419) (75,362) (783,618) ---------- ------------ ---------- ------------ Net change ........... 125,206 1,317,242 146,358 1,531,065 ---------- ------------ ---------- ------------ CLASS I SHARES: Proceeds from shares sold 85,241 895,032 136,639 1,430,892 Reinvested distributions 7,325 77,007 1,704 17,758 Cost of shares redeemed . (5,158) (53,879) - - ---------- ------------ ---------- ------------ Net change ........... 87,408 918,160 138,343* 1,448,650* ---------- ------------ ---------- ------------ CLASS Y SHARES: Proceeds from shares sold 1,918,939 20,163,555 1,148,200 11,974,542 Reinvested distributions 63,761 671,061 24,640 256,333 Cost of shares redeemed . (599,076) (6,308,004) (206,468) (2,150,475) ---------- ------------ ---------- ------------ Net change ............ 1,383,624 14,526,612 966,372 10,080,400 ---------- ------------ ---------- ------------ Total transactions in Fund shares .................. 3,239,565 $ 34,030,669 1,864,356 $ 19,467,688 ========== ============ ========== ============
* For the period August 6, 2001 to December 31, 2001. 8. TRUSTEES' FEES AND EXPENSES During the fiscal year there were nine trustees, two of whom were affiliated with the Manager and are not paid any trustee fees. Trustee's fees paid during the year were at the annual rate of $6,750 for carrying out their responsibilities and attendance at regularly scheduled Board Meetings. If additional or special meetings are scheduled for the Fund, separate meeting fees are paid for each such meeting to those Trustees in attendance. The Fund also reimburses Trustees for expenses such as travel, accommodations, and meals incurred in connection with attendance at regularly scheduled or special Board Meetings and at the Annual Meeting of Shareholders. For the fiscal year ended December 31, 2002 such reimbursements averaged approximately $4,700 per Trustee. 9. SECURITIES TRADED ON A WHEN-ISSUED BASIS The Fund may purchase or sell securities on a when-issued basis. When-issued transactions arise when securities are purchased or sold by the Fund with payment and delivery taking place in the future in order to secure what is considered to be an advantageous price and yield to the Fund at the time of entering into the transaction. Beginning on the date the Fund enters into a when-issued transaction, cash or other liquid securities are segregated in the amount of the when-issued transaction. These transactions are subject to market fluctuations and their current value is determined in the same manner as for other securities. 10. DISTRIBUTIONS The Fund declares dividends daily from net investment income and makes payments monthly in additional shares at the net asset value per share, in cash, or in a combination of both, at the shareholder's option. Net realized capital gains, if any, are distributed annually and are taxable. The Fund intends to maintain, to the maximum extent possible, the tax-exempt status of interest payments received from portfolio municipal securities in order to allow dividends paid to shareholders from net investment income to be exempt from regular Federal and State of Kentucky income taxes. However, due to differences between financial statement reporting and Federal income tax reporting requirements, distributions made by the Fund may not be the same as the Fund's net investment income, and/or net realized securities gains. Further, a small portion of the dividends may, under some circumstances, be subject to taxes at ordinary income and/or capital gain rates. For certain shareholders, some dividend income may, under some circumstances, be subject to the alternative minimum tax. At December 31, 2002, the Fund has a capital loss carryover of $1,394,949, $372,062 of which expires on December 31, 2007 and $1,022,887 will expire on December 31, 2008. This carryover is available to offset future net realized gains on securities transactions to the extent provided for in the Internal Revenue Code. To the extent that this loss carryover is used to offset future realized capital gains, it is probable the gains so offset will not be distributed. The tax character of distributions paid by the Fund during its fiscal years ended December 31, 2002 and 2001 is as follows: Distributions paid from YEAR ENDED DECEMBER 31, 2002 2001 ------------ ----------- Net tax-exempt income $ 11,355,823 $10,781,347 Ordinary income 13,045 - Capital gain - - ------------ ----------- $ 11,368,868 $10,781,347 ============ =========== As of December 31, 2002, the components of distributable earnings on a tax basis were as follows: Undistributed ordinary income $ 3,263 Accumulated net realized loss (1,394,949) Unrealized appreciation 13,238,079 Undistributed tax-exempt income 15,576 ----------- $11,861,969 =========== CHURCHILL TAX-FREE FUND OF KENTUCKY FINANCIAL HIGHLIGHTS FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
CLASS A CLASS I -------------------------------------------------- -------------------- YEAR ENDED DECEMBER 31, PERIOD -------------------------------------------------- ENDED 2002 2001 2000 1999 1998 2002 12/31/01(1) ------ ------ ------ ------ ------ ------ ----------- Net asset value, beginning of period .......... $10.31 $10.40 $10.09 $10.81 $10.81 $10.31 $10.44 ------ ------ ------ ------ ------ ------ ------ Income (loss) from investment operations: Net investment income + .................... 0.47 0.50 0.52 0.52 0.53 0.46 0.19 Net gain (loss) on securities (both realized and unrealized) ................ 0.35 (0.09) 0.31 (0.68) 0.01 0.35 (0.13) ------ ------ ------ ------ ------ ------ ------ Total from investment operations ........... 0.82 0.41 0.83 (0.16) 0.54 0.81 0.06 ------ ------ ------ ------ ------ ------ ------ Less distributions (note 10): Dividends from net investment income ....... (0.47) (0.50) (0.52) (0.53) (0.53) (0.46) (0.19) Distributions from capital gains ........... - - - (0.03) (0.01) - - ------ ------ ------ ------ ------ ------ ------ Total distributions ........................ (0.47) (0.50) (0.52) (0.56) (0.54) (0.46) (0.19) ------ ------ ------ ------ ------ ------ ------ Net asset value, end of period ................ $10.66 $10.31 $10.40 $10.09 $10.81 $10.66 $10.31 ====== ====== ====== ====== ====== ====== ====== Total return (not reflecting sales charge) .... 8.15% 4.02% 8.45% (1.51)% 5.13% 7.98% 0.58%++ Ratios/supplemental data Net assets, end of period (in thousands) ... $226,014 $201,604 $196,890 $205,842 $229,667 $2,407 $1,426 Ratio of expenses to average net assets .... 0.72% 0.72% 0.74% 0.72% 0.73% 0.87% 0.83%* Ratio of net investment income to average net assets ....................... 4.50% 4.82% 5.10% 4.95% 4.89% 4.32% 4.47%* Portfolio turnover rate .................... 18.27% 21.44% 6.61% 6.35% 12.79% 18.27% 21.44%++ The expense ratios after giving effect to the expense offset for uninvested cash balances were: Ratio of expenses to average net assets .... 0.71% 0.70% 0.73% 0.71% 0.72% 0.86% 0.82%*
---------- (1) For the period August 6, 2001 to December 31, 2001. + Per share amounts have been calculated using the monthly average shares method. ++ Not annualized. * Annualized. Note: Effective September 11, 1995, Banc One Investment Advisors Corporation became the Fund's Investment Adviser replacing PNC Bank, Kentucky, Inc. and effective on May 1, 1998, pursuant to new management arrangements, was appointed as the Fund's Investment Sub-Adviser. On July 1, 2000, Aquila Management Corporation was appointed as the Fund's Investment adviser. See accompanying notes to financial statements. CHURCHILL TAX-FREE FUND OF KENTUCKY FINANCIAL HIGHLIGHTS (CONTINUED) FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
CLASS C ---------------------------------------------- YEAR ENDED DECEMBER 31, ---------------------------------------------- 2002 2001 2000 1999 1998 ------ ------ ------ ------ ------ Net asset value, beginning of period ......... $10.31 $10.39 $10.08 $10.81 $10.81 ------ ------ ------ ------ ------ Income (loss) from investment operations: Net investment income + ................... 0.38 0.41 0.43 0.43 0.44 Net gain (loss) on securities (both realized and unrealized) ............... 0.35 (0.08) 0.31 (0.69) 0.01 ------ ------ ------ ------ ------ Total from investment operations .......... 0.73 0.33 0.74 (0.26) 0.45 ------ ------ ------ ------ ------ Less distributions (note 10): Dividends from net investment income ...... (0.38) (0.41) (0.43) (0.44) (0.44) Distributions from capital gains .......... - - - (0.03) (0.01) ------ ------ ------ ------ ------ Total distributions ....................... (0.38) (0.41) (0.43) (0.47) (0.45) ------ ------ ------ ------ ------ Net asset value, end of period ............... $10.66 $10.31 $10.39 $10.08 $10.81 ====== ====== ====== ====== ====== Total return (not reflecting sales charge) ... 7.23% 3.24% 7.54% (2.45)% 4.24% Ratios/supplemental data Net assets, end of period (in thousands) ......................... $4,804 $3,355 $1,861 $1,932 $ 949 Ratio of expenses to average net assets ............................. 1.56% 1.56% 1.59% 1.56% 1.59% Ratio of net investment income to average net assets .................. 3.62% 3.92% 4.24% 4.09% 4.04% Portfolio turnover rate ................... 18.27% 21.44% 6.61% 6.35% 12.79% The expense ratios after giving effect to the expense offset for uninvested cash balances were: Ratio of expenses to average net assets .............................. 1.55% 1.55% 1.58% 1.55% 1.57%
CLASS Y ---------------------------------------------- YEAR ENDED DECEMBER 31, ---------------------------------------------- 2002 2001 2000 1999 1998 ------ ------ ------ ------ ------ Net asset value, beginning of period ......... $10.32 $10.40 $10.09 $10.82 $10.82 ------ ------ ------ ------ ------ Income (loss) from investment operations: Net investment income + ................... 0.49 0.51 0.53 0.53 0.54 Net gain (loss) on securities (both realized and unrealized) ................ 0.35 (0.07) 0.32 (0.69) 0.02 ------ ------ ------ ------ ------ Total from investment operations .......... 0.84 0.44 0.85 (0.16) 0.56 ------ ------ ------ ------ ------ Less distributions (note 10): Dividends from net investment income ...... (0.49) (0.52) (0.54) (0.54) (0.55) Distributions from capital gains .......... - - - (0.03) (0.01) ------ ------ ------ ------ ------ Total distributions ....................... (0.49) (0.52) (0.54) (0.57) (0.56) ------ ------ ------ ------ ------ Net asset value, end of period ............... $10.67 $10.32 $10.40 $10.09 $10.82 ====== ====== ====== ====== ====== Total return (not reflecting sales charge) ... 8.30% 4.28% 8.62% (1.46)% 5.26% Ratios/supplemental data Net assets, end of period (in thousands) ......................... $41,223 $25,585 $15,745 $13,346 $14,335 Ratio of expenses to average net assets ............................. 0.57% 0.57% 0.59% 0.57% 0.58% Ratio of net investment income to average net assets .................. 4.63% 4.94% 5.25% 5.09% 5.03% Portfolio turnover rate ................... 18.27% 21.44% 6.61% 6.35% 12.79% The expense ratios after giving effect to the expense offset for uninvested cash balances were: Ratio of expenses to average net assets ............................. 0.56% 0.55% 0.58% 0.56% 0.57%
---------- + Per share amounts have been calculated using the monthly average shares method. Note: Effective September 11, 1995, Banc One Investment Advisors Corporation became the Fund's Investment Adviser replacing PNC Bank, Kentucky, Inc. and effective on May 1, 1998, pursuant to new management arrangements, was appointed as the Fund's Investment Sub-Adviser. On July 1, 2000, Aquila Management Corporation was appointed as the Fund's Investment adviser. See accompanying notes to financial statements. ADDITIONAL INFORMATION (UNAUDITED) TRUSTEES(1) AND OFFICERS
NUMBER OF POSITIONS PORTFOLIOS HELD WITH IN FUND NAME, FUND AND PRINCIPAL COMPLEX OTHER ADDRESS(2) LENGTH OF OCCUPATION(S) OVERSEEN DIRECTORSHIPS AND DATE OF BIRTH SERVICE(3) DURING PAST 5 YEARS BY TRUSTEE HELD BY TRUSTEE ----------------- ---------- ------------------- ---------- --------------- INTERESTED TRUSTEES(4) Lacy B. Herrmann Chairman of the Founder and Chairman of the 12 Director or trustee, OCC New York, NY Board of Trustees Board, Aquila Management Cash Reserves, Inc., OCC (05/12/29) since 1987 Corporation, the sponsoring Accumulation Trust, organization and Manager or Oppenheimer Quest Administrator and/or Adviser Value Funds Group, or Sub-Adviser to each fund of Oppenheimer Small Cap the Aquila(SM) Group of Funds(5) Value Fund, Oppenheimer and Founder, Chairman of the Midcap Fund, and Board of Trustees and Oppenheimer Rochester (currently or until 1998) Group of Funds. President of each since its establishment, beginning in 1984; Director of the Distributor since 1981 and formerly Vice President or Secretary, 1981-1998; President and a Director, STCM Management Company, Inc., sponsor and investment adviser to Capital Cash Management Trust since 1973; Trustee Emeritus, Brown University and active in university, school and charitable organizations. Diana P. Herrmann Trustee since President and Chief Operating 7 None New York, NY 1995 and Officer of the Manager since (02/25/58) President since 1997, a Director since 1984, 1999 Secretary since 1986 and previously its Executive Vice President, Senior Vice President or Vice President, 1986-1997; President, Senior Vice President or Executive Vice President of funds in the Aquila(SM) Group of Funds since 1986; Director of the Distributor since 1997; trustee, Reserve Money-Market Funds, 1999-2000 and Reserve Private Equity Series, 1998- 2000; active in mutual fund and trade organizations and in charitable and volunteer organizations. NON-INTERESTED TRUSTEES Thomas A. Christopher Trustee since Vice President of Robinson, 1 None Danville, KY 1992 Hughes & Christopher, C.P.A.s, (12/19/47) P.S.C., since 1977; President, A Good Place for Fun, Inc., a sports facility, since 1987; active member of the American Institute of Certified Public Accountants. Douglas Dean Trustee since Founder and Chairman of the 1 None Lexington, KY 1987 Board of Directors, Dean, (03/21/49) Dorton & Ford P.S.C., a public accounting firm, since 1982; active as an officer and member of various charitable and community organizations. Carroll F. Knicely Trustee since President, Associated 1 West Kentucky Glasgow, KY 1998 Publications Inc, Glasgow, Corporation; South Gate (12/08/28) Kentucky; director and member, Plaza, Inc.; Knicely and Executive Board of West Knicely, Inc. Kentucky Corporation and director and Secretary-Treasurer, South Gate Plaza, Inc. (owner and developer of shopping centers and commercial real estate); director, Vice President and Treasurer, Knicely and Knicely, Inc. (owner and developer of rental properties and residential real estate); former trustee, Cambellsville University; formerly Secretary of Commerce and Commissioner of Commerce, Commonwealth of Kentucky. Theodore T. Mason Trustee since Executive Director, East Wind 6 Trustee, OCC New York, NY 1992 Power Partners LTD since 1994 Accumulation Trust. (11/24/35) and Louisiana Power Partners, LLC since 1999; President, Alumni Association of SUNY Maritime College since 2002 (First Vice President, 2000-2001, Second Vice President, 1998-2000) and director of the same organization since 1997; Director, STCM Management Company, Inc., since 1973; twice national officer of Naval Reserve Association, commanding officer of four naval reserve units and Captain, USNR (Ret); director, The Navy League of the United States New York Council since 2002; trustee, The Maritime Industry Museum at Fort Schuyler and the Maritime College at Fort Schuyler Foundation, Inc. since 2000. Anne J. Mills Trustee since President, Loring Consulting 5 None Castle Rock, CO 1987 Company since 2001; Vice (12/23/38) President for Business Affairs, Ottawa University, 1992-2001; IBM Corporation, 1965-1991; Budget Review Officer, the American Baptist Churches/USA, 1994-1997; director, the American Baptist Foundation since 1985 and Trustee Emerita, Brown University. William J. Nightingale Trustee since Retired; formerly 2 Ring's End, Inc. Rowayton, CT 1993 Chairman, founder (1975) and (09/16/29) Senior Advisor until 2000 of Nightingale & Associates, L.L.C., a general management consulting firm focusing on interim management, divestitures, turnaround of troubled companies, corporate restructuring and financial advisory services. James R. Ramsey Trustee since President, University of 1 None Louisville, KY 1987 Louisville since Nov. 2002; (11/14/48) Professor of Economics, University of Louisville, 1999-present; Kentucky Governor's Senior Policy Advisor and State Budget Director, 1999-2002; Vice Chancellor for Finance and Administration, the University of North Carolina at Chapel Hill, 1998 to 1999; previously Vice President for Finance and Administration at Western Kentucky University, State Budget Director for the Commonwealth of Kentucky, Chief State Economist and Executive Director for the Office of Financial Management and Economic Analysis for the Commonwealth of Kentucky, Adjunct Professor at the University of Kentucky, Associate Professor at Loyola University-New Orleans and Assistant Professor at Middle Tennessee State University. OFFICERS Thomas S. Albright Senior Vice Senior Vice President and N/A N/A Louisville, KY President since Portfolio Manager, Churchill (07/26/52) 2000 Tax-Free Fund of Kentucky since July 2000; Vice President and Co-portfolio manager, Tax-Free Fund For Utah since 2001; Vice President and Portfolio Manager, Banc One Investment Advisors, Inc., 1994-2000. Jerry G. McGrew Senior Vice President of the Distributor N/A N/A New York, NY President since since 1998, Registered (06/18/44) 1994 Principal since 1993, Senior Vice President, 1997-1998 and Vice President, 1993-1997; Senior Vice President, Aquila Rocky Mountain Equity Fund and five Aquila Bond Funds and Vice President, Churchill Cash Reserves Trust, 1995-2001. James M. McCullough Vice President Senior Vice President or Vice N/A N/A Portland, OR since 2000 President of Aquila Rocky (06/11/45) Mountain Equity Fund and four Aquila Bond Funds; Senior Vice President of the Distributor since 2000; Director of Fixed Income Institutional Sales, CIBC Oppenheimer & Co. Inc., Seattle, WA, 1995-1999. Jason T. McGrew Vice President Vice President, Churchill N/A N/A Elizabethtown, KY since 2001 Tax-Free Fund of Kentucky (08/14/71) since 2001, Assistant Vice President, 2000-2001; Investment Broker with Raymond James Financial Services 1999-2000 and with J.C. Bradford and Company 1997- 1999; Associate Broker at Prudential Securities 1996-1997. Rose F. Marotta Chief Financial Chief Financial Officer of the N/A N/A New York, NY Officer since 1991 Aquila(SM) Group of Funds since (05/08/24) 1991 and Treasurer, 1981-1991; Treasurer and Director, STCM Management Company, Inc., since 1974; Treasurer of the Manager since 1984 and of the Distributor, 1985-2000. Joseph P. DiMaggio Treasurer since Treasurer of the Aquila(SM) N/A N/A New York, NY 2000 Group of Funds and the (11/06/56) Distributor since 2000; Controller, Van Eck Global Funds, 1993-2000. Edward M. W. Hines Secretary since Partner, Hollyer Brady Smith & N/A N/A New York, NY 1987 Hines LLP, legal counsel to (12/16/39) the Fund, since 1989; Secretary of the Aquila(SM) Group of Funds. Robert W. Anderson Assistant Secretary Compliance Officer of the N/A N/A New York, NY since 2000 Manager since 1998 and (08/23/40) Assistant Secretary of the Aquila(SM) Group of Funds since 2000; trustee, Alpha Strategies Fund since July, 2002; Consultant, The Wadsworth Group, 1995-1998. John M. Herndon Assistant Secretary Assistant Secretary of the N/A N/A New York, NY since 1995 Aquila(SM) Group of Funds since (12/17/39) 1995 and Vice President of the five Aquila Money-Market Funds since 1990; Vice President of the Manager since 1990. Lori A. Vindigni Money-Market, Assistant Treasurer of the N/A N/A New York, NY Bond and Equity Aquila(SM) Group of Funds since (11/02/66) Funds: Assistant 2000; Assistant Vice President Treasurer since of the Manager since 1998; 2000 Fund Accountant for the Aquila(SM) Group of Funds, 1995-1998.
---------- (1) The Fund's Statement of Additional Information includes additional information about the Trustees and is available, without charge, upon request by calling 800-437-1020 (toll free). (2) The mailing address of each Trustee and officer is c/o Churchill Tax-Free Fund of Kentucky, 380 Madison Avenue, New York, NY 10017. (3) Each Trustee holds office until the next annual meeting of shareholders or until his or her successor is elected and qualifies. The term of office of each officer is one year. (4) Mr. Herrmann and Ms. Herrmann are interested persons of the Fund, as that term is defined in the 1940 Act, as officers of the Fund and affiliates of both the Manager and the Distributor. Each is also an interested person as a member of the immediate family of the other. (5) In this material Pacific Capital Cash Assets Trust, Pacific Capital U.S. Government Securities Cash Assets Trust, Pacific Capital Tax-Free Cash Assets Trust and Capital Cash Management Trust, each of which is a money-market fund, are called the "Aquila Money-Market Funds"; Hawaiian Tax-Free Trust, Tax-Free Trust of Arizona, Tax-Free Trust of Oregon, Tax-Free Fund of Colorado, Churchill Tax-Free Fund of Kentucky, Narragansett Insured Tax-Free Income Fund and Tax-Free Fund For Utah, each of which is a tax-free municipal bond fund, are called the "Aquila Bond Funds"; Aquila Rocky Mountain Equity Fund is an equity fund; considered together, these 12 funds are called the "Aquila(SM) Group of Funds." FEDERAL TAX STATUS OF DISTRIBUTIONS (UNAUDITED) This information is presented in order to comply with a requirement of the Internal Revenue Code AND NO ACTION ON THE PART OF SHAREHOLDERS IS REQUIRED. For the fiscal year ended December 31, 2002, $11,355,823 of dividends paid by Churchill Tax-Free Fund of Kentucky, constituting 99.885% of total dividends paid during fiscal 2002, were exempt-interest dividends. Prior to January 31, 2003, shareholders were mailed IRS Form 1099-DIV which contained information on the status of distributions paid for the 2002 CALENDAR YEAR.