PAGE 1
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Keystone Small Company Growth Fund II
Seeks long-term growth of capital by investing in stocks of small companies.
Dear Shareholder:
We are writing to provide you with the first annual report on Keystone Small
Company Growth Fund II for the period from the Fund's commencement of
investment operations on February 21 to May 31, 1996. Following this letter,
we have included a discussion with your Fund's manager discussing portfolio
strategy.
Performance
For the period from February 21 to May 31, 1996, your Fund produced the
following returns:
Class A shares returned 11.50%,
Class B shares returned 11.20%, and
Class C shares returned 11.20%.
We were pleased with your Fund's performance during this initial period of
operations. Your Fund's performance was in line with small company stock
indexes for this relatively short period.
Overall stocks delivered excellent returns during most of the period.
However, the first half of 1996 has been a period of uneven performance as
small company (small-cap) and large-cap stocks took turns leading the market.
In particular, technology stocks, which produced exceptional returns in 1995,
experienced weakness as earnings expectations for some companies were
lowered. Nevertheless, we continue to believe that there are many attractive,
growing small companies in which to invest.
The introduction of this Fund represents a logical extension of Keystone's
small-cap management expertise. For over 60 years we have been successfully
managing stock portfolios of small and growing companies. We attempt to
select stocks of companies with accelerating earnings growth and solid
management teams. We look for companies which we believe have innovative
products and services. In short, we look for tomorrow's market leaders. These
companies tend to be less seasoned and generally have greater stock price
volatility. However, we think we can reduce these risks by carefully
evaluating each company and diversifying among a variety of sectors,
industries and issues.
Valuations still reasonable
One way we measure the attractiveness of small-cap stocks is by comparing the
price-to-earnings ratio (P/E) of small-cap stocks to the Standard & Poor's
500 Index (S&P 500) P/E. The S&P 500 is a broad market average of large-cap
stocks. Historically the ratio of small-cap versus the S&P 500 has ranged
between 1.0 and 2.2. A ratio of 1.0 indicates that small-cap stocks are cheap
compared to large-cap stocks for the same level of earnings. A ratio of 2.2
indicates that small-cap stocks are relatively expensive compared to
large-cap stocks. Our experience tells us that a ratio below 2.0 is
reasonable. As of May 31, 1996, this ratio was 1.6, an indication that
small-cap stocks are still attractively valued relative to larger stocks.
Outlook
We believe that the attractive long-term fundamentals for small-cap stocks
remain intact. We believe the economy is healthy and we continue to see
accelerating earnings growth rates at many small companies. We think exposure
to small-cap stocks is an important component of a well diversified
investment portfolio and, we believe investors will continue to favor
small-cap stocks for their attractive earnings growth rates. However,
periodic corrections are not unusual for small-cap stocks. After the
excellent gains experienced in 1995 and 1996, we would tend to view any
correction as an opportunity for your Fund.
--continued--
<PAGE>
PAGE 2
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Keystone Small Company Growth Fund II
As you evaluate your investment and market conditions, we encourage you to
remember a few investment principles that have withstood the test of time in
all types of markets. Diversify your investments. By putting your money in
different types of investments, you can minimize your risk. Have a long-term
perspective. The longer you keep your money invested, the more time you have
to weather the market's fluctuations. Invest regularly. By making periodic
investments over time, you can build a nest egg and lower your average cost
per share. Of course your investment will fluctuate with market conditions,
and there is no assurance that it will be worth more when you sell your
shares.
Your investment adviser can help you with these strategies by developing a
plan to meet your particular needs. He or she is a professional with the
resources and expertise to help you achieve your investment goals. We
encourage you to take advantage of the services your adviser can provide.
On July 11, 1996, Donald C. Dates, senior vice president, assumed
responsibility as leader of Keystone's small-cap team. Mr. Dates has
extensive investment experience and most recently served as director of
Keystone's research department where he supervised the activities of
Keystone's stock analysts. He is a Chartered Financial Analyst with over 35
years of investment experience.
Don will lead Keystone's small-cap team which is comprised of portfolio
manager Margery Parker and senior analyst David Benhaim. Ms. Parker has 14
years of investment experience and currently manages other Keystone funds
that invest in small-cap stocks. Mr. Benhaim has been a key component of
Keystone's small-cap research and analysis efforts in the technology sector.
We look forward to their contributions to your Fund's management.
We welcome you as a new shareholder of Keystone Small Company Growth Fund II
and look forward to serving your investment needs for many years to come. If
you have any questions or comments about your investment, please feel free to
write to us.
Sincerely,
[/s/ Albert H. Elfner, III]
Albert H. Elfner, III
Chairman and President
Keystone Investments, Inc.
[/s/ George S. Bissell]
George S. Bissell
Chairman of the Board
Keystone Funds
July 1996
[photo Albert H. Elfner, III]
Albert H. Elfner, III
[photo George S. Bissell]
George S. Bissell
<PAGE>
PAGE 3
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A Discussion With
Your Fund's Management
Your Fund is managed by Keystone's small-cap team, headed by Donald C. Dates.
Mr. Dates has over 35 years of investment experience and is a Chartered
Financial Analyst. He holds a BA from Lafayette College and an MBA from
Wharton School of Business. Together with portfolio manager Margery C. Parker
and senior analyst David S. Benhaim, the team searches for small companies
with accelerating earnings growth.
Q What is your investment philosophy in managing the Fund?
A We invest in small company (small-cap) stocks. We find small-caps in
a variety of market sectors that we believe have superior growth rates and
accelerating earnings. Specifically, we seek out companies with projected
earnings growth rates of 20% or more each year. We look for companies with high
levels of profitability and attractive stock prices. These are typically
companies that have distinctive products or services which will set them apart.
Q How is this Fund different from Keystone's Small Company Growth Fund
(S-4)?
A We employ the same strategy in managing both funds. However, Keystone
Small Company Growth Fund II currently holds stocks with a slightly smaller
market capitalization. This is primarily because a smaller fund has greater
flexibility to invest in stocks with smaller market capitalizations. In
addition, a new fund typically has not held securities for a long period,
which could otherwise result in an increase in a holding's market-cap. Right
now we also hold fewer stocks in the portfolio--66 at the end of the period.
Smaller issue sizes and fewer holdings have the potential for greater short
term price fluctuations, but we believe these companies also have excellent
growth prospects.
Q Please describe the market environment during the period.
A The past year provided a good example of how turbulent the small-cap
market can be. Small-cap stocks generally rose during the second half of
1995. However, between September and early January they declined, only to
rebound in mid-January. Technology stocks, which comprised a significant
share of the small company stock indexes, contributed significantly to price
volatility both on the up and down sides.
Q Technology stocks comprised about 25% of net assets on May 31, 1996. What
kinds of stocks did you like?
A We favored software and telecommunications companies. Brisk personal
computer sales and stronger than expected first quarter earnings in 1996
helped many computer and technology related issues. We invested in INSO, the
Fund's largest holding, a leading provider of multilingual communications
products. INSO's products translate, proof and perform other linguistic
functions in several languages for corporations worldwide. The company is a
spin off of Houghton Mifflin, a large publishing company, and we believe INSO
is a solid, well run company.
Q What about the Internet? Did you hold any stocks in this area?
A We saw a variety of good opportunities related to the surge of interest in
the Internet. We held shares of Raptor Systems, which specializes in
"firewall" software--security systems to protect corporate networks that
access the Internet.
Q In the finance area, you held shares of BISYS. What do they do?
A Although BISYS is listed under the finance category, it is both a finance
and software company. BISYS provides services to 401(k) retirement plans in
Fund Profile
Objective: Seeks long-term growth of capital by investing in stocks of small
companies.
Commencement of investment operations: February 21, 1996
Number of stocks: 66
Average market capitalization: $510 million
Newspaper listing: "SmCoGr2B"
<PAGE>
PAGE 4
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Keystone Small Company Growth Fund II
Your Fund Invests In . . .
(bullet) stocks with market capitalizations less than $1 billion at purchase
(bullet) projected earnings growth rates greater than 20%
(bullet) companies with solid management teams and balance sheets
the form of back office support and recordkeeping to banks and financial
services companies. The 401(k) servicing market is a rapidly growing area as
many companies adopt this popular type of retirement plan.
Q You had several holdings in the telecommunications area. Please tell us
about one of your holdings.
A Winstar Communications provided very good performance during the period.
Winstar was founded by several former MCI employees with the intent of
capitalizing on the recently deregulated local telecommunications industry.
Back in the late 1970s and early 1980s no one had heard of the startup long
distance companies MCI and Sprint. Yet, just a few years later, they become
dominant players in the long distance telecommunications industry. We have
been impressed with Winstar's management team and believe that they have the
opportunity to repeat their performance in the local phone service market.
The company is positioned to provide local telecommunications access to
customers through 38 gigahertz (very high frequency) radio communications.
These transmissions are beamed from the rooftops of office buildings
providing better quality communications than fiber optic lines. In major
metropolitan areas this should be a significant advantage, avoiding the usual
costly street excavation to lay phone lines. In addition, the transmissions
are over a narrow bandwidth with virtually no interference from other
signals. We think this provides them with unlimited capacity currently.
Unlike most of our Fund holdings, the company has no earnings yet, but they
have very strong revenue growth.
Q Retail stocks accounted for 4.4% of the portfolio. What are their
strengths and which companies did you own?
A Retail stocks were strong, especially during the second half of the period
when an increase in consumer confidence spurred sales. Success in retailing
favored the extremes--the small, high-end specialty stores on one side, and
the giant "category killers" like The Sports Authority on the other.
Traditional mid-sized department stores felt the squeeze from both sides and
did not fare as well.
Q What other sectors did you favor?
A Biotechnology and health care stocks have been very strong. We believe
these companies have matured over the past five years. In the early 1990s,
many of the fastest growing companies were rising just on publicity and
ideas. Today the focus is on products that are actually on the market or in
the final stages of testing.
Thermo Cardiosystems is a good example of a company with a solid product.
The company makes heart pumps that assist a patient's heart, helping it to
rest. The company's device, the left ventricular assist device (LVAD), has
been used regularly in patients awaiting heart transplants. Recently, the FDA
gave Thermo Cardio approval for clinical trials of long-term home use for
selected patients with no alternative. Physicians
Top 5 Industries
as of May 31, 1996
Percentage of
Industry net assets
- -----------------------------------------
Software services 14.2
- -----------------------------------------
Business services 10.5
- -----------------------------------------
Health care services 8.9
- -----------------------------------------
Telecommunications 8.5
- -----------------------------------------
Finance 8.5
- -----------------------------------------
<PAGE>
PAGE 5
- -------------------------------------
are enthusiastic about LVADs because many patients have made stunning
recoveries. In these patients the pump helps the heart to rest and regain so
much strength that it can be permanently removed. Insurance companies like
the devices because it saves lives and helps patients avoid costly hospital
bills. We think the prospects for the LVAD market are very good, with the
potential to grow to as much as $3 billion annually. The company tripled its
profit last year and it stock price has risen strongly.
Another holding in the drug and health care area is Gilead Sciences. They
are in the forefront of developing treatments for HIV and CMV retinitis, a
complication associated with AIDS. We also held Sequus Pharmaceuticals whose
drug Doxil has proven effective in treating a variety of cancers.
Q What is your outlook?
A We believe the volatility in the small-cap market over the past year was
consistent with the business cycle and created some good opportunities for
investors. We expect a continuation of the generally positive environment for
stocks, but would not be surprised if markets continue to remain volatile in
the coming year. Ultimately we believe that the most successful companies
will be those that have the ability to execute a business plan and grow
regardless of the economic environment.
Top 10 Holdings
as of May 31, 1996
Percentage of
Company Industry net assets
- --------------------------------------------------------------------------
INSO Software services 3.2
- --------------------------------------------------------------------------
BISYS Group Finance 2.9
- --------------------------------------------------------------------------
Cidco Telecommunications 2.8
- --------------------------------------------------------------------------
Thermo Cardiosystems Business services 2.8
- --------------------------------------------------------------------------
Emeritus Health care services 2.6
- --------------------------------------------------------------------------
HCC Insurance Holdings Insurance 2.3
- --------------------------------------------------------------------------
Swift Transportation Transportation 2.3
- --------------------------------------------------------------------------
Winstar Communications Telecommunications 2.2
- --------------------------------------------------------------------------
OM Group Chemicals 2.2
- --------------------------------------------------------------------------
Newpark Resources Oil services 2.0
- --------------------------------------------------------------------------
Q What advantages does the Fund offer investors?
A Keystone Small Company Growth Fund II gives investors access to some of
the fastest growing companies in the world. We think it is a good choice for
long-term investors who can ride out the greater price volatility that
characterizes small-cap stocks. It can also provide important diversification
to an investor's portfolio, and can help reduce the risks associated with
investing in individual small company stocks.
[diamond symbol]
This column is intended to answer
questions about your Fund. If you have a question
you would like answered, please write to:
Keystone Investment Distributors, Inc.
Attn: Shareholder Communications, 22nd Floor,
200 Berkeley Street, Boston, Massachusetts 02116-5034.
<PAGE>
PAGE 6
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Keystone Small Company Growth Fund II
Your Fund's Performance
[BEGIN MOUNTAIN CHART]
Growth of an investment in
Keystone Small Company Growth Fund II Class A
Initial Reinvested
Investment Distributions
---------- -------------
2/96 9378 9378
3/96 9538 9538
4/96 10349 10349
5/96 10509 10509
A $10,000 investment in Keystone Small Company Growth Fund
II Class A made on February 21, 1996 with all distributions reinvested
was worth $10,509 on May 31, 1996. Past performance is no guarantee of future
results.
[END MOUNTAIN CHART]
Class A, Class B, and Class C shares commenced investment operations on
February 21, 1996.
Class A share performance is reported at the current maximum front-end sales
charge of 5.75%.
Class B shares are subject to a contingent deferred sales charge (CDSC) that
declines from 5% to 1% over six years from the month purchased. Performance
assumes that shares were redeemed after the end of the period and reflect the
deduction of a 5% CDSC.
Class C shares are subject to a 1% contingent deferred sales charge (CDSC)
if redeemed during the first twelve-month period held. Performance assumes
that shares were redeemed at the end of the period and reflects the deduction
of the CDSC.
Performance as of May 31, 1996
- ----------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A Class B Class C
<S> <C> <C> <C> <C>
Total return* 11.50% 11.20% 11.20%
Net asset value 2/21/96 $10.00 $10.00 $10.00
5/31/96 $11.15 $11.12 $11.12
Dividends None None None
Capital gains None None None
</TABLE>
* Before deduction of front-end or contingent deferred sales charge (CDSC).
Historical Record as of May 31, 1996
- ------------------------------------------------------------------------
<TABLE>
<CAPTION>
Cumulative total returns Class A Class B Class C
<S> <C> <C> <C>
Life of Class
W/o sales charge 11.50% 11.20% 11.20%
With sales charge 5.09% 6.20% 10.20%
</TABLE>
The investment return and principal value will fluctuate so that your
shares, when redeemed, may be worth more or less than the original cost.
Performance for each class will differ.
You may exchange your shares for another Keystone fund by phone or in
writing for a $10 fee. The exchange fee is waived for individual investors
who make an exchange using Keystone's Automated Response Line (KARL). The
Fund reserves the right to change or terminate the exchange offer.
<PAGE>
PAGE 7
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Growth of an Investment
[BEGIN LINE CHART]
Comparison of change in value of a $10,000 investment in Keystone Small
Company Growth Fund II, and the Russell 2000 Index.
Life of Class
-------------------
Class A 5.09%
Class B 6.20%
Class C 10.20%
February 21, 1996 through May 31, 1996
Russell 2000 Index
Class A Class B Class C (Russell 2000)
2/96 9378 9950 9940 10312
3/96 9538 10110 10110 10525
4/96 10349 10960 10960 11089
5/96 10509 10620 11020 11525
Past performance is no guarantee of future results. The performance of
each Class will vary based on differences in loads and fees paid by the
shareholder investing in the different classes. The Russell 2000 Index is
from January 31, 1996.
[END LINE CHART]
This chart graphically compares your Fund's total return performance to
certain investment indexes. It is the result of fund performance guidelines
issued by the Securities and Exchange Commission. The intent is to provide
investors with more information about their investment.
Components of the chart
The chart is composed of several lines that represent the accumulated value
of an initial $10,000 investment for the period indicated. The lines
illustrate a hypothetical investment in:
1. Keystone Small Company Growth Fund II
The Fund seeks long-term growth of capital by investing in stocks of small
companies. The return is quoted after deducting sales charges (if
applicable), fund expenses and transaction costs and assumes reinvestment of
all distributions.
2. Russell 2000 Index
A broad-based securities market index, the Russell 2000 is an unmanaged index
of stocks with small market capitalizations. The Index represents companies
that may be less established, and may be more concentrated in certain
industries than other indexes. As a result, the Index may be more volatile
than other indexes such as the S&P 500. These securities are independently
selected and compiled according to criteria that may be unrelated to your
Fund's investment objective.
3. Consumer Price Index (CPI)
This index is a widely recognized measure of the cost of goods and services
produced in the U.S. The index contains factors such as prices of services,
housing, food, transportation and electricity which are compiled by the U.S.
Bureau of Labor Statistics. The CPI is generally considered a valuable
benchmark for investors who seek to outperform increases in the cost of
living.
These indexes do not include transaction costs associated with buying and
selling securities, and do not hold cash to meet redemptions. It would be
difficult for most individual investors to duplicate these indexes.
Understanding what the chart means
The chart demonstrates your Fund's total return performance in relation to a
well known investment index and to increases in the cost of living. It is
important to understand what the chart shows and does not show.
This illustration is useful because it charts Fund and index performance
over the same time frame. We believe long-term performance is a more reliable
and useful measure of performance than measurements of short-term returns or
temporary swings in the market. Your financial adviser can help you evaluate
fund performance in conjunction with the other important financial
considerations such as safety, stability and consistency.
<PAGE>
PAGE 8
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Keystone Small Company Growth Fund II
Limitations of the chart
The chart, however, limits the evaluation of Fund performance in several
ways. Because the measurement is based on total returns over a limited period
of time, the comparison often favors those funds which emphasize capital
appreciation when the market is rising. Likewise, when the market is
declining, the comparison usually favors those funds which take less risk.
Performance can be distorted
Funds which are more conservative in their orientation and which place an
emphasis on capital preservation will tend to compare less favorably when the
market is rising. In addition, funds which have income as one of their
objectives also will tend to compare less favorably to relevant indexes.
Indexes may also reflect the performance of some securities which a fund may
be prohibited from buying. A bond fund, for example, may be limited to
investments in only high quality bonds, or a stock fund may only be able to
buy stocks that have been traded on a stock exchange for a minimum number of
years or of a certain company size. Indexes usually do not have the same
investment restrictions as your Fund.
Indexes do not include costs of investing
The comparison is further limited in its utility because the indexes do not
take into account any deductions for sales charges, transaction costs or
other fund expenses. Your Fund's performance figures do reflect such
deductions. Sales charges--whether up-front or deferred--pay for the cost of
the investment advice of your financial adviser. Transaction costs pay for
the costs of buying and selling securities for your Fund's portfolio. Fund
expenses pay for the costs of investment management and various shareholder
services. None of these costs are reflected in index total returns. The
comparison is not completely realistic because an index cannot be duplicated
by an investor--even an unmanaged index--without incurring some charges and
expenses.
One of several measures
The chart is one of several tools you can use to understand your investment.
It should be read in conjunction with the Fund's prospectus, and annual and
semiannual reports. Also, your financial adviser, who understands your
personal financial situation, can best explain the features of your Keystone
fund and how it applies to your financial needs.
Future returns may be different
Shareholders also should be mindful that the long-run performance of either
the Fund or the indexes is not representative of what shareholders should
expect to receive from their Fund investment in the future; it is presented
to illustrate only past performance and is not a guarantee of future returns.
<PAGE>
PAGE 9
- -------------------------------------
Glossary of
Mutual Fund Terms
MUTUAL FUND--A company which combines the investment money of many people
whose financial goals are similar, and invests that money in a variety of
securities. A mutual fund allows the smaller investor the benefits of
diversification, professional management and constant supervision usually
available only to large investors.
PORTFOLIO MANAGER--An investment professional who is responsible for
managing a portfolio's assets prudently and making appropriate investment
decisions, such as which securities to buy, hold and sell, based on the
investment objectives of the portfolio.
STOCK--Equity or ownership interest in a corporation, which represents a
claim on the corporation's assets and earnings.
BOND--Security issued by a government or corporation to those from whom it
has borrowed money. A bond usually promises to pay interest income to the
bondholder at regular intervals and to repay the entire amount borrowed at
maturity date.
CONVERTIBLE SECURITY--A corporate security (usually preferred stock or
bonds) that is exchangeable for a set number of another security type
(usually common stocks) at a pre-stated price.
MONEY MARKET FUND--A mutual fund whose assets are invested in a diversified
portfolio of short-term securities, including commercial paper, bankers'
acceptances, certificates of deposit and other short-term instruments. The
fund pays income which can fluctuate daily. Liquidity and safety of principal
are primary objectives.
NET ASSET VALUE (NAV) PER SHARE--The value of one share of a mutual fund.
The NAV per share is determined by subtracting a fund's total liabilities
from its total assets, and dividing that amount by the number of fund shares
outstanding.
DIVIDEND--A per share distribution of the income earned from the fund's
portfolio holdings. When a dividend distribution is made, the fund's net
asset value drops by the amount of the distribution because the distribution
is no longer considered part of the fund's assets.
CAPITAL GAIN--The profit from the sale of securities, less any losses.
Capital gains are paid to fund shareholders on a per share basis. When a
capital gain distribution is made, the fund's net asset value drops by the
amount of the distribution because the distribution is no longer considered
part of the fund's assets.
YIELD--The annualized rate of income as measured against the current net
asset value of fund shares.
TOTAL RETURN--The change in value of a fund investment over a specified
period of time, taking into account the change in a fund's market price and
the reinvestment of all fund distributions.
SHORT-TERM--An investment with a maturity of one year or less.
LONG-TERM--An investment with a maturity of greater than one year.
AVERAGE MATURITY--The average number of days until the notes, drafts,
acceptances, bonds or other debt instruments in a portfolio become due and
payable.
OFFERING PRICE--The offering price of a share of a mutual fund is the price
at which the share is sold to the public.
<PAGE>
PAGE 10
- -------------------------------------
Keystone Small Company Growth Fund II
SCHEDULE OF INVESTMENTS--May 31, 1996
<TABLE>
<CAPTION>
Number
of Market
Shares Value
- ------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (96.0%) (a)
AIR TRANSPORTATION (1.3%)
Skywest, Inc. (b) 20,000 $ 380,000
- ------------------------------------------------------------------
AUTOMOTIVE (1.3%)
Masland Corp. (b) 14,600 383,250
- ------------------------------------------------------------------
BUILDING (3.7%)
Amre, Inc. 15,000 401,250
Champion Enterprises, Inc. 8,000 324,000
Oakwood Homes Corp. (b) 7,000 339,500
- ------------------------------------------------------------------
1,064,750
- ------------------------------------------------------------------
BUSINESS SERVICES (10.5%)
Allwaste, Inc. 102,000 433,500
G & K Services (b) 12,000 361,500
Insituform Technologies, Inc. 22,000 210,375
Molten Metal Technology, Inc. 15,000 453,750
Peak Technologies Group, Inc. 15,000 361,875
Thermo Cardiosystems, Inc. 15,000 765,000
US Filter Corp. 13,000 453,375
- ------------------------------------------------------------------
3,039,375
- ------------------------------------------------------------------
CHEMICALS (2.0%)
OM Group, Inc. (b) 15,000 603,750
- ------------------------------------------------------------------
CONSUMER GOODS (4.2%)
Blyth Industries, Inc. 10,000 460,000
DeVry, Inc. Del 10,000 397,500
USA Detergents, Inc. 9,100 360,588
- ------------------------------------------------------------------
1,218,088
- ------------------------------------------------------------------
DRUGS (5.9%)
Cephalon, Inc. 3,000 81,375
Cytotherapeutics 10,000 122,500
Gilead Sciences, Inc. 15,000 521,250
Human Genome Sciences, Inc. 2,400 88,200
Magainin Pharmaceutical, Inc. 20,000 225,000
Neurogen Corp. 12,000 346,500
Sequus Pharmaceuticals, Inc. 16,000 342,000
- ------------------------------------------------------------------
1,726,825
- ------------------------------------------------------------------
ELECTRONICS (2.5%)
Merix Corp. 15,000 $ 467,813
SDL, Inc. 6,000 257,250
- ------------------------------------------------------------------
725,063
- ------------------------------------------------------------------
FINANCE (8.5%)
BISYS Group, Inc. 22,000 804,375
BostonFed Bancorp, Inc. (b) 35,000 428,750
Investors Financial Services Corp. (b) 20,000 450,000
Queens County Bancorp (b) 7,000 334,250
RAC Financial Group, Inc. 15,000 436,875
- ------------------------------------------------------------------
2,454,250
- ------------------------------------------------------------------
HEALTH CARE (8.9%)
Conceptus, Inc. 15,000 270,000
Emeritus Corp. 35,000 708,750
Heartport, Inc. 13,000 503,750
Lifecore Biomedical Inc. 22,500 402,188
NCS Healthcare, Inc. 4,000 120,500
PhyMatrix Corp. 15,000 370,312
Ventritex, Inc. 10,000 199,375
- ------------------------------------------------------------------
2,574,875
- ------------------------------------------------------------------
INSURANCE (4.1%)
Blanch (E.W.) Holdings, Inc. (b) 25,000 531,250
HCC Insurance Holdings, Inc. 30,000 648,750
- ------------------------------------------------------------------
1,180,000
- ------------------------------------------------------------------
OFFICE & BUSINESS EQUIPMENT (4.7%)
Cognex Corp. 25,000 446,875
Natural Microsystems Corp. 12,100 453,750
Trimble Navigation Ltd. 20,000 480,000
- ------------------------------------------------------------------
1,380,625
- ------------------------------------------------------------------
OIL SERVICE (3.4%)
Falcon Drilling, Inc. 18,100 435,531
Newpark Resources, Inc. 15,000 543,750
- ------------------------------------------------------------------
979,281
- ------------------------------------------------------------------
RESTAURANTS (1.3%)
Apple South, Inc. (b) 15,000 375,000
- ------------------------------------------------------------------
</TABLE>
<PAGE>
PAGE 11
- -------------------------------------
SCHEDULE OF INVESTMENTS--May 31, 1996
<TABLE>
<CAPTION>
Number
of Market
Shares Value
- ------------------------------------------------------------------
<S> <C> <C>
RETAIL (4.4%)
CDW Computer Centers, Inc. 5,000 $ 409,375
Discount Auto Parts, Inc. 13,000 334,750
Sports Authority, Inc. 17,500 520,625
- ------------------------------------------------------------------
1,264,750
- ------------------------------------------------------------------
SOFTWARE SERVICES (14.2%)
Gemstar Group Ltd 10,000 332,500
Desktop Data, Inc. 16,000 532,000
Epic Design Technology, Inc. 17,000 507,875
Geoworks, Inc. 15,000 528,750
INSO Corp. 16,000 896,000
I2 Technologies, Inc. 13,000 520,000
Maxis, Inc. 17,500 406,875
Raptor System, Inc. 13,000 402,187
- ------------------------------------------------------------------
4,126,187
- ------------------------------------------------------------------
TELECOMMUNICATIONS (8.5%)
Brooks Fiber Properties, Inc. 4,800 161,400
Cidco, Inc. 20,000 790,000
Heartland Wireless Communications, Inc. 20,000 533,750
Spectrian Corp. 15,000 290,625
Winstar Communications, Inc. 20,000 625,000
Xylan Corp. 1,000 63,500
- ------------------------------------------------------------------
2,464,275
- ------------------------------------------------------------------
TEXTILES (1.4%)
Nautica Enterprises, Inc. 16,000 400,000
- ------------------------------------------------------------------
TRANSPORTATION (5.2%)
Landstar System, Inc. 17,000 $ 497,250
Railtex, Inc. 15,000 365,625
Swift Transportation Co., Inc. 35,000 643,125
- ------------------------------------------------------------------
1,506,000
- ------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost--$26,549,673) 27,846,344
- ------------------------------------------------------------------
TOTAL INVESTMENTS
(Cost--$26,549,673) (c) 27,846,344
OTHER ASSETS AND LIABILITIES (4.0%) 1,157,414
- ------------------------------------------------------------------
NET ASSETS (100.0%) $29,003,758
- ------------------------------------------------------------------
</TABLE>
(a) All securities unless indicated with a (b) are non-income-producing.
(b) Income-producing security.
(c) The cost of investments for federal income tax purposes is $26,586,004.
Gross unrealized appreciation and depreciation of investments, based on
identified tax cost, at May 31, 1996 are as follows:
Gross unrealized appreciation $1,889,726
Gross unrealized depreciation (629,386)
---------
Net unrealized appreciation $1,260,340
=========
See Notes to Financial Statements.
<PAGE>
PAGE 12
- -------------------------------------
Keystone Small Company Growth Fund II
FINANCIAL HIGHLIGHTS--CLASS A SHARES
(For a share outstanding throughout the period)
<TABLE>
<CAPTION>
February 21, 1996
(Commencement of
Operations) to
May 31, 1996
==================================================================
<S> <C>
Net asset value beginning of period $ 10.00
- ------------------------------------------------------------------
Income from investment operations:
Net investment loss (0.02)
Net realized and unrealized gain on
investments 1.17
- ------------------------------------------------------------------
Total from investment operations 1.15
- ------------------------------------------------------------------
Net asset value end of period $ 11.15
==================================================================
Total return (b) 11.50%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 2.10%(a)(c)
Total expenses excluding reimbursement 3.70%(c)
Net investment loss (1.41%)(c)
Portfolio turnover rate 13%
Average commissions rate paid $0.0607
- ------------------------------------------------------------------
Net assets end of period (thousands) $ 8,201
==================================================================
</TABLE>
(a) "Ratio of total expenses to average net assets" for the period ended May
31, 1996 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 1.95%.
(b) Excluding applicable sales charges.
(c) Annualized.
See Notes to Financial Statements.
<PAGE>
PAGE 13
- -------------------------------------
FINANCIAL HIGHLIGHTS--CLASS B SHARES
(For a share outstanding throughout the period)
<TABLE>
<CAPTION>
February 21, 1996
(Commencement of
Operations) to
May 31, 1996
==================================================================
<S> <C>
Net asset value beginning of period $ 10.00
- ------------------------------------------------------------------
Income from investment operations:
Net investment loss (0.03)
Net realized and unrealized gain on
investments 1.15
- ------------------------------------------------------------------
Total from investment operations 1.12
- ------------------------------------------------------------------
Net asset value end of period $ 11.12
==================================================================
Total return (b) 11.20%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 2.85%(a)(c)
Total expenses excluding reimbursement 4.45%(c)
Net investment loss (2.16%)(c)
Portfolio turnover rate 13%
Average commissions rate paid $0.0607
- -----------------------------------------------------------------
Net assets end of period (thousands) $12,487
==================================================================
</TABLE>
(a) "Ratio of total expenses to average net assets" for the period ended May
31, 1996 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 2.70%.
(b) Excluding applicable sales charges.
(c) Annualized.
See Notes to Financial Statements.
<PAGE>
PAGE 14
- -------------------------------------
Keystone Small Company Growth Fund II
FINANCIAL HIGHLIGHTS--CLASS C SHARES
(For a share outstanding throughout the period)
<TABLE>
<CAPTION>
February 21, 1996
(Commencement of
Operations) to
May 31, 1996
==================================================================
<S> <C>
Net asset value beginning of period $ 10.00
- ------------------------------------------------------------------
Income from investment operations:
Net investment loss (0.02)
Net realized and unrealized gain on
investments 1.14
- ------------------------------------------------------------------
Total from investment operations 1.12
- -----------------------------------------------------------------
Net asset value end of period $ 11.12
==================================================================
Total return (b) 11.20%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 2.85%(a)(c)
Total expenses excluding reimbursement 4.44%(c)
Net investment loss (2.20%)(c)
Portfolio turnover rate 13%
Average commissions rate paid $0.0607
- ------------------------------------------------------------------
Net assets end of period (thousands) $ 8,315
==================================================================
</TABLE>
(a) "Ratio of total expenses to average net assets" for the period ended May
31, 1996 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 2.70%.
(b) Excluding applicable sales charges.
(c) Annualized.
See Notes to Financial Statements.
<PAGE>
PAGE 15
- -------------------------------------
STATEMENT OF ASSETS AND LIABILITIES--
May 31, 1996
<TABLE>
<S> <C>
Assets (Notes 1 and 4)
Investments at market value
(identified cost--$26,549,673) $27,846,344
Receivable for:
Investments sold 186,178
Fund shares sold 2,496,607
Dividends 1,730
Deferred organization expenses 23,897
Due from investment adviser 17,482
Prepaid expenses 65,517
- ------------------------------------------------------------------
Total assets 30,637,755
- ------------------------------------------------------------------
Liabilities (Notes 2 and 4)
Payable for:
Investments purchased 366,076
Fund shares redeemed 4,933
Due to custodian 1,101,535
Other accrued expenses 161,453
- ------------------------------------------------------------------
Total liabilities 1,633,997
- ------------------------------------------------------------------
Net assets $29,003,758
==================================================================
Net assets represented by (Note 1)
Paid-in capital $27,888,980
Accumulated net realized loss on investments (181,893)
Net unrealized appreciation on investments 1,296,671
- ------------------------------------------------------------------
Total net assets $29,003,758
==================================================================
Net Asset Value
Class A Shares
Net asset value of $8,201,278 / 735,452 shares
outstanding $11.15
Offering price per share ($11.15 / 0.9425)
(based on a sales charge of 5.75% of the
offering price on May 31, 1996) $11.83
Class B Shares
Net asset value of $12,487,070 / 1,123,065
shares outstanding $11.12
Class C Shares
Net asset value of $8,315,410 / 747,923 shares
outstanding $11.12
==================================================================
</TABLE>
STATEMENT OF OPERATIONS--
February 21, 1996 (Commencement
of Operations) to May 31, 1996
<TABLE>
<CAPTION>
<S> <C> <C>
Investment income (Note 1):
Dividends $ 6,737
Interest 9,342
- ------------------------------------------------------------------
Total Income 16,079
- ------------------------------------------------------------------
Expenses (Notes 2 and 4):
Management fee $ 21,221
Transfer agent fees 17,953
Accounting, auditing and legal 8,200
Custodian fees 22,572
Printing 6,800
Amortization of organization expenses 1,480
Distribution Plan expenses 23,682
Registration fees 25,744
Miscellaneous expenses 506
Reimbursement from investment adviser (48,532)
- ------------------------------------------------------------------
Total expenses 79,626
Less: Expenses paid indirectly
(Note 4) (4,406)
- ------------------------------------------------------------------
Net expenses 75,220
- ------------------------------------------------------------------
Net investment loss (59,141)
- ------------------------------------------------------------------
Net realized and unrealized gain
(loss) on investments (Notes 1 and 3):
Net realized loss on investments (181,893)
Net change in unrealized appreciation
on investments 1,296,671
- ------------------------------------------------------------------
Net realized and unrealized gain
on investments 1,114,778
- ------------------------------------------------------------------
Net increase in net assets resulting
from operations $1,055,637
=================================================================
</TABLE>
See Notes to Financial Statements.
<PAGE>
PAGE 16
- -------------------------------------
Keystone Small Company Growth Fund II
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
February 21,
1996
(Commencement
of Operations)
to May 31, 1996
==================================================================================
<S> <C>
Operations:
Net investment loss $ (59,141)
Net realized loss on investments (181,893)
Net change in unrealized appreciation on investments 1,296,671
- --------------------------------------------------------------------------------
Net increase in net assets resulting from operations 1,055,637
- --------------------------------------------------------------------------------
Capital share transactions (Note 2)
Proceeds from shares sold:
Class A Shares 8,267,986
Class B Shares 12,267,442
Class C Shares 8,667,945
Payment for shares redeemed:
Class A Shares (410,693)
Class B Shares (284,594)
Class C Shares (559,965)
- --------------------------------------------------------------------------------
Net increase in net assets resulting from capital share
transactions 27,948,121
- --------------------------------------------------------------------------------
Total increase in net assets 29,003,758
- --------------------------------------------------------------------------------
Net assets:
Beginning of period 0
- --------------------------------------------------------------------------------
End of period $29,003,758
================================================================================
</TABLE>
See Notes to Financial Statements.
16
<PAGE>
PAGE 17
- -------------------------------------
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone Small Company Growth Fund II (the "Fund") is registered under the
Investment Company Act of 1940 as a diversified open-end investment company.
The Fund was organized as a Massachusetts business trust on December 13,
1996. Keystone Investment Management Company ("Keystone") is the Fund's
Investment Adviser. The Fund's investment objective is long-term growth of
capital.
Keystone is a wholly-owned subsidiary of Keystone Investments, Inc. ("KII"),
a Delaware corporation. KII is a private corporation predominately owned by
current and former members of management of Keystone and its affiliates.
Keystone Investor Resource Center, Inc. ("KIRC"), a wholly-owned subsidiary
of Keystone, is the Fund's transfer agent.
The Fund offers Class A, B and C shares. Class A shares are offered at a
public offering price which includes a maximum sales charge of 5.75% payable
at the time of purchase. Class B shares are sold subject to a contingent
deferred sales charge payable upon redemption which varies depending on when
the shares were purchased and how long they have been held. Class C shares
are sold subject to a contingent deferred sales charge payable upon
redemption within one year after purchase. Class C shares are available only
through dealers who have entered into special distribution agreements with
Keystone Investment Distributors Company ("KIDCO"), the Fund's principal
underwriter. KIDCO is a wholly-owned subsidiary of Keystone.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles
which require management to make estimates and assumptions that affect
amounts reported herein. Although actual results could differ from these
estimates, any such differences are expected to be immaterial to the net
assets of the Fund.
A. Investments are usually valued at the closing sales price, or, in the
absence of sales and for over-the-counter securities, the mean of bid and
asked quotations. Management values the following securities at prices it
deems in good faith to be fair under the direction of the Board of Trustees:
(a) securities (including restricted securities) for which complete
quotations are not readily available and (b) listed securities if, in the
opinion of management, the last sales price does not reflect a current value
or if no sale occurred.
Short-term investments maturing in sixty days or less are valued at
amortized cost (original purchase cost as adjusted for amortization of
premium or accretion of discount) which when combined with accrued interest
approximates market. Short-term investments maturing in more than sixty days
for which market quotations are readily available are valued at current
market value. Short-term investments maturing in more than sixty days when
purchased which are held on the sixtieth day prior to maturity are valued at
amortized cost (market value on the sixtieth day adjusted for amortization of
premium or accretion of discount) which when combined with accrued interest
approximates market. Short-term investments denominated in a foreign currency
are adjusted daily to reflect changes in exchange rates.
The Fund enters into currency and other financial futures contracts as a
hedge against changes in interest or currency exchange rates. A futures
contract is an agreement between two parties to buy and sell a specific
amount of a commodity, security, financial instrument, or, in the case of a
stock index, cash at a set
<PAGE>
PAGE 18
- -------------------------------------
Keystone Small Company Growth Fund II
price on a future date. Upon entering into a futures contract, the Fund is
required to deposit with a broker an amount ("initial margin") equal to a
certain percentage of the purchase price indicated in the futures contract.
Subsequent payments ("variation margin") are made or received by the Fund
each day, as the value of the underlying instrument or index fluctuates, and
are recorded for book purposes as unrealized gains or losses by the Fund. For
federal tax purposes, any futures contracts which remain open at fiscal
year-end are marked-to-market and the resultant net gain or loss is included
in federal taxable income.
Investments denominated in a foreign currency are adjusted daily to reflect
changes in exhange rates. Those securities traded in foreign currency amounts
are translated into United States dollars as follows: market value of
investments, assets and liabilities at the daily rate of exchange, purchases
and sales of investment, income and expenses at the rate of exchange
prevailing on the respective dates of such transactions. Net unrealized
foreign exchange gains/losses are a component of unrealized
appreciation/depreciation of investments. In addition to market risk, the
Fund is subject to the credit risk that the other party will not be able to
complete the obligations of the contract.
B. Securities transactions are accounted for no later than one business day
after the trade date. Realized gains and losses are recorded on the
identified cost basis. Interest income is recorded on the accrual basis and
dividend income is recorded on the ex-dividend date. All discounts are
amortized for both financial reporting and federal income tax purposes.
Distributions to shareholders are recorded at the close of business on the
ex-dividend date.
C. The Fund has qualified, and intends to qualify in the future, as a
regulated investment company under the Internal Revenue Code of 1986, as
amended ("Internal Revenue Code"). Thus, the Fund is relieved of any federal
income tax liability by distributing all of its net taxable investment income
and net taxable capital gains, if any, to its shareholders. The Fund intends
to avoid any excise tax liability by making the required distributions under
the Internal Revenue Code.
D. When the Fund enters into a repurchase agreement (a purchase of securities
whereby the seller agrees to repurchase the securities at a mutually agreed
upon date and price) the repurchase price of the securities will generally
equal the amount paid by the Fund plus a negotiated interest amount. The
seller under the repurchase agreement will be required to provide securities
("collateral") to the Fund whose value will be maintained at an amount not
less than the repurchase price, and which generally will be maintained at
101% of the repurchase price. The Fund monitors the value of collateral on a
daily basis, and if the value of collateral falls below required levels, the
Fund intends to seek additional collateral from the seller or terminate the
repurchase agreement. If the seller defaults, the Fund would suffer a loss to
the extent that the proceeds from the sale of the underlying securities were
less than the repurchase price. Any such loss would be increased by any cost
incurred on disposing of such securities. If bankruptcy proceedings are
commenced against the seller under the repurchase agreement, the realization
on the collateral may be delayed or limited. Repurchase agreements entered
into by the Fund will be limited to transactions with dealers or domestic
banks believed to present minimal credit risks, and the Fund will take
constructive receipt of all
<PAGE>
PAGE 19
- -------------------------------------
securities underlying repurchase agreements until such agreements expire.
Pursuant to an exemptive order issued by the Securities and Exchange
Commission, the Fund, along with certain other Keystone funds, may transfer
uninvested cash balances into a joint trading account. These balances are
invested in one or more repurchase agreements that are fully collateralized
by U.S. Treasury and/or Federal Agency obligations.
E. The Fund may enter into forward foreign currency exchange contracts
("contracts") to settle portfolio purchases and sales of securities
denominated in a foreign currency and to hedge certain currency assets.
Contracts are recorded at market value and are marked to market daily.
Realized gains and losses arising from such transactions are included in net
realized gain (loss) on foreign currency related transactions. The Fund is
subject to the credit risk that the other party will not complete the
obligations of the contract.
F. The Fund intends to distribute net investment income and net capital
gains, if any, annually. Distributions are determined in accordance with
income tax regulations. Distributions from taxable net investment income and
net capital gains can exceed book basis net income and net capital gains. The
significant differences between financial statement amounts available for
distribution and distributions made in accordance with income tax regulations
are primarily due to a net operating loss and wash sales.
(2.) Capital Share Transactions
The Declaration of Trust authorizes the issuance of an unlimited number of
shares of beneficial interest without par value. Transactions in shares of
the Fund were as follows:
<TABLE>
<CAPTION>
Class A Shares
---------------------------------------------
February 21, 1996
to May 31, 1996
---------------------------------------------
<S> <C>
Shares sold 772,993
Redemptions (37,541)
--------------------------------------------
Net increase 735,452
============================================
</TABLE>
<TABLE>
<CAPTION>
Class B Shares
---------------------------------------------
February 21, 1996
to May 31, 1996
---------------------------------------------
<S> <C>
Shares sold 1,149,103
Redemptions (26,038)
---------------------------------------------
Net increase 1,123,065
===============================================
</TABLE>
<TABLE>
<CAPTION>
Class C Shares
----------------------------------------------
February 21, 1996
to May 31, 1996
---------------------------------------------
<S> <C>
Shares sold 797,320
Redemptions (49,397)
---------------------------------------------
Net increase 747,923
=============================================
</TABLE>
The Fund bears some of the costs of selling its shares under Distribution
Plans adopted with respect to its Class A, Class B and Class C shares
pursuant to Rule 12b-1 under the Investment Company Act of 1940, as amended
(the "1940 Act"). Under its Distribution Plans, the Fund pays KIDCO, amounts
which in total may not exceed each Distribution Plan's maximum.
The Class A Distribution Plan provides for payments which are currently
limited to 0.25% annually of the average daily net asset value of Class A
shares to pay expenses of the distribution of Class A shares. Amounts paid by
the Fund to KIDCO under the Class A Distribution Plan are currently used to
pay others, such as broker-dealers, service fees at an annual rate of
<PAGE>
PAGE 20
- -------------------------------------
Keystone Small Company Growth Fund II
up to 0.25% of the average net asset value of shares sold by such recipients
and outstanding on the books of the Fund for specific periods.
The Class B Distribution Plan provides for payments at an annual rate of up
to 1.00% of the average daily net asset value of class B shares to pay
expenses of the distribution of Class B shares. Amounts paid by the Fund
under the Class B distribution Plan are currently used to pay others
(broker-dealers) a commission at the time of purchase normally equal to 4.00%
of the value of each Class B share sold plus the first year's service fee in
advance in the amount of 0.25% of the price paid for each Class B share sold.
Beginning approximately 12 months after the purchase of Class B shares, the
broker-dealer or other party will receive service fees at an annual rate of
0.25% of the average daily net asset value of such Class B shares maintained
by such others and outstanding on the Fund's books for specified periods. A
contingent deferred sales charge will be imposed, if applicable, on Class B
shares at rates ranging from a maximum of 5.00% of amounts redeemed during
the first 12 months following the date of purchase to 1.00% of amounts
redeemed during the sixth twelve-month period following the date of purchase.
Class B shares that have been outstanding for eight years following the month
of purchase will automatically convert to Class A shares without a front end
sales charge or exchange fee.
The Class C Distribution Plan provides for payments at an annual rate of up
to 1.00% of the average daily net asset value of Class C shares to pay
expenses for the distribution of Class C shares. Amounts paid by the Fund
under the Class C Distribution Plan are currently used to pay others
(broker-dealers) a commission at the time of purchase in the amount of 0.75%
of the price paid for each Class C share sold, plus the first year's service
fee in advance in the amount of 0.25% of the price paid for each Class C
share. Beginning approximately 15 months after purchase, the broker-dealer or
other party will receive a commission at an annual rate of 0.75% (subject to
applicable limitations imposed by the rules of the National Association of
Securities Dealers, Inc.) ("NASD") plus service fees at the annual rate of
0.25%, respectively, of the average net asset value of such Class C shares
maintained by the recipient and outstanding on the Fund's books for specified
periods.
Each of the Distribution Plans may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting
shares of the respective class. However, after the termination of any
Distribution Plan, at the discretion of the Board of Trustees, payments to
KIDCO may continue as compensation for its services which had been earned
while the Distribution Plan was in effect.
KIDCO intends, but is not obligated, to continue to pay or accrue
distribution costs and service fees which exceed annual maximum payments
permitted to be received by KIDCO from the Fund. KIDCO intends to seek full
payment of such amounts from the Fund (together with annual interest thereon
at the prime rate plus 1.0%) at such time in the future as, and to the extent
that, payment thereof by the Fund would be within permitted limits.
For the period ended May 31, 1996, the Fund paid KIDCO $2,211 under its
Class A Distribution Plan; $2,722 for Class B shares originally sold prior to
June 1, 1995 and exchanged into the Fund, and $10,641 for all new shares sold
under its Class B Distribution Plan; and $8,108 under its Class C
Distribution Plan.
Under the NASD Rule, the maximum uncollected amount for which KIDCO may seek
payment from
<PAGE>
PAGE 21
- -------------------------------------
the Fund under its Class B and C Distribution Plans were $23,574, and $17,858
as of May 31, 1996, respectively.
Presently, the Fund's class-specific expenses are limited to Distribution
Plan expenses incurred by a class of shares.
(3.) Securities Transactions
Cost of purchases and proceeds from sales of investment securities excluding
short-term securities during the period ended May 31, 1996 were $27,942,610
and $1,211,052, respectively.
(4.) Investment Management Agreement and Transactions With Affiliates
The Fund pays Keystone a fee calculated by applying percentage rates starting
at 0.70% and declining as net assets increase, to 0.35% per annum, to the net
asset value of the Fund. During the period ended May 31, 1996, the Fund paid
or accrued to Keystone investment management and administrative services fees
of $21,221, which represented 0.70% of the Fund's average daily net asset
value on an annualized basis.
During the period ended May 31, 1996, the Fund paid or accrued to KIRC
$17,953 for transfer agent fees.
Keystone for a period of time has voluntarily agreed to limit expenses of
Class A Shares of the Fund to 1.95% of average daily net assets and to limit
expenses of Class B shares and Class C shares to 2.70% of the average daily
net assets of the respective class. Keystone will not be required to
reimburse a Fund to the extent it would result in a Fund's inability to
qualify as a regulated investment company under the provisions of the
Internal Revenue Code. In accordance with these expense limitations, Keystone
reimbursed the Fund $48,532 for the period ended May 31, 1996. Keystone does
not intend to seek repayment of these amounts.
The Fund has entered into an expense offset arrangement with its custodian.
For the period ended May 31, 1996, the Fund paid or accrued total custody
fees in the amount of $22,572 and received a credit of $4,406 pursuant to the
expense offset arrangement, resulting in a net custody expense of $18,166.
The assets deposited with the custodian under the expense offset arrangement
could have been invested in income-producing assets.
<PAGE>
PAGE 22
- -------------------------------------
Keystone Small Company Growth Fund II
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Small Company Growth Fund II
We have audited the accompanying statement of assets and liabilities of
Keystone Small Company Growth Fund II including the schedule of investments
as of May 31, 1996, and the related statements of operations and changes in
net assets, and financial highlights for the period from February 21, 1996
(Commencement of Operations) to May 31, 1996. 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 audit.
We conducted our audit in accordance with generally accepted auditing
standards. 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. Our procedures included confirmation of
securities owned as of May 31, 1996 by correspondence with the custodian and
brokers. 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 audit provides 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
Keystone Small Company Growth Fund II as of May 31, 1996, the results of its
operations, changes in its net assets and financial highlights for the period
from February 21, 1996 to May 31, 1996, in conformity with generally accepted
accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
June 28, 1996
<PAGE>
PAGE 23
- -------------------------------------
Keystone's Services
for Shareholders
KEYSTONE AUTOMATED RESPONSE LINE (KARL)--Receive up-to-date account
information on your balance, last transaction and recent Fund distribution.
You may also process transactions such as investments, redemptions and
exchanges using a touch-tone telephone as well as receive quotes on price,
yield, and total return of your Keystone Fund. Call toll-free,
1-800-346-3858.
EASY ACCESS TO INFORMATION ON YOUR ACCOUNT--Information about your Keystone
account is available 24 hours a day through KARL. To speak with a Shareholder
Services representative about your account, call toll-free 1-800-343-2898
between 8:00 A.M. and 6:00 P.M. Eastern time. Retirement Plan investors
should call 1-800-247-4075.
ADDITIONS TO YOUR ACCOUNT--You can buy additional shares for your account at
any time, with no minimum additional investment.
REINVESTMENT OF DISTRIBUTIONS--You can compound the return on your
investment by automatically reinvesting your Fund's distributions at net
asset value with no sales charge.
EXCHANGE PRIVILEGE--You may move your money among funds in the same Keystone
family quickly and easily for a nominal service fee. KARL gives you the added
ability to move your money any time of day, any day of the week. Keystone
offers a variety of funds with different investment objectives for your
changing investment needs.
ELECTRONIC FUNDS TRANSFER (EFT)-- Referred to as the "paper-less
transaction," EFT allows you to take advantage of a variety of preauthorized
account transactions, including automatic monthly investments and systematic
monthly or quarterly withdrawals. EFT is a quick, safe and accurate way to
move money between your bank account and your Keystone account.
CHECK WRITING--Shareholders of Keystone Liquid Trust may exercise the check
writing privilege to draw from their accounts.
EASY REDEMPTION--KARL makes redemption services available to you 24 hours a
day, every day of the year. The amount you receive may be more or less than
your original account value depending on the value of fund shares at time of
redemption.
RETIREMENT PLANS--Keystone offers a full range of retirement plans,
including IRA, SEP-IRA, profit sharing, money purchase, and defined
contribution plans. For more information, please call Retirement Plan
Services, toll-free at 1-800-247-4075.
Keystone is committed to providing you with quality, responsive account
service. We will do our best to assist you and your financial adviser in
carrying out your investment plans.
<PAGE>
[COVER]
KEYSTONE AMERICA
FAMILY OF FUNDS
[TRIANGLE]
Balanced Fund II
Capital Preservation and Income Fund
Government Securities Fund
Intermediate Term Bond Fund
Strategic Income Fund
World Bond Fund
Tax Free Income Fund
California Insured Tax Free Fund
Florida Tax Free Fund
Massachusetts Tax Free Fund
Missouri Tax Free Fund
New York Insured Tax Free Fund
Pennsylvania Tax Free Fund
Fund for Total Return
Global Opportunities Fund
Hartwell Emerging Growth Fund, Inc.
Omega Fund
Fund of the Americas
Small Company Growth Fund II
Strategic Development Fund
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you
invest or send money. For a free prospectus on other Keystone funds, contact
your financial adviser or call Keystone.
[LOGO] KEYSTONE
INVESTMENTS
P.O. Box 2121
Boston, Massachusetts 02106-2121
SCG2-R-7/96
5.1M [recycle logo]
KEYSTONE
[PHOTO]
SMALL COMPANY
GROWTH FUND II
[LOGO]
ANNUAL REPORT
MAY 31, 1996
