<PAGE>
PAGE 1
KEYSTONE SMALL COMPANY GROWTH FUND II
SEEKS LONG-TERM GROWTH OF CAPITAL BY INVESTING IN EMERGING GROWTH COMPANIES.
Dear Shareholder:
We are pleased to report to you on the activities of Keystone Small Company
Growth Fund II for the twelve-month period that ended May 31, l997. Following
this letter, we have included an interview with the Fund's management team
members.
PERFORMANCE
For the twelve-month period, which ended May 31, l997, your Fund produced the
following returns, exclusive of maximum sales charges:
A shares returned -8.07%
B shares returned -8.81%
C shares returned -8.81%
Y shares, which were introduced in the Fund on January 13, l997, generated a
- -2.64% return.
For the full twelve-month period, the Russell 2000 Index rose 6.97% and the
Russell 2000 Growth Index produced a total return of -5.48%.
Your Fund's results were disappointing. It is important to remember, though,
that they occurred during a time when small-company stocks in general, and
technology stocks in particular, lagged behind large-company stock indices.
During this period, we continued to reposition the Fund to place a greater
emphasis on the stocks of companies that we believe have the potential to
produce above-average growth over time.
ENVIRONMENT
During the twelve months, concerns about the pace of economic growth,
accelerating inflation and higher interest rates held back the performance of
small-company stocks. From mid-l996 until late-April 1997, small-company stock
prices fluctuated broadly. During market corrections, small-cap stock prices
declined more than those of large-company stocks; and during market rallies,
their returns rose less than their large-cap counterparts. Finally, in the last
six weeks of the period, the small stock market began to rally as investors
appeared to recognize the attractive relative values there.
STRATEGY
Over the twelve-months, we emphasized companies with market capitalizations of
$1 billion and under. We reduced or eliminated those stocks of companies that we
believed had reached optimal price levels, and we invested in a variety of
high-quality companies that we believed were selling at attractive prices and
that have the potential to generate strong earnings over several years. In
selecting stocks for the portfolio, we focused on businesses that appear to have
sustainable above-average growth prospects. We sought companies in all sectors
of the market, and we emphasized firms that had distinguishing attributes, such
as strong management, unique product lines, and low-cost production. We
diversified your Fund's investments among a number of economic sectors,
including technology, finance, business and consumer services, and industrial
manufacturers.
-- CONTINUED--
<PAGE>
PAGE 2
KEYSTONE SMALL COMPANY GROWTH FUND II
OUTLOOK
Over the next several months, we believe small-company stocks should generate
stronger returns than they have in the recent past. We think economic growth and
inflation should be moderate, and therefore interest rates should be relatively
stable. Historically, small-company stocks have tended to perform well in this
type of environment. In addition, small-company stocks are relatively
inexpensive. Even after they rallied in April and May, valuations on small-
company stocks, in comparison to large-cap stocks, were at their most attractive
levels in several years. We believe these favorable conditions will bode well
for small-cap stocks.
As a small-company investor, you should keep in mind that one of the
characteristics of small-company stocks is their volatility. They tend to
fluctuate in value over short periods of time. Historically, large gains in the
small-cap sector have come during short time frames. Therefore, being invested
in small-caps when they rally is crucial to being a successful small-cap
investor. As we continue to restructure the portfolio, we believe that the
companies in which we have invested are poised to achieve rapid growth and
sustainable profitability. In many areas, such as technology and health care,
these companies are at a stage in their development when they are introducing
products and services that have never existed. Generally, earnings growth in
these types of companies is less dependent on the general level of economic
activity and more on the success of their own particular product cycles.
Thank you for your continued support of Keystone Small Company Growth Fund II.
If you have any questions or comments, we encourage you to write to us.
Sincerely,
/s/ Albert H. Elfner, III
Albert H. Elfner, III
CHAIRMAN
KEYSTONE INVESTMENT MANAGEMENT COMPANY
/s/ George S. Bissell
George S. Bissell
CHAIRMAN OF THE BOARD
KEYSTONE FUNDS
<TABLE>
<S> <C>
(Photo of Albert H. (Photo of George S.
Elfner, III appears here) Bissell appears here)
ALBERT H. ELFNER, III GEORGE S. BISSELL
</TABLE>
June 1997
<PAGE>
PAGE 3
A Discussion With Your
Fund Management Team
(Photo of Thomas L. Holman
appears here)
THOMAS L. HOLMAN IS VICE PRESIDENT AND PORTFOLIO MANAGER OF YOUR FUND. MR.
HOLMAN JOINED KEYSTONE IN JANUARY 1997. PRIOR TO JOINING KEYSTONE, HE WAS
AN INVESTMENT OFFICER AND SECURITIES ANALYST AT INVISTA CAPITAL
MANAGEMENT, A SUBSIDIARY OF THE PRINCIPAL FINANCIAL GROUP, WHERE HE WAS
CO-MANAGER OF PRINCOR GROWTH FUND AND PRINCOR EMERGING GROWTH FUND. MR.
HOLMAN IS A MEMBER OF KEYSTONE'S SMALL COMPANY STOCK TEAM, WHICH IS
COMPOSED OF THREE PORTFOLIO MANAGERS AND FIVE EQUITY ANALYSTS. TOGETHER,
THEY SEARCH FOR STOCKS OF SMALL COMPANIES WITH SUSTAINABLE ABOVE-AVERAGE
GROWTH RATES. THIS TEAM IS HEADED BY J. GARY CRAVEN, SENIOR VICE PRESIDENT
AND CHIEF INVESTMENT OFFICER, SMALL COMPANY STOCKS.
Q WHAT WAS THE INVESTMENT ENVIRONMENT FOR SMALL-CAP STOCKS LIKE DURING THE
TWELVE-MONTH PERIOD?
A It was a volatile environment for small-cap stocks. Small caps generated
strong gains in l995, but midway through l996, the environment changed. Concerns
about slower economic growth and rising interest rates made small-cap stocks
less appealing to investors, and they shifted money to large-company stocks.
Small company stocks were hit hardest during a market correction in the summer
of l996 and, again, during the market downturn that occurred in March and April
of l997. Toward the end of April, however, investors appeared to recognize that
small-cap stock prices were at very attractive price levels and began to favor
small-cap stocks. Small-cap stock prices rose and continued on an upward course
through May 1997.
Q WHAT WAS YOUR STRATEGY FOR MANAGING THE PORTFOLIO DURING THE PERIOD?
A We invested in companies with market capitali-
zations of $1 billion and under. Our strategy was to invest in high-quality
companies that we believe have above average long-term growth prospects and that
were relatively inexpensive. The companies we selected for the portfolio tended
to have strong competitive positions in their market sectors and superior
business models which have the potential to generate high returns on capital.
These business models can include: low cost production, technological
leadership, exceptional distribution systems and high-quality management teams.
Q TECHNOLOGY STOCKS WERE AN IMPORTANT AREA OF INVESTMENT. WHAT WAS ATTRACTIVE
ABOUT TECHNOLOGY STOCKS?
A When we refer to technology stocks, we include a broad area that encompasses
telecommunications, software and hardware businesses. One strategy we employed
was to invest in small companies that are benefitting from doing business with
some of the large, dominant companies in the technology sector. Microsoft, Intel
and Cisco Systems are market leaders. Because they are very large companies, we
would not include them in your Fund's portfolio. However, we can take advantage
of their strength by investing in smaller firms that do business with these
larger companies. Two examples are Avid Technology and Rational Software. Avid
Technology produces editing software for the television and movie industries.
It is currently developing this high-end technical equipment for the corporate
and consumer markets. Rational Software produces software that makes it easier
to write computer programs.
<PAGE>
PAGE 4
KEYSTONE SMALL COMPANY GROWTH FUND II
TOP 5 INDUSTRIES
AS OF MAY 31, 1997
<TABLE>
<CAPTION>
PERCENTAGE OF
INDUSTRY NET ASSETS
<S> <C>
Oil 15.8%
Information Services & Technology 12.2%
Finance & Insurance 9.5%
Healthcare Products & Services 9.0%
Telecommunication Services & Equipment 8.9%
</TABLE>
Q DID YOU MAKE ANY CHANGES IN THE FINANCE AREA?
A We made a number of changes in the finance sector. We eliminated stocks that
we believe had reached their target price levels. We also were concerned about
the impact that increases in interest rates could have on some lenders. As a
result, when the Federal Reserve Board raised rates in March, we repositioned
our investments from sub-prime lenders to higher quality lenders. For example,
we sold automobile loan companies and mortgage lending businesses and increased
our emphasis on quality regional banks. Going forward, we are optimistic about
the potential for financial stocks. We believe that the need for financial
services and products will increase for the rest of the decade and that the
finance sector of the market should be one of the strongest growth areas.
Q OIL SERVICES STOCKS WERE AN AREA OF EMPHASIS FOR THE FUND. DID YOU MAKE
CHANGES IN THIS PART OF THE PORTFOLIO?
A While energy stocks accounted for a significant portion of net assets, we
trimmed the Fund's exposure to oil services stocks as they reached their price
objectives. Even though energy and oil services stocks have strong returns for
more than a year, the level of drilling activity is increasing. We have
concentrated Fund holdings in companies we believe are well positioned to
participate in this activity.
Q SMALL INDUSTRIAL COMPANIES WERE AN IMPORTANT PART OF THE PORTFOLIO. WHAT
ATTRACTED YOU TO THESE TYPES OF COMPANIES?
A We invested in a number of companies that, in addition to meeting our criteria
for attractive prices and potential growth, have another advantage. They are
benefitting from a demographic trend. As the percentage of college graduates
rises in the U.S., more people are going into the white collar professions and
fewer into the construction and heavy industry businesses. As a result, there is
growing demand for products that reduce the labor intensity of these industries.
Therefore, companies that provide quality goods and services for the industrial
sector have an opportunity to become market leaders. Two fund holdings exemplify
this trend: AFC Cable, a firm that produces color-coded metal clad electrical
wiring; and Omniquip, a company that produces telescopic material handlers that
are a more versatile alternative to forklifts.
Q WHAT IS YOUR OUTLOOK?
A We believe there are several factors that bode well for the future. Prices of
small-company stocks are very attractive, relative to their large-cap
counterparts. However, it is going to take earnings growth to drive small-cap
prices higher over the long term. The
<PAGE>
PAGE 5
TOP 10 HOLDINGS
AS OF MAY 31, 1997
<TABLE>
<CAPTION>
PERCENTAGE OF
COMPANY INDUSTRY NET ASSETS
<S> <C> <C>
Falcon Drilling Oil 2.8%
Newpark Resources Inc. Oil 2.6%
Total Renal Care Health Care Products 2.5%
Holdings, Inc. & Services
Seacor Smit, Inc. Oil 2.4%
Cox Radio, Inc. Broadcasting 2.3%
BJ Services Company Oil 2.2%
McLeod, Inc. Telecommunication 2.1%
Services & Equipment
Tower Automotive, Inc. Automotive Equipment 2.1%
& Manufacturing
Omniquip International, Machinery-- 2.1%
Inc. Diversified
Queens City Bancorp Finance & Insurance 2.1%
</TABLE>
development of new products and technologies should add the impetus that these
stocks need to perform well over the long term. We are optimistic about economic
growth. We believe that any increase in interest rates will be relatively small
and will set the stage for moderate economic growth, relatively low inflation,
and lower interest rates over the long term. We think this should be a positive
backdrop for small companies.
(Diamond appears here)
THIS COLUMN IS INTENDED TO ANSWER QUESTIONS ABOUT YOUR FUND.
IF YOU HAVE A QUESTION YOU WOULD LIKE ANSWERED, PLEASE WRITE TO:
EVERGREEN KEYSTONE INVESTMENT SERVICES, INC.
ATTN: SHAREHOLDER COMMUNICATIONS
201 SOUTH COLLEGE STREET, SUITE 400,
CHARLOTTE, N.C. 28288-1195.
<PAGE>
PAGE 6
KEYSTONE SMALL COMPANY GROWTH FUND II
Your Fund's Performance
(Chart appears here with the following information)
Growth of an investment in
Small Company Growth Fund II Class A
2/21/96 2/96 5/96 8/96 11/96 2/97 5/97
Dividend Reinvestment (Customer to supply plot points)
Initial Investment
A $10,000 investment in Keystone Small Company Growth Fund II made on
February 21, 1996 with all distributions reinvested was worth $10,250
on May 31, 1997. Past performance is no guarantee of future results.
The performance of each class may vary based on the differences in loads
and fees paid by shareholders investing in the different classes.
(Chart appears here with the following information)
Comparison of change in value of a $10,000 investment in
Keystone Small Company Growth Fund II Class A and the
Russell 2000 Index
2/21/96 2/96 5/96 8/96 11/96 2/97 5/97
Class A Shares (Customer to supply plot points)
Russell 2000
Past performance is no guarantee of future results. The performance of
each class may vary based on differences in loads and fees paid by the
shareholders investing in the each classes. The Russell 2000 index is an
unmanaged market index. The index does not include transaction costs
associated with buying securities nor any management fees.
Class A shares were introduced on February 21, 1996. Performance is reported at
the current maximum front-end sales charge of 4.75%.
Class B and C shares were introduced on February 21, 1996. Shares purchased
after January 1, 1997 are subject to a contingent deferred sales charge (CDSC)
that declines from 5% to 1% over six years after the month purchased.
Performance assumes that shares were redeemed after the end of a one-year
holding period and reflects the deduction of a 5% CDSC.
Class C shares are subject to a 1% contingent deferred sales charge for 12
months after the month purchased. Performance reflects the return you would have
received after holding shares for one year or more and redeeming after the end
of that period.
Class Y shares were introduced on January 13, 1997. Class Y shares are
available without a front-end charge or contingent deferred sales charge.
<TABLE>
<CAPTION>
TWELVE-MONTH PERFORMANCE AS OF MAY 31, 1997
<S> <C> <C> <C> <C>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Y
<S> <C> <C> <C> <C>
Total Return* (8.07%) (8.81%) (8.81%) (2.64%)
Net asset value
5/31/96 $11.15 $11.12 $11.12 $10.59**
5/31/97 $10.25 $10.14 $10.14 $10.31
Dividends None None None None
Capital gain
distributions None None None None
</TABLE>
*BEFORE DEDUCTION OF FRONT-END OR CONTINGENT DEFERRED SALES CHARGES (CDSC).
TOTAL RETURN FIGURE FOR CLASS Y CALCULATED FOR THE PERIOD FROM JANUARY 13, 1997
(DATE OF INITIAL PUBLIC OFFERING) TO MAY 31, 1997.
** CLASS Y SHARES WERE INITIALLY OFFERED TO THE PUBLIC ON
JANUARY 13, 1997.
[CAPTION]
<TABLE>
<CAPTION>
HISTORICAL RECORD AS OF MAY 31, 1997
<S> <C> <C> <C>
CUMULATIVE TOTAL RETURNS CLASS A CLASS B CLASS C
<S> <C> <C> <C>
1-year w/o sales charge (8.07%) (8.81%) (8.81% )
1-year (12.44%) (13.37%) (9.72% )
Life of Fund 2.50% 1.40% 1.40%
AVERAGE ANNUAL TOTAL RETURN
1-year w/o sales charge (8.07%) (8.81%) (8.81% )
1-year (12.44%) (13.37%) (9.72% )
Life of Fund 1.95% 1.09% 1.09%
</TABLE>
<PAGE>
PAGE 7
SCHEDULE OF INVESTMENTS-- MAY 31, 1997
[CAPTION]
<TABLE>
<CAPTION>
SHARES VALUE
<C> <S> <C> <C>
COMMON STOCKS-- 95.6%
<C> <S> <C> <C>
AUTOMOTIVE EQUIPMENT & MANUFACTURING-- 2.1%
21,100 Tower Automotive Inc............ $ 836,087
BUILDING, CONSTRUCTION & FURNISHINGS-- 3.2%
40,000 Champion Enterprises, Inc....... 735,000
23,000 * Oakwood Homes Corp.............. 546,250
1,281,250
BUSINESS EQUIPMENT & SERVICES-- 6.2%
25,000 Alternative Resources Corp...... 460,938
47,000 Donnelley Enterprise
Solutions..................... 470,000
8,100 Factset Research Systems Inc.... 157,950
15,000 G&K Services.................... 485,625
10,500 Renaissance Solutions Inc....... 384,562
15,400 Vincam Group Inc................ 473,550
2,432,625
CHEMICAL & AGRICULTURAL PRODUCTS-- 1.8%
22,500 * OM Group, Inc................... 708,750
CONSUMER PRODUCTS & SERVICES-- 1.9%
17,000 * Stanhome Inc.................... 533,375
17,500 USA Detergents Inc.............. 225,313
758,688
ELECTRONICS-- 8.8%
12,900 ADFlex Solutions, Inc........... 211,238
20,800 AFC Cable Systems Inc........... 565,500
21,700 Altron Inc...................... 360,763
13,700 * BMC Industries, Inc............. 450,387
22,000 ESS Technology Inc.............. 339,625
17,700 Flextronics International....... 414,844
25,000 Integrated Process Equipment
Corp.......................... 457,812
12,000 Lattice Semiconductor Corp...... 694,500
3,494,669
<CAPTION>
SHARES VALUE
<C> <S> <C> <C>
<CAPTION>
COMMON STOCKS (CONTINUED)
<C> <S> <C> <C>
FINANCE & INSURANCE-- 9.5%
40,000 * BostonFed Bancorp Inc........... $ 605,000
17,000 * CMAC Investment Corp............ 707,625
27,000 * Everen Capital Corporation...... 668,250
14,400 First Alliance Company.......... 354,600
17,000 Firstplus Financial Group Inc... 431,375
5,000 * Investors Financial Services
Corp.......................... 176,875
19,999 * Queens County Bancorp........... 827,459
3,771,184
HEALTHCARE PRODUCTS & SERVICES-- 9.0%
12,400 Cardiothoracic Systems Inc...... 170,500
4,200 CRA Managed Care Inc............ 192,938
19,400 Gilead Sciences Inc............. 522,587
15,800 Heartport Inc................... 380,187
30,000 Lifecore Biomedical Inc......... 418,125
20,000 Neurogen Corp................... 377,500
20,000 Thermo Cardiosystems, Inc....... 537,500
27,000 Total Renal Care Holdings Inc... 972,000
3,571,337
INDUSTRIAL SPECIALTY PRODUCTS & SERVICES-- -
0.4%
5,300 * Trimas Corp..................... 150,388
INFORMATION SERVICES & TECHNOLOGY-- 12.2%
24,300 Avid Technology Inc............. 571,050
20,000 Black Box Corp.................. 705,000
54,200 Clarify Inc..................... 653,787
14,000 Cognex Corp..................... 364,875
20,000 Geoworks........................ 125,625
20,000 Inso Corp....................... 558,750
24,600 Rational Software Corp.......... 462,787
19,024 Synopsys Inc.................... 708,644
25,800 Vantive Corp.................... 693,375
4,843,893
MACHINERY-- DIVERSIFIED-- 4.1%
41,500 Omniquip International Inc...... 832,594
37,000 Rental Service Corp............. 804,750
1,637,344
METAL PRODUCTS & SERVICES-- 2.1%
22,000 Molten Metal Tech Inc........... 155,375
26,300 Oregon Metallurgical Corp....... 677,225
832,600
</TABLE>
<PAGE>
PAGE 8
KEYSTONE SMALL COMPANY GROWTH FUND II
SCHEDULE OF INVESTMENTS-- MAY 31, 1997
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS (CONTINUED)
<C> <S> <C> <C>
LEISURE & TOURISM-- 2.1%
3,400 Anchor Gaming................... $ 144,925
18,700 Promus Hotel Corp............... 675,538
820,463
OIL-- 15.8%
16,000 BJ Services Company............. 884,000
41,900 Denbury Resources, Inc.......... 644,212
24,400 Falcon Drilling................. 1,119,350
14,100 Flores & Rucks Inc.............. 690,900
11,800 * KCS Energy Inc.................. 491,175
20,000 Newpark Resources, Inc.......... 1,050,000
18,700 Seacor Smit Inc................. 967,725
15,000 Swift Energy Company............ 401,250
6,248,612
RETAILING & WHOLESALE-- 3.1%
15,000 Gadzooks Inc.................... 495,000
20,000 Pacific Sunwear of California... 727,500
1,222,500
TELECOMMUNICATION SERVICES & EQUIPMENT--
8.9%
24,000 Aspect Telecommunications
Corp.......................... 540,000
35,000 Centigram Communications Corp... 400,313
36,000 McLeod USA Inc.................. 846,000
30,000 Natural Microsystems Corp....... 736,875
17,100 Proxim Inc...................... 434,981
25,000 Smartalk Teleservices Inc....... 337,500
10,000 Spectrian Corp.................. 221,250
3,516,919
<CAPTION>
SHARES VALUE
<C> <S> <C> <C>
<CAPTION>
COMMON STOCKS (CONTINUED)
<C> <S> <C> <C>
TRANSPORTATION-- 0.6%
9,300 Coach USA Inc Class A........... $ 244,125
COMMERCIAL SERVICES-- 1.5%
21,000 Budget Group Inc................ 585,375
BROADCASTING-- 2.3%
40,800 Cox Radio Inc................... 912,900
TOTAL COMMON STOCKS
<CAPTION>
(COST $37,534,851)............................... 37,869,709
<C> <S> <C> <C>
PAR
VALUE
<CAPTION>
REPURCHASE AGREEMENT-- 3.6%
<C> <S> <C> <C>
$1,439,000 Keystone Joint Repurchase Agreement
(investment in repurchase agreement,
in joint trading account,
purchased 5/30/97, 5.5734%,
maturing 6/2/97, maturity
value $1,439,668)(a)
(Cost-- $1,439,000)........... 1,439,000
<CAPTION>
TOTAL INVESTMENTS
(COST $38,973,851) 99.2% 39,308,709
OTHER ASSETS AND LIABILITIES--
NET 0.8% 322,760
<C> <S> <C> <C>
<CAPTION>
NET ASSETS 100.0% $39,631,469
<C> <S> <C> <C>
</TABLE>
* Income-producing security.
(a) The repurchase agreement is fully collateralized by U.S. Government and/or
agency obligations based on market prices at May 31, 1997.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 9
FINANCIAL HIGHLIGHTS-- CLASS A SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
FEBRUARY 21, 1996
(COMMENCEMENT OF
YEAR ENDED OPERATIONS)
MAY 31, 1997(C) TO MAY 31, 1996
<S> <C> <C>
NET ASSET VALUE BEGINNING OF PERIOD $11.15 $10.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss (0.16) (0.02)
Net realized and unrealized gain (loss) on investments (0.74) 1.17
Total from investment operations (0.90) 1.15
NET ASSET VALUE END OF PERIOD $10.25 $11.15
TOTAL RETURN (A) (8.07%) 11.50%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 1.97% 2.10%(b)
Total expenses, excluding indirectly paid expenses 1.92% 1.95%(b)
Total expenses, excluding reimbursement N/A 3.70%(b)
Net investment loss (1.55%) (1.41%)(b)
PORTFOLIO TURNOVER RATE 5% 13%
AVERAGE COMMISSION RATE PAID $0.0554 $0.0607
NET ASSETS END OF PERIOD (THOUSANDS) $10,779 $ 8,201
</TABLE>
(a) Excluding applicable sales charges.
(b) Annualized.
(c) Calculated based on average shares outstanding.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 10
KEYSTONE SMALL COMPANY GROWTH FUND II
FINANCIAL HIGHLIGHTS-- CLASS B SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
FEBRUARY 21, 1996
(COMMENCEMENT OF
YEAR ENDED OPERATIONS)
MAY 31, 1997(C) TO MAY 31, 1996
<S> <C> <C>
NET ASSET VALUE BEGINNING OF PERIOD $11.12 $10.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss (0.24) (0.03)
Net realized and unrealized gain (loss) on investments (0.74) 1.15
Total from investment operations (0.98) 1.12
NET ASSET VALUE END OF PERIOD $10.14 $11.12
TOTAL RETURN (A) (8.81%) 11.20%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 2.72% 2.85%(b)
Total expenses, excluding indirectly paid expenses 2.67% 2.70%(b)
Total expenses, excluding reimbursement N/A 4.45%(b)
Net investment loss (2.29%) (2.16%)(b)
PORTFOLIO TURNOVER RATE 5% 13%
AVERAGE COMMISSION RATE PAID $0.0554 $0.0607
NET ASSETS END OF PERIOD (THOUSANDS) $21,187 $12,487
</TABLE>
(a) Excluding applicable sales charges.
(b) Annualized.
(c) Calculated based on average shares outstanding.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 11
FINANCIAL HIGHLIGHTS-- CLASS C SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
FEBRUARY 21, 1996
(COMMENCEMENT OF
YEAR ENDED OPERATIONS)
MAY 31, 1997(C) TO MAY 31, 1996
<S> <C> <C>
NET ASSET VALUE BEGINNING OF PERIOD $11.12 $10.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss (0.24) (0.02)
Net realized and unrealized gain (loss) on investments (0.74) 1.14
Total from investment operations (0.98) 1.12
NET ASSET VALUE END OF PERIOD $10.14 $11.12
TOTAL RETURN (A) (8.81%) 11.20%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 2.73% 2.85%(b)
Total expenses, excluding indirectly paid expenses 2.68% 2.70%(b)
Total expenses, excluding reimbursement N/A 4.44%(b)
Net investment loss (2.29%) (2.20%)(b)
PORTFOLIO TURNOVER RATE 5% 13%
AVERAGE COMMISSION RATE PAID $0.0554 $0.0607
NET ASSETS END OF PERIOD (THOUSANDS) $7,661 $8,315
</TABLE>
(a) Excluding applicable sales charges.
(b) Annualized.
(c) Calculated based on average shares outstanding.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 12
KEYSTONE SMALL COMPANY GROWTH FUND II
FINANCIAL HIGHLIGHTS-- CLASS Y SHARES
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD)
<TABLE>
<CAPTION>
JANUARY 13, 1997
(DATE OF INITIAL
PUBLIC OFFERING)
TO MAY 31, 1997(C)
<S> <C>
NET ASSET VALUE BEGINNING OF PERIOD $10.59
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss 0.00
Net realized and unrealized gain (loss) on investments (0.28)
Total from investment operations (0.28)
NET ASSET VALUE END OF PERIOD $10.31
TOTAL RETURN (2.64%)
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 2.23%(a)
Total expenses, excluding indirectly paid expenses 2.23%(a)
Net investment loss (1.26%)(a)
PORTFOLIO TURNOVER RATE 5%
AVERAGE COMMISSION RATE PAID $ 0.0554
NET ASSETS END OF PERIOD (THOUSANDS) $5
</TABLE>
(a) Annualized for the period from May 28, 1997 (commencement of investment
operations) to May 31, 1997.
(c) Calculated based on average shares outstanding.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 13
STATEMENT OF ASSETS AND LIABILITIES
MAY 31, 1997
<TABLE>
<CAPTION>
<S> <C>
ASSETS
Investments at value (identified cost,
$38,973,851) $39,308,709
Cash 823
Receivable for investments sold 713,035
Receivable for Fund shares sold 11,806
Dividends and interest receivable 3,386
Deferred organization expenses 13,164
Prepaid expenses 50,669
Total assets 40,101,592
LIABILITIES
Payable for Fund shares redeemed 210,998
Payable for investments purchased 188,344
Distribution fees payable 9,674
Accrued expenses and other liabilities 61,107
Total liabilities 470,123
NET ASSETS $39,631,469
NET ASSETS REPRESENTED BY
Paid-in capital $40,493,273
Accumulated net realized loss on investments (1,196,662)
Net unrealized appreciation on investments 334,858
Total net assets $39,631,469
NET ASSET VALUE PER SHARE
Class A Shares
Net asset value of $10,778,554/1,051,352
shares outstanding $ 10.25
Offering price per share ($10.25/0.9525)
(based on a sales charge of 4.75%
of the offering price on May 31, 1997) $ 10.76
Class B Shares
Net asset value of $21,186,809/2,089,105
shares outstanding $ 10.14
Class C Shares
Net asset value of $7,661,075/755,277
shares outstanding $ 10.14
Class Y Shares
Net asset value of $5,031/488 shares
outstanding $ 10.31
</TABLE>
STATEMENT OF OPERATIONS
YEAR ENDED MAY 31, 1997
<TABLE>
<CAPTION>
<S> <C> <C>
INVESTMENT INCOME
Dividends $ 70,527
Interest 91,971
Total Income 162,498
EXPENSES
Management fee $ 297,833
Distribution Plan expenses 332,976
Transfer Agent fees 195,716
Registration fees 134,306
Custodian fees 50,734
Miscellaneous expenses 60,138
Total expense 1,071,703
Less: Expenses paid indirectly (21,273)
Net expenses 1,050,430
Net investment loss (887,932)
NET REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized loss on investments (1,014,769)
Net change in unrealized
appreciation on investments (961,813)
Net realized and unrealized loss
on investments (1,976,582)
Net decrease in net assets
resulting from operations $(2,864,514)
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 14
KEYSTONE SMALL COMPANY GROWTH FUND II
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
FEBRUARY 21, 1996
(COMMENCEMENT
YEAR ENDED OF OPERATIONS)
MAY 31, 1997 TO MAY 31, 1996
<S> <C> <C>
OPERATIONS
Net investment loss $ (887,932 ) $ (59,141)
Net realized loss on investments (1,014,769 ) (181,893)
Net change in unrealized appreciation on investments (961,813 ) 1,296,671
Net increase (decrease) in net assets resulting from operations (2,864,514 ) 1,055,637
CAPITAL SHARE TRANSACTIONS
Proceeds from shares sold:
Class A Shares 10,500,455 8,267,986
Class B Shares 24,464,278 12,267,442
Class C Shares 5,257,765 8,667,945
Class Y Shares 5,011 0
Payment for shares redeemed:
Class A Shares (7,163,980 ) (410,693)
Class B Shares (14,359,496 ) (284,594)
Class C Shares (5,211,808 ) (559,965)
Class Y Shares 0 0
Net increase in net assets resulting from capital share transactions 13,492,225 27,948,121
Total increase in net assets 10,627,711 29,003,758
NET ASSETS
Beginning of period 29,003,758 0
End of period $39,631,469 $29,003,758
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 15
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Keystone Small Company Growth Fund II (the "Fund") is a Massachusetts business
trust for which Keystone Investment Management Company ("Keystone") is the
investment adviser and manager. Keystone was formerly a wholly-owned subsidiary
of Keystone Investments, Inc.("KII") and is currently a subsidiary of First
Union Corporation ("First Union").
The Fund is registered under the Investment Company Act of 1940, as amended
(the "1940 Act"), as a diversified, open-end investment company. The Fund offers
several classes of shares. The Fund's investment objective is to seek long-term
growth of capital through investments in emerging growth companies.
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. VALUATION OF SECURITIES
Investments are usually valued at the closing sales price, or in the absence of
sales and for over-the-counter securities, the mean of the bid and asked prices.
Securities for which valuations are not available from an independent pricing
service (including restricted securities) are valued at fair value as determined
in good faith according to procedures established by the Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. REPURCHASE AGREEMENTS
Pursuant to an exemptive order issued by the Securities and Exchange Commission,
the Fund, along with certain other Evergreen 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.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the collateral
daily and will require the seller to provide additional collateral in the event
the market value of the securities pledged falls below the carrying value of the
repurchase agreement.
C. SECURITY TRANSACTIONS AND INVESTMENT INCOME
Securities transactions are accounted for no later than one business day after
the trade date. Realized gains and losses are computed on the identified cost
basis. Interest income is recorded on the accrual basis and includes
amortization of discounts and premiums. Dividend income is recorded on the
ex-dividend date.
D. ORGANIZATION EXPENSES
The Fund's organization expenses are amortized to operations over a five-year
period on a straight-line basis. In the event any of the initial shares of the
Fund are redeemed by First Union during the five-year amortization period,
redemption proceeds will be reduced by any unamortized organization expenses in
the same proportion as the number of initial shares being redeemed bears to the
number of initial shares outstanding at the time of redemption.
E. FEDERAL INCOME TAXES
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 (the
"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 also intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly, no
provision for federal income taxes is required.
<PAGE>
PAGE 16
KEYSTONE SMALL COMPANY GROWTH FUND II
F. DISTRIBUTIONS
The Fund distributes net investment income and net capital gains, if any, at
least annually. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally accepted
accounting principles. These differences are primarily due to the treatment of
net operating losses.
G. CLASS DESCRIPTIONS & ALLOCATIONS
Class A shares are currently offered at a public offering price, which includes
a maximum sales charge of 4.75% payable at the time of purchase. Class B shares
are sold subject to a contingent deferred sales charge that is payable upon
redemption and decreases depending on how long the shares have been held. Class
B shares purchased on or after January 1, 1997 will convert to Class A shares
after seven years. Class B shares purchased prior to January 1, 1997 retain
their existing conversion features. Class C shares are sold subject to a
contingent deferred sales charge payable on shares redeemed within one year
after the month of purchase. Class Y shares are available without a front-end
sales charge or contingent deferred sales charge only to investment advisory
clients of First Union and its affiliates and certain institutional clients.
Class Y shares were initially offered to the public on January 13, 1997.
Investment operations for Class Y began on May 28, 1997.
Income, expenses (other than class specific expenses) and realized and
unrealized gains and losses are prorated among the classes based on the relative
net assets of each class. Currently, class specific expenses are limited to
expenses incurred under the Distribution Plans for each class.
2. CAPITAL SHARE TRANSACTIONS
The Fund's Declaration of Trust authorizes the issuance of an unlimited number
of shares of beneficial interest with no par value. As of May 31, 1997, shares
of beneficial interest of the Fund were divided into Class A, Class B, Class C
and Class Y. Transactions in shares of the Fund were as follows:
<TABLE>
<CAPTION>
FEBRUARY 21, 1996
(COMMENCEMENT OF
YEAR ENDED OPERATIONS)
MAY 31, 1997 TO MAY 31, 1996
<S> <C> <C>
CLASS A
Shares sold 1,023,296 772,993
Shares redeemed (707,396) (37,541)
Net increase 315,900 735,452
CLASS B
Shares sold 2,388,573 1,149,103
Shares redeemed (1,422,533) (26,038)
Net increase 966,040 1,123,065
CLASS C
Shares sold 518,678 797,320
Shares redeemed (511,324) (49,397)
Net increase 7,354 747,923
</TABLE>
<TABLE>
<CAPTION>
JANUARY 13, 1997
(DATE OF INITIAL
PUBLIC OFFERING)
CLASS Y TO MAY 31, 1997
<S> <C>
Shares sold 488
Shares redeemed 0
Net increase 488
</TABLE>
3. SECURITIES TRANSACTIONS
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities and U.S. government securities) for the year ended May 31,
1997, were $57,416,702 and $45,416,755, respectively.
On May 31, 1997, the cost of investments for federal income tax purposes was
$39,039,175, gross unrealized appreciation of investments was $4,950,338 and
gross
<PAGE>
PAGE 17
unrealized depreciation of investments was $4,680,804, resulting in net
unrealized appreciation of $269,534 for federal income income tax purposes. At
May 31, 1997, the Fund had capital loss carryovers of $1,010,468, all of which
expire on May 31, 2005.
4. DISTRIBUTION PLANS
The Fund bears some of the costs of selling its shares under Distribution Plans
adopted for its Class A, B and C shares pursuant to Rule 12b-1 under the 1940
Act. Under the Distribution Plans, the Fund pays its principal underwriter
amounts which are calculated daily and paid monthly.
On December 11, 1996, the Fund entered into a principal underwriting agreement
with Evergreen Keystone Distributors, Inc. (Formerly, Evergreen Fund
Distributor, Inc.) ("EKD"), a wholly owned subsidiary of The BISYS Group, Inc.
Prior to December 11, 1996, Evergreen Keystone Investment Services, Inc.
(Formerly Keystone Investment Distributors Company) ("EKIS"), a wholly owned
subsidiary of Keystone, served as the Fund's principal underwriter.
The Class A Distribution Plan provides for expenditures, which are currently
limited to 0.25% annually of the average daily net assets of the Class A shares,
to pay expenses related to the distribution of Class A shares. During the year
ended May 31, 1997, the Fund paid $30,858 under the Class A Distribution Plan.
Pursuant to the Fund's Class B and Class C Distribution Plans, the Fund pays a
distribution fee, which may not exceed 1.00% annually of the average daily net
assets of Class B and Class C shares, respectively. Of that amount, 0.75% is
used to pay distribution expenses and 0.25% is used to pay service fees. During
the year ended May 31, 1997, the Fund paid or accrued $211,893 under the Class B
Distribution Plan and $90,225 under the Class C Distribution Plan.
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, and subject to the discretion of the Independent Trustees, payments to EKD
and/or EKIS may continue as compensation for services which had been earned
while the Distribution Plan was in effect.
EKD intends, but is not obligated, to continue to pay distribution costs that
exceed the current annual payments from the Fund. EKD intends to seek full
payment of such distribution costs from the Fund at such time in the future as,
and to the extent that, payment thereof by the Class B or Class C shares would
be within permitted limits.
Contingent deferred sales charges paid by redeeming shareholders are paid to
EKD or its predecessor.
5. INVESTMENT MANAGEMENT AGREEMENT AND OTHER AFFILIATED TRANSACTIONS
Under the terms of an investment advisory agreement between the Fund and
Keystone, Keystone serves as the investment adviser and manager to the Fund. As
such, Keystone manages the Fund's investments, provides certain administrative
services and supervises the Fund's daily business affairs. In return, Keystone
is paid a management fee, computed daily and paid monthly, which is determined
by applying percentage rates starting at 0.70% and declining as net assets
increase to 0.35% per annum, to the average daily net asset value of the Fund.
During the year ended May 31, 1997, the Fund paid or accrued $148 to Keystone
for certain accounting services. Evergreen Keystone Service Company ("EKSC")
(formerly Keystone Investor Resource Center, Inc.), a wholly-owned subsidiary of
Keystone, serves as the Fund's transfer and dividend disbursing agent.
Effective January 1, 1997, BISYS Fund Services, Inc. ("BISYS"), an affiliate
of EKD, began serving as the Fund's sub-administrator. As sub-administrator,
BISYS provides the officers of the Fund. For these services, BISYS was paid a
fee by Keystone, which was not a Fund expense.
<PAGE>
PAGE 18
KEYSTONE SMALL COMPANY GROWTH FUND II
Officers of the Fund and affiliated Trustees receive no compensation directly
from the Fund. Currently the Independent Trustees of the Fund receive no
compensation for their services.
6. EXPENSE OFFSET ARRANGEMENT
The Fund has entered into an expense offset arrangement with its custodian. For
the year ended May 31, 1997, the Fund incurred total custody fees of $50,734 and
received a credit of $21,273 pursuant to this expense offset arrangement,
resulting in a net custody expense of $29,461. The assets deposited with the
custodian under this expense offset arrangement could have been invested in
income-producing assets.
<PAGE>
PAGE 19
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, 1997, and the related statement of operations for the year then ended and
the statements of changes in net assets and financial highlights for the year
then ended and 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
audits.
We conducted our audits 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, 1997 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 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
Keystone Small Company Growth Fund II as of May 31, 1997, the results of its
operations for the year then ended and the changes in its net assets and
financial highlights for the year then ended and the period from February 21,
1996 to May 31, 1996, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
June 27, 1997
<PAGE>
PAGE 20
KEYSTONE SMALL COMPANY GROWTH FUND II
ADDITIONAL INFORMATION
(UNAUDITED)
The Fund held a special meeting of shareholders on Monday, December 9, 1996. On
October 18, 1996, the record date for the meeting, the Fund had 4,767,887 shares
outstanding, of which 3,779,030 shares were represented at the meeting. The
votes at the meeting were as follows:
PROPOSAL 1: TO ELECT THE FOLLOWING PERSONS AS TRUSTEE OF THE FUND:
<TABLE>
<CAPTION>
NUMBER OF SHARES
NOMINEES FOR TRUSTEE AFFIRMATIVE WITHHELD
<S> <C> <C>
Lawrence B. Ashkin 3,715,047 63,983
Frederick Amling 3,715,241 63,789
Charles A Austin, III 3,718,320 60,710
Foster Bam 3,715,047 63,983
George S. Bissell 3,715,241 63,789
Edwin D. Campbell 3,715,241 63,789
Charles F. Chapin 3,715,241 63,789
K. Dun Gifford 3,718,320 60,710
James S. Howell 3,715,047 63,983
Leroy Keith, Jr. 3,718,320 60,710
F. Ray Keyser 3,715,241 63,789
Gerald M. McDonnell 3,718,126 60,904
Thomas L. McVerry 3,718,023 61,007
William Walt Pettit 3,718,126 60,904
David M. Richardson 3,718,320 60,710
Russell A Salton, III M.D. 3,718,126 60,904
Michael S. Scofield 3,718,126 60,904
Richard J. Shima 3,718,320 60,710
Andrew J. Simons 3,718,320 60,710
</TABLE>
PROPOSAL 2: TO APPROVE AN INVESTMENT ADVISORY AND MANAGEMENT AGREEMENT BETWEEN
KEYSTONE INVESTMENT
MANAGEMENT COMPANY AND THE FUND:
<TABLE>
<S> <C>
Affirmative 3,592,843
Against 42,704
Abstain 143,483
</TABLE>
<PAGE>
KEYSTONE AMERICA
FAMILY OF FUNDS
(Diamond appears here)
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 Tax Free Fund
Florida Tax Free Fund
Massachusetts Tax Free Fund
Missouri Tax Free Fund
New York 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 Evergreen Keystone funds, contact
your financial adviser or call Evergreen Keystone.
Evergreen Keystone
(Tree appears here) FUNDS (SM) (Keystone symbol appears here)
P.O. Box 2121
Boston, Massachusetts 02106-2121
(Recycle symbol appears here)
SCG2 R541256 7/97
KEYSTONE
(Graphic appears here)
SMALL COMPANY
GROWTH FUND II
Evergreen Keystone
(Tree appears here) FUNDS (SM) (Keystone symbol appears here)
ANNUAL REPORT
MAY 31, 1997
