Page 1
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Keystone Mid-Cap Growth Fund (S-3)
Seeks growth of capital from mid-cap stocks.
Dear Shareholder:
We are writing to report to you on the performance of Keystone Mid-Cap Growth
Fund (S-3) for the twelve-month period which ended August 31, 1996. Following
our letter we have included a discussion with your Fund's manager and
Complete financial information.
Performance
For the twelve-month period, your Fund produced a return of 10.07%, which
nearly matched the 11.87% return of its benchmark, the Standard & Poor's 400
Mid-Cap Index.
These returns reflect the positive performance of the markets and our
careful stock selection during the twelve-month period. Your Fund's returns
were particularly attractive during the first nine months of the period when
mid-cap growth stocks recorded strong performance.
The market was led by stocks of large, high quality companies. Strong
corporate earnings, relatively low interest rates, and controlled inflation
sent stocks to new highs in 1996. However, concerns over the sustainability
of earnings growth rates in a higher interest rate environment mounted in the
Spring of 1996. Stocks declined in response during June and July, with small
and medium market capitalization issues experiencing steeper declines than
large-cap issues. The declines were short-lived, as indications of slower
economic growth appeared and stocks rallied in August and September. Although
selected stocks recovered, this was a period of readjustment for some mid-cap
stocks.
Individual stock selection
In selecting stocks for the portfolio, we seek high-quality medium-sized
companies that we believe have attractive and consistent earnings growth
rates. We attempt to identify businesses with well-established products,
services and management teams. Many of these companies are still in the
accelerated growth phase of their life cycle and offer the potential for
continued strong growth. By investing in mid-cap growth stocks, your Fund
seeks to offer greater growth potential than investing solely in large
company stocks, and more consistent performance than investing only in small
company stocks.
Our outlook
We are expecting the favorable economic fundamentals of 1996 to continue into
1997. However, the stronger-than-expected economic growth of the first half
of 1996 has already begun to show signs of slowing to more moderate levels.
Inflation should remain under control, despite some wage pressures, which
should allow interest rates to remain relatively stable.
For investors with long-term goals, we continue to believe that stocks offer
the best potential returns. However, we are now in the sixth year of a stock
market rally--the longest since the end of World War II. While we have a
favorable outlook for next year, history has shown that strong performance
does not persist indefinitely. Stocks periodically experience price declines.
We witnessed this type of "correction" in June and July, followed by a
recovery in August. With this in mind, we encourage you to keep the above
average stock market returns of the last few years in perspective.
We are pleased to inform you that Keystone has agreed to be acquired by
First Union Corporation. The acquisition is subject to a number of
conditions, including approvals of investment advisory agreements with
Keystone
--Continued--
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Page 2
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by fund shareholders. First Union is a financial services firm based in
Charlotte, North Carolina. It is the nation's sixth largest bank holding
company with assets of approximately $140 billion. First Union, through its
wholly-owned subsidiary Evergreen Asset Management Corp., manages more than
$16 billion in 36 mutual funds. Keystone will remain a separate entity after
its acquisition and will continue to provide investment advisory and
management services to the Fund. We believe First Union's acquisition of
Keystone should strengthen the investment management services we provide to
you.
We appreciate your continued support of Keystone Mid-Cap Growth Fund (S-3).
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 Bissell
George S. Bissell
Chairman of the Board
Keystone Funds
(Photos of Albert H. Elfner, III
and George S. Bissell)
Albert H. Elfner, III George S. Bissell
October 1996
(Dalbar logo)
Dalbar Key Honors
Honoring Commitment to Excellence
Keystone was recently recognized by Dalbar, an independent mutual fund rating
organization, for demonstrating a commitment to serving the needs of
customers. The award is intended to distinguish companies who are committed
to investors and have a proven ability to provide good service.
Keystone Investment Insight Line for Shareholders
Now you can keep up-to-date on your fund's current strategy and outlook by
calling Keystone Investment Insight Line. You can hear Keystone portfolio
managers discuss their latest strategies, or listen to Keystone's
overall market outlook from James McCall, chief investment officer. Of
course, your financial adviser can provide you with more complete information
on Keystone funds. This service is available 24 hours a day, seven days a
week and updated at least monthly.
Keystone Investment Insight Line1-800-346-3858, Press 2 after the greeting
(Graphic of telephone)
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A Discussion With
Your Fund Manager
(Photo of Margery C. Parker)
Margery C. Parker is portfolio manager of your Fund and
Keystone Global Opportunities Fund. Ms. Parker has more than
15 years of investment management experience. She holds a BA
from Wellesley College and an MBA from Babson College.
Together with senior portfolio manager Maureen Cullinane,
head of Keystone's growth stock group, she selects mid-cap stocks
for your Fund.
Q What was the economic environment like?
A This was a favorable environment for medium market capitalization
(mid-cap) stocks for most of the twelve-month period. At the end of 1995,
economic growth was moderate, inflation was contained, and interest rates had
declined. At the beginning of 1996, this environment changed. While stock
prices generally rose, they fluctuated broadly during the period as virtually
every new economic report triggered a debate over growth and inflation and
whether or not the Federal Reserve Board would raise interest rates.
Q In relation to other types of stocks, how did mid-cap stocks perform?
A Mid-cap stocks provided attractive returns, but lagged the large-cap
Standard and Poor's 500 Index (S&P 500) for the twelve-month period which
ended August 31, 1996. However, we believe that mid-cap stocks have greater
growth potential than many large-cap stocks. In addition, mid-cap stocks
generally do not carry the risks and price volatility associated with
small-cap stocks, which experienced sharp price declines this summer. This
correction effected most all stocks, and we believe it helped to wring out
the excesses of the market, bringing stock prices down to more reasonable
levels.
Q What is the attraction of mid-cap stocks for investors?
A In a few words: attractive growth with lower price volatility.
Historically, mid-capitalization stocks have tended to exhibit higher growth
rates than larger-cap stocks, such as those in the S&P 500. They also
generally have provided more consistent earnings than smaller companies. We
define mid-cap as stocks of companies with market capitalizations generally
between $750 million and $3 billion. A stock's market capitalization is
determined by multiplying its current price by the number of shares
outstanding.
Fund Profile
Objective: Seeks growth of capital from mid-cap stocks.
Commencement of investment operations: September 11, 1935
Number of stocks: 76
Net assets: $285 million
Newspaper listing: "MidCapS3"
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Page 4
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Keystone Mid-Cap Growth Fund (S-3)
Your Fund Invests In . . .
(bullet) Dynamic companies with earnings growth rates of 20% or more
(bullet) Companies with strong management, a leading market position, and a
solid balance sheet
(bullet) Primarily medium-sized companies with market capitalizations between
$750 million and $3 billion
(bullet) U.S. stocks and stocks of established foreign companies
Q How do you decide where to invest?
A In managing your Fund, we pursue a disciplined approach to investing that
begins with a detailed analysis of the economy, industry trends and the
business cycle. We consider the effects of economic growth, interest rates,
stock price changes and other measures in our evaluation. Through this
process, we seek to uncover attractive areas for further investigation.
We then conduct individual company research, focusing on a company's
management, financials, product line, and potential to grow earnings at 20%
or more a year. We seek to invest in a diverse group of companies that have a
strong earnings growth records. We conduct extensive analysis on the
company's financial condition including projections for earnings, profits,
and revenues. We also believe it is important to be in frequent contact with
company managements to determine if the company will live up to our
expectations.
Q What companies were you attracted to during the twelve-month period?
A We emphasized a number of companies that fell into the category of
business services. These companies accounted for 12.9% of net assets as of
August 31, 1996. This is not an economic sector, per se. It is a group of
unique companies with specialized products and services. These companies
often have limited competition and are less dependent on the direction of the
economy than other types of businesses. Typically these companies expand
their business through aggressive selling, opening new geographical
territories, or by acquiring smaller firms. This is an eclectic group. One
example is G&K Services, a company that supplies uniforms to a number of
businesses in the Midwest. Uniform companies tend to be small "mom and pop"
operations, and G&K is expanding its business by purchasing some of these
smaller concerns.
Q Energy services companies represented 5.2% of net assets on August 31,
1996. What was attractive here?
A Energy services companies, which are listed as 'oil services' in the
Schedule of Investments beginning on page 9, support the drilling activities
of the energy industry. They may supply oil rigs, tool bits, boats, pumping
equipment or seismology services. Many of these companies undertook major
restructuring programs over the last several years. Their managements have
become more aggressive and they have increased productivity. In addition,
demand for their expertise has increased. This is because, after several
years of overcapacity, demand for energy has increased. In order to rebuild
inventories, the major oil companies have been enlisting the help of energy
services firms. Some of these companies we held in the portfolio include
Diamond Offshore, BJ Services, and Tidewater.
Top 5 Industries
as of August 31, 1996
Percentage of
Industry net assets
- ------------------------------------------------------------
Business services 12.9
- ------------------------------------------------------------
Finance 10.7
- ------------------------------------------------------------
Retail 8.2
- ------------------------------------------------------------
Software services 6.1
- ------------------------------------------------------------
Oil services 5.2
- ------------------------------------------------------------
<PAGE>
Page 5
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Top 10 Holdings
as of August 31, 1996
Percentage of
Stock Industry net assets
- -----------------------------------------------------------------------------
PETsMART Retail 2.3
- -----------------------------------------------------------------------------
U.S. Filter Business services 2.2
- -----------------------------------------------------------------------------
HFS Amusements 2.1
- -----------------------------------------------------------------------------
BMC Software Software services 2.1
- -----------------------------------------------------------------------------
Louisiana Land & Exploration Oil services 2.0
- -----------------------------------------------------------------------------
TCF Financial Finance 2.0
- -----------------------------------------------------------------------------
Cardinal Health Health care services 1.9
- -----------------------------------------------------------------------------
USA Waste Services Business services 1.9
- -----------------------------------------------------------------------------
Staples Retail 1.8
- -----------------------------------------------------------------------------
Gentex Automotive 1.7
- -----------------------------------------------------------------------------
Q The financial sector has been an important part of the portfolio for
several years. What did you find attractive among financial stocks?
A Many of these companies have been benefitting from a consolidation in the
industry. Banks in particular are attempting to lower internal costs, expand
their franchises, and to reach a size where they can be more competitive in a
deregulated environment. One way that many financial institutions are
accomplishing this is through mergers with or acquisitions of other financial
institutions.
We have maintained many of the same financial stocks in the portfolio over
the twelve-month period. As of August 31, 1996, these holdings represented
10.7% of net assets. In the Northeast, Bank of Boston acquired BayBank and
South Boston Savings Bank. Washington Mutual, a bank in Washington state
recently acquired a financial institution in California. With this
acquisition, Washington Mutual expanded into a new market. TCF Financial, a
Midwestern bank, has carved out a niche market for itself. It caters to
customers at the lower end of the retail banking market. Through an extensive
branch network, TCF provides a complete spectrum of financial services,
including checking accounts, savings accounts, mortgages, and investment
services. Another company that has benefitted from the growth in the
financial services industry is BISYS Group. As an outsourcing provider, BISYS
supplies financial services firms with transaction processing, recordkeeping,
and other administrative services.
Q Retail stocks were among the Fund's top industry sectors. After several
years in the doldrums, did retail stocks come into favor?
A It has been a mixed bag for retailers. However, we have continued to focus
on individual specialty retailers that we believe have had solid financial
results and good growth rates. At 8.2% of net assets as of August 31, 1996,
retailers were the Fund's third largest industry weighting. Two companies we
found particularly attractive were PETsMART, a top ten holding, and Kohls.
PETsMART is a national pet supply chain of superstores. It is expanding its
business to include veterinary services and equine products and services. We
believe PETsMART has the potential to continue its rapid growth rate. Kohls
is a high quality Midwest department store. It is planning an expansion into
the Northeast.
Q What is your outlook for mid-cap stocks?
A We believe the combination of moderate economic growth and relatively low
interest rates and inflation should continue to provide a positive investment
environment for growth stocks. In the months ahead, we will continue to stay
with our investment strategy of searching for high quality growth companies
that we believe can provide the Fund with capital appreciation over the long
term.
(diamond)
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 Company
Attn: Shareholder Communications, 22nd Floor
200 Berkeley Street,
Boston, Massachusetts 02116-5034.
<PAGE>
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Keystone Mid-Cap Growth Fund (S-3)
Your Fund's Performance
- --------------------------------------------------------------------------------
[PLOT POINTS FOR MOUNTAIN CHART]
Growth of an investment in
Keystone Mid-Cap Growth Fund (S-3)
8/86 10000 10000
10334 13124
8/88 6806 10526
8904 14055
8/90 7502 12539
9209 16478
8/92 8561 16694
9457 19917
8/94 8942 20158
8789 24475
8/96 8723 26940
A $10,000 investment in Keystone Mid-Cap Growth Fund (S-3) made
on August 31, 1986 with all distributions reinvested was worth
$26,940 on August 31, 1996. Past performance is no guarantee of
future results.
- --------------------------------------------------------------------------------
There is no sales charge when you buy Fund shares. The Fund currently imposes
a contingent deferred sales charge that declines from 4% to 1% if you redeem
shares within four years of purchase. The one- year return reflects the
deduction of the 3% contingent deferred sales charge for those investors who
sold Fund shares after one calendar year. Investors who retained their fund
investment received the one-year return reported in the second column of the
table.
Twelve-Month Performance as of August 31, 1996
- ------------------------------------------------------------------------------
Total return* 10.07%
Net asset value 8/31/95 $9.22
8/31/96 $9.15
Dividends $0.59
Capital gains $0.33
*Before deduction of contingent deferred sales charge (CDSC).
Historical Record as of August 31, 1996
- ------------------------------------------------------------------------------
If you If you did
Cumulative total returns redeemed not redeem
1-year 7.09% 10.07%
5-year 63.49% 63.49%
10-year 169.40% 169.40%
Average annual total return
1-year 7.09% 10.07%
5-year 10.33% 10.33%
10-year 10.42% 10.42%
The investment return and principal value will fluctuate so that your
shares, when redeemed, may be worth more or less than the original cost.
You may exchange your shares to another Keystone fund for a $10 fee by
contacting Keystone directly. 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
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[PLOT POINTS FOR LINE CHART]
Comparison of change in value of a $10,000 investment in Keystone
Mid-Cap Growth Fund (S-3), the Standard and Poor's 400 MidCap
Index, and the Consumer Price Index.
Fund Average
Annual Total Return
-------------------------------
1 Year 5 Year 10 Year
7.09% 10.33% 10.42%
8/86 10000 10000 10000
13124 12036 10428
8/88 10526 10461 10848
14055 14748 11358
8/90 12539 13589 11996
16478 19235 12452
8/92 16694 21263 12844
19917 26467 13200
8/94 20158 27696 13583
24475 34181 13938
8/96 26940 37333 14339
Past performance is no guarantee of future results. The one-year
return reflects the deduction of the Fund's 3% contingent deferred
sales charge for shares held for more than one year.
- --------------------------------------------------------------------------------
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 Mid-Cap Growth Fund (S-3)
The Fund seeks growth of capital from mid-cap stocks. The return is quoted
after deducting sales charges (if applicable), fund expenses and transaction
costs and assumes reinvestment of all distributions.
2. Standard & Poor's 400 MidCap Index (S&P 400)
The S&P 400 is a broad-based unmanaged index of common stock prices. The
index is comprised of stocks of medium-sized U.S. companies. The average
market capitalization of the index is $2.8 billion with stocks ranging from
approximately $200 million to $6.5 billion.
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. Stocks that
comprise S&P indexes are selected and compiled by Standard & Poor's
Corporation according to criteria that may be unrelated to your Fund's
investment objective. 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 and over a long period. Long-term performance is a
more reliable and useful measure of performance than measurements of
short-term returns or temporary swings
<PAGE>
Page 8
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Keystone Mid-Cap Growth Fund (S-3)
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.
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 an extended
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 stocks that have a certain market capitalization. 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
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SCHEDULE OF INVESTMENTS--August 31, 1996 Market
Shares Value
- --------------------------------------------------------------------------
COMMON STOCKS (88.4%)
ADVERTISING & PUBLISHING (1.5%)
Clear Channel Communications, Inc. (a) 53,800 $4,431,775
- --------------------------------------------------------------------------
AEROSPACE (1.3%)
Rohr Industries, Inc. (a) 175,900 3,671,913
- --------------------------------------------------------------------------
AIR TRANSPORTATION (0.2%)
America West Airlines, Inc.,
Class B (a) 35,300 472,138
- --------------------------------------------------------------------------
AMUSEMENTS (4.2%)
Electronic Arts (a) 80,000 2,480,000
HFS, Inc. (a) 100,000 5,987,500
MGM Grand, Inc. (a) 90,000 3,397,500
- --------------------------------------------------------------------------
11,865,000
- --------------------------------------------------------------------------
AUTOMOTIVE (3.4%)
Danaher Corp. 115,000 4,772,500
Gentex Corp. (a) 203,400 4,907,025
- --------------------------------------------------------------------------
9,679,525
- --------------------------------------------------------------------------
BUILDING MATERIALS (2.5%)
Fastenal Co. 85,000 3,984,375
Oakwood Homes Corp. 130,000 3,055,000
- --------------------------------------------------------------------------
7,039,375
- --------------------------------------------------------------------------
BUSINESS SERVICES (12.9%)
Alternative Resource Corp. (a) 120,000 4,350,000
G & K Services, Inc., Class A 150,000 4,500,000
Molten Metal Technology, Inc. (a) 109,900 3,365,687
Paychex, Inc. 21,900 1,177,125
Thermedics, Inc. (a) 130,000 3,542,500
Thermo Electron Corp. 123,000 4,873,875
US Filter Corp. (a) 240,900 6,293,513
USA Waste Services, Inc. (a) 200,000 5,500,000
Viking Office Products, Inc. (a) 130,000 3,363,750
- --------------------------------------------------------------------------
36,966,450
- --------------------------------------------------------------------------
CAPITAL GOODS (1.2%)
Industrie Natuzzi SP ADR 68,300 3,449,150
- --------------------------------------------------------------------------
CHEMICALS (2.6%)
Hanna M.A. Co. 180,000 $3,915,000
OM Group, Inc. 95,000 3,610,000
- --------------------------------------------------------------------------
7,525,000
- --------------------------------------------------------------------------
CONSUMER GOODS (1.2%)
CUC International, Inc. (a) 100,000 3,437,500
- --------------------------------------------------------------------------
DIVERSIFIED COMPANIES (0.7%)
Diebold, Inc. 40,000 2,055,000
- --------------------------------------------------------------------------
DRUGS (2.9%)
Amylin Pharmaceuticals, Inc. (a) 300,000 3,206,250
Gilead Sciences, Inc. (a) 121,400 2,974,300
Guidant Corp. 40,000 2,030,000
- --------------------------------------------------------------------------
8,210,550
- --------------------------------------------------------------------------
ELECTRONICS PRODUCTS (1.3%)
Analog Devices, Inc. (a) 150,000 3,618,750
- --------------------------------------------------------------------------
FINANCE (9.3%)
Bank of Boston Corp. 69,600 3,671,400
BISYS Group, Inc. (a) 120,000 4,312,500
First USA Paymentech, Inc. (a) 77,000 2,906,750
Greenpoint Financial Corp. 110,000 3,918,750
Northern Trust Corp. 45,000 2,961,562
TCF Financial Corp. 149,300 5,580,088
Washington Mutual, Inc. 90,000 3,262,500
- --------------------------------------------------------------------------
26,613,550
- --------------------------------------------------------------------------
FOODS (2.0%)
PanAmerican Beverages, Inc., Class A 75,000 3,168,750
Richfood Holdings, Inc. 70,000 2,642,500
- --------------------------------------------------------------------------
5,811,250
- --------------------------------------------------------------------------
HEALTHCARE SERVICES (4.7%)
Cardinal Health, Inc. 75,000 5,503,125
IDEXX Laboratories, Inc. (a) 86,500 3,384,313
Lifecore Biomedical, Inc. (a) 185,000 3,422,500
Medaphis Corp. (a) 89,000 1,134,750
- --------------------------------------------------------------------------
13,444,688
- --------------------------------------------------------------------------
INSURANCE (1.3%)
SunAmerica, Inc. 55,000 3,746,875
<PAGE>
Page 10
- ---------------------------------------------------------------------------
Keystone Mid-Cap Growth Fund (S-3)
SCHEDULE OF INVESTMENTS--August 31, 1996
Market
Shares Value
- ---------------------------------------------------------------------------
METALS & MINING (1.4%)
UCAR International, Inc. (a) 100,000 $3,900,000
-------------------------------------------------------------------------
NATURAL GAS (2.7%)
CMS Energy Corp. 65,000 1,941,875
Louisiana Land & Exploration Co. 100,000 5,687,500
-------------------------------------------------------------------------
7,629,375
-------------------------------------------------------------------------
OFFICE & BUSINESS EQUIPMENT (1.6%)
EMC Corp. (a) 144,800 2,787,400
Synopsys, Inc. (a) 44,500 1,693,781
-------------------------------------------------------------------------
4,481,181
-------------------------------------------------------------------------
OIL SERVICES (5.2%)
BJ Services Co. (a) 104,000 3,913,000
Diamond Offshore Drilling, Inc. (a) 42,000 2,142,000
Tidewater, Inc. 125,000 4,796,875
Weatherford Enterra, Inc. (a) 135,000 3,881,250
-------------------------------------------------------------------------
14,733,125
-------------------------------------------------------------------------
PAPER & PACKAGING (2.4%)
Temple Inland, Inc. 60,000 2,962,500
Willamette Industries, Inc. 64,000 3,976,000
-------------------------------------------------------------------------
6,938,500
-------------------------------------------------------------------------
RETAIL (8.2%)
Autozone, Inc. (a) 80,000 2,180,000
Global Directmail Corp. (a) 75,000 3,393,750
Kohls Corp. (a) 80,000 3,040,000
PETsMART, Inc. (a) 240,600 6,586,425
Staples, Inc. (a) 263,750 5,225,546
Tiffany & Co. 84,600 2,950,425
-------------------------------------------------------------------------
23,376,146
-------------------------------------------------------------------------
SOFTWARE SERVICES (6.1%)
America Online, Inc. (a) 82,100 2,488,656
BMC Software, Inc. (a) 80,000 5,980,000
Informix Corp. (a) 100,700 2,272,043
Intuit (a) 75,000 2,765,625
McAfee Associates, Inc. (a) 10,600 634,675
SOFTWARE SERVICES -- CONTINUED
Parametric Technology Corp. (a) 60,300 $2,736,113
Transaction System Architects, Inc.,
Class A (a) 14,200 438,425
-------------------------------------------------------------------------
17,315,537
-------------------------------------------------------------------------
TELECOMMUNICATIONS (4.6%)
Brooks Fiber Properties, Inc. (a) 93,000 2,801,625
Heartland Wireless Communications,
Inc. (a) 135,000 2,835,000
Tellabs, Inc. (a) 75,000 4,753,125
Winstar Communications, Inc. (a) 141,500 2,723,875
- ---------------------------------------------------------------------------
13,113,625
- ---------------------------------------------------------------------------
UTILITIES (3.0%)
Allegheny Power Systems, Inc. 120,000 3,555,000
Compania Bolivia de Energia ADR 9,500 408,500
Hawaiian Electric Industries, Inc. 65,000 2,266,875
Teco Energy, Inc. 100,000 2,387,500
- ---------------------------------------------------------------------------
8,617,875
- ---------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost--$226,220,239) 252,143,853
===========================================================================
PREFERRED STOCKS (1.4%)
FINANCE (1.4%)
Banco Bradesco S.A. 256,350,000 2,168,825
Banco Itau S.A. 4,134,400 1,700,127
- ---------------------------------------------------------------------------
TOTAL PREFERRED STOCKS
(COST--$3,530,687) 3,868,952
===========================================================================
Maturity
Value
- ---------------------------------------------------------------------------
SHORT-TERM INVESTMENTS (9.4%)
REPURCHASE AGREEMENTS (9.4%)
Investment in repurchase agreements,
in a joint trading account
purchased 8/30/96, 5.243%, maturing
9/03/96 (b) $27,011,728 26,996,000
===========================================================================
<PAGE>
Page 11
- ---------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS--August 31, 1996
Market
Value
--------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS
(Cost--$26,996,000) $26,996,000
=========================================================
TOTAL INVESTMENTS
(Cost--$256,746,926) 283,008,805
------------------------------------------------------
OTHER ASSETS AND LIABILITIES--NET
(0.8%) 2,365,503
------------------------------------------------------
NET ASSETS (100%) $285,374,308
------------------------------------------------------
(a) Non-income-producing security.
(b) The repurchase agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices at August 31, 1996.
(c) The cost of investments for federal income tax purposes amounted to
$256,746,926.
Gross unrealized appreciation and depreciation of investments, based on
identified tax cost, at August 31, 1996 are as follows:
Gross unrealized
appreciation $36,278,383
Gross unrealized
depreciation (10,016,504)
---------
Net unrealized
appreciation $26,261,879
=========
Legend of Portfolio Abbreviations:
ADR--American Depository Receipt
<PAGE>
Page 12
- -----------------------------------------------------------------------------
Keystone Mid-Cap Growth Fund (S-3)
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
Year Ended August 31,
-----------------------------------------------------------------------
1996 1995 1994 1993 1992 1991
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net asset value beginning of year $9.22 $9.38 $9.92 $8.98 $9.66 $7.87
--------------------------------------------------------------------------------------------------------------
Income from investment operations
Net investment income (loss) (0.09) 0.04 0.02 (0.02) (0.01) 0.05
Net realized and unrealized gain
(loss) on investments and foreign
currency related transactions 0.94 1.72 0.09 1.69 0.10 2.23
--------------------------------------------------------------------------------------------------------------
Total from investment operations 0.85 1.76 0.11 1.67 0.09 2.28
--------------------------------------------------------------------------------------------------------------
Less distributions from
Net investment income (0.39) (0.04) (0.02) 0.00 (0.03) (0.08)
In excess of net investment income (0.20) (0.02) (0.01) 0.00 (0.05) 0.00
Net realized gain on investments (0.33) (1.72) (0.57) (0.73) (0.69) (0.41)
In excess of net realized gain on
investments 0.00 (0.14) 0.00 0.00 0.00 0.00
Tax basis return of capital 0.00 0.00 (0.05) 0.00 0.00 0.00
--------------------------------------------------------------------------------------------------------------
Total distributions (0.92) (1.92) (0.65) (0.73) (0.77) (0.49)
--------------------------------------------------------------------------------------------------------------
Net asset value end of year $9.15 $9.22 $9.38 $9.92 $8.98 $9.66
===============================================================================================================
Total return (a) 10.07% 21.42% 1.21% 19.31% 1.31% 31.42%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.74%(b) 1.32% 1.35% 1.74% 1.69% 1.47%
Net investment income (loss) (0.78%) 0.43% 0.16% (0.21%) (0.12%) 0.74%
Portfolio turnover rate 158% 172% 58% 69% 99% 66%
Average commissions rate paid $0.0053 N/A N/A N/A N/A N/A
--------------------------------------------------------------------------------------------------------------
Net assets end of year (thousands) $285,374 $276,034 $252,351 $292,965 $262,696 $256,070
==============================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Year Ended August 31,
--------------------------------------------------
1990 1989 1988 1987
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net asset value beginning of year $9.34 $7.14 $10.84 $10.49
- ---------------------------------------------------------------------------------------------
Income from investment operations
Net investment income (loss) 0.05 0.17 0.12 0.01
Net realized and unrealized gain
(loss) on investments and foreign
currency related transactions (1.02) 2.18 (2.00) 2.41
- ---------------------------------------------------------------------------------------------
Total from investment operations (0.97) 2.35 (1.88) 2.42
- ---------------------------------------------------------------------------------------------
Less distributions from
Net investment income (0.25) (0.12) (0.16) (0.14)
In excess of net investment income 0.00 0.00 0.00 0.00
Net realized gain on investments (0.25) (0.03) (1.66) (1.93)
In excess of net realized gain on
investments 0.00 0.00 0.00 0.00
Tax basis return of capital 0.00 0.00 0.00 0.00
- ---------------------------------------------------------------------------------------------
Total distributions (0.50) (0.15) (1.82) (2.07)
- ---------------------------------------------------------------------------------------------
Net asset value end of year $7.87 $9.34 $7.14 $10.84
=============================================================================================
Total return (a) (10.79%) 33.53% (19.80%) 31.24%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.54% 1.50% 1.44% 2.05%
Net investment income (loss) 0.93% 2.27% 1.43% 0.08%
Portfolio turnover rate 65% 65% 117% 118%
Average commissions rate paid N/A N/A N/A N/A
- ---------------------------------------------------------------------------------------------
Net assets end of year (thousands) $199,881 $280,084 $223,624 $325,105
=============================================================================================
</TABLE>
(a) Excluding applicable sales charges.
(b) The expense ratio includes indirectly paid expenses for the year ended
August 31, 1996. Excluding indirectly paid expenses, the expense ratio
would have been 1.73%.
See Notes to Financial Statements.
<PAGE>
Page 13
- -----------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES
August 31, 1996
Assets
Investments at market value (identified
cost--$256,746,926) $283,008,805
Cash 909
Receivable for:
Investments sold 4,654,139
Fund shares sold 93,685
Dividends and interest 177,332
Prepaid expenses and other assets 39,383
-------------------------------------------------------------------
Total assets 287,974,253
-------------------------------------------------------------------
Liabilities
Payable for:
Investments purchased 2,480,366
Fund shares redeemed 43,360
Other accrued expenses 76,219
-------------------------------------------------------------------
Total liabilities 2,599,945
-------------------------------------------------------------------
Net assets $285,374,308
===================================================================
Net assets represented by (Note 3)
Paid-in-capital $227,343,435
Accumulated undistributed net investment income 15,092,027
Accumulated net realized gain on investment
transactions 16,676,962
Net unrealized appreciation (depreciation) on
investments and foreign currency related
transactions 26,261,884
-------------------------------------------------------------------
Total net assets $285,374,308
-------------------------------------------------------------------
Net asset value
Net assets of $285,374,308 / 31,173,078 shares
outstanding $9.15
===================================================================
STATEMENT OF OPERATIONS
Year Ended August 31, 1996
Investment income
Dividends (net of foreign withholding
tax of $17,982) $1,820,256
Interest 943,004
- --------------------------------------------------------------------
Total income 2,763,260
- --------------------------------------------------------------------
Expenses (Notes 4 and 5)
Management fee $1,908,509
Transfer agent fees 711,550
Accounting 24,767
Auditing and legal 36,250
Custodian fees 189,739
Printing 30,409
Distribution Plan expenses 2,099,791
Trustees' fees and expenses 9,417
Registration fees 43,514
Miscellaneous expenses 15,881
- --------------------------------------------------------------------
Total expenses 5,069,827
Less: Expenses paid indirectly
(Note 6) (24,378)
- ---------------------------------------------------------------------
Net expenses 5,045,449
- ---------------------------------------------------------------------
Net investment loss (2,282,189)
- ---------------------------------------------------------------------
Net realized and unrealized gain
(loss) on investments and foreign
currency related transactions (Note 3)
Net realized gain on investments 43,961,482
Net realized loss on foreign currency
related transactions (87,947)
- ---------------------------------------------------------------------
Net realized gain on investments and
foreign currency related
transactions 43,873,535
- ---------------------------------------------------------------------
Net change in unrealized appreciation
or depreciation on investments and
foreign currency related
transactions (13,929,242)
- ---------------------------------------------------------------------
Net realized and unrealized gain on
investments and foreign currency
related transactions 29,944,293
- ---------------------------------------------------------------------
Net increase in net assets resulting
from operations $27,662,104
=====================================================================
<PAGE>
Page 14
- -----------------------------------------------------------------------------
Keystone Mid-Cap Growth Fund (S-3)
<TABLE>
<CAPTION>
STATEMENTS OF CHANGES IN NET ASSETS Year Ended August 31,
-----------------------------
1996 1995
==============================================================================================================
<S> <C> <C>
Operations
Net investment income (loss) ($2,282,189) $1,042,062
Net realized gain on investments and foreign currency related transactions 43,873,535 52,906,920
Net change in unrealized appreciation or depreciation on investments and
foreign currency related transactions (13,929,242) (3,702,097)
-------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations 27,662,104 50,246,885
-------------------------------------------------------------------------------------------------------------
Distributions to shareholders from (Note 5)
Net investment income (11,703,529) (1,042,062)
In excess of net investment income (6,074,672) (525,125)
Net realized gain on investment transactions (9,943,735) (49,683,115)
-------------------------------------------------------------------------------------------------------------
Total distributions to shareholders (27,721,936) (51,250,302)
-------------------------------------------------------------------------------------------------------------
Capital share transactions (Note 2)
Proceeds from shares sold 49,458,379 27,462,149
Payments for shares redeemed (64,895,935) (47,931,858)
Net asset value of shares issued in reinvestment of distributions 24,837,684 45,156,148
-------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from capital share transactions 9,400,128 24,686,439
-------------------------------------------------------------------------------------------------------------
Total increase in net assets 9,340,296 23,683,022
Net assets
Beginning of year 276,034,012 252,350,990
-------------------------------------------------------------------------------------------------------------
End of year [including undistributed net investment income as follows:
1996--$15,092,027 and 1995--$13,985,718] $285,374,308 $276,034,012
=============================================================================================================
</TABLE>
See Notes to Financial Statements.
<PAGE>
Page 15
- -----------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone Mid-Cap Growth Fund (S-3) (the "Fund") is a common law trust for
which Keystone Management, Inc. ("KMI") is the Investment Manager and
Keystone Investment Management Company ("Keystone") is the Investment
Adviser. Keystone is a wholly-owned subsidiary of Keystone Investments, Inc.
("KII") and KMI is in turn a wholly-owned subsidiary of Keystone. 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's investment
objective is to provide shareholders with growth of capital.
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 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. Foreign Currency
The books and records of the Fund are maintained in United States ("U.S.")
dollars. Foreign currency amounts are translated into U.S. dollars as
follows: market value of investments, assets and liabilities at the daily
rate of exchange; purchases and sales of investments, income and expenses at
the rate of exchange prevailing on the respective dates of such transactions.
Net unrealized foreign exchange gain (loss) resulting from changes in foreign
currency exchange rates is a component of net unrealized appreciation
(depreciation) on investments and foreign currency transactions. Net realized
foreign currency gains and losses resulting from changes in exchange rates
include foreign currency gains and losses between trade date and settlement
date on investment securities transactions, foreign currency transactions and
the difference between the amounts of interest and dividends recorded on the
books of the Fund and the amount actually received. The portion of foreign
currency gains and losses related to fluctuations in exchange rates between
the initial purchase trade date and sub-
<PAGE>
Page 16
- -----------------------------------------------------------------------------
Keystone Mid-Cap Growth Fund (S-3)
sequent sale trade date is included in realized gain (loss) on foreign
currency transactions.
D. 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.
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 tax is required.
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
differing treatment of short-term gains.
(2.) Capital Share Transactions
The Fund's Declaration of Trust authorizes the issuance of an unlimited
number of shares of beneficial interest with a par value of $1.00.
Transactions in shares of the Fund were as follows:
Year ended August 31,
----------------------------
1996 1995
-----------------------------------------------
Shares sold 5,434,642 3,189,451
Shares redeemed (7,136,623) (5,383,518)
Shares issued in
reinvestment of
distributions 2,946,344 5,233,815
---------------- ----------- -------------
Net increase 1,244,363 3,039,748
================ =========== =============
(3.) Securities Transactions
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities) for the year ended August 31, 1996, were $434,199,796
and $477,408,817, respectively.
(4.) Distribution Plan
The Fund bears some of the costs of selling its shares under a Distribution
Plan (the "Plan") adopted pursuant to Rule 12b-1 under the 1940 Act. Under
the Plan, the Fund pays its principal underwriter, Keystone Investment
Distributors Company ("KIDC"), a wholly-owned subsidiary of Keystone, amounts
which are calculated and paid daily.
Under the Plan, the Fund pays a distribution fee amount which may not exceed
1.00% of the Fund's average daily net assets. Of that amount, 0.75% is used
to pay distribution expenses and 0.25% may be used to pay service fees.
Contingent deferred sales charges paid by redeeming shareholders may be paid
to KIDC. During the year ended August 31, 1996, the Fund received $54,272 in
contingent deferred sales charges.
The Plan 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 Fund.
However, after the termination of the Plan, at the discretion of the Board of
Trustees, payments to KIDC may con-
<PAGE>
Page 17
- -----------------------------------------------------------------------------
tinue as compensation for its services which had been earned while the Plan
was in effect.
KIDC intends, but is not obligated, to continue to pay distribution costs
that exceed the current annual payments from the Fund. KIDC 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 Fund would be
within permitted limits.
(5.) Investment Management Agreement and Other Affiliated Transactions
Under the terms of the Investment Management Agreement between KMI and the
Fund, KMI provides investment management and administrative services to the
Fund. In return, KMI is paid a management fee, computed and paid daily,
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.
KMI has entered into an Investment Advisory Agreement with Keystone under
which Keystone provides investment advisory and management services to the
Fund. In return for its services, Keystone receives an annual fee equal to
85% of the management fee received by KMI.
During the year ended August 31, 1996, the Fund paid or accrued $24,767 to
Keystone for certain accounting services. The Fund paid or accrued $711,550
to Keystone Investor Resource Center, Inc., a wholly-owned subsidiary of
Keystone, for services rendered as the Fund's transfer and dividend
disbursing agent.
Certain officers and/or Directors of Keystone are also officers and/or
Trustees of the Fund. Officers of Keystone and affiliated Trustees receive no
compensation directly from the Fund.
(6.) Expense Offset Arrangement
The Fund has entered into an expense offset arrangement with its custodian.
For the year ended August 31, 1996, the Fund incurred total custody fees of
$189,739 and received a credit of $24,378 pursuant to this expense offset
arrangement, resulting in a net custody expense of $165,361. The assets
deposited with the custodian under this expense offset arrangement could have
been invested in income-producing assets.
(7.) Subsequent Event
On September 6, 1996, Keystone Investments, Inc. entered into an Agreement
and Plan of Acquisition and Merger (the "Acquisition") with First Union
Corporation and First Union National Bank of North Carolina ("First Union")
whereby First Union would acquire all the assets and liabilities of Keystone
Investments, Inc. in exchange for shares of First Union. Subject to the
receipt of the required regulatory and shareholder approvals, the Acquisition
is expected to take place in late December 1996.
<PAGE>
Page 18
- -----------------------------------------------------------------------------
Keystone Mid-Cap Growth Fund (S-3)
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Mid-Cap Growth Fund (S-3)
We have audited the accompanying statement of assets and liabilities of
Keystone Mid-Cap Growth Fund (S-3), including the schedule of investments, as
of August 31, 1996, and the related statement of operations for the year then
ended, the statements of changes in net assets for each of the years in the
two-year period then ended, and the financial highlights for each of the
years in the ten-year period then ended. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with 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 August 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 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 Mid-Cap Growth Fund (S-3), as of August 31, 1996, the results of its
operations for the year then ended, the changes in its net assets for each of
the years in the two-year period then ended, and the financial highlights for
each of the years in the ten-year period then ended, in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
September 27, 1996
<PAGE>
Page 19
- ------------------------------------------------------------------------------
FEDERAL TAX STATUS--FISCAL 1996 DISTRIBUTIONS (Unaudited)
During the fiscal year ended August 31, 1996, distributions of $0.92 per
share were paid in shares or cash. This total includes a taxable long-term
capital gain distribution of $0.33 per share. The remaining $0.59 per share
is short-term capital gains taxable to shareholders as ordinary income in the
year in which received by them or credited to their accounts. Of the ordinary
income distributions, 36% is eligible for the corporate dividend received
deduction.
The above figures may differ from those cited elsewhere in this report due
to differences in the calculation of income and capital gains for accounting
(book) purposes and Internal Revenue Service (tax) purposes.
In January 1997, we will send you complete information on the distributions
paid during the calendar year 1996 to help you in completing your federal tax
return.
<PAGE>
(Back cover page)
KEYSTONE
FAMILY OF FUNDS
(diamond)
Balanced Fund (K-1)
Diversified Bond Fund (B-2)
Growth and Income Fund (S-1)
High Income Bond Fund (B-4)
International Fund Inc.
Liquid Trust
Mid-Cap Growth Fund (S-3)
Precious Metals Holdings, Inc.
Quality Bond Fund (B-1)
Small Company Growth Fund (S-4)
Strategic Growth Fund (K-2)
Tax Free Fund
This report was prepared primarily for the information of the Fund's share-
holders. 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.
(Keystone logo)
P.O. Box 2121
Boston, Massachusetts 02106-2121
S3-R-10/96
20M
(Front cover)
KEYSTONE
(Photo of pine tree)
MID-CAP GROWTH
FUND (S-3)
(Keystone logo)
ANNUAL REPORT
AUGUST 31, 1996
