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[Logo]
INVESTMENT MANAGEMENT
We invented the mutual fund(SM)
MFS INTERMEDIATE
INCOME FUND
SEMIANNUAL REPORT o MAY 31, 1998
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Now two MFS(R) IRA choices (see page 32)
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IN MEMORIAM
A. KEITH BRODKIN
1935 - 1998
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
MFS(R) INVESTMENT MANAGEMENT(SM)
--------------------------- On February 2, 1998, Keith Brodkin, a friend
and leader to everyone at MFS, died
unexpectedly at age 62. His thoughtful
[Photo of A. Keith Brodkin] letters to shareholders on the markets and
economy have been an integral part of
MFS shareholder reports like this one for
--------------------------- many years.
Keith joined MFS in 1970 as the firm's first fixed-income manager, managing
the bond portion of MFS(R) Total Return Fund. He went on to manage our first
pure bond fund, MFS(R) Bond Fund, when it was introduced in 1974, and he was
considered a pioneer in the art of active bond management.
Keith was named President and Chief Investment Officer of MFS in 1987 and
four years later became Chairman and Chief Executive Officer. During his
stewardship, MFS has achieved significant growth in total assets under
management, rising from some $25 billion in 1991 to the over $80 billion
today entrusted to us by three million individual and institutional investors
worldwide. Under Keith's leadership, MFS has carefully but steadily built its
domestic and international investment capabilities through the introduction
of a range of new products and a still-growing staff that now numbers over
100 equity and fixed-income professionals.
Throughout his career, Keith was very active in a wide range of charitable
endeavors. He is survived by his wife and three children.
His leadership, friendship, and wise counsel will be sorely missed.
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TABLE OF CONTENTS
Letter from the Chairman .................................................. 2
Management Review and Outlook ............................................. 4
Performance Summary ....................................................... 10
Portfolio of Investments .................................................. 13
Financial Statements ...................................................... 16
Notes to Financial Statements ............................................. 23
Independent Auditors' Report .............................................. 31
Trustees and Officers ..................................................... 33
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HIGHLIGHTS
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o FOR THE SIX MONTHS ENDED MAY 31, 1998, CLASS A SHARES OF THE FUND PROVIDED
A TOTAL RETURN AT NET ASSET VALUE OF 3.30%, CLASS B SHARES 2.82%, AND
CLASS I SHARES 3.42%. (SEE PERFORMANCE SUMMARY FOR MORE INFORMATION.)
o THE FUND BENEFITED FROM OUR DECISION TO MAINTAIN A SLIGHTLY LONGER
DURATION (A MEASURE OF SENSITIVITY TO CHANGES IN INTEREST RATES) THAN
NORMAL, WHICH PROVIDED POSITIVE RETURNS AS INTEREST RATES DECLINED AND THE
BOND MARKET RALLIED.
o OUR DECISION TO EMPHASIZE MATURITIES IN THE 7- TO 10-YEAR RANGE ALSO
CONTRIBUTED TO PERFORMANCE BECAUSE, ALTHOUGH INTEREST RATES DECLINED
ACROSS ALL MATURITIES, THEY DECLINED MORE SHARPLY IN THE LONGER
MATURITIES.
o WE REMAIN POSITIVE ON THE UNITED STATES BECAUSE INFLATION FUNDAMENTALS
REMAIN SOUND AND THE U.S. MARKET BENEFITS FROM ITS STATUS AS A SAFE HAVEN.
CONSEQUENTLY, WE ARE MAINTAINING A LARGE ALLOCATION TO THE U.S. MARKET.
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NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE
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LETTER FROM THE CHAIRMAN
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[Photo of Jeffrey L. Shames]
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Jeffrey L. Shames
Dear Shareholders:
With the U.S. stock market well into its fourth year of record-breaking
advances, it is necessary to take a cautious outlook. By most commonly accepted
measures, equity valuations appear to have risen to a point at which the stock
market has become more vulnerable to changes in the investment environment such
as rising inflation and interest rates or a slowing economy. As a result, while
we continue to hold a favorable long-term outlook for the equity markets, we
also believe that a market correction is possible in the near term. In such a
correction, equity prices would remain relatively flat or decline, possibly for
an extended period.
Currently, equity investors seem to be primarily focused on interest rates,
which have been relatively stable for several months as inflation has remained
low. In an environment of low interest rates, stocks become more attractive
than most fixed-income investments, while low inflation helps control
companies' costs, such as for raw materials, wages, and benefits. The near-
term outlook for a continuation of this environment appears relatively
favorable. However, this year has seen a marked slowdown in corporate
earnings. This means that as equity prices continue to rise, price-to-earnings
(P/E) ratios, or the amount an investor pays for a stock in relation to the
company's earnings per share, also go up. A year ago, the average P/E ratio
for stocks in the unmanaged Standard & Poor's 500 Composite Index stood at
approximately 21; this spring, the average P/E was 33% higher, at about 28. In
some cases, such as with some of the newer companies associated with the
Internet, P/Es have soared to levels that are unlikely to be sustained.
As long as interest rates remain low and the economy continues to grow,
it is possible that some of these valuations can be supported. We expect
corporate earnings to grow 8% to 10% this year. However, just as no one can
predict market cycles, so too no one can predict economic cycles -- except to
say that these cycles do exist and that an economic slowdown at some point is
inevitable.
Given this reality, we believe it is prudent to remind investors of the need
to take a long-term view and to diversify their investments across a range of
asset classes, including mutual funds that focus on bonds and international
investments as well as on the U.S. stock market. The likelihood of an eventual
market correction also makes it important for us to use original, bottom-up
research to find companies that we think can keep growing or gain market share
in the face of the occasional downturn. To help achieve this, and to provide
the broadest possible coverage of industry sectors and individual companies,
MFS continues to increase its number of full-time research analysts. These
analysts thoroughly investigate each company's earnings potential and position
in its industry as well as the overall prospects for that industry.
MFS also uses active portfolio management on the fixed-income side, taking
advantage of our extensive research and credit analysis to help reduce the
potential for price declines and enhance the opportunity for appreciation.
Every year, both fixed-income and equity managers meet with thousands of
credit issuers and companies. They also attend many presentations, closely
follow sources of industry research, and keep track of competitors.
We believe that applying this discipline of thorough, bottom-up research
to both the equity and fixed-income markets is the best way to provide
favorable long-term performance for our shareholders -- regardless of changes
in the overall market environment.
We appreciate your support and welcome any questions or comments you may have.
Respectfully,
/s/ Jeffrey L. Shames
Jeffrey L. Shames
Chairman and Chief Executive Officer
MFS Investment Management
June 12, 1998
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JEFFREY L. SHAMES, A GRADUATE OF WESLEYAN UNIVERSITY AND THE
MASSACHUSETTS INSTITUTE OF TECHNOLOGY SLOAN SCHOOL OF MANAGEMENT, JOINED
MFS IN 1983. AFTER FOUR YEARS AS AN INDUSTRY ANALYST AND PORTFOLIO
MANAGER, HE WAS NAMED CHIEF EQUITY OFFICER IN 1987 AND PRESIDENT AND A
MEMBER OF THE BOARD OF DIRECTORS IN 1993. MR. SHAMES WAS APPOINTED
CHAIRMAN AND CHIEF EXECUTIVE OFFICER IN FEBRUARY 1998.
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MANAGEMENT REVIEW AND OUTLOOK
For the six months ended May 31, 1998, Class A shares of the Fund provided a
total return of 3.30%, Class B shares 2.82%, and Class I shares 3.42%. These
returns assume the reinvestment of distributions but exclude the effects of
any sales charges and compare to a 3.54% return for the Lehman Brothers
Intermediate Government Bond Index (an unmanaged index comprised of issues of
the U.S. government and its agencies with remaining maturities of less than 10
years); a 3.83% return for the Lehman Brothers Mortgage Index (which includes
maturities of both 15 and 30 years); and a 2.03% return for the J.P. Morgan
Non-Dollar Government Bond Index (an aggregate of actively traded government
bonds of 12 countries with remaining maturities of at least one year).
Q. COULD YOU TALK ABOUT SOME FACTORS THAT CONTRIBUTED TO THE FUND'S PERFORMANCE
OVER THE PAST SIX MONTHS?
A. Two decisions in particular contributed significantly to the Fund's
performance in the U.S. sector. The first was our decision to maintain a
slightly longer duration (a measure of sensitivity to changes in interest
rates) than normal. With the decline in overall interest rates, the longer-
than-index duration provided incrementally positive returns as the market
rallied. The second contributor to performance was our decision to
emphasize maturities in the 7- to 10-year range. Although interest rates
declined across all maturities, they declined more sharply in the longer
maturities. Yields on two-year U.S. Treasuries, for example, declined by 23
basis points (0.23%) for the six-month period, whereas yields on 10-year
Treasuries declined by approximately 30 basis points (0.30%). Our
overweighting in the longer maturities helped performance, as this was the
best-performing maturity sector of the market. In the foreign sector,
investments in the United Kingdom and New Zealand provided attractive
relative returns, and our decision to hedge currency exposure elsewhere
allowed us to avoid adverse currency movements. Investments in Thailand,
however, continued to underperform due to the economic turmoil in Southeast
Asia.
Q. HOW WOULD YOU DESCRIBE THE FIXED-INCOME ENVIRONMENT, BOTH IN THE UNITED
STATES AND OVERSEAS?
A. Although the crisis atmosphere has abated, the situation in Asia still
dominates the global outlook. Thus far, the crisis has only modestly
impacted economies outside the region. The full impact should become more
apparent over the next few quarters. The potential for slower global growth
and low inflation should keep Europe and the United States well supported,
with the potential for a further rally if the downturn is severe. The risk
that the impact won't sufficiently tame the vibrant U.S. economy might
cause the Federal Reserve Board (the Fed) to hike interest rates.
Ironically, this could trigger a sharper drop in global growth and a bond
rally, reversing the Fed's move. It is too soon to tell how the saga will
play out, but we are generally positive on the major markets over the
longer term. The emerging markets remain vulnerable to the ups and downs of
the Asian recovery process. As this process unfolds we will look for
opportunities to acquire assets at attractive valuations.
Q. HOW IS THIS VIEW REFLECTED IN THE FUND'S ALLOCATIONS IN THE UNITED STATES AND
ABROAD?
A. We remain positive on the United States because inflation fundamentals
remain sound and the U.S. market benefits from its status as a safe haven.
Consequently, we are maintaining a large allocation to the U.S. market. In
emerging markets, the past six months have witnessed substantial
volatility. Concerns over the Asian currency crisis, Russian liquidity, and
Brazilian elections have led to sharp swings in bond prices, with a
weakening bias. As the markets have weakened, the Fund gradually has built
up moderate positions from very low levels in selected emerging market
sovereign securities. Current exposure is approximately 6% of net assets.
Q. HOW HAS THE FUND BEEN POSITIONED DURING THE PERIOD THAT THE FED HAS LEFT
INTEREST RATES UNCHANGED?
A. For most of the past six months, the portfolio's duration was 5% to 10%
longer than that of the appropriate benchmark. Strength in employment and
overall economic activity, along with the risk that the Fed might tighten
once again, argued for caution, so we did not position duration more
aggressively. The many positive underpinnings to the market, however, did
suggest we should position the Fund to benefit from opportunities for
capital appreciation as fears of Fed action receded.
Q. HOW DOES YOUR ALLOCATION TO SHORT- AND INTERMEDIATE-TERM TREASURIES REFLECT
YOUR VIEW ON THAT MARKET?
A. In the United States, with household income, job growth, and consumer
confidence quite strong, the rally in shorter maturities has been somewhat
limited by concerns that the Fed would again find it necessary to raise
short-term interest rates. The very favorable performance on the inflation
and fiscal fronts, however, provided a positive underpinning for Treasuries
from which longer maturities were able to benefit more fully. This
environment helped the Fund, given our overweighting in intermediate- and
longer-maturity Treasury and agency securities.
Q. HAVE THERE BEEN ANY UNEXPECTED DEVELOPMENTS IN YOUR MARKETS LATELY?
A. The big surprise this past year has been that robust economic growth,
especially this late in the economic cycle, has coincided with a dramatic
improvement in inflation trends and an overall decline in interest rates.
Even though overall economic activity exceeded what the Fed would consider
a noninflationary pace for much of the year so that the Fed saw it
necessary to increase the federal funds rate to 5.50% on March 25, 1997,
two trends have worked in favor of the market and helped interest rates
move lower. The first has been the sharp decline in the federal
government's deficit borrowing needs. In fact, for the past 12 months the
government was already running a surplus of about $50 billion, and for the
fiscal year ending this October the surplus may be significantly higher.
The second favorable factor has been the decline in inflation rates. Much
to the surprise of most economists, inflation has declined significantly,
with the consumer price index, for example, declining from an annual rate
of 3.3% in 1996 to 1.7% in 1997. These favorable fundamental developments
are important to our constructive view on the U.S. market.
Q. WHAT IS YOUR ALLOCATION TO FOREIGN MARKETS, AND HOW DOES IT REFLECT YOUR
OUTLOOK?
A. Our allocation to the major foreign markets remains at 7%, reflecting the
attractiveness of U.S. interest rates. Of the 12 foreign markets in the
J.P. Morgan Global Index, only the United Kingdom offers a higher
10-year yield than the United States offers. Hence, while we see some
opportunities in these markets, we feel a larger allocation is not
currently warranted. Our allocation to emerging markets has been increased
to 6% because yield spreads have again widened to what we regard as more
attractive levels. We would look to add selectively to this sector if its
best-quality assets cheapen further.
Q. HOW IS THE CONTINUING MOVEMENT TOWARD ECONOMIC UNION IN EUROPE REFLECTED IN
THE FUND'S ALLOCATION TO THOSE COUNTRIES?
A. As we expected, European monetary union (EMU) is set to proceed with a
broad group of 11 countries. For all practical purposes, the sovereign debt
of the initial participants already trades as a single market, with only
isolated opportunities for adding value via market or security selection
within the EMU zone. The major nonparticipants -- the United Kingdom,
Sweden, Denmark, and Greece -- are therefore likely to play an even more
important role within the European segment of
the portfolio.
Q. WHAT ABOUT AUSTRALIA AND NEW ZEALAND?
A. We have had a large portion of our foreign bond exposure in New Zealand. We
remain positive on both New Zealand and Australian bonds, since these
economies are quite vulnerable to a recession in Asia. To date, however,
the economic weakness in these two countries has translated primarily into
weaker currencies rather than lower yields. We expect the bonds to benefit
more going forward.
Q. WHAT DO YOU SEE AS THE BIGGEST RISK IN YOUR MARKETS IN COMING MONTHS?
A. The Asian crisis has increased the level of uncertainty about the economic
and, consequently, the fixed-income outlook. The greatest risk is that we
miss or fail to react to a significant change in economic and inflation
trends.
Q. IS THE FUND STILL FULLY HEDGED BACK INTO THE DOLLAR, AS IT WAS SIX MONTHS
AGO?
A. The dollar has been appreciating versus major foreign currencies for
roughly three years. Several factors suggest that this trend may have
ended. Investors are gaining confidence that the new European currency, the
Euro, will be strong. It may therefore play a more important role in world
trade and investment flows than the combined 11 currencies it will replace.
In addition, the U.S. current-account deficit continues to widen, forcing
foreign investors to hold more dollars. No doubt there is a limit to their
appetite. However, interest rate, growth, and productivity differentials
still favor the dollar. At present, the Fund remains fully hedged back into
dollars, but we will be watching this situation closely.
Q. IN GENERAL, WHAT KIND OF ECONOMIC OR MARKET ENVIRONMENT DO YOU SEE GOING
FORWARD, AND HOW ARE YOU POSITIONING THE FUND FOR IT?
A. Prospects for the economic environment, and especially for the fixed-income
market, are especially positive. The supply-side nature of the economic
expansion, with growth in supply outstripping that of demand, and the boom
in global productive capacity have helped suppress inflation. A declining
profile for inflation at this stage of the economic expansion is
remarkable, and any slowdown in economic growth could quickly trigger
still-lower inflation expectations. Investors have yet to embrace the idea
that the economy is at, or close to, price stability. Although the economy
is showing few signs of weakening, interest rates will have considerable
room to fall after economic activity cools, perhaps bringing us closer to
the long-term objective of price stability.
/s/ Steven E. Nothern /s/ Christopher D. Piros
Steven E. Nothern Christopher D. Piros
Portfolio Manager Portfolio Manager
The opinions expressed in this report are those of the portfolio managers and
are only through the end of the period of the report as stated on the cover.
The managers' views are subject to change at any time based on market and
other conditions, and no forecasts can be guaranteed.
<PAGE>
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PORTFOLIO MANAGERS' PROFILES
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STEVEN E. NOTHERN IS A SENIOR VICE PRESIDENT AND A MEMBER OF THE FIXED
INCOME POLICY COMMITTEE OF MFS(R) INVESTMENT MANAGEMENT(SM). HE IS
PORTFOLIO MANAGER OF MFS(R) GOVERNMENT SECURITIES FUND, MFS(R)
INTERMEDIATE INCOME FUND, AND THE GOVERNMENT SECURITIES SERIES OFFERED
THROUGH MFS(R)/SUN LIFE ANNUITY PRODUCTS. HE ALSO MANAGES MFS(R)
GOVERNMENT MARKETS INCOME TRUST, A CLOSED-END FUND. MR. NOTHERN JOINED MFS
IN 1986 IN THE FIXED INCOME DEPARTMENT AND WAS NAMED VICE PRESIDENT IN
1989 AND SENIOR VICE PRESIDENT IN 1993. HE IS A GRADUATE OF MIDDLEBURY
COLLEGE AND HOLDS A MASTER OF BUSINESS ADMINISTRATION DEGREE FROM BOSTON
UNIVERSITY. HE IS A CHARTERED FINANCIAL ANALYST AND A MEMBER OF THE BOSTON
SECURITY ANALYSTS SOCIETY, INC.
CHRISTOPHER D. PIROS IS A SENIOR VICE PRESIDENT OF MFS(R) INVESTMENT
MANAGEMENT(SM) AND A PORTFOLIO MANAGER OF MFS(R) INTERMEDIATE INCOME FUND
AND MFS(R) INTERMEDIATE INCOME TRUST. HE ALSO MANAGES THE NOMURA GLOBAL
BALANCED OPEN FUND UNDER SUBADVISORY AGREEMENTS WITH NOMURA ASSET
MANAGEMENT CO. OF JAPAN. MR. PIROS JOINED MFS IN 1989 AS VICE PRESIDENT --
QUANTITATIVE SERVICES IN THE FIXED INCOME DEPARTMENT AND WORKED IN THE
INTERNATIONAL FIXED INCOME AREA BEFORE BEING NAMED A PORTFOLIO MANAGER IN
1996. HE WAS NAMED SENIOR VICE PRESIDENT IN 1997. PRIOR TO JOINING MFS, HE
HAD BEEN A VICE PRESIDENT AND SENIOR ECONOMIST IN THE QUANTITATIVE ASSET
MANAGEMENT AREA AT A MAJOR CHICAGO-BASED SECURITIES FIRM AND AN ASSISTANT
PROFESSOR AT THE FUQUA SCHOOL OF BUSINESS AT DUKE UNIVERSITY. HE IS A
GRADUATE OF NORTHWESTERN UNIVERSITY AND HOLDS A PH.D. FROM HARVARD
UNIVERSITY.
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This report is prepared for the general information of shareholders. It is
authorized for distribution to prospective investors only when preceded or
accompanied by a current prospectus. A prospectus containing more information,
including the exchange privilege and all charges and expenses, for any other MFS
product is available from your financial adviser, or by calling MFS at
1-800-225-2606. Please read it carefully before investing or sending money.
<PAGE>
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FUND FACTS
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OBJECTIVE: SEEKS PRESERVATION OF CAPITAL AND HIGH CURRENT INCOME.
COMMENCEMENT OF
INVESTMENT OPERATIONS: AUGUST 1, 1988
CLASS INCEPTION: CLASS A SEPTEMBER 7, 1993
CLASS B AUGUST 1, 1988
CLASS I JANUARY 2, 1997
SIZE: $139.0 MILLION NET ASSETS AS OF MAY 31, 1998
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PERFORMANCE SUMMARY
Because mutual funds are designed for investors with long-term goals, we have
provided cumulative results as well as the average annual total returns for
the applicable time periods. Investment results reflect the percentage change
in net asset value, including reinvestment of dividends.
AVERAGE ANNUAL AND CUMULATIVE TOTAL RATES OF RETURN
THROUGH MAY 31, 1998
<TABLE>
CLASS A
<CAPTION>
6 Months 1 Year 3 Years 5 Years 10 Years/Life*
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<S> <C> <C> <C> <C>
Cumulative Total Return +3.30% +7.06% +20.97% +31.01% +88.37%
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Average Annual Total Return -- +7.06% + 6.55% + 5.55% + 6.65%
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SEC Results -- +1.98% + 4.84% + 4.53% + 6.13%
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</TABLE>
<TABLE>
CLASS B
<CAPTION>
6 Months 1 Year 3 Years 5 Years 10 Years/Life*
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<S> <C> <C> <C> <C> <C>
Cumulative Total Return +2.82% +6.00% +17.32% +24.74% +79.53%
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Average Annual Total Return -- +6.00% + 5.47% + 4.52% + 6.13%
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SEC Results -- +2.00% + 4.57% + 4.20% + 6.13%
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*For the period from the commencement of the Fund's investment operations,
August 1, 1988, through May 31, 1998.
</TABLE>
<TABLE>
CLASS I
<CAPTION>
6 Months 1 Year 3 Years 5 Years 10 Years/Life*
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<S> <C> <C> <C> <C> <C>
Cumulative Total Return +3.42% +7.31% +18.56% +26.06% +82.38%
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Average Annual Total Return -- +7.31% + 5.84% + 4.74% + 6.30%
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*For the period from the commencement of the Fund's investment operations,
August 1, 1988, through May 31, 1998.
</TABLE>
Class A share ("A") SEC results include the maximum 4.75% sales charge. Class
B share ("B") SEC results reflect the applicable contingent deferred sales
charge (CDSC), which declines over six years from 4% to 0%. Class I shares
("I") have no sales charge or Rule 12b-1 fees and are only available to
certain institutional investors.
A results include the performance and the operating expenses (e.g., Rule 12b-1
fees) of B for periods prior to the inception of A. Because operating expenses
of B are greater than those of A, A performance generally would have been
higher than B performance. The B performance included within the A SEC
performance has been adjusted to reflect the maximum initial sales charge
generally applicable to A rather than the CDSC generally applicable to B.
I results include the performance and the operating expenses (e.g., Rule 12b-1
fees) of B for periods prior to the inception of I. Because operating expenses
of B are greater than those of I, I performance generally would have been
higher than B performance. The B performance included in the I performance has
been adjusted to reflect the fact that I have no CDSC.
Performance results reflect any applicable expense subsidies and waivers,
without which the results would have been less favorable. Subsidies and
waivers may be rescinded at any time. See the prospectus for details.
All results are historical and assume the reinvestment of dividends and
capital gains.
Investment return and principal value will fluctuate, and shares, when
redeemed, may be worth more or less than their original cost. Past performance
is no guarantee of future results.
<PAGE>
PORTFOLIO CONCENTRATION AS OF MAY 31, 1998
PORTFOLIO STRUCTURE
Mortgage Backed 40.0%
U.S. Treasury 33.0%
Other Government Agencies 14.0%
International 7.0%
Emerging Markets 6.0%
<PAGE>
PORTFOLIO OF INVESTMENTS -- May 31, 1998
Bonds - 101.3%
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PRINCIPAL AMOUNT
ISSUER (000 OMITTED) VALUE
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U.S. Bonds - 84.5%
U.S. Treasury Obligations - 33.0%
U.S. Treasury Bonds, 10.375s, 2012 $12,900 $ 17,169,126
U.S. Treasury Bonds, 11.875s, 2003 5,000 6,439,850
U.S. Treasury Bonds, 12s, 2013 5,100 7,516,125
U.S. Treasury Bonds, 12.375s, 2004 3,500 4,675,790
U.S. Treasury Bonds, 13.875s, 2011 4,500 6,801,345
U.S. Treasury Notes, 8s, 2001 3,000 3,194,520
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$ 45,796,756
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U.S. Federal Agencies - 13.8%
Federal National Mortgage Assn., 6.65s, 2002 $ 2,000 $ 2,004,375
Federal National Mortgage Assn., 7.5s, 2003 2,246 2,286,807
Federal National Mortgage Assn., 7.55s, 2007 2,000 2,047,180
Federal National Mortgage Assn., 6.5s, 2013, TBA 1,560 1,568,473
Guaranteed Trade Trust, 7.39s, 2006 10,625 11,253,362
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$ 19,160,197
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Government National Mortgage Association - 37.7%
GNMA, 7s, 2012 $ 294 $ 300,694
GNMA, 7.5s, 2023 - 2026 17,264 17,826,909
GNMA, 6.5s, 2028, TBA 6,900 6,867,739
GNMA, 7s, 2008, TBA 15,183 15,479,701
GNMA, 8s, 2026, TBA 5,505 5,723,909
GNMA, 8.5s, 2001, TBA 5,064 5,328,893
Government Trust Certificates, 9.25s, 2001 781 828,997
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$ 52,356,842
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Total U.S. Bonds $117,313,795
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Foreign Bonds - 16.8%
Argentina - 0.4%
Argentina Republic, 8.726s, 2005 $ 500 $ 503,750
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Brazil - 1.0%
Federal Republic of Brazil, 5s, 2014 $ 870 $ 674,372
Federative Republic of Brazil, 9.375s, 2008 800 748,400
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$ 1,422,772
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Bulgaria - 0.3%
National Republic of Bulgaria, 6.563s, 2024 $ 550 $ 435,875
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Denmark - 0.8%
Nykredit, 6s, 2026 DKK 4,047 $ 589,713
Nykredit, 7s, 2024 3,613 539,487
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$ 1,129,200
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Germany - 1.1%
Federal Republic of Germany, 6s, 2007 DEM 600 $ 362,816
Treuhandanstalt, 6.625s, 2003 733 448,784
Federal Republic of Germany, 6.25s, 2006 1,092 669,196
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$ 1,480,796
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Israel - 3.7%
State of Israel, 6.625s, 2003 $ 5,000 $ 5,192,800
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Italy - 0.7%
Republic of Italy, 5.75s, 2002 ITL 860,000 $ 507,604
Republic of Italy, 7.75s, 2006 735,000 494,762
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$ 1,002,366
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Mexico - 2.5%
United Mexican States, 8.625s, 2008 $ 800 $ 789,000
United Mexican States, 9.875s, 2007 2,500 2,625,000
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$ 3,414,000
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New Zealand - 1.9%
Government of New Zealand, 10s, 2002 NZD 610 $ 359,467
Government of New Zealand, 8s, 2001 - 2004 4,020 2,252,118
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$ 2,611,585
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Panama - 0.4%
Republic of Panama, 8.25s, 2008 $ 530 $ 521,388
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Russia - 0.8%
Ministry of Finance, 10s, 2007 $ 600 $ 541,500
Vnesheconombank, 6.719s, 2015 1,000 647,500
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$ 1,189,000
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South Korea - 0.8%
Republic of Korea, 8.875s, 2008 $ 1,150 $ 1,072,479
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United Kingdom - 2.4%
United Kingdom Treasury, 7s, 2001 GBP 500 $ 837,575
United Kingdom Treasury, 9s, 2008 737 1,510,744
United Kingdom Treasury, 9.75s, 2002 533 988,146
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$ 3,336,465
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Total Foreign Bonds $ 23,312,476
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Total Bonds (Identified Cost, $139,775,189) $140,626,271
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Short-Term Obligation - 2.2%
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Federal Home Loan Mortgage, due 6/01/98,
at Amortized Cost $ 3,050 $ 3,050,000
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Call Option Purchased
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PRINCIPAL AMOUNT
OF CONTRACTS
ISSUER/EXPIRATION MONTH/STRIKE PRICE (000 OMITTED) VALUE
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Japanese Government Bond/June/102.12
(Premiums Paid, $4,999) JPY 72,300 $ 13,089
- --------------------------------------------------------------------------------
Total Investments (Identified Cost, $142,830,188) $143,689,360
- --------------------------------------------------------------------------------
Call Option Written
- --------------------------------------------------------------------------------
Japanese Government Bond/June 104.247
(Premiums Received, $1,111) JPY 72,300 $ (3,832)
- --------------------------------------------------------------------------------
Put Options Written
- --------------------------------------------------------------------------------
Canadian Dollars/July/1.430
(Premiums Received, $5,271) CAD 1,409 $ (18,028)
Japanese Government Bond/August/101.801
(Premiums Received, $797) JPY 36,200 (434)
Japanese Government Bond/August/101.801
(Premiums Received, $850) JPY 36,200 (398)
- --------------------------------------------------------------------------------
Total Options Written $ (22,692)
- --------------------------------------------------------------------------------
Other Assets, Less Liabilities - (3.5)% (4,860,165)
- --------------------------------------------------------------------------------
Net Assets - 100.0% $138,806,503
- --------------------------------------------------------------------------------
Abbreviations have been used throughout this report to indicate amounts shown
in currencies other than the U.S. dollar. A list of abbreviations is shown
below.
CAD = Canadian Dollars ITL = Italian Lira
DEM = Deutsche Marks JPY = Japanese Yen
DKK = Danish Krone NZD = New Zealand Dollars
GBP = British Pounds
See notes to financial statements
<PAGE>
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
- --------------------------------------------------------------------------------
MAY 31, 1998
- --------------------------------------------------------------------------------
Assets:
Investments, at value (identified cost, $142,830,188) $143,689,360
Cash 4,742
Net receivable for forward currency exchange contracts to
sell 13,783
Net receivable for forward foreign currency exchange
contracts sold or subject to master netting agreements 15,329
Receivable for Fund shares sold 106,014
Receivable for investments sold 54,111
Interest receivable 1,471,540
Other assets 3,019
------------
Total assets $145,357,898
------------
Liabilities:
Payable for Fund shares reacquired $ 177,096
Payable for investments purchased 6,129,254
Written options outstanding, at value (premiums received,
$8,029) 22,692
Net payable for forward foreign currency exchange
contracts to purchase 8,706
Payable to affiliates -
Management fee 9,094
Shareholder servicing agent fee 1,283
Distribution and service fee 52,151
Administrative fee 171
Accrued expenses and other liabilities 150,948
------------
Total liabilities $ 6,551,395
------------
Net assets $138,806,503
============
Net assets consist of:
Paid-in capital $143,473,124
Unrealized appreciation on investments and translation of
assets and liabilities in foreign currencies 863,783
Accumulated net realized loss on investments and foreign
currency transactions (6,238,850)
Accumulated undistributed net investment income 708,446
------------
Total $138,806,503
============
Shares of beneficial interest outstanding 16,538,589
==========
Class A shares:
Net asset value per share
(net assets of $39,702,515 / 4,736,462 shares of
beneficial interest outstanding) $8.38
=====
Offering price per share (100 / 95.25) $8.80
=====
Class B shares:
Net asset value and offering price per share
(net assets of $99,098,635 / 11,801,490 shares of
beneficial interest outstanding) $8.40
=====
Class I shares:
Net asset value and offering price per share
(net assets of $5,353 / 637 shares of beneficial
interest outstanding) $8.40
=====
On sales of $100,000 or more, the offering price of Class A shares is reduced. A
contingent deferred sales charge may be imposed on redemptions of Class A and
Class B shares.
See notes to financial statements
<PAGE>
FINANCIAL STATEMENTS -- continued
Statement of Operations
- --------------------------------------------------------------------------------
SIX MONTHS ENDED MAY 31, 1998
- --------------------------------------------------------------------------------
Net investment income:
Interest income $ 5,332,004
-----------
Expenses -
Management fee $ 532,316
Trustees' compensation 22,047
Shareholder servicing agent fee 82,785
Distribution and service fee (Class B) 545,061
Administrative fee 9,428
Printing 37,266
Auditing fees 35,603
Custodian fee 31,887
Postage 15,266
Legal fees 1,373
Miscellaneous 51,649
-----------
Total expenses $ 1,364,681
Fees paid indirectly (8,131)
-----------
Net expenses $ 1,356,550
-----------
Net investment income $ 3,975,454
-----------
Realized and unrealized gain (loss) on investments:
Realized gain (loss) (identified cost basis) -
Investment transactions $(1,835,194)
Written option transactions (120,748)
Foreign currency transactions 1,473,054
Interest rate swaps 18,320
Futures contracts (3,233)
-----------
Net realized loss on investments and foreign
currency transactions $ (467,801)
-----------
Change in unrealized appreciation (depreciation) -
Investments $ 1,685,326
Written options 200,959
Translation of assets and liabilities in
foreign currencies (1,173,817)
Interest rate swaps (32,834)
-----------
Net unrealized gain on investments and
foreign currency translation $ 679,634
-----------
Net realized and unrealized gain on
investments and foreign currency $ 211,833
-----------
Increase in net assets from operations $ 4,187,287
===========
See notes to financial statements
<PAGE>
<TABLE>
FINANCIAL STATEMENTS -- continued
Statement of Changes in Net Assets
- ---------------------------------------------------------------------------------------------------------
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
MAY 31, 1998 NOVEMBER 30, 1997
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Increase (decrease) in net assets:
From operations -
Net investment income $ 3,975,454 $ 9,574,847
Net realized loss on investments and foreign currency
transactions (467,801) (140,628)
Net unrealized gain (loss) on investments and foreign
currency translation 679,634 (3,846,648)
------------ ------------
Increase in net assets from operations $ 4,187,287 $ 5,587,571
------------ ------------
Distributions declared to shareholders -
From net investment income (Class A) $ (1,161,779) $ (1,712,211)
From net investment income (Class B) (3,063,406) (7,829,003)
From net investment income (Class I) (149) (137)
------------ ------------
Total distributions declared to shareholders $ (4,225,334) $ (9,541,351)
------------ ------------
Decrease in net assets from Fund share transactions $(11,426,932) $(38,212,945)
------------ ------------
Total decrease in net assets $(11,464,979) $(42,166,725)
Net assets:
At beginning of period 150,271,482 192,438,207
------------ ------------
At end of period (including accumulated undistributed net
investment income of $708,446 and $958,326, respectively) $138,806,503 $150,271,482
============ ============
See notes to financial statements
</TABLE>
<PAGE>
<TABLE>
FINANCIAL STATEMENTS -- continued
Financial Highlights
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED NOVEMBER 30,
SIX MONTHS ENDED ------------------------------------------------------------------
MAY 31, 1998 1997 1996 1995 1994 1993*
- -------------------------------------------------------------------------------------------------------------------------------
CLASS A
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Per share data (for a share outstanding
throughout each period):
Net asset value - beginning of period $ 8.39 $ 8.57 $ 8.59 $ 7.96 $ 8.94 $ 9.11
------ ------ ------ ------ ------ ------
Income from investment operations# -
Net investment income $ 0.26 $ 0.55 $ 0.55 $ 0.57 $ 0.59 $ 0.11
Net realized and unrealized gain
(loss) on investments and foreign
currency transactions 0.01 (0.18) (0.01) 0.61 (0.95) (0.17)
------ ------ ------ ------ ------ ------
Total from investment operations $ 0.27 $ 0.37 $ 0.54 $ 1.18 $(0.36) $(0.06)
------ ------ ------ ------ ------ ------
Less distributions declared to
shareholders -
From net investment income+++ $(0.28) $(0.55) $(0.56) $(0.55) $ -- $(0.09)
From net realized gain on investments
and foreign currency transactions -- -- -- -- -- (0.02)
Tax return of capital -- -- -- -- (0.62) --
------ ------ ------ ------ ------ ------
Total distributions declared to
shareholders $(0.28) $(0.55) $(0.56) $(0.55) $(0.62) $(0.11)
------ ------ ------ ------ ------ ------
Net asset value - end of period $ 8.38 $ 8.39 $ 8.57 $ 8.59 $ 7.96 $ 8.94
====== ====== ====== ====== ====== ======
Total return(+) 3.30%++ 4.59% 6.61% 15.40% (4.27)% (0.66)%++
Ratios (to average net assets)/
Supplemental data:
Expenses## 1.14%+ 1.17% 1.17% 1.14% 1.18% 1.22%+
Net investment income 6.34%+ 6.63% 6.58% 6.81% 7.10% 6.43%+
Portfolio turnover 106% 226% 288% 275% 211% 376%
Net assets at end of period (000 omitted) $39,703 $30,833 $21,291 $12,659 $3,432 $258
*For the period from the inception of Class A, September 7, 1993, through November 30, 1993.
+Annualized.
++Not annualized.
+++The Fund had distributions in excess of net investment income of $0.003 for the year ended
November 30, 1996.
#Per share data for the periods subsequent to November 30, 1993, are based on average shares outstanding.
##For fiscal years ending after September 1, 1995, the Fund's expenses are calculated without reduction for fees paid indirectly.
(+)Total returns for Class A shares do not include the applicable sales charge. If the charge had been included, the results would
have been lower.
See notes to financial statements
</TABLE>
<PAGE>
<TABLE>
FINANCIAL STATEMENTS -- continued
Financial Highlights - continued
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED NOVEMBER 30,
SIX MONTHS ENDED ------------------------------------------------------------
MAY 31, 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------
CLASS B
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per share data (for a share outstanding
throughout each period):
Net asset value - beginning of period $ 8.40 $ 8.57 $ 8.58 $ 7.96 $ 8.93
------ ------ ------ ------ ------
Income from investment operations# -
Net investment income $ 0.22 $ 0.47 $ 0.46 $ 0.48 $ 0.47
Net realized and unrealized gain (loss) on
investments and foreign currency
transactions 0.01 (0.18) (0.01) 0.61 (0.92)
------ ------ ------ ------ ------
Total from investment operations $ 0.23 $ 0.29 $ 0.45 $ 1.09 $(0.45)
------ ------ ------ ------ ------
Less distributions declared to shareholders -
From net investment income+++ $(0.23) $(0.46) $(0.46) $(0.47) $ --
Tax return of capital -- -- -- -- (0.52)
------ ------ ------ ------ ------
Total distributions declared to
shareholders $(0.23) $(0.46) $(0.46) $(0.47) $(0.52)
------ ------ ------ ------ ------
Net asset value - end of period $ 8.40 $ 8.40 $ 8.57 $ 8.58 $ 7.96
====== ====== ====== ====== ======
Total return 2.82%++ 3.57% 5.52% 14.12% (5.24)%
Ratios (to average net assets)/Supplemental data:
Expenses## 2.14%+ 2.19% 2.24% 2.23% 2.22%
Net investment income 5.27%+ 5.61% 5.47% 5.79% 5.60%
Portfolio turnover 106% 226% 288% 275% 211%
Net assets at end of period (000 omitted) $99,099 $119,436 $171,148 $232,312 $292,619
+Annualized.
++Not annualized.
+++The Fund had distributions in excess of net investment income of $0.003 for the year ended November 30, 1996.
#Per share data for the periods subsequent to November 30, 1993, are based on average shares outstanding.
##For fiscal years ending after September 1, 1995, the Fund's expenses are calculated without reduction for fees paid indirectly.
See notes to financial statements
</TABLE>
<PAGE>
<TABLE>
FINANCIAL STATEMENTS -- continued
Financial Highlights - continued
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED NOVEMBER 30, 1993 1992 1991 1990 1989 1988**
- --------------------------------------------------------------------------------------------------------------------------------
CLASS B
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Per share data (for a share outstanding
throughout each period):
Net asset value - beginning of period $ 8.88 $ 9.31 $ 9.23 $ 9.50 $ 9.77 $ 9.47
------ ------ ------ ------ ------ ------
Income from investment operations# -
Net investment income $ 0.47 $ 0.62 $ 0.58 $ 0.59 $ 0.68 $ 0.35
Net realized and unrealized gain
(loss) on investments and
foreign currency transactions 0.26 (0.26) 0.32 (0.02) (0.08) 0.10
------ ------ ------ ------ ------ ------
Total from investment operations $ 0.73 $ 0.36 $ 0.90 $ 0.57 $ 0.60 $ 0.45
------ ------ ------ ------ ------ ------
Less distributions declared to
shareholders -
From net investment income $(0.45) $(0.57) $(0.56) $(0.45) $(0.85) $(0.12)
From net realized gain on investments
and foreign currency transactions (0.16) (0.15) (0.14) -- (0.02) (0.03)
From paid in capital -- (0.07) (0.12) (0.39) -- --
Tax return of capital (0.07) -- -- -- -- --
------ ------ ------ ------ ------ ------
Total distributions declared
to shareholders $(0.68) $(0.79) $(0.82) $(0.84) $(0.87) $(0.15)
------ ------ ------ ------ ------ ------
Net asset value - end of period $ 8.93 $ 8.88 $ 9.31 $ 9.23 $ 9.50 $ 9.77
====== ====== ====== ====== ====== ======
Total return 8.42% 3.93% 10.30% 6.59% 6.60% 14.21%+
Ratios (to average net assets)/
Supplemental data:
Expenses 2.15% 2.20% 2.24% 2.33% 2.47% 2.79%+
Net investment income 5.19% 6.70% 6.65% 6.80% 7.13% 17.14%+
Portfolio turnover 376% 372% 603% 579% 433% 120%
Net assets at end of period (000 omitted) $466,955 $347,588 $196,753 $126,245 $75,039 $30,858
**For the period from the commencement of the Fund's investment operations, August 1, 1988, through November 30, 1988.
+Annualized.
#Per share data for the periods subsequent to November 30, 1993, are based on average shares outstanding.
See notes to financial statements
</TABLE>
<PAGE>
<TABLE>
FINANCIAL STATEMENTS -- continued
Financial Highlights - continued
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED PERIOD ENDED
MAY 31, 1998 NOVEMBER 30, 1997***
- ---------------------------------------------------------------------------------------------------------------
CLASS I
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Per share data (for a share outstanding throughout each period):
Net asset value - beginning of period $ 8.41 $ 8.43
------ ------
Income from investment operations# -
Net investment income $ 0.28 $ 0.61
Net realized and unrealized loss on investments and foreign
currency transactions (0.01) (0.17)
------ ------
Total from investment operations $ 0.27 $ 0.44
------ ------
Less distributions declared to shareholders from net
investment income $(0.28) $(0.46)
------ ------
Net asset value - end of period $ 8.40 $ 8.41
====== ======
Total return 3.42%++ 5.07%++
Ratios (to average net assets)/Supplemental data:
Expenses## 1.12%+ 1.03%+
Net investment income 6.28%+ 6.52%+
Portfolio turnover 106% 226%
Net assets at end of period (000 omitted) $5 $3
***For the period from the inception of Class I, January 2, 1997, through November 30, 1997.
+Annualized.
++Not annualized.
#Per share data are based on average shares outstanding.
##The Fund's expenses are calculated without reduction for fees paid indirectly.
See notes to financial statements
</TABLE>
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(1) Business and Organization
MFS Intermediate Income Fund (the Fund) is a non-diversified series of MFS
Series Trust II (the Trust). The Trust is organized as a Massachusetts
business trust and is registered under the Investment Company Act of 1940, as
amended, as an open-end management investment company.
(2) Significant Accounting Policies
General - The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Investments in foreign securities are vulnerable to the effects of changes in
the relative values of the local currency and the U.S. dollar and to the
effects of changes in each country's legal, political, and economic
environment.
Investment Valuations - Debt securities (other than short-term obligations
which mature in 60 days or less), including listed issues, forward contracts,
and swap agreements, are valued on the basis of valuations furnished by
dealers or by a pricing service with consideration to factors such as
institutional-size trading in similar groups of securities, yield, quality,
coupon rate, maturity, type of issue, trading characteristics, and other
market data, without exclusive reliance upon exchange or over-the-counter
prices. Short-term obligations, which mature in 60 days or less, are valued at
amortized cost, which approximates market value. Non-U.S. dollar denominated
short-term obligations are valued at amortized cost as calculated in the
foreign currency and translated into U.S. dollars at the closing daily
exchange rate. Futures contracts, options, and options on futures contracts
listed on commodities exchanges are reported at market value using closing
settlement prices. Over-the-counter options on securities are valued by
brokers. Over-the-counter currency options are valued through the use of a
pricing model which takes into account foreign currency exchange spot and
forward rates, implied volatility, and short-term repurchase rates. Securities
for which there are no such quotations or valuations are valued at fair value
as determined in good faith by or at the direction of the Trustees.
Repurchase Agreements - The Fund may enter into repurchase agreements with
institutions that the Fund's investment adviser has determined are
creditworthy. Each repurchase agreement is recorded at cost. The Fund requires
that the securities collateral in a repurchase transaction be transferred to
the custodian in a manner sufficient to enable the Fund to obtain those
securities in the event of a default under the repurchase agreement. The Fund
monitors, on a daily basis, the value of the collateral to ensure that its
value, including accrued interest, is greater than amounts owed to the Fund
under each such repurchase agreement. The Fund, along with other affiliated
entities of Massachusetts Financial Services Company (MFS), may utilize a
joint trading account for the purpose of entering into one or more repurchase
agreements.
Foreign Currency Translation - Investment valuations, other assets, and
liabilities initially expressed in foreign currencies are converted each
business day into U.S. dollars based upon current exchange rates. Purchases and
sales of foreign investments, income, and expenses are converted into U.S.
dollars based upon currency exchange rates prevailing on the respective dates of
such transactions. Gains and losses attributable to foreign currency exchange
rates on sales of securities are recorded for financial statement purposes as
net realized gains and losses on investments. Gains and losses attributable to
foreign exchange rate movements on income and expenses are recorded for
financial statement purposes as foreign currency transaction gains and losses.
That portion of both realized and unrealized gains and losses on investments
that results from fluctuations in foreign currency exchange rates is not
separately disclosed.
Written Options - The Fund may write call or put options in exchange for a
premium. The premium is initially recorded as a liability which is
subsequently adjusted to the current value of the options contract. When a
written option expires, the Fund realizes a gain equal to the amount of the
premium received. When a written call option is exercised or closed, the
premium received is offset against the proceeds to determine the realized gain
or loss. When a written put option is exercised, the premium reduces the cost
basis of the security purchased by the Fund. The Fund, as writer of an option,
may have no control over whether the underlying securities may be sold (call)
or purchased (put) and, as a result, bears the market risk of an unfavorable
change in the price of the securities underlying the written option. In
general, written call options may serve as a partial hedge against decreases
in value in the underlying securities to the extent of the premium received.
Written options may also be used as part of an income producing strategy
reflecting the view of the Fund's management on the direction of interest
rates.
Futures Contracts - The Fund may enter into futures contracts for the delayed
delivery of securities or currency, or contracts based on financial indices at
a fixed price on a future date. In entering such contracts, the Fund is
required to deposit with the broker either in cash or securities an amount
equal to a certain percentage of the contract amount. Subsequent payments are
made or received by the Fund each day, depending on the daily fluctuations in
the value of the contract, and are recorded for financial statement purposes
as unrealized gains or losses by the Fund. The Fund's investment in futures
contracts is designed to hedge against anticipated future changes in interest
or exchange rates or securities prices. Investments in interest rate futures
for purposes other than hedging may be made to modify the duration of the
portfolio without incurring the additional transaction costs involved in
buying and selling the underlying securities. Investments in currency futures
for purposes other than hedging may be made to change the Fund's relative
position in one or more currencies without buying and selling portfolio
assets. Investments
in equity index contracts or contracts on related options for purposes other
than hedging, may be made when the Fund has cash on hand and wishes to
participate in anticipated market appreciation while the cash is being
invested. Should interest or exchange rates or securities prices move
unexpectedly, the Fund may not achieve the anticipated benefits of the futures
contracts and may realize a loss.
Forward Foreign Currency Exchange Contracts - The Fund may enter into forward
foreign currency exchange contracts for the purchase or sale of a specific
foreign currency at a fixed price on a future date. Risks may arise upon
entering into these contracts from the potential inability of counterparties
to meet the terms of their contracts and from unanticipated movements in the
value of a foreign currency relative to the U.S. dollar. The Fund will enter
into forward contracts for hedging purposes as well as for non-hedging
purposes. For hedging purposes, the Fund may enter into contracts to deliver
or receive foreign currency it will receive from or require for its normal
investment activities. The Fund may also use contracts in a manner intended to
protect foreign currency-denominated securities from declines in value due to
unfavorable exchange rate movements. For non-hedging purposes, the Fund may
enter into contracts with the intent of changing the relative exposure of the
Fund's portfolio of securities to different currencies to take advantage of
anticipated changes. The forward foreign currency exchange contracts are
adjusted by the daily exchange rate of the underlying currency and any gains
or losses are recorded as unrealized until the contract settlement date. On
contract settlement date, the gains or losses are recorded as realized gains
or losses on foreign currency transactions.
Swap Agreements - The Fund may enter into swap agreements. A swap is an
exchange of cash payments between the Fund and another party which is based on
a specific financial index. Cash payments are exchanged at specified intervals
and the expected income or expense is recorded on the accrual basis. The value
of the swap is adjusted daily and the change in value is recorded as
unrealized appreciation or depreciation. Risks may arise upon entering into
these agreements from the potential inability of counterparties to meet the
terms of their contract and from unanticipated changes in the value of the
financial index on which the swap agreement is based. The Fund uses swaps for
both hedging and non-hedging purposes. For hedging purposes, the Fund may use
swaps to reduce its exposure to interest and foreign exchange rate
fluctuations. For non-hedging purposes, the Fund may use swaps to take a
position on anticipated changes in the underlying financial index.
Investment Transactions and Income - Investment transactions are recorded on
the trade date. Interest income is recorded on the accrual basis. All premium
and discount is amortized or accreted for financial statement and tax
reporting purposes as required by federal income tax regulations. Interest
payments received in additional securities are recorded on the ex-interest
date in an amount equal to the value of the security on such date. Some
securities may be purchased on a "when-issued" or "forward delivery" basis,
which means that the securities will be delivered to the Fund at a future
date, usually beyond customary settlement time.
Fees Paid Indirectly - The Fund's custody fee is calculated as a percentage of
the Fund's average daily net assets. The fee is reduced according to an
arrangement that measures the value of cash deposited with the custodian by
the Fund. This amount is shown as a reduction of expenses on the Statement of
Operations.
Tax Matters and Distributions - The Fund's policy is to comply with the
provisions of the Internal Revenue Code (the Code) applicable to regulated
investment companies and to distribute to shareholders all of its taxable
income, including any net realized gain on investments. Accordingly, no
provision for federal income or excise tax is provided. The Fund files a tax
return annually using tax accounting methods required under provisions of the
Code, which may differ from generally accepted accounting principles, the
basis on which these financial statements are prepared. Accordingly, the
amount of net investment income and net realized gain reported on these
financial statements may differ from that reported on the Fund's tax return
and, consequently, the character of distributions to shareholders reported in
the financial highlights may differ from that reported to shareholders on Form
1099-DIV. Distributions to shareholders are recorded on the ex-dividend date.
The Fund distinguishes between distributions on a tax basis and a financial
reporting basis and requires that only distributions in excess of tax basis
earnings and profits are reported in the financial statements as a tax return
of capital. Differences in the recognition or classification of income between
the financial statements and tax earnings and profits, which result in
temporary over-distributions for financial statement purposes are classified
as distributions in excess of net investment income or net realized gains.
At November 30, 1997, the Fund, for federal income tax purposes, had a capital
loss carryforward of $5,700,141 which may be applied against any net taxable
realized gains of each succeeding year until the earlier of its utilization or
expiration on November 30, 2002, ($4,226,362) and November 30, 2005,
($1,473,779).
Multiple Classes of Shares of Beneficial Interest - The Fund offers multiple
classes of shares, which differ in their respective distribution and service
fees. All shareholders bear the common expenses of the Fund based on average
daily net assets of each class, without distinction between share classes.
Dividends are declared separately for each class. No class has preferential
dividend rights; differences in per share dividend rates are generally due to
differences in separate class expenses. Class B shares will convert to Class A
shares approximately eight years after purchase.
(3) Transactions with Affiliates
Investment Adviser - The Fund has an investment advisory agreement with
Massachusetts Financial Services Company (MFS) to provide overall investment
advisory and administrative services, and general office facilities. The
management fee is computed daily and paid monthly at an annual rate of 0.32%
of average daily net assets and 5.65% of investment income.
Administrator - The Fund has an administrative services agreement with MFS to
provide the Fund with certain financial, legal, shareholder servicing,
compliance, and other administrative services. As a partial reimbursement for
the cost of providing these services, the Fund pays MFS an administrative fee
at the following annual percentages of the Fund's average daily net assets:
First $1 billion 0.0150%
Next $1 billion 0.0125%
Next $1 billion 0.0100%
In excess of $3 billion 0.0000%
The Fund pays no compensation directly to its Trustees who are officers of the
investment adviser, or to officers of the Fund, all of whom receive
remuneration for their services to the Fund from MFS. Certain officers and
Trustees of the Fund are officers or directors of MFS, MFS Fund Distributors,
Inc. (MFD), and MFS Service Center, Inc. (MFSC). The Fund has an unfunded
defined benefit plan for all of its independent Trustees and Mr. Bailey.
Included in Trustees' compensation is a net periodic pension expense of $6,019
for the period ended May 31, 1998.
Distributor - MFD, a wholly owned subsidiary of MFS, as distributor, received
$12,705 for the period ended May 31, 1998, as its portion of the sales charge
on sales of Class A shares of the Fund.
The Trustees have adopted a distribution plan for Class A shares and Class B
shares pursuant to Rule 12b-1 of the Investment Company Act of 1940 as
follows:
The Fund's distribution plan provides that the Fund will pay MFD up to 0.35%
per annum of its average daily net assets attributable to Class A shares in
order that MFD may pay expenses on behalf of the Fund related to the
distribution and servicing of its shares. These expenses include a service fee
paid to each securities dealer that enters into a sales agreement with MFD of
up to 0.25% per annum of the Fund's average daily net assets attributable to
Class A shares which are attributable to that securities dealer and a
distribution fee to MFD of up to 0.10% per annum of the Fund's average daily
net assets attributable to Class A shares. Payments of up to 0.25% per annum
of the service fee will commence under the distribution plan when the value of
the net assets of the fund attributable to Class A shares first equals or
exceeds $40 million. Payments of the 0.10% per annum Class A distribution fee
will commence on such date as the Trustees of the Fund may determine.
The Fund's distribution plan provides that the Fund will pay MFD a
distribution fee of 0.75% per annum, and a service fee of up to 0.25% per
annum, of the Fund's average daily net assets attributable to Class B shares.
MFD will pay to securities dealers that enter into a sales agreement with MFD
all or a portion of the service fee attributable to Class B shares. The
service fee is intended to be consideration for services rendered by the
dealer with respect to Class B shares. MFD retains the service fee for
accounts not attributable to a securities dealer, which amounted to $23,029
for Class B shares for the period ended May 31, 1998. Fees incurred under the
distribution plan during the period ended May 31, 1998, were 1.00% of average
daily net assets attributable to Class B shares on an annualized basis.
Certain Class A shares are subject to a contingent deferred sales charge in
the event of a shareholder redemption within 12 months following purchase. A
contingent deferred sales charge is imposed on shareholder redemptions of
Class B shares in the event of a shareholder redemption within six years of
purchase. MFD receives all contingent deferred sales charges. Contingent
deferred sales charges imposed during the period ended May 31, 1998, were
$45,454 for Class B shares.
Shareholder Servicing Agent - MFSC, a wholly owned subsidiary of MFS, earns a
fee for its services as shareholder servicing agent. The fee is calculated as a
percentage of the Fund's average daily net assets at an effective annual rate of
0.1125%. Prior to January 1, 1998, the fee was calculated as a percentage of the
average daily net assets at an effective annual rate of up to 0.13%.
(4) Portfolio Securities
Purchases and sales of investments, other than purchased option transactions
and short-term obligations, were as follows:
<TABLE>
<CAPTION>
t PURCHASES SALES
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
U.S. government securities $114,269,582 $115,307,314
------------ ------------
Investments (non-U.S. government securities) $ 34,624,027 $ 37,757,213
------------ ------------
</TABLE>
The cost and unrealized appreciation or depreciation in value of the
investments owned by the Fund, as computed on a federal income tax basis, are
as follows:
<TABLE>
<S> <C>
Aggregate cost $142,830,188
------------
Gross unrealized appreciation $ 2,132,646
Gross unrealized depreciation (1,273,474)
------------
Net unrealized appreciation $ 859,172
============
</TABLE>
(5) Shares of Beneficial Interest
The Fund's Declaration of Trust permits the Trustees to issue an unlimited
number of full and fractional shares of beneficial interest (without par
value). Transactions in Fund shares were as follows:
<TABLE>
Class A Shares
<CAPTION>
PERIOD ENDED MAY 31, 1998 YEAR ENDED NOVEMBER 30, 1997
---------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Shares sold 1,484,033 $ 12,460,042 2,190,188 $ 18,397,180
Shares issued to shareholders in
reinvestment of distributions 94,364 789,247 137,190 1,147,221
Shares transferred to Class I -- -- (6) (50)
Shares reacquired (516,665) (4,332,978) (1,135,882) (9,537,169)
---------- ------------ ---------- ------------
Net increase 1,061,732 $ 8,916,311 1,191,490 $ 10,007,182
========== ============ ========== ============
</TABLE>
<TABLE>
Class B Shares
<CAPTION>
PERIOD ENDED MAY 31, 1998 YEAR ENDED NOVEMBER 30, 1997
---------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Shares sold 526,904 $ 4,434,666 957,831 $ 8,034,482
Shares issued to shareholders in
reinvestment of distributions 200,023 1,676,798 503,589 4,220,638
Shares reacquired (3,145,863) (26,457,187) (7,200,752) (60,478,128)
---------- ------------ ---------- ------------
Net decrease (2,418,936) $(20,345,723) (5,739,332) $(48,223,008)
========== ============ ========== ============
</TABLE>
<TABLE>
Class I Shares
<CAPTION>
PERIOD ENDED MAY 31, 1998 YEAR ENDED NOVEMBER 30, 1997
---------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Shares sold 392 $ 3,305 675 $ 5,663
Shares issued to shareholders in
reinvestment of distributions 17 147 16 136
Shares transferred from Class A -- -- 6 50
Shares reacquired (115) (972) (354) (2,968)
---------- ------------ ---------- ------------
Net increase 294 $ 2,480 343 $ 2,881
========== ============ ========== ============
</TABLE>
(6) Line of Credit
The Fund and other affiliated funds participate in a $805 million unsecured line
of credit provided by a syndication of banks under a line of credit agreement.
Borrowings may be made to temporarily finance the repurchase of Fund shares.
Interest is charged to each fund, based on its borrowings, at a rate equal to
the bank's base rate. In addition, a commitment fee, based on the average daily
unused portion of the line of credit, is allocated among the participating funds
at the end of each quarter. The commitment fee allocated to the Fund for the
period ended May 31, 1998 was $303.
(7) Financial Instruments
The Fund trades financial instruments with off-balance-sheet risk in the
normal course of its investing activities in order to manage exposure to
market risks such as interest rates and foreign currency exchange rates. These
financial instruments include written options, forward foreign currency
exchange contracts, swap agreements, and futures contracts. The notional or
contractual amounts of these instruments represent the investment the Fund has
in particular classes of financial instruments and does not necessarily
represent the amounts potentially subject to risk. The measurement of the
risks associated with these instruments is meaningful only when all related
and offsetting transactions are considered.
<TABLE>
Written Option Transactions
<CAPTION>
1998 CALLS 1998 PUTS
------------------------------------ -------------------------------------
PRINCIPAL AMOUNTS PRINCIPAL AMOUNTS
OF CONTRACTS OF CONTRACTS
(000 OMITTED) PREMIUMS (000 OMITTED) PREMIUMS
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Outstanding, beginning of period 7,499 $ 52,297 -- $ --
Options written
Canadian Dollars -- -- 1,409 5,271
Deutsche Marks -- -- 3,692 21,224
Japanese Government Bond 72,300 1,111 144,700 4,091
Options terminated in closing transactions
Deutsche Marks -- -- (3,692) (21,224)
Japanese Government Bond -- -- (72,300) (2,444)
SwissFranc/Deutsche Marks (7,499) (52,297) -- --
------- -------- -------- --------
Options expired
Outstanding, end of period 72,300 $ 1,111 73,809 $ 6,918
------- -------- -------- --------
Options outstanding at end of
period consist of:
Japanese Government Bond 72,300 $ 1,111 72,400 $ 1,647
Canadian Dollars -- -- 1,409 5,271
------- -------- -------- --------
</TABLE>
At May 31, 1998, the Fund had sufficient cash and/or securities at least equal
to the value of the written options.
<TABLE>
Forward Foreign Currency Exchange Contracts
<CAPTION>
NET UNREALIZED
CONTRACTS TO CONTRACTS APPRECIATION
SETTLEMENT DATE DELIVER/RECEIVE IN EXCHANGE FOR AT VALUE (DEPRECIATION)
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Sales 9/25/98 DKK 8,090,149 1,190,428 $1,195,357 $(4,928)
9/25/98 JPY 54,123,513 415,647 396,937 18,711
--------- ---------- -------
1,606,075 $1,592,294 $13,783
Purchases 9/25/98 CAD 842,579 588,628 $ 579,921 $(8,706)
--------- ---------- -------
588,628 $ 579,921 $(8,706)
</TABLE>
Forward foreign currency purchases and sales under master netting agreements
excluded above amounted to a net receivable of $1,362 with Banker's Trust,
$619 with Deutschebank and $13,348 with Merrill Lynch at May 31, 1998.
At May 31, 1998, the Fund had sufficient cash and/or securities to cover any
commitments under these contracts.
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Trustees of MFS Series Trust II and Shareholders of MFS Intermediate
Income Fund:
We have audited the accompanying statement of assets and liabilities,
including the portfolio of investments, of MFS Intermediate Income Fund (one
of the series constituting MFS Series Trust II) as of May 31, 1998, the
related statement of operations for the six months then ended, the statement
of changes in net assets for the six months ended May 31, 1998 and the year
ended November 30, 1997, and the financial highlights for the six months ended
May 31, 1998 and for each of the years in the ten-year period ended November
30, 1997. 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 the securities owned at May
31, 1998 by correspondence with the custodian and brokers; where replies were
not received from brokers, we performed other auditing procedures. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of MFS Intermediate
Income Fund at May 31, 1998, the results of its operations, the changes in its
net assets, and its financial highlights for the respective stated periods in
conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Boston, Massachusetts
July 10, 1998
<PAGE>
<TABLE>
MFS(R) INTERMEDIATE INCOME FUND
<S> <C>
Trustees Secretary
Richard B. Bailey* - Private Investor; Former Stephen E. Cavan*
Chairman and Director (until 1991), MFS
Investment Management Assistant Secretary
James R. Bordewick, Jr.*
Marshall N. Cohan - Private Investor
Custodian
Lawrence H. Cohn, M.D. - Chief of Cardiac State Street Bank and Trust Company
Surgery, Brigham and Women's Hospital; Professor
of Surgery, Harvard Medical School Auditors
Deloitte & Touche LLP
The Hon. Sir J. David Gibbons, KBE - Chief
Executive Officer, Edmund Gibbons Ltd.; Investor Information For MFS stock and bond
Chairman, Colonial Insurance Company, Ltd. market outlooks, call toll free: 1-800-637-4458
anytime from a touch-tone telephone.
Abby M. O'Neill - Private Investor
For information on MFS mutual funds, call your
Walter E. Robb, III - President and Treasurer, financial adviser or, for an information kit,
Benchmark Advisors, Inc. (corporate financial call toll free: 1-800-637-2929 any business day
consultants); President, Benchmark Consulting from 9 a.m. to 5 p.m. Eastern time (or leave a
Group, Inc. (office services) message anytime).
Arnold D. Scott* - Senior Executive Investor Service
Vice President, Director, and Secretary, MFS Service Center, Inc.
MFS Investment Management P.O. Box 2281
Boston, MA 02107-9906
Jeffrey L. Shames* - Chairman, Chief
Executive Officer, and Director, For general information, call toll free:
MFS Investment Management 1-800-225-2606 any business day from
8 a.m. to 8 p.m. Eastern time.
J. Dale Sherratt - President, Insight Resources,
Inc. (acquisition planning specialists) For service to speech- or hearing-impaired, call
toll free: 1-800-637-6576 any business day from 9
Ward Smith - Former Chairman (until 1994), NACCO a.m. to 5 p.m. Eastern time. (To use this
Industries (holding company) service, your phone must be equipped with a
Telecommunications Device for the Deaf.) For
Investment Adviser share prices, account balances, and exchanges,
Massachusetts Financial Services Company call toll free: 1-800-MFS-TALK (1-800-637-8255)
500 Boylston Street anytime from a touch-tone telephone.
Boston, MA 02116-3741
World Wide Web
Distributor www.mfs.com
MFS Fund Distributors, Inc.
500 Boylston Street [Dalbar Logo] For the fourth year in a row,
Boston, MA 02116-3741 MFS earned a #1 ranking in the
DALBAR, Inc. Broker/Dealer
Portfolio Managers Survey, Main Office Operations
Steven E. Nothern* Service Quality Category. The
Christopher D. Piros* firm achieved a 3.42 overall
score on a scale of 1 to 4 in
Treasurer the 1997 survey. A total of 111 firms responded,
W. Thomas London* offering input on the quality of service they
received from 29 mutual fund companies
Assistant Treasurers nationwide. The survey contained questions about
Mark E. Bradley* service quality in 11 categories, including
Ellen Moynihan* "knowledge of operations contact," "keeping you
James O. Yost* informed," and "ease of doing business" with the
firm.
*Affiliated with the Investment Adviser
</TABLE>
<PAGE>
-----------------
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INCOME FUND U.S. Postage
Paid
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INVESTMENT MANAGEMENT -----------------
We invented the mutual fund(SM)
500 Boylston Street
Boston, MA 02116-3741
[DALBAR LOGO]
(C)1998 MFS Fund Distributors, Inc., 500 Boylston Street, Boston, MA 02116-3741
MII-3 7/98 19M 05/205/805
