<PAGE>
SKYLINE FUNDS
SKYLINE SPECIAL EQUITIES PORTFOLIO
INVESTING IN SMALL-SIZED COMPANIES
- ------------------------------STRATEGY
- Value orientation - low price/earnings ratio-
20% plus discount to the market
- Attention to growth - forecasted EPS growth in
the 10% to 20% range
- Focus on "neglected" companies - limited
Wall Street research coverage
- Market cap range of $100 million to $700 million
SEPTEMBER 30, 1997
<PAGE>
LETTER FROM WILLIAM M. DUTTON, PORTFOLIO MANAGER: (1)
- --------------------------------------------------------------------------------
October 14, 1997
Dear Shareholder:
We are pleased to report that the Fund showed a gain of 15.68% for the
third quarter, bringing the year-to-date return to 41.35%. This compares to the
Russell 2000 Index return of 14.88% for the third quarter and 26.60% for the
first nine months of 1997. The net asset value closed the period at $25.67 per
share. The strong results can be attributed to two main factors. First, the
economy has been quite strong, enabling many companies to show strong financial
results. Second, our stock selection has been particularly good in 1997, with
many stocks showing large gains and few issues having significant problems.
The big news of the third quarter was the outperformance of small cap
stocks compared to large cap stocks. Following a three-year period of relative
underperformance, small cap stocks easily beat large cap stocks, with the
Russell 2000 Index posting a 14.9% gain compared to a 7.6% gain for the
S&P 500 Index. In our opinion, this performance reversal occurred because of
superior relative valuation and superior earnings growth. At the start of this
move by small caps in May of 1997, the Russell 2000 Index was trading at
extremely low valuation levels relative to the S&P 500 Index. This set the stage
for a small cap rally when small companies started reporting better earnings
growth than large companies.
The Fund performed well in the quarter despite sector weightings that
disadvantaged the Fund, most notably a low weighting in technology stocks, one
of the strongest sectors in the market. The Fund benefited from strong stock
selection, including very few problem stocks, and better than expected economic
growth. An important theme in the Fund is one of "restructuring," whereby a new
CEO makes changes at a company that has been underperforming in order to enhance
profitability. The restructuring theme has been quite successful for Skyline
over the past year and continues to be an important source of new ideas for the
Fund.
We believe it is possible that small cap stocks could be at the start of an
extended period of outperformance. There are signs that small companies are
showing improvement in business fundamentals after underperforming large
companies for several years. If this trend continues, small stocks could show
powerful absolute and relative performance. Other positives include attractive
relative valuation levels and the increase in the value of the U.S. dollar,
which tends to hurt the financial results of large companies. Therefore, we are
optimistic about the outlook of small cap investing.
/s/ William M. Dutton
PORTFOLIO CHARACTERISTICS(1)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SPECIAL
EQUITIES RUSSELL 2000 S&P 500
<S> <C> <C> <C>
P/E RATIO (MEDIAN) 19.2 23.9 21.6
PRICE/BOOK 2.51 2.98 3.97
PRICE/SALES 0.91 1.53 1.64
- -------------------------------------------------------------------------------------------
EPS GROWTH CURRENT FISCAL 19.9% 21.5% 14.1%
YEAR AVERAGE
- --------------------------------------------------------------------------------------------
MARKET CAP $ WGHTD. MED. $430 million $750 million $35 billion
PORTFOLIO VALUE $462 million $907 billion $7,336 billion
NUMBER OF HOLDINGS 78 1,950 500
- --------------------------------------------------------------------------------------------
TICKER SYMBOL: SKSEX INITIAL INVESTMENT: $1,000
CUSIP #: 830833208 SUBSEQUENT INVESTMENT: $100
</TABLE>
<PAGE>
PERFORMANCE (%)(1)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Qtr 3 YTD Since
1997 1997 1 yr. 3 yrs. 5 yrs. 10 yrs. Inception(2)
<S> <C> <C> <C> <C> <C> <C> <C>
SPECIAL EQUITIES 15.68 41.35 54.40 27.40 25.51 19.64 19.61
RUSSELL 2000 14.88 26.60 33.19 22.96 20.51 12.23 12.38
S&P 500 7.61 29.70 40.67 30.02 20.83 14.72 15.47
</TABLE>
<TABLE>
<CAPTION>
Calendar Years
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987(2)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
SPECIAL EQUITIES 30.4 13.8 (1.2) 22.9 42.5 47.4 (9.3) 24.0 29.7 (16.9)
RUSSELL 2000 16.5 28.4 (1.8) 18.9 18.4 46.1 (19.5) 16.2 24.9 (24.3)
S&P 500 23.3 37.5 1.3 10.0 7.7 30.6 (3.2) 31.4 16.5 (12.0)
</TABLE>
SECTOR WEIGHTINGS (AS OF SEPTEMBER 30, 1997)
- -------------------------------------------------------------------------------
Cash 10.2%
Autos & Transportation 11.3%
Consumer Discretionary 26.1%
Consumer Staples 0.3%
Energy 4.7%
Financial Services 16.9%
Health Care 4.0%
Materials & Processing 14.4%
Producer Durables 10.1%
Technology 2.0%
<TABLE>
<CAPTION>
SECTOR PERFORMANCE (AS OF SEPTEMBER 30, 1997)
- --------------------------------------------------------------------------------------
3Q 1997 YEAR TO DATE
----------------------- ----------------------
SPECIAL RUSSELL SPECIAL RUSSELL
EQUITIES 2000 EQUITIES 2000
<S> <C> <C> <C> <C>
ENERGY 36.2% 32.0% 48.2% 36.3%
PRODUCER DURABLES 22.4 19.1 63.7 39.3
HEALTH CARE 19.6 14.4 25.7 18.8
MATERIALS & PROCESSING 18.1 12.7 50.5 22.0
CONSUMER DISCRETIONARY 16.0 10.7 44.3 25.6
FINANCIAL SERVICES 14.8 13.1 47.8 28.5
AUTOS & TRANSPORTATION 10.9 13.9 20.9 35.5
TECHNOLOGY 4.5 20.8 58.7 20.7
UTILITIES 0.0 11.8 23.7 19.3
OTHER 0.0 9.6 0.0 30.6
CONSUMER STAPLES (8.8) 13.1 (29.5) 34.8
</TABLE>
<PAGE>
STOCK HIGHLIGHTS(3)
- --------------------------------------------------------------------------------
DISCOUNT AUTO PARTS (DAP)
Discount Auto Parts operates a chain of retail stores for the do-it-yourself
(DIY) market in the Southeast, with most of its stores in Florida. The company
had a strong record of growing its DIY business until last year when the firm
chose to saturate its existing markets with new stores. This strategy
temporarily depressed same-store revenue growth and margins but should provide
formidable barriers to potential competition in the Florida market. With the
recent exit of financially troubled competitors from Discount Auto's markets,
same-store DIY sales and margins are poised to improve and propel earnings
higher at a 15%-20% rate for the next few years. In addition, the company is
implementing a low-cost strategy to enter the professional market by utilizing
its existing infrastructure, which could boost earnings beyond our expectations.
Despite the outlook for healthy growth, DAP sells at a multiple well below the
market and its peers.
INTERMET (INMT)
Intermet's core business is the manufacture of precision metal castings for
automotive and industrial customers. The company was revitalized when a new CEO
took the helm in 1994 and focused on improving productivity. Since then, margins
have expanded significantly, driving a large increase in earnings. Despite the
progress made to date, Intermet still has plenty of room to increase earnings.
For the first time in several years, Intermet has a backlog of new business that
will drive revenue growth in 1998 and 1999, assuming Intermet's end markets
remain strong. In addition, margins should continue to expand. This combination
of revenue growth and increased profitability per dollar of revenue should drive
earnings much higher in each of the next two years. The stock is trading at very
low valuations, providing the potential for very strong stock price performance.
TOP TEN HOLDINGS % OF NET ASSETS
- --------------------------------------------------------------------------------
FURON COMPANY
Polymer-based products 2.5%
ALLIED GROUP, INC.
Personal lines insurance 2.0%
MAGNETEK, INC.
Integrated electrical products 1.9%
APPLIED INDUSTRIAL TECHNOLOGIES, INC.
Industrial products distributor 1.9%
DELPHI FINANCIAL GROUP, INC.
Accident & health insurance 1.8%
IHOP CORP.
Restaurant operator 1.8%
GENERAL CABLE CORP.
Wire & cable producer 1.7%
INTERPOOL, INC.
Container leasing firm 1.7%
AMERICAN HERITAGE LIFE INVESTMENT
Life insurance firm 1.7%
CITATION CORP.
Castings manufacturer 1.7%
TOP TEN HOLDINGS 18.7%
<PAGE>
(1) The performance for the one, three, five, and ten years ended September 30,
1997, and for the period April 23, 1987 (inception) through September 30,
1997, is an average annual total return calculation which is described in
the Funds' prospectus. Of course, past performance is no guarantee of
future results. The principal value and return on your investment will
fluctuate and on redemption may be worth more or less than your original
cost.
The Russell 2000 Index is an unmanaged, market value weighted index
comprised of small-sized companies. The S&P 500 Index, a widely quoted
stock market index, includes 500 of the largest companies publicly traded
in America. All figures take into account reinvested dividends. All indexes
and portfolio characteristics are compiled by Frank Russell Company.
Sources: Lipper Analytical Services & Frank Russell Company.
(2) Return is calculated from the Fund's inception on April 23, 1987.
(3) Fund holdings are subject to change and should not be considered a
recommendation to buy individual securities.
This report is not authorized for distribution unless accompanied or preceded by
a current prospectus.
There are risks of investing in a fund of this type which invests in stocks of
small companies, which tend to be more volatile and less liquid than stocks of
large companies.
Distributor: Funds Distributor Inc.
- --------------------------------------------------------------------------------
For 24-hour account information and prices call: 1.800.828.2SKY
To speak with a Skyline Funds Representative
during normal business hours call: 1.800.458.5222
SKYLINE FUNDS
311 South Wacker Dr.
Suite 4500
Chicago, Illinois 60606
<PAGE>
SKYLINE FUNDS
SKYLINE SPECIAL EQUITIES II
INVESTING IN SMALL-SIZED COMPANIES
- -------------------------------STRATEGY
- Value orientation - discounted price/earnings
ratio relative to the market
- Attention to growth - forecasted EPS growth
generally more than 15%
- Focus on "neglected" companies - limited
Wall Street research coverage
- Market cap range of $400 million to $2 billion
SEPTEMBER 30, 1997
<PAGE>
LETTER FROM KENNETH S. KAILIN, PORTFOLIO MANAGER:(1)
- -------------------------------------------------------------------------------
October 14, 1997
Dear Shareholder:
For the three-month period ending September 30, 1997, stock market returns
remained generally vibrant, reflecting almost perfect economic conditions. The
Fund advanced 14.62% during the quarter, basically matching the Russell 2000
Index, a widely quoted small company index. The Fund performed quite well as
compared to the average U.S. stock fund which returned 11.82% in the third
quarter. The net asset value closed the period at $15.60 per share. For the
twelve-month period ending September 30, 1997, the Fund returned 43.98% as
compared to 33.19% for the Russell 2000 Index and 32.59% for the average U.S.
stock fund. The Fund has clearly produced outstanding returns by almost any
measure during the past year.
While the return for the Fund during the quarter nearly matched the
performance of the Russell 2000 Index, the results by broad sector groups tell a
different story. The Fund was heavily weighted in financial, consumer, and to a
lesser degree, producer durable stocks. While the Fund's selection of financial
and consumer issues was highly successful overall, this outperformance was
offset by relative underperformance in producer durables, materials and
processing, and health care stocks. Although the underperformance of these few
sectors was unfortunate, the future relative performance potential of these
sectors is strong. The majority of these stocks sell at a discount to the market
and we expect them to experience healthy near-term profit growth. Energy and
technology stocks produced the best Fund sector returns in the quarter, while
the only sector with a negative return was health care, which was down about 1%.
As we have noted in the past, stock prices are high by most valuation
measures, and the returns investors have witnessed in the past few years are not
likely to continue forever. However, the backdrop of an almost perfect economy
should allow corporate America to continue to produce solid profit gains. If
inflation expectations stay moderate and the economy continues to grow slowly,
stock prices are likely to follow suit. Almost all indicators presently point
toward a continuation of a volatile, but upward, stock market. As always,
conditions can and do change rapidly. We remain upbeat regarding the long-term
outlook for smaller stocks and the Fund's future prospects.
/s/ Kenneth S. Kailin
PORTFOLIO CHARACTERISTICS(1)
- --------------------------------------------------------------------------------
SPECIAL
EQUITIES II RUSSELL 2000
P/E RATIO (MEDIAN) 19.2 23.9
PRICE/BOOK 2.84 2.98
PRICE/SALES 1.04 1.53
- --------------------------------------------------------------------------------
EPS GROWTH CURRENT FISCAL 20.0% 21.5%
YEAR AVERAGE
- --------------------------------------------------------------------------------
MARKET CAP $ WGHTD. MED. $900 million $750 million
PORTFOLIO VALUE $170 million $907 billion
NUMBER OF HOLDINGS 53 1,950
- --------------------------------------------------------------------------------
TICKER SYMBOL: SPEQX INITIAL INVESTMENT: $1,000
CUSIP #: 830833406 SUBSEQUENT INVESTMENT: $100
<PAGE>
PERFORMANCE (%)(1)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Calendar Years
Qtr 3 YTD Since --------------------------------------
1997 1997 1 yr. 3 yrs. Inception(2) 1996 1995 1994 1993(2)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
SPECIAL EQUITIES II 14.62 30.65 43.98 24.33 18.15 26.6 21.0 (1.5) 10.1
RUSSELL 2000 14.88 26.60 33.19 22.96 17.52 16.5 28.4 (1.8) 13.8
</TABLE>
SECTOR WEIGHTINGS (AS OF SEPTEMBER 30, 1997)
- --------------------------------------------------------------------------------
Autos & Transportation 3.9%
Cash 4.9%
Technology 8.3%
Producer Durables 13.7%
Consumer Discretionary 24.5%
Materials & Processing 6.4%
Energy 7.2%
Health Care 5.4%
Financial Services 25.7%
<TABLE>
<CAPTION>
SECTOR PERFORMANCE (AS OF SEPTEMBER 30, 1997)
- --------------------------------------------------------------------------------
3Q 1997 YEAR TO DATE
----------------------- --------------------------
SPECIAL RUSSELL SPECIAL RUSSELL
EQUITIES II 2000 EQUITIES II 2000
<S> <C> <C> <C> <C>
ENERGY 41.1% 32.0% 33.5% 36.3%
TECHNOLOGY 21.4 20.8 45.7 20.7
CONSUMER DISCRETIONARY 16.7 10.7 37.5 25.6
FINANCIAL SERVICES 15.6 13.1 38.3 28.5
AUTOS & TRANSPORTATION 14.4 13.9 33.0 35.5
PRODUCER DURABLES 13.4 19.1 30.3 39.3
MATERIALS & PROCESSING 5.9 12.7 1.6 22.0
UTILITIES 0.0 11.8 22.4 19.3
OTHER 0.0 9.6 0.0 30.6
CONSUMER STAPLES 0.0 13.1 (9.8) 34.8
HEALTH CARE (1.2) 14.4 31.8 18.8
</TABLE>
<PAGE>
STOCK HIGHLIGHTS(3)
- --------------------------------------------------------------------------------
CDI CORP. (CDI)
CDI Corp. is a leading provider of professional and technical personnel on a
project/temporary basis. CDI is benefiting from the powerful trends of
downsizing and outsourcing, as large corporations rely on temporary employees to
perform more and more duties. CDI's new CEO, Mitch Wienick, has assembled a new
management team that has revitalized the company to focus on the rapidly growing
area of information technology employment which encompasses many computer and
telecommunication services. CDI's earnings growth should accelerate as
management's strategy is implemented. Additionally, CDI trades at a significant
discount to its peers and is generally neglected by Wall Street.
SANTA FE ENERGY RESOURCES, INC. (SFR)
Santa Fe Energy Resources, Inc. is an independent oil and gas exploration
company operating throughout the world. In July, SFR spun off its stable but
slow-growing California production operations to shareholders. This move
dramatically changed SFR, leaving it a smaller, faster-growing company. While
still susceptible to changes in oil and gas prices, SFR should show strong
earnings gains, as it increases its production volumes significantly next year
by merely bringing existing international discoveries on line. SFR's significant
transformation has largely gone unnoticed, as SFR's stock is priced at a
discount to other oil and gas producers.
TOP TEN HOLDINGS % OF NET ASSETS
- ----------------------------------------------------------------------------
WORLD COLOR PRESS, INC.
Commercial printer 2.9%
HUGHES SUPPLY INC.
Construction/industrial supplies 2.7%
FORCENERGY INC.
Oil & gas producer 2.6%
FINGERHUT COMPANIES, INC.
Catalog retailer 2.5%
AGCO CORP.
Agriculture equipment producer 2.4%
CMAC INVESTMENT CORP.
Mortgage insurance 2.4%
CINCINNATI MILACRON INC.
Cutting & machine tools 2.3%
INTEGRATED HEALTH SERVICES, INC.
Sub-acute health care services 2.3%
COHERENT, INC.
Laser manufacturer 2.3%
BANCTEC INC.
Financial software/equipment 2.2%
TOP TEN HOLDINGS 24.6%
<PAGE>
(1) The performance for the one and three years ended September 30, 1997, and
for the period February 9, 1993 (inception) through September 30, 1997, is
an average annual total return calculation which is described in the Funds'
prospectus. Of course, past performance is no guarantee of future results.
The principal value and return on your investment will fluctuate and on
redemption may be worth more or less than your original cost.
The Russell 2000 Index is an unmanaged, market value weighted index
comprised of small-sized companies. All figures take into account
reinvested dividends. All indexes and portfolio characteristics are
compiled by Frank Russell Company.
Sources: Lipper Analytical Services & Frank Russell Company.
(2) Return is calculated from the Fund's inception on February 9, 1993.
(3) Fund holdings are subject to change and should not be considered a
recommendation to buy individual securities.
This report is not authorized for distribution unless accompanied or preceded by
a current prospectus.
There are risks of investing in a fund of this type which invests in stocks of
small- and mid-sized companies, which tend to be more volatile and less liquid
than stocks of large companies.
Distributor: Funds Distributor Inc.
- --------------------------------------------------------------------------------
For 24-hour account information and prices call: 1.800.828.2SKY
To speak with a Skyline Funds Representative
during normal business hours call: 1.800.458.5222
SKYLINE FUNDS
311 South Wacker Dr.
Suite 4500
Chicago, Illinois 60606
