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3RD QUARTER REPORT -- September 30, 1999
SKYLINE SPECIAL
EQUITIES PORTFOLIO
SKYLINE SPECIAL EQUITIES PORTFOLIO
SKYLINE SMALL CAP VALUE PLUS
SKYLINE SMALL CAP CONTRARIAN
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LETTER from William M. Dutton, Portfolio Manager:(1) September 30, 1999
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Dear Shareholder:
The stock market struggled in the third quarter with both the Russell
2000 Index and S&P 500 Index showing losses in excess of 6%. Market breadth
was particularly poor with the vast majority of stocks posting declines.
Market weakness in the third quarter can be largely attributed to the Federal
Reserve Board raising interest rates. Also, many cyclical stocks that rallied
in the June quarter failed to hold their gains when company fundamentals
proved to be less robust than expected.
Results for the September quarter were disappointing. The Fund showed a
loss of 12.54% compared to a loss of 6.32% for the Russell 2000 Index. For the
first nine months of 1999, the Fund showed a loss of 11.12% compared to a gain
of 2.37% for the Russell 2000 Index. The Fund trails the Index due to a
combination of factors including sector weightings, stock selection, and an
investment style that was very out of favor.
Part of the Fund's decline during the quarter can be explained by our
value-oriented investment strategy which emphasizes low P/E stocks. Again,
investors embraced momentum-based strategies that place little emphasis on
valuation. Many of our low P/E stocks saw their multiples compressed while the
highest multiple stocks rose to even higher valuation levels. This multiple
compression occurred in many cases even when companies reported very strong
financial results. As a consequence, many stocks look especially attractive
today since their prices are down while their earnings are up.
Our value-oriented strategy also led us to invest in certain sectors that
were out of favor in the period. Areas where the Fund is heavily invested,
such as consumer, financial, and certain economically sensitive sectors,
performed poorly during the period. In contrast, the best performing sectors
in the market for both the quarter and year-to-date were energy, technology,
and utilities, sectors that collectively make up over 25% of the Russell 2000
Index compared to well under 10% of the Fund. Unfortunately, in these sectors
we do not find many attractive investments and consequently the Fund did not
benefit from their recent strong performance.
Finally, the Fund was hurt by a number of poorly performing individual
stocks that declined due to disappointing financial results. Historically, our
risk-averse strategy, which emphasizes low P/E stocks that have low
expectations, helped limit the extent to which stocks fall when negative news
is announced. However, in the recent momentum-oriented market, investors
seemed to ignore valuation completely, sending individual stocks to unusually
depressed levels. As a result, many Fund holdings that had weak fundamentals
saw unusually large declines.
In response to these trends we have made some adjustments to the Fund
that we believe will position it better for the coming months. We have reduced
the number of holdings from 81 to 67 in order to focus on only the very best
ideas. We have sold stocks where company fundamentals showed serious
deterioration and added to our highest confidence positions. Finally, we are
allowing the cash position in the Fund to be above our normal 5% target as we
make these changes.
Recent setbacks only make the outlook for the Fund even more compelling
since many individual stock prices are lower while earnings continue to grow.
The best way to judge the potential of a Fund is to look at each individual
holding and assess its potential based on the current valuation level and the
company's earnings growth outlook. In our opinion, the Fund looks extremely
attractive based on this approach. The Fund currently trades at only 13 times
trailing 12 month earnings, a large discount to the market, despite above
average earnings growth prospects for the companies in the Fund. We believe
this combination of low valuations and good earnings growth prospects creates
a very positive outlook for the Fund going forward.
/S/ WILLIAM M. DUTTON
PORTFOLIO Characteristics(1)
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<TABLE>
<CAPTION>
<S> <C> <C> <C>
SPECIAL
EQUITIES RUSSELL 2000 S&P 500
P/E RATIO (MEDIAN) 13.2 20.8 23.8
PRICE/BOOK 1.79 2.31 4.88
PRICE/SALES 0.60 1.16 2.08
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EPS GROWTH--5 YRS 9.5% 13.8% 14.8%
(HISTORICAL)
EPS GROWTH--1 YR 17.3% 21.9% 19.7%
(FORECASTED)
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MARKET CAP $ WGHTD. MED. $450 million $710 million $65 billion
PORTFOLIO VALUE $307 million $833 billion $10,547 billion
NUMBER OF HOLDINGS 67 1,938 500
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TICKER SYMBOL: SKSEX INITIAL INVESTMENT: $1,000
CUSIP #: 830833208 SUBSEQUENT $100
INVESTMENT:
NET ASSET VALUE (PER $17.58
SHARE):
</TABLE>
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PERFORMANCE (%)(1)
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<TABLE>
<CAPTION>
3Q
1999 YTD 1 yr.
<S> <C> <C> <C>
SPECIAL EQUITIES -12.54 -11.12 -1.38
RUSSELL 2000 -6.32 2.37 19.07
S&P 500 -6.17 5.29 27.73
</TABLE>
<TABLE>
<CAPTION>
Calendar Years
1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
SPECIAL EQUITIES -7.2 35.4 30.4 13.8 -1.2
RUSSELL 2000 -2.6 22.4 16.5 28.4 -1.8
S&P 500 28.8 33.4 23.3 37.5 1.3
</TABLE>
SECTOR Weightings (as of September 30, 1999)
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EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
Autos
&
Transportation 5.4%
Consumer
Discretionary 29.5%
Consumer
Staples 1.8%
Financial
Services 20.7%
Health
Care 5.5%
Materials
&
Processing 14.1%
Producer
Durables 11.9%
Technology 6.6%
Cash 4.5%
</TABLE>
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<TABLE>
<CAPTION>
Since
3 yrs. 5 yrs. 10 yrs. Inception(2)
<S> <C> <C> <C> <C>
SPECIAL
EQUITIES 6.87 10.33 14.04 14.04
RUSSELL
2000 8.70 12.38 10.93 9.96
S&P
500 25.17 25.11 16.84 15.89
</TABLE>
<TABLE>
<CAPTION>
1993 1992 1991 1990 1989 1988 1987(2)
<S> <C> <C> <C> <C> <C> <C> <C>
SPECIAL
EQUITIES 22.9 42.5 47.4 -9.3 24.0 29.7 -16.9
RUSSELL
2000 18.9 18.4 46.1 -19.5 16.2 24.9 -24.3
S&P
500 10.0 7.7 30.6 -3.2 31.4 16.5 -12.0
</TABLE>
SECTOR Performance(1) (as of September 30, 1999)
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<TABLE>
<CAPTION>
3Q 1999 YTD 1999
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SPECIAL RUSSELL SPECIAL RUSSELL
EQUITIES 2000 EQUITIES 2000
<S> <C> <C> <C> <C> <C>
CONSUMER STAPLES 2.8% -6.8% TECHNOLOGY 7.1% 22.2%
TECHNOLOGY -0.7 3.6 MATERIALS & PROCESSING 1.7 -7.0
MATERIALS & PROCESSING -1.1 -12.2 ENERGY -4.8 39.8
ENERGY -8.6 4.2 CONSUMER STAPLES -8.6 -15.9
FINANCIAL SERVICES -12.9 -9.5 CONSUMER DISCRETIONARY -8.7 -1.4
CONSUMER DISCRETIONARY -17.6 -10.8 HEALTH CARE -17.4 -5.5
PRODUCER DURABLES -18.3 -3.3 FINANCIAL SERVICES -20.2 -5.3
HEALTH CARE -20.4 -4.7 PRODUCER DURABLES -21.1 7.0
AUTOS & TRANSPORTATION -29.6 -14.3 AUTOS & TRANSPORTATION -33.8 -6.3
UTILITIES N/A* -0.1 UTILITIES N/A* 20.8
OTHER N/A* -11.9 OTHER N/A* -13.6
</TABLE>
* Not applicable
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STOCK Highlights(3)
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GALLAGHER (ARTHUR J.) (AJG)
Gallagher is a leading property and casualty insurance broker and provider of
risk management (including claims management) services. AJG has been able to
grow its earnings at an above average rate over the last several years by adding
new clients and making accretive acquisitions. A key source of growth for AJG
has been increased demand for its low-cost claims handling services by insurers
who, needing to lower costs to remain competitive, are looking to outsource more
functions. In addition, as more companies self-insure, they need AJG's expertise
to manage claims efficiently. Insurance prices appear to be bottoming after
several years of decline. An improving insurance pricing environment would lead
to an acceleration of its already impressive growth rate. At 15x 1999's earnings
per share estimate, AJG's valuation does not reflect its strong growth outlook.
INVACARE CORPORATION (IVC)
Invacare is the world's leading manufacturer and distributor of home medical
equipment products primarily for the home health care and extended care markets.
Despite a less favorable domestic macro environment over the past few years, as
a result of the 1997 Balanced Budget Act which cut reimbursement to many of
IVC's customers, IVC has continued to post solid growth. A combination of strong
new product introductions and niche acquisitions has enabled IVC to grow at a
much faster rate than the industry. IVC has recently experienced an acceleration
in domestic sales (approximately 70% of total revenues), seen substantial
improvement in international sales and profitability levels, and acquired a
European competitor which should provide a meaningful boost to next year's
earnings. Despite the improved outlook and the company's strong record of
growth, IVC continues to trade at a very modest valuation.
TOP Ten Holdings(3)
<TABLE>
<CAPTION>
% OF NET
ASSETS
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<S> <C>
NEW ENGLAND BUSINESS
Business forms
2.5%
HELLER FINANCIAL, INC.
Commercial finance 2.5%
EG&G, INC.
Conglomerate 2.4%
LANDSTAR SYSTEM, INC.
Truckload carrier 2.4%
BANCWEST CORP.
Commercial bank 2.3%
RAYMOND JAMES FINANCIAL, INC.
Investment services 2.3%
IDEX CORP.
Specialty pump products 2.2%
FINANCIAL SECURITY ASSURANCE HOLDINGS
Municipal bond insurance 2.2%
GALLAGHER & CO. (ARTHUR J.)
Insurance broker 2.2%
KELLWOOD CO.
Apparel manufacturer 2.1%
TOP TEN HOLDINGS 23.1%
</TABLE>
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(1) The performance for the one, three, five, and ten years ended September 30,
1999, and for the period April 23, 1987 (inception) through September 30,
1999, is an average annual return calculation which is described in the
Fund's 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.
Source: 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 CALL: 1.800.828.2SKY
(1.800.828.2759)
To speak with a Skyline Funds Representative during
normal business hours CALL: 1.800.828.2SKY and press 0 when prompted.
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