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3RD QUARTER REPORT -- September 30, 1999
SKYLINE SMALL CAP
CONTRARIAN
SKYLINE SPECIAL EQUITIES PORTFOLIO
SKYLINE SMALL CAP VALUE PLUS
SKYLINE SMALL CAP CONTRARIAN
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LETTER from Daren C. Heitman, Portfolio Manager:(1) September 30, 1999
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Dear Shareholder:
Year to date results for the Fund are very encouraging. Through September
30, the Fund is up 11.59%, which is 9.22% ahead of the Russell 2000 Index's
2.37% return and 10.46% ahead of the average small cap value fund. During the
third quarter, the Fund was down 3.97%, yet held up better than the small cap
value market, which was down 6.32% as measured by the Russell 2000.
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.
In terms of investment styles, growth stock investing performed much
better than value-oriented investing. Growth stock managers benefited from
strong performance in the technology sector, one of only two sectors in the
Russell 2000 to post a gain for the quarter. At the same time, value-oriented
managers were hurt by the decline in cyclical stocks and financial stocks,
sectors in which they tend to invest.
As previously mentioned, the Fund performed well relative to the
Russell 2000 Index and its small cap value peer group. On balance, industry
weightings were a drag on performance during the quarter. Overweighted
positions in poor performing cyclical groups such as materials & processing
and autos & transportation, and an underweighted position in one of the
strongest performing sectors, technology, hurt performance results. Muting
this impact was an underweighted position in financial services, one of the
weakest sectors.
Individual stock selection more than offset the negative industry
weightings due in part to improving company fundamentals. In my last two
quarterly letters, I referenced the ratio of companies in the Fund that were
meeting or beating earnings expectations. This is an important statistic
because the stocks the Fund owns are unlikely to recover until the companies
report better financial results. As expected, this ratio remained in the
70%-80% range during the third quarter. While I would like to eliminate
disappointments altogether, a ratio over 70% is likely to generate good
relative performance given the low valuations of the stocks. My recent
discussions with many companies in the Fund suggest this ratio should remain
healthy into 2000, barring an economic downturn.
Acquisition activity also aided performance as two companies in the Fund
received buy-out offers during the quarter. One of the pursued companies
received an offer 200% above where the stock was trading during the prior
week, an indication of how undervalued some of the stocks in the Fund have
become in this unusual stock market environment. Many of the management teams
and boards of directors of the companies in the Fund apparently agree, since
they are buying stock personally or through company share repurchase programs.
I believe the Fund is very well positioned because based on our analysis,
we own high-quality companies with depressed valuations. In my opinion, the
quality of the average company in the Fund has never been higher, subjectively
measured by the companies' financial histories, competitive position,
management depth, and balance sheet strength. Yet the average valuation of the
stocks held in the Fund is still extremely low at just 1.0x book value per
share. When you own high-quality companies selling at book value, as you do in
the Fund, it is usually just a matter of time before earnings and the stocks
recover.
It is gratifying that the relative performance of the Fund has been strong
so far in 1999 given the difficult environment for our style of small cap
value investing. However, I believe the best performance will occur once the
environment for small cap value investing improves. Many people are looking
for a "catalyst" for small-cap value stocks. One seldom knows beforehand what
specific events will cause investor preferences to change, but like every
other past difficult environment this one will run its course and give way to
better times.
/s/ DAREN HEITMAN
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- - PERFORMANCE (%)(1)
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<TABLE>
<CAPTION>
Calendar Years
3Q Since ---------------------
1999 YTD 1 yr Inception(2) 1998 1997(2)
<S> <C> <C> <C> <C> <C> <C>
SMALL CAP CONTRARIAN -3.97 11.59 12.85 -11.75 -28.4 0.00
RUSSELL 2000 -6.32 2.37 19.07 2.03 -2.6 3.91
S&P 500 -6.17 5.29 27.73 6.59 28.8 0.80
</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 9.5%
Consumer Discretionary 19.4%
Energy 4.4%
Financial Services 11.9%
Health Care 10.2%
Materials & Processing 16.4%
Producer Durables 12.7%
Technology 9.3%
Others 1.6%
Cash 4.6%
</TABLE>
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- - PORTFOLIO Characteristics(1)
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<TABLE>
<CAPTION>
SMALL CAP
CONTRARIAN RUSSELL 2000 S&P 500
<S> <C> <C> <C>
PRICE/BOOK 0.96 2.31 4.88
PRICE/SALES 0.49 1.16 2.08
P/E RATIO (MEDIAN) 12.2 20.8 23.8
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EPS GROWTH--5 YRS 6.2% 13.8% 14.8%
(HISTORICAL)
EPS GROWTH--1 YR 16.9% 21.9% 19.7%
(FORECASTED)
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MARKET CAP $ WGHTD. MED. $200 million $710 million $65 billion
PORTFOLIO VALUE $4.4 million $833 billion $10,547 billion
NUMBER OF HOLDINGS 45 1,938 500
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CUSIP #: 830833604 INITIAL INVESTMENT: $1,000
NET ASSET VALUE (PER $7.99 SUBSEQUENT INVESTMENT: $100
SHARE):
</TABLE>
- - SECTOR Performance(1) (as of September 30, 1999)
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<TABLE>
<CAPTION>
3Q 1999 YTD 1999
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SMALL CAP RUSSELL SMALL CAP RUSSELL
CONTRARIAN 2000 CONTRARIAN 2000
<S> <C> <C> <C> <C> <C>
TECHNOLOGY 40.8% 3.6% TECHNOLOGY 34.1% 22.2%
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MATERIALS & PROCESSING 2.1 -12.2 MATERIALS & PROCESSING 23.4 -7.0
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FINANCIAL SERVICES 1.0 -9.5 ENERGY 19.4 39.8
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OTHER -4.9 -11.9 PRODUCER DURABLES 16.9 7.0
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HEALTH CARE -5.7 -4.7 HEALTH CARE 10.9 -5.5
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PRODUCER DURABLES -11.1 -3.3 CONSUMER DISCRETIONARY 9.7 -1.4
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ENERGY -11.2 4.2 FINANCIAL SERVICES -3.3 -5.3
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AUTOS & TRANSPORTATION -16.5 -14.3 AUTOS & TRANSPORTATION -6.8 -6.3
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CONSUMER DISCRETIONARY -17.1 -10.8 OTHER -53.4 -13.6
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UTILITIES N/A* -0.1 UTILITIES N/A* 20.8
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CONSUMER STAPLES N/A* -6.8 CONSUMER STAPLES N/A* -15.9
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</TABLE>
* Not Applicable
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- - STOCK Highlights(3)
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CLEVELAND-CLIFFS INC. (CLF)
Through third-party management contracts and direct ownership of mines,
Cleveland-Cliffs Inc. produces half of all the iron ore consumed in North
American steel production. Production will decline by 20% in 1999 primarily due
to CLF's efforts to reduce inventory in addition to reduced demand from its
customers. Predictably, this situation will cause earnings to decline sharply in
1999. We purchased the stock at $30 per share, or 80% of book value per share,
and a very low multiple of our earnings estimate of $6.00 per share once
production recovers to a more normal level.
JO-ANN STORES INC. (JAS)
Jo-Ann Stores is a leading retailer of sewing and craft supplies with decades of
operating history. A large acquisition overwhelmed its distribution systems
during last year's all-important holiday season, causing earnings to fall well
short of expectations. This shortfall provided us with the opportunity to
purchase the stock below $14 per share, which is near its book value and less
than 10x the depressed earnings it posted last year of $1.46 per share. With its
logistics problems behind it, JAS should expand its earnings per share to $2.00
or more within the next few years.
- - TOP Ten Holdings(3)
<TABLE>
<CAPTION>
% OF NET
ASSETS
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<S> <C>
QUEST DIAGNOSTICS INC.
Diagnostic testing services 3.0%
WABASH NATIONAL CORP.
Makes truck trailers 2.9%
IMATION CORP.
Data storage products 2.9%
OMNICARE, INC.
Pharmaceutical services 2.8%
CHICAGO BRIDGE & IRON CO.
Maker of steel tanks 2.8%
KENNAMETAL INC.
Metal-cutting tools 2.8%
DT INDUSTRIES, INC.
Packaging equipment 2.7%
ANGELICA CORP.
Textile rental services 2.7%
CREDIT ACCEPTANCE CORP.
Automobile finance services 2.4%
ARROW ELECTRONICS, INC.
Distributes electronic components 2.4%
TOP TEN HOLDINGS 27.4%
</TABLE>
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(1) The performance for the one year ended September 30, 1999, and for period
December 15, 1997 (inception) through September 30, 1999, is an average
annual total 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 and Morningstar, Inc.
(2) Return is calculated from the Fund's inception on December 15, 1997.
(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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