N-30D 1 e-7448.txt SEMI-ANNUAL REPORT DATED 06/30/2001 KAYNE ANDERSON RUDNICK MUTUAL FUNDS ================================================================================ SEMI-ANNUAL REPORT KAYNE ANDERSON RUDNICK LARGE CAP FUND KAYNE ANDERSON RUDNICK SMALL-MID CAP FUND KAYNE ANDERSON RUDNICK INTERNATIONAL FUND KAYNE ANDERSON RUDNICK GROWTH AND OPPORTUNITY FUND KAYNE ANDERSON RUDNICK INTERMEDIATE TOTAL RETURN BOND FUND KAYNE ANDERSON RUDNICK CALIFORNIA INTERMEDIATE TAX-FREE BOND FUND ================================================================================ For the Six Months Ended June 30, 2001 KAYNE ANDERSON RUDNICK MUTUAL FUNDS TABLE OF CONTENTS SHAREHOLDER LETTER ........................................................ 1 KAYNE ANDERSON RUDNICK LARGE CAP FUND Goal .................................................................... 2 Commentary .............................................................. 2 Outlook ................................................................. 3 Schedule of Investments ................................................. 4 KAYNE ANDERSON RUDNICK SMALL-MID CAP FUND Goal .................................................................... 6 Commentary .............................................................. 7 Outlook ................................................................. 8 Schedule of Investments ................................................. 9 KAYNE ANDERSON RUDNICK INTERNATIONAL FUND Goal .................................................................... 12 Commentary .............................................................. 12 New Purchases ........................................................... 13 Outlook ................................................................. 13 Schedule of Investments ................................................. 15 KAYNE ANDERSON RUDNICK GROWTH AND OPPORTUNITY FUND Goal .................................................................... 18 Commentary .............................................................. 18 Outlook ................................................................. 18 Schedule of Investments ................................................. 19 KAYNE ANDERSON RUDNICK INTERMEDIATE TOTAL RETURN BOND FUND Goal .................................................................... 21 Commentary .............................................................. 21 Outlook ................................................................. 22 Schedule of Investments ................................................. 23 KAYNE ANDERSON RUDNICK CALIFORNIA INTERMEDIATE TAX-FREE BOND FUND Goal .................................................................... 26 Commentary .............................................................. 26 Outlook ................................................................. 27 Schedule of Investments ................................................. 28 STATEMENTS OF ASSETS AND LIABILITIES ...................................... 32 STATEMENTS OF OPERATIONS .................................................. 34 STATEMENTS OF CHANGES IN NET ASSETS ....................................... 36 FINANCIAL HIGHLIGHTS ...................................................... 38 NOTES TO FINANCIAL STATEMENTS ............................................. 44 KAYNE ANDERSON RUDNICK MUTUAL FUNDS Dear Shareholder: We are pleased to express appreciation for your investment in the Kayne Anderson Rudnick Mutual Funds. If you are new to the Kayne Anderson Rudnick family of investors, we welcome you. The enclosed semi-annual report contains a commentary and June 30, 2001 financial statements for each of our mutual funds. In each commentary, the portfolio manager reviews the objectives, performance and outlook for the fund. We hope that you will find these comments interesting and timely. As an investment adviser, we have managed private accounts for both equity and fixed-income investors for many years. We are delighted to be able to offer our mutual funds to you so that diversification among asset classes can be readily accomplished. Through these funds, shareholders can structure a diversified portfolio consistent with their personal investment objectives and goals. We thank you again for your investment in the Kayne Anderson Rudnick Mutual Funds. We are committed to assisting you with the realization of your financial goals. As always, we welcome your questions and comments. Sincerely, /s/ Richard A. Kayne /s/ Allan M. Rudnick Richard A. Kayne Allan M. Rudnick Chief Executive Officer Chief Investment Officer Kayne Anderson Rudnick Investment Management, LLC 1 KAYNE ANDERSON RUDNICK LARGE CAP FUND GOAL The KAYNE ANDERSON RUDNICK LARGE CAP FUND portfolio invests in high-quality, large-capitalization companies that enjoy global dominance, excellent management, financial strength, and consistent growth. The investment goal of the Fund is to achieve superior long-term performance by owning some of the world's finest companies. COMMENTARY Since its inception on May 1, 1995, the Fund has returned 13.77% annually through June 30, 2001. However, the most recent six months and twelve months ended June 30, 2001 produced negative returns for the major equity indices and for our Fund. For such periods, the S&P 500 Index declined 6.70% and 14.83%, respectively, the Nasdaq Composite Index declined 12.74% and 45.64%, respectively, and the Fund declined 9.51% and 13.45%, respectively. The markets declined in large part because of the disappointing corporate earnings results announced during the period and an uncertain outlook going forward. Nonetheless, as noted below, we are keeping a long-term view, rather than reacting to current short-term uncertainties. The strongest performing economic sectors in the S&P 500 during the quarter ended June 30, were technology (+12%), capital goods (+12%), and basic materials (+10%). The weakest sectors were utilities (-6%), communication services (-2%), and health care (-1%). Thematically, the strongest areas of the domestic equity markets in the second quarter were lesser quality (B+ stock ranking, as ranked by Standard & Poors) and non-rated companies. In addition, the stocks of small to mid size companies performed much stronger than the larger capitalization equities. A key point of differentiation between the Fund and the S&P 500 is the Fund's singular focus on high quality companies. In a weighting of quality, 88% of the Core Portfolio is invested in companies with stock rankings in the "A" category (as ranked by Standard & Poors) versus 55% for the S&P 500 (see chart below). In addition, 100% of the companies in the Core Portfolio have a credit rating of "A-" to "AAA." (as rated by Standard & Poors.) WEIGHTS BY QUALITY A+, A, A- B+ B, B-, C, D NC --------- ----- ----------- ---- KAR 87.6% 9.0% 3.4% 0.0% S&P 500 54.7% 18.5% 18.8% 8.0% Source: Kayne Anderson Rudnick Investment Management, LLC 2 The mission of the Large Cap Fund is to invest for the long-term in outstanding businesses that possess distinct competitive advantages. These companies consistently have superior profit margins, high returns on investment, material free cash flows, and strong balance sheets. We employ a variety of valuation models, including discounted free cash flow analysis, to determine when the equities of these companies provide an attractive expected rate of return. OUTLOOK The economy has slowed dramatically. The real GDP growth rate has declined from 8.3% at its peak in the fourth quarter of 1999 to 1.2% for the first quarter of 2001. This dramatic deceleration may feel like a recession. However, the economy continues to show growth, albeit at low levels, and we expect that growth to continue and improve over time. In part, our optimistic view relates to consumer spending, which accounts for two-thirds of the national economic activity. The personal consumption expenditure component of the gross domestic product (GDP) grew at a relatively healthy 3.4% annual rate during the first quarter, up from a 2.8% growth rate in the fourth quarter. Further, we expect to see a rebound in corporate profits to begin early next year. And, with inflation under control, the Federal Reserve has continued flexibility to adjust interest rates to help stimulate the economy. The external economic environment is currently difficult for corporate profits in general. However, we believe that, in a year when S&P 500 profits are likely to be down, the underlying profits of the companies in the Fund should be up, and the average return on equity should remain high. Looking longer term, we believe that while profits for the S&P 500 should grow at a mid-to-high single-digit rate, the profits for the companies in the Large Cap Fund should grow at solid double-digit rates, providing the underpinning for attractive growth of investor capital. Our investment principles are founded on the belief that superior companies possess essential competitive advantages that produce high profitability, solid growth and substantial free cash flow. Our focus as long-term investors is on the strength of a company's business advantages and the sustainability of those advantages over time. Our core belief is that we can continue to produce durable, long-term growth of capital for our investors by investing in well-managed, superior businesses. -------------------------------------------------------------------------------- Past performance is no indication of future results. The Fund had an average annual return of 10.84% for the five years ended June 30, 2001. Share prices and returns fluctuate and shares, when redeemed, may be worth more than their original cost. Due to market volatility, Fund performance may fluctuate substantially over the short-term and current performance may differ from that shown. 3 KAYNE ANDERSON RUDNICK LARGE CAP FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) SHARES VALUE -------------------------------------------------------------------------------- COMMON STOCKS: 96.4% CAPITAL GOODS/ELECTRICAL EQUIPMENT: 8.3% 54,780 Emerson Electric Co. .......................... $ 3,314,190 141,060 General Electric Co. .......................... 6,876,675 ------------ 10,190,865 ------------ CAPITAL GOODS/MANUFACTURING--DIVERSIFIED: 2.3% 45,120 Illinois Tool Works, Inc. ..................... 2,856,096 ------------ CONSUMER NON-DURABLES/RESTAURANTS: 4.1% 186,810 McDonald's Corp. .............................. 5,055,079 ------------ CONSUMER STAPLES/BEVERAGES: 3.8% 103,360 Coca-Cola Co. ................................. 4,651,200 ------------ CONSUMER STAPLES/CONSUMER PRODUCTS: 4.8% 92,550 Procter & Gamble Co. .......................... 5,904,690 ------------ CONSUMER STAPLES/FOODS: 2.6% 66,520 Wm. Wrigley, Jr. Co. .......................... 3,116,462 ------------ ENERGY/PETROLEUM--INTERNATIONAL: 4.6% 64,170 Exxon Mobil Corp. ............................. 5,605,250 ------------ FINANCIAL/BANKING: 3.9% 101,880 Wells Fargo & Co. ............................. 4,730,288 ------------ FINANCIAL/FINANCIAL SERVICES: 7.0% 87,600 American Express Co. .......................... 3,398,880 60,920 Fannie Mae .................................... 5,187,338 ------------ 8,586,218 ------------ FINANCIAL/INSURANCE: 7.9% 74,500 American International Group, Inc. ............ 6,407,000 32,240 Marsh & McLennan Companies, Inc. .............. 3,256,240 ------------ 9,663,240 ------------ HEALTH CARE/DRUGS & HOSPITAL SUPPLIES: 14.3% 131,020 Johnson & Johnson ............................. 6,551,000 80,610 Merck & Co., Inc. ............................. 5,151,785 145,700 Pfizer, Inc. .................................. 5,835,285 ------------ 17,538,070 ------------ RAW MATERIALS/CHEMICALS--DIVERSIFIED: 2.7% 67,000 E. I. du Pont de Nemours and Co. .............. 3,232,080 ------------ RETAIL/APPAREL: 3.8% 159,600 Gap, Inc. (The) ............................... 4,628,400 ------------ 4 KAYNE ANDERSON RUDNICK LARGE CAP FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) - (Continued) SHARES VALUE -------------------------------------------------------------------------------- RETAIL/BUILDING PRODUCTS: 2.2% 58,100 Home Depot, Inc. (The) ........................ $ 2,704,555 ------------ TECHNOLOGY/COMMUNICATIONS--EQUIPMENT: 2.6% 171,600 Cisco Systems, Inc.* .......................... 3,123,120 ------------ TECHNOLOGY/COMPUTERS & OFFICE EQUIPMENT: 3.1% 33,810 International Business Machines Corp. ......... 3,820,530 ------------ TECHNOLOGY/DATA SERVICES: 3.7% 90,300 Automatic Data Processing, Inc. ............... 4,487,910 ------------ TECHNOLOGY/SEMICONDUCTORS: 5.4% 171,560 Intel Corp. ................................... 5,018,130 52,000 Texas Instruments, Inc. ....................... 1,638,000 ------------ 6,656,130 ------------ TECHNOLOGY/SOFTWARE: 7.5% 91,890 Microsoft Corp.* .............................. 6,707,970 130,600 Oracle Corp.* ................................. 2,481,400 ------------ 9,189,370 ------------ TELECOMMUNICATION SERVICES/TELEPHONE: 1.8% 54,200 SBC Communications, Inc. ...................... 2,171,252 ------------ TOTAL COMMON STOCKS (cost $119,120,533) ........................................ 117,910,805 ------------ TOTAL INVESTMENTS IN SECURITIES (cost $119,120,533+): 96.4% ................................ 117,910,805 Other Assets less Liabilities: 3.6% .......................... 4,418,069 ------------ NET ASSETS: 100.0% ........................................... $122,328,874 ============ * Non-income producing security. + At June 30, 2001, the basis of investments for federal income tax purposes was the same as their cost for financial reporting purposes. Unrealized appreciation and depreciation were as follows: Gross unrealized appreciation ...................... $ 11,963,791 Gross unrealized depreciation ...................... (13,173,519) ------------ Net unrealized depreciation ........................ $ (1,209,728) ============ See accompanying Notes to Financial Statements. 5 KAYNE ANDERSON RUDNICK SMALL-MID CAP FUND GOAL The goals of the KAYNE ANDERSON RUDNICK SMALL-MID CAP FUND are: * To build a diversified portfolio of the next generation of high quality "blue chip" companies. * To produce returns typical of small and mid cap stocks, but with no more risk than the S&P 500 Index of large stocks. In summary, we strive to buy stocks of high quality companies at discount prices in order to allow clients to participate in the strong growth of small companies while assuming less financial and stock market risk. The following table demonstrates our commitment to these objectives. Our portfolio combines: (1) quality comparable to the high-quality benchmark, the S&P 500 Index of large stocks; (2) growth comparable to the high-growth benchmark, the Russell 2500 Small-Mid Cap Growth Index; and (3) value comparable to the deep-value benchmark, the Russell 2500 Small Mid Cap Value Index.
KAYNE RUSSELL RUSSELL ANDERSON RUSSELL RUSSELL S&P 2500(TM) 2500(TM) RUDNICK 2500(TM) 2000(TM) 500 GROWTH VALUE QUALITY SMALL-MIDCAP INDEX INDEX INDEX INDEX INDEX ------- ------------ ----- ----- ----- ----- ----- Return on Equity - Past 5 Years 24.9% 15.0% 14.2% 24.4% 16.8% 14.1% MORE PROFITABLE Long-Term Debt/Total Capital 28.4% 39.0% 36.4% 44.1% 27.8% 48.3% LESS FINANCIAL RISK Interest Expense Coverage 11.9x 4.8x 5.1x 4.8x 8.4x 3.7x LESS FINANCIAL RISK Earnings Variance - Past 10 Years 27.8% 64.8% 71.4% 40.7% 79.4% 58.5% MORE DEPENDABLE A Rated by S&P 56.3% 13.8% 10.9% 53.7% 4.7% 20.9% BETTER QUALITY GROWTH ------ Earnings Per Share Growth - Past 5 Years 21.2% 13.2% 12.3% 15.5% 22.1% 9.7% RECOVERY Earnings Per Share Growth - Past 10 Years 18.3% 10.1% 9.9% 15.7% 15.6% 8.5% RECESSION Dividend Per Share Growth - Past 5 Years 14.0% 7.0% 7.3% 10.8% 7.9% 6.8% RECOVERY Dividend Per Share Growth - Past 10 Years 13.9% 5.9% 5.6% 10.0% 6.6% 5.8% RECESSION Capital Generation - {ROE x(1-Payout)} 19.7% 11.5% 11.3% 17.2% 15.6% 9.3% FASTER GROWTH VALUE ----- P/E Ratio - Latest 12 months 22.4 27.8 31.1 26.4 61.2 19.6 BETTER VALUE Dividend Yield 0.9% 1.3% 1.2% 1.3% 0.3% 2.1% COMPARABLE INCOME MARKET CHARACTERISTICS ---------------------- $ Weighted Average Market Cap - 4 qtr. average $2.9 b $2.1 b $1.0 b $ 90.1 b $2.0 b $2.2 b COMPARABLE SIZE Largest Market Cap - 4 qtr. average $9.6 b $9.4 b $4.4 b $383.6 b $8.6 b $8.7 b COMPARABLE SIZE Annualized Standard Deviation - Since Inception 12.6% 16.8% 17.3% 13.8% 25.4% 13.5% LESS MARKET RISK
Note: As of June 30, 2001 Data is obtained from Frank Russell Company and is assumed to be reliable. Other principal consultant firms use different algorithms to calculate selected statistics. Estimates are based on certain assumptions and historical information. 6 COMMENTARY As seen in the following chart, corporate earnings in 2001 are experiencing their most serious decline since the 1991 recession. The second quarter of this year is expected to be the most difficult comparison with a 15% decline in S&P 500 earnings. In this environment, the overall stock market as measured by the S&P 500 Index has produced a loss for the first half of 2001 and the small-mid cap market as measured by the Russell 2500 Index has produced a modest gain. Despite the weak stock market environment, the Small-Mid Cap Fund produced a 12.47% return for the first half of the year. We attribute this result to our focus on owning the highest quality businesses in America. Regardless of whether or not corporate earnings recover this year, we believe our portfolio of companies can generate double-digit earnings growth in this difficult year. RUSSELL 2000 EARNINGS PER SHARE [This bar-chart illustrates the earning per share for the Russell 2000 from 1989 through the first half of 2001.] S&P 500 EARNINGS PER SHARE [This bar-chart illustrates the earning per share for the S&P 500 from 1989 through the first half of 2001.] DATA IS OBTAINED FROM FIRST CALL AND IS ASSUMED TO BE RELIABLE. Two of our holdings, E.W. Blanch and Timberline Software, were sold at losses in the first six months of 2001. In each case, growth had faltered and we elected to reinvest the proceeds from these holdings into other companies with stronger prospects. New additions to the Fund year-to-date include: * Black Box Corporation - World's leading direct marketer of communication equipment * Cintas Corporation - Market leader in the corporate uniform industry * Cincinnati Financial - The most "agent friendly" insurer according to Independent Agent Magazine * Equifax - One of the nation's leading credit reporting agencies * Hanover Compressor - The nation's largest natural gas compression fleet serving oil & gas producers * Insituform Technologies - Global leader in rehabilitation of underground sewers using trenchless technologies * Techne - The primary producer of reagent test kits for biotechnology researchers worldwide * Teleflex - Manufactures automotive, marine, industrial, aerospace and medical products with leadership in technical niches 7 OUTLOOK Small stocks are outperforming large stocks this year despite that small and mid cap company earnings are suffering more than their large cap counterparts in the current economic slowdown. We believe this is due to recognition that small stocks are significantly undervalued compared to large cap stocks. This can be seen in the first chart below. The value of small and mid cap stocks has attracted individual and corporate investors alike. RELATIVE PRICE TO CASH FLOW [This line chart illustrates the relative price to cash flow from 1977 through June 2000.] M&A ACTIVITY AMONG SMALLER STOCKS (MARKET CAPITALIZATION BETWEEN $200 MILLION AND $1 BILLION) Year Total Deals-Completed & Funding ---- ------------------------------- 86 49 87 67 88 63 89 58 90 26 91 22 92 31 93 25 94 58 95 72 96 92 97 181 98 156 99 206 00 126 SOURCE: MERRILL LYNCH SMALL CAP RESEARCH As the second chart above shows, corporate investors have reacted to the attractive valuations of small and mid cap stocks via acquisitions. In the Small-Mid Cap Fund, Dallas Semiconductor agreed to be acquired, at a premium price, by Maxim Integrated Products this year. Maxim is the second most profitable semi-conductor company we know, and so, we have elected to hold Maxim Integrated Products following its acquisition of Dallas Semiconductor. Our portfolio is selling at a discount valuation compared to both the small cap and large cap indices, we believe that our companies will experience double-digit earnings growth while the earnings of many small cap and large cap stocks are expected to decline. We believe the Fund is well positioned to perform going forward. 8 KAYNE ANDERSON RUDNICK SMALL-MID CAP FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) SHARES VALUE -------------------------------------------------------------------------------- COMMON STOCKS: 99.5% BASIC MATERIALS/PACKAGING: 3.3% 50,772 Bemis Co. ..................................... $ 2,039,511 10,099 Liqui--Box Corp. .............................. 393,558 ------------ 2,433,069 ------------ BASIC MATERIALS/PAINTS AND COATING: 3.2% 66,120 Valspar Corp. ................................. 2,347,260 ------------ BUSINESS EQUIPMENT & SERVICES/TEXTILES: 2.7% 43,440 Cintas Corp. .................................. 2,009,100 ------------ CAPITAL GOODS/AEROSPACE & DEFENSE: 1.7% 70,301 HEICO Corp.--Class A .......................... 1,261,903 ------------ CAPITAL GOODS/MACHINERY EQUIPMENT: 4.9% 59,807 Federal Signal Corp. .......................... 1,403,670 49,788 Nordson Corp. ................................. 1,319,382 19,260 Teleflex, Inc. ................................ 847,440 ------------ 3,570,492 ------------ CONSTRUCTION/BUILDING AND CONSTRUCTION: 3.1% 62,300 Insituform Technologies, Inc.--Class A* ....... 2,273,950 ------------ CONSUMER CYCLICAL/ADVERTISING: 5.0% 119,555 Catalina Marketing Corp.* ..................... 3,647,623 ------------ CONSUMER CYCLICAL/FURNITURE: 2.7% 107,572 LA-Z Boy, Inc. ................................ 1,990,082 ------------ CONSUMER CYCLICAL/RETAIL: 3.5% 134,700 Claire's Stores, Inc. ......................... 2,607,792 ------------ CONSUMER CYCLICAL/SERVICES: 5.8% 69,765 ABM Industries, Inc. .......................... 2,598,746 34,982 Strayer Education, Inc. ....................... 1,705,372 ------------ 4,304,118 ------------ CONSUMER STAPLES/FOOD: 1.4% 26,307 Tootsie Roll Industries, Inc. ................. 1,013,872 ------------ 9 KAYNE ANDERSON RUDNICK SMALL-MID CAP FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) - (Continued) SHARES VALUE -------------------------------------------------------------------------------- ENERGY/OIL AND GAS PRODUCTION: 6.4% 44,529 Devon Energy Corp. ............................ $ 2,337,773 72,315 Hanover Compressor Co.* ....................... 2,392,903 ------------ 4,730,676 ------------ FINANCIAL/BANKS: 6.1% 122,082 National Commerce Financial Corp. ............. 2,975,138 61,195 Washington Federal, Inc. ...................... 1,500,501 ------------ 4,475,639 ------------ FINANCIAL/FINANCIAL SERVICES: 11.6% 51,004 Eaton Vance Corp. ............................. 1,774,939 47,585 Equifax, Inc. ................................. 1,745,418 58,050 FactSet Research Systems, Inc. ................ 2,072,385 47,790 Fair, Isaac and Company, Inc. ................. 2,954,377 2 Franklin Resources, Inc. ...................... 92 ------------ 8,547,211 ------------ FINANCIAL/INSURANCE: 2.5% 46,325 Cincinnati Financial Corp. .................... 1,829,838 ------------ HEALTH CARE/DRUGS & HOSPITAL SUPPLIES: 7.6% 34,572 King Pharmaceuticals, Inc.* ................... 1,858,245 39,400 Landauer, Inc. ................................ 1,182,000 78,785 Techne Corp.* ................................. 2,560,513 ------------ 5,600,758 ------------ HEALTH CARE/MEDICAL INFORMATION SYSTEMS: 5.4% 132,440 Hooper Holmes, Inc. ........................... 1,357,510 92,965 IMS Health, Inc. .............................. 2,649,503 ------------ 4,007,013 ------------ TECHNOLOGY/COMPUTERS--INTEGRATED SYSTEMS: 6.6% 102,715 Jack Henry & Associates ....................... 3,184,165 76,162 Reynolds & Reynolds Inc.--Class A ............. 1,671,756 ------------ 4,855,921 ------------ TECHNOLOGY/SEMICONDUCTORS: 3.4% 57,099 Maxim Integrated Products, Inc.* .............. 2,524,347 ------------ 10 KAYNE ANDERSON RUDNICK SMALL-MID CAP FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) - (Continued) SHARES VALUE -------------------------------------------------------------------------------- TECHNOLOGY/SOFTWARE & SERVICES: 8.6% 45,580 Black Box Corp.* .............................. $ 3,070,269 55,570 CSG Systems International, Inc.* .............. 3,223,060 ------------ 6,293,329 ------------ TRANSPORTATION/TRANSPORTATION--SERVICES: 4.0% 104,700 C.H. Robinson Worldwide, Inc. ................. 2,920,083 ------------ TOTAL COMMON STOCKS (cost $59,763,054) ......................................... 73,244,076 ------------ TOTAL INVESTMENTS IN SECURITIES (cost $59,763,054+): 99.5% ................................. 73,244,076 ============ Other Assets less Liabilities: 0.5% .......................... 335,813 ------------ NET ASSETS: 100.0% ........................................... $ 73,579,889 ============ * Non-income producing security. + At June 30, 2001, the basis of investments for federal income tax purposes was the same as their cost for financial reporting purposes. Unrealized appreciation and depreciation were as follows: Gross unrealized appreciation ...................... $ 14,501,406 Gross unrealized depreciation ...................... (1,020,384) ------------ Net unrealized appreciation ........................ $ 13,481,022 ============ See accompanying Notes to Financial Statements. 11 KAYNE ANDERSON RUDNICK INTERNATIONAL FUND GOAL The goal of the KAYNE ANDERSON RUDNICK INTERNATIONAL FUND is to achieve superior long-term results by investing in the best quality international companies. We pursue this goal through a focused investment philosophy that relies on the following principles: (1) commitment to quality; (2) long-term vision; (3) independent fundamental research; (4) broad diversification; and (5) valuation-driven decision process. We define quality companies as those possessing a global competitive advantage, management excellence, financial strength and flexibility, high profitability and consistency of earnings. We seek to diversify the fund across countries and industries but do not aim to replicate the country allocation of our benchmark, the MSCI EAFE (Europe, Australia and the Far East) index. COMMENTARY For the six-month period ended June 30, 2001, the International Fund's net asset value fell 19.82% versus a decline of 15.47% for the MSCI EAFE index (in dollar terms). The portfolio's negative return was in line with the performance of the MSCI EAFE Growth Index (-19.31%) for the same period. The portfolio outperformed strongly in April, when it appreciated by 8.25% against a 6.74% increase in the MSCI EAFE Index. This supports our belief that the portfolio is well positioned to outperform in a market recovery, when the global economies stabilize, rather than in a protracted bear market. During the first part of 2001, the downturn in the international equity markets that started in March 2000 accelerated, as it became more evident that the U.S. economic slowdown was spilling over to the rest of the world. A series of profit warnings reflecting precipitous deteriorating business conditions in various industries, such as telecommunications equipment and semiconductors, hurt many stocks even among the best-positioned and financially strong companies. Over the last six months, Europe was the worst performing geographic area with a decline of 17.21% (FTSE Eurotop 300 Index) in dollars, outperforming the Japanese market, which declined 8.26% (MSCI Japan Index) in dollars. Both the euro and the yen weakened against the US dollar, by 9.81% and 8.16%, respectively. This occurred despite the US Federal Reserve Bank's series of aggressive interest rate cuts in 2001. It is our belief that this anomaly reflects the confidence by investors around the world that US fiscal and monetary policies will be successful in putting the world's largest economy back on the growth track. What is good for the US is perceived to be good for the rest of the world. There are two primary reasons for the portfolio's year-to-date underperformance. First, the portfolio was underweighted in Japan-based stocks while overweighted in Europe-based stocks. On one hand, our underweight position in Japanese stocks stems from our cautious view about Japan's short-to-medium term economic outlook and from our difficulty in finding, at reasonable prices, stocks that present the fundamental quality characteristics we favor for our high-quality portfolio. On the other hand, our overweight position in continental Europe reflects our conviction that the region is more advanced than the rest of the world in achieving structural reforms, corporate restructuring, and adoption of shareholder- value-creation principles. We perceive these to be the main drivers of equity performance in the current decade. More importantly, the portfolio has been overweighted in traditional growth sectors as opposed to traditional value or deep-value sectors, both in Europe and Japan. In Europe, stocks belonging to traditional value sectors that do not present our required quality characteristics have been successful so far this year. The best performing sectors include mining, oil and gas, tobacco, steel, and real estate. We are more typically invested in food and beverage, food retailers, insurance, 12 media, information technologies, and marginally, oil and gas, banks, pharmaceuticals, software, and telecommunications services. In Japan, the picture has been similar. Over the past six months, the best performing sectors were oil and coal, mining, rubber products, maritime transportation, fishing and farming, transportation equipment, warehousing, and textiles. During the first six months of this year, fundamental activity in the fund was restrained. We bought Adecco, Glaxo-Smithkline, and SMC (see below), while we sold Compass and Shiseido. Among best performing stocks for the first-half 2001 were Panamco (+44%), Canon (+22.6%), BHP (+4.8%), Repsol (+4.4%), and Rentokil Initial (-0.6%). Among the worst performing stock for this period were Alcatel (-62%), Cable & Wireless (-54%), Nokia (-48%), Zurich Financial Services (-40%), and Vodafone (-37%). NEW PURCHASES ADECCO Based in Switzerland, Adecco is the world's largest staffing company. Its broad geographic diversification profile should help to weather any significant slowdown in the U.S. market. Thanks to an aggressive organic expansion strategy, the company is expected to grow 50% more than the staffing market in general. Historically, management has proven its superior acquisition and execution capabilities. GLAXO-SMITHKLINE Headquartered in the UK, Glaxo-Smithkline is the world's second largest pharmaceutical company with leadership positions in five major therapeutic areas. It enjoys strong research and development capabilities with an annual budget in excess of $4bn and an early stage pipeline that includes 117 compounds. GSK can also leverage it strong sales force and global reach by signing co-promotion or licensing agreements with other drug companies, which has been done already successful by Pfizer or Bristol-Myers Squibb. SMC Based in Japan, SMC is a leading manufacturer of automation devices based on pneumatic technology. The company's unique competitive advantages and exceptionally strong financial position are supporting an aggressive growth strategy aimed at seizing 26% share of each of its markets outside Japan, where it holds 54% market share. OUTLOOK The past six months have been unfavorable to equities generally and to large capitalization growth companies in particular. Only value or deep value stocks did relatively well. We do not believe this is a sustainable phenomenon. We believe longer-term fundamentals continue to favor international large capitalization growth companies, driven by deregulation, restructuring, and increased attention to shareholder value creation. 13 The International Fund is better positioned for a market recovery than for a continued market downturn, as we believe the portfolio's strong outperformance in April confirms. Although the timing of a sustainable recovery is uncertain, we are looking for early signs of recovery toward the end of this year. We own some of the best foreign companies. We believe they will, in time, benefit and emerge stronger from the current difficult environment from which we anticipate they will, rewarding the patient, serious, long-term investor. We continue to believe that an investment strategy that focuses exclusively on the highest quality foreign companies constitutes a long-term winning strategy for the prudent investor. -------------------------------------------------------------------------------- Past performance is no indication of future results. Foreign stock markets tend to be more volatile than the U.S. markets due to economic and political instability and regulatory conditions in some countries. The Fund had a -27.79% return for the twelve months year ended June 30, 2001, since the Fund's inception on October 18, 1996, the Fund has had an average annual return of 7.96% through June 30, 2001. Share prices and returns fluctuate and shares, when redeemed, may be worth more than their original cost. Due to market volatility, Fund performance may fluctuate substantially over the short-term and current performance may differ from that shown. The MSCI EAFE Index is an unmanaged index that is a generally accepted benchmark for major overseas markets. The MSCI EAFE Index consists of securities listed on exchanges in European, Australasian, and Far Eastern markets and includes dividends and distributions, but does not reflect fees, brokerage commissions, or other expenses of investing. The Index weightings represent the relative capitalizations of the major overseas markets included in the index on a U.S. dollar adjusted basis. The FTSE Eurotop 300 Index measures the performance of Europe's largest 300 companies based on market capitalization. 14 KAYNE ANDERSON RUDNICK INTERNATIONAL FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) SHARES VALUE -------------------------------------------------------------------------------- COMMON STOCKS: 91.8% AUSTRALIA: 3.1% 86,732 BHP Ltd. ADR .................................. $ 1,886,421 ------------ FINLAND: 2.8% 78,022 Nokia Corp. ADR ............................... 1,719,605 ------------ FRANCE: 13.2% 9,410 Air Liquide ................................... 1,352,255 65,500 Alcatel ....................................... 1,370,018 63,124 Axa ADR ....................................... 1,778,203 49,070 Groupe Danone ADR ............................. 1,342,064 30,971 Total Fina Elf S.A. ADR ....................... 2,174,164 ------------ 8,016,704 ------------ GERMANY: 4.1% 70,866 SAP AG ADR .................................... 2,486,688 ------------ HONG KONG: 2.7% 27,334 HSBC ADR ...................................... 1,637,307 ------------ JAPAN: 16.4% 45,000 Canon, Inc. ................................... 1,818,328 105,000 Fujitsu, Ltd. ................................. 1,102,784 60,000 Matsushita Electric Industrial Co. ............ 938,988 176,000 Minebea Co., Ltd. ............................. 1,158,467 210 Nippon Telegraph & Telephone Co. .............. 1,094,364 10,000 SMC Corp. ..................................... 1,070,312 25,000 Sony Corp. .................................... 1,643,550 141,000 Sumitomo Mitsui Banking Corp. ................. 1,164,350 ------------ 9,991,143 ------------ MEXICO: 2.6% 77,091 Panamerican Beverages, Inc. ADR ............... 1,564,947 ------------ NETHERLANDS: 10.8% 54,500 Aegon N.V. .................................... 1,534,529 26,137 Heineken N.V. ................................. 1,054,199 30,262 ING Groep N.V. ................................ 1,978,345 63,100 Koninklijke Ahold N.V. ........................ 1,977,049 ------------ 6,544,122 ------------ 15 KAYNE ANDERSON RUDNICK INTERNATIONAL FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) - (Continued) SHARES VALUE -------------------------------------------------------------------------------- SPAIN: 7.5% 78,510 Endesa S.A. ADR ............................... $ 1,246,739 98,311 Repsol S.A. ADR ............................... 1,637,861 133,598 Telefonica S.A. ............................... 1,647,210 ------------ 4,531,810 ------------ SWEDEN: 0.8% 89,052 Ericsson ADR .................................. 482,662 ------------ SWITZERLAND: 10.9% 35,300 Aden SW ....................................... 1,659,930 30,808 Nestle ADR .................................... 1,636,946 62,576 Novartis AG ADR ............................... 2,262,122 3,093 Zurich Financial Services ..................... 1,053,865 ------------ 6,612,863 ------------ UNITED KINGDOM: 16.9% 39,510 Cable & Wireless Plc ADR ...................... 711,180 31,240 Diageo Plc ADR ................................ 1,372,998 40,000 GlaxoSmithKline Plc ........................... 1,128,240 274,613 Invensys Plc ADR .............................. 1,038,916 83,824 Pearson Plc ................................... 1,385,443 538,600 Rentokil Initial Plc .......................... 1,830,540 19,604 Reuters Group Plc ADR ......................... 1,524,211 57,330 Vodafone Group Plc ADR ........................ 1,281,326 ------------ 10,272,854 ------------ TOTAL COMMON STOCKS (cost $64,314,308) ......................................... 55,747,126 ------------ TOTAL INVESTMENTS IN SECURITIES (cost $64,314,308+): 91.8% ................................. 55,747,126 Other Assets less Liabilities: 8.2% .......................... 4,971,144 ------------ NET ASSETS: 100.0% ........................................... $ 60,718,270 ============ * Non-income producing security. + At June 30, 2001, the basis of investments for federal income tax purposes was the same as their cost for financial reporting purposes. Unrealized appreciation and depreciation were as follows: Gross unrealized appreciation ...................... $ 2,705,873 Gross unrealized depreciation ...................... (11,273,055) ------------ Net unrealized depreciation ........................ $ (8,567,182) ============ See accompanying Notes to Financial Statements. 16 KAYNE ANDERSON RUDNICK INTERNATIONAL FUND SCHEDULE OF INVESTMENTS BY INDUSTRY at June 30, 2001 (Unaudited) INDUSTRY PERCENTAGE -------------------------------------------------------------------------------- Insurance 7.2% Oil & Gas 6.3 Diversified Financials 6.0 Communications--Equipment 5.9 Diversified Telecomm Services 5.7 Pharmaceuticals 5.6 Food Products 4.9 Beverages 4.8 Media 4.8 Household Durables 4.2 Software 4.1 Food & Drugs Retailing 3.3 Metals & Mining 3.1 Communication Services & Supplies 3.0 Office Electronics 3.0 Human Resources 2.7 Chemicals 2.2 Wireless Telecomm Services 2.1 Multi-Utilities 2.1 Banks 1.9 Machinery 1.9 Computers & Peripherals 1.8 Hand/Machine Tools 1.8 Beverages--Alcoholic 1.7 Electrical Equipment 1.7 ----- Total Investments in Securities 91.8 Other Assets less Liabilities 8.2 ----- Net Assets 100.0% ===== 17 KAYNE ANDERSON RUDNICK GROWTH AND OPPORTUNITY FUND GOAL The goal of the KAYNE ANDERSON RUDNICK GROWTH AND OPPORTUNITY FUND is to achieve long-term appreciation of capital through a diversified portfolio of domestic and international companies that exhibit above-average growth potential. We pursue this goal through a focused investment philosophy that relies on the following principles: (1) a commitment to quality; (2) long-term vision; (3) independent fundamental research; (4) broad diversification; and (5) a valuation-driven decision process. We define quality as those companies that exhibit such characteristics as market dominance, management excellence, strong free cash flow growth, strong balance sheet and relatively high research and development expenditures. COMMENTARY After a rough start in the first quarter, growth stocks rebounded in the second quarter with positive returns. The S&P 500 Barra Growth Index was up 7.71% in the second quarter but is still down 11.04% for the six months ended June 30th. With our focus on quality growth companies and a long-term investment philosophy, the Growth and Opportunity Fund has outperformed the Growth Index by decreasing 7.86% for the six months ended June 30, 2001. At the end of June, the top 10 holdings in the Growth and Opportunity Fund had returns that showed above-average volatility, both up and down. The stock that declined the most was a high technology company, Cisco Systems. However, the top performers in the portfolio were also in the technology sector. Ranking all 28 stocks in the portfolio, the top three performers for the six-month period were Microsoft (up 68.3% for the six months ended June 30, 2001), AOL Time Warner (up 52.3% for the six months ended June 30, 2001), and Dell Computers (up 50.0% for the six months ended June 30, 2001). Clearly, the market has made some distinction among technology stocks. Again, because we focus on quality, the portfolio was able to outperform, despite the weighting in technology stocks, because the holdings are more defensive in nature. Overall, growth stocks outperformed value stocks during the second quarter. Along with the above-mentioned technology stocks, our holdings in the consumer cyclical sector such as Home Depot and Gap Stores helped pace the Growth and Opportunity Fund's return. The poorest performing sector of the Growth and Opportunity Fund during the quarter was pharmaceutical stocks such as Pfizer and Schering-Plough. OUTLOOK Looking ahead to the second half of the year, we expect the market volatility to continue as companies adjust their spending and guidance based on the uncertain economic conditions. Earnings announcements will be a key driving force as investors react to good and bad news. But just as the lack of economic visibility has created turmoil for the stock market, it will also provide periods of opportunity. As we have said before, the Growth and Opportunity Fund's portfolio is designed to provide a more aggressive equity strategy as one part of a balanced overall asset allocation. The portfolio can be expected to be more volatile, both on the upside and downside, than the broad equity markets. Yet, it is our belief that by owning quality companies at a reasonable price we will be well rewarded by the market over the long-term. We thank you for your continued confidence. 18 KAYNE ANDERSON RUDNICK GROWTH AND OPPORTUNITY FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) SHARES VALUE -------------------------------------------------------------------------------- COMMON STOCK: 83.1% CAPITAL GOODS/ELECTRICAL EQUIPMENT: 5.7% 4,080 General Electric Co. .......................... $ 198,900 ------------ FINANCIAL/FINANCIAL SERVICES: 5.0% 11,410 Schwab (Charles) Corp. ........................ 174,573 ------------ HEALTH CARE/DRUGS & HOSPITAL SUPPLIES: 13.0% 1,500 Amgen, Inc.* .................................. 91,020 1,200 Genentech, Inc.* .............................. 66,120 1,200 Guidant Corp.* ................................ 43,200 5,000 Pfizer, Inc. .................................. 200,250 1,500 Schering-Plough Corp. ......................... 54,360 ------------ 454,950 ------------ HEALTH CARE/HEALTH PRODUCTS: 3.3% 2,320 Johnson & Johnson ............................. 116,000 ------------ RETAIL/APPAREL: 4.6% 5,485 Gap, Inc. (The) ............................... 159,065 ------------ RETAIL/BUILDING PRODUCTS: 5.3% 4,000 Home Depot, Inc. (The) ........................ 186,200 ------------ TECHNOLOGY/COMMUNICATIONS--EQUIPMENT: 8.3% 840 Alcatel S.A. .................................. 17,422 7,745 Cisco Systems, Inc.* .......................... 140,959 1,350 JDS Uniphase Corp.* ........................... 17,212 3,215 Nokia Corp. ADR ............................... 70,859 2,305 Tellabs, Inc.* ................................ 44,440 ------------ 290,892 ------------ TECHNOLOGY/COMPUTERS & OFFICE EQUIPMENT: 3.4% 4,070 Dell Computer Corp.* .......................... 105,616 490 EMC Corp.--Mass* .............................. 14,234 ------------ 119,850 ------------ TECHNOLOGY/COMPUTERS--INTEGRATED SYSTEMS: 0.0% 18 McData Corp.* ................................. 316 ------------ TECHNOLOGY/INTERNET: 6.1% 4,000 AOL Time Warner, Inc.* ........................ 212,000 ------------ 19 KAYNE ANDERSON RUDNICK GROWTH AND OPPORTUNITY FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) - (Continued) SHARES VALUE -------------------------------------------------------------------------------- TECHNOLOGY/SEMICONDUCTORS: 11.1% 1,495 Applied Materials, Inc.* ...................... $ 73,404 1,985 Broadcom Corp.* ............................... 84,879 5,705 Intel Corp. ................................... 166,871 1,400 Linear Technology Corp. ....................... 61,908 ------------ 387,062 ------------ TECHNOLOGY/SOFTWARE: 14.8% 3,000 Microsoft Corp.* .............................. 217,800 5,120 Oracle Corp.* ................................. 97,280 3,195 SAP AG ADR .................................... 112,113 1,895 Siebel Systems, Inc.* ......................... 88,876 ------------ 516,069 ------------ TELECOMMUNICATION SERVICES/TELECOMMUNICATIONS--LONG DISTANCE: 0.1% 220 WorldCom, Inc.--MCI Group ..................... 3,542 ------------ TELECOMMUNICATION SERVICES/TELEPHONE: 2.4% 5,500 WorldCom, Inc.* ............................... 82,280 ------------ TOTAL COMMON STOCKS (cost $3,885,033) .......................................... 2,901,699 ------------ TOTAL INVESTMENTS IN SECURITIES (cost $3,885,033+): 83.1% .................................. 2,901,699 Other Assets less Liabilities: 16.9% ......................... 591,948 ------------ NET ASSETS: 100.0% ........................................... $ 3,493,647 ============ * Non-income producing security. + At June 30, 2001, the basis of investments for federal income tax purposes was the same as their cost for financial reporting purposes. Unrealized appreciation and depreciation were as follows: Gross unrealized appreciation ...................... $ 109,650 Gross unrealized depreciation ...................... (1,092,984) ------------ Net unrealized depreciation ........................ $ (983,334) ============ See accompanying Notes to Financial Statements. 20 KAYNE ANDERSON RUDNICK INTERMEDIATE TOTAL RETURN BOND FUND GOAL The KAYNE ANDERSON RUDNICK INTERMEDIATE TOTAL RETURN BOND FUND seeks to provide total returns in excess of the Lehman Intermediate Government/Credit index, while maintaining quality and liquidity. The Intermediate Total Return Bond Fund strategy is to provide a total return which captures much of the fixed income market return with a combination of income and capital appreciation by adjusting the sectors and maturities of the portfolio in order to capitalize on changing market conditions. COMMENTARY The Federal Open Market Committee (the "Fed") has reduced the Fed Funds Rate six times this year, from a 6.50% to 3.50% level. While the Fed has been very aggressive in their earlier rate reductions, the last two shifts were each .25% rather than the .50% change for each of the previous reductions. This is signaling to the markets that the Fed is approaching the end of the rate reduction cycle. Further reductions in the Fed funds rate will be minor monetary adjustments as opposed to major policy shifts. U.S. TREASURY YIELD CURVE This chart shows two lines at 6/30/01 and 12/31/00 for the US Treasury Yield Curve ranging from 3 months to 23 years. SOURCE: BLOOMBERG The Fed's rate reductions have had a major impact on the shape of the yield curve, shown above. You can easily see that the reduction in rates has been to the short end of the yield curve, (five years or less), while for the remainder of the yield curve interest rates have actually increased. The normalizing of the yield curve is generally considered to be a precursor to economic recovery. 21 The minutes from the May 15th Fed meeting state that "the members anticipated that a neutral balance of risks could be appropriate before long, probably well before substantial evidence had emerged that economic growth had strengthened appreciably...". It is generally accepted that monetary policy shifts take six to 12 months to have an impact on the economy. This means that the fed rate cuts in January have only recently begun to impact the economy, and that any reductions in the rate from here forward will not have an impact on the economy until well into 2002. While the impacts of the Fed's prior monetary policy shifts are just beginning to filter into the economy, we are also feeling the effects of more economic stimulus in the form the new tax bill. Payroll withholding taxes were lowered across the country on July 1st, and refunds were first mailed on July 20th. The Fed believes that the delayed impact of the Fed rate cuts currently in the pipeline, the lower payroll withholdings, and the refund checks rolling into the economy in the next quarter will be enough stimulus to get the country moving at an acceptable pace by 2002. The Total Return Bond Fund has benefited from its short to neutral duration as that portion of the yield curve has performed well. During the second quarter we began reducing our allocation to Treasuries and increasing our allocation in both the corporate and agency sectors. This allowed us to improve the overall yield of the fund. We expect to continue this sector move in the near future. SECTOR DIVERSIFICATION U.S. TREASURY 40% AGENCY 19% INDUSTRIAL 16% FINANCE 14% CMO 3% MORTGAGE-BACKED 6% CASH & EQUIVALENTS 2% OUTLOOK The Fed may continue to reduce the Federal Funds Rate by an additional .25% to .50% basis points over the next few months. While this will again affect the short end of the yield curve, we do not expect to see significant reductions in interest rates beyond ten years in the near future. The Fund is currently positioned to take advantage of this shift. We also expect to see a reduction in the CPI, which is always advantageous to bondholders. 22 KAYNE ANDERSON RUDNICK INTERMEDIATE TOTAL RETURN BOND FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited)
PRINCIPAL COUPON MATURITY AMOUNT RATE DATE VALUE ------------------------------------------------------------------------------------------------- CORPORATE BONDS: 29.3% AEROSPACE: 0.9% $ 335,000 Boeing Capital Corp. ...................... 7.100% 09/27/05 $ 352,003 70,000 Honeywell International ................... 9.200% 02/15/03 74,789 ------------ 426,792 ------------ AUTO/TRUCK MANUFACTURER: 2.6% 1,250,000 Daimlerchrysler National Holding Corp. .... 7.200% 09/01/09 1,249,965 ------------ BANKS: 2.1% 1,000,000 Citicorp .................................. 6.375% 11/15/08 989,810 ------------ BEVERAGES: 3.8% 70,000 Anheuser Busch Companies .................. 6.750% 11/01/06 71,810 236,000 Coca Cola Enterprises, Inc. ............... 6.375% 08/01/01 236,385 1,500,000 Coca-Cola Bottling Co. Consolidated ....... 6.850% 11/01/07 1,478,570 ------------ 1,786,765 ------------ COMMUNICATION SERVICES: 0.4% 175,000 TCI Communications, Inc. .................. 6.375% 05/01/03 177,783 ------------ COMPUTERS--MICRO: 1.6% 750,000 Hewlett-Packard Co. ....................... 7.150% 06/15/05 776,478 ------------ DEPARTMENT STORES: 0.2% 70,000 Sears Roebuck & Co. ....................... 9.450% 07/25/01 70,146 ------------ FINANCE: 14.0% 175,000 Bear Stearns Co. .......................... 6.625% 10/01/04 178,478 825,000 Bear Stearns Co. .......................... 7.800% 08/15/07 869,833 70,000 Beneficial Corp. .......................... 6.600% 09/26/01 70,440 850,000 Boeing Capital Corp. ...................... 5.650% 05/15/06 842,251 1,000,000 Countrywide Home Loans, Inc. .............. 7.450% 09/16/03 1,050,075 300,000 Ford Motor Credit Corp. ................... 6.700% 07/16/04 306,439 500,000 Ford Motor Credit Corp. ................... 9.030% 12/30/09 541,012 1,000,000 General Motors Acceptance Corp. ........... 6.750% 01/15/06 1,016,434 192,000 General Motors Acceptance Corp. ........... 7.125% 05/01/03 197,760 1,000,000 Lehman Brothers Holdings, Inc. ............ 7.250% 10/15/03 1,036,273 500,000 Lehman Brothers Holdings, Inc. ............ 8.750% 05/15/02 516,973 ------------ 6,625,968 ------------
23 KAYNE ANDERSON RUDNICK INTERMEDIATE TOTAL RETURN BOND FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) - (Continued)
PRINCIPAL COUPON MATURITY AMOUNT RATE DATE VALUE ------------------------------------------------------------------------------------------------- INDUSTRIALS: 0.4% $ 175,000 Caterpillar, Inc. ......................... 8.440% 11/26/03 $ 186,842 ------------ MOTION PICTURE PRODUCTION & OTHER SERVICES: 2.6% 1,250,000 Walt Disney Co. (The) ..................... 5.500% 12/29/06 1,221,250 ------------ RETAIL STORES: 0.7% 300,000 Wal-Mart Stores ........................... 6.550% 08/10/04 312,137 ------------ TOTAL CORPORATE BONDS (cost $13,618,384) 13,823,936 ------------ U.S. GOVERNMENT AND GOVERNMENT AGENCY OBLIGATIONS: 68.7% MORTGAGE-BACKED/PASS-THROUGH SECURITIES: 9.4% 358,205 Federal Home Loan Mortgage Corp. .......... 7.000% 04/01/16 363,670 224,845 Federal Home Loan Mortgage Corp. .......... 7.500% 07/01/09 232,723 545,534 Federal Home Loan Mortgage Corp. .......... 7.500% 04/01/14 563,417 1,400,000 Federal National Mortgage Association ..... 6.000% 08/25/08 1,417,381 384,400 Federal National Mortgage Association ..... 7.000% 05/01/14 391,099 145,310 Federal National Mortgage Association ..... 8.000% 01/01/15 152,598 624,091 Government National Mortgage Association... 7.000% 07/20/13 636,956 8,197 Government National Mortgage Association... 8.000% 11/15/21 8,501 218,284 Government National Mortgage Association... 8.000% 07/15/23 226,381 171,379 Government National Mortgage Association... 8.000% 07/15/23 177,736 88,908 Government National Mortgage Association... 8.000% 09/15/26 92,206 44,738 Government National Mortgage Association... 8.000% 11/15/26 46,397 12,041 Government National Mortgage Association... 8.500% 12/15/22 12,585 90,606 Government National Mortgage Association... 8.500% 08/15/25 94,704 25,488 Government National Mortgage Association... 8.500% 06/15/26 26,640 ------------ 4,442,994 ------------ U.S. AGENCY OBLIGATIONS: 18.9% 1,000,000 Federal Home Loan Bank .................... 5.925% 04/09/08 1,003,756 250,000 Federal Home Loan Bank .................... 6.400% 01/26/11 248,475 1,000,000 Federal Home Loan Mortgage Corp. .......... 6.500% 05/09/11 986,300 600,000 Federal National Mortgage Association ..... 5.625% 05/14/04 609,925 1,000,000 Federal National Mortgage Association ..... 6.000% 03/29/11 966,100 500,000 Federal National Mortgage Association ..... 6.440% 04/08/09 499,063 650,000 Federal National Mortgage Association ..... 6.600% 03/11/09 651,667 1,000,000 Federal National Mortgage Association ..... 6.625% 11/15/10 1,036,481 1,305,000 Federal National Mortgage Association ..... 6.750% 07/30/07 1,329,952
24 KAYNE ANDERSON RUDNICK INTERMEDIATE TOTAL RETURN BOND FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) - (Continued)
PRINCIPAL COUPON MATURITY AMOUNT RATE DATE VALUE ------------------------------------------------------------------------------------------------- U.S. AGENCY OBLIGATIONS (CONTINUED) $ 87,000 Federal National Mortgage Association ..... 6.950% 11/13/06 $ 87,940 1,000,000 Federal National Mortgage Association ..... 6.990% 07/09/07 1,023,148 462,000 Federal National Mortgage Association ..... 7.050% 02/12/07 471,244 ------------ 8,914,051 ------------ U.S. TREASURY OBLIGATIONS: 40.4% 1,500,000 U.S. Treasury Bonds ....................... 7.875% 11/15/04 1,643,083 2,050,000 U.S. Treasury Bonds ....................... 11.875% 11/15/03 2,386,940 1,257,000 U.S. Treasury Notes ....................... 5.625% 05/15/08 1,283,123 700,000 U.S. Treasury Notes ....................... 6.000% 08/15/09 728,171 2,000,000 U.S. Treasury Notes ....................... 6.250% 02/15/07 2,109,524 1,500,000 U.S. Treasury Notes ....................... 6.500% 10/15/06 1,595,795 3,330,000 U.S. Treasury Notes ....................... 7.250% 08/15/04 3,576,870 700,000 U.S. Treasury Notes ....................... 7.500% 05/15/02 721,897 4,650,000 U.S. Treasury Notes ....................... 7.500% 02/15/05 5,061,920 ------------ 19,107,323 ------------ TOTAL U.S. GOVERNMENT AND GOVERNMENT AGENCY OBLIGATIONS (cost $31,830,796) ............................................................ 32,464,368 ------------ TOTAL INVESTMENTS IN SECURITIES (cost $45,449,180+): 98.0% .................................................... 46,288,304 Other Assets less Liabilities: 2.0% ............................................. 949,265 ------------ NET ASSETS: 100.0% .............................................................. $ 47,237,569 ============ + At June 30, 2001, the basis of investments for federal income tax purposes was the same as their cost for financial reporting purposes. Unrealized appreciation and depreciation were as follows: Gross unrealized appreciation ......................................... $ 992,449 Gross unrealized depreciation ......................................... (153,325) ------------ Net unrealized appreciation ........................................... $ 839,124 ============
See accompanying Notes to Financial Statements. 25 KAYNE ANDERSON RUDNICK CALIFORNIA INTERMEDIATE TAX-FREE BOND FUND GOAL The KAYNE ANDERSON RUDNICK CALIFORNIA INTERMEDIATE TAX-FREE BOND FUND seeks to provide current income exempt from both federal and California state income taxes, by investing in high quality, intermediate maturity, California municipal securities. COMMENTARY The Federal Open Market Committee (the "Fed") has reduced the Fed Funds Rate six times this year, from a 6.50% to 3.50% level. While the Fed has been very aggressive in their earlier rate reductions, the last two shifts were each .25% rather than the .50% change for each of the previous reductions. This is signaling to the markets that the Fed is approaching the end of the rate-reduction cycle. Further reductions in the Fed funds rate will be minor monetary adjustments as opposed to major policy shifts. U.S. TREASURY YIELD CURVE [This chart shows two lines at 6/30/01 and 12/31/00 for the US Treasury Yield Curve ranging from 3 months to 24 years.] SOURCE: BLOOMBERG The Fed's rate reductions have had a major impact on the shape of the treasury yield curve, shown above. You can easily see that the reduction in rates has been to the short end of the yield curve, (five years or less), while for the remainder of the yield curve interest rates have actually increased. The normalizing of the yield curve is generally considered to be a precursor to economic recovery. The minutes from the May 15th Fed meeting state that "the members anticipated that a neutral balance of risks could be appropriate before long, probably well before substantial evidence had emerged that economic growth had strengthened appreciably...". It is generally accepted that monetary policy shifts take six to 12 months to have an impact on the economy. This means that the fed rate cuts in January have only recently begun to impact the economy, and that any reductions in the rate from here forward will not have an impact on the economy until well into 2002. 26 While the impacts of the Fed's prior monetary policy shifts are just beginning to filter into the economy, we are also feeling the effects of more economic stimulus in the form the new tax bill. Payroll withholding taxes were lowered across the country on July 1st, and refunds were first mailed on July 20th. The Fed believes that the delayed impact of the Fed rate cuts currently in the pipeline, the lower payroll withholdings, and the refund checks rolling into the economy will be enough stimulus to get the country moving at an acceptable pace by 2002. In California, we have been working our way through an electrical crisis, which made many investors unnecessarily nervous. California is now the fifth largest economy in the world. Not only is our economy large, it is also geographically and economically diverse. This has traditionally led to strength in the California municipal bond market. During the first half of 2001, we have seen a convergence of the California and national municipal yield curves. While one might expect that the energy problems in California would have led to the California market moving to higher yield levels, it has in fact been the opposite. California has maintained its low yields, and actually moved lower in the shorter end of the curve, while national bonds have moved to an unusually expensive level. NATIONAL VS. CALIFORNIA TAX FREE YIELD CURVES [This line-chart compares the National vs. California Tax Free Yield at 12/31 and 6/30 from the years 2002 through 2031.] SOURCE: BLOOMBERG AND STONE & YOUNGBERG In the California Tax Free Fund, we have tried to take advantage of nervousness over the electricity problems by purchasing bonds in the secondary markets at cheaper levels than were warranted. The tightening of the national yield curve has led to national funds, as well as our national benchmark, outperforming California funds for the first half of the year. OUTLOOK In January and February of this year, Californians saw electricity prices averaging over $200 per mega-watt hour; during June the average price was $81 per mega-watt hour. We believe we have weathered the storm. The next major hurdle is finding a way to get the investor-owned utilities back on their feet. This may involve another bump in the road for California municipals. If it does, we will take advantage of the higher yields offered at that time. We believe that the year will end with California's yield curve in its traditional location below the national curve as we absorb whatever plan our state government decides on to correct the situation with the investor-owned utilities, and move forward. 27 KAYNE ANDERSON RUDNICK CALIFORNIA INTERMEDIATE TAX-FREE BOND FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited)
PRINCIPAL COUPON MATURITY AMOUNT RATE DATE VALUE ------------------------------------------------------------------------------------------------------------ MUNICIPAL BONDS: 99.9% EDUCATION: 2.9% $ 155,000 Brentwood Union School District ........................ 7.300% 08/01/07 $ 183,869 765,000 Oakland Unified School District Alameda County ......... 5.000% 08/01/15 774,562 ------------ 958,431 ------------ ELECTRIC: 6.9% 1,000,000 M-S-R Public Power Agency California ................... 6.000% 07/01/20 1,051,250 1,000,000 Northern California Public Power Agency ................ 5.000% 07/01/15 1,012,500 200,000 Sacramento, California Municipal Utilities District .... 5.700% 05/15/12 210,250 ------------ 2,274,000 ------------ GENERAL OBLIGATION: 20.0% 250,000 California State ....................................... 5.250% 06/01/16 253,125 200,000 California State ....................................... 5.375% 03/01/06 215,000 5,000 California State ....................................... 5.375% 03/01/06 5,375 45,000 California State ....................................... 5.375% 03/01/06 47,587 1,000,000 California State ....................................... 5.375% 12/01/16 1,003,750 825,000 California State ....................................... 6.250% 04/01/08 917,812 895,000 California State Veteran Bonds ......................... 5.150% 12/01/14 918,494 200,000 California State Veterans Bonds ........................ 6.375% 02/01/27 200,440 200,000 Los Angeles County, California Public Works ............ 5.000% 10/01/16 203,000 500,000 Newport Beach, California .............................. 3.050% 10/01/22 500,000 1,000,000 Oakland, California .................................... 5.875% 06/15/19 1,062,500 300,000 San Diego, California .................................. 5.000% 05/15/13 306,624 1,000,000 San Mateo Redevelopment Agency ......................... 5.400% 08/01/18 1,000,000 ------------ 6,633,707 ------------ HOSPITALS: 7.8% 1,000,000 California Health Facilities Financing Authority ....... 6.250% 10/01/13 1,026,090 560,000 California Statewide Communities ....................... 3.050% 04/01/28 560,000 1,000,000 Stockton, California Health Facilities ................. 5.350% 12/01/09 1,010,000 ------------ 2,596,090 ------------ HOUSING: 6.3% 800,000 California Housing Finance Agency ...................... 5.900% 08/01/17 830,000 960,000 California Housing Finance Agency ...................... 5.950% 08/01/14 1,011,600 250,000 Orange County California Financing Authority ........... 6.250% 09/01/14 256,007 ------------ 2,097,607 ------------
28 KAYNE ANDERSON RUDNICK CALIFORNIA INTERMEDIATE TAX-FREE BOND FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) - (Continued)
PRINCIPAL COUPON MATURITY AMOUNT RATE DATE VALUE ---------------------------------------------------------------------------------------------------------------- IDR/PCR: 10.7% $ 200,000 California Pollution Control Financing Authority ......... 5.850% 12/01/23 $ 168,750 290,000 California State Public Works Board Lease Revenue (community colleges) ..................................... 5.140% 12/01/13 297,613 1,000,000 California State Public Works Board Lease Revenue (FTB)... 5.250% 11/01/20 987,500 300,000 California State Public Works Board Lease Revenue (Dept. of Corrections) ................................... 5.375% 11/01/13 308,625 510,000 California State Public Works Board Lease Revenue (Dept. of Justice) ....................................... 5.500% 09/01/09 545,700 1,000,000 Mountain View, California Shoreline Regional Park ........ 5.500% 08/01/21 1,031,250 200,000 Pinole Redevelopment Agency Tax Allocation ............... 5.600% 08/01/17 204,750 ------------ 3,544,188 ------------ PREREFUNDED: 3.7% 1,000,000 California Educational Facilities Authority Revenues Pomona College ........................................... 6.125% 02/15/08 1,038,200 150,000 Los Angeles Convention & Exhibit Center .................. 9.000% 12/01/20 184,125 ------------ 1,222,325 ------------ TRANSPORTATION: 15.4% 250,000 Long Beach, California Harbor Revenues ................... 6.000% 05/15/06 274,063 1,000,000 Oakland, California Port Authority ....................... 5.600% 11/01/19 1,043,750 750,000 San Francisco, California Bay Area Rapid ................. 5.500% 07/01/15 786,563 1,000,000 San Francisco, California City & County Airport .......... 5.375% 05/01/17 1,021,250 1,000,000 San Francisco, California Port Authority ................. 5.900% 07/01/09 1,072,500 400,000 San Mateo County Transit District ........................ 5.000% 06/01/14 408,500 500,000 Santa Clara Valley Transportation Authority/CA ........... 5.000% 06/01/17 500,000 ------------ 5,106,626 ------------ WATER & SEWER: 26.2% 200,000 California State Department of Water Resources Center Valley Project .................................... 5.650% 12/01/11 210,500 100,000 Irvine Ranch Water District .............................. 2.750% 09/01/06 100,000 400,000 Irvine Ranch Water District .............................. 2.900% 08/01/09 400,000 700,000 Los Angeles, California Water and Power Revenue .......... 4.500% 07/01/13 680,750 700,000 Los Angeles, California Wastewater System ................ 5.000% 06/01/14 714,875 200,000 Los Angeles, California Wastewater System ................ 5.700% 06/01/20 206,250 1,000,000 Marina, California Municipal Water District .............. 5.550% 07/01/13 1,036,250 100,000 Orange County, California Water District ................. 3.050% 08/15/15 100,000
29 KAYNE ANDERSON RUDNICK CALIFORNIA INTERMEDIATE TAX-FREE BOND FUND SCHEDULE OF INVESTMENTS IN SECURITIES at June 30, 2001 (Unaudited) - (Continued)
PRINCIPAL COUPON MATURITY AMOUNT RATE DATE VALUE --------------------------------------------------------------------------------------------------------------- WATER & SEWER (CONTINUED) $1,000,000 Rancho, California Water District Financing Authority ..... 5.875% 11/01/10 $ 1,092,500 1,000,000 Redlands, California Financing Authority .................. 5.000% 09/01/17 1,000,000 1,000,000 San Francisco, California City and County Public Utility... 6.000% 11/01/15 1,027,500 1,000,000 San Jose Clara, California Water .......................... 5.375% 11/15/15 1,031,250 1,000,000 Tulare, California Sewer Revenue .......................... 5.700% 11/15/15 1,062,500 ------------ 8,662,375 ------------ TOTAL MUNICIPAL BONDS (cost $32,076,116) .......................................................................... 33,095,349 ------------ TOTAL INVESTMENTS IN SECURITIES (cost $32,076,116+): 99.9% .................................................................. 33,095,349 Other Assets less Liabilities: 0.1% ........................................................... 32,301 ------------ NET ASSETS: 100.0% ............................................................................ $ 33,127,650 ============ + At June 30, 2001, the basis of investments for federal income tax purposes was the same a their cost for financial reporting purposes. Unrealized appreciation and depreciation were as follows: Gross unrealized appreciation ....................................................... $ 1,104,860 Gross unrealized depreciation ....................................................... (85,627) ------------ Net unrealized appreciation ......................................................... $ 1,019,233 ============
See accompanying Notes to Financial Statements. 30 This page is intentionally left blank 31 KAYNE ANDERSON RUDNICK MUTUAL FUNDS STATEMENTS OF ASSETS AND LIABILITIES at June 30, 2001 (Unaudited)
SMALL-MID LARGE CAP FUND CAP FUND ------------- ------------- ASSETS Investments in securities, at cost ............................ $ 119,120,533 $ 59,763,054 ============= ============= Foreign currency, at cost ..................................... $ -- $ -- ============= ============= Investments in securities, at value ........................... $ 117,910,805 $ 73,244,076 Foreign currency, at value .................................... -- -- Cash .......................................................... 6,171,300 1,884,203 Receivables: Fund shares sold ............................................ -- -- Due from advisor ............................................ -- -- Dividends and interest ...................................... 74,478 73,600 Tax reclaims ................................................ -- -- Prepaid expenses .............................................. -- 6,817 ------------- ------------- Total assets ............................................... 124,156,583 75,208,696 ------------- ------------- LIABILITIES Payables: Securities purchased ....................................... 1,126,341 710,109 Fund shares purchased ...................................... -- -- Distributions to shareholders .............................. 596,089 835,860 Due to advisor ............................................. 73,860 59,804 Accrued expenses .............................................. 31,419 23,034 ------------- ------------- Total liabilities .......................................... 1,827,709 1,628,807 ------------- ------------- NET ASSETS ...................................................... $ 122,328,874 $ 73,579,889 ============= ============= Number of shares issued and outstanding (unlimited shares authorized, no par value) .................. 7,608,101 3,931,758 ------------- ------------- NET ASSET VALUE, OFFERING AND REDEMPTION PRICE PER SHARE.... $ 16.08 $ 18.71 ============= ============= COMPONENTS OF NET ASSETS Paid-in capital ............................................... $ 123,810,046 $ 68,075,592 Accumulated net investment income (loss) ...................... (11,527) (27,961) Accumulated net realized gain (loss) on investments ........... (259,917) (7,948,764) Net unrealized appreciation (depreciation) on: Investments ................................................. (1,209,728) 13,481,022 Foreign currency ............................................ -- -- ------------- ------------- Net assets ................................................. $ 122,328,874 $ 73,579,889 ============= =============
See accompanying Notes to Financial Statements. 32 CALIFORNIA GROWTH AND INTERMEDIATE INTERMEDIATE INTERNATIONAL OPPORTUNITY TOTAL RETURN TAX-FREE FUND FUND BOND FUND BOND FUND ------------ ------------ ------------ ------------ $ 64,314,308 $ 3,885,033 $ 45,449,180 $ 32,076,116 ============ ============ ============ ============ $ 602,864 $ -- $ -- $ -- ============ ============ ============ ============ $ 55,747,126 $ 2,901,699 $ 46,288,304 $ 33,095,349 592,301 -- -- -- 6,061,883 606,945 234,227 66,604 -- -- 185,000 -- -- 1,044 -- -- 85,904 693 778,680 416,216 32,947 40 -- -- 11,544 7,749 2,564 -- ------------ ------------ ------------ ------------ 62,531,705 3,518,170 47,488,775 33,578,169 ------------ ------------ ------------ ------------ 1,707,924 -- -- 307,253 37,001 -- 203,726 116,083 48,765 -- 26,612 10,425 19,745 24,523 20,868 16,758 ------------ ------------ ------------ ------------ 1,813,435 24,523 251,206 450,519 ------------ ------------ ------------ ------------ $ 60,718,270 $ 3,493,647 $ 47,237,569 $ 33,127,650 ============ ============ ============ ============ 4,702,144 407,973 4,334,597 3,072,476 ------------ ------------ ------------ ------------ $ 12.91 $ 8.56 $ 10.90 $ 10.78 ============ ============ ============ ============ $ 69,926,518 $ 5,013,176 $ 46,384,907 $ 31,860,172 (20,840) (17,075) (9,000) 7,802 (613,518) (519,120) 22,538 240,443 (8,567,182) (983,334) 839,124 1,019,233 (6,708) -- -- -- ------------ ------------ ------------ ------------ $ 60,718,270 $ 3,493,647 $ 47,237,569 $ 33,127,650 ============ ============ ============ ============ 33 KAYNE ANDERSON RUDNICK MUTUAL FUNDS STATEMENTS OF OPERATIONS For the Periods Ended June 30, 2001 (Unaudited)
SMALL-MID LARGE CAP FUND CAP FUND ------------ ------------ INVESTMENT INCOME Income Dividends .................................................................. $ 605,609 $ 287,992 Interest ................................................................... 85,513 25,290 ------------ ------------ Total income ............................................................ 691,122 313,282 ------------ ------------ Expenses Advisory fees .............................................................. 458,425 223,749 Registration expense ....................................................... 7,038 6,970 Fund accounting fees ....................................................... 22,186 17,921 Administration fees ........................................................ 29,930 18,148 Transfer agent fees ........................................................ 15,438 10,378 Trustee fees ............................................................... 3,433 3,408 Audit fees ................................................................. 2,497 4,189 Custodian fees ............................................................. 15,413 6,581 Legal fees ................................................................. 4,328 1,460 Reports to shareholders .................................................... 2,459 3,006 Insurance expense .......................................................... 559 204 Miscellaneous .............................................................. 596 1,197 ------------ ------------ Total expenses .......................................................... 562,302 297,211 Add: expenses recouped by advisor ....................................... -- 46,399 Less: fees waived and expenses absorbed ................................. -- -- Less: expenses paid indirectly .......................................... -- (124) ------------ ------------ Net expenses ............................................................ 562,302 343,486 ------------ ------------ Net investment income (loss) .......................................... 128,820 (30,204) ------------ ------------ REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS AND FOREIGN CURRENCY Net realized gain (loss) on investments ...................................... 97,793 (1,182,898) Net realized loss on foreign currency ........................................ -- -- Net unrealized appreciation (depreciation) on: Investments ................................................................ (12,780,290) 8,142,068 Foreign currency ........................................................... -- -- ------------ ------------ Net realized and unrealized gain on investments and foreign currency..... (12,682,497) 6,959,170 ------------ ------------ Net increase (decrease) in net assets resulting from operations ....... $(12,553,677) $ 6,928,966 ============ ============
* Net of foreign tax withheld of $71,233. ** Net of foreign tax withheld of $181. See accompanying Notes to Financial Statements. 34 CALIFORNIA GROWTH AND INTERMEDIATE INTERMEDIATE INTERNATIONAL OPPORTUNITY TOTAL RETURN TAX-FREE FUND FUND BOND FUND BOND FUND ------------- ------------ ------------ ------------ $ 434,761* $ 5,284** $ -- $ -- 21,174 8,414 1,456,979 797,619 ------------- ------------ ------------ ------------ 455,935 13,698 1,456,979 797,619 ------------- ------------ ------------ ------------ 245,682 17,758 118,918 77,179 6,751 5,923 4,582 1,048 21,903 17,841 18,795 21,628 17,917 10,312 16,878 14,932 11,169 8,606 10,063 7,515 3,122 3,559 3,370 3,431 5,798 5,233 3,031 4,091 6,465 443 6,000 3,859 1,877 208 1,510 1,208 2,115 2,123 1,728 364 195 4 224 169 1,299 1,052 3,316 584 ------------- ------------ ------------ ------------ 324,293 73,062 188,415 136,008 37,080 -- 40,396 -- -- (42,289) -- (18,751) (4) -- (129) (2,137) ------------- ------------ ------------ ------------ 361,369 30,773 228,682 115,120 ------------- ------------ ------------ ------------ 94,566 (17,075) 1,228,297 682,499 ------------- ------------ ------------ ------------ (587,344) (409,815) 348,027 368,421 (24,047) -- (11,056,233) 39,945 (19,015) (500,894) (7,267) -- -- -- ------------- ------------ ------------ ------------ (11,674,891) (369,870) 329,012 (132,473) ------------- ------------ ------------ ------------ $ (11,580,325) $ (386,945) $ 1,557,309 $ 550,026 ============= ============ ============ ============ 35 KAYNE ANDERSON RUDNICK MUTUAL FUNDS STATEMENTS OF CHANGES IN NET ASSETS
LARGE CAP FUND SMALL-MID CAP FUND ------------------------------ ------------------------------ SIX MONTHS SIX MONTHS ENDED YEAR ENDED ENDED YEAR ENDED 06/30/01# 12/31/00 06/30/01# 12/31/00 ------------- ------------- ------------- ------------- INCREASE (DECREASE) IN NET ASSETS FROM: OPERATIONS Net investment income (loss) ................................. $ 128,820 $ 409,317 $ (30,204) $ 115,428 Net realized gain (loss) on investments ...................... 97,793 3,862,289 (1,182,898) 6,268,833 Net realized loss on foreign currency ........................ -- -- -- -- Net unrealized appreciation (depreciation) on Investments ................................................. (12,780,290) (6,686,631) 8,142,068 3,148,118 Foreign currency ............................................ -- -- -- -- ------------- ------------- ------------- ------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING........ (12,553,677) (2,415,025) 6,928,966 9,532,379 ------------- ------------- ------------- ------------- DISTRIBUTIONS TO SHAREHOLDERS From net investment income ................................... (347,539) (202,125) (19,055) (95,614) From net realized gain ....................................... (1,042,615) (2,103,740) (2,347,515) (2,984,357) ------------- ------------- ------------- ------------- TOTAL DISTRIBUTIONS ................................... (1,390,154) (2,305,865) (2,366,570) (3,079,971) ------------- ------------- ------------- ------------- CAPITAL SHARE TRANSACTIONS Proceeds from shares sold .................................... 8,280,591 35,673,292 29,409,426 12,857,014 Net asset value of shares issued on reinvestment of distributions ................................................ 794,065 1,917,678 1,530,710 2,730,421 Cost of shares redeemed ...................................... (4,053,932) (25,122,870) (4,482,351) (26,477,202) ------------- ------------- ------------- ------------- NET INCREASE (DECREASE) FROM CAPITAL SHARE TRANSACTIONS.... 5,020,724 12,468,100 26,457,785 (10,889,767) ------------- ------------- ------------- ------------- TOTAL INCREASE (DECREASE) IN NET ASSETS ............... (8,923,107) 7,747,210 31,020,181 (4,437,359) NET ASSETS Beginning of period .......................................... 131,251,981 123,504,771 42,559,708 46,997,067 ------------- ------------- ------------- ------------- END OF PERIOD ................................................ $ 122,328,874 $ 131,251,981 $ 73,579,889 $ 42,559,708 ============= ============= ============= ============= Accumulated net investment income (loss) ..................... $ (11,527) $ 207,192 $ (27,961) $ 21,298 ============= ============= ============= ============= CHANGE IN CAPITAL SHARES Shares sold .................................................. 503,203 1,928,516 1,625,376 833,907 Shares issued on reinvestment of distributions ............... 48,746 108,938 82,164 170,427 Shares redeemed .............................................. (247,640) (1,349,153) (251,591) (1,698,840) ------------- ------------- ------------- ------------- Net increase (decrease) ........................................ 304,309 688,301 1,455,949 (694,506) ============= ============= ============= =============
* Commencement of operations. # Unaudited. See accompanying Notes to Financial Statements. 36
INTERMEDIATE CALIFORNIA TOTAL RETURN INTERMEDIATE INTERNATIONAL FUND GROWTH AND OPPORTUNITY FUND BOND FUND TAX-FREE BOND FUND ---------------------------- ---------------------------- ---------------------------- ---------------------------- SIX MONTHS SIX MONTHS 07/17/00* SIX MONTHS SIX MONTHS ENDED YEAR ENDED ENDED THROUGH ENDED YEAR ENDED ENDED YEAR ENDED 06/30/01# 12/31/00 06/30/01# 12/31/00 06/30/01# 12/31/00 06/30/01# 12/31/00 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ $ 94,566 $ 124,003 $ (17,075) $ 3,078 $ 1,228,297 $ 2,526,002 $ 682,499 $ 1,452,528 (587,344) 1,527,366 (409,815) (109,305) 348,027 (52,824) 368,421 28,652 (24,047) -- -- -- -- -- -- -- (11,056,233) (6,401,952) 34,945 (1,018,279) (19,015) 1,755,943 (500,894) 1,449,699 (7,267) -- -- -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ (11,580,325) (4,750,583) (391,945) (1,124,506) 1,557,309 4,229,121 550,026 2,930,879 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ (115,406) (78,826) -- (3,078) (1,241,101) (2,554,297) (684,375) (1,444,570) (13,193) (1,569,846) -- -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ (128,599) (1,648,672) -- (3,078) (1,241,101) (2,554,297) (684,375) (1,444,570) ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ 57,403,821 60,195,182 1,616,801 6,611,442 8,761,015 6,193,726 16,170,486 15,967,030 130,116 1,454,588 -- 3,234 547,343 1,744,804 101,106 411,905 (36,935,021) (44,012,108) (1,143,348) (2,074,953) (9,484,428) (15,920,099) (14,362,216) (28,374,555) ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ 20,598,916 17,637,662 473,453 4,539,723 (176,070) (7,981,569) 1,909,376 (11,995,620) ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ 8,889,992 11,238,407 81,508 3,412,139 140,138 (6,306,745) 1,775,027 (10,509,311) 51,828,278 40,589,871 3,412,139 -- 47,097,431 53,404,176 31,352,623 41,861,934 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ $ 60,718,270 $ 51,828,278 $ 3,493,647 $ 3,412,139 $ 47,237,569 $ 47,097,431 $ 33,127,650 $ 31,352,623 ============ ============ ============ ============ ============ ============ ============ ============ $ (20,840) $ -- $ (17,075) $ -- $ (9,000) $ 3,804 $ 7,802 $ 9,678 ============ ============ ============ ============ ============ ============ ============ ============ 4,076,437 3,413,087 172,206 535,151 797,715 586,089 1,494,321 1,533,893 10,165 92,252 -- 357 49,963 166,269 9,336 39,528 (2,593,625) (2,493,793) (131,462) (168,279) (863,938) (1,519,193) (1,327,037) (2,745,628) ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ 1,492,977 1,011,546 40,744 367,229 (16,260) (766,835) 176,620 (1,172,207) ============ ============ ============ ============ ============ ============ ============ ============
37 KAYNE ANDERSON RUDNICK LARGE CAP FUND FINANCIAL HIGHLIGHTS For a capital share outstanding throughout each period
SIX MONTHS YEAR ENDED DECEMBER 31, ENDED ----------------------------------------------------- 06/30/01# 2000 1999 1998 1997 1996 ------- ------- ------- ------- ------- ------- Net asset value, beginning of period ....................... $ 17.97 $ 18.67 $ 17.03 $ 17.28 $ 14.32 $ 12.63 ------- ------- ------- ------- ------- ------- INCOME FROM INVESTMENT OPERATIONS: Net investment income .................................... 0.02 0.06 0.04 0.11 0.10 0.08 Net realized and unrealized gain (loss) on investments.... (1.72) (0.44) 2.71 2.38 4.34 2.35 ------- ------- ------- ------- ------- ------- Total income (loss) from investment operations ............. (1.70) (0.38) 2.75 2.49 4.44 2.43 ------- ------- ------- ------- ------- ------- LESS DISTRIBUTIONS: From net investment income ............................... (0.05) (0.03) (0.04) (0.11) (0.11) (0.08) From net realized gain ................................... (0.14) (0.29) (1.07) (2.63) (1.37) (0.66) ------- ------- ------- ------- ------- ------- Total distributions ........................................ (0.19) (0.32) (1.11) (2.74) (1.48) (0.74) ------- ------- ------- ------- ------- ------- Net asset value, end of period ............................. $ 16.08 $ 17.97 $ 18.67 $ 17.03 $ 17.28 $ 14.32 ======= ======= ======= ======= ======= ======= Total return ............................................... (9.51)%** (2.00)% 16.33% 14.14% 30.99% 19.09% Net assets, end of period (millions) ....................... $ 122.3 $ 131.3 $ 123.5 $ 48.6 $ 35.3 $ 26.1 RATIO OF EXPENSES TO AVERAGE NET ASSETS: Before fees waived and expenses absorbed or recouped ..... 0.92%+ 0.90% 1.03% 1.11% 1.18% 1.37% After fees waived and expenses absorbed or recouped ...... 0.92%+ 0.90% 1.03% 1.11% 1.18% 1.37% RATIO OF NET INVESTMENT INCOME TO AVERAGE NET ASSETS (after fees waived and expenses absorbed or recouped)..... 0.21%+ 0.30% 0.28% 0.57% 0.55% 0.59% Portfolio turnover rate .................................. 11%** 42% 33% 76% 51% 23%
# Unaudited ** Not annualized. + Annualized. See accompanying Notes to Financial Statements. 38 KAYNE ANDERSON RUDNICK SMALL-MID CAP FUND FINANCIAL HIGHLIGHTS For a capital share outstanding throughout each period
SIX MONTHS YEAR ENDED DECEMBER 31, 10/18/96* ENDED --------------------------------------- THROUGH 6/30/01# 2000 1999 1998 1997 12/31/96 ------ ------ ------ ------ ------ ------ Net asset value, beginning of ............................. $17.19 $14.82 $15.04 $13.12 $11.06 $10.65 ------ ------ ------ ------ ------ ------ INCOME FROM INVESTMENT OPERATIONS: Net investment income ................................... 0.01 0.04 0.07 0.05 0.02 0.02 Net realized and unrealized gain on investments ......... 2.14 3.54 0.47 2.07 2.14 0.41 ------ ------ ------ ------ ------ ------ Total income from investment operations ................... 2.15 3.58 0.54 2.12 2.16 0.43 ------ ------ ------ ------ ------ ------ LESS DISTRIBUTIONS: From net investment income .............................. (0.01) (0.04) (0.07) (0.05) (0.05) (0.02) From net realized gain .................................. (0.62) (1.17) (0.69) -- (0.05) -- From paid-in capital .................................... -- -- -- (0.15) -- -- ------ ------ ------ ------ ------ ------ Total distributions ....................................... (0.63) (1.21) (0.76) (0.20) (0.10) (0.02) ------ ------ ------ ------ ------ ------ Net asset value, end of period ............................ $18.71 $17.19 $14.82 $15.04 $13.12 $11.06 ====== ====== ====== ====== ====== ====== Total return .............................................. 12.47%** 24.77% 3.64% 16.17% 19.46% 4.00%** Net assets, end of period (millions) ...................... $ 73.6 $ 42.6 $ 47.0 $ 33.0 $ 6.5 $ 0.8 RATIO OF EXPENSES TO AVERAGE NET ASSETS: Before fees waived and expenses absorbed or recouped..... 1.13%+ 1.20% 1.34% 1.35% 3.22% 18.91%+ After fees waived and expenses absorbed or recouped ..... 1.30%+ 1.29% 1.30% 1.30% 1.30% 1.30%+ RATIO OF NET INVESTMENT INCOME TO AVERAGE NET ASSETS (after fees waived and expenses absorbed or recouped).... (0.11)%+ 0.26% 0.53% 0.38% 0.45% 1.58%+ Portfolio turnover rate ................................... 4%** 50% 50% 28% 47% 0%**
* Commencement of operations. ** Not annualized. + Annualized. # Unaudited. See accompanying Notes to Financial Statements. 39 KAYNE ANDERSON RUDNICK INTERNATIONAL FUND FINANCIAL HIGHLIGHTS For a capital share outstanding throughout each period
SIX MONTHS YEAR ENDED DECEMBER 31, 10/18/96* ENDED --------------------------------------- THROUGH 06/30/01# 2000 1999 1998 1997 12/31/96 ------ ------ ------ ------ ------ ------ Net asset value, beginning of period ......................... $16.15 $18.47 $15.51 $12.61 $10.91 $10.65 ------ ------ ------ ------ ------ ------ INCOME FROM INVESTMENT OPERATIONS: Net investment income ...................................... 0.03 0.03 0.12 0.08 0.04 0.01 Net realized and unrealized gain (loss) on investments...... (3.23) (1.82) 4.68 3.25 1.75 0.26 ------ ------ ------ ------ ------ ------ Total income (loss) from investment operations ............... (3.20) (1.79) 4.80 3.33 1.79 0.27 ------ ------ ------ ------ ------ ------ LESS DISTRIBUTIONS: From net investment income ................................. (0.04) (0.03) (0.12) (0.08) (0.05) (0.01) From net realized gain ..................................... -- (0.50) (1.72) (0.35) (0.04) -- ------ ------ ------ ------ ------ ------ Total distributions .......................................... (0.04) (0.53) (1.84) (0.43) (0.09) (0.01) ------ ------ ------ ------ ------ ------ Net asset value, end of period ............................... $12.91 $16.15 $18.47 $15.51 $12.61 $10.91 ====== ====== ====== ====== ====== ====== Total return ................................................. (19.82)%** (9.65)% 31.06% 26.47% 16.42% 2.56%** Net assets, end of period (millions) ......................... $ 60.7 $ 51.8 $ 40.6 $ 35.4 $ 7.0 $ 1.1 RATIO OF EXPENSES TO AVERAGE NET ASSETS: Before fees waived and expenses absorbed or recouped........ 1.25%+ 1.28% 1.47% 1.45% 3.41% 15.74%+ After fees waived and expenses absorbed or recouped......... 1.40%+ 1.38% 1.40% 1.38% 1.40% 1.40%+ RATIO OF NET INVESTMENT INCOME TO AVERAGE NET ASSETS (after fees waived and expenses absorbed or recouped)....... 0.37%+ 0.24% 0.63% 0.85% 0.61% 1.14%+ Portfolio turnover rate ...................................... 8%** 35% 57% 28% 29% 0%**
* Commencement of operations. ** Not annualized. + Annualized. # Unaudited. See accompanying Notes to Financial Statements. 40 KAYNE ANDERSON RUDNICK GROWTH AND OPPORTUNITY FUND FINANCIAL HIGHLIGHTS For a capital share outstanding throughout each period
SIX MONTHS 07/17/00* ENDED THROUGH 06/30/01# 12/31/00 ------ ------ Net asset value, beginning of period ......................................... $ 9.29 $12.92 ------ ------ INCOME FROM INVESTMENT OPERATIONS: Net investment income ...................................................... -- 0.01 Net realized and unrealized loss on investments ............................ (0.73) (3.63) ------ ------ Total loss from investment operations ........................................ (0.73) (3.62) ------ ------ LESS DISTRIBUTIONS: From net investment income ................................................. -- (0.01) Net asset value, end of period ............................................... $ 8.56 $ 9.29 ====== ====== Total return ................................................................. (7.86)%** (28.02)%** Net assets, end of period (millions) ......................................... $ 3.5 $ 3.4 RATIO OF EXPENSES TO AVERAGE NET ASSETS: Before fees waived and expenses absorbed or recouped ....................... 4.11%+ 3.93%+ After fees waived and expenses absorbed or recouped ........................ 1.73%+ 1.48%+ After fees waived, expenses absorbed or recouped, and paid indirectly....... 1.73%+ 1.35%+ RATIO OF NET INVESTMENT INCOME TO AVERAGE NET ASSETS (after fees waived, expenses absorbed or recouped, and paid indirectly)..... (0.96)%+ 0.20%+ Portfolio turnover rate ...................................................... 16%** 7%**
* Commencement of operations. ** Not annualized. + Annualized. # Unaudited. See accompanying Notes to Financial Statements. 41 KAYNE ANDERSON RUDNICK INTERMEDIATE TOTAL RETURN BOND FUND FINANCIAL HIGHLIGHTS For a capital share outstanding throughout each period
SIX MONTHS YEAR ENDED DECEMBER 31, 10/18/96* ENDED --------------------------------------- THROUGH 06/30/01# 2000 1999 1998 1997 12/31/00 ------ ------ ------ ------ ------ ------ Net asset value, beginning of period ....................... $10.82 $10.44 $11.01 $10.75 $10.59 $10.65 ------ ------ ------ ------ ------ ------ INCOME FROM INVESTMENT OPERATIONS: Net investment income .................................... 0.04 0.56 0.50 0.51 0.56 0.09 Net realized and unrealized gain (loss) on investments ......................................... 0.08 0.39 (0.57) 0.30 0.18 (0.07) ------ ------ ------ ------ ------ ------ Total income (loss) from investment operations ............................................... 0.12 0.95 (0.07) 0.81 0.74 0.02 ------ ------ ------ ------ ------ ------ LESS DISTRIBUTIONS: From net investment income ............................... (0.04) (0.57) (0.49) (0.51) (0.58) (0.08) From net realized gain ................................... -- -- (0.01) (0.04) -- -- ------ ------ ------ ------ ------ ------ Total distributions ...................................... (0.04) (0.57) (0.50) (0.55) (0.58) (0.08) ------ ------ ------ ------ ------ ------ Net asset value, end of period ............................. $10.90 $10.82 $10.44 $11.01 $10.75 $10.59 ====== ====== ====== ====== ====== ====== Total return ............................................... 3.41%** 9.40% (0.65)% 7.61% 7.19% 0.20%** Net assets, end of period (millions) ....................... $ 47.2 $ 47.1 $ 53.4 $ 28.3 $ 6.3 $ 5.0 RATIO OF EXPENSES TO AVERAGE NET ASSETS: Before fees waived and expenses absorbed or recouped...... 0.79%+ 0.82% 1.23% 1.00% 2.23% 2.10%+ After fees waived and expenses absorbed or recouped....... 0.96%+ 0.94% 0.94% 0.94% 0.95% 0.95%+ After fees waived, expenses absorbed or recouped, and paid indirectly ...................................... 0.96%+ 0.94% 0.94% 0.94% 0.95% 0.95%+ RATIO OF NET INVESTMENT INCOME TO AVERAGE NET ASSETS (after fees waived, expenses absorbed or recouped, and paid indirectly) .................................... 5.16%+ 5.34% 4.94% 4.93% 5.35% 4.72%+ Portfolio turnover rate..................................... 22%** 10% 64% 49% 27% 0%**
* Commencement of operations. ** Not annualized. + Annualized. # Unaudited. See accompanying Notes to Financial Statements. 42 KAYNE ANDERSON RUDNICK CALIFORNIA INTERMEDIATE TAX-FREE BOND FUND FINANCIAL HIGHLIGHTS For a capital share outstanding throughout each period
SIX MONTH YEAR ENDED DECEMBER 31, 10/28/96* ENDED --------------------------------------- THROUGH 06/30/01# 2000 1999 1998 1997 12/31/96 ------ ------ ------ ------ ------ ------ Net asset value, beginning of period ........................ $10.83 $10.29 $10.77 $10.74 $10.64 $10.65 ------ ------ ------ ------ ------ ------ INCOME FROM INVESTMENT OPERATIONS: Net investment income ..................................... 0.24 0.49 0.44 0.43 0.34 0.01 Net realized and unrealized gain (loss) on investments..... (0.05) 0.54 (0.48) 0.03 0.11 (0.01) ------ ------ ------ ------ ------ ------ Total income from investment operations ..................... 0.19 1.03 (0.04) 0.46 0.45 0.00 ------ ------ ------ ------ ------ ------ LESS DISTRIBUTIONS: From net investment income ................................ (0.24) (0.49) (0.44) (0.43) (0.35) (0.01) ------ ------ ------ ------ ------ ------ Net asset value, end of period .............................. $10.78 $10.83 $10.29 $10.77 $10.74 $10.64 ====== ====== ====== ====== ====== ====== Total return ................................................ 1.75%** 10.18% (0.44)% 4.37% 4.26% 0.02%** Net assets, end of period (millions) ........................ $ 33.1 $ 31.4 $ 41.9 $ 9.4 $ 6.0 $ 5.1 RATIO OF EXPENSES TO AVERAGE NET ASSETS: Before fees waived and expenses absorbed or recouped ...... 0.88%+ 0.96% 1.37% 2.23% 2.29% 2.08%+ After fees waived and expenses absorbed or recouped ....... 0.76%+ 0.75% 0.75% 0.77% 1.56% 1.81%+ After fees waived, expenses absorbed or recouped, and paid indirectly ...................................... 0.75%+ 0.74% 0.71% 0.77% 0.95% 0.95%+ RATIO OF NET INVESTMENT INCOME TO AVERAGE NET ASSETS (after fees waived, expenses absorbed or recouped, and paid indirectly) ..................................... 4.42%+ 4.63% 4.14% 3.88% 2.58% 0.60%+ Portfolio turnover rate ..................................... 40%** 33% 65% 47% 40% 0%**
* Commencement of operations. ** Not annualized. + Annualized. # Unaudited. See accompanying Notes to Financial Statements. 43 KAYNE ANDERSON RUDNICK MUTUAL FUNDS NOTES TO FINANCIAL STATEMENTS (Unaudited) NOTE 1 - ORGANIZATION Kayne Anderson Rudnick Mutual Funds (the "Trust") (formerly Kayne Anderson Mutual Funds) was organized as a Delaware business trust on May 29, 1996 and is registered under the Investment Company Act of 1940 as a diversified, open-end management investment company. The Trust currently consists of six separate diversified series: Large Cap Fund (formerly Rising Dividends Fund), Small - Mid Cap Fund (formerly Small Cap Rising Dividends Fund), International Fund (formerly International Rising Dividends Fund), Growth and Opportunity Fund, Intermediate Total Return Bond Fund and California Intermediate Tax-Free Bond Fund (each a "Fund" and collectively the "Funds"). Between May 29, 1996 and the respective dates of commencement of operations, the Funds had no operations other than those related to organizational matters and the sale of 2,347 shares of the Small-Mid Cap Fund, the International Fund, the Intermediate Total Return Bond Fund and the California Intermediate Tax-Free Bond Fund to Kayne Anderson Rudnick Investment Management, LLC (the "Advisor") (formerly Kayne Anderson Investment Management, LLC) for $25,000, respectively. The Large Cap Fund seeks long-term capital appreciation, with dividend income as a secondary consideration. The Fund invests primarily in equity securities, usually common stocks, of companies generally having a total market capitalization of $1 billion or more. The Small - Mid Cap Fund seeks long-term capital appreciation, with dividend income as a secondary consideration. The Fund invests primarily in equity securities, usually common stocks, of small and mid-capitalization companies which the Fund currently considers to be companies having a total market capitalization of not more than $3 billion. The International Fund seeks long-term capital appreciation, with dividend income as a secondary consideration. The Fund invests primarily in equity securities, usually common stocks, of companies outside the U.S. generally having a total market capitalization of $1 billion or more. The Growth and Opportunity Fund seeks long-term growth of capital. The Fund invests primarily in equity securities, usually common stocks, of companies generally having a total market capitalization of $3 billion or more. The Intermediate Total Return Bond Fund seeks to obtain maximum total return, primarily through current income with capital appreciation as a secondary consideration. The Fund invests primarily in investment grade debt securities and seeks to maintain an average maturity of three to ten years. The California Intermediate Tax-Free Bond Fund seeks current income exempt from federal and California state income tax. The Fund invests primarily in investment grade debt securities and may maintain an average maturity of more than ten years. NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies consistently followed by the Funds. These policies are in conformity with accounting principles generally accepted in the United States of America. 44 KAYNE ANDERSON RUDNICK MUTUAL FUNDS NOTES TO FINANCIAL STATEMENTS (Unaudited) - (Continued) A. SECURITY VALUATION: The Funds' investments are carried at value. Securities listed on an exchange or quoted on a national market system are valued at the last sale price. Securities traded on an exchange or Nasdaq for which there have been no sales and other over-the-counter securities are valued at the mean between the bid and asked prices. Securities for which market quotations are not readily available, if any, are valued by an independent pricing service or determined following procedures approved by the Board of Trustees. Short-term investments are valued at amortized cost, which approximates market value. B. FEDERAL INCOME TAXES: It is the Funds' policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of their taxable income to shareholders. Therefore, no federal income tax provision is required. At June 30, 2001 the Funds had capital loss carryforwards available for federal income tax purposes as follows: Intermediate California Growth & Total Intermediate Capital loss Small - Mid Opportunity Return Tax-Free carryforward Cap Fund Fund Bond Fund Bond Fund ------------ -------- ---- --------- --------- Expiring in: 2008 $6,730,898 $ 102,196 $ 267,489 $ 127,978 2009 58,000 $6,730,898* $ 102,196 $ 325,489 $ 127,978 * Utilization of this capital loss carryforward which arose in connection with the tax-free reorganization with Sefton Small Company Value Fund is limited by federal income tax regulations to $838,736 annually. C. SECURITY TRANSACTIONS, INVESTMENT INCOME AND DISTRIBUTIONS: Security transactions are accounted for on the trade date. Interest income is recognized on the accrual basis. Bond discounts and premiums are amortized over their respective lives. Dividend income and distributions to shareholders are recorded on the ex-dividend date. D. ACCOUNTING ESTIMATES: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements. Actual result could differ from those estimates. 45 KAYNE ANDERSON RUDNICK MUTUAL FUNDS NOTES TO FINANCIAL STATEMENTS (Unaudited) - (Continued) NOTE 3 - INVESTMENT ADVISORY AND MANAGEMENT FEES AND OTHER TRANSACTIONS WITH AFFILIATES The Advisor provides the Funds with investment management services under an Investment Advisory Agreement (the "Agreement"). The Advisor furnishes all investment advice, office space and certain administrative services, and provides personnel as needed by the Funds. As compensation for its services, the Advisor is entitled to a monthly fee at the following annual rates: Large Cap Fund 0.75% Small - Mid Cap Fund 0.85% International Fund 0.95% Growth and Opportunity Fund 1.00% Intermediate Total Return Bond Fund 0.50% California Intermediate Tax-Free Bond Fund 0.50% For the six months ended June 30, 2001, the Funds incurred the following advisory fees: Large Cap Fund $458,425 Small - Mid Cap Fund $223,749 International Fund $245,682 Growth and Opportunity Fund $ 17,758 Intermediate Total Return Bond Fund $118,918 California Intermediate Tax-Free Bond Fund $ 77,179 The Funds are responsible for their own operating expenses. The Advisor has agreed to limit each Fund's total operating expenses by reducing all or a portion of its fees and reimbursing each Fund for expenses, excluding interest, so that their ratio of expenses to average net assets will not exceed the following levels: Small - Mid Cap Fund 1.30% International Fund 1.40% Growth and Opportunity Fund 1.50% Intermediate Total Return Bond Fund 0.95% California Intermediate Tax-Free Bond Fund 0.75% Any fee waived and/or any Fund expense absorbed by the Advisor pursuant to an agreed upon expense cap shall be reimbursed by the Fund to the Advisor, if so requested by the Advisor, provided the aggregate amount of the Fund's current operating expense for such fiscal year does not exceed the applicable limitation on Fund expenses. For the period ended June 30, 2001, the Advisor waived fees and paid expenses of $42,289 and $18,751 for the Growth and Opportunity Fund and California Intermediate Tax-Free Bond Fund, respectively. For the period ended June 30, 2001, the Advisor recouped fees previously waived and expenses absorbed of $46,399, $37,080 and $40,396 for Small - Mid Cap Fund, International Fund and Intermediate Total Return Bond Fund, respectively. 46 KAYNE ANDERSON RUDNICK MUTUAL FUNDS NOTES TO FINANCIAL STATEMENTS (Unaudited) - (Continued) At June 30, 2001, the amount available for reimbursement that has been paid and/or waived by the Advisor on behalf of the Funds are as follows: International Fund $ 2,657 Growth and Opportunity Fund $ 80,706 Intermediate Total Return Bond Fund $ 34,647 California Intermediate Tax-Free Bond Fund $273,562 At June 30, 2001, the Advisor may recapture a portion of the above amounts no later than the dates as stated below:
December 31, ---------------------------------------- Funds: 2001 2002 2003 2004 ------ ------- ------- ------- ------- International Funds $ -- $ 2,657 $ -- -- Growth and Opportunity Fund -- -- $38,417 $42,289 Intermediate Total Return Bond Funds $ -- $34,647 $ -- -- California Intermediate Tax-Free Bond Funds $99,797 $88,631 $66,383 $18,751
Each Fund must pay its current ordinary operating expenses before the Advisor is entitled to any reimbursement. Any such reimbursement is also contingent upon Board of Trustees review and approval prior to the time the reimbursement is initiated. Investment Company Administration, L.L.C. (the "Administrator ") acts as the Funds' Administrator under an Administration Agreement. The Administrator prepares various federal and state regulatory filings, reports and returns for the Funds; prepares reports and materials to be supplied to the trustees; monitors the activities of the Funds' custodian, transfer agent and accountants; coordinates the preparation and payment of Funds' expenses and reviews the Funds' expense accruals. For its services, each Fund pays the Administrator an annual fee equal to 0.075% of the first $40 million of the average daily net assets, 0.050% of the next $40 million, 0.025% of the next $40 million, and 0.010% thereafter, subject to a minimum annual fee of $30,000 per Fund. The Growth and Opportunity Fund pays the Administrator a minimum annual fee of $16,000 in which $5,000 is for the first 6 months and $11,000 is for the second 6 months of its first year of operations. First Fund Distributors, Inc. (the "Distributor ") acts as the Funds' principal underwriter in a continuous public offering of the Funds' shares. The Distributor is an affiliate of the Administrator. Certain officers and Trustees of the Fund are also officers and/or directors of the Advisor. 47 KAYNE ANDERSON RUDNICK MUTUAL FUNDS NOTES TO FINANCIAL STATEMENTS (Unaudited) - (Continued) NOTE 4 - PURCHASES AND SALES OF SECURITIES For the period ended June 30, 2001, the cost of purchases and the proceeds from sales of securities, excluding U.S. Government securities and short-term investments, were as follows: Fund Purchases Sales ---- ----------- ----------- Large Cap Fund $15,716,015 $13,045,017 Small - Mid Cap Fund $26,981,290 $ 2,172,707 International Fund $19,206,493 $ 4,023,661 Growth and Opportunity Fund $ 496,859 $ 534,642 Intermediate Total Return Bond Fund $11,864,751 $ -- California Intermediate Tax-Free Bond Fund $14,843,578 $12,326,821 The Intermediate Total Return Bond Fund purchased $7,779,890 and sold $10,055,906 in U.S. Government securities. There were no purchases or sales of U.S. Government securities by Large Cap Fund, Small - Mid Cap Fund, International Fund, Growth and Opportunity Fund and California Intermediate Tax-Free Bond Fund. 48 ================================================================================ ADVISOR KAYNE ANDERSON RUDNICK INVESTMENT MANAGEMENT, LLC 1800 Avenue of the Stars, 2nd Floor Los Angeles, California 90067 (800) 231-7414 DISTRIBUTOR FIRST FUND DISTRIBUTORS, INC. 4455 East Camelback Road, Suite 261E Phoenix, Arizona 85018 CUSTODIAN AND TRANSFER AGENT INVESTORS BANK & TRUST COMPANY 200 Clarendon Street Boston, Massachusetts 02116 AUDITORS BRIGGS, BUNTING & DOUGHERTY, LLP Two Logan Square, Suite 2121 Philadelphia, Pennsylvania 19103 LEGAL COUNSEL PAUL, HASTINGS, JANOFSKY & WALKER, LLP 345 California Street, 29th Floor San Francisco, California 94104 ================================================================================ This report is intended for the shareholders of the Funds and may not be used as sales literature unless preceded or accompanied by a current prospectus. Past performance results shown in this report should not be considered a representation of future performance. Due to market volatility, fund performance may fluctuate substantially over short-term and current performance may differ from that shown. Share price and returns will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Statements and other information herein are dated and are subject to change.