UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Period Ended March 31, 1996
Commission File Number 0-17383
ML-LEE ACQUISITION FUND II, L.P.
(Exact name of registrant as specified in its Charter)
Delaware 04-3028398
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
World Financial Center
South Tower - 23rd Floor
New York, New York 10080-6123
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (212) 236-7339.
Securities registered pursuant to Section 12(b) of the Act: None.
Name on each exchange on which registered: Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Units of Limited Partnership Interest
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
Aggregate market value of voting securities held by non-affiliates: Not
Applicable.
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PART I - FINANCIAL INFORMATION
ML-LEE ACQUISITION FUND II, L.P.
TABLE OF CONTENTS
Part I. Financial Information
Item 1. Financial Statements
Statements of Assets, Liabilities and Partners'
Capital as of March 31, 1996 and December 31, 1995
Statements of Operations - For the Three
Months Ended March 31, 1996 and 1995
Statements of Changes in Net Assets -
For the Three Months Ended March 31, 1996 and 1995
Statements of Cash Flows - For the Three Months
Ended March 31, 1996 and 1995
Statement of Changes in Partners' Capital at
March 31, 1996
Schedule of Portfolio Investments - March 31, 1996
Notes to Financial Statements
Supplemental Schedule of Realized Gains and
Losses -(Schedule 1)
Supplemental Schedule of Unrealized Appreciation
and Depreciation - (Schedule 2 )
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Part II. Other Information
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
STATEMENTS OF ASSETS, LIABILITIES AND PARTNERS' CAPITAL
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Unaudited
March 31, 1996 December 31, 1995
--------------- ------------------
ASSETS:
Investments - Notes 2,4,5
Portfolio Investments at fair value
Managed Companies (amortized cost $91,268
at March 31, 1996 and $105,477 at December 31, 1995) $ 73,652 $ 88,955
Non-Managed Companies (amortized cost $30,343
at March 31, 1996 and $30,341 at December 31, 1995) 12,706 19,340
Temporary Investments, at amortized cost (cost $37,291
at March 31, 1996 and $10,024 at December 31, 1995) 37,323 10,042
Cash 1 1
Accrued Interest Receivable - Note 2 1,227 2,005
Prepaid Expenses 2 4
========== ==========
TOTAL ASSETS $ 124,911 $ 120,347
========== ==========
LIABILITIES AND PARTNERS' CAPITAL:
Liabilities
Legal and Professional Fees Payable $ 147 $ 363
Reimbursable Administrative Expenses Payable 29 57
Independent General Partners' Fees Payable - Note 9 40 66
Deferred Interest Income - Note 2 483 678
---------- ----------
Total Liabilities 699 1,164
---------- ----------
Partners' Capital - Note 2
Individual General Partner 29 29
Managing General Partner 3,247 1,932
Limited Partners (221,745 Units) 120,936 117,222
---------- ----------
Total Partners' Capital 124,212 119,183
---------- ----------
TOTAL LIABILITIES AND PARTNERS' CAPITAL $ 124,911 $ 120,347
========== ==========
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
For the 3 Months Ended
-------------------------------------
March 31, 1996 March 31, 1995
----------------- -----------------
INVESTMENT INCOME - Notes 2,4,6:
Interest $ 9,692 $ 1,957
Discount 177 286
Dividends 30 -
-------- ---------
TOTAL INCOME 9,899 2,243
-------- ---------
EXPENSES:
Investment Advisory Fee - Note 7 254 391
Fund Administration Fee - Note 8 170 201
Legal and Professional Fees 550 144
Reimbursable Administrative Expenses - Note 8 6 1
Independent General Partners' Fees and Expenses - Note 9 92 44
Insurance Expense 1 1
-------- ---------
TOTAL EXPENSES 1,073 782
-------- ---------
NET INVESTMENT INCOME 8,826 1,461
Net Realized Gain on Investments - Note 4 and Schedule 1 4,264 6,682
Net Change in Unrealized Appreciation (Depreciation)
on Investments: Note 5 and Schedule 2
Publicly Traded Securities (1,094) (13,857)
Nonpublic Securities (6,634) (2,421)
-------- ---------
SUBTOTAL (7,728) (16,278)
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS 5,362 (8,135)
Less: Incentive Fee to Managing General Partner (1,302) (4,863)
-------- ---------
NET INCREASE (DECREASE) AVAILABLE FOR PRO-RATA
DISTRIBUTION TO ALL PARTNERS $ 4,060 $ (12,998)
======== ==========
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
STATEMENTS OF CHANGES IN NET ASSETS
(DOLLARS IN THOUSANDS)
<S> <C> <C>
For the Quarters Ended
----------------------------------
March 31, 1996 March 31, 1995
---------------- -----------------
FROM OPERATIONS:
Net Investment Income $ 8,826 $ 1,461
Net Realized Gain on Investments 4,264 6,682
Net Change in Unrealized Depreciation
From Investments (7,728) (16,278)
---------- -----------
Net Increase (Decrease) in Net Assets 5,362 (8,135)
Resulting from Operations
Cash Distributions to Partners (333) (7,652)
---------- -----------
Total Increase (Decrease) 5,029 (15,787)
NET ASSETS:
Beginning of Year 119,183 166,714
---------- -----------
End of Period $ 124,212 $ 150,927
========== ===========
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
For the 3 Months Ended
--------------------------------
March 31, 1996 March 31, 1995
--------------------------------
Increase in Cash and Cash Equivalents
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest, Dividends and Discount Income $ 10,589 $ 1,689
Legal and Professional Fees (765) (153)
Investment Advisory Fee (254) (391)
Fund Administration Fee (170) (201)
Independent General Partners' Fees and Expenses (118) (56)
Reimbursable Administrative Expenses (35) (39)
Sale of Temporary Investments, Net (27,267) (470)
Proceeds from Sales of Portfolio Company 18,353 7,278
Investments ---------- --------
Net Cash Provided by Operating Activities 333 7,657
---------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash Distributions to Partners (333) (7,652)
---------- --------
Net Cash Applied to Financing Activities (333) (7,652)
---------- --------
Net Increase in Cash - 5
Cash at Beginning of Year 1 1
---------- --------
Cash at End of Year $ 1 $ 6
========== ========
RECONCILIATION OF NET INVESTMENT INCOME
TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net Investment Income $ 8,826 $ 1,461
--------- --------
Adjustments to Reconcile Net Investment Income to
Net Cash Provided by Operating Activities:
(Increase) Decrease in Investments (13,178) 126
(Increase) Decrease in Accrued Interest Receivables 690 (554)
Decrease in Prepaid Expenses 1 1
Decrease in Legal and Professional Fees Payable (216) (9)
Decrease in Reimbursable Administrative Expenses
Payable (28) (38)
Decrease in Independent General Partners' Fees
Payable (26) (12)
Net Realized Gain on Sales of Investments 4,264 6,682
--------- --------
Total Adjustments (8,493) 6,196
--------- --------
Net Cash Provided by Operating Activities $ 333 $ 7,657
========= ========
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C> <C> <C>
Individual Managing
General General Limited
Partner Partner Partners Total
-------------- --------------- -------------- ------------
For the 3 Months Ended March 31, 1996
Partners' Capital at January 1, 1996 $ 29 $ 1,932 $ 117,222 $ 119,183
Allocation of Net Investment Income 2 1,322 7,502 8,826
Allocation of Net Realized Gain on - 10 4,254 4,264
Investments
Allocation of Net Change in Unrealized
Depreciation From Investments (2) (17) (7,709) (7,728)
Cash Distributions to Partners - - (333) (333)
======= ========= ========= ==========
Partners' Capital at March 31, 1996 $ 29 $ 3,247 $ 120,936 $ 124,212
======= ========= ========= ==========
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
MARCH 31, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Principal Fair % Of
Amount/ Investment Investment Value Total
Shares Investment Date Cost(e) (Note 2) Investments
<S> <C> <C> <C> <C> <C>
MEZZANINE INVESTMENTS
MANAGED COMPANIES
ANCHOR ADVANCED PRODUCTS, INC. (b)
$5,867 Anchor Advanced Products, Inc., Sr. Sub. Nt.11.67% due 04/30/00(c) 04/30/90 $ 5,867 $ 5,867
$7,822 Anchor Advanced Products, Inc., Jr. Sub. Nt.17.5% due 04/30/00(c) 04/30/90 7,822 7,822
162,967 Shares Anchor Holdings Inc., Common Stock (d) 04/30/90 1,548 1,548
247,710 Warrants Anchor Holdings Inc., Common Stock Purchase Warrants(d) 04/30/90 0 0
(26.1% of fully diluted common equity assuming exercise
of warrants) 15,237 15,237 12.32
BIG V SUPERMARKETS, INC. (b)
$13,037 Big V Supermarkets, Inc., Sr. Sub. Nt. 14.14% due 03/15/01(c) 12/27/90 13,037 13,037
117,333 Shares Big V Holding Corp., Common Stock(d) 12/27/90 4,107 4,107
(16.6% of fully diluted common equity) 17,144 17,144 13.86
COLE NATIONAL CORPORATION
1,341 Warrants Cole National Corporation, Common Stock Purchase Warrants(d) 09/26/90 0 0
(0.0% of fully diluted common equity assuming exercise
of warrants)
$1,393 13% Sr. Secured Bridge Note
Purchased 09/25/90 $1,393
Repaid 11/15/90 $1,393
Realized Gain $ 0
0 0 0.00
See the Accompanying Notes to the Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
MARCH 31, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Principal Fair % Of
Amount/ Investment Investment Value Total
Shares Investment Date Cost(e) (Note 2)
<S> <C> <C> <C> <C> <C>
2,058,474 Shares FIRST ALERT, INC., (b) Note 5
First Alert, Inc., Common Stock(a)(d) 07/31/92 $ 3,320 $ 13,895
(8.1% of fully diluted common equity)
$ 10,198 12.5% Sub. Note
Purchased 07/31/92 $10,198
Repaid 03/28/94 $10,198
Realized Gain $ 0
3,320 13,895 11.23
GHIRARDELLI HOLDINGS CORPORATION (b) - Note 14
$4,672 Ghirardelli Holdings Corporation, 13% Subordinated Note
due 03/31/02(c) 03/31/92 4,672 4,672
467,200 Shares Ghirardelli Holdings Corporation, Common Stock(d) 03/31/92 934 934
73,692 Shares Ghirardelli Holdings Corporation, Common Stock(d) 05/12/95 234 234
14,016 Shares Ghirardelli Holdings Corporation, Series A Preferred Stock(d) 05/12/95 1,402 1,402
(9.3% of fully diluted common equity)
$7,008 Sr. Bridge Note
Purchased 03/31/92 $7,008
Repaid 06/11/92 $7,008
Realized Gain $ 0
7,242 7,242 5.86
See the Accompanying Notes to the Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
MARCH 31, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Principal Fair % Of
Amount/ Investment Investment Value Total
Shares Investment Date Cost(e) (Note 2) Investments
<S> <C> <C> <C> <C> <C>
HILLS STORES COMPANY - Note 5
458,432 Shares Hills Stores Company, Common Stock(a)(d) 04/03/90 $30,246 $ 5,386
62,616 Shares Hills Stores Company, Common Stock(a)(h) 08/21/95 4,530 736
(4.6% of fully diluted common equity) 34,776 6,122 4.95
PETCO ANIMAL SUPPLIES, INC. (b) - Notes 5,14
175,238 Shares Petco Animal Supplies, Common Stock(a)(d)(f) Various 1,915 5,228
(1.3% of fully diluted common equity)
$52 14% Sr. Sub. Bridge Notes
Purchased various $ 52
Repaid 04/19/91 $ 52
Realized Gain $ 0
$1,667 12.5% Sr. Sub. Notes
Purchased various $1,667
Repaid 03/28/94 $1,667
Realized Gain $ 0
120,143 Shares Common Stock
Purchased various $1,969
Sold 04/26/95 $2,368
Realized Gain $ 399
Total Realized Gain $ 399
1,915 5,228 4.23
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
MARCH 31, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Principal Fair % Of
Amount/ Investment Investment Value Total
Shares Investment Date Cost(e) (Note 2) Investments
<S> <C> <C> <C> <C> <C>
PLAYTEX PRODUCTS, INC. (b) - Note 5
343,726 Shares Playtex Products, Inc., Common Stock(a)(d) 03/29/90 $ 5,299 $ 2,492
(.6% of fully diluted common equity)
$7,333 15% Subordinated Note
Purchased 03/29/90 $7,333
Sold 09/28/90 $7,349
Realized Gain $ 16
84,870 Shares Common Stock
Purchased 03/29/90 $ 282
Sold 12/20/91 $ 328
Realized Gain $ 46
$7,334 15% Subordinated Note
Purchased 03/29/90 $7,334
Sold 02/01/93 $7,327
Realized Loss $ (7)
Total Net Realized Gain $ 55
5,299 2,492 2.01
RESTAURANTS UNLIMITED
$6,044 Restaurants Unlimited, 11% Subordinated Note due 06/30/02(c) 06/03/94 6,044 6,044
391,302 Warrants Restaurants Unlimited, Common Stock Warrants(d) 06/03/94 06/03/94 0 0
(2.1% of fully diluted common equity) 6,044 6,044 4.89
STANLEY FURNITURE COMPANY, INC. (b) - Note 5
23,105 Shares Stanley Furniture Company, Inc.,
Common Stock(a)(d) 06/30/91 291 248
(0.4% of fully diluted common equity)
291 248 0.20
TOTAL INVESTMENT IN MANAGED COMPANIES $ 91,268 $ 73,652 59.55
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
MARCH 31, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Principal Fair % Of
Amount/ Investment Investment Value Total
Shares Investment Date Cost(e) (Note 2) Investments
<S> <C> <C> <C> <C> <C>
NON-MANAGED COMPANIES
BIOLEASE, INC.
$784 BioLease, Inc., 13% Sub. Nt. due 06/06/04 (c) 06/08/94 $ 676 $ 693
96.56 Shares BioLease, Inc., Common Stock (d) 06/08/94 94 94
40,057 Warrants Biotransplant, Inc., Common Stock Purchase Warrants(d) 06/08/94 14 14
784 801 0.65
FITZ AND FLOYD/SYLVESTRI -Notes 5,6,14
$10,281 FFSC, Inc., Adjustable Rate Sr. Sub. Nt. due 03/31/03(c)(g) 03/31/93 10,266 2,448
$ 2,419 FFSC, Inc., Adjustable Rate Sr. Sub. Nt. due 03/31/03(c)(g) 07/30/93 2,414 576
1,511,856 Shares FF Holding Co., Common Stock (d) 03/31/93 15 0
514,636 Shares FF Holding Co., Common Stock (d) 07/30/93 5 0
515,845 Shares FF Holding Co., Common Stock (d) 12/22/94 0 0
12,700 3,024 2.44
FLA. ORTHOPEDICS, INC. - Notes 5,6,12
$4,842 FLA. Acquisition Corp., 12.5% Sub. Nt. due 07/31/99(c)(g) 08/02/93 4,842 0
121,040 Shares FLA. Holdings, Inc. Common Stock(d) 08/02/93 1,513 0
72,624 Warrants FLA. Holdings, Inc. Common Stock Purchase Warrants(d) 08/02/93 0 0
6,355 0 0.00
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
MARCH 31, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Principal Fair % Of
Amount/ Investment Investment Value Total
Shares Investment Date Cost(e) (Note 2) Investments
<S> <C> <C> <C> <C> <C>
NATIONAL TOBACCO COMPANY, L.P.
$3,503 National Tobacco Company, 13% Sub. Nt. due 10/15/98(c) 04/14/92 $ 3,503 $ 3,503
$ 115 National Tobacco Company, 16% Sub. Nt. due 10/15/98(c)(f) 06/30/93 115 115
$ 234 National Tobacco Company, Class A Partnership Int.(d) 04/14/92 234 234
3,852 3,852 3.11
SORETOX - Notes 5,6
$3,503 Stablex Canada, Inc., Sub. Nt. 10% due 06/30/07(c)(f)(g) 06/29/95 3,503 2,590
$3,128 Stablex Canada, Inc., Jr. Sub. Nt. 11% due 06/30/09(c)(f)(g) 06/29/95 3,128 2,439
2,004 Warrants Seaway TLC, Inc. Common Stock Purchase Warrants 06/29/95 0 0
6,631 5,029 4.07
TOTAL INVESTMENT IN NON-MANAGED COMPANIES $ 30,322 $12,706 10.27
SUMMARY OF MEZZANINE INVESTMENTS
Subordinated Notes Various 65,889 49,806 40.27
Partnership Interest 04/14/92 234 234 0.19
Preferred Stock, Common Stock, Warrants and Stock Rights Various 55,467 36,318 29.36
TOTAL MEZZANINE INVESTMENTS $121,590 $86,358 69.82
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
MARCH 31, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Principal Fair % Of
Amount/ Investment Investment Value Total
Shares Investment Date Cost(e) (Note 2) Investments
<S> <C> <C> <C> <C> <C>
TEMPORARY INVESTMENTS
CERTIFICATES OF DEPOSIT AND TIME DEPOSITS
$ 605 Banque Nationale de Paris, 5.2% due 04/29/96 - Note 12 08/18/93 $ 605 $ 605
TOTAL INVESTMENT IN C/D'S AND TIME DEPOSITS 605 605 0.49
COMMERCIAL PAPER
$ 10,000 Ford Motor Credit Company, 5.37%, due 04/09/96 03/25/96 9,978 9,988
$ 10,000 General Electric Credit Corp., 5.37%, due 04/09/96 03/25/96 9,978 9,988
$ 7,050 American General Finance Corp., 5.37%, due 04/09/96 03/25/96 7,034 7,042
$ 9,696 State Streeett Repo, 4.8750%, due 04/01/96 03/29/96 9,696 9,700
TOTAL INVESTMENT IN COMMERCIAL PAPER 36,686 36,718 29.69
TOTAL TEMPORARY INVESTMENTS 37,291 37,323 30.18
TOTAL INVESTMENT PORTFOLIO $158,881 $123,681 100.00%
(a) Publicly traded class of securities.
(b) Represents investment in affiliates as defined in the Investment Company Act of 1940.
(c) Restricted security.
(d) Restricted non-income producing equity security.
(e) Represents original cost and excludes accretion of discount of $20 for Mezzanine Investments
and $32 for Temporary Investments.
(f) Inclusive of receipt of payment-in-kind securities.
(g) Non-accrual investment status.
(h) Non-income producing equity security.
See the Accompanying Notes to Financial Statements.
</TABLE>
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ML-LEE ACQUISITION FUND II, L.P.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 1996
(UNAUDITED)
1. Organization and Purpose
ML-Lee Acquisition Fund II, L.P. ("Fund II") (formerly T.H. Lee
Acquisition Fund II, L.P.) was formed along with ML-Lee Acquisition Fund
(Retirement Accounts) II, L.P. (the "Retirement Fund"; together with Fund II
referred to as the "Funds") and the Certificates of Limited Partnership were
filed under the Delaware Revised Uniform Limited Partnership Act on September
23, 1988. The Funds' operations commenced on November 10, 1989.
Mezzanine Investments II, L.P. (the "Managing General Partner"), subject to
the supervision of the Individual General Partners, is responsible for
overseeing and monitoring Fund II's investments. The Managing General Partner is
a Delaware limited partnership in which ML Mezzanine II Inc. is the general
partner and Thomas H. Lee Advisors II, L.P., the Investment Adviser to the
Funds, is the limited partner. The Individual General Partners are Vernon R.
Alden, Joseph L. Bower and Stanley H. Feldberg (the "Independent General
Partners") and Thomas H. Lee.
Fund II has elected to operate as a business development company under
the Investment Company Act of 1940. Fund II's primary investment objective is to
provide current income and capital appreciation potential by investing in
privately-structured, friendly leveraged buyouts and other leveraged
transactions. Fund II pursues this objective by investing primarily in
subordinated debt and related equity securities issued in conjunction with the
"mezzanine financing" of friendly leveraged buyout transactions, leveraged
acquisitions and leveraged recapitalizations. Fund II may also invest in "bridge
investments" if it is believed that such investments would facilitate the
consummation of a mezzanine financing.
Fund II will terminate no later than January 5, 2000, subject to the right
of the Individual General Partners to extend the term for up to one additional
two-year period and one additional one-year period if it is in the best interest
of Fund II. Fund II will then have five additional years to liquidate its
remaining investments.
2. Significant Accounting Policies
Basis of Accounting
For financial reporting purposes, the records of Fund II are maintained
using the accrual method of accounting. For federal income tax reporting
purposes, the results of operations are adjusted to reflect statutory
requirements arising from book to tax differences. The preparation of financial
statements in accordance with generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts and
disclosures in the financial statements. Actual reported results could vary from
these estimates.
Valuation of Investments
Securities for which market quotations are readily available are valued
by reference to such market quotation using the last trade price (if reported)
or the last bid price for the period. For securities without a readily
ascertainable market value (including securities restricted as to resale for
which a corresponding publicly traded class exists), fair value is determined,
on a quarterly basis, in good faith by the Managing General Partner and the
Investment Adviser with final approval from the Individual General Partners of
Fund II. For privately issued securities in which Fund II typically invests, the
fair value of an investment is its original cost plus accrued value in the case
of original issue discount or deferred pay securities. Such investments will be
revalued if there is an objective basis for doing so at a different price.
Investments will be written down in value if the Managing General Partner and
Investment Adviser believe adverse credit developments of a significant nature
require a write-down of such securities. Investments will be written up in value
only if there has been an arms'-length third party transaction to justify the
increased valuation. Although the Managing General Partner and Investment
Adviser use their best judgment in estimating the fair value of these
investments, there are inherent limitations in any estimation technique.
Therefore, the fair value estimates presented herein are not necessarily
indicative of the amount which Fund II could realize in a current transaction.
Future confirming events will also affect the estimates of fair value and the
effect of such events on the estimates of fair value could be material.
Temporary Investments with maturities of less than 60 days are stated at
amortized cost, which approximates market.
The information presented herein is based on pertinent information
available to the Managing General Partner and Investment Adviser as of March 31,
1996. Although the Managing General Partner and Investment Adviser are not aware
of any factors not disclosed herein that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued since that time, and because investments of companies whose equity is
publicly traded are valued at the last price at March 29, 1996, the current
estimated fair value of these investments may have changed significantly since
that point in time.
Interest Receivable on Investments
Investments generally will be placed on non-accrual status in the event
of a default (after the applicable grace period expires) or if the Investment
Adviser and the Managing General Partner determine that there is no reasonable
assurance of collecting interest.
Payment-In-Kind Securities
All payment-in-kind securities received in lieu of cash interest payments
by Fund II's portfolio companies are recorded at face value (which approximates
accrued interest), unless the Investment Adviser and the Managing General
Partner determine that there is no reasonable assurance of collecting the full
principal amounts of such securities. As of March 31, 1996 and December 31,
1995, Fund II has in its portfolio of investments $557,021 and $751,907,
respectively, of payment-in-kind notes which excludes $359,662 and $7,637,720,
respectively, of payment-in-kind notes received from notes placed on non-accrual
status. As of March 31, 1996 and December 31, 1995, Fund II has in its portfolio
of investments $2,293,457, of payment-in-kind equity.
Investment Transactions
Fund II records investment transactions on the date on which it obtains
an enforceable right to demand the securities or payment therefor. Fund II
records Temporary Investment transactions on the trade date.
Realized gains and losses on investments are determined on the basis of
specific identification for accounting and tax purposes.
Sales and Marketing Expenses, Offering Expenses and Sales Commissions
Sales commissions and selling discounts were allocated to the specific
Partners' accounts in which they were applied. Sales and marketing expenses and
offering expenses were allocated between the Funds in proportion to the number
of Units issued by each Fund and to the Partners in proportion to their capital
contributions.
Deferred Interest Income
All fees received by Fund II upon the funding of Mezzanine or Bridge
Investments are treated as deferred interest income and amortized over the
maturity of such investments.
Partners' Capital
Partners' Capital represents Fund II's equity divided in proportion to
the Partners' Capital Contributions and does not represent the Partners' Capital
Accounts. Profits and losses, when realized, are allocated in accordance with
the provisions of the Partnership Agreement summarized in Note 3.
Interim Financial Statements
The financial information included in this interim report as of March
31, 1996 and for the period then ended has been prepared by management without
an audit by independent certified public accountants. The results for the period
ended March 31, 1996 are not necessarily indicative of the results of the
operations expected for the year and reflect adjustments, all of a normal and
recurring nature, necessary for the fair presentation of the results of the
interim period. In the opinion of Mezzanine Investments II, L.P., the Managing
General Partner of Fund II, all necessary adjustments have been made to the
aforementioned financial information for a fair presentation in accordance with
generally accepted accounting principles.
<PAGE>
3. Allocations of Profits and Losses
Pursuant to the Partnership Agreement, all profits from Temporary
Investments generally are allocated 99.75% to the Limited Partners, 0.23% to the
Managing General Partner and 0.02% to the Individual General Partner. Profits
from Mezzanine Investments will, in general, be allocated as follows:
first, if the capital accounts of any partners have negative balances, to
such partners in proportion to the negative balances in their capital
accounts until the balances of all such capital accounts equal zero,
second, 99.75% to the Limited Partners, 0.23% to the Managing General
Partner and 0.02% to the Individual General Partner until the sum allocated
to the Limited Partners equals any previous losses allocated together with a
cumulative Priority Return of 10% on the average daily amount in Mezzanine
Investments, and any outstanding Compensatory Payments,
third, 69.75% to the Limited Partners, 30.225% to the Managing General
Partner and 0.025% to the Individual General Partner until the Managing
General Partner has received 20.281% of the total profits allocated,
thereafter, 79.75% to the Limited Partners, 20.225% to the Managing General
Partner and 0.025% to the Individual General Partner.
Losses will be allocated in reverse order of profits previously allocated
and thereafter 99.75% to the Limited Partners, 0.23% to the Managing General
Partners and 0.02% to the Individual General Partner.
4. Investment Transactions
On March 22, 1996 by means of merger of Lee-CST Holding Corp. with an
unaffilated third party, Fund II sold its entire investment in CST Office
Products ("CST") for total proceeds of $26.5 million. Fund II received an
aggregate of $21.1 million for the $6,355,000 principal amount 12% senior
subordinated note, the $6,355,000 principal amount 18% junior subordinated note,
approximately $7.5 million in principal amount of 15% payment in kind
subordinated notes issued with respect thereto, plus all outstanding accrued
interest on these notes. Additionally, Fund II received $2.6 million, or $16 per
share, for its common stock and $2.8 million, or $15.99 per share, for its
common stock purchase warrants. Fund II realized a gain of $4.3 million, and
additional interest income of $7.2 million for the payment in kind subordinated
notes that were previously classified as non-accrual.
On August 6, 1991, the Independent General Partners approved a reserve
for follow-on investments of $24.9 million for Fund II. As of March 31, 1996,
the reserve balance was reduced to $9.9 million due to follow-on investments of
$285 in Petco Animal Supplies, $2.4 million in Fitz and Floyd/Silvestri
Corporation, $240,060 in Fine Clothing, Inc., $4.5 million in Hills Stores and
$1.6 million in Ghirardelli Holdings. Additionally, $6.29 million of the reserve
was returned to the partners during 1995. The level of the reserve was based
upon an analysis of potential follow-on investments in specific portfolio
companies that may become necessary to protect or enhance Fund II's existing
investment. As of March 6, 1996, the Independent General Partners have approved
retention of the reserve at its current level.
Because Fund II primarily invests in high-yield private placement
securities, the risk of loss upon default by an issuer is greater than with
investment grade securities because high-yield securities are generally
unsecured and are often subordinated to other creditors of the issuer. Also,
high-yield issuers usually have higher levels of indebtedness and are more
sensitive to adverse economic conditions.
Although Fund II cannot eliminate the risks associated with its
investments in high-yield securities, it has procedures in place to continually
monitor the risks associated with its investments under a variety of market
conditions. Any potential Fund II loss would generally be limited to its
investment in the portfolio company as reflected in the portfolio of
investments.
Should bankruptcy proceedings commence, either voluntarily or by action
of the court against a portfolio company, the ability of Fund II to liquidate
the position or collect proceeds from the action may be delayed or limited.
5. Unrealized Appreciation and Depreciation of Investments
For the three months ended March 31, 1996, Fund II recorded net unrealized
depreciation of $7,727,835 (of which $1,094,319 is net unrealized depreciation
from publicly traded securities and $6,633,516 is net unrealized depreciation
from non-public securities) compared to net unrealized depreciation of
$16,277,574 for the same period in 1995. As of March 31, 1996, Fund II's
cumulative net unrealized depreciation on investments totaled $35,251,050.
For additional information, please refer to the Schedule of Unrealized
Appreciation and Depreciation (Schedule 2).
6. Non-Accrual of Investments
In accordance with Fund II's Accounting Policy, the following notes have
been on non-accrual status since the date indicated:
- Fitz and Floyd/Sylvestri Corporation on January 1, 1994.
- FLA. Orthopedics, Inc., on January 1, 1995.
- Stablex Canada, Inc., on June 29, 1995.
7. Investment Advisory Fee
The Investment Adviser provides the identification, management and
liquidation of portfolio investments for the Funds. As compensation for services
rendered to the Funds, the Investment Adviser receives a quarterly fee at the
annual rate of 1% of assets under management (net offering proceeds reduced by
cumulative capital reductions), with a minimum annual fee of $1.2 million for
Fund II and the Retirement Fund on a combined basis. The Investment Advisory Fee
is calculated and paid quarterly in advance. In addition, the Investment Adviser
receives 95% of the benefit of any MGP Distributions paid to the Managing
General Partner (see Note 10). For the three months ended March 31, 1996 and
1995, Fund II paid $254,070 and $390,624, respectively, in Investment Advisory
Fees to Thomas H. Lee Advisors II, L.P.
8. Fund Administration Fees and Expenses
As compensation for its services, ML Fund Administrators Inc. (the "Fund
Administrator"; an affiliate of the Managing General Partner) is entitled to
receive from the Funds an annual amount of the greater of $500,000 or 0.45% of
the excess of net offering proceeds less 50% of capital reductions. In addition,
ML Mezzanine II Inc., an affiliate of the Fund Administrator and Merrill Lynch &
Co.,Inc., receives 5% of the benefit of any MGP Distributions paid to the
Managing General Partner (see Note 10). The Fund Administration Fee is
calculated and paid quarterly, in advance, by each Fund in proportion with the
net offering proceeds. For the three months ended March 31, 1996 and 1995, Fund
II paid $170,354 and $201,078, respectively, in Fund Administration Fees.
Pursuant to the administrative services agreement between Fund II and the
Fund Administrator, effective November 10, 1993, a portion of the actual
out-of-pocket expenses incurred in connection with the administration of Fund II
is being reimbursed to the Fund Administrator. Actual out-of-pocket expenses
("reimbursable expenses") primarily consist of printing, audits, tax preparation
and custodian fees. For the three months ended March 31, 1996 and 1995, Fund II
incurred $6,403 and $604, respectively, in reimbursable expenses.
9. Independent General Partners' Fees and Expenses
As compensation for their services, each Independent General Partner will
receive a combined annual fee of $40,000 (payable quarterly) from the Funds in
addition to a $1,000 fee for each meeting attended ($500 if a meeting is held on
the same day as a committee meeting of the General Partners) plus reimbursement
for any out-of-pocket expenses incurred. Fees and expenses are allocated between
the Funds in proportion to the number of units issued by each fund. Compensation
for each of the Individual General Partners is reviewed annually. For the three
months ended March 31, 1996 and 1995, Fund II incurred $91,537 and $44,243,
respectively, in Independent General Partners' Fees and Expenses.
10. Related Party Transactions
Fund II's investments generally are made as co-investments with the
Retirement Fund. In addition, certain of the Mezzanine Investments and Bridge
Investments which were made by Fund II involve co-investments with entities
affiliated with the Investment Adviser. Such co-investments are generally
prohibited absent exemptive relief from the Securities and Exchange Commission
(the "Commission"). As a result of these affiliations and Fund II's expectation
of engaging in such co-investments, the Funds together with ML-Lee Acquisition
Fund, L.P., sought an exemptive order from the Commission allowing such
co-investments, which was received on September 1, 1989. Fund II's
co-investments in Managed Companies, and in certain cases its co-investments in
Non-Managed Companies, typically involve the entry by the Funds and other equity
security holders into stockholders' agreements. While the provisions of such
stockholders' agreements vary, such agreements may include provisions as to
corporate governance, registration rights, rights of first offer or first
refusal, rights to participate in sales of securities to third parties, rights
of majority stockholders to compel minority stockholders to participate in sales
of securities to third parties, transfer restrictions, and preemptive rights.
Thomas H. Lee Company, a sole proprietorship owned by Thomas H. Lee, an
Individual General Partner of Fund II and an affiliate of the Investment
Advisor, typically performs certain management services for Managed Companies
and receives management fees in connection therewith, usually pursuant to
written agreements with such companies. In addition, certain of the portfolio
companies have contractual or other relationships pursuant to which they do
business with one another.
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S") is an
affiliate of the Managing General Partner. MLPF&S and certain of its affiliates,
in the ordinary course of their business, perform various financial services for
various portfolio companies of the Funds, which may include investment banking
services, broker/dealer services and economic forecasting, and receive in
consideration therewith various fees, commissions and reimbursements.
Furthermore, MLPF&S and its affiliates or investment companies advised by
affiliates of MLPF&S may, from time to time, purchase or sell securities issued
by portfolio companies of the Funds in connection with its ordinary investment
operations.
For the three months ended March 31, 1996 and 1995, Fund II paid $34,749 and
$38,153, respectively, to the Fund Administrator for reimbursable out-of-pocket
expenses (please refer to Note 8 for further information).
In the first quarter of 1996, Fund II paid the Individual General Partner
distributions totaling $75 and Managing General Partner distributions totaling
$752. As of March 31, 1996, the Managing General Partner has earned a total of
$18,236,290 in MGP Incentive Fees of which $2,433,083 is deferred in payment to
the Managing General Partner as a Deferred Distribution amount (the "Deferred
Distribution") in accordance with the Partnership Agreement. To the extent not
payable to the Managing General Partner, this Deferred Distribution is
distributed to the Partners pro-rata in accordance with their capital
contributions, and certain amounts otherwise later payable to Partners from
distributable cash from operations would instead be payable solely to the
Managing General Partner until the Deferred Distribution amount is paid in full.
11. Litigation
On February 3, 1992 and February 5, 1992, respectively, one Limited Partner
from Fund II and one Limited Partner from the Retirement Fund each commenced
class actions in the US District Court for the District of Delaware, purportedly
on behalf of all persons who purchased limited partnership interests in the
Funds between November 10, 1989 and January 5, 1990, against the Funds, the
Managing General Partner, the Individual General Partners, the Investment
Adviser to the Funds and certain named affiliates of such persons. These
actions, alleging that the defendants in the action made material
misrepresentations or omitted material information in the offering materials for
the Funds concerning the investment purposes of the Funds, were consolidated by
the court on March 31, 1992, and a consolidated complaint was filed by the
plaintiffs on May 14, 1992. In April 1993, plaintiffs filed an amended
complaint, adding claims that certain transactions by the Funds were prohibited
by the federal securities laws applicable to the Funds and their affiliates
under the Investment Company Act of 1940, as amended. The amended complaint also
named the Funds' counsel as a defendant. Defendants moved to dismiss the amended
complaint, and, by Opinion and Order dated March 31, 1994, the Court granted in
part and denied in part the motions to dismiss. Additionally, by its March 31,
1994 Opinion and Order, the Court certified the case as a class action, and
ordered plaintiffs to replead by filing a new complaint reflecting the Court's
rulings. On April 15, 1994, plaintiffs served and filed a new complaint, which
defendants moved to strike for not conforming to the Court's ruling. On August
3, 1994, the Court granted defendants' motion to strike the new complaint.
Plaintiffs thereafter filed a revised second amended complaint dated September
26, 1994. Factual discovery in this litigation has concluded, although
plaintiffs have made application to the Court for permission to conduct
additional fact discovery. The parties have conducted expert discovery, the
conclusion of which is subject to the Courts' decision on a pending motion. The
defendants in this action believe that the remaining claims are without merit,
although whether or not the plaintiffs prevail, the Funds may be obligated to
indemnify and advance litigation expenses to certain of the defendants under the
terms and conditions of various indemnity provisions in the Funds' Partnership
Agreements and separate indemnification agreements, and the amount of such
indemnification and expenses could be material. Fund II has advanced amounts to
the indemnified parties based upon amounts which are deemed reimbursable in
accordance with the indemnification provisions and has included these amounts in
professional fees. The outcome of this case is not determinable at this time.
On August 9, 1994, the same two Limited Partners as noted in the preceding
paragraph commenced another putative class action in the US District Court for
the District of Delaware, purportedly on behalf of all persons who owned limited
partnership interests in the Funds on November 4, 1993, against the Funds, the
Managing General Partners, the Individual General Partners, the Investment
Adviser to the Funds and certain named affiliates of such persons. Plaintiffs
allege that the defendants violated certain provisions of the Investment Company
Act of 1940 and the common law in connection with the sale by certain of the
defendants of shares of common stock of Snapple Beverage Corp. in a November
1993 secondary offering and seek actual and punitive damages and an accounting
in connection therewith. Defendants' motion to dismiss this complaint was denied
on December 29, 1995. On August 4, 1995, while defendants' motion to dismiss the
original complaint was pending, plaintiffs filed an amended complaint alleging
additional violations of the Investment Company Act of 1940 and common law
arising out of the secondary offering. The plaintiffs moved for summary judgment
on certain of these claims. On October 13, 1995, the defendants in this
litigation each filed briefs in opposition to plaintiffs motion and moved to
dismiss the amended complaint. By an Opinion dated March 30, 1996, the Court
denied plaintiffs' motion for partial summary judgment. By order of the same
date, and without opposition by defendants, the Court certified the case as a
class action. Defendants also filed separate motions to dismiss, which have now
been fully briefed and are currently pending. Whether or not the plaintiffs
prevail, the Funds may be obligated to indemnify and advance litigation expenses
to certain of the defendants under the terms and conditions of various indemnity
provisions in the Funds' Partnership Agreements and separate indemnification
agreements. The outcome of this case is not determinable at this time.
On November 2, 3 and 4, 1994, stockholders of Snapple Beverage Corp.
commenced approximately twenty putative class actions in the Delaware Chancery
Court, purportedly on behalf of all public stockholders of Snapple, against
Snapple, the Funds, Thomas H. Lee Equity Partners, L.P., and some or all of
Snapple's directors. Since then, the plaintiffs have filed a Consolidated
Amended Complaint against Snapple, the Funds, Thomas H. Lee Equity Partners,
L.P., some or all of Snapple's directors and Quaker Oats. The complaint alleges
that the sale of Snapple to Quaker Oats was at an unfair price and in violation
of the defendants' fiduciary duties to public stockholders. The plaintiffs
sought an injunction against the merger transaction, an accounting for any
damages suffered by the public stockholders, and attorneys' fees and related
expenses. The Court on November 15, 1994, denied plaintiffs application to take
expedited discovery and request to schedule a preliminary injunction hearing. In
April 1996, the parties filed a Stipulation of Dismissal with the Court. The
Funds may be obligated to indemnify and advance litigation expenses to certain
of the defendants under the terms and conditions of various indemnity provisions
in the Funds' Partnership Agreements and separate indemnification agreements.
On November 27, 1995, one Limited Partner from Fund II and one Limited
Partner from the Retirement Fund filed a putative class action in the United
States District Court for the District of Delaware, purportedly on behalf of all
persons or entities who owned Units in the Funds between April 5, 1991 and
November 27, 1995, against the Funds, the Managing General Partner, the
Individual General Partners, the Investment Adviser to the Funds, and certain
named affiliates of such persons. The complaint contends that the Funds
improperly advanced legal fees and litigation costs to the defendants in
connection with three previously filed lawsuits. The plaintiffs are seeking an
accounting, rescissory or actual damages, punitive damages, plaintiffs'
litigation costs and attorneys fees, pre-judgment and post-judgment interest,
and an injunction barring the defendants from further indemnifying themselves.
The defendants in this action believe that the claims are without merit and have
moved to dismiss the case. Although the defendants believe the advancement of
legal fees and litigation costs was properly made pursuant to indemnification
agreements signed by the defendants, the outcome of this case is not
determinable at this time.
12. Commitments
On August 2, 1993, Fund II established a letter of credit from Banque
Nationale de Paris in favor of FLA. Orthopedics, a Non-Managed portfolio
company. Fund II posted as collateral a $605,200 Banque Nationale de Paris
certificate of deposit which pays an interest rate of 5.2%. If the commitment is
drawn upon, Fund II will receive additional subordinated notes and equity of
FLA. Orthopedics. The letter of credit expired on May 1, 1996.
<PAGE>
13. Income Taxes (Statement of Financial Accounting Standards No. 109)
No provision for income taxes has been made since all income and losses are
allocated to Fund II's partners for inclusion in their respective tax returns.
Pursuant to the Statement of Financial Accounting Standards No. 109 -
Accounting for Income Taxes, Fund II is required to disclose any difference in
the tax basis of Fund II's assets and liabilities versus the amounts reported in
the financial statements. Generally, the tax basis of Fund II's assets
approximate the amortized cost amounts reported in the financial statements.
This amount is computed annually and as of December 31, 1995, the tax basis of
Fund II's assets are less than the amounts reported in the financial statements
by $25,133,719. This difference is primarily attributable to net unrealized
appreciation on investments which has not been recognized for tax purposes.
14. Subsequent Events
On March 20, 1996, Petco Animal Supplies announced a 3-for-2 stock split
effective April 15, 1996. On April 4, 1996, Petco filed a registration statement
with the Securities and Exchange Commission for an offering of 3,333,333 shares
of Common Stock, which has been adjusted to 5 million shares as a result of the
stock split. Of the 5 million post-split shares offered, 2.6 million were
offered by Petco and the remaining shares were offered by certain current
stockholders, including Fund II. The offering was effected on April 30, 1996 and
Fund II sold its entire investment in Petco, which consisted of 175,238 shares
of Common Stock and received net proceeds of $4,794,457 or $27.36 per share.
Fund II realized a gain of $2,879,333 on the sale.
Operating performance at Fitz & Floyd/Silvestri, Corp. ("Fitz & Floyd"), a
Non-Managed Company in Fund II's portfolio, while improving from 1994 has fallen
substantially below plan. On March 29, 1996, Fitz & Floyd filed a voluntary
petition for protection under Chapter 11 of the United States Bankruptcy Code,
and continued operating the business as debtor-in-possession. The Investment
Adviser, Fitz & Floyd management and the senior lender, CIT, are working to
restructure the company. As a result of such filing, Fund II has agreed to
guarantee its pro-rata share of up to $4,000,000 of debtor-in-posession
financing for Fitz & Floyd.
On April 1, 1996, Fund II sold its entire investment in Ghirardelli
Holdings Corp. ("Ghirardelli") to an investor group comprised of the Chief
Executive Officer of Ghirardelli and certain other investors. Fund II received
net proceeds from the sale of $9,514,184, which consisted of $4,931,815 as
prepayment for the 13% Subordinated Note (including $104,082 of accrued
interest), $3,052,117 for the common stock and $1,530,251 for the preferred
stock (including $26,475 of accrued dividends). The sale resulted in a realized
gain of $2,168,502 to Fund II.
On April 26, 1996, the Individual General Partners approved a special
second quarter 1996 cash distribution totaling $9,409,747 which represents net
distributable capital proceeds from the sale of Ghirardelli (the "Ghirardelli
Distribution") on April 1, 1996 (including a return of capital of $7,240,150).
The total amount distributed to the Limited Partners of record as of April 1,
1996 was $9,386,466 or $42.33 per Unit, which was distributed on May 3, 1996.
The Managing General Partner received a total of $21,164 with respect to its
interest in Fund II. Thomas H. Lee, as an Individual General Partner, received
$2,117 with respect to his interest in Fund II.
On April 26, 1996, the Individual General Partners approved the first
quarter 1996 cash distribution totaling $27,591,317 which represents net
distributable capital proceeds of $18,352,595 from the sale of CST (which
includes return of capital of $14,013,634) net investment income of $9,135,343
from Mezzanine Investments and $103,379 income from Temporary Investments. The
total amount distributed to the Limited Partners was $22,181,152 or $100.03 per
Unit, which was distributed on May 3, 1996. The Managing General Partner
received a total of $50,015 with respect to its interest in Fund II and
$5,355,148 in performance incentive fees (of which $3,734,771 was a Deferred
Distribution payment as defined in Note 10). Thomas H. Lee, as an Individual
General Partner, received $5,002 with respect to his interest in Fund II.
Subsequent to the payment of this distribution and the Ghirardelli Distribution
described above, the remaining Deferred Distribution Amount is $650,551.
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE 1
ML-LEE ACQUISITION FUND II, L.P.
SUPPLEMENTAL SCHEDULE OF REALIZED GAINS AND LOSSES
FOR THE 3 MONTHS ENDED MARCH 31, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C> <C> <C>
Investment Realized
SECURITY Number of Shares Cost Net Proceeds Gain
- ----------------------------------------- ------------------------------------ --------------- --------------
CST Office Products, Inc.
Common Stock 162,949 $ 1,304 $ 2,607 $ 1,303
Subordinated Notes $ 12,710 12,710 12,837 127
Purchase Warrants 177,207 - 2,834 2,834
-------- -------- --------
Total $ 14,014 $ 18,278 $ 4,264
======== ======== ========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE 2
ML-LEE ACQUISITION FUND II, L.P.
SUPPLEMENTAL SCHEDULE OF UNREALIZED APPRECIATION AND DEPRECIATION
FOR THE PERIOD ENDED MARCH 31, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Total Unrealized
Appreciation/ Total Unrealized Total Unrealized
(Depreciation) Appreciation/ Appreciation/
Investment Fair for the quarter ended (Depreciation) (Depreciation)
SECURITY Cost Value March 31, 1996 December 31, 1995 March 31, 1996
- -------------------------------------- ---------- --------- --------------------- --------------------- --------------------
PUBLICLY TRADED/UNDERLYING
SECURITY PUBLICLY TRADED:
First Alert
Common Stock * $ 3,320 $ 13,895 $ (3,860) $ 14,434 $ 10,574
Hills Stores
Common Stock * 34,776 6,122 977 (29,631) (28,654)
Petco
Common Stock * 1,915 5,228 1,811 1,502 3,313
Playtex
Common Stock * 5,299 2,492 (86) (2,721) (2,807)
Stanley
Common Stock * 291 248 64 (106) (42)
----------- ------------- --------------
TOTAL UNREALIZED APPRECIATION
(DEPRECIATION) FROM PUBLICLY
TRADED SECURITIES $ (1,094) $ (16,522) $ (17,616)
----------- ------------- --------------
NON PUBLIC SECURITIES:
Fitz and Floyd/Sylvestri
Common Stock * 20 - - (20) (20)
Adjusted Rate Senior Note * 10,266 3,024 (6,634) (3,025) (9,659)
FLA. Orthopedics, Inc.
Common Stock* 1,513 - - (1,513) (1,513)
Subordinated Note 4,842 - - (4,842) (4,842)
Stablex Canada Inc.
Subordinated Notes* 6,631 5,029 - (1,602) (1,602)
----------- ------------- --------------
TOTAL UNREALIZED APPRECIATION
(DEPRECIATION) FROM NON PUBLIC
SECURITIES $ (6,634) $ (11,002) $ (17,636)
----------- ------------- --------------
NET UNREALIZED APPRECIATION
(DEPRECIATION) $ (7,728) $ (27,524) $ (35,252)
=========== ============= ==============
* Restricted security.
</TABLE>
<PAGE>
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Liquidity & Capital Resources
As of March 31, 1996, capital contributions from the Limited Partners and
the General Partners totaled $222,295,000 in the public offering of ML-Lee
Acquisition Fund II, L.P. ("Fund II"), the final closing for which was held on
December 20, 1989. Net proceeds which were available for investment to Fund II
as of March 31, 1996 were $147,150,822, after adjusting for returns of capital
to partners, volume discounts, sales commissions and organizational, offering,
sales and marketing expenses.
At March 31, 1996, Fund II had outstanding a total of $121,588,918 invested
in Mezzanine Investments representing $91,267,776 Managed and $30,321,142
Non-Managed portfolio investments. The remaining proceeds were invested in
Temporary Investments primarily comprised of commercial paper with maturities of
less than two months.
Fund II invested substantially all of its net proceeds in Mezzanine
Investments, consisting of high-yield subordinated debt and/or preferred stock
linked with an equity participation, of middle market companies in connection
with friendly leveraged acquisitions, recapitalizations and other leveraged
financings. Fund II's Mezzanine Investments typically were issued in private
placement transactions which are generally subject to certain restrictions on
sales thereby limiting their liquidity. Fund II was fully invested as of
December 20, 1992, which was within 36 months from the date of the final closing
(after including the reserve for follow-on investments and exclusive of amounts
available for reinvestment). The reinvestment period for various amounts of
capital proceeds received during the last twelve months of Fund II's investment
period terminated at various times through December 18, 1993.
Upon the consummation of the sale of Snapple Common Stock in December,
1994, Fund II received proceeds of approximately $68 million. As provided by the
Partnership Agreement, the Managing General Partner of Fund II received
incentive fees from this transaction to the extent certain returns of capital
and priority returns were achieved. The Managing General Partner was entitled to
an incentive MGP distribution of approximately $14.8 million, $4.86 million of
which was deferred in payment (the "Deferred Distribution Amount") to the
Managing General Partner in accordance with the Partnership Agreement. This
Deferred Distribution Amount is distributed to the Partners pro-rata in
accordance with their capital contributions, and certain amounts otherwise later
payable to Limited Partners from distributable cash from operations are instead
payable to the Managing General Partner until the Deferred Distribution Amount
is paid in full. The Limited Partners received approximately $58.3 million or
$263.08 per Unit from the Snapple proceeds on December 14, 1994. Following the
distributions of proceeds from the sale of CST Office Products and Ghirardelli
as described in Note 14 to the Financial Statements, as of May 15, 1996, the
Deferred Distribution Amount owed to the Managing General Partner was $650,551.
On August 6, 1991, the Independent General Partners approved a reserve
for follow-on investments of $24.9 million for Fund II. As of March 31, 1996,
the reserve balance was reduced to $9.9 million due to follow-on investments of
$285 in Petco Animal Supplies, $2.4 million in Fitz and Floyd/Silvestri
Corporation, $240,060 in Fine Clothing, Inc., $4.5 million in Hills Stores and
$1.6 million in Ghirardelli Holdings. Additionally, $6.29 million of the reserve
was returned to the partners during 1995. The level of the reserve was based
upon an analysis of potential follow-on investments in specific portfolio
companies that may become necessary to protect or enhance Fund II's existing
investment. As of March 6, 1996, the Independent General Partners have approved
retention of the reserve at its current level.
All net proceeds from the sale of Mezzanine Investments received by Fund
II in the future will be distributed to its partners unless applied to or set
aside for expenses or follow-on investments.
The proportion of distributions provided by net investment income has
dropped significantly from prior years due primarily to increased sales and
redemptions of Mezzanine Investments and the resulting decrease in investment
income as those holdings cease to generate interest income. Pursuant to the
terms of the Partnership Agreement, all net investment income from Mezzanine
Investments will be distributed to the Managing General Partner until the
Managing General Partner receives an amount equal to any outstanding Deferred
Distribution Amount. Given these circumstances, it is expected that the majority
of future cash distributions to Limited Partners will almost entirely be derived
from gains and recovered capital from asset sales, which are subject to market
conditions and are inherently unpredictable as to timing. Assuming there are no
asset sales in a particular quarter, Limited Partners are expected to receive
only small amounts of net distributable cash, which are estimated to be less
than one dollar per Limited Partnership Unit each quarter. Distributions
therefore are expected to vary significantly in amount and may not be made in
every quarter.
Investment in High-Yield Securities
Fund II invests primarily in subordinated debt and preferred stock
securities ("High-Yield Securities"), generally linked with an equity
participation, issued in conjunction with the mezzanine financing of privately
structured, friendly leveraged acquisitions, recapitalizations and other
leveraged financings. High-Yield Securities are debt and preferred equity
securities that are unrated or are rated by Standard & Poor's Corporation as BB
or lower and by Moody's Investor Services, Inc. as Ba or lower. Risk of loss
upon default by the issuer is significantly greater with High-Yield Securities
than with investment grade securities because High-Yield Securities are
generally unsecured and are often subordinated to other creditors of the issuer.
Also, these issuers usually have high levels of indebtedness and are more
sensitive to adverse economic conditions, such as recession or increasing
interest rates, than investment grade issuers. Most of these securities are
subject to resale restrictions and generally there is no quoted market for such
securities.
Although Fund II cannot eliminate the risks associated with its
investments in High-Yield Securities, it has established risk management
policies. Fund II subjected each prospective investment to rigorous analysis and
made only those investments that were recommended by the Investment Adviser and
that met Fund II's investment guidelines or that had otherwise been approved by
the Managing General Partner and the Independent General Partners. Fund II's
investments were measured against specified Fund II investment and performance
guidelines. To limit the exposure of Fund II's capital in any single issuer,
Fund II limited the amount of its investment in a particular issuer. Fund II's
Investment Adviser also continually monitors portfolio companies in order to
minimize the risks associated with its investments in High-Yield Securities.
Certain issuers of Securities held by Fund II (First Alert, Hills,
Petco, Playtex and Stanley Furniture) have registered their equity securities in
public offerings. Although the equity securities of the same class presently
held by Fund II (other than Hills and Stanley Furniture) were not registered in
these offerings, Fund II has the ability under Rule 144 under the Securities Act
of 1933 to sell publicly traded equity securities held by it for at least two
years on the open market, subject to the volume restrictions set forth in that
rule. The Rule 144 volume restrictions generally are not applicable to equity
securities of non-affiliated companies held by Fund II for at least three years.
In certain cases, Fund II has agreed not to make any sales of equity securities
for a specified hold-back period following a public offering.
The Investment Adviser reviews each portfolio company's financial
statements quarterly. In addition, the Investment Adviser routinely reviews and
discusses financial and operating results with the company's management and
where appropriate, attends board of director meetings. In some cases,
representatives of the Investment Adviser, acting on behalf of the Funds (and
affiliated investors where applicable), serve as one or more of the directors on
the boards of portfolio companies. Fund II may, from time to time, make
follow-on investments to the extent necessary to protect or enhance its existing
investments.
Results of Operations
Investment Income and Expenses
The investment income from operations for the quarter consists primarily of
interest and discount income earned on the investment of proceeds from partners'
contributions in Mezzanine Investments and short-term money market instruments.
For the three months ended March 31, 1996, Fund II had investment income of
$9,898,813, as compared to $2,242,722 for the same period in 1995. The increase
of $7,655,591 in 1996 investment income as compared to 1995 is due to the
recognition of previously unrecorded interest income of payment-in-kind
securities related to the sale of CST Office Products, Inc.
Major expenses for the period consisted of Legal and Professional Fees,
Investment Advisory Fees, Fund Administration Fees and Administrative Expenses.
Legal and Professional Fees were primarily incurred in connection with
the litigation proceedings as described in Note 11 to the Financial Statements.
Legal and Professional fees for the three months ended March 31, 1996 and 1995
were $550,035 and $144,631, respectively. These expenses are attributable to
legal fees incurred and advanced on behalf of indemnified defendants as well as
fees incurred directly by Fund II in connection with the aforementioned
litigation proceedings.
The Investment Adviser and Fund Administrator both receive their
compensation on a quarterly basis. The Investment Advisory Fee paid to the
Investment Adviser for the quarter ended March 31, 1996 and 1995 was $254,070
and $390,624, respectively, and was calculated at an annual rate of 1.0% of
assets under management (net offering proceeds reduced by cumulative capital
reductions), with a minimum annual amount of $1,200,000 for Fund II and the
Retirement Fund on a combined basis. The decrease in the Investment Advisory Fee
is primarily the result of returns of capital distributed to Limited Partners.
Additionally, in accordance with a Court approved settlement in August 1995,
Fund II is required, for Investment Advisory Fee and Fund Administration Fee
calculation purposes only, to consider a realized loss on the original
investment in Hills Stores. The loss is calculated as the difference between the
original cost of the Hills Note that was held by Fund II and the market value of
Hills stock as of August 10, 1995. As a result of this calculation, which became
effective in October 1995, the Investment Advisory Fee is expected to decrease
by approximately $50,000 per quarter.
The Fund Administration Fee paid to the Fund Administrator for the
quarter ended March 31, 1996 and 1995 was $170,354 and $201,078, respectively,
and was calculated at an annual rate of 0.45% of the excess of net offering
proceeds, less 50% of capital reductions.
Pursuant to the administrative services agreement between Fund II and
the Fund Administrator, effective November 10, 1993, a portion of the actual
out-of-pocket expenses incurred in connection with the administration of Fund II
is reimbursable to the Fund Administrator. Actual out-of-pocket expenses
("reimbursable expenses") primarily consist of printing, audits, tax preparation
and custodian fees. For the quarter ended March 31, 1996 and 1995, Fund II had
reimbursable expenses of $6,403 and $604, respectively.
For the three months ended March 31, 1996, Fund II had net investment
income of $8,825,346 as compared to $1,460,371 for the same period in 1995. The
increase of $7,364,975 in 1996 net investment income as compared to 1995 is due
to the recognition of interest income from payment-in-kind securities related to
the sale of CST Office Products, Inc., partially offset by higher Legal and
Professional Fees.
Net Assets
Fund II's net assets increased by $5,028,298 during the three months ended
March 31, 1996, due to the payment of cash distributions to partners of $333,445
and net unrealized depreciation of $7,727,835, partially offset by realized
gains from the sale of CST Office Products, Inc. of $4,264,232 and net
investment income of $8,825,346. This compares to the decrease in net assets of
$15,786,779 for the three months ended March 31, 1995 resulting from the payment
of cash distributions to partners of $7,651,674 ($595,886 of the cash
distributions paid was return of capital from the sales of portfolio
investments) and net unrealized depreciation of $16,277,574, partially offset by
net investment income of $1,460,371 and realized gains from investments of
$6,682,098.
Unrealized Appreciation and Depreciation on Investments
For the three months ended March 31, 1996, Fund II recorded net unrealized
depreciation of $7,727,835 (of which $1,094,319 is net unrealized depreciation
from publicly traded securities and $6,633,516 is net unrealized depreciation
from non-public securities) compared to net unrealized depreciation of
$16,277,574 for the same period in 1995. As of March 31, 1996, Fund II's
cumulative net unrealized depreciation on investments totaled $35,251,050.
Fund II's valuation of the Common Stock of First Alert, Hills, Petco,
Playtex and Stanley Furniture reflect their closing market prices at March 29,
1996.
The Managing General Partner and the Investment Adviser review the
valuation of Fund II's portfolio investments that do not have a readily
ascertainable market value on a quarterly basis with final approval from the
Individual General Partners. Portfolio investments are valued at original cost
plus accrued value in the case of original issue discount or deferred pay
securities. Such investments will be revalued if there is an objective basis for
doing so at a different price. Investments will be written down in value if the
Managing General Partner and Investment Advisor believe adverse credit
developments of a significant nature require a write-down of such securities.
Investments will be written up in value only if there has been an arms'-length
third party transaction to justify the increased valuation.
A substantial number of Fund II's assets (at cost) are invested in
private placement securities for which there are no ascertainable market values.
Although the Managing General Partner and Investment Adviser use their best
judgment in estimating the fair value of these investments, there are inherent
limitations in any estimation technique. Therefore, the fair value estimates
presented herein are not necessarily indicative of the amount which Fund II
could realize in a current transaction.
The First Alert, Petco, Hills (in part), Playtex and Stanley Furniture
securities held by Fund II are restricted securities under the SEC's Rule 144
and can only be sold under that rule, in a registered public offering, or
pursuant to an exemption from the registration requirement. In addition, resale
in some cases is restricted by lockup or other agreements. Fund II may be
considered an affiliate of First Alert and Stanley Furniture under the SEC's
Rule 144, and therefore any resale of securities of those companies, under Rule
144, is limited by the volume limitations in that rule. Accordingly, the values
referred to in the financial statements for the remaining First Alert, Hills,
Petco, Playtex and Stanley Furniture securities held by Fund II do not
necessarily represent the prices at which these securities could currently be
sold.
The information presented herein is based on pertinent information
available to the Managing General Partner and Investment Adviser as of March 31,
1996. Although the Managing General Partner and Investment Adviser are not aware
of any factors not disclosed herein that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued since that time, and the current estimated fair value of these
investments may have changed significantly since that point in time.
For additional information, please refer to Supplemental Schedule of
Unrealized Appreciation and Depreciation (Schedule 2).
<PAGE>
Realized Gains and Losses
For the three months ended March 31, 1996, Fund II had net realized gains
from the sale of CST Office Products, Inc. of $4,264,232, as compared to
$6,682,098 for the same period in 1995.
For additional information, please refer to the Supplemental Schedule of
Realized Gains and Losses (Schedule 1).
Cash Distributions
On April 26, 1996, the Individual General Partners approved the first
quarter 1996 cash distribution totaling $27,591,317 which represents net
distributable capital proceeds of $18,352,595 from the sale of CST (which
includes return of capital of $14,013,634) net investment income of $9,135,343
from Mezzanine Investments and $103,379 income from Temporary Investments. The
total amount distributed to the Limited Partners was $22,181,152 or $100.03 per
Unit, which was distributed on May 3, 1996. The Managing General Partner
received a total of $50,015 with respect to its interest in Fund II and
$5,355,148 in performance incentive fees. Thomas H. Lee, as an Individual
General Partner, received $5,002 with respect to his interest in Fund II.
On April 26, 1996, the Individual General Partners approved a special
second quarter 1996 cash distribution totaling $9,409,747 which represents net
distributable capital proceeds from the sale of Ghirardelli on April 1, 1996
(which includes return of capital of $7,240,150). The total amount distributed
to the Limited Partners of record as of April 1, 1996 was $9,386,466 or $42.33
per Unit, which was distributed on May 3, 1996. The Managing General Partner
received a total of $21,164 with respect to its interest in Fund II. Thomas H.
Lee, as an Individual General Partner, received $2,117 with respect to his
interest in Fund II.
<PAGE>
Part II - Other Information
Items 1 - 5 are herewith omitted as the response to all items is either
none or not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 27 - Financial Data Schedule for the quarter ending March 31,
1996.
(b) Reports on form 8-K: None
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized on this
15th day of May, 1996.
ML-LEE ACQUISITION FUND II, L.P.
By: Mezzanine Investments II, L.P.,
Managing General Partner
By: ML Mezzanine II Inc.,
its General Partner
Dated: May 15, 1996 /s/ Audrey Bommer
Audrey Bommer
Vice President and Treasurer
(Chief Financial Officer)
Dated: May 15, 1996 /s/ Roger F. Castoral, Jr.
Roger F. Castoral, Jr.
Assistant Treasurer
(Principal Accounting Officer)
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized on this
15th day of May, 1996.
ML-LEE ACQUISITION FUND II, L.P.
By: Mezzanine Investments II, L.P.,
Managing General Partner
By: ML Mezzanine II Inc.,
its General Partner
Dated: May 15, 1996
Audrey Bommer
Vice President and Treasurer
(Chief Financial Officer)
Dated: May 15, 1996
Roger F. Castoral, Jr.
Assistant Treasurer
(Principal Accounting Officer)
<TABLE> <S> <C>
<ARTICLE> 6
<LEGEND>
This schedule contains summary financial information extracted from the
first quarter 1996 Form 10Q Statements of Assets, Liabilities and Partners'
Capital and Statements of Operations and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<INVESTMENTS-AT-COST> 158,879,594
<INVESTMENTS-AT-VALUE> 123,680,562
<RECEIVABLES> 1,227,449
<ASSETS-OTHER> 3,152
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 124,911,163
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 699,199
<TOTAL-LIABILITIES> 699,199
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 0
<SHARES-COMMON-STOCK> 221,745
<SHARES-COMMON-PRIOR> 221,745
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (35,251,096)
<NET-ASSETS> 124,211,964
<DIVIDEND-INCOME> 30,115
<INTEREST-INCOME> 9,674,307
<OTHER-INCOME> 194,391
<EXPENSES-NET> 1,073,467
<NET-INVESTMENT-INCOME> 8,825,346
<REALIZED-GAINS-CURRENT> 4,264,232
<APPREC-INCREASE-CURRENT> (7,727,835)
<NET-CHANGE-FROM-OPS> 5,361,742
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 333,445
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> 5,028,298
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 254,070
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1,073,467
<AVERAGE-NET-ASSETS> 121,697,818
<PER-SHARE-NAV-BEGIN> 528.63
<PER-SHARE-NII> 33.83
<PER-SHARE-GAIN-APPREC> (34.76)
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> 1.50
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<PER-SHARE-NAV-END> 545.38
<EXPENSE-RATIO> 0.009
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
