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 September 30, 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.
<PAGE>
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 September 30, 1996 and December 31, 1995
Statements of Operations - For the Three and Nine Months Ended September 30,
1996 and 1995
Statements of Changes in Net Assets - For the Nine Months Ended
September 30, 1996 and 1995
Statements of Cash Flows - For the Nine Months Ended
September 30, 1996 and 1995
Statement of Changes in Partners' Capital at September 30, 1996
Schedule of Portfolio Investments - September 30, 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
<PAGE>
<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
STATEMENTS OF ASSETS, LIABILITIES AND PARTNERS' CAPITAL
(DOLLARS IN THOUSANDS)
<S> <C> <C>
September 30, 1996 December 31, 1995
---------------- -----------------
ASSETS:
Investments - Notes 2,4,5
Portfolio Investments at fair value
Managed Companies (amortized cost $82,111
at September 30, 1996 and $105,477 at December 31, 1995) $ 57,629 $ 88,955
Non-Managed Companies (amortized cost $21,628
at September 30, 1996 and $30,341 at December 31, 1995) 8,862 19,340
Temporary Investments, at amortized cost (cost $9,679
at September 30, 1996 and $10,024 at December 31, 1995) 9,687 10,042
Cash (of which $115 is restricted at September 30, 1996) 134 1
Accrued Interest Receivable - Note 2 1,072 2,005
Prepaid Expenses - 4
---------------- -----------------
TOTAL ASSETS $ 77,384 $ 120,347
================ =================
LIABILITIES AND PARTNERS' CAPITAL:
Liabilities
Legal and Professional Fees Payable $ 175 $ 363
Reimbursable Administrative Expenses Payable - Note 8 33 57
Independent General Partners' Fees Payable - Note 9 37 66
Deferred Interest Income - Note 2 344 678
---------------- ----------------
Total Liabilities 589 1,164
---------------- ----------------
Partners' Capital - Note 2
Individual General Partner 21 29
Managing General Partner 1,630 1,932
Limited Partners (221,745 Units) 75,144 117,222
---------------- ----------------
Total Partners' Capital 76,795 119,183
---------------- ----------------
TOTAL LIABILITIES AND PARTNERS' CAPITAL $ 77,384 $ 120,347
================ ================
</TABLE>
See the Accompanying Notes to Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C> <C> <C>
For the Three Months Ended For the Nine Months Ended
------------------------------ -------------------------------
September 30, September 30, September 30, September 30,
1996 1995 1996 1995
------------ ------------ ----------- ------------
INVESTMENT INCOME - Notes 2,4,6:
Interest $ 1,238 $ 1,765 $ 12,270 $ 5,097
Discount and Dividend Income 204 215 783 765
------------ ------------ ----------- ------------
TOTAL INCOME 1,442 1,980 13,053 5,862
------------ ------------ ----------- ------------
EXPENSES:
Investment Advisory Fee - Note 7 238 374 756 1,157
Fund Administration Fee - Note 8 167 197 510 600
Legal and Professional Fees 236 614 1,207 1,003
Reimbursable Administrative Expenses - Note 8 33 10 100 90
Independent General Partners' Fees and Expenses - Note 9 20 42 173 122
Insurance Expense 1 1 3 4
---------- ------------ ----------- ------------
TOTAL EXPENSES 695 1,238 2,749 2,976
---------- ------------ ----------- ------------
NET INVESTMENT INCOME 747 742 10,304 2,886
Net Realized Gain (Loss) on Investments - Note 4
and Schedule 1 (4,842) - 5,890 7,081
Net Change in Unrealized Appreciation (Depreciation)
on Investments: Note 5 and Schedule 2
Publicly Traded Securities 2,875 (4,668) (7,961) (7,220)
Nonpublic Securities 4,842 - (1,792) (2,421)
---------- ------------ ----------- ------------
SUBTOTAL 7,717 (4,668) (9,753) (9,641)
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS 3,622 (3,926) 6,441 326
Less: Incentive Fee Earned by Managing General Partner - (892) (5,366) (2,938)
---------- ------------ ----------- ------------
NET INCREASE (DECREASE) AVAILABLE FOR PRO-RATA
DISTRIBUTION TO ALL PARTNERS $ 3,622 $ (4,818) $ 1,075 $ (2,612)
========== ============ =========== =============
</TABLE>
See the Accompanying Notes to Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
STATEMENTS OF CHANGES IN NET ASSETS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
For the Nine Months Ended
-------------------------------------------
September 30, September 30,
1996 1995
--------------- ---------------
FROM OPERATIONS:
Net Investment Income $ 10,304 $ 2,886
Net Realized Gain on Investments 5,890 7,081
Net Change in Unrealized Depreciation
From Investments (9,753) (9,641)
--------------- ---------------
Net Increase in Net Assets
Resulting from Operations 6,441 326
Cash Distributions to Partners (48,829) (17,861)
--------------- ---------------
Total Decrease (42,388) (17,535)
NET ASSETS:
Beginning of Year 119,183 166,714
--------------- ---------------
End of Period $ 76,795 $ 149,179
=============== ===============
</TABLE>
See the Accompanying Notes to Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
For the Nine Months Ended
--------------------------------------
September 30, September 30,
1996 1995
--------------- --------------
Increase in Cash and Cash Equivalents CASH FLOWS FROM OPERATING ACTIVITIES:
Interest, Dividends and Discount Income $ 13,890 $ 5,746
Legal and Professional Fees (1,394) (570)
Investment Advisory Fee (756) (1,157)
Fund Administration Fee (510) (600)
Independent General Partners' Fees and Expenses (202) (144)
Reimbursable Administrative Expenses (124) (156)
(Purchase) Sale of Temporary Investments, Net (261) 6,731
Proceeds from Sales of Portfolio Company Investments 38,319 9,646
Purchase of Portfolio Company Investments - (1,635)
-------------- --------------
Net Cash Provided by Operating Activities 48,962 17,861
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash Distributions to Partners (48,829) (17,861)
-------------- --------------
Net Cash Applied to Financing Activities (48,829) (17,861)
-------------- --------------
Net Increase in Cash 133 -
Cash at Beginning of Year 1 1
-------------- --------------
Cash at End of Year $ 134 $ 1
============== ==============
RECONCILIATION OF NET INVESTMENT INCOME
TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net Investment Income $ 10,304 $ 2,886
-------------- --------------
Adjustments to Reconcile Net Investment Income to
Net Cash Provided by Operating Activities:
Decrease in Investments 32,167 7,659
(Increase) Decrease in Accrued Interest and Dividend Receivables 838 (116)
Decrease in Prepaid Expenses 4 3
(Decrease) Increase in Legal and Professional Fees Payable (188) 369
Decrease in Reimbursable Administrative Expenses Payable (24) -
Decrease in Independent General Partners' Fees Payable (29) (21)
Net Realized Gain on Sales of Investments 5,890 7,081
-------------- --------------
Total Adjustments 38,658 14,975
-------------- --------------
Net Cash Provided by Operating Activities $ 48,962 $ 17,861
============== ==============
</TABLE>
See the Accompanying Notes to Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
STATEMENT 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 Nine Months Ended September 30, 1996
Partners' Capital at January 1, 1996 $ 29 $ 1,932 $ 117,222 $119,183
Allocation of Net Investment Income 2 2,826 7,476 10,304
Allocation of Net Realized Gain on Investments 1 3,068 2,821 5,890
Allocation of Net Change in Unrealized
Depreciation From Investments (2) (22) (9,729) (9,753)
Cash Distributions to Partners (9) (6,174) (42,646) (48,829)
======= ========= ========= ========
Partners' Capital at September 30, 1996 $ 21 $ 1,630 $ 75,144 $ 76,795
======= ========= ========= ========
</TABLE>
See the Accompanying Notes to Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30, 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 20.00
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 22.51
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
2,058,474 Shares FIRST ALERT, INC., (b) Note 5
First Alert, Inc., Common Stock(a)(d) 07/31/92 3,320 12,094
(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 12,094 15.88
HILLS STORES COMPANY - Note 5
458,432 Shares Hills Stores Company, Common Stock(a)(d) 04/03/90 30,246 3,266
62,616 Shares Hills Stores Company, Common Stock(a)(h) 08/21/95 4,530 446
(4.6% of fully diluted common equity) 34,776 3,712 4.87
</TABLE>
See the Accompanying Notes to the Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30, 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 $ 3,008
(.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 3,008 3.95
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 7.93
STANLEY FURNITURE COMPANY, INC. (b) - Note 5,13
23,105 Shares Stanley Furniture Company, Inc.,
Common Stock(a)(d) 06/30/91 291 390
(0.4% of fully diluted common equity)
291 390 0.51
TOTAL INVESTMENT IN MANAGED COMPANIES $ 82,111 $ 57,629 75.65
NON-MANAGED COMPANIES
BIOLEASE, INC.
$784 BioLease, Inc., 13% Sub. Nt. due 06/06/04 (c) 06/08/94 $ 676 $ 701
96.56 Shares BioLease, Inc., Common Stock (d) 06/08/94 94 94
10,014 Warrants Biotransplant, Inc., Common Stock Purchase Warrants(d) 06/08/94 14 14
784 809 1.06
FITZ AND FLOYD/SYLVESTRI -Notes 5,6
$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 3.97
FLA. ORTHOPEDICS, INC. - Notes 4,5
19,366 Shares FLA. Holdings, Inc. Series B Preferred Stock(d) 08/02/93 1,513 0
3,822 Warrants FLA. Holdings, Inc. Common Stock Purchase Warrants(d) 08/02/93 0 0
$4,842 12.5% Subordinated Note
Purchased 08/02/93 $ 4,842
Surrendered 08/16/96 $ 0
Realized Loss $(4,842)
121,040 Common Stock
Purchased 08/02/93 $ 1,513
Exchanged 08/02/96
19,366 Series B Preferred Stock $ 1,513
Realized Gain $ 0
1,513 0 0.00
See the Accompanying Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30, 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>
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 6.60
TOTAL INVESTMENT IN NON-MANAGED COMPANIES $ 21,628 $ 8,862 11.63
SUMMARY OF MEZZANINE INVESTMENTS
Subordinated Notes Various 57,599 41,524 54.51
Preferred Stock, Common Stock, Warrants and Stock Rights Various 46,140 24,967 32.77
TOTAL MEZZANINE INVESTMENTS $103,739 $66,491 87.28
TEMPORARY INVESTMENTS
COMMERCIAL PAPER
$ 450 General Electric Credit Corp, 4.95% due 10/01/96 09/19/96 449 450
$ 400 Americann General Finance Corp., 5.10% due 10/01/96 09/26/96 400 400
$ 8,850 American General Finance Corp., 5.30%, due 10/11/96 09/26/96 8,830 8,837
TOTAL INVESTMENT IN COMMERCIAL PAPER 9,679 9,687 12.72
TOTAL TEMPORARY INVESTMENTS 9,679 9,687 12.72
TOTAL INVESTMENT PORTFOLIO $113,418 $ 76,178 100.00%
(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 $25 for Mezzanine Investments
and $8 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>
<PAGE>
ML-LEE ACQUISITION FUND II, L.P.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 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. Following such time periods, Fund II will 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.
<PAGE>
The information presented herein is based on pertinent information
available to the Managing General Partner and Investment Adviser as of September
30, 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 Septeber 30, 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 September 30, 1996 and December 31,
1995, Fund II has in its portfolio of investments $441,900 and $751,907,
respectively, of payment-in-kind notes which excludes $734,702 and $7,637,720,
respectively, of payment-in-kind notes received from notes placed on non-accrual
status. As of September 30, 1996 and December 31, 1995, Fund II has in its
portfolio of investments $29,059 and $2,293,457, respectively, 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 September
30, 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 September 30, 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 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 was 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.
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 $9,628,915, which consisted of $4,931,815 as
prepayment for the 13% Subordinated Note (including $77,607 of accrued
interest), $3,166,847 for the common stock (of which $114,730 is proceeds held
in escrow) and $1,530,253 for the preferred stock (including $26,475 of accrued
dividends). The sale resulted in a realized gain of $2,283,302 to Fund II.
On May 17, 1996, pursuant to a Redemption and Repurchase Agreement with
National Tobacco Company, a Non-Managed Company in Fund II's portfolio, and
certain existing lenders, Fund II received net proceeds of $5,218,585 from the
repayment and redemption of its investment in National Tobacco. In connection
with the Agreement, National Tobacco prepaid the Subordinated Notes, plus all
accrued and unpaid interest, and redeemed the partnership interest in National
Tobacco held by Fund II. Fund II recognized a gain of $1,304,801 from the
transaction.
On August 2, 1996, Fund II entered into a Stock Purchase and Settlement
Agreement with Florida Orthopedics Inc. and various other affiliated entities.
In connection with this agreement, Fund II (I) surrrendered its 12.5%
subordinated note and, (II) exchanged all of its common stock and common stock
purchase warrants for the issuance of new preferred equity and new common stock
purchase warrants. Fund II realized a loss of $4.8 million on the subordinated
note surrendered.
On August 6, 1991, the Independent General Partners approved a reserve for
follow-on investments of $24.9 million for Fund II. As of September 30, 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 August 8, 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 nine months ended September 30, 1996, Fund II recorded net
unrealized depreciation of $9,752,935 as compared to net unrealized depreciation
of $9,640,975 for the same period in 1995. As of September 30, 1996, Fund II's
cumulative net unrealized depreciation on investments totaled $37,276,197.
For the three months ended September 30, 1996, Fund II recorded net
unrealized appreciation of $7,716,095 as compared to net unrealized depreciation
of $4,668,098 recorded for the comparable period of 1995. For additional
information, please refer to the Supplemental 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.
- 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. For the nine months ended September
30, 1996 and 1995, Fund II paid $756,219 and $1,156,833, respectively, in
Investment Advisory Fees to Thomas H. Lee Advisors II, L.P. For the three months
ended September 30, 1996 and 1995, Fund II paid $237,985 and $373,533,
respectively, in Investment Advisory Fees.
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. The Fund
Administration Fee is calculated and paid quarterly, in advance, by each Fund in
proportion with the net offering proceeds. For the nine months ended September
30, 1996 and 1995, Fund II paid $509,713 and $599,851, respectively, in Fund
Administration Fees. For the three months ended September 30, 1996 and 1995,
Fund II paid $166,734 and $197,233, respectively, in Fund Administration Fees.
Pursuant to the administrative services agreement between Fund II and the
Fund Administrator, 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 nine
months ended September 30, 1996 and 1995, Fund II incurred $99,847 and $90,182,
respectively, in reimbursable expenses. For the three months ended September 30,
1996 and 1995, Fund II incurred $33,000 and $10,048, 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 nine
months ended September 30, 1996 and 1995, Fund II incurred $172,591 and
$122,394, respectively, in Independent General Partners' Fees and Expenses. For
the three months ended September 30, 1996, Fund II incurred $19,480 in
Independent General Partners Fees and Expenses as compared to $41,911 for the
same period in 1995.
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.
During the nine month period ending September 30, 1996, Fund II paid the
Individual General Partner distributions totaling $9,616 and Managing General
Partner distributions totaling $6,173,845 (which includes $6,077,683 of
incentive fees). As of September 30, 1996, the Managing General Partner has
earned a total of $22.8 million in MGP Incentive Fees of which $1.5 million is
deferred in payment to the Managing General Partner as a deferred distribution
amount (the "Deferred Distribution Amount") in accordance with the Partnership
Agreement. To the extent not payable to the Managing General Partner, this
Deferred Distribution Amount 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 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 the Court
denied by an order dated June 30, 1996. The parties are now engaged in
discovery. 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 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, which motion is pending. 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. 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.
13. Subsequent Events
On October 15, 1996 Stanley Furniture Company, Inc. filed a registration
statement with the Securities and Exchange Commission relating to a proposed
secondary offering of 2.4 million shares of its common stock (plus an additional
358,902 shares subject to the underwriters' over-allotment option,) whereby,
Fund II and certain affiliates of the Thomas H. Lee Company would have sold all
of their shares. The registration statement has not yet become effective. The
Registration statement was declared effective on November 7, 1996. On November
13, 1996, the offering was amended to an aggregate of 1,150,000 shares, which
includes 150,000 shares subject to the underwriters' over-allotment option. If
the underwriters do not exercise the over-allotment option, Stanley Furniture
has agreed to purchase such shares from the selling shareholders. Pursuant to
this offering, Fund II will sell a total of 9,631 shares.
On November 5, 1996, the Individual General Partners approved the Third
Quarter 1996 cash distribution totalling $432,322 which consisted of $183,244 of
net income from temporary investments and $249,078 of net investment income from
Mezzanine Investments during the third quarter. The total amount to be
distributed to Limited Partners is $181,831 or $.82 per Unit. The Managing
General Partner will receive $410, which represents its interest in Fund II and
$250,041 in performance incentive fees. Thomas H. Lee, as an Individual General
Partner, will receive $41 which represents his interest in Fund II. This cash
distribution is expected to be paid on November 14, 1996.
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE 1
ML-LEE ACQUISITION FUND II, L.P.
SUPPLEMENTAL SCHEDULE OF REALIZED GAINS AND LOSSES
FOR THE 9 MONTHS ENDED SEPTEMBER 30, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C> <C> <C>
Par Value/ Investment Realized
SECURITY Number of Shares Cost Net Proceeds Gain(Loss)
- --------------------------------------------------- ---------------- ----------- ------------ --------
FOR THE THREE MONTHS ENDED MARCH 31, 1996
CST Office Products, Inc.
Common Stock 162,949 $ 1,304 $ 2,607 $ 1,303
Notes $ 12,710 12,710 12,837 127
Warrants 177,207 - 2,834 2,834
- --------------------------------------------------- ----------- ------------ --------
TOTAL FOR THE THREE MONTHS ENDED MARCH 31, 1996 $ 14,014 $ 18,278 $ 4,264
- --------------------------------------------------- ----------- ------------ --------
FOR THE THREE MONTHS ENDED JUNE 30, 1996
Ghirardelli Holding Corp.
Notes $ 4,672 4,672 4,854 182
Common Stock 540,892 1,168 3,167 1,999
Preferred Stock 14,016 1,402 1,505 103
Petco Animal Supplies
Common Stock 175,238 1,915 4,794 2,879
National Tobacco Company, LP
Notes $ 3,618 3,618 4,843 1,225
Partnership Interest $ 234 234 314 80
- --------------------------------------------------- ----------- ------------ --------
TOTAL FOR THE THREE MONTHS ENDED JUNE 30, 1996 $ 13,009 $ 19,477 $ 6,468
- --------------------------------------------------- ----------- ------------ --------
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996
Florida Orthopedics
Subordinated Note $ 4,842 4,842 - (4,842)
- --------------------------------------------------- ----------- ------------ --------
TOTAL FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996 $ 4,842 $ - $ (4,842)
- --------------------------------------------------- ----------- ------------ --------
TOTAL FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 $ 31,865 $ 37,755 $ 5,890
- --------------------------------------------------- =========== ============ ========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE 2
ML-LEE ACQUISITION FUND II, L.P.
SUPPLEMENTAL SCHEDULE OF UNREALIZED APPRECIATION AND DEPRECIATION
FOR THE PERIOD ENDED SEPTEMBER 30, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Total Unrealized Total Unrealized
Appreciation/ Appreciation/
(Depreciation) (Depreciation) Total Unrealized Total Unrealized
for the three for the nine Appreciation/ Appreciation/
SECURITY months ended months ended (Depreciation) (Depreciation)
Investment Fair September 30, September 30, December 31, September 30,
Cost Value 1996 1996 1995 1996
- -------------------------------------- ------- -------- --------- ----------- ------------- --------------
PUBLICLY TRADED/UNDERLYING
SECURITY PUBLICLY TRADED:
First Alert
Common Stock * $ 3,320 $ 12,093 $ 3,860 $ (5,661) $ 14,434 $ 8,773
Hills Stores
Common Stock * 34,776 3,712 (912) (1,433) (29,631) (31,064)
Playtex
Common Stock * 5,299 3,008 (214) 430 (2,721) (2,291)
Stanley
Common Stock * 291 390 141 205 (106) 99
-------- ----------- ------------- --------------
TOTAL UNREALIZED APPRECIATION
(DEPRECIATION) FROM PUBLICLY
TRADED SECURITIES $ 2,875 $ (6,459) $ (18,024) $ (24,483)
-------- ----------- ------------- --------------
NON PUBLIC SECURITIES:
Fitz and Floyd/Sylvestri
Common Stock * 20 - - - (20) (20)
Adjustable Rate Senior Note * 10,679 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 4,842 $ (1,792) $ (11,002) $ (12,794)
-------- ----------- ------------- --------------
REVERSAL OF UNREALIZED DEPRECIATION/
APRECIATION FROM SECURITIES SOLD:
Petco
Common Stock - - - (1,502) 1,502 -
-------- ----------- ------------- --------------
NET UNREALIZED APPRECIATION
(DEPRECIATION) $ 7,717 $ (9,753) $ (27,524) $ (37,277)
======== =========== ============= ==============
* Restricted security.
</TABLE>
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Liquidity & Capital Resources
As of September 30, 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 September 30, 1996 were $114,430,667, after adjusting for returns of
capital to partners, volume discounts, sales commissions and organizational,
offering, sales and marketing expenses.
At September 30, 1996, Fund II had outstanding a total of $103,738,673
invested in Mezzanine Investments representing $82,111,052 Managed and
$21,627,621 Non-Managed portfolio investments. The remaining proceeds were
invested in Temporary Investments comprised of commercial paper with maturities
of less than one month.
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 was distributed to the Partners pro-rata in
accordance with their capital contributions and amounts otherwise later payable
to Limited Partners from distributable cash from operations were instead payable
to the Managing General Partner until the Deferred Distribution Amount was paid
in full. As a result of prior transactions that generated net distributable cash
proceeds and Deferred Distribution Amounts, the Deferred Distribution Amount
owed to the Managing General Partner subsequent to the November 14, 1996
distribution is $1.5 million.
On August 6, 1991, the Independent General Partners approved a reserve for
follow-on investments of $24.9 million for Fund II. As of September 30, 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 August 8, 1996, the Independent General Partners have approved
retention of the reserve at its current level.
On February 6, 1996, the New York State Supreme Court, County of New York,
issued a decision in Winston v. Mezzanine Investments et al., L.P. No. 28657/91
(the "Winston Litigation"), opining that the incentive distributions made to the
managing general partner of ML-Lee Acquisition Fund, L.P. (Fund I") had been
incorrectly calculated under Fund I's Amended and Restated Agreement of Limited
Partnership and that, under what the Court concluded was the correct
methodology, the managing general partner of Fund I had been overpaid. The
defendants in the Winston Litigation have stated that they intend to appeal the
decision. If the methodology adopted by the Court in the Winston Litigation were
affirmed on appeal and were applied to Fund II, the incentive distributions
heretofore paid by Fund II to the Fund II Managing General Partner may have been
understated and the computation of such incentive distribution may be subject to
adjustment on a retroactive and going forward basis. Whether the Managing
General Partner has, in fact, been underpaid and the amount of any such
underpayment, depends upon the future performance of Fund II, whether the
decision in the Winston Litigation is affirmed and whether it is applied to Fund
II. Fund II believes it has sufficient funds to pay any additional amounts that
could be payable to the Managing General Partner in such regard.
Operating performance at Fitz & Floyd/Silvestri, Corp. ("Fitz & Floyd"), a
Non-Managed Company in Fund II's portfolio, 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 continues operating the
business as debtor-in-possession. While in Chapter 11, Fitz & Floyd divested its
Silvestri Division and used the proceeds to pay down the pre-petition balance on
its revolving line of credit. Subsequently, Syratech Corporation, the acquirer
of the Silvestri Division, agreed to finance the necessary credit enhancement
requested by the Company's provider of debtor-in-possession financing. Fund II
obtained bankruptcy court authority to exercise its rights under a pledge of the
stock of Fitz & Floyd. Subsequently, an officer of the Investment Advisor was
appointed the sole director of Fitz & Floyd. The Investment Advisor is Chairman
of the unsecured creditors committee and is working to implement a plan of
reorganization.
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, 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.
<PAGE>
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 nine months ended September 30, 1996, Fund II had investment income
of $13,052,729, as compared to $5,861,519 for the same period in 1995. The
increase of $7,191,210 in 1996 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.
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 nine months ended September 30, 1996 and
1995 were $1,207,323 and $1,003,338, 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. Legal and Professional Fees for the three
months ended September 30, 1996 and 1995 were $236,353 and $612,814,
respectively.
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 nine months ended September 30, 1996 and 1995 was
$756,219 and $1,156,833, 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. For the three months ended September 30, 1996
and 1995, Fund II paid $237,985 and $373,533, respectively, in Investment
Advisory Fees.
The Fund Administration Fee paid to the Fund Administrator for the nine
months ended September 30, 1996 and 1995 was $509,713 and $599,851,
respectively, and was calculated at an annual rate of 0.45% of the excess of net
offering proceeds, less 50% of capital reductions. For the three months ended
September 30, 1996 and 1995, Fund II paid $166,734 and $197,233, respectively,
in Fund Administration Fees.
Pursuant to the administrative services agreement between Fund II and the
Fund Administrator, 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 nine
months ended September 30, 1996 and 1995, Fund II incurred reimbursable expenses
of $99,847 and $90,182, respectively. For the quarters ended September 30, 1996
and 1995, reimbursable expenses totaled $33,000 and $10,048, respectively.
For the nine months ended September 30, 1996, Fund II had net investment
income of $10,303,854 as compared to $2,885,370 for the same period in 1995. The
increase of $7,418,484 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. For the three months ended September 30,
1996, Fund II had net investment income of $747,064 as compared to $742,273 for
the same period in 1995.
<PAGE>
Net Assets
Fund II's net assets decreased by $42,388,527 during the nine months ended
September 30, 1996, due to the payment of cash distributions to partners of
$48,829,459 and net unrealized depreciation of $9,752,935, partially offset by
realized gains from the sale of Mezzanine Investments of $5,890,013 and net
investment income of $10,303,854. This compares to the decrease in net assets of
$17,535,749 for the nine months ended September 30, 1996 resulting from the
payment of cash distributions to partners of $17,861,057 and net unrealized
depreciation of $9,640,975, partially offset by net investment income of
$2,885,370 and realized gains from investments of $7,080,913.
Unrealized Appreciation and Depreciation on Investments
For the nine months ended September 30, 1996, Fund II recorded net
unrealized depreciation of $9,752,935 compared to net unrealized depreciation of
$9,640,975 for the same period in 1995. As of September 30, 1996, Fund II's
cumulative net unrealized depreciation on investments totaled $37,276,197.
For the three months ended September 30, 1996, Fund II recorded net
unrealized appreciation of $7,716,095 as compared to net unrealized depreciation
of $4,668,098 recorded for the comparable period in 1995. For additional
information, please refer to the Supplemental Schedule of Unrealized
Appreciation and Depreciation - Schedule 2.
Fund II's valuation of the Common Stock of First Alert, Hills, Playtex and
Stanley Furniture reflect their closing market prices at September 30, 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 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.
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, 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, 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 September
30, 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.
<PAGE>
Realized Gains and Losses
For the nine months ended September 30, 1996, Fund II had net realized
gains from the sale of Mezzanine Investments of $5,890,013 as compared to
$7,080,913 for the same period in 1995.
For the three months ended September 30, 1996, Fund II had a net realized
loss from investments of $4,841,600. No realized gains or losses were recorded
for the comparable period in 1995. For additional information, please refer to
the Supplemental Schedule of Realized Gains and Losses - Schedule 1.
Cash Distributions
On November 5, 1996, the Individual General Partners approved the Third
Quarter 1996 cash distribution totalling $432,322 which consisted of $183,244 of
net income from temporary investments and $249,078 of net investment income from
Mezzanine Investments during the third quarter. The total amount to be
distributed to Limited Partners is $181,831 or $.82 per Unit. The Managing
General Partner will receive $410, which represents its interest in Fund II and
$250,041 in performance incentive fees. Thomas H. Lee, as an Individual General
Partner, will receive $41 which represents his interest in Fund II. This cash
distribution is expected to be paid on November 14, 1996.
<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 September 30,
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 14th day of
November, 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: November 14, 1996 /s/ Audrey Bommer
Audrey Bommer
Vice President and Treasurer
(Chief Financial Officer)
Dated: November 14, 1996 /s/ Roger F. Castoral, Jr.
Roger F. Castoral, Jr.
Vice President and 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 14th day of
November, 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: November 14, 1996
Audrey Bommer
Vice President and Treasurer
(Chief Financial Officer)
Dated: November 14, 1996
Roger F. Castoral, Jr.
Vice President and Assistant Treasurer
(Principal Accounting Officer)
<TABLE> <S> <C>
<ARTICLE> 6
<LEGEND>
This schedule contains summary financial information extracted from the
third 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> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<INVESTMENTS-AT-COST> 113,418,103
<INVESTMENTS-AT-VALUE> 76,177,412
<RECEIVABLES> 1,072,026
<ASSETS-OTHER> 134,257
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 77,383,695
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 588,556
<TOTAL-LIABILITIES> 588,556
<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
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<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (37,276,196)
<NET-ASSETS> 76,795,139
<DIVIDEND-INCOME> 30,447
<INTEREST-INCOME> 12,688,576
<OTHER-INCOME> 333,706
<EXPENSES-NET> 2,748,875
<NET-INVESTMENT-INCOME> 10,303,854
<REALIZED-GAINS-CURRENT> 5,890,013
<APPREC-INCREASE-CURRENT> (9,752,935)
<NET-CHANGE-FROM-OPS> 6,440,931
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 10,625,532
<DISTRIBUTIONS-OF-GAINS> 12,484,564
<DISTRIBUTIONS-OTHER> 25,719,363
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> (42,388,527)
<ACCUMULATED-NII-PRIOR> 0
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<GROSS-ADVISORY-FEES> 756,219
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<GROSS-EXPENSE> 2,748,875
<AVERAGE-NET-ASSETS> 97,989,405
<PER-SHARE-NAV-BEGIN> 528.63
<PER-SHARE-NII> 33.71
<PER-SHARE-GAIN-APPREC> (43.87)
<PER-SHARE-DIVIDEND> 0
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<AVG-DEBT-PER-SHARE> 0
</TABLE>
