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, 1997
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, 1997 and December 31, 1996
Statements of Operations - For the Three and Nine Months
Ended September 30, 1997 and 1996
Statements of Changes in Net Assets - For the Nine Months Ended
September 30, 1997 and 1996
Statements of Cash Flows - For the Nine Months Ended
September 30, 1997 and 1996
Statement of Changes in Partners' Capital at September 30, 1997
Schedule of Portfolio Investments - September 30, 1997
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>
(Unaudited)
September 30, 1997 December 31, 1996
-------------------- -----------------
ASSETS:
Investments - Notes 2,4,5
Portfolio Investments at fair value
Managed Companies (amortized cost $68,066
at September 30, 1997 and $81,990 at December 31, 1996) $ 36,671 $ 51,516
Non-Managed Companies (amortized cost $23,967
at September 30, 1997 and $21,608 at December 31, 1996) 8,439 8,865
Temporary Investments, at amortized cost (cost $4,434
at September 30, 1997 and $10,199 at December 31, 1996) 4,443 10,217
Cash (of which $115 is restricted at December 31, 1996) 1 125
Accrued Interest Receivable - Note 2 616 951
Prepaid Expenses -- 4
---------- ------------
TOTAL ASSETS $ 50,170 $ 71,678
========== ============
LIABILITIES AND PARTNERS' CAPITAL:
Liabilities
Legal and Professional Fees Payable $ 145 $ 159
Reimbursable Administrative Expenses Payable Note 8 50 45
Independent General Partners' Fees Payable - Note 9 22 33
Deferred Interest Income - Note 2 162 326
---------- ------------
Total Liabilities 379 563
---------- ------------
Partners' Capital - Note 2
Individual General Partner 15 19
Managing General Partner 289 1,368
Limited Partners (221,745 Units) 49,487 69,728
---------- ------------
Total Partners' Capital 49,791 71,115
---------- ------------
TOTAL LIABILITIES AND PARTNERS' CAPITAL $ 50,170 $ 71,678
========== ============
</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,
1997 1996 1997 1996
------------- ------------- ------------- -------------
INVESTMENT INCOME - Notes 2,4,6:
Interest $ 855 $ 1,238 $ 3,663 $ 12,270
Discount and Dividend Income 77 204 5,746 783
------------- ------------- ------------- -------------
TOTAL INCOME 932 1,442 9,409 13,053
------------- ------------- ------------- -------------
EXPENSES:
Investment Advisory Fee - Note 7 164 238 582 756
Fund Administration Fee - Note 8 150 167 470 510
Legal and Professional Fees -- 236 99 1,207
Reimbursable Administrative Expenses - Note 8 50 33 129 100
Independent General Partners' Fees and Expenses - Note 9 19 20 95 173
Insurance Expense 2 1 4 3
------------- ------------- ------------- -------------
TOTAL EXPENSES 385 695 1,379 2,749
------------- ------------- ------------- -------------
NET INVESTMENT INCOME 547 747 8,030 10,304
Net Realized Gain on Investments - Note 4 and Schedule 1 -- (4,842) 50 5,890
Net Change in Unrealized Appreciation (Depreciation)
on Investments: Note 5 and Schedule 2
Publicly Traded Securities 1,125 2,875 (920) (7,961)
Nonpublic Securities (412) 4,842 (2,788) (1,792)
------------- ------------- ------------- -------------
SUBTOTAL 713 7,717 (3,708) (9,753)
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 1,260 3,622 4,372 6,441
Less: Earned Incentive Distribution to
Managing General Partner (80) -- (2,834) (5,366)
------------- ------------- ------------- -------------
NET INCREASE AVAILABLE FOR PRO-RATA
DISTRIBUTION TO ALL PARTNERS $ 1,180 $ 3,622 $ 1,538 $ 1,075
============= ============= ============= =============
See the Accompanying Notes to Financial Statements.
</TABLE>
<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,
1997 1996
------------ ------------
FROM OPERATIONS:
Net Investment Income $ 8,030 $ 10,304
Net Realized Gain on Investments 50 5,890
Net Change in Unrealized Depreciation From Investments (3,708) (9,753)
------------ ------------
Net Increase in Net Assets Resulting from Operations 4,372 6,441
Cash Distributions to Partners (25,696) (48,829)
------------ ------------
Total Decrease (21,324) (42,388)
NET ASSETS:
Beginning of Year 71,115 119,183
------------- ------------
End of Period $ 49,791 $ 76,795
============= ============
</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,
1997 1996
------------- -------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest, Dividends and Discount Income $ 8,746 $ 13,890
Legal and Professional Fees (108) (1,394)
Investment Advisory Fee (582) (756)
Fund Administration Fee (471) (510)
Independent General Partners' Fees and Expenses (107) (202)
Reimbursable Administrative Expenses (124) (124)
(Purchase) Sale of Temporary Investments, Net 5,766 (261)
Follow On Investment (2,420) --
Proceeds from Sales of Portfolio Company Investments 14,872 38,319
------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 25,572 48,962
------------- -------------
CASH FLOWS APPLIED TO FINANCING ACTIVITIES:
Cash Distributions to Partners (25,696) (48,829)
------------- -------------
NET CASH APPLIED TO FINANCING ACTIVITIES (25,696) (48,829)
------------- -------------
Net Increase in Cash (124) 133
Cash at Beginning of Year 125 1
------------- -------------
CASH AT END OF PERIOD $ 1 $ 134
============= =============
RECONCILIATION OF NET INVESTMENT INCOME
TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net Investment Income $ 8,030 $ 10,304
------------- -------------
ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME (LOSS)
TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Decrease in Investments 18,172 32,167
(Increase) Decrease in Accrued Interest,
Dividend and Discount Receivable (664) 838
Decrease in Prepaid Expenses 4 4
Decrease in Legal and Professional Fees Payable (14) (188)
(Decrease) Increase in Reimbursable Administrative Expenses Payable 5 (24)
Decrease in Independent General Partners' Fees Payable (11) (29)
Net Realized Gain on Sales of Investments 50 5,890
------------- -------------
TOTAL ADJUSTMENTS 17,542 38,658
------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 25,572 $ 48,962
============= =============
</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 Three Months Ended September 30, 1997
Partners' Capital at January 1, 1997 $ 19 $ 1,368 $ 69,728 $ 71,115
Allocation of Net Investment Income 2 2,337 5,691 8,030
Allocation of Net Realized Gain on Investments -- -- 50 50
Allocation of Net Change in Unrealized
Depreciation From Investments (1) (8) (3,699) (3,708)
Cash Distributions to Partners (5) (3,408) (22,283) (25,696)
---------- ---------- ---------- ----------
Partners' Capital at September 30, 1997 $ 15 $ 289 $ 49,487 $ 49,791
========== ========== ========== ==========
</TABLE>
See the Accompanying Notes to Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
September 30, 1997
(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) - Note 4
410,677 Shares Anchor Holdings Inc., Common Stock (d) 04/30/90 $ 1,396 $ 1,396
$5,867 11.67 Sr. Sub. Note
$7,822 17.50 Jr. Sub. Note
Purchased 4/30/90 $13,689
Repaid 4/02/97 $13,689
Realized Gain $ -
162,967 Shares Common Stock
Purchased 4/30/90 $ 1,548
Excersise 247,710 Warrants 4/2/97 $ 2,354
Return of Capital Proceeds
from the Anchor Dividend $(2,506)
Cost Basis of Equity $ 1,396 ------------------------------
1,396 1,396 2.82
------------------------------
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 34.60
------------------------------
CINNABON INTERNATIONAL, INC.
(formerly Restaurants Unlimited)
$6,044 Cinnabon, 11% Subordinated Note due 06/30/02(c) 06/03/94 6,044 6,044
391,302 Warrants Cinnabon, Common Stock Warrants(d) 06/03/94 06/03/94 0 0
(2.1% of fully diluted common equity) ------------------------------
6,044 6,044 12.20
------------------------------
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 6,175
(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 6,175 12.46
------------------------------
</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, 1997
(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 $ 1,977
62,616 Shares Hills Stores Company, Common Stock(a)(h) 08/21/95 4,530 270
(4.1% of fully diluted common equity) --------------------------------
34,776 2,247 4.53
--------------------------------
PLAYTEX PRODUCTS, INC. (b) - Note 5
343,726 Shares Playtex Products, Inc., Common Stock(a)(d) 03/29/90 5,299 3,480
(.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 3,480 7.02
--------------------------------
STANLEY FURNITURE COMPANY, INC. (b) - Notes 4,5,13
6,921 Shares Stanley Furniture Company, Inc., Common Stock(a)(d) 06/30/91 87 185
(.3% of the fully diluted common equity)
9,631 Shares Common Stock
Purchased 6/30/91 $ 121
Sold 8,375 Shares 11/13/96 $ 127
Sold 1,256 Shares 12/13/96 $ 19
Realized Gain $ 25
Purchased 272 Shares 6/30/91 $ 4
Sold 2/7/97 $ 7
Realized Gain $ 3
Purchased 6,281 Shares 6/30/91 $ 79
Sold 6/30/97 $ 126
Realized Gain $ 47
Total Net Realized Gain $ 75
--------------------------------
87 185 0.37
--------------------------------
TOTAL INVESTMENT IN MANAGED COMPANIES $ 68,066 $ 36,671 74.00
================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
September 30, 1997
(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.- Note 5
$784 BioLease, Inc., 13% Sub. Nt. due 06/06/04 (c) 06/08/94 $ 676 $ 392
96.56 Shares BioLease, Inc., Common Stock (d) 06/08/94 94 0
10,014 Warrants Biotransplant, Inc., Common Stock Purchase Warrants(d) 06/08/94 14 14
-------------------------------
784 406 .82
-------------------------------
FITZ AND FLOYD -Notes 4,5
$2,420 Fitz and Floyd, 12% Sub. Nt. due 04/15/04 (c) 04/15/97 2,420 2,420
8,470 Shares Fitz and Floyd, Series A Preferred Stock (d) 04/15/97 12,619 3,023
51,425 Shares Fitz and Floyd, Common Stock (d) 04/15/97 0 0
1,324,508 Shares Common Stock
Purchased various $ 20
Surrendered May 1996 $ -
Realized Loss $ (20)
$10,281 Sr. Sub. Note
$2,419 Sr. Sub. Note
Purchased various $12,679
Exchanged 04/11/97
8,470 Sh Series A Preferred Stock and
51,245 Shares Common Stock $12,679
Realized Gain $ 0
Total Realized Loss $ (20) -------------------------------
15,039 5,443 10.99
-------------------------------
FLA. ORTHOPEDICS, INC. - Notes 5,6
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
Total Realized Loss $(4,842)
-------------------------------
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, 1997
(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 0
2,004 Warrants Seaway TLC, Inc. Common Stock Purchase Warrants 06/29/95 0 0
-----------------------------
6,631 2,590 5.22
-----------------------------
TOTAL INVESTMENT IN NON-MANAGED COMPANIES $ 23,967 $ 8,439 17.03
=============================
SUMMARY OF MEZZANINE INVESTMENTS
Subordinated Notes Various 28,808 24,483 49.40
Preferred Stock, Common Stock, Warrants and Stock Rights Various 63,225 20,627 41.63
-----------------------------
TOTAL MEZZANINE INVESTMENTS $ 92,033 $45,110 91.03
=============================
TEMPORARY INVESTMENTS
COMMERCIAL PAPER
$ 4,126 Ford Motor Credit Corp. 5.47% due 10/01/97 09/19/97 4,117 4,126
$ 317 Ford Motor Credit Corp. 5.57% due 10/01/97 09/25/97 317 317
-----------------------------
TOTAL INVESTMENT IN COMMERCIAL PAPER 4,434 4,443 8.97
-----------------------------
TOTAL TEMPORARY INVESTMENTS $ 4,434 $ 4,443 8.97
-----------------------------
TOTAL INVESTMENT PORTFOLIO $ 96,467 $ 49,553 100.00%
=============================
(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 $33 for Mezzanine Investments
and $9 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, 1997
(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 such extension 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.
<PAGE>
The information presented herein is based on pertinent information
available to the Managing General Partner and Investment Adviser as of September
30, 1997. 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 September 30, 1997, 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, 1997, Fund II had in
its portfolio of investments $441,900 of payment-in-kind notes, which excludes
$1.8 million of payment-in-kind notes received from notes placed on non-accrual
status and $29,059 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, as defined in the Partnership Agreement, 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, 1997 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, 1997 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
Partner and 0.02% to the Individual General Partner.
4. Investment Transactions
During February 1997, Fund II sold 272 shares of Stanley Furniture for $24
per share and received total proceeds of $6,528 and recognized a gain of $3,105.
On June 30, 1997, Fund II entered into a stock purchase agreement with Stanley
Furniture whereby Fund II sold 6,281 shares of Stanley Furniture for $20 per
share. Fund II received total proceeds of $125,620 and recognized a gain of
$46,582.
On April 2, 1997, Anchor Advanced Products, Inc., a Delaware corporation
("Anchor"), completed a recapitalization pursuant to which Anchor issued
$100,000,000 aggregate principal amount of Senior Notes due 2004 and entered
into a new credit facility (the "Recapitalization"). As part of the
Recapitalization, Anchor repaid substantially all of its outstanding debt,
including all accrued interest and any premiums in connection therewith. As a
result, Anchor repaid the Senior Subordinated Note and Junior Subordinated Note
held by Fund II, together with all accrued interest and prepayment premiums for
an aggregate of $14.5 million.
Immediately prior to the Recapitalization, Fund II owned 162,967 shares of
the common stock of Anchor Holdings, Inc., the parent of Anchor. Immediately
after the consummation of the Recapitalization, Fund II exercised its warrants
to purchase common stock (at an exercise price of $9.50 per share) and acquired
an additional 247,710 shares of common stock, bringing its total holdings of
common stock to 410,677 shares. In connection with the Recapitalization,
Holdings paid a dividend to all holders of Holdings common stock of record as of
April 2, 1997, in the amount of $19.02 per share (the "Anchor Dividend"). As a
result of such dividend, the Fund received $7.8 million, of which approximately
32% or $2.5 million was returned to partners as return of capital.
On April 11, 1997 the Bankruptcy Court confirmed a plan of Reorganization
for Fitz & Floyd. As a result, on April 14, 1997, a follow-on investment of $2.4
million was made in Fitz and Floyd and Fund II received a $2.4 million 12%
subordinated note. Additionally, Fund II exchanged the $12.6 million adjustable
notes, which Fund II previouslly held, for Series A Preferred Stock and Class A
Common Stock in Fitz and Floyd. No gain or loss was recorded on the trasaction.
On August 6, 1991, the Independent General Partners approved a reserve for
follow-on investments of $24.9 million for Fund II. As of November 14, 1997, the
remaining reserve balance was $3.1 million due to follow-on investments in Petco
Animal Supplies, Fitz and Floyd, Fine Clothing, Inc., Hills Stores, Ghirardelli
Holdings and Anchor Advanced Products. Additionally, $8.29 million of the
reserve has been returned to the partners. 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.
Because Fund II primarily invested 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.
<PAGE>
5. Unrealized Appreciation and Depreciation of Investments
For the nine months ended September 30, 1997, Fund II recorded net
unrealized depreciation of $3,707,926 as compared to net unrealized depreciation
of $9,752,935 for the same period in 1996. As of September 30, 1997, Fund II's
cumulative net unrealized depreciation on investments totaled $46,954,876.
For the three months ended September 30, 1997, Fund II recorded net
unrealized appreciation of $713,280 as compared to net unrealized appreciation
of $7,716,095 recorded for the comparable period in 1996. 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:
- 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 and realized losses), 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 nine
months ended September 30, 1997 and 1996, Fund II paid $582,001 and $756,219,
respectively, in Investment Advisory Fees to Thomas H. Lee Advisors II, L.P. For
the three months ended September 30, 1997 and 1996, Fund II paid $164,431 and
$237,985, 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 and 50% of
realized losses. 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 nine months ended September
30, 1997 and 1996, Fund II paid $470,514 and $509,713, respectively, in Fund
Administration Fees. For the three months ended September 30, 1997 and 1996,
Fund II paid $150,185 and $166,734, 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 nine months ended September 30, 1997 and 1996, Fund
II incurred $129,074 and $99,847, respectively, in reimbursable expenses. For
the three months ended September 30, 1997 and 1996, Fund II incurred $50,281 and
$33,000, respectively, in reimbursable expenses.
Beginning in November 1997, the Fund Administration Fee will be calculated
at an annual amount of $400,000 for Fund II and the Retirement Fund on a
combined basis, plus 100% of all reimbursable expenses incurred by the Fund.
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, 1997 and 1996, Independent General Partners Fees and
Expenses for Fund II totalled $95,695 and $172,591, respectively. For the three
months ended September 30, 1997, Fund II incurred $19,302 in Independent General
Partners Fees and Expenses as compared to $19,480 for the same period in 1996.
<PAGE>
10. Related Party Transactions
Fund II's investments generally were 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, 1997, Fund II paid the
Individual General Partner distributions totaling $5,024 and Managing General
Partner distributions totaling $3,407,508 (which includes $3,357,265 of
incentive fees). As of September 30, 1997, the Managing General Partner has
earned a total of $24.8 million in MGP Incentive Fees, none of which is deferred
in payment to the Managing General Partner as a Deferred Distribution amount
(the "Deferred Distribution",) at this time, in accordance with the Partnership
Agreement. To the extent not payable to the Managing General Partner, any
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.
<PAGE>
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 matter. 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 Legal and Professional Fees. In the
opinion of legal counsel, 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. In the opinion of legal
counsel, the outcome of this case is not determinable at this time.
<PAGE>
12. Income Taxes (Statement of Financial Accounting Standards No. 109)
No provision for income taxes has been made because 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. As of December 31, 1996, the tax basis of Fund II's
assets are greater than the amounts reported in the financial statements by
$44.1 million. This difference is attributable to net unrealized depreciation on
investments which has not been recognized for tax purposes.
13. Subsequent Events
On November 3, 1997, the Individual General Partners approved the Third
Quarter 1997 cash distribution totalling $1,304,854 which consisted of Return of
the Reserve for Follow-On Investments of $1,000,000, Distributable Cash from
Temporary Investments of $39,959 and Distributable Cash from Mezzanine
Investments of $264,895. The total amount to be distributed to Limited Partners
is $1,221,815 or $5.51 per Unit. The Managing General Partner will receive
$2,757, in proportion to its capital contribution and $80,006 as an MGP
distribution. Thomas H. Lee, as an Individual General Partner, will receive $276
which represents his interest in Fund II. This cash distribution will be paid on
November 14, 1997.
On November 11, 1997, Stanley Furniture Company announced the repurchase of
a total of 413,201 shares of its Common Stock from Fund II and affiliates of the
Thomas H. Lee Company, including the Retirement Fund and the ML Lee Acquisition
Fund, L.P. for $25 per share. As a result, Fund II is expected to sell a total
of 3,460 shares and receive proceeds of $86,500. Fund II will continue to hold
3,461 shares subsequent to this repurchase. Net Distributable Proceeds from the
sale will be distributed to Limited Partners of record as of the closing date,
which is expected to be in November 1997.
<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, 1997
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C> <C> <C>
Par Value or Original Realized
SECURITY Number of Shares Cost Net Proceeds Gain
- ----------------------------------------------- ---------------- ---------- ------------ ----------
For the 3 Months Ended March 31, 1997
- -----------------------------------------------
Stanley Furniture
Common Stock 272 $ 4 $ 7 $ 3
- ----------------------------------------------- ---------- ----------- ----------
Total for the 3 Months Ended March 31, 1997 4 7 3
- ----------------------------------------------- ---------- ----------- ----------
For the 3 Months Ended June 30, 1997
Stanley Furniture
Common Stock 6,281 79 126 47
- ----------------------------------------------- ---------- ----------- ----------
Total for the 3 Months Ended June 30, 1997 79 126 47
- ----------------------------------------------- ---------- ----------- ----------
Total for the 9 Months Ended September 30, 1997 $ 83 $ 133 $ 50
=============================================== ========== =========== ==========
</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, 1997
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Unrealized Unrealized
Appreciation/ Appreciation/ Total Total
(Depreciation) (Depreciation) Unrealized Unrealized
for the Three for the Nine Appreciation/ Appreciation/
Investment Fair months ended months ended (Depreciation)at (Depreciation) at
SECURITY Cost Value September 30, September 30, December 31, September 30,
1997 1997 1996 1997
- ------------------------------------------------------------------------------------------------------------------------------------
PUBLICLY TRADED SECRITIES
First Alert
Common Stock* $ 3,320 $ 6,175 $ 386 $ (772) $ 3,627 $ 2,855
Hills Stores
Common Stock* 34,776 2,247 456 (879) (31,650) (32,529)
Playtex
Common Stock* 5,299 3,480 258 730 (2,549) (1,819)
Stanley
Common Stock* 87 185 25 1 98 99
------ -------- -------- --------
TOTAL UNREALIZED APPRECIATION
(DEPRECIATION) FROM PUBLICLY
TRADED SECURITIES $1,125 $ (920) $(30,474) $(31,394)
------ -------- -------- --------
NON PUBLIC SECURITIES:
Biolease
Common Stock* $ 94 $ -- $ (94) $ (94) $ -- $ (94)
Subordinated Notes* 676 392 (318) (318) -- (318)
Fitz and Floyd
Common Stock* 12,619 3,024 -- 63 (9,659) (9,596)
FLA. Orthopedics, Inc.
Preferred Stock* 1,513 -- -- -- (1,513) (1,513)
Sortex
Subordinated Notes* 6,631 2,590 -- (2,439) (1,602) (4,041)
------ -------- -------- ---------
TOTAL UNREALIZED DEPRECIATION
FROM NON PUBLIC SECURITIES $ (412) $ (2,788) $(12,774) $ (15,562)
------ -------- -------- ---------
TOTAL NET UNREALIZED APPRECIATION
(DEPRECIATION) $ 713 $ (3,708) $(43,248) $ (46,956)
====== ======== ======== =========
* Restricted Securities
</TABLE>
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Liquidity & Capital Resources
As of September 30, 1997, Fund II had a total of $92.0 million invested in
Mezzanine Investments representing $68.0 million Managed and $24.0 million
Non-Managed portfolio investments. These investments were financed by net
offering proceeds and debt financing. This represents a $11.6 million decrease
versus the total invested in Mezzanine Investments at December 31, 1996 of
$103.6 million. The decrease in investments is due primarily to the sales and
redemptions of Portfolio Investments.
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.
As provided by the Partnership Agreement, the Managing General Partner of
Fund II is entitled to receive an incentive distribution after Limited Partners
have received their Priority Return of 10% per annum. The Managing General
Partner is required to defer a portion of any incentive fee earned from the sale
of portfolio investments in excess of 20% of realized capital gains, net
realized capital losses and unrealized depreciation, in accordance with the
Partnership Agreement (the "Deferred Distribution Amount"). This Deferred
Distribution Amount is distributable 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.
On August 6, 1991, the Independent General Partners approved a reserve for
follow-on investments of $24.9 million for Fund II. As of November 14, 1997, the
remaining reserve balance was $3.1 million due to follow-on investments in Petco
Animal Supplies, Fitz and Floyd, Fine Clothing, Inc., Hills Stores, Ghirardelli
Holdings and Anchor Advanced Products. Additionally, $8.29 million of the
reserve has been returned to the partners. 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.
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.
The proportion of distributions provided by net investment income has
decreased 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. It is expected that the majority of
future cash distributions to Limited Partners will almost entirely be derived
from recovered capital and gains, from asset sales, if any, 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.
<PAGE>
Investment in High-Yield Securities
Fund II invested 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 Advisor 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 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 one year 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 two 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 nine months ended September 30, 1997, Fund II had investment income
of $9,409,199 as compared to $13,052,729 for the same period in 1996. The
decrease of $3,643,530 in 1997 investment income as compared to 1996 is due to
the sale of income producing portfolio companies, as well as recognition of
previously unrecorded interest income of payment-in-kind securities totalling
$7.2 million related to the sale of CST Office Products, Inc. in March of 1996.
Major expenses for the period consisted of Investment Advisory Fees and
Fund Administration Fees.
<PAGE>
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, 1997 and 1996 was
$582,001 and $756,219, respectively, and was calculated at an annual rate of
1.0% of assets under management (net offering proceeds reduced by cumulative
capital reductions and realized losses), 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. For the three months ended September 30, 1997
and 1996, Investment Advisory Fees paid to the Investment Adviser were $164,431
and $237,985, respectively.
The Fund Administration Fee paid to the Fund Administrator for the nine
months ended September 30, 1997 and 1996 was $470,514 and $509,713,
respectively, and was calculated at an annual rate of 0.45% of the excess of net
offering proceeds, less 50% of capital reductions and 50% of realized losses.
For the three months ended September 30, 1997 and 1996, the Fund Administration
Fee paid to the Fund Administrator was $150,185 and $166,734, respectively.
Beginning in November of 1997, the Fund Administration Fee will change to
an annual amount of $400,000 for Fund II and the Retirement Fund on a combined
basis, plus 100% of all reimbursable expenses (as defined below) incurred by the
Fund.
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 nine months ended September 30, 1997 and 1996, Fund
II incurred reimbursable expenses $129,074 and $99,847, respectively. For the
three months ended September 30, 1997 and 1996, Fund II incurred $50,281 and
$33,000, respectively, in reimbursable expenses.
For the nine months ended September 30, 1997, Fund II had net investment
income of $8,029,619 as compared to $10,303,854 for the same period in 1996. The
decrease of $2,274,235 in 1997 net investment income as compared to 1996 is due
to the recognition of interest income from payment-in-kind securities related to
the sale of CST Office Products, Inc., in March of 1996, partially offset by
lower Legal and Professional Fees and Investment Advisory Fees. Legal and
Professional Fees were lower in 1997 than in 1996 partially due to a rebate of
approximately $287 thousand pertaining to legal fees paid by Fund II on behalf
of Fitz and Floyd pertaining to the Plan of Reorganization.
For the three months ended September 30, 1997, Fund II had net investment
income of $546,994 as compared to $747,064 for the same period in 1996. The
decrease in 1997 net investment income is due to sales of income generating debt
securities partially offset by lower Investment Advisory Fees and Legal and
Professional Fees.
Net Assets
Fund II's net assets decreased by $21,324,305 during the nine months ended
September 30, 1997 due to the payment of cash distributions to partners of
$25,695,686 and net unrealized depreciation of $3,707,926, partially offset by
realized gains from the sale of Mezzanine Investments of $49,688 and net
investment income of $8,029,619. This compares to the decrease in net assets of
$42,388,527 for the nine months ended September 30, 1996 resulting from the
payment of cash distributions to partners of $48,829,459 and net unrealized
depreciation of $9,752,935, partially offset by net investment income of
$10,303,854 and realized gains from investments of $5,890,013.
Unrealized Appreciation and Depreciation on Investments
For the nine months ended September 30, 1997, Fund II recorded net
unrealized depreciation of $3,707,926 as compared to net unrealized depreciation
of $9,752,935 for the same period in 1996. As of September 30, 1997, Fund II's
cumulative net unrealized depreciation on investments totaled $46,954,876.
For the three months ended September 30, 1997, Fund II recorded net
unrealized appreciation of $713,280 as compared to net unrealized appreciation
of $7,716,095 recorded for the comparable period in 1996. 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, 1997.
<PAGE>
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.
Approximately 53% of Fund II's mezzanine investments (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, 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, 1997. 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.
Realized Gains and Losses
For the nine months ended September 30, 1997, Fund II had net realized
gains from the sale of Mezzanine Investments of $49,688 as compared to
$5,890,013 for the same period in 1996.
For the quarter ended September 30, 1997, Fund II had no realized gains
from investments. For the comparable period in 1996, Fund II had a realized loss
of $4,841,600. For additional information, please refer to the Supplemental
Schedule of Realized Gains and Losses - Schedule 1.
Cash Distributions
On November 3, 1997, the Individual General Partners approved the Third
Quarter 1997 cash distribution totalling $1,304,854 which consisted of Return of
the Reserve for Follow-On Investments of $1,000,000, Distributable Cash from
Temporary Investments of $39,959 and Distributable Cash from Mezzanine
Investments of $264,895. The total amount to be distributed to Limited Partners
is $1,221,815 or $5.51 per Unit. The Managing General Partner will receive
$2,757, in proportion to its capital contribution and $80,006 as an MGP
distribution. Thomas H. Lee, as an Individual General Partner, will receive $276
which represents his interest in Fund II. This cash distribution will be paid on
November 14, 1997.
Because most of Fund II's debt holdings were previously sold or redeemed,
remaining portfolio interest income expected to be received by Fund II may not
be sufficient to cover Fund II's expenses in the future. As a result, any
interest income received will be used to pay Fund II expenses any may not be
available for distribution. The majority of future cash distributions to Limited
Partners will be derived from recovered capital and gains, from asset sales, if
any, which are dependent upon future market conditions and therefore are
inherently unpredictable. Cash distributions, therefore, are likely to vary
significantly in amount and may not be made in every quarter.
Should Limited Partner's decide to sell their Units, any such sale will be
recorded on the books and records of Fund II quarterly, only upon the
satisfactory completion and acceptance of Fund II's transfer documents. There
can be no assurances that such transfer will be effected before any specified
date. Additionally, pursuant to the Partnership Agreement, until a transfer is
recognized, the Limited Partner of record (i.e. the transferor) is entitled to
receive all the benefits and burdens of ownership of Units, and any transferee
has no rights to distributions of sale proceeds generated at any time prior to
the recognition of the transfer and assignment. Accordingly, Distributable Cash
from Investments for a quarter and Distributable capital Proceeds from sales
after transfer or assignment have been entered into, but before such transfer
and assignment is recognized, would be payable to the transferor and not the
transferee.
<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, 1997.
(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 12th day of
November, 1997.
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 12, 1997 /s/ Audrey Bommer
Audrey Bommer
Vice President and Treasurer
(Chief Financial Officer)
Dated: November 12, 1997 /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 12th day of
November, 1997.
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 12, 1997
Audrey Bommer
Vice President and Treasurer
(Chief Financial Officer)
Dated: November 12, 1997
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 1997 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-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<INVESTMENTS-AT-COST> 96,465,887
<INVESTMENTS-AT-VALUE> 49,553,777
<RECEIVABLES> 615,634
<ASSETS-OTHER> 592
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 50,170,003
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 378,785
<TOTAL-LIABILITIES> 378,785
<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> (46,954,876)
<NET-ASSETS> 49,791,216
<DIVIDEND-INCOME> 5,305,161
<INTEREST-INCOME> 3,940,534
<OTHER-INCOME> 163,504
<EXPENSES-NET> 1,379,581
<NET-INVESTMENT-INCOME> 8,029,619
<REALIZED-GAINS-CURRENT> 49,688
<APPREC-INCREASE-CURRENT> (3,707,926)
<NET-CHANGE-FROM-OPS> 4,371,380
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 8,051,981
<DISTRIBUTIONS-OF-GAINS> 184,638
<DISTRIBUTIONS-OTHER> 17,459,068
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> (21,324,306)
<ACCUMULATED-NII-PRIOR> 0
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<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 582,001
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1,379,581
<AVERAGE-NET-ASSETS> 60,453,370
<PER-SHARE-NAV-BEGIN> 314.44
<PER-SHARE-NII> 25.66
<PER-SHARE-GAIN-APPREC> (16.68)
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> (100.49)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 223.16
<EXPENSE-RATIO> 0.023
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
