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 0-17382
ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
(Exact name of registrant as specified in its Charter)
Delaware 04-3028397
(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 of each exchange onwhich registered: Not Applicable Securities
registered pursuant to Section 12(g) of the Act:
Units of Limited Partnership Interest
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___.
Aggregate market value of voting securities held by non-affiliates: Not
Applicable.
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PART I - FINANCIAL INFORMATION
ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) 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
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ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
STATEMENTS OF ASSETS, LIABILITIES AND PARTNERS' CAPITAL
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Unaudited
September 30, December 31,
1996 1995
------------- -------------
ASSETS:
Investments - Notes 2,4,5
Portfolio Investments at fair value
Managed Companies (amortized cost $46,564
at September 30, 1996 and $63,435 at December 31, 1995) $ 38,555 $ 62,874
Non-Managed Companies (amortized cost $17,366
at September 30, 1996 and $24,931 at December 31, 1995) 8,243 16,970
Temporary Investments, at amortized cost (cost $8,233
at September 30, 1996 and $8,202 at December 31, 1995) 8,239 8,218
Cash (of which $130 is restricted at September 30, 1996) 155 1
Accrued Interest Receivable - Note 2 410 1,237
Prepaid Expenses - 4
------------- -------------
TOTAL ASSETS $ 55,602 $ 89,304
============= =============
LIABILITIES AND PARTNERS' CAPITAL:
Liabilities
Legal and Professional Fees Payable $ 120 $ 311
Reimbursable Administrative Expenses Payable -Note 8 26 46
Independent General Partners' Fees Payable - Note 9 25 45
Deferred Interest Income - Note 2 199 426
------------- -------------
Total Liabilities 370 828
------------- -------------
Partners' Capital - Note 2
Individual General Partner 20 28
Managing General Partner 4,303 4,897
Limited Partners (177,515 Units) 50,909 83,551
------------- -------------
Total Partners' Capital 55,232 88,476
------------- -------------
TOTAL LIABILITIES AND PARTNERS' CAPITAL $ 55,602 $ 89,304
============= =============
See the Accompanying Notes to Financial Statements.
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ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <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 $ 691 $ 1,436 $ 6,881 $ 4,557
Discount & Dividends 170 41 618 70
--------------- --------------- --------------- ---------------
TOTAL INCOME 861 1,477 7,499 4,627
--------------- --------------- --------------- ---------------
EXPENSES:
Investment Advisory Fee - Note 7 184 257 629 802
Fund Administration Fee - Note 8 132 149 414 452
Legal and Professional Fees 179 536 980 854
Reimbursable Administrative Expenses - Note 8 25 22 79 72
Independent General Partners' Fees and Expenses - Note 9 16 33 144 98
Insurance Expense 1 1 3 4
--------------- --------------- --------------- ---------------
TOTAL EXPENSES 537 998 2,249 2,282
--------------- --------------- --------------- ---------------
NET INVESTMENT INCOME 324 479 5,250 2,345
Net Realized Gain (Loss) on Investments - Note 4
and Schedule 1 (3,158) - 4,749 7,836
Net Change in Unrealized Appreciation/(Depreciation)
from Investments - Note 5 and Schedule 2:
Publicly Traded Securities 3,789 (1,452) (7,447) (6,572)
Nonpublic Securities 3,158 - (1,180) (1,579)
--------------- --------------- --------------- ---------------
SUBTOTAL 6,947 (1,452) (8,627) (8,151)
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS 4,113 (973) 1,372 2,030
Less: Incentive Fees Earned by Managing General Partner - (799) (2,566) (5,583)
--------------- --------------- --------------- ---------------
NET INCREASE (DECREASE) AVAILABLE FOR PRO-RATA
DISTRIBUTION TO ALL PARTNERS $ 4,113 $ (1,772) $ (1,194) $ (3,553)
=============== =============== =============== ===============
See the Accompanying Notes to Financial Statements.
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ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
STATEMENTS OF CHANGES IN NET ASSETS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
For the Nine months Ended
----------------------------------------
September 30, 1996 September 30, 1995
------------------ ------------------
FROM OPERATIONS:
Net Investment Income $ 5,250 $ 2,345
Net Realized Gain on Investments 4,749 7,836
Net Change in Unrealized Depreciation from Investments (8,627) (8,151)
------------------ ------------------
Net Increase in Net Assets Resulting from Operations 1,372 2,030
Cash Distributions to Partners (34,616) (16,554)
------------------ ------------------
Total Decrease (33,244) (14,524)
NET ASSETS:
Beginning of Year 88,476 133,591
------------------ ------------------
End of Period $ 55,232 $ 119,067
================== ==================
See the Accompanying Notes to Financial Statements.
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ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
For the Nine Months Ended
-------------------------------------------
September 30, 1996 September 30, 1995
------------------ ------------------
Increase (Decrease) in Cash and Cash Equivalents
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest, Dividends and Discount Income $ 8,299 $ 4,259
Fund Administration Fee (414) (452)
Investment Advisory Fee (629) (802)
Independent General Partners' Fees and Expenses (164) (141)
(Purchase) Sale of Temporary Investments, Net (425) 6,536
Purchase of Portfolio Company Investments - (1,865)
Proceeds from Sales of Portfolio Company Investments 29,373 9,568
Reimbursable Administrative Expenses (99) (125)
Legal and Professional Fees (1,171) (424)
------------------ ------------------
Net Cash Provided by Operating Activities 34,770 16,554
------------------ ------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash Distributions to Partners (34,616) (16,554)
------------------ ------------------
Net Cash Applied to Financing Activities (34,616) (16,554)
------------------ ------------------
Net Increase in Cash 154 -
Cash at Beginning of Period 1 1
------------------ ------------------
Cash at End of Period $ 155 1
================== ==================
RECONCILIATION OF NET INVESTMENT INCOME
TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net Investment Income $ 5,250 $ 2,345
------------------ ------------------
Adjustments to Reconcile Net Investment Income to
Net Cash Provided by Operating Activities:
Decrease in Investments 24,198 6,403
(Increase) Decrease in Accrued Interest and Dividend Receivables 800 (368)
Decrease in Prepaid Expenses 4 3
Increase (Decrease) in Legal and Professional Fees Payable (191) 377
Decrease in Reimbursable Administrative Expenses Payable (20) -
Decrease in Independent General Partners' Fees Payable (20) (42)
Net Realized Gains on Sales of Investments 4,749 7,836
------------------ ------------------
Total Adjustments 29,520 14,209
------------------ ------------------
Net Cash Provided by Operating Activities $ 34,770 $ 16,554
================== ==================
See the Accompanying Notes to Financial Statements.
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ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
STATEMENT OF CHANGES IN PARTNERS' CAPITAL
(DOLLARS IN THOUSANDS)
<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 $ 28 $ 4,897 $ 83,551 $ 88,476
Allocation of Net Investment Income 2 1,877 3,371 5,250
Allocation of Net Realized Gain on Investments 1 2,702 2,046 4,749
Allocation of Net Change in Unrealized
Depreciation From Investments (3) (24) (8,600) (8,627)
Cash Distributions to Partners (8) (5,149) (29,459) (34,616)
---------- -------- ---------- ----------
Partners' Capital at September 30, 1996 $ 20 $ 4,303 $ 50,909 $ 55,232
========== ======== ========== ==========
See the Accompanying Notes to Financial Statements.
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ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Fair % Of
Principal Investment Investment Value Total
Amount/Shares Investment Date Cost(e) (Note 2) Investments
<S> <C> <C> <C> <C> <C>
MEZZANINE INVESTMENTS
MANAGED COMPANIES
ANCHOR ADVANCED PRODUCTS, INC. (b)
$3,133 Anchor Advanced Products, Inc., Sr. Sub. Nt. 11.67% due 04/30/00 (c) 04/30/90 $3,133 $3,133
$4,178 Anchor Advanced Products, Inc., Jr. Sub. Nt. 17.5% due 04/30/00 (c) 04/30/90 4,178 4,178
87,033 Shares Anchor Holdings, Inc., Common Stock (d) 04/30/90 827 827
132,290 Warrants Anchor Holdings, Inc., Common Stock Purchase Warrants(d) 04/30/90 0 0
(13.9% of fully diluted common equity assuming exercise
of warrants) 8,138 8,138 14.79
BIG V SUPERMARKETS, INC. (b)
$6,963 Big V Supermarkets, Inc., Sr. Sub. Nt. 14.14% due 03/15/01(c) 12/27/90 6,963 6,963
62,667 Shares Big V Holding Corp., Inc., Common Stock(d) 12/27/90 2,193 2,193
(8.8% of fully diluted common equity) 9,156 9,156 16.64
COLE NATIONAL CORPORATION
717 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)
$744 13% Sr. Secured Bridge Note
Purchased 09/25/90 $744
Repaid 11/15/90 $744
Realized Gain $ 0
0 0 0.00
FIRST ALERT, INC.(b) - Note 5
2,281,524 Shares First Alert, Inc., Common Stock(a)(d) 07/31/92 3,680 13,404
(8.9% of fully diluted common equity)
$11,302 12.5% Subordinated Note
Purchased 07/31/92 $11,302
Repaid 03/28/94 $11,302
Realized Gain $ 0
3,680 13,404 24.35
HILLS STORES COMPANY - Note 5
244,818 Shares Hills Stores Company, Common Stock(a)(d) 04/03/90 16,153 1,745
33,427 Shares Hills Stores Company, Common Stock(a)(h) 08/21/95 2,418 238
(2.5% of fully diluted common equity) 18,571 1,983 3.60
See the Accompanying Notes to Financial Statements.
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ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Fair % Of
Principal Investment Investment Value Total
Amount/Shares Investment Date Cost(e) (Note 2) Investments
<S> <C> <C> <C> <C> <C>
PLAYTEX PRODUCTS, INC.(b) - Note 5
183,560 Shares Playtex Products, Inc., Common Stock(a)(d) 03/29/90 $ 2,830 $ 1,606
(0.3% of fully diluted common equity)
$3,916 15% Subordinated Note
Purchased 03/29/90 $3,916
Sold 09/28/90 $3,925
Realized Gain $ 9
45,323 Shares Common Stock
Purchased 03/29/90 $ 151
Sold 12/20/91 $ 175
Realized Gain $ 24
$3,916 15% Subordinated Note
Purchased 03/29/90 $3,916
Sold 02/01/93 $3,912
Realized Loss $ (4)
Total Net Realized Gain $ 29
2,830 1,606 2.92
RESTAURANTS UNLIMITED
$3,956 Restaurants Unlimited, 11% Sub. Nt. due 06/30/02(c) 06/03/94 3,956 3,956
256,083 Warrants Restaurants Unlimited, Common Stock Warrants(d) 06/03/94 0 0
(1.4% of fully diluted common equity) 3,956 3,956 7.19
STANLEY FURNITURE COMPANY, INC. (b) - Note 5,13
18,511 Shares Stanley Furniture Company, Inc., Common Stock(a)(d) 06/30/91 233 312
(0.4% of fully diluted common equity) 233 312 0.56
TOTAL INVESTMENT IN MANAGED COMPANIES $46,564 $38,555 70.05
See the Accompanying Notes to Financial Statements.
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ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30, 1996
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Fair % Of
Principal Investment Investment Value Total
Amount/Shares Investment Date Cost(e) (Note 2) Investments
<S> <C> <C> <C> <C> <C>
NON-MANAGED COMPANIES
BIOLEASE, INC.
$513 Biolease, Inc., 13% Sub. Nt. due 06/06/04(c) 06/08/94 $ 443 $ 459
63.20 Shares Biolease, Inc., Common Stock(d) 06/08/94 62 62
6,554 Warrants Biotransplant, Inc., Common Stock Purchase Warrants(d) 06/08/94 9 9
514 530 0.96
FITZ AND FLOYD/SILVESTRI (b) - Notes 5,6
$6,719 FFSC, Inc., Adjustable Rate Sr. Sub. Nt. due 03/31/03(c)(g) 03/31/93 6,709 1,600
$1,581 FFSC, Inc., Adjustable Rate Sr. Sub. Nt. due 03/31/03(c)(g) 07/30/93 1,578 376
988,144 Shares FF Holding Co., Common Stock(d) 03/31/93 10 0
336,364 Shares FF Holding Co., Common Stock(d) 07/30/93 3 0
337,155 Shares FF Holding Co., Common Stock(d) 12/22/94 0 0
8,300 1,976 3.59
FLA. ORTHOPEDICS, INC - Notes 4,5
12,634 Shares FLA. Holdings, Inc. Series B Preferred Stock (d) 08/02/93 987 0
2,493 Warrants FLA. Holdings, Inc. Common Stock Purchase Warrants(d) 08/02/93 0 0
$3,158 12.5% Subordinated Note
Purchased 08/02/93 $ 3,158
Surrendered 08/16/96 $ 0
Realized Loss $(3,158)
78,960 Common Stock
Purchased 08/02/93 $ 987
Exchanged 08/02/96
2,493 Series B Preferred Stock $ 987
Realized Gain $ 0
987 0 0.00
SORETOX - Notes 5,6
$3,997 Stablex Canada, Inc., Sr. Sub. Nt. 10% due 06/30/07(c)(f)(g) 06/29/95 3,997 2,955
$3,568 Stablex Canada, Inc., Jr. Sub. Nt. 11% due 06/30/09(c)(f)(g) 06/29/95 3,568 2,782
2,286 Warrants Seaway TLC, Inc. Common Stock Purchase Warrants 06/29/95 0 0
7,565 5,737 10.43
TOTAL INVESTMENT IN NON-MANAGED COMPANIES $17,366 $ 8,243 14.98
SUMMARY OF MEZZANINE INVESTMENTS
Subordinated Notes Various 34,525 26,402 47.97
Preferred Stock, Common Stock, Warrants and Stock Rights Various 29,405 20,396 37.06
TOTAL MEZZANINE INVESTMENTS $63,930 $ 46,798 85.03
TEMPORARY INVESTMENTS
COMMERCIAL PAPER
$ 240 General Electric Credit Corp., 4.95% due 10/01/96 09/19/96 240 240
$ 400 American General Finance Corp., 5.10% due 10/01/96 09/26/96 400 400
$ 7,610 American General Finance Corp., 5.30%, due 10/11/96 09/26/96 7,593 7,599
TOTAL INVESTMENT IN COMMERCIAL PAPER 8,233 8,239 14.97
TOTAL TEMPORARY INVESTMENTS $ 8,233 $ 8,239 14.97
TOTAL INVESTMENT PORTFOLIO $72,163 $ 55,037 100.00%
(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 $16 for Mezzanine Investments and $6 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.
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ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
(UNAUDITED)
1. Organization and Purpose
ML-Lee Acquisition Fund (Retirement Accounts) II, L.P. (the "Retirement
Fund") (formerly T.H. Lee Acquisition Fund (Retirement Accounts) II, L.P.) was
formed along with ML-Lee Acquisition Fund II, L.P. ("Fund II"; collectively
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 the Retirement Fund'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.
The Retirement Fund has elected to operate as a business development
company under the Investment Company Act of 1940. The Retirement Fund'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. The Retirement Fund 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. The
Retirement Fund may also invest in "bridge investments" if it is believed that
such investments would facilitate the consummation of a mezzanine financing.
The Retirement Fund will terminate no later than December 20, 1999, 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 the Retirement Fund. Following such time periods, the
Retirement Fund will have five additional years to liquidate its remaining
investments.
2. Significant Accounting Policies
Basis of Accounting
For financial reporting purposes, the records of the Retirement Fund 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
the Retirement Fund. For privately issued securities in which the Retirement
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Fund 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 the Retirement Fund
could realize in a current transaction. Future confirming events will also
affect the estimates of fair value and the effect of such events on the
estimates of fair value could be material.
Temporary Investments with maturities of less than 60 days are stated at
amortized cost, which approximates market.
The information presented herein is based on pertinent information
available to the Managing General Partner and Investment Adviser as of 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 September 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 the Retirement Fund'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, the Retirement Fund has in its portfolio of investments
$504,150 and $739,601, respectively, of payment-in-kind notes which excludes
$1,063,132 and $4,298,447, respectively, of payment-in-kind notes received from
notes placed on non-accrual status. As of September 30, 1996 and December 31,
1995, the Retirement Fund has in its portfolio of investments $14,640 and
$1,224,548, respectively of payment-in-kind equity.
Investment Transactions
The Retirement Fund records investment transactions on the date on which
it obtains an enforceable right to demand the securities or payment therefor.
The Retirement Fund records Temporary Investment transactions on the trade date.
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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 the Retirement Fund 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 the Retirement Fund'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 the Retirement Fund, all necessary adjustments have been made
to the aforementioned financial information for a fair presentation in
accordance with generally accepted accounting principles.
3. Allocations of Profits and Losses
Pursuant to the Partnership Agreement, all profits from Temporary
Investments generally are allocated 99.69% to the Limited Partners, 0.28% to the
Managing General Partner and 0.03% 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, 99.69% to the Limited Partners, 0.28% to the Managing General
Partner and 0.03% 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, 69.69% to the Limited Partners, 30.281% to the Managing General
Partner and .029% to the Individual General Partner until the Managing
General Partner has received 20.281% of the total profits allocated,
thereafter, 79.69% to the Limited Partners, 20.281% to the Managing General
Partner and 0.029% to the Individual General Partner.
Losses will be allocated in reverse order of profits previously allocated
and thereafter 99.69% to the Limited Partners, 0.28% to the Managing General
Partner and 0.03% to the Individual General Partner.
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4. Investment Transactions
On March 22, 1996 by means of merger of Lee-CST Holding Corp. with an
unaffiliated third party, the Retirement Fund sold its entire investment in CST
Office Products ("CST") for total proceeds of $14.2 million. The Retirement Fund
received an aggregate of $11.3 million for the $3,395,000 principal amount 12%
senior subordinated note, the $3,395,000 principal amount 18% junior
subordinated note, approximately $4 million in principal amount of 15% payment
in kind subordinated notes issued with respect thereto, plus all outstanding
accrued interest on these notes. Additionally, the Retirement Fund received $1.4
million, or $16 per share, for its common stock and $1.5 million, or $15.99 per
share, for its common stock purchase warrants. The Retirement Fund realized a
gain of $2.3 million, and additional interest income of $3.9 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 the Retirement Fund. The offering was effected on April 30, 1996, and
the Retirement Fund sold its entire investment in Petco, which consisted of
93,568 shares of Common Stock and received net proceeds of $2,560,021 or $27.36
per share. The Retirement Fund realized a gain of $1,537,444 on the sale.
On April 1, 1996, the Retirement Fund 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. The
Retirement Fund received net proceeds from the sale of $10,980,618, which
consisted of $5,624,296 as prepayment for the 13% Subordinated Note (including
$88,504 of accrued interest), $3,611,207 for the common stock (of which $130,540
is being held in escrow) and $1,745,115 for the preferred stock (including
$30,192 of accrued dividends). The sale resulted in a realized gain of
$2,603,522 to the Retirement Fund.
On May 17, 1996, pursuant to a Redemption and Repurchase Agreement with
National Tobacco Company, a Non-Managed Company in the Retirement Fund's
portfolio, and certain existing lenders, the Retirement Fund received net
proceeds of $5,953,721 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 the Retirement Fund. The
Retirement Fund recognized a gain of $1,488,606 from the transaction.
On August 2, 1996, the Retirement Fund entered into a Stock Purchase and
Settlement Agreement with Florida Orthopedics Inc. and various other affiliated
entities. In connection with this agreement, the Retirement Fund (I) surrendered
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. The Retirement Fund realized a loss of $3.2
million on the subordinated note surrendered.
On August 6, 1991, the Independent General Partners approved a reserve for
follow-on investments of $20.0 million for the Retirement Fund. As of September
30, 1996, the reserve balance was reduced to $8.2 million due to follow-on
investments of $153 in Petco Animal Supplies, $1.6 million in Fitz and
Floyd/Silvestri, Corporation, $128,270 in Fine Clothing, Inc., $2.5 million in
Hills Stores and $1.9 million in Ghirardelli Holdings. Additionally, $5.7
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 the
Retirement Fund's existing investment. As of August 8, 1996, the Independent
General Partners have approved retention of the reserve at its current level.
Because the Retirement Fund 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 the Retirement Fund 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 Retirement Fund 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 the Retirement Fund 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, 1996, the Retirement Fund recorded
net unrealized depreciation of $8,627,011 compared to net unrealized
depreciation of $8,150,451 for the same period in 1995. As of this date, the
Fund's cumulative net unrealized depreciation on investments totalled
$17,149,443.
For the three months ended September 30, 1996, the Retirement Fund recorded
net unrealized appreciation of $6,947,985 as compared to net unrealized
depreciation recorded for the comparable period in 1995 of $1,451,422. For
additional information, please refer to the Supplemental Schedule of Unrealized
Appreciation and Depreciation - Schedule 2.
6. Non-Accrual of Investments
In accordance with the Retirement Fund's Accounting Policy, the following
securities have been on non-accrual status since the date indicated:
- Fitz and Floyd/Silvestri 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
the Retirement Fund and Fund II 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, 1996 and
1995, the Retirement Fund paid $629,018 and $802,112 respectively, in Investment
Advisory Fees to Thomas H. Lee Advisors II, L.P. For the three months ended
September 30, 1996 and 1995, the Retirement Fund paid $183,604 and $257,196,
respectively, in Investment Advisory Fees to Thomas H. Lee Advisors II, L.P.
8. Fund Administration Fees and Expenses
As compensation for its services, ML Fund Administrators Inc. (the "Fund
Administrator"; an affiliate of the Managing General Partner), is entitled to
receive from the Funds an annual amount of the greater of $500,000 or 0.45% of
the excess of net offering proceeds less 50% of capital reductions. In addition,
ML Mezzanine II Inc., an affiliate of the Fund Administrator and of 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, 1996 and 1995,
the Retirement Fund paid $413,547 and $452,493, respectively, in Fund
Administration Fees. For the three months ended September 30, 1996 and 1995, the
Retirement Fund paid $131,983 and $148,542, respectively, in Fund Administration
Fees.
Pursuant to the administrative services agreement between the Retirement
Fund and the Fund Administrator, a portion of the actual out-of-pocket expenses
incurred in connection with the administration of the Retirement Fund 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, the
Retirement Fund incurred $79,507 and $72,127, respectively, in reimbursable
expenses. For the three months ended September 30, 1996 and 1995, the Retirement
Fund incurred $26,000 and $22,163, respectively, in reimbursable expenses.
<PAGE>
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 Independent General Partners is reviewed annually. For the nine
months ended September 30, 1996 and 1995, the Retirement Fund incurred $144,191
and $98,375, respectively, in Independent General Partners' Fees and Expenses.
For the three months ended September 30, 1996 and 1995, the Retirement Fund
incurred $15,706 and $32,658, respectively, in Independent General Partners'
Fees and Expenses.
10. Related Party Transactions
The Retirement Fund's investments generally are made as co-investments with
Fund II. In addition, certain of the Mezzanine Investments and Bridge
Investments which were made by the Retirement Fund 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 the
Retirement Fund'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. The Retirement Fund'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 the Retirement Fund and an affiliate of the
Investment Adviser, 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 months ending September 30, 1996, the Retirement Fund paid
Individual General Partner distributions totaling $8,298 and Managing General
Partner distributions totaling $5,148,657, which includes $5,065,680 of
performance incentive fees. As of September 30, 1996, the Managing General
Partner has earned a total of $28.6 million in MGP Incentive Fees of which $2.7
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.
<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 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. The Retirement Fund 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
paragraphs 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
defendants 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.
<PAGE>
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 because all income and
losses are allocated to the Retirement Fund's partners for inclusion in their
respective tax returns.
Pursuant to the Statement of Financial Accounting Standards No. 109
Accounting for Income Taxes, the Retirement Fund is required to disclose any
difference in the tax basis of the Retirement Fund's assets and liabilities
versus the amounts reported in the financial statements. Generally, the tax
basis of the Retirement Fund'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 the Retirement Fund's assets are less than
the amounts reported in the financial statements by $9,598,909 This difference
is primarily attributable to unrealized depreciation and 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, the
Retirement Fund and certain affiliates of the Thomas H. Lee Company would have
sold all of their shares. 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, the Retirement Fund will sell a total
of 7,716 shares.
On November 5, 1996, the Individual General Partners approved the Third
Quarter 1996 cash distribution totaling $106,840, which represents $138,547
income from Temporary Investments offset by a net loss of $31,707 from Mezzanine
Investments . The total amount to be distributed to the Limited Partners is
$106,509 or $.60 per Unit, which is expected to be distributed on November 14,
1996. The Managing General Partner will receive a total of $301 with respect to
its interest in the Retirement Fund. Thomas H. Lee, as an Individual General
Partner, will receive $30 with respect to his interest in the Retirement Fund.
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE 1
ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) 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.
Commom Stock 87,051 $ 696 $ 1,393 $ 697
Notes $ 6,790 6,790 6,857 67
Warrants 94,668 - 1,514 1,514
- ---------------------------------------------------- ------------ ------------- ------------
TOTAL FOR THE THREE MONTHS ENDED MARCH 31, 1996 $ 7,486 $ 9,764 $ 2,278
- ---------------------------------------------------- ------------ ------------- ------------
FOR THE THREE MONTHS ENDED JUNE 30, 1996
Ghirardelli Holding Corp.
Notes $ 5,328 5,328 5,666 338
Common Stock 616,839 1,332 3,480 2,148
Preferred Stock 15,984 1,598 1,715 117
Petco Animal Supplies
Common Stock 93,568 1,023 2,560 1,537
National Tobacco Company, LP
Notes $ 4,128 4,128 5,525 1,397
Partnership Interest $ 266 266 358 92
- ---------------------------------------------------- ------------ ------------- ------------
TOTAL FOR THE THREE MONTHS ENDED JUNE 30, 1996 $ 13,675 $ 19,304 $ 5,629
- ---------------------------------------------------- ------------ ------------- ------------
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996
Florida Orthopedics
Subordinated Note $ 3,158 3,158 - (3,158)
- ---------------------------------------------------- ------------ ------------- ------------
TOTAL FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996 $ 3,158 $ - $ (3,158)
- ---------------------------------------------------- ------------ ------------- ------------
TOTAL FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 $ 24,319 $ 29,068 $ 4,749
==================================================== ============ ============= ============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE 2
ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) 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>
Total Unrealized Total Unrealized
Appreciation/ Appreciation/
(Depreciation) (Depreciation) Total Unrealized Total Unrealized
for the three for the nine Appreciation/ Appreciation/
months ended months ended (Depreciation) (Depreciation)
SECURITY 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 * $ 3,680 $ 13,404 $ 4,278 $ (6,274) $ 15,998 $ 9,724
Hills Stores
Common Stock * 18,571 1,983 (487) (764) (15,823) (16,587)
Playtex
Common Stock * 2,830 1,606 (115) 229 (1,453) (1,224)
Stanley
Common Stock * 233 312 113 164 (85) 79
---------- --------- ----------- ----------
TOTAL UNREALIZED APPRECIATION
(DEPRECIATION) FROM PUBLICLY
TRADED SECURITIES $ 3,789 $ (6,645) $ (1,363) $ (8,008)
---------- --------- ----------- ----------
NON PUBLIC SECURITIES:
Fitz and Floyd/Silvestri
Common Stock * 13 - - - (13) (13)
Adj. Rate Sr Subordinated Note * 8,287 1,976 - (4,338) (1,975) (6,313)
FLA. Orthopedics, Inc.
Common Stock* 987 - - - (987) (987)
Subordinated Note * - - 3,158 3,158 (3,158) -
Stablex Canada Inc.
Subordinated Note* 7,565 5,737 - - (1,828) (1,828)
---------- --------- ----------- ----------
TOTAL UNREALIZED APPRECIATION
(DEPRECIATION) FROM NON PUBLIC
SECURITIES $ 3,158 $ (1,180) $ (7,961) $ (9,141)
---------- --------- ----------- ----------
REVERSAL OF UNREALIZED (APPRECIATION)
DEPRECIATION FROM INVESTMENTS SOLD:
Petco Animal Supplies, Inc. - - - (802) 802 -
NET UNREALIZED APPRECIATION ---------- --------- ----------- ----------
(DEPRECIATION) $ 6,947 $ (8,627) $ (8,522) $ (17,149)
========== ========= =========== ==========
* 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, 1996, capital contributions from the Limited Partners
and the General Partners totaled $178,065,000 in the public offering of ML-Lee
Acquisition Fund (Retirement Accounts) II, L.P. (the "Retirement Fund"), the
final closing for which was held on December 20, 1989. Net proceeds available
for investment by the Retirement Fund as of September 30, 1996 were $81,712,427,
after adjusting for returns of capital distributed to partners, volume
discounts, sales commissions and organizational, offering, sales and marketing
expenses.
As of September 30, 1996, the Retirement Fund had outstanding a total of
$63,928,725 invested in Mezzanine Investments representing $46,563,125 Managed
and $17,365,600 Non-Managed portfolio investments. The remaining proceeds were
invested in Temporary Investments comprised of commercial paper with maturities
of less than one month.
The Retirement Fund 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. The Retirement Fund's Mezzanine Investments typically were
issued in private placement transactions which are generally subject to certain
restrictions on sales thereby limiting their liquidity. The Retirement Fund 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
the Retirement Fund's investment period terminated at various times through
December 18, 1993.
Upon the consummation of the sale of Snapple Common Stock in December 1994,
the Retirement Fund received proceeds of approximately $78 million. As provided
by the Partnership Agreement, the Managing General Partner of the Retirement
Fund 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 $21 million,
approximately $6.7 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 certain
amounts otherwise payable to Limited Partners from distributable cash from
operations instead were payable to the Managing General Partner until the
Deferred Distribution Amount was paid in full. As a result of prior sales
transactions that generated net distrubutable cash proceeds and Deferred
Distribution Amounts, the Deferred Distribution Amount owed to the Managing
General Partner subsequent to the November 14, 1996 distribution is $2,711,602.
On August 6, 1991, the Independent General Partners approved a reserve for
follow-on investments of $20.0 million for the Retirement Fund. As of September
30, 1996, the reserve balance was reduced to $8.2 million due to follow-on
investments of $153 in Petco Animal Supplies, $1.6 million in Fitz and
Floyd/Silvestri, Corporation, $128,270 in Fine Clothing, Inc., $2.5 million in
Hills and $1.9 million in Ghirardelli. Additionally, $5.7 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 the Retirement Fund'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 the Retirement Fund, the incentive
distributions heretofore paid by the Retirement Fund to the Retirement Fund's
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
the Retirement Fund , whether the decision in the Winston Litigation is affirmed
and whether it is applied to the Retirement Fund. The Retirement Fund believes
it has sufficient funds to pay any additional amounts that could be payable to
the Managing General Partner in such regard.
<PAGE>
Operating performance at Fitz & Floyd/Silvestri, Corp., a Non-Managed
Company in the Retirement Fund'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 continued 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. The
Retirement Fund 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 the
Retirement Fund 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 from Temporary Investments, 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
The Retirement Fund 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 the Retirement Fund cannot eliminate the risks associated with
its investments in High-Yield Securities, it has established risk management
policies. The Retirement Fund subjected each prospective investment to rigorous
analysis and made only those investments that were recommended by the Investment
Adviser and that met the Retirement Fund's investment guidelines or that had
otherwise been approved by the Managing General Partner and the Independent
General Partners. The Retirement Fund's investments were measured against
specified Retirement Fund investment and performance guidelines. To limit the
exposure of the Retirement Fund's capital in any single issuer, the Retirement
Fund limited the amount of its investment in a particular issuer. The Retirement
Fund'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 the Retirement Fund (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 the Retirement Fund (other than Hills and Stanley Furniture) were not
registered in these offerings, the Retirement Fund 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 the
Retirement Fund for at least three years. In certain cases, the Retirement Fund
has agreed not to make any sales of equity securities for a specified hold-back
period following a public offering.
<PAGE>
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. The Retirement Fund 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 period 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, the Retirement Fund had
investment income of $7,498,974 as compared to $4,626,991 for the same period in
1995. The increase of $2,871,983 in 1996 investment income as compared to 1995
is due to the recognition of interest income from PIK securities related to the
sale of CST Office Products, Inc.
For the three months ended September 30, 1996, the Retirement Fund had
investment income of $860,888 as compared to $1,476,782 for the same period in
1995.
Major expenses for the period consisted of Legal and Professional Fees,
Investment Advisory Fees, Fund Administration Fees and Administrative Expenses.
Legal and Professional Fees are 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 $979,937 and $853,745, respectively. These expenses are attributable
to legal fees incurred and advanced on behalf of indemnified defendants as well
as fees incurred directly by the Retirement Fund in connection with the
aforementioned litigation proceedings. Legal and Professional fees for the three
months ended September 30, 1996 and 1995 were $179,293 and $536,470,
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
$629,018 and $802,112, 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 the
Retirement Fund and Fund II on a combined basis. For the three months ended
September 30, 1996 and 1995, the Investment Advisory Fee paid to the Investment
Advisor was $183,604 and $257,196, respectively.
The Fund Administration Fee paid to the Fund Administrator for the nine
months ended September 30, 1996 and 1995 was $413,547 and $452,493,
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, the Retirement Fund paid $131,983 and $148,542,
respectively, in Fund Administration Fees.
Pursuant to the administrative services agreement between the Retirement
Fund and the Fund Administrator, a portion of the actual out-of-pocket expenses
incurred in connection with the administration of the Retirement Fund 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, the
Retirement Fund incurred $79,507 and $72,127, respectively, in reimbursable
expenses. For the three months ended September 30, 1996 and 1995, reimbursable
expenses totaled $26,000 and $22,163, respectively.
For the nine months ended September 30, 1996, the Retirement Fund had net
investment income of $5,249,592 as compared to $2,344,587 for the same period in
1995. The increase of $2,905,005 in 1996 net investment income as compared to
1995 is due to the recognition of interest income from PIK securities related to
the sale of CST Office Products, Inc. For the three months ended September 30,
1996, the Retirement Fund had net investment income of $323,233 as compared to
$478,557 for the same period in 1995.
<PAGE>
Net Assets
The Retirement Fund's net assets decreased by $33,243,753 during the nine
months ended September 30, 1996 due to the payment of cash distributions to
partners of $34,615,569 and net unrealized depreciation of $8,627,011 partially
offset by realized gains from the sales of securities of $4,749,235 and net
investment income of $5,249,592. This compares to the decrease in net assets of
$14,523,140 for the nine months ended September 30, 1995 resulting from the
payment of cash distributions to partners of $16,553,571 and net unrealized
depreciation of $8,150,451 partially offset by net investment income of
$2,344,587 and realized gains from investments of $7,836,295.
Unrealized Appreciation and Depreciation on Investments
For the nine months ended September 30, 1996, the Retirement Fund recorded
net unrealized depreciation of $8,627,011 compared to net unrealized
depreciation of $8,150,451 for the same period in 1995. As of this date, the
Fund's cumulative net unrealized depreciation on investments totalled
$17,149,443. For further information see the Supplemental Schedule of Unrealized
Appreciation and Depreciation - Schedule 2.
For the three months ended September 30, 1996, the Retirement Fund recorded
net unrealized appreciation of $6,946,985 as compared to net unrealized
depreciation recorded for the comparable period in 1995 of $1,451,422.
The Retirement Fund'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 the Retirement Fund'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 the Retirement Fund'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
the Retirement Fund could realize in a current transaction.
<PAGE>
The First Alert, Hills, Playtex and Stanley Furniture securities held by
the Retirement Fund 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. The Retirement Fund 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 the Retirement Fund 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.
Realized Gains and Losses
For the nine months ended September 30, 1996, the Retirement Fund had a net
realized gain from the sales of investments of $4,749,235 as compared to
$7,836,295 in realized gains for the same period in 1995.
For the three months ended September 30, 1996, the Retirement Fund had a
net realized loss from investments of $3,158,400. No realized gains or losses
were recorded for the comparative 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 totaling $106,840, which represents $138,547
income from Temporary Investments offset by a net loss of $31,707 from Mezzanine
Investments . The total amount to be distributed to the Limited Partners is
$106,509 or $.60 per Unit, which is expected to be distributed on November 14,
1996. The Managing General Partner will receive a total of $301 with respect to
its interest in the Retirement Fund. Thomas H. Lee, as an Individual General
Partner, will receive $30 with respect to his interest in the Retirement Fund.
<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 (RETIREMENT
ACCOUNTS) 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 (RETIREMENT
ACCOUNTS) 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
September 30, 1996 Form 10-Q 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> 72,161,240
<INVESTMENTS-AT-VALUE> 55,036,437
<RECEIVABLES> 410,527
<ASSETS-OTHER> 154,860
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 55,601,823
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 369,547
<TOTAL-LIABILITIES> 369,547
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 0
<SHARES-COMMON-STOCK> 177,515
<SHARES-COMMON-PRIOR> 177,515
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (17,149,443)
<NET-ASSETS> 55,232,276
<DIVIDEND-INCOME> 34,721
<INTEREST-INCOME> 7,237,276
<OTHER-INCOME> 226,978
<EXPENSES-NET> 2,249,382
<NET-INVESTMENT-INCOME> 5,249,592
<REALIZED-GAINS-CURRENT> 4,749,235
<APPREC-INCREASE-CURRENT> (8,627,011)
<NET-CHANGE-FROM-OPS> 1,371,816
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 5,373,160
<DISTRIBUTIONS-OF-GAINS> 8,774,348
<DISTRIBUTIONS-OTHER> 20,468,055
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> (33,243,753)
<ACCUMULATED-NII-PRIOR> 0
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<OVERDISTRIB-NII-PRIOR> 0
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<GROSS-ADVISORY-FEES> 629,018
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 2,249,382
<AVERAGE-NET-ASSETS> 71,854,154
<PER-SHARE-NAV-BEGIN> 470.67
<PER-SHARE-NII> 18.99
<PER-SHARE-GAIN-APPREC> (48.45)
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> 165.95
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<AVG-DEBT-PER-SHARE> 0
</TABLE>
