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 0-17382
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, 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
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<TABLE>
<CAPTION>
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,
1997 1996
------------ ------------
ASSETS:
Investments - Notes 2,4,5
Portfolio Investments at fair value
Managed Companies (amortized cost $39,008
at September 30, 1997 and $46,467 at December 31, 1996) $ 23,909 $ 32,302
Non-Managed Companies (amortized cost $18,894
at September 30, 1997 and $17,353 at December 31, 1996) 6,776 8,244
Temporary Investments, at amortized cost (cost $5,072
at September 30, 1997 and $8,390 at December 31, 1996) 5,083 8,405
Cash (of which $131 is restricted at December 31, 1996) 1 141
Accrued Interest Receivable - Note 2 341 531
Prepaid Expenses -- 4
------------ ------------
TOTAL ASSETS $ 36,110 $ 49,627
============ ============
LIABILITIES AND PARTNERS' CAPITAL:
Liabilities
Legal and Professional Fees Payable $ 110 $ 119
Reimbursable Administrative Expenses Payable - Note 8 40 35
Independent General Partners' Fees Payable - Note 9 19 28
Deferred Interest Income - Note 2 91 188
------------ ------------
Total Liabilities 260 370
------------ ------------
Partners' Capital - Note 2
Individual General Partner 15 18
Managing General Partner 249 2,566
Limited Partners (177,515 Units) 35,586 46,673
------------ ------------
Total Partners' Capital 35,850 49,257
------------ ------------
TOTAL LIABILITIES AND PARTNERS' CAPITAL $ 36,110 $ 49,627
============ ============
See the Accompanying Notes to Financial Statements.
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) 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 $ 470 $ 691 $ 2,027 $ 6,881
Discount & Dividends 79 170 3,176 618
------------ ------------ ------------ ------------
TOTAL INCOME 549 861 5,203 7,499
------------ ------------ ------------ ------------
EXPENSES:
Investment Advisory Fee - Note 7 142 184 472 629
Fund Administration Fee - Note 8 123 132 378 414
Legal and Professional Fees -- 179 88 980
Reimbursable Administrative Expenses-Note 8 40 25 104 79
Independent General Partners' Fees and Expenses - Note 9 18 16 83 144
Insurance Expense 2 1 4 3
------------ ------------ ------------ ------------
TOTAL EXPENSES 325 537 1,129 2,249
------------ ------------ ------------ ------------
NET INVESTMENT INCOME 224 324 4,074 5,250
Net Realized Gain (Loss) on Investments - Note 4 & Schedule 1 -- (3,158) 40 4,749
Net Change in Unrealized Appreciation (Depreciation)
from Investments: Note 5 and Schedule 2:
Publicly Traded Securities 829 3,789 (935) (7,447)
Nonpublic Securities (269) 3,158 (3,010) (1,180)
------------ ------------ ------------ ------------
SUBTOTAL 560 6,947 (3,945) (8,627)
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 784 4,113 169 1,372
Less: Earned Incentive Distributions to
Managing General Partner (17) -- (2,739) (2,566)
------------ ------------ ------------ ------------
NET INCREASE (DECREASE) AVAILABLE FOR PRO-RATA
DISTRIBUTION TO ALL PARTNERS $ 767 $ 4,113 $ (2,570) $ (1,194)
============ ============ ============ ============
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
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, September 30,
1997 1996
------------ ------------
FROM OPERATIONS:
Net Investment Income $ 4,074 $ 5,250
Net Realized Gain on Investments 40 4,749
Net Change in Unrealized Depreciation from Investments (3,945) (8,627)
------------ ------------
Net Increase in Net Assets Resulting from Operations 169 1,372
Cash Distributions to Partners (13,576) (34,616)
------------ ------------
Total Decrease $ (13,407) $ (33,244)
NET ASSETS:
Beginning of Year 49,257 88,476
------------ ------------
End of Period $ 35,850 $ 55,232
============ ============
See the Accompanying Notes to Financial Statements.
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<CAPTION>
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, September 30,
1997 1996
------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest, Dividends and Discount Income $ 4,849 $ 8,299
Fund Administration Fee (378) (414)
Investment Advisory Fee (472) (629)
Independent General Partners' Fees and Expenses (92) (164)
(Purchase) Sale of Temporary Investments, Net 3,317 (425)
Purchase of Follow On Investents (1,580) --
Proceeds from Sales of Portfolio Company Investments 7,983 29,373
Reimbursable Administrative Expense (99) (99)
Legal and Professional Fees (92) (1,171)
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 13,436 34,770
------------ ------------
CASH FLOWS APPLIED TO FINANCING ACTIVITIES:
Cash Distributions to Partners (13,576) (34,616)
------------ ------------
NET CASH APPLIED TO FINANCING ACTIVITIES (13,576) (34,616)
------------ ------------
Net Increase (Decrease) in Cash (140) 154
Cash at Beginning of Period 141 1
------------ ------------
CASH AT END OF PERIOD $ 1 $ 155
============ ============
RECONCILIATION OF NET INVESTMENT INCOME
TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net Investment Income $ 4,074 $ 5,250
------------ ------------
ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME
TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Decrease in Investments 9,685 24,198
(Increase) Decrease in Accrued Interest Receivables (354) 800
Decrease in Prepaid Expenses 4 4
Decrease in Legal and Professional Fees Payable (9) (191)
Increase (Decrease) in Reimbursable Administrative Expenses Payable 5 (20)
Decrease in Independent General Partners' Fees Payable (9) (20)
Net Realized Gains on Sales of Investments 40 4,749
------------ ------------
TOTAL ADJUSTMENTS 9,362 29,520
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 13,436 $ 34,770
============ ============
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
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, 1997
Partners' Capital at January 1, 1997 $ 18 $ 2,566 $ 46,673 $ 49,257
Allocation of Net Investment Income 1 629 3,444 4,074
Allocation of Net Realized Gain on Investments -- -- 40 40
Allocation of Net Change in Unrealized
Depreciation From Investments (1) (11) (3,933) (3,945)
Cash Distributions to Partners (3) (2,935) (10,638) (13,576)
------------- ------------- ------------- -------------
Partners' Capital at September 30, 1997 $ 15 $ 249 $ 35,586 $ 35,850
============= ============= ============= =============
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30, 1997
(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) - NOTE 4
87,033 Shares Anchor Holdings, Inc., Common Stock (d) 04/30/90 745 745
132,290 Warrants Anchor Holdings, Inc., Common Stock (d) 04/30/90 0 0
$3,133 11.67% Sr. Sub. Note
$4,178 17.50% Jr. Sub. Note
Purchased 4/30/90 $ 7,311
Repaid 4/2/97 $ 7,311
Realized Gain $ 0
87,033 Shares Common Stock
Purchased 4/30/90 $ 827
Excersise 132,290 Warrants 4/2/97 $ 1,256
Return of Capital Proceeds from the
Anchor Dividend $(1,338)
Cost Basis of Equity $ 745 ------------------------------
745 745 2.08
------------------------------
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 25.60
------------------------------
CINNABON INTERNATIONAL, INC.
(formerly Restaurants Unlimited)
$3,956 Cinnabon, 11% Sub. Nt. due 06/30/02(c) 06/03/94 3,956 3,956
256,083 Warrants Cinnabon, Common Stock Warrants(d) 06/03/94 0 0
(1.4% of fully diluted common equity) ------------------------------
3,956 3,956 11.06
------------------------------
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 6,845
(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 6,845 19.14
------------------------------
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
September 30, 1997
(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>
HILLS STORES COMPANY - Note 5
244,818 Shares Hills Stores Company, Common Stock(a)(d) 04/03/90 $16,153 $ 1,056
33,427 Shares Hills Stores Company, Common Stock(a)(h) 08/21/95 2,418 144
(2.5% of fully diluted common equity) ------------------------------
18,571 1,200 3.36
------------------------------
PLAYTEX PRODUCTS, INC.(b) - Note 5
183,560 Shares Playtex Products, Inc., Common Stock(a)(d) 03/29/90 2,830 1,859
(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 1,859 5.20
------------------------------
STANLEY FURNITURE COMPANY, INC. (b) - Notes 4,5, 13
5,545 Shares Stanley Furniture Company, Inc., Common Stock(a)(d) 06/30/91 70 148
(0.3% of fully diluted common equity)
7,716 Shares Common Stock
Purchased 6/30/91 $ 97
Sold 6,710 Shares 11/13/96 $ 102
Sold 1,006 Shares 12/13/96 $ 15
Realized Gain $ 20
Purchased 218 Shares 6/30/91 $ 3
Sold 2/07/97 $ 5
Realized Gain $ 2
Purchased 5,032 Shares 6/30/91 $ 64
Sold 6/30/97 $ 101
Realized Gain $ 37
Total Net Realized Gain $ 59 ------------------------------
70 148 0.41
------------------------------
TOTAL INVESTMENT IN MANAGED COMPANIES $39,008 $23,909 66.85
==============================
See the Accompanying Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
September 30, 1997
(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 $ 256
63.20 Shares Biolease, Inc., Common Stock(d) 06/08/94 62 0
6,554 Warrants Biotransplant, Inc., Common Stock Purchase Warrants(d) 06/08/94 9 9
-----------------------------
514 265 .74
-----------------------------
FITZ AND FLOYD - Notes 4,5
$1,580 Fitz and Floyd, 12% Sub. Nt. due 4/15/04(c) 04/15/97 1,580 1,580
5,530 Shares Fitz and Floyd, Series A Preferred Stock(d) 04/15/97 8,248 1,976
33,575 Shares Fitz and Floyd, Common Stock(d) 04/15/97 0 0
1,661,663 Shares Common Stock
Purchased Various $ 13
Surrendered May 1996 $ 0
Realized loss $ (13)
$6,719 Sr. Sub. Note
$1,581 Sr. Sub. Note
Purchased Various $8,248
Exchanged 4/11/97
6,530 Series A Preferred Stock and
33,575 Shares common Stock $8,248
Realized Gain $ 0
Total Realized Loss $ (13) -----------------------------
9,828 3,556 9.94
-----------------------------
FLA. ORTHOPEDICS, INC - Notes 5,6
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
Total Realized Loss $(3,158) -----------------------------
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 0
2,286 Warrants Seaway TLC, Inc. Common Stock Purchase Warrants 06/29/95 0 0
-----------------------------
7,565 2,955 8.26
-----------------------------
TOTAL INVESTMENT IN NON-MANAGED COMPANIES $18,894 $ 6,776 18.94
=============================
</TABLE>
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<TABLE>
<CAPTION>
ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
SCHEDULE OF PORTFOLIO INVESTMENTS
SEPTEMBER 30, 1997
(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>
SUMMARY OF MEZZANINE INVESTMENTS
Subordinated Notes Various $20,507 $ 15,710 43.92
Preferred Stock, Common Stock, Warrants and Stock Rights Various 37,395 14,975 41.87
-----------------------------
TOTAL MEZZANINE INVESTMENTS $57,902 $ 30,685 85.79
=============================
TEMPORARY INVESTMENTS
COMMERCIAL PAPER
$ 4,327 Ford Motor Credit Corp. 5.47% due 10/01/97 09/16/97 4,317 4,327
$ 756 Ford Motor Credit Corp. 5.57% due 10/01/97 09/25/97 755 756
-----------------------------
TOTAL INVESTMENT IN COMMERCIAL PAPER 5,072 5,083 14.21
-----------------------------
TOTAL TEMPORARY INVESTMENTS $ 5,072 $ 5,083 14.21
-----------------------------
TOTAL INVESTMENT PORTFOLIO $62,974 $ 35,768 100.00%
=============================
(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 $22 for Mezzanine Investments
and $11 for Temporary Investments.
(f) Inclusive of receipt of payment-in-kind securities.
(g) Non-accrual investment status.
(h) Non-income producing equity security.
See the Accompanying Notes to Financial Statements.
</TABLE>
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ML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(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 on 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 such extension
is in the best interest of the Retirement Fund. The Retirement Fund 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 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
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, 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 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, 1997, the
Retirement Fund has in its portfolio of investments $504,150 of payment-in-kind
notes which excludes $2.0 million of payment-in-kind notes received from notes
placed on non-accrual status and $14,640 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.
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 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 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.
4. Investment Transactions
During February 1997, the Retirement Fund sold 218 shares of Stanley
Furniture for $24 per share and received total proceeds of $5,232 and recognized
a gain of $2,488. On June 30, 1997, the Retirement Fund entered into a stock
purchase agreement with Stanley whereby the Retirement Fund sold 5,032 shares of
Stanley Furniture for $20 per share. The Retirement Fund received total proceeds
of $100,640 and recognized a gain of $37,321.
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 the Retirement Fund, together with all accrued interest and prepayment
premiums for an aggregate of $7,775,731.
Immediately prior to the Recapitalization, the Retirement Fund owned 87,033
shares of the common stock of Anchor Holdings, Inc., the parent of Anchor.
Immediately after the consummation of the Recapitalization, the Retirement Fund
exercised its warrants to purchase common stock (at an exercise price of $9.50
per share) and acquired an additional 132,290 shares of common stock, bringing
its total holdings of common stock to 219,323 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 Retirement Fund received
$4.2 million, of which approximately 32% or $1.3 million was returned to
partners as a return of captial.
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 $1.6
million was made in Fitz and Floyd and Fund II received a $1.6 million 12%
subordinated note. Additionally, the Retirement Fund exchanged the $8.2 million
adjustable notes, which the Retirement Fund previously 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 $20.0 million for the Retirement Fund. As of November
14, 1997, the remaining reserve balance was $3.3 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, $7.7
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 the
Retirement Fund's existing investment.
The Managing General Partner has established a reserve for future
Retirement Fund expenses of $500,000 from proceeds received from the sale of
Anchor Advanced Products on April 2, 1997.
Because the Retirement Fund 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 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.
5. Unrealized Appreciation and Depreciation of Investments
For the nine months ended September 30, 1997, the Retirement Fund recorded
net unrealized depreciation of $3,945,427 as compared to net unrealized
depreciation of $8,627,011 for the same period in 1996. As of September 30,
1997, the Retirement Fund's cumulative net unrealized depreciation on
investments totalled $27,236,769.
For the three months ended September 30, 1997, the Retirement Fund recorded
net unrealized appreciation of $559,687 as compared to net unrealized
appreciation recorded for the comparable period in 1996 of $6,946,985. 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:
- FLA Orthopedics, Inc. on January 1, 1995.
- Stablex Canada, Inc. on September 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 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, 1997 and 1996, the Retirement Fund paid $472,308 and
$629,018, respectively, in Investment Advisory Fees to Thomas H. Lee Advisors
II, L.P. For the three months ended September 30, 1997 and 1996, the Retirement
Fund paid $142,385 and $183,604, 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 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, the Retirement Fund paid $378,288 and $413,547, respectively,
in Fund Administration Fees. For the three months ended September 30, 1997 and
1996, the Retirement Fund paid $122,710 and $131,983, respectively, in Fund
Administration Fees.
Pursuant to the administrative services agreement between Retirement Fund
and the Fund Administrator, effective November 10, 1993, 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, 1997 and 1996, the Retirement Fund incurred $104,347 and $79,507,
respectively, in reimbursable expenses. For the three months ended September 30,
1997 and 1996, the Retirement Fund incurred $40,250 and $26,000, respectively,
in reimbursable expenses.
Beginning in November 1997, the Fund Administration Fee will be calculated
at an annual amount of $400,000 for the Retirement Fund and Fund II 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 the Retirement Fund totalled $83,263 and $144,191, respectively.
For the three months ended September 30, 1997, the Retirement Fund incurred
$18,452 as compared to $15,706 for the same period in 1996.
10. Related Party Transactions
The Retirement Fund's investments generally were 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 month period ending September 30, 1997, the Retirement Fund
paid Individual General Partner distributions totaling $2,997 and Managing
General Partner distributions totaling $2,934,523 (which includes $2,904,556 of
incentive fees). As of September 30, 1997, the Managing General Partner has
earned a total of $28.9 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.
11. Litigation
On February 3, 1992 and February 5, 1992, respectively, one Limited Partner
from the Retirement Fund and one Limited Partner from Fund II 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 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
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. In the
opinion of legal counsel, the outcome of this case is not determinable at this
time.
On November 27, 1995, one Limited Partner from the Retirement Fund and one
Limited Partner from Fund II 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. On December 18, 1996, the Court denied the
defendants' motion to dismiss. Although the defendants believe the advancement
of legal fees and litigation costs was properly made pursuant to indemnification
agreements signed by the defendants, in the opinion of legal counsel, 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. As of December 31,
1996, the tax basis of the Retirement Fund's assets are greater than the amounts
reported in the financial statements by $23.9 million. This difference is
attributable to 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 totaling $1,091,201, which represents a Return of
the Reserve for Follow-On Investments of $1,000,000, Distributable Cash from
temporary investments of $32,382, Distributable Cash from Mezzanine Investments
of $58,818. The total amount to be distributed to the Limited Partners is
$1,070,415 or $6.03 per Unit. The Managing General Partner will receive $3,015
in proportion to its capital contribution and $17,469 as an MGP distribution.
Thomas H. Lee, as an Individual General Partner, will receive $301 with respect
to his interest in the Retirement Fund. 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 the Retirement Fund and
affiliates of the Thomas H. Lee Company including Fund II and the ML Lee
Acquisition Fund, L.P. for $25 per share. As a result, the Retirement Fund is
expected to sell a total of 2,772 shares and receive proceeds of $69,300. The
Retirement Fund will continue to hold 2,773 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 (RETIREMENT ACCOUNTS) 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 218 $ 3 $ 5 $ 2
- ----------------------------------------------- ---------- ----------- ----------
Total for the 3 Months Ended March 31, 1997 3 5 2
- ----------------------------------------------- ---------- ----------- ----------
For the 3 Months Ended June 30, 1997
Stanley Furniture
Common Stock 5,032 63 101 38
- ----------------------------------------------- ---------- ----------- ----------
Total for the 3 Months Ended June 30, 1997 63 101 38
- ----------------------------------------------- ---------- ----------- ----------
Total for the 9 Months Ended September 30, 1997 $ 66 $ 106 $ 40
=============================================== ========== =========== ==========
</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, 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 SECURITIES
First Alert
Common Stock* $ 3,680 $ 6,845 $ 428 $ (855) $ 4,020 $ 3,165
Hills Stores
Common Stock* 18,571 1,200 243 (470) (16,902) (17,372)
Playtex
Common Stock* 2,830 1,859 138 391 (1,362) (971)
Stanley Furniture
Common Stock* 70 148 20 (1) 79 78
------ -------- -------- --------
TOTAL UNREALIZED APPRECIATION
(DEPRECIATION) FROM PUBLICLY
TRADED SECURITIES $ 829 $ (935) $(14,165) $(15,100)
------ -------- -------- --------
NON PUBLIC SECURITIES:
Biolease
Common Stock* $ 62 $ -- $ (62) $ (62) $ -- $ (62)
Subordinated Notes* 443 256 (207) (207) -- (207)
Fitz and Floyd
Common Stock* 9,828 3,558 -- 41 (6,311) (6,270)
FLA. Orthopedics, Inc.
Preferred Stock* 987 -- -- -- (987) (987)
Stablex Canada Inc.
Subordinated Notes* 7,565 2,955 -- (2,782) (1,828) (4,610)
------ -------- -------- --------
TOTAL UNREALIZED DEPRECIATION
FROM NON PUBLIC SECURITIES $ (269) $ (3,010) $ (9,126) $(12,136)
------ -------- -------- --------
TOTAL NET UNREALIZED APPRECIATION
(DEPRECIATION) $ 560 $ (3,945) $(23,291) $(27,236)
====== ======== ======== ========
* 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, the Retirement Fund had a total of $57.9 million
invested in Mezzanine Investments representing $39.0 million Managed and $18.9
million Non-Managed portfolio investments. These investments were financed by
net offering proceeds and debt financing. This represents a $5.9 million
decrease versus the total invested in Mezzanine Investments at December 31, 1996
of $63.8 million. The decrease in investments is due primarily to the sales and
redemptions of Portfolio Investments.
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.
As provided by the Partnership Agreement, the Managing General Partner of
the Retirement Fund 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
distribution 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 $20.0 million for the Retirement Fund. As of November
14, 1997, the remaining reserve balance was $3.3 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, $7.7
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 the
Retirement Fund's existing investment.
The Managing General Partner has established a reserve for future
Retirement Fund expenses of $500,000 from proceeds received from the sale of
Anchor Advanced Products on April 2, 1997.
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.
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 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 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 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 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 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 the Retirement Fund for at least two 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.
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 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, the Retirement Fund had
investment income of $5,203,422 as compared to $7,498,974 for the same period in
1996. The decrease of $2,295,552 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 $3.9 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.
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
$472,308 and $629,018, 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 the Retirement Fund and Fund II 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 $142,385
and $183,604, respectively.
The Fund Administration Fee paid to the Fund Administrator for the nine
months ended September 30, 1997 and 1996 was $378,288 and $413,547,
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 $122,710 and $131,983, respectively.
Beginning in November of 1997, the Fund Administration Fee will change to
an annual amount of $400,000 for the Retirement Fund and Fund II on a combined
basis, plus 100% of all reimbursable expenses (as defined below) incurred by the
Fund.
Pursuant to the administrative services agreement between the Retirement
Fund and the Fund Administrator, effective November 10, 1993, 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, 1997 and 1996, the Retirement Fund incurred reimbursable expenses of
$104,347 and $79,507, respectively. For the quarters ended September 30, 1997
and 1996, reimbursable expenses totaled $40,250 and $26,000, respectively.
For the nine months ended September 30, 1997, the Retirement Fund had net
investment income of $4,073,649 as compared to $5,249,592 for the same period in
1996. The decrease of $1,175,943 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 $231 thousand pertaining to legal fees paid by the
Retirement Fund on behalf of Fitz and Floyd pertaining to the Plan of
Reorganization.
For the three months ended September 30, 1997, the Retirement Fund had net
investment income of $223,617 as compared to $323,233 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
The Retirement Fund's net assets decreased by $13,407,963 during the nine
months ended September 30, 1997 due to the payment of cash distributions to
partners of $13,575,994 and net unrealized depreciation of $3,945,427, partially
offset by realized gains from the sale of Mezzanine Investments of $39,809 and
net investment income of $4,073,649. This compares to the decrease in net assets
of $33,243,753 for the nine months ended September 30, 1996 resulting from the
payment of cash distributions to partners of $34,615,569 and net unrealized
depreciation of $8,627,011, partially offset by net investment income of
$5,249,592 and realized gains from investments of $4,749,235.
Unrealized Appreciation and Depreciation on Investments
For the nine months ended September 30, 1997, the Retirement Fund recorded
net unrealized depreciation of $3,945,427 compared to net unrealized
depreciation of $8,626,011 for the same period in 1996. As of September 30,
1997, the Retirement Fund's cumulative net unrealized depreciation on
investments totalled $27,236,769.
For the three months ended September 30, 1997, the Retirement Fund recorded
net unrealized appreciation of $559,687 as compared to net unrealized
appreciation of $6,946,985 recorded for the comparable period in 1996. For
additional information, please refer to the Supplemental Schedule of Unrealized
Appreciation and Depreciation - Schedule 2.
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, 1997.
The Managing General Partner and the Investment Adviser review the
valuation of the Retirement Fund 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 57% of the Retirement Fund'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 the Retirement Fund could realize in a current
transaction.
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 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, the Retirement Fund had net
realized gains from the sale of Mezzanine Investments of $39,809 as compared to
$4,749,235 for the same period in 1996.
For the quarter ended September 30, 1997, the Retirement Fund had no
realized gains from investments. For the comparable period in 1996, the
Retirement Fund had a realized loss of $3,158,400. 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 totaling $1,091,201, which represents a Return of
the Reserve for Follow-On Investments of $1,000,000, Distributable Cash from
temporary investments of $32,382, Distributable Cash from Mezzanine Investments
of $58,818. The total amount to be distributed to the Limited Partners is
$1,070,415 or $6.03 per Unit. The Managing General Partner will receive $3,015
in proportion to its capital contribution and $17,469 as an MGP distribution.
Thomas H. Lee, as an Individual General Partner, will receive $301 with respect
to his interest in the Retirement Fund. This cash distribution will be paid on
November 14, 1997.
Because most of the Retirement Fund's debt holdings were previously sold or
redeemed, remaining portfolio interest income expected to be received by the
Retirement Fund may not be sufficient to cover the Retirement Fund's expenses in
the future. As a result, any interest income received will be used to pay the
Retirement Fund 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 the Retirement Fund quarterly, only upon
the satisfactory completion and acceptance of the Retirement Fund'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(RETIREMENT ACCOUNTS)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(RETIREMENT ACCOUNTS)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
September 30, 1997 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-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<INVESTMENTS-AT-COST> 62,972,726
<INVESTMENTS-AT-VALUE> 35,768,162
<RECEIVABLES> 341,411
<ASSETS-OTHER> 645
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 36,110,218
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 261,055
<TOTAL-LIABILITIES> 261,055
<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> (27,236,769)
<NET-ASSETS> 35,849,163
<DIVIDEND-INCOME> 2,833,233
<INTEREST-INCOME> 2,272,654
<OTHER-INCOME> 97,534
<EXPENSES-NET> 1,129,773
<NET-INVESTMENT-INCOME> 4,073,649
<REALIZED-GAINS-CURRENT> 39,809
<APPREC-INCREASE-CURRENT> (3,945,427)
<NET-CHANGE-FROM-OPS> 168,031
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 3,538,626
<DISTRIBUTIONS-OF-GAINS> 185,423
<DISTRIBUTIONS-OTHER> 9,851,945
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> (13,407,963)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 472,308
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1,129,773
<AVERAGE-NET-ASSETS> 42,553,139
<PER-SHARE-NAV-BEGIN> 262.93
<PER-SHARE-NII> 19.40
<PER-SHARE-GAIN-APPREC> (22.16)
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> 59.93
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 200.47
<EXPENSE-RATIO> 0.027
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
