<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
-------- --------
Commission File Number 0-25000
ML PRINCIPAL PROTECTION L.P.
----------------------------
ML PRINCIPAL PROTECTION TRADING L.P.
------------------------------------
(Rule 140 Co-Registrant)
(Exact Name of Registrant as
specified in its charter)
Delaware
- ---------------------------- 13-3750642 (Registrant)
(State or other jurisdiction of 13-3775509 (Co-Registrant)
incorporation or organization) --------------------------------
(IRS Employer Identification No.)
c/o Merrill Lynch Investment Partners Inc.
Merrill Lynch World Headquarters South Tower, 6th Fl.
World Financial Center New York, New York 10080-6106
-------------------------------------------------------
(Address of principal executive offices)
(Zip Code)
212-236-5662
-----------------------------------------------
(Registrant's telephone number, including area code)
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
---- ----
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
ML PRINCIPAL PROTECTION L.P.
--------------------------------
(a Delaware limited partnership)
--------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
----------------------------------------------
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
ASSETS
- ------
<S> <C> <C>
Cash $ 855 $ 1,423
Accrued interest 882,739 38,562
U.S. Government obligations 73,149,685 94,651,930
Equity in commodity futures trading accounts:
Cash and options premiums 20,201,380 6,127,948
Net unrealized profit on open contracts 4,097,504 2,958,084
----------- ------------
TOTAL $98,332,163 $103,777,947
=========== ============
LIABILITIES AND PARTNERS' CAPITAL
- ----------------------------------
LIABILITIES:
Redemptions payable $ 2,681,000 $ 636,155
Profit Shares payable 858,764 591,195
Brokerage commissions payable 547,791 494,349
Administrative fees payable 15,651 14,330
----------- ------------
Total liabilities 4,103,206 1,736,029
----------- ------------
Minority Interest 852,277 815,233
----------- ------------
PARTNERS' CAPITAL:
General Partners (6654.61 and 23141.61 Units) 746,872 2,564,153
Limited Partners (837491.94 and 989140.56 Units) 92,629,808 105,628,837
Subscriptions receivable (0 and 69,663.05 Units) - (6,966,305)
----------- ------------
Total partners' capital 93,376,680 101,226,685
----------- ------------
TOTAL $98,332,163 $103,777,947
=========== ============
</TABLE>
NET ASSET VALUE PER UNIT (Note 2)
See notes to consolidated financial statements.
2
<PAGE>
ML PRINCIPAL PROTECTION L.P.
--------------------------------
(a Delaware limited partnership)
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
<TABLE>
<CAPTION>
For the three For the three For the nine For the nine
months ended months ended months ended months ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------------- ------------ ----------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Trading profit (loss):
Realized $ 3,313,972 $ (66,580) $ 4,910,716 $ 3,655,767
Change in unrealized 4,914,987 1,069,429 1,976,361 (334,138)
------------------- ------------ ----------------- -------------
Total trading results 8,228,959 1,002,849 6,887,077 3,321,629
------------------- ------------ ----------------- -------------
Interest income 1,329,442 1,290,326 4,299,498 3,473,238
------------------- ------------ ----------------- -------------
Total revenues 9,558,401 2,293,175 11,186,575 6,794,867
------------------- ------------ ----------------- -------------
EXPENSES:
Profit Shares 729,850 43,978 1,434,119 542,376
Brokerage commissions 1,630,551 1,276,885 4,885,403 3,418,130
Administrative fees 46,587 36,482 139,583 97,661
------------------- ------------ ----------------- -------------
Total expenses 2,406,988 1,357,345 6,459,105 4,058,167
------------------- ------------ ----------------- -------------
INCOME BEFORE
MINORITY INTEREST $ 7,151,413 935,830 4,727,470 2,736,700
Minority interest (75,249) (9,020) (37,044) (21,309)
------------------- ------------ ----------------- -------------
NET INCOME $ 7,076,164 $ 926,810 $ 4,690,426 $ 2,715,391
=================== ============ ================= =============
NET INCOME PER UNIT:
Weighted average number of units
outstanding 910,322 869,337 979,067 772,306
=================== ============ ================= =============
Weighted average net income
per Limited Partner
and General Partner Unit $ 7.77 $ 1.07 $ 4.79 $ 3.52
=================== ============ ================= =============
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
ML PRINCIPAL PROTECTION L.P.
--------------------------------
(a Delaware limited partnership)
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
-------------------------------------------------------
For the nine months ended September 30, 1998 and 1997
-----------------------------------------------------
<TABLE>
<CAPTION>
Limited General Subscriptions
Units Partners Partner Receivable Total
------------------ --------------------- ------------------ ----------------- -------------
<S> <C> <C> <C> <C> <C>
PARTNERS' CAPITAL,
December 31, 1996 723,659.97 $ 76,542,105 $ 2,301,180 $ - $ 78,843,285
Subscriptions 263,933.00 26,228,032 165,268 - 26,393,300
Distributions - (2,447,252) (50,719) - (2,497,971)
Net Income - 2,636,634 78,757 - 2,715,391
Redemptions (157,760.47) (17,077,572) - - (17,077,572)
------------ ------------------- ------------ ----------------- -------------
PARTNERS' CAPITAL,
September 30, 1997 829,832.50 $ 85,881,947 $ 2,494,486 $ - $ 88,376,433
============ =================== ============ ================= =============
PARTNERS' CAPITAL,
December 31, 1997 942,619.12 $ 105,628,837 $ 2,564,153 $ (6,966,305) $101,226,685
Subscriptions 130,030.49 13,003,049 - - 13,003,049
Subscriptions receivable 69,663.26 - - 6,966,305 6,966,305
Distributions - (986,857) (26,118) - (1,012,975)
Net Income - 4,674,077 16,349 - 4,690,426
Redemptions (298,166.32) (29,689,298) (1,807,512) - (31,496,810)
------------ ------------------- ------------ ----------------- -------------
PARTNERS' CAPITAL,
September 30, 1998 844,146.55 $ 92,629,808 $ 746,872 $ - $ 93,376,680
============ =================== ============ ================= =============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
ML PRINCIPAL PROTECTION L.P.
----------------------------
(formerly ML Principal Protection Plus L.P.)
(a Delaware limited partnership)
------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These financial statements have been prepared without audit. In the opinion
of management, the financial statements contain all adjustments (consisting
of only normal recurring adjustments) necessary to present fairly the
consolidated financial position of ML Principal Protection L.P. (the
"Partnership" or the "Fund") as of September 30, 1998 and the results of its
operations for the nine months ended September 30, 1998 and 1997. However,
the operating results for the interim periods may not be indicative of the
results expected for the full year.
Certain information and footnote disclosures normally included in annual
financial statements prepared in accordance with generally accepted
accounting principles have been omitted. It is suggested that these
financial statements be read in conjunction with the financial statements
and notes thereto included in the Partnership's Annual Report on Form 10-K
filed with the Securities and Exchange Commission for the year ended
December 31, 1997 (the "Annual Report").
2. NET ASSET VALUE PER UNIT
For financial reporting purposes, the Partnership deducted the total
organizational and initial offering costs payable to the General Partner at
inception for purposes of determining Net Asset Value. Such deduction was
allocated pro-rata among the outstanding Units of each series based upon the
aggregate Net Asset Value of each series, and then equally among all Units
of the same series. For all other purposes (including computing Net Asset
Value for redemptions) the Partnership deducted the organizational and
initial offering cost reimbursements only as actually paid. The
organizational and initial offering cost reimbursement was completed in
October 1997. At September 30, 1998 and December 31, 1997 the Net Asset
Values of the different series of Units for financial reporting purposes and
for all other purposes were:
5
<PAGE>
September 30, 1998
<TABLE>
<CAPTION>
Net Asset Number Net Asset Value
Value of Units per Unit
--------------- --------------- ----------------
<S> <C> <C> <C>
Series A Units $ 14,061,012 117,402.00 $ 119.77
Series B Units 1,730,655 15,125.00 114.42
Series C Units 2,531,246 23,204.00 109.09
Series D Units 6,924,142 61,831.00 111.98
Series E Units 6,735,820 58,539.26 115.06
Series F Units 3,382,118 30,952.64 109.27
Series G Units 3,451,033 31,951.70 108.01
Series H Units 2,267,514 20,945.73 108.26
Series K Units 7,492,711 67,621.00 110.80
Series L Units 10,802,967 100,097.00 107.92
Series M Units 12,917,274 118,022.56 109.45
Series N Units 7,310,523 69,296.42 105.50
Series O Units 8,772,790 82,874.24 105.86
Series P Units 4,996,875 46,284.00 107.96
------------ --------------- ------------
Totals $ 93,376,680 844,146.55
============ ===============
</TABLE>
6
<PAGE>
December 31, 1997
<TABLE>
<CAPTION>
Number Net Asset
Net Asset Value of Units Value per Unit
------------------ -------------------- ---------------
<S> <C> <C> <C>
Series A Units $ 17,716,313 155,778.00 $ 113.73
Series B Units 2,865,130 25,100.00 114.15
Series C Units 4,061,256 37,551.00 108.15
Series D Units 10,499,613 95,504.00 109.94
Series E Units 7,685,677 70,255.86 109.40
Series F Units 6,136,370 56,275.48 109.04
Series G Units 5,470,415 51,354.50 106.52
Series H Units 5,610,794 52,626.22 106.62
Series K Units 12,127,411 115,752.00 104.77
Series L Units 14,732,144 144,314.00 102.08
Series M Units 14,321,562 138,108.06 103.70
------------ ------------------- ------------
Totals $101,226,685 942,619.12
============ ===================
</TABLE>
7
<PAGE>
3 ANNUAL DISTRIBUTIONS
The Partnership makes annual fixed-rate distributions, payable irrespective
of profitability, of between $2 and $5 per Unit on Units issued prior to July
16, 1996. The Partnership may also pay discretionary distributions on such
Series of Units of up to 50% of any Distributable New Appreciation, as defined
on such Units. No distributions are payable on Units issued after July 16,
1996. As of September 30, 1998, the Partnership has made the following
distributions:
<TABLE>
<CAPTION>
Distribution Fixed-Rate Discretionary
Series Date Distribution Distribution
--------- ----------- -------------- -------------
<C> <S> <C> <C> <C>
1998
- ----
Series B 1/1/98 $3.50 $1.50
Series C 4/1/98 3.50 -
Series D 7/1/98 3.50 -
Series F 1/1/98 3.50 1.25
Series G 4/1/98 3.50 -
Series H 7/1/98 3.50 -
1997
- ----
Series A 10/1/97 $3.50 $ -
Series B 1/1/97 3.50 3.00
Series C 4/1/97 3.50 4.00
Series D 7/1/97 3.50 1.00
Series E 10/1/97 3.50 2.00
Series F 1/1/97 3.50 2.50
Series G 4/1/97 3.50 3.50
Series H 7/1/97 3.50 2.50
1996
- ----
Series A 10/1/96 $3.50 $2.50
Series B 1/1/96 3.50 2.50
Series C 4/1/96 3.50 -
Series D 7/1/96 3.50 -
Series E 10/1/96 3.50 -
1995
- ----
Series A 10/1/95 $3.50 $2.50
</TABLE>
8
<PAGE>
4. FAIR VALUE AND OFF-BALANCE SHEET RISK
The Partnership's total trading results by reporting category for the respective
periods were as follows:
<TABLE>
<CAPTION>
For the three For the three For the nine For the nine
months ended months ended months ended months ended
September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997
------------------ ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
Interest rates $ 7,857,314 $ 2,447,990 $ 7,316,649 $ 1,395,869
Stock indices 236,242 453,554 514,015 990,144
Commodities (388,782) (1,179,624) (35,532) 571,345
Currencies 880,069 213,843 1,660,839 1,616,740
Energy 199,062 (430,209) (1,085,978) (1,362,836)
Metals (554,946) (502,705) (1,482,916) 110,367
------------------ ------------------- ------------------- -------------------
$ 8,228,959 $ 1,002,849 $ 6,887,077 $ 3,321,629
================== =================== =================== ===================
</TABLE>
The contract/notional values of the Trading Partnership's open derivative
instrument positions as of September 30, 1998 and December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
-------------------------------------------- -----------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
--------------------- --------------------- ------------------- --------------------
<S> <C> <C> <C> <C>
Interest rates $ 337,187,507 $ 49,558,657 $ 121,435,283 $ 85,620,621
Stock indices 3,645,567 7,191,202 1,665,588 8,854,122
Commodities 7,527,342 10,806,964 11,663,786 21,791,599
Currencies 132,565,006 85,991,320 70,272,888 147,312,282
Energy 3,224,372 344,610 1,085,885 9,041,759
Metals 5,881,197 5,638,233 4,412,002 19,039,071
--------------------- --------------------- ------------------ --------------------
$ 490,030,991 $ 159,530,986 $ 210,535,432 $ 291,659,454
===================== ===================== ================== ====================
</TABLE>
9
<PAGE>
The contract/notional values of the Trading Partnership's exchange-traded and
non-exchange-traded open derivative instrument positions as of September 30,
1998 and December 31, 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
--------------------------------------- -----------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------ -------------------- ------------------- --------------------
<S> <C> <C> <C> <C>
Exchange
traded $ 403,229,213 $ 81,883,956 $ 142,565,779 $ 183,223,917
Non-Exchange
traded 86,801,778 77,647,030 67,969,653 108,435,537
------------------ ------------------- ------------------- ---------------------
$ 490,030,991 $ 159,530,986 $ 210,535,432 $ 291,659,454
================== =================== =================== =====================
</TABLE>
The average fair value, based on contract/notional value, of the Trading
Partnership's derivative instrument positions which were open as of the end of
each calendar month during the nine months ended September 30, 1998 and the year
ended December 31, 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------------------- ------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------- ------------------- ------------------ ---------------------
<S> <C> <C> <C> <C>
Interest rates $ 324,550,879 $ 107,539,712 $ 177,189,103 $ 68,697,138
Stock indices 8,305,754 4,689,350 7,544,449 4,040,832
Commodities 9,715,656 16,097,461 13,113,725 11,481,639
Currencies 127,939,356 153,129,967 70,061,899 113,287,725
Energy 2,127,839 4,894,708 3,621,533 3,415,726
Metals 8,863,566 12,680,654 7,369,251 14,913,348
----------------- ------------------- ------------------ ----------------------
$ 481,503,050 $ 299,031,852 $ 278,899,960 $ 215,836,408
================= =================== ================== ======================
</TABLE>
The gross unrealized profit and the net unrealized profit on the Trading
Partnership's open derivative instrument positions as of September 30, 1998 and
December 31, 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------------- -----------------------------------
Gross Net Gross Net
Unrealized Unrealized Unrealized Unrealized
Profit Profit Profit Profit
------------ ------------------ ------------- -------------
<S> <C> <C> <C> <C>
Exchange
traded $ 4,280,218 $ 3,168,866 $ 3,263,519 $ 2,416,539
Non-Exchange
traded 2,537,321 928,638 2,119,281 541,545
------------ ------------------- ------------ -------------
$ 6,817,539 $ 4,097,504 $ 5,382,800 $ 2,958,084
============ =================== ============ =============
</TABLE>
4. SUBSEQUENT EVENTS
On October 1, 1998 distributions were announced with respect to Series A
Units and Series E Units. Series A Units received an annual fixed rate
distribution equal to $3.50 per Unit. Series E Units received an annual
fixed rate distribution equal to $3.50 per Unit. No discretionary
distribution was paid.
10
<PAGE>
Item 2: Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
- -------------
Performance Summary
January 1, 1997 to September 30, 1997 by Quarter
- ------------------------------------------------
January 1, 1997 to March 31, 1997
In currency markets, the U.S. dollar rallied and started 1997 on a strong
note, rising to a four-year high versus the Japanese yen and two-and-a-half year
highs versus the Deutsche mark and the Swiss franc. Profitable results were
seen throughout the quarter in currency trading.
Global interest rate markets began the year on a volatile note, as
investors evaluated economic data for signs of inflation. January and March
were profitable months for interest rate trading.
In energy markets, a slump in crude oil prices was characteristic of its
lackluster performance from the beginning of the year. Early in 1997,
volatility returned in the energy markets, reflecting the impact of a winter
significantly warmer than normal. January and March saw losses in energy
trading; February, however, was profitable.
Agricultural commodity trading proved profitable in February and March.
Soybean prices reached their highest level in over eight years, on continued
demand and fears that inventories could fall to critically low levels before the
next harvest.
April 1, 1997 to June 30, 1997
In the currency markets, the dollar underwent a significant correction in
the Spring against the Japanese yen due to the G7 finance ministers'
determination that a further dollar advance would be counter-productive to their
current goals. Currency trading was unprofitable for the quarter.
Global interest rate trading provided unprofitable results for the quarter.
Profits were seen in May and June; losses however were apparent in April.
During April, U.S. bond prices moved in a directionless pattern, as investors
remained concerned over inflation and its impact on further increases in
interest rates by the U.S. Federal Reserve.
Energy trading was unprofitable throughout the quarter. In June crude oil
trended downward during the beginning of the month, before a sudden price
reversal occurred amid speculation that Iraq exports could be delayed until
August. Price movement of heating oil and unleaded gas proved to be trendless.
Agricultural commodity trading proved profitable for the quarter. May's
profits were due to coffee prices surging beyond three dollars a pound for the
first time in twenty years, on the possibility of frost in Brazil and reports of
poor crops in smaller countries.
July 1, 1997 to September 30, 1997
In the currency markets, the U.S. dollar rose dramatically in July,
reflecting the dollar's role as a haven for currency traders skeptical over the
"Euro", the new single European currency that is supposed to start replacing
several European national denominations 1n 1999. Beginning in August, the
dollar corrected against the Eurocurrencies in advance of well-advertised
tightening by the Bundesbank. Currency trading was unprofitable in August and
September.
Global interest rate trading was profitable in July and September. During
the third quarter, economic data in key countries was positive indicating lower
inflation and igniting a worldwide rally in the bond markets. Specifically,
investor sentiment was particularly strong in the U.S., where prices on the 30-
year Treasury bond and 10-year Treasury note rose to their highest levels in
over two years. This followed a largely positive economic report delivered by
Federal Reserve Chairman Greenspan in testimony before Congress.
Energy trading was unprofitable throughout the quarter. By the middle of
the year, the decline in prices reversed sharply as Saudi Arabia and Iran,
together representing about 45% of OPEC's oil production joined forces to
pressure oil-producing nations to stay within OPEC production quotas.
11
<PAGE>
Agricultural commodity trading was unprofitable throughout the quarter. Soybean
and corn prices were on an upward trend in July as rain missed the driest
growing areas and more hot weather was forecast.
January 1, 1998 to September 30, 1998 by Quarter
- ------------------------------------------------
January 1, 1998 to March 31, 1998
The Fund's most profitable positions during the quarter were in the global
interest rate markets, particularly in European bonds where an extended bond
market rally continued despite an environment of robust growth in the United
States, Canada and the United Kingdom, as well as a strong pick-up in growth in
continental Europe. Specifically, strong gains were recorded in French and
German bonds.
Gold and crude oil trading resulted in losses. Gold prices drifted
sideways and lower as Asian demand continued to slow and demand in the Middle
East was affected by low oil prices. Initially buoyed on concerns about a U.S.-
led military strike against Iraq, crude oil fell to a nine year low, as the
globally warm winter, the return of Iraq as a producer and the Asian economic
crisis added to OPEC's supply glut problems.
Trading results in stock index markets were mixed, but marginally
profitable, despite a strong first-quarter performance by the U.S. equity market
as several consecutive weekly gains were recorded with most market averages
setting new highs. Results in currency trading were also mixed, but marginally
profitable. Strong gains were realized in positions on the Swiss franc, which
weakened versus the U.S. dollar, while trading losses resulted from positions in
the Deutsche mark and the Australian dollar.
Agricultural commodity markets provided profits. Live cattle and hog
prices trended downward throughout the quarter resulting in strong gains.
Cotton prices moved mostly upward during the quarter, but dropped off sharply at
the end of March, causing losses.
April 1, 1998 to June 30, 1998
As swings in the U.S. dollar and developments in Japan affected bond
markets, the Fund's interest rate trading during the quarter resulted in losses,
particularly in Eurodollar deposits and U.S. Treasury bonds. Early in the
quarter, Treasury trading was range-bound, as concern that the economy might be
overheating was balanced by the potential impact of the Asian recession.
Additionally, Australian bonds and bills saw a dramatic drop in prices in early
June, as dollar-bloc currencies remained under pressure versus the U.S. dollar
due to the Japanese/Asian crisis.
Metals and energy trading also resulted in losses. The depressed gold
market weakened further following news of a European Central Bank consensus that
ten to fifteen percent of reserves should be made up of gold bullion which was
at the low end of expectations. Despite production cuts initiated by OPEC at
the end of March, world oil supplies remained excessive and oil prices stood at
relatively low levels throughout the quarter.
Results in currency trading were profitable. Strong gains were realized in
positions on the Japanese yen, which weakened during June to an eight-year low
versus the U.S. dollar. Trading results in stock index markets were also
profitable as the Asia-Pacific region's equity markets weakened across the
board. In particular, Hong Kong's Hang Seng index trended downward during most
of the quarter and traded at a three-year low.
Agricultural commodity trading produced profits. Although the U.S. soybean
crop got off to a good start which contributed to higher yield expectations and
a more burdensome supply outlook, soybean prices traded in a volatile pattern
for the second half of the quarter. Sugar futures maintained mostly a
downtrend, as no major buyers emerged to support the market. Similarly, coffee
prices trended downward, as good weather conditions in Central America and
Mexico increased the prospects of more output from these countries.
July 1, 1998 to September 30, 1998
Fund performance in July was essentially flat. In August and continuing
into September, financial markets in general were characterized by a flight to
quality that resulted from uncertainty over Russia's solvency, continued
weakness in Asia, and concerns that recessionary conditions would spread to the
United States and Europe. These factors, combined with generally less liquid
market conditions, led to a marked widening in bond credit spreads and a broad
sell-off in world-wide equity markets. Managed futures funds exhibited strong
non-correlation to world markets in August and again in September, generating
significant profits on the long side of interest rates and the short side of the
commodity markets.
12
<PAGE>
Interest rate trading was particularly profitable during the quarter in
positions in Eurodollars, German and Japanese bonds, and U.S. Treasury notes and
bonds. The growth rate of the world bond market declined to its lowest level
since 1987 at 7.7%, down 4.0% from the last peak in 1993. Global investors
poured funds into such instruments as U.S. Treasury issues and German Bunds,
staging a major flight to quality. As a result, there was a significant
widening of credit spreads on a global basis. Global fund managers also
increased their already-overweight exposure to U.S. Treasuries to a record high.
The impact of these events was that in September, the yield on the Japanese 5-
year bond fell to .67%, an all-time low, German 10-year Bunds fell to 3.89%,
representing almost a 100-year low, and the 30-year bond in the U.S. dropped to
its lowest level on record.
The Fund profited from its currency trading during the quarter with
significant gains from short Japanese yen and Canadian dollar positions, as well
as long Deutsche mark positions. In the currency markets, Japan's problems
spread to other sectors of the global economy, causing commodities prices to
decline as demand from the Asian economies weakened, in turn putting pressure on
Canada's commodity-sensitive currency. In Germany, the federal election
resulted in a shift to the left, as Chancellor Helmut Kohl, after sixteen years
in office, lost to Gerhard Schroder. Surprisingly, this promoted a continued
strengthening of the Deutsche mark versus the U.S. dollar.
As U.S. equity markets declined in July and August, the Fund profited from
short positions in the S&P 500(R), most notably during August, when the index
dropped 14.5%. Volatility in September made for a difficult trading
environment, and the Fund incurred modest losses in the stock index sector
during September, but remained profitable for the quarter overall in these
markets.
Energy trading also resulted in gains for the quarter. Short heating oil
positions proved profitable for the Fund as the market for heating oil prices
dropped to its lowest level in more than a decade (the previous low was in
1986). Unleaded gas positions also generated strong profits for the Fund.
In the metals markets, gold prices attempted to move higher against a
backdrop of volatility in major equity markets, increasing concerns about
emerging markets, economic chaos in Russia, weakness in the U.S. dollar, and
increasing worries about global economic conditions. However, gold was unable
to extend rallies and build any significant upside momentum resulting in a
trendless environment and resulting losses in gold positions for the Fund.
The agricultural sector generated losses overall for the quarter. Although
as commodity markets collapsed in August, profits were generated on the short
side, in September, the Fund was caught on the long side of the soybean complex
resulting in losses as the U.S. soybean crop increased relative to the USDA's
production estimate as a result of timely rains, which contributed to lower
prices.
MONTH-END NET ASSET VALUE PER SERIES A UNIT
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
Jan. Feb. Mar. Apr. May Jun. Jul Aug Sep
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1997 $113.00 (a) $114.63 (a) $114.69 (a) $113.89 (a) $112.28 (a) $113.05 (a) $116.48 (a) $113.59 (a) $114.53(a)
- -----------------------------------------------------------------------------------------------------------------------
1998 $113.84 (b) $113.25 (b) $113.37 (b) $111.46 (b) $112.48 (b) $111.69 (b) $111.09 (b) $116.00 (b) $119.77(b)
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) After reduction for $6.00 per Series A Unit distribution declared on
October 1, 1995 and $6.00 per Series A Unit distribution declared on
October 1, 1996.
(b) After reduction for a $3.50 per Series A distribution declared on October
1, 1997 and the distributions described in (a), resulting in a total
distribution of $15.50 inception to date.
As of July 1, 1996, the Fund changed its name to ML Principal Protection
L.P. Such change was due to the General Partner restructuring the continuous
offerings to be sold without a guaranteed annual fixed-rate distribution or a
discretionary distribution as previously offered under ML Principal Protection
Plus L.P.
Year 2000 Compliance
- --------------------
As the millennium approaches, Merrill Lynch has undertaken initiatives to
address the Year 2000 problem (the "Y2K problem"). The Y2K problem is the
result of a widespread programming technique that causes computer systems to
identify a date based on the last two numbers of a year, with the assumption
that the first two numbers of the year are "19." As a result, the year 2000
would be stored as "00," causing computers to incorrectly interpret the year as
1900. Left uncorrected, the Y2K problem may cause information technology
systems (e.g., computer databases) and non-information technology systems (e.g.,
elevators) to produce incorrect data or cease operating completely.
Merrill Lynch believes that it has identified and evaluated its internal Y2K
problem and that the company is devoting sufficient resources to renovating
technology systems that are not already Year 2000 compliant. Merrill Lynch
expects the renovation phase (as discussed below) of its Year 2000 efforts to be
substantially completed by December 31, 1998, thereby allowing the company to
13
<PAGE>
focus on additional testing efforts and integration of the Year 2000 programs of
recent acquisitions during 1999. In order to focus attention on the Y2K
problem, management has deferred certain other technology projects; however this
deferral is not expected to have a material adverse effect on the company's
business, results of operations, or financial condition.
The failure of Merrill Lynch's technology systems relating to a Y2K problem
would likely have a material adverse effect on the company's business, results
of operations, or financial condition. This effect could include disruption of
normal business transactions, such as the settlement, execution, processing, and
recording of trades in securities, commodities, currencies, and other assets.
The Y2K problem could also increase Merrill Lynch's exposure to risk and its
need for liquidity.
In 1995, Merrill Lynch established the Year 2000 Compliance Initiative, which
is an enterprisewide effort to address the risks associated with the Y2K
problem, both internal and external. The Year 2000 Compliance Initiative's
efforts to address the risks associated with the Y2K problem have been organized
into six segments or phases: planning, pre-renovation, renovation, production
testing, certification, and integration testing.
The planning phase involved defining the scope of the Year 2000 Compliance
Initiative, including its annual budget and strategy, and determining the level
of expert knowledge available within Merrill Lynch regarding particular systems
or applications. The pre-renovation phase involved developing a detailed
enterprisewide inventory of applications and systems, identifying the scope of
necessary renovations to each application or system, and establishing a
conversion schedule. During the renovation phase, source codes are actually
converted, date fields are expanded or windowed (windowing is used on an
exception basis only), test data is prepared, and each system or application is
tested using a variety of Year 2000 scenarios. The production testing phase
validates that a renovated system is functionally the same as the existing
production version, that renovation has not introduced defects, and that
expanded or windowed date fields continue to handle current dates properly. The
certification phase validates that a system can run successfully in a Year 2000
environment. Finally, the integration testing phase, which will occur
throughout 1999, validates that a system can successfully interface with both
internal and external systems.
In 1996 and 1997, as part of the planning and pre-renovation phases, both
plans and funding of plans for inventory, preparation, renovation, and testing
of computer systems for the Y2K problem were approved. All plans for both
mission-critical and non-mission-critical systems are tracked and monitored.
The work associated with the Year 2000 Compliance Initiative has been
accomplished by Merrill Lynch employees, with the assistance of consultants
where necessary.
As part of the production testing and certification phases, Merrill Lynch has
performed, and will continue to perform, both internal and external Year 2000
testing intended to address the risks from the Y2K problem. In July 1998,
Merrill Lynch participated in an industrywide Year 2000 systems test sponsored
by the Securities Industry Association ("SIA"), in which selected firms tested
their computer systems in mock stock trades that simulated dates in December
1999 and January 2000. Merrill Lynch will participate in further industrywide
testing sponsored by the SIA, currently scheduled for March and April 1999,
which will involve an expanded number of firms, transactions, and conditions.
Merrill Lynch also participated in a test sponsored by the Bank of England's
Central Gilts Office.
Each business area within Merrill Lynch also continues to develop specific
contingency plans, with the particular choice of contingency action dependent on
the severity of the problem being addressed, the availability of alternative
products, and the level of importance of the business activity supported by the
problematic system. As part of the Year 2000 Compliance Initiative, Merrill
Lynch has undertaken a business readiness/risk management effort in which each
line of business will identify scenarios in order to develop plans to reduce
risks associated with a Y2K problem.
Merrill Lynch continues to survey and communicate with parties with whom it
has important relationships that may be associated with information technology
Y2K problems, as well as parties that may be associated with non-information
technology Y2K problems, such as landlords. Management is unable, at this
point, to ascertain whether all such third parties will successfully address the
Y2K problem, particularly parties outside the U.S., where it is believed that
remediation efforts relating to the Y2K problem may be less advanced than in the
U.S. Merrill Lynch will continue to monitor third parties' Year 2000 readiness
to determine whether additional or alternative measures are necessary. Such
measures may include the selection of alternate third parties or other efforts
designed to mitigate some of the effects of a third party's noncompliance. In
light of the interdependency of the parties in or serving the financial markets,
however, there can be no assurance that all Y2K problems will be identified and
remediated on a timely basis or that all remediation efforts will be successful.
The failure of securities exchanges, clearing organizations, vendors, clients,
or regulators to resolve their own processing issues in a timely manner could
have a material adverse effect on Merrill Lynch's business, results of
operations, or financial condition.
Nearly 10% of the current year's technology budget has been allocated to the
Year 2000 Compliance Initiative. As of the end of the 1998 third quarter, the
total estimated expenditures associated with the entire Year 2000 Compliance
Initiative were expected to be approximately $400 million, of which $160 million
is remaining. The majority of these remaining expenditures are expected to
cover software remediation, testing, and contingency planning. There can be no
assurance that the costs associated with such remediation efforts will not
exceed those currently anticipated by Merrill Lynch, or that the costs
associated with the remediation efforts or the possible failure of such
remediation efforts would not have a material adverse effect on Merrill Lynch's
14
<PAGE>
business, results of operations, or financial condition.
European Economic and Monetary Union ("EMU")
- --------------------------------------------
As of January 1, 1999, the "euro" will be adopted as the common legal currency
of participating member states of the EMU. The euro and participating member
currencies will co-exist through July 1, 2002, with the euro gradually replacing
member national currencies. The introduction of and conversion to the euro is
expected to have significant implications for the business, as well as the
computer systems and operational processes, of Merrill Lynch.
The introduction of the euro will bring about fundamental changes in the
structure and nature of the European financial markets, including the creation
of a unified, more liquid capital market in Europe. As financial markets in EMU
member states converge and local barriers are removed, competition is expected
to increase. Merrill Lynch does not expect the introduction of the euro to have
a negative effect on its business, currency risk, or competitive positioning in
the European markets. The International Swaps and Derivatives Association, Inc.
has established an EMU protocol agreement that parties to derivatives contracts
may use to amend their agreements to ensure continuity of contract during the
conversion period. Merrill Lynch is a party to this protocol agreement.
Merrill Lynch's program to address the introduction of and conversion to the
euro and the associated systems and operational implications and challenges has
been divided into three phases: analysis, mobilization, and implementation. The
analysis phase began in the third quarter of 1997 and focused upon analyzing the
likely implications of the EMU and assessing the operational and systems impact
on Merrill Lynch. During this phase, a database containing the primary
compliance challenges of the EMU was developed, and working groups were
established to drive the EMU preparation effort within the different product
lines and principal operating locations. The mobilization phase began in the
fourth quarter of 1997 and focused upon developing project plans and
establishing an organizational and project structure to address various business
requirements. The implementation phase, which began in December 1997, is
concerned with implementing the operational and systems changes identified as
necessary to ensure Merrill Lynch's compliance with EMU. The implementation
phase is expected to continue into the first quarter of 1999 to resolve any
post-conversion issues.
With respect to operational and systems matters, the introduction of the euro
will affect all Merrill Lynch facilities that transact, distribute, or provide
custody or recordkeeping for securities or cash denominated in the currency of a
participating member state. Merrill Lynch systems or procedures that handle
such securities or cash may require modification. The procedural and systems
modifications that Merrill Lynch has identified as necessary for conversion to
the euro include, but are not limited to, such activities as:
. modification of application systems to enable the systems to recognize and
process the euro on an ongoing basis;
. conversion of data, which will require updates to master files to reflect
redenomination;
. alteration of transaction data that includes converting trading and cash
positions from member currency to the euro;
. procedural modifications to reflect the replacement of member currency bank
accounts and settlement instructions with euro equivalents; and
. development of the capability for certain business functions to translate
member currencies into euro at a fixed exchange rate until July 2002.
The introduction of the euro exposes Merrill Lynch to operational and systems
risks in that the necessary systems modifications will affect clearance,
settlement, and financial reporting of transactions. If not handled correctly,
these modifications could result in failed trades and other improper accounting
for transactions.
The success of Merrill Lynch's euro conversion efforts also is dependent on
the euro-compliance of third parties, such as trading counterparties, financial
intermediaries (for example, securities and commodities exchanges, depositories,
clearing organizations, and commercial banks), and vendors. Merrill Lynch will
monitor risks associated with third parties on a regular basis, including, for
example, performing assessments of counterparties' readiness.
In anticipation of the introduction of the euro, the financial authorities and
securities exchanges of certain of the EMU member states are conducting market
tests to assess euro-conversion readiness. Merrill Lynch is participating in
such testing procedures as required, and to date the outcome of each of those
tests has been satisfactory. In addition to participating in the testing
procedures of the EMU member states' financial authorities and securities
exchanges, Merrill Lynch also is implementing its own internal testing
procedures, including four systemwide practice sessions, to prepare for the
conversion. The purpose of these practice sessions is to better ensure that the
conversion plans are comprehensive and that the schedule is acceptable. The
results of such practice sessions will be evaluated and used to identify those
areas in which further modification or remediation is necessary. While Merrill
Lynch will engage in these testing procedures, certain elements of the
conversion process can only be undertaken for the first time during the
conversion. Accordingly, there can be no assurances that the tests will
identify all system deficiencies and necessary modifications prior to the
conversion.
Due to the unprecedented scale of change, including the volume and magnitude
of transactions affected and the number of third parties involved, market
participants are anticipating a period of some disruption immediately following
15
<PAGE>
the conversion. Merrill Lynch has developed, and is continuing to develop,
contingency plans in an effort to reduce the impact of such disruptions on its
business.
As of the end of the 1998 third quarter, the total estimated expenditures
associated with the introduction of and conversion to the euro are expected to
be approximately $79 million, of which approximately $20 million is remaining
(of these amounts, $71 million and $19 million, respectively, pertain to 1998).
These remaining expenditures are expected to be spent on EMU compliance efforts
and project administration. Merrill Lynch expects to become fully EMU-compliant
during the 1998 fourth quarter.
Merrill Lynch believes that it has identified and evaluated those systems and
operational modifications necessary for the conversion to the euro and is in the
process of implementing the identified modifications. In light of the
interdependency of the parties in or serving the financial markets, however,
there can be no assurance that all necessary modifications will be identified
and renovated on a timely basis, that all modification efforts will be
successful, or that all third parties with whom Merrill Lynch's operations
interface will be EMU-ready. In addition, there can be no assurance that the
remaining euro conversion expenditures will not exceed those anticipated by
Merrill Lynch at this time or that the expenditures associated with the
conversion efforts and the possible failure of such conversion efforts will not
have a material adverse effect on Merrill Lynch's business, results of
operations, or financial condition.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable
16
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
There are no pending legal proceedings to which the Partnership or the
General Partner is a party.
Item 2. Changes in Securities and Use of Proceeds
(a) None.
(b) None.
(c) None.
(d) The Fund has 5,250,000 Units of limited partnership interest
registered, with an aggregate price of $525,000,000. The Fund has
sold 1,598,940.26 Units of limited partnership interest, with an
aggregate price of $159,894,026.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
There are no exhibits required to be filed with this report.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the first nine months of
fiscal 1998.
17
<PAGE>
SIGNATURES
Pursuant to the requirements 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.
ML PRINCIPAL PROTECTION L.P.
----------------------------------------
(formerly ML Principal Protection Plus L.P.)
By: MERRILL LYNCH INVESTMENT PARTNERS INC.
(General Partner)
Date: November 11, 1998 By /s/ JOHN R. FRAWLEY, JR.
----------------------------------------
John R. Frawley, Jr.
Chairman, Chief Executive Officer,
President and Director
Date: November 11, 1998 By /s/ JO ANN DI DARIO
----------------------------------------
Jo Ann Di Dario
Vice President, Chief Financial Officer
and Treasurer
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> SEP-30-1998 SEP-30-1997
<CASH> 855 1,294
<RECEIVABLES> 25,181,623 7,211,808
<SECURITIES-RESALE> 0 0
<SECURITIES-BORROWED> 0 0
<INSTRUMENTS-OWNED> 73,149,685 84,091,473
<PP&E> 0 0
<TOTAL-ASSETS> 98,332,163 91,304,575
<SHORT-TERM> 0 0
<PAYABLES> 4,955,483 2,928,142
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0 0
0 0
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<OTHER-SE> 93,376,680 88,376,433
<TOTAL-LIABILITY-AND-EQUITY> 98,332,163 91,304,575
<TRADING-REVENUE> 6,887,077 3,321,629
<INTEREST-DIVIDENDS> 4,299,498 3,473,238
<COMMISSIONS> 6,496,149 4,079,476
<INVESTMENT-BANKING-REVENUES> 0 0
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<INCOME-PRETAX> 4,690,426 2,715,391
<INCOME-PRE-EXTRAORDINARY> 4,690,426 2,715,391
<EXTRAORDINARY> 0 0
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<NET-INCOME> 4,690,426 2,715,391
<EPS-PRIMARY> 4.79 3.52
<EPS-DILUTED> 4.79 3.52
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