10-Q 1 lee210q063001-final.txt 6/30/01 FORM 10-Q 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 Quarterly Period Ended June 30, 2001 Commission File Number 0-17383 ML-LEE ACQUISITION FUND II, L.P. (Exact name of registrant as specified in its Governing Instruments) Delaware 04-3028398 (State or other jurisdiction (IRS Employer Identification No.) of incorporation or organization) 4 World Financial Center - 26th Floor New York, NY 10080 (Address of principal executive offices and zip code) Registrant's telephone number, including area code: (800) 288-3694 Securities registered pursuant to Section 12(b) of the Act: Title of each Class Name of each exchange on which registered None 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 ___. ML-LEE ACQUISITION FUND II, L.P. TABLE OF CONTENTS PART I - FINANCIAL INFORMATION Item 1. Financial Statements Statements of Assets, Liabilities and Partners' Capital As of June 30, 2001 (Unaudited) and December 31, 2000 (Unaudited) Statements of Operations For the Three and Six Months Ended June 30, 2001 and 2000 (Unaudited) Statements of Changes in Net Assets For the Six Months Ended June 30, 2001 and 2000 (Unaudited) Statements of Cash Flows For the Six Months Ended June 30, 2001 and 2000 (Unaudited) Statements of Changes in Partners' Capital For the Six Months Ended June 30, 2001 (Unaudited) Schedule of Portfolio Investments As of June 30, 2001 (Unaudited) Notes to Financial Statements (Unaudited) Supplemental Schedule of Unrealized Appreciation (Depreciation) - Schedule 1 (Unaudited) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantative and Qualitative Disclosure About Market Risk

ML-LEE ACQUISITION FUND II, L.P. NOTES TO FINANCIAL STATEMENTS JUNE 30, 2001 (UNAUDITED) 1. Organization ML-Lee Acquisition Fund II, L.P. ("Fund II") was formed along with ML-Lee Acquisition Fund (Retirement Accounts) II, L.P. (the "Retirement Fund"; 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. Capital contributions from the Limited Partners and the General Partners (as defined below) totaled $222,295,000 in the public offering of Fund II, the final closing for which was held on January 5, 1990. Mezzanine Investments II, L.P. (the "Managing General Partner"), subject to the supervision of the Individual General Partners (as defined below and hereinafter with the Managing General Partner as the "General Partners"), is responsible for overseeing and monitoring of Fund II's investments. The Managing General Partner is a Delaware limited partnership in which ML Mezzanine II Inc. is the general partner and Thomas H. Lee Advisors II, L.P., the Investment Adviser to the Funds, is the limited partner. The Individual General Partners are Vernon R. Alden, Joseph L. Bower and Stanley H. Feldberg (the "Independent General Partners") and Thomas H. Lee. ML Fund Administrators Inc. (the "Fund Administrator") is an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. and is responsible for the day to day administrative services necessary for the operations of Fund II. 2. Basis of Accounting For financial reporting purposes, the records of Fund II are maintained using the accrual method of accounting. 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. The financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial condition, results of operations and cash flows for the periods presented. Such adjustments consisted of those of a normal recurring nature. The results of operations for the three and six months ended June 30, 2001 are not necessarily indicative of the results that may be achieved for the entire year. Footnote disclosure which substantially duplicates the disclosure contained in Fund II's Annual Report on Form 10-K for the year ended December 31, 2000, which is hereby incorporated by reference, has been omitted. 3. Investment Transactions Before consenting to the distribution of all or part of Fund II's reserves, at the quarterly meetings held since September 19, 2000, the General Partners reviewed certain contractual covenants, commitments and contingencies which may affect Fund II by virtue of its investments in Big V and Big V Holdings Corp. ("BVH", Big V's parent company and defined herein with Big V and certain other related entities as the "Big V Entities"). Such potential obligations arise from letter agreements (the "Agreements") entered into by Wakefern Food Corporation ("Wakefern", Big V's current supplier), Big V (together with certain of its related companies), and Fund II (together with other investor groups in Big V) in December 1990 and November 1993. Since the covenants, commitments and contingencies associated with the Agreements may have the effect of delaying and/or decreasing the amount of future distributions, the General Partners determined that further distributions should not be made until any responsibilities of Fund II with respect to such covenants, commitments and contingencies have been determined. On November 22, 2000, following careful analysis of its business operations, finances, and the outlook for the operating region in which Big V competes with other supermarket retailers, the Big V Entities filed voluntary petitions under Chapter 11 of the United States Bankruptcy Code (the "Big V Bankruptcy") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"), in order to implement a major financial and operational restructuring of its business. At issue in the Big V Bankruptcy and related litigation, among other things, are the terms under which change in the Wakefern distribution agreement can be effectuated and the cost of such change, if any, to Big V. Particularly, Big V, together with other related entities, initiated litigation with Wakefern seeking a declaration that Big V could exit the Wakefern food cooperative by tendering the shares of Wakefern owned by Big V back to Wakefern, and transition to a new supplier and continue to operate as an independent grocery store chain, without incurring a payment obligation to Wakefern (a so-called "Withdrawal Penalty") under the various agreements by and among Big V and its affiliates, Wakefern and other members of Wakefern (the "Wakefern Litigation"). Wakefern took the position that such an effort by Big V would trigger a Withdrawal Penalty. On August 9, 2001, after conducting a trial in July 2001, the Bankruptcy Court indicated that it would enter judgment in favor of Wakefern in the Wakefern Litigation, thereby denying the request by the Big V Entities for a declaration that Big V could exit the Wakefern food cooperative by tendering the shares of Wakefern owned by Big V back to Wakefern, and transition to a new supplier and continue to operate as an independent grocery store chain, without incurring a Withdrawal Penalty. The Bankruptcy Court also indicated that at some date in the future it would issue a written decision supporting the entry of such judgment in favor of Wakefern. However, the Bankruptcy Court did not rule on, among other things, the amount of the payment that would be due to Wakefern if Big V were to pursue the course of action described in the Wakefern Litigation or whether the payment obligation might otherwise be unenforceable. On August 9, 2001, the Bankruptcy Court also deferred ruling until August 23, 2001 on the request by the Big V Entities for an extension of their exclusive period of time to propose a plan of reorganization in the Chapter 11 cases. The exclusive period thus has automatically been extended to that date. Currently, Fund II holds a Senior Subordinated Note issued by Big V with outstanding principal of approximately $10.4 million (the "Senior Subordinated Note"), as well as 117,333 shares of BVH common stock. At the time of the Big V Bankruptcy filing, Big V had failed to make the November 15, 2000 interest payment due Fund II under the Senior Subordinated Note held by Fund II. Since the Big V Bankruptcy filing, the December 15, 2000 and March 15, 2001 principal payments and the February 15, 2001 and March 15, 2001 interest payments due Fund II under such note have been stayed. As a result of the uncertainties surrounding the Big V Bankruptcy, Fund II stopped accruing interest on the Senior Subordinated Note as of January 1, 2001. Based on the Bankruptcy Court's indication that it will enter judgment in favor of Wakefern in the Wakefern Litigation and the potential impact that this decision has on the ability of Big V to transition to a new supplier without incurring a Withdrawal Penalty (subject to potential further litigation about the amount or enforceability of that Withdrawal Penalty), Fund II, in accordance with its valuation procedures, has determined, as of June 30, 2001, to retain a carrying value of approximately $10.4 million for the Senior Subordinated Note and to write down the carrying value for the 117,333 shares of BVH common stock to a nominal valuation of approximately $7,000. The actual value, however, that might be realized by Fund II with respect to its debt and equity investments in the Big V Entities remains dependent in large part on the ultimate outcome of the Big V Bankruptcy and related litigation, including the litigation with Wakefern. Specifically, if the Big V Bankruptcy or related litigation proceedings are not ultimately resolved in Big V's favor and/or the costs to Big V of transferring the Wakefern distribution agreement are substantial, the value of Fund II's debt and equity investments in the Big V Entities as set forth herein may be impaired, and Fund II could conceivably be exposed to losses in excess of its original debt and equity investments in the Big V Entities. Neither the Investment Adviser nor the General Partners, however, can predict the ultimate outcome of the Big V Bankruptcy proceedings, including such proceedings' ultimate impact on the value of the Big V Senior Subordinated Note or the BVH equity held by Fund II, or the timing or amount of payments, if any, that might be made to Fund II pursuant to Big V's plan of reorganization. In addition, the General Partners cannot currently predict how the Big V Bankruptcy may affect the timing of the ultimate liquidation of Fund II, or the amount of proceeds that Limited Partners will ultimately receive. Fund II's Investment Adviser will continue to monitor developments in the Big V Bankruptcy and update Fund II's General Partners as needed. It is possible that the carrying value of such investments, particularly the carrying value of the Senior Subordinated Note at its outstanding principal balance, could be further negatively impacted by developments in the Big V Bankruptcy. In addition, the General Partners will continue to review Fund II's reserves each quarter in light of the foregoing matter, and distributions will be made in accordance with Fund II's Partnership Agreement. Currently, Fund II has reserved all Mezzanine Investment sale, paydown and maturity proceeds received since August 1999, as well as income from operations since the third quarter 1999. 4. Non-Accrual of Investments In accordance with Fund II's Accounting Policy, the following securities have been on non-accrual status since the dates indicated: - Florida Orthopedics, Inc. January 1, 1995 - Big V Supermarkets, Inc. January 1, 2001 5. Payment-In-Kind Securities All payment-in-kind securities received in lieu of cash interest payments by Fund II's portfolio companies are recorded at face value (which approximates accrued interest), unless the Investment Adviser and the Managing General Partner determine that there is no reasonable assurance of collecting the full principal amounts of such securities. In accordance with this policy, as of December 31, 2000, Fund II's portfolio of investments excluded approximately $168,000 of such payment-in-kind notes received from BioLease, Inc. ("BioLease"). As a result of the July 2001 sale of Fund II's investments in BioLease and BioTransplant, Inc. ("BioTransplant")(see Note 7), the collection of the payment-in-kind notes was reasonably assured. Therefore, as of June 30, 2001, Fund II recognized the December 31, 2000 note balance of $168,000 plus an additional $20,000 related to the six month period ended June 30, 2001. 6. Related Party Transactions The Investment Adviser, pursuant to an investment management agreement among the Investment Adviser, the Thomas H. Lee Company and Fund II dated November 10, 1989, is responsible for the identification, management and liquidation of Mezzanine Investments and Bridge Investments for Fund II. The Investment Adviser is entitled to receive an Investment Advisory Fee as compensation for these services (see Note 7). As compensation for its services, the Fund Administrator, an affiliate of the Managing General Partner, is entitled to receive a Fund Administration Fee. In addition, the Fund Administrator is entitled to reimbursement of 100% of out-of-pocket expenses incurred by the Fund Administrator on behalf of the Funds ("Reimbursable Administrative Expenses"). Reimbursable Administrative Expenses primarily consist of printing, audit and tax preparation, legal fees and expenses, and custodian fees. As provided by the Partnership Agreement, the Managing General Partner of Fund II is entitled to receive an incentive distribution after Limited Partners have received their Priority Return of 10% per annum ("MGP Distributions"). Of the MGP Distributions, the Investment Adviser is entitled to receive 95% and ML Mezzanine II Inc. is entitled to receive 5%. During 2001, the Managing General Partner received no cash distributions. 7. Subsequent Events On July 10, 2001, Fund II sold all of its debt and equity investments in BioLease and BioTransplant for net proceeds of approximately $838,000 (including $188,000 received for the payment-in-kind notes discussed in Note 5). In connection with this sale, Fund II reversed $270,000 of unrealized depreciation and recorded $46,000 of unrealized appreciation at June 30, 2001 related to the BioLease subordinated notes and recognized a net realized loss of approximately $50,000 during the third quarter of 2001 related to the BioLease subordinated notes and the BioLease common stock. On July 17, 2001, the Independent General Partners, on behalf of Fund II, accepted a proposal made by the Investment Adviser to reduce the annual Investment Advisory Fee payable to the Investment Adviser by 50%. A similar reduction was approved for ML-Lee Acquisition Fund (Retirement Accounts) II, L.P. (the "Retirement Fund"). Accordingly, the combined annual Investment Advisory Fee payable by Fund II and the Retirement Fund will be $600,000. Such reductions will be made effective retroactive to July 1, 2001.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity & Capital Resources At the regular quarterly meeting of the General Partners of ML-Lee Acquisition Fund II, L.P. ("Fund II"), held on December 14, 1999, Vernon R. Alden, Joseph L. Bower, Stanley H. Feldberg and Thomas H. Lee (the "Individual General Partners") determined to extend the initial ten year term of Fund II, which was due to terminate January 5, 2000, for an additional two year period, pursuant to Section 2.4 of the Partnership Agreement. Such extension will allow Fund II to more effectively deal with its assets pending their liquidation. The term of Fund II will now expire on January 5, 2002. In addition, the Individual General Partners have the right, pursuant to the Partnership Agreement, to extend the term of Fund II for an additional one year period if they determine that such extension is in the best interest of Fund II. Fund II will then have an additional five year period to liquidate its remaining assets. On July 17, 2001, the Independent General Partners, on behalf of Fund II, accepted a proposal made by the Investment Adviser to reduce the annual Investment Advisory Fee payable to the Investment Adviser by 50%. A similar reduction was approved for ML-Lee Acquisition Fund (Retirement Accounts) II, L.P. (the "Retirement Fund", and together with Fund II referred to as the "Funds"). Accordingly, the combined annual Investment Advisory Fee payable by the Funds will be $600,000. Such reductions will be made effective retroactive to July 1, 2001. On August 6, 1991, the Independent General Partners approved a reserve for follow-on investments of approximately $24,900,000 for Fund II. As of August 14, 2001, this remaining reserve balance was approximately $3,100,000 due to follow-on investments in Petco Animal Supplies, Fitz and Floyd, Inc., Fine Clothing, Inc., Hills Stores, Ghirardelli Holdings, Anchor Advanced Products, and BioTransplant Inc. Additionally, approximately $8,300,000 of the reserve has been returned to the partners. The level of the reserve was based upon an analysis of potential follow-on investments in specific portfolio companies that may become necessary to protect or enhance Fund II's existing investment. On July 10, 2001, Fund II sold all of its debt and equity investments in BioLease, Inc. ("BioLease") and BioTransplant, Inc. ("BioTransplant") for net proceeds of approximately $838,000 (including $188,000 received for the payment-in-kind notes discussed in Note 5 of Notes to Financial Statements). In connection with this sale, Fund II recognized a net realized loss of approximatley $50,000 during the third quarter of 2001. Before consenting to the distribution of all or part of Fund II's reserves, at the quarterly meetings held since September 19, 2000, the General Partners reviewed certain contractual covenants, commitments and contingencies which may affect Fund II by virtue of its investments in Big V and Big V Holdings Corp. ("BVH", Big V's parent company and defined herein with Big V and certain other related entities as the "Big V Entities"). Such potential obligations arise from letter agreements (the "Agreements") entered into by Wakefern Food Corporation ("Wakefern", Big V's current supplier), Big V (together with certain of its related companies), and Fund II (together with other investor groups in Big V) in December 1990 and November 1993. Since the covenants, commitments and contingencies associated with the Agreements may have the effect of delaying and/or decreasing the amount of future distributions, the General Partners determined that further distributions should not be made until any responsibilities of Fund II with respect to such covenants, commitments and contingencies have been determined. On November 22, 2000, following careful analysis of its business operations, finances, and the outlook for the operating region in which Big V competes with other supermarket retailers, the Big V Entities filed voluntary petitions under Chapter 11 of the United States Bankruptcy Code (the "Big V Bankruptcy") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"), in order to implement a major financial and operational restructuring of its business. At issue in the Big V Bankruptcy and related litigation, among other things, are the terms under which change in the Wakefern distribution agreement can be effectuated and the cost of such change, if any, to Big V. Particularly, Big V, together with other related entities, initiated litigation with Wakefern seeking a declaration that Big V could exit the Wakefern food cooperative by tendering the shares of Wakefern owned by Big V back to Wakefern, and transition to a new supplier and continue to operate as an independent grocery store chain, without incurring a payment obligation to Wakefern (a so-called "Withdrawal Penalty") under the various agreements by and among Big V and its affiliates, Wakefern and other members of Wakefern (the "Wakefern Litigation"). Wakefern took the position that such an effort by Big V would trigger a Withdrawal Penalty. On August 9, 2001, after conducting a trial in July 2001, the Bankruptcy Court indicated that it would enter judgment in favor of Wakefern in the Wakefern Litigation, thereby denying the request by the Big V Entities for a declaration that Big V could exit the Wakefern food cooperative by tendering the shares of Wakefern owned by Big V back to Wakefern, and transition to a new supplier and continue to operate as an independent grocery store chain, without incurring a Withdrawal Penalty. The Bankruptcy Court also indicated that at some date in the future it would issue a written decision supporting the entry of such judgment in favor of Wakefern. However, the Bankruptcy Court did not rule on, among other things, the amount of the payment that would be due to Wakefern if Big V were to pursue the course of action described in the Wakefern Litigation or whether the payment obligation might otherwise be unenforceable On August 9, 2001, the Bankruptcy Court also deferred ruling until August 23, 2001 on the request by the Big V Entities for an extension of their exclusive period of time to propose a plan of reorganization in the Chapter 11 cases. The exclusive period thus has automatically been extended to that date. Currently, Fund II holds a Senior Subordinated Note issued by Big V with outstanding principal of approximately $10.4 million (the "Senior Subordinated Note"), as well as 117,333 shares of BVH common stock. At the time of the Big V Bankruptcy filing, Big V had failed to make the November 15, 2000 interest payment due Fund II under the Senior Subordinated Note held by Fund II. Since the Big V Bankruptcy filing, the December 15, 2000 and March 15, 2001 principal payments and the February 15, 2001 and March 15, 2001 interest payments due Fund II under such note have been stayed. As a result of the uncertainties surrounding the Big V Bankruptcy, Fund II stopped accruing interest on the Senior Subordinated Note as of January 1, 2001. Based on the Bankruptcy Court's indication that it will enter judgment in favor of Wakefern in the Wakefern Litigation and the potential impact that this decision has on the ability of Big V to transition to a new supplier without incurring a Withdrawal Penalty (subject to potential further litigation about the amount or enforceability of that Withdrawal Penalty), Fund II, in accordance with its valuation procedures, has determined, as of June 30, 2001, to retain a carrying value of approximately $10.4 million for the Senior Subordinated Note and to write down the carrying value for the 117,333 shares of BVH common stock to a nominal valuation of approximately $7,000. The actual value, however, that might be realized by Fund II with respect to its debt and equity investments in the Big V Entities remains dependent in large part on the ultimate outcome of the Big V Bankruptcy and related litigation, including the litigation with Wakefern. Specifically, if the Big V Bankruptcy or related litigation proceedings are not ultimately resolved in Big V's favor and/or the costs to Big V of transferring the Wakefern distribution agreement are substantial, the value of Fund II's debt and equity investments in the Big V Entities as set forth herein may be impaired, and Fund II could conceivably be exposed to losses in excess of its original debt and equity investments in the Big V Entities. Neither the Investment Adviser nor the General Partners, however, can predict the ultimate outcome of the Big V Bankruptcy proceedings, including such proceedings' ultimate impact on the value of the Big V Senior Subordinated Note or the BVH equity held by Fund II, or the timing or amount of payments, if any, that might be made to Fund II pursuant to Big V's plan of reorganization. In addition, the General Partners cannot currently predict how the Big V Bankruptcy may affect the timing of the ultimate liquidation of Fund II, or the amount of proceeds that Limited Partners will ultimately receive. Fund II's Investment Adviser will continue to monitor developments in the Big V Bankruptcy and update Fund II's General Partners as needed. It is possible that the carrying value of such investments, particularly the carrying value of the Senior Subordinated Note at its outstanding principal balance, could be further negatively impacted by developments in the Big V Bankruptcy. In addition, the General Partners will continue to review Fund II's reserves each quarter in light of the foregoing matter, and distributions will be made in accordance with Fund II's Partnership Agreement. Currently, Fund II has reserved all Mezzanine Investment sale, paydown and maturity proceeds received since August 1999, as well as income from operations since the third quarter 1999. As of June 30, 2001, Fund II had outstanding a total (at cost) of $16,908,000 invested in Mezzanine Investments representing $14,537,000 Managed and $2,371,000 Non-Managed portfolio investments, and Temporary Investments of $19,255,000 comprised of commercial paper with maturities of less than 60 days. As provided by the Partnership Agreement, the Managing General Partner of Fund II is entitled to receive an incentive distribution after Limited Partners have received their Priority Return of 10% per annum ("MGP Distributions"). The Managing General Partner is required to defer a portion of any MGP 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"). Any 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. As of June 30, 2001, there is no outstanding Deferred Distribution Amount. As recovered capital from portfolio company sales is distributed to Limited Partners, the Limited Partners' net asset value ("NAV") per Unit is reduced accordingly, and the corresponding interest income previously generated by such holdings will no longer be received by Fund II. After the July 10, 2001 sale of Fund II's investment in BioLease and BioTransplant, Fund II has only two portfolio companies remaining, neither of which is income producing. As a result, it is expected that any future cash available to pay distributions to Partners (to the extent such cash is not reserved for expenses and contingencies - see discussion of the Big V Bankruptcy above) will be derived entirely from recovered capital and gains from asset sales, which are subject to market conditions and are inherently unpredictable as to timing. Investment in High-Yield Securities Fund II invested primarily in subordinated debt and preferred stock securities ("High-Yield Securities"), generally linked with an equity participation, issued in conjunction with the mezzanine financing of privately structured, friendly leveraged acquisitions, recapitalizations and other leveraged financings. High-Yield Securities are debt and preferred equity securities that are unrated or are rated by Standard & Poor's Corporation as BB or lower and by Moody's Investor Services, Inc. as Ba or lower. Risk of loss upon default by the issuer is significantly greater with High-Yield Securities than with investment grade securities because High-Yield Securities are generally unsecured and are often subordinated to other creditors of the issuer. Also, these issuers usually have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than investment grade issuers. Most of these securities are subject to resale restrictions and generally there is no quoted market for such securities. Although Fund II cannot eliminate the risks associated with its investments in High-Yield Securities, it has established risk management policies. Fund II subjected each prospective investment to rigorous analysis and made only those investments that were recommended by the Investment Adviser and that met Fund II's investment guidelines or that had otherwise been approved by the Managing General Partner and the Independent General Partners. Fund II's investments were measured against specified Fund II investment and performance guidelines. To limit the exposure of Fund II's capital in any single issuer, Fund II limited the amount of its investment in a particular issuer. Fund II's Investment Adviser also continually monitors portfolio companies in order to minimize the risks associated with its investments in High-Yield Securities. The Investment Adviser reviews each portfolio company's financial statements quarterly. In addition, the Investment Adviser routinely reviews and discusses financial and operating results with the company's management and where appropriate, attends board of director meetings. In some cases, representatives of the Investment Adviser, acting on behalf of the Funds (and affiliated investors where applicable), serve as one or more of the directors on the boards of portfolio companies. Fund II may, from time to time, make follow-on investments to the extent necessary to protect or enhance its existing investments. Forward Looking Information In addition to historical information contained or incorporated by reference in this report on Form 10-Q, Fund II may make or publish forward-looking statements about management expectations, strategic objectives, business prospects, anticipated financial performance, and other similar matters. In order to comply with the terms of the safe harbor for such statements provided by the Private Securities Litigation Reform Act of 1995, Fund II notes that a variety of factors, many of which are beyond its control, affect its operations, performance, business strategy, and results and could cause actual results and experience to differ materially from the expectations expressed in these statements. These factors include, but are not limited to, the effect of changing economic and market conditions, trends in business and finance and in investor sentiment, the level of volatility of interest rates, the actions undertaken by both current and potential new competitors, the impact of current, pending, and future legislation and regulation both in the United States and throughout the world, the impact of current ongoing litigation as it relates to Fund II, and the other risks and uncertainties detailed in this Form 10-Q. Fund II undertakes no responsibility to update publicly or revise any forward-looking statements. Results of Operations Net Investment Income For the three and six months ended June 30, 2001, Fund II had net investment income of $63,000 and $15,000, respectively, as compared to net investment income for the three and six months ended June 30, 2000 of $456,000 and $1,066,000, respectively. The decrease in net investment income during 2001, as compared to 2000, is primarily attributable to a decrease in interest income from Mezzanine Investments and an increase in legal and professional fees, partially offset by an increase in interest and discount income from Temporary Investments and from the recognition of BioLease deferred interest income, as discussed below. Investment Income and Expenses The total investment income from operations for the three and six months ended June 30, 2001 and 2000 consists primarily of interest and discount income earned on the investment of proceeds from Partner's contributions in Mezzanine Investments and short-term money market instruments. For the three and six months ended June 30, 2001 and 2000, Fund II had investment income of $420,000, $726,000, $742,000 and $1,668,000, respectively. The decrease in investment income during 2001, as compared to 2000, is primarily attributable to a decrease in income earned on Mezzanine Investments as result of the non-accrual status of Big V in 2001 and a non-recurring $205,000 adjustment in the first quarter of 2000 to correct for a 1999 understatement of Mezzanine Investment income. This decrease was partially offset by an increase in income earned on Temporary Investments as a result of investing Mezzanine Investment sale, paydown and maturity proceeds received since August 1999, as well as on income from operations from the third quarter 1999 and subsequent quarters, all of which have been reserved; and by the 2001 recognition of the BioLease payment-in-kind note representing deferred interest income on the BioLease subordinated note. Major expenses for the three and six months ended June 30, 2001 and 2000 consisted of Investment Advisory Fees, Administrative Expenses, and Legal and Professional Fees. The Investment Adviser and Fund Administrator both receive their compensation on a quarterly basis. The total Investment Advisory Fees incurred by Fund II to the Investment Adviser for the three and six months ended June 30, 2001 and 2000 were $167,000, $333,000, $167,000 and $333,000, respectively, and were 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 Funds on a combined basis. On July 17, 2001, the Independent General Partners, on behalf of Fund II, accepted a proposal made by the Investment Adviser to reduce the annual Investment Advisory Fee payable to the Investment Adviser by 50%. A similar reduction was approved for the Retirement Fund. Accordingly, the combined annual Investment Advisory Fee payable by the Funds will be $600,000. Such reductions will be made effective retroactive to July 1, 2001. As compensation for its services, the Fund Administrator is entitled to receive an annual amount of $400,000 for the Funds on a combined basis, plus reimbursement of 100% of out-of-pocket expenses incurred by the Fund Administrator on behalf of Fund II ("Reimbursable Administrative Expenses"). Reimbursable Administrative Expenses primarily consist of printing, audit, tax preparation, legal fees and expenses, and custodian fees. For the three and six months ended June 30, 2001 and 2000, Fund II incurred Fund Administration Fees of $55,000, $111,000, $55,000 and $111,000, respectively. For the three and six months ended June 30, 2001 and 2000, Fund II incurred $61,000, $117,000, $43,000 and $103,000, respectively, in Reimbursable Administrative Expenses. Legal and professional fees for the three and six months ended June 30, 2001 and 2000 were $54,000, $100,000, $0 and $11,000, respectively. The increase in legal and professional fees for 2001, as compared to 2000, is primarily attributable to the legal fees incurred by Fund II in connection with the Big V Bankruptcy. Net Assets Fund II's net assets decreased by $3,769,000 during the six months ended June 30, 2001, due to net unrealized depreciation of $4,054,000, partially offset by net investment income of $15,000 and a reversal of unrealized depreciation of $270,000. During the six months ended June 30, 2000, Fund II's net assets increased by $1,106,000, due to net investment income of $1,106,000 and a reversal of unrealized depreciation of $47,000 partially offset by a net realized loss of $7,000. Unrealized Appreciation and Depreciation on Investments Fund II recorded net unrealized depreciation of $4,054,000 during the six months ended June 30, 2001. In addition, as a result of dispositions of Mezzanine Investments, Fund II recorded a reversal of unrealized depreciation of $270,000 during the six months ended June 30, 2001, as compared to a $47,000 reversal of unrealized depreciation during the six months ended June 30, 2000. Fund II's cumulative net unrealized depreciation on investments as of June 30, 2001 totaled $5,661,000. 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 Investment Adviser and is approved by the Managing General Partner with final approval from the Individual General Partners of Fund II. For privately issued securities in which Fund II typically invests, the fair value of an investment is generally its original cost plus accrued value in the case of original issue discount or deferred pay securities. Such investments generally 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 Investment Adviser and the General Partners 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 Investment Adviser and the General Partners use their best judgment in estimating the fair value of these investments, there are inherent limitations in any estimation technique. Therefore, the fair value estimates presented herein are not necessarily indicative of the amount which Fund II could realize in a current transaction. Future confirming events will also affect the estimates of fair value and the effect of such events on the estimates of fair value could be material. As a result of total net realized and unrealized appreciation and depreciation recorded by Fund II through June 30, 2001, Limited Partners' net asset value ("NAV") was $137.49 per Unit. Fund II's net assets as of that date included its holdings in Big V and BVH (approximately 33.6% of net assets) and other private placement securities (approximately 2.7% of net assets), for which there are no ascertainable market values, and commercial paper (approximately 62.2% of net assets), which is stated at amortized cost. The June 30, 2001 NAV figure does not reflect any change that may subsequently have occurred in the value of Fund II's holdings. Moreover, in light of the Big V Bankruptcy filing, there is a high degree of uncertainty associated with Fund II's estimate of the value of its investments in Big V and BVH (see also Liquidity and Capital Resources above). Finally, the Big V Bankruptcy and related litigation may potentially have an effect on other assets of Fund II. The previously computed NAV does not represent the Units' current market value, and Limited Partners may not be able to realize this value upon a sale of their Units or ultimate liquidation of Fund II's assets. The information presented herein is based on pertinent information available to the Investment Adviser and Managing General Partner. The Investment Adviser and Managing General Partner are not aware of any factors not disclosed herein that would significantly affect the estimated fair value amounts. For additional information please refer to Supplemental Schedule of Unrealized Appreciation (Depreciation) - Schedule 1. Should a Limited Partner decide to sell his Units, any such sale will be recorded on the books and records of Fund II quarterly, only upon the satisfactory completion and acceptance of Fund II's transfer documents. There can be no assurances that such transfer will be effected before any specified date. Additionally, pursuant to the Partnership Agreement, until a transfer is recognized, the Limited Partner of record (i.e. the transferor) is entitled to receive all the benefits and burdens of ownership of Units, and any transferee has no rights to distributions of sale proceeds generated at any time prior to the recognition of the transfer and assignment. Accordingly, Distributable Cash from Investments for a quarter and Distributable Capital Proceeds from sales after transfer or assignment have been entered into, but before such transfer and assignment is recognized, would be payable to the transferor and not the transferee. Item 3. Quantitative and Qualitative Disclosure About Market Risk As of June 30, 2001, Fund II maintains a portion of its cash equivalents in financial instruments with original maturities of three months or less. These financial instruments are subject to interest rate risk, and will decline in value if interest rates increase. A significant increase or decrease in interest rates is not expected to have a material effect on Fund II's financial position. PART II - OTHER INFORMATION Item 1. Legal Proceedings. ----------------- None Item 2. Changes in Securities and Use of Proceeds. ----------------------------------------- None Item 3. Defaults Upon Senior Securites. ------------------------------ 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. -------------------------------- None 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 the 20th day of August, 2001. ML-LEE ACQUISITION FUND II, L.P. By: Mezzanine Investments II, L.P. Managing General Partner By: ML Mezzanine II Inc., its General Partner Dated: August 20, 2001 By: /s/ Kevin T. Seltzer ---------------------------------- Kevin T. Seltzer ML Mezzanine II, Inc. Vice President and Treasurer (Principal Financial Officer of Registrant)

ML LEE ACQUISITION FUND II L P 10-Q