-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VA/nhOMqS2bRs7qomf9FuGKdoUoF4gW5NgXORRstntmOknmfxSOnhv9/PnPvAMYR A0NvNO6x4Pz0XM1AzT29/Q== 0000950130-98-001568.txt : 19980331 0000950130-98-001568.hdr.sgml : 19980331 ACCESSION NUMBER: 0000950130-98-001568 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: ML PRINCIPAL PROTECTION LP CENTRAL INDEX KEY: 0000917259 STANDARD INDUSTRIAL CLASSIFICATION: SECURITY & COMMODITY BROKERS, DEALERS, EXCHANGES & SERVICES [6200] IRS NUMBER: 133750642 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-25000 FILM NUMBER: 98578355 BUSINESS ADDRESS: STREET 1: 6TH FL, SOUTH TOWER, M L WORLD HDQR STREET 2: C/O ML FUTURES INVESTMENT PARTNERS INC CITY: NEW YORK STATE: NY ZIP: 10080-6106 BUSINESS PHONE: 2122364161 MAIL ADDRESS: STREET 1: C/O MERRILL LYNCH INVESTMENT PARTNERS IN STREET 2: WORLD FINANCIAL CENTER S TOWER 6TH FL CITY: NEW YORK STATE: NY ZIP: 10080-6106 FORMER COMPANY: FORMER CONFORMED NAME: ML PRINCIPAL PROTECTION PLUS LP DATE OF NAME CHANGE: 19940616 FORMER COMPANY: FORMER CONFORMED NAME: SECTOR STRATEGY FUND VII LP DATE OF NAME CHANGE: 19940107 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ML PRINCIPAL PROTECTION TRADING LP CENTRAL INDEX KEY: 0000925433 STANDARD INDUSTRIAL CLASSIFICATION: ASSET-BACKED SECURITIES [6189] IRS NUMBER: 133775509 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 033-73914-01 FILM NUMBER: 98578356 BUSINESS ADDRESS: STREET 1: ML INVESTMENT PARTNERS INC STREET 2: WORLD FINANCIAL CENTER S TOWER 6TH FL CITY: NEW YORK STATE: NY ZIP: 10080-6106 BUSINESS PHONE: 2122364167 MAIL ADDRESS: STREET 1: MERRILL LYNCH INVESTMENT PARTNERS STREET 2: WORLD FINANCIAL CENTER S TOWER 6TH FL CITY: NEW YORK STATE: NY ZIP: 10080-6106 FORMER COMPANY: FORMER CONFORMED NAME: ML PRINCIPAL PROTECTION PLUS TRADING LP DATE OF NAME CHANGE: 19940616 10-K405 1 ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended: December 31, 1997 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission file number: 0-25000 ML PRINCIPAL PROTECTION L.P. (formerly, ML Principal Protection Plus L.P.) --------------------------------------------- (Exact name of registrant as specified in its charter) ML Principal Protection Trading L.P. (formerly, ML Principal Protection Plus Trading L.P.) ----------------------------------------------------- (Rule 140 Co-Registrant) 13-3750642 (Registrant) DELAWARE 13-3775509 (Co-Registrant) - ------------------------------- -------------------------- (State of other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) C/O MERRILL LYNCH INVESTMENT PARTNERS INC. MERRILL LYNCH WORLD HEADQUARTERS WORLD FINANCIAL CENTER SOUTH TOWER, 6TH FLOOR, NEW YORK, NY 10080-6106 ------------------------------------------------ (Address of principal executive offices) Registrant's telephone number, including area code: (212) 236-5662 -------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Limited Partnership Units ---------------------------------------- (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 ----- ------ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Aggregate market value of the voting and non-voting stock held by non-affiliates of the registrant: the registrants are limited partnerships; as of February 1, 1998, limited partnership units with an aggregate value of $97,854,937 were outstanding and held by non-affiliates. DOCUMENTS INCORPORATED BY REFERENCE The registrant's "1997 Annual Report and Independent Auditors' Report," the annual report to security holders for the fiscal year ended December 31, 1997, is incorporated by reference into Part II, Item 8, and Part IV hereof and filed as an Exhibit herewith. ML PRINCIPAL PROTECTION L.P. ANNUAL REPORT FOR 1997 ON FORM 10-K Table of Contents ----------------- PART I ------
PAGE ---- Item 1. Business............................................................ 1 Item 2. Properties.......................................................... 9 Item 3. Legal Proceedings................................................... 9 Item 4. Submission of Matters to a Vote of Security Holders................. 9 PART II ------- Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............................................... 9 Item 6. Selected Financial Data........................................... 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations......................................... 15 Item 7A. Quantitative and Qualitative Disclosures About Market Risk........ 19 Item 8. Financial Statements and Supplementary Data....................... 19 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......................................... 19 PART III -------- Item 10. Directors and Executive Officers of the Registrant............... 20 Item 11. Executive Compensation........................................... 22 Item 12. Security Ownership of Certain Beneficial Owners and Management... 22 Item 13. Certain Relationships and Related Transactions................... 22 PART IV ------- Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.... 23
-i- PART I ITEM 1: BUSINESS -------- (a) General Development of Business: ------------------------------- ML Principal Protection L.P. (formerly, ML Principal Protection Plus L.P.) (the "Partnership" or the "Fund") was organized under the Delaware Revised Uniform Limited Partnership Act on January 3, 1994 and began trading operations on October 12, 1994. The Partnership changed its name to ML Principal Protection L.P. as of July 1, 1996. The Fund is a multi-strategy, multi-market managed futures investment employing a range of proprietary strategies diversified across major markets of the global economy -- financials, currencies, energy, metals and agriculture. The Fund trades in the international futures and forward markets under the direction of multiple independent professional advisors (the "Trading Advisors," or the "Advisors"). The Fund's objectives are achieving, through speculative trading, long-term capital appreciation while controlling performance volatility. Merrill Lynch Investment Partners Inc. (the "General Partner" or "MLIP") acts as the general partner of the Partnership, and selects and allocates the Fund's assets among the Advisors, each of which trades independently of the others. MLIP also determines what percentage of the Fund's assets to allocate to trading and what percentage to hold in reserve. Merrill Lynch Futures Inc. (the "Commodity Broker" or "MLF") is the Partnership's commodity broker. Merrill Lynch Asset Management, L.P. ("MLAM") provides cash management services to the Partnership, pursuant to guidelines established by MLIP for which MLAM assumes no responsibility, investing Fund assets in securities issued by the U.S. Government and its agencies ("Government Securities"). The General Partner is a wholly-owned subsidiary of Merrill Lynch Group Inc., which in turn is a wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML&Co."). The Commodity Broker is an indirect wholly-owned subsidiary of ML&Co. (ML&Co. and its affiliates are herein sometimes referred to as "Merrill Lynch.") The Partnership does not trade directly but rather through a subsidiary limited partnership, ML Principal Protection Trading L.P. (formerly, ML Principal Protection Plus Trading, L.P.) (the "Trading Partnership"), of which the General Partner is the general partner and the Partnership the sole limited partner. See Item 1(c), "Narrative Description of Business -- Two-Tier Structure of the Fund." The Fund offers its units of limited partnership interest ("Units") and receives and processes subscriptions, on a continuous basis, throughout each calendar quarter at $100 per Unit. Investors whose subscriptions are accepted at any time during a calender quarter are admitted to the Fund as Limited Partners as of the beginning of the immediately following quarter. Investors' customer securities accounts are debited in the amount of their subscriptions on settlement dates throughout each quarter shortly after their subscriptions are accepted by MLIP. Subscription proceeds received during a quarter are held in escrow pending investment in Units as of the beginning of the following quarter. All interest earned on subscriptions while held in escrow is paid to the investors on or about the date that Units are issued to them or their subscription is rejected. The Units sold at the beginning of each calendar quarter (and also May 1, 1997) are sold in separate series, each of which has its own Net Asset Value. All series trade pursuant to the same Advisor combination, but because they begin trading at different times they have different Net Asset Values and may have different percentages of their capital invested in the Trading Partnership and allocated to the Trading Advisors for management. Only the assets attributable to each series of Units and allocated to the Trading Partnership are allocated to the Trading Advisors for management. All outstanding series of Units currently being issued initially allocate approximately 75% of their total capital to the Trading Partnership, holding the rest in reserve at the Partnership level. MLIP may from time to time direct certain individual Advisors to manage their Fund accounts as if they were managing up to 50% more equity than the actual capital allocated to them. This additional leverage is subject to the condition that the Fund as a whole will not trade as if it had in excess of 20% more equity than actual capital. -1- When the Fund began trading in October 1994, it had an initial capitalization of $32,000,000. Through December 31, 1997, a total of an additional $110,143,741 had been invested in the Units at subsequent quarter-end closings and also a May 1, 1997 closing (the last sale of the Units occurred as of October 15, 1997). Through December 31, 1997, Units with an aggregate Net Asset Value of $49,025,567 have been redeemed (including December 31, 1997 redemptions which were not actually paid out until January 1998), the Partnership's capitalization was $101,226,685, and the Fund had a total of 3,783 Limited Partners. Through December 31, 1997, the net gain in the Net Asset Value per Series A Unit (the initial series of Units) was 13.73%, the highest month-end Net Asset Value of a Series A Unit was $116.48 (after reducing such Net Asset Value by distributions of $15.50 per Series A Unit ), as of July 1997 , and the lowest $101.04, as of October 1994. The outstanding Series of Units are entitled to fixed-rate annual distributions (which cannot be reduced prior to the first Principal Assurance Date, as defined below, for such Series) and may also receive certain discretionary distributions. MLIP does not presently intend to make any distributions on any series of Units sold after July 16, 1996. The Fund is a "principal protected" commodity pool. ML&Co. provides the guarantee described below ML&Co.'s under 1(c), "Narrative Description of Business -- ML&Co.'s 'Principal Protection' Undertaking to the Fund" that all Units of any given series will have a Net Asset Value -- after payment of all fixed-rate annual as well as discretionary distributions on such Units, in the case of Units sold on or prior to July 16, 1996 -- of at least their initial $100 subscription price as of a specified date after their issuance (the "Principal Assurance Date" for such series, seven years after issuance for all outstanding Series of Units, anticipated to be generally five years after issuance for Series sold after July 16, 1996). This guarantee does not prevent substantial losses, but rather serves only as a form of "stop loss," limiting the maximum loss which investors who retain their Units until such Units' Principal Assurance Date can incur. In order to protect ML&Co. from any liability under its guarantee, MLIP imposes substantial opportunity costs on the Partnership by deleveraging its trading, retaining a substantial portion of the Fund's assets in the Partnership rather than investing such assets in the Trading Partnership for allocation to trading. At such time, if any, as the Net Asset Value per Unit of a Series declined to 110% or less of the present value of $100, plus any fixed-rate annual distributions due on such Series, discounted back from the Principal Assurance Date, MLIP would terminate trading with respect to such Series altogether in order to ensure that ML&Co. incurred no financial obligation to the Fund under ML&Co.'s guarantee of the minimum Net Asset Value per Unit of such Series. In the case of Units sold after July 16, 1996, the potential opportunity costs of the Fund's "principal protection" are significantly increased due to the fact that in the event that MLIP deleverages any particular series of Units, it must deleverage all series to the same degree. A series could be deleveraged as a result of losses which accrued subsequent to such series having recognized profits more than sufficient to offset such losses, but which were earned before a more recent series was issued and, consequently, were not available to offset the same losses incurred by such series. Conversely, losses incurred before a particular series is issued could indirectly cause a further deleveraging of such series' trading due to the effect of such losses on the leverage which MLIP believes it is appropriate to use for an earlier-issued series. (b) Financial Information about Industry Segments: --------------------------------------------- The Partnership's business constitutes only one segment for financial reporting purposes, i.e., a speculative "commodity pool." (c) Narrative Description of Business: --------------------------------- GENERAL The Fund trades in the international futures, options on futures and forward markets, with the objectives of achieving long-term capital appreciation while controlling performance volatility. -2- One of the objectives of the Fund is to provide diversification for a limited portion of the risk segment of the Limited Partners' portfolios. Commodity pool performance has historically often demonstrated a low degree of performance correlation with traditional stock and bond holdings. Since it began trading, the Fund's returns have, in fact, frequently been significantly non-correlated (not, however, negatively correlated) with the United States stock and bond markets. Due to certain concerns expressed by the Securities and Exchange Commission (the "SEC") regarding whether the different series of Units issued by the Partnership were significantly similar to each other for the Partnership to be considered to be engaged in a "continuous offering" of the same class of security, i.e., the Units (which the Partnership must be in order not to be able to offer the Units on an ongoing open-end basis), MLIP changed the terms of all series to be issued after July 16, 1996 to provide that: (i) no distributions are intended to be made on any such series; (ii) any discretionary trading leverage adjustments would have to be made so that after any such adjustments all series were trading at the same degree of leverage (i.e., with the same percentage of their total capital invested in the Trading Partnership and allocated to the Advisors for management); and (iii) all series would have the same five year "Time Horizon" between their respective issuance dates and their respective Principal Assurance Dates. The series issued on and prior to July 16, 1996 have seven-year Time Horizons, are entitled to fixed rate as well as discretionary distributions and contemplate MLIP adjusting the leverage of each series in MLIP's discretion on an individual series-by-series basis. ML&CO.'S "PRINCIPAL PROTECTION" UNDERTAKING TO THE FUND ML&Co. has agreed to contribute sufficient capital to the Partnership so that it will have adequate funds, after adjusting for all liabilities to third parties, that the Net Asset Value per Unit of each Series will be no less than $100 as of the Principal Assurance Date for such Series (after the payment of all distributions, if any, on Units of such Series). This guarantee, which is effective with respect to any given Series as of the Principal Assurance Date for such Series, is a guarantee only of a return of an investor's initial investment (plus distributions, if any), and not on a present value basis, not a guarantee of profit. OPERATION OF A SERIES AFTER ITS PRINCIPAL ASSURANCE DATE MLIP may determine to dissolve a Series as of its Principal Assurance Date, to extend the ML&Co. guarantee for a certain period of time (resetting the minimum Net Asset Value per Unit of such Series guaranteed by ML&Co.) or to continue to operate such Series without a "principal protection" feature. TWO-TIER STRUCTURE OF THE FUND The Fund does not trade in the futures and forward markets directly, but rather through the Trading Partnership, of which the Fund is the sole limited, and MLIP the sole general partner. The Fund's liability for any trading losses is limited to the Fund's investment in the Trading Partnership. USE OF PROCEEDS AND CASH MANAGEMENT INCOME Subscription Proceeds. MLIP pays from its own funds the selling --------------------- commissions relating to the sale of the Units. Accordingly, 100% of the proceeds of Unit sales are received in cash by the Partnership and available for use in its speculative trading. In such trading, the Partnership's assets are used as security for and to pay the Partnership's trading losses as well as any expenses and redemptions. The primary use of the proceeds of the sale of the Units is to permit the Advisors to trade on a speculative basis in a wide range of different futures, forwards and options on futures markets on behalf of the Trading Partnership. While being used for this purpose, the Partnership's assets are also generally available for cash management and to earn interest, as more fully described below under "-- Available Assets." Market Sectors. The Partnership trades in a diversified group of -------------- markets under the direction of multiple independent Advisors. These Advisors can, and do, from time to time materially alter the allocation of their overall trading commitments among different market sectors. Except in the case of certain trading programs which are purposefully limited in the markets which they trade, there is essentially no restriction on the commodity interests which may be traded by any Advisor or the rapidity with which an Advisor may alter its market sector allocations. -3- The Fund's financial statements contain information relating to the market sectors traded by the Fund. There can, however, be no assurance as to which markets may be included in the Fund's portfolio or as to in which market sectors the Fund's trading may be concentrated at any one time or over time. Market Types. The Partnership trades on a variety of United States ------------ and foreign futures exchanges. Applicable exchange rules differ significantly among different countries and exchanges. Substantially all of the Fund's off- exchange trading takes places in the highly liquid, institutionally-based currency forward markets. The forward markets are generally unregulated, and in its forward trading the Fund does not deposit margin with respect to its positions. The Partnership's forward currency trading is executed exclusively through the Foreign Exchange Service Desk (the "F/X Desk") operated by MLIP and certain of its affiliates, with MLF as the "back-to-back" intermediary to the ultimate counterparties, which include Merrill Lynch International Bank ("MLIB") with which the Advisors trade on behalf of the Fund. As in the case of its market sector allocations, the Fund's commitments to different types of markets -- U.S. and non-U.S., regulated and unregulated -- differ substantially from time to time as well as over time. The Fund has no policy restricting its relative commitments to any of these different types of markets. The Fund's financial statements contain information relating to the types of markets traded by the Fund. There can, however, be no assurance as to in which markets the Fund may trade or the Fund's trading may be concentrated at any one time or over time. Custody of Assets. All of the Fund's assets -- other than the assets ----------------- managed by MLAM and held in a custodial account as described below under "--The Fund's U.S. Dollar Available Assets Managed by MLAM" -- are currently held in customer accounts at Merrill Lynch. Available Assets. The Fund earns interest, as described below, on its ---------------- "Available Assets," which can be generally described as the cash actually held by the Fund or invested in short-term Treasury bills. Available Assets are held primarily in U.S. dollars or in U.S. dollar denominated Government Securities, and to a lesser extent in foreign currencies, and are comprised of the following: (a) the Fund's cash balances managed by MLAM or held in the offset accounts (as described below) -- which include "open trade equity" (unrealized gain and loss on open positions) on United States futures contracts, which is paid into or out of the Fund's account on a daily basis; and (b) the Fund's cash balance in foreign currencies derived from its trading in non-U.S. dollar denominated futures and options contracts, which includes open trade equity on those exchanges which settle gains and losses on open positions in such contracts prior to closing out such positions. Available Assets do not include, and the Fund does not earn interest on, the Fund's gains or losses on its open forward, commodity option and certain foreign futures positions since such gains and losses are not collected or paid until such positions are closed out. The Partnership's Available Assets may be greater than, less than or equal to the Fund's Net Asset Value (on which the redemption value of the Units is based) primarily because Net Asset Value reflects all gains and losses on open positions as well as accrued but unpaid expenses. The interest income arrangements for the Partnership's U.S. dollar Available Assets differ from those applicable to its non-U.S. dollar Available Assets. Interest income, once accrued by the Fund, is subject to the risk of trading losses. The Fund's U.S. Dollar Available Assets Managed by MLAM. ------------------------------------------------------- Approximately 80% of the Fund's U.S. dollar Available Assets are managed directly by MLAM, pursuant to guidelines established by MLIP for which MLAM assumes no responsibility, in the Government Securities markets. MLIP's objective in retaining MLAM to provide cash management services to the Fund is to enhance the return earned on the Fund's U.S. dollar Available Assets managed by MLAM to slightly above the 91-day Treasury bill rate, while maintaining minimal (but by no means eliminating) market risk in the Fund's cash management operations. The Government Securities acquired by MLAM on behalf of the Fund are maintained in a custodial account at a Merrill Lynch affiliate and are specifically traceable to the Fund. All income earned on such Government Securities inures to the benefit of the Fund. -4- MLF pays all fees due to MLAM in respect of its management of a portion of the Fund's U.S. dollar Available Assets, at no additional cost to the Fund. MLAM does business as Merrill Lynch Asset Management. MLAM is a limited partnership. ML&Co. is its limited partner, and Princeton Services, Inc., a wholly-owned subsidiary of ML&Co., is the general partner. Interest Earned on the Fund's U.S. Dollar Available Assets Not Managed ---------------------------------------------------------------------- by MLAM. The following description relates to the approximately 20% of the - ------- Fund's U.S. dollar Available Assets not managed by MLAM. The Fund's U.S. dollar Available Assets not managed by MLAM are held in cash in offset accounts and in short-term Treasury bills purchased from dealers unaffiliated with Merrill Lynch. Offset accounts are non-interest bearing demand deposit accounts maintained with banks unaffiliated with Merrill Lynch. An integral feature of the offset arrangements is that the participating banks specifically acknowledge that the offset accounts are MLF customer accounts, not subject to any Merrill Lynch liability. MLF credits the Partnership, as of the end of each month, with interest at the effective daily 91-day Treasury bill rate on the average daily U.S. dollar Available Assets held in the offset accounts during such month. The Fund receives all the interest paid on the short-term Treasury bills in which it invests. The use of the offset account arrangements for the Partnership's U.S. dollar Available Assets not managed by MLAM may be discontinued by Merrill Lynch whether or not Merrill Lynch otherwise continues to maintain its offset arrangements. The offset arrangements are dependent on the banks' continued willingness to make overnight credits available to Merrill Lynch, which, in turn, is dependent on the credit standing of ML&Co. If Merrill Lynch were to determine that the offset arrangements had ceased to be practicable (either because ML&Co. credit lines at participating banks were exhausted or for any other reason), Merrill Lynch would thereafter attempt to invest all of the Fund's U.S. dollar Available Assets not managed by MLAM to the maximum practicable extent in short-term United States Treasury bills. All interest earned on the U.S. dollar Available Assets so invested would be paid to the Fund, but MLIP would expect the amount of such interest to be less than that available to the Fund under the offset account arrangements. The remaining U.S. dollar Available Assets of the Fund not managed by MLAM would be kept in cash to meet variation margin payments and pay expenses, but would not earn interest for the Fund. The banks at which the offset accounts are maintained make available to Merrill Lynch interest-free overnight credits, loans or overdrafts in the amount of the Fund's U.S. dollar Available Assets held in the offset accounts, charging Merrill Lynch a small fee for this service. The economic benefits derived by Merrill Lynch -- net of the interest credits paid to the Fund and the fee paid to the offset banks -- from the offset accounts have not exceeded 3/4 of 1% per annum of the Fund's average daily U.S. dollar Available Assets not managed by MLAM and held in the offset accounts. These revenues to Merrill Lynch are in addition to the Brokerage Commissions and Administrative Fees paid by the Fund to MLF and MLIP, respectively. Interest Paid by Merrill Lynch on the Fund's Non-U.S. Dollar Available ---------------------------------------------------------------------- Assets. Under the single currency margining system implemented for the - ------- Partnership, the Partnership itself does not deposit foreign currencies to margin trading in non-U.S. dollar denominated futures contracts and options. MLF provides the necessary margin, permitting the Fund to retain the monies which would otherwise be required for such margin as part of the Partnership's U.S. dollar Available Assets. The Partnership does not earn interest on foreign margin deposits provided by MLF. The Partnership does, however, earn interest on its non-U.S. dollar Available Assets. Specifically, the Fund is credited by Merrill Lynch with interest at the local short-term rate on realized and unrealized gains on non-U.S. dollar denominated positions for such gains actually held in cash by the Fund (MLAM does not manage any of the Fund's non- U.S. dollar Available Assets.). Merrill Lynch charges the Fund Merrill Lynch's cost of financing realized and unrealized losses on such positions. In order to avoid the expense of daily currency conversions, the Partnership holds foreign currency gains and finances foreign currency losses on an interim basis until converted into U.S. dollars and either paid into or out of the Partnership's U.S. dollar Available Assets. Foreign currency gains or losses on open positions are not converted into U.S. dollars until the positions are closed. Assets of the Partnership while held in foreign currencies are subject to exchange rate risk. -5- ____________________ The General Partner has determined that there may have been a miscalculation in the interest credited to the Fund for a period prior to November 1996. Accordingly, Merrill Lynch has credited the Fund's investors. For current Merrill Lynch clients, this credit, which includes compounded interests, appears on the December 1997 account statements. The total amount of the adjustment is approximately $54,000. CHARGES The following table summarizes the charges incurred by the Fund during 1995, 1996 and 1997.
1995 1996 1997 --------- --------- -------- % OF % OF % OF AVERAGE AVERAGE AVERAGE DOLLAR MONTH-END DOLLAR MONTH-END DOLLAR MONTH-END COST AMOUNT NET ASSETS* AMOUNT NET ASSETS AMOUNT NET ASSETS* ---- ------ ------------ ------ ---------- ------ ----------- Brokerage Commissions $3,303,292 5.92% $4,775,116 5.77% $4,833,598 5.64% Administrative Fees - - 129,057 0.16 138,103 0.16 Reimbursement of Organizational and Initial Offering Costs 79,700 0.14 79,700 0.10 61,989 0.07 Profit Shares 652,366 1.17 978,264 1.18 931,522 1.09 ---------- ---- ---------- ---- ---------- ---- Total $4,035,358 7.23% $5,962,137 7.21% $5,965,212 6.96% ========== ==== ========== ==== ========== ====
* Only approximately 60% of the Fund's average month-end Net Assets were allocated to trading during the periods presented. Series of Units issued subsequent to July 16, 1996 (no such Units have been issued as of the date of this Report) will commence trading with 75% of their assets allocated to trading. Consequently, the percentage figures presented would be correspondingly higher as a percentage of the Fund's average month-end Net Assets. ____________________ THE FLAT-RATE BROKERAGE COMMISSIONS AND ADMINISTRATIVE FEES WILL IN THE FUTURE BE HIGHER THAN THOSE IN THE FOREGOING TABLE AS THE UNITS ISSUED AFTER JULY 16, 1996 WILL TRADE AT 75% RATHER THAN 60% INITIAL LEVERAGE. ____________________ -6- The foregoing table does not reflect the bid-ask spreads paid by the Fund on its forward trading, or the benefits which may be derived by Merrill Lynch from the deposit of certain of the Fund's U.S. dollar available assets in offset accounts. See Item 1(c), "Narrative Description of Business -- Use of Proceeds and Cash Management Income." The Fund's average month-end Net Assets during 1995, 1996 and 1997 equaled $55,827,125, $82,789,767 and $85,646,152 respectively. During 1995, 1996 and 1997, the Fund earned $3,415,670, $4,545,186 and $4,873,872 in interest income, or approximately 6.12%, 5.49% and 5.69% of the Fund's average month-end Net Assets. Effective January 1, 1997, MLIP reduced the Fund's annual Brokerage Commissions from 9.25% to 8.75% of trading assets (i.e., assets committed to trading). DESCRIPTION OF CURRENT CHARGES
RECIPIENT NATURE OF PAYMENT AMOUNT OF PAYMENT - --------- ----------------- ----------------- MLF Brokerage Commissions A flat-rate monthly commission of 0.7291 of 1% (an 8.75% annual rate) of the Fund's month-end assets committed to trading. The Fund initially commits 8.75% of the capital attributable to each series of Units issued after July 16, 1996 to trading. During 1995, 1996 and 1997, the round-turn (each purchase and sale or sale and purchase of a single futures contract) equivalent rate of the Fund's flat-rate Brokerage Commissions was approximately $134, $116, and $116 respectively. The round-turn rate for 1995 and 1996 reflect Brokerage Commissions at the rate of 9.25% per annum. As of January 1, 1997, the 9.25% per annum Brokerage Commissions were reduced to 8.75% per annum (0.7291 of 1% of the Fund's month-end assets). MLF Use of Fund assets Merrill Lynch may derive an economic benefit from the deposit of certain of the Fund's U.S. dollar Available Assets not managed by MLAM in offset accounts; this benefit to date has not exceeded 3/4 of 1% of such average daily U.S. dollar Available Assets. MLIP Administrative Fees The Fund pays MLIP a monthly Administrative Fee equal to 0.020833 of 1% (a 0.25 of 1% annual rate) of the Fund's month-end assets committed to trading. MLIP pays the Fund's routine administrative costs. MLIB Bid-ask spreads Under MLIP's F/X Desk arrangements, MLIB receives bid-ask spreads on the forward trades it executes with the Fund.
-7- DESCRIPTION OF CURRENT CHARGES (cont) Other Bid-ask spreads The counterparties other than MLIB with which the Counterparties F/X Desk deals each also receive bid-ask spreads on the forward trades executed with the Fund. MLIP F/X Desk service fees Under the F/X Desk arrangements, MLIP or another Merrill Lynch entity receives a service fee equal, at current exchange rates, to approximately $5.00 to $12.50 on each purchase or sale of each futures contract-equivalent forward contract executed with counterparties other than MLIB. MLIB EFP differentials MLIB or an affiliate receives a differential spread for exchanging the Fund's spot currency positions (which are acquired through the F/X Desk, as described above) for equivalent futures positions. Government Bid-ask spreads The dealers with which MLAM executes Government Securities Securites trades include bid-ask spreads in the prices Dealers they quote to the Fund. Trading Advisors Profit Shares Prior to January 1, 1997, all Advisors received quarterly Profit Shares ranging from 15% to 25% (depending on the Trading Advisor) of any New Trading Profit. As of January 1, 1997, a number of Advisors agreed to receive only annual Profit Shares. Profit Shares are also paid upon redemption of Units. New Trading Profit is calculated separately in respect of each Advisor, irrespective of the overall performance of the Fund. The Fund may pay substantial Profit Shares during periods when it is incurring significant overall losses. MLF; Extraordinary expenses Actual costs incurred; none paid to date, and expected Others to be negligible.
------------------------ REGULATION The General Partner, the Trading Advisors and the Commodity Broker are each subject to regulation by the Commodity Futures Trading Commission (the "CFTC") and the National Futures Association. Other than in respect of its periodic reporting requirements under the Securities Exchange Act of 1934, and the registration of the Units for continuous public distribution under the Securities Act of 1933, the Partnership itself is generally not subject to regulation by the Securities and Exchange Commission. However, MLIP itself is registered as an "investment adviser" under the Investment Advisers Act of 1940. (i) through (xii) -- not applicable. (xiii) The Partnership has no employees. -8- (d) Financial Information about Foreign and Domestic Operations and Export ---------------------------------------------------------------------- Sales: - ----- The Partnership and the Trading Partnership do not engage in material operations in foreign countries, nor is a material portion of the Partnership's revenues derived from customers in foreign countries. The Trading Partnership does, however, trade, from the United States, on a number of foreign commodity exchanges. ITEM 2: PROPERTIES ---------- Neither the Partnership nor the Trading Partnership use any physical properties in the conduct of its business. The Partnership's and the Trading Partnership's only place of business is the place of business of the General Partner (see Item 10 herein). The General Partner performs all administrative services for the Partnership and the Trading Partnership from the General Partner's offices. ITEM 3: LEGAL PROCEEDINGS ----------------- ML&Co. -- the sole stockholder of Merrill Lynch Group, Inc. (which is the sole stockholder of MLIP) -- as well as certain of its subsidiaries and affiliates have been named as defendants in civil actions, arbitration proceedings and claims arising out of their respective business activities. Although the ultimate outcome of these actions cannot be ascertained at this time and the results of legal proceedings cannot be predicted with certainty, it is the opinion of management that the result of these matters will not be materially adverse to the business operations of financial condition of MLIP or the Fund. MLIP itself has never been the subject of any material litigation. On June 24, 1997, the CFTC accepted an Offer of Settlement from MLF and others, in a matter captioned "In the Matter of Mitsubishi Corporation and Merrill Lynch Futures Inc., et al.," CFTC Docket No. 97-10, pursuant to which MLF, without admitting or denying the allegations against it, consented to a finding by the Commission that MLF had violated Section 4c(a)(A) of the Commodity Exchange Act, relating to wash sales (the CFTC alleged that the customer entered nearly simultaneous orders without the intent to engage in a bona fide trading transaction), and CFTC Regulation 1.37(a), relating to recordkeeping requirements. MLF agreed to cease and desist from violating Section 4c(a)(A) of the Act and Regulation 1.37(a), and to pay a civil monetary penalty of $175,000. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- The Partnership has never submitted any matters to a vote of its Limited Partners. PART II ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS --------------------------------------------------------------------- (a) Market Information: ------------------ There is no established public trading market for the Units, nor will one develop. Rather, Limited Partners may purchase or redeem Units as of the end of each month at Net Asset Value, subject to certain early redemption charges. Units redeemed prior to the Principal Assurance Date are not entitled to any benefits under the Merrill Lynch & Co., Inc. guarantee. (b) Holders: ------- As of December 31, 1997, there were 3,793 holders of Units, including the General Partner. -9- (c) Dividends: --------- For series issued on or prior to July 16, 1996, the Partnership makes annual fixed-rate distributions, payable irrespective of profitability, of between $2 and $5 per Unit (depending upon the series). The General Partner may also make discretionary distributions of up to 50% of any Distributable New Appreciation, as defined, recognized as of each twelve-month anniversary of the issuance of each series of Units, subject to an annual limit of 4% of the Net Asset Value per Unit of each series as of the beginning of the preceding twelve- month period. The first such distribution with respect to the Series A Units took place on October 1, 1995. At such time Series A Unitholders received a fixed-rate distribution equal to $3.50 per Unit and a discretionary distribution equal to $2.50 per Unit (for a total distribution of $6.00 per Unit). Series A Unitholders received another distribution of $6.00 per Unit on October 1, 1996. Series A Unitholders received a fixed-rate distribution of $3.50 on October 1, 1997. The first distribution with respect to Series B Units took place on January 1, 1996. At such distribution, Series B Unitholders also received a fixed-rate distribution equal to $3.50 per Unit and a discretionary distribution equal to $2.50 per Unit (for a total distribution of $6.00 per Unit). On January 1, 1997, Series B received a fixed-rate distribution of $3.50 and a discretionary distribution of $3.00. The first of such distributions for Series C, D and E of a fixed rate distribution of $3.50 per Unit took place on April 1, 1996, July 1, 1996 and October 1, 1996, respectively. On April 1, 1997, Series C received a fixed rate dividend of $3.50 and a discretionary dividend of $4.00. On July 1, 1997, Series D received a fixed-rate dividend of $3.50 and a discretionary dividend of $1.00. On October 1, 1997, Series E received a fixed- rate dividend of $3.50 and a discretionary dividend of $2.00. On January 1, 1997, Series F received a fixed-rate dividend of $3.50 and a discretionary dividend of $2.50. On April 1, 1997, Series G received a fixed-rate dividend of $3.50 and a discretionary dividend of $3.50. On July 1, 1997, Series H received a fixed-rate distribution of $3.50 and a discretionary distribution of $2.50. Distributions, whether fixed-rate or discretionary, do not reduce the $100 minimum Net Asset Value per Unit assured to investors as of the Principal Assurance Date for their series of Units. The Fund does not make any distributions on any series of Units issued subsequent to July 16, 1996. (d) Recent Sales of Unregistered Securities; --------------------------------------- Use of Proceeds from Registered Securities ------------------------------------------ The Fund has 2,250,000 Units of limited partnership interest, with an aggregate price of $225,000,000. The Fund has sold 1,467,958.85 Units of limited partnership interest, with an aggregate price of $146,890,977. -10- ITEM 6: SELECTED FINANCIAL DATA ----------------------- The following selected financial data has been derived from the audited financial statements of the Partnership:
JANUARY 1, JANUARY 1, OCTOBER 12, 1994 1997 1996 JANUARY 1, 1995 (COMMENCEMENT TO TO TO OF OPERATIONS) TO DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, ------------ ------------ ------------ ------------ 1997 1996 1995 1994 ---- ---- ---- ---- INCOME STATEMENT DATA Revenues: Trading Profits (Loss) Realized Gain (Loss) $ 5,412,457 $ 9,038,064 $ 4,407,833 $ (363,054) Change in Unrealized (Loss) Gain 1,083,826 (396,221) 1,355,377 1,115,935 ------------ ----------- ----------- ----------- Total Trading Results 6,496,283 8,641,843 5,763,210 752,881 Interest Income 4,873,872 4,545,186 3,415,670 377,303 ------------ ----------- ----------- ----------- Total Revenues 11,370,155 13,187,029 9,178,880 1,130,184 ------------ ----------- ----------- ----------- Expenses: Brokerage Commissions 4,833,598 4,775,116 3,303,292 405,653 Administrative Fees/1/ 138,103 129,057 - 10,964 Profit Shares 931,522 978,264 652,366 129,169 ------------ ----------- ----------- ----------- Total Expenses 5,903,223 5,882,437 3,955,658 545,786 ------------ ----------- ----------- ----------- Net Income Before Minority Interest 5,466,932 7,304,592 5,223,222 584,398 Minority Interest /2/ (46,687) (81,228) (36,730) (4,504) ------------ ----------- ----------- ----------- Net Income $ 5,420,245 $ 7,223,364 $ 5,186,492 $ 579,894 ============ =========== =========== ===========
-11-
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, ------------ ------------ ------------ ------------ 1997 1996 1995 1994 ---- ---- ---- ---- BALANCE SHEET DATA/3/ - ------------------ AGGREGATE NET ASSET VALUE (Series A-M) $101,226,685 $78,905,273 $74,846,544 $32,314,228 NET ASSET VALUE PER UNIT Series A $ 113.73/4/ $ 110.70/5/ $ 106.96/6/ $101.76 Series B $ 114.15/4/ $ 114.24/5/ $ 110.36 N/A Series C $ 108.15/4/ $ 109.33/5/ $ 103.35 N/A Series D $ 109.94/4/ $ 108.19/5/ $ 102.34 N/A Series E $ 109.40/4/ $ 108.58/5/ $ 102.72 N/A Series F $ 109.04/4/ $ 108.92 N/A N/A Series G $ 106.52/4/ $ 107.32 N/A N/A Series H $ 106.62/4/ $ 106.47 N/A N/A Series K $ 104.77/4/ N/A N/A N/A Series L $ 102.08/4/ N/A N/A N/A Series M $ 103.70/4/ N/A N/A N/A
/1/ As of January 1, 1996, a portion of the Brokerage Commissions were reclassified as Administrative Fees, at no additional cost to the Fund. Certain amounts in prior periods have been reclassified to conform to the current period presentation of the Administrative Fees. /2/ MLIP is general partner of the Trading Partnership. Because the Fund owns substantially all of the Trading Partnership, Trading Partnership activities are referred to as Fund activities in this Report. The minority interest represents MLIP's share, as general partner of the Trading Partnership, of the Trading Partnership's profit or loss. /3/ Balance Sheet Data is based on redemption values which differ immaterially from Net Asset Values as determined under Generally Accepted Accounting Principals ("GAAP") due to the treatment of organizational and initial offering cost reimbursements. /4/ Net of aggregate distributions of $15.50 per Unit on the Series A Units, $12.50 on the B Units and $11.00 on the Series C, $8.00 on the Series D Units, $9.00 on the Series E Units, $6.00 on the Series F Units, $7.00 on the Series G Units and $6.00 on the Series H Units. /5/ Net of aggregate distributions of $12.00 per Unit on the Series A Units, $6.00 on the B Units and $3.50 on the Series C, D and E Units. /6/ Net of the distribution of $6.00 per Unit on the Series A Unit. - -------------------- -12- ML PRINCIPAL PROTECTION L.P. DECEMBER 31, 1997 Type of Pool: Multi-Advisor; Selected Advisor/Publicly-Offered/"Principal Protected"/(1)/ Inception of Trading: October 12, 1994 Aggregate Subscriptions: 141,979,656 Current Capitalization: $101,226,685 Worst Monthly Drawdown:/(2)/ (3.70)% (2/96) Worst Peak-to-Valley Drawdown:/(3)/ (3.70)% (2/96)
- ---------------------------------------------------- MONTHLY RATES OF RETURN/(4)/ - ---------------------------------------------------- MONTH 1997 1996 1995 1994 - ---------------------------------------------------- January 2.06% 2.45% (0.55)% -- - ---------------------------------------------------- February 1.44 (3.70) 2.24 -- - ---------------------------------------------------- March 0.05 1.06 4.17 -- - ---------------------------------------------------- April (0.70) 3.10 0.91 -- - ---------------------------------------------------- May (1.43) (1.98) 1.20 -- - ---------------------------------------------------- June 0.70 1.36 (0.21) -- - ---------------------------------------------------- July 3.14 (1.68) (1.30) -- - ---------------------------------------------------- August (2.71) 0.49 0.95 -- - ---------------------------------------------------- September 0.86 1.62 (0.32) -- - ---------------------------------------------------- October (0.43) 4.25 0.29 1.04 - ---------------------------------------------------- November 0.80 2.50 0.69 0.32 - ---------------------------------------------------- December 2.22 (0.20) 2.12 0.40 - ---------------------------------------------------- Compound 6.01% 9.36% 10.55% 1.76% Rate of Return (2 2/3% months) - ----------------------------------------------------
Rates of Return are presented on a composite, not a series-by-series, basis. _________________________ THE UNITS ISSUED AFTER JULY 16, 1996 COMMENCE TRADING WITH 75% OF THEIR ASSETS ALLOCATED TO TRADING. ALL SERIES OF UNITS ISSUED TO DATE HAVE TRADED AT ONLY APPROXIMATELY 60% LEVERAGE. INCREASING TRADING LEVERAGE SHOULD INCREASE MONTHLY RATES OF RETURN (BOTH POSITIVE AND NEGATIVE), DRAWDOWNS, PROFIT POTENTIAL, RISK AND VOLATILITY. _________________________ (1) Pursuant to applicable CFTC regulations, a "Multi-Advisor" fund is defined as one that allocates no more than 25% of its trading assets to any single manager. The Fund does not currently allocate more than 25% of its trading assets to any single Advisor but may do so in the future; consequently, it is referred to as a"Multi-Advisor; Selected Advisor" fund. Certain funds, including funds sponsored by MLIP, are structured so as to guarantee to investors that their investment will be worth no less than a specified amount (typically, the initial purchase price) as of a date certain after the date of investment. The CFTC refers to such funds as "principal protected." The ML&Co. Guarantee and MLIP related deleveraging of the Fund's trading provides the "principal protection" feature of the Fund. (2) Worst Monthly Drawdown represents the largest negative Monthly Rate of Return experienced by the Fund; a drawdown is measured on the basis of month-end Net Asset Value only, and does not reflect intra-month figures. (3) Worst Peak-to-Valley Drawdown represents the greatest percentage decline from a month-end cumulative Monthly Rate of Return without such cumulative Monthly Rate of Return being equaled or exceeded as of a subsequent month-end. For example, if the Monthly Rate of Return was (1)% in each of January and February, 1% in March and (2)% in April, the Peak-to-Valley Drawdown would still be continuing at the end of April in the amount of approximately (3)%, whereas if the Monthly Rate of Return had been approximately 3% in March, the Peak-to-Valley Drawdown would have ended as of the end of February at approximately the (2)% level. (4) Monthly Rate of Return is the net performance of the Fund during the month of determination (including interest income and after all expenses accrued or paid) divided by the total equity of the Fund as of the beginning of such month. The composite returns of the Fund reflect the results of the Fund as a whole, not the performance of any single series of Units (however, the composite returns closely match during the same period the performance of all series then outstanding). Although the series begin trading at different times and, accordingly, have materially different cumulative returns, as all series participate in the same trading account and at approximately the same degree of leverage, the only significant difference between the performance of different series during a given month is typically the different amount of Profit Shares paid. In no month has any series had a rate of return 10% higher or lower than any other series. -13-
MONTH-END NET ASSET VALUE PER SERIES A UNIT - ------------------------------------------------------------------------------------------------------------------------------------ JAN. FEB. MAR. APR. MAY JUNE JULY AUG. SEPT. OCT. NOV. DEC. - ------------------------------------------------------------------------------------------------------------------------------------ 1994 N/A N/A N/A N/A N/A N/A N/A N/A N/A $ 101.04 $ 101.36 $ 101.76 1995 $ 101.36 $ 103.63 $ 107.94 $ 109.09 $ 110.40 $ 110.18 $ 108.94 $ 109.98 $ 109.62 $ 103.91* $ 104.63* $ 106.96* - ------------------------------------------------------------------------------------------------------------------------------------ 1996 $ 109.65* $ 105.56* $ 106.69* $ 110.05* $ 107.82* $ 109.33* $ 107.51* $ 108.04* $ 109.80* $108.24** $ 110.93** $ 110.70** - ------------------------------------------------------------------------------------------------------------------------------------ 1997 $113.00** $114.63** $114.69** $113.89** $112.28** $113.05** $116.48** $113.59** $114.53** $110.69** $111.50*** $113.73*** - ------------------------------------------------------------------------------------------------------------------------------------
* After reduction for the $6.00 per Series A Unit distribution made as of October 1, 1995. ** After reduction for the second $6.00 per Series A Unit distribution made as of October 1, 1996. *** After reduction for the $3.50 per Series A Unit distribution made as of October 1, 1997. -14- ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS - --------------------- THE TWO-TIER STRUCTURE OF THE FUND The Fund does not trade directly through opening managed accounts with the Advisors, but rather through investing in the Trading Partnership. The Trading Partnership, in turn, allocates substantially all of its capital to the Advisors, and the different series of Units share pro rata in the overall profits and losses of the Trading Partnership based on their respective investments in it. No series of Units can lose more in its trading than the amount which such series has invested in the Trading Partnership. Although different series of Units invest different percentages of their overall capital in the Trading Partnership, all assets so invested are 100% allocated to trading. All trading losses are shared pro rata among the different series based on their respective investments in the Trading Partnership. The use of the Trading Partnership by the Fund has no effect on the leverage at which the different series of Units trade. The Fund trades through investing in the Trading Partnership rather than directly, solely in order to eliminate the highly unlikely risk that one series of Units might be subject to paying trading debts attributable to another. This risk arises because it is theoretically possible that catastrophic losses could deplete all the assets of a particular series allocated to the Advisors for management. Any remaining losses would remain a debt of the Fund to which all other series' capital would be subject. The Fund/Trading Partnership structure eliminates the risk of such inter-series liability. The CFTC would not permit the Fund to continue the offering of the Units unless such inter-series liability were eliminated. For example, assume that each of Series I and Series II Units had $10 million in capital, and Series I allocated $9.5 million (95% leverage) and Series II $8.5 million (85% leverage) to the Trading Partnership. If losses bankrupted the Trading Partnership, each Series' trading account would share pro rata in such losses. The Series I Units would create a larger deficit balance because of the higher degree of leverage at which that Series traded. However, there would be no risk that, for example, a $3 million deficit balance allocable to Series I trading account would be subject to being repaid from any of the $1.5 million withheld from trading by the Series II Units (or from any of the $0.5 million withheld from trading by the Series I Units, for that matter), because the Fund itself is not liable for the debts of its subsidiary Trading Partnership. Any deficit balance incurred by a bankrupt Trading Partnership would become an uncollectible debt due to MLF. MLF accepts such deficit balance risk each time it accepts a limited liability entity such as the Trading Partnership as a client. There is no benefit (or detriment) to investors from the two-tier Fund/Trading Partnership structure other than permitting the Fund to issue the series of Units at different times, which series, may, over time, trade with different percentages of their capital allocated to trading. OPERATIONAL OVERVIEW; ADVISOR SELECTIONS The Fund's results of operations depend on MLIP's ability to select Advisors and the Advisors' ability to trade profitably. MLIP's selection procedures and trading leveraging analysis, as well as the Advisors' trading methods, are confidential, so that substantially the only available information relevant to the Fund's results of operations is its actual performance record to date. [Global Futures and Forward Market Chart Appears Here] MLPF&S Investors | Custody | |-------------------Agreement | Cash Management | Limited Partnership of Fund and Trading | Units Partnership Assets held | | at MLPF&S and MLF | | Sole | | | General | |----------- ML Principal Partner MLAM ------------------------------- Protection L.P. ------------- MLIP Cash Management | Investment (the "Fund") | of Fund and Trading | Advisory | | Partnership Assets held| Contract Sole | at MLPF&S and MLF | Limited Partner | Sole | | Customer | | General | -Agreement--------ML Principal---------| Partner MLF ---------------------------- Protection Trading L.P. F/X Desk (the "Trading Service Agreement Partnership") | | | Advisor Advisor Advisor | | | Global Futures and Forward Markets -15- However, because of the speculative nature of its trading, the Fund's past performance is not necessarily indicative of its future results. MLIP's decision to terminate or reallocate assets among Trading Advisors is based on a combination of numerous factors. Advisors are, in general, terminated primarily for unsatisfactory performance, but other factors -- for example, a change in MLIP's or an Advisor's market outlook, apparent deviation from announced risk control policies, excessive turnover of positions, changes in principals, commitment of resources to other business activities, etc. -- may also have a role in the termination or reallocation decision. The market judgment and experience of MLIP's principals is an important factor in its allocation decisions. MLIP has no timetable or schedule for making Advisor changes or reallocations, and generally makes a medium- to long-term commitment to all Advisors selected. There can be no assurance as to the frequency or number of the Advisor changes that may take place in the future, or as to how long any of the current Advisors will continue to manage assets for the Partnership. RESULTS OF OPERATIONS General. MLIP believes that multi-advisor futures funds should be ------- regarded as medium- to long-term (i.e., three to five year) investments, but it is difficult to identify trends in the Fund's operations and virtually impossible to make any predictions regarding future results based on the results to date. An investment in the Fund may be less successful over a longer than a shorter period. Markets with sustained price trends tend to be more favorable to managed futures investments than whipsaw, choppy markets, but (i) this is not always the case, (ii) it is impossible to predict when price trends will occur and (iii) different Advisors are affected differently by trending markets as well as by particular types of trends. MLIP attempts to control credit risk in the Fund's futures, forward and options trading (the Fund does not trade derivatives other than futures and forward contracts and options thereon) by trading only through MLF. MLF acts solely as a broker or counterparty to the Fund's trades; it does not advise with respect to, or direct, any such trading. MLIP attempts to control the market risk inherent in the Fund's trading by MLIP multi-advisor structuring and Trading Advisor selection. MLIP reviews the positions acquired by the Advisors on a daily basis in an effort to determine whether the overall positions of the Fund may have become what MLIP analyzes as being excessively concentrated in a limited number of markets or under the direction of generally similar strategies -- in which case MLIP may, as of the next month-end or quarter-end, adjust the Fund's Advisor combination and/or allocations so as to attempt to reduce the risk of such over-concentration occurring in the future. MLIP also adjusts the percentage of each series' capital allocated to trading, with the principal objective of protecting ML&Co. from any liability under its guarantee of a $100 minimum Net Asset Value per Unit as of the Principal Assurance Date for each of the respective series of Units. The market risk to the Fund is limited by the combination of its "principal protection" feature and its multi-advisor strategy. Prior to July 16, 1996, all series of Units initially allocated approximately 60% of their assets to trading. All series of Units sold after July 16, 1996 initially allocate 75% of their assets to trading. MLIP's determination as to how much of a series' capital to allocate to trading from time to time -- again, a determination primarily dictated by MLIP's objective of ensuring that ML&Co. is never required to make any payments under its guarantee that the Net Asset Value per Unit of each series will be at least $100 as of such series' Principal Assurance Date-- has a material impact on the performance of such series. In the case of Units issued subsequent to July 16, 1996, MLIP's ability to adjust the leverage at which these series trade is restricted by the regulatory requirement that if MLIP adjusts the leverage of any one such series, it must adjust the leverage of all such series so that all are trading with the same percentage of their total capital allocated to trading. MLIP may consider making distributions on the Units offered subsequent to July 16, 1996 under certain circumstances (for example, if substantial profits are recognized); however, MLIP does not presently intend to do so. MLIP has, however, undertaken to make certain distributions on all Units issued on or prior to July 16, 1996. The performance of the different series of Units differs somewhat over the same period, primarily, because as the various series begin trading at different times, they pay different Profit Shares (although at the same base rates), during the same periods. PERFORMANCE SUMMARY 1995 In 1995, prevailing price trends in several key markets enabled the Advisors to trade profitably for the Fund. Although trading in many of the traditional commodity markets may have been lackluster, the currency and financial markets offered exceptional trading conditions. After months characterized by very difficult trading environments, solid price trends across many markets (including U.S. Treasury and non-dollar bond markets) began to emerge during the first quarter of 1995. In the second quarter of 1995, market volatility once again began to affect trading, as many previously strong price trends began to weaken and, in some cases, reverse. The U.S. dollar hit new lows versus the Japanese yen and Deutschemark before rebounding sharply. In addition, there were strong indications that the U.S. economy was slowing which, when coupled with a failure of the German Central Bank to lower interest rates, stalled a rally in the German bond market. During the -16- third quarter there was a correction in U.S. bond prices after several months of a strong uptrend. Despite exposure to the global interest-rate markets, the Fund's long positions in U.S. Treasury bonds had a negative impact on performance. Throughout August and into September, the U.S. dollar rallied sharply against the Japanese yen and the Deutschemark as a result of the coordinated intervention by major central banks and widespread recognition of the growing banking crisis in Japan. Despite continued price volatility during the final quarter of 1995, the Trading Advisors were able to identify several trends in key markets. U.S. Treasury bond prices continued their strong move upward throughout November, due both to weak economic data and optimism on federal budget talks. As the year ended, the yield on the 30-year Treasury bond was pushed to its lowest level in more than two years. 1996 1996 began with the East Coast blizzard, continuing difficulties in the U.S. federal budget talks and an economic slowdown having a negative impact on many markets. The Fund was profitable in January due to the strong profits in currency trading as the U.S. dollar reached a 23-month high against the Japanese yen. In February, however, the Fund incurred its worst monthly loss due to the sudden reversals in several strong price trends and considerable volatility in the currency and financial markets. During March, large profits were taken in the crude oil and gasoline markets as strong demand continued and talks between the United Nations and Iraq were suspended. This trend continued into the second quarter, during which strong gains were also recognized in the agricultural markets as a combination of drought and excessive rain drove wheat and grain prices to historic highs. In the late summer and early fall months, the Fund continued to trade profitably as trending prices in a number of key markets favorably impacted the Fund's performance. In September heating oil hit a five-year high on soaring prices in Europe, and the Fund was also able to capitalize on downward trends in the metals markets. Strong trends in the currency and global bond markets produced significant gains in October and November, but the year ended with declining performance as December witnessed the reversal of several strong upward trends and increased volatility in key markets. 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. However, the dollar underwent two significant corrections during the year. The first correction occurred 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. From August through mid-November, the dollar corrected against the Eurocurrencies in advance of a well-advertised tightening by the Bundesbank. By mid-December the dollar had bounced back to new highs against the yen and was rallying against the mark. Global interest rate markets began the year on a volatile note, as investors evaluated economic data for signs of inflation. By the middle of the year, 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. Effects of the plunge in the Hong Kong stock market in late October spread rapidly throughout the world's financial markets, including global bond markets. After continued volatility in subsequent months made trading difficult, 1997 interest rate trading ended on a positive note when U.S. and Japanese bond markets rallied as a flight to safety from plunging stock markets around the world occurred in December. 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. By mid-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. In December, financial and economic problems in Asia reduced demand for oil, and in combination with ample supplies, resulted in crude oil prices declining once again. PERFORMANCE OVERVIEW The principal variables which determine the net performance of the Partnership are gross profitability and interest income. During all periods set forth under "Selected Financial Data," the interest rates in many countries were at unusually low levels. This negatively impacted revenue because interest income is typically a major component of commodity pool profitability. In addition, low interest rates are frequently associated with reduced fixed income market volatility, and in static markets the Fund's profit potential generally tends to be diminished. On the other hand, during periods of higher interest rates, the relative attractiveness of a high risk investment such as the Fund may be reduced as compared to high yielding and much lower risk fixed-income investments. The Partnership's Brokerage Commissions and Administrative Fees are a constant percentage of assets allocated to trading. The only Fund costs (other than the insignificant F/X Desk service fees, EFP differentials and organizational and offering cost reimbursement payments as well as bid-ask spreads on forward contracts) which are not based on a percentage of the Fund's assets allocated to trading are the Profit Shares payable to the Trading Advisors on an Advisor-by-Advisor basis. During periods when Profit Shares are a high percentage of net trading gains, it is likely that there has been substantial performance non-correlation among Advisors (so that the total Profit Shares paid to those Advisors which have traded profitably are a high percentage, or perhaps even in excess, of total profits recognized, as other Advisors have incurred offsetting losses, reducing overall trading gains but not the Profit Shares paid to successful Advisors) -- suggesting the likelihood of generally trendless, non-consensus markets. -17- The events that primarily determine the Partnership's profitability are those that produce sustained and major price movements. The Advisors are generally more likely to be able to profit from sustained trends, irrespective of their direction, than from static markets. During the course of the Partnership's performance to date, such events have ranged from Federal Reserve Board reductions in interest rates, the apparent refusal of Iraq to arrive at a settlement which would permit it to sell oil internationally, the inability of the U.S. government to agree upon a federal budget, and a combination of drought and excessive rain negatively impacting U.S. agricultural harvesting as well as planting. While these events are representative of the type of circumstances which materially affect the Fund, the specific events which will do so in the future cannot be predicted or identified. Unlike many investment fields, there is no meaningful distinction in the operation of the Fund between realized and unrealized profits. Most of the contracts traded by the Fund are highly liquid and can be closed out at any time. Furthermore, the profits on many open positions are effectively realized on a daily basis through the payment of variation margin. Except in unusual circumstances, factors -- regulatory approvals, cost of goods sold, employee relations and the like -- which often materially affect an operating business have virtually no impact on the Fund. THE DIFFERENT SERIES OF UNITS All series of Units issued after July 16, 1996 begin trading with the same percentage (75%) of their total capital allocated to trading (by investment in the Trading Partnership). All Series issued prior to such date began trading with 60% of their total capital allocated to trading. All series trade in a common trading account and are subject to the same method of calculating their fees. Furthermore, any discretionary action taken by MLIP -- e.g., making a distribution or adjusting trading leverage -- must be done in such a way, that all Units receive the same distributions (if any) as well as having the same percentage of capital allocated to trading after the adjustment. Despite these fundamental similarities among the different series, because the series begin trading at different times they are likely to come, as a result of trading profits and losses, to have different percentages of their capital allocated to trading, pay different Profit Shares (although to the same group of Advisors) and have different Net Asset Values. LIQUIDITY AND CAPITAL RESOURCES The amount of capital raised for the Fund should not, except at extremely high levels of capitalization, have a significant impact on its operations. The Fund's costs are generally proportional to its asset base and, within broad ranges of capitalization, the Advisors' trading positions (and the resulting gains and losses) should increase or decease in approximate proportion to the size of the Fund account managed by each of them, respectively. The Partnership raises additional capital only through the continuous offering of its Units. Inflation per se is not a significant factor in the Fund's profitability, although inflationary cycles can give rise to the type of major price movements that can have a materially favorable or adverse impact on the Fund's performance. Changes in the level of prevailing interest rates could have a material effect on the Fund's trading leverage. Interest rates directly affect the calculation of the discounted value (discounted back from the relevant Principal Assurance Date) of the guaranteed $100 minimum Net Asset Value per Unit and, accordingly, the assets which a given series of Units has available for trading. In its trading to date, the Fund has from time to time had substantial unrealized gains and losses on its open positions. These gains or losses are received or paid on a periodic basis as part of the routine clearing cycle on exchanges or in the over-the-counter markets (the only over-the-counter market in which the Fund trades is the inter-bank forward market in currencies). In highly unusual circumstances, market illiquidity could make it difficult for certain Advisors to close out open positions, and any such illiquidity could expose the Fund to significant losses, or cause it to be unable to recognize unrealized gains. However, in general, there is no meaningful difference between the Fund's realized and unrealized gains. THE YEAR 2000 COMPUTER ISSUE Merrill Lynch's modifications for Year 2000 systems compliance are proceeding according to plan and are expected to be completed in early 1999. Based on information currently available, the remaining expenditures are estimated at $200 million and will cover hardware and software upgrades, systems consulting, and computer maintenance. These expenditures are not expected to have a material adverse impact on Merrill Lynch's financial position, results of operations, or cash flows in future periods. However, the failure of Merrill Lynch's securities exchanges, clearing organizations, vendors, clients, or regulators to resolve their own processing issues in a timely manner could result in a material financial risk. Merrill Lynch is devoting necessary resources to address all Year 2000 issues in a timely manner. ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ---------------------------------------------------------- Not applicable. -18- ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------------------------------------------- The financial statements required by this Item are included in Exhibit 13.01. The supplementary financial information ("selected quarterly financial data" and "information about oil and gas producing activities") specified by Item 302 of Regulation S-K is not applicable. ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE - -------------------- There were no changes in or disagreements with accountants on accounting and financial disclosure. PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------ (a,b) Identification of Directors and Executive Officers: -------------------------------------------------- As a limited partnership, the Partnership itself has no officers or directors and is managed by the General Partner. Trading decisions are made by the Trading Advisors on behalf of the Partnership. The directors and executive officers of MLIP as of February 1, 1998 and their respective business backgrounds are as follows. John R. Frawley, Jr. Chairman, Chief Executive Officer, President and Director Jeffrey F. Chandor Senior Vice President, Director of Sales, Marketing and Research and Director Joseph H. Moglia Director Allen N. Jones Director Stephen G. Bodurtha Director Michael A. Karmelin Chief Financial Officer, Vice President and Treasurer Steven B. Olgin Vice President, Secretary and Director of Administration
John R. Frawley, Jr. was born in 1943. Mr. Frawley is Chairman, Chief Executive Officer, President and a Director of MLIP and Co-Chairman of MLF. He joined Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S") in 1966 and has served in various positions, including Retail and Institutional Sales, Manager of New York Institutional Sales, Director of Institutional Marketing, Senior Vice President of Merrill Lynch Capital Markets and Director of International Institutional Sales. Mr. Frawley holds a Bachelor of Science degree from Canisius College. Mr. Frawley served on the CFTC's Regulatory Coordination Advisory Committee from its formation in 1990 through its dissolution in 1994. Mr. Frawley is currently serving his fourth consecutive one-year term as Chairman of the Managed Funds Association (formerly, the Managed Futures Association), a national trade association that represents the managed futures, hedge funds and fund of funds industry. Mr. Frawley is also a Director of that organization. Mr. Frawley currently serves on a panel created by the Chicago Mercantile Exchange and The Board of Trade of the City of Chicago to study cooperative efforts related to electronic trading, common clearing and the issues regarding a potential merger. Jeffrey F. Chandor was born in 1942. Mr. Chandor is Senior Vice President, the Director of Sales, Marketing and Research and a Director of MLIP. He joined MLPF&S in 1971 and has served as the Product Manager of International Institutional Equities, Equity Derivatives and Mortgage-Backed Securities as well as Managing Director of International Sales in the United States, and Managing Director of Sales in Europe. Mr. Chandor holds a Bachelor of Arts degree from Trinity College, Hartford, Connecticut. Joseph H. Moglia was born in 1949. He is a director of MLIP. In 1971, he graduated from Fordham University with a Bachelor of Arts degree in Economics. He later received his Master of Science degree from the University of Delaware. He taught at the high school and college level for sixteen years. Mr. Moglia joined MLPF&S in 1984, and has served in a number of senior roles, including Director of New York Fixed Income Institutional Sales, Director of Global Fixed Institutional Sales, and Director of the -19- Municipal Division. He is currently Senior Vice President and Director of the Investment Strategy and Product Group in Merrill Lynch Private Client, and Director of Middle Markets. Allen N. Jones was born in 1942. Mr. Jones is a Director of MLIP and, from July 1995 until January 1998, Mr. Jones was Chairman of the Board of Directors of MLIP. Mr. Jones graduated from the University of Arkansas with a Bachelor of Science, Business Administration degree in 1964. Since June 1992, Mr. Jones has held the position of Senior Vice President of MLPF&S. From June 1992 through February 1994, Mr. Jones was the President and Chief Executive Officer of Merrill Lynch Insurance Group, Inc. ("MLIG") and remains on the Board of Directors of MLIG and its subsidiary companies. From February 1994 to April 1997, Mr. Jones was the Director of Individual Financial Services of the Merrill Lynch Private Client Group. In April 1997, Mr. Jones became the Director of Private Client marketing. Stephen G. Bodurtha was born in 1958. Mr. Bodurtha is a Director of MLIP. In 1980, Mr. Bodurtha graduated from Wesleyan University, Middletown, Connecticut with a Bachelor of Arts degree in Government, magna cum laude. From 1980 to 1983, Mr. Bodurtha worked in the Investment Banking Division of Merrill Lynch. In 1985, he was awarded his Master of Business Administration degree from Harvard University, where he also served as Associates Fellow (1985-1986). From 1986 to 1989, Mr. Bodurtha held the positions of Associate and Vice President with Kidder, Peabody & Co., Incorporated where he worked in their Financial Futures & Options Group. Mr. Bodurtha joined MLPF&S in 1989 and has held the position of First Vice President since 1995. He has been the Director in charge of MLPF&S's Structured Investments Group since 1995. Michael A. Karmelin was born in 1947. Mr. Karmelin is Chief Financial Officer, Vice President and Treasurer of MLIP. Prior to joining MLIP in April 1997, Mr. Karmelin was Chief Financial Officer of Merrill Lynch, Hubbard Inc. ("ML Hubbard"), a sponsor of real estate limited partnerships. Mr. Karmelin joined ML Hubbard in January 1994 and was a Vice President of ML Hubbard. From May 1994 to April 1997, he was the Chief Financial Officer of ML Hubbard, responsible for its accounting, treasury and tax functions. Prior to joining ML Hubbard, Mr. Karmelin held several senior financial positions with ML&Co and MLPF&S from December 1985 to December 1993, including Vice President/Senior Financial Officer Corporate Real Estate and Purchasing, Manager Commitment Control/Capital Budgeting, and Senior Project Manager/Project Analysis. Prior to joining ML&Co., Mr. Karmelin was employed at Avco Corporation for 17 years, where he held a variety of financial positions. Mr. Karmelin holds a B.B.A. degree in Accounting from Baruch College, C.U.N.Y. and a Master of Business Administration degree in Corporate Strategy and Finance from New York University. Mr. Karmelin passed the Certified Public Accounting examination in 1974 and is a member of the Treasury Management Association, the Institute of Management Accountants and The Strategic Leadership Forum. Steven B. Olgin was born in 1960. Mr. Olgin is Vice President, Secretary and the Director of Administration of MLIP. He joined MLIP in July 1994 and became a Vice President in July 1995. From 1986 until July 1994, Mr. Olgin was an associate of the law firm of Sidley & Austin. In 1982, Mr. Olgin graduated from The American University with a Bachelor of Science degree in Business Administration and a Bachelor of Arts degree in Economics. In 1986, he received his Juris Doctor degree from The John Marshall Law School. Mr. Olgin is a member of the Managed Funds Association's Government Relations Committee and has served as an arbitrator for the NFA. Mr. Olgin is also a member of the Committee on Futures Regulation of the Association of the Bar of the City of New York. Messrs. Moglia and Bodurtha became Directors in January 1998. As of December 31, 1997, the principals of MLIP had no investment in the Fund and MLIP's general partner interest in the Fund was valued at approximately $2.6 million. MLIP acts as general partner to twelve public futures funds whose units of limited partnership interest are registered under the Securities Exchange Act of 1934: The Futures Expansion Fund Limited Partnership, The Growth and Guarantee Fund L.P., ML Futures Investments II L.P., ML Futures Investments L.P., John W. Henry & Co./Millburn L.P., The S.E.C.T.O.R. Strategy Fund/SM/ L.P., The SECTOR Strategy Fund/SM/ II L.P., The SECTOR Strategy Fund/SM/ V L.P., The SECTOR Strategy Fund/SM/ VI L.P., ML Global Horizons L.P., ML JWH Strategic Allocation Fund L.P. and the Fund. Because MLIP serves as the sole general partner of each of these funds, the officers and directors of MLIP effectively manage them as officers and directors of such funds. (c) Identification of Certain Significant Employees: ----------------------------------------------- None. (d) Family Relationships: -------------------- None. (e) Business Experience: ------------------- See Item 10(a)(b) above. (f) Involvement in Certain Legal Proceedings: ---------------------------------------- -20- None. (g) Promoters and Control Persons: ----------------------------- Not applicable. ITEM 11: EXECUTIVE COMPENSATION ---------------------- The directors and officers of the General Partner are remunerated by the General Partner in their respective positions. The Partnership does not itself have any officers, directors or employees. The Partnership pays Brokerage Commissions to an affiliate of the General Partner and Administrative Fees to the General Partner. The General Partner or its affiliates may also receive certain economic benefits from holding certain of the Fund's dollar Available Assets in offset accounts, as described in Item 1(c) above. The directors and officers receive no "other compensation" from the Partnership, and the directors receive no compensation for serving as directors of the General Partner. There are no compensation plans or arrangements relating to a change in control of either the Partnership or the General Partner. ITEM 12: SECURITY OWNERSHIP OF CERTAIN OWNERS AND MANAGEMENT --------------------------------------------------- (a) Security Ownership of Certain Beneficial Owners: ----------------------------------------------- As of December 31, 1997, no person or "group" is known to be or have been the beneficial owner of more than five percent of the Units. (b) Security Ownership of Management: -------------------------------- As of December 31, 1997, the General Partner owned 23,141.61 Units (unit-equivalent general partnership interests), which was less than 3% of the total Units outstanding. (c) Changes in Control: ------------------ None. ITEM 13: CERTAIN RELATIONSHIPS AND RELATED EXCHANGE OF FUTURES TRANSACTIONS ------------------------------------------------------------------ (a) Transactions with Management and Others: --------------------------------------- The General Partner acts as administrative and trading manager of the Fund. The General Partner provides all normal ongoing administrative functions of the Partnership, such as accounting, legal and printing services. The General Partner, which receives the Administrative Fee, pays all expenses relating to such services. (b) Certain Business Relationships: ------------------------------ MLF, an affiliate of the General Partner, acts as the principal commodity broker for the Partnership. In 1997, the Partnership accrued: (i) Brokerage Commissions of $4,833,598 to the Commodity Broker, which included $949,508 in consulting fees accrued by the Commodity Broker to the Trading Advisors; and (ii) Administrative Fees of $138,103 to MLIP. In addition, MLIP and its affiliates may have derived certain economic benefit from maintaining a portion of the Fund's assets in "offset accounts" as described under Item 1(c), "Narrative Description of Business -- Use of Proceeds and Cash Management -- Income Interest Earned on the Fund's U.S. Dollar Available Assets not managed by MLAM" and Item 11, "Executive Compensation" herein, as well as from the Fund's F/X Desk and exchange of futures for physical ("EFP") trading. See Item 1(c), "Narrative Description of Business -- Charges" and "-- Description of Current Charges" for a discussion of other business dealings between MLIP affiliates and the Partnership. (c) Indebtedness of Management: -------------------------- The Partnership is prohibited from making any loans, to management or otherwise. (d) Transactions with Promoters: --------------------------- Not applicable. -21- PART IV ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K --------------------------------------------------------------- (a)1. Financial Statements (found in Exhibit 13.01): Page ---- Independent Auditors' Report 1 Consolidated Statements of Financial Condition as of December 31, 1997 and 1996 2 For the years ended December 31, 1997, 1996 and 1995: Consolidated Statements of Operations 3 Consolidated Statements of Changes in Partners' Capital 4 Notes to Financial Statements 5-14 (a)2. Financial Statement Schedules: ----------------------------- Financial statement schedules not included in this Form 10-K have been omitted for the reason that they are not required or are not applicable or that equivalent information has been included in the financial statements or notes thereto. (a)3. Exhibits: -------- The following exhibits are incorporated by reference or are filed herewith to this Annual Report on Form 10-K: Designation Description - ----------- ----------- 1.01 Selling Agreement among the Partnership, the General Partner, Merrill Lynch Futures Inc., the Selling Agent and the Trading Advisors. Exhibit 1.01: Is incorporated herein by reference from Exhibit 1.01 - ----------- contained in Amendment No. 1 to the Registration Statement (File No. 33-73914) filed on July 14, 1994, on Form S-1 under the Securities Act of 1933 (the "Registrant's Registration Statement.") 1.01(a) Form of Selling Agreement Amendment among the Partnership, the General Partner, Merrill Lynch Futures Inc., the Selling Agent and the Trading Advisors. Exhibit 1.01(a): Is incorporated herein by reference from Exhibit 1.01(a) - --------------- contained in the Registrant's report on Form 10-K for the year ended December 31, 1997. 3.01(i) Amended and Restated Limited Partnership Agreement of the Partnership. Exhibit 3.01(i): Is incorporated herein by reference from Exhibit 3.01(ii) - --------------- contained in the Registrant's Registration Statement (as Exhibit A). 3.01(ii) Amended and Restated Limited Partnership Agreement of the Trading Partnership. Exhibit 3.01(ii): Is incorporated herein by reference from Exhibit 3.01(ii) - ---------------- contained in Registrant's the Registration Statement. 3.05(ii) Amended and Restated Certificate of Limited Partnership of the Partnership, dated July 27, 1995. Exhibit 3.05(ii): Is incorporated herein by reference from Exhibit 3.05(ii) - ---------------- contained in the Registrant's report on Form 10-Q for the Quarter Ended June 30, 1995. 10.01(h) Form of Advisory Agreement among the Partnership, the General Partner, Merrill Lynch Futures Inc. and each Trading Advisor. Exhibit 10.01(h): Is incorporated herein by reference from Exhibit 10.01(h) - ---------------- contained in the Registrant's report on Form 10-Q for the Quarter Ended June 30, 1995. 10.02 Form of Consulting Agreement between Merrill Lynch Futures Inc. and each trading advisors. Exhibit 10.02: Is incorporated herein by reference from Exhibit 10.02 - ------------- contained in the Registrant's Registration Statement. -22- 10.03 Form of Customer Agreement between the Trading Partnership and Merrill Lynch Futures Inc. Exhibit 10.03 Is incorporated herein by reference from Exhibit 10.03 - ------------- contained in the Registrant's Registration Statement (as Exhibit B). 10.05 Merrill Lynch & Co., Inc. Guarantee. Exhibit 10.05: Is incorporated herein by reference from Exhibit 10.05 - ------------- contained in the Registrant's Registration Statement (as Exhibit B). 10.06 Form of Subscription Agreement and Power of Attorney. Exhibit 10.06: Is incorporated herein by reference from Exhibit 10.06 - ------------- contained in the Registrant's Registration Statement (as Exhibit D). 10.07(a) Foreign Exchange Desk Service Agreement, dated July 1, 1993 among Merrill Lynch International Bank, Merrill Lynch Investment Partners Inc., Merrill Lynch Futures Inc. and various MLIP funds. Exhibit 10.07(a): Is incorporated herein by reference from Exhibit 10.07 - ---------------- contained in the Registrant's Registration Statement (as Exhibit D). 10.07(b) Amendment to Foreign Exchange Desk Service Agreement, dated July 14, 1994, among Merrill Lynch Investment Bank, Merrill Lynch Investment Partners Inc., Merrill Lynch Futures Inc. and the Fund. Exhibit 10.07(b): Is incorporated herein by reference from Exhibit 10.07 - ---------------- contained in the Registrant's Registration Statement. 10.08 Investment Advisory Contract between Merrill Lynch Futures, the Partnership, the Trading Partnership and MLAM. Exhibit 10.08: Is incorporated herein by reference from Exhibit 10.08 - ------------- contained in the Registrant's Registration Statement. 10.09(a) Form of Advisory and Consulting Agreement Amendment among the General Partner, each Advisor, the Partnership and Merrill Lynch Futures Inc. Exhibit 10.09(a): Is incorporated herein by reference from Exhibit 10.09(a) - ---------------- contained in the Registrant's report on Form 10-K for the year ended December 31, 1996. 10.09(b) Form of Amendment to the Customer Agreement among the Partnership and MLF. Exhibit 10.09(b): Is incorporated herein by reference from Exhibit 10.09(b) - ---------------- contained in the Registrant's report on Form 10-K for the year ended December 31, 1996. . 13.01 1997 Annual Report and Independent Auditors' Report. Exhibit 13.01: Is filed herewith. - ------------- 28.01 Prospectus of the Partnership dated January 25, 1996. Exhibit 28.01: Is incorporated by reference as filed with the Securities and - ------------- Exchange Commission pursuant to Rule 424 under the Securities Act of 1933, Registration Statement (File No. 33-73914) on Form S-1 (effective January 25, 1996). (b) Report on Form 8-K: ------------------ No reports on Form 8-K were filed during the fourth quarter of 1997. -23- 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. ML PRINCIPAL PROTECTION TRADING L.P. By: MERRILL LYNCH INVESTMENT PARTNERS INC. General Partner By: /s/ John R. Frawley, Jr. ------------------------ John R. Frawley, Jr. Chairman, Chief Executive Officer, President and Director (Principal Executive Officer) Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed on March 25, 1998 by the following persons on behalf of the Registrant and in the capacities indicated.
Signature Title Date - --------- ----- ---- /s/John R. Frawley, Jr. Chairman, Chief Executive Officer, President and Director March 25, 1998 - ------------------------- (Principal Executive Officer) John R. Frawley, Jr. /s/Michael A. Karmelin Vice President, Chief Financial Officer and Treasurer March 25, 1998 - ------------------------- (Principal Financial and Accounting Officer) Michael A. Karmelin /s/Jeffrey F. Chandor Senior Vice President, Director of Sales, March 25, 1998 - ------------------------- Marketing and Research and Director Jeffrey F. Chandor /s/Allen N. Jones Director March 25, 1998 - ------------------------- Allen N. Jones
(Being the principal executive officer, the principal financial and accounting officer and a majority of the directors of Merrill Lynch Investment Partners Inc.) MERRILL LYNCH INVESTMENT General Partner of Registrant March 25, 1998 PARTNERS INC.
By/s/ John R. Frawley, Jr. ------------------------ John R. Frawley, Jr. -24- ML PRINCIPAL PROTECTION L.P. ANNUAL REPORT FOR 1997 ON FORM 10-K INDEX TO EXHIBITS ----------------- Exhibit ------- Exhibit 13.01 1997 Annual Report and Independent Auditors' Report -25- EX-13.01 2 1997 ANNUAL REPORT AND INDEPENDENT AUDITORS REPORT ML PRINCIPAL PROTECTION L.P. (Formerly, ML Principal Protection Plus L.P.) (A Delaware Limited Partnership) Consolidated Financial Statements for the Years Ended December 31, 1997, 1996 and 1995 and Independent Auditors' Report To: The Limited Partners of ML PRINCIPAL PROTECTION L.P. ML Principal Protection Plus L.P. (the "Fund" or "Partnership") ended its fourth fiscal year of trading on December 31, 1997 with an increase in Net Asset Value ("NAV"). During 1997, trading profits were generated in the currency, interest rate, metals, agriculture and stock index markets while losses were incurred in energy trading. Please see the accompanying summary financial information for the NAV of your series of Units. Trend reversals and extreme market volatility, affected by such factors as the Asian flu and El Nio, were characteristic of most of 1997. However, the year proved to be a profitable one overall for the Fund as trends in several key markets enabled the Trading Advisors to profit despite the significant obstacles. Although trading results in several sectors may have been lackluster, the global currency and bond markets offered noteworthy trading opportunities, which resulted in significant profits in these markets during the year. Additionally, the currency and interest rate sectors of the Fund's portfolio represented its largest percentage of market commitments. 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. However, the dollar underwent two significant corrections during the year. The first correction occurred 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. From August through mid-November, the dollar corrected against the Eurocurrencies in advance of a well-advertised tightening by the Bundesbank. By mid-December the dollar had bounced back to new highs against the yen and was rallying against the mark. Global interest rate markets began the year on a volatile note, as investors evaluated economic data for signs of inflation. By the middle of the year, 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. Effects of the plunge in the Hong Kong stock market in late October spread rapidly throughout the world's financial markets, including global bond markets. After continued volatility in subsequent months made trading difficult, 1997 interest rate trading ended on a positive note when U.S. and Japanese bond markets rallied as a flight to safety from plunging stock markets around the world occurred in December. 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. By mid-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. In December, financial and economic problems in Asia reduced demand for oil, and in combination with ample supplies, resulted in crude oil prices declining once again. Although the overall return for the Fund might have paled in comparison to some of the popular market indices during 1997, a significant observation is worth noting. From the time the Dow Jones industrial average hit its high of 8259.31 in August through the end of the year, it declined 4.25% with a continued increase in volatility. Conversely, the Fund, which has been designed with the objective of producing returns non-correlated to traditional debt and equity markets, steadily improved performance during the same time period. We appreciate your continued investment in the Fund and look forward to 1998 and the trading opportunities it may bring. Sincerely, John R. Frawley, Jr. President MERRILL LYNCH INVESTMENT PARTNERS INC. (General Partner) FOR THE EXCLUSIVE USE OF INVESTORS IN ML PRINCIPAL PROTECTION L.P. THIS ANNUAL REPORT IS NOT AN OFFER TO SELL NOR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES. AN OFFER CAN ONLY BE MADE BY THE PROSPECTUS, AS SUPPLEMENTED, WHICH CONTAINS IMPORTANT INFORMATION CONCERNING RISK FACTORS, PERFORMANCE AND OTHER MATERIAL ASPECTS OF THE FUND, TOGETHER WITH SUMMARY FINANCIAL INFORMATION CURRENT WITHIN 60 DAYS. THE PROSPECTUS MUST BE READ CAREFULLY BEFORE ANY DECISION WHETHER TO INVEST IS MADE. THIS ANNUAL REPORT MUST NOT BE REPRODUCED OR DISTRIBUTED IN ANY MANNER. FUTURES TRADING IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. ML PRINCIPAL PROTECTION L.P. (formerly, ML Principal Protection Plus L.P.) (A Delaware Limited Partnership) ------------------------------
TABLE OF CONTENTS Page ---- INDEPENDENT AUDITORS' REPORT 1 CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995: Consolidated Statements of Financial Condition 2 Consolidated Statements of Income 3 Consolidated Statements of Changes in Partners' Capital 4 Notes to Consolidated Financial Statements 5-14
INDEPENDENT AUDITORS' REPORT - ---------------------------- To the Partners of ML Principal Protection L.P.: We have audited the accompanying consolidated statements of financial condition of ML Principal Protection L.P. (formerly, ML Principal Protection Plus L.P.) (a Delaware limited partnership; the "Partnership") as of December 31, 1997 and 1996, and the related consolidated statements of income and changes in partners' capital for each of the three years in the period ended December 31, 1997. These consolidated financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of ML Principal Protection L.P. as of December 31, 1997 and 1996, and the results of their operations for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP February 6, 1998 New York, New York ML PRINCIPAL PROTECTION L.P. (formerly, ML Principal Protection Plus L.P.) (A Delaware Limited Partnership) ------------------------------ CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION DECEMBER 31, 1997 AND 1996
1997 1996 ------------------ ---------------- ASSETS Cash $ 1,423 $ 328 Accrued interest receivable (Note 2) 38,562 23,501 U. S. Government obligations (Note 1) 94,651,930 72,815,648 Equity in commodity futures trading accounts: Cash and option premiums 6,127,948 7,177,888 Net unrealized profit on open contracts 2,958,084 1,677,317 ------------- ------------- TOTAL $ 103,777,947 $ 81,694,682 ============= ============= LIABILITIES AND PARTNERS' CAPITAL LIABILITIES: Redemptions payable $ 636,155 $ 966,906 Brokerage commissions payable (Note 2) 494,349 378,291 Administrative fees payable (Note 2) 14,330 10,224 Profit Shares payable (Note 4) 591,195 658,800 Organizational and initial offering costs payable (Note 1) -- 68,630 ------------- ------------- Total liabilities 1,736,029 2,082,851 ------------- ------------- Minority Interest 815,233 768,546 ------------- ------------- PARTNERS' CAPITAL: General Partner (23,141.61 Units and 20,873.06 Units) 2,564,153 2,301,180 Limited Partners (989,140.56 Units and 702,786.91 Units) 105,628,837 76,542,105 Subscriptions Receivable (69,663.05 Units and 0 Units) (6,966,305) -- ------------- ------------- Total partners' capital 101,226,685 78,843,285 ------------- ------------- TOTAL $ 103,777,947 $ 81,694,682 ============= =============
NET ASSET VALUE PER UNIT (Note 5) See notes to consolidated financial statements. -2- ML PRINCIPAL PROTECTION L.P. (formerly, ML Principal Protection Plus L.P.) (A Delaware Limited Partnership) ------------------------------ CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 --------------- --------------- -------------- REVENUES: Trading profit (loss): Realized $ 5,412,457 $ 9,038,064 $ 4,407,833 Change in unrealized 1,083,826 (396,221) 1,355,377 ------------ ------------ ------------ Total trading results 6,496,283 8,641,843 5,763,210 Interest income (Note 2) 4,873,872 4,545,186 3,415,670 ------------ ------------ ------------ Total revenues 11,370,155 13,187,029 9,178,880 ------------ ------------ ------------ EXPENSES: Profit Shares (Note 4) 931,522 978,264 652,366 Brokerage commissions (Note 2) 4,833,598 4,775,116 3,303,292 Administrative fees (Note 2) 138,103 129,057 -- ------------ ------------ ------------ Total expenses 5,903,223 5,882,437 3,955,658 ------------ ------------ ------------ INCOME BEFORE MINORITY INTEREST 5,466,932 7,304,592 5,223,222 ------------ ------------ ------------ Minority interest in income (46,687) (81,228) (36,730) ------------ ------------ ------------ NET INCOME $ 5,420,245 $ 7,223,364 $ 5,186,492 ============ ============ ============ NET INCOME PER UNIT OF PARTNERSHIP INTEREST: Weighted average number of Units outstanding (Note 6) 818,689 754,428 551,944 ============ ============ ============ Net income per weighted average General Partner $ 6.62 $ 9.57 $ 9.40 and Limited Partner Unit ============ ============ ============
See notes to consolidated financial statements. -3- ML PRINCIPAL PROTECTION L.P. (formerly, ML Principal Protection Plus L.P.) (A Delaware Limited Partnership) ------------------------------ CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Limited General Subscriptions Units Partners Partner Receivable Total --------------- ------------------ --------------- ---------------- -------------- PARTNERS' CAPITAL, DECEMBER 31, 1994 317,562.00 $ 31,017,854 $ 1,074,985 $ -- $ 32,092,839 Redemptions (47,810.02) (5,054,249) -- -- (5,054,249) Subscriptions 444,567.00 43,851,304 605,396 -- 44,456,700 Distributions -- (1,771,806) (63,432) -- (1,835,238) Net income -- 5,037,038 149,454 -- 5,186,492 ---------- ------------- ------------- ------------- ------------- PARTNERS' CAPITAL, DECEMBER 31, 1995 714,318.98 73,080,141 1,766,403 -- 74,846,544 Redemptions (245,127.36) (25,748,519) -- -- (25,748,519) Subscriptions 254,468.35 25,102,217 344,618 -- 25,446,835 Distributions -- (2,833,925) (91,014) -- (2,924,939) Net income -- 6,942,191 281,173 -- 7,223,364 ---------- ------------- ------------- ------------- ------------- PARTNERS' CAPITAL, DECEMBER 31, 1996 723,659.97 76,542,105 2,301,180 -- 78,843,285 Redemptions (183,442.91) (19,816,833) -- -- (19,816,833) Subscriptions 472,065.11 46,994,656 211,855 -- 47,206,511 Subscriptions Receivable (69,663.05) -- -- (6,966,305) (6,966,305) Distributions -- (3,362,913) (97,305) -- (3,460,218) Net income -- 5,271,822 148,423 -- 5,420,245 ---------- ------------- ------------- ------------- ------------- PARTNERS' CAPITAL, DECEMBER 31, 1997 942,619.12 $ 105,628,837 $ 2,564,153 $ (6,966,305) $ 101,226,685 ========== ============= ============= ============= =============
See notes to consolidated financial statements. -4- ML PRINCIPAL PROTECTION L.P. (formerly, ML Principal Protection Plus L.P.) (A Delaware Limited Partnership) ------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization - ------------ ML Principal Protection L.P. (formerly, ML Principal Protection Plus L.P.) (the "Partnership") was organized as an open-ended fund under the Delaware Revised Uniform Limited Partnership Act on January 3, 1994 and commenced trading activities on October 12, 1994. The Partnership engages in both the speculative trading of futures, options on futures and forward contracts on a wide range of commodities through ML Principal Protection Trading L.P. (formerly, ML Principal Protection Plus Trading L.P.) (the "Trading Partnership"), of which the Partnership is the sole limited partner and investing in U.S. Government Securities, as defined. Merrill Lynch Investment Partners Inc. (formerly, ML Futures Investment Partners Inc.) (the "General Partner" or "MLIP"), a wholly- owned subsidiary of Merrill Lynch Group Inc., which, in turn, is a wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("Merrill Lynch"), is the general partner of both the Partnership and the Trading Partnership and Merrill Lynch Futures Inc. ("MLF"), also an affiliate of Merrill Lynch, is the Trading Partnership's commodity broker. Merrill Lynch Asset Management, L.P. ("MLAM"), another affiliate of Merrill Lynch, provides cash management services to the Partnership investing in Government Securities, as defined. Substantially all of the Partnership's assets are held in accounts maintained at MLF or Merrill Lynch, Pierce, Fenner & Smith Incorporated, a Merrill Lynch affiliate. The General Partner has agreed to maintain a general partner's interest of at least 1% of the total capital in each of the Partnership and the Trading Partnership. The General Partner and the Limited Partners share in the profits and losses of the Partnership, and the General Partner and the Partnership share in the profits and losses of the Trading Partnership, in proportion to the respective interests in the Partnership and the Trading Partnership owned by each. The consolidated financial statements include the accounts of the Trading Partnership in which the Partnership is the sole limited partner. All related transactions and intercompany balances between the Partnership and the Trading Partnership are eliminated in consolidation. The ownership by the General Partner in the Trading Partnership represents a minority interest when the financial results of the Trading Partnership are consolidated into those of the Partnership. The General Partner's share of the Trading Partnership's profits and losses is deducted from the Consolidated Statements of Income, and the General Partner's interest in the Trading Partnership reduces partners' capital on the Consolidated Statements of Financial Condition and the Consolidated Statements of Changes in Partners' Capital. The Partnership issues units of limited partnership interest ("Units") generally as of the beginning of each calendar quarter (and also as of May 1, 1997). Each series has its own Net Asset Value per Unit. Different series may allocate different percentages of their total capital to trading, but all series trade under the direction of the same combination of independent advisors (the "Trading Advisors" or the "Advisors"), chosen from time to time by MLIP to manage the Trading Partnership's trading. MLIP selects the Advisors to manage the Partnership's assets, and allocates and reallocates the Partnership's trading assets among existing, replacement and additional Advisors. -5- MLIP also determines what percentage of the Partnership's total capital to allocate to trading from time to time, attempting to balance the desirability of reducing the opportunity costs of the Partnership's "principal protection" structure against the necessity of preventing Merrill Lynch from ever being required to make any payments to the Partnership under the Merrill Lynch guarantee (see Note 7). Estimates - ---------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Revenue Recognition - ------------------- Commodity futures, options on futures and forward contract transactions are recorded on the trade date, and open contracts are reflected in net unrealized profit on open contracts in the Consolidated Statements of Financial Condition at the difference between the original contract value and the fair value. The change in net unrealized profit (loss) on open contracts from one period to the next is reflected in change in unrealized in the Consolidated Statements of Income. Fair value is based on quoted market prices on the exchange or market on which the contract is traded. U.S. Government Securities - -------------------------- The Partnership invests a portion of its assets in obligations of the U.S. Treasury and certain other U.S. government agencies ("Government Securities") under the direction of MLAM within the parameters established by MLIP for which MLAM accepts no responsibility. These investments are carried at fair value. Organizational and Initial Offering Costs, Operating Expenses and Selling - ------------------------------------------------------------------------- Commissions ----------- The General Partner advanced all organizational and initial offering costs relating to the Partnership and the Trading Partnership. The Partnership and Trading Partnership reimbursed the General Partner for such costs in 36 monthly installments. For financial reporting purposes, the Partnership deducted the organizational and initial offering reimbursement costs of $239,100 from partners' capital at inception. For all other purposes (including determining Net Asset Values of the Units), the Partnership deducts the organizational and initial offering cost reimbursements only as actually paid. The General Partner pays all routine operating costs (including legal, accounting, printing, postage and similar administrative expenses) of the Partnership and the Trading Partnership, including the cost of the ongoing offering of the Units. The General Partner receives administrative fees as well as a portion of the brokerage commissions paid to MLF by the Partnership as reimbursement for the foregoing expenses. No selling commissions have been or are paid by Limited Partners. Income Taxes - ------------ No provision for income taxes has been made in the accompanying consolidated financial statements as each Partner is individually responsible for reporting income or loss based on such Partner's respective share of the Partnership's consolidated income and expenses as reported for income tax purposes. Redemptions - ----------- -6- A Limited Partner may require the Partnership to redeem some or all of such Partner's Units at Net Asset Value as of the close of business on the last business day of any month upon ten calendar days' notice. Units redeemed on or prior to the end of the twelfth full month after purchase are assessed an early redemption charge of 3% of their Net Asset Value as of the date of redemption. Dissolution of the Partnership - ------------------------------ The Partnership will terminate on December 31, 2024, or at an earlier date if certain conditions occur, as well as under certain other circumstances as set forth in the Limited Partnership Agreement. 2. RELATED PARTY TRANSACTIONS MLAM manages substantially all of the Partnership's available U.S. dollar assets, pursuant to guidelines established by MLIP for which MLAM assumes no responsibility, in the U.S. Government Securities markets. MLF pays MLAM annual management fees of .20 of 1% on the first $25 million of Partnership capital managed by MLAM, .15 of 1% on the next $25 million of capital, .125 of 1% on the next $50 million, and .10 of 1% on capital in excess of $100 million. Such fees are paid quarterly in arrears and are calculated on the basis of the average daily assets managed by MLAM. A portion of the Partnership's U.S. dollar assets are held at MLF in cash. On the cash held at MLF, the Partnership receives interest from Merrill Lynch at the prevailing 91-day U.S. Treasury bill rate. Merrill Lynch may derive certain economic benefits, in excess of the interest which Merrill Lynch pays to the Partnership, from possession of such cash. Merrill Lynch credits the Partnership with interest on the Partnership's non- U.S. dollar-denominated assets based on local short-term rates. Merrill Lynch charges the Partnership Merrill Lynch's cost of financing realized and unrealized losses on the Partnership's non-U.S. dollar-denominated positions. The General Partner has determined that there may have been a miscalculation in the interest credited to the Partnership for a period prior to November 1996 (such period may extend prior to that covered by these financial statements). Accordingly, the General Partner credited current and former investors who maintained a Merrill Lynch customer account in December 1997 with interest which was compounded. Former investors who do not maintain a Merrill Lynch customer account will be credited as their response forms are processed. The total amount of the adjustment is approximately $54,000. Since this amount was paid directly to investors by the General Partner, it is not reflected in these financial statements. The General Partner has determined that interest has been calculated appropriately since November 1996. Prior to 1996, the Partnership paid brokerage commissions to MLF in respect of each series of Units at a flat monthly rate equal to .792 of 1% (a 9.5% annual rate) of such series' month-end assets allocated to trading. Effective January 1, 1996, this rate was reduced to .771 of 1% (a 9.25% annual rate) of each series' month-end assets allocated to trading and the Partnership began to pay MLIP a monthly administrative fee of .021 of 1% (a .25% annual rate) of each series' month-end assets allocated to trading (this recharacterization had no economic effect on the Partnership). Effective January 1, 1997, each series' brokerage commission percentage was reduced to .729 of 1% (an 8.75% annual rate) of such series' month-end assets allocated to trading. Assets committed to trading are not reduced for purposes of calculating brokerage commissions and administrative fees by any accrued brokerage commissions, administrative fees, Profit Shares or other fees or charges. The General Partner estimates that the round-turn equivalent commission rate charged to the Partnership during the years ended December 31, 1997, 1996 and -7- 1995, was approximately $116, $116 and $134, respectively, not including, in calculating round-turn equivalents, forward contracts on a futures-equivalent basis. MLF pays the Trading Advisors annual Consulting Fees, ranging up to 4% of the Partnership's average month-end assets allocated to them for management, after reduction for a portion of the brokerage commissions accrued with respect to such assets. The Partnership trades forward contracts through a foreign exchange service desk (the "F/X Desk") established by MLIP. The F/X Desk gives the Partnership access to counterparties in addition to (but also including) Merrill Lynch International Bank ("MLIB"). MLIP or another Merrill Lynch entity charges a service fee equal to, at current exchange rates, approximately $5.00 to $12.50 on each purchase or sale (not round-turn) of a futures contract-equivalent face amount of a given currency traded in the forward markets. No service fees are charged on trades awarded to MLIB (which receives bid-ask spreads on such trades). In its exchange of futures for physical ("EFP") trading with Merrill Lynch, the Partnership acquires spot or forward (collectively, "cash") currency positions through the F/X Desk in the same manner and on the same terms as in the case of the Partnership's other F/X Desk trading. When the Partnership exchanges these positions for futures, there is a differential between the prices of the two positions. This differential reflects, in part, the different settlement dates of the cash and the futures contracts and prevailing interest rates, but also includes a pricing spread in favor of MLIB or another Merrill Lynch entity. The Advisors, to date, have made little use of EFPs. The Partnership's F/X Desk service fee and EFP differential costs have, to date, totaled no more than .25 of 1% per annum of the Partnership's average month-end assets. -8- 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 December 31, 1997, the Partnership has made the following distributions: Series Distribution Fixed-Rate Discretionary Date Distribution Distribution --------- ----------------------------------------------- 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 4. AGREEMENTS The Trading Partnership and the Advisors have each entered into Advisory Agreements. These Advisory Agreements generally terminate one year after they are entered into, subject to certain renewal rights exercisable by the Partnership. The Advisors determine the commodity futures and forward contract trades to be made on behalf of their respective Partnership accounts, subject to certain trading policies and to certain rights reserved for the General Partner. Profit Shares, generally ranging from 15% to 25% of any New Trading Profit, as defined, recognized by each Advisor individually, irrespective of the overall performance of any series, either as of the end of each calendar quarter or year, are paid to the appropriate Advisors. Profit Shares are also paid out in respect of Units redeemed as of the end of interim months to the extent of the applicable percentage of any New Trading Profit attributable to such Units. 5. 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 deducts the organizational and initial offering cost reimbursements only as actually paid. The organizational and initial offering cost reimbursement was -9- completed in October 1997. At December 31, 1997 the Net Asset Values of the different series of Units for financial reporting purposes and for all other purposes were:
Net Asset Value Number Net Asset Value of Units per Unit ---------------------------------------------------------------------------------------- ------------------------------------------------------------------- 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 ----------------- ----------------- $ 101,226,685 942,619.12 ================= =================
As of December 31, 1996, the Net Asset Value of the different series of Units for financial reporting purposes and for all other purposes were as follows:
Net Asset Value Net Asset Value per Unit ------------------------------------------ ------------------------------------- All Other Financial Number All Other Financial Purposes Reporting of Units Purposes Reporting ----------------------------------------------------------- ------------------------------------- ---------------------------------------------------------------------------------------------------- Series A Units $ 21,048,780 $ 21,031,369 190,136.00 $ 110.70 $ 110.61 Series B Units 3,447,686 3,444,936 30,179.00 114.24 114.15 Series C Units 4,996,014 4,992,389 45,696.00 109.33 109.25 Series D Units 12,582,502 12,567,310 116,303.00 108.19 108.06 Series E Units 10,484,159 10,476,812 96,561.50 108.58 108.50 Series F Units 10,179,910 10,173,793 93,465.62 108.92 108.85 Series G Units 6,967,116 6,962,973 64,920.50 107.32 107.25 Series H Units 9,199,107 9,193,703 86,398.35 106.47 106.41 ---------------- ----------------- ----------------- Total $ 78,905,274 $ 78,843,285 723,659.97 ================ ================= =================
6. WEIGHTED AVERAGE UNITS Weighted average number of Units outstanding was computed for purposes of disclosing consolidated net income per weighted average Unit. The weighted average Units at December 31, 1997, 1996 and 1995 equals the Units outstanding as of such date, adjusted proportionately for Units redeemed or issued based on the respective length of time each was outstanding during such period. -10- 7. MERRILL LYNCH & CO., INC. GUARANTEE Merrill Lynch has guaranteed to the Partnership that it will have sufficient net assets, as of the Principal Assurance Date for each series of Units, that the Net Asset Value per Unit of such series as of such Principal Assurance Date will equal, after reduction for all liabilities to third parties and all distributions paid to such Units, not less than $100. 8. FAIR VALUE AND OFF-BALANCE SHEET RISK The Partnership trades futures, options on futures and forward contracts on interest rates, stock indices, commodities, currencies, energy and metals. The Partnership's total trading results by reporting category for the years ended December 31, 1997, 1996 and 1995 were as follows: Total Trading Results -------------------------------------------------- 1997 1996 1995 --------------- --------------- --------------- Interest Rates $ 1,706,686 $ 3,183,955 $ 3,933,366 Stock Indices 232,314 (746,255) 587,931 Commodities 679,157 20,119 (447,486) Currencies 3,911,109 3,301,360 2,914,300 Energy (1,278,003) 3,280,677 238,988 Metals 1,245,020 (398,013) (1,463,889) --------------- --------------- --------------- $ 6,496,283 $ 8,641,843 $ 5,763,210 =============== =============== =============== Market Risk - ----------- Derivative financial instruments involve varying degrees of off-balance sheet market risk, and changes in the level or volatility of interest rates, foreign currency exchange rates or market values of the financial instruments or commodities underlying such derivative instruments frequently result in changes in the Partnership's unrealized profit on such derivative instruments as reflected in the Consolidated Statements of Financial Condition. The Partnership's exposure to market risk is influenced by a number of factors, including the relationships among the derivative instruments held by the Trading Partnership as well as the volatility and liquidity in the markets in which the derivative instruments are traded. The General Partner has procedures in place intended to control market risk, although there can be no assurance that they will, in fact, succeed in doing so. The procedures focus primarily on monitoring the trading of the Advisors selected from time to time for the Partnership, adjusting the percentage of the Partnership's total assets allocated to trading with respect to each Series of Units, calculating the Net Asset Value of the Advisors' respective Partnership accounts as of the close of business on each day and reviewing outstanding positions for over-concentrations -- both on an Advisor-by-Advisor and on an overall Partnership basis. While the General Partner does not itself intervene in the markets to hedge or diversify the Partnership's market exposure, the General Partner may urge Advisors to reallocate positions, or itself reallocate Partnership assets among Advisors (although typically only as of the end of a month), in an attempt to avoid over-concentrations. However, such interventions are unusual. Except in cases in which it appears that an Advisor has begun to deviate from past practice and trading policies or to be trading erratically, the General Partner's basic risk control procedures consist simply of the ongoing process of Advisor monitoring and selection, with the market risk controls being applied by the Advisors themselves. One important aspect of the General Partner's risk controls is its adjustments to the leverage at which each Series of Units trades. By controlling the percentage of each series' assets allocated to trading, the General -11- Partner can directly affect the market exposure of the Partnership. Leverage control is the principal means by which the General Partner hopes to be able to ensure that Merrill Lynch is never required to make any payments under its guarantee that the Net Asset Value per Unit of each series will equal no less than $100 as of the Principal Assurance Date for such series. Fair Value - ---------- The derivative instruments traded by the Trading Partnership are marked to market daily with the resulting unrealized profit recorded in the Consolidated Statements of Financial Condition and the related profit (loss) reflected in trading revenues in the Consolidated Statements of Income. The contract/notional values of the Trading Partnership's open derivative instrument positions as of December 31, 1997 and 1996 were as follows:
1997 1996 -------------------------------------------- -------------------------------------------- Commitment to Commitment to Commitment to Commitment to Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures, Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards) ------------------ ----------------- ------------------ ------------------ Interest Rates $ 121,435,283 $ 85,620,621 $ 103,258,306 $ 38,270,540 Stock Indices 1,665,588 8,854,122 4,259,475 2,340,013 Commodities 11,663,786 21,791,599 8,541,433 12,761,047 Currencies 70,272,888 147,312,282 53,592,111 86,479,803 Energy 1,085,885 9,041,759 5,566,768 - Metals 4,412,002 19,039,071 4,593,702 14,839,516 ------------------ ----------------- ------------------ ------------------ $ 210,535,432 $ 291,659,454 $ 179,811,795 $ 154,690,919 ================== ================= ================== ==================
Substantially all of the Trading Partnership's open derivative instruments outstanding as of December 31, 1997, expire within one year. The contract/notional values of the Trading Partnership's exchange-traded and non-exchange-traded derivative instrument positions as of December 31, 1997 and 1996 were as follows:
1997 1996 -------------------------------------------- -------------------------------------------- Commitment to Commitment to Commitment to Commitment to Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures, Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards) ------------------ ----------------- ----------------- ------------------ Exchange-Traded $ 142,565,779 $ 183,223,917 $ 133,757,339 $ 85,639,298 Non- Exchange-Traded 67,969,653 108,435,537 46,054,456 69,051,621 ------------------ ----------------- ----------------- ------------------ $ 210,535,432 $ 291,659,454 $ 179,811,795 $ 154,690,919 ================== ================= ================= ==================
-12- The average fair values, based on contract/notional values, of the Trading Partnership's derivative instrument positions which were open as of the end of each calendar month during the years ended December 31, 1997 and 1996 were as follows:
1997 1996 -------------------------------------------- ------------------------------------------- Commitment to Commitment to Commitment to Commitment to Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards) ------------------------------------------------------------------------------------------------ Interest Rates $ 177,189,103 $ 68,697,138 $ 224,985,973 $ 91,029,835 Stock Indices 7,544,449 4,040,832 10,235,486 2,492,230 Commodities 13,113,725 11,481,639 13,316,970 7,175,841 Currencies 70,061,899 113,287,725 94,601,907 115,671,672 Energy 3,621,533 3,415,726 6,862,906 1,348,945 Metals 7,369,251 14,913,348 13,579,528 19,196,951 ------------------ ------------------ ----------------- ----------------- $ 278,899,960 $ 215,836,408 $ 363,582,770 $236,915,474 ================== ================== ================= =================
A portion of the amounts indicated as off-balance sheet risk reflects offsetting commitments to purchase and to sell the same derivative instrument on the same date in the future. These commitments are economically offsetting but are not, as a technical matter, offset in the forward markets until the settlement date. Credit Risk - ----------- The risks associated with exchange-traded contracts are typically perceived to be less than those associated with over-the-counter (non-exchange-traded) transactions, because exchanges typically (but not universally) provide clearinghouse arrangements in which the collective credit (in some cases limited in amount, in some cases not) of the members of the exchange is pledged to support the financial integrity of the exchange. In over-the-counter transactions, on the other hand, traders must rely solely on the credit of their respective individual counterparties. Margins, which may be subject to loss in the event of a default, are generally required in exchange trading, and counterparties may require margin in the over-the-counter markets. The fair value amounts in the above tables represent the extent of the Trading Partnership's market exposure in the particular class of derivative instrument, but not the credit risk associated with counterparty nonperformance. The credit risk associated with these instruments, from counterparty nonperformance, is the net unrealized profit, if any, included on the Consolidated Statements of Financial Condition. The Trading Partnership also has credit risk because the sole counterparty or broker with respect to most of the Trading Partnership's assets is MLF. -13- The gross unrealized profit and the net unrealized profit on the Trading Partnership's open derivative instrument positions as of December 31, 1997 and 1996 were as follows:
1997 1996 --------------------------------------- --------------------------------------- Gross Unrealized Net Unrealized Gross Unrealized Net Unrealized Profit Profit Profit Profit --------------------------------------------------------------------------------------- Exchange-Traded $ 3,263,519 $ 2,416,539 $ 2,090,698 $ 1,611,482 Non-Exchange-Traded 2,119,281 541,545 1,172,965 65,835 --------------- --------------- --------------- --------------- $ 5,382,800 $ 2,958,084 $ 3,263,663 $ 1,677,317 =============== =============== =============== ===============
The Partnership controls credit risk by dealing almost exclusively with Merrill Lynch entities as brokers and counterparties. The Partnership, in its normal course of business, enters into various contracts, with MLF acting as its commodity broker. Pursuant to the brokerage arrangement with MLF, to the extent that such trading results in receivables from and payables to MLF, these receivables and payables are offset and reported as a net receivable or payable. 9. SUBSEQUENT EVENT Effective January 1, 1998, distributions were announced for Series B and Series F. The Series B Unitholders received a fixed-rate distribution of $3.50 per Series B Unit as well as a discretionary distribution equal to $1.50. The Series F Unitholders received a fixed-rate distribution of $3.50 per Series F Unit as well as a discretionary distribution equal to $1.25. To the best of the knowledge and belief of the undersigned, the information contained in this report is accurate and complete. /s/ Michael A. Karmelin ----------------------- Michael A. Karmelin Chief Financial Officer Merrill Lynch Investment Partners Inc. General Partner of ML Principal Protection L.P. -14- EX-27 3 FINANCIAL DATA SCHEDULE
BD 0000917259 ML PRINCIPAL PROTECTION L.P. 12-MOS 12-MOS DEC-31-1997 DEC-31-1996 JAN-01-1997 JAN-01-1996 DEC-31-1997 DEC-31-1996 1,423 328 9,124,594 8,878,706 0 0 0 0 94,651,930 72,815,648 0 0 103,777,947 81,694,682 0 0 1,736,029 2,082,851 0 0 0 0 0 0 0 0 0 0 0 0 0 0 102,041,918 79,611,831 103,777,947 81,694,682 6,496,283 8,641,843 4,873,872 4,545,186 4,833,598 4,775,116 0 0 0 0 0 0 0 0 5,420,245 7,223,364 5,420,245 7,223,364 0 0 0 0 5,420,245 7,223,364 6.62 9.57 6.62 9.57
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