10-Q 1 a2046371z10-q.txt 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2001 -------------- OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ---------------- ---------------- Commission File Number 0-25000 ML PRINCIPAL PROTECTION L.P. ML PRINCIPAL PROTECTION TRADING L.P. (Rule 140 Co-Registrant) (Exact Name of Registrant as specified in its charter) Delaware 13-3750642 (Registrant) ------------------------------- 13-3775509 (CO-REGISTRANT) (State or other jurisdiction of -------------------------------- incorporation or organization) (IRS Employer Identification No.) c/o Merrill Lynch Investment Partners Inc. Princeton Corporate Campus 800 Scudders Mill Road - Section 2G Plainsboro, New Jersey 08536 ---------------------------- (Address of principal executive offices) (Zip Code) 609-282-6996 --------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---- ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements ML PRINCIPAL PROTECTION L.P. (a Delaware limited partnership) CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

NET ASSET VALUE PER UNIT See notes to consolidated financial statements. 2 ML PRINCIPAL PROTECTION L.P. (a Delaware limited partnership) CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

See notes to consolidated financial statements. 3 ML PRINCIPAL PROTECTION L.P. (a Delaware limited partnership) CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL For the three months ended March 31, 2001 and March 31, 2000 (unaudited)

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 (unaudited) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES These financial statements have been prepared without audit. In the opinion of management, the financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the consolidated financial position of ML Principal Protection L.P. (the "Partnership") as of March 31, 2001, and the results of its operations for the three month period ended March 31, 2001. However, the operating results for the interim periods may not be indicative of the results expected for the full year. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the Partnership's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2000 (the "Annual Report"). On January 1, 2001, the Trading Partnership was dissolved. The General Partner redeemed its entire investment and the Partnership immediately invested its redemption proceeds directly into MM LLC, giving the Partnership a direct investment in MM LLC rather than through the Trading Partnership. This action did not effect the operation of the Partnership or MM LLC and was done at no cost to the investors. Any costs have been absorbed by MLIP. MLIP continues to maintain a 1% General Partner interest in the Partnership. 2. INVESTMENTS Effective September 1, 2000, the Partnership consolidated its trading accounts with those of certain other multi-advisor managed future funds sponsored by Merrill Lynch Investment Partners Inc. ("MLIP"). The Partnership is no longer trading directly through managed accounts with each of its Trading Advisors, but is investing in a limited liability company, ML Multi-Manager Portfolio LLC ("MM LLC"). As of September 1, 2000, the Multi-Manager LLC had an aggregate capitalization of approximately $264 million. The consolidation was effected by having the Partnership close its existing individual trading accounts and invest in MM LLC, which maintains a single account with each Advisor selected. MM LLC is managed by MLIP, has no investors other than multi-advisor funds sponsored by MLIP, and serves solely as the vehicle through which the assets of such funds are combined in order to be managed through single rather than multiple accounts. The consolidation of the Partnership's trading accounts through MM LLC should result in improved order execution. By investing in MM LLC rather than trading as separate entities, participating funds receive the same price on their allocable portions of bulk orders rather than MLIP having to allocate individual contracts acquired at different prices among different fund accounts. In addition, by pooling their capital in MM LLC, participating funds are able to maintain access to the full range of Trading Advisors - irrespective of how small an individual fund's capital base may become. No additional fees or charges were incurred by the Partnership or any investor as a result of the consolidation. MLIP absorbed all costs related to the consolidation. As a result of consolidating the Partnership's trading accounts, Merrill Lynch Futures Inc. ("MLF"), which receives flat-rate brokerage fees from the Partnership, should be able to recognize future savings on its trade processing costs. MLIP and MLF are responsible for the administration and monitoring of MM LLC as well as each participating fund, and in doing so will have access to the same "real time" trade and position information as was the case for the Partnership's managed accounts. 5 As of March 31, 2001 and December 31, 2000 the Partnership had an investment in MM LLC of $20,074,670 and 19,921,935. Total revenues and fees with respect to the Partnership's investment are set forth as follows:

A condensed statements of financial condition and statements of operations for MM LLC are set forth as follows:

6 3. NET ASSET VALUE PER UNIT At March 31, 2001 and December 31, 2000, the Net Asset Values of the different series of Units were:

7 4. ANNUAL DISTRIBUTIONS The Partnership makes annual fixed-rate distributions, payable irrespective of profitability, of $3.50 per Unit on Units issued prior to May 1, 1997. 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 May 1, 1997. As of March 31, 2001, the Partnership has made the following distributions:

8 5. FAIR VALUE AND OFF-BALANCE SHEET RISK As of September 1, 2000, the Partnership is invested indirectly in derivative instruments, but does not itself hold any derivative instrument positions. The application of the provisions of Statement of Financial Accounting ("SFAS") No. 133, as amended by SFAS No. 137, did not have a significant effect on the financial statements, nor will the application of the provisions of SFAS No. 138 have a significant effect on the financial statements. MARKET RISK Derivative instruments involve varying degrees of off-balance sheet market risk. Changes in the level or volatility of interest rates, foreign currency exchange rates or the market values of the underlying financial instruments or commodities underlying such derivative instruments frequently results in changes in the Partnership's net unrealized profit (loss) on such derivative instruments with respect to Partnership assets invested in MM LLC as reflected in the Statements of Financial Condition of MM LLC. The Partnership's exposure to market risk is influenced by a number of factors, including the relationships among the derivative instruments held by MM LLC as well as the volatility and liquidity of the markets in which the derivative instruments are traded. MLIP has procedures in place intended to control market risk exposure, although there can be no assurance that they will, in fact, succeed in doing so. These procedures focus primarily on monitoring the trading of the Advisors, calculating the Net Asset Value of the Partnership as of the close of business on each day and reviewing outstanding positions for over-concentrations. While MLIP does not itself intervene in the markets to hedge or diversify the Partnership's market exposure through MM LLC, MLIP may urge the Advisors to reallocate positions in an attempt to avoid over-concentrations. However, such interventions are unusual. Except in cases in which it appears that the Advisors have begun to deviate from past practice or trading policies or to be trading erratically, MLIP's basic risk control procedures consist simply of the ongoing process of advisor monitoring, with the market risk controls being applied by the Advisors themselves. 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 9 to loss in the event of a default, are generally required in exchange trading, and counterparties may also require margin in the over-the-counter markets. The Partnership, through MM LLC, has credit risk in respect of its counterparties and brokers, but attempts to mitigate this risk by dealing exclusively with Merrill Lynch entities as clearing brokers. The Partnership, through MM LLC, in its normal course of business, enters into various contracts with Merrill Lynch Futures ("MLF") acting as its commodity broker. Pursuant to the brokerage agreement with MLF (which includes a netting arrangement), to the extent that such trading results in receivables and payables are offset and reported as a net receivable or payable and are included in MM LLC in the Statements of Financial Condition under Equity in commodity futures trading accounts in the Statements of Financial Condition. Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MONTH-END NET ASSET VALUE PER SERIES A UNIT

(a) After reductions for distribution declared of $6.00, $6.00, $3.50, $3.50 and $3.50 per Series A Unit as of October 1995, 1996, 1997, 1998 and 1999, respectively. (b) After reduction for a $3.50 per Series A Unit distribution declared on October 1, 2000 and the distributions described in (a), resulting in a total distribution of $26.00 inception to date. Performance Summary January 1, 2001 to March 31, 2001 All of the Partnerships trading assets are invested in MM LLC. The Partnership recognizes trading profits or losses as an investor in MM LLC. The following commentary describes trading results of MM LLC for the First Quarter of 2001. Trading in the interest rate sector was highly profitable for the Partnership during the quarter. Long positions in the Euro resulted in gains in January. The impact of the weakening U.S. economy and the Federal Reserve's move to cut interest rates was felt throughout the interest rate futures market, as Euro futures contracts rose dramatically since December 2000. Euro-yen and Euro-bund cross futures trading produced gains for the sector. Agricultural trading was profitable despite losses sustained early in the quarter. During January, the agricultural sector faced weak grain and oilseed prices. Excellent growing weather in the U.S., Argentina and Brazil, concerns about U.S. export potential and inventories at historically high levels kept the markets on the defensive. Contract lows in cotton produced gains for short positions. The cotton market sank to a 15 year low as a result of short supply and increased demand. Potential increased planting paired with a drop in demand forced prices lower. Currency trading resulted in gains for the Partnership. Losses were realized during January and February on long Euro and Swiss franc trading. After rallying from a low of 82--83 cents to 96 cents, the Euro corrected back to the 90 cent level, despite strong fundamentals. This resulted in losses for the Partnership's long positions. The sector rebounded strongly in March on substantial gains from short Japanese yen positions. Trading in the metals markets was successful. Losses from short silver positions were sustained in January as silver had minor technical run as it reached it's four month high. Short silver positions were profitable in February as silver prices reversed its earlier trend and declined as the market was generally weak and on gold's failure to rally weighed on the market. March was a volatile trading month as another attempted gold rally failed, resulting in gains in short positions. Stock index trading was moderately successful despite uncertainty in equity markets. Short S&P 500 and NASDAQ positions resulted in gains as global equity markets remain caught between negative news about earnings and the potential positive effects of further monetary easing. Energy trading was the only unprofitable sector during the quarter. Natural gas prices pulled back in January after rallying during the last few months, resulting in losses. Crude oil prices were driven lower by both a seasonal downturn in global oil usage and heavier than normal refinery maintenance work, reducing the demand. Short natural gas positions were unprofitable in March on concerns over supply availability. January 1, 2000 to March 31, 2000 Energy trading was profitable for the quarter due to long crude oil and unleaded gas positions. Despite the possibility of OPEC increasing oil production by 5%, crude oil prices continued to rise as such a hike would still leave oil inventories at levels much below normal during the balance of the year. Prices began to decline in mid-March as Iran backed down from its position on the point of "no increase" and again later in the month as OPEC announced a production increase of 1.716 million barrels per day offsetting some gains from the previous two months. In currency trading, the Euro declined against the U.S. dollar as officials from the Group of Seven met and failed to express concern about the low levels of the European currency producing profits for the quarter. Some other contributing factors to the decline of the Euro include the slow pace of microeconomic reform in Europe, plans for a European withholding tax and the scale of direct investment flows outside of Europe. Stock index trading was profitable for the quarter. Positions in IBEX 35 (Milan), DAX German Stock Index and CAC 40 Euro futures resulted in profits for the Partnership. Investor sentiment in Germany has been positive, as German macroeconomic fundamentals continue to improve and in 2001, consumers will benefit from a large cut in personal income taxes. The last month of the quarter sustained profits in the Hong Kong Hang Seng and the S&P 500 as investors focused more on value stocks. 10 Agricultural commodity trading produced losses for the quarter. Gains in pork belly and coffee positions were outweighed by losses in short corn positions which were due to dry conditions in Argentina, which led to high corn prices. Metals trading alternated from profitable to unprofitable, however, the sector ended the quarter with losses. Prices rose during the period in base metals as concerns over higher interest rates and the decline in stock prices globally created defensive tones in the market. High aluminum inventories caused prices to decline on the London Metals Exchange. Late in the quarter, copper prices rose over rumors of increased demand from China, having an adverse effect on the short positions held. Short Eurodollar trading was profitable as the currency continued to decline in January. The European Union ministers blamed the currency's slide in January on rapid U.S. growth and fears that the Federal Reserve will increase U.S. interest rates. These profits were far outweighed by losses in the U.S. 10-year Treasury note positions and long U.S. Treasury positions as the yield curve fluctuated widely during the quarter. Cash Management Prior to June 2000, the Partnership invested a portion of its assets in Government Securities. Effective June 2000, the Partnership liquidated the Government Securities held and now invests a portion of its assets in Commercial Paper. These holdings generally have maturities of 30, 60, and 90 days and are held to maturity. The investments in Commercial Paper are directed by MLIP. 11 PART II - OTHER INFORMATION Item 1. Legal Proceedings There are no pending legal proceedings to which the Partnership or the General Partner is a party. Item 2. Changes in Securities and Use of Proceeds (a) None. (b) None. (c) None. (d) The Partnership has units registered with an aggregate price of $462,114,000. Through March 31, 2001 the Partnership has sold units with an aggregate price of $164,506,495. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits There are no exhibits required to be filed with this report. (b) Reports on Form 8-K There were no reports on Form 8-K filed during the first three months of first quarter 2001. 12 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ML PRINCIPAL PROTECTION L.P. (formerly ML Principal Protection Plus L.P.) By: MERRILL LYNCH INVESTMENT PARTNERS INC. (General Partner) Date: May 15, 2001 By /s/ RONALD S. ROSENBERG ----------------------- Ronald S. Rosenberg Chairman and Director Date: May 15, 2001 By /s/ MICHAEL L. PUNGELLO ----------------------- Michael L. Pungello Vice President, Chief Financial Officer and Treasurer 13

ML PRINCIPAL PROTECTION LP 10-Q