ML PRINCIPAL PROTECTION LP - 10-Q Quarterly Report

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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, 2003

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.
----------------------------
(Exact Name of Registrant as
specified in its charter)

Delaware 13-3750642 (Registrant)
- -------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)

c/o Merrill Lynch Investment Managers LLC
222 Broadway
27th Floor
New York, NY 10038-2510
----------------------------------------
(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)

STATEMENTS OF FINANCIAL CONDITION

See notes to financial statements.

2

ML PRINCIPAL PROTECTION L.P.
(a Delaware Limited Partnership)

STATEMENTS OF OPERATIONS
(unaudited)

See notes to financial statements.
Certain 2002 information has been changed to conform to 2003 presentation.

3

ML PRINCIPAL PROTECTION L.P.
(a Delaware Limited Partnership)

STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
For the three months ended March 31, 2003 and 2002
(unaudited)

See notes to financial statements.

4

ML PRINCIPAL PROTECTION L.P.
(a Delaware Limited Partnership)

NOTES TO 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
financial position of ML Principal Protection L.P. (the "Partnership") as
of March 31, 2003, and the results of its operations for the three months
ended March 31, 2003 and 2002. The operating results for the interim
periods may not be indicative of the results for the full year.

Certain information and footnote disclosures normally included in quarterly
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America 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, 2002.

2. INVESTMENT IN MM LLC

As of March 31, 2003 and December 31, 2002, the Partnership had an
investment in ML Multi-Manager Portfolio LLC ("MM LLC") of $16,603,957 and
$16,280,408, respectively. As of March 31, 2003, and December 31, 2002, the
Partnership's percentage ownership share of MM LLC was 9.79% and 9.39%,
respectively.

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

5

3. NET ASSET VALUE PER UNIT

Prior to the opening of business on January 2, 2003, Series A through F and
K through N, those series whose guarantee had come to term on or before
December 31, 2002, were consolidated into a new series, Series A 2003, with
a $1.00 per Unit Net Asset Value. The aggregate Net Asset Value of each
investor's new Units is equal to the aggregate Net Asset Value of their
original Units at December 31, 2002. The consolidation had no economic
effect on the investors. MLIM AS LLC contribution $5,499 to the
Partnership, the amount necessary due to the effects of rounding, to insure
all investors received Units equal in value to their original holdings at
December 31, 2002. The following is a listing of the number of new Units
each investor received of Series A for each Unit of their original series
holding.

After the series consolidation, the brokerage commission rate for Series A
2003 was reduced to a monthly rate of 0.604 of 1% (a 7.25% annual rate).

At March 31, 2003 and December 31, 2002, the Net Asset Values of the
different series of Units were:

March 31, 2003

6

December 31, 2002

4. QUARTERLY DISTRIBUTIONS

The Partnership makes quarterly 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. The Principal Assurance Dates for Series A through F and K
through N came to term on or before December 31, 2002 and were not renewed.
The above Series Units remain outstanding, with 100% of their assets
allocated to trading, without any "principal protection" feature and no
longer pay quarterly distributions. The Partnership has made the following
distributions for the fiscal year ended December 31, 2002, and for the
three month period ended March 31, 2003:

7

5. FAIR VALUE AND OFF-BALANCE SHEET RISK

The nature of this Partnership has certain risks, which can not be
presented on the financial statements. The following summarizes some of
those risks.

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 financial instruments
or commodities underlying such derivative instruments frequently result in
changes in the Partnership's net unrealized profit on such derivative
instruments as reflected in the Statements of Financial Condition or, with
respect to Partnership assets invested in MM LLC, the net unrealized
profit (loss) as reflected in the respective 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 such derivative instruments are traded.

The General Partner, Merrill Lynch Investment Managers LLC ("MLIM LLC") 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
selected from time to time by MM LLC, and include calculating the Net Asset
Value of their respective Partnership accounts and MM LLC 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 MLIM LLC does not itself intervene in the markets
to hedge or diversify the Partnership's market exposure, MLIM LLC may urge
Advisors to reallocate positions, or itself reallocate Partnership assets
through MM LLC 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 or trading policies or to
be trading erratically, MLIM LLC'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.

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 Partnership, through MM LLC, has credit risk in respect of its
counterparties and brokers, but attempts to mitigate this risk by dealing
almost 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 Pierce Fenner & Smith
("MLPF&S") acting as its commodity broker. Pursuant to the brokerage
agreement with MLPF&S (which includes a netting arrangement), to the extent
that

8

such trading results in receivables from and payables to MLPF&S, these
receivables and payables are offset and reported as a net receivable or
payable in the financial statements of MM LLC in the 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
- -------------

(a) After reduction of $29.50 per Series A Unit distributions from
inception to date.

(b) After series consolidation on January 1, 2003.

Performance Summary

All of the Partnership's trading assets are invested in MM LLC. The
Partnership recognizes trading profits or losses as an investor in MM LLC.
The following commentary describes the trading results of MM LLC.

January 1, 2003 to March 31, 2003

The Partnership experienced gains in the currency, energy, interest rate
and stock index sectors and losses in the agricultural commodity and metals
sectors. Overall, for the quarter, the Partnership experienced gains.

The currency forward and futures trading had the most significant gains for
the quarter. The weakening U.S. dollar was continuing to decline as it has
for over a year and the Partnership was well positioned to capitalize on
its U.S dollar positions against other currencies. The largest gains
versus the U.S. dollar during January and February were with the
Australian dollar and Canadian dollar. In March, on hopes that the war
with Iraq would be short, the U.S. dollar strengthened and returned some
of the profits earned early in the year.

Energy was a profitable sector for the quarter. With the continuation of
the strike in Venezuela, the tensions with Iraq and the cold winter, long
positions in oil and natural gas were profitable in the beginning of the
year. In February, the best performing month, natural gas prices rose
nearly 40% in a single day citing expected severely cold weather and supply
shortages. The Partnership profited from this event but such volatility
caused many of the Advisors to reduce their long positions. This helped the
Partnership retain profits as prices declined in crude oil and natural gas
in March.

Interest rate futures were also profitable for the quarter. February had
significant gains offsetting losses in both January and March. U.S. and
European bonds rallied amid concerns of a global economic slowdown
benefiting the Partnership's long exposures. Selective long/short rate
exposure globally was the main driver to gains generated in the sector. The
global fixed income markets continued their upward climb until mid-March
when expectations of a short conflict triggered the liquidation of many
fixed income investments hurting long exposures.

Trading in stock indices posted slight gains for the quarter. The market
was choppy throughout the quarter making trading difficult. The Partnership
was able to realize some gains in January on short positions as most
indices recorded three-month lows. During the rest of the quarter, choppy
markets caused short positions to be covered to protect against the risk of
significant losses.

9

The metals sector had losses for the quarter. Gold drove profits in January
as it continued its run up. The general perception of risks in the
financial markets and the geopolitical situation unfolding was the main
driver for the gold market in January. The Partnership sustained losses in
February and March as the long bias in precious metals hurt the portfolio
when gold reversed its rising trend in February and continued to decline.
Gold's appeal as a safe investment diminished.

Trading in agricultural commodities posted losses for the quarter. The
Partnership held positions in sugar, livestock and the soybean complex.
Livestock markets were off in February as Russia imposed an import limit to
help its domestic production. Sugar was to blame for losses in March as
prices reversed and hit a two-month low.

January 1, 2002 to March 31, 2002

The energy sector was the only profitable trading strategy for the quarter.
Natural gas short positions were profitable as the positions benefited from
the mild weather in the United States. The sector experienced large
declines in February due to increased concerns of the health of world
economies. This lead to price instability. Gains were realized in March in
the physical commodity markets, as fears of increased conflicts in the
Middle East could potentially result in a shortage of oil supplies.

Trading in stock indices resulted in losses for the quarter. Long equity
exposures suffered losses in choppy market conditions as profit forecasts
fell short and concern over the Enron accounting situation deepened.
Uncertainty in the global marketplace prevailed, making for extremely
difficult trading conditions. Long positions appreciated in March, notably
in Japan, Germany and France, but not enough to offset earlier losses.

Conflicting economic reports was the cause for losses in the interest rate
sector. These reports prompted the Advisors to flip exposures from long
positions to short positions in most major international bond markets
during the quarter. European fixed income exposures posted losses under
particularly direction-less markets. Global bond prices declined on growing
optimism for a stronger economic outlook for the remainder of 2002.

Trading in the metals sector was down for the quarter. Short positions in
base metals were unsuccessful early on as base metals prices soared on the
hope that an economic recovery in the United States would boost demand.
Precious metal prices declined as the U.S. economy continued to show signs
of stabilizing and inflation concerns waned. Long gold positioning
generated gains as prices rose above $300 for the first time in two years.

Currency trading resulted in losses for the Partnership. In January, gains
were generated in short Japanese yen positions as the Japanese yen
continued to depreciate against the U.S. dollar due to continued
deterioration of economic fundamentals in Japan. In February, all of the
futures traded currencies appreciated against the U.S. dollar, except the
Canadian dollar. March was a relatively volatile month for G-7 currencies.
The U.S. dollar fell from 133 to 127.50 Japanese yen during the first week,
and then almost completely reversed the move by month-end, causing losses.

Agricultural trading was the least successful strategy. During January and
February, coffee prices were in a downward trend. This trend sharply
reversed in March as reduced exports from Mexico and Central America
trimmed inventories of exchange-approved soybeans in U.S. warehouses. As
prices rose, the Partnership's short positions sustained losses.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

10

Not applicable

Item 4. Controls and Procedures

Merrill Lynch Investment Managers LLC, the General Partner of ML Principal
Protection L.P., with the participation of the General Partner's Chief
Executive Officer and the Chief Financial Officer, has evaluated the
effectiveness of the design and operation of its disclosure controls and
procedures with respect to the Partnership within 90 days of the filing
date of this quarterly report, and, based on their evaluation, have
concluded that these disclosure controls and procedures are effective.
Additionally, there were no significant changes in the Partnership's
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.

11

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

There are no pending legal proceedings to which the Partnership or
MLIM LLC is a party.

Item 2. Changes in Securities and Use of Proceeds

(a) None.
(b) None.
(c) None.
(d) None

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

As of February 28, 2003, the general partner interest and the
management authority of the Partnership was assigned from MLIM
Alternative Strategies LLC to Merrill Lynch Investment Managers LLC,
a wholly-owned subsidiary of Merrill Lynch Investment Managers, as
part of an internal Merrill Lynch reorganization. This change did not
affect the personnel involved in the management of the Partnership.

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
fiscal 2003.

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.

By: MERRILL LYNCH INVESTMENT
MANAGERS LLC
General Partner

Date: May 15, 2003 By /s/ FABIO P. SAVOLDELLI
-----------------------
Fabio P. Savoldelli
Executive Vice President, Chief Investment Officer and
Managing Director - Alternative Strategies Division
(Principal Executive Officer)

Date: May 15, 2003 By /s/ PATRICK HAYWARD
-------------------
Patrick Hayward
Chief Financial Officer
(Principal Financial and Accounting Officer)

13

EXHIBIT 99

Form of Certification Pursuant to Section 1350 of Chapter 63 of
---------------------------------------------------------------
Title 180 of the United States Code
-----------------------------------

I, Fabio P. Savoldelli, certify that:

1. I have reviewed this quarterly report on Form 10-Q of ML Principal Protection
L.P.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls;

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: May 15, 2003
- -----------------------
By /s/ FABIO P. SAVOLDELLI
-----------------------
Fabio P. Savoldelli
Executive Vice President, Chief Investment Officer and Managing Director -
Alternative Strategies Division
(Principal Executive Officer)

14

EXHIBIT 99 (a)

AS ADOPTED TO
-------------
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
---------------------------------------------

In connection with this quarterly report of ML Principal Protection L.P. on Form
10-Q for the period ended March 31, 2003 as filed with the Securities and
Exchange Commission on the date hereof, I, Fabio P. Savoldelli certify, pursuant
to 18 U.S.C. Section 1350, as adopted pursuant of the Sarbanes-Oxley Act of
2002, that:

1. This quarterly report fully complies with the requirements of Section 13 or
15(d) of the Securities and Exchange Act of 1934; and

2. The information contained in this quarterly report fairly presents, in all
material respects, the financial condition and results of operations of ML
Principal Protection L.P.

Date: May 15, 2003
- -----------------------
By /s/ FABIO P. SAVOLDELLI
-----------------------
Fabio P. Savoldelli
Executive Vice President, Chief Investment Officer and Managing Director -
Alternative Strategies Division
(Principal Executive Officer)

15

EXHIBIT 99

Form of Certification Pursuant to Section 1350 of Chapter 63 of
---------------------------------------------------------------
Title 180 of the United States Code
-----------------------------------

I, Patrick Hayward, certify that:

1. I have reviewed this quarterly report on Form 10-Q of ML Principal Protection
L.P.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):

a) all significant deficiencies, in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls;

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: May 15, 2003
- -----------------------
By /s/ PATRICK HAYWARD
-----------------------
Patrick Hayward
Chief Financial Officer
(Principal Financial and Accounting Officer)

16

EXHIBIT 99 (a)

AS ADOPTED TO
-------------
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
---------------------------------------------

In connection with this quarterly report of ML Principal Protection L.P. on Form
10-Q for the period ended March 31, 2003 as filed with the Securities and
Exchange Commission on the date hereof, I, Patrick Hayward certify, pursuant to
18 U.S.C. Section 1350, as adopted pursuant of the Sarbanes-Oxley Act of 2002,
that:

1. This quarterly report fully complies with the requirements of Section 13 or
15(d) of the Securities and Exchange Act of 1934; and

2. The information contained in this quarterly report fairly presents, in all
material respects, the financial condition and results of operations of ML
Principal Protection L.P.

Date: May 15, 2003
- -----------------------
By /s/ PATRICK HAYWARD
-----------------------
Patrick Hayward
Chief Financial Officer
(Principal Financial and Accounting Officer)

17