ITEM 1. BUSINESS
General
The duty free industry is a multi-billion dollar world-wide industry. Duty free merchandise generally consists of well-known brands of luxury goods, such as liquor, perfumes and cosmetics, tobacco products, gifts and other items which are often subject to high rates of taxation when sold in domestic markets for domestic consumption. Duty free merchandise sold in the United States includes imported liquor, tobacco products and luxury goods, as well as domestic products, sold free of federal duties, excise taxes and state and local sales taxes. Such merchandise is also generally exempt, within certain allowances, from import duties and taxes at the traveler's destination.
The duty free industry developed in the United States after World War II as international travel increased. This increase encouraged the development of a system which allows a traveler to buy merchandise free of all duties and sales and excise taxes imposed on domestically consumed goods. In general, travelers can save 20% to 60% on the purchase of duty free merchandise in the United States, compared to the retail price of the same merchandise in the country of their destination. Most countries have allowances on the import of duty free goods. Changes in the duty free allowances of foreign countries or in the eligibility requirements for duty free purchases, as well as changes in tax and duty rates imposed by foreign jurisdictions, affect sales of duty free merchandise in United States duty free shops. As a result of the generally high taxes and duties imposed in certain foreign countries, it may be more economical for some travelers to exceed these allowances and pay the import duties imposed by the country of their destination.
Sales to the diplomatic community are based on reciprocal agreements between countries, under which duty free purchasing privileges are given to foreign diplomats serving in the host country. In the United States, all orders placed by foreign diplomats for duty free merchandise must be approved by both the Treasury and State Departments to confirm the diplomat's eligibility for such purchases.
Duty Free International, Inc. (the "Company") operates in several distinct markets of the duty free industry. The Company is the leading operator of duty free stores along the United States/Canada and United States/Mexico borders, one of the leading operators of duty free and retail stores in international airports in the United States and Puerto Rico, and is a prime concessionaire and supplier of merchandise to international airlines' inflight duty free shops. The Company is also the largest supplier of duty free merchandise to foreign diplomats in the United States and is a major supplier of merchandise to merchant and cruise ships from ports in the Northeast United States and Miami, Florida.
ORGANIZATION AND OPERATIONS
The Company was formed as a Maryland corporation in 1983 to acquire 19 border stores and one airport store. Since its founding, the Company has grown to be one of the world's largest chains of duty free stores operating 166 stores and employing over 2,000 people serving locations in the United States, Puerto Rico, the Caribbean and on international airlines' inflight duty free shops. The Company has grown by expanding into additional airport and United States border locations and by business acquisitions.
On April 24, 1992, the Company acquired by merger UETA, Inc. ("UETA Merger") which is the leading operator of duty free stores on the United States side of the United States/Mexico border. The 30 UETA duty free stores give the Company a presence at 14 border crossings in the states of Texas, Arizona and California. The UETA Merger included three duty free stores at two Texas airports (San Antonio and McAllen) and off- airport duty free locations in Orlando and Miami, Florida. UETA also serves cruise and merchant ships in Miami, and serves diplomatic and wholesale markets from a location in Miami. The acquisition was accounted for as a pooling of interests with new shares of the Company's common stock being exchanged for a 100% interest in UETA.
On May 1, 1994, the Company purchased Inflight Sales Group Limited ("Inflight"), and certain non-competition rights, for approximately $73,300,000. Inflight is the leading concessionaire and supplier of on- board duty free merchandise to international airlines and is a leading supplier of amenity kits to international airlines for distribution to first class and premium class travelers. Inflight currently operates the on-board duty free concessions for 21 international airlines, including Delta, Northwest and United Airlines. In addition, through its exclusive arrangements with certain suppliers, Inflight sells duty free merchandise to numerous other international airlines. Inflight has warehouse, distribution and administrative facilities in New York, Singapore, Hong Kong and the United Kingdom.
During the third quarter of fiscal 1995, the Company undertook a restructuring plan to improve the Company's profitability. A pre-tax charge to earnings of $7,571,000 was taken during the year ended January 29, 1995 as a result of restructuring. The implementation of the plan reduced the Company's workforce by approximately 210 employees and a total of 23 stores and business locations were closed in fiscal 1995 and 1996. Also, in the third quarter of fiscal 1995, the Company changed its method of evaluating the recoverability of intangible assets. Under the new method, fair values of intangible assets are determined based on the discounted future operating cash flows of the related acquired operations over the useful life of each intangible asset. Previously, impairment was measured using undiscounted cash flows. Had the previous policy remained in effect, there would have been no significant impairment as of January 29, 1995. The change in accounting for intangible assets resulted in a write-down of asset value, and a one- time, pre-tax charge to earnings of $46,002,000 during the year ended January 29, 1995. The fiscal year 1996 pre-tax amortization charge associated with the assets written down would have been $3,500,000. Although the write-down had no impact on the Company's cash position, it does result in a more appropriate balance sheet valuation of the remaining goodwill and other intangible assets. The Company took a $38,935,000 ($1.43 per share) after-tax charge to earnings during the year ended January 29, 1995 encompassing all costs associated with the revaluation of its intangible assets, the store and business closures, and workforce reductions.
The company is organized into four operating divisions: the Border Division, the Airport Division, the Diplomatic and Wholesale Division and the Inflight Division.
BORDER DIVISION
The Border Division operates the largest chain of duty free stores along the United States/Canada and United States/Mexico borders. The Division operates a total of 66 stores at 44 border crossings.
UETA, Inc. ("UETA" or the "Southern Border Division") operates 30 duty free stores along the Mexican border in the states of Texas, Arizona and California. The Southern Border Division provides Mexican/American border traffic with access to luxury items such as premium watches, fragrances and cosmetics, top quality liquor and tobacco products, beer, wine, gourmet foods, designer jewelry and other high quality gifts. UETA is the exclusive duty free distributor on the United States side of the Mexican border for liquor brands produced by United Distillers Group (Duty Free) Ltd. Due to the peso devaluation in December 1994 and the resulting $41,319,000 decrease in sales during fiscal 1996 when compared to fiscal 1995, UETA reduced its selling, general and administrative expenses by approximately $5,000,000 during fiscal 1996 when compared to fiscal 1995. The expense reductions related primarily to lower employee and other operating expenses resulting from employee terminations, a reduction in the number of hours stores were open and reductions of advertising and promotion expenses. In spite of the peso devaluation, UETA intends to continue to increase customer awareness of the value of duty free shopping through marketing and advertising, and to adjust product assortment in order to meet the preferences of duty free shoppers. Economic factors, such as the value of the Mexican peso versus the U.S. dollar and the Mexican economy have had and may continue to have a significant effect on UETA's net sales and earnings. (See Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 1996 Annual Report to Stockholders which is incorporated by reference to this document.)
AMMEX Tax and Duty Free Shops, Inc. and AMMEX Tax and Duty Free Shops West, Inc. (collectively, "AMMEX" or the "Northern Border Division") operate 36 duty free and retail stores along the Canadian border in the states of New York, Vermont, Maine, Washington, Michigan, Idaho, Montana, North Dakota and Minnesota. The duty free stores sell a wide variety of quality, brand-name merchandise to individuals traveling from the United States to Canada, a majority of whom are Canadians returning home. Retail locations carry groceries, snacks, souvenirs and gift items. AMMEX also operates currency exchanges and gas stations at several high volume border locations. AMMEX's objectives have been to attract a greater percentage of the eligible travelers crossing the border into Canada and to sell more goods to each customer by remodelling and expanding stores and through sales training, merchandising, advertising and promotion. Ammex's comparable store sales in fiscal 1996 (excluding sales of stores closed under the restructuring plan and two stores purchased in July 1995) increased by 2.4% when compared to fiscal 1995. The improvement in sales trends from fiscal 1995 (when there was a 22.1% decrease in sales from fiscal 1994) was due primarily to the anniversary of the decrease in Canadian taxes which occurred in the first quarter of fiscal 1995, and an increase in average transaction spend amounts by customers resulting from Ammex's marketing and promotion programs. The above was partially offset by the continued negative trend in Canadian traffic across the United States/Canada border during fiscal 1996. Economic factors, such as the continuing economic recession in Canada, selected reductions in Canadian domestic taxes, and the reduced value of the Canadian dollar versus the U.S. dollar have had and may have a significant effect upon the Northern Border Division's net sales and earnings.
AIRPORT DIVISION
Fenton Hill American, Limited (the "Airport Division") operates 100 duty free and retail stores in 14 international airports, and in the Caribbean and South Florida markets. During fiscal 1996, the Airport Division opened 16 new stores which included 12 new travel retail stores at Denver International Airport, three new duty free stores at Boston's
Logan International Airport and an additional duty free store at the San Juan International Airport. The Airport Division's retail mix currently includes duty free shops, which sell premium merchandise such as top- quality liquor and tobacco products and exclusive fragrances and cosmetics, and specialty stores such as The Athlete's Foot (branded athletic-wear), Bodyography (natural personal care products), The Sports Section (regional sports-theme shops), standard news and gift shops, and bookstores. Additionally, the Airport Division has entered into equity partnerships and strategic alliances at a number of international airports which have resulted in the Airport Division being awarded 21 concessions. The Airport Division will attempt to increase the number of equity partnerships and strategic alliances in the future.
The Airport Division also operates a number of stores not located in airports. It serves cruise ship passengers and airport bound customers through 12 shops located in Miami and Orlando, Florida. In Washington, D.C., the Airport Division operates a retail luxury gift store which serves the diplomatic community. The Division also operates 12 retail stores on the Caribbean islands of St. Thomas, Aruba, Bonaire, Curacao and St. Maarten.
During the past several years, the Airport Division has grown through acquisitions, obtaining new airport concessions and expanding existing locations. With the potential for expansion of the Division's current airport stores, as well as for development of other new specialty retailing concepts, management believes that it will continue to find opportunities for new airport locations and other airport retail and duty free businesses. The Airport Division's sales volume and its overall results of operations can be affected by factors relating to the airline industry over which the Division has no control, including which airlines operate at particular terminals, which routes are serviced by those airlines, levels of airline passenger traffic, and economic and other conditions affecting the airline industry in general.
DIPLOMATIC AND WHOLESALE DIVISION
The Diplomatic and Wholesale Division is the leading domestic supplier of duty free merchandise to the foreign diplomatic community in the United States, principally embassies, consulates and United Nations missions in Washington, D.C. and New York City. Foreign diplomats with official status and foreign military personnel in training throughout the United States can order duty free merchandise directly from the Division's salespersons or from its catalog. The Diplomatic and Wholesale Division is also a supplier of merchandise to merchant and cruise ships from ports in the northeastern United States and Miami.
The Diplomatic and Wholesale Division owns and operates a 110,000 square foot warehouse/distribution center in Glen Burnie, Maryland, and a new 140,000 square foot warehouse/distribution center in South Miami, Florida. The new warehouse and distribution center is well-situated to serve cruise ship requirements from the port of Miami, as well as supporting the Company's supply needs for its locations in the Caribbean. During fiscal 1996, the Diplomatic and Wholesale Division continued to de-emphasize low gross margin sales in order to provide greater distribution capabilities to the Company's stores, thus providing more resources for the Company's higher profit operations.
INFLIGHT DIVISION
The Inflight Division ("Inflight") is a leading concession operator and supplier of on-board duty free merchandise to international airlines through on-board concessions and wholesale programs, and is a major supplier of international airlines' first class and premium class
amenity kits. Currently, Inflight operates the on-board duty free concessions for 21 airlines. The Division's concession programs fully operate the on-board duty free concessions for airlines. Inflight purchases products and manages every aspect of duty free sales on the airlines' flights, including magazine and videotape promotions. With a percentage of total sales paid in royalties to the airline, this program provides airlines with a risk-free means of incrementally increasing their earnings. The Division's wholesale program provides merchandise to airlines which operate their on-board duty free programs on international flights. The carrier runs all promotions, manages the program and owns the inventory which is bought from Inflight. Inflight has exclusive distribution agreements for certain geographic markets with many well-recognized names in the luxury products industry, including Chanel, Christian Dior, Hermes, Mont Blanc, Yves Saint Laurent, Elizabeth Arden and Lancaster. Additionally, it maintains warehouse and station locations throughout the U.S., Pacific Rim, Europe and South America. During fiscal 1996, the Inflight Division was awarded the contract to operate Air Canada's on-board duty free concession program beginning March 1, 1996. In the future, Inflight will continue to pursue other on-board duty free concession contracts with international airlines not currently served by the Company. The Company believes Inflight will be a significant contributor to its growth as air travel and airline competition grows.
The Inflight Division's sales volume and results of operations can be affected by factors relating to the airline industry over which the Division has no control, including levels of international airline passenger traffic, economic and other conditions affecting the airline industry in general, and the value of foreign currencies versus the U.S. dollar.
REGULATION
Duty free stores and operations are specifically authorized and recognized as a separate class of bonded warehouse by the Duty Free Sales Enterprises Act of 1988, which was enacted by the United States Congress as part of the Omnibus Trade and Competitiveness Act of 1988.
Duty free merchandise is shipped by domestic and foreign suppliers "in bond" (without taxes or duties) to bonded warehouses in the United States. Bonded warehouses are subject to supervision by the United States Customs Service ("Customs Service") and may only be used to store merchandise which has not entered the domestic market. Because the United States collects no taxes or duties on merchandise sold by duty free stores and other duty free operations, all merchandise shipped from a bonded warehouse to a duty free store or other duty free location remains "under bond" and therefore subject to a high degree of regulation by the Customs Service and by the Bureau of Alcohol, Tobacco and Firearms (the "Bureau"), each of which are agencies of the United States Department of the Treasury.
The Bureau also requires corporations to which it issues permits to notify it in the event of a change in the officers or directors of the corporate operator or if there is a change in the corporate operator's ownership. The Bureau requires certain background information on any stockholder who acquires 10% or more of the common stock of a corporate operator and will not permit ownership by any such stockholder it deems unacceptable. The Company therefore has established the right to require the redemption or the prompt disposition, under certain circumstances, of all or any portion of the shares of Common Stock owned by a stockholder which totals to more than 9% of the outstanding Common Stock.
SUPPLIERS, DISTRIBUTION AND INVENTORY CONTROL
The Company purchases products from numerous vendors, including manufacturers and distributors. As is typical throughout the duty free industry, the Company does not have any significant long-term or exclusive purchase commitments. Management believes that alternative sources of supply are available for each category of merchandise purchased by the Company.
Merchandise is generally shipped directly from vendors to the bonded warehouses and distribution centers located in Glen Burnie, Maryland, Laredo, Texas and Miami, Florida. However, certain merchandise is shipped directly to the Company's regional bonded warehouses and store locations. To control inventory levels, management uses various automated replenishment systems. Frequent shipments are then made to the Border, Airport, and Inflight Divisions' warehouses or stores to assure full stocking levels. Merchandise is delivered daily by truck to the diplomatic communities in Washington, D.C. and New York City. The Company's trucks are also used to supply duty free merchandise to merchant and passenger ships.
Duty free inventory is strictly controlled to comply with Customs Service regulations. The Company must keep detailed records documenting the receipt and sale of all duty free merchandise. Failure to maintain such records may result in the payment of penalties and all taxes and duties which would have been imposed on the domestic sale of such merchandise. The Company's computerized inventory control system allows it to identify product needs, to arrange for prompt reorders from vendors, and to support compliance with Customs Service record-keeping requirements. Slow moving products also can be identified and more appropriate product mixes maintained. Historically, inventory shrinkage has been minimal due to the Company's inventory system and procedures. The Company rarely experiences problems with obsolescence, because most inventory turns frequently and most products have a relatively long shelf-life.
The Company's suppliers provide significant sales support in a variety of ways, including in-store displays, gift-with-purchase items, advertisements, brochures, printed shopping bags, staff training, signs and sales personnel. In addition, some distributors and manufacturers rent space in certain duty free stores for the display of transparencies containing brand-name advertisements. Many suppliers also purchase advertising space in the catalogs produced by the various divisions. Some suppliers also rent space in the Company's warehouses and pay a fee for processing shipments of their merchandise.
ECONOMIC CONDITIONS AND EXCHANGE RATES
The principal customers of the Company are residents of foreign countries whose purchases of duty free merchandise may be affected by trends in the economies of foreign countries and changes in the value of the U.S. dollar relative to their own currencies. Any significant increase in the value of the U.S. dollar relative to the currencies of foreign countries, particularly Canada, Mexico and Japan, could have an adverse impact on the number of travelers visiting the United States and the dollar amount of duty free purchases made by them from the Company. A significant increase in gasoline prices or a shortage of fuel may also reduce the number of international travelers and thereby adversely affect the Company's sales. In addition, the Company imports a significant portion of its products from Western Europe and Canada at prices negotiated either in U.S. dollars or foreign currencies. As a result, the Company's costs are affected by fluctuations in the value of
the U.S. dollar in relation to major Western European and Canadian currencies. A decrease in the purchasing power of the U.S. dollar relative to other currencies causes a corresponding increase in the purchase price of products. The Company enters into foreign exchange forward contracts as a hedge against a portion of its exposure to currency fluctuations on commitments to purchase merchandise.
COMPETITION
The Airport Division can experience significant competition when negotiating or bidding for new concession leases or renewal of existing leases in those locations where the operating authority requires such negotiating or bidding. Competitors bid for the exclusive right to operate in a particular airport or, in the case of some larger airports, in a particular airport terminal servicing one or more airlines. The Company's lease and concession agreements for duty free stores at the New York City airports are consistent with airport leases in the region in that they are terminable by the lessor upon 30 days notice, and also may be subject to re-bid at the end of the operator's lease at which time sealed bids are submitted by prospective operators or negotiations are undertaken with the authority. Most of Inflight's concession contracts are subject to 30 to 120 day cancellation clauses cancelable by the Company or the airline.
Approximately four other companies operate duty free stores in the United States along the Canadian border, most of which have historically remained within specific areas outside of the Company's geographic regions. A small number of regional duty free companies operate along the Mexican border and compete with the Company. Large discount chains that are not duty free operators, such as Price Club and Sam's Club, compete with the Company for customers crossing the United States/Mexico border. Approximately 15 companies operate duty free stores at airports in the United States. The largest such company is Duty Free Shoppers Group, Ltd., a privately held company and the largest duty free operator in the world. The Inflight Division has one major competitor which operates international airlines' on-board duty free concessions. The majority of international airlines operate their own on-board duty free concessions. There are a large number of competitors offering wholesale merchandise to international airlines. The principal competition for diplomatic sales consists of purchases made directly from European suppliers. There are no material competitors currently operating in the principal ports served by the Diplomatic and Wholesale Division except for Miami, Florida. There are significant competitors which can make sales to the Company's passenger and merchant vessel customers when those customers visit ports not served by the Company.
ITEM 2.

ITEM 2. PROPERTIES
The Border Division operates 66 duty free and retail gift stores at 44 border crossings. Five of the stores are owned and operated by agents who receive commissions based on sales. The Company owns 38 of its border stores and leases 23 border stores. The Airport Division leases 100 store locations. The Company's leases for its stores at the New York City airports are terminable by the lessor upon 30 days notice. The leases at certain border and most airport locations provide for base monthly rentals and typically require payment of additional rent based on a percentage of sales. Inflight has relatively small warehouse, distribution and administrative facilities in New York, Singapore, Hong Kong and the United Kingdom.
The Company owns a 110,000 square foot office/distribution center near the Baltimore/Washington International Airport in Glen Burnie, Maryland , leases a 145,000 square foot distribution center in Laredo, Texas of which 70,000 square feet is subleased, and owns a 140,000 square foot administrative, warehouse and distribution facility in South Miami, Florida. The Company also owns or leases other smaller regional warehouse facilities. The Company owns its 33,000 square foot headquarters in Ridgefield, Connecticut which is partially subleased. The Company believes its facilities are adequate for current operations.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
The United States Customs Service is investigating the operations of a subsidiary's bonded warehouse in Seattle, Washington. The Customs Service has thus far issued 16 notices of liquidated damages in the aggregate amount of $712,000 relating to alleged violations of customs rules governing the handling and sale of bonded merchandise.
Certain former stockholders of UETA, Inc. and certain stockholders of Overseas Trading Corporation (1987) Limited, an affiliate of UETA, Inc., commenced an action against the Company, certain of its directors and officers and Goldman, Sachs & Co., which was the financial advisor to UETA, in the Superior Court, New Castle County, Delaware. In their complaint which was filed on or about December 19, 1994, plaintiffs allege that the Company and its officers and directors made false and misleading statements and omissions in connection with the Company's issuance of its common stock in connection with its acquisition in April 1992 of UETA, Inc. and of certain assets of Overseas Trading Corporation (1987) Limited, all in violation of state statutory and common law. The relief sought includes unspecified amounts of actual and punitive damages. The Company and its officers and directors intend to defend this action vigorously. Certain of the plaintiffs in this action had filed a similar complaint (on or about May 30, 1994) against the same defendants in the Superior Court of the State of Arizona, Pima County. This action was dismissed by court order on November 17, 1994, pursuant to stipulation of the parties, without prejudice to the commencement by those plaintiffs of an action in the courts of the State of Delaware.
Certain other former stockholders of UETA, Inc. commenced an action against the Company and Goldman, Sachs & Co. in the District Court, 285th Judicial District, Bexar County, Texas. In their complaint which was filed on or about June 14, 1994, these plaintiffs also allege that the Company made false and misleading statements and omissions in connection with the Company's acquisition of UETA, Inc. and the Company's issuance of its common stock in connection therewith to these plaintiffs. The relief sought includes unspecified amounts of actual and punitive damages and rescission of the transaction and/or rescissionary damages in an unspecified amount. After a hearing on November 17, 1994 on the defendants' motion to dismiss the action, the District Court abated and stayed this action pending the final determination of the plaintiffs' claims against the defendants in Delaware. On March 1, 1995, the Texas Court of Appeals, Fourth District (San Antonio) denied the plaintiffs leave to file a petition for a writ of mandamus seeking relief from the District Court's order, and on October 17, 1995, the Supreme Court of Texas denied plaintiff's leave to file a similar petition for a writ of mandamus. The plaintiffs have since made a motion before the District Court requesting reconsideration of its original order. In April 1995, the plaintiffs commenced an action in the Superior Court, New Castle County, Delaware against the Company, each of its directors and officers who were named as defendants in the aforementioned Delaware action and Goldman, Sachs & Co. In their complaint, the plaintiffs allege against the Company and its officers
and directors essentially the same claims under state statutory and common law as they have alleged in their Texas action. The relief sought in this action includes an unspecified amount of damages, including actual and/or recessionary damages and punitive damages. The Company and its officers and directors intend to defend these actions vigorously.
On July 8, 1994, the Company commenced an action against each of the plaintiffs in the foregoing Arizona and Texas actions in the Court of Chancery, New Castle County, Delaware for injunctive and declaratory relief as well as damages based upon their commencement of the above- referenced actions in the Arizona and Texas state courts, rather than in the courts of the state of Delaware as stipulated in the agreements executed in connection with the acquisition of UETA, Inc. The relief sought by the Company in its complaint also includes a request for an order enjoining each of the plaintiffs in the foregoing actions from litigating any claims arising from the acquisition of UETA, Inc. in any forum other than the courts of the state of Delaware. Motions to dismiss the Company's complaint have been made by all the defendants named in this action and the Company moved for summary judgement on certain of its causes of action.
Currently, the legal proceedings described above are not expected to have a material effect on the Company's financial condition, results of operations, liquidity or cash flows.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Incorporated by reference to the 1996 Annual Report to Stockholders, page 14.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
Incorporated by reference to the 1996 Annual Report to Stockholders, inside front cover.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Incorporated by reference to the 1996 Annual Report to Stockholders, pages 10-14.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Incorporated by reference to the 1996 Annual Report to Stockholders as set forth in Part IV Item 14, and the supplementary data on the inside front cover of such annual report.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference to the Company's Proxy Statement with respect to its 1996 Annual Meeting of Stockholders, pages 2 - 5.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the Company's Proxy Statement with respect to its 1996 Annual Meeting of Stockholders, pages 6 - 10.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the Company's Proxy Statement with respect to its 1996 Annual Meeting of Stockholders, pages 12 and 13.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the Company's Proxy Statement with respect to its 1996 Annual Meeting of Stockholders, pages 7 and 8.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)
1. Financial Statements (Incorporated by reference to the 1996 Annual Report to Stockholders, pages 15-24 and 9):
- Consolidated Balance Sheets as of January 28, 1996 and January 29, 1995.
- Consolidated Statements of Operations, Stockholders' Equity, and Cash Flows for each of the years in the three- year period ended January 28, 1996.
- Notes to the Consolidated Financial Statements.
- Independent Auditors' Report.
2. Financial Statement Schedules filed as part of this report:
- Independent Auditors' Report.
- Schedule II - Valuation and Qualifying Accounts for each of the years in the three-year period ended January 28, 1996.
- All other schedules have been omitted because the required information is not significant or is not applicable.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
3. Exhibits:
2.1 - Second Consent and Amendment, dated as of December 15, 1994, among Duty Free International, Inc., the Sellers named therein and the Additional Recipients named therein, amending the Stock Purchase Agreement, dated as of March 24, 1994, as amended by the Consent and Amendment, dated as of May 1, 1994, which were both filed as Exhibits 2.1 and 2.2, respectively, to the Company's Current Report on Form 8-K dated May 1, 1994. (10)
3.1 - Charter of the Company. (2)
3.2 - By-Laws of the Company as amended to October 18, 1993. (7)
4.1 - Senior Indenture between Duty Free International, Inc. and The Chase Manhattan Bank, N.A., as trustee, dated as of January 15, 1994. (6)
4.2 - Form of 7% Note Due 2004. (6)
10.1 - Agreement by and between United Distillers Group (Duty Free) Ltd. and Overseas Trading Corporation. (8)
10.2 - Agreement dated January 1, 1989 by and between United Distillers Group (Duty Free) Ltd. and Samuel Meisel and Company, Inc. (1)
10.3 - Credit Agreement dated as of May 26, 1995 among Duty Free International, Inc., the Banks signatory thereto and the Chase Manhattan Bank, N.A. as agent. (3)
10.4 - 1989 Stock Option Plan for Duty Free International, Inc., and related form of stock option agreement as amended and restated effective February 11, 1993 (8) and May 20, 1994 (10) (compensatory plan).
10.5 - Incentive Compensation Plan (1) (compensatory plan).
10.6 - Indemnity Agreement by and between Duty Free International, Inc. and Jack Africk.(1)
10.7 - Stockholders Agreement dated as of April 24, 1992 among Duty Free International, Inc., DFI Group Acquisition Corp., UETA, Inc., Overseas Trading Corporation (1987) Limited, and each of the persons and entities listed in Exhibit A thereto. (4)
10.8 - Escrow Agreement dated as of April 24, 1992 among Duty Free International, Inc., the persons and entities listed in Exhibit A thereto and The First National Bank of Maryland, as escrow agent. (4)
10.9 - Agreement and Plans of Merger and Reorganization dated as of March 16, 1992 by and among UETA, Inc., Overseas Trading Corporation (1987) Limited, Capin's Duty-Free Warehouse, Inc., Duty Free International, Inc. and DFI Group Acquisition Corp. (4)
12.1 - Ratios of Earnings to Fixed Charges. (3)
13.1 - 1996 Annual Report to Stockholders.(3)
18.1 - Preferability letter regarding change in accounting principle. (9)
21.1 - Subsidiaries.(3)
23.1 - Consent of KPMG Peat Marwick LLP.(3)
24.1 - Powers of Attorney for Jack Africk, David H. Bernstein, John A. Couri, Carl Reimerdes and Susan H. Stackhouse. (3)
27.1 - Financial Data Schedule.(3)
Notes: (1) Previously filed as an Exhibit to the Registration Statement of the Company on Form S-1, File No. 33-27842 declared effective May 11, 1989.
(2) Previously filed as an Exhibit to the Company's Registration Statement on Form S-1, File No. 33-43071, declared effective November 29, 1991.
(3) Filed herewith.
(4) Previously filed as an Exhibit to the Company's Current Report on Form 8-K dated April 24, 1992.
(5) Previously filed as an Exhibit to the Company's Annual Report on Form 10-K dated April 20, 1992.
(6) Previously filed as an Exhibit to the Company's Current Report on Form 8-K dated January 15, 1994.
(7) Previously filed as an Exhibit to the Company's Current Report on Form 8-K dated December 27, 1993.
(8) Previously filed as an Exhibit to the Company's Annual Report on Form 10-K dated April 27, 1993.
(9) Previously filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended October 31, 1994.
(10) Previously filed as an Exhibit to the Company's Annual Report on Form 10-K dated April 20, 1995.
(b) Reports on Form 8-K:
(i) The Company did not file a Current Report on Form 8-K during the quarter ended January 28, 1996.
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, this 19th day of April, 1996.
DUTY FREE INTERNATIONAL, INC.
By: /s/ Alfred Carfora --------------------------------- Alfred Carfora President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - ------------------- ----------------------- --------------
* - ------------------- Jack Africk Director April 19, 1996
* - ------------------- David H. Bernstein Director April 19, 1996
/s/ Alfred Carfora - ------------------- Director, President and Alfred Carfora Chief Executive Officer April 19, 1996
* - ------------------- John A. Couri Director April 19, 1996
/s/ Gerald F. Egan Vice President of Finance, - ------------------- Treasurer, Secretary and Gerald F. Egan Chief Financial Officer ** April 19, 1996
* - ------------------- Carl Reimerdes Director, Vice President April 19, 1996
* - ------------------- Susan H. Stackhouse Director April 19, 1996
* By: /s/ Alfred Carfora ------------------------ Alfred Carfora Attorney-in-fact
** Principal Financial and Accounting Officer
DUTY FREE INTERNATIONAL, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENT SCHEDULES
PAGE ----
Independent Auditors' Report
Schedule II - Valuation and Qualifying Accounts for the three-year period ended January 28, 1996.
All other schedules are omitted because they are not applicable, or not required, or because the required information is included in the consolidated financial statements or notes thereto.
INDEPENDENT AUDITORS' REPORT
The Board of Directors Duty Free International, Inc.:
Under date of February 26, 1996, we reported on the consolidated balance sheets of Duty Free International, Inc. and subsidiaries as of January 28, 1996 and January 29, 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended January 28, 1996. In connection with our audits of the aforementioned consolidated financial statements, we have also audited the related financial statement schedule "Schedule II - Valuation and Qualifying Accounts". The financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, this financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
KPMG PEAT MARWICK LLP
Baltimore, Maryland February 26, 1996
DUTY FREE INTERNATIONAL, INC. AND SUBSIDIARIES EXHIBIT INDEX
Sequential Exhibit Page No. Description of Exhibit Number - ------- ---------------------------------------------- ----------
2.1 - Second Consent and Amendment, dated as of December 15, 1994, among Duty Free International, Inc., the Sellers named therein and the Additional Recipients named therein, amending the Stock Purchase Agreement, dated as of March 24, 1994, as amended by the Consent and Amendment, dated as of May 1, 1994, which were both filed as Exhibits 2.1 and 2.2, respectively, to the Company's Current Report on Form 8-K dated May 1, 1994. (10)
3.1 - Charter of the Company. (2)
3.2 - By-Laws of the Company as amended to October 18, 1993. (7)
4.1 - Senior Indenture between Duty Free International, Inc. and The Chase Manhattan Bank, N.A., as trustee, dated as of January 15, 1994. (6)
4.2 - Form of 7% Note Due 2004. (6)
10.1 - Agreement by and between United Distillers Group (Duty Free) Ltd. and Overseas Trading Corporation. (8)
10.2 - Agreement dated January 1, 1989 by and between United Distillers Group (Duty Free) Ltd. and Samuel Meisel and Company, Inc. (1)
10.3 - Credit Agreement dated as of May 26, 1995 among Duty Free International, Inc., the Banks signatory thereto and the Chase Manhattan Bank, N.A. as agent. (3)
10.4 - 1989 Stock Option Plan for Duty Free International, Inc., and related form of stock option agreement as amended and restated effective February 11, 1993 (8) and May 20, 1994 (10) (compensatory plan).
10.5 - Incentive Compensation Plan (1) (compensatory plan).
10.6 - Indemnity Agreement by and between Duty Free International, Inc. and Jack Africk.(1)
10.7 - Stockholders Agreement dated as of April 24, 1992 among Duty Free International, Inc., DFI Group Acquisition Corp., UETA, Inc., Overseas Trading Corporation (1987) Limited, and each of the persons and entities listed in Exhibit A thereto. (4)
10.8 - Escrow Agreement dated as of April 24, 1992 among Duty Free International, Inc., the persons and entities listed in Exhibit A thereto and The First National Bank of Maryland, as escrow agent. (4)
10.9 - Agreement and Plans of Merger and Reorganization dated as of March 16, 1992 by and among UETA, Inc., Overseas Trading Corporation (1987) Limited, Capin's Duty-Free Warehouse, Inc., Duty Free International, Inc. and DFI Group Acquisition Corp. (4)
12.1 - Ratios of Earnings to Fixed Charges. (3)
13.1 - 1996 Annual Report to Stockholders. (3)
18.1 - Preferability letter regarding change in accounting principle. (9)
21.1 - Subsidiaries. (3)
23.1 - Consent of KPMG Peat Marwick LLP. (3)
24.1 - Powers of Attorney for Jack Africk, David H. Bernstein, John A. Couri, Carl Reimerdes and Susan H. Stackhouse. (3)
27.1 - Financial Data Schedule. (3)
Notes: (1) Previously filed as an Exhibit to the Registration Statement of the Company on Form S-1, File No. 33-27842 declared effective May 11, 1989.
(2) Previously filed as an Exhibit to the Company's Registration Statement on Form S-1, File No. 33-43071, declared effective November 29, 1991.
(3) Filed herewith.
(4) Previously filed as an Exhibit to the Company's Current Report on Form 8-K dated April 24, 1992.
(5) Previously filed as an Exhibit to the Company's Annual Report on Form 10-K dated April 20, 1992.
(6) Previously filed as an Exhibit to the Company's Current Report on Form 8-K dated January 15, 1994.
(7) Previously filed as an Exhibit to the Company's Current Report on Form 8-K dated December 27, 1993.
(8) Previously filed as an Exhibit to the Company's Annual Report on Form 10-K dated April 27, 1993.
(9) Previously filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended October 31, 1994.
(10) Previously filed as an Exhibit to the Company's Annual Report on Form 10-K dated April 20, 1995.


Item 1. Business
(a) General development of business
SEI II L.P. (the "Partnership" or the "Registrant") (formerly known as Shearson Equipment Investors - II) is a limited partnership organized April 6, 1981 under the Partnership Law of the State of New York to engage in the acquisition of various types of equipment and other property. The Partnership acquired, through direct forms of ownership, various types of equipment which do not incorporate high levels of technology and are therefore not likely to be subject to technological obsolescence.
A Registration Statement on Form S-1, Registration No. 2-72177, filed with the Securities and Exchange Commission and relating to the public offering (the "Offering") of the limited partnership interests in the Partnership (the "Interests"), became effective on June 25, 1981, the date on which the Partnership's operations commenced. The Offering was completed as of October 2, 1981. As of that date, there were 3,614 Interests outstanding, (including 22 Interests purchased by the general partner and two Interests each purchased by the two initial limited partners) which represent aggregate capital contributions to the Partnership of $18,059,950.
The general partner of the Partnership is SEI II Equipment Inc. (the "General Partner") (formerly Shearson Equipment Management Corporation), a Delaware corporation which is an affiliate of Lehman Brothers Inc. ("LB"). Under the Partnership Agreement, the General Partner has exclusive authority to manage the operations and affairs of the Partnership and to make all decisions regarding the business of the Partnership; but the acquisition, sales, financing or refinancing of any item of equipment must be approved by a majority of the members of the investment committee, whose members are designated by the President of the General Partner. For a discussion of the investment committee, see Item 10. "Directors and Executive Officers of the Registrant."
At December 31, 1982, the Partnership had completed the acquisition of its equipment portfolio. Equipment acquired by the Partnership is either operated by or on behalf of the Partnership under operating agreements.
Commencing January 1, 1993, the General Partner engaged a new marine equipment operator, Midwest Marine Management Company ("Midwest Marine"), to manage the Partnership's barge fleet, pursuant to the terms of a Management Agreement. The Management Agreement expired December 31, 1996, but was renewed at maturity, as provided for under the terms of the Management Agreement. The Management Agreement now expires December 31, 1997.
(b) Financial information about industry segments
As of December 31, 1996, the Partnership's business consisted of one segment, the investment in a fleet of 25 covered hopper river barges. With the exception of such services as are provided by the Partnership to users of its equipment, the Partnership does not engage in sales of goods or services.
(c) Narrative description of business
See Paragraphs (a) and (b) above and Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations."
(d) Employees
The Partnership has no employees.
Item 2.

Item 2. Properties
During the period ended December 31, 1982, the Partnership acquired various items of equipment which together constitute the Partnership's entire equipment portfolio. No equipment purchases were made subsequent to December 31, 1982, nor does the Partnership expect that it will acquire any additional equipment. All of the equipment has been pledged as collateral under the credit agreement described in Note 4 to the Partnership's financial statements. Commencing in 1987, the Partnership sold the following assets: two 2 offshore supply vessels, a drilling rig, and 82 railcars, with the proceeds being used to repay Partnership debt. The Partnership currently owns 25 covered river hopper barges which are engaged in the intercoastal waterway transportation of goods.
Item 3.

Item 3. Legal Proceedings
In March 1996, a purported class action, on behalf of all Limited Partners, was brought against the Partnership, Lehman Brothers Inc., Smith Barney Holdings Inc., and a number of other limited partnerships in New York State Supreme Court. The complaint alleges claims of common law fraud and deceit, negligent misrepresentation, breach of fiduciary duty and breach of implied covenant of good faith and fair dealing. The defendants intend to defend the action vigorously.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to the limited partners for a vote during the fourth quarter of the year for which this report is filed.
PART II
Item 5.

Item 5. Market for the Registrant's Limited Partnership Interests and Related Security Holder Matters
(a) Market Price Information
The only outstanding or authorized securities of the Registrant are the Interests. There is no market for the Interests, nor is one expected to develop. The Partnership Agreement imposes substantial restrictions on the transfer of an Interest.
(b) Holders
The number of holders of Interests as of December 31, 1996 was 1,442.
(c) Cash Distributions per Interest
To the extent that funds are available and subject to the provisions of the Partnership Agreement, the Partnership will make cash distributions from operations to holders of Interests on a quarterly basis. Cash distributions from operations are made at the sole discretion of the General Partner. The Partnership Agreement prohibits the investment of cash available for distributions from operations in other than temporary money market investments or United States government securities. Cash distributions from operations are paid 99% to the limited partners and 1% to the General Partner and are distributed to each limited partner entitled to such distribution in the ratio in which the number of Interests owned by such limited partner bears to the total number of Interests issued, outstanding and held by limited partners entitled to such distribution.
No cash distributions have been made to the partners since the third quarter of 1982.
Item 6.

Item 6. Selected Financial Data
The information set forth below should be read in conjunction with the Partnership's financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations," also included herein.
Years Ended December 31, 1996 1995 1994 1993 1992 Operating revenues $2,579,822 $2,892,077 $1,852,384 $1,710,410 $2,268,236 Income from operations 592,153 882,829 383,191 64,416 246,662 Interest and miscellaneous income 271,734 220,098 93,874 61,143 59,164 Other income -- -- -- -- -- Interest expense (653,375) (692,302) (547,495) (470,340) (489,937) Net Income (Loss) 210,512 410,625 (70,430) (344,781) (184,111) Net Income (Loss) Per Interest 57.67 112.48 (19.29) (94.45) (50.43) Total Assets at Period-End 9,432,600 8,539,370 7,413,095 6,919,509 6,888,038 Long-term Debt at Period-End 7,839,000 7,839,000 7,839,000 7,839,000 7,839,000 Accrued interest expense due to affiliate 9,311,189 8,657,814 7,965,512 7,418,017 6,947,677
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
(a) Liquidity and Capital Resources
The interest rate of the Partnership's note payable obligation (the "Note") was 8.25% at December 31, 1996, compared to 8.75% at December 31, 1995. No interest was paid relating to the Note for the 12 months ended December 31, 1996, and, as a result, the Partnership's accrued and deferred interest increased to $9,824,043 at December 31, 1996, compared to $9,170,668 at December 31, 1995. Accrued and deferred interest is payable at maturity of the Note. The Note had a maturity date of January 3, 1997, and on that date the amount of accrued and unpaid interest on the Note was $9,829,360. On January 3, 1997, the maturity date of the Note was extended until January 2, 1998, or the date on which the Partnership sells the barges, and the terms of the Note were modified as described below.
On January 3, 1997, the Partnership entered into a First Amended and Restated Credit Note ("Amended Note") with Buttonwood Leasing Corporation. At that time, a principal payment of $5,500,000 was made by the Partnership reducing the principal amount from $7,839,000 to $2,339,000.
In accordance with the Amended Note, the Partnership is required to pay quarterly installments of principal only on April 1, 1997, July 1, 1997, and October 1, 1997 (each a "Payment Date") in an amount equal to the amount of interest accrued on the unpaid principal balance from the later of January 3, 1997 or the immediately preceding Payment Date. In addition, the Partnership is required to pay interest on the unpaid principal balance on the Amended Note at maturity. Interest on the outstanding principal balance of the Amended Note shall be computed using simple interest at a rate equal to the Prime Rate as charged by Bank America Illinois.
In addition to the quarterly principal installments, the Partnership is required to make a cash sweep payment, which is applied to principal, on or before the 60th day after the end of each calendar quarter commencing March 31, 1997. The amount of each cash sweep payment will be equal to 90% of Net Operating Income (as defined in the Amended Note) minus the scheduled principal installments paid on any debt permitted by Section 9(c) of the Credit Agreement (as defined in the Amended Note) for the immediately preceding calendar quarter of the Partnership.
During 1996, the Partnership's fleet of 25 covered hopper river barges continued to operate on the inland waterways of the United States. Although Partnership operations in the first half of 1996 were relatively stronger than usual due to the lingering effects of an abundant harvest in 1994, conditions for barge traffic deteriorated in the second half of the year as a result of a comparatively smaller 1995 harvest. Because the crops harvested in one year are typically shipped in the following year, the smaller 1995 harvest did not impact the Partnership's operations until 1996. Additionally, many farmers had shipped all of their previously held crop inventories by mid-1996, further reducing the quantity of goods available for shipment in the third and fourth quarters of last year. These factors decreased the demand for barges and led to intensified competition among barge owners and, consequently, lower barge revenue rates in the second half of 1996. As a result, Partnership operating revenues and net income were lower than the year before. Although last year's harvest was relatively strong, it is anticipated that it will not likely be transported until mid-1997, after farmers have replenished their depleted crop inventories. The General Partner is currently exploring the potential of commencing efforts to sell the Partnership's barge fleet during 1997. The ability to sell, however, will be dictated by market conditions and there can be no assurance that a sale will occur. Furthermore, it is highly unlikely that the barges will be sold for an amount which is equal to or in excess of the Partnership's existing indebtedness.
The Partnership's cash and cash equivalents balance totaled $5,703,859 at December 31, 1996, compared to $4,238,441 at December 31, 1995. The increase is primarily due to cash flow provided by operating activities. At December 31, 1996, the amount due from the Partnership's equipment manager was $425,549, compared to $673,652 at December 31, 1995. The decrease is primarily due to the timing of the distributions of net revenues from the equipment manager.
(b) Results of Operations
1996 versus 1995 For the year ended December 31, 1996, the Partnership generated net income of $210,512, compared to $410,625 for the year ended December 31, 1995. The decrease in net income is mainly the result of lower operating revenues.
Operating revenues for the year ended December 31, 1996 totaled $2,579,822, compared to $2,892,077 for the year ended December 31, 1995. The decrease in operating revenues was primarily attributable to a decrease in the average barge revenue rate during the latter half of 1996.
Interest and miscellaneous income was $271,734 for the year ended December 31, 1996, compared to $220,098 for the year ended December 31, 1995. The increase is mainly due to an increase in interest income due to a higher cash balance invested.
Operating costs decreased slightly to $1,438,584 for the year ended December 31, 1996, compared to $1,454,871 for the year ended December 31, 1995. Interest expense for the year ended December 31, 1996 was $653,375 compared with $692,302 for the year ended December 31, 1995. The reduction is due to a decrease in the prime rate charged on the outstanding principal amount of the Note.
1995 versus 1994 For the year ended December 31, 1995, the Partnership generated net income of $410,625, compared to a net loss of $70,430 for the year ended December 31, 1994. The difference is primarily attributable to increased operating revenues.
Operating revenues for the year ended December 31, 1995 totaled $2,892,077, compared to $1,852,384 for the year ended December 31, 1994. The increase is primarily attributable to an increase in barge utilization. The record harvest of soybeans in 1994 positively impacted revenue during 1995 as there was a greater quantity of goods to transport. Strong U.S. exports in 1995 also contributed to increased barge utilization. Furthermore, revenues were lower than usual in 1994 as a result of the 1993 floods which damaged crops and reduced utilization.
Interest and miscellaneous income increased to $220,098 for the year ended December 31, 1995, compared to $93,874 for the year ended December 31, 1994. The increase is mainly due to an increase in interest income due to a higher cash balance invested and higher interest rates.
Operating costs for the year ended December 31, 1995 were $1,454,871, compared to $949,093 for the year ended December 31, 1994. The increase is primarily attributable to increased towing costs as a result of greater utilization in 1995, and lower than normal towing costs for the first three quarters of 1994.
Interest expense for the year ended December 31, 1995 totaled to $692,302 compared with $547,495 for the year ended December 31, 1994. The increase is due to an increase in the prime rate charged on the outstanding principal amount of the Note.
Item 8.

Item 8. Financial Statements and Supplementary Data
See item 14 "Exhibits, Financial Statement Schedules, and Reports on Form 8-K" for a listing of the financial statements filed with this report.
Item 9.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant
The Partnership has no officers or directors and its affairs are managed by its General Partner, SEI II Equipment Inc. Decisions as to which items of equipment should be acquired, sold, financed or refinanced by the Partnership and whether such acquisitions should be direct or indirect, are made by an investment committee designated by the President of the General Partner. The investment committee has the right, power and authority to utilize the services of affiliates of the General Partner for assistance in evaluating the suitability of equipment for investment by the Partnership.
Certain officers and directors of the General Partner are now serving (or in the past have served) as officers or directors of entities which act as general partners of a number of limited partnerships which have sought protection under the provisions of the federal Bankruptcy Code. The partnerships which have filed bankruptcy petitions own assets which have been adversely affected by the economic conditions in the markets in which that asset is located and, consequently, the partnerships sought protection of the bankruptcy laws to protect the partnerships' assets from loss through foreclosure.
The following is a brief description of the directors and executive officers of the General Partner:
Name Office Rocco F. Andriola President and Director Regina M. Hertl Vice President and Chief Financial Officer Michael T. Marron Vice President
Rocco F. Andriola, 38, is a Managing Director of Lehman Brothers in its Diversified Asset Group and has held such position since October 1996. Since joining Lehman Brothers in 1986, Mr. Andriola has been involved in a wide range of restructuring and asset management activities involving real estate and other direct investment transactions. From June 1991 through September 1996, Mr. Andriola held the position of Senior Vice President in Lehman's Diversified Asset Group. From June 1989 through May 1991, Mr. Andriola held the position of First Vice President in Lehman's Capital Preservation and Restructuring Group. From 1986- 89, Mr. Andriola served as a Vice President in the Corporate Transactions Group of Shearson Lehman Brothers' office of the general counsel. Prior to joining Lehman Brothers, Mr. Andriola practiced corporate and securities law at Donovan Leisure Newton & Irvine in New York. Mr. Andriola received a B.A. from Fordham University, a J.D. from New York University School of Law, and an LLM in Corporate Law from New York University's Graduate School of Law.
Regina M. Hertl, 38, is a First Vice President of Lehman Brothers in its Diversified Asset Group and is responsible for the investment management of commercial and residential real estate, and a venture capital portfolio. From January 1988 through December 1988, Ms. Hertl was Vice President of the Real Estate Accounting Group within the Controller's Department of Shearson Lehman Brothers. From September 1986 through December 1987, she was an Assistant Vice President responsible for real estate accounting analysis within the Controller's Department at Shearson. From September 1981 to September 1986, Ms. Hertl was employed by the accounting firm of Coopers & Lybrand. Ms. Hertl, who is a Certified Public Accountant, graduated from Manhattan College in 1981 with a B.S. degree in Accounting.
Michael T. Marron, 33, is a Vice President of Lehman Brothers and has been a member of the Diversified Asset Group since 1990 where he has actively managed and restructured a diverse portfolio of syndicated limited partnerships. Prior to joining Lehman Brothers, Mr. Marron was associated with Peat Marwick Mitchell & Co. serving in both its audit and tax divisions from 1985 to 1989. Mr. Marron received a B.S. degree from the State University of New York at Albany in 1985 and is a Certified Public Accountant.
Item 11.

Item 11. Executive Compensation
Neither of the General Partners nor any of their directors and officers received any compensation from the Partnership. See Item 13 below with respect to a description of certain transactions of the General Partners and their affiliates with the Partnership.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) Security ownership of certain beneficial owners
No person (including any "group" as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934) is known to the Partnership to be the beneficial owner of more than 5% of the outstanding Interests as of December 31, 1996.
(b) Security ownership of management
Under the terms of the Limited Partnership Agreement, the Partnership's affairs are managed by the General Partner. An affiliate of the General Partner owns 22 interests and shares in the profits, losses and distributions of the Partnership.
(c) Changes in Control
None.
Item 13.

Item 13. Certain Relationships and Related Transactions
Pursuant to a Management Agreement dated June 25, 1981 between the Partnership and the General Partner, the General Partner is entitled to receive equipment management fees for services rendered in the management of equipment owned by the Partnership. The amount of the equipment management fees charged is the lesser of (i) the aggregate of amounts customarily charged by third parties for similar services or (ii) 5% of annual gross revenues, however, in the event the General Partner subcontracts to third parties for services to be rendered in the management of the equipment, any management fee paid to a third party will reduce the fee otherwise earned by the General Partner, but not below 1% of gross revenues. For the year ended December 31, 1996, equipment management fees aggregating $149,771 were expensed by the Partnership. Of this amount, $123,973 was due or paid by the Partnership to an independent, third-party operator, and $25,798 was earned by the General Partner. The fee as earned by the General Partner added to uncollected fees for prior years and, as of December 31, 1996, $696,999 remains to be paid to the General Partner. In accordance with the Partnership Agreement, the General Partner has deferred its rights to receive such fees until such time as the Partnership is in a position to make cash distributions to all partners.
The General Partner is also entitled to receive, for services rendered, a Partnership management fee equal to 5% of cash distributions from operations. Such services relate to decision-making as to the terms of acquisitions and dispositions of equipment, selecting, retaining and supervising consultants, engineers, lenders and others, maintaining the books and records of the Partnership and otherwise generally managing the day-to-day operations of the Partnership. The Partnership management fees are payable at the same time as, but only if and when, cash distributions from operations are paid to the limited partners. Partnership management fees are in addition to all other fees, commissions or compensation paid or permitted to be paid to the General Partner or its affiliates. For the year ended December 31, 1996, no Partnership management fees were paid to the General Partner.
First Data Investor Services Group, formerly The Shareholder Services Group, provides partnership accounting and investor relations services for the Registrant. The Registrant's transfer agent and certain tax reporting services are provided by Service Data Corporation. Both First Data Investor Services Group and Service Data Corporation are unaffiliated companies. For additional information regarding fees paid and reimbursed to the General Partner or its affiliates during 1996, 1995 and 1994, see Note 4 to the Financial Statements in Item 14, "Exhibits, Financial Statement Schedules, and Reports on Form 8-K."
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) Financial statements:
SEI II L.P. Page Number Balance Sheets at December 31, 1996 and 1995 Statements of Partners' Deficit for the years ended December 31, 1996, 1995 and 1994 Statements of Operations for the years ended December 31, 1996, 1995, and 1994 Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 Notes to the Financial Statements Report of Independent Public Accountants
(2) Financial Statement Schedules:
No schedules are presented because the information is not applicable or is included in the Financial Statements or the notes thereto.
(3) Exhibits:
3.1 Agreement of Limited Partnership dated June 25, 1981 (filed as Exhibit 3b to Registration Statement on Form S-1 as filed with the Securities and Exchange Commission on May 7, 1981, No. 2-72177 and incorporated herein by reference).
3.1 Certificate of Limited Partnership of the Partnership as filed in the office of the County Clerk of New York County on April 6, 1981(filed as Exhibit 3a to Registration Statement on Form S-1 as filed with the Securities and Exchange Commission on May 7, 1981, No. 2-72177 and incorporated herein by reference).
10.1 Acquisition Services Agreement between the Partnership and the General Partner dated June 25, 1981 (filed as Exhibit 12c to Registration Statement on Form S-1 as filed with the Securities and Exchange Commission on May 7, 1981, No. 2-72177 and incorporated herein by reference).
10.2 Management Agreement between the Partnership and the General Partner dated June 25, 1981 (filed as Exhibit 12d to Registration Statement on Form S-1 as filed with the Securities and Exchange Commission on May 7, 1981, No. 2-72177 and incorporated herein by reference).
10.3 Agreement for Financial Advisory Services between the Partnership and Shearson Leasing Corporation dated June 25, 1981 (filed as Exhibit 12e to Registration Statement on Form S-1 as filed with the Securities and Exchange Commission on May 7, 1981, No. 2-72177 and incorporated herein by reference).
10.4 First Amended and Restated Credit Agreement between SEI 2 L.P. and Buttonwood Leasing Corporation dated January 3, 1997.
10.5 First Amended and Restated Credit Note between SEI 2 L.P. and Buttonwood Leasing Corporation dated January 3, 1997.
27.0 Financial Data Schedule.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of the year for which this report is filed.
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.
SEI II L.P.
BY: SEI II EQUIPMENT INC. General Partner
Date: March 27, 1997 BY: /s/ Rocco F. Andriola Name: Rocco F. Andriola Title: President and Director
Date: March 27, 1997 BY: /s/ Regina Hertl Name: Regina Hertl Title: Vice President and Chief Financial Officer
Date: March 27, 1997 BY: /s/ Michael T. Marron Name: Michael T. Marron Title: Vice President
Balance Sheets At December 31, At December 31, 1996 1995 Assets Property: Equipment $ 8,306,724 $8,306,724 Less accumulated depreciation (5,011,716) (4,679,447) Net Equipment 3,295,008 3,627,277
Cash and cash equivalents 5,703,859 4,238,441 Due from equipment manager 425,549 673,652 Other assets 8,184 -- Total Assets $ 9,432,600 $8,539,370 Liabilities and Partners' Deficit Liabilities: Accounts payable and accrued expenses $ 34,173 $ 30,628 Accrued interest expense due to affiliate 9,311,189 8,657,814 Deferred interest payable to affiliate 512,854 512,854 Due to General Partner 696,999 671,201 Note payable to affiliate 7,839,000 7,839,000 Total Liabilities 18,394,215 17,711,497 Partners' Deficit: General Partner (251,806) (253,911) Limited Partners (3,614 units outstanding) (8,709,809) (8,918,216) Total Partners' Deficit (8,961,615) (9,172,127) Total Liabilities and Partners' Deficit $9,432,600 $8,539,370
Statements of Partners' Deficit For the years ended December 31, 1996, 1995 and 1994 General Limited Partner Partners Total Balance at December 31, 1993 $(257,313) $(9,255,009) $(9,512,322) Net Loss (704) (69,726) (70,430) Balance at December 31, 1994 (258,017) (9,324,735) (9,582,752) Net Income 4,106 406,519 410,625 Balance at December 31, 1995 (253,911) (8,918,216) (9,172,127) Net Income 2,105 208,407 210,512 Balance at December 31, 1996 $(251,806) $(8,709,809) $(8,961,615)
Statements of Operations For the years ended December 31, 1996 1995 1994 Revenues Operating revenues $2,579,822 $2,892,077 $1,852,384 Operating Expenses Operating costs 1,438,584 1,454,871 949,093 Depreciation 332,269 332,269 332,269 Professional and other expenses 50,201 44,660 48,422 Equipment management fee - Operators 123,973 131,683 105,558 General Partner 25,798 28,921 18,524 Insurance 16,844 16,844 15,327 Total Operating Expenses 1,987,669 2,009,248 1,469,193 Income from operations 592,153 882,829 383,191 Other Income (Expense): Interest and miscellaneous income 271,734 220,098 93,874 Interest expense (653,375) (692,302) (547,495) Total Other Expense (381,641) (472,204) (453,621) Net Income (Loss) $ 210,512 $ 410,625 $ (70,430) Net Income (Loss) Allocated: To the General Partner $ 2,105 $ 4,106 $ (704) To the Limited Partners 208,407 406,519 (69,726) $ 210,512 $ 410,625 $ (70,430) Per limited partnership unit (3,614 outstanding) $57.67 $112.48 $(19.29)
Statements of Cash Flows For the years ended December 31, 1996 1995 1994 Cash Flows From Operating Activities Net Income (Loss) $210,512 $410,625 $(70,430) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 332,269 332,269 332,269 Increase (decrease) in cash arising from changes in operating assets and liabilities Due from equipment manager 248,103 (151,569) (162,238) Other assets (8,184) -- -- Accounts payable and accrued expenses 3,545 (5,573) (2,003) Accrued interest expense due to affiliate 653,375 692,302 547,495 Due to General Partner 25,798 28,921 18,524 Net cash provided by operating activities 1,465,418 1,306,975 663,617 Net increase in cash and cash equivalents 1,465,418 1,306,975 663,617 Cash and cash equivalents, beginning of period 4,238,441 2,931,466 2,267,849 Cash and cash equivalents, end of period $5,703,859 $4,238,441 $2,931,466
Notes to the Financial Statements December 31, 1996, 1995 and 1994
1. Organization SEI II L.P. (the "Partnership") was organized under the Partnership Act of the State of New York on April 6, 1981. The term of the Partnership will continue through December 31, 2011, unless terminated and dissolved sooner pursuant to the Partnership Agreement.
The general partner is SEI II Equipment Inc. (the "General Partner"), formerly Shearson Equipment Management Corp., an affiliate of Lehman Brothers Inc. On July 31, 1993, certain of Shearson Lehman Brothers Inc.'s domestic retail brokerage and management businesses were sold to Smith Barney, Harris Upham & Co. Inc. Included in the purchase was the name "Shearson." Consequently, the General Partner's name was changed to SEI II Equipment Inc. to delete any reference to "Shearson."
The Partnership's business consists of one segment, the investment in a fleet of 25 covered hopper river barges which are engaged in the intercoastal waterway transportation of goods. With the exception of such services as are provided by the Partnership to users of its equipment, the Partnership does not engage in the sales of goods or services.
Upon formation of the Partnership, an affiliate of the General Partner contributed $1,000 and purchased 22 partner units for $100,650. The initial Limited Partners contributed $18,300 for four partner units. An additional 3,588 limited partnership units were then sold at a price of $5,000 per unit. The offering was completed as of October 2, 1981. As of that date, there were 3,614 interests outstanding, (including 22 interests purchased by an affiliate of the General Partner and two interests each purchased by the two initial limited partners) which represent aggregate capital contributions to the Partnership of $18,059,950.
The General Partner has entered into an agreement with an independent equipment manager for the operation of the Partnership's equipment. The results of such operations are reported to the General Partner by the independent equipment manager and have been reflected in the accompanying financial statements.
2. Significant Accounting Policies
Basis of Accounting - The accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. Revenues are recognized as earned and expenses are recorded as obligations are incurred.
Equipment Manager - On January 1, 1993, the Partnership transferred management of its assets to a new equipment manager, Midwest Marine Management Company ("Midwest Marine"). Midwest Marine operates the barge fleet and provides for pooling of all owners' assets. Due to this pooling, the Partnership is entitled to a proportion of the pooled net revenues; therefore, the Partnership does not record operating assets or liabilities other than the balance due from Midwest Marine.
Equipment and Depreciation - The equipment balance at December 31, 1996 and 1995 consisted of 25 covered hopper river barges, stated at cost. Depreciation for financial reporting purposes is computed on a straight-line basis over the estimated useful lives of 25 years.
Accounting for Impairment - In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of " ("FAS 121"), which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. FAS 121 also addresses the accounting for long- lived assets that are expected to be disposed of. The Partnership adopted FAS 121 in the fourth quarter of 1995.
Cash Equivalents - Cash equivalents consist of short-term highly liquid investments with maturities of three months or less from the date of purchase. The carrying amount approximates fair value because of the short maturity of these investments. Concentration of Credit Risk Financial instruments which potentially subject the Partnership to a concentration of credit risk principally consist of cash in excess of the financial institution's insurance limits. The Partnership invests available cash with high credit quality financial institutions.
Fair Value of Financial Instruments - Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments" ("FAS 107"), requires that the Partnership disclose the estimated fair values of its financial instruments. Fair values generally represent estimates of amounts at which a financial instrument could be exchanged between willing parties in a current transaction other than in forced liquidation.
Fair Value estimates are subjective and are dependent on a number of significant assumptions based on management's judgment regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. In addition, FAS 107 allows a wide range of valuation techniques, therefore, comparisons between entities, however similar, may be difficult.
Income Taxes - No provision for income taxes has been made in the accompanying financial statements since such taxes are the responsibility of the individual partners rather than that of the Partnership.
Use of 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.
3. Partnership Allocations
The Partnership Agreement substantially provides for the following:
Distribution of Partnership Funds - Net cash from operations shall be distributed at the discretion of the General Partner, 99% to the Limited Partners and 1% to the General Partner.
Cash from sales or refinancings shall be allocated and paid first to all partners until the amount of all distributions received by them equals their positive capital account balances. Any balance will be allocated to the Limited Partners until the cumulative amount of distributions made to them equals their Original Invested Capital plus a cumulative 10% per annum return as defined. Thereafter, cash will be distributed 85% to the Limited Partners and 15% to the General Partner. The cumulative amount of distributions to date does not exceed the required distributions as of December 31, 1996.
Cash distributions to the partners are presently prohibited by the amended credit agreement with the Partnership's lender (Note 4). No cash distributions have been made by the General Partner since the third quarter of 1982.
Allocation of Income and Losses - All operating profits and losses and losses from sales or refinancings shall be allocated 1% to the General Partner and 99% to the Limited Partners. Profits from sales or refinancings shall be allocated to the General Partner based on the greater of either 1% of such profits or the amount distributable to the General Partner, as defined in the Partnership Agreement. Any remaining profits shall be allocated to the Limited Partners.
4. Related Party Transactions
General Partner Fees - The Partnership Agreement specifies that the General Partner will receive (a) an equipment management fee in an amount that will not exceed 5% of the annual gross revenues of all equipment owned by the Partnership; (b) in the event the General Partner subcontracts to third parties for services to be rendered in the management of the equipment, any management fee paid to a third party will reduce the fee otherwise earned by the General Partner, but not below 1% of gross revenues. As of December 31, 1996, $696,999 in equipment management fees earned by the General Partner remains to be paid to the General Partner. In accordance with the Partnership Agreement, the General Partner has deferred its rights to receive such fees until such time as the Partnership is in a position to make cash distributions to all partners.
Cash and Cash Equivalents - Cash and cash equivalents reflected on the Partnership's balance sheet at December 31, 1995 were on deposit with an affiliate of the General Partner. As of December 31, 1996, no cash and cash equivalents were on deposit with an affiliate of the General Partner or the Partnership.
Long-term Debt - On May 30, 1986, the Partnership restructured its long-term debt which had been in default since June 1985. Buttonwood Leasing Corporation (the "Purchaser"), which is a corporation affiliated with the General Partner, purchased from the Partnership's lenders (the "Banks") the Promissory Note dated December 9, 1981 (the "Note") originally executed by the Partnership in favor of the Banks. The Purchaser agreed to waive enforcement of certain financial covenants contained in the loan documentation, covenants of which the Partnership was not in compliance. Subsequent to the Note purchase, the Purchaser entered into an understanding with the Partnership on the following terms and conditions. First, the principal amount of the loan would remain the same. Second, interest would be charged on the outstanding principal amount of the Note at a rate equal to the prime rate charged by Bank America Illinois, formerly Continental Illinois National Bank, which was 8.25% at December 31, 1996, 8.75% at December 31, 1995 and 7.75% at December 31, 1994. Accrued and deferred interest is payable at maturity of the Note. The Note had a maturity date of January 3, 1997, and on that date the amount of accrued and unpaid interest on the Note was $9,829,360.
On January 3, 1997, the Partnership entered into a First Amended and Restated Credit Note ("Amended Note") with Buttonwood Leasing Corporation which extended the maturity date of the Note from January 3, 1997 to the earlier of January 2, 1998, or the date on which the Partnership sells the barges. At that time, a principal payment of $5,500,000 was made on the Note, reducing the principal amount from $7,839,000 to $2,339,000.
In accordance with the Amended Note, the Partnership is required to pay quarterly installments of principal only on April 1, 1997, July 1, 1997, and October 1, 1997 (each a "Payment Date") in an amount equal to the amount of interest accrued on the unpaid principal balance from the later of January 3, 1997 or the immediately preceding Payment Date. In addition, the Partnership is required to pay interest on the unpaid principal balance at maturity on January 2, 1998. Interest on the outstanding principal balance of the Amended Note shall be computed using simple interest at a rate equal to the Prime Rate as charged by Bank America Illinois.
In addition to the quarterly principal installments, the Partnership is required to make a cash sweep payment, which is applied to principal, on or before the 60th day after the end of each calendar quarter commencing March 31, 1997. The amount of each cash sweep payment will be equal to 90% of Net Operating Income (as defined in the Amended Note) minus the scheduled principal installments paid on any debt permitted by Section 9(c) of the Credit Agreement (as defined in the Amended Note) for the immediately preceding calendar quarter of the Partnership.
The fair market value of the Amended Note is substantially less than its carrying amount. It is not practicable for the Partnership to estimate the fair value of this financial instrument as no quoted market price exists and the cost of obtaining an independent valuation appears excessive to the Partnership.
5. Litigation In March 1996, a purported class action, on behalf of all Limited Partners, was brought against the Partnership, Lehman Brothers Inc., Smith Barney Holdings Inc., and a number of other limited partnerships in New York State Supreme Court. The complaint alleges claims of common law fraud and deceit, negligent misrepresentation, breach of fiduciary duty and breach of implied covenant of good faith and fair dealing. The defendants intend to defend the action vigorously.
6. Reconciliation of Differences between Financial Statements and the Partnership's Tax Return
Net income, as reported in 1996 $ 210,512 Adjustments- Depreciation differential between the Accelerated Cost Recovery System (ACRS) and depreciation for financial reporting 332,269 Increase in accrued operating expenses 3,545 Management fee expense 25,798 Increase in accrued interest expense due to affiliate 653,375
Total adjustments 1,014,987
Net income per the Partnership's 1996 tax return $ 1,225,499
Net income allocation:
Limited Partners (3,614 interests) $ 1,213,244 General Partner 12,255 $ 1,225,499
Per Limited Partnership interest $335.71
Partners' deficit, as reported December 31, 1996 $(8,961,615) Adjustments, as above 1,014,987 Adjustments, prior years 6,245,235 Syndication expenses 1,740,961
Partners' deficit, per the Partnership's 1996 tax return $ 39,568
The partners' deficit reported on the Partnership's tax return is allocable to the partners as follows:
Limited Partners (3,614 interests) $ (159,695) General Partner 199,263 $ 39,568
The Partnership's tax returns and the amounts of distributable Partnership income or loss are subject to examination by federal and state taxing authorities. In the event of an examination of the Partnership's tax return, the tax liability of the partners could be changed if an adjustment in the Partnership's income or loss is ultimately sustained by the taxing authorities.
Report of Independent Public Accountants
To the Partners of SEI II L.P.:
We have audited the accompanying statements of financial condition of SEI II L.P. (a New York limited partnership) as of December 31, 1996 and 1995, and the related statements of operations, partners' deficit and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of SEI II L.P. as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts February 7, 1997