SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
__X__ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended November 28, 1997
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: 000-25178
GS FINANCIAL PRODUCTS U.S., L.P.
(Exact name of registrant as specified in its charter)
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CAYMAN ISLANDS 52-1919759
(State or other jurisdiction of incorporation or organization) (I.R.S. employer identification no.)
P.O. Box 896, Harbour Centre, North Church Street
Grand Cayman, Cayman Islands, British West Indies
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (809) 945-1326
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Securities registered pursuant to Section 12(b) of the Act:
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Title of each class: Name of each exchange on which registered:
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Nikkei 225 Indexed Notes due December 22, 2000 American Stock Exchange
S&P Enhanced Stock Index Growth Notes due August 9, 2002 New York Stock Exchange
3% Citicorp Exchangeable Notes due August 28, 2002 American Stock Exchange
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Securities registered pursuant to Section 12(g) of the Act:
Limited partnership interests
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes __X__ No______
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K: __X__
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant. The aggregate market value shall be
computed by reference to the price at which the common equity was sold, or the
average bid and asked prices of such common equity, as of a specified date
within 60 days prior to the date of filing. (See definition of affiliate in Rule
405.): Not Applicable
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GS FINANCIAL PRODUCTS U.S., L.P.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED NOVEMBER 28, 1997
Form 10-K Item Number:
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Page No.
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PART I
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Item 1: Business...........................................................................3
Item 2: Properties........................................................................16
Item 3: Legal Proceedings.................................................................16
Item 4: Submission of Matters to a Vote of Security-Holders...............................16
PART II
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Item 5: Market for the Company's Common Equity and
Related Stockholder Matters....................................................17
Item 6: Selected Financial Data...........................................................17
Item 7: Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................................17
Item 8: Financial Statements and Supplementary Data.......................................26
Item 9: Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure.........................................26
PART III
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Item 10: Directors and Executive Officers of the Registrant................................27
Item 11: Executive Compensation............................................................28
Item 12: Security Ownership of Certain Beneficial Owners and Management....................28
Item 13: Certain Relationships and Related Transactions....................................29
PART IV
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Item 14: Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................32
Index to Financial Statements of the Company...............................................F-1
Signatures................................................................................F-16
Exhibit Index
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PART I
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ITEM 1: BUSINESS
General
GS Financial Products U.S., L.P. (the "Company") was formed as a Cayman
Islands exempted limited partnership on February 5, 1992. All the partnership
interests in the Company are owned by subsidiaries of The Goldman Sachs Group,
L.P. ("Group"). The Company currently owns a portfolio consisting principally of
$28 billion notional amount of interest rate swaps, interest rate options, index
swaps, currency options, currency forwards and currency swaps denominated in a
variety of currencies.
The Company is a derivative products company engaged in the business of
entering into, as principal or guarantor, a variety of types of transactions
involving financial instruments such as interest rate swaps, interest rate
options (e.g., interest rate caps, interest rate floors and options on interest
rate swaps), currency swaps and options, commodity swaps and options, index
swaps and forward contracts (collectively, "Derivative Transactions").
Generally, the Company enters into or guarantees Derivative Transactions in
situations where two or more counterparties (typically including a related
party) wish to enter into one or more Derivative Transactions between
themselves, but want the Company to substitute its credit for that of one or
more of the counterparties. Market practice for such transactions is that the
Company typically substitutes its own credit for that of one or more of the
counterparties by entering into each of such transactions directly as principal.
Such Derivative Transactions may also include the use of futures or the purchase
of the underlying instruments subject to the transactions, such as foreign
currencies, physical commodities and securities. In addition, from time to time
the Company issues structured notes.
The Company observes limits on its activities in order to avoid becoming
subject to regulation in one or more countries in which it does business. As
discussed under "Regulation" below, the principal limitation on the Company's
business is that it will generally only transact business in instruments which,
in its opinion, do not constitute "securities" under the United States federal
securities laws. However, the Company may engage in transactions in securities
to the extent that the Company does not believe that such transactions are of a
magnitude or of a nature that will cause the Company to become subject to
regulation. Currently, there are no regulations which materially restrict the
ability of the Company to effect transactions in commodities or futures
contracts or options on futures contracts.
HEDGING OF DERIVATIVE TRANSACTIONS
Because of the nature of its business, the Company does not intend to incur
any payment or delivery obligation unless it is entitled to receive an equal or
greater payment or delivery from one or more third parties (which may be
affiliates of Group). In general, the Company refers to transactions where all
of the payment obligations or delivery obligations can be met from cash flows or
delivery obligations from one or more other transactions in its portfolio as
being "hedged", and as not having "market risk". It is important to note in this
regard that the Company hedges its cash flow on a portfolio basis, not a
transaction by transaction basis. Accordingly, a particular payment or delivery
obligation under a transaction may not be offset by a single corresponding
transaction.
Hedging is a strategy by which the Company seeks to eliminate market risk.
Obligations incurred by the Company may be hedged in several ways. For example,
if the Company enters into a contract requiring it to make a payment to a
counterparty based on an index, the Company may enter into one or more contracts
that require one or more other counterparties, which may be affiliates of Group,
to make an equal or greater cash payment to the Company based on the same index.
Similarly, the Company will only enter into an obligation to pay a fixed amount
(e.g., issue a fixed rate bond), if it also acquires one or more assets which
entitle the Company to receive amounts which are equal to or greater than the
amounts it owes.
In its simplest form, the Company may hedge obligations by entering into
transactions which mirror the Company's obligation. For example, if under a
10-year interest rate swap with a $100 million notional principal amount the
Company is obligated to make semi-annual payments to Party A based on a floating
rate of interest, e.g., LIBOR, and receive payments based on a fixed rate of
interest, e.g., 6.50%, the Company may hedge its payment obligations under the
interest rate swap by entering into an interest rate swap with Party B with the
same maturity and notional principal amount under which Party B is obligated to
make semi-annual payments to the Company based on LIBOR and the Company is
obligated to make payments to Party B based on a 6.47% fixed rate of interest.
Over the
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term of the swaps, the Company's total revenue from the two swaps would consist
of the .03% difference between the amounts paid by the two counterparties. This
type of hedge eliminates all market risk and leaves the Company exposed to the
credit risk of either Party A or Party B, depending on the level of the
underlying index or interest rate (e.g., LIBOR).
The Company also may hedge obligations by entering into transactions which
generate cash flows which exceed the Company's obligations. In such cases, the
Company would typically have a cost to acquire the hedged position, and would
recover that cost together with a return, over the life of the hedged position.
For example, the Company may enter into two interest rate swaps which are
identical to those in the example above, except that Party A would agree to make
payments based on a fixed rate of 8.50% instead of 6.50%, in return for an
up-front payment by the Company. The up-front payment would equal the present
value of the 2.00% difference between the 8.50% paid by Party A and the 6.50%
market level for similar swaps. In such a case, the Company may fund the
up-front payment by issuing debt. The debt would be repaid from the difference
between the 8.50% received from Party A and the 6.47% paid to Party B, over the
life of the swaps. Over the term of the swaps, the Company's total revenue from
the two swaps would consist of the difference between the amounts paid by the
two counterparties, less the amount originally paid by the Company to Party A.
This would be partially offset by interest on the debt issued to fund the
up-front payment. This type of hedge also eliminates all market risk and leaves
the Company exposed to the credit risk of either Party A or Party B, depending
on the level of the underlying index (e.g., LIBOR). However, the profitability
of this type of hedge depends on the difference between the Company's cost of
funds and the discount rate applied to determine the amount of the up-front
payment.
In a more complex manner, the Company may hedge obligations by using futures
contracts, options on futures or other derivative instruments generally traded
on a futures exchange or board of trade, or by holding a portfolio of financial
instruments or physical commodities. In an interest rate swap, for example, the
Company's payment obligations could be hedged by the purchase of a series of
futures contracts which require payments to the Company based on LIBOR, so long
as the payment flows on the futures contracts can be expected to match exactly
or exceed the payment obligations on the swap. Regardless of the method used to
hedge an obligation, however, the Company is essentially placing itself between
two or, in certain circumstances, more separate counterparties, thereby enabling
each counterparty to rely on the Company's credit rather than the corresponding
counterparty's credit. Like other types of hedges discussed above, the Company
would use these types of hedges only if they completely eliminated all market
risk. The advantage of these types of hedges is that they typically do not
introduce as much credit risk as a hedge with another counterparty. For example,
if the Company uses futures to hedge, the counterparty is an exchange
clearinghouse and the credit exposure is subject to margin requirements.
Because the Company anticipates that all of its obligations will be offset
by equal or greater obligations from third parties, the Company will, in the
absence of a counterparty default, be protected against the effects of market
fluctuations. As discussed above, however, the Company will enter into
transactions as principal. Accordingly, in the event of a default by a
counterparty, the Company will be exposed to the risk of loss because it will
remain obligated to comply with its payment or delivery obligations to the
non-defaulting counterparty. Under such circumstances, the Company may sustain
losses, the amount of which will depend upon a number of factors, including
whether the defaulting counterparty had accrued payment obligations to the
Company, whether the Company is able to enter into a transaction to replace the
position on which the default occurred and whether the Company is able to
terminate the non-defaulted position. See "Entering into New Derivative
Transactions and Risk Management -- Credit Quality and Counterparty Credit
Risk", "Monitoring the Portfolio" and "Documentation" below.
DERIVATIVE TRANSACTIONS
The following is a summary of the types of instruments that the Company
currently anticipates entering into, purchasing, selling and issuing in the
course of its business. As discussed above, the Company's current portfolio of
Derivative Transactions consists principally of interest rate swaps and options,
index swaps, currency forwards and currency swaps and options denominated in a
variety of currencies. Nevertheless, the Company may expand its portfolio to
include the entering into of a variety of additional Derivative Transactions.
The exact extent and timing of the expansion of the Company's portfolio will
depend upon market conditions and other factors beyond the Company's control.
Margin or collateral is sometimes required to be deposited by one or both
parties to a Derivative Transaction. The Company does not expect generally to
require counterparties to post margin or collateral in respect of Derivative
Transactions. Changes in general market practices or in counterparties'
perception of the Company's
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creditworthiness could result in the Company generally being required to post
collateral or margin in the future. Additionally, as described in more detail
below, certain exchange traded instruments always require margin deposits.
The Company does not currently anticipate entering into a transaction which
requires it to post margin or collateral unless it anticipates having sufficient
unpledged assets to satisfy such margin or collateral requirements. For example,
the Company may agree to post margin or collateral if it were to receive an
equivalent amount of margin or collateral under the related transactions.
The Company does not limit the concentration of its portfolio in any one
type of instrument. As a result, the Company's portfolio could consist entirely
of one kind of instrument, or it could contain many types of instruments. See
"Entering into New Derivative Transactions and Risk Management" below.
The Company may also engage in Derivative Transactions to hedge its cost of
funds. For example, the Company may issue a debt obligation with a return linked
to an index, and enter into a Derivative Transaction with a third party or a
Group affiliate to hedge the indexed component of the debt obligation at terms
which will result in a cost of funds to the Company which is either fixed or
floating based on a short-term interest rate. See "Structured Notes" below.
INTEREST RATE AND CURRENCY SWAPS
An interest rate swap is a bilateral agreement that requires each party to
make periodic payments to the other party, the amounts of which are determined
on the basis of a stated fixed or floating rate of interest and a specified
notional principal amount. Typically, one party agrees to make payments in an
amount equal to a fixed rate of interest multiplied by the notional principal
amount, while the other party agrees to make payments in an amount equal to a
particular floating interest rate (e.g., LIBOR) multiplied by the notional
amount. The payment obligations of the parties might also be based on two
different floating rates. On each scheduled payment date, the amount required to
be paid by one party is netted against the amount required to be paid by the
other party and only this net amount is paid by one party to the other. Neither
party actually pays the notional principal amount at any time during the term of
the swap. Under a currency swap, one party agrees to pay a fixed or a floating
amount of a specified currency on each payment date, and the other party agrees
to pay a fixed or floating amount of a different currency. In contrast with
interest rate swaps, the parties to currency swaps typically exchange the
notional principal amount of each currency at initiation and maturity.
Interest rate and currency swaps generally require periodic payments and
extend for periods of up to 10 years. However, some interest rate and currency
swaps may extend for substantially longer periods of time, such as 30 years or
more. Such transactions are entered into by each party acting as principal and
typically may not be transferred or terminated without counterparty consent. As
a result, interest rate and currency swaps have limited liquidity. By entering
into a swap, a party assumes the risk of adverse interest or exchange rate
fluctuations, which could result in the party's being obligated to make payments
to its counterparty over a significant period of time.
INTEREST RATE CAPS AND FLOORS
An interest rate cap provides the purchaser with the right to receive
payments in an amount equal to the excess of a floating interest rate over a
specified fixed rate, multiplied by a stated notional principal amount. An
interest rate floor provides the purchaser with the right to receive payments in
an amount equal to the excess of a fixed interest rate over a floating rate,
multiplied by a stated notional principal amount. The purchaser of a cap or
floor pays a non-refundable fee (which may be referred to as a "premium") for
this right, but has no further payment obligations. In contrast to a swap,
therefore, a cap or floor imposes continuing payment obligations only on the
seller, and the purchaser cannot lose more than the fee paid. In addition, the
seller has no ongoing credit exposure to the purchaser. The seller, however, is
subject to risk of loss to the full extent of any adverse fluctuations in
interest rates above, in the case of a cap, or below, in the case of a floor,
the fixed rate and the purchaser therefore incurs exposure to the seller's
credit. For this reason, the seller may be required to deposit margin or
collateral. Conversely, the seller's potential profit on the transaction is
limited to the amount of the fee.
Payments are required to be made under caps and floors on periodic scheduled
payment dates, or on a single date. As in the case of swaps, interest rate caps
and floors are entered into by each party acting as principal and may not be
transferred or terminated without counterparty consent, although the purchaser
may simply allow the cap or floor to expire and forfeit the fee.
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CURRENCY FORWARDS
Forward contracts on currencies are contractual obligations between two
parties to purchase and sell a specific quantity of one currency for a specific
quantity of a second currency (thereby creating a fixed exchange rate between
the two currencies) at a stated time in the future. Forward contracts generally
may not be liquidated prior to the stated maturity date, although the parties to
a forward contract may agree to enter into a second offsetting transaction with
the same maturity, thereby fixing each party's profit or loss on the two
transactions. As a result, a party to a forward contract must be prepared to
perform its obligations under the contract in full.
Forward contracts are entered into by the parties as principals and
generally may not be transferred or terminated without counterparty consent.
Each party's profit or loss on the transaction will be determined by changes in
the exchange rate between the two currencies that are the subject of the forward
contract.
CURRENCY OPTIONS
An option on a currency provides the purchaser, or "holder", with the right,
but not the obligation, to purchase, in the case of a "call" option, or to sell,
in the case of a "put" option, a stated quantity of the underlying currency at a
fixed exchange rate up to a stated expiration date (or, in the case of certain
options, on such date). The holder pays a non-refundable fee for the option,
referred to as the "premium", but cannot lose more than this amount. In contrast
to a forward contract, an option imposes a binding obligation only on the
seller, or "writer", of the option. Upon the holder's exercise of the option,
the writer is obligated to complete the transaction in the underlying currency.
An option becomes worthless to the holder when it expires.
As in the case of interest rate caps and floors, the writer of a currency
option has no ongoing credit exposure to the purchaser. Because the writer must
complete the purchase or sale of the underlying currency upon the purchaser's
exercise of the option, however, the writer is exposed to potentially unlimited
losses in the event of adverse fluctuations in the relevant exchange rate. The
purchaser therefore has ongoing credit exposure to the writer and the writer may
be required to deposit margin or collateral. Currency options are entered into
by the parties as principals, and may not be transferred or terminated without
counterparty consent (although, as in the case of caps and floors, the purchaser
may simply allow the option to expire and forfeit the premium).
FUTURES CONTRACTS
A futures contract is a bilateral agreement providing for the purchase and
sale of a security (such as government bonds), currency, physical commodity or
index for a specified price. By its terms, a futures contract provides for a
specified delivery month in which the security, currency or commodity is to be
delivered or, in the case of a futures contract on an index of interest rates or
certain financial instruments, in which a cash settlement is to be paid. Unlike
other types of derivative instruments described above, futures contracts are
traded only on organized exchanges and may be entered into only through brokers
that are members of the relevant exchanges. The exchange clearinghouse acts as
the counterparty to each futures contract executed through the exchange, and is
responsible for all clearance and settlement functions. In contrast to most
other derivative instruments described herein, therefore, the parties to a
futures contract do not deal with each other as principals and assume the credit
risk of an exchange clearinghouse, rather than the credit risk of a particular
counterparty. In addition, because of the clearinghouse system, positions in
futures contracts may be liquidated by entering into offsetting transactions in
the same contract, which serves to terminate the position. As a result, futures
positions may be terminated without counterparty consent, subject to the
availability of a liquid secondary market on which to effect the offsetting
transaction on the relevant exchange. Most futures contracts are settled in this
manner rather than through the delivery of the underlying instrument or
commodity.
Upon entering into a futures contract, an amount of cash or cash equivalents
must be deposited with the broker by the purchaser and the seller as "initial
margin". Subsequent payments to and from the broker, referred to as "variation
margin", are then made on a daily basis as the value of the underlying security,
currency, commodity or index fluctuates in value, thereby making positions in
the futures contract more or less valuable, a process known as "marking to
market". The Company will be subject to margin requirements in connection with
the futures contracts into which it enters.
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OPTIONS ON FUTURES CONTRACTS
An option on a futures contract provides the holder with the right, but not
the obligation, to enter into a "long" position in the underlying futures
contract, in the case of a "call" option, or a "short" position in the
underlying futures contract, in the case of a "put" option, at a fixed price up
to a stated expiration date. As in the case of other options, the holder pays a
non-refundable premium for the option, but cannot lose more than this amount.
The writer of an option on a futures contract, however, is subject to
initial and variation margin requirements in connection with the option and is
exposed to potentially unlimited losses. The Company will be subject to margin
requirements in connection with options on futures contracts written by it.
Options on futures contracts are traded on the same exchanges as the underlying
futures contracts, and may only be entered into through brokers which are
members of the relevant exchanges. Positions in options on futures contracts are
cleared through the relevant exchange clearinghouse, in the same manner, and
subject to the same considerations, as those discussed above under "Futures
Contracts".
FORWARD CONTRACTS ON PHYSICAL COMMODITIES
Forward contracts on physical commodities are contractual obligations by two
parties to purchase and sell a stated quantity of a commodity for a specified
price at a stated time in the future. Forward contracts on physical commodities
generally are used either to effect purchases and sales of the commodity in the
future or to hedge against the risk of adverse fluctuations in the value of the
commodity. The Company may enter into forward contracts on physical commodities
in a manner substantially similar to its use of currency forwards, and will seek
to hedge positions in such contracts either through the establishment of
offsetting forward positions or an offsetting position in futures contracts on
the same commodity.
COMMODITY OPTIONS
An option on a physical commodity provides the purchaser with the right, but
not the obligation, to purchase the underlying commodity, in the case of a call
option, or to sell the underlying commodity, in the case of a put option, at any
time up to a stated expiration date for a specified price. As in the case of
other types of options, the holder pays the writer a non-refundable premium for
the option but cannot lose more than this amount. Upon the holder's exercise of
the option, the writer is obligated to complete the transaction in the
underlying physical commodity.
COMMODITY SWAPS
A commodity swap, which is substantially similar to a swap on interest rates
or currency exchange rates, is a bilateral agreement between two parties to
exchange payments on regularly scheduled dates, based on changes in the value of
a specified commodity. One party to the transaction undertakes to pay a fixed
amount on each payment date, while the other party agrees to pay a floating rate
based on the price of the underlying commodity, in each case, multiplied by a
notional quantity of the commodity. On each payment date, the parties net the
payments owed by each party, and only the net amount is paid by one party to the
other.
Commodity swaps may extend over substantial periods of time and generally
require payments to be made on a quarterly basis. Such transactions are entered
into by each party acting as principal and typically may not be transferred or
terminated without counterparty consent. As a result, commodity swaps have
limited liquidity. By entering into a commodity swap, each party assumes the
risk of adverse changes in the value of the underlying commodity, which could
result in either party being obligated to make payments to its counterparty over
a significant period of time.
INDEX SWAPS
An index swap is a bilateral agreement between two parties based on the
value of an index of one or more currencies (including baskets of currencies),
one or more commodities (including baskets of commodities), one or more
securities (including baskets of securities) and/or any other index. One party
(Party A) may undertake to pay a decrease in a specified notional value of a
selected index below a specified level in exchange for the agreement by the
other party (Party B) to pay any increase of the selected index above a
specified level. As with commodity swaps, on each payment date the parties net
the payments owed by each party, and only the net amount is paid by one party to
the other. Index swaps generally extend from relatively short periods (six
months) to medium-term maturities (three
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to five years). Payments are exchanged periodically at intervals negotiated by
the parties. On relatively short-term Derivative Transactions, the exchange of
payments is generally only made on the swap termination date.
In an index swap, both parties assume the risk of changes in the value of
the selected index, since, in the example above, if the index value on the
payment date is less than its value on the inception date, Party A will owe the
difference to Party B. On the other hand, if the index value on the payment date
is more than its value on the inception date, Party B will owe the difference to
Party A. In either case, any interest owed under the index swap will be added to
or netted against the amounts owed in respect of changes in the index.
STRUCTURED NOTES
As discussed under "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview", the Company has entered into a
number of transactions in which the Company issues Medium Term Notes ("Notes"),
where payments on the Notes are determined by reference to the performance of a
single equity security or an equity index. Certain of the Notes are subject to
redemption at the option of the Company if certain conditions are met. The terms
of a Note linked to a single stock may either allow for or mandatorily require
the holder to exchange the notes into an amount of the underlying security. The
Company has purchased equity securities and has entered into Derivative
Transactions with Affiliates of Group and purchased exchange traded options to
eliminate its market risk on the Notes. The cost of hedging an equity-linked
Medium Term Note may use up a substantial portion of the proceeds from the
issuance of such Note.
SECURITIES OWNED
As of November 28, 1997, securities owned consisted of shares of common
stock of Oxford Health Plans, Inc. (market value approximately $11.4 million)
and shares of common stock of Citicorp (market value approximately $83.8
million). The Company purchased these securities to hedge certain of the
Company's exposures incurred by its issuance of two series of Medium Term Notes,
one of which is mandatorily exchangeable at maturity into shares of common stock
of Oxford Health Plans, Inc. and the other of which is exchangeable, at the
option of the holder, into shares of Citicorp common stock.
ENTERING INTO NEW DERIVATIVE TRANSACTIONS AND RISK MANAGEMENT
In connection with entering into any Derivative Transaction, the Company
seeks to ensure that its obligations under any new Derivative Transactions can
be "hedged" with other Derivative Transactions. The Company also considers a
variety of factors, including any existing exposure of the Company and Group and
its affiliates to the proposed counterparty, the level and volatility of the
index to which the transaction would be linked, the credit quality of the
proposed counterparty and the credit risk it is undertaking in connection with
entering into such Derivative Transaction as well as the impact of any
additional such risk on its portfolio of Derivative Transactions. In addition,
prior to entering into a Derivative Transaction, the Company must determine that
the spread on such Derivative Transaction is satisfactory in light of the credit
risk associated with such Derivative Transaction. The Board of Directors of GS
Financial Products US Co. (the "Corporate General Partner"), the general partner
of the Company, has approved the Company's procedures to monitor and control the
credit quality of, and the Company's exposure to, counterparties as described
below and under "Monitoring the Portfolio" below. Such procedures may be changed
at any time and from time to time. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Overview" in item 7 for a
discussion of the current review of the Company's business and operations.
In connection with the Company entering into new Derivative Transactions, it
is important to recognize that Group has control over the amount of new business
that the Company originates and that the Company may decline to enter into a
transaction that meets its credit standards but exceeds the exposure limits set
by Group for itself and its affiliates. See "Credit Quality and Counterparty
Credit Risk -- Counterparty Credit Quality" below.
MARKET RISK AND LIQUIDITY EXPOSURES
The Company intends to manage its portfolio of Derivative Transactions so
that cash payments to the Company from its portfolio will be sufficient to make,
when due, all required payments on all the Company's liabilities, including
payments of principal, premium, if any, and interest on any indebtedness. As a
result, the Company anticipates that it will not incur any obligation unless it
enters into one or more Derivative Transactions which provide it with, or
entitle it to receive, an equal or greater amount from a third party, which may
be an affiliate of Group. In addition, the
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Company does not anticipate incurring any obligation unless it has scheduled
cash sources that are available on or before the dates of the required payments
on the obligation. For example, if the Company enters into a contract requiring
it to make payments based on an index, the Company may concurrently enter into a
contract that requires a third party to make equal or greater payments to the
Company based on the same index at the same time. As a result, so long as none
of its counterparties defaults, the Company believes that it bears no market
risk (i.e., its ability to satisfy its obligations will not be affected by
market conditions).
The Company does not currently engage in, nor does it anticipate engaging
in, "dynamic hedging" (i.e., entering into cash or Derivative Transactions which
are expected approximately, but not exactly, to offset the economics of the
transactions being hedged and which are adjusted from time to time to maintain
the hedge ratio). Generally, dynamic hedging strategies would not permit the
Company to be certain that, absent a default, cash flows would be sufficient to
satisfy all of the related liabilities.
CREDIT QUALITY AND COUNTERPARTY CREDIT RISK
The Company anticipates that it will make payments on its obligations,
including any indebtedness, principally or exclusively with cash on hand and
receipts from its portfolio of Derivative Transactions. As a result, the
Company's ability to meet its obligations will depend on its ability to collect
the amounts owed pursuant to such Derivative Transactions. Accordingly, defaults
by counterparties with large obligations to the Company could materially and
adversely affect the Company's financial position, results of operations and
cash flows.
The amount which the Company would lose, that is, the amount the Company
would be required to pay to obtain a replacement instrument to hedge its
obligations on any Derivative Transaction (the "loss"), upon a counterparty
default on a particular transaction would be determined principally by the level
of the indices to which payments on the instruments issued by that counterparty
were linked. In the case of a default by a counterparty to an interest rate
swap, for example, the amount of the Company's loss would depend principally on
the level of interest rates. Similarly, the amount of the Company's loss on a
default in a currency swap would depend principally on currency exchange rates
whereas the amount of the Company's loss on a default in a Derivative
Transaction linked to the price of a commodity (such as gold or oil) would
depend upon the price of such commodity. The size of the loss would be affected
by the level of such indices at the time of default and, if the Company were
unable to replace the defaulted instrument or terminate its hedging
transactions, the changes in the level of such indices after the default and
prior to maturity of the hedging transactions. A number of the instruments in
which the Company intends to transact business have limited liquidity and
therefore could be difficult to replace. For any particular transaction there
will also be a number of other factors which can affect the amount of the
Company's potential loss. Depending on the terms of the transaction, these can
include, for example, the time remaining until maturity of the transaction, the
availability of any netting provisions in the agreement with the counterparty
and changes in the supply and demand for that type of transaction.
The Company utilizes several techniques to assess and limit credit risk as
described below. The Company's procedures to monitor and control the credit
quality of, and the Company's exposure to, counterparties as described below may
be changed at any time by the Board of Directors of the Corporate General
Partner of the Company. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview" for a discussion of the current
review of the Company's business and operations.
Counterparty Credit Quality. The Company's principal means of controlling
its credit risk is to substitute its credit principally for highly creditworthy
counterparties. By doing so, the Company anticipates that it will experience a
relatively low frequency of counterparty defaults.
The Company anticipates that it will substitute its credit principally for
obligors rated "A" or better by one or more nationally recognized statistical
rating organizations. However, the Company may do business with counterparties
rated below "A" and may enter into Derivative Transactions with unrated
counterparties.
Pursuant to an Origination Agreement with Goldman, Sachs & Co. ("GS&Co.") as
described under "Certain Relationships and Related Transactions -- Operational
and Administrative Relationships with Group -- New Business Services Agreements"
in Item 13, GS&Co. has agreed to provide, or cause to be provided, credit
reviews of counterparties. The Company has been advised by GS&Co. that the
credit quality of each counterparty to a new Derivative Transaction (regardless
of the extent of existing Derivative Transactions with such counterparty) will
be evaluated by the credit department of one of its affiliates. This evaluation
includes a review of the credit exposure of
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Group and its affiliates to the counterparty's credit. The Company has further
been advised by GS&Co. that these credit reviews are performed by
representatives of its credit department and that they are responsible for
conducting due diligence as to the credit quality of potential counterparties
for the purposes of other activities of Group and its affiliates. GS&Co.'s role
is solely to provide information to the Company, and it has no liability to the
Company in respect of the provision of such credit reviews except in the case of
gross negligence. Generally, the Company does not anticipate entering into
transactions which otherwise might meet its standards but exceed any exposure
limits set by Group for itself and its affiliates. This may result in less
business for the Company, since Group and its affiliates may have large existing
exposures to certain counterparties.
COLLATERAL OR MARGIN. In certain circumstances, the Company may reduce its
credit exposure to a counterparty by requiring that the counterparty deposit
margin or collateral. When accepting margin or collateral, the Company generally
accepts highly liquid and creditworthy securities (e.g., U.S. Treasury bonds and
notes and securities issued or backed by U.S. government agencies). The Company
calculates credit exposure net of collateral when it believes that it has a
perfected security interest in such collateral under an enforceable security
agreement.
DOCUMENTATION. To reduce the amount of its credit exposure, the Company
anticipates that many of its swaps, currency options, forward contracts and
other similar transactions will be subject to master agreements which provide,
among other things, for net payments between the parties in certain
circumstances and for the closing out, on a net settlement basis, of all
outstanding transactions upon a default by, or insolvency events affecting,
either party. A common form of such an agreement, particularly for interest rate
and currency swaps, is the form published by the International Swaps and
Derivatives Association, Inc. (the "ISDA Agreement"), although other forms may
be used as well. The Company anticipates that it will enter into transactions
with GS Financial Products International, L.P. ("FPI") and Goldman Sachs Capital
Markets, L.P. ("GSCM") in order to hedge its obligations on transactions between
the Company and third parties. In order to facilitate such transactions, the
Company has entered into ISDA Agreements with both FPI and GSCM. The obligations
of GSCM under its ISDA Agreement have been unconditionally guaranteed by Group.
Accordingly, the Company treats Group as the obligor with respect to the
Derivative Transactions entered into under the ISDA Agreement with GSCM. For a
summary of notional or contractual amounts involved in transactions with such
affiliates at November 28, 1997 and November 29, 1996, see Note 3 to the
Company's audited financial statements included in Item 14 below.
Currently, Derivative Transactions shown in the Company's financial
statements on a net basis are subject to agreements that contain close-out
netting provisions that the Company believes are enforceable. In considering the
enforceability of any netting provisions, the Company relies on advice from
counsel. Any such analysis will depend on the country, governing law, type of
transactions and counterparty involved.
In certain circumstances, the Company may be unable or unwilling to take
credit risk in a particular transaction, due to the Company's determination of
the credit risks present. In some limited cases, the Company may be able to
enter into such a transaction by structuring it on a limited-recourse basis,
thereby eliminating its credit exposure to one counterparty. In such a
transaction, the Company would enter into a Derivative Transaction with one
counterparty ("Party A"). The Company would hedge that transaction with a
different counterparty ("Party B") in a transaction where the Company would not
be obligated to make payments to Party B if payments are not received by the
Company from Party A. (Party B would not, however, have a security interest in
the transaction with Party A.) As a result, the Company would have no credit
exposure to Party A. The Company has entered into this type of transaction with
GSCM in the position of Party B.
AGGREGATE CREDIT RISK. Another technique which the Company may use to limit
the total credit risk to which it is exposed (i.e., the replacement cost of its
portfolio) is to limit the growth of its business. If the Company's total credit
risk exceeded levels which the Company found to be acceptable, the Company would
not enter into any Derivative Transactions which would increase its total credit
risk, and would, in the absence of transactions which decrease its total credit
risk, limit its operations to collecting payments from assets as they mature and
holding such payments in cash equivalents until they are used to satisfy its
liabilities (i.e., it would operate in run-off mode).
The Company's principal measurement of its total credit risk (the "Total
Credit Risk") is an evaluation of the likelihood that the Company's cash
receipts will be insufficient to meet its payment obligations on a timely basis
as a result of counterparty defaults, market risk, or differences in timing of
payment receipts and obligations. The Company estimates the Total Credit Risk
using computer based simulations which take into account the timing and amount
of payments required on the Company's assets, liabilities, and contingent
liabilities, the level and volatility of any indices to which those payments are
linked and the credit ratings of any counterparties who could owe money to the
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Company. These simulation programs were developed by GS&Co. and are periodically
updated by GS&Co. to reflect new product types. The assumptions used in the
models are changed from time to time when the Company, in consultation with
GS&Co. and with concurrence of the appropriate rating agency(s), determines that
such changes would result in a more accurate measurement of its credit risk.
The Company estimates its credit risk (i.e., replacement cost) in respect of
Derivative Transactions using financial models developed by its affiliates to
estimate fair value. The models incorporate market data for the relevant
instruments or for instruments with similar characteristics. Fair value is
estimated at a specified point in time. The nature, size, and timing of
transactions and the liquidity of the markets may not ultimately allow for the
realization of these values. The Company's estimates of its credit risk are
solely internal and neither the models nor the assumptions used in such models
are reviewed by third parties.
The Company considers the credit risks posed by its existing portfolio to be
below the levels it would find acceptable. The Company periodically monitors its
exposure to individual counterparties and reviews its credit exposure to a
counterparty prior to entering into any new transaction with such counterparty.
If the Company determines that its exposure to any counterparty exceeds a level
it deems acceptable, the Company will seek to reduce its exposure as described
under "Monitoring the Portfolio" below.
AFFILIATE CREDIT RISK LIMITS. The Company enters into Derivative
Transactions with affiliates of Group (such affiliates, other than FPI, the
"Group Affiliates"), principally GSCM. The Company also enters into hedging
transactions with GSCM and FPI. Because the obligations of Group Affiliates will
be guaranteed by Group, the Company treats Group as the obligor on these
transactions for purposes of measuring its credit exposure. The Company may,
therefore, have a significant credit exposure to Group in the future, in which
case a default by Group would have a material adverse effect on the Company's
financial position, results of operations and cash flows. The Company does not
expect, however, that such credit exposure would exceed the Company's net worth.
In order to limit its exposure to Group, the Company subjects transactions
with Group Affiliates to an additional credit limit over and above the limits
discussed above which are applicable to other obligors. Specifically, the
Company will not acquire any receivables issued or written by Group Affiliates
if, after giving effect to such acquisition and to the effect of any netting
agreements, the value of all such receivables would exceed 15% of the Company's
total assets. For a discussion of the Company's policies with respect to netting
agreements, see "Documentation" above. At November 28, 1997, the Company had
credit exposure of $23.0 million to Group or Group Affiliates. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources" under Item 7.
The Company from time to time enters into Derivative Transactions with FPI.
The Company is a general partner of FPI. The Company does not intend to observe
any credit limits on transactions with FPI, or with any other entity in which it
becomes a general partner in the future. The Company does not consider it
important to limit its direct credit exposure to any entity in which it is a
general partner, because as a general partner the Company is contingently liable
for all of the obligations of such entities (including transactions entered into
with third parties).
MONITORING THE PORTFOLIO
The Company monitors its portfolio on an ongoing basis to verify that there
is no market or liquidity exposure and that its credit risk to obligors is at a
level the Company considers acceptable. The Company recalculates its estimates
of Total Credit Risk when it believes there is a significant change in the
composition of its portfolio, the credit quality of its counterparties or the
indices to which its Derivative Transactions are linked. Typically, the Total
Credit Risk is recalculated at least monthly.
If credit risk to one or more obligors exceeds levels which the Company
considers acceptable, then the Company may attempt to reduce its exposure to
such obligors by entering into one or more Derivative Transactions which would
have the effect of reducing such risk. Such Derivative Transactions could
include, for example, assigning or terminating a Derivative Transaction upon a
counterparty downgrade. However, counterparty consent would generally be
required for a sale or termination, and such consent may be difficult to obtain.
It may also be difficult to sell obligations of counterparties which are
perceived as weak credits. There can be no assurance that the Company would be
able to enter into Derivative Transactions which decrease the Total Credit Risk.
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COMPETITION
The market for Derivative Transactions is highly competitive. The principal
means of competition are perceived credit quality, pricing and flexibility.
In general, the Company competes with U.S. and international banks, U.S. and
international insurance companies and other similar financial institutions. Many
of these institutions have well-established reputations in the market for
Derivative Transactions and have significantly more capital than the Company.
The Company will also compete with current and future affiliates of Group
which are in businesses substantially similar to that of the Company. These are
FPI and Goldman Sachs Mitsui Marine Derivative Products, L.P. ("GSMMDP"), which
was organized by Group and Mitsui Marine and Fire Insurance Co., Ltd. Neither of
these entities is restricted from competing with the Company and the Company
believes that each does so or intends to do so. The Company is a general partner
of FPI and the directors and executive officers of the Company are also
directors or executive officers of one or both of GSMMDP or FPI. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview" under Item 7 and "Directors and Executive Officers of
the Registrant" under Item 10. Further, since each of these entities is directly
or indirectly controlled by Group, Group may increase or decrease the level or
vary the composition of new business in which any of these entities, including
the Company, engages. No assurances can be given as to whether Group will
allocate business to the Company or to one of its other highly rated affiliates.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview" for a discussion of the current review of the Company's
business and operations.
The Company anticipates that Group and certain counterparties may prefer to
use the Company's affiliates for certain Derivative Transactions because the
Company will be subject to the reporting obligations of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), whereas the Company's affiliates
are not. Such reporting obligations may require inclusion in public filings of
information that counterparties do not wish to disclose and may increase,
because of the involvement of counsel and accountants assisting in such filings,
the costs associated with such transactions. Due principally to restrictions
imposed by the United States federal securities laws, the Company does not
expect that FPI or GSMMDP will compete with it for any transaction which would
require such affiliate to issue an instrument which is a security under such
laws to a U.S. person. In addition, because the Company will be able to access
the U.S. capital markets, the Company's cost of funds may be lower than the cost
of funds for the Company's affiliates. The Company believes Group has organized
these entities to take advantage of the flexibility and cost advantages each of
such entities provides.
GSMMDP is highly rated, conducts a similar business as the Company and can
be expected to be a significant competitor of the Company. The Company
anticipates that GSMMDP will engage principally in Derivative Transactions with
counterparties rated in the three highest rating categories by one or more
nationally recognized statistical rating agencies. As a result, the Company does
not anticipate that it will compete with GSMMDP for transactions involving
counterparties with ratings below the three highest categories. For transactions
where the Company competes with GSMMDP, in addition to the factors described
above, the Company anticipates that a number of counterparties may prefer GSMMDP
due to its credit support from owners with a longer operating history, larger
capital base, and more diversified business than the Company. However, the
Company is unable to predict the degree to which potential counterparties may
prefer GSMMDP to the Company. One of the directors of the Corporate General
Partner is also a director and President of the general partner of GSMMDP and
another director is a director of the general partner of GSMMDP. See "Directors
and Executive Officers of the Registrant" under Item 10.
FPI is a highly rated derivative products company. FPI has the same
executive officers as the Company. The Company anticipates that FPI will engage
in certain transactions that the Company intends to avoid due to regulatory
considerations, i.e., transactions which involve the purchase by FPI of
instruments which may be "securities" within the meaning of the United States
federal securities laws. However, the Company also expects that FPI will compete
with the Company for all types of other transactions. The Company does not
expect most counterparties to have a preference between itself and FPI. As a
result, the Company expects competition with FPI to be based principally on the
factors described above. See "Directors and Executive Officers of the
Registrant" under Item 10.
Counterparties with the highest credit rating are the most desired. The
Company's long term debt and counterparty credit risk have been rated in the
highest rating category by Standard & Poor's Ratings Group ("S&P") and Fitch
IBCA, Inc. ("Fitch" and, together with S&P, the "Rating Agencies"),
respectively. A reduction in the Company's long term debt or counterparty credit
risk rating may adversely affect the Company's ability to compete successfully.
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Price competition is reflected in the spread between the hedged positions.
The Company intends to keep its spreads competitive with the marketplace.
REGULATION
In certain jurisdictions where the Company's counterparties are located,
particularly the United States, there exist regulatory schemes which are
designed for brokers, dealers, investment companies or banks. These regulatory
schemes typically have capital and other requirements with which the Company
could not comply.
The Company limits the types of Derivative Transactions in which it acts as
counterparty in order to avoid becoming subject to such regulations. The
principal limitation is that the Company proposes to engage primarily in
transactions involving instruments which are not, in its view, "securities"
within the meaning of the United States federal securities laws. As a result of
such limitations on its business and the capital structure of the Company, the
Company believes that it is not required to be licensed, registered or
authorized under any current securities, commodities, or banking laws of the
Cayman Islands or the United States. Accordingly, neither the Company nor the
Corporate General Partner is registered as a broker-dealer under the Exchange
Act (or any similar state law); nor are they registered as investment companies
under the Investment Company Act of 1940 (or any similar state law).
There can be no assurance, however, that regulatory authorities in one or
more jurisdictions would not take a contrary view regarding the applicability of
any such laws (including the applicability of the broker-dealer regulation
requirements of the Exchange Act and the requirements of the Investment Company
Act of 1940). For example, the Securities and Exchange Commission (the
"Commission") has generally not addressed the question of what constitutes a
"security" within the meaning of the Exchange Act, and has broadly interpreted
the definition of "security" under the Investment Company Act of 1940 in the
context of applying the registration requirements of that Act. In addition,
Congress and United States governmental agencies, including the Commodity
Futures Trading Commission and the Government Accounting Office, have considered
or are considering issues relating to derivative instruments generally and the
appropriateness of alternative regulatory approaches. Were the Commission to
take the position that the transactions in which the Company engages involve
"securities", it might seek to require the Company to register as a
broker-dealer or investment company.
Application of these or any of the other regulatory schemes in their current
form would have a material adverse effect on the business of the Company. The
Company cannot, of course, predict the outcomes of any other current or future
considerations of issues such as the definition of securities under the federal
securities laws or the appropriateness or method of regulation of derivative
instruments. Any of these may have a material adverse effect on the business of
the Company.
As discussed herein, the Company is a general partner in FPI whose business
involves the purchase and sale of instruments that constitute "securities" and
whose liabilities are held primarily outside the United States. FPI is also not
registered as a broker-dealer under the Exchange Act or as an investment company
under the Investment Company Act of 1940, or licensed, registered or authorized
under any other securities, commodities or banking laws of the Cayman Islands or
the United States. As with the Company, there can be no assurance that the
Commission or regulatory authorities in other jurisdictions would not take a
contrary view and require such licensing, registration or authorization. In the
event such were required, by virtue of the Company's general partnership
interest in FPI and transactions in which the Company may engage with FPI, any
such licensing, registration or authorization could have a material adverse
effect on the business of the Company.
The Commission has proposed rules that would allow derivative products
companies, such as the Company, to voluntarily register as broker-dealers with
the Commission under a regime which would exempt such companies from certain
regulations applicable to "full service" broker-dealers while permitting such
companies to engage in Derivative Transactions which the Commission deems
securities under current law. Depending on the final form of the rules, the
Company may decide to register as a limited broker-dealer and expand its
business to include Derivative Transactions involving securities. Alternatively,
the Company may determine to continue to limit its business activities in order
to avoid being subject to such regulation. Any decision in this regard will be
made only after final rules are issued and only after the company has weighed
the benefits of entering into Derivative Transactions involving securities
against the Company's ability to comply, and the costs associated with complying
with, the final rules.
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From time to time bills have been introduced in the U.S. Congress which, if
enacted into law, would impose varying degrees of regulation on certain of the
types of Derivative Transactions in which the Company acts as counterparty. Such
regulation could adversely affect certain of the Company's business activities.
RATING INFORMATION
The Company's long term debt and counterparty credit risk have been rated
AAA by S&P and Fitch. The Company believes that such ratings were based upon,
among other things, the legal separation of the Company from Group, the absence
of market risk in the Company's portfolio, the credit quality of the Company's
counterparties, the capital of the Company available to absorb defaults, and the
procedures implemented by the Company to monitor and control the credit quality
of, and the Company's exposure to, counterparties. See "Entering into New
Derivative Transactions and Risk Management" and "Monitoring the Portfolio"
above.
There can be no assurance that S&P and Fitch will continue to rate the
Company's long term debt and counterparty credit risk, respectively, in their
highest category and any decrease in such ratings may adversely affect the
Company's ability to compete successfully. See "Competition" above.
A long term debt and counterparty risk rating is not a recommendation to
purchase, sell or hold a security or enter into a Derivative Transaction with
the Company. Such rating does not comment as to the market price of a security
or the suitability of entering into a Derivative Transaction for a particular
investor or counterparty. Long term debt and counterparty credit risk ratings
may be changed or withdrawn at any time by the applicable Rating Agency.
CAYMAN ISLANDS TAXATION
Under existing legislation, the Government of the Cayman Islands will not
impose any income or profits tax, capital gains tax, capital transfer tax,
estate duty or inheritance tax upon the Company or the general or limited
partners thereof. Furthermore, the Company has obtained a Tax Exemption
Certificate from the Governor of the Cayman Islands which is effective for a
period of 50 years from March 3, 1992. The undertaking contained in that
certificate provides, in accordance with the provisions of Section 17(1) of the
Cayman Islands Exempted Limited Partnership Law, that no law thereafter enacted
in the Cayman Islands imposing any tax to be levied on profits, income, capital
gains or appreciation will apply to the Company or to any partner thereof in
respect of the operations or assets of such exempted limited partnership or the
partnership interest of a partner therein; and that the aforesaid taxes and any
tax in the nature of estate duty or inheritance tax will not be payable in
respect of the obligations of the Company or the interests of the partners
therein. The Company is liable, however, to pay the Government of the Cayman
Islands a nominal annual registration fee.
UNITED STATES TAXATION
The Company, as a partnership, is not subject to U.S. federal income taxes.
Prior to January 1, 1997, the Company was required by U.S. federal tax
regulations to withhold income tax on behalf of its partners. These payments
were made on behalf of the Company by a related party. As of January 1, 1997,
the Company is no longer required to withhold taxes on behalf of its partners
under U.S. federal tax regulations.
Certain of the Company's income is subject to a 4% New York City
unincorporated business tax. The statements of income for the fiscal years ended
November 28, 1997, November 29, 1996 and November 24, 1995, include a provision
for unincorporated business tax on income earned by the Company related to doing
business in New York City. Depending upon the manner in which the business of
the Company will be operated in other jurisdictions, there is a possibility that
one or more such jurisdictions would impose tax on the profits of the Company.
IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS
The Company has made in this Annual Report on Form 10-K and anticipates that
it will make in future filings with the Commission, in press releases and
otherwise, written and oral forward-looking statements. Any statement concerning
the Company's expectations, beliefs, or intentions about future conditions or
events should be considered to be forward-looking and should be understood to be
subject to the factors discussed below, among others, which may cause actual
results for the Company to differ materially from those anticipated by such
forward-looking statements.
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The Company's expectation that it will not be subject to market risk, that
it will receive an equal or greater payment or delivery with respect to any
payment or delivery obligation it incurs, and that it will have scheduled cash
sources that are available on or before the required payment of an obligation is
dependent upon the absence of counterparty default. While the Company has
procedures in place to monitor the credit quality of its counterparties, the
credit quality of a counterparty may be affected by economic, political and
other events beyond the Company's control. Defaults by counterparties with large
obligations to the Company could materially and adversely affect the Company's
financial condition, results of operations and cash flows.
Group indirectly controls the Company and all of its business activities.
Group has several affiliates that compete with the Company for Derivative
Transactions and has its own credit policies for counterparties. No assurance
can be given that Group will not allocate transactions to its other affiliates
or will permit the business of the Company to continue to expand. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview" for a discussion of the current review of the Company's
business and operations.
The Company expects routinely to enter into transactions with GSCM and other
affiliates of Group. The obligations of GSCM will be guaranteed by Group and the
obligations of other Group affiliates may also be guaranteed by Group. The
Company may, therefore, have a significant credit exposure to Group in the
future. If the Company has a material exposure to Group, a default by Group
would have a material and adverse effect on the Company.
In certain circumstances the Company anticipates that it would attempt to
enter into Derivative Transactions to replace a defaulted transaction or to
reduce the risk of default. Failure to replace a defaulted Derivative
Transaction or the inability to enter into a Derivative Transaction to reduce
the risk of default could prevent the Company from eliminating the market or
credit risk with respect to one or more other Derivative Transactions. The
Company's ability to enter into replacement Derivative Transactions or other
risk reducing Derivative Transactions will be limited by the availability of
appropriate counterparties willing to enter into suitable Derivative
Transactions. No assurance can be given that the Company will be able to enter
into replacement or risk reducing Derivative Transactions.
The Company anticipates that it will continue to depend upon affiliates of
Group for the performance of essential management, operational, and
administrative functions and the solicitation of new business. The failure of
the relevant Group affiliate to perform those functions could prevent the
Company from continuing to expand its business.
The Company limits the types of instruments that it enters into as principal
or guarantees in order to avoid becoming subject to regulation. The enactment of
new legislation or new interpretations of existing statutes and regulations may
cause the Company to become subject to regulation in one or more countries. If
the Company were to become subject to regulation, no assurance can be given that
the Company would be able to comply with the applicable regulatory requirements.
While the Company believes that in the case of credit exposures calculated
on a "net basis" (i.e., adding the positive and negative values) or net of
collateral that it has in place an enforceable netting agreement or an
enforceable security interest, no assurance can be given that a court under all
circumstances would enforce the netting agreement or recognize the validity of
the security interest.
The Company expects to make profits, if any, principally from the spread
between hedge transactions, which spread is expected to be a small percentage of
the notional amount of such transactions. The size of the spread between
transactions is subject to market forces and may be materially adversely
impacted by competitive or other economic conditions.
The Company's long term debt and counterparty credit risk have been rated in
the highest categories by the Rating Agencies. A change in the Company's ratings
would materially adversely impact its ability to compete successfully. The
Company's ratings may be changed or withdrawn at any time by any of the Rating
Agencies, based upon factors selected solely by the Rating Agencies.
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ITEM 2: PROPERTIES
The Company does not own any real property and owns minimal physical assets.
The Company leases its office from an affiliate under a Space Sharing Agreement.
See "Certain Relationships and Related Transactions -- Operational and
Administrative Relationships with Group -- Administrative Services Agreements"
under Item 13.
ITEM 3: LEGAL PROCEEDINGS
The Company is not a party to any legal proceedings.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
Not applicable
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PART II
ITEM 5: MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All of the Company's general partnership and limited partnership interests
are indirectly held by Group (see Item 12). Accordingly, there is no public
market, in the United States or elsewhere, for the Company's limited partnership
interests. See "Liquidity and Capital Resources" under Item 7.
The Company, as a partnership, is not subject to U.S. federal income taxes.
Prior to January 1, 1997 the Company was required by U.S. federal tax
regulations to withhold income tax on behalf of its partners. These payments
were made on behalf of the Company by a related party. Such withholdings were
accounted for as a distribution to partners. As of January 1, 1997, the Company
is no longer required to withhold taxes on behalf of its partners under U.S.
federal tax regulations. There is no reciprocal tax treaty between the Cayman
Islands and the United States.
Partners' capital is not subject to withdrawal or redemption on demand by
the partners. The Company anticipates that it will make distributions to
partners in the future. However, the amount of such dividends and distributions
will be limited to ensure that the Company's ability to meet its obligations is
not adversely affected.
ITEM 6: SELECTED FINANCIAL DATA
The selected income statement data for the fiscal years ended November 26,
1993, November 25, 1994, November 24, 1995, November 29, 1996 and November 28,
1997, and the balance sheet data as of November 26, 1993, November 25, 1994,
November 24, 1995, November 29, 1996 and November 28, 1997 are derived from
financial statements of the Company. The selected financial data should be read
in conjunction with the financial statements of the Company and notes thereto
contained in Item 14.
(U.S. dollars in thousands, except ratios)
<TABLE>
<S> <C> <C> <C> <C> <C>
Fiscal Year Fiscal Year Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended Ended Ended
Nov. 26, 1993 Nov. 25, 1994 Nov. 24, 1995 Nov. 29, 1996 Nov. 28, 1997
------------- ------------- ------------- ------------- -------------
Income Statement Data:
Revenues, net of interest expense $5,694 $11,844 $13,461 $15,393 $15,558
Operating expenses 882 1,645 878 879 722
Income before taxes 4,812 10,199 12,583 14,514 14,836
Net income 4,812 10,199 12,280 13,933 14,228
Balance Sheet Data:
Total assets $168,661 $334,068 $425,052 $370,975 $581,683
Long-term borrowings 0 0 40,383 116,778 276,489
Partners' capital 106,737 117,042 124,805 134,043 148,121
Other Data
Ratio of earnings to fixed charges(1) Not applicable 378X (2) 26X 5X 2.6X
<FN>
Notes: (1) For purposes of computing the ratio of earning to fixed charges,
earnings as adjusted consist of net income plus income taxes and fixed
charges. Fixed charges consist of interest expense and amortization of
debt issuance costs.
(2) The Company does not consider this ratio to be meaningful since it is
based on $5,000,000 in principal amount of the Company's Series A
Medium-Term Notes outstanding only 42 days during fiscal 1994.
</FN>
</TABLE>
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a derivative products company engaged in the business of
entering into, as principal or guarantor, a variety of types of Derivative
Transactions, principally interest rate swaps, interest rate options (e.g.,
interest rate caps, interest rate floors and options on interest rate swaps),
currency swaps and currency options, index
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<PAGE>
swaps, commodity swaps and options and forward contracts. Generally, the Company
enters into or guarantees Derivative Transactions in situations where two or
more counterparties wish to enter into one or more Derivative Transactions
between themselves, but want the Company to substitute its credit for that of
one or more of the counterparties. Market practice for such transactions is that
the Company typically substitutes its own credit for that of one or more of the
counterparties by entering into each of such transactions directly as principal.
Such Derivative Transactions may also include the use of futures contracts, or
the purchase of the underlying instruments subject to the transactions, such as
foreign currency, physical commodities and securities. The Company's owned or
guaranteed Derivative Transactions consist principally of interest rate swaps,
interest rate options, index swaps, currency options, currency forwards and
currency swaps denominated in a variety of currencies. See "Business" in Item 1.
In addition, from time to time the Company issues structured notes.
At November 28, 1997, the Company had entered into or guaranteed $21 billion
notional amount of interest rate swaps and options and $7 billion notional
amount of currency options, forwards and swaps with a total of 83
counterparties.
In general, the Company refers to transactions where all of the payment
obligations or delivery obligations can be met from cash flow or delivery
obligations from one or more transactions in its portfolio as being "hedged". It
is important to note in this regard that the Company hedges its cash flow on a
portfolio basis, not on a transaction by transaction basis. Accordingly, any
particular payment or delivery obligation under a transaction may not be offset
with a single corresponding transaction.
Through November 28, 1997, substantially all of the Company's Derivative
Transactions involved some degree of hedging with affiliates. The Company has
entered into or guaranteed $16 billion notional amount of Derivative
Transactions with affiliates principally to hedge exposures on third party
transactions. In general, the notional amount of Derivative Transactions with
affiliates exceeds that with non-affiliates due to the greater notional amount
of affiliate versus non-affiliate transactions guaranteed, as well as Derivative
Transactions between the Company and affiliates which hedge the Company's
interest rate or currency exposure on surplus cash flow from its portfolio, or
which are intended to mitigate total credit risk.
As of November 28, 1997, the Company has equity-linked Medium Term Notes
outstanding with a carrying value of $276 million. The Company expects to
continue to issue equity-linked Medium Term Notes in the future. The Company
intends to utilize the majority of the proceeds received from such issuances to
acquire shares of common stock, purchase or write exchange traded and
over-the-counter options and enter into interest rate and equity-linked swaps to
hedge its obligations under the Notes. The remainder of the net proceeds from
each issuance will be added to the Company's working capital to support its
operating activities.
The Company does not intend to be exposed to market risk (see "Business --
Entering into New Derivative Transactions and Risk Management -- Market Risk and
Liquidity Exposures" under Item 1). As a result, the Company expects to make
profits, if any, principally from the "spread" between the hedged transactions.
The spread between the hedged transactions will depend upon the type of
instrument subject to the transaction, the size of the transaction and the
creditworthiness of the counterparties. Generally, the spread between the hedged
transactions will be a small percentage (usually less than .10%) of the notional
amount of the transactions. The Derivative Transactions business is highly
competitive, however, and the spread for any set of hedged transactions may be
less than .01%. See "Business -- Competition" under Item 1.
For a discussion of affiliates of Group that may compete with the Company,
see "Business -- Competition" under Item 1. It is important to recognize that,
since each of these affiliates is directly or indirectly controlled by Group,
Group may increase or decrease the level or vary the composition of new business
in which any of these affiliates, including the Company, engages. No assurances
can be given as to whether Group will allocate business to the Company or to one
of its other highly rated affiliates.
Since October 1997 Group has undertaken a review of the operations of the
Company and certain other Group Affiliates engaged in the derivative products
business in order to reassess the scope of their activities, to evaluate the
level and nature of staffing and to review the procedures that are in place to
handle the type and volume of businesses that they may pursue. During this
review, the Company and FPI have not entered into any new Derivative
Transactions and have not issued any new debt securities. This lack of activity
by the Company has negatively affected the Company's results of operations for
the 1997 fourth fiscal quarter. In addition, this lack of activity is expected
to have a significant negative effect on the Company's results of operations in
the first and second fiscal
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<PAGE>
quarters of 1998, and it may affect later quarters depending upon the timing of
the completion and implementation of the review.
As the year 2000 approaches, an issue has emerged regarding how existing
application software programs and operating systems can distinguish between the
year 2000 and the year 1900. Systems that do not properly recognize the year
2000 could generate erroneous data or fail.
The Company recognizes the need to ensure its operations will not be
adversely affected by Year 2000 software failures. As discussed under "Certain
Relationships and Related Transactions -- Operational and Administrative
Relationships with Group -- Administrative Services Agreements" under Item 13,
the Company's administrative services are provided through a Custodian
Agreement. As a result, the Company is relying on Group and its affiliates to
properly address the Year 2000 issue. The Company has been advised by Group that
Group and its affiliates have assessed the computer systems on which the Company
relies and have established a process for evaluating and managing the risks
associated with this problem. Based on this advice, the Company currently does
not expect that the Year 2000 issue will have a material adverse effect on its
financial position, results of operations or cash flows.
RESULTS OF OPERATIONS
Changes in the Company's revenues are highly dependent on the volume, term
and type of new transactions originated. Derivative Transactions are recorded at
their estimated fair value. As a result, a substantial portion of the
intermediation profit from new Derivative Transactions may be recognized upon
entering into such transactions. Hence, the Company's profitability may be
extremely variable from quarter to quarter, depending on the volume of new
origination.
Although certain of the interest rate swaps in the Company's current
portfolio require payments in currencies other than U.S. dollars, the Company
has entered into Derivative Transactions with affiliates of Group which entitle
it to receive equal or greater amounts of the same currencies. To the extent
that the Company has or is entitled to receive amounts of currencies other than
the U.S. dollar which amounts are not needed to service the Company's
obligations, the Company's reported earnings will be affected by changes in the
value (expressed in U.S. dollars) of such currencies. However, as of November
28, 1997, the Company does not consider its exposure to currencies other than
the U.S. dollar to be material to its financial condition since, even if the
Company were to realize no value from any currencies other than the U.S. dollar,
its net worth would be reduced by less than 1%. As the Company is unable to
predict the movement of foreign currencies, the Company is unable to predict
whether its net worth would be reduced as a result of such exposure.
Changes in interest rates will change the present value of any cash flows
which the Company is entitled to receive in the future. The Company, therefore,
may experience fluctuations in reported earnings as a result of changes in
interest rates. However, the sensitivity as of November 28, 1997 of the
Company's portfolio at that date to interest rates is such that a one percentage
point adverse change in interest rates would reduce the Company's net worth by
less than 1%. As the Company is unable to predict the movement of interest
rates, the Company is unable to predict whether its net worth would be reduced
as a result of such exposure.
Neither the Company nor its partners are subject to any income or profits
tax, capital gains tax, capital transfer tax, estate duty or inheritance tax
under the laws of the Cayman Islands. Further, the Company has obtained a Tax
Exemption Certificate from the Governor of the Cayman Islands, which is
effective for 50 years from March 3, 1992, which provides that no law thereafter
enacted in the Cayman Islands imposing any tax on profits, income, capital gains
or appreciation may apply to the Company or any partner thereof. See "Business
- -- Cayman Islands Taxation" under Item 1.
The Company, as a partnership, is not subject to U.S. federal income taxes.
Prior to January 1, 1997, the Company was required by U.S. federal tax
regulations to withhold income tax on behalf of its partners. These payments
were made on behalf of the Company by a related party. For the fiscal year ended
November 29, 1996, the related party remitted $4.53 million to tax authorities,
the entire amount of which the Company repaid to the related party. As of
January 1, 1997, the Company is no longer required to withhold taxes on behalf
of its partners under U.S. federal tax regulations.
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<PAGE>
Certain of the Company's income is subject to a 4% New York City
unincorporated business tax. The statements of income for the fiscal years ended
November 28, 1997, November 29, 1996 and November 24, 1995, include a provision
for unincorporated business tax on income earned by the Company related to doing
business in New York City. Depending upon the manner in which the business of
the Company will be operated in other jurisdictions, there is a possibility that
one or more such jurisdictions would impose tax on the profits of the Company.
FISCAL 1997 COMPARED WITH FISCAL 1996
For fiscal 1997, the Company reported revenues net of interest expense of
$15.6 million, consisting principally of intermediation profits of $10.6 million
and net interest income of $5.0 million. This represented an increase in
reported revenues net of interest expense of 1.3% compared to fiscal 1996.
During the period, the Company entered into or guaranteed 656 Derivative
Transactions with non-affiliates, and 683 Derivative Transactions with
affiliates. The aggregate notional principal amount of Derivative Transactions
entered into or guaranteed by the Company during the period was $18.3 billion,
which resulted in initial intermediation profits of $7.3 million. Other
intermediation profit for the period was $3.3 million, resulting principally
from an increase in the present value of the expected surplus cash flows from
the Company's portfolio due primarily to a reduction in the time remaining until
those cash flows are realized. The Company incurred interest expense of $9.3
million during fiscal 1997 as a result of an increase in the Company's long term
debt. See "Liquidity and Capital Resources" below.
For fiscal 1996, the Company reported revenues net of interest expense of
$15.4 million, which consisted principally of $11.6 million in intermediation
profits and net interest income of $3.8 million. During fiscal 1996, the Company
entered into or guaranteed 315 Derivative Transactions with non-affiliates,
including 8 transactions which the Company purchased from an affiliate at their
market value, and 369 hedging Derivative Transactions with affiliates. The
aggregate notional principal amount of Derivative Transactions entered into or
guaranteed by the Company during the period was $18.6 billion, which resulted in
initial intermediation profits of $7.0 million, including $473 thousand which
resulted from transactions purchased from affiliates. The remainder of
intermediation profits for fiscal 1996 resulted from an increase in the present
value of the expected surplus cash flows from the Company's portfolio due to a
reduction in the time remaining until those cash flows are realized. The Company
incurred interest expense of $3.6 million during fiscal 1996.
Interest income for fiscal 1997 increased to $14.2 million, compared to $7.5
million during the preceding year, primarily as a result of larger average
balances of cash and cash equivalents. Total intermediation profit for the
fiscal year ended November 28, 1997 decreased approximately $1 million or 8.2%
as compared to fiscal 1996. Initial intermediation profit for fiscal 1997
increased by $0.3 million or 4.3% over fiscal 1996, reflecting a significant
increase in the number of Derivative Transactions entered into with
non-affiliates, mostly offset by a reduction in the average notional amount of
such transactions and the shorter maturities of such transactions. Other
intermediation profit decreased by $1.3 million to $3.3 million in fiscal 1997
versus other intermediation profit of $4.6 million in fiscal 1996. The decrease
principally reflected a decrease in the average net investment in Derivative
Transactions during the year. Interest expense of $9.3 million for the fiscal
year ended November 28, 1997 increased significantly from the $3.6 million
incurred in the same fiscal period in 1996. This increase was the result of the
significant increase in the average long term debt outstanding in fiscal 1997 as
compared to fiscal 1996. The effective weighted average interest rate for long
term borrowings was 5.91% for fiscal 1997 and 5.41% for fiscal 1996.
Operating expenses for the fiscal year ended November 28, 1997 were $722
thousand, decreased from $879 thousand during the same period in 1996. Fees and
expense reimbursement to Group affiliates included within operating expenses
were $197 thousand and $211 thousand for the fiscal years ended November 28,
1997 and November 29, 1996, respectively. Other operating expenses were $525
thousand and $668 thousand for the fiscal years ended November 28, 1997 and
November 29, 1996, respectively, and consisted principally of legal, accounting
and rating agency fees.
Net income of $14.2 million for the 1997 fiscal year increased by 2% or $0.3
million from fiscal 1996 net income of $13.9 million. Total assets as of
November 28, 1997 were $582 million, consisting principally of Derivative
Transactions, cash and cash equivalents and securities owned.
As described in "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Overview" above, the Group has undertaken a review
of the operations of the Company and certain other Group Affiliates engaged in
the derivative products business. Since the commencement of this review, the
Company has not entered into any new Derivative Transactions. This lack of
activity by the Company has negatively affected the
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<PAGE>
Company's results of operations in the 1997 fourth fiscal quarter relative to
the fourth fiscal quarter of the prior year. See "Supplementary Financial
Information" under Item 14.
Net cash provided by operating activities during fiscal 1997 was $126
million, which principally reflected a reduction in the net investment in
Derivative Transactions, unrealized losses on the Oxford Health Plans, Inc.
common stock purchased as a hedge of a Medium Term Note and net income. Net cash
provided by financing activities during fiscal 1997 was $161 million reflecting
the issuance of Medium-Term Notes. Net cash used in investing activities during
fiscal 1997 was $137 million reflecting the purchase of securities as a hedge of
the Medium-Term Notes. See "Liquidity and Capital Resources" below. In
comparison, for the 1996 fiscal year, cash used in operating activities was
$115.8 million which principally reflected the pre-payment of certain
liabilities under Derivative Transactions with affiliates. Net cash provided by
financing activities during fiscal 1996 was $64.0 million, principally
reflecting proceeds on the issuance of the Company's Medium-Term Notes.
FISCAL 1996 COMPARED WITH FISCAL 1995
For fiscal 1996, the Company reported revenues net of interest expense of
$15.4 million, consisting principally of intermediation profits of $11.6 million
and net interest income of $3.8 million. This represented an increase in
reported revenues net of interest expense of 14.4% compared to fiscal 1995.
During the period, the Company entered into or guaranteed 315 Derivative
Transactions with non-affiliates, including 8 transactions which the Company
purchased from an affiliate at their market value, and 369 hedging Derivative
Transactions with affiliates. The aggregate notional principal amount of
Derivative Transactions entered into or guaranteed by the Company during the
period was $18.6 billion, which resulted in initial intermediation profits of
$7.0 million, including $473 thousand which resulted from transactions purchased
from affiliates. Other intermediation profit for the period was $4.6 million,
resulting principally from an increase in the present value of the expected
surplus cash flows from the Company's portfolio due primarily to a reduction in
the time remaining until those cash flows are realized. The Company incurred
interest expense of $3.6 million during fiscal 1996.
For fiscal 1995, the Company reported revenues net of interest expense of
$13.5 million, which consisted principally of $7.9 million in intermediation
profits and net interest income of $5.6 million. During fiscal 1995, the Company
entered into or guaranteed 86 Derivative Transactions with non-affiliates,
including 9 transactions which the Company purchased from an affiliate at their
market value, and 98 hedging Derivative Transactions with affiliates. The
aggregate notional principal amount of Derivative Transactions entered into or
guaranteed by the Company during the period was $23.8 billion, which resulted in
initial intermediation profit of $6.7 million, including $784 thousand which
resulted from transactions purchased from affiliates. The remainder of
intermediation profits for fiscal 1995 resulted from an increase in the present
value of the expected surplus cash flows from the Company's portfolio due to a
reduction in the time remaining until those cash flows are realized. The Company
incurred interest expense of $471 thousand during fiscal 1995.
Interest income for fiscal 1996 increased to $7.5 million, compared to $6.0
million during the preceding year, as a result of larger average balances of
cash and cash equivalents. Total intermediation profit for the fiscal year ended
November 29, 1996 increased approximately $3.7 million or 47% as compared to
fiscal 1995. Initial intermediation profit for fiscal 1996 increased by $0.3
million or 4% over fiscal 1995, reflecting a significant increase in the number
of Derivative Transactions entered into with non-affiliates, mostly offset by a
reduction in the notional amount of such transactions as well as the shorter
maturities of such transactions. Other intermediation profit increased by $3.4
million to $4.6 million in fiscal 1996 versus other intermediation profit of
$1.2 million in fiscal 1995. The increase principally reflected an increase in
the average net investment in Derivative Transactions during the year. Interest
expense of $3.6 million for the fiscal year ended November 29, 1996 increased
significantly from the $0.5 million incurred in the same fiscal period in 1995.
This increase was the result of the significant increase in the average long
term debt outstanding in fiscal 1996 as compared to fiscal 1995. The effective
weighted average interest rate for long term borrowings was 5.41% for fiscal
1996 and 5.89% for fiscal 1995.
Operating expenses for the fiscal year ended November 29, 1996 were $879
thousand, virtually unchanged from $878 thousand during the same period in 1995.
Fees and expense reimbursement to Group affiliates included within operating
expenses were $211 thousand and $195 thousand for the fiscal years ended
November 29, 1996 and November 24, 1995, respectively. Other operating expenses
were $668 thousand and $685 thousand for the fiscal years ended November 29,
1996 and November 24, 1995, respectively, and consisted principally of legal,
accounting and rating agency fees.
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<PAGE>
Net income of $13.9 million for the 1996 fiscal year increased by 13.5% or
$1.7 million from fiscal 1995 net income of $12.3 million. Total assets as of
November 29, 1996 were $371 million, consisting principally of Derivative
Transactions and cash and cash equivalents.
Net cash used in operating activities during fiscal 1996 was $115.8 million,
which principally reflected the prepayment of certain liabilities under
Derivative Transactions with affiliates. Net cash provided by financing
activities during fiscal 1996 was $64.0 million principally reflecting proceeds
on issuance of the Company's Medium-Term Notes. In comparison, for the 1995
fiscal year, cash provided from operating activities was $80.1 million and
principally reflected receipts exceeding payments on Derivative Transactions.
Net cash provided from financing activities during fiscal 1995 was $35.0
million, which reflected the repayment of the Company's Medium-Term Series A-1
Notes and the issuance of the Company's Nikkei 225 Index Notes due December 22,
2000.
LIQUIDITY AND CAPITAL RESOURCES
The Company conducts its business in a manner designed to require that cash
payments to the Company from its portfolio, taking into account market
fluctuations and the possibility of default, will be sufficient to make when due
all required payments on all the Company's liabilities, including payments of
principal and interest on borrowings. The Company needs capital principally to
absorb potential losses due to counterparty defaults. If counterparties were to
default on their obligations to the Company, these losses could be substantial.
However, based on the credit quality of its counterparties (including
affiliates), the Company does not currently anticipate any default losses and
has not recorded any provisions for credit losses. For a discussion of the
effects of a counterparty default, see "Business -- Entering into New Derivative
Transactions and Risk Management -- Credit Quality and Counterparty Credit Risk"
under Item 1.
The Company believes that the best measure, at any point in time, of its
credit exposure to a particular counterparty is the cost it would incur to
replace the obligations of that counterparty if it defaulted, net of any high
quality marketable securities posted as collateral by the counterparty. The
Company believes that under current market conditions it could enter into
replacement contracts for all of its contracts if the counterparties were to
default. However, there can be no assurance that the Company could enter into
such replacement contracts due to factors beyond the control of the Company,
such as the limited liquidity of many of the Company's assets and the potential
unavailability of suitable replacement contracts. Where several transactions
with one counterparty are subject to a master agreement which provides for
netting and which the Company believes is legally enforceable under relevant
law, the Company calculates the exposure resulting from those transactions on a
net basis, i.e., adding the positive and negative value; and where the
transactions are not subject to such a netting agreement, the Company calculates
its exposure on a gross basis, i.e., adding only positive values. This method is
identical to that used for calculating the amount of Derivative Transactions
recorded on the Company's balance sheet. As a result, at any point in time, the
Company's aggregate credit exposure in respect of an asset equals the cost of
replacing such asset less the value of any collateral posted by the counterparty
and any Derivative Transactions structured on a limited recourse basis as
discussed under "Documentation" in Item 1. The Company has applied Financial
Accounting Standards Board Interpretation No. 39, "Offsetting of Amounts
Relating to Certain Contracts", for financial reporting purposes for all periods
presented.
In certain circumstances, the Company may reduce its credit exposure to a
counterparty by requiring that the counterparty deposit margin or collateral.
When accepting margin or collateral, the Company generally accepts high quality
marketable securities (e.g., U.S. Treasury bonds or notes and securities issued
or backed by U.S. governmental agencies). The Company calculates credit exposure
net of collateral when it believes that it has a perfected security interest in
such collateral under an enforceable agreement.
The composition, at November 29, 1996 and November 28, 1997, of the
Company's credit exposures is shown in the tables below according to the
long-term debt ratings of the obligors by S&P rating and by the industry and
location of the obligors. (Totals do not equal Derivative Transactions reported
as assets principally because credit exposures include cash and cash equivalents
and exclude certain Derivative Transactions where the Company believes that it
does not have credit risk -- e.g., Derivative Transactions reported as assets in
respect of which collateral has been received to the extent of the value of the
collateral received and any Derivative Transactions structured on a limited
recourse basis as discussed under "Documentation" in Item 1.) At November 29,
1996 and November 28, 1997, the Company's counterparties consisted largely of
banks located in Europe, North America and Japan, as well as Group Affiliates.
It is important to note that the Company's credit exposures will fluctuate as a
result of new transactions, as well as changes in the replacement cost of
existing transactions due to changes in, among
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<PAGE>
other things, the level of indices to which transactions are linked, supply and
demand for particular transactions and the time remaining until maturity of the
transactions.
Current Credit Exposure - By S&P Rating of Obligor:
---------------------------------------------------
(U.S. dollars in millions)
November 29, 1996 November 28, 1997
----------------- -----------------
S&P Rating: $ Percent $ Percent
- ----------- ----- ------- ----- -------
AAA $125.3 34.0% $127.8 28.8%
AA+ 10.0 2.7 77.1 17.4
AA 31.9 8.7 70.4 15.9
AA- 23.6 6.4 33.2 7.5
A+ 84.1 22.8 86.1 19.4
A 48.8 13.2 11.0 2.5
A- 45.1 12.2 37.1 8.4
Below A- 0.0 0.0 0.3 0.1
------ ----- ------ -----
Total $368.8 100.0% $443.0 100.0%
====== ===== ====== =====
Current Credit Exposure - By Country of Obligor's Headquarters:
---------------------------------------------------------------
(U.S. dollars in millions)
November 29, 1996 November 28, 1997
----------------- -----------------
Country: $ Percent $ Percent
- -------- ----- ------- ----- -------
U.S. $178.7 48.4% $253.2 57.2%
Switzerland 28.3 7.7 70.3 15.9
France 65.5 17.7 58.6 13.2
Germany 6.9 1.9 36.9 8.3
Japan 69.7 18.9 24.0 5.4
Netherlands 17.6 4.8 0 0.0
Other 2.1 0.6 0 0.0
------ ----- ------ -----
Total $368.8 100.0% $443.0 100.0%
====== ===== ====== =====
Current Credit Exposure - By Obligor Industry:
----------------------------------------------
(U.S. dollars in millions)
November 29, 1996 November 28, 1997
----------------- -----------------
Industry: $ Percent $ Percent
- --------- ----- ------- ----- -------
Banks $257.7 69.9% $336.5 76.0%
Financials 43.3 11.7 60.2 13.5
Industrials 48.4 13.1 28.7 6.5
Government Agencies 19.4 5.3 17.6 4.0
------ ----- ------ -----
Total $368.8 100.0% $443.0 100.0%
====== ===== ====== =====
The Company has entered into and expects to continue to enter into
transactions with FPI or GSCM (obligations of GSCM being unconditionally
guaranteed by Group) in order to hedge transactions with third parties.
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<PAGE>
(The notional amount of Derivative Transactions with affiliates exceeds that
with non-affiliates due to a greater notional amount of affiliate versus
non-affiliate transactions guaranteed, as well as Derivative Transactions
between the Company and affiliates which hedge the Company's interest rate or
currency exposure on surplus cash flow from its portfolio, or which are intended
to mitigate total credit risk.) At November 28, 1997, the Company had $16
million and $7 million of credit exposure to GSCM and FPI, respectively, as a
result of these transactions. Due to the level of credit exposure to Group or
its affiliates at November 28, 1997, the Company does not believe that financial
information with respect to Group is material to investors in the Company's debt
securities.
The Company anticipates that its credit exposures may be highly concentrated
since financial instruments reported as assets may be transacted with a limited
number of counterparties. At November 29, 1996 the Company had credit exposure
net of collateral exceeding 10% of its total assets to Banque Nationale de Paris
and Morgan Guaranty Trust Company of New York. Banque Nationale de Paris and
Morgan Guaranty Trust Company of New York were rated A+ and AAA, respectively,
by S&P at November 29, 1996. At November 28, 1997, the Company had credit
exposure net of collateral exceeding 10% of its total assets to Republic
National Bank, Union Bank of Switzerland, Morgan Guaranty Trust Company of New
York and Banque Nationale de Paris. Collectively, such exposures represented 44%
of total assets. The Company would incur a large loss if these counterparties
were to default. The Company's largest credit exposure to any one counterparty
was $70 million, or 12% of total assets, to Union Bank of Switzerland. However,
Republic National Bank, Union Bank of Switzerland, Morgan Guaranty Trust Company
of New York and Banque Nationale de Paris were rated AA, AA+, AAA and A+,
respectively, by S&P at November 28, 1997, and the Company currently does not
anticipate any loss as a result of these exposures. Additionally, the Company
currently does not consider its credit exposure to any counterparty excessive
since none of such exposures exceeded the Company's net worth.
As of November 28, 1997, the Company was a party to Derivative Transactions
with a notional amount of $28 billion. Of these, $7.2 billion notional amount
with an estimated fair market value of $72 million represented Derivative
Transactions which could not expose the Company to credit risk (e.g., options
written). The composition of the remainder of the Company's Derivative
Transactions by maturity and counterparty S&P rating is illustrated below. It
should be noted that notional principal amount is not a measure of market or
credit risk.
Notional Amount of Derivative Transactions With Potential Credit
Exposure By Maturity:
----------------------------------------------------------------
(U.S. dollars in millions)
November 29, 1996 November 28, 1997
----------------- -----------------
$ Percent $ Percent
----- ------- ----- -------
1994-1996 $850 3.6% $0 0.0%
1997-1999 12,918 54.0 8,374 40.1
2000-2003 4,671 19.5 5,792 27.8
2004-2005 2,549 10.7 2,107 10.1
2006-2021 2,895 12.2 4,580 22.0
------ ----- ------- -----
Total $23,883 100.0% $20,853 100.0%
======= ===== ======= =====
-24-
<PAGE>
Notional Amount of Derivative Transactions With Potential Credit Exposure
By Credit Quality of Obligor:
-------------------------------------------------------------------------
(U.S. dollars in millions)
November 29, 1996 November 28, 1997
----------------- -----------------
S&P Rating: $ Percent $ Percent
- ----------- ----- ------- ----- -------
AAA $2,727 11.4% $3,415 16.4%
AA+ 472 2.0 239 1.1
AA 696a 2.9 303 1.5
AA- 1,133 4.7 438 2.1
A+ 274 1.1 66 0.3
A 1,465 6.1 1,112 5.3
A- 1,088 4.6 1,552 7.4
Below A- 290a 1.2 114a 0.6
Affiliates 15,738 66.0 13,614 65.3
------- ----- ------- ------
Total $23,883 100.0% $20,853 100.0%
======= ===== ======= =====
(a) Includes Derivative Transactions which were collateralized in part.
Notional Amount of Derivative Transactions With Potential Credit Exposure
By Principal Underlying Index Type:
-------------------------------------------------------------------------
(U.S. dollars in millions)
November 29, 1996 November 28, 1997
----------------- -----------------
$ Percent $ Percent
----- ------- ----- -------
Interest rate $19,910 83.4% $16,498 79.1%
Currency 3,923 16.4 4,271 20.5
Other 50 0.2 84 0.4
------- ----- ------- -----
Total $23,883 100.0% $20,853 100.0%
======= ===== ======= =====
The notional amount of currencies, expressed in U.S. dollars at November 28,
1997, to be exchanged under currency options and currency swaps outstanding at
November 28, 1997 (see "Currency" in the table above) were U.S. dollars ($728
million), European currency units (approximately $328 million), Japanese yen
(approximately $695 million), Dutch guilders (approximately $625 million),
Deutsche marks (approximately $456 million), British pounds (approximately $631
million), Italian lire (approximately $509 million), French francs
(approximately $94 million), Australian dollars (approximately $17 million),
Argentine pesos (approximately $30 million), Brazilian real (approximately $41
million), Hong Kong dollars (approximately $41 million), Swiss francs
(approximately $23 million), Spanish pesetas (approximately $26 million),
Mexican pesos (approximately $16 million) and Canadian dollars (approximately
$11 million).
The fair values of Derivative Transactions as of November 28, 1997 and the
average monthly fair values of such instruments for the fiscal year then ended,
computed in accordance with the Company's netting policy, are as follows:
November 28, 1997 Average
----------------- -------
(U.S. dollars in millions) Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
Non-affiliates
- --------------
Derivative Transactions $173.0 $154.0 $175.1 $131.2
Affiliates
- ----------
Derivative Transactions 19.6 0.0 14.0 0.0
-25-
<PAGE>
The Company is also a general partner of FPI and, as such, would ultimately
be liable for all the obligations of FPI if it were insolvent. At November 28,
1997, FPI had total liabilities of $203 million. The Company, after analyzing
the financial position, results of operations and cash flows of FPI, believes
that FPI will be able to meet its obligations under its outstanding liabilities.
Accordingly, the Company does not believe that it is necessary to, and has not,
established a reserve with respect to FPI's obligations under its liabilities.
At November 28, 1997, the Company had $291 million of cash and cash
equivalents available to meet its payment obligations. The Company believes that
such level of cash and cash equivalents is sufficient to enable it to meet all
of its current payment obligations. The Company anticipates that it will make
distributions to partners in the future. However, the amount of such dividends
and distributions will be limited to ensure the Company's ability to meet its
obligations is not adversely affected.
The Company may expand its portfolio by purchasing new Derivative
Transactions, principally from affiliates of Group. The Company has an effective
registration statement that initially covered $500 million of Medium-Term Notes.
As of November 28, 1997, the Company had $266 million available for future
issuance under such registration statement. The Company has issued and
outstanding $40 million face amount of Nikkei 225 indexed Notes due December 22,
2000, $73 million face amount of S&P Enhanced Stock Index Growth Notes due
August 9, 2002, approximately $41 million initial principal amount of 7%
Mandatorily Exchangeable Notes due July 23, 1999 (Subject to Mandatory Exchange
into Shares of Common Stock of Oxford Health Plans, Inc.) ("Oxford"), and $120
million principal amount of 3% Citicorp Exchangeable Notes due August 28, 2002
("Citicorp"). The single stock related note issuances (i.e., Oxford and
Citicorp) are an integral part of individually structured derivative
transactions. Payments on the above Notes are determined by reference to the
performance of a single equity security or an equity index. The terms of a Note
linked to a single stock may either allow for or mandatorily require the holder
to exchange the notes into an amount of the underlying security. The Company has
purchased equity securities and has entered into Derivative Transactions with
Affiliates of Group and purchased exchange traded options to eliminate its
market risk on the Notes. The cost of hedging an equity-linked Medium Term Note
may use up a substantial portion of the proceeds from the issuance of such Note.
The Company intends to continue to issue equity-linked Medium-Term Notes in the
future. As a result, the Company's leverage will increase. The Company's
activities also may include purchasing new instruments, primarily interest rate
and currency swaps, and entering into hedges which convert the return on such
Derivative Transactions into a fixed or floating rate of return on the Company's
investment.
As of November 28, 1997, securities owned consisted of shares of common
stock of Oxford Health Plans, Inc. (market value approximately $11.4 million)
and shares of common stock of Citicorp (market value approximately $83.8
million). The Company purchased these securities to hedge certain of the
Company's exposures incurred by its issuance of two series of Medium Term Notes,
one of which is mandatorily exchangeable at maturity into shares of common stock
of Oxford Health Plans, Inc. and the other of which is exchangeable, at the
option of the holder, into shares of Citicorp common stock.
Partners' capital is not subject to withdrawal or redemption on demand by
the partners. However, prior to January 1, 1997, the Company was required by
U.S. federal tax regulations to withhold income tax on behalf of its partners.
This withholding, which is accounted for as a distribution to partners, amounted
to $4.530 million for the fiscal year ended 1996. Other than such withholding,
all net income during fiscal 1996 and fiscal 1997, respectively, was retained in
partners' capital. At November 28, 1997, the Company had $148 million of
partners' capital. The Company believes that this level of partners' capital is
sufficient for it to continue to expand both the type and the volume of its
Derivative Transactions.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Financial Statements and Schedules on page F-1.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable
-26-
<PAGE>
PART III
--------
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Partnership Agreement (as defined in Item 12) of the Company provides
for the conduct and management of the Company's business to be performed by the
Corporate General Partner. The Company does not compensate the directors or
officers of the Corporate General Partner for their services to the Company. The
compensation received by a director or officer of the Corporate General Partner
from Group or its affiliates is not determined by reference to the services
performed by such director or officer for the Corporate General Partner.
The table below sets forth the names, ages and positions of the persons who
are the directors and executive officers of the Corporate General Partner. All
the directors below are also directors of GS Financial Products Co. ("GSFP
Co."), the managing general partner of FPI, and Executive Vice Presidents of the
general partner of Group.
NAME AGE POSITION
- ---- --- --------
Richard E. Witten 44 Director
Oki Matsumoto 34 Director
Thomas K. Montag 41 Director
Kipp Nelson 38 Director
Mark Zurack. 41 Director
Greg Swart 30 President
Amy Furman 32 Secretary
Daphine Campbell 32 Vice President
Richard E. Witten has been a Director of the Corporate General Partner since
August 22, 1994. Mr. Witten became a general partner of GS&Co. in 1990. In
November 1996, Mr. Witten became a participating limited partner of Group.
Oki Matsumoto has been a Director of the Corporate General Partner since May
1, 1995. Mr. Matsumoto became a general partner of GS&Co. and a director of
Goldman Sachs (Japan) Limited in 1994. Mr. Matsumoto was a vice president of
GS&Co. prior to that time. In November 1996, Mr. Matsumoto became a
participating limited partner of Group.
Thomas K. Montag has been a Director of the Corporate General Partner since
May 1, 1995. Mr. Montag became a general partner of GS&Co. in November 1994 and
was a vice president of GS&Co. prior to that time. Mr. Montag is a Director of
the corporate general partner of GSMMDP. Commencing in October 1993, Mr. Montag
has served intermittently as president and vice president of the corporate
general partner of GSMMDP. In November 1996, Mr. Montag became a participating
limited partner of Group.
Kipp Nelson has been a Director of the Corporate General Partner since May
1, 1995. Mr. Nelson became a general partner of GS&Co. in November 1994 and was
a vice president of GS&Co. prior to that time. Mr. Nelson has also been a
managing director of Goldman Sachs International since February 1995. In
November 1996, Mr. Nelson became a participating limited partner of Group.
Mark Zurack has been a Director of the Corporate General Partner since April
1, 1997. Mr. Zurack became a general partner of GS&Co. in November 1994 and was
a vice president of GS&Co. prior to that time. In November 1996 Mr. Zurack
became a participating limited partner of Group.
Greg Swart has been President of the Corporate General Partner since
February 5, 1992. Mr. Swart is also the President of GSFP Co., the managing
general partner of FPI. Mr. Swart has been an employee of Goldman Sachs (Cayman)
Trust, Limited ("Cayman Trust"), a Group Affiliate, since October 1991 and was
an Assistant Manager in the Controllers Department of Goldman Sachs
International ("GSI") from January 1990 to January 1991.
-27-
<PAGE>
Amy Furman has been Secretary of the Corporate General Partner since August,
1996. Ms. Furman is also the Secretary of GSFP Co., the managing general partner
of FPI. Ms. Furman has been an employee of Cayman Trust since May 1994 and prior
to that was an associate at Penn Corp. Financial Group from January 1992 to
October 1993.
Daphine Campbell has been a Vice President of the Corporate General Partner
since August 1996. Ms. Campbell has been an employee of Cayman Trust since
January 1993 and prior to that was an employee of Midland Bank Trust (Cayman)
from January 1989 to December 1992.
The President, Vice President and the Secretary are responsible to the Board
of Directors for the execution of transactions approved by the Board and the
administration of the business of the Corporate General Partner (including the
business of the Company) pursuant to authorities given by the Board. There are
no other officers of the Corporate General Partner or the Company.
ITEM 11: EXECUTIVE COMPENSATION
The Company does not employ any persons to conduct its business and does not
maintain any employee benefit plans. Instead, as discussed above under
"Directors and Executive Officers" in Item 10, the conduct and management of the
Company's business is performed by the Corporate General Partner. Neither the
directors nor the officers of the Corporate General Partner receive any
compensation from the Company for their services to the Company. As discussed
under "Certain Relationships and Related Transactions" in Item 13, the Company
engages Group Affiliates to perform operational and administrative functions.
The Company expensed $211 thousand and $197 thousand during the fiscal years
ended November 29, 1996 and November 28, 1997, respectively, for services
provided by Group Affiliates pursuant to the Custodian and Space Sharing
Agreements (as defined in Item 13). Additionally, the Company paid Group
Affiliates $702 thousand for services rendered in connection with the issuance
of its long term notes, pursuant to the Origination Agreements (as defined in
Item 13) during the fiscal year ended November 28, 1997. No services were
obtained or charged under the Origination Agreements during the fiscal year
ended November 29, 1996 since all transactions in that year were done on a
principal basis. See "Certain Relationships and Related Transactions -- Summary
of Expenses" in Item 13.
The Company and the affiliates of Group providing services to the Company
are all subsidiaries of Group. Each director of the Corporate General Partner,
as a participating limited partner of Group, has substantially the same interest
in the profits of the Company as he has in the profits of the affiliates that
provide services to the Company. Accordingly, the directors of the Corporate
General Partner are not benefited by these inter-company payments.
Under the Partnership Agreement (as defined in Item 12) of the Company, the
Corporate General Partner has an interest in the profits and losses of the
Company which may not fall below 0.2%. This interest is intended, in part, to
compensate the Corporate General Partner for the services of its officers and
directors to the Company. No other payments to the Corporate General Partner
will be made as a result of the performance of services by the officers and
directors of the Corporate General Partner to the Company. The Corporate General
Partner does not incur expenses on its own behalf as a result of its being
Corporate General Partner.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Company was formed February 5, 1992 pursuant to a limited partnership
agreement (as amended and restated, the "Partnership Agreement"). There are two
partners of the Company, the Corporate General Partner, which is both a general
and a limited partner, and GS Financial Products, L.P. ("GSFP"), a limited
partner.
The sole business of the Corporate General Partner is to manage the Company.
As of November 28, 1997, the Corporate General Partner had equity of $2.2
million, and assets of $2.8 million (principally cash and cash equivalents).
The Corporate General Partner has one authorized and outstanding deferred
share (the "Deferred Share") held by Deutsche Morgan Grenfell Nominees (Cayman)
Ltd., a Cayman Islands company ("DMGCL"). Under the Articles of Association of
the Corporate General Partner, the Deferred Share has sufficient voting power to
permit its holder to
-28-
<PAGE>
block an attempt to voluntarily dissolve the Corporate General Partner or the
Company, even in circumstances where Group or its affiliates have become subject
to insolvency proceedings. The Deferred Share has no other economic or voting
rights. DMGCL holds the Deferred Share as beneficial owner and not as trustee
for the holders of any indebtedness of the Company and owes no duty to holders
of the indebtedness, or other creditors of the Company, with respect to the
exercise of the voting rights attached to the Deferred Share.
In the event of an insolvency of the Company and an inadequacy of the assets
of the Company to satisfy its liabilities, under Cayman Islands law, the assets
of the Corporate General Partner would become available to the creditors of the
Company. The Corporate General Partner is a Cayman Islands exempted limited
liability company. As a result, under Cayman Islands law, creditors of the
Company would have no recourse against the owners of the Corporate General
Partner. Accordingly, in an insolvency proceeding, creditors of the Company
would have only the assets of the Company and the Corporate General Partner
available to satisfy their claims. This is similar to the protection afforded
shareholders of a corporation organized in the United States.
The sole shareholder of the Corporate General Partner is GSFP, a Cayman
Islands exempted limited partnership. GSFP has two partners, GSFP Co., a general
partner, and GSCI Holdings L.L.C. ("Holdings"), a limited partner. GSFP is also
the managing general partner of FPI, while the Company is a general partner of
FPI.
GSFP Co. is a Cayman Islands limited liability company, all of the ordinary
shares of which are owned by Holdings. Like the Corporate General Partner, GSFP
Co. has one authorized and outstanding deferred share. Under the Articles of
Association of GSFP Co. the deferred share has sufficient voting power to permit
its holder to block an attempt to dissolve voluntarily GSFP Co., even in
circumstances where Group or its affiliates have become subject to insolvency
proceedings.
Holdings is a Delaware limited liability company which is owned by Group and
GS Equity Markets, L.P., a partnership controlled by Group.
Group is the parent company of the Goldman Sachs organization. As discussed
above, Group directly and indirectly owns all of the ordinary shares of
Holdings. In addition, all of the directors of the Corporate General Partner are
also Executive Vice Presidents of the general partner of Group. Therefore, Group
effectively controls the business and operations of the Company. See "Directors
and Executive Officers of the Registrant" under Item 10. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Overview" for a discussion of the current review of the Company's business and
operations. However, liabilities of the Company are not liabilities of, or
guaranteed by, Group or any partner thereof or controlling person thereof.
Accordingly, neither Group nor any such person has any liability with respect to
any indebtedness or other obligations of the Company.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
HEDGING TRANSACTIONS WITH GSCM AND FPI
In the ordinary course of business, the Company enters into hedging
transactions with GSCM and/or FPI. As of November 28, 1997 and November 29,
1996, the notional amounts of the Derivative Transactions with GSCM were $15.7
billion and $16.8 billion, respectively. As of November 28, 1997 and November
29, 1996, the notional amounts of the Derivative Transactions with FPI were
$0.04 billion and $1.0 billion, respectively.
OPERATIONAL AND ADMINISTRATIVE RELATIONSHIPS WITH GROUP
The Company has engaged Group Affiliates to perform substantially all of its
operational and administrative functions. These services include both services
which the Company believes are essential to its ability to continue to function
("Administrative Services"), as well as those services which it needs in order
to continue to expand its business ("New Business Services"). The Company will
not enter into any agreement or Derivative Transaction with any affiliate of
Group on terms that it believes are less favorable than arm's length. The
Company believes that the fees it has paid or will pay to Group Affiliates under
the Administrative Services and New Business Services agreements are at least as
favorable as would be available from non-affiliated entities. Each of these
agreements had an original term of 10 years. While each of these agreements
provides for resignation or termination of the appointment of the relevant Group
Affiliate upon 60 days' written notice, the relevant Group Affiliate is not
permitted to
-29-
<PAGE>
resign until a successor is appointed. Were the Company to replace Group
Affiliates as the providers of services under these agreements, it is uncertain
whether such services could be obtained at the same expense.
The Company has also entered into backup arrangements with Deutsche Morgan
Grenfell (Cayman) Limited to provide Administrative Services if the Group
Affiliates providing the Administrative Services were unable to do so or were
terminated by the Company. However, in the case of New Business Services, if a
Group Affiliate performing New Business Services were unable to perform or were
terminated by the Company, the Company might not be able to find a successor to
perform such services. Without New Business Services, the Company may be unable
to enter into any further Derivative Transactions, at which point its business
may in practice be restricted to collecting the payments from its assets as they
mature and holding such payments in cash equivalents until they are used to
satisfy its liabilities.
Following are summaries of certain provisions of the Company's agreements
regarding operational and administrative services with Group Affiliates. These
summaries do not purport to be complete and are subject to, and are qualified in
their entirety by reference to, copies of the agreements, which are exhibits
hereto. See Item 14.
ADMINISTRATIVE SERVICES AGREEMENTS
The services which the Company considers Administrative Services include the
maintenance of books, records and accounts, the preparation and distribution of
financial statements and other such material, and the investment on a short-term
basis of the Company's excess cash resources pursuant to prearranged guidelines.
These services currently are provided under an agreement (the "Custodian
Agreement") with Cayman Trust. In addition, pursuant to another agreement (the
"Space Sharing Agreement"), Cayman Trust provides for the non-exclusive use
within its premises of space for the Company's business uses, including
directors' and partners' meetings, as well as telecopy facilities and separate
telephone and post office box facilities. Each of the Company's agreements with
Cayman Trust was entered into on November 27, 1992. The Custodian Agreement
requires the Company to pay fees of $150,000 per annum, subject to renegotiation
under materially changed circumstances, while the Space Sharing Agreement
requires the Company to pay fees of $5,000 per annum, plus reasonable expenses.
Additionally, the Company holds brokerage accounts with two Group
Affiliates, GS&Co. and GSI, and various Group Affiliates may provide custody
services for, and clear and settle transactions by, the Company.
NEW BUSINESS SERVICES AGREEMENTS
Each of GS&Co. and GSI provides or will provide New Business Services
pursuant to separate agreements with the Company (together, the "Origination
Agreements"). Under these Agreements, each of GS&Co. and GSI has agreed to use
reasonable efforts to obtain bids from third parties with respect to proposed
transactions between third parties and the Company. In addition, GS&Co. has
agreed to provide, or cause to be provided, analyses of products and
transactions and credit reviews of counterparties. See "Business -- Entering
into New Derivative Transactions and Risk Management -- Credit Quality and
Counterparty Credit Risk -- Counterparty Credit Quality" under Item 1. GS&Co.
has no liability in respect of the provision of such credit reviews except in
the case of gross negligence. GS&Co. also provides, pursuant to another
agreement (the "Calculation Agreement"), certain technical and administrative
services to the Company, principally those required in connection with new
Derivative Transactions such as performing calculations designed to measure
credit and other risks to which the Company may be subject.
The Origination Agreements and the Calculation Agreement require the Company
to pay an amount equal to 105% of the costs and expenses of providing the
services covered by the agreements, apportioned in accordance with Group's
apportionment of such expenses for federal income tax purposes. In addition, if
the Company enters into a transaction based on a bid provided pursuant to an
Origination Agreement, the Company would pay a fee equal to the fee which
typically would be charged to third parties with respect to those services. For
an interest rate swap, the fee would generally be the present value of between
.001% and .01% per year of the notional principal amount of the interest rate
swap.
The Company does not currently anticipate making any changes to the method
pursuant to which costs are apportioned under the Origination and Calculation
Agreements. The Company expects the level of such expenses to continue to
increase in proportion with increases, if any, in the volume of Derivative
Transactions entered into. The Company believes that its costs would be
substantially similar if it were to obtain from third parties the services
-30-
<PAGE>
provided pursuant to these agreements and that the method of cost allocation
used in such agreements is reasonable.
SUMMARY OF EXPENSES
The following table summarizes the charges paid by the Company during the
fiscal years ended November 24, 1995, November 29, 1996 and November 28, 1997
pursuant to the foregoing agreements. No services were obtained or charged under
the Origination Agreements through November 29, 1996, since all of the
transactions prior to such date were done on a principal basis. The payments
under the GS&Co. Origination Agreement for the 1997 fiscal year related to
services performed by GS&Co. in connection with the issuance of equity-linked
Medium Term Notes. The payments will be amortized over the life of the Notes.
The Company expects to make similar payments in connection with future
equity-linked note issuances. Charges under the Calculation Agreement for the
period were determined by applying the standard hourly overhead rates used by
Group for the time spent by individuals providing services under such Agreement.
<TABLE>
<CAPTION>
GROUP AFFILIATE BASIS OF COMPENSATION EXPENSES INCURRED
AGREEMENT DESCRIPTION OF SERVICE PARTY THERETO COMPENSATION DURING THE FISCAL YEARS ENDED
- ------------ ---------------------- --------------- ------------ ------------------------------
(U.S. DOLLARS IN THOUSANDS)
NOV. 24, 1995 NOV. 29, 1996 NOV. 26, 1997
------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Custodian "Back Office", i.e., Cayman Trust $150,000 per annum $150.0 $150.0 $150.0
Agreement payment processing,
accounting, cash
management, custody
Space Sharing Office Space Cayman Trust $5,000 per annum $5.0 $5.0 $5.0
Agreement
Origination Opportunities to bid on GS&Co. Cost plus 5% $0.0 $0.0 $702.0a
Agreement intermediation of third
party transactions
Origination Opportunities to bid on GSI Cost plus 5% $0.0 $0.0 $0.0
Agreement intermediation of third
party transactions
Calculation Credit Risk limit GS&Co. Cost plus 5% $40.5 $56.0 $42.0
Agreement calculations
<FN>
(a) Payments were capitalized and will be amortized over the life of the Notes.
</FN>
</TABLE>
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<PAGE>
PART IV
-------
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS A PART OF THIS REPORT:
1. Financial Statements
The financial statements are listed on page F-1 hereof
2. Financial Statement Schedules
None required
(b) REPORTS ON FORM 8-K:
None
(c) EXHIBITS:
EXHIBIT NO. DESCRIPTION
- ----------- -----------
1.1 Distribution Agreement, dated January 3, 1996, between
the Company and Goldman, Sachs & Co. ("GS&Co.")*
3.1 Certificate of Registration of the Company**
3.2(a) Amended and Restated Limited Partnership Agreement of
the Company**
3.2 (b) Amendment, dated November 24, 1993, to the Amended and
Restated Partnership Agreement of the Company**
3.3 Memorandum of Association of the Corporate General Partner**
3.4 Restates Articles of Association of the Corporate General
Partner**
4.1 Indenture between the Company and The Bank of New York,
as Trustee, dated October 11, 1994***
10.1 Origination Agreement, dated January 5, 1994, between Goldman
Sachs International Limited and the Company**
10.2 Origination Agreement, dated November 27, 1992, between GS&Co.
and the Company**
10.3 International Swaps and Derivative Association, Inc. Master
Agreement, dated November 4, 1993, between the Company and
GS Financial Products International, L.P. ("GSFPI")**
10.4 International Swaps and Derivatives Association, Inc. Master
Agreement, dated February 24, 1993 (the "GSCM Agreement"),
between the Company and Goldman Sachs Capital Markets, L.P.
("GSCM")**
10.5 Guaranty, dated February 24, 1993, by The Goldman Sachs Group,
L.P. of GSCM's obligations under the GSCM Agreement**
10.6 Calculation Agreement, dated January 5, 1994, between the
Company and GS&Co.**
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<PAGE>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.7(a) Custodian Agreement, dated November 27, 1992 (the "Custody
Agreement") between the Company and Goldman Sachs (Cayman)
Trust, Limited ("Cayman Trust")****
10.7(b) Amendment No. 1, dated as of February 14, 1996, to the Custody
Agreement*****
10.8 Space Sharing Agreement, dated November 27, 1992, between
Cayman Trust and the Company**
10.9 Back-up Agreement, dated June 10, 1993, between Morgan
Grenfell (Cayman) Limited and the Company**
10.10 Assignment and Assumption Agreement, dated as of November 23,
1992, among the Company, GS&Co., GSCM and Group** +
12.1 Statement re computation of ratios of earnings to fixed
charges
23.1 Consent of Coopers & Lybrand L.L.P.
27.1 Financial Data Schedule
99.1 Tax Exemption Certificate of the Company**
99.2 Tax Exemption Certificate of the Corporate General Partner**
Notes
- ------------
* Incorporated herein by reference to the same numbered exhibit to the
Company's Current Report on Form 8-K dated January 3, 1996.
** Incorporated herein by reference from the same numbered exhibit to the
Company's Registration Statement on Form S-1 (File No. 33-71544), dated
October 7, 1994.
*** Incorporated herein by reference to the same numbered exhibit to the
Company's Quarterly Report on Form 10-Q for the quarter ended August 26,
1994.
**** Incorporated herein by reference to Exhibit 10.7 to the Company's
Registration Statement on Form S-1 (File No. 33-71544), dated
October 7, 1994.
***** Incorporated herein by reference to the same numbered exhibit to the
Company's Annual Report on Form 10-K for the year ended November 24, 1995.
+ A portion of this exhibit has been omitted pursuant to an order of the
Securities and Exchange Commission dated October 6, 1994.
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<PAGE>
INDEX TO FINANCIAL STATEMENTS OF THE COMPANY
Report of Independent Accountants........................................F-2
Balance Sheets as of November 29, 1996 and November 28, 1997.............F-3
Statements of Income for the fiscal years ended November 24, 1995,
November 29, 1996 and November 28, 1997...........................F-4
Statements of Changes in Partners' Capital for the fiscal years
ended November 24, 1995, November 29, 1996 and November 28,
1997..............................................................F-5
Statements of Cash Flows for the fiscal years ended November 24, 1995,
November 29, 1996 and November 28, 1997...........................F-6
Notes to Financial Statements............................................F-7
Supplementary Financial Information (Unaudited)..........................F-14
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
----------
To the Partners, GS Financial Products U.S., L.P.:
We have audited the accompanying balance sheets of GS FINANCIAL PRODUCTS U.S.,
L.P. as of November 29, 1996 and November 28, 1997, and the related statements
of income, changes in partners' capital and cash flows for the fiscal years
ended November 24, 1995, November 29, 1996 and November 28, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 GS Financial Products U.S.,
L.P., as of November 29, 1996 and November 28, 1997, and the results of its
operations and its cash flows for the fiscal years ended November 24, 1995,
November 29, 1996 and November 28, 1997, in conformity with accounting
principles generally accepted in the United States.
COOPERS & LYBRAND L.L.P.
New York, New York
January 22, 1998.
F-2
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
<TABLE>
<CAPTION>
BALANCE SHEETS
(U.S. dollars in thousands)
----------
<S> <C> <C>
November 29, 1996 November 28, 1997
----------------- -----------------
Assets:
Cash and cash equivalents (Note 1) $141,550 $291,375
Securities owned, at fair value (Note 2) 0 95,185
Derivative transactions, at fair value
(Notes 1, 3 and 4):
Affiliate 5,273 19,561
Non-affiliate 222,493 172,956
Investment in affiliates (Note 5) 952 780
Other assets 707 1,826
------- -------
Total assets $370,975 $581,683
======== ========
Liabilities and Partners' Capital:
Derivative transactions, at fair value
(Notes 1, 3 and 4):
Affiliate $ 4,157 $0
Non-affiliate 107,401 153,983
Long-term borrowings (Note 6) 116,778 276,489
Other liabilities and accrued expenses 8,596 3,090
------- -------
Total liabilities 236,932 433,562
Commitments and contingencies (Note 5)
Partners' capital:
Limited Partners 133,364 147,373
General Partner 679 748
------- --------
Total partners' capital 134,043 148,121
------- --------
Total liabilities and partners' capital $370,975 $581,683
======== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-3
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
<TABLE>
<CAPTION>
STATEMENTS OF INCOME
(U.S. dollars in thousands)
----------
Fiscal Years Ended
----------------------------------------------------------
November 24, 1995 November 29, 1996 November 28, 1997
----------------- ----------------- -----------------
<S> <C> <C> <C>
Revenues:
Intermediation profit (Notes 1, 3 and 4) $7,898 $11,570 $10,622
Interest 6,025 7,460 14,224
Equity in (loss) earnings of affiliate (Note 5) 9 (10) (23)
------- ------- --------
Total revenues 13,932 19,020 24,823
Interest expense (Note 6) 471 3,627 9,265
------- ------- -------
Revenues, net of interest expense 13,461 15,393 15,558
Expenses:
Operating (Note 4) 878 879 722
------- ------- -------
Income before taxes 12,583 14,514 14,836
Income taxes (Note 8) 303 581 608
------- ------- -------
Net Income $12,280 $13,933 $14,228
======= ======= =======
</TABLE>
The accompanying notes are an integral part of the financial statements
F-4
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
<TABLE>
<CAPTION>
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
(U.S. dollars in thousands)
----------
General Limited Total
Partner's Capital Partners' Capital Partners' Capital
----------------- ----------------- -----------------
<S> <C> <C> <C>
Balance, November 25, 1994 $595 $116,447 $117,042
Change in cumulative translation adjustment (1) (30) (31)
Net Income 61 12,219 12,280
Distribution to partners (22) (4,464) (4,486)
--- ------- -------
Balance, November 24, 1995 633 124,172 124,805
Change in cumulative translation adjustment (1) (164) (165)
Net Income 69 13,864 13,933
Distribution to partners (22) (4,508) (4,530)
--- ------- -------
Balance, November 29, 1996 679 133,364 134,043
Change in cumulative translation adjustment (1) (149) (150)
Net Income 70 14,158 14,228
--- ------- -------
Balance, November 28, 1997 $748 $147,373 $148,121
==== ======== ========
</TABLE>
The accompanying notes are an integral part of the financial statements
F-5
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
<TABLE>
<CAPTION>
STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
----------
FISCAL YEARS ENDED
----------------------------------------------------------
NOVEMBER 24, 1995 NOVEMBER 29, 1996 NOVEMBER 28, 1997
----------------- ----------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net Income $12,280 $13,933 $14,228
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in (earnings) loss of affiliate (9) 10 23
Unrealized loss on securities owned 0 0 41,613
(Decrease) in long-term borrowing due to
embedded derivative transactions, net 0 0 (1,087)
Decreases (increases) in operating assets:
Derivative transactions, at fair value:
Affiliate 0 (4,050) (14,288)
Non-affiliate 24,308 7,833 49,537
Other assets (188) (490) (1,119)
Increases (decreases) in operating liabilities:
Derivative transactions, at fair value:
Affiliate (15,791) (149,481) (4,157)
Non-affiliate 56,977 8,681 46,582
Other liabilities and accrued expenses 2,549 7,748 (5,506)
------ -------- -------
Net cash provided by (used in) operating activities 80,126 (115,816) 125,826
Cash flows from investing activities:
Short term investments (24,690) 24,690 0
Purchase of securities owned 0 0 (136,798)
------ -------- -------
Net cash provided by (used in) investing activities (24,690) 24,690 (136,798)
Cash flows from financing activities:
Repayment of short-term borrowings (5,000) 0 0
Proceeds from long-term borrowings 40,000 73,000 160,797
Distribution to partners 0 (9,016) 0
------ -------- -------
Net cash provided by financing activities 35,000 63,984 160,797
Net increase (decrease) in cash and cash equivalents 90,436 (27,142) 149,825
Cash and cash equivalents, beginning of period 78,256 168,692 141,550
-------- -------- --------
Cash and cash equivalents, end of period $168,692 $141,550 $291,375
======== ======== ========
Supplemental disclosure of cash flow information:
Interest paid $280 $1,067 $4,824
Income taxes paid $0 $752 $155
The accompanying notes are an integral part of the financial statements
</TABLE>
F-6
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
Notes to Financial Statements
----------
1. Business and Significant Accounting Policies:
The business of GS Financial Products U.S., L.P. (the "Company") is to
enter into, as principal or guarantor, a variety of types of transactions
involving financial instruments such as interest rate swaps, interest rate
options (e.g., interest rate caps, interest rate floors and options on
interest rate swaps), currency swaps and options, commodity swaps and
options, index swaps and forward contracts (collectively, "Derivative
Transactions"). Generally, the Company enters into or guarantees Derivative
Transactions in situations where two or more counterparties (typically
including a related party) wish to enter into one or more Derivative
Transactions between themselves but want the Company to substitute its
credit for that of one or more of the counterparties. Market practice for
such transactions is that the Company typically substitutes its own credit
for that of one or more of the counterparties by entering into each of such
transactions directly as principal. Such Derivative Transactions may also
include the use of futures, or the purchase of the underlying instruments
subject to the transactions, such as foreign currency, physical commodities
and securities. Because it conducts its business exclusively on a matched
basis, the Company is subject to credit risk but not market risk (as
described under Derivative Transactions -- see Note 3). In addition, from
time to time the Company issues structured notes. (See Note 6.)
The Company's long term debt and counterparty credit risk have been rated
AAA by Standard & Poor's Ratings Group ("S&P") and Fitch IBCA, Inc.
("Fitch"). There can be no assurance that S&P and Fitch will continue to
rate the Company's long term debt and counterparty credit risk,
respectively, in their highest category and any decrease in such ratings
may adversely affect the Company's ability to compete successfully.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts.
The Company is organized as a Cayman Islands exempted limited partnership.
All of the partnership interests in the Company are owned by subsidiaries
of The Goldman Sachs Group, L.P. ("Group").
The Company's financial statements have been prepared in accordance with
accounting principles generally accepted in the United States. The
statements are reported in U.S. dollars, the functional currency of the
Company. Assets and liabilities denominated in currencies other than the
U.S. dollar are measured using exchange rates prevailing as of the balance
sheet dates. Revenues and expenses are measured at weighted average rates
of exchange for the periods. The Company's equity in gains or losses
resulting from translating the financial statements of affiliates in which
it has invested, whose functional currency is other than the U.S. dollar,
is recorded as cumulative translation adjustments and included in partners'
capital.
The Company's Derivative Transactions and securities owned are recorded on
a trade date basis.
Securities owned are recorded at their fair value. Derivative Transactions
are recorded at their estimated fair value. As a result, due to the nature
of the Company's activities, a substantial portion of the intermediation
profit from credit enhancing new Derivative Transactions may be recognized
upon entering into such transactions. Such amounts were $7.3 million, $7.0
million and $6.7 million for the fiscal years ended 1997, 1996 and 1995,
respectively.
The remainder of intermediation profit for these periods resulted
principally from an increase in the present value of the expected surplus
cash flows from the Company's portfolio due to a reduction in time
remaining until those cash flows are realized (including the impact of all
hedges). Intermediation profit earned on performance guarantees is deferred
and amortized over the term of the guarantee. (See Notes 3 & 4).
Fair value for all securities owned is based on quoted market prices. Fair
value for all Derivative Transactions is estimated by using financial
models developed by affiliates, which incorporate market data for the
relevant instruments or for instruments with similar characteristics. Fair
value is estimated at a specified point in time.
Continued
F-7
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
Notes to Financial Statements (Continued)
----------
The nature, size, and timing of transactions and the liquidity of the
markets may not ultimately allow for the realization of these values.
Certain transactions entered into under master agreements and other
arrangements that provide the Company, in its opinion, with the right of
setoff in the event of a bankruptcy or default by the counterparty are
presented net in the balance sheets.
Cash equivalents are short-term, highly liquid investments, including time
deposits at banks with original maturities of three months or less.
At November 28, 1997, the Company had credit exposure exceeding 10% of its
total assets to four counterparties, which represented 44% of total assets.
All four counterparties had a rating of A+ or better from at least one
internationally recognized credit rating agency. At November 29, 1996, the
Company had credit exposure exceeding 10% of its total assets to two
counterparties, which represented 26% of total assets. Both of the
counterparties had a rating of single A or better from at least one
internationally recognized credit rating agency.
Certain prior year amounts have been reclassified to conform with the
November 28, 1997 presentation.
2. Securities Owned:
As of November 28, 1997 securities owned consisted of shares of common
stock of Oxford Health Plans, Inc. (fair value approximately $11.4 million)
and shares of common stock of Citicorp (fair value approximately $83.8
million). The Company purchased these securities to hedge certain of the
Company's exposures incurred by its issuance of two series of debt
securities, one of which is mandatorily exchangeable at maturity into
shares of common stock of Oxford Health Plans, Inc. and the other of which
is exchangeable, at the option of the holder, into shares of Citicorp
common stock. (See Note 6.)
3. Derivative Transactions:
The fair values of Derivative Transactions entered into under master
agreements and other arrangements that provide the Company, in its opinion,
with a right of setoff in the event of bankruptcy and default by the
counterparty are presented on a net basis in the balance sheets. Derivative
Transactions are principally interest rate swaps, interest rate options,
index swaps, currency options, currency forwards and currency swaps which
are denominated in various currencies. The fair values of swap and forward
agreements in a gain position, as well as options purchased are reported,
in accordance with the Company's netting policy, as assets in "Derivative
Transactions". Similarly, the fair value of swap and forward agreements in
a loss position as well as options written are reported as liabilities in
"Derivative Transactions". Derivative Transactions reported, in accordance
with the Company's netting policy, as assets are principally obligations of
major international financial institutions, primarily banks, which are
rated A+ or better by at least one internationally recognized rating
agency.
Futures contracts are exchange-traded standardized contractual commitments
to buy or sell a specified quantity of a financial instrument, currency or
commodity at a specified price and future date. Forward contracts are
over-the-counter ("OTC") contracts between two parties who agree to
exchange a specified quantity of a financial instrument, currency or
commodity at a specified price and future date. Option contracts convey the
right to buy (call option) or sell (put option) a financial instrument,
currency or commodity at a pre-determined price. For written option
contracts, the writer receives a premium in exchange for bearing the risk
of unfavorable changes in the financial instrument, currency or commodity.
Swaps are OTC contracts between two parties who agree to exchange periodic
cash flow streams calculated on a pre-determined contractual (notional)
amount.
Continued
F-8
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
Notes to Financial Statements (Continued)
----------
In the normal course of its business the Company enters into various
Derivative Transactions whereby the Company agrees to pay amounts that may
increase in the event of changes in the level of an underlying index. The
Company enters into such transactions with counterparties only if it is
able to enter into offsetting transactions that entitle the Company to
receive amounts that are equal to or in excess of the amounts it owes. As a
result, so long as none of its counterparties defaults, the Company
believes that it bears no market risk (i.e., its ability to satisfy its
obligations will not be affected by market conditions).
While the ultimate excess cash flows on these offsetting transactions will
be positive or zero, the reported revenues in any period (based on the
discounted value of these excess cash flows) will be impacted by changes in
interest rates or foreign currency exchange rates.
The Company's principal risk in respect of Derivative Transactions owned or
guaranteed is the credit risk associated with potential failure by
counterparties to perform under the terms of their obligations to the
Company. Credit exposure is measured by the loss the Company would record
in such a circumstance and equals, at any point in time, the cost of
replacing such financial instruments, net of collateral. As of November 29,
1996 and November 28, 1997, the Company's aggregate credit exposure in
respect of Derivative Transactions was approximately $226 million and $152
million, respectively.
The Company limits its credit risk by doing business principally with
highly rated counterparties. In certain circumstances, the Company may also
require a counterparty to post marketable securities, principally U.S.
government agency and U.S. treasury securities, as collateral in order to
reduce the amount of the Company's credit exposure. The Company had
obtained collateral of approximately $5 million related to Derivative
Transactions as of November 28, 1997.
The Company also limits its credit risk by observing certain limitations on
new Derivative Transactions. If such limits exceed management's criteria,
the Company will not enter into any transaction which increases that risk.
The calculation of these limitations incorporates the net assets of the
Company's general partner which is ultimately liable for the Company's
obligations (See Note 7).
A summary of the notional or contractual amounts ($ in millions) of the
Company's Derivative Transactions by principal characteristic follows. It
should be noted that notional principal amount is not a measure of market
or credit risk.
<TABLE>
<S> <C> <C>
November 29, 1996 November 28, 1997
----------------- -----------------
Non-affiliates
Interest rate swap agreements $6,869 $5,809
Currency options written 1,034 909
Currency options purchased 594 589
Interest rate options written 1,800 1,471
Interest rate options purchased 1,481 1,787
Currency and other swap agreements 502 162
Foreign currency forwards 393 1,552
Affiliates
Interest rate swap agreements $9,879 $8,003
Currency options written 594 396
Currency options purchased 1,034 1,103
Interest rate options written 1,481 1,742
Interest rate options purchased 2,458 2,081
Currency and other swap agreements 1,974 893
Foreign currency forwards 393 1,535
</TABLE>
Continued
F-9
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
Notes to Financial Statements (Continued)
----------
The notional amount of Derivative Transactions with affiliates differs from
that with non-affiliates generally due to a different notional amount of
affiliate versus non-affiliate transactions guaranteed, as well as to
Derivative Transactions between the Company and affiliates which hedge the
Company's interest rate or currency exposure on surplus cash flow from its
portfolio, or which are intended to mitigate total credit risk.
As described in Note 1, Derivative Transactions are carried at estimated
fair value, with the resulting gains and losses recognized currently as
intermediation profit. The fair values of Derivative Transactions owned or
issued as of November 28, 1997 and the average monthly fair values of such
instruments for the fiscal year then ended, computed in accordance with the
Company's netting policy, are as follows:
<TABLE>
<CAPTION>
(U.S. dollars in millions) November 28, 1997 Average
-------------------------- ------------------- --------------------
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
<S> <C> <C> <C> <C>
Non-affiliates
--------------
Derivative transactions $173.0 $154.0 $175.1 $131.2
Affiliates
----------
Derivative transactions 19.6 0.0 14.0 0.0
</TABLE>
4. Related Party Transactions:
During the fiscal years ended 1996 and 1995, the Company purchased third
party interest rate swaps and options from an affiliate at fair value and
hedged these purchases with Derivative Transactions issued to affiliates.
Intermediation profit related to these transactions were $473 thousand and
$784 thousand for the fiscal years ended 1996 and 1995, respectively. There
were no transactions purchased from affiliates during fiscal 1997.
In the ordinary course of business, the Company enters into hedging
transactions with affiliates. Through November 28, 1997, substantially all
of the Company's Derivative Transactions involved some degree of hedging
with affiliates.
The Company paid approximately $702 thousand to an affiliate related to the
issuance of certain medium-term notes pursuant to an origination agreement.
The Company has deferred and will amortize these costs over the lives of
the related notes.
In accordance with agreements with certain affiliates, technical and
administrative services may be provided to the Company for an amount
representing 105% of the cost incurred. In addition, the Company has
entered into a custodian and space sharing agreement with another affiliate
for which an agreed upon fee per annum is charged. The Company also obtains
brokerage and custodial services from affiliates. For the fiscal years
ended 1997, 1996 and 1995, approximately $197 thousand, $211 thousand and
$195 thousand were charged for such services, respectively.
5. Investment in Affiliates:
The Company owns an approximate 2% general and limited partnership interest
in GS Financial Products International, L.P. ("FPI"). The Company accounts
for its investment in FPI under the equity method because of its
non-managing general partner interest in FPI.
Continued
F-10
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
Notes to Financial Statements (Continued)
----------
FPI is engaged in a business similar to that of the Company. As of November
28, 1997, its assets consist principally of cash and cash equivalents and
equity securities of entities organized under Japanese law. Under Cayman
Islands law, as a general partner, the Company would be liable for all of
the liabilities of FPI if the assets of FPI were inadequate to meet its
obligations. As of November 28, 1997, FPI had total liabilities of $203
million. The Company, after analyzing the financial position, results of
operations and cash flows of FPI, believes that FPI will be able to meet
its obligations under its outstanding liabilities. Accordingly, the Company
does not believe that it is necessary to, and has not, established a
reserve with respect to FPI's obligations under its liabilities.
FPI's functional currency is the Japanese yen, and the amounts presented
below were translated at the appropriate yen/dollar exchange rate.
Selected financial data for FPI (U.S. dollars in millions):
Fiscal years ended
--------------------------------------------------------
November 24, 1995 November 29, 1996 November 28, 1997
----------------- ----------------- -----------------
Total assets $516 $400 $235
Total liabilities 406 304 203
Partners' capital 110 96 32
Net (loss) income 0.9 (0.3) (2.7)
The decrease in capital in fiscal 1997 is a result of a Y6 billion
distribution of capital made by FPI to GS Financial Products, L.P., one of
the Company's limited partners. As a result of this distribution, the
Company's general and limited partnership interest in FPI increased from 1%
to 2%.
6. Long-term Borrowings:
The Company has issued both principal protected and non-principal protected
Medium Term Notes ("Notes"). The payments on the Notes are determined by
reference to the performance of a single equity security or an equity
index. The Company's obligations to the holders of the Notes will fluctuate
based on the closing price of the applicable equity security or equity
index. Certain of the Notes are subject to redemption at the option of the
Company if certain conditions are met. The terms of a Note linked to a
single stock may either allow for or mandatorily require the holder to
exchange the Notes into an amount of the underlying security. The cost of
hedging an equity-linked Medium Term Note may use up a substantial portion
of the proceeds from the issuance of such Note.
The Company has ascribed, where applicable, the proceeds from the Notes to
the underlying principal component and the embedded Derivative
Transactions. The amounts ascribed to the principal component will accrete,
under the effective interest rate method, to the stated principal amount
over time. The embedded Derivative Transactions are recorded at estimated
fair value.
The Company has purchased equity securities and has entered into various
Derivative Transactions with affiliates and has purchased exchange traded
options to eliminate its market risk on the Notes. (See Note 3 for a
discussion of credit risk on Derivative Transactions.) The fixed rates on
Notes linked to an equity index have been effectively converted to U.S.
dollar-based floating interest rate costs by entering into Derivative
Transactions with affiliates. The gains and losses on these Derivative
Transactions hedging the principal component are deferred and the periodic
receipts and payments are recognized as adjustments to interest expense and
are accrued over the life of the Notes. For the year ended November 28,
1997, interest expense on the notes linked to a single stock was $2.9
million which is primarily offset by amounts recorded in interest income.
As discussed in Note 1, securities owned and the Derivative Transactions
hedging the embedded Derivative Transactions are recorded at fair value and
estimated fair value, respectively.
Continued
F-11
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
Notes to Financial Statements (Continued)
----------
<TABLE>
<S> <C> <C>
November 29, 1996 November 28, 1997
----------------- -----------------
Nikkei Indexed Notes due December 22, 2000(1) $40,449 $52,008
S&P Enhanced Stock Index Growth Notes due August 9, 2002(2) 76,329 94,380
7% Mandatorily Exchangeable Notes due July 23, 1999(3) N/A 16,808
(Subject to Mandatory Exchange into Shares of
Common Stock of Oxford Health Plans, Inc.)
3% Citicorp Exchangeable Notes due August 28, 2002(4) N/A 113,293
------- ---------
$116,778 $276,489
======== ========
<FN>
(1) The $40 million face amount of Nikkei Indexed Notes are principal protected
and have no stated coupon. The carrying value is inclusive of an embedded
written option to the note holders of $11.6 million as at November 29, 1996
and $19.0 million as at November 28, 1997.
(2) The $73 million face amount of S&P Enhanced Stock Index Growth Notes are
principal protected and have no stated coupon. The carrying value is
inclusive of an embedded written option to the note holders of $25.3
million as at November 29, 1996 and $40.1 million as at November 28, 1997.
(3) The 7% Mandatorily Exchangeable Notes due July 23, 1999 do not have a face
amount, but had an initial principal amount of $40.8 million which
represented 477,865 notes at the prevailing market price of Oxford Health
Plans, Inc. common stock on the date of issue. The principal repayment
amount will be determined by the closing price of the Oxford Health Plans,
Inc. common stock at maturity and, accordingly, the carrying value will
fluctuate based upon the prevailing market price of the common stock. The
ability of the note holders to participate in the appreciation of the
Oxford Health Plans, Inc. common stock is limited and cannot exceed a
closing price of $129.77 per note at maturity. The carrying value is
inclusive of the embedded Derivative Transactions of ($29.4) million as at
November 28, 1997.
(4) The $120 million face amount of Citicorp Exchangeable Notes are principal
protected and are exchangeable in $250,000 increments by the note holders
into 1,455 shares per increment of Citicorp common stock. In addition, the
Notes are redeemable by the Company at various times after September 14,
1999 at the face amount, plus accrued interest, if the note holders have
not exercised their exchange option. The carrying value is inclusive of the
embedded Derivative Transactions, net of $8.6 million as at November 28,
1997.
Including the impact of the Derivative Transactions, the weighted average
interest rate for the notes was 5.91% as of November 28, 1997 and 5.41% as
of November 29, 1996.
</FN>
</TABLE>
7. Liability of General Partner:
The Company's sole general partner is GS Financial Products US Co. (the
"Corporate General Partner"). Under Cayman Islands law, the Corporate
General Partner, but not its shareholders, would be liable for all of the
obligations of the Company if the assets of the Company were inadequate to
meet its obligations. The sole business of the Corporate General Partner is
to manage the Company.
The assets of the Corporate General Partner consist principally of cash and
cash equivalents. The Corporate General Partner had assets of $12.3 million
and equity of approximately $12.2 million as of November 29, 1996 and
assets of approximately $2.8 million and equity of approximately $2.2
million as of November 28, 1997. The decrease in total assets and equity is
the result of a $10 million distribution paid by the Corporate General
Partner to GS Financial Products, L.P., one of the Company's limited
partners.
Continued
F-12
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
Notes to Financial Statements (Continued)
----------
8. Income Taxes:
The Company, as a partnership, is not subject to U.S. federal income taxes.
Prior to January 1, 1997, the Company was required by U.S. federal tax
regulations to withhold income tax on behalf of its partners. These
payments were made on behalf of the Company by a related party. For the
fiscal year ended November 29, 1996, the related party remitted $4.53
million to tax authorities, the entire amount of which the Company repaid
to the related party. As of January 1, 1997, the Company is no longer
required to withhold taxes on behalf of its partners under U.S. federal tax
regulations.
Certain of the Company's income is subject to a 4% New York City
unincorporated business tax. The statement of income for the fiscal years
ended November 28, 1997, November 29, 1996 and November 24, 1995 includes a
provision for unincorporated business tax on income earned by the Company
related to doing business in New York City.
F-13
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
SUPPLEMENTARY FINANCIAL INFORMATION
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
1996 FISCAL QUARTERS ENDED
(U.S. dollars in thousands) February 23 May 31 August 30 November 29
----------- ------ --------- -----------
<S> <C> <C> <C> <C>
Total revenues 4,072 4,007 4,419 6,522
Revenues, net of interest expense 3,511 3,375 3,568 4,939
Net income 3,083 3,061 3,264 4,525
1997 FISCAL QUARTERS ENDED
(U.S. dollars in thousands) February 28 May 31 August 29 November 28
----------- ------ --------- -----------
Total revenues 6,424 4,524 7,076 6,799
Revenues, net of interest expense 4,822 2,923 5,125 2,688
Net income 4,457 2,674 4,692 2,405
</TABLE>
F-14
<PAGE>
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized on this 26th day of
February, 1998.
GS FINANCIAL PRODUCTS U.S., L.P.
acting by its general partner, GS Financial
Products US Co.
By: /s/ Greg Swart
-------------------------------------------
Greg Swart
President, Principal Financial Officer
and Principal Accounting Officer
For and on behalf of GS Financial Products US
Co., managing general partner of GS Financial
Products U.S., L.P.
F-15
<PAGE>
SIGNATURES
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.
Signatures Capacity Date
---------- -------- ----
position with general partner
/s/ Richard E. Witten Director February 26, 1998
- -------------------------
Richard E. Witten
/s/ Oki Matsumoto Director February 26, 1998
- -------------------------
Oki Matsumoto
/s/ Thomas K. Montag Director February 26, 1998
- -------------------------
Thomas K. Montag
/s/ Kipp Nelson Director February 26, 1998
- -------------------------
Kipp Nelson
/s/ Mark Zurack Director February 26, 1998
- -------------------------
Mark Zurack
/s/ Greg Swart President, February 26, 1998
- ------------------------- Principal Financial Officer and
Greg Swart Principal Accounting Officer
F-16
GS FINANCIAL PRODUCTS U.S., L.P.
EXHIBIT 12.1
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
FISCAL YEARS ENDED
---------------------------------------------------------------------------------------
(U.S. dollars in thousands) Nov. 26, 1993 Nov. 25, 1994 Nov. 24, 1995 Nov. 29, 1996 Nov. 28, 1997
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Earnings:
Income from continuing operations
before income taxes 4,812 10,199 12,583 14,514 14,836
Add: Fixed charges 0 27 500 3,643 9,265
----- ------ ------ ------ ------
Earnings as adjusted 4,812 10,226 13,083 18,157 24,101
Fixed charges:
Interest expense 0 27 471 3,627 9,265
Debt amortization expense 0 0 29 16 0
Interest portion of rent expense 0 0 0 0 0
----- ------ ------ ------ ------
Total fixed charges 0 27 500 3,643 9,265
Ratio of earnings to fixed charges N/A 378x(1) 26x 5x 2.6x
For purposes of computing the ratio of earnings to fixed charges, earnings as
adjusted consist of net income plus income taxes and fixed charges. Fixed
charges consist of interest expense and amortization of debt issuance costs.
<FN>
Note (1): The Company does not consider this ratio to be meaningful since it is
based on $5,000,000 in principal amount of the Company's Series A
Medium Term Notes outstanding only 42 days during fiscal 1994.
</FN>
</TABLE>
EXHIBIT NO. 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statement of GS
Financial Products U.S., L.P. (the "Company") on Form S-3 (File No. 33-99948),
filed with the Securities and Exchange Commission on December 1, 1995, of our
report dated January 22, 1998 on our audits of the financial statements of GS
Financial Products U.S., L.P. as of November 29, 1996 and November 28, 1997 and
for the fiscal years ended November 24, 1995, November 29, 1996 and November 28,
1997, which report is included in the Annual Report on Form 10-K.
COOPERS & LYBRAND L.L.P.
New York, New York
February 26, 1998.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
annual financial statements of GS Financial Products U.S., L.P. and is
qualified in its entirety by reference to such financial statements
contained in GS Financial Products U.S., L.P.'s Form 10-K for the fiscal
year ended November 28, 1997.
</LEGEND>
<CIK> 0000914720
<NAME> GS Financial Products U.S., L.P.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> NOV-28-1997
<PERIOD-START> NOV-30-1996
<PERIOD-END> NOV-28-1997
<CASH> 291,375
<SECURITIES> 95,185
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 581,683
<CURRENT-LIABILITIES> 3,090
<BONDS> 276,489
0
0
<COMMON> 0
<OTHER-SE> 148,121
<TOTAL-LIABILITY-AND-EQUITY> 581,683
<SALES> 0
<TOTAL-REVENUES> 24,823
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 722
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 9,265
<INCOME-PRETAX> 14,836
<INCOME-TAX> 608
<INCOME-CONTINUING> 14,228
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,228
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<FN>
<F1>
Notes
- -----------------
Balances relating to derivative transactions are not reflected in the above
figures.
</FN>
</TABLE>
