SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
--- EXCHANGE ACT OF 1934.
For the quarterly period ended February 27, 1998
OR
[__] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period ______ to ______
Commission File Number: 000-25178
GS FINANCIAL PRODUCTS U.S., L.P.
(Exact name of registrant as specified in its charter)
CAYMAN ISLANDS 52-1919759
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
P.O. Box 896, Harbour Centre, North Church Street N/A
Grand Cayman, Cayman Islands, British West Indies
(Address of principal executive offices) (Zip Code)
(Registrant's Telephone Number, Including Area Code) (809) 945-1326
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
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
---- ----
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes No
---- ----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date _______.
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
Form 10-Q
PART I: FINANCIAL INFORMATION Page No.
- ------------------------------ --------
Item 1: Financial Statements (Unaudited):
Condensed Statements of Income for the Three
Fiscal Months Ended February 28, 1997 and
February 27, 1998 3
Condensed Balance Sheets as of November 28, 1997 and
February 27, 1998 4
Condensed Statement of Changes in Partners' Capital for
the Three Fiscal Months Ended February 27, 1998 5
Condensed Statements of Cash Flows for the Three Fiscal
Months Ended February 28, 1997 and February 27, 1998 6
Notes to the Condensed Financial Statements 7
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Liquidity and Capital Resources 17
Item 3: Not Applicable
PART II: OTHER INFORMATION
Item 1: Legal Proceedings 24
Item 4: Submission of Matters to a Vote of Security Holders 24
Item 6: Exhibits and Reports on Form 8-K 24
Signature 25
-2-
<PAGE>
PART I: FINANCIAL INFORMATION
GS FINANCIAL PRODUCTS U.S., L.P.
CONDENSED STATEMENTS OF INCOME
(U.S. dollars in thousands)
(Unaudited)
---------
<TABLE>
<CAPTION>
FOR THE THREE FISCAL MONTHS ENDED
---------------------------------------
FEBRUARY 28, 1997 FEBRUARY 27, 1998
----------------- -----------------
<S> <C> <C>
REVENUES:
Intermediation profit $4,336 $218
Interest 2,102 5,553
Equity in loss of affiliate (14) (2)
----- -----
Total revenues 6,424 5,769
Interest expense 1,602 3,312
----- -----
Revenues, net of interest expense 4,822 2,457
EXPENSES:
Operating 179 376
----- -----
Income before taxes 4,643 2,081
Income taxes 186 84
----- -----
Net Income $4,457 $1,997
====== ======
</TABLE>
The accompanying notes are an integral part of the unaudited condensed
financial statements.
-3-
<PAGE>
<TABLE>
<CAPTION>
GS FINANCIAL PRODUCTS U.S., L.P.
CONDENSED BALANCE SHEETS
(U.S. dollars in thousands)
(Unaudited)
---------
NOVEMBER 28, 1997 FEBRUARY 27, 1998
----------------- -----------------
<S> <C> <C>
ASSETS:
Cash and cash equivalents (Note 1) $291,375 $304,956
Securities owned, at fair value (Note 2) 95,185 100,634
Derivative Transactions, at fair value
(Notes 1, 3 & 4):
Affiliate 19,561 5,952
Non-affiliate 172,956 161,226
Investment in affiliate (Note 5) 780 788
Other assets 1,826 1,927
-------- -------
Total assets $581,683 $575,483
======== ========
LIABILITIES AND PARTNERS' CAPITAL:
Derivative Transactions, at fair value
(Notes 1, 3 & 4):
Non-affiliate $153,983 $135,375
Long-term borrowings (Note 6) 276,489 282,818
Other liabilities and accrued expenses 3,090 7,162
-------- -------
Total liabilities 433,562 425,355
Commitments and contingencies (Note 5)
Partners' capital:
Limited Partners 147,373 149,370
General Partner 748 758
-------- -------
Total partners' capital 148,121 150,128
-------- -------
Total liabilities and
partners' capital $581,683 $575,483
======== ========
</TABLE>
The accompanying notes are an integral part of the unaudited condensed
financial statements.
-4-
<PAGE>
<TABLE>
<CAPTION>
GS FINANCIAL PRODUCTS U.S., L.P.
CONDENSED STATEMENT OF CHANGES IN PARTNERS' CAPITAL
FOR THE THREE FISCAL MONTHS ENDED FEBRUARY 27, 1998
(U.S. dollars in thousands)
(Unaudited)
---------
GENERAL LIMITED TOTAL
PARTNER'S CAPITAL PARTNERS' CAPITAL PARTNERS' CAPITAL
----------------- ----------------- -----------------
<S> <C> <C> <C>
Balance, November 28, 1997 $748 $147,373 $148,121
Net Income 10 1,987 1,997
Translation adjustment 0 10 10
-------- ----------- ----------
Balance, February 27, 1998 $758 $149,370 $150,128
======== =========== ==========
</TABLE>
The accompanying notes are an integral part of the unaudited condensed
financial statements.
-5-
<PAGE>
<TABLE>
<CAPTION>
GS FINANCIAL PRODUCTS U.S., L.P.
CONDENSED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
(Unaudited)
---------
FOR THE THREE FISCAL MONTHS ENDED
---------------------------------------
FEBRUARY 28, 1997 FEBRUARY 27, 1998
----------------- -----------------
<S> <C> <C>
Cash flows from operating activities:
Net Income $4,457 $1,997
Adjustments to reconcile net income to
net cash provided by operating activities:
Equity in loss of affiliate 14 2
Unrealized gain on securities owned 0 (5,449)
Increase in long-term borrowings due to 0 6,329
embedded derivative transactions, net
Decreases (increases) in operating assets:
Derivative Transactions, at fair value:
Affiliate 456 13,609
Non-affiliate 16,826 11,730
Other assets 298 (101)
(Decreases) Increases in operating liabilities:
Derivative Transactions, at fair value:
Affiliate (4,157) 0
Non-affiliate 23,198 (18,608)
Other liabilities and accrued expenses 19,825 4,072
---------- --------
Net cash provided by operating activities 60,917 13,581
---------- --------
Net increase in cash and cash equivalents 60,917 13,581
Cash and cash equivalents, beginning of period 141,550 291,375
---------- --------
Cash and cash equivalents, end of period $202,467 $304,956
========== ========
Supplemental disclosure of cash flow information:
Interest paid $1,004 $1,780
Income taxes paid 0 0
</TABLE>
The accompanying notes are an integral part of the unaudited condensed
financial statements.
-6-
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
-----------
1. BUSINESS AND BASIS OF PRESENTATION:
----------------------------------
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).
Since October 1997, The Goldman Sachs Group, L.P. ("Group") has undertaken
a review of the operations of the Company and certain other affiliates of
Group 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 GS
Financial Products International, L.P. ("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 first fiscal quarter of 1998. In addition,
this lack of activity is expected to have a significant negative effect on
the Company's results of operations in the second fiscal quarter of 1998,
and it may affect later quarters depending upon the timing of the
completion and implementation of the findings of the review.
The unaudited condensed financial statements should be read in conjunction
with the audited financial statements of the Company as of and for the
fiscal years ended November 29, 1996 and November 28, 1997, included in the
Company's Annual Report on Form 10-K for the fiscal year ended November 28,
1997. Results for the three fiscal month periods presented are not
necessarily indicative of results for a full fiscal year. In the opinion of
management, all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation have been reflected.
The condensed balance sheet data as of November 28, 1997 was derived from
audited financial statements but does not include all disclosures required
under generally accepted accounting principles.
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 the partnership interests in the Company are owned by subsidiaries of
Group.
Continued
-7-
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
-----------
The financial 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 intermediation profit amounts
were $3.0 million for the fiscal quarter ended February 28, 1997, and zero
for the fiscal quarter ended February 27, 1998 due to the review described
above.
The remainder of intermediation profit for the fiscal quarter ended
February 28, 1997 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). The intermediation profit for the
fiscal quarter ended February 27, 1998 was principally attributable to the
recognition of the residual performance guarantee fees on transactions
which were terminated prior to original maturity due to the early
termination of the underlying Derivative Transactions at the request of the
counterparties thereto.
Intermediation profit earned on performance guarantees is deferred and
amortized over the term of the guarantee (see Notes 3 & 4). Unamortized
guarantee fees are recognized as intermediation profit upon any early
termination of the underlying Derivative Transactions.
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. 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 February 27, 1998 and November 28, 1997, the Company had credit exposure
net of collateral exceeding 10% of its total assets to four counterparties,
which represented 45% and 44% of total assets, respectively. Each of the
counterparties had a rating of single A+ or better from at least one
internationally recognized credit rating agency.
Certain prior period amounts have been reclassified to conform with the
February 27, 1998 presentation.
-8-
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
-----------
1. SECURITIES OWNED:
----------------
As of February 27, 1998 and November 28, 1997, securities owned consisted
of shares of common stock of Oxford Health Plans, Inc. (fair value
approximately $8.2 million and $11.4 million, respectively) and shares of
common stock of Citicorp (fair value approximately $92.4 million and $83.8
million, respectively). 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, in accordance
with the Company's netting policy, 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
single 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.
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 exchange rates.
The Company's principal risk in respect of Derivative Transactions entered
into 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"). 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
-9-
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
-----------
a Derivative Transaction in a gain position, net of collateral posted by
the counterparty and any Derivative Transactions structured on a limited
recourse basis. As of November 28, 1997 and February 27, 1998, the
Company's aggregate Credit Exposure in respect of Derivative Transactions
was approximately $152 million and approximately $145 million,
respectively.
The Company limits its Credit Exposure 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 has
obtained collateral of approximately $5 million related to Derivative
Transactions as at February 27, 1998.
The Company also limits its Credit Exposure 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 (U.S. dollars 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>
<CAPTION>
NOVEMBER 28, 1997 NOVEMBER 27, 1998
----------------- -----------------
<S> <C> <C>
Non-affiliates
Interest rate swap agreements $5,809 $5,024
Currency options written 1,115 1,014
Currency options purchased 384 331
Interest rate options written 922 922
Interest rate options purchased 2,336 2,205
Currency and other swap agreements 162 162
Foreign currency forwards 1,552 391
Affiliates
Interest rate swap agreements $8,003 $7,680
Currency options written 396 331
Currency options purchased 1,103 1,014
Interest rate options written 1,742 1,674
Interest rate options purchased 2,081 2,022
Currency and other swap agreements 893 755
Foreign currency forwards 1,535 373
</TABLE>
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 Exposure.
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 as of
November 28, 1997 and February 27, 1998 and the average monthly fair values
of such instruments for the fiscal year ended November 28, 1997 and the
three fiscal months ended February 27, 1998, computed in accordance with
the Company's netting policy, are as follows:
-10-
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
-----------
<TABLE>
<CAPTION>
(U.S. dollars in millions) AS OF NOVEMBER 28, 1997 AS OF FEBRUARY 27, 1998
- ------------------------- Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
<S> <C> <C> <C> <C>
Derivative Transactions
- -----------------------
Non-affiliates $173.0 $154.0 $161.2 $135.4
Affiliates 19.6 0.0 6.0 0.0
</TABLE>
<TABLE>
<CAPTION>
Average Monthly Fair Value
--------------------------
(U.S. dollars in millions)
TWELVE FISCAL MONTHS ENDED THREE FISCAL MONTHS ENDED
NOVEMBER 28, 1997 FEBRUARY 27, 1998
-------------------------- --------------------------
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
<S> <C> <C> <C> <C>
Derivative Transactions
- -----------------------
Non-affiliates $175.1 $131.2 $170.6 $142.0
Affiliates 14.0 0.0 12.4 0.0
</TABLE>
4. RELATED PARTY TRANSACTIONS:
-------------------------
In the ordinary course of business, the Company enters into hedging and
performance guarantee transactions with affiliates. Through February 27,
1998, substantially all of the Company's Derivative Transactions involved
some degree of hedging with affiliates.
As of February 27, 1998, the Company had $17.6 million of cash deposited in
a brokerage account with an affiliate.
During 1997, 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 is amortizing 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 three fiscal
months ended February 28, 1997 and February 27, 1998, approximately $42
thousand and $38 thousand, respectively, were charged for such services.
5. INVESTMENT IN AFFILIATE:
-----------------------
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.
FPI is engaged in a business similar to that of the Company. As of February
27, 1998, 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 February 27, 1998, FPI had total liabilities of $201
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.
-11-
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
-----------
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):
NOVEMBER 28, 1997 FEBRUARY 27, 1998
----------------- -----------------
Total assets $235 $233
Total liabilities 203 201
Partners' capital 32 32
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. Hedging of
equity-linked Notes has utilized substantially all of the proceeds from the
issuance of such Notes.
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 exchange traded options and
has entered into various Derivative Transactions with affiliates to
eliminate its market risk on the Notes. (See Note 3 for a discussion of
Credit Exposure on Derivative Transactions.) The fixed interest 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 three fiscal months ended
February 27, 1998, interest expense on Notes linked to a single stock was
$1.6 million, which was primarily offset by amounts recorded in interest
income. As discussed in Note 1, securities owned are recorded at fair value
and the Derivative Transactions hedging the embedded Derivative
Transactions are recorded at estimated fair value.
NOVEMBER 28, 1997 NOVEMBER 27, 1998
----------------- -----------------
Nikkei Indexed Notes due
December 22, 2000(1) $52,008 $52,845
S&P Enhanced Stock Index Growth
Notes due August 9, 2002(2) 94,380 101,759
7% Mandatorily Exchangeable Notes 16,808 12,114
due July 23, 1999(3) (Subject to
Mandatory Exchange into Shares of
Common Stock of Oxford Health Plans,
Inc.)
3% Citicorp Exchangeable Notes due
August 28, 2002(4) 113,293 116,100
======= =======
$276,489 $282,818
======== ========
-12-
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
-----------
(1) $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 $19.0 million as
at November 28, 1997 and $19.3 million as at February 27, 1998.
(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
$40.1 million as at November 28, 1997 and $46.6 million as at February
27, 1998.
(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 and ($32.6) million as at February 27, 1998.
(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 and $11.7 million as at
February 27, 1998.
Including the impact of the Derivative Transactions, the weighted average
interest rate for the Notes was 5.40% as of February 28, 1997 and 4.84% as
of February 27, 1998.
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.
The Corporate General Partner had assets of approximately $2.8 million and
equity of approximately $2.2 million as of November 28, 1997 and February
27, 1998.
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. 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
quarters ended February 28, 1997 and February 27, 1998, include a provision
for unincorporated business tax on income earned by the Company related to
doing business in New York City.
-13-
<PAGE>
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 options, index 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. Derivative Transactions entered into or guaranteed
by the Company consist principally of interest rate swaps, interest rate
options, index swaps, currency options, currency forwards and currency swaps
denominated in a variety of currencies. In addition, from time to time the
Company issues structured notes.
At February 27, 1998, the Company had entered into or guaranteed $19.5 billion
notional amount of interest rate swaps and options and $4.4 billion notional
amount of currency options, forwards and swaps with a total of 67
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 February 27, 1998, substantially all of the Company's Derivative
Transactions involved some degree of hedging with affiliates. The Company has
entered into or guaranteed $13.8 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 February 27, 1998, the Company has equity-linked Medium-Term Notes
outstanding with a carrying value of $283 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 "exchange traded" and over-the-counter
options and enter into interest rate and equity-linked swaps with affiliates to
hedge its obligations under the Notes. The remainder of the new proceeds from
each issuance will be added to the Company's working capital to support its
operating activities.
Since October 1997, Group has undertaken a review of the operations of the
Company and certain other affiliates of Group 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
-14-
<PAGE>
results of operations for the 1998 first 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 second fiscal quarter 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 recognize the year 2000 could
generate erroneous data or fail.
The Company recognizes the need to ensure that its operations will not be
adversely affected by Year 2000 software failures. As discussed under Footnote 4
to the condensed financial statements included in this form 10-Q (Related Party
Transactions), 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, term and
type 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 February 27, 1998, 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 February 27, 1998 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 is 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.
-15-
<PAGE>
The Company, as a partnership, is not subject to U.S. federal income taxes.
Prior to January 1, 1997, the Company was required by United States federal tax
regulations to withhold income tax on behalf of its 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.
Certain of the Company's income is subject to a 4% New York City unincorporated
business tax. The statements of income for the fiscal quarters ended February
27, 1998 and February 28, 1997 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.
THREE FISCAL MONTHS ENDED FEBRUARY 27, 1998 VERSUS THREE FISCAL MONTHS
ENDED FEBRUARY 28, 1997
As described in "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Overview" above, Group has undertaken a review of the
operations of the Company and certain other affiliates of Group engaged in the
derivative products business. Since the commencement of this review, the Company
has not entered into nor guaranteed any new Derivative Transactions. This lack
of activity by the Company has negatively affected the Company's result of
operations in the 1998 first fiscal quarter relative to the same fiscal quarter
of the prior year.
For the fiscal quarter ended February 27, 1998, the Company reported revenues
net of interest expense of $2.5 million, consisting principally of net interest
income of $2.2 million. This represented a decrease in reported revenues net of
interest expense of 49% compared to the fiscal quarter ended February 28, 1997.
During the period, the Company did not enter into or guarantee any new
Derivative Transactions. The Company incurred interest expense of $3.3 million
during the fiscal quarter ended February 27, 1998.
For the three fiscal months ended February 28, 1997, the Company reported
revenues net of interest expense of $4.8 million, which consisted principally of
intermediation profits of $4.3 million and net interest income of $0.5 million.
During the three fiscal months ended February 28, 1997, the Company entered into
or guaranteed 133 Derivative Transactions with non-affiliates and 135 hedging
Derivative Transactions with affiliates. The aggregate notional principal amount
of Derivative Transactions entered into or guaranteed by the Company during the
period was $3.6 billion, which resulted in initial intermediation profit of $3.0
million. The remainder of intermediation profits for the three fiscal month
period ended February 28, 1997 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 $1.6 million during the three fiscal months ended February
28, 1997.
Interest income for the fiscal quarter ended February 27, 1998 was $5.6 million
or 164% more than the same fiscal period of the previous year, primarily as a
result of a larger cash and cash equivalents balance. Other intermediation
profit was $0.2 million for the fiscal quarter ended February 27, 1998 compared
to other intermediation profit of $1.3 million in the first fiscal quarter of
1997. This decrease principally reflected a decrease in the average net
investment in Derivative Transactions during the quarter. The intermediation
profit for this period was principally attributable to the recognition of the
residual performance guarantee fees on transactions which were terminated prior
to original maturity due to the early termination of the underlying Derivative
Transactions at the request of the counterparties thereto. Interest expense of
$3.3 million for the fiscal quarter ended February 27, 1998 increased
significantly from the $1.6 million incurred in the same fiscal period in 1997.
This increase was the result of the increase in the long-term debt outstanding.
The effective weighted average interest rate for long-term borrowings was 4.84%
for the fiscal quarter ended February 27, 1998, as compared to 5.40% for the
fiscal quarter ended February 28, 1997.
-16-
<PAGE>
Operating expenses for the three fiscal months ended February 27, 1998 were $376
thousand, compared to $179 thousand in the fiscal quarter ended February 28,
1997. Fees and expense reimbursement to Group affiliates included within
operating expenses were $38 thousand and $42 thousand for the fiscal quarters
ended February 27, 1998 and February 28, 1997, respectively. Other operating
expenses were $338 thousand and $137 thousand for the three fiscal month periods
ended February 27, 1998 and February 28, 1997, respectively, and consisted
principally of legal and accounting fees relating to the review of the Company's
operations and amortization of debt issuance costs.
Net income of $2.0 million for the fiscal quarter ended February 27, 1998
decreased by 55% or $2.5 million from the fiscal quarter ended February 28, 1997
net income of $4.5 million. This decrease was primarily due to the lack of
activity described above. Total assets as of February 27, 1998 were $575
million, consisting principally of Derivative Transactions, cash and cash
equivalents, and securities owned.
Net cash provided by operating activities during the fiscal quarter ended
February 27, 1998 was $13.6 million, which primarily reflected receipts of cash
which reduced the Company's net investment in Derivative Transactions. In
comparison, for the fiscal quarter ended February 28, 1997, net cash provided by
operating activities was $60.9 million and principally reflected receipts
exceeding payments on Derivative Transactions including the receipt of certain
payments under Derivative Transactions with affiliates, prior to their original
maturity.
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.
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 values; 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. 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
-17-
<PAGE>
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, November 28, 1997 and February 27, 1998,
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 short-term investments,
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.) At November 29, 1996,
November 28, 1997 and February 27, 1998, the Company's counterparties consisted
largely of banks located in Europe, North America and Japan, as well as
affiliates of Group. 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 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.
<TABLE>
<CAPTION>
Current Credit Exposure - By S&P Rating of Obligor:
--------------------------------------------------
(U.S. dollars in millions)
NOVEMBER 29, 1996 NOVEMBER 28, 1997 FEBRUARY 27, 1998
----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
S&P Rating: $ Percent $ Percent $ Percent
- ----------- ------ ------- ------ ------- ------ -------
AAA $125.3 34.0% $127.8 28.8% $130.8 29.1%
AA+ 10.0 2.7 77.1 17.4 79.6 17.7
AA 31.9 8.7 70.4 15.9 69.9 15.7
AA- 23.6 6.4 33.2 7.5 33.6 7.5
A+ 84.1 22.8 86.1 19.4 96.5 21.4
A 48.8 13.2 11.0 2.5 7.7 1.7
A- 45.1 12.2 37.1 8.4 31.3 6.9
Below A- 0.0 0.0 0.3 0.1 0.8 0.2
------ ----- ------ ----- ------ ------
Total $368.8 100.0% $443.0 100.0% $450.2 100.0%
====== ===== ====== ===== ====== ======
Current Credit Exposure - By Country of Obligor's Headquarters:
---------------------------------------------------------------
(U.S. dollars in millions)
NOVEMBER 29, 1996 NOVEMBER 28, 1997 FEBRUARY 27, 1998
----------------- ----------------- -----------------
Country: $ Percent $ Percent $ Percent
- -------- ------ ------- ------ ------- ------ -------
U.S. $178.7 48.4% $253.2 57.2% $266.1 59.0%
Switzerland 28.3 7.7 70.3 15.9 70.3 15.6
France 65.5 17.7 58.6 13.2 58.9 13.1
Germany 6.9 1.9 36.9 8.3 39.3 8.7
Japan 69.7 18.9 24.0 5.4 14.6 3.3
Netherlands 17.6 4.8 0.0 0.0 0.0 0.0
Other 2.1 0.6 0.0 0.0 1.0 0.3
------ ----- ------ ----- ------ ------
Total $368.8 100.0% $443.0 100.0% $450.2 100.0%
====== ===== ====== ====== ====== ======
</TABLE>
-18-
<PAGE>
<TABLE>
<CAPTION>
Current Credit Exposure - By Obligor Industry:
---------------------------------------------
(U.S. dollars in millions)
November 29, 1996 November 28, 1997 February 27, 1998
----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Industry: $ Percent $ Percent $ Percent
- -------- ------ ------- ------ ------- ------ -------
Banks $257.7 69.9% $336.5 76.0% $310.7 69.0%
Financials 43.3 11.7 60.2 13.5 66.1 14.7
Industrials 48.4 13.1 28.7 6.5 29.7 6.6
Government Agencies 19.4 5.3 17.6 4.0 43.7 9.7
------ ----- ------ ----- ------ -----
Total $368.8 100.0% $443.0 100.0% $450.2 100.0%
====== ===== ====== ===== ====== ======
</TABLE>
The Company has entered into and expects to continue to enter into transactions
with FPI or Goldman Sachs Capital Markets, L.P. ("GSCM") (obligations of GSCM
being unconditionally guaranteed by Group) in order to hedge transactions with
third parties. (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 February 27, 1998, the Company had $20.0
million of credit exposure to FPI and GSCM, collectively, as a result of these
transactions. Due to the level of credit exposure to Group or its affiliates at
February 27, 1998, 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 February 27, 1998, the Company had credit exposure
net of collateral exceeding 10% of its total assets to Republic National Bank,
Morgan Guaranty Trust Company of New York, Banque Nationale de Paris and Union
Bank of Switzerland. Collectively, such exposures represent 45% of total assets.
The Company would incur a large loss if any of 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, Morgan Guaranty Trust Company of New York, Banque Nationale de
Paris and Union Bank of Switzerland were rated AA, AAA, A+ and AA+,
respectively, by S&P at February 27, 1998, and the Company currently does not
anticipate any loss as a result of this exposure. Additionally, since the
Company's credit exposure to any one counterparty does not exceed the Company's
net worth, the Company does not consider its credit exposure excessive.
As of February 27, 1998, the Company was a party to Derivative Transactions with
a notional amount of $23.9 billion. Of these, $6.0 billion notional amount
represented Derivative Transactions which could not expose the Company to credit
risk (e.g., options written and Derivative Transactions structured on a limited
recourse basis). 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.
-19-
<PAGE>
<TABLE>
<CAPTION>
Notional Amount of Derivative Transactions with
-----------------------------------------------
Potential Credit Exposure - By Maturity:
---------------------------------------
(U.S. dollars in millions)
NOVEMBER 29, 1996 NOVEMBER 28, 1997 FEBRUARY 27, 1998
----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
$ Percent $ Percent $ Percent
------ ------- ------ ------- ------ -------
1995-1996 $850 3.6% $0 0.0% $0 0.0%
1997-1999 12,918 54.0 8,374 40.1 6,336 35.5
2000-2002 3,000 19.5 4,278 21.5 4,420 24.8
2003-2005 4,220 10.7 3,621 17.4 2,766 15.5
2006-2021 2,895 12.2 4,580 22.0 4,332 24.2
------- ----- ------- ----- ------ -----
Total $23,883 100.0% $20,853 100.0% 17,854 100.0%
======= ===== ======= ===== ====== =====
</TABLE>
<TABLE>
<CAPTION>
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 FEBRUARY 27, 1998
----------------- ----------------- -----------------
S&P Rating $ Percent $ Percent $ Percent
- ---------- ------ ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
AAA $2,727 11.4% $3,415 16.4% $2,643 14.8%
AA+ 472 2.0 239 1.1 134 0.7
AA 696(a) 2.9 303 1.5 300 1.7
AA- 1,133 4.7 438 2.1 286 1.6
A+ 274 1.1 66 0.3 651 3.6
A 1,465 6.1 1,112 5.3 613 3.4
A- 1,088 4.6 1,552 7.4 1,270 7.1
Below A- 290(a) 1.2 114(a) 0.6 114(a) 0.4
Affiliates 15,738 66.0 13,614 65.3 11,843 66.4
------- ----- ------- ----- ------- -----
Total $23,883 100.0% $20,853 100.0% $17,854 100.0%
======= ===== ======= ===== ======= =====
<FN>
(a) Includes Derivative Transactions which are collateralized in part.
</FN>
</TABLE>
<TABLE>
<CAPTION>
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 FEBRUARY 27, 1998
----------------- ----------------- -----------------
$ Percent $ Percent $ Percent
------ ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Interest rate $19,910 83.4% $16,498 79.1% $15,206 85.2%
Currency 3,923 16.4 4,271 20.5 2,555 14.3
Other 50 0.2 84 0.4 92 0.5
------- ----- ------- ----- ------- -----
Total $23,883 100.0% $20,853 100.0% $17,854 100.0%
======= ===== ======= ===== ======= =====
</TABLE>
The notional amount of currencies, expressed in U.S. dollars at February 27,
1998, to be exchanged under currency options and currency swaps outstanding at
February 27, 1998 were U.S. dollars ($738 million), Japanese yen (approximately
$374 million), British pounds (approximately $271 million), Dutch guilders
(approximately $292 million), European currency units (approximately $327
million), German marks (approximately $141 million), Italian lire (approximately
$264 million), Brazilian real (approximately $23 million), French francs
(approximately $80 million), Argentine pesos
-20-
<PAGE>
(approximately $30 million), Hong Kong dollars (approximately $10 million),
Mexican pesos (approximately $16 million), and Australian dollars (approximately
$1 million).
The fair values of Derivative Transactions as of November 28, 1997 and February
27, 1998 and the average monthly fair values of such instruments for the fiscal
year ended November 28, 1997 and the fiscal three months ended February 27,
1998, computed in accordance with the Company's netting policy, are as follows:
<TABLE>
<CAPTION>
(U.S. dollars in millions) NOVEMBER 28, 1997 FEBRUARY 27, 1998
- ------------------------- Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
Derivative Transactions
- -----------------------
<S> <C> <C> <C> <C>
Non-affiliates $173.0 $154.0 $161.2 $135.4
Affiliates 19.6 0.0 6.0 0.0
Average Monthly Fair Value
--------------------------
(dollar amounts in millions)
TWELVE FISCAL MONTHS ENDED THREE FISCAL MONTHS ENDED
NOVEMBER 28, 1997 FEBRUARY 27, 1998
-------------------------- --------------------------
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
Derivative Transactions
- -----------------------
Non-affiliates $175.1 $131.2 $170.6 $142.0
Affiliates 14.0 0.0 12.4 0.0
</TABLE>
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 February 27,
1998, FPI had total liabilities of $201 million. The Company, after analyzing
the financial position, results of operations and cash flows of FPI, believes
that FPI will be able to meet the 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 February 27, 1998, the Company had $305 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, such 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 "shelf"
registration statement that initially covered $500 million of Medium-Term Notes.
As of February 27, 1998, 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 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 such note 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 hedging of an equity-linked Medium-Term Note has
utilized a substantial
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<PAGE>
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 February 27, 1998, securities owned consisted of shares of common stock of
Oxford Health Plans, Inc. (fair value approximately $8.2 million) and shares of
common stock of Citicorp (fair value approximately $92.4 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. All net income during the three month periods ending February 28, 1997
and February 27, 1998, respectively, was retained in partners' capital. At
February 27, 1998, the Company had $150 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.
IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS
The Company has made in this Quarterly Report on Form 10-Q and anticipates that
it will make in future filings with the Securities and Exchange 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.
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
results of operations, financial condition 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 recent review by Group of the Company's 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
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<PAGE>
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. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Overview" for a discussion of
the Company's reliance upon Group and its affiliates with respect to the Year
2000 issue.
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 S&P and Fitch (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
either of the Rating Agencies, based upon factors selected solely by the Rating
Agencies.
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<PAGE>
PART II: OTHER INFORMATION
- --------------------------
ITEM 1: LEGAL PROCEEDINGS
No litigation was commenced against the Company through February 27, 1998.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
12.1 Statement re computation of ratios of earnings to fixed charges
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a Report on Form 8-K, dated February 26, 1998, relating to the
audited balance sheets of GS Financial Products US Co. as of November 29, 1996
and November 28, 1997, which report included items 5 and 7.
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<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GS FINANCIAL PRODUCTS U.S., L.P.
acting by its general partner, GS Financial
Products US Co.
Date: April 13, 1998 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.
-25-
GS FINANCIAL PRODUCTS U.S., L.P.
EXHIBIT 12.1
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
FISCAL QUARTERS ENDED
--------------------------------------
(Unaudited U.S. dollars in thousands) February 28, 1997 February 27, 1998
----------------- -----------------
Earnings:
Income from continuing operations
before income taxes $4,643 $2,081
Add: Fixed charges 1,617 3,402
Earnings as adjusted 6,260 5,483
Fixed charges:
Interest expense $1,602 $3,312
Debt amortization expense 15 90
Interest portion of rent expense 0 0
------ ------
Total fixed charges $1,617 $3,402
Ratio of earnings to fixed charges 3.9x 1.6x
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.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
unaudited quarterly condensed 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-Q for
the three fiscal months ended February 27, 1998.
</LEGEND>
<CIK> 0000914720
<NAME> GS Financial Products U.S., L.P.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> NOV-27-1998
<PERIOD-END> FEB-27-1998
<CASH> 304,956
<SECURITIES> 100,634
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 575,483
<CURRENT-LIABILITIES> 7,162
<BONDS> 282,818
0
0
<COMMON> 0
<OTHER-SE> 150,128
<TOTAL-LIABILITY-AND-EQUITY> 575,483
<SALES> 0
<TOTAL-REVENUES> 5,769
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 376
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,312
<INCOME-PRETAX> 2,081
<INCOME-TAX> 84
<INCOME-CONTINUING> 1,997
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,997
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<FN>
<F1>
Balances relating to derivative transactions are not reflected in the above
figures.
</FN>
</TABLE>
