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 27, 1998
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)
Cayman Islands 52-1919759
(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
P.O. Box 896, Harbour Centre, North Church Street
Grand Cayman, Cayman Islands, British West Indies N/A
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (345)945-1326
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<CAPTION>
Title of each class: Name of each exchange on which registered:
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<S> <C>
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
</TABLE>
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
AS FILED WITH THE SEC ON FEBRUARY 25, 1999
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GS FINANCIAL PRODUCTS U.S., L.P.
Annual Report on Form 10-K
For the Fiscal Year Ended November 27, 1998
Form 10-K Item Number:
Page No.
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PART I
Item 1: Business . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2: Properties . . . . . . . . . . . . . . . . . . . . . . . . 20
Item 3: Legal Proceedings . . . . . . . . . . . . . . . . . . . . 20
Item 4: Submission of Matters to a Vote of Security-Holders . . . . 20
PART II
Item 5: Market for the Company's Common Equity and
Related Stockholder Matters . . . . . . . . . . . . . . . . 20
Item 6: Selected Financial Data . . . . . . . . . . .. . . . . . . 21
Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . 21
Item 8: Financial Statements and Supplementary Data . . . . . . . 35
Item 9: Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure . . . . . . . . . . 35
PART III
Item 10: Directors and Executive Officers of the Registrant . . . . 35
Item 11: Executive Compensation . . . . . . . . . . . . . . . . . . 37
Item 12: Security Ownership of Certain Beneficial Owners and
Management . . . . . . . . . . . . . . . . . . . . . . . . 38
Item 13: Certain Relationships and Related Transactions . . . . . . 39
PART IV
Item 14: Exhibits, Financial Statement Schedules, and Reports on
Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . 42
Index to Financial Statements of the Company . . . . . . . . . . . . F-1
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-18
Exhibit Index
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PART I
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 or guarantees a portfolio consisting
principally of approximately $12 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. In addition, the Company
issued an aggregate of $175 million of Medium-Term Notes ("Notes"), the
principal payments on which are determined by reference to the performance of a
single equity security or an equity index.
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 an affiliate of the Company 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.
In accordance with market practice, the Company does this 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 currencies, physical
commodities and securities. In addition, from time to time the Company issues
structured notes.
Since October 1997, Group has undertaken a review of the business and 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 all of fiscal 1998.
In addition, this lack of activity is expected to have a significant negative
effect on the Company's results of operations in the first fiscal quarter of
1999, and may affect later quarters depending upon the timing of the completion
of the review and the implementation of any findings.
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.
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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 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 but 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 that 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 but 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.
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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" and "Monitoring the Portfolio" 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 by
entering into a greater variety of additional Derivative Transactions. The exact
extent and timing of the expansion of the Company's portfolio will depend upon
the completion and findings of the review by Group referred to above.
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 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.
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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.
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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.
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
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derivative instruments decribed 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.
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.
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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 any 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 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" under Item 7, the Company has entered
into a number of transactions in which the Company issued Medium-Term Notes,
where payments on the Notes are determined by
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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 for 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 substantially all
of the proceeds from the issuance of such Note.
Securities Owned
As of November 27, 1998, securities owned consisted of shares of common stock of
Oxford Health Plans, Inc. (fair value approximately $1.9 million) and shares of
common stock of Citigroup, Inc. ("Citigroup") (fair value approximately $36.9
million). The Company purchased these securities to hedge certain of the
Company's exposures incurred by its issuance of two series of 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 Citigroup 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 risk on its portfolio of Derivative Transactions. In addition, prior
to entering into a Derivative Transaction, the Company must determine whether
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" under
Item 7 for a discussion of the ongoing 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 direct 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 Company does not anticipate incurring
any obligation unless it has scheduled cash
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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. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Overview" under Item 7 for a discussion of the current
review of the Company's business and operations.
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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. The Company generally structures its transactions with unrated
counterparties on a limited recourse basis.
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"
under 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 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 such representatives 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 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 27, 1998 and November
28, 1997, see Note 4 to the Company's audited financial statements included in
Item 14 below.
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Derivatives are reported on the balance sheet on a net-by-counterparty basis
where management believes a legal right of setoff exists under an enforceable
master netting agreement. 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 presented. In certain 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 that 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 new Derivative Transactions which would increase its total
credit risk, and would, in the absence of Derivative Transactions which would
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 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. 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.
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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 27, 1998, the Company had
credit exposure of $22.7 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. In addition, Group recently established Goldman Sachs
Financial Markets, L.P. ("GSFM") and is in the process of applying to the
Securities and Exchange Commission (the "Commission") to register GSFM as an
over-the-counter ("OTC") derivatives dealer. Group expects GSFM to be
operational in the second quarter of 1999. No assurances can be given as to
whether Group will allocate business to the Company or to one of its other
highly rated affiliates or to GSFM. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Overview" under Item 7 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 have disclosed 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. However, GSFM may issue securities and may compete with
the Company for securities based transactions. 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
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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 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. See "Directors and Executive Officers of the
Registrant" under Item 10. The Company anticipates that FPI may 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 may 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.
GSFM, subject to registration with the Commission, will engage primarily in
securities-based OTC Derivatives Transactions. While Group does not presently
anticipate that GSFM will engage in Derivatives Transactions that would
otherwise be engaged in by the Company, no assurances can be given that Group
will not in the future allocate such business to GSFM instead of the Company.
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.
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 Commission has generally not addressed the
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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, OTC derivatives 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. 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 requirement could have a material adverse effect on the business
of the Company.
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
the Rating Agencies. 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 the Rating Agencies 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
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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.
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 27, 1998,
November 28, 1997 and November 29, 1996 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.
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.
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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. Further, Group has been
engaged in a review of the Company's operations since October 1997 and there can
be no assurance as to the outcome of this review. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Overview" under
Item 7.
The Company may routinely 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
conducting its business, including making payments to its counterparties and
ensuring compliance with its operational guidelines. In this regard, Group has
informed the Company of its preparations for the Year 2000. A failure by the
relevant Group affiliate to be Year 2000 compliant could materially adversely
affect the business, results of operations and financial condition of the
Company. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations Year 2000 Readiness Disclosure" under Item 7.
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.
One of the ways the Company expects to make profits, if any, is 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.
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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.
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
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 "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- 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 distributions will be limited to ensure
that the Company's ability to meet its obligations is not adversely affected.
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<PAGE>
ITEM 6: SELECTED FINANCIAL DATA
The selected income statement data for the fiscal years ended November 27, 1998,
November 28, 1997, November 29, 1996, November 24, 1995 and November 25, 1994,
and the balance sheet data as of November 27, 1998, November 28, 1997, November
29, 1996, November 24, 1995 and November 25, 1994 are derived from the Company's
audited financial statements. 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>
<CAPTION>
Fiscal Year Fiscal Year Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended Ended Ended
Nov. 27, 1998 Nov. 28, 1997 Nov. 29, 1996 Nov. 24, 1995 Nov. 25, 1994
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Revenues, net of interest expense $11,516 $15,558 $15,393 $13,461 $11,844
Operating expenses 1,964 (1) 722 879 878 1,645
Income before taxes 9,552 14,836 14,514 12,583 10,199
Net income 9,170 14,228 13,933 12,280 10,199
Balance Sheet Data:
Total assets $460,794 $581,683 $370,975 $425,052 $334,068
Long-term borrowings 209,033 276,489 116,778 40,383 0
Partners' capital 157,319 148,121 134,043 124,805 117,042
Other Data
Ratio of earnings to fixed charges (2) 1.6X 2.6X 5X 26X 378X (3)
<FN>
Notes: (1) The increase in operating expenses in fiscal 1998 as compared to fiscal 1997 is due, in part, to additional
consulting fees and amounts billed to the Company by GS&Co. pursuant to the Calculation Agreement (as defined
and described under Item 13) relating to the aforementioned review by Group. The remainder of the increase is
attributable to a write-off of debt issuance costs relating to the retirements of the $27 million principal
amount of Oxford Notes (as defined under Item 7) and $72 million principal amount of Citicorp Notes (as defined
under Item 7) during fiscal 1998.
(2) 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.
(3) 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 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 (typically including an affiliate of
the Company) 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. In accordance with market practice, the Company does
this 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
-21-
<PAGE>
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. See "Business" in Item 1. In addition, from time to time
the Company issues structured notes.
At November 27, 1998, the Company had entered into or guaranteed $10.4 billion
notional amount of interest rate swaps and options and $1.4 billion notional
amount of currency options, forwards and swaps with a total of 35
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, except with respect to certain
interest rate swaps entered into to hedge the interest rate risk on its
outstanding debt, 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.
Substantially all of the Company's Derivative Transactions involve some degree
of hedging with affiliates. The Company has entered into or guaranteed $6.5
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 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 structured notes and interest rate or
currency exposure on surplus cash flow from its portfolio or which are intended
to mitigate total credit risk.
As of November 27, 1998, the Company had equity-linked Medium-Term Notes
outstanding with a carrying value of $212 million. Subject to the outcome of the
review of the Company's business and operations discussed below, the Company
expects to continue to issue equity-linked Medium-Term Notes in the future. The
Company intends to utilize substantially all 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
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.
-22-
<PAGE>
Since October 1997, Group has undertaken a review of the business and 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 results of operations for
all of fiscal 1998. In addition, this lack of activity is expected to have a
significant negative effect on the Company's results of operations in the first
fiscal quarter of 1999, and may affect later quarters depending upon the timing
of the completion of the review and the implementation of any findings.
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 origination.
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 United States 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.
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 27, 1998,
November 28, 1997 and November 29, 1996, 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 1998 Compared with Fiscal 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 neither entered into nor guaranteed any new Derivative Transactions. This
lack of activity by the Company has negatively affected the Company's results of
operations in fiscal 1998 relative to fiscal 1997. See "Supplementary Financial
Information" under Item 14.
-23-
<PAGE>
For fiscal 1998, the Company reported revenues, net of interest expense, of
$11.5 million, consisting principally of net interest income of $9.2 million and
intermediation profits of $2.4 million. This represented a decrease in reported
revenues, net of interest expense, of 26.0% compared to fiscal 1997. During the
period, the Company did not enter into or guarantee any new Derivative
Transactions due to the aforementioned review by Group. The Company incurred
interest expense of $15.7 million during fiscal 1998 relating to equity-linked
Medium-Term Notes. See "-- Liquidity and Capital Resources" below.
Interest income for fiscal 1998 increased to $24.9 million, compared to $14.2
million during the preceding year, primarily as a result of amounts recorded as
interest income on Derivative Transactions relating to Notes issued by the
Company that are linked to a single stock. As a result of the aforementioned
review by Group, the Company did not earn any initial intermediation profit
during fiscal 1998. Other intermediation profit decreased by $0.9 million to
$2.4 million in fiscal 1998 versus other intermediation profit of $3.3 million
in fiscal 1997. $2.9 million of other intermediation profit reflected
amortization of performance guarantee fees, including accelerated amortization
of performance guarantee fees in an aggregate amount of $2.2 million relating to
transactions that were terminated at the request of the counterparties prior to
maturity during fiscal 1998. This was offset in part by a decrease in the
present value of the expected cash flows of the Company's portfolio. Interest
expense of $15.7 million for the fiscal year ended November 27, 1998 increased
significantly from the $9.3 million incurred in the same fiscal period in 1997.
This increase was the result of the significant increase in the average amount
of long term debt outstanding in fiscal 1998 as compared to fiscal 1997. The
effective weighted average interest rate for long term borrowings was 5.99% for
fiscal 1998 and 5.91% for fiscal 1997.
Operating expenses for the fiscal year ended November 27, 1998 increased 172% to
$2.0 million from $722 thousand during the same period in 1997. Other operating
expenses were $1.4 million and $525 thousand for the fiscal years ended November
27, 1998 and November 28, 1997, respectively. The increase is due, in part, to
additional consulting fees and amounts billed to the Company from GS&Co. under
the Calculation Agreement relating to the aforementioned review by Group. See
"Certain Relationships and Related Transactions -- Operational and
Administrative Relationships with Group -- Summary of Expenses" under Item 13.
The remainder of the increase is attributable to a write-off of debt issuance
costs relating to the retirements of $27 million 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.) (the "Oxford Notes")
and $72 million principal amount of 3% Citicorp Exchangeable Notes due August
28, 2002 (the "Citicorp Notes") during fiscal 1998. Fees and expense
reimbursement to Group affiliates included within operating expenses were $603
thousand and $197 thousand for the fiscal years ended November 27, 1998 and
November 28, 1997, respectively.
Net income of $9.2 million for the 1998 fiscal year decreased by 35.5% or $5.1
million from fiscal 1997 net income of $14.2 million. This decrease was
primarily due to the lack of activity described above. Total assets as of
November 27, 1998 were $461 million, consisting principally of cash and cash
equivalents, Derivative Transactions and securities owned, a decline of 20.8%
from total assets of $582 million as of November 28, 1997.
Net cash provided by operating activities during fiscal 1998 was $25.5 million,
which principally reflected an increase in long-term borrowings due to embedded
Derivative Transactions, unrealized losses on common stock purchased as a hedge
of Medium-Term Notes and net income. Net cash used in financing activities
during fiscal 1998 was $75.7 million reflecting repurchase and retirement of $27
million aggregate principal amount of Oxford Notes and $72 million aggregate
principal amount of Citicorp Notes. Net cash provided by investing activities
during fiscal 1998 was $52.4 million reflecting the sale of securities that were
hedging Medium-
-24-
<PAGE>
Term Notes which were repurchased and retired. See "-- Liquidity and Capital
Resources" below. In comparison, for the 1997 fiscal year, net cash provided by
operating activities was $125.8 million which principally reflected a reduction
in the net investment in Derivative Transactions, unrealized losses on the
Oxford common stock purchased as a hedge of the Oxford Notes and net income. Net
cash provided by financing activities during fiscal 1997 was $161 million
reflecting the issuance of equity-linked 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.
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 1.2% 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 the issuance of equity-linked Medium-Term Notes. 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 amount of 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.
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<PAGE>
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 2.1% 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 cash and cash
equivalents, Derivative Transactions and securities owned.
As described in "-- Overview" above, 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 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 fiscal
1996, 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, offset in part by distributions to the Company's
partners. Net cash provided by investing activities during fiscal 1996 was $24.7
million, which reflected a reduction of the Company's investment in time
deposits with a maturity of greater than three months.
Quantitative and Qualitative Disclosures about Market Risk
Market-Sensitive Instruments and Risk Management
See "-- Overview" and "Business -- Hedging of Derivative Transactions" under
Item 1 for a description of the Company's portfolio composition and hedging
strategies.
Interest-Rate Risk Management. Changes in interest rates will change the present
value of any cash flows which the Company is entitled to receive in the future.
As a result, the Company may experience fluctuations in reported revenues. The
aggregate hypothetical reduction in reported revenues from the Company's
portfolio as of November 27, 1998 that would have resulted from a hypothetical
100 basis point increase in interest rates across the entire yield curve, is
estimated to be $20 thousand. Because the Company is unable to predict the
movement of interest rates, the Company is unable to predict whether its
reported revenues would be reduced as a result of such exposure.
In addition, the Company has issued Medium-Term Notes with an aggregate
principal amount of $175 million, the principal payments on which are determined
by reference to the performance of a
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<PAGE>
single equity security or an equity index (see "-- Equity-Price Risk Management"
below). The interest rate component on the Notes has been hedged by entering
into Derivative Transactions with affiliates, thereby eliminating the remaining
interest-rate risk in respect of the Notes.
Foreign-Exchange Risk Management. 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 revenues will be
affected by changes in the value (expressed in U.S. dollars) of such currencies.
However, as of November 27, 1998, the Company does not consider its exposure to
currencies other than the U.S. dollar to be material to its financial condition.
Based on the value of the Company's non-U.S. dollar net assets as of November
27, 1998, its reported revenues would be reduced by $846 thousand if the Company
were to realize no value from such currencies. As the Company is unable to
predict the movement of foreign currencies, the Company is unable to predict
whether its reported revenues would be reduced as a result of such exposure.
Equity-Price Risk Management. As of November 27, 1998, the Company had
equity-linked Medium-Term Notes outstanding with a carrying value of $212
million. 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. As the Company's
exposure to fluctuations in the market price of the equity securities, exchange
traded options and Derivative Transactions with affiliates is offset by changes
in its liability for the face or principal amount of the equity-linked Notes,
fluctuations in the prices for such securities and options will not result in a
reduction of the Company's reported revenues. As discussed above in "--
Interest-Rate Risk Management", the interest rate component on the Notes has
been hedged by entering into Derivative Transactions with affiliates, thereby
eliminating the remaining market risk in respect of the Notes.
Commodity-Price Risk Management. The Company had no positions sensitive to
commodity-price risk as of November 27, 1998.
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
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<PAGE>
potential unavailability of suitable replacement contracts. Where several
transactions with one counterparty are subject to a master agreement which
provides for netting and which management 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 value 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 of any Derivative Transactions structured on a limited recourse
basis as discussed under "Business -- Entering into New Derivative Transactions
and Risk Management -- Credit Quality and Counterparty Credit Risk --
Documentation" in Item 1. 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 only 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 27, 1998 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
guarantees and exclude certain Derivative Transactions where the Company
believes that it does not have credit risk -- e.g., any collateralized portion
of Derivative Transactions reported as assets to the extent of the value of the
collateral received and any Derivative Transactions structured on a limited
recourse basis as discussed under " Business -- Entering into New Derivative
Transactions and Risk Management -- Credit Quality and Counterparty Credit Risk
- -- Documentation" in Item 1.) At November 27, 1998 and November 28, 1997, the
Company's counterparties consisted largely of banks located in Europe and North
America, 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.
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<PAGE>
Current Credit Exposure - By S&P Rating of Obligor:
---------------------------------------------------
(U.S. dollars in millions)
November 27, 1998 November 28, 1997
----------------- -----------------
S&P Rating: $ Percent $ Percent
- ----------- ------ ------- ------ -------
AAA $104.5 25.0% $127.8 28.8%
AA+ 78.4 18.8 77.1 17.4
AA 36.9 8.8 70.4 15.9
AA- 158.4 38.0 33.2 7.5
A+ 24.9 6.0 86.1 19.4
A 11.1 2.7 11.0 2.5
A- 0.0 0.0 37.1 8.4
Below A- 3.0 0.7 0.3 0.1
------ ------ ------ -------
Total $417.2 100.0% $443.0 100.0%
----- ====== ====== ====== =======
Current Credit Exposure - By Country of Obligor's Headquarters:
---------------------------------------------------------------
(U.S. dollars in millions)
November 27, 1998 November 28, 1997
----------------- -----------------
Country: $ Percent $ Percent
- -------- ------ ------- ------ -------
U.S. $239.9 57.5% $253.2 57.2%
Switzerland 41.2 9.9 70.3 15.9
France 30.1 7.2 58.6 13.2
Germany 62.6 15.0 36.9 8.3
Japan 3.0 0.7 24.0 5.4
Netherlands 38.5 9.2 0.0 0.0
Other 1.9 0.5 0.0 0.0
------ ----- ------ -----
Total $417.2 100.0% $443.0 100.0%
====== ===== ====== =====
Current Credit Exposure - By Obligor Industry:
----------------------------------------------
(U.S. dollars in millions)
November 27, 1998 November 28, 1997
----------------- -----------------
Industry: $ Percent $ Percent
- --------- ------ ------- ------ -------
Banks $311.1 74.6% $318.6 71.9%
Financials 39.1 9.4 60.2 13.6
Industrials 10.6 2.5 28.7 6.5
Government Agencies 56.4 13.5 35.5 8.0
------ ----- ------ -----
Total $417.2 100.0% $443.0 100.0%
====== ===== ====== =====
The Company has entered into and, subject to the conclusion and findings of
Group's review of its operations, 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. (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 equity-linked Medium-Term Notes and
interest rate or currency exposure on surplus cash flow from its portfolio or
which are intended to mitigate total credit risk.) At November 27, 1998, the
Company had $9.7 million and $2.2 million of credit exposure to GSCM and FPI,
respectively, as a result of
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these transactions. In addition, the Company had $13.0 million of credit
exposure to Goldman Sachs International ("GSI") as a result of transactions
guaranteed. Due to the level of credit exposure to Group or its affiliates at
November 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 November 27, 1998, the Company had credit exposure
net of collateral exceeding 10% of its total assets to Bank of America, NA and
Commerzbank AG. The combined exposures to these two banks represent 24% of the
Company's total assets. The Company's largest credit exposure to any one
counterparty was $60 million, or 13% of its total assets, to Bank of America,
NA. Bank of America, NA and Commerzbank AG both were rated AA- by S&P at
November 27, 1998. The Company would incur a large loss if either of these two
counterparties were to default, but 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. At November 28, 1997, the
Company had credit exposure 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. All four counterparties had a rating of A+ or better from at
least one internationally recognized credit rating agency.
As of November 27, 1998, the Company was a party to Derivative Transactions with
a notional amount of $11.8 billion. Of these, $3.9 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.
Notional Amount of Derivative Transactions With Potential Credit Exposure
By Maturity:
-------------------------------------------------------------------------
(U.S. dollars in millions)
November 27, 1998 November 28, 1997
----------------- -----------------
$ Percent $ Percent
------ ------- ------- -------
1997-1999 $1,968 24.7% $8,374 40.1%
2000-2002 1,535 19.3 4,528 21.7
2003-2005 1,913 24.1 3,371 16.2
2006-2008 1,624 20.4 2,713 13.0
2009-2021 915 11.5 1,867 9.0
------ ----- ------- -----
Total $7,955 100.0% $20,853 100.0%
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Notional Amount of Derivative Transactions With Potential Credit Exposure
By Credit Quality of Obligor:
-------------------------------------------------------------------------
(U.S. dollars in millions)
November 27, 1998 November 28, 1997
----------------- -----------------
S&P Rating: $ Percent $ Percent
- ----------- ------ ------- ------ -------
AAA $1,437 18.1% $3,415 16.4%
AA+ 433 5.4 239 1.1
AA 300 3.8 303 1.5
AA- 189 2.4 438 2.1
A+ 101 1.3 66 0.3
A 453 5.7 1,112 5.3
A- 0 0.0 1,552 7.4
Below A- 124 1.6 114 (a) 0.6
Affiliates 4,918 61.7 13,614 65.3
------ ----- ------- -----
Total $7,955 100.0% $20,853 100.0%
====== ===== ======= =====
(a) Includes Derivative Transactions which were collateralized in part and
therefore reflect reduced credit exposure.
Notional Amount of Derivative Transactions With Potential Credit Exposure
By Principal Underlying Index Type:
-------------------------------------------------------------------------
(U.S. dollars in millions)
November 27, 1998 November 28, 1997
----------------- -----------------
$ Percent $ Percent
------ ------- ------ -------
Interest rate $7,059 88.7% $16,498 79.1%
Currency 860 10.8 4,271 20.5
Other 36 0.5 84 0.4
------ ----- ------ -----
Total $7,955 100.0% $20,853 100.0%
====== ===== ======= =====
The notional amount of currencies, expressed in U.S. dollars at November 27,
1998, to be exchanged under currency options and currency swaps outstanding at
November 27, 1998 (see "Currency" in the table above) were U.S. dollars ($150
million), European currency units (approximately $120 million), Japanese yen
(approximately $54 million), Dutch guilders (approximately $162 million),
Deutsche marks (approximately $221 million), British pounds (approximately $99
million), Italian lire (approximately $38 million) and French francs
(approximately $16 million).
The fair values of Derivative Transactions as of November 27, 1998 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 27, 1998 Average
----------------- -------
(U.S. dollars in millions) Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
Non-affiliates
- --------------
Derivative Transactions $115.0 $89.1 $148.2 $122.4
Affiliates
- ----------
Derivative Transactions 11.9 0.0 12.3 0.0
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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
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 27,
1998, FPI had total liabilities of $137 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.
As of November 27, 1998, FPI's long-term debt securities were rated Aaa, AAA and
AAA by Moody's Investors Service, Inc. ("Moody's"), S&P and Fitch, respectively.
At November 27, 1998, the Company had $294 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
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 Notes. As of November 27, 1998,
the Company had $226 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 $13.5 million initial principal amount of Oxford Notes and $48
million principal amount of Citicorp Notes. The single stock related Note
issuances (i.e., the Oxford Notes and the Citicorp Notes) 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 the Citicorp Notes allow, and the terms of the Oxford
Notes 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 hedging of the
equity-linked Notes has utilized substantially all of the proceeds from the
issuance of such Notes. Subject to the completion of the review of the Company's
business and operations discussed above under "-- Overview", the Company intends
to continue to issue equity-linked Notes. 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.
On July 16, 1998, the Company repurchased and then retired approximately 67% of
the Oxford Notes for $7.1 million, representing 320,000 such Notes. Prior to
repurchase, the Notes were held by an affiliate. The Company recognized a loss
of $65 thousand on the retirement, primarily
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consisting of expenses relating to the early termination of a Derivative
Transaction related to the Notes.
On November 20, 1998, the Company repurchased and then retired 60% of the
Citicorp Notes for $68.6 million, representing $72 million aggregate face value
of such Notes. Prior to repurchase, the Notes were held by an affiliate. The
Company recorded no gain or loss on the retirement.
As of November 27, 1998, securities owned consisted of shares of Oxford common
stock of Oxford Health Plans, Inc. (fair value approximately $1.9 million) and
shares of Citigroup common stock (fair value approximately $36.9
million).
Partners' capital is not subject to withdrawal or redemption on demand by the
partners. All net income during fiscal 1997 and fiscal 1998, respectively, was
retained in partners' capital. At November 27, 1998, the Company had $157
million of partners' capital. Subject to the completion and review of the
Company's business and operations discussed above under "-- Overview", 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.
YEAR 2000 READINESS DISCLOSURE
As discussed under "Certain Relationships and Related Transactions --
Operational and Administrative Relationships with Group -- Administrative
Services Agreements" under Item 13, substantially all of the Company's
operational and administrative functions are provided by affiliates of Group.
Group has advised the Company as follows with respect to Year 2000 issues:
YEAR 2000
With the new millennium approaching, many institutions around the world are
reviewing and modifying their computer systems to ensure that they are Year 2000
compliant. The issue, in general terms, is that many existing computer systems
and microprocessors with data functions (including those in non-information
technology equipment and systems) use only two digits to identify a year in the
date field with the assumption that the first two digits of the year are always
"19". Consequently, on January 1, 2000, computers that are not Year 2000
compliant will read the year as 1900. Systems that calculate, compare or sort
using the incorrect date will malfunction.
Group, which for purposes of this discussion of Year 2000 includes its
affiliates, has determined that it will be required to modify or replace
portions of its information technology systems, both hardware and software, and
its non-information technology systems so that they will properly recognize and
utilize dates beyond December 31, 1999. Group presently believes that with
modifications to existing software, conversions to new software and replacement
of some hardware, the Year 2000 issue will be satisfactorily resolved in its own
systems worldwide. However, if such modifications and conversions are not made
or are not completed on a timely basis, or if Group's identification and
assessment of "mission-critical" systems proves to have been incorrect or
incomplete, the Year 2000 issue would have a material adverse effect on the
Company. Moreover, even if these changes are successful, failure of third
parties to which Group is financially or operationally linked to address their
own system problems would have a material adverse effect on the Company.
Group's Year 2000 plans are based on a five phase approach, which includes
awareness; inventory, assessment and planning; remediation; testing; and
implementation. In 1997, the awareness phase (in which Group defined the scope
and components of the problem, its methodology and approach and obtained senior
management support and funding) was
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completed. Group completed the inventory, assessment and planning phase for its
systems by September 30, 1997. By December 1998, Group had completed the
remediation phase for approximately 99% of its mission-critical systems and had
completed the application testing and implementation phases for approximately
95% of its mission-critical systems. Group plans to complete these phases for
the few remaining mission-critical systems by the end of March 1999. During the
first half of calendar 1999, Group is scheduled to conduct internal integration
testing with respect to critical securities and transaction flows in order to
validate that its systems can successfully perform critical business functions
beginning in January 2000. With respect to its non-mission-critical systems,
Group expects to complete its Year 2000 efforts during calendar 1999.
For technology products that are supplied by third-party vendors, Group has
completed an inventory, ranked products according to their importance, and
developed a strategy for achieving Year 2000 readiness for substantially all
non-compliant versions of software and hardware. While this process included
collecting information from vendors, Group is not relying solely on vendors'
verification that products are Year 2000 compliant or ready. Rather, Group is
also testing vendor-supplied products that it considers mission-critical to help
determine whether they will perform properly and support Group's systems
beginning in January 2000. As of December 31, 1998, Group's mainframe platform
and products had been tested and substantial progress had been made in testing
Group's telecommunications and non-mainframe technology infrastructure. Since
telecommunications carriers have indicated that they will not test with
individual companies, Group is relying on information provided by these vendors
as to whether they are Year 2000 compliant.
Group is also addressing Year 2000 issues that may exist outside its own
technology activities, including its facilities and other business processes, as
well as external service providers and other third parties with which it
interfaces. Group has inventoried and ranked its customers, business and trading
partners, utilities, exchanges, depositories, clearing and custodial banks and
other third parties with which Group has important financial and operational
relationships.
By the end of December 1998, Group had participated in approximately 50
"external", i.e., industry-wide or point-to-point, tests of its systems,
including the "Beta" test sponsored by the Securities Industry Association
("SIA") for its U.S. members in July 1998, which Group successfully completed.
By the end of June 1999, Group expects to have participated in approximately 120
additional external tests of its U.S. systems, including the SIA "Streetwide"
test scheduled for March 1999, and other major industry tests in those global
markets where Group conducts significant business.
Group has created an assessment program to monitor the Year 2000 preparedness of
its customers and trading counterparties and considers Year 2000 preparedness as
part of the credit review process. Assessments for material customers and
counterparties were substantially complete (96%) as of September 30, 1998.
Group's efforts to evaluate the risks posed by third parties is ongoing and
Group expects to take mitigation steps, as appropriate, to reduce exposure to
these parties who pose financial or operational risks to Group and its
affiliates, including the Company. In addition, Group is inventorying its
facilities in over fifty locations, including buildings that are owned by Group
or controlled by landlords. Testing is underway for building management systems,
including elevators, fire and safety systems, and other products with embedded
chip technology.
If third parties with whom the Company interacts have Year 2000 problems that
are not remedied, problems could include the following: (i) in the case of
vendors, disruption of important services upon which the Company depends, such
as telecommunications and electrical power; (ii) in the case of data providers,
receipt of inaccurate or out-of-date information that would impair the
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<PAGE>
Company's ability to perform critical data functions, such as pricing the
Company's securities or other assets; (iii) in the case of financial
intermediaries such as exchanges and clearing agents, in failed trade
settlements, inability to trade in certain markets and disruption of funding
flows; (iv) in the case of counterparties and customers, financial and
accounting difficulties for those parties that expose the Company to increased
credit risk and lost business. Disruption or suspension of activity in the
world's financial markets is also possible.
Acknowledging that a Year 2000 failure, whether internal or external, could have
an adverse effect on the ability to conduct day-to-day business, Group is
employing a comprehensive and global approach to contingency planning. Group's
contingency planning effort is based on the presumption that any component in
the environment could fail, whether it be an internally developed, mission-
critical application, a vendor product or service, a facility or other third
parties, including exchanges, clearinghouses and depositories. Group expects to
have contingency plans covering the businesses of the Company completed by
October 15, 1999.
Group has incurred and expects to continue to incur expenses allocable to
internal staff, as well as costs for outside consultants, to complete the
remediation and testing of internally-developed systems, replacement and testing
of third-party products and services, including non-technological products and
services, in order to achieve Year 2000 compliance as well as in connection with
Group's Year 2000 contingency planning efforts. Group currently estimates that
these costs will total between $140 million and $150 million, over half of which
has been spent to date. These estimates include the cost of technology personnel
but do not include the cost of most non-technology personnel involved in Group's
Year 2000 effort. The remaining cost of Group's Year 2000 program is expected to
be incurred in 1999 and early 2000.
The costs of the Year 2000 program and the date on which Group plans to complete
the Year 2000 modifications are based on current estimates, which reflect
numerous assumptions about future events, including the continued availability
of certain resources, the timing and effectiveness of third-party remediation
plans and other factors. The Company can give no assurance that these estimates
will be achieved, and actual results could differ materially from Group's plans.
Specific factors that might cause material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct relevant computer source codes and embedded chip
technology, the results of internal and external testing and the timeliness and
effectiveness of remediation efforts of third parties.
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
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
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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.
NAME AGE POSITION
- ---- --- --------
Noel B. Donohoe 40 Director
C. Douglas Fuge 43 Director and President
Jonathan M. Lopatin 44 Director
Kenneth A. Miller 48 Director
Thomas K. Montag 42 Director
Mark A. Zurack 42 Director
Denis Dennehy 28 Vice President
Jay J. Ryan 36 Vice President
Brian J. Lee 32 Treasurer
Patrick E. Harris 40 Secretary
Noel Donohoe has been a Director of the Corporate General Partner since December
7, 1998. Mr. Donohoe became a Managing Director of GS&Co. in September 1998, and
was a Vice President of GS&Co. prior to that time.
C. Douglas Fuge has been a Director and President of the Corporate General
Partner since December 7, 1998. Mr. Fuge is also the President of GSFP Co., the
managing general partner of FPI. Mr. Fuge became a Managing Director of GS&Co.
in November 1996, and was a Vice President of GS&Co. prior to that time.
Jonathan M. Lopatin has been a Director of the Corporate General Partner since
December 7, 1998. Mr. Lopatin became general partner of GS&Co. in November 1994
and was a vice president of GS&Co. prior to that time. In November 1996, Mr.
Lopatin became a participating limited partner of Group and an Executive Vice
President of the general partner of Group.
Kenneth A. Miller has been a Director of the Corporate General Partner since
December 7, 1998. Mr. Miller became a Managing Director of GS&Co. in October
1996, and was a Vice President of GS&Co. prior to that time.
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 and an Executive Vice President of the general partner of
Group.
Mark A. 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 and an Executive Vice President
of the general partner of Group.
Denis Dennehy has been Vice President of the Corporate General Partner since
February 23, 1999. Mr. Dennehy is also a Vice President of GSFP Co., the
managing general partner of FPI.
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Mr. Dennehy has been a vice president of GS&Co. since 1998. Mr. Dennehy has been
an employee of GS&Co. since February 1996 and prior to that was a treasury
associate of GSI.
Jay J. Ryan has been Vice President of the Corporate General Partner since
February 23, 1999. Mr. Ryan is also a Vice President of GSFP Co., the managing
general partner of FPI. Mr. Ryan has been a vice president of GS&Co. since 1992.
Brian J. Lee has been Treasurer of the Corporate General Partner since February
23, 1999. Mr. Lee is also Treasurer of GSFP Co., the managing general partner of
FPI. Mr. Lee has been a vice president of GS&Co. since 1996. Prior to that time,
Mr. Lee was a financial analyst of GS&Co.
Patrick E. Harris has been Secretary of the Corporate General Partner since
February 23, 1999. Mr. Harris is also Secretary of GSFP Co., the managing
general partner of FPI. Mr. Harris has been Associate General Counsel of GS&Co.
since 1999. Prior to that time, Mr. Harris was Assistant General Counsel of
GS&Co.
The President, the Vice Presidents and the Treasurer 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 $174 thousand and $155 thousand during the fiscal years
ended November 27, 1998 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 equity-linked Medium-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. In addition, no services were obtained or charged
under the Origination Agreements during fiscal 1998 as a result of the review of
the Company's business and operations discussed above under "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Overview" under Item 7. The Company also expensed $429 thousand and $42 thousand
during the fiscal years ended November 27, 1998 and November 28, 1997,
respectively, for services provided by Group Affiliates pursuant to the
Calculation Agreement (as defined in Item 13). The significant increase in
expenses billed under the Calculation Agreement in fiscal 1998 as compared to
fiscal 1997 was due primarily to expenses related to the aforementioned review.
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 that
is a participating limited partner of Group has substantially the same interest
in the profits of the Company as he has in the profits of
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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 27, 1998, the Corporate General Partner had equity of $2.4 million,
and assets of $2.6 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 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.,
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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
either Executive Vice Presidents of the general partner of Group or Managing
Directors of entities controlled by 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 27, 1998 and November 28, 1997, the
notional amounts of the Derivative Transactions with GSCM were $6.5 billion and
$15.7 billion, respectively. As of each of November 27, 1998 and November 28,
1997, the notional amounts of the Derivative Transactions with FPI were $40
million.
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 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.
-39-
<PAGE>
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 Goldman Sachs (Cayman) Trust, Limited ("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 and the Custodian Agreement was amended on February 14, 1996. The Custodian
Agreement requires the Company to pay fees of $150,000 per annum plus variable
expenses, 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 a brokerage account with The Goldman Sachs Trust
Company, 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. As described under
"Executive Compensation" under Item 11, amounts charged under the Calculation
Agreement during fiscal 1998 increased significantly from fiscal 1997 as a
result of the review of the Company's business and operations discussed above
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Overview" under Item 7.
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,
-40-
<PAGE>
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
fluctuate in proportion with changes, 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
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 27, 1998, November 28, 1997 and November 29, 1996 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. In addition, no services were
obtained or charged under the Origination Agreements during fiscal 1998 as a
result of the review of the Company's business and operations discussed above
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Overview" under Item 7. 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 estimated overhead rates for the time spent by individuals providing
services under such Agreement.
<TABLE>
<CAPTION>
GROUP AFFILIATE BASIS OF COMPENSATION EXPENSE INCURRED
AGREEMENT DESCRIPTION OF SERVICE PARTY THERETO COMPENSATION DURING THE FISCAL YEARS ENDED
- ------------ ---------------------- --------------- ------------ ------------------------------
(U.S. DOLLARS IN THOUSANDS)
NOV. 27, 1998 NOV. 28, 1997 NOV. 29, 1996
------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Custodian "Back Office", i.e., Cayman Trust $150,000 per annum $168.7 $150.0 $150.0
Agreement payment processing, plus variable
accounting, cash expenses
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 $702.0(a) 0.0
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% $428.9(b) $42.0 $56.0
Agreement calculations and other
administrative services
<FN>
(a) Payments were capitalized and will be amortized over the life of the Notes. $262 thousand of these costs were written off in
1998 as part of the repurchase and retirement of the Oxford Notes and Citicorp Notes. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Results of Operations -- Fiscal 1998 Compared with Fiscal 1997" under Item
7.
(b) The increase in the amount billed to the Company under the Calculation Agreement in fiscal 1998 as compared to fiscal 1997 is
attributable to increased technical and administrative services provided to the Company in conjunction with Group's review of
the Company's business and operations. See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview" under Item 7.
</FN>
</TABLE>
-41-
<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:
The Company filed a report on Form 8-K, dated November 20, 1998, to report the
repurchase by the Company from GS&Co., and the cancellation, of $72,000,000
aggregate face amount of the Company's 3% Citicorp Exchangeable Notes due August
28, 2002.
(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 Restated 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.**
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.**
-42-
<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 PricewaterhouseCoopers LLP
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.
-43-
<PAGE>
INDEX TO FINANCIAL STATEMENTS OF THE COMPANY
Report of Independent Accountants ..................................... F-2
Balance Sheets as of November 27, 1998 and November 28, 1997........... F-3
Statements of Income for the fiscal years ended November 27, 1998,
November 28, 1997 and November 29, 1996 ............................... F-4
Statements of Changes in Partners' Capital for the fiscal years
ended November 27, 1998, November 28, 1997 and November 29, 1996....... F-5
Statements of Cash Flows for the fiscal years ended November 27,
1998, November 28, 1997 and November 29, 1996 ......................... F-6
Notes to Financial Statements ......................................... F-7
Supplementary Financial Information (Unaudited) ....................... F-17
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
-------------
To the Partners,
GS Financial Products U.S., L.P.:
In our opinion, the accompanying balance sheets and the related statements of
income, changes in partners' capital and cash flows present fairly, in all
material respects, the financial position of GS Financial Products U.S., L.P.
(the "Company") at November 27,1998 and November 28,1997, and the results of its
operations and its cash flows for the three fiscal years in the period ended
November 27,1998, in conformity with generally accepted accounting principles.
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 of these statements in accordance with
generally accepted auditing standards, which require that we plan and perform
the audits 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,
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.
PricewaterhouseCoopers LLP
New York, New York
February 25, 1999.
F-2
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
BALANCE SHEETS
(U.S. dollars in thousands)
----------
November 27, 1998 November 28, 1997
----------------- -----------------
ASSETS:
Cash and cash equivalents $293,636 $291,375
Securities owned, at fair value 38,828 95,185
Derivative transactions, at fair value
Affiliate 11,865 19,561
Non-affiliate 114,958 172,956
Investment in affiliates 804 780
Other assets 703 1,826
-------- --------
Total assets $460,794 $581,683
======== ========
LIABILITIES AND PARTNERS' CAPITAL:
Current portion of long-term borrowings $2,573 $0
Derivative transactions, at fair value
Affiliate 0 0
Non-affiliate 89,078 153,983
Long-term borrowings 209,033 276,489
Other liabilities and accrued expenses 2,791 3,090
-------- --------
Total liabilities 303,475 433,562
Commitments and contingencies
Partners' capital:
Limited Partners 156,525 147,373
General Partner 794 748
-------- --------
Total partners' capital 157,319 148,121
-------- --------
Total liabilities and partners' capital $460,794 $581,683
======== ========
The accompanying notes are an integral part of the financial statements.
F-3
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
<TABLE>
STATEMENTS OF INCOME
(U.S. dollars in thousands)
----------
<CAPTION>
Fiscal Years Ended
----------------------------------------------------------
November 27 1998 November 28, 1997 November 28, 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
REVENUES:
Intermediation profit $ 2,356 $10,622 $11,570
Interest 24,893 14,224 7,460
Equity in loss of affiliate (5) (23) (10)
------- ------- ---------
Total revenues 27,244 24,823 19,020
Interest expense 15,728 9,265 3,627
------- ------- -------
Revenues, net of interest expense 11,516 15,558 15,393
EXPENSES:
Operating 1,964 722 879
------- ------- -------
Income before taxes 9,552 14,836 14,514
Income taxes 382 608 581
------- ------- -------
Net Income $ 9,170 $14,228 $13,933
======= ======= =======
</TABLE>
The accompanying notes are an integral part of the financial statements
F-4
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
<TABLE>
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
(U.S. dollars in thousands)
----------
<CAPTION>
General Limited Total
Partner's Capital Partners' Capital Partners' Capital
----------------- ----------------- -----------------
<S> <C> <C> <C>
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
Change in cumulative translation adjustment 0 28 28
Net Income 46 9,124 9,170
-------------------------------------------------------------
Balance, November 27, 1998 $794 $156,525 $157,319
=============================================================
</TABLE>
The accompanying notes are an integral part of the financial statements
F-5
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
<TABLE>
STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
----------
<CAPTION>
NOVEMBER 27, 1998 NOVEMBER 28, 1997 NOVEMBER 29, 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net Income $9,170 $14,228 $13,933
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in loss of affiliate 5 23 10
Unrealized loss on securities owned 3,924 41,613 0
Increase (decrease) in long-term borrowing
due to embedded derivative transactions, net 10,767 (1,087) 0
Decreases (increases) in operating assets:
Derivative transactions, at fair value:
Affiliate 7,696 (14,288) (4,050)
Non-affiliate 57,998 49,537 7,833
Other assets 1,123 (1,119) (490)
Increases (decreases) in operating liabilities:
Derivative transactions, at fair value:
Affiliate 0 (4,157) (149,481)
Non-affiliate (64,905) 46,582 8,681
Other liabilities and accrued expenses (300) (5,506) 7,748
-----------------------------------------------------------
Net cash provided by (used in) operating activities 25,478 125,826 (115,816)
Cash flows from investing activities:
Short term investments 0 0 24,690
Purchase of securities owned 0 (136,798) 0
Sales of securities owned 52,433 0 0
-----------------------------------------------------------
Net cash provided by (used in) investing activities 52,433 (136,798) (24,690)
Cash flows from financing activities:
Repurchase of long-term borrowings (75,650) 0 0
Proceeds from long-term borrowings 0 160,797 73,000
Distribution to partners 0 0 (9,016)
-----------------------------------------------------------
Net cash (used in) provided by financing activities (75,650) 160,797 63,984
Net increase (decrease) in cash and cash equivalents 2,261 149,825 (27,142)
Cash and cash equivalents, beginning of period 291,375 141,550 168,692
-----------------------------------------------------------
Cash and cash equivalents, end of period $293,636 $291,375 $141,550
===========================================================
Supplemental disclosure of cash flow information:
Interest paid $9,703 $4,824 $1,067
Income taxes paid $364 $155 $752
</TABLE>
The accompanying notes are an integral part of the financial statements
F-6
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO THE FINANCIAL STATEMENTS
------------
1. DESCRIPTION OF BUSINESS:
-----------------------
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 an affiliate of the Company) 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. In
accordance with market practice, the Company does this 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. Because it conducts its
business exclusively on a matched basis, the Company is subject to credit
risk but not market risk on Derivative Transactions (as described under
"Derivative Transactions" -- see Note 4). In addition, from time to time,
the Company issues structured notes (see Note 7).
Since October 1997, The Goldman Sachs Group, L.P. ("Group") has undertaken
a review of the business and 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 fiscal year 1998. In
addition, this lack of activity is expected to have a significant negative
effect on the Company's results of operations in the first fiscal quarter
of 1999, and it may affect later quarters depending upon the timing of the
completion of the review and the implementation of any findings.
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.
2. SIGNIFICANT ACCOUNTING POLICIES:
-------------------------------
BASIS OF PRESENTATION
These financial statements have been prepared in accordance with generally
accepted accounting principles that require management to make estimates
and assumptions that affect the financial statements and related
disclosures. These estimates and assumptions are based on judgement and
available information and, consequently, actual results could be materially
different from these estimates.
The Company is organized as a Cayman Islands exempted limited partnership.
All the partnership interests in the Company are owned by subsidiaries of
Group.
F-7
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO THE FINANCIAL STATEMENTS
------------
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 a cumulative translation adjustment and included in
partners' capital.
Certain transactions entered into by the Company are presented on a
net-by-counterparty basis, where management believes a right of setoff
exists under an enforceable master netting agreement.
Certain prior period amounts have been reclassified to conform with the
November 27, 1998 presentation.
CASH AND CASH EQUIVALENTS
Cash equivalents are short-term, highly liquid investments and include time
deposits at banks with original maturities of three months or less.
FINANCIAL INSTRUMENTS
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 $0, $7.3 million,
and $7.0 million for the fiscal years ended 1998, 1997 and 1996,
respectively.
Other intermediation profit was $2.4 million for the fiscal year ended
1998. $2.9 million of other intermediation profit reflected amortization of
performance guarantee fees, including accelerated amortization of
performance guarantee fees in an aggregate amount of $2.2 million relating
to transactions that were terminated at the request of the counterparties
prior to maturity during fiscal 1998. This was offset in part by a decrease
in the present value of the expected cash flows of the Company's portfolio.
The other intermediation profit for the fiscal year ended 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).
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. The
nature, size, and timing of transactions and the liquidity of the markets
may not ultimately allow for the realization of these values.
Intermediation profit earned on performance guarantees is deferred and
amortized over the term of the guarantee (see Notes 4 & 5). Unamortized
guarantee fees are recognized as
F-8
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO THE FINANCIAL STATEMENTS, CONTINUED
------------
intermediation profit upon any early termination of the underlying
Derivative Transactions, as noted above.
PROVISION FOR 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.
The Company's income is subject to a 4% New York City unincorporated
business tax. The statements of income for the fiscal 1998 and fiscal 1997
include a provision for unincorporated business tax on income earned by the
Company related to doing business in New York City.
CREDIT EXPOSURE
At November 27, 1998, the Company had Credit Exposure (as defined in Note 4
below) exceeding 10% of its total assets to two counterparties, which
represented 24% of total assets. These two counterparties had a rating of
AA- or better from at least one internationally recognized credit rating
agency. 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.
ACCOUNTING DEVELOPMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income", effective for fiscal years beginning after December
15, 1997, with reclassification of earlier periods required for comparative
purposes. SFAS No. 130 establishes standards for the reporting and
presentation of comprehensive income and its components in the financial
statements. The Company intends to adopt this standard beginning in fiscal
year 1999. This Statement is limited to issues of reporting and
presentation and, therefore, will not affect the Company's results of
operations or financial condition.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", effective for fiscal years beginning
after June 15, 1999. SFAS No. 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. This Statement requires that an
entity recognize all derivatives as either assets or liabilities on the
balance sheet and measure those instruments at fair value. The accounting
for changes in the fair value of a derivative depends on its intended use
of the derivative and the resulting designation. The Company intends to
adopt this standard beginning in fiscal year 2000 and is currently
assessing its impact.
F-9
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO THE FINANCIAL STATEMENTS, CONTINUED
------------
3. SECURITIES OWNED:
----------------
As of November 27, 1998 and November 28, 1997, securities owned consisted
of shares of common stock of Oxford Health Plans, Inc. (fair value
approximately $1.9 million and $11.4 million, respectively) and shares of
common stock of Citigroup, Inc. (fair value approximately $36.9 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
Citigroup, Inc. common stock. (See Note 7.)
4. DERIVATIVE TRANSACTIONS:
-----------------------
The fair values of Derivative Transactions entered into by the Company are
presented in the balance sheets on a net-by-counterparty basis, where
management believes a right of setoff exists under an enforceable master
netting agreement. 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, at fair value".
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, at fair value". 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.
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.
F-10
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO THE FINANCIAL STATEMENTS, CONTINUED
------------
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 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 27,
1998 and November 28, 1997, the Company's aggregate credit exposure in
respect of Derivative Transactions was approximately $124 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 $3 million related to Derivative
Transactions as of November 27, 1998.
The Company also limits its credit risk by observing certain limitations on
new Derivative Transactions. If such limits exceed management's criteria,
the Company will not enter into any transaction which increases that risk.
The calculation of these limitations incorporates the net assets of the
Company's general partner which is ultimately liable for the Company's
obligations (See Note 8).
A summary of the notional or contractual amounts ($ 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.
November 27, 1998 November 28, 1997
----------------- -----------------
Non-affiliates
Interest rate swap agreements $2,385 $5,809
Currency options written 304 909
Currency options purchased 108 589
Interest rate options written 826 1,471
Interest rate options purchased 1,450 1,787
Currency and other swap agreements 162 162
Foreign currency forwards 66 1,552
Equity options purchased 37 84
Affiliates
Interest rate swap agreements $3,413 $8,003
Currency options written 108 396
Currency options purchased 304 1,103
Interest rate options written 1,450 1,742
Interest rate options purchased 826 2,081
Currency and other swap agreements 312 893
Foreign currency forwards 64 1,535
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
F-11
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO THE FINANCIAL STATEMENTS, CONTINUED
------------
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 2, 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 27, 1998 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:
(U.S. dollars in millions) November 27, 1998 Average
-------------------------- -------------------- --------------------
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
Non-affiliates
--------------
Derivative transactions $115.0 $89.1 $148.2 $122.4
Affiliates
----------
Derivative transactions 11.9 0.0 12.3 0.0
(U.S. dollars in millions) November 28, 1997 Average
-------------------------- -------------------- --------------------
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
Non-Affiliates
--------------
Derivative transactions 173.0 $154.0 $175.0 131.2
Affiliates
----------
Derivative transactions 19.6 0.0 14.0 0.0
5. RELATED PARTY TRANSACTIONS:
--------------------------
In the ordinary course of business, the Company enters into hedging
transactions with affiliates. Through November 27, 1998, substantially all
of the Company's Derivative Transactions involved some degree of hedging
with affiliates.
The Company paid approximately $702 thousand during fiscal 1997 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. $262 thousand of these costs
were written-off in fiscal 1998 as part of the repurchase and retirement of
$27 million 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.) and $72 million principal amount of 3% Citicorp
Exchangeable Notes due August 28, 2002.
During the fiscal year ended November 29, 1996, 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 was $473 thousand for
the fiscal year ended November 29, 1996. There were no transactions
purchased from affiliates during fiscal 1998 or fiscal 1997.
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
F-12
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO THE FINANCIAL STATEMENTS, CONTINUED
------------
obtains brokerage and custodial services from affiliates at market rates.
For the fiscal years ended 1998, 1997 and 1996, approximately $603
thousand, $197 thousand and $211 thousand were charged for such services,
respectively.
6. INVESTMENT IN AFFILIATES:
------------------------
The Company owns an approximate 2% general and limited partnership interest
in 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 November
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 November 27, 1998, FPI had total liabilities of $137
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 to its liabilities.
As of November 27, 1998, FPI's long-term debt securities were rated Aaa,
AAA and AAA by Moody's Investors Service, Inc. ("Moody's"), S&P and Fitch,
respectively.
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 27, 1998 November 28, 1997 November 29, 1996
----------------- ----------------- -----------------
Total assets $170 $235 $400
Total liabilities 137 203 304
Partners' capital 33 32 96
Net loss (0.2) (2.7) (0.3)
The decrease in capital in fiscal 1997 is a result of a (Y)6 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%.
7. LONG-TERM BORROWINGS:
--------------------
The Company has issued both principal protected and non-principal protected
equity-linked 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
F-13
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO THE FINANCIAL STATEMENTS, CONTINUED
------------
the underlying security. The 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 has entered into various
Derivative Transactions with affiliates and has purchased exchange traded
options to eliminate its market risk on the Notes. (See Note 4 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 27,
1998, interest expense on the Notes linked to a single stock was $9.4
million which is primarily offset by amounts recorded in interest income.
As discussed in Note 2, securities owned and the Derivative Transactions
hedging the embedded Derivative Transactions are recorded at fair value and
estimated fair value, respectively.
<TABLE>
<CAPTION>
November 27, 1998 November 28, 1997
----------------- -----------------
<S> <C> <C>
Nikkei Indexed Notes due December 22, 2000(1) $49,818 $52,008
S&P Enhanced Stock Index Growth Notes due August 9, 2002(2) 116,399 94,380
7% Mandatorily Exchangeable Notes due July 23, 1999(3) 2,573 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) 42,816 113,293
-------- --------
Total long-term borrowings $211,606 $276,489
Current portion of long-term borrowings(3) 2,573 --
-------- --------
Long-term borrowings, les current portion $209,033 $276,489
======== ========
</TABLE>
(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 $14.7 million as
at November 27, 1998 and $19.0 million as at November 28, 1997.
(2) The $73 million face amount of S&P Enhanced Stock Index Growth Notes
is principal protected and has no stated coupon. The carrying value is
inclusive of an embedded written option to the holders of such notes
of $58.6 million as at November 27, 1998 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. On July
16, 1998, the Company repurchased and then retired approximately 67%
of the notes for $7.1 million, representing 320,000 notes. The
remaining notes have an outstanding principal amount of $13.5 million
after the repurchase and retirement, and the carrying value of the
remaining notes of $2.6 million is included in current portion of
long-term borrowings in the November 27, 1998 balance sheet. The
principal repayment amount at maturity will be determined by the
closing price of the Oxford Health Plans, Inc. common stock at
maturity and, accordingly, the carrying
F-14
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
NOTES TO THE FINANCIAL STATEMENTS, CONTINUED
------------
value will fluctuate based upon the prevailing market price of the
common stock. The ability of the holders of such notes 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 includes the embedded Derivative
Transactions of ($10.9) million and ($29.4) million as at November 27,
1998 and November 28, 1997, respectively.
(4) The 3% Citicorp Exchangeable Notes are principal protected and are
exchangeable in $250,000 increments by the holders of such Notes at
the rate of 3,637.5 shares of Citigroup, Inc. common stock per
increment. 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. On November 20, 1998, the Company repurchased and
then retired 60% of the Notes, for $68.6 million reducing the
outstanding principal amount from $120 million to $48 million. The
carrying value includes the embedded Derivative Transactions of ($0.7)
million and ($8.6) million as at November 27, 1998 and November 28,
1997, respectively.
Including the impact of the Derivative Transactions, the weighted average
interest rate for the notes was 5.99% as of November 27, 1998 and 5.91% as
of November 28, 1997.
On July 16, 1998, the Company repurchased and then retired approximately
67% of the 7% Mandatorily Exchangeable Notes due July 23, 1999 for $7.1
million, representing 320,000 such notes. Prior to repurchase, the notes
were held by an affiliate. The Company recognized a loss of $65 thousand on
the retirement, which was recorded in other intermediation profit,
primarily consisting of expenses relating to the early termination of a
Derivative Transaction related to the notes.
On October 8, 1998, Citicorp common shares were converted into Citigroup,
Inc. common shares at the ratio of 2.5 Citigroup common shares for each
Citicorp common share as a result of the merger between Citicorp and
Travelers Group Inc.
On November 20, 1998, the Company repurchased and then retired 60% of the
3% Citicorp Exchangeable Notes due August 28, 2002 for $68.6 million,
representing $72 million aggregate face value of such notes. Prior to
repurchase, the notes were held by an affiliate. The Company recorded no
gain or loss on the retirement.
8. 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 $2.6 million
and equity of approximately $2.24 million as of November 27, 1998 and
assets of approximately $2.8 million and equity of approximately $2.4
million as of November 28, 1997.
9. 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
F-15
<PAGE>
January 1, 1997, the Company is no longer required to withhold taxes on
behalf of its partners under U.S. federal tax regulations.
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
27, 1998, November 28, 1997 and November 29, 1996 includes a provision for
unincorporated business tax on income earned by the Company related to
doing business in New York City.
F-16
<PAGE>
GS FINANCIAL PRODUCTS U.S., L.P.
SUPPLEMENTARY FINANCIAL INFORMATION
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
1998 Fiscal Quarters Ended
(U.S. dollars in thousands) February 27 May 29 August 28 November 27
----------- ------ --------- -------------
Total revenues 5,769 5,551 6,002 9,922
Revenues, net of interest
expense 2,457 2,271 1,865 4,923
Net income (1) 1,997 1,893 1,552 3,728
1997 Fiscal Quarters Ended
(U.S. dollars in thousands) February 28 May 31 August 29 November 28(1)
----------- ------ --------- -------------
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
1996 Fiscal Quarters Ended
(U.S. dollars in thousands) February 23 May 31 August 30 November 29
----------- ------ --------- -------------
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
(1) Since October 1997, Group has undertaken a review of the business and
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 has not entered into
any new Derivative Transactions and has not issued any new debt securities.
This lack of activity by the Company has negatively affected the Company's
results of operations for the fourth fiscal quarter of 1997 and all of
fiscal 1998. In addition, this lack of activity is expected to have a
significant negative effect on the Company's results of operations in the
first fiscal quarter of 1999, and may affect later quarters depending upon
the timing of the completion of the review and the implementation of any
findings.
F-17
<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 25th day of
February, 1999.
GS FINANCIAL PRODUCTS U.S., L.P.
acting by its general partner, GS Financial
Products US Co.
By: /s/ C. Douglas Fuge
----------------------------------------------
C. Douglas Fuge
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-18
<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/ Noel B. Donohoe Director February 23, 1999
- -----------------------
Noel B. Donohoe
Director,
/s/ C. Douglas Fuge President, February 23, 1999
- ----------------------- Principal Financial Officer and
C. Douglas Fuge Principal Accounting Officer
/s/ Jonathan M. Lopatin Director February 23, 1999
- -----------------------
Jonathan M. Lopatin
/s/ Kenneth A. Miller Director February 19, 1999
- -----------------------
Kenneth A. Miller
/s/ Thomas K. Montag Director February 23, 1999
- -----------------------
Thomas K. Montag
/s/ Mark A. Zurack Director February 23, 1999
- -----------------------
Mark A. Zurack
F-19
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. 27, 1998 Nov. 28, 1997 Nov. 29, 1996 Nov. 24, 1995 Nov. 25, 1994
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Earnings:
Income from continuing operations
before income taxes 9,552 14,836 14,514 12,583 10,199
Add: Fixed charges 16,189 9,265 3,643 500 27
Earnings as adjusted 25,741 24,101 18,157 13,083 10,226
Fixed charges:
Interest expense 15,728 9,265 3,627 471 27
Debt amortization expense 461(2) 0 16 29 0
Interest portion of rent expense 0 0 0 0 0
------ ----- ----- ------ ------
Total fixed charges 16,189 9,265 3,643 500 27
Ratio of earnings to fixed charges 1.6x 2.6x 5x 26x 378x(1)
<FN>
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.
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.
Note (2): Includes $262 thousand of costs that were written off in 1998 as part of the repurchase and retirement of the
Oxford Notes and Citicorp Notes.
</FN>
</TABLE>
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) of
our report dated February 22, 1999, on our audits of the financial statements of
GS Financial Products U.S., L.P. as of November 27, 1998 and November 28, 1997
and for the fiscal years ended November 27, 1998, November 28, 1997 and November
29, 1996, which report is included in the Annual Report on Form 10-K.
PricewaterhouseCoopers LLP
New York, New York
February 25, 1999.
<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 27, 1998.
</LEGEND>
<CIK> 0000914720
<NAME> GS Financial Products U.S., L.P.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> NOV-27-1998
<PERIOD-END> NOV-27-1998
<CASH> 293,636
<SECURITIES> 38,828
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 460,794
<CURRENT-LIABILITIES> 2,573
<BONDS> 209,033
0
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 460,794
<SALES> 0
<TOTAL-REVENUES> 27,244
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 1,964
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 15,728
<INCOME-PRETAX> 9,552
<INCOME-TAX> 382
<INCOME-CONTINUING> 9,170
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,170
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<FN>
<F1>
Notes
- ------------------
Balances relating to derivative transactions are not reflected in the above
figures.
</FN>
</TABLE>
