SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 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: 0-19070 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 3, L.P. - -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) Delaware 13-3544867 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) One New York Plaza, 13th Floor, New York, New York 10292 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 778-7866 N/A - -------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report. Indicate by check CK 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 _CK_ No __ Part I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 3, L.P. (a limited partnership) STATEMENTS OF FINANCIAL CONDITION (Unaudited) March 31, December 31, 1998 1997 - --------------------------------------------------------------------------------------------------- ASSETS Equity in commodity trading accounts: Cash $ 3,622,828 $ 3,247,888 U.S. Treasury bills, at amortized cost 13,085,429 14,063,335 Net unrealized gain on open commodity positions 556,094 795,209 Options, at market 100,442 124,575 ----------- ------------ Total assets $17,364,793 $18,231,007 ----------- ------------ ----------- ------------ LIABILITIES AND PARTNERS' CAPITAL Liabilities Redemptions payable $ 706,728 $ 587,036 Accrued expenses 60,248 64,500 Management fees payable 36,147 37,646 Due to affiliates 43,305 20,512 ----------- ------------ Total liabilities 846,428 709,694 ----------- ------------ Commitments Partners' capital Limited partners (98,804 and 103,033 units outstanding) 16,352,857 17,346,056 General partner (1,000 and 1,041 units outstanding) 165,508 175,257 ----------- ------------ Total partners' capital 16,518,365 17,521,313 ----------- ------------ Total liabilities and partners' capital $17,364,793 $18,231,007 ----------- ------------ ----------- ------------ Net asset value per limited and general partnership unit ('Units') $ 165.51 $ 168.35 ----------- ------------ ----------- ------------ - --------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements. 2 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 3, L.P. (a limited partnership) STATEMENTS OF OPERATIONS (Unaudited) Three months ended March 31, ----------------------- 1998 1997 - --------------------------------------------------------------------------------------------------- REVENUES Net realized gain (loss) on commodity transactions $ 370,561 $ (973,338) Change in net unrealized gain on open commodity positions (302,688) 1,444,749 Interest from U.S. Treasury bills 182,166 187,985 --------- ---------- 250,039 659,396 --------- ---------- EXPENSES Commissions 333,091 389,496 Other transaction fees 57,348 63,813 Management fees 111,225 151,444 Incentive fees -- 226,785 General and administrative 44,595 45,805 --------- ---------- 546,259 877,343 --------- ---------- Net loss $(296,220) $ (217,947) --------- ---------- --------- ---------- ALLOCATION OF NET LOSS Limited partners $(293,257) $ (215,766) --------- ---------- --------- ---------- General partner $ (2,963) $ (2,181) --------- ---------- --------- ---------- NET LOSS PER WEIGHTED AVERAGE LIMITED AND GENERAL PARTNERSHIP UNIT Net loss per weighted average limited and general partnership unit $ (2.85) $ (1.88) --------- ---------- --------- ---------- Weighted average number of limited and general partnership units outstanding 104,074 116,211 --------- ---------- --------- ---------- - --------------------------------------------------------------------------------------------------- STATEMENT OF CHANGES IN PARTNERS' CAPITAL (Unaudited) LIMITED GENERAL UNITS PARTNERS PARTNER TOTAL - ---------------------------------------------------------------------------------------------------- Partners' capital--December 31, 1997 104,074 $17,346,056 $175,257 $17,521,313 Net loss -- (293,257) (2,963) (296,220) Redemptions (4,270) (699,942) (6,786) (706,728) ------- ----------- -------- ----------- Partners' capital--March 31, 1998 99,804 $16,352,857 $165,508 $16,518,365 ------- ----------- -------- ----------- ------- ----------- -------- ----------- - ---------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements. 3 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 3, L.P. (a limited partnership) NOTES TO FINANCIAL STATEMENTS MARCH 31, 1998 (Unaudited) A. General These financial statements have been prepared without audit. In the opinion of management, the financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of Prudential-Bache Capital Return Futures Fund 3, L.P. (the 'Partnership') as of March 31, 1998 and the results of its operations for the three months ended March 31, 1998 and 1997. However, the operating results for the interim periods may not be indicative of the results expected for a full year. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been omitted. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the Partnership's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 1997. Certain balances from the prior year have been reclassified to conform with the current financial statement presentation. B. Related Parties Seaport Futures Management, Inc. (the 'General Partner') and its affiliates perform services for the Partnership which include, but are not limited to: brokerage services, accounting and financial management, registrar, transfer and assignment functions, investor communications, printing and other administrative services. The costs incurred for these services for the three months ended March 31, 1998 and 1997 were: 1998 1997 ----------------------------------------------------------------------------------- Commissions $333,091 $389,496 General and administrative 25,650 25,672 -------- -------- $358,741 $415,168 -------- -------- -------- -------- The Partnership maintains its trading and cash accounts at Prudential Securities Incorporated ('PSI'), the Partnership's commodity broker and an affiliate of the General Partner. Except for the portion of assets that is deposited as margin to maintain forward currency contract positions as further discussed below, the Partnership's assets are maintained either with PSI or, for margin purposes, with the various exchanges on which the Partnership is permitted to trade. The Partnership acting through its trading managers, executes over-the-counter, spot, forward and/or option foreign exchange transactions with PSI. PSI then engages in back-to-back trading with an affiliate, Prudential-Bache Global Markets Inc. ('PBGM'). PBGM attempts to earn a profit on such transactions. PBGM keeps its prices on foreign currency competitive with other interbank currency trading desks. All over-the-counter currency transactions are conducted between PSI and the Partnership pursuant to a line of credit. PSI may require that collateral be posted against the marked-to-market position of the Partnership. C. Credit and Market Risk Since the Partnership's business is to trade futures, forward and options contracts, its capital is at risk due to changes in the value of these contracts (market risk) or the inability of counterparties to perform under the terms of the contracts (credit risk). Futures, forward and options contracts involve varying degrees of off-balance sheet risk; and changes in the level of volatility of interest rates, foreign currency exchange rates or the market values of the contracts (or commodities underlying the contracts) frequently result in changes in the Partnership's unrealized gain (loss) on open commodity positions reflected in the statements of financial condition. The Partnership's exposure to market risk is influenced by a number of factors including the relationships among the contracts held by the Partnership as well as the liquidity of the markets in which the contracts are traded. 4 Futures and options contracts are traded on organized exchanges and are thus distinguished from forward contracts which are entered into privately by the parties. The credit risks associated with futures and options contracts are typically perceived to be less than those associated with forward contracts, because exchanges typically provide clearinghouse arrangements in which the collective credit (subject to certain limitations) of the members of the exchanges is pledged to support the financial integrity of the exchange. On the other hand, the Partnership must rely solely on the credit of its broker (PSI) with respect to forward transactions. The Partnership presents unrealized gains and losses on open forward positions as a net amount in the statements of financial condition because it has a master netting agreement with PSI. The General Partner attempts to minimize both credit and market risks by requiring the Partnership's trading managers to abide by various trading limitations and policies. The General Partner monitors compliance with these trading limitations and policies which include, but are not limited to, executing and clearing all trades with creditworthy counterparties (currently, PSI is the sole counterparty or broker); limiting the amount of margin or premium required for any one commodity or all commodities combined; and generally limiting transactions to contracts which are traded in sufficient volume to permit the taking and liquidating of positions. The General Partner may impose additional restrictions (through modifications of such trading limitations and policies) upon the trading activities of the trading managers as it, in good faith, deems to be in the best interests of the Partnership. PSI, when acting as the Partnership's futures commission merchant in accepting orders for the purchase or sale of domestic futures and options contracts, is required by Commodity Futures Trading Commission ('CFTC') regulations to separately account for and segregate as belonging to the Partnership all assets of the Partnership relating to domestic futures and options trading and is not to commingle such assets with other assets of PSI. At March 31, 1998 and December 31, 1997, such segregated assets totalled $12,734,610 and $13,304,825, respectively. Part 30.7 of the CFTC regulations also requires PSI to secure assets of the Partnership related to foreign futures and options trading which totalled $4,498,587 and $4,996,751 at March 31, 1998 and December 31, 1997, respectively. There are no segregation requirements for assets related to forward trading. As of March 31, 1998, the Partnership's open futures, forward and options contracts mature within one year. At March 31, 1998 and December 31, 1997, gross contract amounts of open futures, forward and options contracts are: 1998 1997 ------------ ------------ Financial Futures and Options Contracts: Commitments to purchase $ 72,452,651 $232,456,787 Commitments to sell 148,637,064 3,415,906 Currency Futures and Options Contracts: Commitments to purchase 26,726,732 3,813,407 Commitments to sell 24,720,225 20,598,159 Other Futures and Options Contracts: Commitments to purchase 3,797,640 3,477,900 Commitments to sell 6,317,339 7,212,160 Currency Forward Contracts: Commitments to purchase 4,147,099 2,621,143 Commitments to sell -- 477,804 Other Forward Contracts: Commitments to purchase 3,912,761 333,510 The gross contract amounts represent the Partnership's potential involvement in a particular class of financial instrument (if it were to take or make delivery on an underlying futures, forward or options contract). The gross contract amounts significantly exceed the future cash requirements as the Partnership intends to close out open positions prior to settlement and thus is generally subject only to the risk of loss arising from the change in the value of the contracts. As such, the Partnership considers the 'fair value' of its futures, forward and options contracts to be the net unrealized gain or loss on the contracts (plus premiums on options). Thus, the amount at risk associated with counterparty nonperformance of all contracts is the net unrealized gain included in the statements of financial condition. The market risk associated with the Partnership's commitments to purchase commodities is limited to the gross contract amounts involved, 5 while the market risk associated with its commitments to sell is unlimited since the Partnership's potential involvement is to make delivery of an underlying commodity at the contract price; therefore, it must repurchase the contract at prevailing market prices. At March 31, 1998 and December 31, 1997, the fair value of open futures, forward and options contracts was: 1998 1997 -------------------------------- -------------------------- Assets Liabilities Assets Liabilities -------------- -------------- ---------- ------------ Futures Contracts: Domestic exchanges Financial $ 112,195 $ 15,875 $ 204,288 $ 83,550 Currencies 473,732 40,322 171,503 10,585 Other 118,066 140,649 279,386 41,549 Foreign exchanges Financial 70,065 95,741 396,408 9,479 Other 27,319 84,292 63,081 103,725 Forward Contracts: Currencies -- 19,542 -- 68,270 Other 151,138 -- -- 2,299 Options Contracts: Domestic exchanges Financial 49,875 -- 23,375 -- Currencies 34,650 -- 101,200 -- Foreign exchanges Other 15,917 -- -- -- -------------- -------------- ---------- ------------ $1,052,957 $396,421 $1,239,241 $319,457 -------------- -------------- ---------- ------------ -------------- -------------- ---------- ------------ The following table presents the average fair value of futures, forward and options contracts during the three months ended March 31, 1998 and 1997, respectively. 1998 1997 -------------------------------- -------------------------- Assets Liabilities Assets Liabilities -------------- -------------- ---------- ------------ Futures Contracts: Domestic exchanges Financial $ 162,289 $ 38,893 $ 167,725 $ -- Currencies 201,153 30,952 12,591 550 Other 155,886 101,500 228,526 87,923 Foreign exchanges Financial 552,424 32,279 256,671 167,678 Other 77,135 80,815 421,325 31,620 Forward Contracts: Currencies -- 95,466 -- -- Other 95,096 575 -- -- Options Contracts: Domestic exchanges Financial 18,313 -- -- -- Currencies 33,963 -- -- -- Other -- -- 11,875 -- Foreign exchanges Other 3,979 -- 691 -- -------------- -------------- ---------- ------------ $1,300,238 $380,480 $1,099,404 $287,771 -------------- -------------- ---------- ------------ -------------- -------------- ---------- ------------ 6 The following table presents the Partnership's trading revenues for the three months ended March 31, 1998 and 1997. 1998 1997 ---------- --------- Futures Contracts: Domestic exchanges Financial $ (259,713) $ (9,818) Currencies (171,104) (146,417) Other (347,872) 687,525 Foreign exchanges Financial 1,115,381 (812,490) Other (198,049) 577,415 Forward Contracts: Currencies (124,937) -- Other 194,234 -- Options Contracts: Domestic exchanges Financial (46,735) -- Currencies (88,275) 183,984 Other -- 3,300 Foreign exchanges Other (5,057) (12,088) ---------- --------- $ 67,873 $ 471,411 ---------- --------- ---------- --------- 7 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 3, L.P. (a limited partnership) ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources The Partnership commenced operations on May 30, 1990 with gross proceeds of $65,520,000. After accounting for organizational and offering costs, the Partnership's net proceeds were $64,222,750. At the inception of the Partnership, 60% of the net proceeds was allocated to trading activity. In conjunction with a letter of credit ('Letter of Credit'), the remaining 40% was placed in reserve and invested in investment grade interest-bearing obligations ('Reserve Assets'). On June 30, 1995, the Letter of Credit expired and the Reserve Assets matured with the resulting proceeds allocated to commodities trading. As of March 31, 1998, 100% of the Partnership's net assets were allocated to commodities trading. A significant portion of the net asset value was held in U.S. Treasury bills (which represented approximately 76% of the net asset value prior to redemptions payable) and cash, which are used as margin for the Partnership's trading in commodities. Inasmuch as the sole business of the Partnership is to trade in commodities, the Partnership continues to own such liquid assets to be used as margin. The percentage that U.S. Treasury bills bears to the total net assets varies each day, and from month to month, as the market value of commodity interests change. The balance of the total net assets is held in cash. All interest earned on the Partnership's interest-bearing funds is paid to the Partnership. The commodities contracts are subject to periods of illiquidity because of market conditions, regulatory considerations and other reasons. For example, commodity exchanges limit fluctuations in commodity futures contract prices during a single day by regulations referred to as 'daily limits.' During a single day, no trades may be executed at prices beyond the daily limit. Once the price of a futures contract for a particular commodity has increased or decreased by an amount equal to the daily limit, positions in the commodity can neither be taken nor liquidated unless traders are willing to effect trades at or within the limit. Commodity futures prices have occasionally moved the daily limit for several consecutive days with little or no trading. Such market conditions could prevent the Partnership from promptly liquidating its commodity futures positions. Since the Partnership's business is to trade futures, forward and options contracts, its capital is at risk due to changes in the value of these contracts (market risk) or the inability of counterparties to perform under the terms of the contracts (credit risk). The General Partner attempts to minimize these risks by requiring the Partnership's trading managers to abide by various trading limitations and policies. See Note C to the financial statements for a further discussion on the credit and market risks associated with the Partnership's futures, forward and options contracts. The Partnership does not have, nor does it expect to have, any capital assets. Redemptions by limited partners and the General Partner recorded for the three months ended March 31, 1998 were $699,942 and $6,786, respectively, and from commencement of operations, May 30, 1990, through March 31, 1998 totalled $62,729,553 and $739,749, respectively. Future redemptions will impact the amount of funds available for investment in commodity contracts in subsequent periods. Results of Operations The net asset value per Unit as of March 31, 1998 was $165.51, a decrease of 1.69% from the December 31, 1997 net asset value per Unit of $168.35. The Partnership's positive performance during the month of January resulted from profits in the financial, index, energy and metal sectors, which were somewhat offset by losses in the currency, soft and grain sectors. As U.S. bond yields fell below 6%, global bond prices rose during the first two weeks of January. During the second half of the month, fears over a possible acceleration of the Asian financial crisis began to subside. Consequently, global bond prices declined from their mid-January peak as investors pulled back from bonds. This correction caused the Partnership to cover many long bond positions resulting in profits in German, U.S., French, Italian, British and Euroswiss bonds. In the index sector, gains were achieved in the U.S. Dollar Index, the French CAC 40 and the Hong Kong Hang Seng. Gains were somewhat offset by losses, particularly in the soft sector as coffee prices surged on supply concerns prompted by tight 8 stockpiles and dry weather conditions. Currency sector positions were unprofitable as fears regarding the Far East waned and investors were no longer as concerned with the flight to quality. This shift resulted in the Partnership experiencing losses in Japanese yen, Australian dollar and British pound positions and in Canadian dollar/Japanese yen and Japanese yen/British pound crossrate positions. The Partnership's negative performance during the month of February resulted from losses in the currency, soft, index and energy sectors. Gains were achieved in the metal, grain and financial sectors. Currency sector positions lost value as a reversal in the Japanese yen on hopes that the Japanese government might take stronger fiscal action to improve the economy, led to losses in the Partnership's short positions. Positions in the German deutsche mark and British pound lost, and crossrate positions in the Japanese yen/deutsche mark, Canadian dollar/deutsche mark and Canadian dollar/Japanese yen were also unprofitable. Prices in both coffee and cocoa declined during the month resulting in losses for the soft sector. As U.S. indices continued to rally, short S&P 500 positions experienced losses. Additionally, positions in the Hong Kong Hang Seng and Japanese Nikkei were not profitable. Long positions in silver profited as prices soared in response to significant buying by a larger investor, helping to offset Partnership losses. Positions in zinc and aluminum added value as well. In the grain sector, the Partnership gained from positions in corn, soybean meal and soybean oil. The Partnership's negative performance during the month of March resulted from losses in the financial, metal, soft, energy, grain and index sectors. Gains were achieved in the currency sector. In the financial sector, U.S. bond yields reversed direction and rose due to reduced deflationary market expectations. Additionally, in Japan, bond prices varied widely on reports that a government stimulus package would fall short of necessary measures. Both market actions generated losses for the Partnership. Euroswiss and French notional bond positions lost value as well. Short gold positions in the metal sector were the most unprofitable for the Partnership as prices soared on renewed buying as a hedge against inflation. Positions in nickel and zinc also suffered losses. A pledge by OPEC members to curtail production caused crude and light crude oil prices to spike, resulting in losses for the Partnership in the energy sector. On the positive side, the Partnership profited in the currency sector as investors began to move away from the Swiss franc. Japanese yen positions and Japanese yen/deutsche mark crossrates were profitable. Interest income from U.S. Treasury bills decreased by $5,819 for the three months ended March 31, 1998 as compared to the same period in 1997 primarily due to the effect of redemptions on funds available for investment in U.S. Treasury bills. Commissions are calculated on the net asset value on the first day of each month and, therefore, vary based on monthly trading performance and redemptions. The monthly net asset values during the first three months of 1997 were boosted by strong trading performance during the latter part of 1996 and continued positive trading performance during the first three months of 1997. However, the effect of poor trading performance during the second quarter of 1997 as well as redemptions on the monthly net asset values caused commissions to decrease by $56,405 for the three months ended March 31, 1998 as compared to the same period in 1997. Other transaction fees consist of National Futures Association, exchange, floor brokerage and clearing fees which are based on the number of trades the trading managers execute. Other transaction fees decreased by $6,465 for the three months ended March 31, 1998 as compared to the same period in 1997 primarily due to lower trading volume. All trading decisions are currently being made by Sjo, Inc. and Willowbridge Associates Inc. (the 'Trading Managers'). Management fees are calculated on the net asset value allocated to each Trading Manager as of the end of each month and, therefore, are affected by trading performance and redemptions. Management fees decreased by $40,219 for the three months ended March 31, 1998 as compared to the same period in 1997 for the same reasons commissions decreased as discussed above. Incentive fees are based on New High Net Trading Profits generated by each Trading Manager, as defined in the Advisory Agreements among the Partnership, the General Partner and each Trading Manager. Despite overall net trading losses for the Partnership in 1997, Willowbridge Associates Inc., earned incentive fees of $226,785. These fees were primarily attributable to strong trading performance during the latter part of 1996 capped off by positive trading performance during the first three months of 1997. There were no incentive fees earned during the three months ended March 31, 1998. 9 General and administrative expenses decreased by $1,210 for the three months ended March 31, 1998 as compared to the same period in 1997. These expenses include reimbursements of costs incurred by the General Partner on behalf of the Partnership, in addition to accounting, audit, tax and legal fees as well as printing and postage costs related to reports sent to limited partners. 10 PART II. OTHER INFORMATION Item 1. Legal Proceedings--There are no material legal proceedings pending by or against the Registrant or the General Partner. Item 2. Changes in Securities--None Item 3. Defaults Upon Senior Securities--None Item 4. Submission of Matters to a Vote of Security Holders--None Item 5. Other Information--None Item 6. Exhibits and Reports on Form 8-K: (a) Exhibits 4.1 Agreement of Limited Partnership of the Registrant, dated as of November 27, 1989 as amended and restated as of January 30, 1990 (incorporated by reference to Exhibits 3.1 and 4.1 to the Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 1990) 4.2 Subscription Agreement (incorporated by reference to Exhibit 4.2 to the Registrant's Registration Statement on Form S-1, File No. 33-32355) 4.3 Request for Redemption (incorporated by reference to Exhibit 4.3 to the Registrant's Registration Statement on Form S-1, File No. 33-32355) 27.1 Financial Data Schedule (filed herewith) (b) Reports on Form 8-K--None 11 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Prudential-Bache Capital Return Futures Fund 3, L.P. By: Seaport Futures Management, Inc. A Delaware corporation, General Partner By: /s/ Steven Carlino Date: May 14, 1998 ---------------------------------------- Steven Carlino Vice President Chief Accounting Officer for the Registrant 12