1
Exhibit 13.2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Directors and Shareholders,
The Goldman Sachs Group, Inc.:
In our opinion, the accompanying consolidated statements of financial
condition and the related consolidated statements of earnings, changes in
stockholders' equity and partners' capital, cash flows and comprehensive income
present fairly, in all material respects, the consolidated financial position of
The Goldman Sachs Group, Inc. and Subsidiaries (the "firm") as of November 26,
1999 and November 27, 1998, and the results of their consolidated operations and
their consolidated cash flows for each of the three fiscal years in the period
ended November 26, 1999, in conformity with accounting principles generally
accepted in the United States. These financial statements are the responsibility
of the firm's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with auditing standards generally accepted in
the United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, 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.
/s/ PRICEWATERHOUSECOOPERS LLP
New York, New York
January 21, 2000.
46
2
CONSOLIDATED STATEMENTS OF EARNINGS
YEAR ENDED NOVEMBER
---------------------------------
1999 1998 1997
---- ---- ----
(IN MILLIONS, EXCEPT SHARE AND
PER SHARE AMOUNTS)
Revenues
Global capital markets
Investment banking.................................... $ 4,359 $ 3,368 $ 2,587
Trading and principal investments..................... 5,758 2,015 2,303
Asset management and securities services................ 2,524 2,085 1,456
Interest income......................................... 12,722 15,010 14,087
----------- ------- -------
Total revenues................................ 25,363 22,478 20,433
Interest expense........................................ 12,018 13,958 12,986
----------- ------- -------
Revenues, net of interest expense..................... 13,345 8,520 7,447
Operating expenses
Compensation and benefits, excluding employee initial
public offering awards................................ 6,459 3,838 3,097
Nonrecurring employee initial public offering
awards(1)............................................. 2,257 -- --
Amortization of employee initial public offering
awards................................................ 268 -- --
Brokerage, clearing and exchange fees................... 446 424 357
Market development...................................... 364 287 206
Communications and technology........................... 306 265 208
Depreciation and amortization........................... 337 242 178
Occupancy............................................... 314 207 168
Professional services and other......................... 402 336 219
Charitable contribution................................. 200 -- --
----------- ------- -------
Total operating expenses...................... 11,353 5,599 4,433
Pre-tax earnings........................................ 1,992 2,921 3,014
(Benefit)/provision for taxes........................... (716) 493 268
----------- ------- -------
Net earnings............................................ $ 2,708 $ 2,428 $ 2,746
=========== ======= =======
Earnings per share
Basic................................................. $ 5.69 -- --
Diluted............................................... 5.57 -- --
Average common shares outstanding
Basic................................................. 475,883,756 -- --
Diluted............................................... 485,803,960 -- --
- ---------------
(1) Includes expense of $666 million related to the initial irrevocable
contribution of shares of common stock to a defined contribution plan.
The accompanying notes are an integral part of these consolidated financial
statements.
47
3
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF NOVEMBER
--------------------
1999 1998
---- ----
(IN MILLIONS, EXCEPT
SHARE AND PER SHARE
AMOUNTS)
Assets
Cash and cash equivalents...................................... $ 3,055 $ 2,836
Cash and securities segregated in compliance with U.S.
federal and other regulations................................ 9,135 7,887
Receivables from brokers, dealers and clearing
organizations................................................ 4,490 4,321
Receivables from customers and counterparties.................. 30,140 14,953
Securities borrowed............................................ 78,418 69,158
Securities purchased under agreements to resell................ 37,106 37,484
Right to receive securities.................................... 1,604 7,564
Financial instruments owned, at fair value
Commercial paper, certificates of deposit and time
deposits................................................... 1,435 1,382
U.S. government, federal agency and sovereign
obligations................................................ 22,193 24,789
Corporate debt............................................... 9,821 10,744
Equities and convertible debentures.......................... 16,381 11,066
State, municipal and provincial obligations.................. 756 918
Derivative contracts......................................... 30,661 21,299
Physical commodities......................................... 562 481
Other assets................................................... 4,734 2,498
-------- --------
$250,491 $217,380
======== ========
Liabilities and Equity
Short-term borrowings, including commercial paper.............. $ 37,756 $ 27,430
Payables to brokers, dealers and clearing organizations........ 2,129 730
Payables to customers and counterparties....................... 57,405 46,208
Securities loaned.............................................. 9,169 11,088
Securities sold under agreements to repurchase................. 40,183 36,257
Obligation to return securities................................ 1,595 9,783
Financial instruments sold, but not yet purchased, at fair
value
U.S. government, federal agency and sovereign obligations.... 19,170 22,360
Corporate debt............................................... 2,642 1,441
Equities and convertible debentures.......................... 14,002 6,406
Derivative contracts......................................... 28,488 24,722
Physical commodities......................................... 586 966
Other liabilities and accrued expenses......................... 6,269 3,699
Long-term borrowings........................................... 20,952 19,906
-------- --------
240,346 210,996
Commitments and contingencies
Partners' capital allocated for income taxes and potential
withdrawals.................................................. -- 74
Partners' capital.............................................. -- 6,310
Preferred stock, par value $0.01 per share; 150,000,000
shares authorized, no shares issued and outstanding.......... -- --
Common stock, par value $0.01 per share; 4,000,000,000
shares authorized, 441,421,899 shares issued and
outstanding.................................................. 4 --
Restricted stock units; 76,048,404 units issued and
outstanding.................................................. 4,339 --
Nonvoting common stock, par value $0.01 per share;
200,000,000 shares authorized, 7,440,362 shares issued and
outstanding.................................................. -- --
Additional paid-in capital..................................... 7,359 --
Retained earnings.............................................. 444 --
Unearned compensation.......................................... (2,038) --
Accumulated other comprehensive income......................... 37 --
-------- --------
10,145 6,310
-------- --------
$250,491 $217,380
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
48
4
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS'
EQUITY AND PARTNERS' CAPITAL
YEAR ENDED NOVEMBER
-------------------------------
1999 1998 1997
---- ---- ----
(IN MILLIONS, EXCEPT PER SHARE
AMOUNTS)
Partners' capital
Balance, beginning of year................................ $ 6,310 $ 6,107 $ 5,309
Transfer of beginning partners' capital allocated for
income taxes and potential withdrawals.................. 74 -- --
Net earnings.............................................. 2,264 (1) 2,428 2,746
Capital contributions..................................... 48 9 89
Return on capital and certain distributions to partners... (306) (619) (557)
Termination of profit participation plans................. -- (368) --
Transfers to partners' capital allocated for income taxes
and potential withdrawals, net.......................... -- (1,247) (1,480)
Distributions of remaining partners' capital.............. (4,520)(2) -- --
Exchange of partnership interests for shares of common
stock................................................... (3,901) -- --
Transfer to accumulated other comprehensive income........ 31 -- --
------- ------- -------
Balance, end of year...................................... -- 6,310 6,107
Common stock, par value $0.01 per share
Balance, beginning of year................................ -- -- --
Common stock issued....................................... 4 -- --
------- ------- -------
Balance, end of year...................................... 4 -- --
Restricted stock units
Balance, beginning of year................................ -- -- --
Restricted stock units granted, net of forfeitures of $42
million................................................. 4,339 -- --
------- ------- -------
Balance, end of year...................................... 4,339 -- --
Nonvoting common stock, par value $0.01 per share
Balance, beginning of year................................ -- -- --
Nonvoting common stock issued............................. -- -- --
------- ------- -------
Balance, end of year...................................... -- -- --
Additional paid-in capital
Balance, beginning of year................................ -- -- --
Exchange of partnership interests for shares of common
stock................................................... 3,901 -- --
Issuance of common stock.................................. 2,891 -- --
Issuance of common stock contributed to a defined
contribution plan....................................... 674 -- --
Dividends paid............................................ (107)(3) -- --
------- ------- -------
Balance, end of year...................................... 7,359 -- --
Retained earnings
Balance, beginning of year................................ -- -- --
Net earnings.............................................. 444 (4) -- --
------- ------- -------
Balance, end of year...................................... 444 -- --
Unearned compensation
Balance, beginning of year................................ -- -- --
Restricted stock units granted, net of forfeitures of $23
million................................................. (2,311) -- --
Amortization of restricted stock units.................... 273 -- --
------- ------- -------
Balance, end of year...................................... (2,038) -- --
Accumulated other comprehensive income
Balance, beginning of year................................ -- -- --
Transfer from partners' capital........................... (31) -- --
Currency translation adjustment........................... 68 -- --
------- ------- -------
Balance, end of year...................................... 37 -- --
------- ------- -------
$10,145 $ 6,310 $ 6,107
======= ======= =======
- ---------------
(1) Represents net earnings of the partnership from November 28, 1998 through
May 6, 1999.
(2) Represents the retired limited partners' exchanges of partnership interests
for cash and junior subordinated debentures, the redemption of senior
limited partnership interests for cash and other distributions of partners'
capital in accordance with the partnership agreement.
(3) Represents two quarterly dividends of $0.12 per common share each.
(4) Represents net earnings of the corporation from May 7, 1999 through November
26, 1999.
The accompanying notes are an integral part of these consolidated financial
statements.
49
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED NOVEMBER
--------------------------------
1999 1998 1997
---- ---- ----
(IN MILLIONS)
Cash flows from operating activities
Net earnings.............................................. $ 2,708 $ 2,428 $ 2,746
Noncash items included in net earnings
Depreciation and amortization........................... 337 242 178
Deferred income taxes................................... (1,387) 23 32
Stock-based compensation................................ 2,989 -- --
Changes in operating assets and liabilities
Cash and securities segregated in compliance with U.S.
federal and other regulations........................... (1,248) (2,984) (670)
Net receivables from brokers, dealers and clearing
organizations........................................... 1,453 (789) (1,599)
Net payables to customers and counterparties.............. (3,990) 14,664 5,029
Securities borrowed, net.................................. (11,179) (21,158) (10,814)
Financial instruments owned, at fair value................ (13,718) 148 (7,439)
Financial instruments sold, but not yet purchased, at fair
value................................................... 9,059 7,559 11,702
Other, net................................................ 2,387 (71) 905
-------- -------- --------
Net cash (used for)/provided by operating activities.... (12,589) 62 70
Cash flows from investing activities
Property, leasehold improvements and equipment............ (656) (476) (259)
Financial instruments owned, at fair value................ 189 (180) (360)
Acquisitions, net of cash acquired........................ (187) -- (74)
-------- -------- --------
Net cash used for investing activities.................. (654) (656) (693)
Cash flows from financing activities
Short-term borrowings, net................................ 755 2,193 1,082
Securities sold under agreements to repurchase, net....... 4,304 (5,909) (4,717)
Issuance of long-term borrowings.......................... 11,000 10,527 7,734
Repayment of long-term borrowings......................... (753) (2,058) (1,855)
Capital contributions..................................... 48 9 89
Dividends paid............................................ (107) -- --
Returns on capital and certain distributions to
partners................................................ (306) (619) (557)
Termination of the profit participation plans............. -- (368) --
Proceeds from issuance of common stock.................... 2,633 -- --
Partners' capital distributions, net...................... (4,112) -- --
Partners' capital allocated for income taxes and potential
withdrawals............................................. -- (1,673) (2,034)
-------- -------- --------
Net cash provided by/(used for) financing activities.... 13,462 2,102 (258)
Net increase/(decrease) in cash and cash equivalents.... 219 1,508 (881)
Cash and cash equivalents, beginning of year.............. 2,836 1,328 2,209
-------- -------- --------
Cash and cash equivalents, end of year.................... $ 3,055 $ 2,836 $ 1,328
======== ======== ========
- ---------------
SUPPLEMENTAL DISCLOSURES:
Cash payments for interest approximated the related expense for each of the
fiscal years presented. Payments of income taxes were $463 million for the year
ended November 1999 and were immaterial for the years ended November 1998 and
1997.
Noncash activities:
In connection with the firm's conversion to corporate form, junior
subordinated debentures of $371 million were issued to retired limited partners
in exchange for their partnership interests.
Common stock issued in connection with acquisitions was $245 million in
1999.
The accompanying notes are an integral part of these consolidated financial
statements.
50
6
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEAR ENDED NOVEMBER
-------------------
1999 1998 1997
---- ---- ----
(IN MILLIONS)
Net earnings................................................ $2,708 $2,428 $2,746
Other comprehensive income, net of tax
Currency translation adjustment........................... 37 (31) (28)
------ ------ ------
Comprehensive income........................................ $2,745 $2,397 $2,718
====== ====== ======
The accompanying notes are an integral part of these consolidated financial
statements.
51
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1/DESCRIPTION OF BUSINESS
The Goldman Sachs Group, Inc. (Group Inc.), a Delaware corporation,
together with its consolidated subsidiaries (collectively, the firm), is a
global investment banking and securities firm that provides a wide range of
financial services worldwide to a substantial and diversified client base. On
May 7, 1999, the firm converted from a partnership to a corporation and
completed its initial public offering.
The firm's activities are divided into two business segments:
GLOBAL CAPITAL MARKETS. This segment comprises Investment Banking, which
includes Financial Advisory and Underwriting, and Trading and Principal
Investments, which includes Fixed Income, Currency and Commodities (FICC),
Equities and Principal Investments (Principal Investments primarily represents
net revenues from the firm's merchant banking investments); and
ASSET MANAGEMENT AND SECURITIES SERVICES. This segment comprises Asset
Management, Securities Services and Commissions.
NOTE 2/SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Group Inc.
and its U.S. and international subsidiaries including Goldman, Sachs & Co.
(GS&Co.) and J. Aron & Company in New York, Goldman Sachs International (GSI) in
London and Goldman Sachs (Japan) Ltd. (GSJL) in Tokyo. Certain reclassifications
have been made to prior-year amounts to conform to the current-year
presentation. All material intercompany transactions and balances have been
eliminated.
These consolidated financial statements have been prepared in accordance
with generally accepted accounting principles that require management to make
estimates and assumptions regarding trading inventory valuations, the outcome of
pending litigation, and other matters that affect the consolidated financial
statements and related disclosures. These estimates and assumptions are based on
judgment and available information and, consequently, actual results could be
materially different from these estimates.
Unless otherwise stated herein, all references to 1999, 1998 and 1997 refer
to the firm's fiscal year ended, or the date, as the context requires, November
26, 1999, November 27, 1998 and November 28, 1997, respectively.
CASH AND CASH EQUIVALENTS
The firm defines cash equivalents as highly liquid overnight deposits held
in the ordinary course of business.
REPURCHASE AGREEMENTS AND COLLATERALIZED FINANCING ARRANGEMENTS
Securities purchased under agreements to resell and securities sold under
agreements to repurchase, principally U.S. government, federal agency and
investment-grade non-U.S. sovereign obligations, represent short-term
collateralized financing transactions and are carried at their contractual
amounts plus accrued interest. These amounts are presented on a net-by-
counterparty basis where management believes a legal right of setoff exists
under an enforceable netting agreement. The firm takes possession of securities
purchased under agreements to resell, monitors the market value of these
securities on a daily basis and obtains additional collateral as appropriate.
Securities borrowed and loaned are recorded on the statements of financial
condition based on the amount of cash collateral advanced or received. These
transactions are generally collateralized by either cash, securities or letters
of credit. The firm takes possession of securities borrowed, monitors the market
value of securities loaned and obtains additional collateral as appropriate.
Income or expense is recognized as interest over the life of the transaction.
52
8
FINANCIAL INSTRUMENTS
Gains and losses on financial instruments and commission income and related
expenses are recorded on a trade date basis in the consolidated statements of
earnings. The consolidated statement of financial condition as of November 1999
generally reflects purchases and sales of financial instruments, including
agency transactions, on a trade date basis. The consolidated statement of
financial condition as of November 1998 generally reflects these transactions on
a settlement date basis. Recording these transactions on a trade date basis
would not have resulted in a material adjustment to the consolidated statement
of financial condition as of November 1998.
Substantially all financial instruments used in the firm's trading and
nontrading activities are carried at fair value or amounts that approximate fair
value, and unrealized gains and losses are recognized in earnings. Fair value is
based generally on listed market prices or broker or dealer price quotations. To
the extent that prices are not readily available, or if liquidating the firm's
position is reasonably expected to affect market prices, fair value is based on
either internal valuation models or management's estimate of amounts that could
be realized under current market conditions, assuming an orderly liquidation
over a reasonable period of time. Certain over-the-counter (OTC) derivative
instruments are valued using pricing models that consider, among other factors,
current and contractual market prices, time value, and yield curve and/or
volatility factors of the underlying positions. The fair value of the firm's
trading and nontrading assets and liabilities is discussed further in Notes 3, 4
and 5.
PRINCIPAL INVESTMENTS
Principal investments are carried at fair value, generally based upon
quoted market prices or comparable substantial third-party transactions. Where
fair value is not readily ascertainable, principal investments are recorded at
cost or management's estimate of the realizable value.
The firm is entitled to receive merchant banking overrides (i.e., an
increased share of a fund's income and gains) when the return on the fund's
investments exceeds certain threshold returns. Overrides are based on investment
performance over the life of each merchant banking fund, and future investment
underperformance may require amounts previously distributed to the firm to be
returned to the funds. Accordingly, overrides are recognized in earnings only
when management determines that the probability of return is remote. Overrides
are included in "Asset management and securities services" on the consolidated
statements of earnings.
DERIVATIVE CONTRACTS
Derivatives used for trading purposes are reported at fair value and are
included in "Derivative contracts" on the consolidated statements of financial
condition. Gains and losses on derivatives used for trading purposes are
generally included in "Trading and principal investments" on the consolidated
statements of earnings.
Derivatives used for nontrading purposes include interest rate futures
contracts and interest rate and currency swap agreements, which are primarily
utilized to convert a substantial portion of the firm's fixed rate debt into
U.S. dollar-based floating rate obligations. Gains and losses on these
derivatives are generally deferred and recognized as adjustments to interest
expense over the life of the derivative contract. Gains and losses resulting
from the early termination of derivatives used for nontrading purposes are
generally deferred and recognized over the remaining life of the underlying
debt. If the underlying debt is terminated prior to its stated maturity, gains
and losses on these transactions, including the associated hedges, are
recognized in earnings immediately.
Derivatives are reported on a net-by-counterparty basis on the consolidated
statements of financial condition where management believes a legal right of
setoff exists under an enforceable netting agreement.
PROPERTY, LEASEHOLD IMPROVEMENTS AND EQUIPMENT
Depreciation and amortization generally are computed using accelerated cost
recovery methods for all property and equipment and for leasehold improvements
where the term of the lease is greater than the economic useful life of the
asset. All other leasehold improvements are amortized on a straight-line basis
over the term of the lease.
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GOODWILL
The cost of acquired companies in excess of the fair value of net assets at
acquisition date is recorded as goodwill and amortized over periods of 15 to 20
years on a straight-line basis.
INVESTMENT BANKING
Underwriting revenues and fees from mergers and acquisitions and other
corporate finance advisory assignments are recorded when the underlying
transaction is completed under the terms of the engagement. Syndicate expenses
related to securities offerings in which the firm acts as an underwriter or
agent are deferred until the related revenue is recognized.
EARNINGS PER SHARE
Earnings per share (EPS) is computed in accordance with Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." Basic EPS
is calculated by dividing net earnings by the weighted average number of common
shares outstanding. Common shares outstanding includes common stock and
nonvoting common stock as well as restricted stock units for which no future
service is required as a condition to the delivery of the underlying common
stock. Diluted EPS includes the determinants of basic EPS and, in addition,
reflects the dilutive effect of common stock deliverable pursuant to the
restricted stock units and stock options for which future service is required as
a condition to the delivery of the underlying common stock.
STOCK-BASED COMPENSATION
The firm has elected to account for stock-based employee compensation plans
in accordance with Accounting Principles Board Opinion (APB) No. 25, "Accounting
for Stock Issued to Employees," as permitted by SFAS No. 123, "Accounting for
Stock-Based Compensation." In accordance with APB No. 25, compensation expense
is not recognized for stock options that have no intrinsic value on the date of
grant. Compensation expense is recognized immediately for restricted stock units
for which future service is not required as a condition to the delivery of the
underlying shares of common stock. For restricted stock units with future
service requirements, compensation expense is recognized over the relevant
vesting period using an accelerated amortization methodology.
INCOME TAXES
The firm accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," which requires the recognition of tax benefits or
expenses on the temporary differences between the financial reporting and tax
bases of its assets and liabilities. As a partnership, the firm was primarily
subject to unincorporated business taxes and taxes in foreign jurisdictions on
certain of its operations. As a corporation, the earnings of the firm are
subject to U.S. federal, foreign, state and local taxes. As a result of its
conversion to corporate form, the firm recognized the tax effect of the change
in its income tax rate on both its deferred tax assets and liabilities and the
earnings attributable to the period from May 7, 1999 to the end of the fiscal
year. The firm's tax assets and liabilities are presented as a component of
"Other assets" and "Other liabilities and accrued expenses," respectively, on
the consolidated statements of financial condition.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities denominated in non-U.S. currencies are translated at
rates of exchange prevailing on the date of the statement of financial
condition, and revenues and expenses are translated at average rates of exchange
for the fiscal year. Gains or losses on translation of the financial statements
of a non-U.S. operation, where the functional currency is other than the U.S.
dollar, are reflected as a separate component of equity. Gains or losses on
foreign currency transactions are included in the consolidated statements of
earnings.
As a partnership, the firm reported the cumulative translation adjustment
as a component of "Partners' capital allocated for income taxes and potential
withdrawals" on the consolidated statement of financial condition. Effective
with the firm's conversion to corporate form, the cumulative translation
adjustment is reported as "Accumulated other comprehensive income" on the
consolidated statement of financial condition.
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10
ACCOUNTING DEVELOPMENTS
In June 1999, the Financial Accounting Standards Board issued SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities -- Deferral of the
Effective Date of FASB Statement No. 133 -- an amendment of FASB Statement No.
133," which deferred to fiscal years beginning after June 15, 2000 the effective
date of the accounting and reporting requirements of SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities." 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 in the statement of
financial condition and measure those instruments at fair value. The accounting
for changes in the fair value of a derivative instrument depends on its intended
use and the resulting designation. The firm intends to adopt the provisions of
SFAS No. 133 deferred by SFAS No. 137 in fiscal 2001 and is currently assessing
their effect.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position (SOP) No.
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," effective for fiscal years beginning after December 15, 1998. SOP
No. 98-1 requires that certain costs of computer software developed or obtained
for internal use be capitalized and amortized over the useful life of the
related software. The firm previously expensed the cost of all software
development in the period it was incurred. The adoption of SOP No. 98-1 is not
expected to have a material effect on the firm's results of operations or
financial condition. The firm intends to adopt the provisions of SOP No. 98-1 in
fiscal 2000.
NOTE 3/FINANCIAL INSTRUMENTS
Financial instruments, including both cash instruments and derivatives, are
used to manage market risk, facilitate customer transactions, engage in
proprietary transactions and meet financing objectives. These instruments can be
either executed on an exchange or negotiated in the OTC market.
Transactions involving financial instruments sold, but not yet purchased,
entail an obligation to purchase a financial instrument at a future date. The
firm may incur a loss if the market value of the financial instrument
subsequently increases prior to the purchase of the instrument.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the firm's assets and liabilities are carried at fair
value or amounts that approximate fair value.
Trading assets and liabilities, including derivative contracts used for
trading purposes, are carried at fair value and reported as financial
instruments owned and financial instruments sold, but not yet purchased, on the
consolidated statements of financial condition. Nontrading assets and
liabilities are generally carried at fair value or amounts that approximate fair
value.
Nontrading assets include cash and cash equivalents; cash and securities
segregated in compliance with U.S. federal and other regulations; receivables
from brokers, dealers and clearing organizations; receivables from customers and
counterparties; securities borrowed; securities purchased under agreements to
resell; right to receive securities; and certain investments, primarily those
made in connection with the firm's merchant banking activities.
Nontrading liabilities include short-term borrowings; payables to brokers,
dealers and clearing organizations; payables to customers and counterparties;
securities loaned; securities sold under agreements to repurchase; obligation to
return securities; other liabilities and accrued expenses; and long-term
borrowings. The fair value of the firm's long-term borrowings and associated
hedges is discussed in Note 5.
TRADING AND PRINCIPAL INVESTMENTS
The firm's Trading and Principal Investments business, a component of the
Global Capital Markets segment, facilitates customer transactions and takes
proprietary positions through market making in and trading of securities,
currencies, commodities and swaps, and other derivatives. Derivative financial
instruments are often used to hedge cash instruments or other derivative
financial instruments as an integral part of the firm's strategies. As a result,
it is necessary to view the results of any activity on a fully integrated basis,
including cash positions, the
55
11
effect of related derivatives and the financing of the underlying positions.
Net revenues include allocations of interest income and expense to specific
securities, commodities and other positions in relation to the cash generated
by, or funding requirements of, the underlying positions.
The following table sets forth the net revenues of Trading and Principal
Investments:
YEAR ENDED NOVEMBER
--------------------------
1999 1998 1997
---- ---- ----
(IN MILLIONS)
FICC................................................... $2,862 $1,438 $2,055
Equities............................................... 1,961 795 573
Principal Investments.................................. 950 146 298
------ ------ ------
Total........................................ $5,773 $2,379 $2,926
====== ====== ======
RISK MANAGEMENT
The firm seeks to monitor and control its risk exposure through a variety
of separate but complementary financial, credit, operational and legal reporting
systems. Management believes that it has effective procedures for evaluating and
managing the market, credit and other risks to which it is exposed. The
Management Committee, the firm's primary decision-making body, determines (both
directly and through delegated authority) the types of business in which the
firm engages, approves guidelines for accepting customers for all product lines,
outlines the terms under which customer business is conducted and establishes
the parameters for the risks that the firm is willing to undertake in its
business.
The Firmwide Risk Committee, which reports to senior management and meets
weekly, is responsible for managing and monitoring all of the firm's risk
exposures. In addition, the firm maintains segregation of duties, with credit
review and risk-monitoring functions performed by groups that are independent
from revenue-producing departments.
MARKET RISK. The potential for changes in the market value of the firm's
trading positions is referred to as "market risk." The firm's trading positions
result from underwriting, market-making and proprietary trading activities.
Categories of market risk include exposures to interest rates, currency
rates, equity prices and commodity prices. A description of each market risk
category is set forth below:
- Interest rate risks primarily result from exposures to changes in the
level, slope and curvature of the yield curve, the volatility of interest
rates, mortgage prepayment speeds and credit spreads.
- Currency rate risks result from exposures to changes in spot prices,
forward prices and volatilities of currency rates.
- Equity price risks result from exposures to changes in prices and
volatilities of individual equities, equity baskets and equity indices.
- Commodity price risks result from exposures to changes in spot prices,
forward prices and volatilities of commodities, such as electricity,
natural gas, crude oil, petroleum products, and precious and base metals.
These risk exposures are managed through diversification, by controlling
position sizes and by establishing hedges in related securities or derivatives.
For example, the firm may hedge a portfolio of common stock by taking an
offsetting position in a related equity-index futures contract. The ability to
manage these exposures may, however, be limited by adverse changes in the
liquidity of the security or the related hedge instrument and in the correlation
of price movements between the security and the related hedge instrument.
CREDIT RISK. Credit risk represents the loss that the firm would incur if
a counterparty or issuer of securities or other instruments held by the firm
fails to perform its contractual obligations to the firm. To reduce credit
exposures, the firm seeks to enter into netting agreements with counterparties
that permit the firm to offset receivables and payables with such
counterparties. In addition, the firm attempts to further reduce credit risk by
entering into agreements that enable us to obtain collateral from a
counterparty, to terminate or reset the terms of transactions after specified
time periods or upon the occurrence of credit-related events, by seeking
third-party guarantees of the counterparty's obligations, and through the use of
credit derivatives.
Credit concentrations may arise from trading, underwriting and securities
borrowing activities and may be impacted by changes in economic, industry or
political factors. The firm's concentration of credit risk is monitored actively
by the Credit Policy Committee. As of
56
12
November 1999 and 1998, U.S. government and federal agency obligations
represented 7% of the firm's total assets. In addition, most of the firm's
securities purchased under agreements to resell are collateralized by U.S.
government, federal agency and other sovereign obligations.
DERIVATIVE ACTIVITIES
Most of the firm's derivative transactions are entered into for trading
purposes. The firm uses derivatives in its trading activities to facilitate
customer transactions, to take proprietary positions and as a means of risk
management. The firm also enters into nontrading derivative contracts to manage
the interest rate and currency exposure on its long-term borrowings. Nontrading
derivatives related to the firm's long-term borrowings are discussed in Note 5.
Derivative contracts are financial instruments, such as futures, forwards,
swaps or option contracts, that derive their value from underlying assets,
indices, reference rates or a combination of these factors. Derivatives may
involve future commitments to purchase or sell financial instruments or
commodities, or to exchange currency or interest payment streams. The amounts
exchanged are based on the specific terms of the contract with reference to
specified rates, securities, commodities or indices.
Derivative contracts exclude certain cash instruments, such as
mortgage-backed securities, interest-only and principal-only obligations, and
indexed debt instruments, that derive their values or contractually required
cash flows from the price of some other security or index. Derivatives also
exclude option features that are embedded in cash instruments, such as the
conversion features and call provisions embedded in bonds. The firm has elected
to include commodity-related contracts in its derivative disclosure, although
not required to do so, as these contracts may be settled in cash or are readily
convertible into cash.
The gross notional (or contractual) amounts of derivative financial
instruments represent the volume of these transactions and not the amounts
potentially subject to market risk. In addition, measurement of market risk is
meaningful only when all related and offsetting transactions are taken into
consideration.
Gross notional (or contractual) amounts of derivative financial instruments
used for trading purposes with off-balance-sheet market risk are set forth
below:
AS OF NOVEMBER
------------------------
1999 1998
---- ----
(IN MILLIONS)
Interest Rate
Financial futures and forward settlement
contracts....................................... $ 422,465 $ 406,302
Swap agreements................................... 2,581,100 1,848,977
Written option contracts.......................... 509,841 423,561
Equity
Financial futures and forward settlement
contracts....................................... 10,082 7,405
Swap agreements................................... 3,423 2,752
Written option contracts.......................... 113,653 54,856
Currency and Commodity
Financial futures and forward settlement
contracts....................................... 460,941 420,138
Swap agreements................................... 110,159 51,502
Written option contracts.......................... 193,989 183,929
57
13
Market risk on purchased option contracts is limited to the market value of
the option; therefore, purchased option contracts have no off-balance-sheet
market risk.
The gross notional (or contractual) amounts of purchased option contracts
used for trading purposes are set forth below:
AS OF NOVEMBER
--------------------
1999 1998
---- ----
(IN MILLIONS)
Purchased Option Contracts
Interest rate........................................ $484,104 $509,770
Equity............................................... 114,680 59,571
Currency and commodity............................... 210,421 186,748
The firm utilizes replacement cost as a measure of derivative credit risk.
Replacement cost, as reported in "Financial instruments owned, at fair value" on
the consolidated statements of financial condition, represents amounts
receivable from various counterparties, net of any unrealized losses, owed where
management believes a legal right of setoff exists under an enforceable netting
agreement. Replacement cost for purchased option contracts is the market value
of the contract. The firm controls its credit risk through an established credit
approval process, by monitoring counterparty limits, obtaining collateral where
appropriate and, in some cases, entering into enforceable netting agreements.
The fair value of derivative financial instruments used for trading
purposes, computed in accordance with the firm's netting policy, is set forth
below:
AS OF NOVEMBER
------------------------------------------------
1999 1998
---------------------- ----------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
(IN MILLIONS)
Year End
Forward settlement contracts............. $ 4,555 $ 4,625 $ 4,061 $ 4,201
Swap agreements.......................... 12,052 11,587 10,000 11,475
Option contracts......................... 14,018 12,274 7,140 9,038
------- ------- ------- -------
Total.................................... $30,625 $28,486 $21,201 $24,714
======= ======= ======= =======
Monthly Average
Forward settlement contracts............. $ 3,877 $ 3,619 $ 4,326 $ 3,979
Swap agreements.......................... 10,414 11,210 7,340 8,158
Option contracts......................... 9,249 9,707 6,696 8,958
------- ------- ------- -------
Total.................................... $23,540 $24,536 $18,362 $21,095
======= ======= ======= =======
58
14
NOTE 4/SHORT-TERM BORROWINGS
The firm obtains secured short-term financing principally through the use
of repurchase agreements and securities lending agreements, collateralized
mainly by U.S. government, federal agency, investment-grade foreign sovereign
obligations and equity securities. The firm obtains unsecured short-term
borrowings through issuance of commercial paper, promissory notes and bank
loans. The carrying value of these short-term obligations approximates fair
value due to their short-term nature.
Short-term borrowings are set forth below:
AS OF NOVEMBER
------------------
1999 1998
---- ----
(IN MILLIONS)
Commercial paper....................................... $ 9,403 $10,008
Promissory notes....................................... 11,061 10,763
Bank loans and other(1)................................ 17,292 6,659
------- -------
Total(2)............................................... $37,756 $27,430
======= =======
- ---------------
(1) As of November 1999 and November 1998, short-term borrowings included $10.82
billion and $2.96 billion, respectively, of long-term borrowings maturing
within one year.
(2) As of November 1999 and November 1998, weighted average interest rates for
short-term borrowings, including commercial paper, were 5.66% and 5.19%,
respectively.
The firm maintains unencumbered securities with a market value in excess of
all uncollateralized short-term borrowings.
NOTE 5/LONG-TERM BORROWINGS
The firm's long-term borrowings are set forth below:
AS OF NOVEMBER
------------------
1999 1998
---- ----
(IN MILLIONS)
Fixed Rate Obligations(1)
U.S. dollar.......................................... $ 8,236 $ 5,260
Non-U.S. dollar...................................... 1,980 2,066
Floating Rate Obligations(2)
U.S. dollar.......................................... 9,697 11,858
Non-U.S. dollar...................................... 1,039 722
------- -------
Total(3)............................................... $20,952 $19,906
======= =======
- ---------------
(1) During 1999 and 1998, interest rates on U.S. dollar fixed rate obligations
ranged from 5.56% to 12.00% and from 5.74% to 10.10%, respectively. During
1999 and 1998, non-U.S. dollar fixed rate obligations interest rates ranged
from 0.85% to 9.51% and from 1.90% to 9.51%, respectively.
(2) Floating interest rates generally are based on LIBOR, the U.S. treasury bill
rate or the federal funds rate. Certain equity-linked and indexed
instruments are included in floating rate obligations.
(3) Long-term borrowings bear fixed or floating interest rates and have
maturities that range from one to 30 years from the date of issue.
59
15
Long-term borrowings by maturity date are set forth below:
AS OF NOVEMBER
----------------------------------------------------------------
1999 1998
------------------------------ ------------------------------
U.S. NON-U.S. U.S. NON-U.S.
DOLLAR DOLLAR TOTAL DOLLAR DOLLAR TOTAL
------ -------- ----- ------ -------- -----
(IN MILLIONS)
Maturity Dates
1999....................... $ -- $ -- $ -- $ 2,443 $ 199 $ 2,642
2000....................... 2,527 114 2,641 4,293 272 4,565
2001....................... 3,145 327 3,472 2,261 148 2,409
2002....................... 1,638 594 2,232 1,669 265 1,934
2003....................... 1,522 404 1,926 1,409 412 1,821
2004....................... 1,857 134 1,991 1,310 43 1,353
2005 - Thereafter.......... 7,244 1,446 8,690 3,733 1,449 5,182
------- ------ ------- ------- ------ -------
Total............ $17,933 $3,019 $20,952 $17,118 $2,788 $19,906
======= ====== ======= ======= ====== =======
The firm enters into nontrading derivative contracts, such as interest rate
and currency swap agreements, to effectively convert a substantial portion of
its fixed rate long-term borrowings into U.S. dollar-based floating rate
obligations. Accordingly, the aggregate carrying value of these long-term
borrowings and related hedges approximates fair value.
The effective weighted average interest rates for long-term borrowings,
after hedging activities, are set forth below:
AS OF NOVEMBER
-----------------------------------
1999 1998
---------------- ---------------
AMOUNT RATE AMOUNT RATE
------ ---- ------ ----
($ IN MILLIONS)
Fixed rate obligations........................ $ 650 10.17% $ 222 8.09%
Floating rate obligations..................... 20,302 6.03 19,684 5.63
------- -------
Total............................... $20,952 6.16 $19,906 5.66
As of November 1999 and November 1998, the notional amounts of the related
swap agreements used for nontrading purposes were $12.94 billion and $10.21
billion, respectively.
The fair value and carrying value of these agreements are set forth below:
AS OF NOVEMBER
------------------------------------------------
1999 1998
--------------------- ---------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
(IN MILLIONS)
Fair value................................. $ 3 $159 $519 $7
Carrying value............................. 36 2 98 8
60
16
NOTE 6/COMMITMENTS AND CONTINGENCIES
LITIGATION
The firm is involved in a number of judicial, regulatory and arbitration
proceedings concerning matters arising in connection with the conduct of its
businesses. Management believes, based on currently available information, that
the results of such proceedings, in the aggregate, will not have a material
adverse effect on the firm's financial condition, but might be material to the
firm's operating results for any particular period, depending, in part, upon the
operating results for such period.
LEASES
The firm has obligations under long-term noncancelable lease agreements,
principally for office space, expiring on various dates through 2019. Certain
agreements are subject to periodic escalation charges for increases in real
estate taxes and other charges. Minimum rental commitments, net of minimum
sublease rentals, under noncancelable leases for 2000 and the succeeding four
years and thereafter and rent charged to operating expense for the last three
years are set forth below:
(IN MILLIONS)
Minimum Rental Commitments
2000.................................................... $ 203
2001.................................................... 183
2002.................................................... 182
2003.................................................... 181
2004.................................................... 154
2005 - Thereafter....................................... 836
------
Total......................................... $1,739
======
Net Rent Expense
1999.................................................... $ 154
1998.................................................... 104
1997.................................................... 87
OTHER COMMITMENTS
The firm acts as an investor in merchant banking transactions, which
includes making long-term investments in equity and debt securities in privately
negotiated transactions, corporate acquisitions and real estate transactions. In
connection with these activities, the firm had commitments to invest up to $1.09
billion and $1.39 billion in corporate and real estate merchant banking
investment funds and a bridge loan fund as of November 1999 and November 1998,
respectively.
In connection with loan origination and participation, the firm had loan
commitments of $9.38 billion and $1.51 billion as of November 1999 and November
1998, respectively. These commitments are agreements to lend to counterparties,
have fixed termination dates and are contingent on all conditions to borrowing
set forth in the contract having been met. Since these commitments may expire
unused, the total commitment amount does not necessarily reflect the actual
future cash flow requirements.
The firm also had outstanding guarantees of $575 million and $790 million
relating to its fund management activities as of November 1999 and November
1998, respectively.
The firm had pledged securities of $35.83 billion and $22.88 billion as
collateral for securities borrowed of approximately equivalent value as of
November 1999 and November 1998, respectively.
The firm had commitments to enter into repurchase and resale agreements of
$30.58 billion and $46.26 billion as of November 1999 and November 1998,
respectively.
The firm provides letters of credit issued by various banks to
counterparties in lieu of securities or cash to satisfy various collateral and
margin deposit requirements. Letters of credit outstanding were $10.30 billion
and $8.81 billion as of November 1999 and November 1998, respectively.
61
17
NOTE 7/EQUITY CAPITAL
On May 7, 1999, the firm converted from a partnership to a corporation and
completed its initial public offering. In that offering, the firm sold
51,000,000 shares of common stock. In addition, the firm completed a number of
transactions to have Group Inc. succeed to the business of The Goldman Sachs
Group, L.P. These transactions included the exchange of the partnership
interests of the participating limited partners (PLPs), retired limited
partners, Sumitomo Bank Capital Markets, Inc. and Kamehameha Activities
Association for shares of common stock. As of November 1999, the firm had equity
of $10.15 billion.
Shares of nonvoting common stock are convertible into shares of common
stock on a one-for-one basis upon transfer by Sumitomo Bank Capital Markets,
Inc., the beneficial owner of such shares as of November 1999, to a third party,
and in certain other circumstances.
As of November 1998, the firm had $6.31 billion in partners' capital, which
included both the general partner's and limited partners' capital. Partners'
capital allocated for income taxes and potential withdrawals represented
management's estimate of net amounts distributable, primarily to the PLPs, under
the Partnership Agreement, for items including, among other things, income taxes
and capital withdrawals.
NOTE 8/EARNINGS PER SHARE
The computations of basic and diluted EPS are set forth below:
YEAR ENDED
NOVEMBER 1999
-------------
(IN MILLIONS, EXCEPT SHARE
AND PER SHARE AMOUNTS)
Numerator for basic and diluted EPS -- earnings
available to common stockholders.................... $2,708
===========
Denominator for basic EPS -- weighted average number
of common shares.................................... 475,883,756
Effect of dilutive securities
Restricted stock units.............................. 5,657,350
Stock options....................................... 4,262,854
-----------
Dilutive potential common shares...................... 9,920,204
-----------
Denominator for diluted EPS -- weighted average number
of common shares and dilutive potential common
shares.............................................. 485,803,960
===========
Basic EPS............................................. $ 5.69
Diluted EPS........................................... 5.57
NOTE 9/EMPLOYEE BENEFIT PLANS
The firm sponsors various pension plans and certain other postretirement
benefit plans, primarily healthcare and life insurance, which cover most
employees worldwide. The firm also provides certain benefits to former or
inactive employees prior to retirement. A summary of these plans is set forth
below:
DEFINED BENEFIT PENSION PLANS AND POSTRETIREMENT PLANS
The firm maintains a defined benefit pension plan for substantially all
U.S. employees. Employees of certain non-U.S. subsidiaries participate in
various local defined benefit plans. These plans generally provide benefits
based on years of credited service and a percentage of the employee's eligible
compensation. In addition, the firm has unfunded postretirement benefit plans
that provide medical and life insurance for eligible retirees, employees and
dependents in the United States.
62
18
The following tables provide a summary of the changes in the plans'
projected benefit obligations and the fair value of assets for 1999 and 1998,
and a statement of the funded status of the plans as of November 1999 and
November 1998:
NOVEMBER 1999 NOVEMBER 1998
------------------------------- -------------------------------
U.S. NON-U.S. POST- U.S. NON-U.S. POST-
PENSION PENSION RETIREMENT PENSION PENSION RETIREMENT
------- -------- ---------- ------- -------- ----------
(IN MILLIONS)
Benefit Obligation
Balance, beginning of year............. $108 $120 $ 60 $ 90 $ 77 $ 52
Service cost........................... 4 15 3 3 11 2
Interest cost.......................... 8 5 4 7 4 4
Actuarial (gain)/loss.................. (10) (4) (4) 10 30 4
Benefits paid.......................... (2) (4) (2) (2) (1) (2)
Effect of foreign exchange rates....... -- 6 -- -- (1) --
---- ---- ---- ---- ---- ----
Balance, end of year................... $108 $138 $ 61 $108 $120 $ 60
==== ==== ==== ==== ==== ====
Fair Value of Plan Assets
Balance, beginning of year............. $133 $ 75 $ -- $131 $ 56 $ --
Actual return on plan assets........... 17 11 -- 4 11 --
Firm contributions..................... -- 26 2 -- 10 3
Benefits paid.......................... (2) (4) (2) (2) (1) (3)
Effect of foreign exchange rates....... -- 2 -- -- (1) --
---- ---- ---- ---- ---- ----
Balance, end of year................... $148 $110 $ -- $133 $ 75 $ --
==== ==== ==== ==== ==== ====
Prepaid/(Accrued) Benefit Cost
Funded Status.......................... $ 40 $(28) $(61) $ 25 $(45) $(60)
Unrecognized actuarial loss............ 2 14 5 20 23 9
Unrecognized transition obligation..... (37) 23 -- (40) 22 --
Unrecognized prior service cost........ -- -- (2) -- -- (2)
---- ---- ---- ---- ---- ----
Prepaid/(accrued) benefit cost......... $ 5 $ 9 $(58) $ 5 $ -- $(53)
==== ==== ==== ==== ==== ====
For plans in which the accumulated benefit obligation exceeded plan assets,
the projected benefit obligation and aggregate accumulated benefit obligation
was $138 million and $121 million as of November 1999, respectively, and $85
million and $85 million as of November 1998, respectively. The fair value of
plan assets for these plans was $110 million and $57 million as of November 1999
and November 1998, respectively. For plans in which the accumulated benefit
obligation exceeded the fair value of plan assets, the effect of recognizing
this amount would not have been material to the consolidated statements of
financial condition or comprehensive income.
63
19
The components of pension expense/(income) and postretirement expense are
set forth below:
YEAR ENDED NOVEMBER 1999 YEAR ENDED NOVEMBER 1998
------------------------------- -------------------------------
U.S. NON-U.S. POST- U.S. NON-U.S. POST-
PENSION PENSION RETIREMENT PENSION PENSION RETIREMENT
------- -------- ---------- ------- -------- ----------
(IN MILLIONS)
Service cost........................... $ 4 $15 $3 $ 3 $11 $2
Interest cost.......................... 8 5 4 7 4 4
Expected return on plan assets......... (10) (5) -- (10) (4) --
Net amortization....................... (2) 3 -- (3) 2 --
---- --- -- ---- --- --
Total.................................. $ -- $18 $7 $ (3) $13 $6
==== === == ==== === ==
The weighted average assumptions used to develop net periodic pension cost
and the actuarial present value of the projected benefit obligation are set
forth below. The assumptions represent a weighted average of the assumptions
used for the U.S. and international plans and are based on the economic
environment of each applicable country.
YEAR ENDED NOVEMBER
--------------------
1999 1998 1997
---- ---- ----
Defined Benefit Pension Plans
U.S. Plans
Discount rate............................................. 7.5% 7.0% 7.5%
Rate of increase in future compensation levels............ 5.0 5.0 5.0
Expected long-term rate of return on plan assets.......... 7.5 7.5 7.5
International Plans
Discount rate............................................. 4.6 5.0 5.7
Rate of increase in future compensation levels............ 4.3 4.7 5.3
Expected long-term rate of return on plan assets.......... 6.0 6.0 7.0
Postretirement Plans
Discount rate............................................. 7.5 7.0 7.5
Rate of increase in future compensation levels............ 5.0 5.0 5.0
For measurement purposes, a 6.6% annual rate of increase in the per capita
cost of covered healthcare benefits was assumed for the fiscal year ending
November 2000. The rate was assumed to decrease gradually to 5.0% for the fiscal
year ending November 2008 and remain at that level thereafter.
64
20
The assumed cost of healthcare has an effect on the amounts reported for
the firm's healthcare plans. A 1% change in the assumed healthcare cost trend
rate would have the following effects:
1% INCREASE 1% DECREASE
------------ ------------
1999 1998 1999 1998
---- ---- ---- ----
(IN MILLIONS)
Cost................................................... $1 $1 $(1) $(1)
Obligation............................................. 9 9 (8) (7)
DEFINED CONTRIBUTION PLANS
The firm contributes to employer-sponsored U.S. and international defined
contribution plans. The firm's contribution to these plans was $94 million, $70
million and $68 million for 1999, 1998 and 1997, respectively.
The firm has also established a nonqualified defined contribution plan (the
Plan) for certain senior employees. Shares of common stock contributed to the
Plan in 1999 and outstanding as of November 1999 were 12,660,685. The shares of
common stock will vest and generally be distributable to the participant on
specified future dates if the participant satisfies certain conditions and the
participant's employment with the firm has not been terminated, with certain
exceptions for terminations of employment due to death or a change in control.
Dividends on the underlying shares of common stock are paid currently to the
participants. Forfeited shares remain in the Plan and are reallocated to other
participants. Contributions to the Plan are expensed on the date of grant. Plan
expense in 1999 was $674 million, including $666 million granted in connection
with the firm's initial public offering.
NOTE 10/EMPLOYEE INCENTIVE PLANS
STOCK INCENTIVE PLAN
The firm sponsors a stock incentive plan that provides for grants of
incentive stock options, nonqualified stock options, stock appreciation rights,
dividend equivalent rights, restricted stock, restricted stock units and other
stock-based awards. The stock incentive plan also permits the making of loans to
purchase shares of common stock.
The total number of shares of common stock that may be issued under the
stock incentive plan through fiscal 2002 may not exceed 300,000,000 shares and,
in each fiscal year thereafter, may not exceed 5% of the issued and outstanding
shares of common stock, determined as of the last day of the immediately
preceding fiscal year, increased by the number of shares available for awards in
previous fiscal years but not covered by awards granted in such years. As of
November 1999, 183,440,631 shares were available for grant under the stock
incentive plan.
RESTRICTED STOCK UNITS
The firm issued restricted stock units to employees in 1999 under the stock
incentive plan, primarily in connection with its initial public offering and as
part of year-end compensation. Of the total restricted stock units outstanding
as of November 1999, (i) 40,344,481 units required future service as a condition
to the delivery of the underlying shares of common stock, and (ii) 35,703,923
units did not require future service. In all cases, delivery of the underlying
shares of common stock is conditioned on the grantee's satisfying certain other
requirements outlined in the award agreements.
65
21
The activity related to these restricted stock units during 1999 is set
forth below:
RESTRICTED STOCK UNITS OUTSTANDING
-----------------------------------
NO FUTURE SERVICE FUTURE SERVICE
REQUIRED REQUIRED
----------------- --------------
(IN MILLIONS, EXCEPT UNIT AMOUNTS)
Outstanding, beginning of year....................... -- --
Granted............................................ 36,127,314 40,780,999
Forfeited.......................................... (355,177) (436,518)
Delivered.......................................... (68,214) --
----------- -----------
Outstanding, end of year............................. 35,703,923 40,344,481
=========== ===========
Noncash compensation expense, net of forfeitures..... $2,042 $273
The future noncash compensation expense related to the restricted stock
units for which future service is required is set forth below:
COMPENSATION
EXPENSE
------------
(IN MILLIONS)
2000.................................................. $ 733
2001.................................................. 610
2002.................................................. 429
2003.................................................. 214
2004.................................................. 52
------
Total................................................. $2,038
======
STOCK OPTIONS
Stock options granted to employees during 1999 will generally become
exercisable in equal installments on or about the third, fourth and fifth
anniversaries of the date of grant if the grantee has satisfied certain
conditions and the grantee's employment with the firm has not been terminated,
with certain exceptions for terminations of employment due to death, retirement,
extended absence or a change in control. Once service requirements have been
met, these options will generally remain exercisable, subject to satisfaction of
certain conditions, until the tenth anniversary of the date of grant. Pursuant
to APB No. 25, compensation expense was not recognized for those options that
had no intrinsic value on the date of grant. The dilutive effect of these
options is included in diluted common shares outstanding under SFAS No. 128.
The activity of these stock options during 1999 is set forth below:
OPTIONS WEIGHTED AVERAGE WEIGHTED AVERAGE
OUTSTANDING EXERCISE PRICE REMAINING LIFE (YEARS)
----------- ---------------- ----------------------
Outstanding, beginning of
year.......................... -- $ -- --
Granted....................... 40,863,172 52.91 --
Exercised..................... -- -- --
Forfeited..................... (503,506) 53.00 --
----------
Outstanding, end of year........ 40,359,666 52.91 9.42
==========
66
22
The weighted average fair value of options granted through November 1999
was $16.13 per option. Fair value is estimated as of the grant date based on a
binomial option pricing model using the following weighted average assumptions:
Risk-free interest rate.................................... 6.1%
Expected life.............................................. 7 years
Expected volatility........................................ 30.0%
Dividend yield............................................. 1.0%
PRO FORMA EFFECT OF SFAS NO. 123
If the firm were to recognize compensation expense under the fair
value-based method of SFAS No. 123 with respect to options granted, net earnings
would have decreased resulting in pro forma net earnings and EPS as follows:
YEAR ENDED
NOVEMBER 1999
-------------
(IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
Net earnings, as reported....................... $2,708
Pro forma net earnings.......................... 2,650
EPS, as reported
Basic........................................... $ 5.69
Diluted......................................... 5.57
Pro forma EPS
Basic........................................... $ 5.57
Diluted......................................... 5.45
In the table above, pro forma compensation expense associated with option
grants is recognized over the relevant vesting period. The effect of applying
SFAS No. 123 in the pro forma disclosure above is not representative of the
potential pro forma effect on net earnings in future periods.
NOTE 11/INCOME TAXES
Prior to its conversion to corporate form, the firm operated as a
partnership and generally was not subject to U.S. federal and state income
taxes. The earnings of the firm, however, were subject to local unincorporated
business taxes. In addition, certain non-U.S. subsidiaries were subject to
income taxes in their local jurisdictions. The partners of the firm's
predecessor partnership were taxed on their proportionate share of the
partnership's taxable income or loss. Effective with the conversion from a
partnership to a corporation on May 7, 1999, the firm became subject to U.S.
federal, state and local corporate income taxes.
67
23
The components of the net tax (benefit)/expense reflected on the
consolidated statements of earnings are set forth below:
YEAR ENDED NOVEMBER
-------------------
1999 1998 1997
---- ---- ----
(IN MILLIONS)
Current Taxes
U.S. federal............................................. $ 16 $ 16 $ 5
State and local.......................................... 67 28 87
Non-U.S. ................................................ 588 426 144
------- ---- ----
Total current tax expense...................... 671 470 236
Deferred Taxes
U.S. federal............................................. (688) -- --
State and local.......................................... (342) (3) (4)
Non-U.S. ................................................ (357) 26 36
------- ---- ----
Total deferred tax (benefit)/expense........... (1,387) 23 32
------- ---- ----
Net tax (benefit)/expense................................ $ (716) $493 $268
======= ==== ====
Deferred income taxes reflect the net tax effects of temporary differences
between the financial reporting and tax bases of assets and liabilities. These
temporary differences result in taxable or deductible amounts in future years
and are measured using the tax rates and laws that will be in effect when such
differences are expected to reverse. In connection with the conversion from a
partnership to a corporation, the firm recognized a deferred tax benefit related
to the revaluation of net deferred tax assets recorded as a partnership.
Additionally, deferred tax assets were recorded as a result of acquisitions
during 1999.
Significant components of the firm's deferred tax assets and liabilities
are set forth below:
AS OF NOVEMBER
--------------
1999 1998
---- ----
(IN MILLIONS)
Deferred Tax Assets
Compensation and benefits................................... $1,397 $44
Foreign tax credits......................................... 140 --
Depreciation and amortization............................... 57 14
Other, net.................................................. 226 14
------ ---
1,820 72
Less: valuation allowance(1)................................ (83) --
------ ---
Total deferred tax assets......................... 1,737 72
------ ---
Deferred Tax Liabilities
Unrealized gains............................................ 257 33
------ ---
Total deferred tax liabilities.................... 257 33
------ ---
Net deferred tax assets..................................... $1,480 $39
====== ===
- ---------------
(1) Relates primarily to the ability to recognize tax benefits associated with
non-U.S. operations.
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A reconciliation of the U.S. federal statutory income tax rate to the
firm's effective income tax rate is set forth below:
YEAR ENDED NOVEMBER
----------------------------
1999 1998)(1) 1997(1)
---- -------- -------
U.S. federal statutory income tax rate................. 35.0% --% --%
Increase related to:
State and local taxes, net of U.S. income tax
effects.............................................. 5.0 0.9 2.8
Foreign................................................ -- 15.5 6.0
Other.................................................. -- 0.5 0.1
----- ---- ---
Rate before one-time events............................ 40.0 16.9 8.9
Revaluation of deferred tax assets upon change in tax
status............................................... (41.4)(2) -- --
Rate benefit for partnership period.................... (37.7)(3) -- --
Other.................................................. 3.2 -- --
----- ---- ---
Total tax (benefit)/expense............................ (35.9)% 16.9% 8.9%
===== ==== ===
- ---------------
(1) The U.S. federal statutory income tax rate is not applicable to 1998 or 1997
because the firm operated as a partnership and generally was not subject to
corporate federal income taxes. U.S. federal taxes paid by subsidiary
corporations are included in "Other" for 1998 and 1997.
(2) The deferred tax benefit recognized upon the firm's change in tax status
from partnership to corporate form primarily reflects the revaluation of the
deferred tax assets and liabilities at the firm's corporate income tax rate.
(3) The rate benefit for the partnership period relates to the firm's earnings
prior to its conversion to corporate form, which generally were not subject
to corporate income taxes.
NOTE 12/REGULATED SUBSIDIARIES
GS&Co. is a registered U.S. broker-dealer subsidiary, which is subject to
the Securities and Exchange Commission's "Uniform Net Capital Rule," and has
elected to compute its net capital in accordance with the "Alternative Net
Capital Requirement" of that rule. As of November 1999 and November 1998, GS&Co.
had regulatory net capital, as defined, of $2.92 billion and $3.25 billion,
respectively, which exceeded the amounts required by $2.31 billion and $2.70
billion, respectively.
GSI, a registered U.K. broker-dealer and subsidiary of Group Inc., is
subject to the capital requirements of the Securities and Futures Authority
Limited, and GSJL, a Tokyo-based broker-dealer, is subject to the capital
requirements of the Japanese Ministry of Finance and the Financial Supervisory
Agency. As of November 1999 and November 1998, GSI and GSJL were in compliance
with their local capital adequacy requirements.
Certain other subsidiaries of the firm are also subject to capital adequacy
requirements promulgated by authorities of the countries in which they operate.
As of November 1999 and November 1998, these subsidiaries were in compliance
with their local capital adequacy requirements.
NOTE 13/BUSINESS SEGMENTS
In reporting to management, the firm's operating results are categorized
into the following two principal segments: Global Capital Markets; and Asset
Management and Securities Services.
GLOBAL CAPITAL MARKETS
The Global Capital Markets segment includes services related to the
following:
INVESTMENT BANKING. The firm provides a broad range of investment banking
services to a diverse group of corporations, financial institutions, governments
and individuals. The firm's investment banking activities are divided into two
categories:
- FINANCIAL ADVISORY. Financial Advisory includes advisory assignments
with respect to mergers and acquisitions, divestitures, corporate defense
activities, restructurings and spin-offs; and
- UNDERWRITING. Underwriting includes public offerings and private
placements of equity and debt securities.
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TRADING AND PRINCIPAL INVESTMENTS. The firm's Trading and Principal
Investments business facilitates transactions with a diverse group of
corporations, financial institutions, governments and individuals and takes
proprietary positions through market making in and trading of fixed income and
equity products, currencies, commodities, and swaps and other derivatives.
Trading and Principal Investments is divided into three categories:
- FICC. The firm makes markets in and trades fixed income products,
currencies and commodities, structures and enters into a wide variety of
derivative transactions, and engages in proprietary trading and arbitrage
activities;
- EQUITIES. The firm makes markets in and trades equities and
equity-related products, structures and enters into equity derivative
transactions, and engages in proprietary trading and equity arbitrage;
and
- PRINCIPAL INVESTMENTS. Principal Investments primarily represents net
revenues from the firm's merchant banking investments.
ASSET MANAGEMENT AND SECURITIES SERVICES
The Asset Management and Securities Services segment includes services
related to the following:
- ASSET MANAGEMENT. Asset Management generates management fees by
providing investment advisory services to a diverse client base of
institutions and individuals;
- SECURITIES SERVICES. Securities Services includes prime brokerage,
financing services and securities lending and the firm's matched book
businesses, all of which generate revenue primarily in the form of fees
or interest rate spreads; and
- COMMISSIONS. Commissions include agency transactions for clients on
major stock and futures exchanges and revenues from the increased share
of the income and gains derived from the firm's merchant banking funds.
BASIS OF PRESENTATION
In reporting segments, certain of the firm's business lines have been
aggregated where they have similar economic characteristics and are similar in
each of the following areas: (i) the nature of the services they provide, (ii)
their methods of distribution, (iii) the types of clients they serve and (iv)
the regulatory environments in which they operate.
The firm allocates revenues and expenses between the two segments. Due to
the integrated nature of the business segments, estimates and judgments have
been made in allocating certain revenue and expense items. Transactions between
segments are based on specific criteria or approximate third-party rates. Total
operating expenses include corporate items that have not been allocated to
either business segment. The allocation process is based on the manner in which
management views the business of the firm.
The segment information presented in the table below is prepared according
to the following methodologies:
- Revenues and expenses directly associated with each segment are included
in determining pre-tax earnings.
- Net revenues in the firm's segments include allocations of interest
income and expense to specific securities, commodities and other
positions in relation to the cash generated by, or funding requirements
of, the underlying positions. Net interest is allocated to the Trading
and Principal Investments component of Global Capital Markets and the
Securities Services component of Asset Management and Securities
Services. Net interest is included within segment net revenues as it is
consistent with the way in which management assesses segment performance.
- Overhead expenses not directly allocable to specific segments are
allocated ratably based on direct segment expenses.
- The nonrecurring expenses associated with the firm's conversion to
corporate form and related transactions are not allocated to individual
segments as management excludes them in evaluating segment performance.
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26
SEGMENT OPERATING RESULTS
Management believes that the following information provides a reasonable
representation of each segment's contribution to consolidated pre-tax earnings
and total assets:
YEAR ENDED NOVEMBER
--------------------------------
1999 1998 1997
---- ---- ----
(IN MILLIONS)
Global Capital Markets
Net revenues(1)............................... $ 10,132 $ 5,747 $ 5,513
Operating expenses(2)......................... 6,232 3,978 3,228
-------- -------- --------
Pre-tax earnings(3)........................... $ 3,900 $ 1,769 $ 2,285
======== ======== ========
Segment assets................................ $127,515 $102,724 $ 99,974
======== ======== ========
Asset Management and Securities Services
Net revenues(1)............................... $ 3,213 $ 2,773 $ 1,934
Operating expenses(2)......................... 2,396 1,621 1,205
-------- -------- --------
Pre-tax earnings(3)........................... $ 817 $ 1,152 $ 729
======== ======== ========
Segment assets................................ $121,693 $114,293 $ 78,193
======== ======== ========
Total
Net revenues(1)............................... $ 13,345 $ 8,520 $ 7,447
Operating expenses(2)......................... 11,353(5) 5,599 4,433
-------- -------- --------
Pre-tax earnings.............................. $ 1,992 $ 2,921 $ 3,014
======== ======== ========
Total assets(4)............................... $250,491 $217,380 $178,401
======== ======== ========
- ---------------
(1) Net revenues include net interest as set forth in the table below:
YEAR ENDED NOVEMBER
------------------------
1999 1998 1997
---- ---- ----
(IN MILLIONS)
Global Capital Markets........................... $ 15 $ 364 $ 623
Asset Management and Securities Services......... 689 688 478
---- ------ ------
Total net interest............................... $704 $1,052 $1,101
==== ====== ======
(2) Operating expenses include depreciation and amortization as set forth in the
table below:
YEAR ENDED NOVEMBER
--------------------
1999 1998 1997
---- ---- ----
(IN MILLIONS)
Global Capital Markets.............................. $228 $158 $119
Asset Management and Securities Services............ 109 84 59
---- ---- ----
Total depreciation and amortization................. $337 $242 $178
==== ==== ====
(3) The pre-tax earnings of the firm's segments in 1999 reflect payments for
services rendered by managing directors who, prior to the firm's conversion
to corporate form, were profit participating limited partners. In prior
years, these payments were accounted for as distributions of partners'
capital rather than as compensation and benefits expense. As a result, these
payments are not reflected in the operating expenses of the firm's segments
in 1998 and 1997 and, therefore, the pre-tax earnings of the firm's segments
in these years are not comparable with 1999.
(4) Includes deferred tax assets relating to the firm's conversion to corporate
form and certain other assets that management believes are not allocable to
a particular segment.
(5) Includes the following expenses that have not been allocated to the firm's
segments: (i) nonrecurring employee initial public offering awards of $2.26
billion, (ii) the ongoing amortization of employee initial public offering
awards of $268 million and (iii) the charitable contribution to The Goldman
Sachs Foundation of $200 million made at the time of the firm's initial
public offering.
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27
The following table sets forth the net revenues of the firm's two segments:
YEAR ENDED NOVEMBER
---------------------------
1999 1998 1997
---- ---- ----
(IN MILLIONS)
Financial Advisory.................................... $ 2,270 $1,774 $1,184
Underwriting.......................................... 2,089 1,594 1,403
------- ------ ------
Investment Banking.................................... 4,359 3,368 2,587
------- ------ ------
FICC.................................................. 2,862 1,438 2,055
Equities.............................................. 1,961 795 573
Principal Investments................................. 950 146 298
------- ------ ------
Trading and Principal Investments..................... 5,773 2,379 2,926
------- ------ ------
Total Global Capital Markets.......................... 10,132 5,747 5,513
------- ------ ------
Asset Management...................................... 919 675 458
Securities Services................................... 772 730 487
Commissions........................................... 1,522 1,368 989
------- ------ ------
Total Asset Management and Securities Services........ 3,213 2,773 1,934
------- ------ ------
Total net revenues.................................... $13,345 $8,520 $7,447
======= ====== ======
GEOGRAPHIC INFORMATION
Due to the highly integrated nature of international financial markets, the
firm manages its businesses based on the profitability of the enterprise as a
whole. Accordingly, management believes that profitability by geographic region
is not necessarily meaningful.
The firm's revenues, expenses and identifiable assets are generally
allocated based on the country of domicile of the legal entity providing the
service.
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28
The following table sets forth the total net revenues, pre-tax earnings, and
identifiable assets of the firm and its consolidated subsidiaries by geographic
region allocated on the basis described above:
YEAR ENDED NOVEMBER
-------------------------------------
1999 1998 1997
---- ---- ----
(IN MILLIONS)
Net Revenues
United States.............................. $ 8,536 $ 5,133 $ 4,724
Other Americas............................. 327 308 379
United Kingdom............................. 3,103 1,893 1,570
Other Europe............................... 375 333 190
Asia....................................... 1,004 853 584
--------- --------- ---------
Total net revenues......................... $ 13,345 $ 8,520 $ 7,447
========= ========= =========
Pre-tax Earnings(1)
United States.............................. $ 2,878 $ 1,315 $ 1,737
Other Americas............................. 184 209 302
United Kingdom............................. 1,203 746 625
Other Europe............................... 198 216 89
Asia....................................... 254 435 261
Other...................................... (2,725)(3) -- --
--------- --------- ---------
Total pre-tax earnings..................... $ 1,992 $ 2,921 $ 3,014
========= ========= =========
Identifiable Assets
United States.............................. $ 238,875 $ 213,971 $ 189,622
Other Americas............................. 6,118 6,596 8,512
United Kingdom............................. 119,350 94,025 69,260
Other Europe............................... 11,737 8,820 7,555
Asia....................................... 18,088 19,536 13,085
Eliminations and other(2).................. (143,677) (125,568) (109,633)
--------- --------- ---------
Total identifiable assets.................. $ 250,491 $ 217,380 $ 178,401
========= ========= =========
- ---------------
(1) The pre-tax earnings of the firm in 1999 reflect payments for services
rendered by managing directors who, prior to the firm's conversion to
corporate form, were profit participating limited partners. In prior years,
these payments were accounted for as distributions of partners' capital
rather than as compensation and benefits expense. As a result, these
payments are not reflected in the firm's operating expenses in 1998 and 1997
and, therefore, the pre-tax earnings in these years are not comparable with
1999.
(2) Reflects eliminations and certain assets that are not allocable to a
particular geographic region.
(3) Includes the following expenses that have not been allocated to the firm's
geographic regions: (i) nonrecurring employee initial public offering awards
of $2.26 billion, (ii) the ongoing amortization of employee initial public
offering awards of $268 million and (iii) the charitable contribution to The
Goldman Sachs Foundation of $200 million made at the time of the firm's
initial public offering.
NOTE 14/SUBSEQUENT EVENTS
On December 20, 1999, the Board of Directors of Group Inc. declared a
dividend of $0.12 per share to be paid on February 24, 2000 to voting and
nonvoting common shareholders of record on January 24, 2000.
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