<PAGE> 1
Filed Pursuant to Rule 424(b)(3)
Registration No. 333-75213
Prospectus Supplement B
to
Prospectus Dated May 12, 1999
------------------------
THE GOLDMAN SACHS GROUP, INC.
6.65% Notes due 2009
------------------------
On July 9, 1999, Goldman Sachs filed its Quarterly Report on Form 10-Q for
the period ended May 28, 1999 with the Securities and Exchange Commission. A
copy of that report is attached to, and is a part of, this prospectus
supplement. You should read this prospectus supplement in conjunction with the
prospectus dated May 12, 1999.
See "Risk Factors" beginning on page 11 of the prospectus dated May 12,
1999 to read about factors you should consider before investing in the notes.
------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY
BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
Goldman, Sachs & Co., a subsidiary of Goldman Sachs, will use this
prospectus supplement in connection with offers and sales of the notes in
market-making transactions.
Goldman, Sachs & Co.
------------------------
Prospectus Supplement dated July 9, 1999.
<PAGE> 2
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED MAY 28, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD TO
THE GOLDMAN SACHS GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 13-4019460
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
85 BROAD STREET, NEW YORK, NY 10004
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
(212) 902-1000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
REPORT)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [ ] Yes [X] No
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. [ ] Yes [ ] No
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of May 28, 1999, there were 467,271,909 shares of the registrant's
common stock outstanding, including 30,025,946 shares of common stock underlying
the restricted stock units awarded to employees in connection with the
registrant's initial public offering for which future service is not required as
a condition to the delivery of the underlying shares of common stock. In
addition, there were 7,440,362 shares of the registrant's nonvoting common stock
outstanding as of May 28, 1999.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 3
THE GOLDMAN SACHS GROUP, INC.
FORM 10-Q
<TABLE>
<CAPTION>
Page No.
PART I: FINANCIAL INFORMATION --------
<S> <C> <C>
Item 1: Financial Statements (Unaudited):
Condensed Consolidated Statements of Earnings for the
periods ended May 28, 1999 and May 29, 1998............... 2
Condensed Consolidated Statements of Financial Condition as
of May 28, 1999 and November 27, 1998..................... 3
Condensed Consolidated Statements of Changes in
Stockholders' Equity and Partners' Capital for the periods
ended May 28, 1999 and November 27, 1998.................. 4
Condensed Consolidated Statements of Cash Flows for the
periods ended May 28, 1999 and May 29, 1998............... 5
Notes to Condensed Consolidated Financial Statements........ 6
Review Report of Independent Accountants.................... 17
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 18
Item 3: Quantitative and Qualitative Disclosures About Market
Risk...................................................... 31
PART II: OTHER INFORMATION
Item 1: Legal Proceedings........................................... 31
Item 2: Changes in Securities and Use of Proceeds................... 32
Item 5: Other Information........................................... 33
Item 6: Exhibits and Reports on Form 8-K............................ 34
Signatures............................................................ 36
</TABLE>
1
<PAGE> 4
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MAY SIX MONTHS ENDED MAY
--------------------------- ---------------------------
1999 1998 1999 1998
---- ---- ---- ----
(in millions, except share and per share amounts)
<S> <C> <C> <C> <C>
REVENUES:
Investment banking................ $ 1,002 $ 954 $ 1,904 $ 1,587
Trading and principal
investments..................... 1,719 1,311 3,117 2,426
Asset management and securities
services........................ 616 469 1,159 981
Interest income................... 3,018 3,829 6,031 7,472
------------ ------------ ------------ ------------
Total revenues............... 6,355 6,563 12,211 12,466
Interest expense, principally on
short-term funding.............. 2,886 3,574 5,747 7,005
------------ ------------ ------------ ------------
Revenues, net of interest
expense.................... 3,469 2,989 6,464 5,461
OPERATING EXPENSES:
Compensation and benefits,
excluding employee initial
public offering awards.......... 1,953 1,489 3,228 2,589
Non-recurring employee initial
public offering awards(1)....... 2,257 -- 2,257 --
Amortization of employee initial
public offering awards.......... 39 -- 39 --
Brokerage, clearing and exchange
fees............................ 109 101 220 194
Market development................ 78 80 155 134
Communications and technology..... 71 63 149 121
Depreciation and amortization..... 61 62 158 104
Occupancy......................... 67 49 145 93
Professional services and other... 121 108 212 167
Charitable contribution........... 200 -- 200 --
------------ ------------ ------------ ------------
Total operating expenses..... 4,956 1,952 6,763 3,402
Pre-tax (loss)/earnings........... (1,487) 1,037 (299) 2,059
(Benefit)/provision for taxes..... (1,827) 190 (1,646) 328
------------ ------------ ------------ ------------
Net earnings...................... $ 340 $ 847 $ 1,347 $ 1,731
============ ============ ============ ============
Earnings per share:
Basic........................... $ 0.72 $ 2.84
Diluted......................... 0.71 2.81
Average common shares outstanding:
Basic........................... 474,712,271 474,712,271
Diluted......................... 479,908,301 479,908,301
</TABLE>
- ---------------
(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 condensed consolidated
financial statements.
2
<PAGE> 5
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)
<TABLE>
<CAPTION>
AS OF
--------------------------
MAY 1999 NOVEMBER 1998
-------- -------------
(in millions, except share
and per share amounts)
<S> <C> <C>
ASSETS:
Cash and cash equivalents................................... $ 3,542 $ 2,836
Cash and securities segregated in compliance with U.S.
federal and other regulations (principally U.S. government
obligations).............................................. 7,710 7,887
Receivables from brokers, dealers and clearing
organizations............................................. 4,004 4,321
Receivables from customers and counterparties............... 22,730 14,953
Securities borrowed......................................... 79,198 69,158
Securities purchased under agreements to resell............. 44,088 37,484
Right to receive securities................................. 7,171 7,564
Financial instruments owned, at fair value:
Commercial paper, certificates of deposit and time
deposits................................................ 1,882 1,382
U.S. government, federal agency and sovereign
obligations............................................. 25,190 24,789
Corporate debt............................................ 9,850 10,744
Equities and convertible debentures....................... 11,208 11,066
State, municipal and provincial obligations............... 1,030 918
Derivative contracts...................................... 21,652 21,299
Physical commodities...................................... 701 481
Other assets................................................ 4,676 2,498
-------- -------------
$244,632 $ 217,380
======== =============
LIABILITIES AND EQUITY:
Short-term borrowings, including commercial paper........... $ 31,601 $ 27,430
Payables to brokers, dealers and clearing organizations..... 1,033 730
Payables to customers and counterparties.................... 34,062 36,179
Securities loaned........................................... 24,384 21,117
Securities sold under agreements to repurchase.............. 41,092 36,257
Obligation to return securities............................. 10,610 9,783
Financial instruments sold, but not yet purchased, at fair
value:
U.S. government, federal agency and sovereign
obligations............................................. 32,395 22,360
Corporate debt............................................ 2,015 1,441
Equities and convertible debentures....................... 8,944 6,406
Derivative contracts...................................... 23,180 24,722
Physical commodities...................................... 778 966
Other liabilities and accrued expenses...................... 4,831 3,699
Long-term borrowings........................................ 21,851 19,906
-------- -------------
236,776 210,996
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, 437,245,963 shares issued and
outstanding............................................... 4 --
Restricted stock units; 63,318,815 units issued and
outstanding............................................... 3,356 --
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.................................. 7,205 --
Accumulated deficit......................................... (917) --
Unearned compensation....................................... (1,726) --
Accumulated other comprehensive loss........................ (66) --
-------- -------------
7,856 6,310
-------- -------------
$244,632 $ 217,380
======== =============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE> 6
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY AND PARTNERS' CAPITAL
(UNAUDITED)
<TABLE>
<CAPTION>
PERIOD ENDED
-------------------------
MAY 1999 NOVEMBER 1998
-------- -------------
(in millions, except per
share amounts)
<S> <C> <C>
Partners' capital
Balance, beginning of period.............................. $ 6,310 $ 6,107
Transfer of beginning partners' capital allocated for
income taxes and potential withdrawals.................. 74 --
Net earnings.............................................. 2,264(1) 2,428
Capital contributions..................................... 48 9
Returns on capital and certain distributions to
partners................................................ (306) (619)
Termination of Profit Participation Plans................. -- (368)
Transfers to partners' capital allocated for income taxes
and potential withdrawals, net.......................... -- (1,247)
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 period.................................... -- 6,310
Common stock, par value $0.01
Balance, beginning of period.............................. -- --
Common stock issued....................................... 4 --
------- -------
Balance, end of period.................................... 4 --
Restricted stock units
Balance, beginning of period.............................. -- --
Restricted stock units granted............................ 3,356 --
------- -------
Balance, end of period.................................... 3,356 --
Nonvoting common stock, par value $0.01
Balance, beginning of period.............................. -- --
Nonvoting common stock issued............................. -- --
------- -------
Balance, end of period.................................... -- --
Additional paid-in capital
Balance, beginning of period.............................. -- --
Exchange of partnership interests for shares of common
stock................................................... 3,901 --
Initial public offering of common stock................... 2,638 --
Issuance of common stock contributed to a defined
contribution plan....................................... 666 --
------- -------
Balance, end of period.................................... 7,205 --
Accumulated deficit
Balance, beginning of period.............................. -- --
Net loss.................................................. (917)(3) --
------- -------
Balance, end of period.................................... (917) --
Unearned compensation
Balance, beginning of period.............................. -- --
Restricted stock units granted............................ (1,765) --
Amortization of restricted stock units.................... 39 --
------- -------
Balance, end of period.................................... (1,726) --
Accumulated other comprehensive loss
Balance, beginning of period.............................. -- --
Transfer from partners' capital........................... (31) --
Currency translation adjustment........................... (35) --
------- -------
Balance, end of period.................................... (66) --
------- -------
$ 7,856 $ 6,310
======= =======
</TABLE>
- ---------------
(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 net loss of the corporation from May 7, 1999 through May 28,
1999.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE> 7
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
--------------------
MAY 1999 MAY 1998
-------- --------
(in millions)
<S> <C> <C>
Cash flows from operating activities:
Net earnings.............................................. $ 1,347 $ 1,731
Non-cash items included in net earnings:
Depreciation and amortization........................... 158 104
Deferred income taxes................................... (2,139) 24
Employee initial public offering awards................. 2,296 --
Changes in operating assets and liabilities:
Cash and securities segregated in compliance with U.S.
federal and other regulations.......................... 177 (1,140)
Net receivables from brokers, dealers and clearing
organizations.......................................... 619 52
Net payables to customers and counterparties............ (9,894) 3,083
Securities borrowed, net................................ (6,773) (11,837)
Financial instruments owned, at fair value.............. (1,212) (14,897)
Financial instruments sold, but not yet purchased, at
fair value............................................. 12,873 5,243
Other, net.............................................. 1,062 383
-------- --------
Net cash used for operating activities................ (1,486) (17,254)
Cash flows from investing activities:
Property, leasehold improvements and equipment............ (196) (197)
Financial instruments owned, at fair value................ 143 (159)
-------- --------
Net cash used for investing activities................ (53) (356)
Cash flows from financing activities:
Short-term borrowings, net................................ (955) (863)
Securities sold under agreements to repurchase, net....... (1,768) 12,234
Issuance of long-term borrowings.......................... 7,000 9,210
Repayment of long-term borrowings......................... (301) (1,025)
Capital contributions..................................... 48 6
Returns on capital and certain distributions to
partners................................................ (306) (311)
Proceeds from issuance of common stock.................... 2,639 --
Partners' capital distributions, net...................... (4,112) --
Partners' capital allocated for income taxes and potential
withdrawals............................................. -- (759)
-------- --------
Net cash provided by financing activities............. 2,245 18,492
Net increase in cash and cash equivalents............... 706 882
Cash and cash equivalents, beginning of period.............. 2,836 1,328
-------- --------
Cash and cash equivalents, end of period.................... $ 3,542 $ 2,210
======== ========
</TABLE>
- ---------------
SUPPLEMENTAL DISCLOSURES:
Cash payments for interest approximated the related expense for each of the
fiscal periods presented. Payments of income taxes were not material.
The junior subordinated debentures of $371 million that were issued to the
retired limited partners in exchange for their partnership interests were
excluded from the consolidated statement of cash flows as they represented
non-cash items.
Employee initial public offering awards include $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 condensed consolidated
financial statements.
5
<PAGE> 8
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
The Firm's activities are divided into three principal business lines:
- Investment Banking, which includes financial advisory services and
underwriting;
- Trading and Principal Investments, which includes fixed income, currency
and commodities ("FICC"), equities and principal investments (principal
investments reflect primarily the Firm's investments in its merchant
banking funds); and
- Asset Management and Securities Services, which includes asset
management, securities services and commissions.
NOTE 2. INITIAL PUBLIC OFFERING
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 and received net proceeds of $2.64 billion.
NOTE 3. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the parent
company, 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. These consolidated financial statements are unaudited and should be read
in conjunction with the audited consolidated financial statements included in
the Prospectus, dated May 3, 1999, of Group Inc., filed with the Securities and
Exchange Commission pursuant to Rule 424(b) under the Securities Act of 1933.
The condensed consolidated financial information as of and for the period ended
November 27, 1998 and for the period ended May 29, 1998 has been derived from
audited consolidated financial statements not included herein.
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.
These unaudited consolidated financial statements reflect all adjustments,
consisting only of normal recurring adjustments, that are, in the opinion of
management, necessary for a fair statement of the operating results in the
interim periods presented. Interim period operating results may not be
indicative of the operating results for a full year.
Unless otherwise stated herein, all references to May 1999 and May 1998
refer to either the Firm's three-month fiscal period ended or its six-month
fiscal period ended, or the date, as the
6
<PAGE> 9
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
context requires, May 28, 1999 and May 29, 1998, respectively. All references to
1998 refer to the Firm's fiscal year ended, or the date, as the context
requires, November 27, 1998.
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 Statement of
Financial Accounting Standards ("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 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 three-week period from May 7, 1999 to the end of its second
quarter. 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.
COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income", which establishes standards for the reporting
and presentation of comprehensive income and its components in the financial
statements. This Statement is effective for fiscal years beginning after
December 15, 1997 and was adopted by the Firm in the first quarter of 1999. The
components of comprehensive income are set forth below:
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED MAY ENDED MAY
---------------- ----------------
1999 1998 1999 1998
------ ------ ------ ------
(in millions)
<S> <C> <C> <C> <C>
Net earnings................................... $ 340 $ 847 $1,347 $1,731
Currency translation adjustment................ (29) (54) (35) (59)
------ ------ ------ ------
Total comprehensive income..................... $ 311 $ 793 $1,312 $1,672
====== ====== ====== ======
</TABLE>
As a partnership, the Firm's cumulative translation adjustment was reported
as a component of "Partners' capital allocated for income taxes and potential
withdrawals" on the consolidated statement of financial condition. It was not
reported as a separate component of equity because it was not material. In
connection with the conversion to corporate form, the cumulative
7
<PAGE> 10
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
translation adjustment is reported as a component of "Accumulated other
comprehensive loss" in stockholders' equity on the consolidated statement of
financial condition.
NOTE 4. 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. For purposes of the consolidated statements of financial condition
only, purchases and sales of financial instruments, including agency
transactions, are generally recorded on a settlement date basis. Recording such
transactions on a trade date basis would not result in a material adjustment to
the consolidated statements of financial condition.
Substantially all financial instruments used in the Firm's trading and
non-trading 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, 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
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 Firm's Trading and Principal Investments business facilitates customer
transactions and takes proprietary positions through market-making in and
trading of fixed income and equity products, 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 effect
of related derivatives and the financing of the underlying positions.
Net revenues represent total revenues less allocations of interest expense
to specific securities, commodities and other positions in relation to the level
of financing incurred by each. The following table sets forth the net revenues
of the Firm's Trading and Principal Investments business:
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED MAY ENDED MAY
---------------- ----------------
1999 1998 1999 1998
---- ---- ---- ----
(in millions)
<S> <C> <C> <C> <C>
FICC......................................... $ 911 $ 934 $1,787 $1,675
Equities..................................... 618 294 1,073 659
Principal investments........................ 189 168 215 244
------ ------ ------ ------
Total Trading and Principal Investments...... $1,718 $1,396 $3,075 $2,578
====== ====== ====== ======
</TABLE>
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 non-trading derivative contracts to manage
the interest rate and currency exposure on its long-term borrowings.
8
<PAGE> 11
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
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 each 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 disclosures, although
not required to do so, as these contracts may be settled in cash or are readily
convertible into cash.
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
included in "Trading and principal investments" on the consolidated statements
of earnings.
The Firm utilizes replacement cost as its 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 master
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, using legally enforceable master 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:
<TABLE>
<CAPTION>
AS OF MAY 1999 AS OF NOVEMBER 1998
---------------------------- ----------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
(in millions)
<S> <C> <C> <C> <C>
Forward settlement contracts.......... $ 3,770 $ 3,429 $ 4,061 $ 4,201
Swap agreements....................... 9,301 10,345 10,000 11,475
Option contracts...................... 8,542 9,397 7,140 9,038
------- ------- ------- -------
Total................................. $21,613 $23,171 $21,201 $24,714
======= ======= ======= =======
</TABLE>
Derivatives used for non-trading 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
transactions 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 non-trading 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
9
<PAGE> 12
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
recognized in earnings immediately. The fair value and carrying value of
derivatives used for non-trading purposes are set forth below:
<TABLE>
<CAPTION>
AS OF MAY 1999 AS OF NOVEMBER 1998
---------------------------- ---------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
(in millions)
<S> <C> <C> <C> <C>
Fair value.............................. $78 $8 $519 $7
Carrying value.......................... 39 9 98 8
</TABLE>
NOTE 5. 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:
<TABLE>
<CAPTION>
AS OF
-------------------------
MAY 1999 NOVEMBER 1998
-------- -------------
(in millions)
<S> <C> <C>
Commercial paper........................................... $ 8,015 $10,008
Promissory notes........................................... 12,083 10,763
Bank loans and other(1).................................... 11,503 6,659
------- -------
Total...................................................... $31,601 $27,430
======= =======
</TABLE>
- ---------------
(1) As of May 1999 and November 1998, short-term borrowings included $5,448
million and $2,955 million, respectively, of long-term borrowings maturing
within one year.
The Firm maintains unencumbered securities with a market value in excess of
all uncollateralized short-term borrowings.
NOTE 6. EARNINGS PER SHARE
Earnings per share ("EPS") is computed in accordance with SFAS No. 128,
"Earnings Per Share". Basic EPS is calculated by dividing net earnings by the
weighted-average number of common shares outstanding. Diluted EPS includes the
determinants of basic EPS and, in addition, gives effect to dilutive potential
common shares.
10
<PAGE> 13
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
The computations of basic and diluted EPS are set forth below:
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
MAY 1999 MAY 1999
------------ ----------
(in millions, except for share and per
share amounts)
<S> <C> <C>
Numerator for basic and diluted earnings per share --
earnings available to common stockholders.......... $ 340 $ 1,347
============ ============
Denominator for basic earnings per share -- weighted-
average number of common shares (1)................ 474,712,271 474,712,271
Effect of dilutive securities:
Restricted stock units............................. 2,432,037 2,432,037
Stock options...................................... 2,763,993 2,763,993
------------ ------------
Dilutive potential common shares..................... 5,196,030 5,196,030
------------ ------------
Denominator for diluted earnings per
share -- weighted-average number of common shares
and dilutive potential common shares............... 479,908,301 479,908,301
============ ============
Basic earnings per share........................... $ 0.72 $ 2.84
Diluted earnings per share......................... 0.71 2.81
</TABLE>
- ---------------
(1) Includes common stock, nonvoting common stock and the restricted stock units
awarded to employees for which future service is not required as a condition
to the delivery of the underlying shares of common stock.
NOTE 7. EMPLOYEE INCENTIVE PLANS
STOCK INCENTIVE PLAN
The Firm sponsors a stock incentive plan which provides for grants of
incentive stock options, nonqualifed 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 five percent 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.
On May 7, 1999, the Firm granted the following awards under the stock
incentive plan to its employees other than managing directors who were profit
participating limited partners.
FORMULA RESTRICTED STOCK UNITS
Formula-based restricted stock units ("Formula RSUs") granted to employees
on May 7, 1999 and outstanding as of the end of the period were 30,025,946. The
common stock underlying these Formula RSUs will generally be deliverable in
equal installments on or about the first, second and third anniversaries of the
date of grant. While no additional service is required to obtain delivery of the
underlying common stock, delivery of the common stock is conditioned on the
grantee's satisfying certain requirements. For purposes of calculating basic
earnings per share and book value per share, the shares of common stock
underlying the Formula RSUs are
11
<PAGE> 14
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
included in common shares outstanding. During the period ended May 1999, the
Firm recorded $1.59 billion in compensation expense related to these Formula
RSUs.
DISCRETIONARY RESTRICTED STOCK UNITS
Discretionary restricted stock units ("Discretionary RSUs") granted to
employees on May 7, 1999 and outstanding as of the end of the period were
33,292,869. Discretionary RSUs will vest, and the underlying common stock will
be delivered, 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. For purposes of calculating basic
earnings per share and book value per share, the shares of common stock
underlying these restricted stock units are excluded from common shares
outstanding since future service is required as a condition to the delivery of
the underlying shares of common stock. The dilutive effect of these restricted
stock units is, however, included in diluted common shares outstanding under the
treasury stock method. The Firm will record non-cash expense of approximately
$1.76 billion (before giving effect to forfeitures) related to these awards over
the related service period.
DISCRETIONARY OPTIONS
Discretionary options granted to employees on May 7, 1999 and outstanding
as of the end of the period were 40,127,592. These options generally will become
exercisable in equal installments commencing 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. Due to vesting requirements, there were
no options exercisable as of May 1999. Once vested, 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, no compensation
expense was recognized on the date of grant since these options had no intrinsic
value. The dilutive effect of these options is included in diluted common shares
outstanding under the treasury stock method. As of May 1999, the outstanding
options had a weighted-average exercise price of $53 and a weighted-average
remaining life of approximately 10 years.
The weighted-average fair value of options granted through May 1999 was
$16.02 per option. Fair value is estimated as of the grant date based on a
binomial option pricing model using the following weighted-average assumptions:
<TABLE>
<CAPTION>
AS OF MAY 1999
--------------
<S> <C>
Risk-free interest rate..................................... 6.1%
Expected life............................................... 7 years
Expected volatility......................................... 30.0%
Dividend yield.............................................. 1.0%
</TABLE>
Pro Forma Effect of SFAS No. 123
In accordance with APB No. 25, compensation expense was not recognized on
the grant of discretionary options since these options had no intrinsic value on
the date of grant. If the Firm were to recognize compensation expense under the
fair value-based method of SFAS No. 123,
12
<PAGE> 15
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
net earnings would have decreased by $8 million, resulting in pro forma net
earnings and earnings per share as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
MAY 1999 MAY 1999
------------------ ----------------
(in millions, except for share and per
share amounts)
<S> <C> <C>
Net earnings, as reported....................... $ 340 $ 1,347
Pro forma net earnings.......................... 332 1,339
EPS, as reported:
Basic........................................... $ 0.72 $ 2.84
Diluted......................................... 0.71 2.81
Pro forma EPS:
Basic........................................... $ 0.70 $ 2.82
Diluted......................................... 0.69 2.79
Basic common shares outstanding................. 474,712,271 474,712,271
Diluted common shares outstanding............... 479,908,301 479,908,301
</TABLE>
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.
DEFINED CONTRIBUTION PLAN
In addition to the stock incentive plan, the Firm has established a
non-qualified defined contribution plan (the "Plan") for certain senior
employees. Shares of common stock contributed to and outstanding in the Plan as
of May 1999 were 12,555,866. The initial irrevocable contribution of shares of
common stock to the Plan in connection with the initial public offering will
vest and be distributable to the participant in equal installments on or about
the third, fourth and fifth anniversaries of the date of grant 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 will be reallocated to the remaining participants. The
Firm's expense for the Plan was $666 million through May 1999, resulting from
the immediate recognition of expense related to contributions made in connection
with the initial public offering.
NOTE 8. 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 of the 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. The components of pre-
13
<PAGE> 16
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
tax losses and income tax benefits reflected on the consolidated statements of
earnings are set forth below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
MAY 1999 MAY 1999
------------------ ----------------
(in millions)
<S> <C> <C>
Pre-tax loss:
U.S. ............................................. $(1,041) $ (298)
Non-U.S. ......................................... (446) (1)
------- -------
Total pre-tax loss...................... $(1,487) $ (299)
======= =======
Current taxes:
U.S. federal...................................... $ 129 $ 132
State and local................................... 31 54
Non-U.S. ......................................... 156 307
------- -------
Total current tax expense............... 316 493
Deferred taxes:
U.S. federal ..................................... (1,461) (1,461)
State and local................................... (451) (449)
Non-U.S. ......................................... (231) (229)
------- -------
Total deferred tax benefit.............. (2,143) (2,139)
------- -------
Total tax benefit....................... $(1,827) $(1,646)
======= =======
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the financial reporting and tax bases of assets and liabilities and are
measured using the enacted 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 of $825
million primarily related to the revaluation of net deferred tax assets recorded
in accordance with the provisions of SFAS No. 109. Significant components of the
Firm's net deferred tax assets as of May 1999 are set forth below:
<TABLE>
<CAPTION>
AS OF MAY 1999
--------------
(in millions)
<S> <C>
Deferred tax assets:
Compensation and benefits................................. $1,832
Unrealized gains/losses................................... 82
Depreciation and amortization............................. 51
Other, net................................................ 325
------
Total net deferred tax assets before valuation
allowance....................................... 2,290
Less: valuation allowance(1)...................... (113)
------
Total net deferred tax assets..................... $2,177
======
</TABLE>
(1) Relates primarily to the ability to recognize tax benefits associated with
foreign operations.
14
<PAGE> 17
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
A reconciliation of the statutory U.S. federal income tax rate of 35% to
the Firm's effective income tax rate is set forth below:
<TABLE>
<CAPTION>
TAX BENEFIT
--------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
MAY 1999 MAY 1999
------------------ ----------------
<S> <C> <C>
U.S. statutory tax rate......................... 35.0% 35.0%
Increase related to:
State and local taxes, net of U.S. income tax
effects.................................... 5.7 5.7
Other......................................... 0.3 0.3
------ ------
Rate before one-time events..................... 41.0 41.0
Revaluation of deferred tax assets upon the
change in tax status.......................... 55.5 275.9
Rate benefit for partnership period............. 30.0 251.5
Other........................................... (3.6) (17.9)
------ ------
Total tax benefit............................... 122.9% 550.5%
====== ======
</TABLE>
The deferred tax assets recognized upon the change in tax status of the
Firm primarily reflect the revaluation of the Firm's deferred tax assets and
liabilities at the Firm's corporate income tax rate. The Firm's effective tax
rate includes a rate benefit attributable to the fact that the Firm generally
was not subject to corporate taxes on its earnings prior to its conversion to
corporate form.
NOTE 9. COMMITMENTS AND CONTINGENCIES
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.
NOTE 10. REGULATED SUBSIDIARIES
GS&Co., a registered U.S. broker-dealer and subsidiary of Group Inc., 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 May 1999, GS&Co. had regulatory net
capital, as defined, of $2.90 billion, which exceeded the amount required by
$2.36 billion.
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 May 1999, GSI and GSJL were in compliance with their local capital
adequacy requirements.
15
<PAGE> 18
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
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 May 1999, these subsidiaries were in compliance with their local capital
adequacy requirements.
NOTE 11. SUBSEQUENT EVENT
On June 23, 1999, the Board of Directors of Group Inc. declared a dividend
of $0.12 per share to be paid on August 27, 1999 to voting and nonvoting common
stockholders of record on August 12, 1999.
16
<PAGE> 19
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS
---------------
To the Directors and Shareholders,
The Goldman Sachs Group, Inc.:
We have reviewed the condensed consolidated statement of financial
condition of The Goldman Sachs Group, Inc. and Subsidiaries (the "Company") as
of May 28, 1999, and the condensed consolidated statements of earnings for the
three and six months ended May 28, 1999 and the three months ended May 29, 1998,
and the condensed consolidated statements of cash flows and changes in
stockholders' equity and partners' capital for the six months ended May 28,
1999. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the accompanying condensed financial statements for them to be
in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated statements of financial condition of The Goldman
Sachs Group, L.P. and Subsidiaries as of May 29, 1998 and November 27, 1998, and
the related consolidated statements of earnings, changes in partners' capital
and cash flows for the six months ended May 29, 1998 and the year ended November
27, 1998 (not presented herein); and in our reports dated August 3, 1998 and
January 22, 1999, respectively, we expressed unqualified opinions on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying condensed consolidated statement of financial condition as of
November 27, 1998, the condensed consolidated statement of earnings for the six
months ended May 29, 1998, the condensed consolidated statement of changes in
partners' capital for the year ended November 27, 1998 and the condensed
consolidated statement of cash flows for the six months ended May 29, 1998, is
fairly stated, in all material respects, in relation to the financial statements
from which it has been derived.
/s/ PricewaterhouseCoopers LLP
New York, New York
July 8, 1999.
17
<PAGE> 20
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
Goldman Sachs is a global investment banking and securities firm that
provides a wide range of financial services worldwide to a substantial and
diversified client base.
Our activities are divided into three principal business lines:
- - Investment Banking, which includes financial advisory services and
underwriting;
- - Trading and Principal Investments, which includes fixed income, currency and
commodities ("FICC"), equities and principal investments (principal
investments reflect primarily our investments in our merchant banking funds);
and
- - Asset Management and Securities Services, which includes asset management,
securities services and commissions.
All references to May 1999 and May 1998 refer to either our three-month
fiscal period ended or our six-month fiscal period ended, or the date, as the
context requires, May 28, 1999 and May 29, 1998, respectively. All references to
1998 refer to our fiscal year ended, or the date, as the context requires,
November 27, 1998.
When we use the terms "Goldman Sachs", "we" and "our", we mean, prior to
our conversion to corporate form, The Goldman Sachs Group, L.P., a Delaware
limited partnership, and its consolidated subsidiaries and, after our conversion
to corporate form, The Goldman Sachs Group, Inc. ("Group Inc."), a Delaware
corporation, and its consolidated subsidiaries.
INITIAL PUBLIC OFFERING
On May 7, 1999, we converted from a partnership to a corporation and
completed our initial public offering. In that offering, we sold 51,000,000
shares of common stock and received net proceeds of $2.64 billion.
BUSINESS ENVIRONMENT
During the second quarter of 1999, global markets continued to be strong as
a result of a favorable macroeconomic environment, which benefited our key
businesses. The U.S. economy continued its strong growth rate amidst low
unemployment and favorable inflation and interest rate conditions, leading to
record highs in the major U.S. equity market indices. The financial markets
declined towards the end of the fiscal quarter as inflation concerns arose and
interest rates trended upwards in the United States. European financial markets
posted positive gains following interest rate cuts and renewed signs of economic
expansion, while financial markets in Asia and Latin America continued to
improve as the economies of Japan and Brazil stabilized.
RESULTS OF OPERATIONS
The composition of our net revenues has varied over time as financial
markets and the scope of our operations have changed. The composition of net
revenues can also vary over the shorter term due to fluctuations in U.S. and
global economic and market conditions. In addition, Goldman Sachs' conversion
from a partnership to a corporation and related transactions have affected, and
will continue to affect, our operating results in several significant ways:
1. FORMER PARTNER COMPENSATION. As a corporation, payments for services
rendered by managing directors who were profit participating limited partners
are included in compensation
18
<PAGE> 21
and benefits expense. These payments were previously accounted for as
distributions of partners' capital rather than as compensation and benefits
expense.
2. ONGOING STOCK-BASED COMPENSATION. Our current compensation plans
provide that, in lieu of a portion of ongoing cash compensation, compensation
will be awarded to employees in the form of restricted stock units. Of the total
restricted stock units that we currently anticipate granting in lieu of ongoing
cash compensation, 50% will require future service as a condition to the
delivery of the underlying shares of common stock. In accordance with Accounting
Principles Board Opinion ("APB") No. 25, these restricted stock units will be
recorded as compensation expense over the four-year service period following the
date of grant. We expect to record this expense over the service period as
follows: 52%, 28%, 14%, and 6% in years one, two, three and four, respectively.
3. AMORTIZATION OF EMPLOYEE INITIAL PUBLIC OFFERING AWARDS. We have
recorded, and will continue to record over the five-year vesting period
following the date of grant, non-cash expense related to the amortization of the
discretionary restricted stock units awarded to employees in connection with our
initial public offering. We expect to record non-cash expense of approximately
$115 million related to these awards in each of the third and fourth quarters of
1999.
4. INCOME TAXES. As a corporation, our operating results have been, and
will continue to be, subject to a higher tax rate than we incurred as a
partnership. Our effective tax rate for the period from May 7, 1999 to the end
of the second quarter, excluding the effect of non-recurring items, was 41%.
For a further discussion of the effect of these items on our actual and pro
forma operating results, see "-- Operating Expenses" and "-- Pro Forma Operating
Results" below. As a result of these and other factors, period-to-period
comparisons may not be meaningful and interim period operating results may not
be indicative of the operating results for a full year.
OVERVIEW
The following table sets forth our net revenues, pre-tax (loss)/earnings,
net earnings and diluted earnings per share:
FINANCIAL OVERVIEW
(in millions, except per share amounts)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED MAY ENDED MAY
--------------------- ------------------
1999(1) 1998 1999(1) 1998
------- ---- ------- ----
<S> <C> <C> <C> <C>
Net revenues........................... $ 3,469 $ 2,989 $ 6,464 $ 5,461
Pre-tax (loss)/earnings................ (1,487) 1,037 (299) 2,059
Net earnings........................... 340 847 1,347 1,731
Diluted earnings per share............. 0.71 -- 2.81 --
</TABLE>
- ---------------
(1) Includes three weeks as a corporation.
------------------------
Our net earnings of $340 million, or $0.71 per diluted share, in the
three-month period ended May 1999 were reduced by $672 million, or $1.40 per
diluted share, due to non-recurring items, associated with Goldman Sachs'
conversion to corporate form and related transactions. For a further discussion
of the non-recurring charges and benefits affecting our operating results in the
second quarter of 1999, see "-- Operating Expenses" and "-- Provision for Taxes"
below.
19
<PAGE> 22
Our net revenues were $3.47 billion in the three-month period ended May
1999, an increase of 16% compared to the same period in 1998. Net revenues in
Investment Banking increased 5% due to higher financial advisory fees,
particularly in mergers and acquisitions. Net revenues in Trading and Principal
Investments increased 23% primarily due to a strong performance in equities. Net
revenues in Asset Management and Securities Services increased 17% due to higher
asset management fees and increased equity commissions.
Our net revenues were $6.46 billion in the six-month period ended May 1999,
an increase of 18% compared to the same period in 1998. Net revenues in
Investment Banking increased 20% due to higher levels of mergers and
acquisitions and equity underwriting activity. Trading and Principal Investments
increased 19% primarily due to strong net revenue growth in equities. Net
revenues in Asset Management and Securities Services increased 15% principally
due to growth in asset management fees.
The following table sets forth the net revenues of our principal business
lines:
NET REVENUES BY PRINCIPAL BUSINESS LINE
(in millions)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED MAY ENDED MAY
---------------- ----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Investment Banking........................... $1,002 $ 954 $1,904 $1,587
Trading and Principal Investments............ 1,718 1,396 3,075 2,578
Asset Management and Securities Services..... 749 639 1,485 1,296
------ ------ ------ ------
Total net revenues........................... $3,469 $2,989 $6,464 $5,461
====== ====== ====== ======
</TABLE>
------------------------
Net revenues in our principal business lines represent total revenues less
allocations of interest expense to specific securities, commodities and other
positions in relation to the level of financing incurred by each position.
Interest expense is allocated to Trading and Principal Investments and the
securities services component of Asset Management and Securities Services. Net
revenues may not be indicative of the relative profitability of any principal
business line.
INVESTMENT BANKING
Goldman Sachs provides a broad range of financial advisory and underwriting
services to a diverse group of corporations, financial institutions, governments
and individuals. The following table sets forth the net revenues of our
Investment Banking business:
INVESTMENT BANKING NET REVENUES
(in millions)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED MAY ENDED MAY
---------------- ----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Financial advisory......................... $ 510 $ 436 $1,032 $ 799
Underwriting............................... 492 518 872 788
------ ------ ------ ------
Total Investment Banking................... $1,002 $ 954 $1,904 $1,587
====== ====== ====== ======
</TABLE>
------------------------
Investment Banking generated net revenues of $1 billion in the three-month
period ended May 1999, an increase of 5% compared to the same period in 1998.
Our mergers and
20
<PAGE> 23
acquisitions and equity new issues businesses were strong, reflecting active
markets resulting from, among other factors, the continuing trend toward
consolidation and globalization in many industries. Revenue growth in the second
quarter of 1999 was especially strong in the technology, energy and power,
healthcare, and communications, media and entertainment industry groups.
Revenues from debt underwriting benefited from the favorable interest rate
environment although they declined from a particularly strong period in the
prior year.
Investment Banking generated net revenues of $1.90 billion in the six-month
period ended May 1999, an increase of 20% compared to the same period in 1998.
Revenue growth was strong in our mergers and acquisitions and equity new issues
businesses. For the calendar year through May, we ranked number one in announced
and completed worldwide and U.S. mergers and acquisitions.(1) We also maintained
our strong market position in equity underwriting, ranking first in worldwide
initial public offerings and second in worldwide public common stock offerings
over the same period.(2) The debt underwriting business continued to benefit
from the favorable interest rate environment, generating net revenues that were
comparable to the strong prior year period.
- ---------------
(1) Securities Data Company -- January 1 to May 31, 1999. Mergers and
acquisitions statistics are based on the dollar value of transactions for
the period indicated, taken as a whole, with full credit to both target and
acquiring companies' advisors.
(2) Securities Data Company -- January 1 to May 31, 1999. Underwriting
statistics are based on the dollar value of total proceeds raised (exclusive
of any option to purchase additional shares) with full credit to each
bookrunner for the period indicated, taken as a whole.
TRADING AND PRINCIPAL INVESTMENTS
Our Trading and Principal Investments business facilitates customer
transactions and takes proprietary positions through market-making in and
trading of fixed income and equity products, currencies, commodities, and swaps
and other derivatives. Net revenues from principal investments do not include
management fees and the increased share of the income and gains from our
merchant banking funds to which Goldman Sachs is entitled when the return on
investments exceeds certain threshold returns to fund investors. These
management fees and increased shares of income and gains are included in the net
revenues of Asset Management and Securities Services. The following table sets
forth the net revenues of our Trading and Principal Investments business:
TRADING AND PRINCIPAL INVESTMENTS NET REVENUES
(in millions)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED MAY ENDED MAY
---------------- ----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
FICC....................................... $ 911 $ 934 $1,787 $1,675
Equities................................... 618 294 1,073 659
Principal investments...................... 189 168 215 244
------ ------ ------ ------
Total Trading and Principal Investments.... $1,718 $1,396 $3,075 $2,578
====== ====== ====== ======
</TABLE>
------------------------
The Trading and Principal Investments business achieved net revenues of
$1.72 billion in the three-month period ended May 1999, an increase of 23%
compared to the same period in 1998. Net revenues in FICC declined modestly
compared to a particularly strong period in 1998 as lower net revenues in
currencies were partially offset by a strong performance in commodities. Our
credit-sensitive fixed income businesses continued to benefit from the recovery
in the fixed income markets that began in the latter part of 1998. Net revenues
in equities increased 110%
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<PAGE> 24
primarily due to increased customer demand in equity derivatives and in our
shares businesses in the United States and Europe and a strong performance in
equity arbitrage, due in part to increased activity in the mergers and
acquisitions market. Principal investments net revenues increased 13% due to
higher mark-to-market gains on certain investments in our merchant banking funds
partially offset by lower gains on the disposition of investments.
The Trading and Principal Investments business achieved net revenues of
$3.07 billion in the six-month period ended May 1999, an increase of 19%
compared to the same period in 1998. Net revenues in FICC increased 7% as higher
net revenues in mortgages, commodities and emerging market debt were partially
offset by lower net revenues in fixed income derivatives and currencies. Net
revenues in equities increased 63% primarily due to strong customer demand in
equity derivatives and in our shares businesses in the United States and Europe
and higher net revenues in equity arbitrage. Net revenues from principal
investments decreased 12% due to lower gains on the disposition of investments
compared to the prior year, partially offset by higher net revenues related to
mark-to-market gains on certain investments in our merchant banking funds.
ASSET MANAGEMENT AND SECURITIES SERVICES
Our Asset Management and Securities Services business is comprised of asset
management, securities services and commissions. Securities services includes
prime brokerage, financing services and securities lending and our matched book
businesses. Revenues from the increased share of the income and gains derived
from our merchant banking funds are included in commissions. The following table
sets forth the net revenues of our Asset Management and Securities Services
business:
ASSET MANAGEMENT AND SECURITIES SERVICES NET REVENUES
(in millions)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED MAY ENDED MAY
---------------- ----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Asset management............................. $ 214 $ 145 $ 416 $ 284
Securities services.......................... 174 174 381 344
Commissions.................................. 361 320 688 668
------ ------ ------ ------
Total Asset Management and Securities
Services................................... $ 749 $ 639 $1,485 $1,296
====== ====== ====== ======
</TABLE>
------------------------
Goldman Sachs' assets under supervision are comprised of assets under
management, on which we typically generate fees based on a percentage of their
value, and other client assets, on which we earn commissions. The following
table sets forth our assets under supervision:
ASSETS UNDER SUPERVISION
(in millions)
<TABLE>
<CAPTION>
AS OF MAY AS OF NOVEMBER
-------------------- --------------------
1999 1998 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Assets under management............. $206,553 $165,226 $194,821 $135,929
Other client assets................. 176,369 125,419 142,018 102,033
-------- -------- -------- --------
Total assets under supervision...... $382,922 $290,645 $336,839 $237,962
======== ======== ======== ========
</TABLE>
22
<PAGE> 25
The Asset Management and Securities Services business achieved net revenues
of $749 million in the three-month period ended May 1999, an increase of 17%
compared to the same period in 1998. Performance was strong in asset management
and commissions while net revenues in securities services were comparable to the
prior year period. Asset management revenues increased 48%, primarily reflecting
a 29% increase in average assets under management as well as changes in the
composition of assets managed. Net revenues from securities services were
comparable to the prior year across all components of the business, including
securities lending, financing services and our fixed income matched book.
Commission revenues increased 13% as generally strong and volatile equity
markets resulted in increased transaction volumes in listed equity securities.
The Asset Management and Securities Services business achieved net revenues
of $1.49 billion in the six-month period ended May 1999, an increase of 15%
compared to the same period in 1998. Asset management revenues increased 46%
compared to the same period in 1998, primarily reflecting a 35% increase in
average assets under management as well as changes in the composition of assets
managed. Net revenues from securities services increased 11% primarily due to
growth in securities lending and financing services. Commission revenues
increased 3% compared to a particularly strong period in the prior year as
generally strong and volatile equity markets resulted in continued healthy
transaction volumes in listed equity securities.
OPERATING EXPENSES
The following table sets forth our operating expenses and number of
employees:
OPERATING EXPENSES AND EMPLOYEES
($ in millions)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED MAY ENDED MAY
------------------ ------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Compensation and benefits, excluding
employee initial public offering
awards................................. $ 1,953 $ 1,489 $ 3,228 $ 2,589
Non-recurring employee initial public
offering awards........................ 2,257 -- 2,257 --
Amortization of employee initial public
offering awards........................ 39 -- 39 --
Brokerage, clearing and exchange fees.... 109 101 220 194
Market development....................... 78 80 155 134
Communications and technology............ 71 63 149 121
Depreciation and amortization............ 61 62 158 104
Occupancy................................ 67 49 145 93
Professional services and other.......... 121 108 212 167
Charitable contribution.................. 200 -- 200 --
------- ------- ------- -------
Total operating expenses................. $ 4,956 $ 1,952 $ 6,763 $ 3,402
======= ======= ======= =======
Employees at period end(1)............... 13,454 11,440
</TABLE>
- ---------------
(1) Excludes employees of Goldman Sachs' property management subsidiaries.
Substantially all of the costs of these employees are reimbursed to Goldman
Sachs by the real estate investment funds to which these companies provide
property management services. In addition, as of May 1999, we had
approximately 3,800 temporary staff and consultants.
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<PAGE> 26
Operating expenses were $4.96 billion in the three-month period ended May
1999, an increase of 154% compared to the same period in 1998 primarily due to
non-recurring charges associated with Goldman Sachs' conversion to corporate
form and related transactions. These non-recurring charges included $2.26
billion for employee initial public offering awards and $200 million for a
contribution to the Goldman Sachs Fund, a charitable foundation.
Compensation and benefits, excluding employee initial public offering
awards, increased 31% in the second quarter of 1999 compared to the same period
in 1998. This increase was due to additional compensation expense recorded in
the second quarter of 1999 equal to 50% of the estimated annual compensation and
benefits of the managing directors who were profit participating limited
partners in 1999 based on the annualized results for the first half of 1999,
offset in part by the effect of issuing restricted stock units to employees, in
lieu of a portion of ongoing cash compensation, for which future service will be
required as a condition to the delivery of the underlying shares of common
stock. In accordance with APB No. 25, these restricted stock units will be
recorded as compensation expense over the four-year vesting period following the
date of grant.
In addition, operating expenses in the second quarter of 1999 reflect
non-cash expense of $39 million attributable to the one-month period following
Goldman Sachs' conversion to corporate form. As discussed above in "Results of
Operations -- 3. Amortization of Employee Initial Public Offering Awards", this
non-cash expense relates to the amortization of the discretionary restricted
stock units awarded to employees in connection with our initial public offering.
We will record non-cash expense related to these restricted stock units over the
five-year vesting period following the date of grant. The future expense related
to these restricted stock units is not dependent on our operating results in any
given period.
Brokerage, clearing and exchange fees increased 8% during the quarter
primarily due to higher transaction volumes in commodities, fixed income
derivatives and futures contracts. Communications and technology expenses
increased 13% reflecting higher telecommunications and market data costs
associated with higher employment levels and additional spending on technology
initiatives. Occupancy expenses increased 37% reflecting additional office space
needed to accommodate growth in employment levels. Professional services and
other expenses increased 12% due to higher levels of business activity.
Operating expenses were $6.76 billion in the six-month period ended May
1999, an increase of 99% over the same period in 1998 primarily due to the
non-recurring charges described above. Compensation and benefits, excluding
employee initial public offering awards, was 50% of net revenues during the
six-month period ended May 1999.
Brokerage, clearing and exchange fees increased 13% in the six-month period
ended May 1999 primarily due to higher transaction volumes in fixed income
derivatives, futures contracts and commodities. Market development expenses
increased 16% primarily due to higher levels of advertising and business
activity. Communications and technology expenses increased 23% reflecting higher
telecommunications and market data costs associated with growth in employment
levels and additional spending on technology initiatives. Depreciation and
amortization increased 52% due to certain fixed asset write-offs and to capital
expenditures on leasehold improvements and technology-related and
telecommunications equipment in support of Goldman Sachs' increased worldwide
activities. Occupancy expenses increased 56% reflecting additional office space
needed to accommodate growth in employment levels. Professional services and
other expenses increased 27% due to higher levels of business activity.
PROVISION FOR TAXES
The provision for taxes in the second quarter of 1999 reflected a net
benefit of $1.83 billion primarily due to non-recurring items. These
non-recurring items included a net benefit of $825 million related to our
conversion to corporate form, a benefit of $880 million related to the
24
<PAGE> 27
granting of employee initial public offering awards and a benefit of $80 million
related to the contribution to the Goldman Sachs Fund. Goldman Sachs' effective
tax rate for the period from May 7, 1999 to the end of the second quarter,
excluding the effect of these non-recurring items, was 41%.
PRO FORMA OPERATING RESULTS
The following table sets forth our pro forma condensed consolidated
statement of earnings for the six-month period ended May 1999:
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF EARNINGS
($ in millions, except share and per share amounts)
<TABLE>
<CAPTION>
SIX MONTHS ENDED MAY 1999
------------------------------------------------
PRO FORMA
ACTUAL ADJUSTMENTS PRO FORMA
------ ----------- ---------
<S> <C> <C> <C>
Total revenues................... $ 12,211 $ -- $ 12,211
Interest expense, principally on
short-term funding............. 5,747 7(a) 5,754
------------ ------------ ------------
Revenues, net of interest
expense........................ 6,464 (7) 6,457
Compensation and benefits,
excluding employee initial
public offering awards......... 3,228 -- 3,228
Non-recurring employee initial
public offering awards......... 2,257 (2,257)(b) --
Amortization of employee initial
public offering awards......... 39 192(c) 231
Other operating expenses......... 1,239 (200)(d) 1,039
------------ ------------ ------------
Total operating expenses......... 6,763 (2,265) 4,498
Pre-tax (loss)/earnings.......... (299) 2,258 1,959
(Benefit)/provision for taxes.... (1,646) 2,449(e) 803
------------ ------------ ------------
Net earnings..................... $ 1,347 $ (191) $ 1,156
============ ============ ============
Ratio of earnings to fixed
charges........................ 0.95x 1.34x
Average common shares
outstanding:
Basic.......................... 474,712,271 3,698,113(f) 478,410,384
Diluted........................ 479,908,301 11,044,771(g) 490,953,072
Earnings per share:
Basic.......................... $ 2.84 $ 2.42
Diluted........................ 2.81 2.35
</TABLE>
------------------------
BASIS OF PRESENTATION. The Pro Forma Condensed Consolidated Statement of
Earnings was prepared as if our conversion to corporate form and related
transactions had taken place at the beginning of fiscal 1998. If the Pro Forma
Condensed Consolidated Statement of Earnings had been prepared as if our
conversion to corporate form and related transactions had taken place at the
beginning of fiscal 1999, diluted earnings per share would have been increased
by $0.07 to $2.42 in the six-month period ended May 1999.
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<PAGE> 28
For purposes of calculating the ratio of earnings to fixed charges,
"earnings" represent pre-tax earnings plus fixed charges and "fixed charges"
represent interest expense plus that portion of rent expense that, in our
opinion, approximates the interest factor included in rent expense.
NOTES TO PRO FORMA ADJUSTMENTS.
(a) Adjustment to reflect the interest expense on junior subordinated
debentures issued to the retired limited partners in exchange for their
interests in The Goldman Sachs Group, L.P. and certain affiliates.
(b) Adjustment to eliminate the non-recurring effect of the expense related
to 30,025,946 restricted stock units awarded to employees based on a formula,
for which future service is not required as a condition to the delivery of the
underlying shares of common stock, and the initial irrevocable contribution of
12,555,866 shares of common stock to our defined contribution plan.
(c) Adjustment to reflect additional amortization related to 33,292,869
restricted stock units awarded to employees on a discretionary basis, which vest
in equal installments in years three, four and five following the date of grant
(May 7, 1999). These restricted stock units had a value of $1.76 billion on date
of grant, approximately 26% of which will be amortized as a non-cash expense in
the twelve months following the date of grant. The remaining 74% of the value of
these restricted stock units will be amortized over the next four years as
follows: 26%, 26%, 15% and 7% in years two, three, four and five, respectively.
(d) Adjustment to eliminate the non-recurring expense related to the
charitable contribution to the Goldman Sachs Fund.
(e) Adjustment to reflect a pro forma provision for income taxes for
Goldman Sachs in corporate form at an effective tax rate of 41%.
(f) Adjustment to basic average common shares outstanding to reflect the
shares of common stock underlying the restricted stock units that were assumed
to be awarded in lieu of ongoing cash compensation in fiscal 1998 for which
future service would not have been required as a condition to the delivery of
the underlying shares of common stock.
(g) Adjustment to diluted average common shares outstanding to reflect the
additional dilutive effect of the common stock deliverable pursuant to the
restricted stock units and stock options awarded to employees on a discretionary
basis for which future service is required as a condition to the delivery of the
underlying shares of common stock. Adjustment also reflects the dilutive effect
of the shares of common stock underlying the restricted stock units that were
assumed to be awarded in lieu of ongoing cash compensation in fiscal 1998 for
which future service would have been required as a condition to the delivery of
the underlying shares of common stock. For purposes of calculating pro forma
diluted average common shares outstanding, we used the initial public offering
price of $53 per share from the beginning of fiscal 1998 until May 4, 1999, the
day trading in our common stock commenced. Thereafter, we used actual daily
closing prices.
LIQUIDITY
MANAGEMENT OVERSIGHT OF LIQUIDITY
Management believes that one of the most important issues for a company in
the financial services sector is access to liquidity. Accordingly, Goldman Sachs
has established a comprehensive structure to oversee its liquidity and funding
policies.
The Finance Committee has responsibility for establishing and assuring
compliance with our asset and liability management policies and has oversight
responsibility for managing liquidity risk, the size and composition of our
balance sheet and our credit ratings. The Finance
26
<PAGE> 29
Committee meets monthly, and more often when necessary, to evaluate our
liquidity position and funding requirements.
Our Treasury Department manages the capital structure, funding, liquidity
and relationships with creditors and rating agencies globally. The Treasury
Department works jointly with our global funding desk in managing our
borrowings. The global funding desk is primarily responsible for our
transactional short-term funding activity.
LIQUIDITY POLICIES
In order to maintain an appropriate level of liquidity, management has
implemented several liquidity policies as outlined below.
DIVERSIFICATION OF FUNDING SOURCES AND LIQUIDITY PLANNING. Goldman Sachs
maintains diversified funding sources with both banks and non-bank lenders
globally. Management believes that Goldman Sachs' relationships with its lenders
are critical to its liquidity. We maintain close contact with our primary
lenders to keep them advised of significant developments that affect us.
We access liquidity in a variety of markets in the United States as well as
in Europe and Asia. In addition, we make extensive use of the repurchase
agreement market and have raised debt publicly as well as in the private
placement, the Securities and Exchange Commission's Rule 144A and the commercial
paper markets, and through Eurobonds, money broker loans, commodity-based
financings, letters of credit and promissory notes. We seek to structure our
liabilities to avoid significant amounts of debt coming due on any one day or
during any single week or year. In addition, we maintain and update annually a
liquidity crisis plan that provides guidance in the event of a liquidity crisis.
The annual update of this plan is reviewed and approved by our Finance
Committee.
ASSET LIQUIDITY. Goldman Sachs maintains a highly liquid balance sheet.
Many of our assets are readily funded in the repurchase agreement markets, which
generally have proven to be a consistent source of funding, even in periods of
market stress. Substantially all of our inventory turns over rapidly and is
marked-to-market daily. We maintain long-term borrowings and equity capital
substantially in excess of our less liquid assets.
DYNAMIC LIQUIDITY MANAGEMENT. Goldman Sachs seeks to manage the
composition of its asset base and the maturity profile of its funding to ensure
that it can liquidate its assets prior to its liabilities coming due, even in
times of liquidity stress. We have traditionally been able to fund our liquidity
needs through collateralized funding, such as repurchase transactions and
securities lending, as well as short-term and long-term borrowings and equity
capital. To further evaluate the adequacy of our liquidity management policies
and guidelines, we perform weekly "stress funding" simulations of disruptions in
our access to unsecured credit.
EXCESS LIQUIDITY. In addition to maintaining a highly liquid balance sheet
and a significant portion of longer-term liabilities to assure liquidity even
during adverse conditions, we seek to maintain a liquidity cushion that consists
principally of unencumbered U.S. government and agency obligations to ensure the
availability of immediate liquidity. This pool of highly liquid assets averaged
$14.17 billion during 1998.
LIQUIDITY RATIO MAINTENANCE. It is Goldman Sachs' policy to further manage
its liquidity by maintaining a "liquidity ratio" of at least 100%. This ratio
measures the relationship between the loan value of our unencumbered assets and
our short-term unsecured liabilities. The maintenance of this liquidity ratio is
intended to ensure that we could fund our positions on a fully secured basis in
the event that we were unable to replace our unsecured debt maturing within one
year. Under this policy, we seek to maintain unencumbered assets in an amount
that, if pledged or sold, would provide the funds necessary to replace unsecured
obligations that are scheduled to mature (or where holders have the option to
redeem) within the coming year.
27
<PAGE> 30
INTERCOMPANY FUNDING. Most of the liquidity of Goldman Sachs is raised by
Group Inc., which then lends the necessary funds to its subsidiaries and
affiliates. We carefully manage our intercompany exposure by generally requiring
intercompany loans to have maturities equal to or shorter than the maturities of
the aggregate borrowings of Group Inc. This policy ensures that the
subsidiaries' obligations to Group Inc. will generally mature in advance of
Group Inc.'s third-party long-term borrowings. In addition, many of the advances
made to Group Inc.'s subsidiaries and affiliates are secured by marketable
securities or other liquid collateral. We generally fund our equity investments
in subsidiaries with equity capital.
THE BALANCE SHEET
Goldman Sachs maintains a highly liquid balance sheet that fluctuates
significantly between financial statement dates. The following table sets forth
our total assets, adjusted assets, leverage ratios and book value per share:
<TABLE>
<CAPTION>
AS OF
---------------------------------------------
MAY 1999 FEBRUARY 1999(5) NOVEMBER 1998
-------- ---------------- -------------
($ in billions, except per share amounts)
<S> <C> <C> <C>
Total assets..................................... $ 245 $ 231 $ 217
Adjusted assets(1)............................... 158 152 145
Leverage ratio(2)................................ 31.1x 34.9x 34.5x
Adjusted leverage ratio(3)....................... 20.1x 23.1x 23.0x
Book value per share(4).......................... $16.55 -- --
</TABLE>
- ---------------
(1) Adjusted assets represent total assets less securities purchased under
agreements to resell, certain securities borrowed transactions and the
increase in total assets related to the adoption of the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 125 that were
deferred by SFAS No. 127.
(2) Leverage ratio equals total assets divided by equity capital.
(3) Adjusted leverage ratio equals adjusted assets divided by equity capital.
(4) Book value per share as of May 1999 was based on common shares outstanding,
including the shares of common stock deliverable pursuant to the
formula-based restricted stock units, of 474,712,271.
(5) As of February 26, 1999.
------------------------
As of May 1999 and November 1998, we held approximately $1.10 billion and
$1.04 billion, respectively, in high-yield debt securities and $1.66 billion and
$1.49 billion, respectively, in bank loans, all of which are valued on a
mark-to-market basis. These assets may be relatively illiquid during times of
market stress. We seek to diversify our holdings of these assets by industry and
by geographic location.
As of May 1999 and November 1998, we held approximately $1.03 billion and
$1.17 billion, respectively, of emerging market debt securities, and $21 million
and $109 million, respectively, in emerging market loans, all of which are
valued on a mark-to-market basis. Of the $1.05 billion and $1.28 billion in
emerging market debt securities and loans, as of May 1999 and November 1998,
respectively, approximately $674 million and $968 million were sovereign
obligations, many of which are collateralized as to principal at stated
maturity.
CREDIT RATINGS
Goldman Sachs relies upon the debt capital markets to fund a significant
portion of its day-to-day operations. The cost and availability of debt
financing is influenced by our credit ratings. Credit ratings are also important
to us when competing in certain markets and when seeking to engage in
longer-term transactions, including over-the-counter derivatives. A reduction in
our
28
<PAGE> 31
credit ratings could increase our borrowing costs and limit our access to the
capital markets. This, in turn, could reduce our earnings and adversely affect
our liquidity.
The following table sets forth our credit ratings as of May 1999:
<TABLE>
<CAPTION>
SHORT-TERM DEBT LONG-TERM DEBT
--------------- --------------
<S> <C> <C>
Moody's Investors Service, Inc. ..................... P-1 A1
Standard & Poor's Ratings Services................... A-1+ A+
Fitch IBCA, Inc. .................................... F1+ AA-
CBRS Inc............................................. A-1 (High) A+
</TABLE>
------------------------
LONG-TERM DEBT
As of May 1999, our consolidated long-term borrowings were $21.85 billion.
Substantially all of these borrowings were unsecured and consisted principally
of senior borrowings with maturities extending to 2024. The weighted average
maturity of our long-term borrowings as of May 1999 was approximately five
years. Substantially all of our long-term borrowings are swapped into U.S.
dollar obligations with short-term floating rates of interest in order to
minimize our exposure to interest rates and foreign exchange movements.
YEAR 2000 READINESS DISCLOSURE
With the year 2000 approaching, many institutions around the world are
reviewing and modifying their computer systems to ensure that they are Year 2000
compliant. The issue, in general terms, is that many existing computer systems
and microprocessors (including those in non-information technology equipment and
systems) use only two digits to identify a year in the date field with the
assumption that the first two digits of the year are always "19". Consequently,
on January 1, 2000, computers that are not Year 2000 compliant may read the year
as 1900. Systems that calculate, compare or sort using the incorrect date may
malfunction.
Goldman Sachs has determined that it will be required to modify or replace
portions of its information technology systems, both hardware and software, and
its non-information technology systems so that they will properly recognize and
utilize dates beyond December 31, 1999. We currently believe that with
modifications to existing software, conversions to new software and replacement
of some hardware, the Year 2000 issue will be satisfactorily resolved in our own
systems worldwide. However, if such modifications and conversions are not made
or are not completed on a timely basis, the Year 2000 issue could have a
material adverse effect on Goldman Sachs. Moreover, even if these changes are
successful, failure of third parties to which we are financially or
operationally linked to address their own Year 2000 problems could also have a
material adverse effect on Goldman Sachs.
By the end of June 1999, we had completed the remediation, testing and
implementation phases for all of our systems, except for the implementation of
three applications that are scheduled for July and early August 1999. In March
1999, we completed the first cycle of our internal integration testing with
respect to critical U.S. securities and transaction flows. The remaining cycle,
which related primarily to non-U.S. products, was completed in June 1999. This
integration testing was intended to validate that our systems can successfully
perform critical business functions beginning in January 2000 and was completed
successfully with no material problems. By the end of June 1999, we also had
completed testing and implementation of vendor-supplied technology products that
we consider mission-critical, although with respect to products that run in
multiple locations, implementation at some locations is expected to continue
through September 1999.
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<PAGE> 32
We are also addressing Year 2000 issues that may exist outside our own
technology activities, including our facilities, external service providers and
other third parties with which Goldman Sachs interfaces. We have inventoried and
ranked our customers, business and trading partners, utilities, exchanges,
depositories, clearing and custodial banks and other third parties with which
Goldman Sachs has important financial and operational relationships. We are
continuing to assess the Year 2000 preparedness of these parties.
By the end of June 1999, Goldman Sachs had participated in approximately
150 "external", i.e., industry-wide or point-to-point, tests with exchanges,
clearing houses and other industry utilities, as well as the "Streetwide" test
sponsored by the Securities Industry Association for its U.S. members and
completed in April 1999. Goldman Sachs successfully completed all of these tests
with no material problems. By the end of October 1999, we expect to have
participated in approximately 20 additional external tests, including major
industry tests in those global markets where Goldman Sachs conducts significant
business.
Acknowledging that a Year 2000 failure, whether internal or external, could
have an adverse effect on our ability to conduct day-to-day business, we are
employing a comprehensive and global approach to contingency planning. By the
end of June 1999, contingency plans for our core business units were
substantially completed. We expect that contingency plans for the rest of our
business will be completed by the end of September 1999.
We have incurred, and expect to continue to incur, expenses allocable to
internal staff, as well as costs for outside consultants, to complete the
remediation and testing of internally developed systems and the replacement and
testing of third-party products and services, including non-technology products
and services, in order to achieve Year 2000 compliance and in connection with
contingency planning for the date change and related activities. We currently
estimate that these costs will total approximately $170 million, a substantial
majority of which has been spent to date. These estimates include the cost of
technology personnel but do not include the cost of most non-technology
personnel involved in our Year 2000 effort. We expect to incur the remaining
cost of our Year 2000 program during the remainder of 1999 and early 2000.
If third parties with whom we interact have Year 2000 problems that are not
remedied, we could be adversely affected in various ways. We describe these and
other risks associated with the Year 2000 problem in our Prospectus, dated May
18, 1999, filed with the Securities and Exchange Commission pursuant to Rule
424(b) under the Securities Act of 1933 in connection with our medium-term note
program. That Prospectus also describes our contingency planning regarding the
Year 2000 problem. The information that appears in that Prospectus under the
following captions, as updated by the information that appears in this quarterly
report, is incorporated by reference into and made a part of this quarterly
report:
- - "Risk Factors -- Our Computer Systems and Those of Third Parties May Not
Achieve Year 2000 Readiness -- Year 2000 Readiness Disclosure"
- - "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Management -- Operational and Year 2000 Risks -- Year 2000
Readiness Disclosure"
This incorporated information has also been filed as an exhibit to this
quarterly report.
The costs of our Year 2000 program and the date on which we plan to
complete the Year 2000 modifications are based on current estimates, which
reflect numerous assumptions about future events, including the continued
availability of resources, the timing and effectiveness of third-party
remediation plans and other factors. We can give no assurance that these
estimates will be achieved, and actual results could differ materially from our
plans. Specific factors that might cause material differences include, but are
not limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct relevant computer source codes and embedded chip
technology, the results of internal and external testing and the timeliness and
effectiveness of remediation efforts of third parties.
30
<PAGE> 33
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 for one year 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. We intend to adopt the provisions of SFAS No. 133
deferred by SFAS No. 137 in fiscal 2001 and are currently assessing its effect.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and qualitative disclosures about market risk are included
under the captions "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Risk Management -- Market Risk" and "-- Non-Trading
Risk" in the Prospectus, dated May 3, 1999 (the "Prospectus"), of The Goldman
Sachs Group, Inc., filed with the Securities and Exchange Commission pursuant to
Rule 424(b) under the Securities Act of 1933.
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
The following developments have occurred with respect to certain matters
previously reported under the caption "Business -- Legal Matters" in the
Prospectus.
Antitrust Matters Relating to Underwritings
On May 7, 1999, the defendants moved to dismiss the amended complaint in
the action alleging a conspiracy to discourage or restrict the resale of
securities for a period after public offerings. In addition, on March 15, 1999,
the plaintiffs filed a consolidated amended complaint in the actions alleging a
conspiracy to fix at 7% the discount that underwriting syndicates receive from
issuers of shares in certain offerings, and the defendants moved to dismiss that
consolidated amended complaint on April 29, 1999.
Reichhold Chemicals Litigation
The order staying the U.K. Commercial Court litigation against Goldman
Sachs International was upheld by an appellate court on June 28, 1999.
Plaintiffs have indicated their intention to seek a further review by the House
of Lords.
AMF Securities Litigation
Several additional purported class action lawsuits were filed in connection
with the underwriting of AMF Bowling, Inc., and on July 1, 1999, the U.S.
District Court for the Southern District of New York ordered that the plaintiffs
file a consolidated amended class action complaint by August 2, 1999.
Iridium Securities Litigation
Goldman, Sachs & Co. has been named as a defendant in two purported class
action lawsuits commenced beginning on May 26, 1999 in the U.S. District Court
for the District of Columbia. These lawsuits were brought on behalf of
purchasers of Class A common stock of Iridium World Communications, Ltd. in a
January 1999 underwritten secondary offering of
31
<PAGE> 34
7,500,000 shares of Class A common stock at a price of $33.40 per share, as well
as in the secondary market. The defendants in the actions include Iridium,
certain of its officers and directors, Motorola, Inc. (an investor in Iridium)
and the lead underwriters in the offering, including Goldman, Sachs & Co.
The complaints in both actions allege violations of the disclosure
requirements of the federal securities laws and seek compensatory and/or
rescissory damages. Goldman, Sachs & Co. underwrote 996,500 shares of common
stock and Goldman Sachs International underwrote 320,625 shares of common stock,
for a total offering price of approximately $44 million.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
RECENT SALES OF UNREGISTERED SECURITIES
In connection with its conversion to corporate form, Group Inc. issued on
May 7, 1999: (i) 265,019,073 shares of Group Inc.'s common stock, par value
$0.01 per share ("Common Stock"), to certain managing directors who were profit
participating limited partners of The Goldman Sachs Group, L.P. in exchange for
all of these managing directors' interests in The Goldman Sachs Group, L.P. and
certain other affiliates; (ii) 47,270,551 shares of Common Stock and $295
million principal amount of 12% junior subordinated debentures of the Group Inc.
(the "Debentures") to certain retired limited partners of The Goldman Sachs
Group, L.P. in exchange for all of such limited partners' interests in The
Goldman Sachs Group, L.P. and certain other affiliates; (iii) 30,425,052 shares
of Common Stock and 7,440,362 shares of Group Inc.'s nonvoting common stock, par
value $0.01 per share ("Nonvoting Common Stock"), to Sumitomo Bank Capital
Markets, Inc. ("SBCM") in exchange for its interests in The Goldman Sachs Group,
L.P. and Goldman, Sachs & Co.; and (iv) 30,975,421 shares of Common Stock to
Kamehameha Activities Association ("KAA") in exchange for its interests in The
Goldman Sachs Group, L.P. Also, simultaneously with its conversion to corporate
form on May 7, 1999, Group Inc. made awards of restricted stock units and/or
stock options to substantially all of its employees and made an irrevocable
contribution of shares of Common Stock to a nonqualified defined contribution
plan.
The offering and sale of the shares of Common Stock, Debentures and
Nonvoting Common Stock to the managing directors who were profit participating
limited partners, retired limited partners, SBCM and KAA were not registered
under the Securities Act of 1933 because the offering and sale (i) were made in
reliance on the exemption provided by Section 4(2) of the Securities Act of 1933
and Rule 506 thereunder for transactions by an issuer not involving a public
offering (with the recipients representing their intentions to acquire the
securities for their own accounts and not with a view to the distribution
thereof and acknowledging that the securities were issued in a transaction not
registered under the Securities Act of 1933) or (ii) were made outside the
United States pursuant to Regulation S under the Securities Act of 1933 to
persons who were not citizens or residents of the United States. The foregoing
employee awards and contribution of Common Stock were not registered under the
Securities Act of 1933 because the awards and contribution either did not
involve an offer or sale for purposes of Section 2(a)(3) of the Securities Act
of 1933, in reliance on the fact that the awards were made to a relatively broad
class of employees who provided no consideration in exchange for their awards,
or were offered and sold in transactions not involving a public offering, exempt
from registration under the Securities Act of 1933 pursuant to Section 4(2) and
in compliance with Rule 506 thereunder.
On April 13, 1999, Group Inc. entered into an arrangement with a group of
10 employees pursuant to which a portion of a performance-based bonus that is
payable to such employees in 2002 will be paid in shares of Common Stock of
Group Inc. valued at $53.00 per share. Under this arrangement, up to 386,500
shares of Common Stock may be issued. The offering and sale of these 386,500
shares of Common Stock were made pursuant to Rule 701 under the Securities Act
of 1933.
32
<PAGE> 35
USE OF PROCEEDS
The effective date of Group Inc.'s first registration statement, filed on
Form S-1 under the Securities Act of 1933 (File No. 333-74449) relating to Group
Inc.'s initial public offering of Common Stock, was April 30, 1999. A total of
69,000,000 shares of Group Inc.'s Common Stock were sold. Of this amount,
55,200,000 shares were offered in the United States and Canada (the "U.S.
Offering"), 9,200,000 shares were offered outside the United States, Canada and
the Asia/ Pacific region (the "International Offering") and 4,600,000 shares
were offered in the Asia/ Pacific region (the "Asia/Pacific Offering", and
together with the U.S. Offering and the International Offering, the
"offerings"). The managing underwriters for the U.S. Offering were Goldman,
Sachs & Co., Bear, Stearns & Co. Inc., Credit Suisse First Boston Corporation,
Donaldson, Lufkin & Jenrette Securities Corporation, Lehman Brothers Inc.,
Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities Inc.,
Morgan Stanley & Co. Incorporated, PaineWebber Incorporated, Prudential
Securities Incorporated, Salomon Smith Barney Inc., Sanford C. Bernstein & Co.,
Inc. and Schroder & Co. Inc. The managing underwriters for the International
Offering were Goldman Sachs International, ABN AMRO Rothschild, Banque Nationale
de Paris, BAYERISCHE HYPO- und VEREINSBANK Aktiengesellschaft, Cazenove & Co.,
Commerzbank Aktiengesellschaft, Deutsche Bank AG London, ING Barings Limited as
Agent for ING Bank N.V., London Branch, Kleinwort Benson Limited,
MEDIOBANCA -- Banca di Credito Finanziaro S.p.A., Paribas and UBS AG, acting
through its division Warburg Dillon Read. The managing underwriters for the
Asia/Pacific Offering were Goldman Sachs (Asia) L.L.C., BOCI Asia Limited, China
Development Industrial Bank Inc., China International Capital Corporation
Limited, Daiwa Securities (H.K.) Limited, The Development Bank of Singapore Ltd,
HSBC Investment Bank Asia Limited, Jardine Fleming Securities Limited, KOKUSAI
Securities (Hong Kong) Limited, Kotak Mahindra (International) Limited, The
Nikko Merchant Bank (Singapore) Limited, Nomura International plc, Samsung
Securities Co., Ltd., Standard Chartered Asia Limited and Were Stockbroking
Limited.
The offerings commenced on May 3, 1999 and were completed on May 7, 1999.
Of the 69,000,000 shares of Common Stock registered, 51,000,000 shares were
offered and sold by Group Inc., and 9,000,000 shares were offered and sold by
each of SBCM and KAA. The aggregate offering price was $2.7 billion with respect
to the shares offered and sold by Group Inc. and $477 million with respect to
the shares offered and sold by each of SBCM and KAA. The underwriting discount
was $155,250,000, $73 million of which was paid to affiliates of Group Inc.
Group Inc. incurred approximately $9 million of other expenses in connection
with the offerings. The net proceeds to Group Inc. totaled $2.6 billion.
From the time of receipt through May 28, 1999, the proceeds were all applied
towards working capital.
ITEM 5: OTHER INFORMATION
CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
We have included in this Form 10-Q filing, and from time to time our
management may make, statements which may constitute "forward-looking
statements" within the meaning of the safe harbor provisions of The Private
Securities Litigation Reform Act of 1995. These forward-looking statements are
not historical facts but instead represent only our belief regarding future
events, many of which, by their nature, are inherently uncertain and outside of
our control. It is possible that our actual results may differ, possibly
materially, from the anticipated results indicated in these forward-looking
statements. Important factors that could cause actual results to differ from
those in our specific forward-looking statements include, but are not limited
to, the following:
- a decline in general economic conditions or the global financial
markets;
- losses caused by financial or other problems experienced by third
parties;
- losses due to unidentified or unanticipated risks;
33
<PAGE> 36
- a lack of liquidity, i.e., ready access to funds, for use in our
businesses;
- problems brought about by computers that cannot properly distinguish
between the years "1900" and "2000"; and
- competitive pressure.
Additional information regarding these and other important factors that
could cause actual results to differ from those in our forward-looking
statements is contained under the caption "Risk Factors" in the Prospectus. We
hereby incorporate by reference those risk factors (other than those contained
under the captions "Our Computer Systems and Those of Third Parties May Not
Achieve Year 2000 Readiness -- Year 2000 Readiness Disclosure", "Our Common
Stock May Trade at Prices Below the Initial Public Offering Price", "The
Liquidity of Our Common Stock May Be Adversely Affected by an Inability of
Goldman, Sachs & Co. to Act as a Market-Maker in the Common Stock", and "We
Expect to Record a Substantial Pre-Tax Loss in the Second Quarter of Fiscal
1999") into this Form 10-Q.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
<TABLE>
<C> <S>
2.1 Plan of Incorporation (incorporated herein by reference to
Exhibit 2.1 to Group Inc.'s registration statement on Form
S-1 (No. 333-74449)).
2.2 Agreement and Plan of Merger of The Goldman Sachs
Corporation into The Goldman Sachs Group, Inc. (incorporated
herein by reference to Exhibit 2.2 to Group Inc.'s
registration statement on Form S-1 (No. 333-75213)).
2.3 Agreement and Plan of Merger of The Goldman Sachs Group,
L.P. into The Goldman Sachs Group, Inc. (incorporated herein
by reference to Exhibit 2.3 to Group Inc.'s registration
statement on Form S-1 (No. 333-75213)).
3.1 Amended and Restated Certificate of Incorporation of The
Goldman Sachs Group, Inc. (incorporated herein by reference
to Exhibit 3.1 to Group Inc.'s registration statement on
Form S-1 (No. 333-75213)).
3.2 Amended and Restated By-Laws of The Goldman Sachs Group,
Inc. (incorporated herein by reference to Exhibit 3.2 to
Group Inc.'s registration statement on Form S-1 (No.
333-75213)).
4.1 Indenture, dated as of May 19, 1999, between The Goldman
Sachs Group, Inc. and The Bank of New York, as trustee
(incorporated herein by reference to Exhibit 6 to Group
Inc.'s registration statement on Form 8-A (No. 001-14965)).
10.1 The Goldman Sachs 1999 Stock Incentive Plan (incorporated
herein by reference to Exhibit 10.15 to Group Inc.'s
registration statement on Form S-1 (No. 333-75213)).
10.2 The Goldman Sachs Defined Contribution Plan (incorporated
herein by reference to Exhibit 10.16 to Group Inc.'s
registration statement on Form S-1 (No. 333-75213)).
10.3 Letter Agreement with Mr. Weinberg (incorporated herein by
reference to Exhibit 10.17 to Group Inc.'s registration
statement on Form S-1 (No. 333-74449)).
10.4 The Goldman Sachs Partner Compensation Plan (incorporated
herein by reference to Exhibit 10.18 to Group Inc.'s
registration statement on Form S-1 (No. 333-75213)).
10.5 Form of Employment Agreement (incorporated herein by
reference to Exhibit 10.19 to Group Inc.'s registration
statement on Form S-1 (No. 333-75213)).
10.6 Form of Agreement Relating to Noncompetition and Other
Covenants (incorporated herein by reference to Exhibit 10.20
to Group Inc.'s registration statement on Form S-1 (No.
333-75213)).
10.7 Form of Pledge Agreement (incorporated herein by reference
to Exhibit 10.21 to Group Inc.'s registration statement on
Form S-1 (No. 333-75213)).
10.8 Form of Award Agreement (Formula RSUs) (incorporated herein
by reference to Exhibit 10.22 to Group Inc.'s registration
statement on Form S-1 (No. 333-75213)).
</TABLE>
34
<PAGE> 37
<TABLE>
<C> <S>
10.9. Form of Award Agreement (Discretionary RSUs) (incorporated
herein by reference to Exhibit 10.23 to Group Inc.'s
registration statement on Form S-1 (No. 333-75213)).
10.10 Form of Option Agreement (Discretionary Options)
(incorporated herein by reference to Exhibit 10.24 to Group
Inc.'s registration statement on Form S-1 (No. 333-75213)).
10.11 Tax Indemnification Agreement, dated as of May 7, 1999,
among The Goldman Sachs Group, Inc. and various parties
(incorporated herein by reference to Exhibit 10.25 to Group
Inc.'s registration statement on Form S-1 (No. 333-75213)).
10.12 Form of Shareholders' Agreement among The Goldman Sachs
Group, Inc. and various parties (incorporated herein by
reference to Exhibit 10.26 to Group Inc.'s registration
statement on Form S-1 (No. 333-75213)).
10.13 Instrument of Indemnification (incorporated herein by
reference to Exhibit 10.27 to Group Inc.'s registration
statement on Form S-1 (No. 333-75213)).
10.14 Form of Indemnification Agreement (incorporated herein by
reference to Exhibit 10.28 to Group Inc.'s registration
statement on Form S-1 (No. 333-75213)).
10.15 Letter Agreement, dated March 15, 1999, among Kamehameha
Activities Association and The Goldman Sachs Group, L.P.
(the "Kamehameha Letter Agreement") (incorporated herein by
reference to Exhibit 10.31 to Group Inc.'s registration
statement on Form S-1 (No. 333-74449)).
10.16 Letter Agreement, dated March 15, 1999, among The Sumitomo
Bank, Limited, Sumitomo Bank Capital Markets, Inc. and The
Goldman Sachs Group, L.P. (the "Sumitomo Letter Agreement")
(incorporated herein by reference to Exhibit 10.33 to Group
Inc.'s registration statement on Form S-1 (No. 333-74449)).
10.17 Amendment to Kamehameha Letter Agreement (filed as Exhibit
10.15 hereof), dated April 30, 1999, among Kamehameha
Activities Association, the Trustees of the Estate of
Bernice Pauahi Bishop, The Goldman Sachs Group, L.P. and The
Goldman Sachs Group, Inc. (incorporated herein by reference
to Exhibit 10.35 to Group Inc.'s registration statement on
Form S-1 (No. 333-75213)).
10.18 Amendment to Sumitomo Letter Agreement (filed as Exhibit
10.16 hereof), dated April 30, 1999, among The Sumitomo
Bank, Limited, Sumitomo Bank Capital Markets, Inc., The
Goldman Sachs Group, L.P., The Goldman Sachs Group, Inc. and
Goldman, Sachs & Co. (incorporated herein by reference to
Exhibit 10.36 to Group Inc.'s registration statement on Form
S-1 (No. 333-75213)).
10.19 Voting Agreement, dated as of April 30, 1999, by and among
The Goldman Sachs Group, Inc., on the one hand, and The
Trustees of the Estate of Bernice Pauahi Bishop and
Kamehameha Activities Association, on the other hand
(incorporated herein by reference to Exhibit 10.37 to Group
Inc.'s registration statement on Form S-1 (No. 333-75213)).
10.20 Voting Agreement, dated as of April 30, 1999, by and among
The Goldman Sachs Group, Inc., on the one hand, and The
Sumitomo Bank, Limited, and Sumitomo Bank Capital Markets,
Inc., on the other hand (incorporated herein by reference to
Exhibit 10.38 to Group Inc.'s registration statement on Form
S-1 (No. 333-75213)).
11.1 Statement re computation of per share earnings.
12.1 Statement re computation of ratios of earnings to fixed
charges.
15.1 Letter re Unaudited Interim Financial Information.
19.1 Information incorporated by reference into Part I of Form
10-Q.
27.1 Financial Data Schedule.
99.1 Information incorporated by reference into Part II of Form
10-Q.
</TABLE>
(b) Reports on Form 8-K:
None.
35
<PAGE> 38
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.
THE GOLDMAN SACHS GROUP, INC.
By: /s/ DAVID A. VINIAR
------------------------------------
Name: David A. Viniar
Title: Chief Financial Officer
By: /s/ SARAH G. SMITH
------------------------------------
Name: Sarah G. Smith
Title: Principal Accounting
Officer
Date: July 9, 1999
36
<PAGE> 39
EXHIBIT 11.1
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
-------------------------- ------------------------
May 1999 May 1999
(in millions, except share and per share amounts)
<S> <C> <C>
Earnings available to common stockholders $ 340 $ 1,347
============ =============
Weighted-average number of common shares 474,712,271 474,712,271
Effect of dilutive securities:
Restricted stock units 2,432,037 2,432,037
Stock options 2,763,993 2,763,993
------------ -------------
Dilutive potential common shares 5,196,030 5,196,030
------------ -------------
Weighted-average number of common
shares and dilutive potential common shares 479,908,301 478,908,301
============ =============
BASIC EARNINGS PER SHARE $ 0.72 $ 2.84
============ =============
DILUTED EARNINGS PER SHARE 0.71 2.81
============ =============
</TABLE>
<PAGE> 40
EXHIBIT 12.1
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
ACTUAL
----------------------------------
SIX MONTHS ENDED MAY
--------------------
1999 1998
-------- --------
($ in millions)
<S> <C> <C>
Net earnings $ 1,347 $ 1,731
Add:
(Benefit)/provision for taxes (1,646) 328
Portion of rents representative of an interest factor 48 31
Interest expense on all indebtedness 5,747 7,005
-------- --------
Earnings, as adjusted $ 5,496 $ 9,095
======== ========
Fixed charges:
Portion of rents representative of an interest factor $ 48 $ 31
Interest expense on all indebtedness 5,747 7,005
-------- --------
Fixed charges $ 5,795 $ 7,036
======== ========
-------- --------
Ratio of earnings to fixed charges 0.95x 1.29x
======== ========
<CAPTION>
PRO FORMA
---------------------
SIX MONTHS ENDED MAY
---------------------
1999
--------
($ in millions)
<S> <C>
Net earnings $ 1,156
Add:
Provision for taxes 803
Portion of rents representative of an interest factor 48
Interest expense on all indebtedness 5,754
--------
Earnings, as adjusted $ 7,761
========
Fixed charges:
Portion of rents representative of an interest factor $ 48
Interest expense on all indebtedness 5,754
--------
Fixed charges $ 5,802
========
--------
Ratio of earnings to fixed charges 1.34x
========
</TABLE>
<PAGE> 41
EXHIBIT 15.1
July 9, 1999
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Re: The Goldman Sachs Group, Inc.
Registration Statement on Form S-8 (No. 333-80839)
Commissioners:
We are aware that our report dated July 8, 1999 on our review of the condensed
consolidated statement of financial condition of The Goldman Sachs Group, Inc.
and Subsidiaries (the "Company") as of May 28, 1999, and the condensed
consolidated statements of earnings for the three and six months ended May 28,
1999 and the three months ended May 29, 1998, and the condensed consolidated
statements of cash flows and changes in stockholders' equity and partners'
capital for the six months ended May 28, 1999 and included in the Company's
Quarterly Report on 10-Q is incorporated by reference in this registration
statement. Pursuant to Rule 436(c) under the Securities Act of 1933, that report
should not be considered a part of this Registration Statement prepared or
certified by us within the meaning of Sections 7 and 11 of that Act.
Very truly yours,
/s/ PricewaterhouseCoopers LLP
<PAGE> 42
Exhibit 19.1
OUR COMPUTER SYSTEMS AND THOSE OF THIRD PARTIES MAY NOT ACHIEVE YEAR 2000
READINESS--YEAR 2000 READINESS DISCLOSURE
With the year 2000 approaching, many institutions around the world are
reviewing and modifying their computer systems to ensure that they are Year 2000
compliant. The issue, in general terms, is that many existing computer systems
and microprocessors (including those in non-information technology equipment
and systems) use only two digits to identify a year in the date field with the
assumption that the first two digits of the year are always "19". Consequently,
on January 1, 2000, computers that are not Year 2000 compliant may read the
year as 1900. Systems that calculate, compare or sort using the incorrect data
may malfunction.
The Year 2000 problems described below could disrupt our normal funding
administration process, resulting in late payments or the payment of wrong
amounts on our debt, including the notes. If sufficiently severe and
protracted, these problems could also lead the rating agencies to reduce our
credit ratings, which could hurt the market value of the notes and possibly
your ability to resell them.
Our Computer Systems May Fail
Because we are dependent, to a very substantial degree, upon the proper
functioning of our computer systems, a failure of our systems to be Year 2000
compliant would have a material adverse effect on us. Failure of this kind
could, for example, cause settlement of trades to fail, lead to incomplete or
inaccurate accounting, recording or processing of trades in securities,
currencies, commodities and other assets, result in generation of erroneous
results or give rise to uncertainty about our exposure to trading risks and our
need for liquidity. If not remedied, potential risks include business
interruption or shutdown, financial loss, regulatory actions, reputational harm
and legal liability.
The Computer Systems of Third Parties on Which We Depend May Fail
We depend upon the proper functioning of third-party computer and
non-information technology systems. These parties include trading
counterparties, financial intermediaries such as securities and commodities
exchanges, depositories, clearing agencies, clearing houses and commercial
banks and vendors such as providers of telecommunication services and other
utilities. We continue to assess counterparties, intermediaries and vendors
with whom we have important financial or operational relationships to determine
the extent of their Year 2000 preparedness. We have not yet received sufficient
information from all parties about their Year 2000 preparedness to assess the
effectiveness of their efforts. Moreover, in many cases, we are not in a
position to verify the accuracy or completeness of the information we receive
from third parties and as a result are dependent on their willingness and
ability to disclose, and to address, their Year 2000 problems. In addition, in
some international markets in which we do business, the level of awareness and
remediation efforts relating to the Year 2000 issue may be less advanced than
in the United States.
<PAGE> 43
If third parties with whom we interact have Year 2000 problems that are not
remedied, problems could include the following:
- - in the case of vendors, disruption of important services upon which Goldman
Sachs depends, such as telecommunications and electrical power;
- - in the case of third-party data providers, receipt of inaccurate or
out-of-date information that would impair our ability to perform critical data
functions, such as pricing our securities or other assets;
- - in the case of financial intermediaries, such as exchanges and clearing
agents, failed trade settlements, inability to trade in certain markets and
disruption of funding flows;
- - in the case of banks and other lenders, disruption of capital flows
potentially resulting in liquidity stress; and
- - in the case of counterparties and customers, financial and accounting
difficulties for those parties that expose Goldman Sachs to increased credit
risk and lost business.
Disruption or suspension of activity in the world's financial markets is
also possible.
Our Revenues May Decline If Market Activity Decreases Shortly Before and After
the Year 2000
We believe that uncertainty about the success of remediation efforts
generally may cause many market participants to reduce the level of their market
activities temporarily as they assess the effectiveness of these efforts during
a "phase-in" period beginning in late 1999. We believe that lenders are likely
to take similar steps, which will result in a reduction in available funding
sources. Consequently, there may be a downturn in customer and general market
activity for a short period of time before and after January 1, 2000. If this
occurs, our net revenues may be adversely affected, possibly materially,
depending on how long the reduction in activity continues and how broadly it
affects the markets. In addition, we expect to reduce our own trading activities
and the size of our balance sheet in order to manage the number and type of our
transactions that settle during this period and our related funding needs. This
also could reduce our net revenues. We cannot predict the magnitude of the
impact that these kinds of reductions would have on our businesses.
We May Be Exposed to Litigation as a Result of Year 2000 Problems
We may be exposed to litigation with our customers and counterparties as a
result of Year 2000 problems. For example, litigation could arise from problems
relating to our internal systems or to external systems on which we depend, as
well as from problems involving companies in which our clients or the funds we
manage hold investments.
Our Year 2000 Program May Not Be Effective and Our Estimates of Timing and Cost
May Not Be Accurate
Our Year 2000 program may not be effective and our estimates about the
timing and cost of completing our program may not be accurate. For a
description of our program and the steps that remain to be taken, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Management -- Operational and Year 2000 Risks -- Year 2000
Readiness Disclosure".
<PAGE> 44
YEAR 2000 READINESS DISCLOSURE. Goldman Sachs has determined that it will
be required to modify or replace portions of its information technology systems,
both hardware and software, and its non-information technology systems so that
they will properly recognize and utilize dates beyond December 31, 1999. We
presently believe that with modifications to existing software, conversions to
new software and replacement of some hardware, the Year 2000 issue will be
satisfactorily resolved in our own systems worldwide. However, if such
modifications and conversions are not made or are not completed on a timely
basis, the Year 2000 issue would have a material adverse effect on Goldman
Sachs. Moreover, even if these changes are successful, failure of third parties
to which we are financially or operationally linked to address their own Year
2000 problems would also have a material adverse effect on Goldman Sachs. For a
description of the Year 2000 issue and some of the related risks, including
possible problems that could arise, see "Risk Factors -- Our Computer Systems
and Those of Third Parties May Not Achieve Year 2000 Readiness -- Year 2000
Readiness Disclosure".
Recognizing the broad scope and complexity of the Year 2000 problem, we
have established a Year 2000 Oversight Committee to promote awareness and ensure
the active participation of senior management. This Committee, together with
numerous subcommittees chaired by senior managers throughout Goldman Sachs and
our Global Year 2000 Project Office, is responsible for planning, managing and
monitoring our Year 2000 efforts on a global basis. Our Management Controls
Department assesses the scope and sufficiency of our Year 2000 program and
verifies that the principal aspects of our Year 2000 program are being
implemented according to plan.
Our Year 2000 plans are based on a five-phase approach, which includes
awareness; inventory, assessment and planning; remediation; testing; and
implementation. The awareness phase (in which we defined the scope and
components of the problem, our methodology and approach and obtained senior
management support and funding) was completed in September 1997. We also
completed the inventory, assessment and planning phase for our systems in
September 1997. By the end of March 1999, we completed the remediation, testing
and implementation phases for 99% or our mission-critical systems, and we plan
to complete these three phases for the remaining 1% by the end of June 1999. In
March 1999, we completed the first cycle of our internal integration testing
with respect to critical securities and transaction flows. This cycle, which
related to U.S. products, was completed successfully with no material problem.
The remaining cycle, which will relate primarily to non-U.S. products, is to be
completed in June 1999. This testing is intended to validate that our systems
can successfully perform critical business functions beginning in January 2000.
With respect to our non-mission-critical systems, we expect to complete our Year
2000 efforts during calendar 1999.
For technology products that are supplied by third-party vendors, we have
completed an inventory, ranked products according to their importance and
developed a strategy for achieving Year 2000 readiness for substantially all
non-compliant versions of software and hardware. While this process included
collecting information from vendors, we are not relying solely on vendors'
verifications that their products are Year 2000 compliant or ready. As of March
31, 1999, we had substantially completed testing and implementation of
vendor-supplied technology products that we consider mission-critical. With
respect to telecommunications carriers, we are relying on information provided
by these vendors as to whether they are Year 2000 compliant because these
vendors have indicated that they will not test with individual companies.
We are also addressing Year 2000 issues that may exist outside our own
technology activities, including our facilities, external service providers and
other third parties with which we interface. We have inventoried and ranked our
customers, business and trading partners, utilities, exchanges, depositories,
clearing and custodial banks and other third
<PAGE> 45
parties with which we have important financial and operational relationships.
We are continuing to assess the Year 2000 preparedness of these customers,
business and trading partners and other third parties.
By the end of March 1999, we had participated in approximately 115
"external", i.e., industry-wide or point-to-point, tests with exchanges,
clearing houses and other industry utilities, as well as the "Beta" test
sponsored by the Securities Industry Association for its U.S. members in July
1998. We successfully completed all of these tests, as well as the Securities
Industry Association "Streetwide" test in April 1999, with no material
problems. By the end of June 1999, we expect to have participated in
approximately 60 additional external tests, including major industry tests in
those global markets where we conduct significant businesses.
Acknowledging that a Year 2000 failure, whether internal or external, could
have an adverse effect on the ability to conduct day-to-day business, we are
employing a comprehensive and global approach to contingency planning. Our
contingency planning objective is to identify potential system failure points
that support processes that are critical to our mission and to develop
contingency plans for those failures that may reasonably be expected to occur,
with the general goal of ensuring, to the maximum extent practical, that minimum
acceptable levels of service can be maintained by us. In the event of system
failures, our contingency plans will not guarantee that existing levels of
service will be fully maintained, especially if these failures involve external
systems or processes over which we have little or no direct control or involve
multiple failures across a variety of systems.
We anticipate that contingency plans for our core business units will be
substantially complete during June 1999, and by September 30, 1999 for the rest
of our businesses. In addition, we are developing contingency plans for funding
and balance sheet management and other related activities. We expect our
contingency plans to include establishing additional sources of liquidity that
could be drawn upon in the event of systems disruption. We are also developing
a crisis management group to guide us through the transition period. We expect
to reduce trading activity in the period leading up to January 2000 to minimize
the impact of potential Year 2000-related failures. A reduction in trading
activity by us or by other market participants in anticipation of possible Year
2000 problems could adversely affect our results of operations, as discussed
under "Risk Factors -- Our Computer Systems and Those of Third Parties May Not
Achieve Year 2000 Readiness -- Year 2000 Readiness Disclosure".
We have incurred and expect to continue to incur expenses allocable to
internal staff, as well as costs for outside consultants, to complete the
remediation and testing of internally developed systems and the replacement and
testing of third-party products and services, including non-technology products
and services, in order to achieve Year 2000 compliance. We currently estimate
that these costs will total approximately $150 million, a substantial majority
of which has been spent to date. These estimates include the cost of technology
personnel but do not include the cost of most non-technology personnel involved
in our Year 2000 effort. The remaining cost of our Year 2000 program is
expected to be incurred in 1999 and early 2000. The Year 2000 program costs
will continue to be funded through operating cash flow. These costs are
expensed as incurred. We do not expect that the costs associated with
implementing our Year 2000 program will have a material adverse effect on our
results of operations, financial condition, liquidity or capital resources.
The costs of the Year 2000 program and the date on which we plan to
complete the Year 2000 modifications are based on current estimates, which
reflect numerous assumptions about future events, including the continued
availability of resources, the timing and effectiveness of third-party
remediation plans and other factors. We can give no assurance that these
estimates will be achieved, and actual results could differ materially from our
plans. Special factors that might cause material differences include, but are
not limited to, the availability and cost of personnel trained in this area,
the ability to locate and correct
<PAGE> 46
relevant computer source codes and embedded chip technology, the results of
internal and external testing and the timeliness and effectiveness of
remediation efforts of third parties.
In order to focus attention on the Year 2000 problem, management has
deferred several technology projects that address other issues. However, we do
not believe that this deferral will have a material adverse effect on our
results of operations or financial condition.
<PAGE> 47
[ARTICLE] BD<F1>
[MULTIPLIER] 1,000,000
<TABLE>
<S> <C>
[PERIOD-TYPE] 6-MOS
[FISCAL-YEAR-END] NOV-26-1999
[PERIOD-START] NOV-30-1998<F2>
[PERIOD-END] MAY-28-1999
[CASH] 11,252<F3>
[RECEIVABLES] 26,734
[SECURITIES-RESALE] 44,088
[SECURITIES-BORROWED] 79,198
[INSTRUMENTS-OWNED] 71,513
[PP&E] 994<F4>
[TOTAL-ASSETS] 244,632
[SHORT-TERM] 31,601
[PAYABLES] 35,095
[REPOS-SOLD] 41,092
[SECURITIES-LOANED] 24,384
[INSTRUMENTS-SOLD] 67,312
[LONG-TERM] 21,851
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[COMMON] 4
[OTHER-SE] 7,852
[TOTAL-LIABILITY-AND-EQUITY] 244,632
[TRADING-REVENUE] 3,117<F5>
[INTEREST-DIVIDENDS] 6,031
[COMMISSIONS] 688<F6>
[INVESTMENT-BANKING-REVENUES] 1,904
[FEE-REVENUE] 471<F6>
[INTEREST-EXPENSE] 5,747
[COMPENSATION] 3,228<F7>
[INCOME-PRETAX] (299)
[INCOME-PRE-EXTRAORDINARY] (299)
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] 1,347
[EPS-BASIC] 2.84
[EPS-DILUTED] 2.81
<FN>
<F1>The amounts disclosed in the financial data summary should be read in
conjunction with the condensed consolidated financial statements and the notes
thereto.
<F2>Represents the first Monday of the period.
<F3>Includes cash and cash equivalents and cash and securities segregated in
compliance with U.S. federal and other regulations as disclosed on the
condensed consolidated statement of financial condition.
<F4>Included in other assets on the condensed consolidated statement of
financial condition.
<F5>Includes revenues from principal investments, which mainly represents
revenues from investments in merchant banking funds.
<F6>Included in revenues from asset management and securities services on the
condensed consolidated statement of earnings.
<F7>Excludes non-recurring employee initial public offering awards and
amortization of employee initial public offering awards.
</FN>
</TABLE>
<PAGE> 48
Exhibit 99.1
RISK FACTORS
An investment in the common stock involves a number of risks, some of
which, including market, liquidity, credit, operational, legal and regulatory
risks, could be substantial and are inherent in our businesses. You should
carefully consider the following information about these risks, together with
the other information in this prospectus, before buying shares of common stock.
MARKET FLUCTUATIONS COULD ADVERSELY AFFECT OUR BUSINESSES IN MANY WAYS
As an investment banking and securities firm, our businesses are
materially affected by conditions in the financial markets and economic
conditions generally, both in the United States and elsewhere around the world.
The equity and debt markets in the United States and elsewhere have achieved
record or near record levels, and this favorable business environment will not
continue indefinitely. In the event of a market downturn, our businesses could
be adversely affected in many ways, including those described below. Our
revenues are likely to decline in such circumstances and, if we were unable to
reduce expenses at the same pace, our profit margins would erode. For example,
in the second half of fiscal 1998, we recorded negative net revenues from our
Trading and Principal Investments business and from mid-August to mid-October
the number of equity underwritings and announced mergers and acquisitions
transactions in which we participated declined substantially due to adverse
economic and market conditions. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Business Environment" for a
discussion of the market environment in which we operated during that period.
Even in the absence of a market downturn, we are exposed to substantial risk of
loss due to market volatility.
We May Incur Significant Losses from Our Trading and Investment Activities Due
to Market Fluctuations and Volatility
We generally maintain large trading and investment positions in the
fixed income, currency, commodity and equity markets. To the extent that we own
assets, i.e., have long positions, in any of those markets, a downturn in those
markets could result in losses from a decline in the value of those long
positions. Conversely, to the extent that we have sold assets we do not own,
i.e., have short positions, in any of those markets, an upturn in those markets
could expose us to potentially unlimited losses as we attempt to cover our short
positions by acquiring assets in a rising market. We may from time to time have
a trading strategy consisting of holding a long position in one asset and a
short position in another, from which we expect to earn revenues based on
changes in the relative value of the two assets. If, however, the relative value
of the two assets changes in a direction or manner that we did not anticipate or
against which we are not hedged, we might realize a loss in those paired
positions. We incurred significant losses in our Trading and Principal
Investments business in the second half of fiscal 1998 from this type of
"relative value" trade. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Business Environment" for a discussion of
those losses and the market environment in which we operated during that period.
In addition, we maintain substantial trading positions that can be adversely
affected by the level of volatility in the financial markets, i.e., the degree
to which trading prices fluctuate over a particular period, in a particular
market, regardless of market levels.
Our Investment Banking Revenues May Decline In Adverse Market or Economic
Conditions
Unfavorable financial or economic conditions would likely reduce the
number and size of transactions in which we provide underwriting, mergers and
acquisitions advisory and other services. Our Investment Banking revenues, in
the form of financial advisory and underwriting fees, are directly related to
the number and size of the transactions in which we participate and would
therefore be adversely affected by a sustained market downturn. In particular,
our results of operations would be adversely affected by a significant
<PAGE> 49
reduction in the number or size of mergers and acquisitions transactions.
We May Generate Lower Revenues from Commissions and Asset Management Fees in a
Market Downturn
A market downturn could lead to a decline in the volume of transactions
that we execute for our customers and, therefore, to a decline in the revenues
we receive from commissions and spreads. In addition, because the fees that we
charge for managing our clients' portfolios are in many cases based on the value
of those portfolios, a market downturn that reduces the value of our clients'
portfolios or increases the amount of withdrawals would reduce the revenue we
receive from our asset management business.
Holding Large and Concentrated Positions May Expose Us to Large Losses
Concentration of risk in the past has increased the losses that we have
incurred in our arbitrage, market-making, block trading, underwriting and
lending businesses and may continue to do so in the future. Goldman Sachs has
committed substantial amounts of capital to these businesses, which often
require Goldman Sachs to take large positions in the securities of a particular
issuer or issuers in a particular industry, country or region. Moreover, the
trend in all major capital markets is towards larger and more frequent
commitments of capital in many of these activities. For example, as described
under "Business - Trading and Principal Investments - Equities", we are
experiencing an increase in the number and size of block trades that we execute,
and we expect this trend to continue.
Our Hedging Strategies May Not Prevent Losses
If any of the variety of instruments and strategies we utilize to hedge our
exposure to various types of risk are not effective, we may incur losses. Many
of our strategies are based on historical trading patterns and correlations. For
example, if we hold a long position in an asset, we may hedge this position by
taking a short position in an asset where the short position has, historically,
moved in a direction that would offset a change in value in the long position.
However, these strategies may not be fully effective in mitigating our risk
exposure in all market environments or against all types of risk. We have often
hedged our exposure to corporate fixed income securities by taking a short
position in U.S. Treasury securities, since historically the value of U.S.
Treasury securities has changed in a manner similar to changes in the value of
corporate fixed income securities. Due to the move by investors to higher credit
quality fixed income securities in mid-August to mid-October 1998, however, the
prices for corporate fixed income securities declined while the prices for U.S.
Treasury securities increased and, as a result, we incurred losses on both
positions. Unexpected market developments also affected other hedging strategies
during this time, and unanticipated developments could impact these or different
hedging strategies in the future. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Risk Management" for a
discussion of the policies and procedures we use to identify, monitor and manage
the risks we assume in conducting our businesses and of refinements we have made
to our risk management policies and procedures as a result of our recent
experience.
A Prolonged Market Downturn Could Impair Our Operating Results
While we encountered extremely difficult market conditions in mid-August to
mid-October 1998, the financial markets rebounded late in the fourth quarter of
fiscal 1998. At some time in the future, there may be a more sustained period of
market decline or weakness that will leave us operating in a difficult market
environment and subject us to the risks that we describe in this section for a
longer period of time.
Market Risk May Increase the Other Risks That We Face
In addition to the potentially adverse effects on our businesses described
above, market risk could exacerbate other risks that we face. For example, if we
incur substantial
<PAGE> 50
trading losses, our need for liquidity could rise sharply while our access to
liquidity could be impaired. In addition, in conjunction with a market downturn,
our customers and counterparties could incur substantial losses of their own,
thereby weakening their financial condition and increasing our credit risk to
them. Our liquidity risk and credit risk are described below.
OUR RISK MANAGEMENT POLICIES AND PROCEDURES
MAY LEAVE US EXPOSED TO UNIDENTIFIED OR UNANTICIPATED RISK
We have devoted significant resources to develop our risk management
policies and procedures and expect to continue to do so in the future.
Nonetheless, our policies and procedures to identify, monitor and manage risks
may not be fully effective. Some of our methods of managing risk are based upon
our use of observed historical market behavior. As a result, these methods may
not predict future risk exposures, which could be significantly greater than the
historical measures indicate. For example, the market movements of the late
third and early fourth quarters of fiscal 1998 were larger and involved greater
divergences in relative asset values than we anticipated. This caused us to
experience trading losses that were greater and recurred more frequently than
some of our risk measures indicated were likely to occur. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Business Environment" for a discussion of the market environment in which we
operated during the second half of fiscal 1998 and "-- Risk Management" for a
discussion of the policies and procedures we use to identify, monitor and manage
the risks we assume in conducting our businesses and of refinements we have
made to our risk management policies and procedures as a result of our recent
experience.
Other risk management methods depend upon evaluation of information
regarding markets, clients or other matters that is publicly available or
otherwise accessible by Goldman Sachs. This information may not in all cases be
accurate, complete, up-to-date or properly evaluated. Management of operational,
legal and regulatory risk requires, among other things, policies and procedures
to record properly and verify a large number of transactions and events, and
these policies and procedures may not be fully effective.
LIQUIDITY RISK COULD IMPAIR OUR ABILITY TO FUND OPERATIONS
AND JEOPARDIZE OUR FINANCIAL CONDITION
Liquidity, i.e., ready access to funds, is essential to our businesses. In
addition to maintaining a cash position, we rely on three principal sources of
liquidity: borrowing in the debt markets; access to the repurchase and
securities lending markets; and selling securities and other assets. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity" for a discussion of our sources of liquidity.
An Inability to Access the Debt Capital Markets Could Impair Our Liquidity
We depend on continuous access to the debt capital markets to finance our
day-to-day operations. An inability to raise money in the long-term or
short-term debt markets, or to engage in repurchase agreements or securities
lending, could have a substantial negative effect on our liquidity. Our access
to debt in amounts adequate to finance our activities could be impaired by
factors that affect Goldman Sachs in particular or the financial services
industry in general. For example, lenders could develop a negative perception of
our long-term or short-term financial prospects if we incurred large trading
losses, if the level of our business activity decreased due to a market
downturn, if regulatory authorities took significant action against us or if we
discovered that one of our employees had engaged in serious unauthorized or
illegal activity. Our ability to borrow in the debt markets also could be
impaired by factors that are not specific to Goldman Sachs, such as a severe
disruption of the financial markets or negative views about the prospects for
the investment banking, securities or financial services industries generally.
We also depend on banks to finance our day-to-day operations. As a result
of the recent consolidation in the banking industry,
<PAGE> 51
some of our lenders have merged or consolidated with other banks and financial
institutions. While we have not been materially adversely affected to date, it
is possible that further consolidation could lead to a loss of a number of our
key banking relationships and a reduction in the amount of credit extended to
us.
An Inability to Access the Short-Term Debt Markets Could Impair Our Liquidity
We depend on the issuance of commercial paper and promissory notes as a
principal source of unsecured short-term funding for our operations. As of
February 26, 1999, Goldman Sachs had $21.63 billion of outstanding commercial
paper and promissory notes with a weighted-average maturity of approximately 75
days. Our liquidity depends to an important degree on our ability to refinance
these borrowings on a continuous basis. Investors who hold our outstanding
commercial paper and promissory notes have no obligation to purchase new
instruments when the outstanding instruments mature.
Our Liquidity Could Be Adversely Affected If Our Ability to Sell Assets Is
Impaired
If we were unable to borrow in the debt capital markets, we would need to
liquidate assets in order to meet our maturing liabilities. In certain market
environments, such as times of market volatility or uncertainty, overall market
liquidity may decline. In a time of reduced liquidity, we may be unable to sell
some of our assets, or we may have to sell assets at depressed prices, which
could adversely affect our results of operations and financial condition.
Our ability to sell our assets may be impaired by other market
participants seeking to sell similar assets into the market at the same time. In
the late third and early fourth quarters of fiscal 1998, for example, the
markets for some assets were adversely affected by simultaneous attempts by a
number of institutions to sell similar assets.
A Reduction in Our Credit Ratings Could Adversely Affect Our Liquidity
and Competitive Position and Increase Our Borrowing Costs
Our borrowing costs and our access to the debt capital markets depend
significantly on our credit ratings. These ratings are assigned by rating
agencies, which may reduce or withdraw their ratings or place Goldman Sachs on
"credit watch" with negative implications at any time. Credit ratings are also
important to Goldman Sachs when competing in certain markets and when seeking to
engage in longer-term transactions, including over-the-counter derivatives. A
reduction in our credit ratings could increase our borrowing costs and limit our
access to the capital markets. This, in turn, could reduce our earnings and
adversely affect our liquidity. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity -- Credit Ratings"
for additional information concerning our credit ratings.
CREDIT RISK EXPOSES US TO LOSSES CAUSED
BY FINANCIAL OR OTHER PROBLEMS
EXPERIENCED BY THIRD PARTIES
We are exposed to the risk that third parties that owe us money,
securities or other assets will not perform their obligations. These parties
include our trading counterparties, customers, clearing agents, exchanges,
clearing houses and other financial intermediaries as well as issuers whose
securities we hold. These parties may default on their obligations to us due to
bankruptcy, lack of liquidity, operational failure or other reasons. This risk
may arise, for example, from holding securities of third parties; entering into
swap or other derivative contracts under which counterparties have long-term
obligations to make payments to us; executing securities, futures, currency or
commodity trades that fail to settle at the required time due to non-delivery by
the counterparty or systems failure by clearing agents, exchanges, clearing
houses or other financial intermediaries; and extending credit to our clients
through bridge or margin loans or other arrangements. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Manage-
<PAGE> 52
ment--Credit Risk" for a further discussion of the credit risks to which we are
exposed.
We May Suffer Significant Losses from Our Credit Exposures
In recent years, we have significantly expanded our swaps and other
derivatives businesses and placed a greater emphasis on providing credit and
liquidity to our clients. As a result, our credit exposures have increased in
amount and in duration. In addition, as competition in the financial services
industry has increased, we have experienced pressure to assume longer-term
credit risk, extend credit against less liquid collateral and price more
aggressively the credit risks that we take.
Our Clients and Counterparties May Be Unable to Perform Their Obligations to Us
as a Result of Economic or Political Conditions
Country, regional and political risks are components of credit risk, as
well as market risk. Economic or political pressures in a country or region,
including those arising from local market disruptions or currency crises, may
adversely affect the ability of clients or counterparties located in that
country or region to obtain foreign exchange or credit and, therefore, to
perform their obligations to us. See "--We Are Exposed to Special Risks in
Emerging and Other Markets" for a further discussion of our exposure to these
risks.
Defaults by a Larger Financial Institution Could Adversely Affect Financial
Markets Generally and Us Specifically
The commercial soundness of many financial institutions may be closely
interrelated as a result of credit, trading, clearing or other relationships
between the institutions. As a result, concerns about, or a default by, one
institution could lead to significant liquidity problems or losses in, or
defaults by, other institutions. This is sometimes referred to as "systemic
risk" and may adversely affect financial intermediaries, such as clearing
agencies, clearing houses, banks, securities firms and exchanges, with which
we interact on a daily basis.
The possibility of default by a major market participant in the second
half of fiscal 1998 and concerns throughout the financial industry regarding
the resulting impact on markets led us to participate in an industry-wide
consortium that invested in Long-Term Capital Portfolio, L.P., which is
described under "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity--The Balance Sheet". Actual defaults,
increases in perceived default risk and other similar events could arise in the
future and could have an adverse effect on the financial markets and on Goldman
Sachs.
The Information That We Use in Managing Our Credit Risk May Be Inaccurate or
Incomplete
Although we regularly review our credit exposure to specific clients and
counterparties and to specific industries, countries and regions that we
believe may present credit concerns, default risk may arise from events or
circumstances that are difficult to detect, such as fraud. We may also fail to
receive full information with respect to the trading risks of a counterparty.
In addition, in cases where we have extended credit against collateral, we may
find that we are undersecured, for example, as a result of sudden declines in
market values that reduce the value of collateral.
<PAGE> 53
OTHER OPERATIONAL RISKS MAY DISRUPT OUR BUSINESSES, RESULT IN REGULATORY ACTION
AGAINST US OR LIMIT OUR GROWTH
We face operational risk arising from mistakes made in the confirmation or
settlement of transactions or from transactions not being properly recorded,
evaluated or accounted for. Our businesses are highly dependent on our ability
to process, on a daily basis, a large number of transactions across numerous
and diverse markets in many currencies, and the transactions we process have
become increasingly complex. Consequently, we rely heavily on our financial,
accounting and other data processing systems. If any of these systems do not
operate properly or are disabled, we could suffer financial loss, a disruption
of our businesses, liability to clients, regulatory intervention or
reputational damage. The inability of our systems to accommodate an increasing
volume of transactions could also constrain our ability to expand our
businesses. In recent years, we have substantially upgraded and expanded the
capabilities of our data processing systems and other operating technology, and
we expect that we will need to continue to upgrade and expand in the future to
avoid disruption of, or constraints on, our operations.
LEGAL AND REGULATORY RISKS ARE INHERENT AND SUBSTANTIAL IN OUR BUSINESSES
Substantial legal liability or a significant regulatory action against
Goldman Sachs could have a material financial effect or cause significant
reputational harm to Goldman Sachs, which in turn could seriously harm our
business prospects.
Our Exposure to Legal Liability is Significant
We face significant legal risks in our businesses and the volume and
amount of damages claimed in litigation against financial intermediaries are
increasing. These risks include potential liability under securities or other
laws for materially false or misleading statements made in connection with
securities and other transactions, potential liability for the "fairness
opinions" and other advice we provide to participants in corporate transactions
and disputes over the terms and conditions of complex trading arrangements. We
also face the possibility that counterparties in complex or risky trading
transactions will claim that we improperly failed to tell them of the risks or
that they were not authorized or permitted to enter into these transactions
with us and that their obligations to Goldman Sachs are not enforceable.
Particularly in our rapidly growing business focused on high net worth
individuals, we are increasingly exposed to claims against Goldman Sachs for
recommending investments that are not consistent with a client's investment
objectives or engaging in unauthorized or excessive trading. During a
prolonged market downturn, we would expect these types of claims to increase.
We are also subject to claims arising from disputes with employees for alleged
discrimination or harassment, among other things. These risks often may be
difficult to assess or quantify and their existence and
<PAGE> 54
magnitude often remain unknown for substantial periods of time. We incur
significant legal expenses every year in defending against litigation, and we
expect to continue to do so in the future. See "Business--Legal Matters" for a
discussion of some of the legal matters in which we are currently involved.
Extensive Regulation of Our Businesses Limits Our Activities and May Subject Us
to Significant Penalties
The financial services industry is subject to extensive regulation. Goldman
Sachs is subject to regulation by governmental and self-regulatory organizations
in the United States and in virtually all other jurisdictions in which it
operates around the world.
The requirements imposed by our regulators are designed to ensure the
integrity of the financial markets and to protect customers and other third
parties who deal with Goldman Sachs and are not designed to protect our
shareholders. Consequently, these regulations often serve to limit our
activities, including through net capital, customer protection and market
conduct requirements. We face the risk of significant intervention by regulatory
authorities, including extended investigation and surveillance activity,
adoption of costly or restrictive new regulations and judicial or administrative
proceedings that may result in substantial penalties. Among other things, we
could be fined or prohibited from engaging in some of our business activities.
See "Business--Regulation" for a further discussion of the regulatory
environment in which we conduct our businesses.
Legal Restrictions on Our Clients May Reduce the Demand for Our Services
New laws or regulations or changes in enforcement of existing laws or
regulations applicable to our clients may also adversely affect our businesses.
For example, changes in antitrust enforcement could affect the level of mergers
and acquisitions activity and changes in regulation could restrict the
activities of our clients and, therefore, the services we provide on their
behalf.
EMPLOYEE MISCONDUCT COULD HARM
GOLDMAN SACHS AND IS DIFFICULT TO
DETECT AND DETER
There have been a number of highly publicized cases involving fraud or
other misconduct by employees in the financial services industry in recent
years, and we run the risk that employee misconduct could occur. Misconduct by
employees could include binding Goldman Sachs to transactions that exceed
authorized limits or present unacceptable risks, or hiding from Goldman Sachs
unauthorized or unsuccessful activities, which, in either case, may result in
unknown and unmanaged risks or losses. Employee misconduct could also involve
the improper use or disclosure of confidential information, which could result
in regulatory sanctions and serious reputational or financial harm. It is not
always possible to deter employee misconduct and the precautions we take to
prevent and detect this activity may not be effective in all cases.
THE FINANCIAL SERVICES INDUSTRY IS INTENSELY
COMPETITIVE AND RAPIDLY CONSOLIDATING
The financial services industry--and all of our businesses--are intensely
competitive, and we expect them to remain so. We compete on the basis of a
number of factors, including transaction execution, our products and services,
innovation, reputation and price. We have experienced intense price competition
in some of our businesses in recent years, such as underwriting fees on
investment grade debt offerings and privatizations. We believe we may experience
pricing pressures in these and other areas in the future as some of our
competitors seek to obtain market share by reducing prices.
We Face Increased Competition Due to a Trend Toward Consolidation
In recent years, there has been substantial consolidation and convergence
among companies in the financial services industry. In particular, a number of
large commercial banks, insurance companies and other broad-based financial
services firms have established or acquired broker-dealers or have merged with
other financial institutions. Many of these firms have the ability to offer a
wide
<PAGE> 55
range of products, from loans, deposit-taking and insurance to brokerage, asset
management and investment banking services, which may enhance their competitive
position. They also have the ability to support investment banking and
securities products with commercial banking, insurance and other financial
services revenues in an effort to gain market share, which could result in
pricing pressure in our businesses.
Consolidation Has Increased Our Need for Capital
This trend toward consolidation and convergence has significantly increased
the capital base and geographic reach of our competitors. This trend has also
hastened the globalization of the securities and other financial services
markets. As a result, we have had to commit capital to support our international
operations and to execute large global transactions.
Our Ability to Expand Internationally Will Depend on Our Ability to Compete
Successfully with Local Financial Institutions
We believe that some of our most significant challenges and opportunities
will arise outside the United States, as described under "Industry and Economic
Outlook". In order to take advantage of these opportunities, we will have to
compete successfully with financial institutions based in important non-U.S.
markets, particularly in Europe. Some of these institutions are larger, better
capitalized and have a stronger local presence and a longer operating history
in these markets.
Our Revenues May Decline Due to Competition from Alternative Trading Systems
Securities and futures transactions are now being conducted through the
Internet and other alternative, non-traditional trading systems, and it appears
that the trend toward alternative trading systems will continue and probably
accelerate. A dramatic increase in computer-based or other electronic trading
may adversely affect our commission and trading revenues, reduce our
participation in the trading markets and associated access to market
information and lead to the creation of new and stronger competitors.
WE ARE EXPOSED TO SPECIAL RISKS IN EMERGING AND OTHER MARKETS
In conducting our businesses in major markets around the world, including
many developing markets in Asia, Latin America and Eastern Europe, we are
subject to political, economic, legal, operational and other risks that are
inherent in operating in other countries. These risks range from difficulties
in settling transactions in emerging markets to possible nationalization,
expropriation, price controls and other restrictive governmental actions. We
also face the risk that exchange controls or similar restrictions imposed by
foreign governmental authorities may restrict our ability to convert local
currency received or held by us in their countries into U.S. dollars or other
currencies, or to take those dollars or other currencies out of those countries.
To date, a relatively small part of our businesses has been conducted in
emerging and other markets. As we expand our businesses in these areas, our
exposure to these risks will increase.
Turbulence in Emerging Markets May Adversely Affect Our Businesses
In the last several years, various emerging market countries have
experienced severe economic and financial disruptions, including significant
devaluations of their currencies and low or negative growth rates in their
economies. The possible effects of these conditions include an adverse impact
on our businesses and increased volatility in financial markets generally.
Moreover, economic or market problems in a single country or region are
increasingly affecting other markets generally. For example, the economic
crisis in Russia in August 1998 adversely affected other emerging markets and
led to turmoil in financial markets worldwide. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Business
Environment" for a discussion of the business environment in which we operated
during the second half of fiscal 1998. A continuation of these situations could
adversely affect global economic conditions and world markets and, in turn,
could adversely affect our businesses. Among the risks are
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regional or global market downturns and, as noted above, increasing liquidity
and credit risks, particularly in Japan where the economy continues to be weak
and we have significant exposure.
Compliance with Local Laws and Regulations May Be Difficult
In many countries, the laws and regulations applicable to the securities
and financial services industries are uncertain and evolving, and it may be
difficult for us to determine the exact requirements of local laws in every
market. Our inability to remain in compliance with local laws in a particular
foreign market could have a significant and negative effect not only on our
businesses in that market but also on our reputation generally. These
uncertainties may also make it difficult for us to structure our transactions
in such a way that the results we expect to achieve are legally enforceable in
all cases. See "-- Legal and Regulatory Risks Are Inherent and Substantial in
Our Businesses -- Our Exposure to Legal Liability is Significant" for
additional information concerning these matters and "Business -- Regulation"
for a discussion of the regulatory environment in which we conduct our
businesses.
OUR CONVERSION TO CORPORATE FORM
MAY ADVERSELY AFFECT OUR ABILITY TO RECRUIT,
RETAIN AND MOTIVATE KEY EMPLOYEES
Our performance is largely dependent on the talents and efforts of highly
skilled individuals. Competition in the financial services industry for
qualified employees is intense. Our continued ability to compete effectively
in our businesses depends on our ability to attract new employees and to retain
and motivate our existing employees.
In connection with the offerings and the conversion of Goldman Sachs from
partnership to corporate form, the managing directors who were profit
participating limited partners will receive substantial amounts of common stock
in exchange for their interests in Goldman Sachs. Because these shares of common
stock will be received in exchange for partnership interests, ownership of
these shares will not be dependent upon these partners' continued employment.
However, these shares will be subject to certain restrictions on transfer under
a shareholders' agreement and a portion may be pledged to support these
partners' obligations under noncompetition agreements. The transfer restrictions
under the shareholders' agreement may, however, be waived, as described under
"Certain Relationships and Related Transactions -- Shareholders' Agreement --
Transfer Restrictions" and "--Waivers". The steps we have taken to encourage
the continued service of these individuals after the offerings may not be
effective. For a description of the compensation plan for our senior
professionals to be implemented after the offerings, see "Management -- The
Partner Compensation Plan".
In connection with the offerings and conversion of Goldman Sachs from
partnership to corporate form, employees, other than the managing directors who
were profit participating limited partners, will receive grants of restricted
stock units, stock options or interests in a defined contribution plan. The
incentives to attract, retain and motivate employees provided by these awards
or by future arrangements may not be as effective as the opportunity, which
existed prior to conversion, to become a partner of Goldman Sachs. See
"Management -- The Employee Initial Public Offering Awards" for a description
of these awards.
GOLDMAN SACHS WILL BE CONTROLLED BY ITS
MANAGING DIRECTORS WHOSE INTERESTS MAY
DIFFER FROM THOSE OF OTHER SHAREHOLDERS
Upon completion of the offerings, our managing directors will collectively
own not less than 281,000,000 shares of common stock, or 60% of the total
shares of common stock outstanding, which includes the shares of common stock
underlying the restricted stock units to be awarded based on a formula. These
shares will be subject to a shareholders' agreement, which will provide for
coordinated voting by the parties. Further, both Sumitomo Bank Capital Markets,
Inc. and Kamehameha Activities Association, which together will own 43,400,473
shares of common stock, or 9.3% of the total shares of common stock
outstanding after consummation of the offerings, have agreed to vote their
shares of common stock in the same manner as a majority of the shares held by
our
9
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managing directors are voted. See "Certain Relationships and Related
Transactions -- Shareholders' Agreement -- Voting" and "-- Voting Agreement"
for a discussion of these voting arrangements.
As a result of these arrangements, the managing directors initially
will be able to elect our entire board of directors, control the management and
policies of Goldman Sachs and, in general, determine, without the consent of
the other shareholders, the outcome of any corporate transaction or other
matter submitted to the shareholders for approval, including mergers,
consolidations and the sale of all or substantially all of the assets of
Goldman Sachs. The managing directors initially will be able to prevent or
cause a change in control of Goldman Sachs.
Provisions of Our Organizational Documents May Discourage an Acquisition of
Goldman Sachs
Our organizational documents contain provisions that will impede the
removal of directors and may discourage a third party from making a proposal to
acquire us. For example, our board of directors may, without the consent of
shareholders, issue preferred stock with greater voting rights than the common
stock. See "Description of Capital Stock -- Certain Anti-Takeover Matters" for
a discussion of these anti-takeover provisions.
OUR SHARE PRICE MAY DECLINE DUE TO THE
LARGE NUMBER OF SHARES ELIGIBLE
FOR FUTURE SALE
Sales of substantial amounts of common stock, or the possibility of
such sales, may adversely affect the price of the common stock and impede our
ability to raise capital through the issuance of equity securities. See "Shares
Eligible for Future Sale" for a discussion of possible future sales of common
stock.
Upon consummation of the offerings, there will be 467,271,909 shares
of common stock outstanding. Of these shares, the 69,000,000 shares of common
stock sold in the offerings will be freely transferable without restriction or
further registration under the Securities Act of 1933. The remaining
398,271,909 shares of common stock will be available for future sale upon the
expiration or the waiver of transfer restrictions or in accordance with
registration rights. See "Shares Eligible for Future Sale" for a discussion of
the shares of common stock that may be sold into the public market in the
future.
