GOLDMAN SACHS GROUP INC, 10-Q, 2000-10-10

GOLDMAN SACHS GROUP INC
10-Q, 2000-10-10
SECURITY BROKERS, DEALERS & FLOTATION COMPANIES

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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 August 25, 2000

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.

For the transition period to

Commission File Number: 001-14965

The Goldman Sachs Group, Inc.

(Exact name of registrant as specified in its charter)






Delaware (State or Other Jurisdiction of Incorporation or Organization)		13-4019460 (I.R.S. Employer Identification No.)

85 Broad Street, New York, NY (Address of principal executive offices)		10004 (Zip Code)

(212) 902-1000

(Registrant’s Telephone Number, Including Area Code)

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. [X] Yes [ ] No

APPLICABLE ONLY TO CORPORATE ISSUERS

As of September 22, 2000, there were 454,235,989 shares of the registrant’s common stock outstanding.

TABLE OF CONTENTS


PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
	CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
	CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
	CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND PARTNERS’ CAPITAL (UNAUDITED)
	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
	CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
	NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
	Review Report of Independent Accountants
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3: Quantitative and Qualitative Disclosures About Market Risk
PART II: OTHER INFORMATION
Item 1: Legal Proceedings
Item 2: Changes in Securities and Use of Proceeds
Item 5: Other Information
Item 6: Exhibits and Reports on Form 8-K
SIGNATURES
AGREEMENT AND PLAN OF MERGER
FORM OF INDEMNIFICATION AGREEMENT
AMENDMENT NO. 1 TO TAX INDEMNIFICATION AGREEMENT
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
STATEMENT RE COMPUTATION OF RATIOS OF EARNINGS
LETTER RE UNAUDITED INTERIM FINANCIAL INFO
FINANCIAL DATA SCHEDULE

The Goldman Sachs Group, Inc.

FORM 10-Q


		Page No.

PART I:	FINANCIAL INFORMATION





Item 1:	Financial Statements (Unaudited)




	Condensed Consolidated Statements of Earnings for the periods ended August 25, 2000 and August 27, 1999		2




	Condensed Consolidated Statements of Financial Condition as of August 25, 2000 and November 26, 1999		3




	Condensed Consolidated Statements of Changes in Stockholders’ Equity and Partners’ Capital for the periods ended August 25, 2000 and November 26, 1999		4




	Condensed Consolidated Statements of Cash Flows for the periods ended August 25, 2000 and August 27, 1999		5




	Condensed Consolidated Statements of Comprehensive Income for the periods ended August 25, 2000 and August 27, 1999		6




	Notes to Condensed Consolidated Financial Statements		7




	Review Report of Independent Accountants		14





Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations		15





Item 3:	Quantitative and Qualitative Disclosures About Market Risk		26





PART II:	OTHER INFORMATION





Item 1:	Legal Proceedings		26




Item 2:	Changes in Securities and Use of Proceeds		27




Item 5:	Other Information		27




Item 6:	Exhibits and Reports on Form 8-K		28




Signatures			29

PART I: FINANCIAL INFORMATION

Item 1: Financial Statements

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(UNAUDITED)



			Three Months Ended August				Nine Months Ended August

			2000		1999		2000		1999


			(in millions, except share and per share amounts)
Revenues
Global capital markets




	Investment banking		$	1,316	$	1,150	$	4,131	$	3,054




	Trading and principal investments			2,112		1,423		5,543		4,540




Asset management and securities services				872		629		2,758		1,788




Interest income				4,551		3,238		12,579		9,269

		Total revenues		8,851		6,440		25,011		18,651




Interest expense				4,324		3,032		11,836		8,779

	Revenues, net of interest expense			4,527		3,408		13,175		9,872
Operating expenses




Compensation and benefits, excluding employee initial public offering awards				2,263		1,704		6,587		4,932




Nonrecurring employee initial public offering awards (1)				—		—		—		2,257




Amortization of employee initial public offering awards				102		115		314		154




Brokerage, clearing and exchange fees				136		108		419		328




Market development				126		92		343		247




Communications and technology				111		75		304		224




Depreciation and amortization				119		71		322		229




Occupancy				116		76		312		221




Professional services and other				181		85		464		297




Charitable contribution				—		—		—		200

		Total operating expenses		3,154		2,326		9,065		9,089




Pre-tax earnings				1,373		1,082		4,110		783




Provision/(benefit) for taxes				549		444		1,644		(1,202	)

Net earnings			$	824	$	638	$	2,466	$	1,985

Earnings per share




Basic			$	1.71	$	1.34	$	5.10	$	4.18




Diluted				1.62		1.32		4.85		4.11
Average common shares outstanding




Basic				481,252,647		474,694,245		483,403,066		474,698,130




Diluted				508,894,645		483,892,677		508,181,472		483,146,111


(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.

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(UNAUDITED)



		As of

		August 2000			November 1999


		(in millions, except share
		and per share amounts)
Assets




Cash and cash equivalents		$	3,036		$	3,055




Cash and securities segregated in compliance with U.S. federal and other regulations			14,370			9,135




Receivables from brokers, dealers and clearing organizations			5,167			4,490




Receivables from customers and counterparties			23,995			30,140




Securities borrowed			87,631			78,418




Securities purchased under agreements to resell			41,016			37,106




Right to receive securities			1,717			1,604
Financial instruments owned, at fair value




	Commercial paper, certificates of deposit and time deposits		1,070			1,435




	U.S. government, federal agency and sovereign obligations		24,056			22,193




	Corporate debt		12,360			9,821




	Equities and convertible debentures		20,902			16,381




	State, municipal and provincial obligations		822			756




	Derivative contracts		32,848			30,661




	Physical commodities		444			562




Other assets			5,570			4,734

		$	275,004		$	250,491

Liabilities and Stockholders’ Equity




Short-term borrowings, including commercial paper		$	37,917		$	37,756




Payables to brokers, dealers and clearing organizations			3,420			2,129




Payables to customers and counterparties			57,879			57,405




Securities loaned			6,535			9,169




Securities sold under agreements to repurchase			42,697			40,183




Obligation to return securities			4,098			1,595
Financial instruments sold, but not yet purchased, at fair value




	U.S. government, federal agency and sovereign obligations		23,062			19,170




	Corporate debt		4,521			2,642




	Equities and convertible debentures		13,019			14,002




	Derivative contracts		32,786			28,488




	Physical commodities		690			586




Other liabilities and accrued expenses			7,159			6,269




Long-term borrowings			28,528			20,952

			262,311			240,346
Commitments and contingencies
Stockholders’ Equity




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, 455,226,134 and 441,421,899 shares issued, 454,535,989 and 441,421,899 shares outstanding as of August 2000 and November 1999, respectively			5			4




Restricted stock units; 67,361,270 and 76,048,404 units issued and outstanding as of August 2000 and November 1999, respectively			4,048			4,339




Nonvoting common stock, par value $0.01 per share; 200,000,000 shares authorized, 7,440,362 shares issued and outstanding as of November 1999			—			—




Additional paid-in capital			7,728			7,359




Retained earnings			2,747			444




Unearned compensation			(1,681	)		(2,038	)




Accumulated other comprehensive (loss)/income			(89	)		37




Treasury stock, at cost, par value $0.01 per share; 690,145 shares as of August 2000			(65	)		—

	Total stockholders’ equity		12,693			10,145

		$	275,004		$	250,491

The accompanying notes are an integral part of these condensed consolidated financial statements.

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN

STOCKHOLDERS’ EQUITY AND PARTNERS’ CAPITAL

(UNAUDITED)



		Period Ended

		August 2000			November 1999


		(in millions, except
		per share amounts)
Partners’ capital




	Balance, beginning of period	$	—		$	6,310




	Transfer of beginning partners’ capital allocated for income taxes and potential withdrawals		—			74




	Net earnings		—			2,264	(1)




	Capital contributions		—			48




	Return on capital and certain distributions to partners		—			(306	)




	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		—			—
Common stock, par value $0.01 per share




	Balance, beginning of period		4			—




	Issued		1			4

	Balance, end of period		5			4
Restricted stock units




	Balance, beginning of period		4,339			—




	Granted		363			4,381




	Delivered		(501	)		—




	Forfeited		(153	)		(42	)

	Balance, end of period		4,048			4,339
Nonvoting common stock, par value $0.01 per share




	Balance, beginning of period		—			—




	Issued		—			—

	Balance, end of period		—			—
Additional paid-in capital




	Balance, beginning of period		7,359			—




	Exchange of partnership interests for shares of common stock		—			3,901




	Issuance of common stock		369			2,891




	Issuance of common stock contributed to a defined contribution plan		—			674




	Dividends paid		—			(107	)(3)

	Balance, end of period		7,728			7,359
Retained earnings




	Balance, beginning of period		444			—




	Net earnings		2,466			444	(4)




	Dividends paid		(163	)		—

	Balance, end of period		2,747			444
Unearned compensation




	Balance, beginning of period		(2,038	)		—




	Restricted stock units granted		(363	)		(2,334	)




	Restricted stock units forfeited		126			23




	Amortization of restricted stock units		594			273

	Balance, end of period		(1,681	)		(2,038	)
Accumulated other comprehensive (loss)/ income




	Balance, beginning of period		37			—




	Transfer from partners’ capital		—			(31	)




	Currency translation adjustment		(126	)		68

	Balance, end of period		(89	)		37
Treasury stock, at cost, par value $0.01 per share




	Balance, beginning of period		—			—




	Shares repurchased		(65	)		—

	Balance, end of period		(65	)		—

		$	12,693		$	10,145


(1)	Represents net earnings of the partnership from November 28, 1998 through May 6, 1999.
(2)	Represents the retired limited partners’ exchanges of partnership interests for cash and junior subordinated debentures, the redemption of senior limited partnership interests for cash and other distributions of partners’ capital in accordance with the partnership agreement.
(3)	Represents two quarterly dividends of $0.12 per common share each.
(4)	Represents net earnings of the corporation from May 7, 1999 through November 26, 1999.

The accompanying notes are an integral part of these condensed consolidated financial statements.

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)



				Nine Months
				Ended August

				2000			1999


				(in millions)
Cash flows from operating activities




	Net earnings			$	2,466		$	1,985
	Noncash items included in net earnings




		Depreciation and amortization			322			229




		Stock-based compensation			576			2,405
	Changes in operating assets and liabilities




		Cash and securities segregated in compliance with U.S. federal and other regulations			(5,235	)		(1,058	)




		Net receivables from brokers, dealers and clearing organizations			614			116




		Net payables to customers and counterparties			6,619			(3,812	)




		Securities borrowed, net			(11,847	)		(9,025	)




		Financial instruments owned, at fair value			(9,187	)		(5,983	)




		Financial instruments sold, but not yet purchased, at fair value			10,173			10,012




		Other, net			474			(176	)

			Net cash used for operating activities		(5,025	)		(5,307	)
Cash flows from investing activities




	Property, leasehold improvements and equipment				(990	)		(368	)




	Financial instruments owned, at fair value				(118	)		119

			Net cash used for investing activities		(1,108	)		(249	)
Cash flows from financing activities




	Short-term borrowings, net				(5,092	)		720




	Issuance of long-term borrowings				13,157			9,098




	Repayment of long-term borrowings				(327	)		(572	)




	Securities sold under agreements to repurchase, net				(1,396	)		(2,842	)




	Common stock repurchased				(65	)		—




	Dividends paid				(163	)		(53	)




	Capital contributions				—			48




	Returns on capital and certain distributions to partners				—			(306	)




	Proceeds from issuance of common stock				—			2,639




	Partners’ capital distributions, net				—			(4,112	)

			Net cash provided by financing activities		6,114			4,620




		Net decrease in cash and cash equivalents			(19	)		(936	)




Cash and cash equivalents, beginning of period					3,055			2,836

Cash and cash equivalents, end of period				$	3,036		$	1,900

SUPPLEMENTAL DISCLOSURES:

Cash payments for interest approximated the related expense for each of the fiscal periods presented.

Payments of income taxes were $1.59 billion and $236 million for the nine months ended August 25, 2000 and August 27, 1999, respectively.

Other, net for the nine months ended August 27, 1999 includes an increase in deferred tax assets of $1.78 billion associated with the firm’s conversion to corporate form and related transactions.

Noncash activities:

In connection with the firm’s conversion to corporate form, junior subordinated debentures of $371 million were issued to retired limited partners in exchange for their partnership interests.

The accompanying notes are an integral part of these condensed consolidated financial statements.

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)



	Three Months					Nine Months
	Ended August					Ended August

	2000			1999		2000			1999


	(in millions)




Net earnings	$	824		$	638	$	2,466		$	1,985




Currency translation adjustment, net of tax		(16	)		47		(126	)		12

Comprehensive income	$	808		$	685	$	2,340		$	1,997

The accompanying notes are an integral part of these condensed consolidated financial statements.

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. On May 7, 1999, the firm converted from a partnership to a corporation and completed its initial public offering.

The firm’s activities are divided into two segments:

• Global Capital Markets. This segment comprises Investment Banking, which includes Financial Advisory and Underwriting, and Trading and Principal Investments, which includes Fixed Income, Currency and Commodities (“FICC”), Equities and Principal Investments (Principal Investments primarily represents net revenues from the firm’s merchant banking investments); and

• Asset Management and Securities Services. This segment comprises Asset Management, Securities Services and Commissions.

Note 2. Significant Accounting Policies

Basis of Presentation

The condensed consolidated financial statements include the accounts of Group Inc. and its U.S. and international subsidiaries including Goldman, Sachs & Co. (“GS&Co.”) and J. Aron & Company in New York, Goldman Sachs International (“GSI”) in London and Goldman Sachs (Japan) Ltd. (“GSJL”) in Tokyo. These condensed consolidated financial statements are unaudited and should be read in conjunction with the audited consolidated financial statements included in the Annual Report on Form 10-K of Group Inc. for the fiscal year ended November 26, 1999. The condensed consolidated financial information as of and for the period ended November 26, 1999 has been derived from audited consolidated financial statements not included herein. Certain reclassifications have been made to prior-year amounts to conform to the current-year presentation. All material intercompany transactions and balances have been eliminated.

These condensed 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 condensed 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 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 August 2000 and August 1999 refer to the firm’s fiscal period ended, or the date, as the context requires, August 25, 2000 and August 27, 1999, respectively. All references to November 1999 refer to the firm’s fiscal year ended, or the date, as the context requires, November 26, 1999.

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(UNAUDITED)

Accounting Developments

In September 2000, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities — a replacement of FASB Statement No. 125”, which revises the standards for accounting for securitizations and other transfers of financial assets and collateral. In addition, specific implementation guidelines have been established to further distinguish transfers of financial assets that are sales from transfers that are secured borrowings. SFAS No. 140 is effective for transfers occurring after March 31, 2001 and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The firm intends to adopt the provisions of SFAS No. 140 in 2001 and is currently assessing its effect.

In June 2000, the FASB issued SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities”, which is an amendment of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The Statement is effective concurrently with SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities — Deferral of the Effective Date of FASB Statement No. 133 — an amendment of FASB Statement No. 133”, which deferred to fiscal years beginning after June 15, 2000 the effective date of the accounting and reporting requirements of SFAS No. 133. These statements establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively, referred to as “derivatives”), and for hedging activities. These statements require that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. The accounting for changes in the fair value of a derivative instrument depends on its intended use and the resulting designation. The firm intends to adopt the provisions of SFAS No. 133 deferred by SFAS No. 137 and amended by SFAS No. 138 in fiscal 2001 and is currently assessing its effect.

In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position (“SOP”) No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use”. SOP No. 98-1 requires capitalization of certain internal use software costs. SOP No. 98-1 was adopted by the firm in the first quarter of fiscal 2000 and was not material to the firm’s financial condition or its results of operations for the quarter and nine months ended August 2000.

Note 3. Financial Instruments

Gains and losses on financial instruments and commission income and related expenses are recorded on a trade date basis in the condensed consolidated statements of earnings. The condensed consolidated statements of financial condition generally reflect purchases and sales of financial instruments, including agency transactions, on a trade date basis.

Substantially all financial instruments used in the firm’s trading and nontrading activities are carried at fair value or amounts that approximate fair value, and unrealized gains and losses are recognized in earnings. Fair value is based generally on listed market prices or broker or dealer price quotations. To the extent that prices are not readily available, or if liquidating the firm’s position is reasonably expected to affect market prices, fair value is based on either internal valuation models or management’s estimate of amounts that could be realized under current market conditions, assuming an orderly liquidation over a reasonable period of time. Certain over-the-counter derivative instruments are valued using pricing models that consider, among

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(UNAUDITED)

other factors, current and contractual market prices, time value, and yield curve and/or volatility factors of the underlying positions.

Derivative Activities

Most of the firm’s derivative transactions are entered into for trading purposes. The firm uses derivatives in its trading activities to facilitate customer transactions, to take proprietary positions and as a means of risk management. The firm also enters into nontrading derivative contracts to manage the interest rate and currency exposure on its long-term borrowings.

Derivative contracts are financial instruments, such as futures, forwards, swaps or option contracts, that derive their value from underlying assets, indices, reference rates or a combination of these factors. Derivatives may involve future commitments to purchase or sell financial instruments or commodities, or to exchange currency or interest payment streams. The amounts exchanged are based on the specific terms of the contract with reference to specified rates, securities, commodities or indices.

Derivative contracts exclude certain cash instruments, such as mortgage-backed securities, interest-only and principal-only obligations, and indexed debt instruments, that derive their values or contractually required cash flows from the price of some other security or index. Derivatives also exclude option features that are embedded in cash instruments, such as the conversion features and call provisions embedded in bonds. The firm has elected to include commodity-related contracts in its derivative disclosure, although not required to do so, as these contracts may be settled in cash or are readily convertible into cash.

The firm utilizes replacement cost as a measure of derivative credit risk. Replacement cost, as reported in “Financial instruments owned, at fair value” on the condensed consolidated statements of financial condition, represents amounts receivable from various counterparties, net of any unrealized losses, where management believes a legal right of setoff exists under an enforceable netting agreement. Replacement cost for purchased option contracts is the market value of the contract. The firm controls its credit risk through an established credit approval process, by monitoring counterparty limits, obtaining collateral where appropriate and, in some cases, entering into enforceable netting agreements.

The fair value of derivative financial instruments used for trading purposes, computed in accordance with the firm’s netting policy, is set forth below:



	As of August 2000				As of November 1999

	Assets		Liabilities		Assets		Liabilities


	(in millions)




Forward settlement contracts	$	4,680	$	4,419	$	4,555	$	4,625




Swap agreements		15,507		14,982		12,052		11,587




Option contracts		12,659		13,335		14,018		12,274

Total	$	32,846	$	32,736	$	30,625	$	28,486

Derivatives used for nontrading purposes generally include interest rate futures contracts and interest rate and currency swap agreements, which are primarily utilized to convert a substantial portion of the firm’s fixed rate debt into U.S. dollar-based floating rate obligations. Gains and losses on these derivatives are generally deferred and recognized as adjustments to interest expense over the life of the derivative contract. Gains and losses resulting from the early termination of derivatives used for nontrading purposes are generally deferred and recognized

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(UNAUDITED)

over the remaining life of the underlying debt. If the underlying debt is terminated prior to its stated maturity, gains and losses on these transactions, including the associated hedges, are recognized in earnings immediately.

The fair value and carrying value of derivatives used for nontrading purposes are set forth below:



	As of August 2000				As of November 1999

	Assets		Liabilities		Assets		Liabilities


	(in millions)




Fair value	$	13	$	595	$	3	$	159




Carrying value		2		50		36		2

Note 4. Short-Term Borrowings

The firm obtains secured short-term financing principally through the use of repurchase agreements and securities lending agreements, collateralized mainly by U.S. government, federal agency, investment-grade foreign sovereign obligations and equity securities. The firm obtains unsecured short-term borrowings through issuance of commercial paper, promissory notes and bank loans. The carrying value of these short-term obligations approximates fair value due to their short-term nature.

Short-term borrowings are set forth below:



	As of

	August 2000		November 1999


	(in millions)




Commercial paper	$	15,201	$	9,403




Promissory notes		13,330		11,061




Bank loans and other(1)		9,386		17,292

Total	$	37,917	$	37,756


(1)	As of August 2000 and November 1999, short-term borrowings included $5.95 billion and $10.82 billion, 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 5. Equity

In March 2000, the Board of Directors of Group Inc. approved a common stock repurchase program authorizing the repurchase of up to 15 million shares of the firm’s common stock. For the nine months ended August 2000, the firm repurchased 690,145 shares of its common stock.

On August 21, 2000, Sumitomo Bank Capital Markets, Inc. exchanged all 7,440,362 shares of its nonvoting common stock, par value $0.01 per share, of Group Inc. for an equal number of shares of common stock.

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

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(UNAUDITED)

common shares outstanding. Diluted EPS includes the determinants of basic EPS and, in addition, gives effect to dilutive potential common shares.

The computations of basic and diluted EPS are set forth below:



		Three Months Ended August				Nine Months Ended August

		2000		1999		2000		1999


		(in millions, except share and per share amounts)




Numerator for basic and diluted EPS — earnings available to common stockholders		$	824	$	638	$	2,466	$	1,985

Denominator for basic EPS — weighted average number of common shares(1)			481,252,647		474,694,245		483,403,066		474,698,130




Effect of dilutive securities Restricted stock units			17,101,019		4,987,721		14,775,882		4,508,530




	Stock options		10,540,979		4,210,711		10,002,524		3,939,451

Dilutive potential common shares			27,641,998		9,198,432		24,778,406		8,447,981

Denominator for diluted EPS — weighted average number of common shares and dilutive potential common shares			508,894,645		483,892,677		508,181,472		483,146,111

Basic EPS		$	1.71	$	1.34	$	5.10	$	4.18




Diluted EPS			1.62		1.32		4.85		4.11


(1)	Includes common stock and nonvoting common stock as well as restricted stock units awarded to employees for which no future service is required as a condition to the delivery of the underlying shares of common stock.

Note 7. 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 8. Regulated Subsidiaries

GS&Co. is a registered U.S. broker-dealer subsidiary, which is subject to the Securities and Exchange Commission’s “Uniform Net Capital Rule,” and has elected to compute its net capital in accordance with the “Alternative Net Capital Requirement” of that rule. As of August 2000, GS&Co. had regulatory net capital, as defined, of $4.31 billion, which exceeded the amount required by $3.63 billion.

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(UNAUDITED)

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 Financial Services Agency. As of August 2000, GSI and GSJL were in compliance with their local capital adequacy requirements.

Certain other subsidiaries of the firm are also subject to capital adequacy requirements promulgated by authorities of the countries in which they operate. As of August 2000, these subsidiaries were in compliance with their local capital adequacy requirements.

Note 9. Business Segments

In reporting to management, the firm’s operating results are categorized into two principal segments: Global Capital Markets; and Asset Management and Securities Services. For a further discussion of the firm’s segments, see the firm’s Annual Report on Form 10-K for the fiscal year ended November 1999.

Management believes that the following information provides a reasonable representation of each segment’s contribution to consolidated pre-tax earnings and total assets:



		Three Months				Nine Months
		Ended August				Ended August

		2000		1999		2000		1999


		(in millions)




Global Capital	Net revenues	$	3,436	$	2,597	$	9,753	$	7,576




Markets	Operating expenses		2,211		1,623		6,389		4,701

	Pre-tax earnings	$	1,225	$	974	$	3,364	$	2,875

	Segment assets	$	143,039	$	116,680	$	143,039	$	116,680





Asset Management	Net revenues	$	1,091	$	811	$	3,422	$	2,296




and Securities	Operating expenses		841		588		2,362		1,777

Services	Pre-tax earnings	$	250	$	223	$	1,060	$	519

	Segment assets	$	130,974	$	118,283	$	130,974	$	118,283





Total	Net revenues	$	4,527	$	3,408	$	13,175	$	9,872




	Operating expenses(1)		3,154		2,326		9,065		9,089	(3)

	Pre-tax earnings	$	1,373	$	1,082	$	4,110	$	783

	Total assets(2)	$	275,004	$	236,273	$	275,004	$	236,273


(1)	Includes the ongoing amortization of employee initial public offering awards that has not been allocated to the firm’s segments.

(2)	Includes deferred tax assets relating to the firm’s conversion to corporate form and certain other assets that are not allocable to a particular segment.

(3)	Includes nonrecurring employee initial public offering awards of $2.26 billion and a charitable contribution to The Goldman Sachs Foundation of $200 million made at the time of the firm’s initial public offering that have not been allocated to the firm’s segments.

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(UNAUDITED)

Note 10. Subsequent Events

The Board of Directors of Group Inc. declared a dividend of $0.12 per share to be paid on November 20, 2000 to common stockholders of record on October 23, 2000.

On September 11, 2000, the firm announced an agreement to combine with Spear, Leeds & Kellogg, L.P. (“SLK”), a leader in securities clearing and execution, floor-based market making and off-floor market making. As part of this agreement, the consideration will include approximately 34 million shares of Group Inc. common stock and approximately $2 billion in cash. In addition, the firm is establishing a $900 million retention pool in Group Inc. common stock for all SLK employees, which will have varying vesting and delivery provisions. The transaction is expected to close before year-end, and is subject to customary regulatory and other approvals.

Review Report of Independent Accountants

To the Directors and Shareholders,

The Goldman Sachs Group, Inc.

We have reviewed the accompanying condensed consolidated statement of financial condition of The Goldman Sachs Group, Inc. and Subsidiaries (the “Company”) as of August 25, 2000, the related condensed consolidated statements of earnings for the three and nine months ended August 25, 2000 and August 27, 1999, the condensed consolidated statement of changes in stockholders’ equity and partners’ capital for the nine months ended August 25, 2000, the condensed consolidated statements of cash flows for the nine months ended August 25, 2000 and August 27, 1999, and the condensed consolidated statements of comprehensive income for the three and nine months ended August 25, 2000 and August 27, 1999. These condensed 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 auditing standards generally accepted in the United States of America, 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 consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We previously audited in accordance with auditing standards generally accepted in the United States of America, the consolidated statement of financial condition of The Goldman Sachs Group, Inc. and Subsidiaries as of November 26, 1999, and the related consolidated statements of earnings, changes in stockholders’ equity and partners’ capital, cash flows and comprehensive income for the year ended November 26, 1999 (not presented herein); and in our report dated January 21, 2000, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial condition as of November 26, 1999, and the condensed consolidated statement of changes in stockholders’ equity and partners’ capital for the year ended November 26, 1999, is fairly stated in all material respects in relation to the consolidated financial statements from which it has been derived.

/s/ PricewaterhouseCoopers LLP

New York, New York

October 9, 2000.


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 services worldwide to a substantial and diversified client base. On May 7, 1999, we converted from a partnership to a corporation and completed our initial public offering.

Our activities are divided into two segments:

• Global Capital Markets. This segment comprises Investment Banking, which includes Financial Advisory and Underwriting, and Trading and Principal Investments, which includes Fixed Income, Currency and Commodities (“FICC”), Equities and Principal Investments (Principal Investments primarily represents net revenues from our merchant banking investments); and

• Asset Management and Securities Services. This segment comprises Asset Management, Securities Services and Commissions.

Unless specifically stated otherwise, all references to August 2000 and August 1999 refer to our fiscal period ended, or the date, as the context requires, August 25, 2000 and August 27, 1999, respectively. All references to November 1999 and November 1998, unless specifically stated otherwise, refer to our fiscal year ended, or the date, as the context requires, November 26, 1999 and November 27, 1998, respectively.

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.

Business Environment

During the quarter, economic growth in the world economy continued to be strong, although the pace of growth slowed primarily as a result of earlier increases in interest rates, stabilization in asset prices and rising oil prices.

Growth in the U.S. economy was driven by strong exports and corporate investment. Despite these factors, the rate of growth declined during the quarter as some elements of consumer spending slowed and residential investment fell. U.S. equity markets rebounded from the sharp declines at the end of the prior quarter, particularly the Nasdaq which gained 23% during the fiscal quarter. The fixed income markets generally benefited from narrowing credit spreads and steady short-term interest rates.

The European economy continued to grow at a healthy rate, fueled by strong growth in foreign demand, consumer spending and corporate investment. During the quarter, the European Central Bank continued to raise short-term rates in response to inflation and the weakness of the euro.

Economic growth in Japan slowed from the exceptional rates recorded earlier in the year. Despite this slowdown, deflationary pressures receded and growth in investment rose significantly amidst a rebound in corporate profitability. The Bank of Japan’s zero-rate policy was terminated and interest rates were raised for the first time in a decade. Growth fell back to more normal rates in several other Asian economies as exports slowed modestly, and corporate investment failed to rebound to earlier levels.

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. As a result, period-to-period comparisons may not be meaningful. In addition, Goldman Sachs’ conversion to corporate form has 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, prior to our conversion to corporate form, were profit participating limited partners are included in compensation and benefits expense. Prior to our conversion to corporate form, these payments were accounted for as distributions of partners’ capital rather than as compensation and benefits expense.

2. Ongoing Stock-Based Compensation. As part of compensation, restricted stock units and other forms of stock-based compensation can be awarded to employees. Of the total restricted stock units that were granted at the end of November 1999, approximately 50% require future service as a condition to the delivery of the underlying shares of common stock. In accordance with Accounting Principles Board Opinion No. 25, these restricted stock units with future service requirements will generally be recorded as compensation expense over the four-year service period following the date of grant 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, noncash expense related to the amortization of certain restricted stock units awarded to employees in connection with our initial public offering. These restricted stock units had a value of $1.76 billion at date of grant, approximately 26% of which was amortized as a noncash expense, after giving effect to forfeitures, in the 12 months following the date of grant. The remaining 74% of the value of these restricted stock units is being amortized over the next four years as follows: 26%, 26%, 15% and 7% in years two, three, four and five, respectively.

4. Income Taxes. As a corporation, our operating results have become, and will continue to be, subject to U.S. federal, state and local corporate income taxes, and, therefore, to a higher tax rate than we incurred as a partnership. Our effective tax rate for the quarter and the nine-month period ended August 2000 was 40%.

Overview

The following table sets forth a summary of our financial results:

Financial Overview

(in millions, except per share amounts)



	Three Months Ended August						Nine Months Ended August


	Actual				Pro Forma		Actual				Pro Forma

	2000		1999		1999		2000		1999(1)		1999




Net revenues	$	4,527	$	3,408	$	3,408	$	13,175	$	9,872	$	9,865




Pre-tax earnings		1,373		1,082		1,082		4,110		783		3,041




Net earnings		824		638		638		2,466		1,985		1,794




Diluted earnings per share		1.62		1.32		1.31		4.85		4.11		3.73


(1)	Includes 23 weeks as a partnership.

Pro forma net earnings reflect the results of Goldman Sachs as if our conversion to corporate form and related transactions had taken place at the beginning of 1999.

Pro forma net earnings do not give effect to the following items due to their nonrecurring nature:

• the employee initial public offering award of restricted stock units, for which future service is not required as a condition to the delivery of the underlying shares of common stock;

• the initial irrevocable contribution of shares of common stock to the defined contribution plan;

• the recognition of certain net tax assets; and

• a contribution to The Goldman Sachs Foundation, a charitable foundation.

Pro forma net earnings give effect to the following items:

• interest expense on junior subordinated debentures issued to retired limited partners in exchange for their partnership interests;

• the amortization of the restricted stock units awarded to employees in connection with our initial public offering, for which future service is required as a condition to the delivery of the underlying shares of common stock; and

• the provision for income taxes in corporate form.

For the purpose of calculating pro forma diluted average common shares outstanding for the quarter and nine months ended August 1999 we used the initial public offering price of $53 per share from the beginning of fiscal 1999 until May 4, 1999, the day trading in our common stock commenced.

The following table sets forth the net revenues, operating expenses and pre-tax earnings of our segments:

Results by Segment

(in millions)



		Three Months				Nine Months
		Ended August				Ended August

		2000		1999		2000		1999

Global Capital	Net revenues	$	3,436	$	2,597	$	9,753	$	7,576




Markets	Operating expenses		2,211		1,623		6,389		4,701

	Pre-tax earnings	$	1,225	$	974	$	3,364	$	2,875





Asset Management	Net revenues	$	1,091	$	811	$	3,422	$	2,296




And Securities	Operating expenses		841		588		2,362		1,777


Services	Pre-tax earnings	$	250	$	223	$	1,060	$	519


Total	Net revenues	$	4,527	$	3,408	$	13,175	$	9,872




	Operating expenses(1)		3,154		2,326		9,065		9,089	(2)

	Pre-tax earnings	$	1,373	$	1,082	$	4,110	$	783


(1)	Includes the ongoing amortization of employee initial public offering awards that has not been allocated to our segments.

(2)	Includes nonrecurring employee initial public offering awards of $2.26 billion and a charitable contribution to The Goldman Sachs Foundation of $200 million made at the time of our initial public offering that have not been allocated to our segments.

Global Capital Markets

The components of the Global Capital Markets segment are set forth below:

Investment Banking. Goldman Sachs provides a broad range of investment banking services to a diverse group of corporations, financial institutions, governments and individuals. Our investment banking activities are divided into two categories:

• Financial Advisory. Financial Advisory includes advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, restructurings and spin-offs; and

• Underwriting. Underwriting includes public offerings and private placements of equity and debt securities.

Trading and Principal Investments. Our Trading and Principal Investments business facilitates transactions with a diverse group of corporations, financial institutions, governments and individuals and takes proprietary positions through market making in and trading of fixed income and equity products, currencies, commodities, and swaps and other derivatives. Trading and Principal Investments is divided into three categories:

• FICC. We make markets in and trade fixed income products, currencies and commodities, structure and enter into a wide variety of derivative transactions, and engage in proprietary trading and arbitrage activities;

• Equities. We make markets in and trade equities and equity-related products, structure and enter into equity derivative transactions, and engage in proprietary trading and equity arbitrage; and

• Principal Investments. Principal Investments primarily represents net revenues from our merchant banking investments.

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.

Substantially all of our inventory is marked-to-market daily and, therefore, its value and our net revenues are subject to fluctuations based on market movements. In addition, net revenues derived from our principal investments in privately held concerns and in real estate may fluctuate significantly depending on the revaluation or sale of these investments in any given period.

The following table sets forth the net revenues of our Global Capital Markets segment:

Global Capital Markets Net Revenues

(in millions)



	Three Months				Nine Months
	Ended August				Ended August

	2000		1999		2000		1999

Financial Advisory	$	673	$	616	$	1,968	$	1,648




Underwriting		648		534		2,183		1,406

Investment Banking		1,321		1,150		4,151		3,054

FICC		872		661		2,522		2,448




Equities		763		458		2,707		1,531




Principal Investments		480		328		373		543

Trading and Principal Investments		2,115		1,447		5,602		4,522

Total	$	3,436	$	2,597	$	9,753	$	7,576

Three Months Ended August 2000 versus Three Months Ended August 1999

Net revenues in Global Capital Markets increased 32% to $3.44 billion, reflecting strong revenue growth in Investment Banking and Trading and Principal Investments. Operating expenses increased 36%, principally due to higher levels of compensation commensurate with growth in net revenues, and increased costs associated with global expansion, higher employment levels and increased business activity. Pre-tax earnings were $1.23 billion compared to $974 million in 1999.

Net revenues in Investment Banking increased 15% to $1.32 billion. Revenue growth was strong in all major regions. Financial Advisory net revenues increased 9% as we capitalized on increased mergers and acquisitions activity in the communications, media and entertainment and high technology sectors. Net revenues in Underwriting increased 21% as we benefited from increased new issue activity in global equity markets. Net revenue growth was largely driven by strong performances in the communications, media and entertainment and high technology sectors. Our investment banking transaction backlog as of August 2000 remained strong.

Net revenues in Trading and Principal Investments increased 46% to $2.12 billion. FICC net revenues increased 32%, primarily due to increased customer flow in fixed income derivatives and improved performances in the Japanese and European government bond businesses, partially offset by lower net revenues from decreased customer activity in our commodities and high-yield businesses. Net revenues in Equities rose 67%, primarily resulting from strength in equity derivatives and higher transaction volumes in our U.S. and European shares businesses. Principal Investments net revenues increased 46% to $480 million. These net revenues included significant gains, balanced between realized and unrealized, on certain of our merchant banking investments in the high technology and telecommunications sectors.

Nine Months Ended August 2000 versus Nine Months Ended August 1999

Net revenues in Global Capital Markets increased 29% to $9.75 billion, reflecting strong performances in both Investment Banking and Trading and Principal Investments. Operating expenses increased 36%, principally due to higher levels of compensation commensurate with growth in net revenues, and increased costs associated with global expansion and higher levels of business activity. Pre-tax earnings were $3.36 billion compared to $2.88 billion in 1999.

Investment Banking net revenues increased 36% to $4.15 billion. Net revenues in Financial Advisory and Underwriting increased 19% and 55%, respectively, reflecting continued strength in our mergers and acquisitions and equity new issues businesses, particularly in the communications, media and entertainment and high technology sectors. Net revenue growth was strong in all major regions.

Net revenues in Trading and Principal Investments increased 24% to $5.60 billion. FICC net revenues grew 3%, as increased customer flow in our fixed income derivatives business was partially offset by lower net revenues in our credit-sensitive (which includes high-yield debt, bank loans and investment-grade corporate debt), commodities and U.S. government bond businesses. Net revenues in Equities increased 77%, primarily due to strength in equity derivatives and higher transaction volumes in our U.S. and European shares businesses. Principal Investments decreased 31% primarily due to lower unrealized gains in technology and telecommunications stocks, partially offset by higher net revenues from the disposition of investments.

Asset Management and Securities Services

The components of the Asset Management and Securities Services segment are set forth below:

• Asset Management. Asset Management generates management fees by providing investment advisory services to a diverse client base of institutions and individuals;

• Securities Services. Securities Services includes prime brokerage, financing services and securities lending, and our matched book businesses, all of which generate revenues primarily in the form of fees or interest rate spreads; and

• Commissions. Commissions include agency transactions for clients on major stock and futures exchanges and revenues from the increased share of the income and gains derived from our merchant banking funds.

The following table sets forth the net revenues of our Asset Management and Securities Services segment:

Asset Management and Securities Services Net Revenues

(in millions)



	Three Months				Nine Months
	Ended August				Ended August

	2000		1999		2000		1999

Asset Management	$	327	$	221	$	987	$	637




Securities Services		234		195		724		576




Commissions		530		395		1,711		1,083

Total	$	1,091	$	811	$	3,422	$	2,296

Our assets under supervision consist of assets under management and other client assets. Assets under management typically generate fees based on a percentage of their value and include our mutual funds, separate accounts managed for institutional and individual investors, our merchant banking funds and other alternative investment funds. Other client assets consist of assets in brokerage accounts of primarily high-net-worth individuals, on which we earn commissions. Substantially all assets under supervision are valued as of calendar month-end.

The following table sets forth our assets under supervision:

Assets Under Supervision

(in millions)



	As of August 31,				As of November 30,

	2000		1999		1999		1998

Assets under management	$	307,851	$	220,522	$	258,045	$	194,821




Other client assets		273,090		192,034		227,424		142,018

Total	$	580,941	$	412,556	$	485,469	$	336,839

Three Months Ended August 2000 versus Three Months Ended August 1999

Net revenues in Asset Management and Securities Services increased 35% to $1.09 billion as all major components of the business exhibited strong growth. Operating expenses increased 43%, principally due to higher levels of compensation commensurate with growth in net revenues, and increased costs associated with global expansion, higher employment levels and increased business activity. Pre-tax earnings were $250 million compared to $223 million in 1999.

Net revenues in Asset Management increased 48%, primarily reflecting a 37% increase in average assets under management as well as favorable changes in the composition of assets managed. Strong net inflows and market appreciation led to the growth in assets under management. Securities Services net revenues were 20% higher, primarily due to increased customer balances in securities lending and margin lending, partially offset by reduced spreads in the fixed income matched book. Commissions increased 34%, primarily due to higher transaction volumes in global equity markets. Revenues from the increased share of income and gains from our merchant banking funds also contributed to the increase in Commissions.

Nine Months Ended August 2000 versus Nine Months Ended August 1999

Net revenues in Asset Management and Securities Services increased 49% to $3.42 billion, due to increased contributions from all major components of the business. Operating expenses increased 33% due to higher levels of compensation commensurate with growth in net revenues, and increased costs associated with global expansion and higher levels of business activity. Pre-tax earnings were $1.06 billion compared to $519 million in 1999.

Net revenues in Asset Management increased 55%, primarily due to a 35% increase in average assets under management, as well as favorable changes in the composition of assets managed. Securities Services net revenues increased 26%, reflecting the impact of higher customer balances in our securities lending and margin lending businesses. This increase was partially offset by reduced spreads in our fixed income matched book. Commissions increased 58% due to increased worldwide transaction volumes and higher net revenues from the increased share of income and gains from our merchant banking funds.

Operating Expenses

The following table sets forth our operating expenses and number of employees:

Operating Expenses and Employees

($ in millions)



	Three Months				Nine Months
	Ended August				Ended August

	2000		1999		2000		1999

Compensation and benefits, excluding employee initial public offering awards	$	2,263	$	1,704	$	6,587	$	4,932




Nonrecurring employee initial public offering awards		—		—		—		2,257




Amortization of employee initial public offering awards		102		115		314		154




Brokerage, clearing and exchange fees		136		108		419		328




Market development		126		92		343		247




Communications and technology		111		75		304		224




Depreciation and amortization		119		71		322		229




Occupancy		116		76		312		221




Professional services and other		181		85		464		297




Charitable contribution		—		—		—		200

Total operating expenses	$	3,154	$	2,326	$	9,065	$	9,089

Employees at period end (1)		18,666		14,454


(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.

Three Months Ended August 2000 versus Three Months Ended August 1999

Operating expenses increased 36% to $3.15 billion, primarily reflecting increased compensation and benefits commensurate with higher net revenues levels.

Compensation and benefits expense increased 33% to $2.26 billion. The ratio of compensation and benefits to net revenues was 50% for each of the quarters ended August 2000 and August 1999. Employment levels increased 29%, reflecting growth in our businesses. Expenses associated with our temporary staff and consultants were $183 million, an increase of 71%, reflecting increased global expansion and consulting costs associated with technology initiatives.

Brokerage, clearing and exchange fees increased 26% primarily due to higher levels of trading volumes in equity derivatives and U.S. equities. Market development expenses increased 37%, principally due to higher levels of travel and entertainment costs associated with growth in employment levels and business activity. Communications and technology expenses increased 48%, reflecting higher telecommunications and market data costs associated with higher employment levels. Additional spending on technology initiatives also led to the increase in communications and technology expenses. Depreciation and amortization expenses increased 68% primarily due to additional technology-related equipment expenditures, leasehold improvements and telecommunications equipment needed for our continued global expansion. Occupancy expenses increased 53%, reflecting continued office expansion needed to accommodate growth in employment levels. Professional services and other expenses increased significantly due to increased business activity.

Nine Months Ended August 2000 versus Nine Months Ended August 1999

Operating expenses of $9.07 billion remained at prior year levels. In 1999, operating expenses included nonrecurring charges associated with Goldman Sachs’ conversion to corporate form and related transactions. These nonrecurring charges included $2.26 billion for employee initial public offering awards and $200 million for a contribution to The Goldman Sachs Foundation. Excluding the effect of these nonrecurring charges, operating expenses increased 37%.

Compensation and benefits expense increased 34% to $6.59 billion. The ratio of compensation and benefits to net revenues was 50% for each of the nine-month periods ended August 2000 and August 1999. Expenses associated with our temporary staff and consultants were $447 million, an increase of 53% compared with 1999, reflecting increased global expansion and consulting costs associated with technology initiatives.

Brokerage, clearing and exchange fees increased 28% primarily due to higher transaction volumes in equity derivatives and U.S. and European equities. Market development expenses increased 39%, principally due to higher levels of travel and entertainment costs associated with growth in employment levels and business activity. Communications and technology expenses increased 36%, reflecting higher telecommunications and market data costs associated with higher employment levels, and additional spending on technology initiatives. Depreciation and amortization expenses increased 41% primarily due to leasehold improvements and technology-related and telecommunications equipment in support of our increased worldwide activities. Occupancy expenses increased 41%, reflecting global office expansion needed to accommodate increased employment levels. Professional services and other expenses increased 56% due to higher levels of business activity.

Provision for Taxes

The provision for taxes for the quarter and nine months ended August 2000 was $549 million and $1.64 billion, respectively. Goldman Sachs’ effective tax rate for the quarter and year to date was 40%.

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, which are described below.

Diversification of Funding Sources and Liquidity Planning. Goldman Sachs seeks to maintain broad and diversified funding sources globally. These diversified funding sources include insurance companies, mutual funds, banks, bank trust departments and other asset managers. Management believes that Goldman Sachs’ relationships with its lenders are critical to its liquidity.

We access liquidity in a variety of markets in the United States, Europe and Asia. We make extensive use of the repurchase agreement markets and have raised debt publicly as well as in the private placement and 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.

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. A substantial portion of our

inventory turns over rapidly and is marked-to-market daily. We maintain long-term borrowings and stockholders’ equity substantially in excess of our less liquid assets.

Excess Liquidity. In addition to maintaining a highly liquid balance sheet and a significant amount 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.

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 security-based and 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 to our access to unsecured credit.

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.

Intercompany Funding. Most of the liquidity of Goldman Sachs is raised by the parent company, Group Inc. The parent company 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 the parent company. This policy ensures that the subsidiaries’ obligations to the parent company will generally mature in advance of the parent company’s third-party long-term borrowings. In addition, many of the advances made to our 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:



	As of

	August			November
	2000			1999


	($ in billions, except
	per share amounts)




Total assets	$	275		$	250




Adjusted assets(1)		199			188




Leverage ratio(2)		21.7	x		24.7	x




Adjusted leverage ratio(3)		15.6	x		18.5	x




Book value per share(4)	$	26.43		$	20.94


(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 certain provisions of Statement of Financial Accounting Standards No. 125.

(2)	Leverage ratio equals total assets divided by stockholders’ equity.

(3)	Adjusted leverage ratio equals adjusted assets divided by stockholders’ equity.

(4)	Book value per share was based on common shares outstanding, including restricted stock units granted to employees with no future service requirements, of 480,263,530 as of August 2000 and 484,566,184 as of November 1999.

As of August 2000, we held approximately $2.43 billion in high-yield debt and emerging market securities and $2.55 billion in bank loans. 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 August 2000, the aggregate carrying value of our principal investments held directly or through our merchant banking funds was $3.54 billion, which consisted of corporate principal investments with an aggregate carrying value of $2.63 billion and real estate investments with an aggregate carrying value of $913 million.

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 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 August 2000:


	Short-Term Debt		Long-Term Debt

CBRS		A-1 (High)		AA




Fitch		F1+		AA-




Moody’s		P-1		A1




Standard & Poor’s		A-1+		A+




Thomson Financial BankWatch		TBW-1		AA

Long-Term Debt

As of August 2000, our consolidated long-term borrowings were $28.53 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 August 2000 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 rate and foreign exchange movements.

Item 3: Quantitative and Qualitative Disclosures About Market Risk

For a description of our risk management policies and procedures, value-at-risk (VaR) model, including such model’s assumptions and limitations, and nontrading risk sensitivity analysis, see Part II, Item 7A “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the fiscal year ended November 26, 1999 and the information incorporated by reference therein.

PART II: OTHER INFORMATION

Item 1: Legal Proceedings

The following supplements and amends our discussion set forth under Part I, Item 3 “Legal Proceedings” in our Annual Report on Form 10-K for the fiscal year ended November 26, 1999, as updated by our Quarterly Reports on Form 10-Q for the quarters ended February 25, 2000 and May 26, 2000.

Antitrust Matters

The Goldman Sachs Group, Inc. is a named defendant in a purported class action filed on August 17, 2000 in the U.S. District Court for the Southern District of Florida by an alleged issuer in a 1996 initial public offering. The action asserts substantively similar allegations to the New York action which alleges a conspiracy to fix at 7% the discount that underwriting syndicates receive from issuers of shares in certain offerings. On October 2, 2000, defendants, most of which are named in the New York action, moved to transfer the action to the New York federal court.

In the lawsuit alleging a conspiracy to preclude the multiple listing of equity options on the exchanges, certain defendants including Hull Trading Co. L.L.C. have entered into a settlement, subject to court approval, pursuant to which Hull will be required to pay an aggregate of $2.475 million.

Rockefeller Center Properties, Inc. Litigation

On July 18, 2000, the federal district court granted plaintiffs’ motion for leave to file an amended complaint. Defendants have renewed their motion to dismiss with respect to the amended complaint.

Reichhold Chemicals Litigation

The lawsuit brought by Reichhold Chemicals, Inc. and Reichhold Norway ASA was dismissed on August 29, 2000 pursuant to a settlement.

HUD Litigation

The civil action under the qui tam provisions of the federal False Claims Act was voluntarily dismissed without prejudice on August 28, 2000.

Laidlaw Bondholders Litigation

Goldman, Sachs & Co. has been named as a defendant in purported class actions filed on September 24, 2000 in the U.S. District Court for the Southern District of New York and on September 22, 2000 in the U.S. District Court for the District of South Carolina arising from certain offerings of debentures by Laidlaw, Inc. during 1997-1999. The defendants include Laidlaw, certain of its officers and directors, the lead underwriters for the offerings (including Goldman, Sachs & Co., which was lead manager in the offerings), and Laidlaw’s outside auditors. The offerings included a total of $1.125 billion principal amount of debentures, of which Goldman, Sachs & Co. underwrote $286.25 million.

The lawsuits, brought by certain institutional holders of the debentures, allege that the prospectuses issued in connection with the offerings were false and misleading in violation of the disclosure requirements of the federal securities laws. The plaintiffs are seeking, among other things, unspecified damages.

World Online Litigation

On September 11, 2000, several Dutch World Online shareholders as well as a Dutch entity purporting to represent the interests of certain World Online shareholders commenced a proceeding in Amsterdam District Court against “ABN AMRO Bank N.V., also acting under the name of ABN AMRO Rothschild”, alleging misrepresentations and omissions relating to the initial public offering of World Online in March 2000. The lawsuit seeks, among other things, the return of the purchase price of the shares purchased by the plaintiffs or unspecified damages. Neither Goldman, Sachs & Co. nor Goldman Sachs International has been named in the proceeding, but the firm and ABN AMRO Rothschild served as joint global co-ordinators of the offering.

Item 2: Changes in Securities and Use of Proceeds

On August 21, 2000, Sumitomo Bank Capital Markets, Inc. exchanged all 7,440,362 shares of its nonvoting common stock, par value $.01 per share, of Group Inc. for an equal number of shares of common stock. The issuance of common stock upon exchange was not registered under the Securities Act of 1933 in reliance on Section 3(a)(9) thereof as involving exclusively the exchange of one security of Group Inc. for another security of Group Inc. where no commission or other remuneration was paid in connection with the exchange.

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 due to unidentified or unanticipated risks;

• competitive pressure, including for our employees;

• a lack of liquidity, i.e., ready access to funds, for use in our business;

• losses caused by financial or other problems experienced by third parties; and

• volatility or a downturn in the technology and communications sectors.

Additional information regarding these and other important factors that could cause actual results to differ from those in our forward-looking statements is contained in our prospectus, dated August 1, 2000 (as filed with the SEC on August 2), under the caption “Risk Factors”.

Forward-looking statements regarding the expected date of completion of the transaction with Spear, Leeds & Kellogg, L.P. are subject to the risk that the closing conditions will not be satisfied, including the risk that the necessary regulatory and other approvals will not be obtained.

Statements about our investment banking transaction backlog also may constitute forward-looking statements. Such statements are subject to the risk that the terms of these transactions may be modified or that they may not be completed at all; therefore, the net revenues that we expect to earn from these transactions may differ, possibly materially, from those currently expected. Important factors that could result in a modification of the terms of a transaction or a transaction not being completed include, in the case of underwriting transactions, a decline in general economic conditions, volatility in the securities markets generally or an adverse development with respect to the issuer of the securities and, in the case of financial advisory transactions, a decline in the securities markets, an adverse development with respect to a party to the transaction or a failure to obtain a required regulatory approval. Other important factors that could adversely affect our investment banking transactions are contained in our prospectus, dated August 1, 2000 (as filed with the SEC on August 2), under the caption “Risk Factors”.

Rule 144 Sales Program

On September 22, 2000, our Board of Directors approved a program to permit the former profit participating limited partners of The Goldman Sachs Group, L.P. and the former owners of our Hull subsidiary to sell, in a coordinated manner, a portion of their shares of common stock in accordance with the volume and manner of sale limitations of Rule 144 under the Securities Act of 1933. Sales under the program commenced on September 25, 2000.

Item 6: Exhibits and Reports on Form 8-K

(a) Exhibits:


2.1		Agreement and Plan of Merger, dated as of September 10, 2000, by and between The Goldman Sachs Group, Inc. and SLK LLC.
10.1		Form of Indemnification Agreement, dated as of July 5, 2000.
10.2		Form of Amendment No. 1, dated as of July 10, 2000, to the Pledge Agreement, dated as of May 7, 1999 (incorporated by reference to Exhibit F to Amendment No. 4 to Schedule 13D, filed July 11, 2000 (No. 005-56295)).
10.3		Amendment No. 1, dated as of September 5, 2000, to the Tax Indemnification Agreement, dated as of May 7, 1999.
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.
27.1		Financial Data Schedule.

(b) Reports on Form 8-K:

On July 18, 2000, Group Inc. filed a Current Report on Form 8-K reporting the sale of $1,250,000,000 principal amount of its 7.625% Notes due 2005.

On July 31, 2000, Group Inc. filed a Current Report on Form 8-K reporting the waiver of transfer restrictions to permit its former partners to pledge Group Inc. common stock to obtain loan commitments to invest in certain merchant banking funds sponsored by Group Inc.

On September 11, 2000, Group Inc. filed a Current Report attaching its press release announcing the agreement to combine with Spear, Leeds & Kellogg, L.P.

On September 19, 2000, Group Inc. filed a Current Report on Form 8-K reporting the firm’s net earnings for its fiscal third quarter ended August 25, 2000.

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: October 10, 2000

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[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.


[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.


	•	Global Capital Markets. This segment comprises Investment Banking, which includes Financial Advisory and Underwriting, and Trading and Principal Investments, which includes Fixed Income, Currency and Commodities (“FICC”), Equities and Principal Investments (Principal Investments primarily represents net revenues from the firm’s merchant banking investments); and

	•	Asset Management and Securities Services. This segment comprises Asset Management, Securities Services and Commissions.


	•	the employee initial public offering award of restricted stock units, for which future service is not required as a condition to the delivery of the underlying shares of common stock;

	•	the initial irrevocable contribution of shares of common stock to the defined contribution plan;

	•	the recognition of certain net tax assets; and

	•	a contribution to The Goldman Sachs Foundation, a charitable foundation.


	•	interest expense on junior subordinated debentures issued to retired limited partners in exchange for their partnership interests;

	•	the amortization of the restricted stock units awarded to employees in connection with our initial public offering, for which future service is required as a condition to the delivery of the underlying shares of common stock; and

	•	the provision for income taxes in corporate form.


	•	Financial Advisory. Financial Advisory includes advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, restructurings and spin-offs; and

	•	Underwriting. Underwriting includes public offerings and private placements of equity and debt securities.


	•	FICC. We make markets in and trade fixed income products, currencies and commodities, structure and enter into a wide variety of derivative transactions, and engage in proprietary trading and arbitrage activities;

	•	Equities. We make markets in and trade equities and equity-related products, structure and enter into equity derivative transactions, and engage in proprietary trading and equity arbitrage; and

	•	Principal Investments. Principal Investments primarily represents net revenues from our merchant banking investments.


	•	Asset Management. Asset Management generates management fees by providing investment advisory services to a diverse client base of institutions and individuals;

	•	Securities Services. Securities Services includes prime brokerage, financing services and securities lending, and our matched book businesses, all of which generate revenues primarily in the form of fees or interest rate spreads; and

	•	Commissions. Commissions include agency transactions for clients on major stock and futures exchanges and revenues from the increased share of the income and gains derived from our merchant banking funds.


	•	a decline in general economic conditions or the global financial markets;

	•	losses due to unidentified or unanticipated risks;


	•	competitive pressure, including for our employees;

	•	a lack of liquidity, i.e., ready access to funds, for use in our business;

	•	losses caused by financial or other problems experienced by third parties; and

	•	volatility or a downturn in the technology and communications sectors.