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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended May 28, 1999, and the six-month period ended May 28, 1999, for The Goldman Sachs Group, Inc. The filing is significant as it marks the firm's conversion from a partnership to a corporation and the completion of its Initial Public Offering (IPO) on May 7, 1999. The firm operates in three principal business lines: Investment Banking, Trading and Principal Investments, and Asset Management and Securities Services.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 16% for the quarter and 18% for the six-month period compared to the prior year. Investment Banking revenues rose 5% (quarter) and 20% (six months), driven by higher advisory fees. Trading and Principal Investments revenues increased 23% (quarter) and 19% (six months), primarily due to strong equity performance.
• Operating Expenses: Total operating expenses surged 154% for the quarter and 99% for the six-month period. This increase is largely attributable to non-recurring charges associated with the IPO and corporate conversion, including $2.26 billion in employee IPO awards and a $200 million charitable contribution.
• Profitability: While net earnings were reported as $340 million for the quarter, this figure was reduced by $672 million due to non-recurring items. On a pro forma basis (excluding non-recurring items), diluted EPS for the six-month period would have been $2.35.
• Tax Status: The firm transitioned from a partnership (pass-through taxation) to a corporation, becoming subject to U.S. federal, state, and local corporate income taxes effective May 7, 1999. This resulted in a significant deferred tax benefit of $825 million recognized upon conversion.

Guidance, Outlook, and Risks

• Management Commentary: Management notes that period-to-period comparisons may not be meaningful due to the structural changes from the IPO. The firm expects to record non-cash expense of approximately $115 million related to IPO awards in each of the third and fourth quarters of 1999.
• Liquidity: The firm maintains a highly liquid balance sheet with a liquidity ratio of at least 100%. As of May 1999, the firm held approximately $14.17 billion in unencumbered U.S. government and agency obligations as a liquidity cushion.
• Year 2000 Readiness: The firm estimates total costs for Year 2000 remediation and contingency planning at approximately $170 million. By the end of June 1999, remediation and testing were completed for all systems except three applications scheduled for July/August implementation.
• Legal Proceedings: The firm is involved in various proceedings, including antitrust matters regarding underwritings, the Reichhold Chemicals litigation, and class action lawsuits related to AMF Securities and Iridium underwritings. Management believes these will not have a material adverse effect on financial condition.
• Dividend: On June 23, 1999, the Board declared a dividend of $0.12 per share payable on August 27, 1999.

Investor Verification Checklist

• Non-Recurring Charges: Verify the impact of the $2.26 billion employee IPO awards and $200 million charitable contribution on reported earnings versus pro forma earnings.
• Stock-Based Compensation: Review the amortization schedule for the $1.76 billion in discretionary restricted stock units granted at the IPO, which will be expensed over a five-year period.
• Pro Forma Tax Rate: Confirm the effective tax rate of 41% applied to the corporate period and the implications of the deferred tax asset revaluation.
• Liquidity Ratios: Assess the "Adjusted Leverage Ratio" of 20.1x and the composition of unencumbered assets relative to short-term unsecured liabilities.
• Year 2000 Costs: Monitor the remaining $170 million budget for Y2K compliance and the status of third-party vendor remediation.