Business Context and Reporting Period
Company: The Goldman Sachs Group, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: August 27, 1999
Context: This report covers the third quarter of fiscal 1999, a period marked by the firm's conversion from a partnership to a corporation and the completion of its Initial Public Offering (IPO) on May 7, 1999. The financial results reflect the transition to corporate tax status and significant non-recurring compensation expenses related to the IPO.
Key Financial Metrics
| Metric (in millions) | Three Months Ended Aug 27, 1999 |
Nine Months Ended Aug 27, 1999 |
Nine Months Ended Aug 28, 1998 |
|---|---|---|---|
| Total Revenues | $6,440 | $18,651 | $18,201 |
| Net Revenues (Revenues less interest expense) | $3,408 | $9,872 | $7,605 |
| Pre-tax Earnings | $1,082 | $783 | $2,814 |
| Net Earnings | $638 | $1,985 | $2,384 |
| Diluted EPS | $1.32 | $4.11 | $4.11 |
| Total Assets (as of period end) | $236,273 | $236,273 | $217,380 |
| Short-term Borrowings | $36,612 | $36,612 | $27,430 |
| Long-term Borrowings | $20,340 | $20,340 | $19,906 |
| Cash and Cash Equivalents | $1,900 | $1,900 | $2,836 |
Material Changes vs. Prior Period
- Revenue Growth: Net revenues increased 59% in the quarter and 30% in the nine-month period compared to the prior year. Investment Banking revenues rose 20%, while Trading and Principal Investments saw substantial growth across all components (FICC, Equities, and Principal Investments).
- Expense Surge: Total operating expenses increased 67% in the quarter and 90% in the nine-month period. This was primarily driven by the conversion to corporate form, which reclassified partner distributions as compensation expense, and significant non-recurring IPO-related charges.
- Non-Recurring Items: The nine-month period included $2.26 billion in non-recurring employee IPO awards and a $200 million charitable contribution. These items significantly impacted pre-tax earnings.
- Tax Impact: The firm recognized a net tax benefit of $1.2 billion for the nine-month period, largely due to a $825 million deferred tax benefit from the revaluation of assets upon conversion to corporate status. Excluding non-recurring items, the effective tax rate was 41%.
- Liquidity: Cash and cash equivalents decreased from $2.84 billion to $1.90 billion. Short-term borrowings increased by $9.18 billion to fund operations and balance sheet growth.
Guidance, Outlook, and Risks
- Management Commentary: Management noted that period-to-period comparisons may not be meaningful due to the structural changes from the partnership-to-corporation conversion. Pro forma results (excluding non-recurring IPO items) show diluted EPS of $3.63 for the nine-month period.
- Year 2000 Readiness: The firm estimates total Year 2000 compliance costs at approximately $173 million, with $147 million already spent. Remediation and testing for critical systems are complete, though risks remain regarding third-party failures.
- Liquidity Management: The firm maintains a "liquidity ratio" of at least 100% (unencumbered assets vs. short-term unsecured liabilities) and holds a cushion of unencumbered U.S. government obligations. Credit ratings remain strong (A1/A+).
- Legal Proceedings: Several significant litigations are ongoing, including the Mobile Media settlement (in principle), Rockefeller Center Properties appeal, and a False Claims Act action regarding HUD loan auctions. Management believes these will not have a material adverse effect on financial condition in the aggregate.
- Acquisition: On September 24, 1999, the firm completed the acquisition of The Hull Group, a market maker in equity derivatives.
Investor Verification Checklist
- Pro Forma Adjustments: Verify the pro forma earnings per share ($3.63) to understand underlying profitability excluding the one-time $2.26 billion IPO compensation charge.
- Stock-Based Compensation: Review the amortization schedule for the $1.76 billion in restricted stock units awarded to employees, which will impact future earnings over the next five years.
- Tax Rate Normalization: Confirm the effective tax rate of 41% for the corporate period, noting the significant one-time tax benefit that inflated current net earnings.
- Leverage Ratios: Monitor the adjusted leverage ratio (19.5x) and the composition of short-term borrowings ($36.6 billion) to assess funding stability.
- Year 2000 Contingency: Assess the status of third-party vendor readiness, as the firm's operations depend on external systems that may fail despite internal compliance.