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To the Partners,
In our opinion, the accompanying consolidated statements of financial
condition and the related consolidated statements of earnings, changes in
partners' capital and cash flows (included on pages F-3 to F-23 of this
prospectus) present fairly, in all material respects, the consolidated financial
position of The Goldman Sachs Group, L.P. and Subsidiaries (the "Firm") as of
November 27, 1998 and November 28, 1997, and the results of their consolidated
operations and their consolidated cash flows for the three years in the period
ended November 27, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Firm's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards, which require that we
plan and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
We have also previously audited, in accordance with generally accepted
auditing standards, the consolidated statements of financial condition as of
November 29, 1996, November 24, 1995 and November 25, 1994, and the related
consolidated statements of earnings, changes in partners' capital and cash flows
for the years ended November 24, 1995 and November 25, 1994 (none of which are
presented herein); and we expressed unqualified opinions on those consolidated
financial statements. In our opinion, the information set forth in the selected
historical consolidated income statement and balance sheet data for each of the
five years in the period ended November 27, 1998 (included on pages 34 and 35 of
this prospectus) is fairly stated, in all material respects, in relation to the
consolidated financial statements from which it has been derived.
PricewaterhouseCoopers LLP
New York, New York
Supplemental disclosures:
Cash payments for interest approximated the related expense for each of the
fiscal periods presented. Payments of income taxes were not material.
A zero coupon bond of $32 million representing a portion of the acquisition
price of CIN Management Limited was recorded on the consolidated statement of
financial condition as of November 1996 and was excluded from the consolidated
statement of cash
flows as it represented a non-cash item.
An increase in total assets and liabilities of $11.64 billion related to the
provisions of SFAS No. 125 that were deferred under SFAS No. 127 was excluded
from the consolidated statement of cash flows for the year ended November 1998
as it represented a non-cash item.
Note 1. Description of Business
The Goldman Sachs Group, L.P., a Delaware limited partnership ("Group
L.P."), together with its consolidated subsidiaries (collectively, the "Firm"),
is a global investment banking and securities firm that provides a wide range of
services worldwide to a substantial and diversified client base.
Basis of Presentation
The consolidated financial statements include the accounts of Group
L.P. and its U.S. and international subsidiaries including Goldman, Sachs & Co.
("GS&Co.") and J. Aron & Company in New York, Goldman Sachs International
("GSI") in London and Goldman Sachs (Japan) Ltd. ("GSJL") in Tokyo. Certain
reclassifications have been made to prior year amounts to conform to the current
presentation.
These consolidated financial statements have been prepared in
accordance with generally accepted accounting principles that require management
to make estimates and assumptions regarding trading inventory valuations,
partner retirements, the outcome of pending litigation and other matters that
affect the consolidated financial statements and related disclosures. These
estimates and assumptions are based on judgment and available information and,
consequently, actual results could be materially different from these
estimates.
Unless otherwise stated herein, all references to 1996, 1997 and 1998
refer to the Firm's fiscal year ended, or the date, as the context requires,
November 29, 1996, November 28, 1997 and November 27, 1998, respectively.
Cash and Cash Equivalents
The Firm defines cash equivalents as highly liquid overnight deposits
held in the ordinary course of business.
Repurchase Agreements and Collateralized Financing Arrangements
Securities purchased under agreements to resell and securities sold
under agreements to repurchase, principally U.S. government, federal agency and
investment-grade foreign sovereign obligations, represent short-term
collateralized financing transactions and are carried at their contractual
amounts plus accrued interest. These amounts are presented on a net-by-
counterparty basis, where management believes a legal right of setoff exists
under an enforceable master netting agreement. The Firm takes possession of
securities purchased under agreements to resell, monitors the market value of
the underlying securities on a daily basis and obtains additional collateral as
appropriate.
Securities borrowed and loaned are recorded on the statements of
financial condition based on the amount of cash collateral advanced or received.
These transactions are generally collateralized by either cash, securities or
letters of credit. The Firm takes possession of securities borrowed, monitors
the market value of securities loaned and obtains additional collateral as
appropriate. Income or expense is recognized as interest over the life of the
transaction.
Financial Instruments
Gains and losses on financial instruments and commission income and
related expenses are recorded on a trade date basis in the consolidated
statements of earnings. For purposes of the consolidated statements of financial
condition only, purchases and sales of financial instruments, including agency
transactions, are generally recorded on a settlement date basis. Recording such
transactions on a trade date basis would not result in a material adjustment to
the consolidated statements of financial condition.
Substantially all financial instruments used in the Firm's trading and
non-trading activities are carried at fair value or amounts that approximate
fair value and unrealized gains and losses are recognized in earnings. Fair
value is based generally on listed market prices or broker or dealer price
quotations. To the extent that prices are not readily available, fair value is
based on either internal valuation models or management's estimate of amounts
that could be realized under current market conditions, assuming an orderly
liquidation over a reasonable period of time. Certain over-the-counter ("OTC")
derivative instruments are valued using pricing models that consider, among
other factors, current and contractual market prices, time value, and yield
curve and/or volatility factors of the underlying positions. The fair value of
the Firm's trading and non-trading assets and liabilities is discussed further
in Notes 3, 4 and 5.
Principal Investments
Principal investments are carried at fair value, generally as evidenced
by quoted market prices or by comparable substantial third-party transactions.
Where fair value is not readily ascertainable, principal investments are
recorded at cost or management's estimate of the realizable value.
The Firm is entitled to receive merchant banking overrides (i.e.,
an increased share of a fund's income and gains) when the return on the fund's
investments exceeds certain threshold returns. Overrides are based on investment
performance over the life of each merchant banking fund, and future investment
underperformance may require amounts previously distributed to the Firm to be
returned to the funds. Accordingly, overrides are recognized in earnings only
when management determines that the probability of return is remote. Overrides
are included in "Asset Management and Securities Services" on the consolidated
statements of earnings.
Derivative Contracts
Derivatives used for trading purposes are reported at fair value and
are included in "Derivative contracts" on the consolidated statements of
financial condition. Gains and losses on derivatives used for trading purposes
are included in "Trading and Principal Investments" on the consolidated
statements of earnings.
Derivatives used for non-trading purposes include interest rate futures
contracts and interest rate and currency swap agreements, which are primarily
utilized to convert a substantial portion of the Firm's fixed rate debt into
U.S. dollar-based floating rate obligations. Gains and losses on these
transactions are generally deferred and recognized as adjustments to interest
expense over the life of the derivative contract. Gains and losses resulting
from the early termination of derivatives used for non-trading purposes are
generally deferred and recognized over the remaining life of the underlying
debt. If the underlying debt is terminated prior to its stated maturity, gains
and losses on these transactions, including the associated hedges, are
recognized in earnings immediately.
Derivatives are reported on a net-by-counterparty basis on the
consolidated statements of financial condition where management believes a legal
right of setoff exists under an enforceable master netting agreement.
Property, Leasehold Improvements and Equipment
Depreciation and amortization generally are computed using accelerated
cost recovery methods for all property and equipment and for leasehold
improvements where the term of the lease is greater than the economic useful
life of the asset. All other leasehold improvements are amortized on a
straight-line basis over the term of the lease.
Goodwill
The cost of acquired companies in excess of the fair value of net
assets acquired at acquisition date is recorded as goodwill and amortized over
periods of 15 to 25 years on a straight-line basis.
Provision for Taxes
The Firm accounts for income taxes incurred by its corporate
subsidiaries in accordance with Statement of Financial Accounting Standards
("SFAS") No. 109, "Accounting for Income Taxes". The consolidated statements of
earnings for the periods presented include a provision for, or benefit from,
income taxes on income earned, or losses incurred, by Group L.P. and its
subsidiaries including a provision for, or benefit from, unincorporated business
tax on income earned, or losses incurred, by Group L.P. and its subsidiaries
conducting business in New York City. No additional income tax provision is
required in the consolidated statements of earnings because Group L.P. is a
partnership and the remaining tax effects accrue directly to its partners.
Foreign Currency Translation
Assets and liabilities of subsidiaries whose functional currency is
other than the U.S. dollar are translated using currency exchange rates
prevailing at the end of the period presented, while revenues and expenses are
translated using average exchange rates during the period. Gains or losses
resulting from the translation of foreign currency financial statements are
recorded as cumulative translation adjustments, and are included as a component
of "Partners' capital allocated for income taxes and potential withdrawals" on
the consolidated statements of financial condition. Gains or losses resulting
from foreign exchange transactions are recorded in earnings.
Investment Banking
Underwriting revenues and fees from mergers and acquisitions and other
corporate finance advisory assignments are recorded when the underlying
transaction is completed under the terms of the engagement. Syndicate expenses
related to securities offerings in which the Firm acts as an underwriter or
agent are deferred until the related revenue is recognized.
Accounting Developments
In June 1996, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities", effective for transactions occurring after
December 31, 1996. SFAS No. 125 establishes standards for distinguishing
transfers of financial assets that are accounted for as sales from transfers
that are accounted for as secured borrowings.
The provisions of SFAS No. 125 relating to repurchase agreements,
securities lending transactions and other similar transactions were deferred by
the provisions of SFAS No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125", and became effective for transactions
entered into after December 31, 1997. This Statement requires that the
collateral obtained in certain types of secured lending transactions be recorded
on the balance sheet with a corresponding liability reflecting the obligation to
return such collateral to its owner.
Effective January 1, 1998, the Firm adopted the provisions of SFAS No. 125 that
were deferred by SFAS No. 127. The adoption of this standard increased the
Firm's total assets and liabilities by $11.64 billion as of November 1998.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share"
("EPS"), effective for periods ending after December 15, 1997, with restatement
required for all prior periods. SFAS No. 128 establishes new standards for
computing and presenting EPS. This Statement replaces primary and fully diluted
EPS with "basic EPS", which excludes dilution, and "diluted EPS", which includes
the effect of all potentially dilutive common shares and other dilutive
securities. Because the Firm has not historically reported EPS, this Statement
will have no impact on the Firm's historical financial statements. This
Statement will, however, apply to financial statements of the Firm prepared
after the offerings.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income", effective for fiscal years beginning after December 15, 1997, with
reclassification of earlier periods required for comparative purposes. SFAS No.
130 establishes standards for the reporting and presentation of comprehensive
income and its components in the financial statements. The Firm intends to adopt
this standard in the first quarter of fiscal 1999. This Statement is limited to
issues of reporting and presentation and, therefore, will not affect the Firm's
results of operations or financial condition.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information", effective for fiscal years beginning
after December 15, 1997, with reclassification of earlier periods required for
comparative purposes. SFAS No. 131 establishes the criteria for determining an
operating segment and establishes the disclosure requirements for reporting
information about operating segments. The Firm intends to adopt this standard at
the end of fiscal 1999. This Statement is limited to issues of reporting and
presentation and, therefore, will not affect the Firm's results of operations or
financial condition.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits", effective for fiscal years
beginning after December 15, 1997, with restatement of disclosures for earlier
periods required for comparative purposes. SFAS No. 132 revises certain
employers' disclosures about pension and other post-retirement benefit plans.
The Firm intends to adopt this standard at the end of fiscal 1999. This
Statement is limited to issues of reporting and presentation and, therefore,
will not affect the Firm's results of operations or financial condition.
In March 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
("SOP") No. 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use", effective for fiscal years beginning after December
15, 1998. SOP No. 98-1 requires that certain costs of computer software
developed or obtained for internal use be capitalized and amortized over the
useful life of the related software. The Firm currently expenses the cost of all
software development in the period in which it is incurred. The Firm intends to
adopt this Statement in fiscal 2000 and is currently assessing its effect.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", effective for fiscal years beginning after
June 15, 1999. SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and
for hedging activities. This Statement requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
condition and measure those instruments at fair value. The accounting for
changes in the fair value of a derivative instrument depends on its intended use
and the resulting designation. The Firm intends to adopt this standard in fiscal
2000 and is currently assessing its effect.
Note 3. Financial Instruments
Financial instruments, including both cash instruments and derivatives,
are used to manage market risk, facilitate customer transactions, engage in
trading transactions and meet financing objectives. These instruments can be
either executed on an exchange or negotiated in the OTC market.
Transactions involving financial instruments sold, but not yet
purchased, entail an obligation to purchase a financial instrument at a future
date. The Firm may incur a loss if the market value of the financial instrument
subsequently increases prior to the purchase of the instrument.
Fair Value of Financial Instruments
Substantially all of the Firm's assets and liabilities are carried at
fair value or amounts that approximate fair value.
Trading assets and liabilities, including derivative contracts used for
trading purposes, are carried at fair value and reported as financial
instruments owned and financial instruments sold, but not yet purchased on the
consolidated statements of financial condition. Non-trading assets and
liabilities are carried at fair value or amounts that approximate fair
value.
Non-trading assets include cash and cash equivalents, cash and
securities segregated in compliance with U.S. federal and other regulations,
receivables from brokers, dealers and clearing organizations, receivables from
customers and counterparties, securities borrowed, securities purchased under
agreements to resell, right to receive securities and certain investments,
primarily those made in connection with the Firm's merchant banking
activities.
Non-trading liabilities include short-term borrowings, payables to
brokers, dealers and clearing organizations, payables to customers and
counterparties, securities loaned, securities sold under agreements to
repurchase, obligation to return securities, other liabilities and accrued
expenses and long-term borrowings. Fair value of the Firm's long-term borrowings
and associated hedges is discussed in Note 5.
Trading and Principal Investments
The Firm's Trading and Principal Investments business facilitates
customer transactions and takes proprietary positions through market-making in
and trading of securities, currencies, commodities and swaps and other
derivatives. Derivative financial instruments are often used to hedge cash
instruments or other derivative financial instruments as an integral part of the
Firm's strategies. As a result, it is necessary to view the results of any
activity on a fully-integrated
basis, including cash positions, the effect of related derivatives and the
financing of the underlying positions.
Net revenues represent total revenues less allocations of interest
expense to specific securities, commodities and other positions in relation to
the level of financing incurred by each. The following table sets forth the net
revenues of the Firm's Trading and Principal Investments business:
Risk Management
The Firm seeks to monitor and control its risk exposure through a
variety of separate but complementary financial, credit, operational and legal
reporting systems for individual entities and the Firm as a whole. Management
believes that it has effective procedures for evaluating and managing the
market, credit and other risks to which it is exposed. The Management Committee,
the Firm's primary decision-making body, determines (both directly and through
delegated authority) the types of business in which the Firm engages, approves
guidelines for accepting customers for all product lines, outlines the terms
under which customer business is conducted and establishes the parameters for
the risks that the Firm is willing to undertake in its business.
Market Risk. The Firmwide Risk Committee, which reports to
senior management and meets weekly, is responsible for managing and monitoring
all of the Firm's risk exposures. In addition, the Firm maintains segregation of
duties, with credit review and risk-monitoring functions performed by groups
that are independent from revenue-producing departments.
The potential for changes in the market value of the Firm's trading
positions is referred to as "market risk". The Firm's trading positions result
from underwriting, market-making and proprietary trading activities.
The broadly defined categories of market risk include exposures to
interest rates, currency rates, equity prices and commodity prices.
Credit Risk. Credit risk represents the loss that the Firm would
incur if a counterparty or issuer of securities or other instruments it holds
fails to perform its contractual obligations to the Firm. To reduce its credit
exposures, the Firm seeks to enter into netting agreements with counterparties
that permit the Firm to offset receivables and payables with such
counterparties. The Firm does not take into account any such agreements when
calculating credit risk, however, unless management believes a legal right of
setoff exists under an enforceable master netting agreement.
Credit concentrations may arise from trading, underwriting and
securities borrowing activities and may be impacted by changes in economic,
industry or political factors. The Firm's concentration of credit risk is
monitored actively by the Credit Policy Committee. As of November 1998, U.S.
government and federal agency obligations represented 7% of the Firm's total
assets. In addition, most of the Firm's securities purchased under agreements to
resell are collateralized by U.S. government, federal agency and sovereign
obligations.
Derivative Activities
Most of the Firm's derivative transactions are entered into for trading
purposes. The Firm uses derivatives in its trading activities to facilitate
customer transactions, to take proprietary positions and as a means of risk
management. The Firm also enters into non-trading derivative contracts to manage
the interest rate and currency exposure on its long-term borrowings. Non-
trading derivatives related to the Firm's long-term borrowings are discussed in
Note 5.
Derivative contracts are financial instruments, such as futures,
forwards, swaps or option contracts, that derive their value from underlying
assets, indices, reference rates or a combination of these factors. Derivatives
may involve future commitments to purchase or sell financial instruments or
commodities, or to exchange currency or interest payment streams. The amounts
exchanged are based on the specific terms of the contract with reference to
specified rates, securities, commodities or indices.
Derivative contracts exclude certain cash instruments, such as
mortgage-backed securities, interest-only and principal-only obligations and
indexed debt instruments, that derive their values or contractually required
cash flows from the price of some other security or index. Derivatives also
exclude option features that are embedded in cash instruments, such as the
conversion
features and call provisions embedded in bonds. The Firm has elected to include
commodity-related contracts in its derivative disclosure, although not required
to do so, as these contracts may be settled in cash or are readily convertible
into cash.
The gross notional (or contractual) amounts of derivative financial
instruments represent the volume of these transactions and not the amounts
potentially subject to market risk. In addition, measurement of market risk is
meaningful only when all related and offsetting transactions are taken into
consideration. Gross notional (or contractual) amounts of derivative financial
instruments used for trading purposes with off-balance-sheet market risk are set
forth below:
Market risk on purchased option contracts is limited to the market
value of the option; therefore, purchased option contracts have no
off-balance-sheet market risk. The gross notional (or contractual) amounts of
purchased option contracts used for trading purposes are set forth below:
The Firm utilizes replacement cost as its measure of derivative credit
risk. Replacement cost, as reported in financial instruments owned, at fair
value on the consolidated statements of financial condition, represents amounts
receivable from various counterparties, net of any unrealized losses owed where
management believes a legal right of setoff exists under an enforceable master
netting agreement. Replacement cost for purchased option contracts is the market
value of the contract. The Firm controls its credit risk through an established
credit
approval process, by monitoring counterparty limits, obtaining collateral where
appropriate and, in some cases, using legally enforceable master netting
agreements.
The fair value of derivative financial instruments used for trading
purposes, computed in accordance with the Firm's netting policy, is set forth
below:
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:
(1) As of November 1997 and November 1998, short-term borrowings
included $2,454 million and $2,955 million of long-term borrowings
maturing within one year, respectively.
(2) Weighted average interest rates for total short-term borrowings,
including commercial paper, were 5.43 % as of November 1997 and
5.19% as of November 1998.
The Firm maintains unencumbered securities with a market value in
excess of all uncollateralized short-term borrowings.
Note 5. Long-Term Borrowings The Firm's long-term borrowings are set forth below:
(1) Interest rate ranges for U.S. dollar and non-U.S. dollar fixed rate obligations are set forth below:
(2) Floating interest rates generally are based on LIBOR, the U.S. treasury bill rate or the federal funds rate. Certain equity-linked and indexed instruments are included in floating rate obligations. (3) Long-term borrowings bear fixed or floating interest rates and have maturities that range from 1 to 30 years from the date of issue. Long-term borrowings by maturity date are set forth below:
The Firm enters into non-trading derivative contracts, such as interest rate and currency swap agreements, to effectively convert a substantial portion of its fixed rate long-term borrowings into U.S. dollar-based floating rate obligations. Accordingly, the aggregate carrying value of these long-term borrowings and related hedges approximates fair value. The effective weighted average interest rates for long-term borrowings, after hedging activities, are set forth below:
The notional amounts, fair value and carrying value of the related swap agreements used for non-trading purposes are set forth below:
Note 6. Commitments and Contingencies Litigation The Firm is involved in a number of judicial, regulatory and arbitration proceedings concerning matters arising in connection with the conduct of its businesses. Management believes, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on the Firm's financial condition, but might be material to the Firm's operating results for any particular period, depending, in part, upon the operating results for such period. Leases The Firm has obligations under long-term non-cancelable lease agreements, principally for office space, expiring on various dates through 2016. Certain agreements are subject to periodic escalation charges for increases in real estate taxes and other charges. Minimum rental commitments, net of minimum sublease rentals, under non-cancelable leases for 1999 and the succeeding four years and rent charged to operating expense for the last three years are set forth below:
Other Commitments The Firm acts as an investor in merchant banking transactions which includes making long-term investments in equity and debt securities in privately negotiated transactions, corporate acquisitions and real estate transactions, and in connection with a bridge loan fund. In connection with these activities, the Firm had commitments to invest up to $670 million and $1.39 billion in corporate and real estate merchant banking investment and bridge loan funds as of November 1997 and November 1998, respectively. In connection with loan origination and participation, the Firm had loan commitments of $5.23 billion and $1.51 billion as of November 1997 and November 1998, respectively. These commitments are agreements to lend to counterparties, have fixed termination dates and are contingent on all conditions to borrowing set forth in the contract having been met. Since these commitments may expire unused, the total commitment amount does not necessarily reflect the actual future cash flow requirements. The Firm also had outstanding guarantees of $786 million and $790 million relating to its fund management activities as of November 1997 and November 1998, respectively. The Firm had pledged securities of $23.60 billion and $22.88 billion as collateral for securities borrowed of approximately equivalent value as of November 1997 and November 1998, respectively. The Firm obtains letters of credit issued to counterparties by various banks that are used in lieu of securities or cash to satisfy various collateral and margin deposit requirements. Letters of credit outstanding were $10.13 billion and $8.81 billion as of November 1997 and November 1998, respectively. Note 7. Employee Benefit Plans The Firm sponsors various pension plans and certain other post-retirement benefit plans, primarily health care and life insurance, which cover most employees worldwide. The Firm also provides certain benefits to former or inactive employees prior to retirement. Plan benefits are primarily based on the employee's compensation and years of service. Pension costs are determined actuarially and are funded in accordance with the Internal Revenue Code. Plan assets are held in a trust and consist primarily of listed stocks and U.S. bonds. A summary of these plans is set forth below: Defined Benefit Pension Plans The components of pension expense/(income) are set forth below:
The weighted average assumptions used to develop net periodic pension cost and the actuarial present value of the projected benefit obligation are set forth below. The assumptions represent a weighted average of the assumptions used for the U.S. and international plans and are based on the economic environment of each applicable country.
The funded status of the qualified plans is set forth below:
Post-Retirement Plans The Firm has unfunded post-retirement benefit plans that provide medical and life insurance for eligible retirees, employees and dependents. The Firm's accrued post-retirement benefit liability was $50 million and $53 million as of November 1997 and November 1998, respectively. The Firm's expense for these plans was $6 million, $7 million and $6 million in the years ended 1996, 1997 and 1998, respectively. Post-Employment Plans Post-employment benefits include, but are not limited to, salary continuation, supplemental unemployment benefits, severance benefits, disability-related benefits, and continuation of health care and life insurance coverage provided to former or inactive employees after employment but before retirement. The accrued but unfunded liability under the plans was $12 million and $10 million as of November 1997 and November 1998, respectively. The Firm's expense for these plans was $2 million in each of the fiscal years ended 1996, 1997 and 1998. Defined Contribution Plans The Firm contributes to employer sponsored U.S. and international defined contribution plans. The Firm's contribution to the U.S. plans was $39 million, $44 million and $48 million for the years ended 1996, 1997 and 1998, respectively. The Firm's contribution to the international plans was $7 million, $14 million and $10 million for the years ended 1996, 1997 and 1998, respectively. Note 8. Capital Partners' Capital Partners' capital includes both the general partner's and limited partners' capital and is subject to certain withdrawal restrictions. As of November 1998, the Firm had $6.31 billion in partners' capital. Managing directors that are participating limited partners in Group L.P. ("PLPs") who elect to retire are entitled to redeem their capital over a period of not less than five years following retirement, but often reinvest a significant portion of their capital as limited partners for longer periods. Partners' capital was reduced by $368 million in 1998 due to the termination of the Profit Participation Plans under which certain employees received payments based on the earnings of the Firm. Partners' capital allocated for income taxes and potential withdrawals represents management's estimate of net amounts currently distributable, primarily to the PLPs, under the Partnership Agreement, for items including, among other things, income taxes and capital withdrawals. Sumitomo Bank Capital Markets, Inc. ("SBCM"), a limited partner that had capital invested of approximately $834 million as of November 1998, may require Group L.P. to redeem its capital over a five-year period beginning no earlier than 2007. Kamehameha Activities Association ("KAA"), a limited partner that had capital invested of approximately $757 million as of November 1998, may require Group L.P. to redeem $391 million of its capital over a five-year period beginning no earlier than 2010 and $366 million of its capital over a five-year period beginning no earlier than 2013. Institutional Limited Partners (other than SBCM and KAA) had aggregate capital invested of $755 million as of November 1998. Group L.P. must repay these Institutional Limited Partners' capital as follows: $270 million in six equal annual installments commencing in December 2001, $257 million in March 2005, $146 million in November 2013 and $82 million in November 2023. Group L.P. may defer any required redemption of capital if the redemption would cause a subsidiary subject to regulatory authority to be in violation of the rules of such authority or if the withdrawal of funds to satisfy the redemption from an unregulated subsidiary would have a material effect on such subsidiary. Regulated Subsidiaries GS&Co. is a registered U.S. broker-dealer subsidiary, which is subject to the Securities and Exchange Commission's "Uniform Net Capital Rule", and has elected to compute its net capital in accordance with the "Alternative Net Capital Requirement" of that rule. As of November 1997 and November 1998, GS&Co. had regulatory net capital, as defined, of $1.77 billion and $3.25 billion, respectively, which exceeded the amounts required by $1.37 billion and $2.70 billion, respectively. GSI, a registered U.K. broker-dealer and subsidiary of Group L.P., is subject to the capital requirements of the Securities and Futures Authority Limited and GSJL, a Tokyo-based broker-dealer, is subject to the capital requirements of the Japanese Ministry of Finance and the Financial Supervisory Agency. As of November 1997 and November 1998, GSI and GSJL were in compliance with their local capital adequacy requirements. Certain other subsidiaries of the Firm are also subject to capital adequacy requirements promulgated by authorities of the countries in which they operate. As of November 1997 and November 1998, these subsidiaries were in compliance with their local capital adequacy requirements. Note 9. Geographic Data The Firm's activities as an investment banking and securities firm constitute a single business segment pursuant to SFAS No. 14 "Financial Reporting for Segments of a Business Enterprise". Due to the highly integrated nature of international financial markets, the Firm manages its business based on the profitability of the enterprise as a whole, not by geographic region. Accordingly, management believes that profitability by geographic region is not necessarily meaningful. The total revenues, net revenues, pre-tax earnings and identifiable assets of Group L.P. and its consolidated subsidiaries by geographic region are summarized below:
(1) Americas principally represents the United States. Note 10. Quarterly Results (unaudited)
To the Partners,
We have reviewed the condensed consolidated statement of financial condition of The Goldman Sachs Group, L.P. and Subsidiaries (the "Firm") as of February 26, 1999, and the related condensed consolidated statements of earnings, and cash flows for the three months ended February 26, 1999 and February 27, 1998 and the related condensed consolidated statement of changes in partners' capital for the three months ended February 26, 1999 (included on pages F-25 to F-33 of this prospectus). These financial statements are the responsibility of the Firm's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated financial statements for them to be in conformity with generally accepted accounting principles. PricewaterhouseCoopers LLP
New York, New York
Supplemental disclosures: Cash payments for interest approximated the related expense for each of the fiscal periods presented. Payments of income taxes were not material. The increases in total assets and liabilities related to the provisions of Statement of Financial Accounting Standards No. 125 that were deferred under Statement of Financial Accounting Standards No. 127 were excluded from the consolidated statements of cash flows as they represented non-cash items.
Note 1. Description of Business The Goldman Sachs Group, L.P., a Delaware limited partnership ("Group L.P."), together with its consolidated subsidiaries (collectively, the "Firm"), is a global investment banking and securities firm that provides a wide range of services worldwide to a substantial and diversified client base.
The Firm's activities are divided into three principal business
lines:
Note 2. Significant Accounting Policies Basis of Presentation The consolidated financial statements include the accounts of Group L.P. 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. The consolidated financial statements are unaudited and should be read in conjunction with the audited consolidated financial statements included elsewhere in this prospectus. These consolidated financial statements have been prepared in accordance with generally accepted accounting principles that require management to make estimates and assumptions regarding trading inventory valuations, partner retirements, 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. The unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, that are, in the opinion of management, necessary for a fair statement of the results for 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 February 1998 and February 1999 refer to the Firm's fiscal quarter ended, or the date, as the context requires, February 27, 1998 and February 26, 1999, respectively. Comprehensive Income In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income", which establishes standards for the reporting and presentation of comprehensive income and its components in the financial statements. This Statement is effective for fiscal years beginning after December 15, 1997 and was adopted by the Firm in the first quarter of 1999. The components of comprehensive income are set forth below:
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 consolidated statements of earnings. For purposes of the consolidated statement of financial condition only, purchases and sales of financial instruments, including agency transactions, are generally recorded on a settlement date basis. Recording such transactions on a trade date basis would not result in a material adjustment to the consolidated statement of financial condition. Substantially all financial instruments used in the Firm's trading and non-trading activities are carried at fair value or amounts that approximate fair value and unrealized gains and losses are recognized in earnings. Fair value is based generally on listed market prices or broker or dealer price quotations. To the extent that prices are not readily available, fair value is based on either internal valuation models or management's estimate of amounts that could be realized under current market conditions, assuming an orderly liquidation over a reasonable period of time. Certain over-the-counter derivative instruments are valued using pricing models that consider, among other factors, current and contractual market prices, time value, and yield curve and/or volatility factors of the underlying positions. The Firm's Trading and Principal Investments business facilitates customer transactions and takes proprietary positions through market-making in and trading of securities, currencies, commodities and swaps and other derivatives. Derivative financial instruments are often used to hedge cash instruments or other derivative financial instruments as an integral part of the Firm's strategies. As a result, it is necessary to view the results of any activity on a fully-integrated basis, including cash positions, the effect of related derivatives and the financing of the underlying positions. Net revenues represent total revenues less allocations of interest expense to specific securities, commodities and other positions in relation to the level of financing incurred by each. The following table sets forth the net revenues of the Firm's Trading and Principal Investments business:
Derivative Activities Most of the Firm's derivative transactions are entered into for trading purposes. The Firm uses derivatives in its trading activities to facilitate customer transactions, to take proprietary positions and as a means of risk management. The Firm also enters into non-trading derivative contracts to manage the interest rate and currency exposure on its long-term borrowings. 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. Derivatives used for trading purposes are reported at fair value and are included in "Derivative contracts" on the consolidated statement of financial condition. Gains and losses on derivatives used for trading purposes are included in "Trading and Principal Investments" on the consolidated statements of earnings. The Firm utilizes replacement cost as its measure of derivative credit risk. Replacement cost, as reported in financial instruments owned, at fair value on the consolidated statement of financial condition, represents amounts receivable from various counterparties, net of any unrealized losses owed where management believes a legal right of setoff exists under an enforceable master netting agreement. Replacement cost for purchased option contracts is the market value of the contract. The Firm controls its credit risk through an established credit approval process, by monitoring counterparty limits, obtaining collateral where appropriate and, in some cases, using legally enforceable master netting agreements. The fair value of derivative financial instruments used for trading purposes, computed in accordance with the Firm's netting policy, is set forth below:
Derivatives used for non-trading purposes include interest rate futures contracts and interest rate and currency swap agreements, which are primarily utilized to convert a substantial portion of the Firm's fixed rate debt into U.S. dollar-based floating rate obligations. Gains and losses on these transactions are generally deferred and recognized as adjustments to interest expense over the life of the derivative contract. Gains and losses resulting from the early termination of derivatives used for non-trading purposes are generally deferred and recognized over the remaining life of the underlying debt. If the underlying debt is terminated prior to its stated maturity, gains and losses on these transactions, including the associated hedges, are recognized in earnings immediately. The fair value and carrying value of derivatives used for non-trading purposes are set forth below:
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 February 1999, short-term borrowings included $6,285 million 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. 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 February 1999, GS&Co. had regulatory net capital, as defined, of $2.89 billion, which exceeded the amount required by $2.40 billion. GSI, a registered U.K. broker-dealer and subsidiary of Group L.P., is subject to the capital requirements of the Securities and Futures Authority Limited and GSJL, a Tokyo-based broker-dealer, is subject to the capital requirements of the Japanese Ministry of Finance and the Financial Supervisory Agency. As of February 1999, 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 February 1999, these subsidiaries were in compliance with their local capital adequacy requirements. Note 6. 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.
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