Goldman Sachs 2004 Annual Report Download - page 48

management’s฀discussion฀and฀analysis
46฀฀฀G O L D M A N ฀ S A C H S ฀ 2004฀ ANNUAL฀REPO RT
46฀฀฀G O L D M A N ฀ S A C H S ฀ 2 004฀ A N N U A L ฀ R E P O RT
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Operating expenses were $2.97 billion in 2004, 19% higher
than 2003, primarily due to increased compensation and bene-
fits expenses resulting from higher discretionary compensation
and increased levels of employment. These increases were par-
tially offset by lower occupancy expenses, primarily reflecting
lower exit costs associated with reductions in our global office
space, and reduced amortization of identifiable intangible
assets, as 2003 included impairment charges in respect of cer-
tain distribution rights. Depreciation and amortization expenses
were also lower. Pre-tax earnings of $401 million in 2004
increased 94% compared with 2003.
2 00 3฀ v er su s฀ 2 00 2฀– ฀Net revenues in Investment Banking of
$2.71 billion for 2003 decreased 4% compared with 2002. Net
revenues in Financial Advisory of $1.20 billion decreased 20%
compared with 2002, primarily reflecting a decline in industry-
wide completed mergers and acquisitions. Net revenues in our
Underwriting business of $1.51 billion increased 13% com-
pared with 2002, primarily reflecting an increase in industry-
wide debt new issuance activity. Equity Underwriting net
revenues decreased compared with 2002, primarily reflecting a
decline in industry-wide total equity underwriting volume,
including initial public offerings, partially offset by higher net
revenues from convertible issuances. The reduction in Investment
Banking net revenues reflects lower levels of activity in the
industrial and financial institutions sectors, partially offset by
increased activity in the healthcare and natural resources sec-
tors. Our investment banking backlog at the end of 2003 was
slightly higher than at the end of 2002.(1)
Operating expenses were $2.50 billion in 2003, 2% higher than
2002, primarily due to increased compensation and benefits
expenses, with higher discretionary compensation more than
offsetting the impact of lower levels of employment. The
increase in discretionary compensation in Investment Banking
reflected, among other factors, the overall performance of
Goldman Sachs, continued strong relative performance in the
business (as evidenced by our high rankings and market share),
as well as the somewhat improved business environment at the
end of 2003. Operating expenses also increased due to intangible
asset impairment charges in respect of certain distribution
rights, higher professional fees, reflecting increased legal fees,
and increased occupancy expenses, primarily related to exit
costs associated with reductions in our global office space.
These expense increases were partially offset by lower other
expenses, market development expenses and communications
and technology expenses, reflecting the impact of reduced
employment levels, lower levels of business activity and continued
cost-containment discipline. Pre-tax earnings of $207 million
in 2003 decreased 45% compared with 2002.
Trading฀and฀Principal฀Investments฀
Our Trading and Principal Investments segment is divided into
three components:
• ficc฀– ฀We make markets in and trade interest rate and
credit products, mortgage-backed securities and loans, cur-
rencies and commodities, structure and enter into a wide
variety of derivative transactions, and engage in
proprietary trading.
• equities ฀–฀We make markets in, act as a specialist for,
and trade equities and equity-related products, structure
and enter into equity derivative transactions, and engage in
proprietary trading. We also execute and clear customer
transactions on major stock, options and futures
exchanges worldwide.
• pri n cipa l฀ in v est m ent s ฀– ฀Principal Investments pri-
marily represents net revenues from our merchant banking
investments, including the increased share of the income
and gains derived from our merchant banking funds when
the return on a fund’s investments exceeds certain thresh-
old returns (merchant banking overrides), as well as unre-
alized gains or losses from our investment in the convertible
preferred stock of SMFG.
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 rev-
enues 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. We also regularly enter into large transactions as part of
our trading businesses. The number and size of such transac-
tions may affect our results of operations in a given period.
Net revenues from Principal Investments do not include man-
agement fees generated from our merchant banking funds.
These management fees are included in the net revenues of the
Asset Management and Securities Services segment.
(1)฀฀Our฀investment฀banking฀backlog฀represents฀an฀estimate฀of฀our฀future฀net฀rev-
enues฀from฀ investment฀ banking฀ transactions฀where฀ we฀ believe฀ that฀ future฀
revenue฀realization฀is฀more฀likely฀than฀not.฀