Report of the Treasurer to the Council for the Year Ended December 31, 2004 (2005)

To the Council of the National Academy of Sciences:

This report, “Treasurer’s Report to the Council of the National Academy of Sciences,” presents the financial position and results of operations as well as a review of the endowment and trust activities of our Academy for the year ended December 31, 2004.

In December 2004, the National Academies successfully completed our first joint fundraising campaign, Shaping the Future: Science, Engineering, and Medicine in Society. Targeted to achieve a $300 million goal, the campaign exceeded expectations with a final total of more than $332 million. More than $90 million of that represented direct contributions, pledges, estate-based gifts, and foundation grants to the NAS – exceeding our Academy-specific goal by $50 million.

Shaping the Future has helped to build recognition of the Academy’s role as leader of the scientific enterprise and to establish a “culture of philanthropy” among NAS members, who increasingly understand the value of philanthropic investment in the Academy and its programs. During the seven-year campaign, more than 1,000 members made gifts to the Academy, representing support from half the membership. And more than $6,000,000 was contributed through estate-based philanthropy. The most notable of member gifts received during the campaign was Dan Koshland’s contribution of $30 million to establish the Marian Koshland Science Museum – which opened in April 2004 and has been an extremely successful vehicle for communication with the public on science and science policy. The Academies also benefited from significant foundation support during the campaign, including gifts such as the $40 million grant from the W.M. Keck Foundation for the dynamic new Keck Futures Initiative; a $2.5 million gift, complemented by another $2.5 million in matching funds, from the W.K. Kellogg Foundation in support of the IOM Health of the Public Fund; and a $20 million pledge from the Bill and Melinda Gates Foundation for a capacity-building initiative in Africa (described below).

In 2004, the Academy received new gifts and pledges totaling $2,942,051. Notable among those were significant program support provided by Academy members P. Roy Vagelos, Richard Atkinson, and Philip Needleman, and a $250,000 annual fund pledge by the Gates Foundation. The 2004 total also included $362,644 contributed to the Annual Fund by 513 members – representing a 25 percent participation rate. Members’ unrestricted annual gifts provide support for continuing activities and give the Academy flexibility to respond to significant issues as they arise.

Members of the Presidents’ Circle – a philanthropic group primarily comprised of business and industry executives who take an active interest in science, engineering, and medicine – continued their tradition of philanthropic support for the National Academies. In 2004, they provided more than $3.7 million in gifts and pledges to support Academies’ efforts in science education reform, enhanced communication and outreach activities, and programs that encourage disadvantaged minority students to pursue careers in science, engineering, and medicine. Notable for their strong philanthropic support in 2004 were Circle members George P. Mitchell, Jack Anderson, Diane Bernstein, Jim Clark, Jerry Grossman, Bob James, and Burt McMurtry. During the course of the Shaping the Future campaign, Presidents’ Circle members contributed more than $30 million to the Academies.

The Academy continues to place an emphasis on work with the international science community, toward the goals of enhancing science capacity and increasing the opportunities for policymakers around the world to benefit from the evidence-based advice of their nations’ best scientists. A number of foundations have been supportive of these efforts. In the most notable example of 2004, the Gates Foundation formally awarded $20 million for a 10-year National Academies initiative – Enabling African Scientific Communities to Provide Policy Advice in the Public Interest – designed to build the capacity of African academies of science to increase the contribution of African scientists and health experts to policy decisions made by their governments, with an emphasis on sustainable choices for promoting health and reducing

disease. The Gates project is now in the early stages of implementation with the three initial partners selected – the science academies of Nigeria, Uganda, and South Africa. Strategic planning grants have also been awarded to the science academies of Cameroon, Senegal, Ghana, and Kenya; and the initiative will support meetings and symposia to promote collaboration and joint learning among sub-Saharan Africa’s science academies.

In addition, the John D. and Catherine T. MacArthur Foundation made a grant of $600,000 to help underwrite continuation of the important work of the Committee on International Security and Arms Control. And the Committee on Human Rights has benefited from new support from organizations such as the Alfred P. Sloan Foundation and the Ewing Marion Kauffman Foundation.

With the assistance of the Finance Committee (see Committee roster on page 51), I am responsible for the prudent management of the endowment and trust fund portfolio. The goal of the endowment is to provide stable support for the NAS General Fund, the NAS and IOM activities, and the Presidents’ initiatives within the NRC program. To achieve this goal, the NAS Council, acting on the recommendation of the Finance Committee, has adopted a spending limitation designed to maintain the purchasing power of the endowment over time by reinvesting a portion of the annual total investment return. The spending limitation caps annual spending at 5 percent of the three-year average market value of the participating funds in the investment pool.

Each year, the investment performance of the NAS portfolio is compared to a composite market benchmark portfolio for the year. The benchmark portfolio is a composite index consisting of the Standard and Poor’s 500 Index (35 percent), the Russell 2000 Index (15 percent), the EAFE Index (15 percent), the Emerging Markets Index (5 percent), the Lehman Aggregate (25 percent), and the Non U.S. dollar Fixed Income Index (5 percent), and was developed to reflect the asset allocation within the NAS portfolio.

Market values of the Endowment and Trust Investment Pool, after withdrawals, for the years ended December 31, 2004 and 2003, are displayed in the following chart:

At the beginning of 2004, the NAS endowment consisted of $267.8 million in assets. During the year, the Endowment received contributions of $30.1 million, had expenditures and transfers of $12.4 million, and received a total return on investments of $36.3 million, resulting in an ending asset balance of $321.9 million. For the year, the portfolio returned 14.0% versus 12.8% for the benchmark described above. During 2004, the portfolio’s slight overweight in equity was beneficial to the portfolio’s annual performance. The portfolio gained 9.2% during the fourth quarter, which accounts for most of its 14.0% gain for the year. By capturing most of the upside performance in the good years, and generating comparatively smaller losses in the down years, the portfolio has been able to outperform the market benchmark. For the last five years ending 12/31/04, the NAS return is 4.3%, compared to the market composite benchmark of 2.8% and for the last ten years ending 12/31/04, the NAS return is 10.1%, compared with the market composite benchmark of 9.6%.

The next chart presents the investment structure adopted by the NAS Finance Committee in 1995 for its asset allocation strategy and compares this target to the portfolio allocation at December 31, 2004.

• See Schedule 2-A on page 21 for details of investments by asset class.

• Included in the $321.9 million total market value of the Endowment and Trust Investment Pool as of December 31, 2004, are the amounts of $50.8 million, $21.8 million, and $6.8 million for the IOM, TNAC, and Woods Hole Endowment Funds, respectively. TNAC denotes The National Academies’ Corporation (Beckman Center), which is equally owned by the National Academy of Sciences and the National Academy of Engineering Fund (see note 1 to the Financial Statements).

• Withdrawals of $9.4 million were made to fund the President’s Committee, NAS General Fund’s activity, and prizes and awards for the current period. Additional withdrawals of $3.0 million were made to fund IOM, Woods Hole, and TNAC activity.

• Several award trust funds have existed for more than 100 years, while others were established more recently. The Home Secretary oversees the nomination process that selects award recipients and recommends to the Council (subject to legal and financial review) changes in the award cycle, amounts of the honoraria, and any other administrative changes.

The NAS General Fund accounts for the activities of the Council, the Officers, and the Members. The primary funding for these activities is received from the NAS Unrestricted Endowment, based on the 5% spending rule.

For fiscal year 2004, the General Fund revenue totaled $6.1 million and expenditures totaled $6.3 million, resulting in a $235,000 deficit. Comparable figures for CY03 were $6.1 million in revenues, $6.2 million in expenditures, with a deficit of $75,000.

The NAS Reserve is the accumulation of prior year surpluses, and one of the anticipated and appropriate uses of the NAS Reserve is to provide a cushion for ongoing operation during periods of revenue shortfalls. The $235,000 deficit was funded by the NAS Reserve, resulting in a balance of $1.4 million in the NAS Reserve at December 31, 2004.

The 2004 NAS General Fund activity is summarized as follows:

• Financial results of the Proceedings of the National Academy of Sciences are shown below for the years ended December 31, 2004, and December 31, 2003:

NAS owns the following facilities:

• The Keck Center of the National Academies at 500 Fifth St., NW in Washington, D.C.

• The National Academy of Sciences Building at 2101 Constitution Ave., NW in Washington, D.C.

• Jonsson Study Center at 314 Quisset Dr. in Woods Hole, Massachusetts.

• Arnold and Mabel Beckman Center at 100 Academy Drive in Irvine, California (jointly owned with the National Academy of Engineering through The National Academies Corporation).

NAS is leasing the following facilities:

• The Cecil and Ida Green Office Building at 2001 Wisconsin Ave. in Washington, D.C.

• National Academy Press Printing Facility at 8700 Spectrum Drive in Landover, Maryland.

During the past few years, the NAS Council has directed senior management to explore the facility options available to the Academy, so that when the Green Building lease expires in 2007, the staff currently there may be relocated to adequate office space. The options reviewed included (1) purchasing the air rights over the adjacent fire station and starting construction of an additional 3 to 8 floors of building space over the fire station, (2) purchasing the land under the fire station from the DC Government, and integrating the building of a new fire station with the building of an additional 3 to 8 floors of building space above the fire station, and (3) putting a hold on the construction decision, and seeking to lease space for the short term in a building close to the Keck Center.

In their December 2004 meeting, the Council reviewed the future prospects for NRC growth, the current status of federal funding, and the current staffing levels and concluded that it would not be in the best interests of the Academies to build additional space at this time. The Council approved moving staff now located in the Green Building to existing space in the Keck Center and NAS building and to a relatively small amount of rented space near the Keck Center when the lease on the Green Building expires in July 2007. The Council also approved the relocation of the data center to the Keck Center. Although the Council decided that an addition to the Keck Center will not be constructed at this time, options for future development will be kept open to the extent possible. The Council also approved the renovation of conference facilities in the NAS building and more frequent shuttle service between the NAS building and the Keck Center.

The two main sources of revenue for the NRC are the U.S. government and private / nonfederal entities. The total contract and grant revenue from both of these sources totaled $218.4 million in 2004 and $258.7 million in 2003.

NRC activities conducted in response to requests from a broad range of U.S. government agencies are funded through cost-reimbursable non-fee contracts and grants. The total amount reimbursed by the U.S. government agencies in the year ended December 31, 2004 was $176.4 million (see chart below and the Statement of Activities), and in the year ended December 31, 2003 was $184.5 million.

• In the past ten years, the basic core of NRC programs, which is represented by the Government contracts and grants, has experienced relatively small percentage changes from one year to the next. In the past two years, the NRC programs funded by the government decreased 4.4% and 1.5% for the year ended December 31, 2004 and December 31, 2003, respectively. Although this is a decrease, this change represents a relative stabilization in the revenues that increased in the years before 2003.

Private sponsors supplemented government projects and provided for new initiatives by funding $42.0 million of awards in 2004, compared with $74.2 million in 2003. The private and nonfederal revenues were received in the form of Contracts and Grants ($34.8M) and other contributions ($7.2M). (See Statement of Activities.)

• The private contracts and grants decreased from $68.1 million in 2003 to $34.8 million in 2004, primarily due to a $40 million grant from The W.M. Keck Foundation that was received and recorded as revenue in 2003. Not considering this contribution, there was an increase in other private contracts and grants from 2003 to 2004 due to a variety of contributions from various foundations as noted in the Development Office Programs section.

• The Other contributions revenue increased from $6.1 million in 2003 to $7.2 million in 2004.

• The NRC programs include funding from Government and private sources. Almost all contracts and grants are cost-reimbursable agreements. Therefore, even if the revenues and expenses are not equal in any one given year, the revenues and expenses will be the same over the life of the award.

• As in many universities and nonprofit institutions, managing indirect cost expenditures for funding of necessary support services while keeping these costs in reasonable proportion to program expenditures continues to be a challenge. Historically, NRC management has successfully maintained a relatively steady relationship between program and support costs, i.e., the growth rate of indirect costs was approximately equal to the growth rate of direct costs. In 2004, total indirect expenses were $61.6 million compared to an approved budget of $62.3 million. As the 2005 program revenues are expected to remain consistent with the prior year, the NAS Council authorized a 2005 indirect expense budget of $63.0 million in order to maintain the desired relationship between indirect and direct costs. This budget includes a 3.0 percent increase in the base salary compensation structure in order to maintain a

competitive position in the marketplace for hiring and retaining staff.

• There are many financial transactions exchanged between the member organizations of the National Academies. The NRC serves as the clearinghouse for these transactions. However, it is important to note that only the financial activity and results of the NAS, NRC, and IOM are included in these financial statements.

• The financial activity and results of the National Academy of Engineering, the National Academy of Engineering Fund, and the National Academies Corporation (Beckman Center) are audited and reported separately. Financial information for the NAE and the NAEF is available on request from the NAE Finance Office; information for the Beckman Center is available from the NAS Controller’s Office.

The results of operations, per the NAS Statement of Activities, are summarized as follows:

Each year, the overall financial condition of the NAS can be reviewed by taking into account the increase or decrease in the net assets of the organization. During 2003 and 2004, the NAS has been able to increase its net assets, due in large part to the favorable results from the Endowment investments and from generous gifts from donors.

The NAS and NRC continue to be in sound financial condition. The NRC program has been stable and indirect expenses are under control. With regard to the NAS, the balance sheet is strong, the endowment investment return of 14% has outperformed the benchmarks, there is a substantial balance in the NAS reserve, and the capital campaign was successful by all measures. As has been the case for a number of years, our internal and external auditing programs continue to disclose no material weaknesses.

Based on the foregoing, I conclude that NAS continues to have the financial resources, discipline, and understanding of its operating components to responsibly respond to the many opportunities and challenges presented by an ever-changing external environment.

Ronald L. Graham

Treasurer