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OCR for page 37
Report of the Treasurer to the Council of the National Academy of Sciences
III.
Financial Condition
OCR for page 38
Report of the Treasurer to the Council of the National Academy of Sciences
Report of the Auditing Committee of the National Academy of Sciences
June 2007
Dr. Ralph Cicerone,
President
National Academy of Sciences
Dear Dr. Cicerone:
In accordance with Bylaw V–6 of the National Academy of Sciences, the firm of KPMG, LLP was retained to conduct an audit of the accounts of the Treasurer for the year ended December 31, 2006, and to report to the Auditing Committee.
The independent accountants have completed their audit of the financial statements and have submitted their report, a copy of which is attached, concerning financial statements to which they refer. The Auditing Committee has reviewed the report and recommends its acceptance in compliance with the governing bylaw and that the opinion of the independent accountants be published with the report of the Treasurer.
Respectfully submitted,
JACK HALPERN,
Chair
JERRY P. GOLLUB
GERALD M. RUBIN
M. GORDON WOLMAN
PURNELL W. CHOPPIN
National Academy of Sciences
THE NATIONAL ACADEMIES
Advisers to the Nation on Science, Engineering, and Medicine
2101 Constitution Avenue, NW
Washington, DC 20418
OCR for page 39
Report of the Treasurer to the Council of the National Academy of Sciences
KPMG LLP
2001 M Street, NW Washington, DC 20036
Independent Auditors’ Report
The Auditing Committee
National Academy of Sciences:
We have audited the accompanying statements of financial position of the National Academy of Sciences (NAS) as of December 31, 2006 and 2005, and the related statements of activities and cash flows for the years then ended. These financial statements are the responsibility of NAS’ management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards 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 consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of NAS’ internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of NAS as of December 31, 2006 and 2005, and its changes in net assets and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.
June 4, 2007
KPMG LLP. KPMG LLP, a U.S. limited liability partnership, is a member of KPMG International, a Swiss cooperative.
OCR for page 40
Report of the Treasurer to the Council of the National Academy of Sciences
NATIONAL ACADEMY OF SCIENCES
Statements of Financial Position
December 31, 2006 and 2005
(Dollars in thousands)
Assets
2006
2005
Current assets:
Cash and cash equivalents
$
3,782
$
3,640
Short-term investments (note 3)
45,785
48,609
Contracts receivable – U.S. government (note 11)
41,304
45,474
Contributions and other receivables (note 5)
16,175
11,188
Publications and supplies inventories
1,387
1,683
Prepaid expenses and other current assets
3,092
3,364
Total current assets
111,525
113,958
Other assets (notes 12, 14, and 15)
11,883
10,499
Long-term investments (note 3)
429,321
373,827
Contributions receivable, net (note 5)
38,017
38,219
Property and equipment, net (note 4)
135,415
132,623
Einstein Memorial
1,723
1,723
$
727,884
$
670,849
Liabilities and Net Assets
Liabilities:
Current liabilities:
Accounts payable and accrued expenses
$
32,262
$
28,397
Deferred revenue (note 6)
27,646
19,995
Line of credit (note 7)
3,765
17,528
Other current liabilities (note 12)
9,985
11,014
Total current liabilities
73,658
76,934
Bonds payable (note 12)
122,709
124,282
Funds held on behalf of others (note 3)
23,014
22,584
Note payable (note 13)
3,027
10,000
Accrued employee benefits (note 14)
7,321
7,613
Other long-term liabilities (note 12)
1,858
3,257
Total liabilities
231,587
244,670
Net assets:
Unrestricted
180,569
129,498
Temporarily restricted (note 8)
206,438
190,844
Permanently restricted (note 9)
109,290
105,837
Total net assets
496,297
426,179
Commitments and contingencies (notes 3, 11, 12, 14, 16, and 17)
Total liabilities and net assets
$
727,884
$
670,849
See accompanying notes to financial statements.
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Report of the Treasurer to the Council of the National Academy of Sciences
NATIONAL ACADEMY OF SCIENCES
Statements of Activities
Years ended December 31, 2006 and 2005
(Dollars in thousands)
2006
2005
Unrestricted
Temporarily restricted
Permanently restricted
Totals
Unrestricted
Temporarily restricted
Permanently restricted
Totals
Revenues, gains, and other support:
Government contracts and grants (note 11)
$
178,926
-
-
178,926
$
179,871
-
-
179,871
Private contracts and grants
20,987
30,544
-
51,531
20,421
24,175
-
44,596
Other contributions
3,898
122
3,453
7,473
3,315
419
8,210
11,944
Fees and publications
19,832
-
-
19,832
18,975
-
-
18,975
Investment income, net (note 3)
34,795
33,619
-
68,414
18,066
17,441
-
35,507
Other income (note 12)
9,311
-
-
9,311
11,959
-
-
11,959
Net assets released from restriction (note 8)
48,691
(48,691)
-
-
22,465
(22,465)
-
-
Total revenues, gains, and other support
316,440
15,594
3,453
335,487
275,072
19,570
8,210
302,852
Expenses (notes 12,14, and 15):
Programs (note 10)
221,656
-
-
221,656
223,531
-
-
223,531
Management and general
41,154
-
-
41,154
40,211
-
-
40,211
Fundraising
2,559
-
-
2,559
2,329
-
-
2,329
Total expenses
265,369
-
-
265,369
266,071
-
-
266,071
Change in net assets
51,071
15,594
3,453
70,118
9,001
19,570
8,210
36,781
Net assets at beginning of the year
129,498
190,844
105,837
426,179
120,497
171,274
97,627
389,398
Net assets at end of the year
$
180,569
206,438
109,290
496,297
$
129,498
190,844
105,837
426,179
See accompanying notes to financial statements.
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Report of the Treasurer to the Council of the National Academy of Sciences
NATIONAL ACADEMY OF SCIENCES
Statements of Cash Flows
Years ended December 31, 2006 and 2005
(Dollars in thousands)
2006
2005
Cash flows from operating activities:
Change in net assets
$
70,118
$
36,781
Adjustments to reconcile change in net assets to net cash provided by operating activities:
Depreciation and amortization
6,660
6,719
Loss on disposal of property and equipment
123
21
Gain on sale of property and equipment
-
(1,911)
Bad debt expense
161
66
Net gain on investments
(48,925)
(20,844)
Net gain on investments held on behalf of others
(430)
(791)
Amortization of deferred gain
(738)
(746)
Gain on interest rate swap
(708)
(650)
Contributions restricted for construction or endowment
(3,635)
(3,922)
(Increase) decrease in assets:
Other receivables
(4,947)
(2,601)
Contracts receivable — U.S. government
4,169
1,225
Publications and supplies inventories
296
4
Prepaid expenses and other current assets
272
(78)
Other assets
(675)
(2,207)
Increase (decrease) in liabilities:
Accounts payable and accrued expenses
3,865
(1,145)
Deferred revenue
7,651
(1,303)
Other current liabilities
739
17
Funds held on behalf of others
430
791
Accrued lease liability and deferred gain
(661)
(9)
Accrued employee benefits
(292)
(3,489)
Net cash provided by operating activities
33,473
5,928
Cash flows from investing activities:
Additions to property and equipment
(9,582)
(1,410)
Proceeds from sale of property and equipment
-
2,000
Sales or maturities of investments
255,416
185,701
Purchases of investments
(258,730)
(192,792)
Net cash used in investing activities
(12,896)
(6,501)
Cash flows from financing activities:
Contributions restricted for construction or endowment
3,635
3,922
Proceeds from line of credit
109,793
128,399
Payments on line of credit
(123,556)
(125,662)
Proceeds from bank note
3,027
-
Payments on bank note
(10,000)
-
Payments on bond principal
(1,505)
(1,445)
Payments on capital lease liability
(1,829)
(4,436)
Net cash provided by financing activities
(20,435)
778
Net increase (decrease) in cash and cash equivalents
142
205
Cash and cash equivalents, beginning of year
3,640
3,435
Cash and cash equivalents, end of year
$
3,782
$
3,640
Supplemental disclosure of cash flow information:
Interest paid
$
6,019
$
5,772
See accompanying notes to financial statements.
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Report of the Treasurer to the Council of the National Academy of Sciences
NATIONAL ACADEMY OF SCIENCES
Notes to Financial Statements
December 31, 2006 and 2005
(1)
ORGANIZATION AND RELATED ENTITIES
(a)
National Academy of Sciences
The National Academy of Sciences (NAS) was formed under a charter that was passed as an Act of Incorporation by the United States Congress and signed into law on March 3, 1863. NAS operates as a private cooperative society of distinguished scholars engaged in scientific or engineering research, dedicated to the furtherance of science and its use for the general welfare. NAS is exempt from federal income taxes under Section 501(c)(3) of the Internal Revenue Code, except for unrelated business income.
(b)
National Research Council
Most of the activities undertaken by NAS are carried out through the divisions and boards of the National Research Council (NRC), which draw on a wide cross section of the nation’s leading scientists and engineers for advisory services to government agencies and Congress. To respond effectively to both the disciplinary concerns of the research community and the complex interdisciplinary problems facing American society, NRC is organized into the following five major units responsible for most study activities:
Division of Behavioral and Social Sciences and Education
Division on Earth and Life Studies
Division on Engineering and Physical Sciences
Policy and Global Affairs Division
Transportation Research Board
NRC activities are under the control of the NAS governance structure, and therefore are included in the NAS financial statements.
(c)
Institute of Medicine
The Institute of Medicine (IOM), established in 1970, conducts studies of policy issues related to health and medicine. IOM issues position statements on these policies, cooperates with the major scientific and professional societies in the field, identifies qualified individuals to serve on study groups in other organizational units, and disseminates information to the public and the relevant professions. IOM was established as a separate membership organization within NAS. The financial activities and results of IOM are included in the NAS financial statements.
(d)
National Academy of Engineering
The National Academy of Engineering (NAE) was established in 1964 under the charter of NAS as a related parallel organization, autonomous in its governance, administration, and the selection of its members. NAE shares with NAS the responsibility for advising the federal government on scientific issues. The NAE conducts both independent program activities and activities through the NRC. The results of these activities are included in the NAS financial statements.
(e)
National Academy of Engineering Fund
The National Academy of Engineering Fund (NAEF) is a separately incorporated not-for-profit organization established and controlled by NAE to raise funds to support its goals. The financial activities and results of NAEF are not included in the NAS financial statements.
(f)
The National Academies’ Corporation
The National Academies’ Corporation (TNAC) was separately incorporated in 1986 as a not-for-profit corporation for the purpose of constructing and maintaining a study and conference facility. This facility, the Arnold and Mabel Beckman Center, located in Irvine, California, operates to expand and support the general activities of NAS, NRC, IOM, and NAE. NAS and NAEF are 50 – 50 joint venturers of TNAC, and therefore share control. The financial position and results of TNAC are not consolidated in the NAS financial statements. NAS utilized the Beckman Center for meetings in 2006 and 2005, for which NAS paid $286,000 and $275,000, respectively.
(2)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a)
Basis of Accounting
Net assets, revenues, gains, and losses are classified based on the existence or absence of donor-imposed restrictions. Accordingly, net assets of NAS are classified and reported as follows:
Permanently restricted – Net assets subject to donor-imposed stipulations that they be maintained in perpetuity by NAS. Generally, the donors of these assets permit NAS to use all or part of the income earned on related investments for general or specific purposes.
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Report of the Treasurer to the Council of the National Academy of Sciences
Temporarily restricted – Net assets subject to donor-imposed stipulations that may or will be met either by actions of NAS and/or the passage of time. When a donor restriction expires, temporarily restricted net assets are reclassified to unrestricted net assets.
Unrestricted – Net assets arising from exchange transactions and contributions not subject to donor imposed stipulations.
(b)
Cash Equivalents
NAS reports liquid, temporary investments purchased with original maturities of three months or less as cash equivalents.
(c)
Investments
Investments are stated at fair value. The fair value of all debt and equity securities with a readily determinable fair value are based on quotations obtained from national security exchanges. Alternative investments, consisting of hedge funds and private placement equities, which are not readily marketable, are carried at estimated fair values as provided by the investment managers. Management reviews and evaluates the values provided by the investment managers and agrees with the valuation methods and assumptions used in determining the fair value of the alternative investments.
Investments in real estate mortgages are recorded at cost, which approximates fair value, and consist of mortgages on certain administrative facilities that NAS occupies.
Changes in the fair value of investments are reported within investment income in the statements of activities.
Certain investments are pooled for long-term investment purposes. Investments in the pool are administered as an open-end investment trust, with shares of the pool funds expressed in terms of participating capital units (PCUs). PCU values are used to determine equity in the allocation of investment income among funds in the pool whenever additional funds are contributed or withdrawn.
(d)
Contributions
Contributions, including unconditional promises to give, are recognized as revenues in the period received. Conditional promises to give are not recognized until all conditions on which receipt depends are substantially met.
Gifts of land, buildings, or equipment are reported as unrestricted net assets unless explicit donor stipulations specify how the donated assets must be used. Temporary restrictions on gifts that must be used to acquire long-lived assets are released in the period in which the assets are acquired or placed in service.
Allowances are recorded for estimated uncollectible contributions based upon management’s judgment and analysis of the credit worthiness of the donor, past collection experience, and other relevant factors. Contributions to be received after one year are discounted at an appropriate rate commensurate with risks involved. Amortization of the discount is recorded as additional revenue and is used in accordance with donor imposed restrictions, if any, on the contributions.
NAS performs certain fundraising activities on behalf of NAEF. NAS collected a total of $4.0 million and $3.7 million in 2006 and 2005, respectively, on behalf of NAEF. NAS disbursed $3.9 million and $3.4 million to NAEF from these collected amounts in 2006 and 2005, respectively. Amounts collected but not yet remitted to NAEF are reported as assets and liabilities in the NAS financial statements.
(e)
Contracts and Grants
The majority of NAS activities are performed under cost-reimbursable contracts with the U.S. government. Federal sponsors individually providing more than 10% of NAS revenues are summarized below:
Federal agency sponsor
Percentage of NAS revenues
2006
2005
Department of Transportation
31%
26%
Department of Health and Human Services
11%
13%
National Aeronautics and Space Administration
5%
11%
NAS records federal contracts as exchange transactions, recognizing revenue as recoverable costs are incurred.
Revenues from nonfederal grants qualifying as contributions are recorded by NAS upon notification of the grant award. Such grants are classified as temporarily restricted net assets when use of the grant funds are limited to specific areas of study or to be used in future periods.
(f)
Deferred Revenue
For both federal and nonfederal grants and contracts that are determined to be exchange transactions, revenue is recognized as the related costs are incurred. Funds received in advance of being earned for these grants are recorded as deferred revenue in the statements of financial position.
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Report of the Treasurer to the Council of the National Academy of Sciences
(g)
Fair Value of Financial Instruments
The carrying value of bonds payable in the financial statements was less than their fair value by approximately $3.2 million and $3.4 million on December 31, 2006 and 2005, respectively.
NAS makes limited use of derivative financial instruments for the purpose of managing interest rate risks. Current market pricing models are used to estimate fair values of interest rate swap agreements. The fair market value of all other financial instruments in the financial statements approximates their reported carrying values.
(h)
Inventories
Inventories are stated at the lower of cost or net realizable value and include both work-in-process and finished goods related to publication activities. The majority of NAS publication inventories and supplies reside with an NAS unit, the National Academy Press (NAP). NAP uses the full absorption costing methodology in pricing finished products. This methodology includes direct printing and related indirect costs.
(i)
Property and Equipment
Depreciation of NAS buildings and equipment is computed on a straight-line basis using the following lives:
Buildings – 40 to 50 years
Building and leasehold improvements – lesser of the remaining life of the building or improvement
Furniture and equipment – 4 to 10 years
The Einstein Memorial sculpture is valued at cost and is not depreciated. Construction-in-progress is not depreciated until the related assets are placed in service.
(j)
Use of Estimates
The preparation of these financial statements in conformity with U.S. generally accepted accounting principles requires management to make certain estimates and assumptions. These estimates and assumptions may affect the reported amounts of assets and liabilities and disclosures in the financial statements. Actual results could differ from those estimates.
(k)
Reclassifications
Certain amounts from the prior year have been reclassified to conform to the current year presentation.
(3)
INVESTMENTS
Investments, which are reported at fair value (except as noted), consisted of the following as of December 31, 2006 and 2005 (dollars in thousands):
2006
2005
Short-term investments:
Cash equivalents
$
7,640
$
8,972
Bonds and notes
23,540
21,715
Equity securities
14,605
17,922
Total short-term investments
$
45,785
$
48,609
Long-term investments:
Pooled endowment and trust investments:
Cash equivalents
$
19,519
$
20,841
Bonds and notes
32,772
32,902
Equity securities
252,744
227,898
Real estate
17,726
16,308
Hedge funds
69,197
42,066
Private placements
13,598
11,546
405,556
351,561
Other long-term investments:
Cash equivalents
819
2,717
Bonds and notes
8,369
10,100
Equity securities
14,577
9,449
23,765
22,266
Total long-term investments
$
429,321
$
373,827
NAS received proceeds from the sale and leaseback of the Green/Harris facility of approximately $36 million in 2000 (see note 12). Remaining proceeds were invested within other long-term investments, and are available for future payments toward related obligations to the former landlord. In 2006 and 2005, NAS made lease payments of approximately $2.4 million and $2.3 million, respectively.
Vanguard equity funds comprised approximately $142 million and $125 million of the total equity securities funds at December 31, 2006 and 2005, respectively.
At December 31, 2006 and 2005, real estate investments include real estate mortgages at cost and shares of real estate investment trusts at fair value.
NAS invests a portion of its endowment in hedge funds. The unrealized gain on these funds, which is included as a component of investment income in the accompanying statements of activities, was approximately $5.5 million and $4.6 million for the years ended December 31, 2006 and 2005, respectively.
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Report of the Treasurer to the Council of the National Academy of Sciences
Private equity investments are comprised of limited partnership interests. NAS had remaining commitments at December 31, 2006 and 2005 to provide approximately $4.1 million and $5.7 million, respectively, to these partnerships.
As of December 31, 2006 and 2005, respectively, NAS held alternative investments with fair values of approximately $82.8 million and $53.6 million. These fair values were estimated by the general partners of these investment funds in the absence of readily ascertainable values at those dates.
TNAC, a related entity, invests certain of its assets in the NAS long-term investment pool. TNAC investments participate in the investment pool experience proportionally with all other funds in this pool. The NAS obligation to TNAC for these funds held in trust, which totaled approximately $23 million as of both December 31, 2006 and 2005, is reported as funds held on behalf of others in the statements of financial position.
Investment income is reported net of investment expenses of approximately $472,000 and $569,000 for the years ended December 31, 2006 and 2005, respectively, and is comprised of the following (dollars in thousands):
2006
2005
Interest and dividends income
$ 19,489
$ 14,663
Net gain on investments
48,925
20,844
Total investment income, net
$ 68,414
$ 35,507
(4)
PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 2006 and 2005, were as follows (dollars in thousands):
2006
2005
Land
$
29,689
$
29,689
Furniture and equipment
31,040
30,285
Buildings and improvements
108,608
108,285
Construction in progress
776
170
Leasehold improvements
6,960
6,894
177,073
175,323
Less accumulated depreciation and amortization
(41,658)
(42,700)
Total property and equipment, net
$
135,415
$
132,623
(5)
CONTRIBUTIONS RECEIVABLE
Contributions not yet collected are included in contributions and other receivables (current) and contributions receivable (long term) in the statements of financial position, and mature as follows (dollars in thousands):
Years ending December 31
2007
$
11,119
2008
4,500
2009
3,355
2010
3,271
2011
11,628
Thereafter
22,045
55,918
Less discount at rates from 3% to 5% to estimate net present value
(6,782)
Less allowance for uncollectible contributions
(108)
49,028
Less current portion
(11,011)
Total contributions receivable, long-term
$
38,017
At December 31, 2005, the discount on contributions receivable was $7.7 million at rates ranging from 3% to 5%. The allowance for uncollectible contributions was $47,000 at December 31, 2005.
(6)
DEFERRED REVENUE
Deferred revenue consisted of the following as of December 31, 2006 and 2005 (dollars in thousands):
2006
2005
Advances from private grants and contract sponsors
$21,383
$13,844
Advances from U.S. government sponsors
2,604
3,207
Publication subscriptions and other
3,659
2,944
Total deferred revenue
$27,646
$19,995
(7)
LINE OF CREDIT
NAS is party to a $22 million unsecured line of credit from Bank of America which bears interest at LIBOR plus 0.40% and expires on July 31, 2007. Interest expense related to the line of credit for the years ended December 31, 2006 and 2005, was approximately $445,000 and $343,000, respectively.
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Report of the Treasurer to the Council of the National Academy of Sciences
(8)
TEMPORARILY RESTRICTED NET ASSETS
Temporarily restricted net assets were available for the following purposes as of December 31, 2006 and 2005 (dollars in thousands):
2006
2005
Sponsored research and advisory programs
$174,650
$164,170
Prizes and awards
27,243
22,838
Woods Hole facility
4,545
3,836
Total temporarily restricted net assets
$206,438
$190,844
Temporarily restricted net assets were released from restriction for the following purposes during the years ended December 31, 2006 and 2005 (dollars in thousands):
2006
2005
Sponsored research and advisory programs
$47,352
$21,031
Prizes and awards
759
1,169
Woods Hole facility
580
265
Total temporarily restricted net assets released from restriction
$48,691
$22,465
(9)
PERMANENTLY RESTRICTED NET ASSETS
The income generated by permanently restricted net assets is available to support donor-specified programs. As of December 31, 2006 and 2005, NAS held the following permanently restricted net assets, classified by the purpose for which the income is to be used (dollars in thousands):
2006
2005
Sponsored research and advisory programs
$104,177
$100,725
Prizes and awards
5,113
5,112
Total permanently restricted net assets
$109,290
$105,837
(10)
PROGRAM EXPENSES
Program expenses for the years ended December 31, 2006 and 2005 are summarized as follows (dollars in thousands):
2006
2005
Transportation Research Board
$
59,045
$
54,873
Policy and Global Affairs
53,625
64,784
Institute of Medicine
23,626
23,640
Earth and Life Sciences
20,247
19,588
Engineering and Physical Sciences
17,318
18,048
Behavioral and Social Sciences and Education
15,876
11,119
Proceedings of the National Academy of Sciences
11,627
11,117
National Academy Press
6,533
6,817
National Academy of Engineering
6,240
6,240
Koshland Science Museum
1,614
1,579
NAS and National Sciences Resource Center
5,905
5,726
Total program expenses
$221,656
$223,531
(11)
RECOVERY OF INDIRECT COSTS
NAS receives indirect cost recovery on its federal contracts and grants. An overhead assessment is applied to direct salaries, accrued leave, fringe benefits, and services provided by outside contractors (e.g., temporary personnel agencies, consultants) on NAS property. A general and administrative assessment (G&A) is applied to direct costs and overhead less subcontract costs and stipends. Therefore, both the overhead and G&A rates are applied to projects incurring direct salaries and other direct costs such as travel. If a program does not require direct salaries, such as a travel grant program, a subcontract/flow-through administration rate is applied. Certain off-site work (not performed on NAS property) is assessed reduced overhead rates.
NAS bills for indirect cost recovery throughout the year based on negotiated rates. At the end of each year, NAS compares actual expenses incurred in each of its cost pools to the amounts recovered based on its billing rates. The difference is recorded as its indirect cost carryforward. If NAS overrecovers on its indirect costs during the year, a liability is recorded. If NAS underrecovers, a receivable is recorded.
NAS has a cumulative net underrecovery of approximately $2.4 million and $4.3 million as of December 31, 2006 and 2005, respectively, which is included in the contracts receivable balance in the statements of financial position.
(12)
BUILDING PROJECT AND FINANCING
(a)
Building Project Revenue Bonds
In January 1999, the District of Columbia issued $130,960,000 of tax-exempt revenue bonds on behalf of NAS. Proceeds from the sale of the revenue bonds financed the cost of the acquisition of 44,250 square feet of land and related construction of an office building, as
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Report of the Treasurer to the Council of the National Academy of Sciences
well as paid certain costs of issuing the bonds. This building consolidates most of NAS’ program activities into one location. The facility was occupied in July 2002.
NAS is obligated under the revenue bonds as follows (dollars in thousands):
2006
2005
Series 1999A revenue bonds, serial, with interest rates ranging from 4.1% to 5% maturing at various dates from January 1, 2007 through 2012
$
10,650
$
12,155
Series 1999A revenue bonds, term Interest rate 5%, due January 1, 2019
17,085
17,085
Interest rate 5%, due January 1, 2028
32,545
32,545
Series 1999B revenue bonds, term, at flexible rates (3.37% in 2006 and 2.59% in 2005) due January 1, 2039
32,500
32,500
Series 1999C revenue bonds, term, at variable rates (3.52% in 2006 and 2.21% in 2005) due January 1, 2039
32,500
32,500
Total bonds, at face value
125,280
126,785
Less unamortized discount and premium
(1,006)
(998)
Total bonds payable
124,274
125,787
Less current portion (included in other current liabilities)
(1,565)
(1,505)
Bonds payable, long-term
$
122,709
$
124,282
The serial and term bonds represent unsecured general obligations of NAS.
Interest on all Series 1999A revenue bonds is payable semiannually every January 1 and July 1. Interest on the 1999B and 1999C bonds is payable monthly.
The term bonds maturing on January 1, 2019, and January 1, 2028, are subject to mandatory redemption by operation of sinking fund installments. The installment payments for the term bonds maturing January 1, 2019, begin on January 1, 2013, and range from $2.1 to $2.8 million per year through the maturity date. Installment payments for the term bond maturing January 1, 2028, begin on January 1, 2020, and range from $2.9 to $4.3 million per year through the maturity date.
Scheduled maturities and sinking fund requirements are as follows (dollars in thousands):
Years ending December 31:
2007
$
1,565
2008
1,645
2009
1,725
2010
1,810
2011
1,905
Thereafter
116,630
$
125,280
Interest expense on the bonds payable for 2006 and 2005 totaled $5.2 million and $4.6 million, respectively.
(b)
Interest Rate Swaps
In October 1999, NAS entered into a swap agreement, with an effective date of February 1, 2000. This swap agreement related to the $66 million face amount of its Series 1999A revenue bonds. The agreement provides for NAS to receive 4.97% in interest on a notional amount of $65 million and to pay interest at a floating rate option based on the weekly interest rate resets of tax exempt variable-rate issues per the BMA Municipal Swap Index.
NAS entered into this swap agreement to manage its exposure to interest rate changes. The fixed-rate debt obligations expose NAS to variability in the cost recovery stream due to changes in interest rates. NAS recovers the costs of borrowing through a capital investment incentive rate that is set by the U.S. government and is tied to a variable index. If interest rates increase, the capital investment incentive recovery increases.
Conversely, if interest rates decrease, the capital investment incentive recovery decreases. Therefore, NAS entered into a derivative instrument that ties the fixed-rate debt to a variable index to manage fluctuations in cash flows resulting from interest rate risk. By using derivative financial instruments to hedge exposures to changes in interest rates, NAS exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes NAS, which creates credit risk for NAS. When the fair value of a derivative contract is negative, NAS owes the counterparty, and therefore, it does not possess credit risk. NAS minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties.
In January 2001, NAS amended the October 1999 agreement by assuming responsibility for the fixed rate payments for the period 2001-2003 in exchange for an immediate cash payment of $2,435,000. Beginning January 1, 2004, the variable rate swap transaction becomes effective again with 16 years remaining under the agreement.
In October 2001, NAS further amended the agreement for the 2004-2020 period by agreeing to give up the benefit of any 30-day period during which the BMA index remains below 2.25% for the entire 30 days. Each time this occurs, the rate on the swap portfolio reverts to the fixed rate noted above for that month only. In January 2004, NAS further amended the swap agreement to delay the implementation of the 2.25% floor agreement until February 2005.
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In accordance with Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities, for the year ended December 31, 2006 and 2005, NAS recorded a gain on the change in the fair value of its derivative instruments in the amount of approximately $708,000 and $650,000 respectively, which is included in other income in the accompanying statements of activities. The fair value of the interest rate swap was $1.9 million and $1.1 million as of December 31, 2006 and 2005, respectively, and is included in other assets on the statements of financial position.
(c)
Sale-Leaseback of Green/Harris Facility
In 1999, under a separate trust agreement, the Trustee, an unrelated third party, held record legal title to the Green/Harris facility that was under lease by NAS for a portion of its operations. This trust agreement would have conveyed title to NAS in 2007. In 2000, NAS entered into a contract with a third party to sell its future interest in the property for approximately $36 million. NAS simultaneously agreed to lease back the entire facility until 2002 (at a monthly rate of $400,000) and a portion of the facility until 2007 (at a monthly rate of $200,000). These amounts are included in future minimum rental payments summarized in note 16.
The sale-leaseback transaction resulted in a gain of $6.8 million, of which $430,000 and $1.2 million were deferred at December 31, 2006 and 2005, respectively. The deferred gain will be fully recognized by 2007. The deferred gain is reported within other current liabilities in the statements of financial position.
Under the original lease agreement with the Trustee, NAS remains obligated through 2007 for remaining lease payments, which have a present value of approximately $2.8 million and $7.5 million as of December 31, 2006 and 2005, respectively. This obligation is included within other current liabilities in the statements of financial position.
(13)
NOTE PAYABLE
At December 31, 2005, NAS had a loan agreement of $10 million with Bank of America, with a maturity date of July 31, 2010. Interest on the note was calculated at 30-day LIBOR plus 50 basis points and was payable monthly. The interest rate at December 31, 2005 was 4.84%. In July 2006, NAS chose to repay this loan in full.
During 2006, NAS entered into a loan agreement with Bank of America for an amount up to $5 million. The principal balance of this note on December 31, 2006 is payable in equal monthly installments until January 1, 2012. On December 31, 2006, the principal balance was approximately $3.8 million. The note bears interest at 30-day LIBOR plus 40 basis points. The interest rate at December 31, 2006 was 5.75%.
(14)
EMPLOYEE BENEFITS
(a)
Retirement Plans
NAS has a noncontributory defined contribution retirement plan covering substantially all of its employees (based on certain benefit eligibility requirements). The plan is intended to qualify under Section 401(a) of the Internal Revenue Code and uses Teachers Insurance and Annuity Association/College Retirement Equities Fund (TIAA/CREF) group retirement annuity contracts as the investment vehicle. Participants in this plan vest immediately. NAS has received a favorable determination letter from the IRS on the qualification of this plan under Section 401(a) of the Internal Revenue Code.
In addition, NAS has a voluntary employee contribution retirement plan that is funded solely by employee contributions made on a pretax salary-reduction basis under Section 403(b) of the Internal Revenue Code. The investment vehicles under this voluntary plan are retirement annuity contracts issued by TIAA/CREF and mutual funds offered by the Vanguard Group, Inc.
Pension expense for the years ended December 31, 2006 and 2005, amounted to approximately $9.4 and $9.1 million, respectively. The NAS policy is to fund pension benefits as they are earned. The NAS normal retirement age is 60, but there is no mandatory age for retirement.
(b)
Deferred Compensation
NAS holds long-term investments as part of a deferred compensation arrangement for certain employees. The fair value of these investments was approximately $4.6 million as of both December 31, 2006 and 2005, which is reported within other assets in the statements of financial position. The related obligation is included in accrued employee benefits in the statements of financial position.
(c)
Postretirement and Postemployment Benefits
NAS provides certain health and life insurance benefits for employees retired due to length of service. All benefit-eligible employees may become eligible for service retiree benefits if they reach age 60 while working for NAS and complete 5 years of service in a benefit-eligible status for medical and life benefits. In addition, certain health and life insurance benefits are provided for employees retired due to disability. A benefit-eligible employee may become eligible for disabled retiree benefits if deemed totally disabled under NAS’ disability
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insurance or if they are eligible for disability benefits from the Social Security Administration. Life insurance benefits are provided based on coverage at date of disability and health insurance may be continued if the disabled retiree had participated in an NAS health insurance plan for 5 years at the date of disability. Insurance companies whose premiums are determined on an experience-rated basis provide life and health insurance benefits for retirees. Medicare supplement insurance is not experience rated. The retiree welfare plan is contributory for health insurance purposes for employees who retire after January 1, 1990. Participant contributions for health insurance are based on a percentage of the monthly premium paid by NAS (from 25% to 100%). The participant contribution is also based on their date of retirement, length of service and choice of health insurance carrier.
NAS has elected to recognize the initial postretirement benefit obligation over a period of 20 years. The accrued postretirement benefit obligation is reported in accrued employee benefits on the statements of financial position.
Effective January 1, 2007, NAS increased the life insurance benefit from $3,000 to $10,000. This change is shown as a plan amendment in the change in benefit obligation.
In 2006, the Financial Accounting Standards Board issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, which is effective for NAS for the year ended December 31, 2007. This statement requires that an employer recognize the funded status of its benefit plans in its statement of financial position and report the corresponding gains and losses in its statement of activities.
The following table presents the changes in benefit obligations, changes in plan assets, funded status, and the components of net periodic benefit cost for the years ended December 31, 2006 and 2005 (dollars in thousands):
2006
2005
Life insurance benefits
Health benefits
Total
Life insurance benefits
Health benefits
Total
Change in benefits obligations:
Benefit obligation, January 1
$
811
$
13,719
$
14,530
$
814
$
15,379
$
16,193
Service cost
14
664
678
13
671
684
Interest cost
45
772
817
45
864
909
Plan participant contributions
-
(104)
(104)
-
(130)
(130)
Plan amendments
1,781
-
1,781
-
-
-
Actuarial gain
(79)
(524)
(603)
(56)
(2,368)
(2,424)
Benefits paid
(6)
(568)
(574)
(5)
(697)
(702)
Benefits obligation, December 31
$
2,566
$
13,959
$
16,525
$
811
$
13,719
$
14,530
Change in plan assets, combined:
Fair value of plan assets, January 1
$
-
$
9,695
$
9,695
$
-
$
5,430
$
5,430
Actual return on plan assets
-
1,542
1,542
-
314
314
Employer contributions
-
1,153
1,153
5
4,523
4,528
Plan participants contributions
-
104
104
-
125
125
Benefits paid
-
(574)
(574)
(5)
(697)
(702)
Fair value of plan assets, December 31
$
-
$
11,920
$
11,920
$
-
$
9,695
$
9,695
Funded status:
Unfunded benefit obligation
$
(2,566)
$
(2,039)
$
(4,605)
$
(811)
$
(4,024)
$
(4,835)
Unrecognized transition obligation
193
-
193
218
-
218
Unrecognized prior service cost
1,903
(131)
1,772
140
(150)
(10)
Unrecognized net actuarial (gain) loss
(275)
198
(77)
(203)
1,782
1,579
Accrued benefit cost
$
(745)
$
(1,972)
$
(2,717)
$
(656)
$
(2,392)
$
(3,048)
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Report of the Treasurer to the Council of the National Academy of Sciences
2006
2005
Life insurance benefits
Health benefits
Total
Life insurance benefits
Health benefits
Total
Components of net periodic benefit cost:
Service cost
$
14
$
664
$
678
$
13
$
671
$
684
Interest cost
45
772
817
45
864
909
Expected return on plan assets
-
(728)
(728)
-
(435)
(435)
Amortization of transition obligation
25
-
25
26
-
26
Amortization of prior service cost
18
(19)
(1)
18
(19)
(1)
Amortization of unrecognized (gains) losses
(13)
44
31
(7)
312
305
Net periodic cost
$
89
$
733
$
822
$
95
$
1,393
$
1,488
The assumptions used to determine net periodic benefit cost for years ended December 31, 2006 and 2005 are as follows:
2006
2005
Discount rate
5.75%
5.75%
Expected long-term return on plan assets
7.5%
8.0%
The assumptions used to calculate the accumulated postretirement benefit obligation for the years ended December 31, 2006 and 2005 are as follows:
2006
2005
Discount rate
5.75%
5.75%
NAS postretirement benefit plan asset allocations at December 31, 2006 and 2005, by asset category are as follows:
2006
2005
Cash
5%
31%
Bonds and notes
25%
15%
Equity securities
70%
54%
100%
100%
The investment objective of the Plan is to produce a rate of return over the long term that will provide for some fund growth, curb against the effect of inflation, and provide for some stability in different market environments. The fund is diversified between fixed income and equity investments. With this diversification and investment in broader market funds, there is reasonable assurance that no single security or class of securities will have a disproportionate impact on the Plan assets. Equity securities are targeted at 60% and bonds and notes at 40%. A large cash transfer was made at the end of 2005 that was not invested as of December 31, 2005.
The overall long-term rate of return was developed by estimating the long-term real rate of return for the Plan’s asset mix, while taking into account the effects of inflation. This estimate was developed by evaluating the history and similar asset allocation of the NAS Endowment.
NAS expects to contribute to the Plan the actuarially determined net periodic cost for 2007, which is $923,000.
The following benefit payments, which reflect future services, are expected to be paid, as of December 31, 2006 (dollars in thousands):
Years ending December 31:
2007
$
787
2008
889
2009
1,000
2010
1,052
2011
1,128
2012-2016
6,401
$
11,257
The measurement date of the plan assets and benefit obligations for 2006 and 2005 is December 31, 2006 and 2005, respectively.
The trend rate for growth in healthcare costs used in calculating the accumulated postretirement benefit obligation was 9.5% and 9.6% during the years ended December 31, 2006 and 2005, respectively, declining gradually to 5% in the year 2018. The healthcare cost trend rate assumption has a significant impact on the postretirement benefit costs and obligations. The effect of a 1% change in the assumed healthcare cost trend rate at December 31, 2006, would have resulted in an estimated $1.6 million increase or $1.4 million decrease in the postretirement benefit obligation and an estimated
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Report of the Treasurer to the Council of the National Academy of Sciences
$211,000 increase or $174,000 decrease in the 2006 benefit expense.
The effect of a 1% change in the assumed healthcare cost trend rate at December 31, 2005, would have resulted in an estimated $1.6 million increase or $1.4 million decrease in the postretirement benefit obligation and an estimated $223,000 increase or $184,000 decrease in the 2005 benefit expense.
(15)
RELATED PARTY TRANSACTIONS
The NAS Council authorized a non-interest bearing, collateralized advance to an employee in connection with the purchase of the employee’s residence. In May 2005, the agreement between the parties was executed. It provides that the repayment obligation will be adjusted to allocate to each party its proportional share of the appreciation or depreciation in the value of the residence, which is based on the relative financing percentage provided by each party. The agreement will terminate upon pay-back of the advance, sale of the property, or the end of the individual’s employment with NAS, which will not exceed 12 years. The estimated present value of the receivable at December 31, 2006 and 2005, is $2.5 million and $2.25 million, respectively, and is included in other assets on the statement of financial position.
(16)
COMMITMENTS AND CONTINGENCIES
(a)
Leases
NAS is committed to several noncancelable operating leases for office space. Future minimum rental payments due under noncancelable operating leases are as follows (dollars in thousands):
Years ending December 31:
Minimum rentals
2007
$
3,146
2008
1,910
2009
1,948
2010
1,831
2011
1,643
Thereafter
8,535
$
19,013
The total of minimum rental payments to be received in 2007 under noncancelable subleases as of December 31, 2006 is approximately $1.6 million. Rental expense amounted to approximately $3.7 million and $3.0 million for the years ended December 31, 2006 and 2005, respectively.
(b)
Contingencies
NAS receives a portion of its revenues directly or indirectly from federal government grants and contracts, all of which are subject to audit by the Defense Contract Audit Agency, which has completed its examinations through December 31, 2004. A contingency exists relating to unexamined periods to refund any amounts received in excess of allowable costs. Management is of the opinion that no material liability will result from future audits.
(17)
RISKS AND UNCERTAINTIES
NAS invests in various investment securities. Investment securities are exposed to various risks such as interest rate, market and credit risks. Due to the level of risk associated with investment securities, it is at least reasonably possible that changes in the values of investment securities will occur in the near term and that such changes could materially affect the amounts reported.
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Report of the Treasurer to the Council of the National Academy of Sciences
OFFICERS
Ralph J. Cicerone, President
Barbara A. Schaal, Vice President
John I. Brauman, Home Secretary
Michael T. Clegg, Foreign Secretary
Ronald L. Graham, Treasurer
FINANCE COMMITTEE
Ronald L. Graham, Chair
Elwyn R. Berlekamp
Ralph J. Cicerone
David M. Kipnis
Lawrence R. Klein
William J. Rutter
Paul A. Samuelson
IOM Representative: John D. Stobo
BUDGET AND INTERNAL AFFAIRS COMMITTEE
Ronald L. Graham, Chair
Claude R. Canizares
Barbara A. Schaal
Susan R. Wessler
Y.W. Kan
AUDITING COMMITTEE
Jack Halpern, Chair
Jerry P. Gollub
Gerald M. Rubin
M. Gordon Wolman
Purnell W. Choppin
FINANCIAL MANAGEMENT STAFF
Archie L. Turner, Chief Financial Officer
Didi Salmon, Controller
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Representative terms from entire chapter:
financial statements
