See accompanying notes to financial statements.
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Report of the Treasurer of the National Academy of Sciences NATIONAL ACADEMY OF SCIENCES Statements of Financial Position December 31, 2007 and 2006 (Dollars in thousands) Assets 2007 2006 Current assets: Cash and cash equivalents $ 3,203 $ 3,782 Short-term investments (note 3) 46,941 45,785 Contracts receivable – U.S. government (note 11) 45,566 41,304 Contributions and other receivables (note 5) 16,377 16,175 Other current assets 3,813 4,479 Total current assets 115,900 111,525 Other assets (notes 2, 12, 14, and 16) 12,266 11,883 Long-term investments (note 3) 464,908 429,321 Contributions receivable, net (note 5) 37,312 38,017 Property and equipment, net (notes 4 and 15) 129,671 135,415 Einstein Memorial 1,723 1,723 $ 761,780 $ 727,884 Liabilities and Net Assets Liabilities: Current liabilities: Accounts payable and accrued expenses $ 30,770 $ 32,262 Deferred revenue (note 6) 31,414 27,646 Line of credit (note 7) 3,345 3,765 Other current liabilities (note 12) 5,533 8,631 Total current liabilities 71,062 72,304 Bonds payable (note 12) 121,067 122,709 Funds held on behalf of others (note 3) 11,804 23,014 Note payable (note 13) 2,270 3,027 Accrued employee benefits (note 14) 5,879 7,321 Other long-term liabilities (notes 2, 12, and 15) 9,409 3,212 Total liabilities 221,491 231,587 Net assets: Unrestricted 191,130 180,569 Temporarily restricted (note 8) 238,325 206,438 Permanently restricted (note 9) 110,834 109,290 Total net assets 540,289 496,297 Commitments and contingencies (notes 3, 11, 12, 14, 17, and 18) Total liabilities and net assets $ 761,780 $ 727,884 See accompanying notes to financial statements.
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Report of the Treasurer of the National Academy of Sciences Statements of Activities Years ended December 31, 2007 and 2006 (Dollars in thousands) 2007 2006 Unrestricted Temporarily restricted Permanently restricted Totals Unrestricted Temporarily restricted Permanently restricted Totals Revenues, gains, and other support: Government contracts and grants (note 11) $ 178,021 - - 178,021 $ 178,926 - - 178,926 Private contracts and grants 20,071 28,763 - 48,834 20,987 30,544 - 51,531 Other contributions 4,511 12,825 1,544 18,880 3,898 122 3,453 7,473 Fees and publications 19,909 - - 19,909 19,832 - - 19,832 Investment income, net (note 3) 23,636 24,290 - 47,926 34,795 33,619 - 68,414 Other income (note 12) 6,944 - - 6,944 9,311 - - 9,311 Net assets released from restriction (note 8) 33,991 (33,991) - - 48,691 (48,691) - - Total revenues, gains, and other support 287,083 31,887 1,544 320,514 316,440 15,594 3,453 335,487 Expenses (notes 12, 14, and 15): Programs (note 10) 225,164 - - 225,164 221,656 - - 221,656 Management and general 48,452 - - 48,452 41,154 - - 41,154 Fundraising 2,302 - - 2,302 2,559 - - 2,559 Total expenses 275,918 - - 275,918 265,369 - - 265,369 Change in net assets, before adoption of SFAS No. 158 11,165 31,887 1,544 44,596 51,071 15,594 3,453 70,118 Effect of adoption of SFAS No. 158 (note 14) (604) - - (604) - - - - Change in net assets 10,561 31,887 1,544 43,992 51,071 15,594 3,453 70,118 Net assets at beginning of the year 180,569 206,438 109,290 496,297 129,498 190,844 105,837 426,179 Net assets at end of the year $ 191,130 238,325 110,834 540,289 $ 180,569 206,438 109,290 496,297 See accompanying notes to financial statements.
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Report of the Treasurer of the National Academy of Sciences Statements of Cash FlowsYears ended December 31, 2007 and 2006(Dollars in thousands) 2007 2006 Cash flows from operating activities: Change in net assets $ 43,992 $ 70,118 Adjustments to reconcile change in net assets to net cash provided by operating activities: Depreciation and amortization 7,571 6,660 Loss on disposal of property and equipment 50 123 Bad debt expense 322 161 Net gain on investments (20,098) (48,925) Net gain on investments held on behalf of others (562) (430) Amounts collected on behalf of others (5,630) (4,000) Amounts remitted on behalf of others 17,402 3,900 Amortization of deferred gain (430) (738) Change in value of interest rate swap 2,325 (708) Change in value of split-interest agreements (121) (87) Effect of adoption of SFAS No. 158 604 - Contributions restricted for construction or endowment (3,997) (3,635) (Increase) decrease in assets: Other receivables 181 (4,947) Contracts receivable — U.S. government (4,262) 4,169 Publications and supplies inventories 401 296 Other assets (183) (316) Increase (decrease) in liabilities: Accounts payable and accrued expenses (1,492) 3,865 Deferred revenue 3,768 7,651 Other current liabilities (1,702) 839 Funds held on behalf of others (11,210) 430 Other long-term liabilities 3,692 (661) Accrued employee benefits (2,046) (292) Net cash provided by operating activities 28,575 33,473 Cash flows from investing activities: Additions to property and equipment (1,874) (9,582) Sales or maturities of investments 294,044 255,416 Purchases of investments (321,899) (258,730) Net cash used in investing activities (29,729) (12,896) Cash flows from financing activities: Contributions restricted for construction or endowment 3,997 3,635 Proceeds from line of credit 108,029 109,793 Payments on line of credit (108,449) (123,556) Proceeds from bank note - 3,027 Payments on bank note (757) (10,000) Proceeds from interest rate swaption 2,150 - Payments on bond principal (1,565) (1,505) Payments on capital lease liability (2,830) (1,829) Net cash provided by (used in) financing activities 575 (20,435) Net increase (decrease) in cash and cash equivalents (579) 142 Cash and cash equivalents, beginning of year 3,782 3,640 Cash and cash equivalents, end of year $ 3,203 $ 3,782 Supplemental disclosure of cash flow information: Interest paid $ 6,324 $ 6,019 See accompanying notes to financial statements.
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Report of the Treasurer of the National Academy of Sciences NATIONAL ACADEMY OF SCIENCES Notes to Financial Statements December 31, 2007 and 2006 (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). The NRC draws 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 divisions responsible for most study activities: Behavioral and Social Sciences and Education Earth and Life Studies 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. In May 2007, NAS began managing the operations of the Beckman Center. TNAC contributed $851,000 to the NRC for the year ended December 31, 2007, towards the operation of the Beckman Center. In addition, in March 2007, TNAC contributed $11.7 million to the NRC to be spent on programs conducted in whole or in part at the Beckman Center. (2) SUMMARY OF SIGNIFICANT CCOUNTING 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:
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Report of the Treasurer of the National Academy of Sciences 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. 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 $4.9 million and $4.0 million in 2007 and 2006, respectively, on behalf of NAEF. NAS disbursed $4.9 million and $3.9 million to NAEF from these collected amounts in 2007 and 2006, 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 2007 2006 Department of Transportation 33% 31% Department of Health and Human Services 9% 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 is limited to specific areas of study or is designated for use 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 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 $2.4 million and $3.2 million on December 31, 2007 and 2006, 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) Split-Interest Agreements Charitable gift annuity agreements are classified as other assets in the statements of financial position. NAS pays periodically a fixed amount of the assets to the beneficiary designated by the donor. Upon termination of an annuity, the remainder interest in the assets is available for use by NAS as restricted or unrestricted in accordance with the donor’s designation. At December 31, 2007 and 2006, NAS had assets of $3.0 million and $2.8 million, respectively. NAS has recorded a liability of $1.4 million and $1.5 million at December 31, 2007 and 2006, respectively, representing the present value of future cash payments to annuitants based on the annuitant’s life expectancy. (k) 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. (l) Reclassifications Certain amounts from the prior year have been reclassified to conform to the current year presentation. (m) New Accounting Standards On January 1, 2007, NAS adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 requires that a tax position be recognized or derecognized based on a “more likely than not” threshold. This applies to positions taken or expected to be taken in a tax return. The implementation of FIN 48 had no impact on NAS’s statement of financial position or statement of activities. NAS does not believe its financial statements include any uncertain tax positions. As discussed in note 14, NAS adopted the provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, effective December 31, 2007. (3) INVESTMENTS Investments, which are reported at fair value (except as noted), consisted of the following as of December 31, 2007 and 2006 (dollars in thousands): 2007 2006 Short-term investments: Cash equivalents $ 4,570 $ 7,640 Bonds and notes 29,477 23,540 Equity securities 12,894 14,605 Total short-term investments $ 46,941 $ 45,785 Long-term investments: Pooled endowment and trust investments: Cash equivalents $ 22,086 $ 19,519 Bonds and notes 58,429 32,772 Equity securities 264,824 252,744 Real estate 13,597 17,726 Hedge funds 65,487 69,197 Private placements 13,622 13,598 438,045 405,556
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Report of the Treasurer of the National Academy of Sciences 2007 2006 Other long-term investments: Cash equivalents 503 819 Bonds and notes 9,054 8,369 Equity securities 17,306 14,577 26,863 23,765 Total long-term investments $ 464,908 $ 429,321 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 were available for payments toward related obligations to the former landlord. These payments concluded in 2007. Vanguard equity funds comprised approximately $119 million and $142 million of the total equity securities funds at December 31, 2007 and 2006, respectively. At December 31, 2007 and 2006, real estate investments include shares of real estate investment trusts at fair value. At December 31, 2006, real estate investments also include real estate mortgages at cost. 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 $5.2 million and $5.5 million for the years ended December 31, 2007 and 2006, respectively. Private equity investments are comprised of limited partnership interests. NAS had remaining commitments at December 31, 2007 and 2006, to provide approximately $5.2 million and $4.1 million, respectively, to these partnerships. As of December 31, 2007 and 2006, respectively, NAS held alternative investments with fair values of approximately $79.1 million and $82.8 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 $11.8 million and $23.0 million as of December 31, 2007 and 2006, respectively, 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 $566,000 and $472,000 for the years ended December 31, 2007 and 2006, respectively, and is comprised of the following (dollars in thousands): 2007 2006 Interest and dividends income $ 27,828 $ 19,489 Net gain on investments 20,098 48,925 Total investment income, net $ 47,926 $ 68,414 (4) PROPERTY AND EQUIPMENT Property and equipment as of December 31, 2007 and 2006, is comprised of the following (dollars in thousands): 2007 2006 Land $ 29,689 $ 29,689 Furniture and equipment 32,096 31,040 Buildings and improvements 109,063 108,608 Construction in progress 240 776 Leasehold improvements 7,286 6,960 178,374 177,073 Less accumulated depreciation and amortization (48,703) (41,658) Total property and equipment, net $ 129,671 $ 135,415 (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 2008 $ 12,093 2009 5,358 2010 4,551 2011 10,807 2012 5,266 Thereafter 16,779 54,854 Less discount at rates from 3% to 5% to estimated net present value (5,449) Less allowance for uncollectible contributions (208) 49,197 Less current portion (11,885) Total contributions receivable, long-term $ 37,312 At December 31, 2006, the discount on contributions receivable was approximately $6.8 million at rates ranging from 3% to 5%, and the allowance for uncollectible contributions was approximately $108,000.
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Report of the Treasurer of the National Academy of Sciences (6) DEFERRED REVENUE Deferred revenue consisted of the following as of December 31, 2007 and 2006 (dollars in thousands): 2007 2006 Advances from private grants and contract sponsors $24,082 $21,383 Advances from U.S. government sponsors 2,663 2,604 Publication subscriptions and other 4,669 3,659 Total deferred revenue $31,414 $27,646 (7) LINE OF CREDIT NAS is party to a $18 million unsecured line of credit from Bank of America which bears interest at LIBOR plus 0.40% and expires on July 31, 2008. Interest expense related to the line of credit for the years ended December 31, 2007 and 2006, was approximately $497,000 and $445,000, respectively. (8) TEMPORARILY RESTRICTED NET ASSETS Temporarily restricted net assets were available for the following purposes as of December 31, 2007 and 2006 (dollars in thousands): 2007 2006 Sponsored research and advisory programs $203,182 $174,650 Prizes and awards 30,088 27,243 Woods Hole facility 5,055 4,545 Total temporarily restricted net assets $238,325 $206,438 Temporarily restricted net assets were released from restriction for the following purposes during the years ended December 31, 2007 and 2006 (dollars in thousands): 2007 2006 Sponsored research and advisory programs $ 32,989 $ 47,352 Prizes and awards 658 759 Woods Hole facility 344 580 Total temporarily restricted net assets released from restriction $33,991 $48,691 (9) PERMANENTLY RESTRICTED NET ASSETS The income generated by permanently restricted net assets is available to support donor-specified programs. As of December 31, 2007 and 2006, NAS held the following permanently restricted net assets, classified by the purpose for which the income is to be used (dollars in thousands): 2007 2006 Sponsored research and advisory programs $105,720 $104,177 Prizes and awards 5,114 5,113 Total permanently restricted net assets $110,834 $109,290 (10) PROGRAM EXPENSES Program expenses for the years ended December 31, 2007 and 2006, are summarized as follows (dollars in thousands): 2007 2006 Transportation Research Board $ 65,179 $ 59,045 Policy and Global Affairs 55,911 53,625 Institute of Medicine 20,388 23,626 Earth and Life Sciences 19,435 20,247 Engineering and Physical Sciences 18,839 17,318 Behavioral and Social Sciences and Education 13,886 15,876 Proceedings of the National Academy of Sciences 12,280 11,627 National Academy Press 5,479 6,533 National Academy of Engineering 4,950 6,240 Koshland Science Museum 1,932 1,614 NAS and National Sciences Resource Center 6,885 5,905 Total program expenses $225,164 $221,656 (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 carryfor-
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Report of the Treasurer of the National Academy of Sciences ward. 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 $3.1 million and $2.4 million as of December 31, 2007 and 2006, 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 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): 2007 2006 Series 1999A revenue bonds, serial, interest rate 5%, maturing at various dates from January 1, 2008 through 2012 $ 9,085 $ 10,650 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 (3.62% in 2007 and 3.37% in 2006) due January 1, 2039 32,500 32,500 Series 1999C revenue bonds, term, at variable rates (3.62% in 2007 and 3.52% in 2006) due January 1, 2039 32,500 32,500 Total bonds, at face value 123,715 125,280 Less unamortized discount and premium (1,003) (1,006) Total bonds payable 122,712 124,274 Less current portion (included in other current liabilities) (1,645) (1,565) Bonds payable, long-term $121,067 $122,709 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: 2008 $ 1,645 2009 1,725 2010 1,810 2011 1,905 2012 2,000 Thereafter 114,630 $ 123,715 Interest expense on the bonds payable for 2007 and 2006 totaled $5.3 million and $5.2 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
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Report of the Treasurer of the National Academy of Sciences does not possess credit risk. NAS minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties. NAS amended the agreement for the 2005-2020 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. NAS entered into a swaption agreement on August 21, 2007, that gives the counterparty the option to require NAS to enter into an additional swap agreement related to the Series 1999A Revenue Bonds. If executed by the counterparty, the swap will be effective on May 1, 2009, and require NAS to pay 5.00% on a notional amount of $55 million and to receive a floating rate equal to 67% of 1-month LIBOR + 0.41%. The counterparty paid NAS a premium of $2.2 million in advance to enter into this agreement. Under Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities, the fair value of the swap and swaption must be recorded in the NAS financial statements. Accordingly, for the year ended December 31, 2007, NAS recorded a loss on the change in the fair value of its swap agreement of $185,000, and for the year ended December 31, 2006, NAS recorded a gain on the change in the fair value of its swap agreement of $708,000, which is included in other income in the accompanying statements of activities. The fair value of the interest rate swap was $1.7 million and $1.9 million as of December 31, 2007 and 2006, respectively, and is included in other assets on the statements of financial position. The fair value of the swaption at December 31, 2007, is recorded as a liability of $4.3 million in other long-term liabilities and represents the estimated cost to NAS to cancel the agreement at the reporting date and is based on pricing models that consider interest rates and other market factors. The change in the fair value of the swaption is a net loss of approximately $2.2 million for the year ended December 31, 2007, included in other income in the statements of activities. (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). The sale-leaseback transaction resulted in a gain of $6.8 million, of which $430,000 was deferred at December 31, 2006, and is reported within other current liabilities in the statements of financial position. The deferred gain was fully recognized during 2007. At December 31, 2006, NAS had remaining lease payments with a present value of $2.8 million, which is included within other current liabilities in the statements of financial position. NAS completed remaining lease payments in July 2007, under the original lease agreement with the Trustee. (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. 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 is payable in equal monthly installments until January 1, 2012. On December 31, 2007 and 2006, the principal balance was approximately $3.0 million and $3.8 million, respectively. The note bears interest at 30-day LIBOR plus 40 basis points. The interest rate at December 31, 2007, was 5.245%. (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
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Report of the Treasurer of the National Academy of Sciences retirement annuity contracts issued by TIAA/CREF and mutual funds offered by the Vanguard Group, Inc. Pension expense for the years ended December 31, 2007 and 2006, amounted to approximately $9.8 and $9.4 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 frozen deferred compensation arrangement for certain employees. The fair value of these investments was approximately $4.1 million and $4.6 million as of December 31, 2007 and 2006, respectively, 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’ long-term disability 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 benefit plan is contributory for health insurance purposes for employees who retired on or 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. 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 2006 change in benefit obligation. 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. In 2006, the Financial Accounting Standards Board issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, which NAS has adopted 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. NAS reported the funded status of the accumulated postretirement benefit obligation of $1.8 million as a component of accrued employee benefits liability at December 31, 2007. NAS recorded the effect of adopting SFAS No. 158 of $604,000 for the year ended December 31, 2007. The effects of applying SFAS No. 158 on NAS’ financial position as of December 31, 2007, were as follows: Before SFAS No. 158 After SFAS No. 158 Accrued employee benefits $ 5,275 $ 5,879 Total liabilities 220,887 221,491 Total net assets 540,893 540,289 Items not yet recognized as a component of net periodic benefit cost which are reported as effect of adoption of recognition provisions of FASB Statement No. 158 in 2007 are as follows (dollars in thousands): 2007 Life insurance benefits Health benefits Total Net actuarial gain $ (715) $ (410) $ (1,125) Prior service cost (credit) (112) 1,674 1,562 Unrecognized net initial obligation - 167 167 Total $ (827) $ 1,431 $ 604 Estimated amounts to be amortized into net periodic benefit cost over the next fiscal year relate to prior service costs, net gain and net initial obligation recognition are $210,013, $18,134, and $25,703, respectively, for the postretirement life insurance and health benefit plan.
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Report of the Treasurer of the National Academy of Sciences 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 year ended December 31, 2007 (dollars in thousands): 2007 Life insurance benefits Health benefits Total Change in benefits obligations: Benefit obligation, January 1 $ 2,566 $ 13,959 $ 16,525 Service cost 48 612 660 Interest cost 142 785 927 Plan participant contributions - 117 117 Actuarial gain (137) (1,015) (1,152) Benefits paid (9) (607) (616) Benefits obligation, December 31 $ 2,610 $ 13,851 $ 16,461 Change in plan assets, combined: Fair value of plan assets, January 1 $ - $ 11,920 $ 11,920 Actual return on plan assets - 797 797 Employer contributions 2,333 109 2,442 Plan participants contributions - 117 117 Benefits paid (9) (607) (616) Fair value of plan assets, December 31 $ 2,324 $ 12,336 $ 14,660 Funded status $ (286) $ (1,515) $ (1,801) Components of net periodic benefit cost: Service cost $ 48 $ 613 $ 661 Interest cost 142 785 927 Expected return on plan assets - (899) (899) Recognized prior service cost (credit) 229 (19) 210 Recognized actuarial (gain) loss (2) - (2) Recognized net initial obligation (asset) 26 - 26 Net periodic cost $ 443 $ 480 $ 923 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 year ended December 31, 2006 (dollars in thousands): 2006 Life insurance benefits Health benefits Total Change in benefits obligations: Benefit obligation, January 1 $ 811 $ 13,719 $ 14,530 Service cost 14 664 678 Interest cost 45 772 817 Plan participant contributions N/A (104) (104) Plan amendments 1,781 N/A 1,781 Actuarial gain (79) (524) (603) Benefits paid (6) (568) (574) Benefits obligation, December 31 $ 2,566 $ 13,959 $ 16,525 Change in plan assets, combined: Fair value of plan assets, January 1 $ - $ 9,695 $ 9,695 Actual return on plan assets - 1,542 1,542 Employer contributions - 1,153 1,153 Plan participants contributions - 104 104 Benefits paid - (574) (574) Fair value of plan assets, December 31 $ - $ 11,920 $ 11,920 Funded status: Unfunded benefit obligation $ (2,566) $ (2,039) $ (4,605) Unrecognized transition obligation 193 - 193 Unrecognized prior service cost 1,903 (131) 1,772 Unrecognized net actuarial (gain) loss (275) 198 (77) Accrued benefit cost $ (745) $ (1,972) $ (2,717) Components of net periodic benefit cost: Service cost $ 14 $ 664 $ 678 Interest cost 45 772 817 Expected return on plan assets - (728) (728) Amortization of transition obligation 25 - 25 Amortization of prior service cost 18 (19) (1) Amortization of unrecognized (gains) losses (13) 44 31 Net periodic cost $ 89 $ 733 $ 822
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Report of the Treasurer of the National Academy of Sciences The assumptions used to determine net periodic benefit cost for years ended December 31, 2007 and 2006, are as follows: 2007 2006 Discount rate 6.00% 5.75% Expected long-term return on plan assets 7.50% 7.50% The assumptions used to calculate the accumulated postretirement benefit obligation for the years ended December 31, 2007 and 2006, are as follows: 2007 2006 Discount rate 6.00% 5.75% NAS postretirement benefit plan asset allocations at December 31, 2007 and 2006, by asset category are as follows: 2007 2006 Cash 11% 5% Bonds and notes 15% 25% Equity securities 74% 70% 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. The Plan assets are invested with long-term growth strategy, with a 70% equity guideline. 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 2008, which is approximately $840,000. In addition, in 2008, NAS expects to contribute the outstanding $1.8 million in postretirement benefit obligation. The following benefit payments, which reflect future services, are expected to be paid in future years as noted, as of December 31, 2007 (dollars in thousands): Years ending December 31: 2008 $ 840 2009 969 2010 1,039 2011 1,117 2012 1,178 2013-2017 6,584 $ 11,727 The measurement date of the plan assets and benefit obligations for 2007 and 2006 is December 31, 2007 and 2006, respectively. The trend rate for growth in healthcare costs used in calculating the accumulated postretirement benefit obligation was 9.5% during both years ended December 31, 2007 and 2006, 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, 2007, would have resulted in an estimated $1.5 million increase or $1.3 million decrease in the postretirement benefit obligation and an estimated $203,000 increase or $167,000 decrease in the 2007 benefit expense. 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 $211,000 increase or $174,000 decrease in the 2006 benefit expense. (15) CONDITIONAL ASSET RETIREMENT OBLIGATION In March 2005, the Financial Accounting Standards Board (FASB) issued the FASB Interpretation No. 47 (FIN 47). This interpretation clarifies the term “conditional asset retirement obligation” as it is used in FASB Statement No. 143, Accounting for Asset Retirement Obligations, and requires a liability to be recorded if the fair value of the obligation to retire an asset can be reasonably estimated. Asset retirement obligations covered by FIN 47 include those for which an entity has a legal obligation to perform an asset retirement activity. However, the timing and/or method of settling the obligation are conditional on a future event that may or may not be within the control of the entity.
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Report of the Treasurer of the National Academy of Sciences In accordance with FIN 47, NAS recorded an asset retirement obligation for which fair value of the liability could be reasonably estimated relating to the regulatory remediation of asbestos and other hazardous materials in one of its office buildings. Accordingly, NAS recorded a charge to management and general expense of $1.5 million for the year ended December 31, 2007. NAS recorded a liability for asset retirement obligations of $1.7 million in other long term liabilities and increased the carrying value of the related building assets by $364,000, less accumulated depreciation of $291,000. (16) RELATED PARTY TRANSACTIONS The NAS Council has authorized two agreements providing non-interest bearing, collateralized advances to two employees in connection with the purchase of the employee’s residence. The agreements between the parties were executed in May 2005 and May 2007. They each provide 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 agreements 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 receivables at December 31, 2007 and 2006, is $3.5 million and $2.5 million, respectively, and is included in other assets on the statement of financial position. (17) 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): Year ending December 31: 2008 $ 1,910 2009 1,948 2010 1,831 2011 1,643 2012 1,686 Thereafter 6,849 $ 15,867 Rental expense amounted to approximately $2.1 million and $3.7 million for the years ended December 31, 2007 and 2006, 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 and final settlements of examined periods to refund any amounts received in excess of allowable costs. Management is of the opinion that no material liability will result from such audits. (c) Litigation NAS is a defendant or otherwise involved in several lawsuits. While the ultimate outcome of the litigation is uncertain, NAS management believes that it has strong legal positions, intends to vigorously defend its actions, and has concluded that the probable outcomes will not have a material impact on NAS. (18) 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.