Notes to Financial Statements

December 31, 2010 and 2009

(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.

(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

  • 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 independent program activities and activities through the NRC. The results of both 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. TNAC is controlled by NAS and NAEF. The financial position and results of TNAC are not consolidated in the NAS financial statements.


NAS manages the operations of the Beckman Center. There were no contributions from TNAC to the NRC during 2010 and 2009 to support operations of the Beckman Center. TNAC contributed $5,000 and $4,000 to the NRC for the years ending December 31, 2010 and 2009, respectively, to be spent on programs conducted in whole or in part at the Beckman Center.

(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:



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separate membership organization within NAS. The NATIONAL ACADEMY OF SCIENCES financial activities and results of IOM are included in the Notes to NAS financial statements. Financial Statements (d) National Academy of Engineering The National Academy of Engineering (NAE) was December 31, 2010 and 2009 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 (1) ORGANIZATION AND RELATED shares with NAS the responsibility for advising the federal government on scientific issues. The NAE ENTITIES conducts independent program activities and activities through the NRC. The results of both of these activities (a) National Academy of Sciences are included in the NAS financial statements. The National Academy of Sciences (NAS) was formed (e) National Academy of Engineering Fund under a charter that was passed as an Act of Incorporation by the United States Congress and signed into law on The National Academy of Engineering Fund (NAEF) is a March 3, 1863. NAS operates as a private cooperative separately incorporated not-for-profit organization society of distinguished scholars engaged in scientific or established and controlled by NAE to raise funds to engineering research, dedicated to the furtherance of support its goals. The financial activities and results of science and its use for the general welfare. NAEF are not included in the NAS financial statements. (b) National Research Council (f) The National Academies’ Corporation Most of the activities undertaken by NAS are carried out The National Academies’ Corporation (TNAC) was through the divisions and boards of the National Research separately incorporated in 1986 as a not-for-profit Council (NRC). The NRC draws on a wide cross section corporation for the purpose of constructing and maintain- of the nation’s leading scientists and engineers for ing a study and conference facility. This facility, the advisory services to government agencies and Congress. Arnold and Mabel Beckman Center, located in Irvine, To respond effectively to both the disciplinary concerns California, operates to expand and support the general of the research community and the complex interdiscipli- activities of NAS, NRC, IOM, and NAE. TNAC is nary problems facing American society, NRC is organ- controlled by NAS and NAEF. The financial position and ized into the following five major divisions responsible results of TNAC are not consolidated in the NAS for most study activities: financial statements.  Behavioral and Social Sciences and Education NAS manages the operations of the Beckman Center.  Earth and Life Studies There were no contributions from TNAC to the NRC  Engineering and Physical Sciences during 2010 and 2009 to support operations of the  Policy and Global Affairs Beckman Center. TNAC contributed $5,000 and $4,000  Transportation Research Board to the NRC for the years ending December 31, 2010 and 2009, respectively, to be spent on programs conducted in NRC activities are under the control of the NAS govern- whole or in part at the Beckman Center. ance structure, and therefore are included in the NAS financial statements. (2) SUMMARY OF SIGNIFICANT (c) Institute of Medicine ACCOUNTING POLICIES The Institute of Medicine (IOM), established in 1970, conducts studies of policy issues related to health and (a) Basis of Accounting medicine. IOM issues position statements on these policies, cooperates with the major scientific and Net assets, revenues, gains, and losses are classified based professional societies in the field, identifies qualified on the existence or absence of donor-imposed restrictions. individuals to serve on study groups in other organiza- Accordingly, net assets of NAS are classified and tional units, and disseminates information to the public reported as follows: and the relevant professions. IOM was established as a 45

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Permanently restricted – Net assets subject to do- appropriate rate commensurate with risks involved. nor-imposed stipulations that they be maintained in Amortization of the discount is recorded as additional perpetuity by NAS. Generally, the donors of these assets revenue and is used in accordance with donor-imposed permit NAS to use all or part of the income earned on restrictions, if any, on the contributions. related investments for general or specific purposes. NAS performs certain fundraising activities on behalf of Temporarily restricted – Net assets subject to do- NAEF. NAS collected a total of $4.1 million and nor-imposed stipulations that may or will be met either by $5.3 million in 2010 and 2009, respectively, on behalf of actions of NAS and/or the passage of time. When a donor NAEF. NAS disbursed $4.1 million and $5.2 million to restriction expires, temporarily restricted net assets are NAEF from these collected amounts in 2010 and 2009, reclassified to unrestricted net assets. respectively. Amounts collected but not yet remitted to NAEF are reported as assets and liabilities in the NAS Unrestricted – Net assets arising from exchange transac- financial statements. tions and contributions not subject to donor-imposed (e) Contracts and Grants stipulations. (b) Cash Equivalents The majority of NAS activities are performed under cost-reimbursable contracts with the U.S. government. NAS reports liquid, temporary investments purchased For the years ended December 31, 2010 and 2009, the with original maturities of three months or less as cash Department of Transportation provided 45% and 44%, equivalents. respectively, of NAS government grant and contract revenue. (c) Investments NAS records federal contracts as exchange transactions, Investments are stated at fair value. Changes in the fair recognizing revenue as recoverable costs are incurred. value of investments are reported within investment income in the statements of activities. Revenues from nonfederal grants qualifying as contribu- tions are recorded by NAS upon notification of the grant Certain investments are pooled for long-term investment award. Such grants are classified as temporarily restricted purposes. Investments in the pool are administered as an net assets when use of the grant funds is limited to open-end investment trust, with shares of the pool funds specific areas of study or is designated for use in future expressed in terms of participating capital units (PCUs). periods. PCU values are used to determine equity in the allocation of investment income among funds in the pool whenever (f) Deferred Revenue additional funds are contributed or withdrawn. For both federal and nonfederal grants and contracts that (d) Contributions are determined to be exchange transactions, revenue is recognized as the related costs are incurred. Funds Contributions, including unconditional promises to give, received in advance of being earned for these grants are are recognized as revenues in the period received. recorded as deferred revenue in the statements of financial Conditional promises to give are not recognized until all position. conditions on which receipt depends are substantially met. (g) Inventories Gifts of land, buildings, or equipment are reported as unrestricted net assets unless explicit donor stipulations Inventories are stated at the lower of cost or net realizable specify how the donated assets must be used. Temporary value and include both work in-process and finished restrictions on gifts that must be used to acquire goods related to publication activities. The majority of long-lived assets are released in the period in which the NAS publication inventories and supplies reside with an assets are acquired or placed in service. NAS unit, the National Academy Press (NAP). NAP uses the full absorption costing methodology in pricing Allowances are recorded for estimated uncollectible finished products. This methodology includes direct contributions based upon management’s judgment and printing and related indirect costs. Inventories are analysis of the credit worthiness of the donor, past included in other current assets in the statements of collection experience, and other relevant factors. Contri- financial position. butions to be received after one year are discounted at an 46

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(h) Property and Equipment guidance requires fair value measurement disclosures for each class of assets and liabilities and enhanced disclo- Depreciation of NAS buildings and equipment is sures for transfers among the fair value hierarchy. computed on a straight-line basis using the following lives: Effective December 31, 2009, NAS applied the guidance in FASB Accounting Standards Update 2009-12, Fair Asset Class Depreciable Lives Value Measurements and Disclosures – Investments in Buildings 40 years Certain Entities That Calculate Net Asset Value per Share Buildings and leasehold Lesser of the remaining (or Its Equivalent), to its investments including hedge improvements life of the building or funds and private placement equity investments. This improvement guidance permits, as a practical expedient, the fair value Furniture and equipment 4 to 10 years of investments within its scope to be estimated using net Capitalized software 3 to 10 years asset value (NAV) per share or its equivalent. The Einstein Memorial sculpture is valued at cost and is Effective December 31, 2009, NAS applied the guidance not depreciated. Construction-in-progress is not depreci- in FASB ASC Topic 855, Subsequent Events ated until the related assets are placed in service. (FASB ASC 855), which establishes general standards of Capitalized software is amortized over its depreciable life accounting for and disclosure of events that occur after when it is ready for its intended use and placed in service. the statement of financial position date but before the financial statements are issued. FASB ASC 855 also (i) Split-Interest Agreements requires disclosure of the date through which an entity has evaluated subsequent events. Charitable gift annuity agreements are classified as other assets in the statements of financial position. Periodically, (l) Use of Estimates NAS pays a fixed amount of the assets to the beneficiary designated by the donor. Upon termination of an annuity, The preparation of these financial statements in confor- the remainder interest in the assets is available for use by mity with U.S. generally accepted accounting principles NAS as restricted or unrestricted assets in accordance requires management to make certain estimates and with the donor’s designation. At December 31, 2010 and assumptions. These estimates and assumptions may affect 2009, NAS had charitable gift annuity assets of the reported amounts of assets and liabilities and disclo- $2.1 million and $2.4 million, respectively. NAS has sures in the financial statements. Actual results could recorded a liability of $1.3 million and $1.4 million at differ from those estimates. December 31, 2010 and 2009, respectively, representing (m) Reclassifications the present value of estimated future cash payments to annuitants based on the annuitant’s life expectancy. Certain amounts from the prior year have been reclassi- (j) Income Taxes fied to conform to the current year presentation. NAS is exempt from federal income taxes under Sec- tion 501(c)(3) of the Internal Revenue Code, except for (3) INVESTMENTS unrelated business income. NAS recognizes the effect of income tax positions only if those positions are more Investments, which are reported at fair value (except as likely than not of being sustained. NAS does not believe noted), consisted of the following as of December 31, its financial statements include any uncertain tax posi- 2010 and 2009 (dollars in thousands): tions. 2010 2009 (k) Recently Adopted Accounting Pronouncements Short-term investments: Cash equivalents $ 12,503 $ 8,990 Effective December 31, 2010, NAS applied the guidance Bonds and notes 31,666 29,561 in FASB Accounting Standards Update 2010-06, Fair Equity securities 12,608 10,562 Value Measurements and Disclosures – Improving Total short-term investments $ 56,777 $ 49,113 Disclosures about Fair Value Measurements, to its financial assets and liabilities disclosed at fair value. This 47

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(continued) 2010 2009 2010 2009 Long-term investments: Interest and dividends income $ 9,610 $ 8,379 Investment pool, including endowment assets: Net gain on investments 49,231 70,998 Cash equivalents $ 6,381 $ 7,699 Total investment income $ 58,841 $ 79,377 Bonds and notes 38,775 39,998 Equity securities 263,900 239,112 Hedge funds 55,303 45,536 (4) FAIR VALUE MEASUREMENTS Private equity 19,570 12,035 383,929 344,380 Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit Other long-term investments: price) in the principal or most advantageous market for Cash equivalents 3,004 1,291 the asset or liability in an orderly transaction between Bonds and notes 16,463 13,583 market participants on the measurement date. FASB ASC Equity securities 19,666 16,909 Topic 820 establishes a fair value hierarchy, which requires an entity to maximize the use of observable 39,133 31,783 inputs and minimize the use of unobservable inputs when Total long-term investments $ 423,062 $ 376,163 measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: Vanguard equity funds comprised approximately Level 1: Quoted prices in active markets for identical $97.0 million and $85.5 million of the total equity assets or liabilities. securities funds at December 31, 2010 and 2009, respec- tively. Level 2: Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted NAS holds alternative investments, comprised of private prices in markets that are not active; or other inputs that equity securities and hedge funds, in its long-term are observable or can be corroborated by observable investment pool. At December 31, 2010 and 2009, these market data for substantially the full term of the assets or funds had a fair value of approximately $74.9 million and liabilities. $57.6 million, respectively. The unrealized gain on the hedge funds was approximately $4.1 million and Level 3: Unobservable inputs that are supported by little $2.6 million for the years ended December 31, 2010 and or no market activity and that are significant to the fair 2009, respectively, and is included as a component of value of the asset or liabilities. investment income in the accompanying statements of activities. Private equity investments are comprised of The following discussion describes the valuation method- limited partnership interests. NAS had remaining ologies used for financial assets measured at fair value. commitments at December 31, 2010 and 2009 to provide The techniques utilized in estimating the fair values are approximately $3.6 million and $5.1 million, respectively, affected by the assumptions used, including discount rates to these partnerships. and estimates of the amount and timing of future cash flows. Care should be exercised in deriving conclusions TNAC, a related entity, invests certain of its assets in the about NAS’ business, its value or financial position based NAS long-term investment pool. TNAC investments on the fair value information of financial assets presented participate in the investment pool experience proportion- below. ally with all other funds in this pool. The NAS obligation to TNAC for these funds held in trust, which totaled Fair value estimates are made at a specific point in time, approximately $9.9 million and $8.8 million as of based on available market information and judgments December 31, 2010 and 2009, respectively, is reported as about the financial asset, including estimates of timing, funds held on behalf of others in the statements of amount of expected future cash flows and the credit financial position. standing of the issuer. In some cases, the fair value estimates cannot be substantiated by comparison to Investment income is reported net of investment expenses independent markets. In addition, the disclosed fair value of approximately $446,000 and $691,000 for the years may not be realized in the immediate settlement of the ended December 31, 2010 and 2009, respectively, and is financial asset. Furthermore, the disclosed fair values do comprised of the following (dollars in thousands): not reflect any premium or discount that could result from offering for sale at one time an entire holding of a particular financial asset. Potential taxes and other 48

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expenses that would be incurred in an actual sale or provided by alternative investment fund managers include settlement are not reflected in amounts disclosed. estimates, appraisals, assumptions and methods that are reviewed by management. When necessary, NAS adjusts The following methods and assumptions were used to NAV for contributions, distributions, or general market estimate the fair value of each class of financial instru- conditions subsequent to the latest NAV valuation date ments: when calculating fair value. Since the most significant valuation inputs are not observable in the marketplace, the The carrying value of cash equivalents such as money alternative investment valuations are disclosed in Level 2 market funds approximates the fair value because of the or Level 3. The distinction is that those funds which are short maturity of these investments. These amounts are available for redemption in the near term at NAV are disclosed in Level 1. included in Level 2. NAS’ fixed maturity investments (bonds and notes), other Funds on deposit with trustee are held in U.S. Treasury than U.S. Treasury securities, generally do not trade on a securities or funds of U.S. Treasury securities and daily basis. The fair value estimates of such debt securi- therefore included in Level 1. Charitable gift annuity ties are based on prices provided by NAS’ investment investments and deferred compensation investments are managers and custodian bank. Both the investment held in debt and equity mutual funds along with some managers and the custodian bank use a variety of pricing U.S. Treasury securities, all of which are included in sources to determine market valuations. Each designate Level 1. The deferred compensation obligation to specific pricing services or indexes for each sector of the employees is equal to the fair value of the investments market based upon the provider’s expertise. NAS’ debt held and is disclosed in the same levels as the investment securities portfolio is highly liquid, which allows for a assets. high percentage of the portfolio to be priced through pricing services. Accordingly, the estimates of fair value NAS has interest rate swap agreements covering the for such debt securities are included in Level 2 inputs. variable-rate bonds payable. The fair value of the swaps The estimated values of U.S. Treasury securities are based are determined using pricing models based on observable on actively traded market prices and are accordingly market data such as prices of instruments with similar included in the bonds and notes amount in Level 1. maturities and characteristics, interest rate yield curves, and measures of interest rate volatility. The value was Fair values of exchange-traded equity securities have determined after considering the potential impact of been determined by NAS from observable market collateralization and netting agreements, adjusted to quotations on major trade exchanges. Accordingly, such reflect nonperformance risk of both the counterparty and equity securities are disclosed in Level 1. NAS. Accordingly, the interest rate swaps are included in Level 2. NAS also invests in debt and equity mutual funds. For purposes of the fair value disclosure, mutual funds are The funds held on behalf of others liability approximates presented based on the class of the underlying investment the investments held in NAS’ long-term investment pool holdings. The fair values of such mutual funds are based on behalf of TNAC. Therefore, the liability is disclosed in on observable market information from active markets. the same levels as the investment assets. Accordingly, the estimates of fair value for such mutual funds are included in Level 1. The following table presents NAS’ fair value hierarchy for those assets and liabilities measured at fair value on a Fair value of alternative investments including private recurring basis at December 31, 2010 (dollars equity securities and hedge funds is based on the alterna- in thousands): tive investment fund managers’ NAV. Valuations Fair value measurements at December 31 using: Fair Value Level 1 Level 2 Level 3 Financial Assets: Short-term and long-term investments: Cash equivalents $ 21,888 $ 21,888 $ - $ - Bonds and notes U.S. treasuries/government bonds 6,964 5,844 1,120 - Mortgage-backed securities 32,044 16,980 15,064 - Corporate bonds 26,122 11,146 14,976 - Non-U.S. fixed income 21,774 21,774 - - 49

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Fair value measurements at December 31 using: (continued) Fair Value Level 1 Level 2 Level 3 Equity securities U.S. large stock 70,619 70,619 - - U.S. small/mid cap 67,547 67,547 - - Non-U.S. stocks (developed countries) 89,016 89,016 - - Non-U.S. stocks (emerging countries) 57,054 57,054 - - Real estate stocks 11,938 11,938 - - Hedge funds Fund of fund – multi-strategies 27,104 - 27,104 - Multi-strategies/multi-vehicle 11,028 - - 11,028 Fixed income single strategy 1,185 - 1,185 - Long/short equity 15,986 - 2,500 13,486 Private equity Asia 12,725 - - 12,725 Global 4,840 - - 4,840 Domestic 2,005 - - 2,005 Total short-term and long-term investments 479,839 373,806 61,949 44,084 Deposit with trustee Bonds and notes U.S. treasuries/government bonds 47,216 47,216 - - Total deposit with trustee 47,216 47,216 Charitable gift annuity assets: Cash equivalents 56 56 - - Bonds and notes U.S. treasuries/government bonds 66 66 - - Mortgage-backed securities 376 376 - - Corporate bonds 86 86 - - Equity securities U.S. small/mid cap 1,475 1,475 - - Total charitable gift annuity assets 2,059 2,059 - - Deferred compensation assets: Cash equivalents 13 13 - - Bonds and notes U.S. treasuries/government bonds 97 97 - - Corporate bonds 426 426 - - Equity securities U.S. large stock 164 164 - - U.S. small/mid cap 1,279 1,279 - - Non-U.S. stocks (developed countries) 339 339 - - Total deferred compensation assets 2,318 2,318 - - Total financial assets $ 531,432 $ 425,399 $ 61,949 $ 44,084 Financial Liabilities: Funds held on behalf of others $ 9,918 $ 7,984 $ 795 $ 1,139 Deferred compensation liability 2,318 2,318 - - Interest rate swaps 10,534 - 10,534 - Total financial liabilities $ 22,770 $ 10,302 $ 11,329 $ 1,139 50

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The following table presents NAS’ fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis at December 31, 2009 (dollars in thousands): Fair value measurements at December 31 using: Fair Value Level 1 Level 2 Level 3 Financial Assets: Short-term and long-term investments: Cash equivalents $ 17,980 $ 17,980 $ - $ - Bonds and notes U.S. treasuries/government bonds 5,470 5,225 245 - Mortgage-backed securities 29,039 17,924 11,115 - Corporate bonds 26,586 9,707 16,879 - Non-U.S. fixed income 22,047 22,047 - - Equity securities U.S. large stock 66,483 66,483 - - U.S. small/mid cap 53,319 53,319 - - Non-U.S. stocks (developed countries) 88,181 88,181 - - Non-U.S. stocks (emerging countries) 48,439 48,439 - - Real estate stocks 10,161 10,161 - - Hedge funds Fund of fund – multi-strategies 34,255 - 34,255 - Multi-strategies/multi-vehicle 10,000 - - 10,000 Fixed income single strategy 1,281 - - 1,281 Private equity Asia 4,990 - - 4,990 Global 5,073 - - 5,073 Domestic 1,972 - - 1,972 Total short-term and long-term investments 425,276 339,466 62,494 23,316 Charitable gift annuity assets: Cash equivalents 125 125 - - Bonds and notes U.S treasuries/government bonds 55 55 - - Mortgage-backed securities 452 452 - - Corporate bonds 118 118 - - Equity securities U.S. small/mid cap 1,631 1,631 - - Total charitable gift annuity assets 2,381 2,381 - - Deferred compensation assets: Cash equivalents 24 24 - - Bonds and notes U.S. treasuries/government bonds 103 103 - - Corporate bonds 324 324 - - Equity securities U.S. large stock 99 99 - - U.S. small/mid cap 1,317 1,317 - - Non-U.S. stocks (developed countries) 522 522 - - Total deferred compensation assets 2,389 2,389 - - Total financial assets $ 430,046 $ 344,236 $ 62,494 $ 23,316 Financial Liabilities: Funds held on behalf of others $ 8,794 $ 7,324 $ 875 $ 595 Deferred compensation liability 2,389 2,389 - - Interest rate swaps 9,210 - 9,210 - Total financial liabilities $ 20,393 $ 9,713 $ 10,085 $ 595 51

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Level 3 assets comprised approximately 9% and 5% of NAS’ total investment portfolio fair value at December 31, 2010 and 2009, respectively. The following table presents the changes in Level 3 assets measured at fair value on a recurring basis for the year ended December 31, 2010 (dollars in thousands): Balance Net gain Transfers out of Balance January 1, (loss) on Level 3 (a) December 2010 investments Purchases Sales 31, 2010 Hedge funds: Multi-strategies/multi-vehicle $ 10,000 $ 1,028 $ - $ - $ - $ 11,028 Fixed income single strategy 1,281 (96) - - (1,185) (b) - Long/short equity - 486 13,000 - - 13,486 Private equity: Asia 4,990 6,407 1,428 (100) - 12,725 Global 5,073 481 90 (804) - 4,840 Domestic 1,972 251 - (218) - 2,005 $ 23,316 $ 8,557 $ 14,518 $ (1,122) $ (1,185) $ 44,084 Notes: (a) NAS’ policy is to recognize transfers in and transfers out as of the end of the reporting period in which the event or change in circumstances occurred. (b) Transferred from Level 3 to Level 2 due to expiration of lock up period allowing for redemption in the near term. The following table presents the changes in Level 3 assets measured at fair value on a recurring basis for the year ended December 31, 2009 (dollars in thousands): Balance Net gain Transfers out of Balance January 1, (loss) on Level 3 (a) December 31, 2009 investments Purchases Sales 2009 Hedge funds: Fund of fund - multi-strategies $ 35,243 $ (449) $ - $ (34,794) $ - $ - Multi-strategies/multi-vehicle 30,040 4,215 10,000 - (34,255) (b) 10,000 Fixed income single strategy - (68) 1,000 349 - 1,281 Private equity: Asia 4,139 155 749 (53) - 4,990 Global 5,554 (512) - 31 - 5,073 Domestic 1,991 58 - (77) - 1,972 $ 76,967 $ 3,399 $ 11,749 $ (34,544) $ (34,255) $ 23,316 Notes: (a) NAS’ policy is to recognize transfers in and transfers out as of the end of the reporting period in which the event or change in circumstances occurred. (b) Transferred from Level 3 to Level 2 due to expiration of lock up period allowing for redemption in the near term. The following table presents the nature and risk of assets with fair values estimated using NAV held at December 31, 2010 (dollars in thousands): Unfunded Redemption Fair Value Commitments Redemption Frequency Notice Period Fund of the hedge fund – multi-strategies (a) $ 27,104 N/A Quarterly 90 days Hedge fund – multi-strategies/multi-vehicle (b) 11,028 N/A Annually, but not currently eligible 365 days Hedge fund – fixed income single strategy (c) 1,185 N/A Quarterly 30 days Hedge fund – long/short equity strategy (d) 15,986 N/A Monthly/Quarterly/Annually 45/60/90 days Private equity – Asia (e) 12,725 2,940 N/A N/A Private equity – Global (f) 4,840 347 N/A N/A Private equity – Domestic (g) 2,005 303 N/A N/A Total $ 74,873 $ 3,590 52

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Notes: the investments. Currently, approximately $2.5M of investments in this category is redeemable within the near (a) This class includes investments in funds of hedge term from December 31, 2010. The remaining invest- funds that use multiple strategies to obtain total returns on ments are not redeemable because the funds include a leveraged basis. Direct and indirect investments are restrictions that do not allow for redemption in the first 12 made using equity long/short, event driven, relative value, months after acquisition. The remaining restriction for and tactical trading strategies. The funds have investments these investments is four to six months at December 31, in multiple investees which may trade various financial 2010. instruments such as, but not limited to, securities sold short, futures, forwards, swaps, and written options. The (e) This class includes several private equity funds that fair values of the investments in this class have been invest in equity, debt or debt-oriented instruments, estimated using the NAV per share of the investments. primarily in privately held companies which own or contractually control operating entities located in the (b) This class includes investments in a multi-strategy, Peoples’ Republic of China and India. Investments held in multi-vehicle hedge fund with the objective of maximiz- India primarily include equity securities of “early to early ing long-term, risk-adjusted returns and capital apprecia- growth stage” companies in multiple sectors, except real tion by investing in securities, investment funds, discre- estate. The fair values of these investments have been tionary accounts, and investment partnerships across a estimated using the NAV of NAS’ ownership interest in broad range of marketable and alternative asset classes. partners’ capital. These investments can never be Asset classes include domestic and international market- redeemed with the funds. Instead, the nature of the able equity securities, hedged equity, real estate, natural investments in this class is that distributions are received resource, fixed income, and private equity and absolute through liquidation of the underlying assets of the funds. return strategies, primarily focused in the United States. It is estimated that the underlying assets of the funds will The fair values of the investments in this class have been be liquidated over 1 to 8 years. estimated using the NAV per share of the investments. Currently, none of the investments in this class are (f) This class includes several global private equity funds redeemable because the fund includes restrictions that do with diverse portfolios consisting primarily of venture not allow for redemption in the first 2 years after acquisi- capital funds, leveraged buyout funds, mid-stage growth tion. The remaining restriction for these investments is capital funds, and international private equity funds. 1 year at December 31, 2010. These investments are focused on several industries including, but not limited to, insurance, services, and (c) This class includes investments in a single strategy consumer-related industries. The fair values of these hedge fund focused on undervalued fixed income investments have been estimated using the NAV of NAS’ securities. Investments held by this fund consist of ownership interest in partners’ capital. These investments U.S. government agency mortgage-backed securities and can never be redeemed with the funds. Instead, the nature derivatives, primarily in the form of collateralized of the investments in this class is that distributions are mortgage obligations. Securities are generally held in the received through liquidation of the underlying assets of portfolio as long as interest rates and repayment rates are the funds. It is estimated that the underlying assets of the unfolding as anticipated. The majority of the investment funds will be liquidated over 1 to 5 years. return is expected to come from trading mortgage-backed securities in attempt to maximize interest income. The fair (g) This class includes several domestic private equity values of the investments in this class have been esti- funds which make investments in domestic equity mated using the NAV per share of the investments. The securities, warrants or other securities that are generally investments in this class are redeemable quarterly. not actively traded at the time of investment. These investments are focused on several industries including, (d) This category is comprised of long-short equity hedge but not limited to, insurance, financial services, con- funds investing in securities of U.S. companies as well as sumer-related, and communications. The fair values of securities of developed and emerging countries. The these investments have been estimated using the NAV of geographical allocation among U.S. equity funds, global NAS’ ownership interest in partners’ capital. These funds and emerging market funds is approximately 42%, investments can never be redeemed with the funds. 42% and 16%, respectively. Each of these funds buys Instead, the nature of the investments in this class is that securities long and sells short securities with the ability to distributions are received through liquidation of the use leverage. These funds can also invest in derivative underlying assets of the funds. It is estimated that the instruments such as forward, futures and options con- underlying assets of the funds will be liquidated over 1 to tracts. The fair values of the investments in this category 2 years. have been estimated using the net asset value per share of 53

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(5) PROPERTY AND EQUIPMENT (7) DEFERRED REVENUE Property and equipment as of December 31, 2010 and Deferred revenue consisted of the following as of 2009, is comprised of the following (dollars December 31, 2010 and 2009 (dollars in thousands): in thousands): 2010 2009 Advances from private grants and contract 2010 2009 sponsors $15,828 $22,257 Land $ 29,689 $ 29,689 Advances from U.S. government sponsors 7,320 4,692 Furniture and equipment 35,030 36,195 Publication subscriptions and other 4,859 5,131 Buildings and improvements 109,518 109,396 Total deferred revenue $28,007 $32,080 Construction in progress 14,207 5,568 Software development in process 5,062 1,255 Leasehold improvements 4,635 7,437 (8) LINE OF CREDIT 198,141 189,540 Less accumulated depreciation and NAS is party to a $22 million unsecured line of credit amortization (63,188) (62,064) from Bank of America, which bears interest at LIBOR Total property and equipment, net $ 134,953 $ 127,476 plus 0.65% and expires on August 30, 2011. Effective November 1, 2010, NAS is also party to a $15 million unsecured line of credit from Wells Fargo, which bears (6) CONTRIBUTIONS RECEIVABLE interest at LIBOR plus 0.65% and expires on October 31, 2011. Interest expense related to the lines of credit for the Contributions not yet collected are included in contribu- years ended December 31, 2010 and 2009, was approxi- tions and other receivables (current) and contributions mately $84,000 and $68,500, respectively. receivable (long-term) in the statements of financial position, and mature as follows (dollars in thousands): (9) TEMPORARILY RESTRICTED NET Years ending December 31: ASSETS 2011 $ 11,156 2012 7,110 Temporarily restricted net assets were available for the following purposes as of December 31, 2010 and 2009 2013 4,164 (dollars in thousands): 2014 3,764 2015 3,901 2010 2009 Thereafter 5,481 Sponsored research and advisory programs $156,557 $147,050 35,576 Less discount at rates from 3% to 6.75% to estimated General endowment 79,400 69,107 net present value (2,185) Prizes and awards 26,385 22,784 Less allowance for uncollectible contributions (701) Woods Hole facility 3,360 2,793 32,690 Total temporarily restricted net assets $265,702 $241,734 Less current portion (10,455) Total contributions receivable, long-term $ 22,235 Temporarily restricted net assets were released from restriction for the following purposes during the years At December 31, 2009, the discount on contributions ended December 31, 2010 and 2009 (dollars receivable was approximately $3.0 million at rates in thousands): ranging from 3% to 6% and the allowance for uncollect- ible contributions was approximately $453,000. 2010 2009 Sponsored research and advisory programs $ 32,040 $ 30,788 General endowment 4,927 5,732 Prizes and awards 799 728 Woods Hole facility 372 390 Total temporarily restricted net assets $ 38,138 $ 37,638 released from restriction 54

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(1) The duration and preservation of the endowment (10) ENDOWMENT fund; (2) The purposes of the institution and the endowment (a) Permanently Restricted Net Assets fund; The income generated by permanently restricted net (3) General economic conditions; assets is available to support donor-specified programs. (4) The possible effect of inflation or deflation; As of December 31, 2010 and 2009, NAS held the (5) The expected total return from income and the following permanently restricted net assets, classified by appreciation of investments; the purpose for which the income is to be used (dollars in (6) Other resources of the institution; and thousands): (7) The investment policy of the institution. 2010 2009 Sponsored research and advisory programs $113,253 $110,122 Return Objectives and Strategies Prizes and awards 5,116 5,240 NAS has adopted an investment and spending policy for Total permanently restricted net assets $118,369 $115,362 endowment assets that is designed to provide a predict- able stream of funding to programs supported by the endowment while seeking to protect the real purchasing (b) Endowment Assets power of the assets from inflation. Accordingly, NAS has The NAS endowment consists of approximately 110 adopted guidelines which feature a material commitment individual funds established to support general operations, to equity and equity-like investments. sponsored research and advisory programs, prizes and The asset allocation guidelines are as follows: awards, and the operations of the Woods Hole facility. The endowment is comprised solely of donor-restricted Guideline endowment funds. The investments of the endowment are Asset Category % included in the NAS long-term investment pool, as described in note 3. U.S. large stocks 25% U.S. small-mid stocks 12% Interpretation of Relevant Law Non-U.S. stocks (developed) 20% Non-U.S. stocks (emerging) 8% NAS has interpreted the District of Columbia “Uniform Real estate stocks 5% Prudent Management of Institutional Funds Act of 2007” Total equity 70% (the Act) as requiring NAS, absent explicit donor stipulations to the contrary, to act in good faith and with U.S. fixed/cash 12% the care that an ordinarily prudent person in a like Non-U.S. fixed 3% position would exercise under similar circumstances in making determinations to appropriate or accumulate Total fixed 15% endowment funds, taking into account both its obligation Hedge funds and alternative to preserve the value of the endowment and its obligation investments 15% to use the endowment to achieve the purposes for which it Total 100% was donated. NAS classifies as permanently restricted net assets (a) the original value of gifts donated to the permanent endowment, (b) the original value of subse- NAS has adopted a spending policy that limits the annual quent gifts to the permanent endowment, and spending to 5% of the three-year average fair value of the (c) accumulations to the permanent endowment required participating funds in the endowment portfolio. This is by the applicable donor gift instrument. The remaining consistent with NAS’ objective to maintain the purchas- portion of donor-restricted endowment funds that are not ing power of the endowment assets held in perpetuity as classified as permanently restricted are classified as well as to provide additional real growth through new temporarily restricted net assets until those amounts are gifts and investment return. appropriated for expenditure by NAS. In making a determination to appropriate or accumulate, NAS adheres to the standard of prudence prescribed by the Act and considers the following factors: 55

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Changes in endowment assets for the fiscal year ended December 31, 2010 are as follows (dollars in thousands): Temporarily Permanently Unrestricted Total Restricted Restricted Endowment assets, January 1, 2010 $ (214) $ 152,382 $ 111,055 $ 263,223 Investment return: Interest and dividend income - 5,021 - 5,021 Net gain on investments 214 34,530 - 34,744 Total investment return 214 39,551 - 39,765 Contributions - - 3,147 3,147 Amounts appropriated for expenditure - (11,074) - (11,074) Other changes: 2009 appropriation expended in 2010 - (2,604) - (2,604) Unspent purpose restricted appropriations - 2,443 - 2,443 Accrued expenses withdrawn in 2011 - 170 - 170 Endowment assets, December 31, 2010 $ - $ 180,868 $ 114,202 $ 295,070 Changes in endowment assets for the fiscal year ended December 31, 2009 are as follows (dollars in thousands): Temporarily Permanently Unrestricted Total Restricted Restricted Endowment assets, January 1, 2009 $ (2,412) $ 112,988 $ 108,524 $ 219,100 Investment return: Interest and dividend income - 4,822 - 4,822 Net gain on investments 2,198 46,101 - 48,299 Total investment return 2,198 50,923 - 53,121 Contributions - - 2,531 2,531 Amounts appropriated for expenditure - (11,089) - (11,089) Other changes: 2008 appropriation expended in 2009 - (3,044) - (3,044) Unspent purpose restricted appropriations - 2,022 - 2,022 Accrued expenses withdrawn in 2010 - 582 - 582 Endowment assets, December 31, 2009 $ (214) $ 152,382 $ 111,055 $ 263,223 Funds with Deficiencies unrestricted net assets. These deficiencies were primarily a result of unfavorable market fluctuations From time to time, the fair value of assets associated that occurred shortly after the investment of new with individual donor-restricted endowment funds may permanently restricted contributions. Subsequent gains fall below the original value of the gift donated to the that restored the fair value of the assets of the endow- permanent endowment. Deficiencies of this nature are ment fund to the required level were classified as an reported as unrestricted net assets. At December 31, increase in unrestricted net assets. 2010, there were no endowment funds with a fair value below the original value of the gift. At December 31, 2009, NAS had deficiencies of $214,000 reported as 56

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NAS has a cumulative net overrecovery of approxi- (11) PROGRAM EXPENSES mately $4.8 million and $2.4 million as of Decem- ber 31, 2010 and 2009, respectively. The overrecovery Program expenses for the years ended December 31, is included in the deferred revenue balance in the 2010 and 2009 are summarized as follows (dollars in statements of financial position. thousands): 2010 2009 (13) BUILDING PROJECT AND Transportation Research Board $112,445 $ 97,045 FINANCING Policy and Global Affairs 55,117 51,111 Institute of Medicine 32,116 27,519 (a) Building Project Revenue Bonds Earth and Life Sciences 21,371 22,123 Engineering and Physical Sciences 18,250 21,043 In January 1999, the District of Columbia issued Series Behavioral and Social Sciences and 1999A, Series 1999B, and Series 1999C tax-exempt 12,042 10,268 Education Proceedings of the National Academy of revenue bonds in the total amount of $130,960,000 on Sciences 11,762 13,425 behalf of NAS. Proceeds from the sale of the revenue National Academy Press 4,412 4,351 bonds financed the cost of the acquisition of National Academy of Engineering 3,158 4,079 44,250 square feet of land and related construction of an Koshland Science Museum 1,850 1,616 office building, as well as paid certain costs of issuing NAS 7,834 8,129 the bonds. This building consolidates most of NAS’ program activities into one location. The facility was Total program expenses $280,357 $260,709 occupied in July 2002. In June 2008, the District of Columbia issued Series (12) RECOVERY OF INDIRECT COSTS 2008A tax-exempt revenue bonds in the amount of $66,325,000 on behalf of NAS. The proceeds were used NAS receives indirect cost recovery on its federal to refund the Series 1999B and Series 1999C revenue contracts and grants. An overhead assessment is applied bonds, as well as pay certain costs of issuing the bonds. to direct salaries, accrued leave, fringe benefits, and services provided by outside contractors (e.g., tempo- In April 2009, the District of Columbia issued Series rary personnel agencies, consultants) on NAS property. 2009A tax-exempt revenue bonds in the amount of A general and administrative assessment (G&A) is $57,500,000 on behalf of NAS. The proceeds were used applied to direct costs and overhead less subcontract to refund the Series 1999A revenue bonds, as well as costs and stipends. Therefore, both the overhead and pay certain costs of issuing the bonds. G&A rates are applied to projects incurring direct salaries and other direct costs such as travel. If a In May 2010, the District of Columbia issued Series program does not require direct salaries, such as a travel 2010A tax-exempt revenue bonds in the amount of grant program, a subcontract/flow-through administra- $59,550,000 on behalf of NAS. These bonds were sold tion rate is applied. Certain off-site work (not performed to finance the cost to restore the NAS headquarters on NAS property) is assessed reduced overhead rates. building on Constitution Avenue in Washington, D.C. and pay for certain costs of issuance. The restoration is NAS bills for indirect cost recovery throughout the year expected to be completed in April 2012. based on negotiated rates. At the end of each year, NAS compares actual expenses incurred in each of its cost The bond proceeds are held by a Trustee and invested in pools to the amounts recovered based on its billing U.S. government obligations or funds of U.S. govern- rates. The difference is recorded as its indirect cost ment obligations. The Trustee reimburses NAS and carryforward. If NAS over recovers on its indirect costs third-party vendors for expenditures related to the during the year, a liability is recorded. If NAS under restoration project. recovers, a receivable is recorded. 57

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The carrying value of bonds payable in the financial NAS is obligated under the revenue bonds as follows statements was approximately $3.7 million greater than (dollars in thousands): fair value as of December 31, 2010 and was approxi- mately equal to fair value on December 31, 2009. 2010 2009 Series 2008A revenue bonds, term, at Interest expense on the bonds payable for 2010 and flexible rates (0.3% in 2010 and 0.6% in 2009) maturing at various dates 2009 totaled $2.0 million and $1.5 million, respectively. from January 1, 2029 through 2039 $ 66,325 $ 66,325 Of this amount, $1.4 million was capitalized as part of Series 2009A revenue bonds, term, at the building restoration project for 2010. No interest flexible rates (0.3% in 2010 and 0.4% expense was capitalized for 2009. in 2009) maturing at various dates from January 1, 2010 through 2028 56,220 57,500 Series 2010A revenue bonds, serial, with (b) Interest Rate Swaps interest rates ranging from 3.0% to 5.0%, maturing at various dates from In October 1999, NAS entered into a swap agreement, April 1, 2013 through 2030 29,385 - with an effective date of February 1, 2000, relating to Series 2010A revenue bonds, term, 13,205 - Interest rate 5%, maturing April 1, 2035 the $66 million face amount of its Series 1999A revenue Interest rate 5%, maturing April 1, 2040 16,960 - bonds. The agreement provides for NAS to receive Total bonds, at face value 182,095 123,825 4.97% in interest on a notional amount of $65 million Plus unamortized premium 1,244 - and to pay interest at a floating rate option based on the Total bonds payable 183,339 123,825 weekly interest rate resets of tax-exempt variable-rate Less current portion (included in other issues per the SIFMA Municipal Swap Index. NAS (2,137) (1,280) current liabilities) amended the agreement for the 2005 – 2020 period by Bonds payable, long-term $ 181,202 $ 122,545 agreeing to give up the benefit of any 30-day period during which the SIFMA index remains below 2.25% for the entire 30 days. Each time this occurs, the rate on The serial and term bonds represent unsecured general the swap portfolio reverts to the fixed rate noted above obligations of NAS. for that month only. Interest on the 2008A and 2009A bonds is payable NAS entered into this fixed-to-variable swap agreement monthly. Interest on the 2010A bonds is payable to manage its exposure to interest rate changes. The semiannually every April 1 and October 1. fixed-rate debt obligations exposed NAS to variability in the cost recovery stream due to changes in interest The term bonds maturing on April 1, 2035, and April 1, rates. NAS recovers the costs of borrowing through a 2040, are subject to mandatory redemption by operation capital investment incentive rate that is set by the of sinking fund installments. Installment payments for U.S. government and is tied to a variable index. If the term bond maturing April 1, 2035, begin on April 1, interest rates increase, the capital investment incentive 2031, and range from $2.4 to $2.9 million per year recovery increases. through the maturity date. Installment payments for the term bond maturing April 1, 2040, begin on April 1, Conversely, if interest rates decrease, the capital 2036, and range from $3.1 to $3.8 million per year investment incentive recovery decreases. Therefore, through the maturity date. NAS entered into a derivative instrument that ties the fixed-rate debt to a variable index to manage fluctua- Scheduled maturities and sinking fund requirements are tions in cash flows resulting from interest rate risk. By as follows (dollars in thousands): using derivative financial instruments to hedge expo- sures to changes in interest rates, NAS exposes itself to Years ending December 31: credit risk and market risk. Credit risk is the failure of 2011 $ 2,000 the counterparty to perform under the terms of the 2012 2,100 derivative contract. When the fair value of a derivative 2013 3,325 contract is positive, the counterparty owes NAS, which 2014 3,475 creates credit risk for NAS. When the fair value of a 2015 3,645 derivative contract is negative, NAS owes the counter- party, and therefore, it does not possess credit risk. NAS Thereafter 167,550 minimizes the credit risk in derivative instruments by $ 182,095 entering into transactions with high-quality counterpar- ties. 58

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In May 2009, NAS entered into an additional swap tively. The note bears interest at 30-day LIBOR plus agreement as a result of a counterparty exercising a 40 basis points. The interest rate at December 31, 2010 swaption related to the Series 1999A Revenue Bonds. and 2009 was 0.66% and 0.63%, respectively. The variable-to-fixed swap requires 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 plus (15) EMPLOYEE BENEFITS 0.41%. The counterparty paid NAS $1.8 million upon execution of the swaption in 2009. (a) Retirement Plans NAS entered into this variable-to-fixed swap agreement NAS has a noncontributory defined contribution in order to preserve the synthetic variable rate achieved retirement plan covering substantially all of its employ- through the 1999 swap agreement once the fixed-rate ees (based on certain benefit eligibility requirements). Series 1999A bonds were refunded with the variable- The plan is intended to qualify under Section 401(a) of rate Series 2009A bonds. the Internal Revenue Code and uses Teachers Insurance and Annuity Association/College Retirement Equities As required by the Derivatives and Hedging topic of the Fund (TIAA/CREF) group retirement annuity contracts FASB ASC, the fair value of the fixed-to-variable swap as the investment vehicle. Participants in this plan vest and the variable-to-fixed swap are recorded in the NAS immediately. NAS has received a favorable determina- financial statements. tion letter from the IRS on the qualification of this plan under Section 401(a) of the Internal Revenue Code. Accordingly, with regard to the fixed-to-variable interest rate swap, NAS recorded a gain on the change In addition, NAS has a voluntary employee contribution in the fair value of its swap agreement of $17,000 for retirement plan that is funded solely by employee the year ended December 31, 2010 and a loss of contributions made on a pretax salary-reduction basis $902,000 for the year ended December 31, 2009, which under Section 403(b) of the Internal Revenue Code. The is included in other income in the accompanying investment vehicles under this voluntary plan are statements of activities. The fair value of the interest retirement annuity contracts issued by TIAA/CREF and rate swap is recorded as an asset of $17,000 as of mutual funds offered by the Vanguard Group, Inc. December 31, 2010 and is included in other assets in the statements of financial position. The fair value of this Pension expense for the years ended December 31, 2010 interest rate swap was recorded as a liability of $35,000 and 2009, amounted to approximately $12.0 million and as of December 31, 2009, and is included in other $11.2 million, respectively. The NAS policy is to fund long-term liabilities in the statements of financial pension benefits as they are earned. The NAS normal position. retirement age is 60, but there is no mandatory age for retirement. Pertaining to the swaption and resultant vari- able-to-fixed interest rate swap, NAS recorded a loss on (b) Deferred Compensation the change in the fair value of approximately $1.3 million for the year ended December 31, 2010 and NAS holds long-term investments as part of a frozen a gain of $3.6 million for the year ended December 31, deferred compensation arrangement for certain employ- 2009. The gain and loss are included in other income in ees. The fair value of these investments was approxi- the statements of activities. The fair value of the swap is mately $2.3 million and $2.4 million as of Decem- recorded as a liability of $10.5 million and $9.2 million ber 31, 2010 and 2009, respectively, which is reported at December 31, 2010 and 2009, respectively, and is within other assets in the statements of financial included in other current liabilities and other long-term position. The related obligation is included in accrued liabilities. employee benefits in the statements of financial position. (c) Postretirement and Postemployment Benefits (14) NOTE PAYABLE NAS provides certain health and life insurance benefits During 2006, NAS entered into a loan agreement with for employees retired due to length of service. All Bank of America for an amount up to $5 million. The benefit-eligible employees may become eligible for principal balance of this note is payable in equal service retiree benefits if they reach age 60 while monthly installments until January 1, 2012. On working for NAS and complete 5 years of service in a December 31, 2010 and 2009, the principal balance was benefit-eligible status for medical and life insurance approximately $0.8 million and $1.5 million, respec- benefits. In addition, certain health and life insurance 59

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benefits are provided for employees retired due to cost over the next fiscal year for the postretirement disability. A benefit-eligible employee may become benefit plan are as follows (dollars in thousands): eligible for disabled retiree benefits if deemed totally disabled under NAS’ long-term disability insurance or if 2010 2009 they are eligible for disability benefits from the Social Security Administration. Life insurance benefits are Prior service cost $ 210 $ 210 provided based on coverage at date of disability and Recognized actuarial loss 302 190 health insurance may be continued if the disabled retiree Recognized net initial obligation 26 26 had participated in an NAS health insurance plan for Total $ 538 $ 426 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 The following table presents the changes in benefit retirees. Medicare supplement insurance is not experi- obligations, changes in plan assets, funded status, and ence rated. The retiree welfare benefit plan is contribu- the components of net periodic benefit cost for the year tory for health insurance purposes for employees who ended December 31, 2010 and 2009 (dollars in thou- retired on or after January 1, 1990. Participant contribu- sands): tions for health insurance are based on a percentage of the monthly premium paid by NAS (from 25% to 2010 2009 100%). The participant contribution is also based on Change in benefit obligations: their date of retirement, length of service and choice of Benefit obligation, January 1 $ 19,914 $ 18,592 health insurance carrier. Service cost 625 613 Interest cost 1,168 1,088 NAS has elected to recognize the initial postretirement Plan participants contributions 105 101 benefit obligation over a period of 20 years. The Actuarial loss 1,307 170 accrued postretirement benefit obligation is reported in Benefits paid (635) (650) accrued employee benefits in the statements of financial Benefits obligation, December 31 22,484 19,914 position. Change in plan assets, combined: Postretirement changes other than net periodic benefit Fair value of plan assets, January 1 17,701 12,200 cost are as follows (dollars in thousands): Actual return on plan assets 1,593 2,550 Employer contributions 891 2,951 2010 2009 Fair value of plan assets, December 31 20,185 17,701 Net actuarial loss (gain) $ 1,041 $ (1,464) $ (2,299) $ (2,213) Funded status Recognized net actuarial loss (190) (469) Components of net periodic benefit Recognized prior service cost (210) (210) cost: Recognized net initial obligation (26) (26) Service cost $ 625 $ 613 Total $ 615 $ (2,169) Interest cost 1,168 1,088 Expected return on plan assets (1,328) (915) Recognized prior service cost 210 210 Items not yet recognized as a component of net periodic Recognized actuarial loss 190 469 benefit cost at December 31, 2010 and 2009 are as Recognized net initial obligation 26 26 follows (dollars in thousands): Net periodic benefit cost $ 891 $ 1,491 2010 2009 The assumptions used to determine net periodic benefit Net actuarial loss $ 4,365 $ 3,513 cost for years ended December 31, 2010 and 2009 are as Prior service cost 932 1,142 follows: Unrecognized net initial obligation 90 117 Total $ 5,387 $ 4,772 2010 2009 Discount rate 6.00% 6.00% Expected long-term return on plan assets 7.50% 7.50% The estimated amounts, measured at year-end, that are expected to be recognized in the net periodic benefit 60

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The assumptions used to calculate the accumulated The following table presents the fair value hierarchy for postretirement benefit obligation for the years ended the postretirement benefit plan assets at December 31, December 31, 2010 and 2009 are as follows: 2010 (dollars in thousands): Fair value measurements 2010 2009 at December 31 using: Discount rate 5.25% 6.00% Fair Value Level 1 Level 2 Level 3 NAS postretirement benefit plan asset allocations at Financial Assets: December 31, 2010 and 2009, by asset class are as Retiree Welfare Benefit Plan investments: follows: Cash equivalents $ 1,034 $ 1,034 $ - $ - Bonds and notes 2010 2009 U.S. treasuries/ Cash 5% 3% gov. bonds 2,395 2,395 - - Mortgage-backed Bonds and notes 18% 22% 1,294 - 1,294 - securities Equity securities 77% 75% Corporate bonds 3,879 3,879 - - 100% 100% Equity securities U.S. small/mid cap 9,823 9,823 - - The investment objective of the Plan is to produce a rate Non-U.S. stocks of return over the long term that will provide for fund (developed countries) 1,760 1,760 - - growth, protect against the effect of inflation, and Total investments $20,185 $18,891 $ 1,294 $ - provide for some stability in different market environ- ments. The fund is diversified between fixed income and equity investments. With this diversification and investment in broader market funds, there is reasonable The following table presents the fair value hierarchy for assurance that no single security or class of securities the postretirement benefit plan assets at December 31, will have a disproportionate impact on the Plan assets. 2009 (dollars in thousands) The Plan assets are invested with a long-term growth Fair value measurements strategy, with a 70% equity guideline. at December 31 using: Fair The overall long-term rate of return was developed by Value Level 1 Level 2 Level 3 estimating the long-term real rate of return for the Financial Assets: Plan’s asset mix, while taking into account the effects of Retiree Welfare Benefit Plan investments: inflation. This estimate was developed by evaluating the history and similar asset allocation of the NAS Endow- Cash equivalents $ 519 $ 519 $ - $ - ment. Bonds and notes U.S. treasuries/ gov. bonds 2,505 2,505 - - Mortgage-backed 911 - 911 - securities Corporate bonds 4,109 3,560 549 - Equity securities U.S. small/mid cap 7,408 7,408 - - Non-U.S. stocks (developed countries) 2,249 2,249 - - Total investments $17,701 $16,241 $ 1,460 $ - The methods and assumptions used to estimate the fair value of each class of financial instrument are further discussed in footnote 4, Fair Value Measurements. 61

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NAS expects to contribute to the Plan the actuarially those for which an entity has a legal obligation to determined net periodic cost for 2011, which is perform an asset retirement activity. However, the approximately $849,000. timing and/or method of settling the obligation are conditional on a future event that may or may not be The following benefit payments, which reflect future within the control of the entity. services, are expected to be paid in future years as noted, as of December 31, 2010 (dollars in thousands): 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 Years ending December 31: other hazardous materials in one of its office buildings. 2011 $ 927 During 2010, NAS remediated a significant portion of 2012 1,104 the asbestos and hazardous materials with the remaining 2013 1,233 remediation expected to occur in early 2011. NAS 2014 1,323 recognized a gain on the settlement of the asset retirement obligation of $785,000 for the year ended 2015 1,432 December 31, 2010, which is included in other income 2016-2020 7,670 in the statement of activities. For the years ended $ 13,689 December 31, 2010 and 2009, NAS has a liability of $60,000 and $1,840,000 included in other long-term liabilities in the statements of financial position. The measurement date of the plan assets and benefit Accretion expense of $0 and $84,000 were included in obligations for 2010 and 2009 is December 31, 2010 management and general expense for the years ended and 2009, respectively. December 31, 2010 and 2009, respectively. The trend rate for growth in healthcare costs used in calculating the accumulated postretirement benefit (17) RELATED PARTY TRANSACTIONS obligation was 8.5% for under age 65 and 6.5% for over age 65 declining gradually to 5% in the year 2017 and 2013 for under age 65 and over age 65, respectively for The NAS Council has authorized two agreements year ended December 31, 2010. The trend rate for providing noninterest-bearing, collateralized advances growth in healthcare costs was 9.0% for under age 65 to two employees in connection with the purchase of and 7.0% for over age 65 for the year ended Decem- each employee’s residence. The agreements between the ber 31, 2009, declining gradually to 5% in the year parties were executed in May 2005 and May 2007. They 2019. The healthcare cost trend rate assumption has a each provide that the repayment obligation will be significant impact on the postretirement benefit costs adjusted to allocate to each party its proportional share and obligations. The effect of a 1% change in the of the appreciation or depreciation in the value of the assumed healthcare cost trend rate at December 31, residence, which is based on the relative financing 2010, would have resulted in an estimated $2.4 million percentage provided by each party. The agreements will increase or $2.0 million decrease in the postretirement terminate upon pay-back of the advance, sale of the benefit obligation and an estimated $226,000 increase or property, or the end of each individual’s employment $186,000 decrease in the 2010 benefit expense. with NAS, which will not exceed 12 years. The estimated present value of the receivables is $3.0 The effect of a 1% change in the assumed healthcare million and $3.3 million at December 31, 2010 and cost trend rate at December 31, 2009, would have 2009, respectively, and is included in other assets in the resulted in an estimated $2.0 million increase or statements of financial position. $1.7 million decrease in the postretirement benefit obligation and an estimated $215,000 increase or $177,000 decrease in the 2009 benefit expense. (18) COMMITMENTS AND CONTINGENCIES (16) CONDITIONAL ASSET (a) Leases RETIREMENT OBLIGATION NAS is committed to several noncancelable operating The Asset Retirement Obligation subtopic of leases for office space. Future minimum rental pay- FASB ASC requires a liability to be recorded if the fair ments due under noncancelable operating leases are as value of the obligation to retire an asset can be reasona- follows (dollars in thousands): bly estimated. Asset retirement obligations include 62

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(c) Litigation Years ending December 31: 2011 $ 3,120 NAS is involved in two litigation matters. While the 2012 2,234 ultimate outcome of the litigation is uncertain, NAS 2013 1,730 management believes that it has a strong legal position, 2014 1,776 intends to vigorously defend against any liability, and has concluded that the probable outcome will not have a 2015 1,822 material impact on NAS. Thereafter 1,522 $ 12,204 (19) RISKS AND UNCERTAINTIES Rental expense amounted to approximately $3.0 million NAS invests in various investment securities. Invest- and $2.6 million for years ended December 31, 2010 ment securities are exposed to various risks such as and 2009, respectively. interest rate, market and credit risks. Due to the level of (b) Contingencies risk associated with investment securities, it is at least reasonably possible that changes in the values of NAS receives a portion of its revenues directly or investment securities will occur in the near term and indirectly from federal government grants and contracts, that such changes could materially affect the amounts all of which are subject to audit by the Defense Contract reported. Audit Agency, which has completed its examinations through December 31, 2005. A contingency exists relating to unexamined periods and final settlements of (20) SUBSEQUENT EVENT examined periods to refund any amounts received in excess of allowable costs. Management is of the opinion NAS has evaluated subsequent events from the balance that no material liability will result from such audits. sheet date through May 25, 2011, the date at which the financial statements were available to be issued, and determined that there are no other items to disclose. 63

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OFFICERS Ralph J. Cicerone, President Barbara A. Schaal, Vice President John I. Brauman, Home Secretary Michael T. Clegg, Foreign Secretary Jeremiah P. Ostriker, Treasurer FINANCE COMMITTEE Jeremiah P. Ostriker, Chair Elwyn R. Berlekamp Ralph J. Cicerone David Donoho Robert Engle Ronald L. Graham Maxine Singer IOM Representative: Larry Shapiro BUDGET AND INTERNAL AFFAIRS COMMITTEE Jeremiah P. Ostriker, Chair Rita R. Colwell Robert Dynes David Ginsburg Barbara A. Schaal Susan Taylor AUDITING COMMITTEE Jerry P. Gollub, Chair George Gloeckler Susan Gottesman Ronald L. Graham Robert H. Wurtz FINANCIAL MANAGEMENT STAFF Didi Salmon, Chief Financial Officer Craig Meyer, Controller 64