Report of the Treasurer for the Year Ended December 31, 2007 (2008)

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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 40 See accompanying notes to financial statements. 

NATIONAL ACADEMY OF SCIENCES Statements of Activities Years ended December 31, 2007 and 2006 (Dollars in thousands) 2007 2006 Temporarily Permanently Temporarily Permanently Unrestricted restricted restricted Totals Unrestricted restricted 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. 41 

NATIONAL ACADEMY OF SCIENCES Statements of Cash Flows Years 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 42 See accompanying notes to financial statements. 

NATIONAL ACADEMY OF SCIENCES and the relevant professions. IOM was established as a separate membership organization within NAS. The Notes to financial activities and results of IOM are included in the NAS financial statements. Financial Statements (d) National Academy of Engineering December 31, 2007 and 2006 The National Academy of Engineering (NAE) was established in 1964 under the charter of NAS as a related parallel organization, autonomous in its governance, (1) ORGANIZATION AND RELATED administration, and the selection of its members. NAE ENTITIES shares with NAS the responsibility for advising the (a) National Academy of Sciences federal government on scientific issues. The NAE conducts both independent program activities and The National Academy of Sciences (NAS) was formed activities through the NRC. The results of these activities under a charter that was passed as an Act of Incorporation are included in the NAS financial statements. by the United States Congress and signed into law on March 3, 1863. NAS operates as a private cooperative (e) National Academy of Engineering Fund society of distinguished scholars engaged in scientific or engineering research, dedicated to the furtherance of The National Academy of Engineering Fund (NAEF) is a science and its use for the general welfare. NAS is exempt separately incorporated not-for-profit organization from federal income taxes under Section 501(c)(3) of the established and controlled by NAE to raise funds to Internal Revenue Code, except for unrelated business support its goals. The financial activities and results of income. 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. NAS and NAEF nary problems facing American society, NRC is organ- are 50 – 50 joint venturers of TNAC, and therefore share ized into the following five major divisions responsible control. The financial position and results of TNAC are for most study activities: not consolidated in the NAS financial statements. • Behavioral and Social Sciences and Education In May 2007, NAS began managing the operations of the Beckman Center. TNAC contributed $851,000 to the • Earth and Life Studies NRC for the year ended December 31, 2007, towards the • Engineering and Physical Sciences operation of the Beckman Center. In addition, in March • Policy and Global Affairs Division 2007, TNAC contributed $11.7 million to the NRC to be • Transportation Research Board spent on programs conducted in whole or in part at the Beckman Center. NRC activities are under the control of the NAS govern- ance structure, and therefore are included in the NAS financial statements. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (c) Institute of Medicine (a) Basis of Accounting The Institute of Medicine (IOM), established in 1970, conducts studies of policy issues related to health and Net assets, revenues, gains, and losses are classified based medicine. IOM issues position statements on these on the existence or absence of donor-imposed restrictions. policies, cooperates with the major scientific and Accordingly, net assets of NAS are classified and professional societies in the field, identifies qualified reported as follows: individuals to serve on study groups in other organiza- tional units, and disseminates information to the public 43 

Permanently restricted – Net assets subject to donor- Gifts of land, buildings, or equipment are reported as imposed stipulations that they be maintained in perpetuity unrestricted net assets unless explicit donor stipulations by NAS. Generally, the donors of these assets permit specify how the donated assets must be used. Temporary NAS to use all or part of the income earned on related restrictions on gifts that must be used to acquire long- investments for general or specific purposes. lived assets are released in the period in which the assets are acquired or placed in service. Temporarily restricted – Net assets subject to donor- imposed stipulations that may or will be met either by Allowances are recorded for estimated uncollectible actions of NAS and/or the passage of time. When a donor contributions based upon management’s judgment and restriction expires, temporarily restricted net assets are analysis of the credit worthiness of the donor, past reclassified to unrestricted net assets. collection experience, and other relevant factors. Contri- butions to be received after one year are discounted at an Unrestricted – Net assets arising from exchange transac- appropriate rate commensurate with risks involved. tions and contributions not subject to donor imposed Amortization of the discount is recorded as additional stipulations. revenue and is used in accordance with donor imposed restrictions, if any, on the contributions. (b) Cash Equivalents NAS performs certain fundraising activities on behalf of NAS reports liquid, temporary investments purchased NAEF. NAS collected a total of $4.9 million and $4.0 with original maturities of three months or less as cash million in 2007 and 2006, respectively, on behalf of equivalents. NAEF. NAS disbursed $4.9 million and $3.9 million to NAEF from these collected amounts in 2007 and 2006, (c) Investments respectively. Amounts collected but not yet remitted to Investments are stated at fair value. The fair value of all NAEF are reported as assets and liabilities in the NAS debt and equity securities with a readily determinable fair financial statements. value are based on quotations obtained from national security exchanges. Alternative investments, consisting (e) Contracts and Grants of hedge funds and private placement equities, which are The majority of NAS activities are performed under cost- not readily marketable, are carried at estimated fair values reimbursable contracts with the U.S. government. Federal as provided by the investment managers. Management sponsors individually providing more than 10% of NAS reviews and evaluates the values provided by the revenues are summarized below: investment managers and agrees with the valuation Percentage of methods and assumptions used in determining the fair NAS revenues value of the alternative investments. Federal agency sponsor 2007 2006 Department of Transportation 33% 31% Investments in real estate mortgages are recorded at cost, Department of Health and Human Services 9% 11% which approximates fair value, and consist of mortgages on certain administrative facilities that NAS occupies. NAS records federal contracts as exchange transactions, recognizing revenue as recoverable costs are incurred. Changes in the fair 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. 44 

(g) Fair Value of Financial Instruments (k) Use of Estimates The carrying value of bonds payable in the financial The preparation of these financial statements in confor- statements was less than their fair value by approximately mity with U.S. generally accepted accounting principles $2.4 million and $3.2 million on December 31, 2007 and requires management to make certain estimates and 2006, respectively. assumptions. These estimates and assumptions may affect the reported amounts of assets and liabilities and disclo- NAS makes limited use of derivative financial instru- sures in the financial statements. Actual results could ments for the purpose of managing interest rate risks. differ from those estimates. Current market pricing models are used to estimate fair values of interest rate swap agreements. The fair market (l) Reclassifications value of all other financial instruments in the financial Certain amounts from the prior year have been reclassi- statements approximates their reported carrying values. fied to conform to the current year presentation. (h) Inventories (m) New Accounting Standards Inventories are stated at the lower of cost or net realizable value and include both work-in-process and finished On January 1, 2007, NAS adopted the provisions of goods related to publication activities. The majority of FASB Interpretation No. 48, Accounting for Uncertainty NAS publication inventories and supplies reside with an in Income Taxes (FIN 48). FIN 48 requires that a tax NAS unit, the National Academy Press (NAP). NAP uses position be recognized or derecognized based on a “more the full absorption costing methodology in pricing likely than not” threshold. This applies to positions taken finished products. This methodology includes direct or expected to be taken in a tax return. The implementa- printing and related indirect costs. tion of FIN 48 had no impact on NAS’s statement of financial position or statement of activities. NAS does not (i) Property and Equipment believe its financial statements include any uncertain tax positions. Depreciation of NAS buildings and equipment is computed on a straight-line basis using the following As discussed in note 14, NAS adopted the provisions of lives: SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, effective • Buildings – 40 to 50 years December 31, 2007. • Building and leasehold improvements – lesser of the remaining life of the building or improvement • Furniture and equipment – 4 to 10 years (3) INVESTMENTS The Einstein Memorial sculpture is valued at cost and is Investments, which are reported at fair value (except as not depreciated. Construction-in-progress is not depreci- noted), consisted of the following as of December 31, ated until the related assets are placed in service. 2007 and 2006 (dollars in thousands): (j) Split-Interest Agreements 2007 2006 Short-term investments: Charitable gift annuity agreements are classified as other Cash equivalents $ 4,570 $ 7,640 assets in the statements of financial position. NAS pays Bonds and notes 29,477 23,540 periodically a fixed amount of the assets to the benefici- Equity securities 12,894 14,605 ary designated by the donor. Upon termination of an Total short-term investments $ 46,941 $ 45,785 annuity, the remainder interest in the assets is available for use by NAS as restricted or unrestricted in accordance Long-term investments: with the donor’s designation. At December 31, 2007 and 2006, NAS had assets of $3.0 million and $2.8 million, Pooled endowment and trust investments: respectively. NAS has recorded a liability of $1.4 million Cash equivalents $ 22,086 $ 19,519 and $1.5 million at December 31, 2007 and 2006, Bonds and notes 58,429 32,772 respectively, representing the present value of future cash Equity securities 264,824 252,744 payments to annuitants based on the annuitant’s life Real estate 13,597 17,726 expectancy. Hedge funds 65,487 69,197 Private placements 13,622 13,598 438,045 405,556 45 

(continued) 2007 2006 ended December 31, 2007 and 2006, respectively, and is Other long-term investments: comprised of the following (dollars in thousands): Cash equivalents 503 819 Bonds and notes 9,054 8,369 2007 2006 Equity securities 17,306 14,577 Interest and dividends income $ 27,828 $ 19,489 26,863 23,765 Net gain on investments 20,098 48,925 Total long-term investments $ 464,908 $ 429,321 Total investment income, net $ 47,926 $ 68,414 NAS received proceeds from the sale and leaseback of the Green/Harris facility of approximately $36 million in (4) PROPERTY AND EQUIPMENT 2000 (see note 12). Remaining proceeds were invested within other long-term investments and were available for Property and equipment as of December 31, 2007 and payments toward related obligations to the former 2006, is comprised of the following (dollars in thou- landlord. These payments concluded in 2007. sands): Vanguard equity funds comprised approximately $119 2007 2006 million and $142 million of the total equity securities Land $ 29,689 $ 29,689 funds at December 31, 2007 and 2006, respectively. Furniture and equipment 32,096 31,040 Buildings and improvements 109,063 108,608 At December 31, 2007 and 2006, real estate investments include shares of real estate investment trusts at fair value. Construction in progress 240 776 At December 31, 2006, real estate investments also Leasehold improvements 7,286 6,960 include real estate mortgages at cost. 178,374 177,073 Less accumulated depreciation and NAS invests a portion of its endowment in hedge funds. amortization (48,703) (41,658) The unrealized gain on these funds, which is included as a Total property and equipment, net $ 129,671 $ 135,415 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 (5) CONTRIBUTIONS RECEIVABLE and 2006, respectively. Contributions not yet collected are included in contribu- Private equity investments are comprised of limited tions and other receivables (current) and contributions partnership interests. NAS had remaining commitments at receivable (long-term) in the statements of financial December 31, 2007 and 2006, to provide approximately position and mature as follows (dollars in thousands): $5.2 million and $4.1 million, respectively, to these partnerships. Years ending December 31 2008 $ 12,093 As of December 31, 2007 and 2006, respectively, NAS 2009 5,358 held alternative investments with fair values of approxi- 2010 4,551 mately $79.1 million and $82.8 million. These fair values were estimated by the general partners of these invest- 2011 10,807 ment funds in the absence of readily ascertainable values 2012 5,266 at those dates. Thereafter 16,779 54,854 TNAC, a related entity, invests certain of its assets in the Less discount at rates from 3% to 5% to estimated NAS long-term investment pool. TNAC investments net present value (5,449) participate in the investment pool experience proportion- Less allowance for uncollectible contributions (208) ally with all other funds in this pool. The NAS obligation 49,197 to TNAC for these funds held in trust, which totaled Less current portion (11,885) approximately $11.8 million and $23.0 million as of Total contributions receivable, long-term $ 37,312 December 31, 2007 and 2006, respectively, is reported as funds held on behalf of others in the statements of financial position. At December 31, 2006, the discount on contributions receivable was approximately $6.8 million at rates Investment income is reported net of investment expenses ranging from 3% to 5%, and the allowance for uncollect- of approximately $566,000 and $472,000 for the years ible contributions was approximately $108,000. 46 

(6) DEFERRED REVENUE the purpose for which the income is to be used (dollars in thousands): Deferred revenue consisted of the following as of December 31, 2007 and 2006 (dollars in thousands): 2007 2006 2007 2006 Sponsored research and advisory programs $105,720 $104,177 Advances from private grants and contract Prizes and awards 5,114 5,113 sponsors $24,082 $21,383 Advances from U.S. government sponsors 2,663 2,604 Total permanently restricted net assets $110,834 $109,290 Publication subscriptions and other 4,669 3,659 Total deferred revenue $31,414 $27,646 (10) PROGRAM EXPENSES Program expenses for the years ended December 31, 2007 (7) LINE OF CREDIT and 2006, are summarized as follows (dollars in thou- sands): NAS is party to a $18 million unsecured line of credit from Bank of America which bears interest at LIBOR 2007 2006 plus 0.40% and expires on July 31, 2008. Interest expense related to the line of credit for the years ended December Transportation Research Board $ 65,179 $ 59,045 31, 2007 and 2006, was approximately $497,000 and Policy and Global Affairs 55,911 53,625 $445,000, respectively. Institute of Medicine 20,388 23,626 Earth and Life Sciences 19,435 20,247 Engineering and Physical Sciences 18,839 17,318 (8) TEMPORARILY RESTRICTED NET Behavioral and Social Sciences and Education 13,886 15,876 ASSETS Proceedings of the National Academy of Sciences 12,280 11,627 Temporarily restricted net assets were available for the National Academy Press 5,479 6,533 following purposes as of December 31, 2007 and 2006 National Academy of Engineering 4,950 6,240 (dollars in thousands): Koshland Science Museum 1,932 1,614 2007 2006 NAS and National Sciences Resource Sponsored research and advisory programs $203,182 $174,650 Center 6,885 5,905 Prizes and awards 30,088 27,243 Total program expenses $225,164 $221,656 Woods Hole facility 5,055 4,545 Total temporarily restricted net assets $238,325 $206,438 (11) RECOVERY OF INDIRECT COSTS NAS receives indirect cost recovery on its federal Temporarily restricted net assets were released from contracts and grants. An overhead assessment is applied restriction for the following purposes during the years to direct salaries, accrued leave, fringe benefits, and ended December 31, 2007 and 2006 (dollars in thou- services provided by outside contractors (e.g., temporary sands): personnel agencies, consultants) on NAS property. A 2007 2006 general and administrative assessment (G&A) is applied Sponsored research and advisory programs $ 32,989 $ 47,352 to direct costs and overhead less subcontract costs and Prizes and awards 658 759 stipends. Therefore, both the overhead and G&A rates are Woods Hole facility 344 580 applied to projects incurring direct salaries and other Total temporarily restricted net assets direct costs such as travel. If a program does not require released from restriction $ 33,991 $ 48,691 direct salaries, such as a travel grant program, a subcon- tract/flow-through administration rate is applied. Certain off-site work (not performed on NAS property) is (9) PERMANENTLY RESTRICTED NET assessed reduced overhead rates. ASSETS NAS bills for indirect cost recovery throughout the year The income generated by permanently restricted net based on negotiated rates. At the end of each year, NAS assets is available to support donor-specified programs. compares actual expenses incurred in each of its cost As of December 31, 2007 and 2006, NAS held the pools to the amounts recovered based on its billing rates. following permanently restricted net assets, classified by The difference is recorded as its indirect cost carryfor- 47 

ward. If NAS overrecovers on its indirect costs during the payments for the term bonds maturing January 1, 2019, year, a liability is recorded. If NAS underrecovers, a begin on January 1, 2013, and range from $2.1 to $2.8 receivable is recorded. million per year through the maturity date. Installment payments for the term bond maturing January 1, 2028, NAS has a cumulative net underrecovery of approxi- begin on January 1, 2020, and range from $2.9 to $4.3 mately $3.1 million and $2.4 million as of December 31, million per year through the maturity date. 2007 and 2006, respectively, which is included in the contracts receivable balance in the statements of financial Scheduled maturities and sinking fund requirements are position. as follows (dollars in thousands): Years ending December 31: (12) BUILDING PROJECT AND 2008 $ 1,645 FINANCING 2009 1,725 (a) Building Project Revenue Bonds 2010 1,810 2011 1,905 In January 1999, the District of Columbia issued 2012 2,000 $130,960,000 of tax-exempt revenue bonds on behalf of Thereafter 114,630 NAS. Proceeds from the sale of the revenue bonds financed the cost of the acquisition of 44,250 square feet $ 123,715 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 Interest expense on the bonds payable for 2007 and 2006 into one location. The facility was occupied in July 2002. totaled $5.3 million and $5.2 million, respectively. NAS is obligated under the revenue bonds as follows (b) Interest Rate Swaps (dollars in thousands): In October 1999, NAS entered into a swap agreement, with an effective date of February 1, 2000. This swap 2007 2006 agreement related to the $66 million face amount of its Series 1999A revenue bonds, serial, Series 1999A revenue bonds. The agreement provides for interest rate 5%, maturing at various dates from January 1, 2008 through NAS to receive 4.97% in interest on a notional amount of 2012 $ 9,085 $ 10,650 $65 million and to pay interest at a floating rate option Series 1999A revenue bonds, term: based on the weekly interest rate resets of tax exempt Interest rate 5%, due January 1, 2019 17,085 17,085 variable-rate issues per the BMA Municipal Swap Index. Interest rate 5%, due January 1, 2028 32,545 32,545 Series 1999B revenue bonds, term, at NAS entered into this swap agreement to manage its flexible rates (3.62% in 2007 and exposure to interest rate changes. The fixed-rate debt 3.37% in 2006) due January 1, 2039 32,500 32,500 Series 1999C revenue bonds, term, at obligations expose NAS to variability in the cost recovery variable rates (3.62% in 2007 and stream due to changes in interest rates. NAS recovers the 3.52% in 2006) due January 1, 2039 32,500 32,500 costs of borrowing through a capital investment incentive Total bonds, at face value 123,715 125,280 rate that is set by the U.S. government and is tied to a Less unamortized discount and premium (1,003) (1,006) variable index. If interest rates increase, the capital Total bonds payable 122,712 124,274 investment incentive recovery increases. Less current portion (included in other current liabilities) (1,645) (1,565) Conversely, if interest rates decrease, the capital invest- Bonds payable, long-term $121,067 $122,709 ment incentive recovery decreases. Therefore, NAS entered into a derivative instrument that ties the fixed-rate The serial and term bonds represent unsecured general debt to a variable index to manage fluctuations in cash obligations of NAS. flows resulting from interest rate risk. By using derivative financial instruments to hedge exposures to changes in Interest on all Series 1999A revenue bonds is payable interest rates, NAS exposes itself to credit risk and market semiannually every January 1 and July 1. Interest on the risk. Credit risk is the failure of the counterparty to 1999B and 1999C bonds is payable monthly. perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the The term bonds maturing on January 1, 2019, and January counterparty owes NAS, which creates credit risk for 1, 2028, are subject to mandatory redemption by opera- NAS. When the fair value of a derivative contract is tion of sinking fund installments. The installment negative, NAS owes the counterparty, and therefore, it 48 

does not possess credit risk. NAS minimizes the credit a monthly rate of $400,000) and a portion of the facility risk in derivative instruments by entering into transactions until 2007 (at a monthly rate of $200,000). with high-quality counterparties. The sale-leaseback transaction resulted in a gain of $6.8 NAS amended the agreement for the 2005-2020 period by million, of which $430,000 was deferred at December 31, agreeing to give up the benefit of any 30-day period 2006, and is reported within other current liabilities in the during which the BMA index remains below 2.25% for statements of financial position. The deferred gain was the entire 30 days. Each time this occurs, the rate on the fully recognized during 2007. swap portfolio reverts to the fixed rate noted above for that month only. At December 31, 2006, NAS had remaining lease payments with a present value of $2.8 million, which is NAS entered into a swaption agreement on August 21, included within other current liabilities in the statements 2007, that gives the counterparty the option to require of financial position. NAS completed remaining lease NAS to enter into an additional swap agreement related to payments in July 2007, under the original lease agreement the Series 1999A Revenue Bonds. If executed by the with the Trustee. 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 (13) NOTE PAYABLE 1-month LIBOR + 0.41%. The counterparty paid NAS a At December 31, 2005, NAS had a loan agreement of $10 premium of $2.2 million in advance to enter into this million with Bank of America, with a maturity date of agreement. July 31, 2010. Interest on the note was calculated at 30- Under Statement of Financial Accounting Standards No. day LIBOR plus 50 basis points and was payable 133 (SFAS 133), Accounting for Derivative Instruments monthly. In July 2006, NAS chose to repay this loan in and Hedging Activities, the fair value of the swap and full. swaption must be recorded in the NAS financial state- ments. Accordingly, for the year ended December 31, During 2006, NAS entered into a loan agreement with 2007, NAS recorded a loss on the change in the fair value Bank of America for an amount up to $5 million. The of its swap agreement of $185,000, and for the year ended principal balance of this note is payable in equal monthly December 31, 2006, NAS recorded a gain on the change installments until January 1, 2012. On December 31, 2007 in the fair value of its swap agreement of $708,000, which and 2006, the principal balance was approximately is included in other income in the accompanying state- $3.0 million and $3.8 million, respectively. The note ments of activities. The fair value of the interest rate swap bears interest at 30-day LIBOR plus 40 basis points. The was $1.7 million and $1.9 million as of December 31, interest rate at December 31, 2007, was 5.245%. 2007 and 2006, respectively, and is included in other assets on the statements of financial position. (14) EMPLOYEE BENEFITS The fair value of the swaption at December 31, 2007, is (a) Retirement Plans recorded as a liability of $4.3 million in other long-term liabilities and represents the estimated cost to NAS to NAS has a noncontributory defined contribution retire- cancel the agreement at the reporting date and is based on ment plan covering substantially all of its employees pricing models that consider interest rates and other (based on certain benefit eligibility requirements). The market factors. The change in the fair value of the plan is intended to qualify under Section 401(a) of the swaption is a net loss of approximately $2.2 million for Internal Revenue Code and uses Teachers Insurance and the year ended December 31, 2007, included in other Annuity Association/College Retirement Equities Fund income in the statements of activities. (TIAA/CREF) group retirement annuity contracts as the investment vehicle. Participants in this plan vest immedi- (c) Sale-Leaseback of Green/Harris Facility ately. NAS has received a favorable determination letter from the IRS on the qualification of this plan under In 1999, under a separate trust agreement, the Trustee, an Section 401(a) of the Internal Revenue Code. unrelated third party, held record legal title to the Green/Harris facility that was under lease by NAS for a In addition, NAS has a voluntary employee contribution portion of its operations. This trust agreement would have retirement plan that is funded solely by employee conveyed title to NAS in 2007. In 2000, NAS entered into contributions made on a pretax salary-reduction basis a contract with a third party to sell its future interest in the under Section 403(b) of the Internal Revenue Code. The property for approximately $36 million. NAS simultane- investment vehicles under this voluntary plan are ously agreed to lease back the entire facility until 2002 (at 49 

retirement annuity contracts issued by TIAA/CREF and shown as a plan amendment in the 2006 change in benefit mutual funds offered by the Vanguard Group, Inc. obligation. Pension expense for the years ended December 31, 2007 NAS has elected to recognize the initial postretirement and 2006, amounted to approximately $9.8 and $9.4 benefit obligation over a period of 20 years. The accrued million, respectively. The NAS policy is to fund pension postretirement benefit obligation is reported in accrued benefits as they are earned. The NAS normal retirement employee benefits on the statements of financial position. age is 60, but there is no mandatory age for retirement. In 2006, the Financial Accounting Standards Board issued (b) Deferred Compensation SFAS No. 158, Employers’ Accounting for Defined NAS holds long-term investments as part of a frozen Benefit Pension and Other Postretirement Plans, which deferred compensation arrangement for certain employ- NAS has adopted for the year ended December 31, 2007. ees. The fair value of these investments was approxi- This statement requires that an employer recognize the mately $4.1 million and $4.6 million as of December 31, funded status of its benefit plans in its statement of 2007 and 2006, respectively, which is reported within financial position and report the corresponding gains and other assets in the statements of financial position. The losses in its statement of activities. NAS reported the related obligation is included in accrued employee funded status of the accumulated postretirement benefit benefits in the statements of financial position. obligation of $1.8 million as a component of accrued employee benefits liability at December 31, 2007. NAS (c) Postretirement and Postemployment Benefits recorded the effect of adopting SFAS No. 158 of $604,000 for the year ended December 31, 2007. NAS provides certain health and life insurance benefits for employees retired due to length of service. All The effects of applying SFAS No. 158 on NAS’ financial benefit-eligible employees may become eligible for position as of December 31, 2007, were as follows: service retiree benefits if they reach age 60 while working for NAS and complete 5 years of service in a benefit- Before SFAS After SFAS eligible status for medical and life benefits. In addition, No. 158 No. 158 certain health and life insurance benefits are provided for Accrued employee benefits $ 5,275 $ 5,879 employees retired due to disability. A benefit-eligible Total liabilities 220,887 221,491 employee may become eligible for disabled retiree Total net assets 540,893 540,289 benefits if deemed totally disabled under NAS’ long-term disability insurance or if they are eligible for disability Items not yet recognized as a component of net periodic benefits from the Social Security Administration. Life benefit cost which are reported as effect of adoption of insurance benefits are provided based on coverage at date recognition provisions of FASB Statement No. 158 in of disability and health insurance may be continued if the 2007 are as follows (dollars in thousands): disabled retiree had participated in an NAS health insurance plan for 5 years at the date of disability. 2007 Insurance companies whose premiums are determined on Life an experience-rated basis provide life and health insur- insurance Health ance benefits for retirees. Medicare supplement insur- benefits benefits Total ance is not experience rated. The retiree welfare benefit Net actuarial gain $ (715) $ (410) $ (1,125) plan is contributory for health insurance purposes for Prior service cost (credit) (112) 1,674 1,562 employees who retired on or after January 1, 1990. Unrecognized net initial Participant contributions for health insurance are based on obligation - 167 167 a percentage of the monthly premium paid by NAS (from Total $ (827) $ 1,431 $ 604 25% to 100%). The participant contribution is also based on their date of retirement, length of service and choice of Estimated amounts to be amortized into net periodic health insurance carrier. benefit cost over the next fiscal year relate to prior service costs, net gain and net initial obligation recognition are Effective January 1, 2007, NAS increased the life $210,013, $18,134, and $25,703, respectively, for the insurance benefit from $3,000 to $10,000. This change is postretirement life insurance and health benefit plan. 50 

The following table presents the changes in benefit The following table presents the changes in benefit obligations, changes in plan assets, funded status, and the obligations, changes in plan assets, funded status, and the components of net periodic benefit cost for the year ended components of net periodic benefit cost for the year ended December 31, 2007 (dollars in thousands): December 31, 2006 (dollars in thousands): 2007 2006 Life Life insurance Health insurance Health benefits benefits Total benefits benefits Total Change in benefits obligations: Change in benefits obligations: Benefit obligation, Benefit obligation, January 1 $ 2,566 $ 13,959 $ 16,525 January 1 $ 811 $ 13,719 $ 14,530 Service cost 48 612 660 Service cost 14 664 678 Interest cost 142 785 927 Interest cost 45 772 817 Plan participant contribu- Plan participant contribu- tions - 117 117 tions N/A (104) (104) Actuarial gain (137) (1,015) (1,152) Plan amendments 1,781 N/A 1,781 Benefits paid (9) (607) (616) Actuarial gain (79) (524) (603) Benefits obligation, Benefits paid (6) (568) (574) December 31 $ 2,610 $ 13,851 $ 16,461 Benefits obligation, December 31 $ 2,566 $ 13,959 $ 16,525 Change in plan assets, combined: Fair value of plan assets, Change in plan assets, combined: January 1 $ - $ 11,920 $ 11,920 Fair value of plan assets, Actual return on plan assets - 797 797 January 1 $ - $ 9,695 $ 9,695 Employer contributions 2,333 109 2,442 Actual return on plan assets - 1,542 1,542 Plan participants contribu- Employer contributions - 1,153 1,153 tions - 117 117 Plan participants contribu- Benefits paid (9) (607) (616) tions - 104 104 Fair value of plan assets, Benefits paid - (574) (574) December 31 $ 2,324 $ 12,336 $ 14,660 Fair value of plan assets, Funded status $ (286) $ (1,515) $ (1,801) December 31 $ - $ 11,920 $ 11,920 Components of net periodic benefit cost: Funded status: Service cost $ 48 $ 613 $ 661 Unfunded benefit obligation $ (2,566) $ (2,039) $ (4,605) Interest cost 142 785 927 Unrecognized transition Expected return on plan obligation 193 - 193 assets - (899) (899) Unrecognized prior service Recognized prior service cost 1,903 (131) 1,772 cost (credit) 229 (19) 210 Unrecognized net actuarial Recognized actuarial (gain) (gain) loss (275) 198 (77) loss (2) - (2) Accrued benefit cost $ (745) $ (1,972) $ (2,717) Recognized net initial obligation (asset) 26 - 26 Components of net periodic benefit cost: Net periodic cost $ 443 $ 480 $ 923 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 unrecog- nized (gains) losses (13) 44 31 Net periodic cost $ 89 $ 733 $ 822 51 

The assumptions used to determine net periodic benefit The following benefit payments, which reflect future cost for years ended December 31, 2007 and 2006, are as services, are expected to be paid in future years as noted, follows: as of December 31, 2007 (dollars in thousands): 2007 2006 Years ending December 31: Discount rate 6.00% 5.75% 2008 $ 840 Expected long-term return on plan assets 7.50% 7.50% 2009 969 2010 1,039 2011 1,117 The assumptions used to calculate the accumulated 2012 1,178 postretirement benefit obligation for the years ended 2013-2017 6,584 December 31, 2007 and 2006, are as follows: $ 11,727 2007 2006 Discount rate 6.00% 5.75% The measurement date of the plan assets and benefit obligations for 2007 and 2006 is December 31, 2007 and NAS postretirement benefit plan asset allocations at 2006, respectively. December 31, 2007 and 2006, by asset category are as follows: The trend rate for growth in healthcare costs used in calculating the accumulated postretirement benefit 2007 2006 obligation was 9.5% during both years ended December Cash 11% 5% 31, 2007 and 2006, declining gradually to 5% in the year Bonds and notes 15% 25% 2018. The healthcare cost trend rate assumption has a Equity securities 74% 70% significant impact on the postretirement benefit costs and 100% 100% obligations. The effect of a 1% change in the assumed healthcare cost trend rate at December 31, 2007, would The investment objective of the Plan is to produce a rate have resulted in an estimated $1.5 million increase or $1.3 of return over the long term that will provide for some million decrease in the postretirement benefit obligation fund growth, curb against the effect of inflation, and and an estimated $203,000 increase or $167,000 decrease provide for some stability in different market environ- in the 2007 benefit expense. ments. The fund is diversified between fixed income and The effect of a 1% change in the assumed healthcare cost equity investments. With this diversification and invest- trend rate at December 31, 2006, would have resulted in ment in broader market funds, there is reasonable an estimated $1.6 million increase or $1.4 million assurance that no single security or class of securities will decrease in the postretirement benefit obligation and an have a disproportionate impact on the Plan assets. The estimated $211,000 increase or $174,000 decrease in the Plan assets are invested with long-term growth strategy, 2006 benefit expense. with a 70% equity guideline. The overall long-term rate of return was developed by (15) CONDITIONAL ASSET RETIREMENT estimating the long-term real rate of return for the Plan’s OBLIGATION asset mix, while taking into account the effects of inflation. This estimate was developed by evaluating the In March 2005, the Financial Accounting Standards history and similar asset allocation of the NAS Endow- Board (FASB) issued the FASB Interpretation No. 47 ment. (FIN 47). This interpretation clarifies the term “condi- tional asset retirement obligation” as it is used in FASB NAS expects to contribute to the Plan the actuarially Statement No. 143, Accounting for Asset Retirement determined net periodic cost for 2008, which is approxi- Obligations, and requires a liability to be recorded if the mately $840,000. In addition, in 2008, NAS expects to fair value of the obligation to retire an asset can be contribute the outstanding $1.8 million in postretirement reasonably estimated. Asset retirement obligations benefit obligation. 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. 52 

In accordance with FIN 47, NAS recorded an asset (b) Contingencies retirement obligation for which fair value of the liability could be reasonably estimated relating to the regulatory NAS receives a portion of its revenues directly or remediation of asbestos and other hazardous materials in indirectly from federal government grants and contracts, one of its office buildings. Accordingly, NAS recorded a all of which are subject to audit by the Defense Contract charge to management and general expense of $1.5 Audit Agency, which has completed its examinations million for the year ended December 31, 2007. NAS through December 31, 2004. A contingency exists recorded a liability for asset retirement obligations of $1.7 relating to unexamined periods and final settlements of million in other long term liabilities and increased the examined periods to refund any amounts received in carrying value of the related building assets by $364,000, excess of allowable costs. Management is of the opinion less accumulated depreciation of $291,000. that no material liability will result from such audits. (16) RELATED PARTY TRANSACTIONS (c) Litigation The NAS Council has authorized two agreements NAS is a defendant or otherwise involved in several providing non-interest bearing, collateralized advances to lawsuits. While the ultimate outcome of the litigation is two employees in connection with the purchase of the uncertain, NAS management believes that it has strong employee’s residence. The agreements between the legal positions, intends to vigorously defend its actions, parties were executed in May 2005 and May 2007. They and has concluded that the probable outcomes will not each provide that the repayment obligation will be have a material impact on NAS. adjusted to allocate to each party its proportional share of the appreciation or depreciation in the value of the (18) RISKS AND UNCERTAINTIES residence, which is based on the relative financing percentage provided by each party. The agreements will NAS invests in various investment securities. Investment terminate upon pay-back of the advance, sale of the securities are exposed to various risks such as interest property, or the end of the individual’s employment with rate, market and credit risks. Due to the level of risk NAS, which will not exceed 12 years. The estimated associated with investment securities, it is at least present value of the receivables at December 31, 2007 and reasonably possible that changes in the values of invest- 2006, is $3.5 million and $2.5 million, respectively, and is ment securities will occur in the near term and that such included in other assets on the statement of financial changes could materially affect the amounts reported. 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. 53