Auditing Committee
June 12, 2018
Dr. Marcia McNutt
President
National Academy of Sciences
Dear Dr. McNutt:
In accordance with paragraph 11 of section II of the Bylaws of the National Academy of Sciences, the firm of Grant Thornton LLP was retained by the Auditing Committee on behalf of the Council to conduct an audit of the accounts of the Treasurer for the year ended December 31, 2017, and to report to the Auditing Committee.
The independent accountants have completed their audit and submitted their report. In accordance with paragraph 13 of section II of the Bylaws, the Auditing Committee has reviewed the report and recommends to the Council that it be accepted and that the opinion of the independent accountants be published with the report of the Treasurer.
Respectfully submitted,
Auditing Committee
Claude R. Canizares, Chair
Ronald L. Graham
Brian W. Matthews
Jeremiah P. Ostriker
Grant Thornton LLP
1250 Connecticut Ave NW, Suite 400
Washington, DC 20036-3531
T 202.296.7800
F 202.833.9165
GrantThornton.com
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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Auditing Committee of
National Academy of Sciences:
We have audited the accompanying financial statements of the National Academy of Sciences (“NAS”), which comprise the statements of financial position as of December 31, 2017 and 2016, and the related statements of activities and cash flows for the years then ended, and the related notes to the financial statements.
Management’s responsibility for the financial statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.
Auditor’s responsibility
Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to NAS’ preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of NAS’ internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the National Academy of Sciences as of December 31, 2017 and 2016, and the changes in its net assets and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.
Washington, DC
June 12, 2018
NATIONAL ACADEMY OF SCIENCES
Statements of Financial Position
As of December 31, 2017 and 2016
(in thousands)
2017 | 2016 | ||
---|---|---|---|
ASSETS | |||
CURRENT ASSETS | |||
Cash and cash equivalents | $ 1,729 | $ 2,440 | |
Restricted cash (Note 2) | 1,296 | 1,593 | |
Contracts receivable, net (Notes 2 and 12) | 68,276 | 66,982 | |
Contributions and other receivables, net (Notes 2 and 6) | 131,299 | 169,585 | |
Other current assets | 11,128 | 12,024 | |
Total current assets | 213,728 | 252,624 | |
Other assets (Notes 2, 13, and 14) | 5,549 | 5,255 | |
Investments (Notes 3 and 4) | 988,460 | 759,888 | |
Contributions receivable, net (Notes 2 and 6) | 12,204 | 131,393 | |
Property and equipment, net (Note 5) | 156,516 | 162,632 | |
Einstein Memorial | 1,723 | 1,723 | |
Total assets | $ 1,378,180 | $ 1,313,515 | |
LIABILITIES AND NET ASSETS | |||
CURRENT LIABILITIES | |||
Accounts payable and accrued expenses | $ 33,897 | $ 31,868 | |
Deferred revenue (Note 7) | 37,608 | 38,982 | |
Lines of credit (Note 8) | 4,781 | 5,543 | |
Other current liabilities (Notes 2 and 13) | 4,733 | 5,490 | |
Total current liabilities | 81,019 | 81,883 | |
Bonds payable, net (Note 13) | 157,540 | 158,089 | |
Funds held on behalf of others (Notes 3 and 4) | 13,298 | 12,059 | |
Accrued employee benefits (Note 14) | 1,999 | 2,634 | |
Other long-term liabilities (Notes 2 and 13) | 8,029 | 9,383 | |
Total liabilities | 261,885 | 264,048 | |
Commitments and contingencies (Notes 3, 12, 13, 14, 16, and 17) | |||
NET ASSETS | |||
Unrestricted | 113,108 | 104,174 | |
Temporarily restricted (Note 9) | 831,841 | 782,378 | |
Permanently restricted (Note 10) | 171,346 | 162,915 | |
Total net assets | 1,116,295 | 1,049,467 | |
Total liabilities and net assets | $ 1,378,180 | $ 1,313,515 |
The accompanying notes are an integral part of these financial statements.
NATIONAL ACADEMY OF SCIENCES
For the years ended December 31, 2017 and 2016
(in thousands)
2017 | 2016 | |||||||
---|---|---|---|---|---|---|---|---|
Unrestricted | Temporarily Restricted | Permanently Restricted | Total | Unrestricted | Temporarily Restricted | Permanently Restricted | Total | |
REVENUES, GAINS, AND OTHER SUPPORT | ||||||||
Government contracts and grants (Note 12) | $ 211,958 | $ - | $ - | $ 211,958 | $ 216,638 | $ - | $ - | $ 216,638 |
Private contracts and grants | 15,967 | 29,144 | - | 45,111 | 15,228 | 37,404 | - | 52,632 |
Gulf Research Program | - | 2,706 | - | 2,706 | - | 6,122 | - | 6,122 |
Other contributions | 3,616 | 19 | 8,431 | 12,066 | 3,104 | 544 | 16,290 | 19,938 |
Fees and publications | 16,504 | - | - | 16,504 | 15,212 | - | - | 15,212 |
Investment income (Note 3) | 14,420 | 88,211 | - | 102,631 | 7,182 | 40,443 | - | 47,625 |
Other income (Note 13) | 14,522 | - | - | 14,522 | 15,717 | - | - | 15,717 |
Net assets released from restriction (Note 9) | 70,617 | (70,617) | - | - | 57,093 | (57,093) | - | - |
Total revenues, gains, and other support | 347,604 | 49,463 | 8,431 | 405,498 | 330,174 | 27,420 | 16,290 | 373,884 |
EXPENSES | ||||||||
Programs (Note 11) | 278,029 | - | - | 278,029 | 266,514 | - | - | 266,514 |
Management and general | 52,672 | - | - | 52,672 | 57,003 | - | - | 57,003 |
Fundraising | 3,213 | - | - | 3,213 | 3,231 | - | - | 3,231 |
Total expenses | 333,914 | - | - | 333,914 | 326,748 | - | - | 326,748 |
Postretirement changes other than net periodic benefit cost (Note 14) | 923 | - | - | 923 | 1,233 | - | - | 1,233 |
Loss on advanced refunding of bonds (Note 13) | 3,833 | - | - | 3,833 | - | - | - | - |
Change in net assets | 8,934 | 49,463 | 8,431 | 66,828 | 2,193 | 27,420 | 16,290 | 45,903 |
Net assets at beginning of year | 104,174 | 782,378 | 162,915 | 1,049,467 | 101,981 | 754,958 | 146,625 | 1,003,564 |
Net assets at end of year | $ 113,108 | $ 831,841 | $ 171,346 | $ 1,116,295 | $ 104,174 | $ 782,378 | $ 162,915 | $ 1,049,467 |
The accompanying notes are an integral part of these financial statements.
NATIONAL ACADEMY OF SCIENCES
For the years ended December 31, 2017 and 2016
(in thousands)
2017 | 2016 | ||
---|---|---|---|
CASH FLOWS FROM OPERATING ACTIVITIES | |||
Change in net assets | $ 66,828 | $ 45,903 | |
Adjustments to reconcile change in net assets to net cash provided by operating activities | |||
Depreciation and amortization | 6,609 | 7,836 | |
Loss on disposal of property and equipment | 33 | - | |
Bad debt (recovery) expense | (825) | 4,932 | |
Net gain on investments | (88,634) | (37,033) | |
Net gain on investments held on behalf of others | (1,546) | (775) | |
Change in value of interest rate swap | (1,171) | (1,342) | |
Change in value of split-interest agreements | 178 | 51 | |
Contributions restricted for endowment | (11,056) | (5,648) | |
(Increase) decrease in assets: | |||
Other receivables | 158,444 | 121,775 | |
Contracts receivable | (1,440) | 12,248 | |
Other current assets | 896 | (3,476) | |
Other assets | (579) | (107) | |
Increase (decrease) in liabilities: | |||
Accounts payable and accrued expenses | 2,029 | (4,941) | |
Deferred revenue | (1,374) | 1,686 | |
Other current liabilities | (615) | (54) | |
Funds held on behalf of others | 1,239 | 880 | |
Other long-term liabilities | 41 | 307 | |
Accrued employee benefits | (635) | (6,242) | |
Net cash provided by operating activities | 128,422 | 136,000 | |
CASH FLOWS FROM INVESTING ACTIVITIES | |||
Additions to property and equipment | (962) | (3,346) | |
Sales or maturities of investments | 820,378 | 460,124 | |
Purchases of investments | (958,770) | (585,721) | |
Net cash used in investing activities | (139,354) | (128,943) | |
CASH FLOWS FROM FINANCING ACTIVITIES | |||
Contributions restricted for endowment | 11,056 | 5,648 | |
Proceeds from lines of credit | 83,117 | 43,166 | |
Payments on lines of credit | (83,879) | (51,292) | |
Proceeds from bond issue | 52,760 | - | |
Payments on bond principal | (53,130) | (3,820) | |
Net cash provided by (used in) financing activities | 9,924 | (6,298) | |
Net (decrease) increase in cash, cash equivalents, and restricted cash | (1,008) | 759 | |
Cash, cash equivalents, and restricted cash, beginning of year | 4,033 | 3,274 | |
Cash, cash equivalents, and restricted cash, end of year | $ 3,025 | $ 4,033 | |
Supplemental disclosure of cash flow information: Interest paid | $ 5,568 | $ 5,559 |
The accompanying notes are an integral part of these financial statements.
NATIONAL ACADEMY OF SCIENCES
Notes to the Financial Statements
December 31, 2017 and 2016
1. ORGANIZATION
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 membership organization of distinguished scholars engaged in scientific or engineering research, dedicated to the furtherance of science and its use for the general welfare.
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 performs its studies and workshops through the following major divisions:
- Behavioral and Social Sciences and Education
- Earth and Life Studies
- Engineering and Physical Sciences
- Gulf Research Program
- Health and Medicine
- 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.
National Academy of Medicine
The Institute of Medicine (“IOM”), which was established in 1970, was reconstituted as the National Academy of Medicine (“NAM”) effective June 1, 2015. NAM is a separate membership organization within NAS, and issues position statements on policy issues related to health and medicine, 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. The financial activities and results of NAM are included in the NAS financial statements.
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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting
Net assets, revenues, gains, and losses are classified based on the existence or absence of donor-imposed restrictions. Accordingly, the net assets of NAS are classified and reported as follows:
Permanently restricted - Net assets subject to donor-imposed stipulations that they be maintained in perpetuity by NAS. Generally, the donors of these assets permit NAS to use all or part of the income earned on related investments for general or specific purposes.
Temporarily restricted - Net assets subject to donor-imposed stipulations that may or will be met either by actions of NAS and/or the passage of time. When a donor restriction expires, temporarily restricted net assets are reclassified to unrestricted net assets.
Unrestricted - Net assets arising from exchange transactions and contributions not subject to donor-imposed stipulations.
Cash Equivalents
NAS reports liquid, temporary investments purchased with original maturities of three months or less as cash equivalents. Cash equivalents managed by NAS’ investment managers as part of its long-term investment strategy are included in investments.
Restricted Cash
Restricted cash includes deposits that are legally restricted for the repayment of NAS’ outstanding bonds.
Investments
Investments are stated at fair value. Changes in the fair value of investments are reported within investment income in the accompanying statements of activities.
Purchases and sales of securities are reflected on a trade-date basis. Gains and losses on sales of securities are based on average cost and are recorded in the accompanying statements of activities in the period in which the securities are sold. Dividends are accrued based on the ex-dividend date. Interest is recognized as earned.
Contributions
Contributions, including unconditional promises to give, are recognized as revenues in the period received. Conditional promises to give are not recognized until all conditions are substantially met.
Revenues from non-federal grants qualifying as contributions are recorded by NAS upon notification of the grant award. Such grants are classified as temporarily restricted net assets when use of the grant funds is limited to specific areas of study or is designated for use in future periods.
Gifts of land, buildings, or equipment are reported as unrestricted net assets unless explicit donor stipulations specify how the donated assets must be used. Temporary restrictions on gifts that must be used to acquire or construct long-lived assets are released in the period in which the assets are acquired and placed in service.
Allowances are recorded for estimated uncollectible contributions based upon management’s judgment and analysis of the creditworthiness of the donor, past collection experience, and other relevant factors. Contributions to be received after one year are discounted at an appropriate rate commensurate with risks involved. Amortization of the discount is recorded as additional revenue and is used in accordance with donor-imposed restrictions, if any, on the contributions.
Gulf Research Program revenue relates to two agreements between NAS and BP Exploration and Production, Inc. (BP) and Transocean Deepwater Inc. (Transocean), respectively. As a result of separate plea agreements between those corporations and the federal government, related to the 2010 Deepwater Horizon disaster, NAS was asked to establish a program focused on human health and environmental protection in the Gulf of Mexico. BP will pay $350.0 million over five years, and Transocean will pay $150.0 million over four years, to fund this 30-year, $500.0 million program. The present value of these payments in 2013 was $471.4 million, which was recognized as revenue in that year. As of December 31, 2017 and 2016, the present value of the balance of these payments due is $115.0 million and $262.3 million, respectively. The unpaid balance due for each agreement is reflected in contributions and other receivables, net (current) in the accompanying statement of financial position as of December 31, 2017. The unpaid balance due for each agreement is reflected in contributions and other receivables, net (current) and contributions receivable, net (long-term) in the accompanying statement of financial position as of December 31, 2016.
Contracts and Grants
The majority of NAS activities are performed under cost-reimbursable contracts and grants with the U.S. government. For the years ended December 31, 2017 and 2016, the Department of Transportation provided 38% and 36%, respectively, of NAS’ government contract and grant revenues.
NAS records federal contracts and grants as exchange transactions, recognizing revenue as recoverable costs are incurred. Revenues from non-federal contracts and grants classified as exchange transactions are also recognized as recoverable costs are incurred.
Contracts receivable consisted of $22.4 million of billed receivables, $42.5 million of unbilled receivables, and $3.4 million of indirect costs under-recovered on federal contracts and grants as of December 31, 2017. Contracts receivable consisted of $19.1 million of billed receivables, $44.6 million of unbilled receivables, and $3.3 million of indirect costs under-recovered on federal contracts and grants as of December 31, 2016.
Allowances are recorded for estimated uncollectible contracts and grants based upon management’s judgment and analysis of the creditworthiness of the sponsoring organization, past collection experience, and other relevant factors. As of December 31, 2017 and 2016, NAS has an allowance for estimated uncollectible contracts and grants of $4.8 million and $4.7 million, respectively, which is reported net of contracts receivable in the accompanying statements of financial position.
Property and Equipment
Depreciation of NAS’ property and equipment is computed on a straight-line basis using the following lives:
Asset Class | Depreciable Lives | |
---|---|---|
Buildings | 40 years | |
Building improvements |
Lesser of the remaining life of the building or improvement |
|
Leasehold improvements |
Lesser of the remaining life of the lease or improvement |
|
Furniture and equipment |
4 to 10 years |
|
Capitalized software |
3 to 10 years |
The Einstein Memorial sculpture is valued at cost and is not depreciated. Work in progress is not depreciated until the related assets are placed in service. Capitalized software is amortized over its depreciable life when it is ready for its intended use and placed in service.
Split-Interest Agreements
Charitable gift annuity agreements are classified as other assets and other long-term liabilities in the accompanying statements of financial position. Periodically, NAS pays a fixed amount of the assets to the beneficiary designated by the donor. Upon termination of an annuity, the remainder interest in the assets, if any, is available for use by NAS as restricted or unrestricted assets in accordance with the donor’s stipulation. At December 31, 2017 and 2016, NAS had charitable gift annuity assets of approximately $3.0 million and $2.7 million, respectively. NAS has recorded a liability of approximately $1.8 million at December 31, 2017 and 2016 representing the present value of estimated future cash payments to annuitants based on the annuitants’ life expectancies.
Deferred Revenue
For both federal and non-federal grants and contracts that are determined to be exchange transactions, revenue is recognized as the related costs are incurred. Funds received in advance of being earned for these grants are recorded as deferred revenue in the accompanying statements of financial position.
Income Taxes
NAS is exempt from federal income taxes under Section 501(c)(3) of the Internal Revenue Code, except for unrelated business income. NAS recognizes the effect of income tax positions only if those positions are more likely than not of being sustained upon examination. NAS does not believe its financial statements include any uncertain tax positions.
Risks and Uncertainties
NAS invests in various investment securities. Investment securities are exposed to various risks such as interest rate, market, and credit risks. Due to the level of risk associated with investment securities, it is at least reasonably possible that changes in the values of investment securities will occur in the near term and that such changes could materially affect the amounts reported. NAS maintains its cash and cash equivalents in various bank accounts and money market funds that, at times, may exceed federally insured limits. NAS’ cash and cash equivalents have been placed with high credit quality financial institutions. NAS has not experienced, nor does it anticipate, any losses with respect to such accounts.
Recently Adopted Accounting Pronouncements
In November 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18). The amendments within ASU 2016-18 require that a statement of cash flows explain the change during the period in total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2019 for entities that are not public business entities and early adoption is permitted. NAS has elected to early adopt this accounting pronouncement for the year ended December 31, 2017 and has applied the amendments using a retrospective transition method to each period presented.
Use of Estimates
The preparation of these financial statements in conformity with U.S. generally accepted accounting principles requires management to make certain estimates and assumptions. These estimates and assumptions may affect the reported amounts of assets and liabilities and disclosures in the financial statements. Actual results could differ from those estimates.
Reclassifications
Certain amounts from the prior year have been reclassified to conform to the current year presentation. There were no changes to total assets, liabilities, net assets, revenues, expenses or changes in net assets as previously reported in the fiscal 2016 financial statements.
3. INVESTMENTS
Investments, which are reported at fair value, consist of the following as of December 31, 2017 and 2016 (in thousands):
2017 | 2016 | ||
---|---|---|---|
Investments: | |||
Program pool investments | |||
Cash and cash equivalents | $ 2,022 | $ 2,917 | |
Bonds and notes | 43,326 | 43,770 | |
Equity | 11,737 | 11,414 | |
57,085 | 58,101 | ||
Gulf Research Program investments | |||
Cash and cash equivalents | 5,194 | 560 | |
Bonds and notes | 189,918 | 110,698 | |
Equity | 188,981 | 111,554 | |
384,093 | 222,812 | ||
Investment pool, including endowment assets | |||
Cash and cash equivalents | 12,639 | 4,288 | |
Bonds and notes | 40,552 | 38,244 | |
Equity | 277,211 | 256,294 | |
Hedge funds | 152,729 | 120,597 | |
Private equity | 23,109 | 23,232 | |
506,240 | 442,655 | ||
Other investments | |||
Cash and cash equivalents | 2,609 | 854 | |
Bonds and notes | 23,867 | 19,432 | |
Equity | 14,566 | 16,034 | |
41,042 | 36,320 | ||
Total investments | $ 988,460 | $ 759,888 |
The National Academies’ Corporation (TNAC, see Note 15), a related entity, invests certain of its assets in the NAS investment pool. TNAC investments participate in the investment pool proportionally with all other funds in this pool.
The NAS obligation to TNAC for these funds held in trust, which totaled approximately $13.3 million and $12.1 million as of December 31, 2017 and 2016, respectively, is reported as funds held on behalf of others in the accompanying statements of financial position. The funds held on behalf of others liability equals the investments held in NAS’ investment pool on behalf of TNAC.
Investment income is reported net of investment expenses of approximately $834,000 and $806,000 for the years ended December 31, 2017 and 2016, respectively, and is comprised of the following (in thousands):
2017 | 2016 | ||
---|---|---|---|
Interest and dividends, net | $ 13,997 | $ 10,592 | |
Net gain on investments | 88,634 | 37,033 | |
Total investment income | $ 102,631 | $ 47,625 |
4. FAIR VALUE MEASUREMENTS
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB Accounting Standards Codification section 820 establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1- Quoted prices in active markets for identical assets or liabilities.
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The following discussion describes the valuation methodologies used for financial assets measured at fair value. The techniques utilized in estimating the fair values are affected by the assumptions used, including discount rates and estimates of the amount and timing of future cash flows. Care should be exercised in deriving conclusions about NAS’ business, its value or financial position based on the fair value information of financial assets presented.
Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial asset, including estimates of timing, amount of expected future cash flows, and the credit standing of the issuer. In some cases, the fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial asset. Furthermore, the disclosed fair values do 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 expenses that would be incurred in an actual sale or settlement are not reflected in amounts disclosed.
The following methods, assumptions, and inputs were used to estimate the fair value of each class of financial instruments:
The carrying value of cash equivalents such as money market funds approximates the fair value because of the short maturity of these investments. These amounts are included in Level 1 of the fair value hierarchy.
NAS’ fixed maturity investments (bonds and notes) include U.S. Treasury securities, mortgage-backed securities, corporate bonds, and mutual funds that invest in these types of securities. Other than U.S. Treasury securities and mutual funds, these investments generally do not trade on a daily basis. The fair value estimates of such debt securities are based on prices provided by NAS’ investment managers and custodian bank. Both the investment managers and the custodian bank use a variety of pricing sources to determine market valuations. Each designate specific pricing services or indexes for each sector of the market based upon the provider’s expertise. NAS’ debt securities portfolio is highly liquid, which allows for a high percentage of the portfolio to be priced through pricing services. Accordingly, the estimates of fair value for such debt securities are included in Level 2 of the fair value hierarchy. The estimated values of U.S. Treasury securities and debt mutual funds are based on actively traded market prices and are, accordingly, included in the bonds and notes amount in Level 1 of the fair value hierarchy.
Fair values of exchange-traded equity securities and mutual funds that invest in equity securities have been determined by NAS from observable market quotations on major trade exchanges. Accordingly, such equity securities are disclosed in Level 1 of the fair value hierarchy.
The reported fair value of alternative investments, including private equity securities and hedge funds is based on the alternative investment fund managers’ net asset value (“NAV”). Private equity investments are comprised of limited partnership interests. Valuations provided by alternative investment fund managers include estimates, appraisals, assumptions, and methods that are reviewed by management. When necessary, NAS adjusts NAV for contributions and distributions subsequent to the latest NAV valuation date when calculating fair value. NAS analyzes the NAVs provided by alternative investment fund managers on a regular basis considering relevant economic and market conditions, applicable benchmarks and its understanding of the nature and related risks of the investments. These investments are not leveled in the fair value hierarchy.
NAS’ policy is to recognize transfers between levels of the fair value hierarchy as of the end of the reporting period in which the event or change in circumstances occurred. There were no transfers among levels during 2017 and 2016.
The following table presents NAS’ fair value hierarchy for those assets measured at fair value on a recurring basis at December 31, 2017 (in thousands):
Total | Fair Value Measurements Using | Investments Measured at Net Asset Value | ||
---|---|---|---|---|
Level 1 | Level 2 | |||
Investments: | ||||
Cash equivalents | $ 21,376 | $ 21,376 | $ - | $ - |
Bonds and notes | ||||
U.S. treasuries/government bonds | 227,415 | 227,415 | - | - |
Mortgage-backed securities | 10,858 | 2,603 | 8,255 | - |
Corporate bonds | 50,788 | 44,652 | 6,136 | - |
Non-U.S. fixed income | 8,602 | 8,602 | - | - |
Equity | ||||
U.S. large equity | 261,322 | 261,322 | - | - |
U.S. small/mid equity | 85,225 | 85,225 | - | - |
Non-U.S. equity (developed) | 71,673 | 71,673 | - | - |
Non-U.S. equity (emerging) | 29,994 | 29,994 | - | - |
Real estate | 8,277 | 8,277 | - | - |
Long/short equity hedge funds | 36,004 | - | - | 36,004 |
Hedge fund investments | 152,729 | - | - | 152,729 |
Private equity funds | 23,109 | - | - | 23,109 |
Total | 987,372 | $ 761,139 | $ 14,391 | $ 211,842 |
Cash held for investment | 1,088 | |||
Total investments | $ 988,460 | |||
Other assets: | ||||
Charitable gift annuity assets | $ 3,022 | $ 2,510 | $ 512 | $ - |
Deferred compensation assets | 963 | 963 | - | - |
Total other assets | $ 3,985 | $ 3,473 | $ 512 | $ - |
The following table presents NAS’ fair value hierarchy for those assets measured at fair value on a recurring basis at December 31, 2016 (in thousands):
Total | Fair Value Measurements Using | Investments Measured at Net Asset Value | ||
---|---|---|---|---|
Level 1 | Level 2 | |||
Investments: | ||||
Cash equivalents | $ 7,119 | $ 7,119 | $ - | $ - |
Bonds and notes | ||||
U.S. treasuries/government bonds | 68,718 | 68,718 | - | - |
Mortgage-backed securities | 102,122 | 74,373 | 27,749 | - |
Corporate bonds | 23,747 | 16,920 | 6,827 | - |
Non-U.S. fixed income | 17,557 | 16,965 | 592 | - |
Equity | ||||
U.S. large equity | 153,688 | 153,688 | - | - |
U.S. small/mid equity | 63,691 | 63,691 | - | - |
Non-U.S. equity (developed) | 59,941 | 59,941 | - | - |
Non-U.S. equity (emerging) | 48,605 | 48,605 | - | - |
Real estate | 15,587 | 15,587 | - | - |
Long/short equity hedge funds | 53,784 | - | - | 53,784 |
Hedge fund investments | 120,597 | - | - | 120,597 |
Private equity funds | 23,232 | - | - | 23,232 |
Total | 758,388 | $ 525,607 | $ 35,168 | $ 197,613 |
Cash held for investment | 1,500 | |||
Total investments | $ 759,888 | |||
Other assets: | ||||
Charitable gift annuity assets | $ 2,729 | $ 2,204 | $ 525 | $ - |
Deferred compensation assets | 855 | 855 | - | - |
Total other assets | $ 3,584 | $ 3,059 | $ 525 | $ - |
The following table presents the nature and risk of assets with fair values estimated using NAV held at December 31, 2017 and 2016 (in thousands):
As of December 31, 2017 | Fair Value As of December 31, 2016 | Redemption Frequency | Redemption Notice Period | ||
---|---|---|---|---|---|
Fair Value | Unfunded Commitments | ||||
Long/short equity funds - U.S. large equity (a) |
$ 36,004 | N/A | $ 53,784 | Quarterly/Annually | 45 days/365 days |
Hedge fund - multistrategies/multivehicle (b) |
152,729 | N/A | 120,597 | Monthly/Quarterly/Annually | 30 days/45 days/365 days |
Private equity - Asia (c) |
17,310 | 2,721 | 19,672 | N/A | N/A |
Private equity - Global (d) |
4,122 | 11,543 | 3,181 | N/A | N/A |
Private equity - Domestic (e) |
1,677 | 3,548 | 379 | N/A | N/A |
Total | $ 211,842 | $ 17,812 | $ 197,613 |
(a) This category relates to long-short equity hedge funds comprised of equity investments in U.S. large cap. Each of these funds buys investments long and sells short with the ability to use leverage. These funds can also invest in derivative instruments such as forward, futures, and option contracts.
(b) This class includes investments in multistrategy, multivehicle hedge funds with the objective of maximizing long term, risk-adjusted returns, and capital appreciation by investing in securities, investment funds, discretionary accounts, and investment partnerships across a broad range of marketable and alternative asset classes. Asset classes include domestic and international marketable equity securities, hedged equity, real estate, natural resource, fixed income, and private equity and absolute return strategies, primarily focused in the United States.
(c) This class includes several private equity funds that invest in equity, debt, or debt-oriented instruments, primarily in privately held companies, which own or contractually control operating entities located in the People’s Republic of China and India. Investments held in India primarily include equity securities of “early to early growth stage” companies in multiple sectors, except real estate. These investments can never be redeemed with the funds. Instead, the nature of the investments in this class is that distributions are received through liquidation of the underlying assets of the funds. It is estimated that the underlying assets of the funds will be liquidated over 1 to 8 years.
(d) This class includes several global private equity funds with diverse portfolios consisting primarily of venture capital funds, leveraged buyout funds, midstage growth capital funds, assets of healthcare companies, and international private equity funds. These investments are focused on several industries including, but not limited to, insurance, services, and consumer-related industries. These investments can never be redeemed with the funds. Instead, the nature of the investments in this class is that distributions are received through liquidation of the underlying assets of the funds. It is estimated that the underlying assets of the funds will be liquidated over 1 to 8 years.
(e) This class includes several domestic private equity funds, which invest in domestic equity securities, warrants, or other securities that are generally not actively traded at the time of investment. These investments are focused on several industries including, but not limited to, insurance, financial services, consumer-related, and communications. These investments can never be redeemed with the funds. Instead, the nature of the investments in this class is that distributions are received through liquidation of the underlying assets of the funds. It is estimated that the underlying assets of the funds will be liquidated over 1 to 9 years.
5. PROPERTY AND EQUIPMENT, NET
Property and equipment as of December 31, 2017 and 2016, is comprised of the following (in thousands):
2017 | 2016 | ||
---|---|---|---|
Land | $ 29,689 | $ 29,689 | |
Furniture and equipment | 31,254 | 31,283 | |
Buildings and improvements | 177,862 | 177,930 | |
Capitalized software | 18,557 | 18,160 | |
Work in progress | 493 | 451 | |
Leasehold improvements | 4,073 | 4,073 | |
261,928 | 261,586 | ||
Less: accumulated depreciation and amortization | (105,412) | (98,954) | |
Total property and equipment, net | $ 156,516 | $ 162,632 |
Depreciation and amortization expense was approximately $7.0 million and $7.9 million for the years ended December 31, 2017 and 2016, respectively.
6. CONTRIBUTIONS RECEIVABLE, NET
Contributions not yet collected are included in contributions and other receivables, net (current) and contributions receivable, net (long-term) in the accompanying statements of financial position, and mature as follows (in thousands):
2017 | 2016 | ||
---|---|---|---|
Less than one year | $ 129,616 | $ 168,651 | |
One to five years | 11,260 | 133,621 | |
Thereafter | 1,800 | 1,800 | |
142,676 | 304,072 | ||
Less: | |||
Discount at rates from 0.73% to 3.35% to estimated net present value | (856) | (4,028) | |
Allowance for uncollectible contributions | (17) | (975) | |
141 803 | 299 069 | ||
Less: current portion | (129,599) | (167,676) | |
Total contributions receivable, net, long-term | $ 12,204 | $ 131,393 |
As of December 31, 2017, 81% of contributions receivable were due from one corporation. As of December 31, 2016, 88% of contributions receivable were due from two corporations. NAS does not believe there is any significant risk associated with collection of these receivables.
During the year ended December 31, 2016, NAS entered into an agreement with a donor to give up to $10 million. The gift is conditioned on receipt of matching gifts for one of NAS’ endowment funds. NAS recognized revenue totaling approximately $7.1 million and $1.7 million for the years ended December 31, 2017 and 2016, respectively, the extent to which the conditions on the pledge have been met. During the year ended December 31, 2017, NAS entered into agreements for two additional conditional contributions totaling $1.7 million. One is conditioned on receipt of matching gifts and one conditioned on the awarding of a prize. NAS recognized revenue totaling approximately $73,000 pertaining to these conditional contributions for the year ended December 31, 2017.
7. DEFERRED REVENUE
Deferred revenue consisted of the following as of December 31, 2017 and 2016 (in thousands):
2017 | 2016 | ||
---|---|---|---|
Advances from private grants and contract sponsors | $ 22,438 | $ 19,923 | |
Advances from U.S. government sponsors | 6,884 | 9,933 | |
Publication subscriptions and other | 8,286 | 7,470 | |
Conditional contribution | - | 1,656 | |
Total deferred revenue | $ 37,608 | $ 38,982 |
8. LINES OF CREDIT
Until September 2017, NAS was party to a $35 million line of credit from Wells Fargo, which bore interest at LIBOR plus 0.55% (2.11% and 1.31% as of December 31, 2017 and 2016, respectively). In September 2017, NAS renewed its line of credit with Wells Fargo for $35 million from October 1, 2017 through December 31, 2017, for $45 million from January 1, 2018 through April 30, 2018, and for $35 million from May 1, 2018 through September 30, 2018. The renewed line of credit bears interest at LIBOR plus 0.55% and expires on September 30, 2018. NAS is also party to a $15 million line of credit from TD Bank, which bears interest at LIBOR plus 0.55% (2.12% and 1.17% as of December 31, 2017 and 2016, respectively) and expires on August 31, 2018. NAS has pledged and granted to each bank a security interest in NAS’ gross revenues.
Interest expense related to the lines of credit for the years ended December 31, 2017 and 2016 totaled approximately $115,000 and $107,000, respectively.
9. TEMPORARILY RESTRICTED NET ASSETS
Temporarily restricted net assets were available for the following purposes as of December 31, 2017 and 2016 (in thousands):
2017 | 2016 | ||
---|---|---|---|
Gulf Research Program | $ 498,216 | $ 485,449 | |
Other sponsored research and advisory programs | 199,971 | 182,057 | |
General endowment | 91,545 | 80,401 | |
Prizes and awards | 37,971 | 31,012 | |
Woods Hole facility | 4,138 | 3,459 | |
Total temporarily restricted net assets | $ 831,841 | $ 782,378 |
Temporarily restricted net assets were released from restriction for the following purposes during the years ended December 31, 2017 and 2016 (in thousands):
2017 | 2016 | ||
---|---|---|---|
Purpose-restricted releases | |||
Gulf Research Program | $ 21,600 | $ 12,544 | |
Other sponsored research and advisory programs | 42,327 | 37,332 | |
Prizes and awards | 995 | 1,556 | |
Woods Hole facility | 327 | 326 | |
Time-restricted releases | |||
General endowment | 5,368 | 5,335 | |
Total temporarily restricted net assets released from restriction | $ 70,617 | $ 57,093 |
10. ENDOWMENT
Permanently Restricted Net Assets
The income generated by permanently restricted net assets is available to support donor-specified programs and general operations. As of December 31, 2017 and 2016, NAS held the following permanently restricted net assets, classified by the purpose for which the income is to be used (in thousands):
2017 | 2016 | ||
---|---|---|---|
Sponsored research and advisory programs | $ 97,751 | $ 89,626 | |
General endowment | 42,775 | 42,574 | |
Prizes and awards | 27,281 | 27,176 | |
Woods Hole facility | 3,539 | 3,539 | |
Total permanently restricted net assets | 171,346 | 162,915 | |
Less: permanently restricted pledges receivable | (10,939) | (13,564) | |
Permanently restricted endowment assets | $ 160,407 | $ 149,351 |
Endowment Assets
The NAS endowment consists of 128 individual funds established to support general operations, sponsored research and advisory programs, prizes and awards, and the operations of the Woods Hole facility. The endowment solely comprises donor-restricted endowment funds. The investments of the endowment are included in the NAS investment pool, as described in Note 3.
Interpretation of Relevant Law
NAS has interpreted the District of Columbia “Uniform Prudent Management of Institutional Funds Act of 2007” (the “Act”) as requiring NAS, absent explicit donor stipulations to the contrary, to act in good faith and with the care that an ordinarily prudent person in a like position would exercise under similar circumstances in making determinations to appropriate for expenditure or accumulate endowment funds, taking into account both its obligation to preserve the value of the endowment and its obligation to use the endowment to achieve the purposes for which it was donated. NAS classifies as permanently restricted net assets (a) the original value of gifts donated to its permanent endowment, (b) the original value of subsequent gifts to its permanent endowment, and (c) accumulations to its permanent endowment required by the applicable donor gift instrument. The remaining portion of donor-restricted endowment funds that are not classified as permanently restricted are classified as temporarily restricted net assets until those amounts are 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:
- The duration and preservation of the endowment fund;
- The purposes of the institution and the endowment fund;
- General economic conditions;
- The possible effect of inflation or deflation;
- The expected total return from income and the appreciation of investments;
- Other resources of the institution; and
- The investment policy of the institution.
Return Objectives and Strategies
NAS has adopted investment and spending policies for endowment assets that are designed to provide a predictable stream of funding to programs supported by its endowment while seeking to protect the real purchasing power of the assets from inflation. Accordingly, NAS has adopted guidelines, which feature a commitment to minimizing volatility while maximizing risk-adjusted return.
The NAS spending policy limits the annual spending to 5% of the three-year average fair value of the participating funds in the endowment portfolio. This is consistent with NAS’ objective to maintain the purchasing power of the endowment assets held in perpetuity as well as to provide additional real growth through new gifts and investment return.
Changes in endowment assets for the fiscal year ended December 31, 2017 are as follows (in thousands):
Unrestricted | Temporarily Restricted | Permanently Restricted | Total | |
---|---|---|---|---|
Endowment assets, beginning of year | $ (229) | $ 204,462 | $ 149,351 | $ 353,584 |
Investment return: | ||||
Interest and dividends, net | - | 6,021 | - | 6,021 |
Net gain on investments | 229 | 45,698 | - | 45,927 |
Total investment return | 229 | 51,719 | - | 51,948 |
Contributions | - | - | 11,056 | 11,056 |
Amounts appropriated for expenditure | - | (11,973) | - | (11,973) |
Endowment assets, end of year | $ - | $ 244,208 | $ 160,407 | $ 404,615 |
Changes in endowment assets for the fiscal year ended December 31, 2016 are as follows (in thousands):
Unrestricted | Temporarily Restricted | Permanently Restricted | Total | |
---|---|---|---|---|
Endowment assets, beginning of year | $ (921) | $ 191,716 | $ 143,592 | $ 334,387 |
Investment return | ||||
Interest and dividends, net | - | 4,443 | - | 4,443 |
Net gain on investments | 692 | 22,046 | - | 22,738 |
Total investment return | 692 | 26,489 | - | 27,181 |
Contributions | - | - | 5,759 | 5,759 |
Amounts appropriated for expenditure | - | (13,743) | - | (13,743) |
Endowment assets, end of year | $ (229) | $ 204,462 | $ 149,351 | $ 353,584 |
Funds with Deficiencies
From time to time, the fair value of assets associated with individual donor-restricted endowment funds may fall below the original value of the gift donated to the permanent endowment. Deficiencies of this nature are reported as unrestricted net assets. At December 31, 2017, there were no endowment funds with a fair value below the original value of the gift. At December 31, 2016, there was one endowment fund with a fair value below the original value of the gift. This deficiency was primarily a result of unfavorable market fluctuations that occurred shortly after the investment of new permanently restricted contributions. Subsequent gains that restore the fair value of the assets of the endowment fund to the required level are classified as an increase in unrestricted net assets.
11. PROGRAM EXPENSES
Program expenses for the years ended December 31, 2017 and 2016 are summarized as follows (in thousands):
2017 | 2016 | ||
---|---|---|---|
Transportation Research Board | $ 79,430 | $ 80,986 | |
Policy and Global Affairs | 72,099 | 68,460 | |
Health and Medicine | 23,228 | 25,456 | |
Gulf Research Program | 22,033 | 11,662 | |
Earth and Life Studies | 17,115 | 17,524 | |
Engineering and Physical Sciences | 16,832 | 16,217 | |
Behavioral and Social Sciences and Education | 13,763 | 14,042 | |
Proceedings of the National Academy of Sciences | 12,682 | 12,115 | |
National Academy of Sciences | 6,258 | 8,701 | |
National Academy of Medicine | 5,771 | 3,919 | |
National Academy of Engineering | 4,814 | 2,973 | |
National Academy Press | 2,857 | 3,308 | |
Koshland Science Museum | 1,147 | 1,151 | |
Total program expenses | $ 278,029 | $ 266,514 |
12. RECOVERY OF INDIRECT COSTS
NAS receives indirect cost recovery on its federal contracts and grants. An overhead assessment is applied to direct salaries, accrued leave, fringe benefits, and services provided by outside contractors (e.g., temporary personnel agencies, consultants) on NAS property. A general and administrative assessment (G&A) is applied to direct costs and overhead less subcontract costs and stipends. Therefore, both the overhead and G&A rates are applied to projects incurring direct salaries and other direct costs such as travel. If a program does not require direct salaries, such as a travel grant program, a subcontract/flow-through administration rate is applied. Certain off-site work (not performed on NAS property) is assessed reduced overhead rates.
NAS bills for indirect cost recovery throughout the year based on negotiated rates. At the end of each year, NAS compares actual expenses incurred in each of its cost pools to the amounts recovered based on its billing rates. The difference is recorded as its indirect cost carryforward. If NAS over recovers on its indirect costs during the year, a liability is recorded. If NAS under recovers, a receivable is recorded.
NAS has a cumulative net under recovery of approximately $3.4 million and $3.3 million as of December 31, 2017 and 2016, respectively. The under recovery is included in the contracts receivable, net balance in the accompanying statements of financial position.
13. BUILDING PROJECT AND FINANCING
Building Project Revenue Bonds
In January 1999, the District of Columbia issued Series 1999A, Series 1999B, and Series 1999C tax-exempt revenue bonds in the amount of $130,960,000 on behalf of NAS. Proceeds from the sale of the revenue bonds financed the cost of the acquisition of 44,250 square feet of land and related construction of an office building, as well as to pay certain costs of issuing the bonds. This building consolidates most of NAS’ program activities into one location.
In June 2008, the District of Columbia issued Series 2008A tax-exempt revenue bonds in the amount of $66,325,000 on behalf of NAS. The proceeds were used to refund the Series 1999B and Series 1999C revenue bonds, as well as to pay certain costs of issuing the bonds.
In April 2009, the District of Columbia issued Series 2009A tax-exempt revenue bonds in the amount of $57,500,000 on behalf of NAS. The proceeds were used to refund the Series 1999A revenue bonds, as well as pay certain costs of issuing the bonds.
In May 2010, the District of Columbia issued Series 2010A tax-exempt revenue bonds in the amount of $59,550,000 on behalf of NAS. These bonds were sold to finance the cost to restore the NAS headquarters building on Constitution Avenue in Washington, DC and to pay for certain costs of issuance. The restoration was completed in 2012.
In December 2012, NAS remarketed the Series 2008A and 2009A bonds as direct bank purchases. The Series 2008A bonds were purchased by Wells Fargo Municipal Capital Strategies LLC; the Series 2009A bonds were purchased by TD Bank, N.A. In May 2017, NAS refinanced the Series 2008A and Series 2009A bonds with the existing banks to extend the mandatory repurchase to May 2027, at which point NAS could renew the direct purchase agreements, remarket the bonds, or repurchase the bonds.
In December 2017, the District of Columbia issued Series 2017A tax-exempt revenue bonds in the amount of $52,760,000 on behalf of NAS. The proceeds were used to advanced refund a portion of the Series 2010A revenue bonds. The Series 2017A bonds were issued as direct bank purchases with Century Subsidiary Investments, Inc. III.
NAS is obligated under the revenue bonds as follows (in thousands):
2017 | 2016 | ||
---|---|---|---|
Series 2008A revenue bonds, term, at flexible rates (1.5% in 2017 and 1.3% in 2016) maturing at various dates from January 1, 2017 through 2039 | $ 59,500 | $ 61,000 | |
Series 2009A revenue bonds, term, at flexible rates (1.4% in 2017 and 0.9% in 2016) maturing at various dates from January 1, 2017 through 2028 | 46,770 | 47,945 | |
Series 2010A revenue bonds, serial, with interest rates ranging from 3.0% to 5.0%, maturing at various dates from April 1, 2017 through 2030 | 4,330 | 24,620 | |
Series 2010A revenue bonds, term: Interest rate 5%, maturing April 1, 2035 | - | 13,205 | |
Interest rate 5%, maturing April 1, 2040 | - | 16,960 | |
Series 2017A revenue bonds, term, with a fixed interest rate of 2.24% until 4/1/2020 and flexible rates thereafter, maturing at various dates from April 1, 2018 through 2040 | 52,760 | - | |
Total bonds, at face value | 163,360 | 163,730 | |
Plus: unamortized premium | 40 | 575 | |
Less: debt issuance costs | (2,093) | (2,305) | |
Total bonds payable | 161,307 | 162,000 | |
Less: current portion (included in other current liabilities) | (3,767) | (3,911) | |
Bonds payable, long-term | $ 157,540 | $ 158,089 |
The serial and term bonds represent unsecured general obligations of NAS.
Interest on the 2008A and 2009A bonds is payable monthly. Interest on the 2010A and 2017A bonds is payable semiannually every April 1 and October 1.
Scheduled maturities are as follows (in thousands):
Years ending December 31: | |
---|---|
2018 | $ 3,740 |
2019 | 4,345 |
2020 | 4,465 |
2021 | 4,845 |
2022 | 4,930 |
Thereafter | 141,035 |
$ 163,360 |
Interest expense on the bonds payable for the years ended December 31, 2017 and 2016 totaled $3.4 million and $3.7 million, respectively.
Interest Rate Swaps
In October 1999, NAS entered into an interest-rate swap agreement, with an effective date of February 1, 2000, relating to the $66 million face amount of its Series 1999A revenue bonds. The agreement provides for NAS to receive 4.97% in interest on a notional amount of $65 million and to pay interest at a floating rate option based on the weekly interest rate resets of tax-exempt variable-rate issues per the Securities Industry and Financial Markets Association (“SIFMA”) Municipal Swap Index. NAS amended the agreement for the 2005−2020 period by 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 swap portfolio reverts to the fixed rate noted above for that month only.
NAS entered into this fixed-to-variable swap agreement to manage its exposure to interest rate changes. The fixed-rate debt obligations exposed NAS to variability in the cost recovery stream due to changes in interest rates. NAS recovers the costs of borrowing through a capital investment incentive rate that is set by the U.S. government and is tied to a variable index. If interest rates increase, the capital investment incentive recovery increases.
Conversely, if interest rates decrease, the capital investment incentive recovery decreases. Therefore, NAS entered into a derivative instrument that ties the fixed-rate debt to a variable index to manage fluctuations in cash flows resulting from interest rate risk. By using derivative financial instruments to hedge exposures to changes in interest rates, NAS exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes NAS, which creates credit risk for NAS. When the fair value of a derivative contract is negative, NAS owes the counterparty, and therefore, it does not possess credit risk. NAS minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties.
In May 2009, NAS entered into an additional swap agreement as a result of a counterparty exercising a swaption related to the Series 1999A Revenue Bonds. 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 one-month LIBOR plus 0.41%.
NAS entered into this variable-to-fixed swap agreement in order to preserve the synthetic variable rate achieved through the 1999 swap agreement once the fixed-rate Series 1999A bonds were refunded with the variable-rate Series 2009A bonds.
With regard to the fixed-to-variable interest rate swap, NAS recorded a loss on the change in the fair value of its swap agreement of approximately $108,000 and $18,000, for the years ended December 31, 2017 and 2016, respectively, which is included in other income in the accompanying statements of activities. The fair value of the interest rate swap was recorded as an asset of $35,000 and $143,000 as of December 31, 2017 and 2016, respectively, and is included in other assets in the accompanying statements of financial position.
Pertaining to the swaption and resultant variable-to-fixed interest rate swap, NAS recorded a gain on the change in the fair value of approximately $1.4 million and $1.5 million for the years ended December 31, 2017 and 2016, respectively, which is included in other income in the statements of activities. The fair value of the swap is recorded as a liability of approximately $6.1 million and $7.5 million as of December 31, 2017 and 2016, respectively, and is included in other current liabilities and other long-term liabilities in the accompanying statements of financial position.
The fair value of the swaps are determined using pricing models based on observable market data such as prices of instruments with similar maturities and characteristics, interest rate yield curves, and measures of interest rate volatility. The value was determined after considering the potential impact of collateralization and netting agreements, adjusted to reflect nonperformance risk of both the counterparty and NAS. Accordingly, the interest rate swaps are included in Level 2.
14. EMPLOYEE BENEFITS
Retirement Plans
NAS has a noncontributory defined-contribution retirement plan covering substantially all of its employees (based on certain benefit eligibility requirements). The funding vehicles under the plan consist of group investments issued by Teachers Insurance and Annuity Association (“TIAA”) and College Retirement Equities Fund (“CREF”), (known collectively as TIAA), as well as mutual funds issued by TIAA, Vanguard Fiduciary Trust Company, and other third parties. Participants in this plan vest immediately. NAS has received a favorable determination letter from the IRS on the qualification of this plan under Section 401(a) of the Internal Revenue Code.
In addition, NAS has a voluntary employee contribution retirement plan that is funded solely by employee contributions made on a pretax salary-reduction basis under Section 403(b) of the Internal Revenue Code. The funding vehicles under the plan consist of group investments issued by TIAA and CREF, as well as mutual funds issued by TIAA, Vanguard Fiduciary Trust Company, and other third parties.
Pension expense for the years ended December 31, 2017 and 2016, amounted to approximately $12.3 million and $12.2 million, respectively. NAS policy is to fund pension benefits as they are earned. NAS normal retirement age is 62, but there is no mandatory age for retirement.
Deferred Compensation
NAS holds investments as part of a frozen deferred compensation arrangement for certain employees. The fair value of these investments totaled approximately $963,000 and $855,000 as of December 31, 2017 and 2016, respectively, which is reported within other assets in the accompanying statements of financial position. The related obligation is included in accrued employee benefits in the accompanying statements of financial position. Deferred compensation investments are held in debt and equity mutual funds along
with some U.S. Treasury securities, all of which are valued using Level 1 inputs (Note 4). The deferred compensation obligation to employees is equal to the fair value of the investments held.
Postretirement and Postemployment Benefits
NAS provides certain health and life insurance benefits for employees retired due to length of service. All benefit-eligible employees may become eligible for service retiree benefits if they reach age 60 while working for NAS and complete five years of service in a benefit-eligible status for medical and 10 years of service for life insurance benefits. In addition, certain health and life insurance benefits are provided for employees retired due to disability. A benefit-eligible employee may become eligible for disabled retiree benefits if deemed totally disabled under NAS’ long-term disability insurance or if they are eligible for disability benefits from the Social Security Administration. Life insurance benefits are provided based on coverage at date of disability and health insurance may be continued if the disabled retiree had participated in an NAS health insurance plan for five years at the date of disability. Insurance companies whose premiums are determined on an experience-rated basis provide life and health insurance benefits for retirees. Medicare supplement insurance is not experience rated. The retiree welfare benefit plan is contributory for health insurance purposes for employees who retired on or after January 1, 1992. Participant contributions for health insurance are based on a percentage of the monthly premium paid by NAS (from 25% to 100%). The participant contribution is also based on their date of retirement, length of service, and choice of health insurance carrier.
The accrued postretirement benefit obligation is reported in accrued employee benefits in the accompanying statements of financial position.
Postretirement changes other than net periodic benefit cost are as follows (in thousands):
2017 | 2016 | ||
---|---|---|---|
New prior service cost | $ (70) | $ - | |
Net actuarial loss | 1,784 | 1,917 | |
Recognized net actuarial loss | (840) | (733) | |
Recognized prior service credit | 49 | 49 | |
Total | $ 923 | $ 1,233 |
Items not yet recognized as a component of net periodic benefit cost at December 31, 2017 and 2016 are as follows (in thousands):
2017 | 2016 | ||
---|---|---|---|
Net actuarial loss | $ 13,096 | $ 12,152 | |
Prior service credit | (266) | (245) | |
Total | $ 12,830 | $ 11,907 |
The estimated amounts, measured at year-end, that are expected to be recognized in the net periodic benefit cost over the next fiscal year for the postretirement benefit plan are as follows (in thousands):
2017 | 2016 | ||
---|---|---|---|
Prior service credit | $ (56) | $ (49) | |
Recognized actuarial loss | 848 | 840 | |
Total | $ 792 | $ 791 |
The following table presents the changes in benefit obligations, changes in plan assets, funded status, and the components of net periodic benefit cost for the years ended December 31, 2017 and 2016 (in thousands):
2017 | 2016 | ||
---|---|---|---|
Change in benefit obligation: | |||
Benefit obligation, beginning of year | $ 39,241 | $ 36,381 | |
Service cost | 1,412 | 1,254 | |
Interest cost | 1,544 | 1,524 | |
Plan participants’ contributions | 100 | 102 | |
Plan amendments | (70) | - | |
Actuarial loss | 4,681 | 788 | |
Benefits provided | (972) | (808) | |
Benefit obligation, end of year | 45,936 | 39,241 | |
Change in plan assets: | |||
Fair value of plan assets, beginning of year | 37,462 | 28,339 | |
Actual return on plan assets | 5,383 | 997 | |
Employer contributions | 2,941 | 8,921 | |
Benefits paid | (886) | (795) | |
Fair value of plan assets, end of year | 44,900 | 37,462 | |
Funded status (underfunded) | $ (1,036) | $ (1,779) |
2017 | 2016 | ||
---|---|---|---|
Components of net periodic benefit cost: | |||
Service cost | $ 1,412 | $ 1,254 | |
Interest cost | 1,544 | 1,524 | |
Expected return on plan assets | (2,486) | (2,125) | |
Recognized prior service credit | (49) | (49) | |
Recognized actuarial loss | 840 | 733 | |
Net periodic benefit cost | $ 1,261 | $ 1,337 |
The assumptions used to determine net periodic benefit cost for the years ended December 31, 2017 and 2016 are as follows:
2017 | 2016 | ||
---|---|---|---|
Discount rate | 4.00 % | 4.25 % | |
Expected long-term return on plan assets | 6.75 % | 7.50 % | |
Rate of increase in healthcare costs: | |||
Under age 65 | 6.41 % | 7.75 % | |
Over age 65 | 5.65 % | 6.25 % |
The assumptions used to calculate the accumulated postretirement benefit obligation for the years ended December 31, 2017 and 2016 are as follows:
2017 | 2016 | ||
---|---|---|---|
Discount rate | 3.50 % | 4.00 % | |
Rate of increase in healthcare costs for next year: | |||
Under age 65 | 6.21 % | 6.41 % | |
Over age 65 | 5.54 % | 5.65 % |
The trend rate for growth in healthcare costs was assumed to decline gradually beginning in 2018 to 4.5% in the year 2038 for the years ended December 31, 2017 and 2016.
The healthcare cost trend rate assumption has a significant impact on the postretirement benefit costs and obligations. The effect of a 1% increase in the assumed healthcare cost trend rate would have resulted in the following effects (in thousands):
2017 | 2016 | ||
---|---|---|---|
Postretirement benefit obligation | $ 7,253 | $ 5,963 | |
Benefit expense | 586 | 551 |
The effect of a 1% decrease in the assumed healthcare cost trend rate would have resulted in the following effects (in thousands):
2017 | 2016 | ||
---|---|---|---|
Postretirement benefit obligation | $ (5,770) | $ (4,759) | |
Benefit expense | (451) | (423) |
NAS postretirement benefit plan asset allocations at December 31, 2017 and 2016, by asset class are as follows:
2017 | 2016 | ||
---|---|---|---|
Cash | 3 % | 2 % | |
Bonds and notes | 48 | 47 | |
Equity | 49 | 51 | |
100 % | 100 % |
The investment objective of the Plan is to produce a rate of return over the long-term that will provide for fund growth, protect against the effect of inflation, and provide for some stability in different market environments. The fund is diversified between fixed income and equity investments. With this diversification and investment in broader market funds, there is reasonable assurance that no single security or class of securities will have a disproportionate impact on the Plan assets. The Plan assets are invested with a long-term growth with reduced volatility strategy.
The overall long-term rate of return was developed by estimating the long-term real rate of return for the Plan’s asset mix, while taking into account the effects of inflation. This estimate was developed by evaluating the history of investments with similar asset allocations.
The following table presents the fair value hierarchy for the postretirement benefit plan assets at December 31, 2017 (in thousands):
Total | Fair Value Measurements Using | ||
---|---|---|---|
Level 1 | Level 2 | ||
Financial assets: | |||
Retiree Welfare Benefit Plan investments: | |||
Cash equivalents | $ 931 | $ 931 | $ - |
Bonds and notes | |||
U.S. treasuries/government bonds | 5,753 | 5,753 | - |
Mortgage-backed securities | 3,513 | - | 3,513 |
Corporate bonds | 10,195 | 8,973 | 1,222 |
Non-U.S. fixed income | 2,277 | 2,246 | 31 |
Equity | |||
U.S. large equity | 11,444 | 11,444 | - |
U.S. small/mid equity | 5,553 | 5,553 | - |
Non-U.S. equity (developed) | 4,984 | 4,984 | - |
Total | 44,650 | $ 39,884 | $ 4,766 |
Cash held for invesment | 250 | ||
Total investments | $ 44,900 |
The following table presents the fair value hierarchy for the postretirement benefit plan assets at December 31, 2016 (in thousands):
Total | Fair Value Measurements Using | ||
---|---|---|---|
Level 1 | Level 2 | ||
Financial assets: | |||
Retiree Welfare Benefit Plan investments: | |||
Cash equivalents | $ 678 | $ 678 | $ - |
Bonds and notes | |||
U.S. treasuries/government bonds | 3,631 | 3,631 | - |
Mortgage-backed securities | 4,010 | - | 4,010 |
Corporate bonds | 7,967 | 7,553 | 414 |
Non-U.S. fixed income | 1,885 | 1,885 | - |
Equity | |||
U.S. large equity | 9,105 | 9,105 | - |
U.S. small/mid equity | 4,394 | 4,394 | - |
Non-U.S. equity (developed) | 5,234 | 5,234 | - |
Non-U.S. equity (emerging) | 308 | 308 | - |
Total | 37,212 | $ 32,788 | $ 4,424 |
Cash held for invesment | 250 | ||
Total investments | $ 37,462 |
The methods and assumptions used to estimate the fair value of each class of financial instrument are further discussed in Note 4.
NAS expects to contribute to the Plan the actuarially determined net periodic cost for 2018, which is approximately $1.1 million.
The following benefit payments, which reflect future services, are expected to be paid in future years as noted, as of December 31, 2017 (in thousands):
2018 | $ 1,457 | |
2019 | 1,593 | |
2020 | 1,695 | |
2021 | 1,832 | |
2022 | 1,951 | |
2023-2027 | 11,241 | |
$ 19,769 |
The measurement date of the plan assets and benefit obligations for 2017 and 2016 is December 31, 2017 and 2016, respectively.
15. RELATED-PARTY TRANSACTIONS
National Academy of Engineering Fund
The National Academy of Engineering Fund (“NAEF”) is a separately incorporated tax-exempt organization established by NAE to raise funds to support its goals. The financial activities and results of NAEF are not included in the NAS financial statements.
NAS performs certain activities in connection with fundraising by NAEF. NAS collected a total of $3.7 million and $4.3 million in 2017 and 2016, respectively, on behalf of NAEF. NAS disbursed $3.8 million and $4.3 million to NAEF from these collected amounts in 2017 and 2016, respectively. Amounts collected but not yet remitted to NAEF are included in other current liabilities in the statements of financial position.
The National Academies’ Corporation
The National Academies’ Corporation (“TNAC”) was separately incorporated in 1986 as a tax-exempt 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, NAM, and NAE. The financial position and results of TNAC are not consolidated in the NAS financial statements. NAS manages the operations of the Beckman Center.
Employees
The NAS Council has authorized an agreement providing a noninterest-bearing, collateralized advance to an employee in connection with the purchase of the employee’s residence. The agreement between the parties was executed in April 2013. The agreement will terminate upon the first to occur of the date the individual ceases to occupy the property as principal residence, sale of the property, or the end of the individual’s employment with NAS. The estimated present value of the receivable totaled $1.5 million at December 31, 2017 and 2016, respectively, and is included in other assets in the accompanying statements of financial position.
16. COMMITMENTS AND CONTINGENCIES
Leases
NAS is committed to one noncancelable operating lease for space. Future minimum rental payments due under the noncancelable operating lease are as follows (in thousands):
Years ending December 31, | ||
---|---|---|
2018 | $ 607 | |
2019 | 625 | |
2020 | 644 | |
2021 | 663 | |
2022 | 683 | |
Thereafter | 2,363 | |
$ 5,585 |
Rental expense totaled approximately $632,000 and $563,000 for the years ended December 31, 2017 and 2016, respectively.
Contingencies
NAS receives a portion of its revenues directly or indirectly from federal government grants and contracts, all of which are subject to audit by the Defense Contract Audit Agency, which has completed its examinations through December 31, 2013. A contingency exists relating to unexamined periods and final settlements of examined periods to refund any amounts received in excess of allowable costs. Management is of the opinion that no material liability will result from such audits.
In the normal course of business NAS may from time to time be subject to various claims and lawsuits. Certain lawsuits may be covered, in full or in part, by external insurance coverage. In the opinion of management, there are no lawsuits outstanding that would have a material adverse effect on the financial statements of NAS.
17. SUBSEQUENT EVENTS
NAS has evaluated subsequent events from the statement of financial position date through June 12, 2018, the date at which the financial statements were issued, and determined that there are no other items to disclose.
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OFFICERS
Marcia McNutt, President
Diane E. Griffin, Vice President
Susan Wessler, Home Secretary
John Hildebrand, Foreign Secretary
William H. Press, Treasurer
FINANCE COMMITTEE
William H. Press, Chair
Elwyn R. Berlekamp
Maureen Cropper
David Donoho
Robert Engle
Mark C. Fishman
Ronald L. Graham
Marcia McNutt
Jose A. Scheinkman
James H. Simons
BUDGET AND INTERNAL AFFAIRS COMMITTEE
William H. Press, Chair
Sylvia T. Ceyer
Ingrid Daubechies
Fred H. Gage
Diane E. Griffin
Peter S. Kim
Thomas D. Pollard
AUDITING COMMITTEE
Claude R. Canizares, Chair
Ronald L. Graham
Brian W. Matthews
Jeremiah P. Ostriker
FINANCIAL MANAGEMENT STAFF
Didi Salmon, Chief Financial Officer
Laura Douglas, Controller
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