University of California, Berkeley MANAGEMENT S DISCUSSION AND ANALYSIS (UNAUDITED)

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1 The objective of Management s Discussion & Analysis (MD&A) is to help readers of the financial statements of the University of California, Berkeley (Berkeley) better understand the financial position and operating activities for the year ended June 30, 2010, with selected comparative information for the years ended June 30, 2009 and This discussion has been prepared by management and should be read in conjunction with the financial statements and the notes to the financial statements. Unless otherwise indicated, years (2010, 2009, 2008) in this discussion refer to the fiscal years ended June 30. INTRODUCTION The University of California was chartered in 1868 and its flagship campus envisioned as a "City of Learning" was established at Berkeley, on San Francisco Bay. Today Berkeley is the world's premier public university and a wellspring of innovation. With more than 36,000 students, 1,700 full-time faculty members, 130 academic departments and 80 interdisciplinary research units, its academic and research community makes key contributions to the economic and social well-being of the Bay Area, California, and the nation through comprehensive excellence in teaching, research and public service. Berkeley ranks first among United States universities in the number of highly ranked graduate programs. In a report published in September 2010, the National Research Council (NRC) placed 48 out of 52 ranked Berkeley doctoral programs within the top 10 nationally. This compared to 46 of 52 programs for Harvard University, which came in second, and 40 of 59 programs for the University of California, Los Angeles (UCLA), in third place. Among its current faculty are: 8 Nobel laureates, 135 members of the National Academy of Sciences, 87 members of the National Academy of Engineering, and 12 recipients of the National Medal of Science. FINANCIAL HIGHLIGHTS Given the campus commitment to maintaining the quality of Berkeley s core mission of excellence in teaching, research and public service, key actions taken over the two years 2010 and 2009 allowed Berkeley s financial position to remain stable despite a dramatic reduction in state general support over the same two-year period. These actions included a system-wide furlough, workforce reduction through early retirements and layoffs, a more aggressive strategy toward utility savings, increases in student tuition and fees, and effective growth in federal and state grants and contracts. The substantial reduction of $264 million state of California general support in the last two years (from $451 million in 2008 to $319 million in each of 2009 and 2010, or $132 million per year) was significantly offset by a temporary allocation of $139 million federal American Recovery and Reinvestment Act (ARRA) stimulus support through the state educational appropriation and an increase in student tuition and fees, net of scholarship allowances, of $112 million in the same twoyear period. 1

2 State General Support, Federal ARRA Stimulus Support and Student Tuition and Fees, net $ In Thousands $1,000,000 $800,000 $51,241 $87,782 Federal ARRA stimulus support $600,000 $450,812 $319,473 $318,850 State general support $400,000 Student tuition and fees, net $200,000 $331,220 $362,099 $411,952 $ Net assets grew $278 million to $3.6 billion. Approximately 87% of net assets are invested in capital assets ($2.8 billion) or restricted ($323 million). The portion of net assets invested in capital assets consists of the net of the costs for land; infrastructure; buildings and improvements; equipment, software and intangibles; libraries and collections; special collections; and construction in progress; net of accumulated depreciation and amortization and the debt associated with these assets. A significant long-term initiative, Operational Excellence, seeks to permanently reduce administrative expenses by $75 million annually through streamlined systems, a simplified organizational structure, and a high performance operating culture. Savings from Operational Excellence will be critical to Berkeley s ability to fund anticipated cost increases in the long term and essential in offsetting the loss of Federal ARRA funding that bolstered its financial position in the last two years. ECONOMIC FACTORS AFFECTING THE FUTURE In the near-term, Berkeley anticipates the loss of federal ARRA funds, both those directed toward the educational mission and those funding competitive grants and contracts. While the state of California s government leadership shows a commitment to funding higher education, recognizing that each dollar spent on higher education redounds in the short and long-term to the health of the economy, Berkeley cannot expect to return to previous funding levels given persistent joblessness and lower tax revenues. California continues to mirror national trends in the global economic recovery. While tuition and fee increases have offset some of the decline in state funding, it is clear that the burden of the cost of higher education continues to fall increasingly on students and families. The 2010 tuition and fees, despite a 15% mid-year increase, brought Berkeley in line with other public flagship universities ($10,334 compared to the peer average of $9,300 for resident lower division undergraduates). Berkeley anticipates increases in tuition, increases in the number of nonresident students, and a continued commitment to increased scholarships. Operational Excellence will result in savings to the Berkeley beginning in fiscal year Savings will ultimately be directed toward improving upon Berkeley s mission: comprehensive excellence in teaching, research and public service. Under the Operational Excellence umbrella, six initiatives are concurrently underway, focused on near-term improvements in student services, energy management, technology and procurement. To enable these strategic efforts, Berkeley is developing a streamlined administrative structure, improving its financial management model and developing a highperformance operating culture. 2

3 OPERATING PERFORMANCE The statement of revenues, expenses and changes in net assets is a presentation of Berkeley s operating performance for the year. It indicates whether the financial condition has improved or deteriorated. In accordance with GASB requirements, certain significant revenues relied upon and budgeted for fundamental operational support of the core instructional mission of Berkeley are mandated to be recorded as nonoperating revenues, including state educational appropriations and private gifts. Berkeley s statement of revenues, expenses, and changes in net assets includes interest and insurance costs associated with the system-wide liabilities omitted from Berkeley s statement of net assets. A summarized comparison of the operating results for 2010 and 2009, arranged in a format that matches the revenue supporting the core activities of Berkeley with the expenses associated with core activities, is as follows (in thousands of dollars): YEAR ENDED JUNE 30, 2010 YEAR ENDED JUNE 30, 2009 $ % Operating Nonoperating Total Operating Nonoperating Total Change Change REVENUES Student tuition and fees, net $411,952 $411,952 $362,099 $362,099 $49,853 14% State educational appropriations: State general support $318, ,850 $319, ,473 (623) (0%) Federal ARRA stimulus support 87,782 87,782 51,241 51,241 36,541 71% Federal Pell grants 43,446 43,446 29,020 29,020 14,426 50% Grants and contracts, net 654, , , ,825 74,124 13% Educational activities and auxiliary enterprises, net 222, , , ,096 (1,741) (1%) Private gifts, net 144, , , ,368 1,504 1% Investment income 114, , , ,533 (2,724) (2%) Other revenues, net 24,713 18,670 43,383 20,510 19,433 39,943 3,440 9% Revenues supporting core activities 1,313, ,429 2,042,398 1,187, ,068 1,867, ,800 9% EXPENSES Salaries and employee benefits 1,174,929 1,174,929 1,193,475 1,193,475 (18,546) (2%) Scholarships and fellowships 80,668 80,668 77,275 77,275 3,393 4% Utilities 35,425 35,425 42,447 42,447 (7,022) (17%) Supplies and materials 144, , , ,976 5,288 4% Depreciation and amortization 149, , , ,210 5,625 4% Other expenses: Subcontracts 141, ,447 90,783 90,783 50,664 56% Travel 36,371 36,371 35,981 35, % Other 141,646 5, , ,188 4, ,518 (21,135) (13%) Expenses associated with core activities 1,904,585 5,737 1,910,322 1,887,335 4,330 1,891,665 18,657 1% Income (loss) from core activities ($590,616) $722, ,076 ($699,805) $675,738 (24,067) 156,143 N/A OTHER CHANGES IN NET ASSETS State capital appropriations 10,922 8,959 1,963 22% Capital gifts and grants, net 22,521 36,598 (14,077) (38%) Transfers from UC 112, ,811 (51,197) (31%) Increase in net assets 278, ,301 (63,311) (34%) NET ASSETS Beginning of year 3,358,065 3,172, ,301 6% End of year $3,636,198 $3,358,065 $278,133 8% 3

4 Operating and nonoperating revenues that support Berkeley's core activities 2010 ($ in thousands) Private gifts, net $144,872 7% Investment income $114,809 6% Other revenues, net $43,383 2% Student tuition and fees, net $411,952 20% Educational activities and auxiliary enterprises, net $222,355 11% State general support $318,850 16% Grants and contracts, net $654,949 32% Federal Pell grants $43,446 2% Federal ARRA stimulus support $87,782 4% Revenues to support Berkeley s core activities, including those classified as nonoperating revenues, were $2.0 billion in State of California educational appropriations, in conjunction with student tuition and fees, are the core components that support the instructional mission of Berkeley. Grants and contracts provide opportunities for undergraduate and graduate students to participate in basic research alongside some of the most prominent researchers in the country. Gifts to Berkeley allow crucial flexibility to faculty for support of their fundamental activities or new academic initiatives. Other significant revenues are from educational activities and auxiliary enterprises such as student housing, food service operations and parking. The percentage of state general support was 16% of all operating and nonoperating revenues in 2010, slightly less than the 17% in However, Federal ARRA stimulus support, the other component of state educational appropriations, increased slightly from 3% in 2009 to 4% in The percentage of student tuition and fees of the total revenues increased slightly to 20% in 2010 from 19% in Grants and contracts share of total revenues for research also increased slightly to 32% in 2010 from 31% in Gifts decreased modestly from 8% in 2009 to 7% in 2010 of the total revenues. The percentage of educational activities, auxiliary enterprises, investment income, Federal Pell grants and all other revenue sources of the total revenue was 21% in 2010 and 22% in Student tuition and fees revenue, net of scholarship allowances, grew by $50 million (14%) from $362 million in 2009 to $412 million in Tuition and fee rate increases and growth in the student population (1.5% undergraduate and.5% graduate students) were contributing factors. The tuition and fee rate increases were necessitated by growth in the demand for resources that has outpaced state educational appropriations. Education fees increased in the Fall 2009 semester and again in the Spring 2010 semester for both undergraduate and graduate students. Non-resident tuition also increased, as did tuition for summer sessions and professional degree programs. 4

5 Enrollment and Tuition and Fee Totals % Change Undergraduates 25,530 25,151 2% resident $10,334 $8,932 16% non-resident $33,051 $29,540 12% Graduate 10,313 10,258 1% resident $11,344 $10,214 11% non-resident $26,386 $25,220 5% Although these represent significant increases, they brought Berkeley s tuition and fees in line with other public flagship universities ($10,334 compared to the peer average of $9,300 for resident lower division undergraduates in ). Berkeley s total student body reached 35,843 in Berkeley and the UC system maintained their commitment to college students from California s financially-disadvantaged families. In concert with student fee increases, Berkeley contained required levels of self-help (as defined by the federal Financial Aid formula) by directing campus-raised funds towards needs-based aid for undergraduates and earmarking onethird of fee increases toward student financial aid. Both of these measures help offset a recipient s total cost of attending. In 2010, Berkeley provided $144 million in financial aid in the form of scholarship allowances that offset tuition and fees, compared to $121 million in 2009, and $112 million in This represents an increase of 29% over the three years, while the percentage of students receiving aid remained near 65% between 2008 and (2010 data is not available yet.) In the chart below, tuition and fees are reported net of aid applied to students accounts. $ In Thousands Tuition and Fees, and Growth of Financial Aid Applied to Tuition and Fees $600,000 $500,000 $400,000 $442,903 $111,683 $483,154 $121,055 $556,252 $144,300 $300,000 Financial aid applied to tuition and fees $200,000 $331,220 $362,099 $411,952 Student tuition and fees, net $100,000 Student tuition and fees, gross $

6 Housing and dining scholarship allowance is similarly applied by the auxiliary toward the students accounts. Amounts paid directly to students are reported as Scholarships and Fellowships expense. Total student financial aid for the three years ended June 30, 2010 is summarized as follows: Applied to student tuition and fees $144,300 $121,055 $111,683 Applied to auxiliary enterprises and other 33,015 31,430 30,753 Total scholarship allowances 177, , ,436 Paid directly to students 80,668 77,275 75,736 Total student financial aid $257,983 $229,760 $218,172 State educational appropriations allocated to Berkeley from the Office of the President of the University of California were $407 million and $371 million in 2010 and 2009, respectively. State educational appropriations included state general support of $319 million for both 2010 and 2009 and temporary federal ARRA stimulus support of $88 million and $51 million in 2010 and 2009, respectively. State educational appropriations, consisting solely of state general support, were $451 million in Federal Pell grants increased $14 million, or 50%, in 2010 to $43 million. The increase was primarily due to a 37% increase in grant recipients and a 13% increase in the maximum award amount. Grants and contracts - Berkeley is consistently rated among the top institutions in the world for the quality and breadth of its research enterprise, for the scholarly distinction of its faculty, for the excellence of its Ph.D. programs, and for the amount of funding received in support of its research programs. Each year, Berkeley receives well over one-half billion dollars in research support from external sources. In the fiscal year ending June 30, 2010, Berkeley submitted about 3,400 proposals and attracted $745 million in new research awards. This represents a 30% increase over the past five years. Many of these awards fund multi-year projects and will be reflected as revenue in subsequent years. The American Recovery and Reinvestment Act (ARRA) was passed by the United States Congress in February 2009 to provide stimulus funding for the nation s economy. Through fiscal year 2010, the campus submitted almost $140 million to ARRA-funded programs and received $66 million in fiscal year Seventy percent of the ARRA funding was from the National Institute of Health (NIH) and the National Science Foundation (NSF). These two agencies provide the most significant portion of Berkeley s federal research funding. In 2010, operating revenues from federal, state, private and local government totaled $655 million. The federal government provided 54% of the total grant and contract operating revenues, and agencies of the state of California, industry, and the non-profit sector supplied the rest. 6

7 Grants and Contracts $ In Thousands $700,000 $600,000 $500,000 $400,000 $300,000 $517,938 $139,138 $75,262 $580,825 $185,045 $77,195 $654,949 $176,357 $121,756 Private and local State $200,000 $303,538 $318,585 $356,836 Federal $100,000 $ Federal grants and contracts for research and other academic activities grew $38 million from a variety of agencies, including the Department of Health and Human Services, the National Science Foundation, the Department of Energy, the Department of Defense, and other federal sponsors. State grants and contracts revenues went up by $45 million, or 58%, from various state departments, such as the California Energy Commission, the California Department of Social Services, the California Office of Traffic Safety, CalTrans and the California Department of Mental Health. Grants and contracts operating revenues from local governments and private companies decreased by $8 million, reflecting the downturn in the economy. In fiscal year 2010, research funding in departments in excess of $20 million included: multidisciplinary programs reporting to the Vice Chancellor of Research - $100 million; the College of Engineering - $47 million; Biological Sciences - $46 million; the School of Public Health - $30 million; Math and Physical Sciences - $28 million; and the College of Natural Resources - $22 million. Educational activities and auxiliary enterprises decreased $2 million to $222 million in Sales and services of educational activities totaled $71 million in 2010 and $75 million in 2009, a decrease of $4 million, as publication sales, ticket sales, royalties, and license fees declined from the prior year. Partially offsetting the decrease in educational activities, auxiliary enterprises revenues increased by approximately $2 million from $149 million in 2009 to $151 million in 2010, attributable mainly to growth in housing fees. Private gifts, mainly restricted as to use, increased $2 million in 2010, from $143 million in 2009 to $145 million in Gifts may be made to Berkeley through UC or the Foundation. In addition to private gifts for operating purposes, gifts are also received for capital purposes - recorded as capital gifts and grants - and for permanent endowments. Permanent endowments are not recorded on Berkeley s books but rather are recorded on either UC s or the Foundation s books. The portion of investment returns earned on endowments held by UC and distributed each year to Berkeley to support its current operations is reflected in investment income. The Foundation s gift transfers to Berkeley increased $6 million from $79 million in 2009 to $85 million in Included in these gift amounts are the payouts from the Foundation -- $35 million and $32 million for 2010 and 2009, respectively. The endowment payout amounts relate to the payout rates approved by the Executive Committee of the Foundation for the preceding years (2009 and 2008) as the payouts are distributed to Berkeley in August of the following fiscal year. The Executive Committee of the Foundation approved a payout rate for 2009 of 4.76% and 5% for

8 Investment income includes expendable endowment income, dividend and interest from the total return investment pool (TRIP) and earnings from the short-term investment pool (STIP), all distributed from the Office of the President. In 2010, STIP earnings decreased $8 million, due primarily to declining interest rates and less cash available for investment. The STIP decrease was partially offset by a $5 million increase in endowment and TRIP income. Other revenues for 2010 of $43 million, including $14 million of state financing appropriations, $5 million of federal financing appropriations and $24 million of other operating and nonoperating revenues, increased $3 million from The state of California financing appropriation, which decreased $6 million in 2010, is directly related to the required rental payments under lease-purchase agreements with the state of California and deferred maintenance projects. The $5 million of federal financing appropriation, new in 2010, was from the Build America Bonds Subsidy, a program authorizing state and local governments to issue Build America Bonds as part of the American Recovery and Reinvestment Act of 2009 (ARRA), which provided a federal subsidy to cover a portion of the interest costs of these Bonds. Lastly, a $4 million increase in other operating revenues was due to growth in rental income from recently acquired properties and increases from various departmental revenue-generating activities. Expenses associated with core activities 2010 ($ in thousands) Other expenses - subcontracts $141,447 7% Other expenses - travel $36,371 2% Other expenses - other $147,383 8% Depreciation and amortization $149,835 8% Supplies and materials $144,264 8% Utilities $35,425 2% Scholarships and fellowships $80,668 4% Salaries and employee benefits $1,174,929 61% Expenses associated with core activities for 2010, totaling $2 billion, increased $19 million, or about 1% from About 61% of Berkeley s expenses in 2010 were related to salaries and benefits, compared to 63% in Subcontracts were 7% of total expenses associated with core activities in 2010 compared to 5% in The percentage of the other categories of expense to total expenses related to core activities remained approximately the same in 2010 as in Salaries and employee benefits of $1.2 billion in 2010 ($940 million of salaries and wages and $235 million of benefits) decreased by $19 million, or 2%, from There were 13,900 full time equivalent employees at Berkeley in Combined salaries and wages for both academic and administrative staff decreased $33 million, or 3%, from While academic salaries increased less than 1%, administrative staff salaries decreased more than 8% in Salary reduction programs, such as the furlough program and the time reduction program, as well as a reduction in staff positions, accounted for the significant decrease in administrative staff salaries in Total benefit costs increased $14 million, or 7%, 8

9 attributable primarily to continued growth in health insurance costs, increase in fee remission payments for graduate student employees and the campus contribution to UC s Retirement Plan (UCRP) that restarted on April 15, Scholarships and fellowships, representing payments of financial aid made directly to students and reported as an operating expense, totaled $81 million in 2010, a $3 million, or 4%, increase over Total scholarship allowances, also a form of scholarship and fellowship cost, increased $25 million to $177 million in Scholarship allowances are reported as an offset to revenue, not as an operating expense. See the Student Tuition and Fees section above for additional financial aid information. Utilities -- consisting of natural gas, electricity, water and sewer, and utility services showed a $7 million, or 17%, decrease from the prior year to $35 million in Most of the decrease was due to a 30% rate reduction for natural gas and lower usage for natural gas, oil and electricity from more aggressive cost-saving efforts. Supplies and materials of $144 million in 2010, increased $5 million, or 4%, from $139 million in The increase was mainly attributable to more operating expenses associated with capital projects and more laboratory instruments and supplies purchased in Depreciation and amortization expense increased $6 million to $150 million in 2010, reflecting the increase in capital assets. Subcontracts expenses increased $50 million, or 56%, from $91 million in 2009 to $141 million in The increase in these expenses, including transfers to other UC campuses for related research projects, highlights the continued competitive and effective nature of Berkeley s research enterprises. Travel expenses remained constant at $36 million for the two years 2010 and Other expenses consist of a variety of expense categories, including rent, insurance, legal settlements, repairs and maintenance, and other nonoperating expenses. These expenses decreased $21million, or 13%, to $147 million in 2010 as departments across the campus lowered their spending on miscellaneous services, printing and publications, building maintenance, and rental of facilities and equipment. Other Changes in Net Assets Other changes in net assets are generally not available to be used to support Berkeley s operating expenses in the current year. State capital appropriations and capital gifts and grants may only be used for the purchase or construction of the specified capital asset. State capital appropriations increased nearly $2 million in 2010, mainly associated with activities for the Durant Hall renovation and the Birge Hall infrastructure improvements in Capital gifts and grants totaled $23million in 2010, decreasing $14 million from The decrease was primarily attributable to a $20 million state capital grant received in 2009 for the Biomedical and Health Science Building. Offsetting this decrease, a $6 million capital gift for equipment was received at Engineering Research in

10 Transfers from UC, primarily between Berkeley and UC s Office of the President, were a $113 million addition to Berkeley s net assets in 2010, compared to a $164 million addition in See Note 10 in the Notes to the Financial Statements for additional detail of the transfers. Capital Spending and Debt/Capital Investments Berkeley continues to make major investments in its capital assets to meet the campus academic and strategic objectives. Enrollment, new academic initiatives, and growth in research all create demand for more space. While some of the demand can be met through renovation of existing buildings, new buildings are also required, particularly for programs that demand high performance infrastructure and other advanced features renovated space cannot provide. Berkeley s capital program can be arranged around five major themes: life safety, intellectual community, campus growth and new initiatives, renewal and maintenance, and sustainable campus. Details on current projects related to these major themes are available on our website, Achievement of these goals is made possible through a varied financial strategy which includes private philanthropy; grants from private foundations, state and federal governments; campus debt; and state bonds. While this year s capital program continued to see support from the state in the form of general obligation and lease revenue bonds, future capital programs are anticipated to rely less on the state and more heavily on campus debt, private philanthropy, and innovative partnerships with for-profit industry, such as the Strategic Energy Partnership with Pacific Gas and Electric and the Energy Biosciences Institute with British Petroleum. Completing Berkeley s capital spending are investments in the acquisition of library books and other special collections, other equipment and software. Using the Financial Statements Berkeley s financial statements are prepared from the official UC records and accounts for the campus. These campuslevel accounts are maintained in accordance with UC policies and relevant accounting principles generally accepted in the United States of America established by the Governmental Accounting Standards Board (GASB). Berkeley s financial statements have not been separately audited but rather are audited as part of the UC financial statement audit. The audited consolidated financial statements of UC are available at: Berkeley s financial report communicates financial information for the Berkeley campus through thee primary financial statements and notes to the financial statements. The three financial statements are the Statements of Net Assets; the Statements of Revenues, Expenses and Changes in Net Assets; and the Statements of Cash Flows. The three financial statements encompass the Berkeley campus and its discretely presented component, the Berkeley Foundation. However, the MD&A and the Notes to Financial Statements focus only on the campus. Information relating to the Berkeley Foundation can be found in its separately issued financial statements report. The notes provide additional information on the Berkeley campus-level accounts that is essential to a full understanding of the financial statements. Berkeley s Statements of Net Assets display all of the assets, liabilities, and net assets reflected in Berkeley s accounts. However, certain significant assets, liabilities, and net assets, such as system-wide investments, self insurance liabilities, revenue bond debt, and endowment funds, are not reflected in Berkeley s campus-level accounts. Therefore, Berkeley s Statements of Net Assets do not reflect a picture of the campus financial position on a stand-alone basis but rather as a campus within the UC system. 10