SRI International and Subsidiaries Consolidated Financial Statements and Supplementary Information December 26, 2015 and December 27, 2014

Transcription

1 SRI International and Subsidiaries Consolidated Financial Statements and Supplementary Information

2 Index Page(s) Independent Auditor s Report... 1 Consolidated Financial Statements Balance Sheets... 2 Statements of Activities and Changes in Net Assets... 3 Statements of Cash Flows

3 Independent Auditor s Report To the Board of Directors of SRI International: We have audited the accompanying consolidated financial statements of SRI International and subsidiaries ( SRI ), which comprise the consolidated balance sheets as of December 26, 2015 and December 27, 2014, and the related consolidated statements of activities and changes in net assets and statements of cash flows for the years then ended. Management s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of the consolidated 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 consolidated 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 the consolidated 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 consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to SRI s preparation and fair presentation of the consolidated 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 SRI s 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 consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of SRI International and its subsidiaries as of December 26, 2015 and December 27, 2014, and the changes in their net assets and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. March 25, 2016 PricewaterhouseCoopers LLP, Three Embarcadero Center, San Francisco, CA T: (415) , F: (813) ,

4 Consolidated Balance Sheets Assets Current assets Cash and cash equivalents $ 2,169 $ 31,337 Restricted cash and cash equivalents 1,324 1,068 Investments 42,769 52,412 Receivables, net 127,765 89,069 Inventory 6,655 4,666 Deferred income taxes 1,283 - Prepaid expenses and other assets 7,765 6,664 Total current assets 189, ,216 Property and equipment, net 105, ,256 Other noncurrent assets 10,807 7,593 Total assets 306, ,065 Liabilities and Net Assets Current liabilities Accounts payable and accrued expenses 62,105 57,718 Client advances and credits 23,831 16,389 Current portion of capital lease obligations Current installments of long-term debt 13,258 14,042 Total current liabilities 99,910 88,769 Long-term portion of capital lease obligations - 1,490 Long-term debt, excluding current installments 14,834 15,870 Other noncurrent liabilities 11,352 11,242 Total liabilities 126, ,371 Net assets Unrestricted 179, ,424 Temporarily restricted 532 1,270 Total net assets 180, ,694 Total liabilities and net assets $ 306,308 $ 295,065 The accompanying notes are an integral part of these consolidated financial statements. 2

5 Consolidated Statements of Activities and Changes in Net Assets Years Ended Unrestricted net assets Project revenue $ 487,301 $ 526,338 Royalty revenue 20,465 16,856 Net revenue 507, ,194 Direct project costs (291,803) (321,470) Excess of net revenue over direct project costs 215, ,724 Indirect expenses Salaries, wages, and benefits 130, ,335 Property and equipment 39,519 41,776 Materials, services, travel, and other 46,699 33,256 Internal research programs 12,709 11,279 Total indirect expenses 228, ,646 Other income (expense) Interest income 1,516 1,642 Interest expense (578) (668) Stanford University separation expense - (1,903) Realized gains on investments 3, Net assets released from restrictions Other, net 9,530 2,499 Total other income (expense) 15,105 2,387 Income (loss) from continuing operations 2,140 (535) Unrealized gain (loss) on investments (166) (130) Income (loss) before income taxes 1,974 (665) Income tax benefit 1,282 6 Change in unrestricted net assets 3,256 (659) Temporarily restricted net assets Change in temporarily restricted net assets Contributions - 92 Net assets released from restrictions (738) (690) Change in temporarily restricted net assets (738) (598) Change in net assets 2,518 (1,257) Net assets - beginning of year 177, ,728 Equity contribution from minority interest Net assets - end of year $ 180,212 $ 177,694 The accompanying notes are an integral part of these consolidated financial statements. 3

6 Consolidated Statements of Cash Flows Years Ended Cash flows from operating activities Change in net assets $ 2,518 $ (1,257) Adjustments to reconcile change in net assets to net cash provided by operating activities Depreciation and amortization 17,507 18,228 Provision for doubtful accounts 84 1,431 (Gain) loss on investments (3,733) 3 Gifts of securities for restricted purposes - (53) (Gain) loss on sale of property and equipment (51) 41 Gain on acquisition of CoGen (6,834) - Change in deferred income taxes (1,283) - Other noncash loss Changes in operating assets and liabilities Restricted cash and cash equivalents (256) 189 Receivables (38,723) 10,028 Inventory (982) (418) Prepaid expenses and other assets (743) (1,992) Other assets (2,634) (807) Accounts payable and accrued expenses 4,434 (7,656) Client advances and credits 7,442 2,307 Other noncurrent liabilities 427 (442) Net cash provided by (used in) operating activities (22,827) 20,138 Cash flows from investing activities Purchase of investments (11,564) (10,197) Sale and maturity of investments 23,357 8,303 Capital expenditures (17,239) (11,137) Proceeds from sale and purchase of property and equipment Net cash used in investing activities (4,767) (13,023) Cash flows from financing activities Principal payments of long-term debt (1,670) (1,700) Payments under capital lease (544) (615) Change in bank overdraft 640 (497) Capital contributions Net cash used in financing activities (1,574) (2,589) Net increase (decrease) in cash and cash equivalents (29,168) 4,526 Cash and cash equivalents Beginning of year 31,337 26,811 End of year $ 2,169 $ 31,337 Supplemental disclosures of cash flow information Cash paid during the year for interest, net of amount capitalized $ 575 $ 703 The accompanying notes are an integral part of these consolidated financial statements. 4

7 1. Nature of Organization and Summary of Significant Accounting Policies Description of Business SRI International and its subsidiaries ( SRI ) include the parent company ( SRI International ), Ravenswood Solutions, and Averatek Corporation ( Averatek ). SRI International is a non-profit, independent research and innovation organization serving government and industry by providing basic and applied research, laboratory and advisory services, technology development and licenses, deployable systems, products, and venture opportunities. The U.S. government, foreign governments, and some of the world s largest companies have been long-standing, major clients of SRI. SRI is headquartered in Menlo Park, California, with facilities in Arlington and Harrisonburg, Virginia; State College, Pennsylvania; Princeton, New Jersey; St. Petersburg, Florida and other offices throughout the United States and overseas. SRI uses a fiscal year that ends on the last Saturday in December. The fiscal years ended each included 52 weeks of operations. SRI s subsidiaries, Averatek and Ravenswood Solutions use a fiscal year that ends on December 31. Ravenswood Solutions On January 9, 2015, Ravenswood Solutions, a Delaware corporation, was incorporated by SRI as a for-profit, wholly owned subsidiary and included in SRI s consolidated financial statements. Ravenswood Solutions provides military, homeland defense and other government and commercial organizations with market-leading technology and services for collective training, test and evaluation, performance assessment and policy analysis exercises. Averatek On June 22, 2007, Averatek, a Delaware corporation, was incorporated and included in SRI s consolidated financial statements. On August 8, 2015, Averatek, issued shares to an unrelated party, thereby reducing SRI s ownership interest to 25.5% which resulted in loss of controlling interest. SRI has deconsolidated Averatek in the 2015 financial statements and transitioned to the equity method as of the date of the transaction. SRI utilized the market approach, derived from the recent share issuance, to determine fair value. The remeasurement of the retained interest in the Averatek resulted in a gain of $1.1 million, which is included in realized gains on investments in the consolidated statement of activities and change in net assets. As of December 26, 2015, SRI owned a 25.5% interest in Averatek and SRI s investment in Averatek is recorded at $0.5 million, which is included in other noncurrent assets in the consolidated balance sheet. Principles of Consolidation The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America and include the accounts of SRI International and its subsidiaries. All material intercompany balances and transactions have been eliminated in the consolidated financial statements. Investments in other affiliated companies over which SRI has significant influence are accounted for on the equity method and are reflected as other noncurrent assets. Contributions All contributions are considered to be available for unrestricted use, unless specifically restricted by the donor. Amounts received that are designated for future periods or are restricted by the donor for specific purposes are reported in the consolidated statements of activities. SRI classifies donorrestricted contributions as unrestricted if the restrictions are met in the same reporting period in which the contributions are received. 5

8 Unrestricted Net Assets Revenue is reported as an increase in unrestricted net assets unless use of the related assets is limited by donor-imposed restrictions. Expenses are reported as decreases in unrestricted net assets. Gains or losses on investments and other assets or liabilities are reported as increases or decreases in unrestricted net assets unless their use is restricted by explicit donor stipulation or by law. Unrestricted net assets for 2015 and 2014 include $0.0 million and $0.2 million of equity contribution from minority interest in Averatek, respectively. Temporary Restricted Net Assets Temporary restricted net assets are net assets that are subject to donor-imposed restrictions that expire with specific actions to be undertaken by SRI and/or the passage of time. Temporary restricted contributions received in 2015 and 2014 were $0.0 million and $0.1 million, respectively. Upon the satisfaction of donor imposed stipulations and/or the passage of time, the associated net assets are released from temporarily restricted net assets and recognized as unrestricted net assets. Measure of Operations SRI considers all revenue and expenses related to operations except equity income or loss from investee companies and unrealized gains or losses from investments. Revenue and Receivables Project revenue consists principally of services performed from contracts with the U.S. government, state and local governments, private foundations and subcontracts with other contractors engaged in such work. SRI performs services under various types of contracts, including fixed-price, timeand-materials and cost-type contracts. Revenue for services performed are generally recognized using the percentage-of-completion method as the costs of performing the work are incurred in accordance with Financial Accounting Standards Board ( FASB ) issued Accounting Standards Codification ( ASC ) , Contractors-Federal Government, Revenue Recognition. Certain project revenue arrangements include contractual restrictions such as ceilings on costs and indirect rates. Anticipated losses on contracts are recognized in the period in which they become evident. Revenue from the sale of products is recorded upon passage of title and risk of loss to the customer, which is generally upon delivery, provided that all other requirements for revenue recognition have been met. SRI receives royalties on certain technology on which it holds patents or copyrights. Royalty income, is recorded when due under the applicable technology transfer agreements and when collectibility is reasonably assured. SRI reports royalty revenue gross of expenses. Royalty related expenses are included in indirect expenses in the consolidated statement of activities and change in net assets. Receivables consist of billed and unbilled revenue. Billed receivables were $69.4 million and $40.0 million and unbilled receivables were $64.8 million and $55.5 million at December 26, 2015 and December 27, 2014, respectively. Contractual retentions are included in other noncurrent assets on the consolidated balance sheets (see note 4). SRI does not have a material credit risk exposure as a majority of receivables are associated with the U.S. government. Remaining receivables consists primarily of contracts with private entities and foreign governments and is widely diversified. While SRI believes there is minimal credit risk given the nature of its customers, significant changes in levels of federal research funding could impact SRI. When events or conditions indicate that amounts outstanding from customers may 6

9 become uncollectible, an allowance is estimated and recorded. Allowance for uncollectible accounts of $0.8 million and $0.7 million are included as a reduction in receivables on the consolidated balance sheets at, respectively. Revenue on Federal government contracts has been recorded using provisional indirect rates. In cases where the final indirect rate settlement will result in a revenue reduction, management has established a reserve. Allowance for indirect rate reserve of $5.7 million and $5.7 million are included as a reduction in receivables on the consolidated balance sheets at December 26, 2015 and December 27, 2014, respectively. Cash Equivalents Cash equivalents consist of short-term highly liquid investments with an original maturity of three months or less when purchased. Cash and cash equivalents consist of cash on hand, demand deposits with banks, highly liquid investments in money market funds, commercial paper, government securities, certificates of deposit, and corporate debt securities, which are readily convertible into cash. Restricted Cash and Cash Equivalents Restricted cash and cash equivalents consist primarily of funds that are contractually restricted for certain purposes, including unspent bond proceeds, and funds deposited for future bond redemption. Investments Investments are recorded at fair value. Net realized and unrealized gains and losses on investments are reflected in the statements of activities and changes in net assets (see note 2). The investment portfolio may be exposed to various risks, including, but not limited to, interest rate, market, sovereign, concentration, counterparty, liquidity and credit risk. Fair Value of Financial Assets and Liabilities ASC 820, Fair Value Measurements, defines fair value 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. ASC 820 also 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 Level 2 Level 3 Quoted prices in active markets for identical assets or liabilities. 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. Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. SRI s financial instruments include cash and cash equivalents, receivables, investments, accounts payable, client advances and credits and long-term debt. 7

10 The carrying amounts of cash and cash equivalents, receivables, accounts payable, and client advances and credits approximate fair value because of the short-term maturity of these financial instruments. The carrying value of SRI s long-term debt approximates fair value because interest rates reflect current market rates offered by lending institutions for loans with similar terms to companies with comparable credit risk. Inventory Inventory consists of product in inventory for sale to customers, as well as supplies used in research activities. Product inventory consist of raw material parts, work-in-process and finished goods. Inventories are valued at the lower of cost or market value, cost being determined by a method that approximates the first-in, first-out method. Property and Equipment Purchased property and equipment are recorded at cost. Donated property and equipment are recorded at their fair value at date of gift. Depreciation of property and equipment is provided over the estimated useful lives of the respective assets. Buildings and improvements are depreciated over various lives, ranging from 10 to 71 years, principally by the straight-line method. Equipment is depreciated over various lives, ranging from 3 to 20 years, by the straight-line method. Leasehold improvements are amortized over the shorter of the term of the respective lease by the straight-line method or their economic life. Property and equipment under capital leases is recorded at the present value of the minimum lease payments at the inception of the leases and is amortized on the straight-line method over the shorter of the lease term or the estimated useful life of the asset. The amortization of assets recorded under capital leases is included in depreciation and amortization expense in the accompanying consolidated statements of activities and unrestricted net assets. Interest costs incurred on borrowed funds during the period of construction of capital assets is capitalized as a component of the cost of acquiring these assets. During 2015 and 2014, SRI capitalized approximately $0.1 million and $0.1 million, respectively, of interest expense related to various construction projects. Repairs and maintenance expenditures are expensed as incurred. Impairment of Long-Lived Assets Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. There were no impairment losses for the years ended. Client Advances and Credits Client advances and credits represent funds received from customers in advance of performing services and recording revenue. Asset Retirement Costs and Obligations SRI reports legal obligations associated with the retirement of long-lived assets in accordance with ASC , Asset Retirement Obligations ( ARO ). The ARO is measured at fair value at the time 8

11 the obligation is incurred. Upon initial recognition of a liability, SRI capitalizes the cost as part of the cost basis of the related long-lived asset and depreciates the asset over the useful life. Estimated AROs of $7.3 million and $7.0 million are included in other noncurrent liabilities in the consolidated balance sheets at, respectively. Changes in the obligation due to revised estimates of the amount or timing of cash flows required to settle the future liability are recognized by increasing or decreasing the carrying amount of the ARO liability and the related long-lived asset. Changes due solely to the passage of time are recognized as an increase in the carrying amount of the liability as an accretion expense. Accretion expense for 2015 and 2014 was $0.4 million and $0.3 million, respectively, and is included in property and equipment expense in the consolidated statement of activities and change in net assets. Income Taxes SRI International is a non-profit corporation and is tax exempt under Section 501(c)(3) of the Internal Revenue Code. Activities that generate unrelated business income, as defined by the Internal Revenue Service, are subject to income taxes. Ravenswood Solutions is a taxable corporation. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Use of Estimates The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results differ from those estimates. 9

12 Revision of Previously Issued Consolidated Balance Sheets SRI s previous financial statements included a disclosure under commitments and contingencies relating to environmental remediation at SRI s site in Princeton, New Jersey. This site was formerly owned by Sarnoff Corporation, which was donated to SRI by General Electric ( GE ) on March 31, 1987 and operated by SRI as a wholly-owned subsidiary until 2011 when it was fully integrated into SRI. The prior disclosure stated that under the terms of an agreement dated March 31, 1987 between SRI and GE, SRI was indemnified for any and all losses, claims, damages or expenses arising from third-party claims resulting from the ownership, operation or management of Sarnoff prior to March 31, 1987, and that SRI believed that GE, through the indemnification, or through other claims, would be held accountable for this remediation. Upon reviewing the donation agreement, SRI determined that the previous legal position resulted in an error. SRI should have previously recorded a loss contingency. As a result of the error, SRI revised opening balances for the earliest period presented. The nature of the error is that GE s indemnification obligation in the donation agreement does not encompass environmental claims. However, SRI may pursue claims against GE for the cost of remediation of environmental matters at the Princeton site through other clauses of the donation agreement, and through other legal claims. A revised disclosure is included in note 11. Correcting the error did not impact the consolidated statements of activities and changes in net assets or the consolidated statements of cash flows. The impact to the 2014 consolidated balance sheet is summarized below Financial Statement Line Items (in thousands of dollars) As previously presented Adjustment As revised Consolidated Balance Sheet Assets Total Assets $ 295,065 $ - $ 295,065 Liabilities and Net Assets Other Noncurrent Liabilities 8,083 3,159 11,242 Total Liabilities 114,212 3, ,371 Net Assets - Unrestricted 179,583 (3,159) 176,424 Net Assets - Temporary Restricted 1,270-1,270 Net Assets 180,853 (3,159) 177,694 Total Liabilities and Net Assets $ 295,065 $ - $ 295,065 10

13 2. Investments Investments consist of the following marketable securities: Equity securities $ 1,077 $ 998 Corporate bonds 41,692 51,414 Total investments $ 42,769 $ 52,412 Net gain (loss) on investments consist of the following: Unrealized Equity securities $ (101) $ (16) Corporate bonds (65) (114) (166) (130) Realized Equity securities 3, Corporate bonds , Net gain (loss) on investments $ 3,733 $ (3) Consistent with ASC , Not-for-Profit Entities, Investments Debt and Equity Securities, SRI reports realized investment returns as operating income and unrealized investment returns as nonoperating income. As gains/losses are realized, the unrealized gains/losses from previous years are reversed. Included in unrealized losses for 2015 and 2014 are unrealized gain reversals of $0.2 million and $0.1 million, respectively. 11

14 The following table represents investments carried at fair value: (in thousands of dollars) Fair Value Measurements at December 26, 2015 Total Level 1 Level 2 Level 3 Fair Value Investments Corporate bonds $ - $ 41,692 $ - $ 41,692 Equity securities 1, ,077 Total investments $ 1,077 $ 41,692 $ - $ 42,769 Fair Value Measurements at December 27, 2014 Total Level 1 Level 2 Level 3 Fair Value Investments Corporate bonds $ - $ 51,414 $ - $ 51,414 Equity securities Total investments $ 998 $ 51,414 $ - $ 52,412 12

15 3. Property and Equipment Property and equipment consist of the following: Land and improvements $ 25,945 $ 23,500 Buildings 212, ,618 Equipment 72,416 72,093 Leasehold improvements 9,887 9,583 Construction-in-progress 8,203 5, , ,009 Less: Accumulated depreciation and amortization (223,562) (214,753) $ 105,771 $ 102,256 Depreciation and amortization expense for the years ended December 26, 2015 and December 27, 2014 was $17.5 million and $18.2 million, respectively. Depreciation expense for the years ended was $15.8 million and $16.1 million, respectively. Fully depreciated property and equipment held by SRI as of December 26, 2015 and December 27, 2014 was $67.1 million and $62.5 million, respectively. SRI acquires government property under federal contracts. Government property is expensed as incurred as a direct project cost and does not appear on our consolidated balance sheets. In 1985, the California Alternative Energy and Advanced Transportation Financing Authority (the Authority ) issued Cogeneration Revenue Bonds to finance the construction of a 5.6 megawatt cogeneration facility at SRI s Menlo Park campus to provide steam and electricity for the campus. Upon completion of the facility in 1987, SRI began leasing the facility from the Authority. Lease payments made by SRI at market utility rates were used to operate the facility and service the bond debt. On April 13, 2015, SRI exercised its option to retire the outstanding debt and purchase the cogeneration facility, resulting in a gain of $6.8 million. The gain is included in other income (other, net) in the consolidated statement of activities and change in net assets. 4. Other Noncurrent Assets Other noncurrent assets consist of the following: Contractual retention and fee withhold receivable $ 9,359 $ 6,577 Investments in affiliates, net 1, Other $ 10,807 $ 7,593 13

16 5. Accounts Payable and Accrued Expenses Accounts payable and accrued expenses consist of the following: Accounts payable $ 28,423 $ 28,923 Accrued payroll, vacation and other employee related accruals 28,917 22,335 Bank overdraft Stanford separation obligation (Note 12) - 1,903 Accrued insurance 2,917 3,306 Other 1,208 1,251 $ 62,105 $ 57,718 14

17 6. Long-Term Debt Long-term debt consists of the following: California Infrastructure and Development Bank Revenue Bond Series 2010 Tax-exempt Variable Rate Demand Revenue Bonds ("Series 2010 Bonds"); interest at 0.02% at December 26, 2015 and 0.05% at December 27, $ 12,221 $ 12,720 California Infrastructure and Development Bank Refunding Revenue Bond Series 2012 Tax-exempt Fixed Rate Bonds ("Series 2012 Bonds") payable through 2028 interest coupon 3% to 5% and weighted average interest 3.858%. 15,871 17,192 Total principal amounts 28,092 29,912 Less: Current installments (13,258) (14,042) Long-term debt, excluding current installments $ 14,834 $ 15,870 Series 2010 Bonds In March 2010, the California Infrastructure and Economic Development Bank issued $15.0 million Tax-Exempt Variable Rate Demand Revenue Bonds (the Series 2010 Bonds ) on behalf of SRI. The proceeds from this bond issuance were for the financing or refinancing of the acquisition, construction, installation, improvement, renovation, remodeling, replacement, furnishing and equipping of certain research facilities owned and operated by SRI and located at SRI s main campus in Menlo Park. The Series 2010 Bonds are subject to optional and mandatory sinking fund redemption and optional and mandatory tender for purchase at any time they remain at a variable interest rate. The bonds are subject to conversion to a term interest rate and mandatory tender upon such conversion. The Series 2010 Bonds are subject to mandatory redemption by lot, from sinking fund payments on September 1, 2011 through SRI has no obligation to make any direct payments with respect to bonds tendered for purchase. The purchase price of bonds tendered is payable only from the proceeds of the remarketing of such bonds and from amounts from a bank letter of credit, currently with Wells Fargo bank. The letter of credit was issued to ensure payment of the bonds to the holders and to enhance the credit rating and marketability of the bonds. Under the bank letter of credit agreement SRI would be obligated to reimburse Wells Fargo for any bonds tendered to Wells Fargo. The available bank letter of credit is $12.8 million on the Series 2010 Bonds with no amounts drawn against the letter of credit at. The letter of credit expires on March 1, 2017, and renews annually. SRI is required to present its bond obligations as a current liability because the letters of credit contains a subjective acceleration clause. 15

18 Under the terms of the various agreements entered into in connection with the issuance of the bonds, SRI must comply with certain covenants including maintenance of corporate existence; maintenance of records and filing of financial statements; payment of taxes, utilities and other charges; maintenance of tax-exempt status of interest on the bonds. In addition, Wells Fargo can accelerate the debt in the event of any breach of material terms, covenants or agreements, any impairment of the collateral or proceeds or any material adverse change that Wells Fargo believes impairs or is substantially likely to impair repayment or performance by SRI. At December 26, 2015, SRI is in compliance with its covenants related to the Series 2010 Bonds. Series 2012 Bonds In June 2012, the California Infrastructure and Economic Development Bank issued $18.6 million Tax-Exempt Fixed Rate Bonds (the Series 2012 Bonds ) on behalf of SRI. The proceeds from this bond issuance refinanced the Series 2003A Bonds. The bonds are subject to a continuing disclosure annual report due May 31 annually and reporting of significant events as and when they occur. At December 26, 2015, SRI is in compliance with its covenants related to the Series 2012 Bonds. Line of Credit As of, SRI has an available line of credit of $23.1 million and $23.5 million, respectively, with Wells Fargo Bank. There was no amount outstanding as of. Borrowings under the line are collateralized by real property. The interest rate on the line of credit as of December 26, 2015 and December 27, 2014 was LIBOR plus 1.5%. The line of credit expires on September 1, SRI s line of credit contains restrictive covenants which require, among other items, the maintenance of defined levels of capital, liabilities to total capital, net excess of revenues over expenses, and earnings. In addition, these covenants limit capital expenditures, loans, advances and investments. At December 26, 2015, SRI is in compliance with its covenants. Based on the borrowing rates currently available to SRI for loans with similar terms and average maturities, the carrying value of long term debt approximated fair value as of December 26, 2015 and December 27, 2014, respectively. Maturities of debt as of December 26, 2015 are expected to be as follows: (in thousands of dollars) 2016 $ 1, , , , ,744 Thereafter 19,850 $ 28,092 16

19 7. Other Noncurrent Liabilities Other noncurrent liabilities consist of the following: Long term asset retirement obligation $ 7,334 $ 6,971 Environmental obligation 3,159 3,159 Long term lease obligation 859 1,112 $ 11,352 $ 11, Leases SRI is obligated under noncancelable capital and operating leases, primarily for office space and equipment that expire through Future minimum lease payments and lease revenue under noncancelable capital and operating leases as of December 26, 2015 were as follows: (in thousands of dollars) Capital Operating Lease Lease Payments Payments Payable Payable 2016 $ 739 $ 5, , , , ,598 Thereafter - 15, $ 39,532 Less: Amount representing interest (23) Present value of minimum lease payments 716 Less: Current portion (716) Long term capital lease obligations $ - Rental expense for all operating leases for the years ended December 26, 2015 and December 27, 2014 was approximately $4.9 million and $5.2 million, respectively. Lease expense for significant leases is recorded on a straight-line basis in the case of pre-established increases in future lease payments. Rental income for all operating leases for the years ended December 26, 2015 and December 27, 2014 was approximately $3.2 million and $3.1 million, respectively, and is reflected as other income on the consolidated statements of activities and change in net assets. 17

20 9. Income Taxes Income tax benefit consists of: Current U.S. federal $ 1,047 $ - State ,282 6 Deferred U.S. federal - - State Total income tax benefit $ 1,282 $ 6 The income tax benefit attributable to pre-tax income differs from the amounts computed by applying the U.S. federal income tax rate of 35% for 2015 and 2014 to pretax income primarily as a result of the portions of SRI income exempt from income taxes and changes in the deferred tax valuation allowance. Deferred tax assets and deferred tax liabilities consist of the following as of December 26, 2015 and December 27, 2014: Net operating loss carryforwards $ 38,208 $ 34,296 Property, plant, and equipment 24 - Total gross deferred tax assets 38,232 34,296 Valuation allowance (36,949) (34,296) Deferred tax assets 1,283 - Deferred tax liabilities - - Net deferred tax liabilities $ - $ - SRI International (parent company) has net operating loss carryforwards for federal and state income tax purposes of approximately $101.7 million and $23.6 million, respectively, which are available to offset future taxable income, if any, and expire in varying amounts between 2015 and Additionally, Ravenswood Solutions has net operating loss carryforwards for federal and state income tax purposes of approximately $1.1 million and $0.1 million, respectively, which are available to offset future taxable income, if any, and expire beginning in SRI International (parent company) has determined based upon the weight of available evidence, that it is more likely than not that the net deferred tax assets will not be realized and, accordingly, have provided a valuation allowance. Ravenswood Solutions, a for-profit entity, has determined, based upon the weight of available evidence, that it is more likely than not that the net deferred tax 18

21 assets will be realized and, accordingly, have not provided a valuation allowance. During the years ended the valuation allowance increased by $2.7 million and $2.6 million, respectively, on a consolidated basis. SRI recognizes interest and penalties as incurred within income tax expense in the consolidated statements of activities and unrestricted net assets. 10. Benefit Plans Certain employees who meet eligibility requirements are covered by defined contribution plans pursuant to Sections 401(a), 401(k) and/or 403(b) of the Internal Revenue Code. Employees in Puerto Rico are covered under a defined contribution plan which is intended to meet the requirements under the 2011 Puerto Rico Code Sections (a) and (d). Additionally, certain amounts are paid or reserved for foreign plans. The obligations under the plans are funded by SRI as necessary each year. Total retirement plan costs were $16.4 million and $18.4 million during the years ended, respectively. 11. Commitments and Contingencies Letter of Credit SRI has outstanding standby letters of credit as performance bonds in the amount of $14.3 million and $14.5 million as of, respectively. Government Contracting Matters Contracts with the U.S. government are subject to extensive legal and regulatory requirements and, from time to time and in the ordinary course of business, agencies of the U.S. government investigate whether the company s operations are conducted in accordance with these requirements and terms of the relevant contracts. Given the inherent complexities in administering federal awards, it is possible that the aforementioned matters could result in disallowances which could be material. Payments to SRI on cost-plus-fee and time-and-materials contracts are subject to adjustment upon audit by the DCAA. DCAA has completed auditing the Company s incurred cost submissions through the years ended In the opinion of management, audit adjustments that may result from audits not yet completed or started are not expected to have a material effect on the Company s financial position, results of operations, or cash flows as the Company has accrued its best estimate of potential disallowances. Litigation Matters SRI is also involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material effect on SRI s consolidated financial position. Other SRI provides limited indemnifications in the ordinary course of business. The impact of these agreements, individually or in the aggregate, is not expected to be material to the consolidated financial statements. As a result, no liabilities related to guarantees and indemnifications have been recorded as of December 26, Under the terms of a donation agreement dated March 31, 1987 between SRI and General Electric ( GE ), GE is responsible for fines imposed or claims made to the extent arising from 19

22 environmental conditions occurring or existing at SRI s site in Princeton, New Jersey, before it was donated to SRI on March 31, SRI is aware of certain environmental matters that will require remediation, the cost of which is estimated at $3.2 million. GE s indemnification obligation in the donation agreement does not encompass environmental claims; thus, SRI has accrued the estimated cost of remediation noted above. SRI may pursue claims against GE, through the donation agreement and through other claims, for the cost of this remediation. 12. Related Party Transactions Under a separation agreement with Stanford University ( Stanford ), SRI is required to pay Stanford one half of 1% of its (and its subsidiaries ) gross revenue from operations, less certain exclusions. SRI entered into an additional agreement with Stanford in October 2015 which waived the payment obligation for fiscal Expense to Stanford under the separation agreement amounted to $1.9 million for the year ended December 27, 2014, of which $1.9 million was outstanding as of December 27, SRI is in discussions with Stanford regarding various options for closer collaboration and to certain tenant lease approval requirements with respect to SRI s Menlo Park campus. Receivables from Stanford amounted to $0.3 million and $0.1 million as of December 26, 2015 and December 27, 2014, respectively. In addition, for the year ended December 26, 2015, awards amounting to $1.6 million and $1.4 million were made to and received from Stanford, respectively. For the year ended December 27, 2014, awards amounting to $1.5 million and $0.7 million were made to and received from Stanford. SRI has a lease arrangement through 2016 with Stanford for research space. Lease income for the year ended amounted to $1.9 million and $1.8 million, respectively. SRI has a common board member with Stanford. SRI also has a common board member with Nuance Communications and held shares of Nuance stock valued at $1.0 million and $0.9 million as of, respectively. SRI had contract revenue of approximately $0.1 million and $0.2 million from investee companies for the years ended, respectively, with no related receivables as of. 13. Subsequent Events SRI has evaluated subsequent events through March 25, 2016, which is the date the consolidated financial statements were available to be issued. 20