SOUTHERN RESEARCH INSTITUTE (A Component Unit of the University of Alabama at Birmingham)

(A Component Unit of the University of Alabama at Birmingham) FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION

TABLE OF CONTENTS INDEPENDENT AUDITORS REPORT 1 MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) 4 FINANCIAL STATEMENTS Statements of Net Position Enterprise Fund 16 Statements of Revenues, Expenses, and Changes in Net Position Enterprise Fund 18 Statements of Cash Flows Enterprise Fund 20 Statements of Plan Net Position OPEB Trust Fund 22 Statements of Changes in Plan Net Position OPEB Trust Fund 23 Notes to the Financial Statements 24 Required Supplementary Information 43 SUPPLEMENTARY INFORMATION Schedule of Expenditures of Federal Awards 44 Notes to Schedule of Expenditures of Federal Awards 49 Independent Auditors Report on Internal Control over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards 50 Independent Auditors Report on Compliance for Each Major Program and on Internal Control over Compliance Required by the Uniform Guidance 52 Schedule of Findings and Questioned Costs 54

INDEPENDENT AUDITORS REPORT The Board of Directors Southern Research Institute Report on the Financial Statements We have audited the accompanying basic financial statements of Southern Research Institute, a component unit of the University of Alabama at Birmingham, as of and for the years ended January 1, 2016 and January 2, 2015, and its discretely presented component unit as of and for the years ended January 1, 2016 and January 2, 2015, and the related notes to the financial statements, which collectively comprise the Institute s basic financial statements, as listed in the table of contents. 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. Auditors Responsibility Our responsibility is to express opinions 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 and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. 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 auditors 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 auditors consider internal control relevant to the entity s 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 the entity 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 financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinions. 1

Opinions In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Southern Research Institute as of January 1, 2016 and January 2, 2015, and the changes in its financial position and its cash flows for the years then ended, and the financial position of its discretely presented component unit as of January 1, 2016 and January 2, 2015, and the changes in its financial position for the years then ended in conformity with accounting principles generally accepted in the United States of America. Emphasis of Matter As discussed in Note 2 to the financial statements, in 2015, the Institute adopted the provisions of GASB Statement No. 75, Accounting and Financial Reporting for Postemployment Benefits Other Than Pensions, which required the Institute to record its obligation (asset) for postemployment benefits other than pensions. This standard has been applied retrospectively, resulting in the restatement of beginning net position. Other Matters Required Supplementary Information Accounting principles generally accepted in the United States of America require that the management s discussion and analysis and other postemployment benefit information on pages 4 through 15 and page 43 be presented to supplement the basic financial statements. Such information, although not a part of the basic financial statements, is required by the Governmental Accounting Standards Board, who considers it to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic, or historical context. We have applied certain limited procedures to the required supplementary information in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management s responses to our inquiries, the basic financial statements, and other knowledge we obtained during our audit of the basic financial statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide any assurance. Other Information Our audit was conducted for the purpose of forming opinions on the financial statements that collectively comprise Southern Research Institute s basic financial statements. The schedule of expenditures of federal awards is presented for purposes of additional analysis as required by Title 2 U.S. Code of Federal Regulations (CFR) Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards, and is not a required part of the basic financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the basic financial statements. The information has been subjected to the auditing procedures applied in the audit of the basic financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the basic financial statements or to the basic financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated, in all material respects, in relation to the basic financial statements as a whole. 2

Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated April 27, 2016, on our consideration of Southern Research Institute s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering Southern Research Institute s internal control over financial reporting and compliance. Birmingham, Alabama April 27, 2016 3

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited)

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) OVERVIEW OF THE FINANCIAL STATEMENTS AND FINANCIAL ANALYSIS Southern Research Institute (the Organization) is pleased to present its financial statements as of January 1, 2016 and January 2, 2015, and for the fiscal years then ended. The objective of management s discussion and analysis is to help readers of the Organization s financial statements better understand the financial position at January 1, 2016 and January 2, 2015, and the operating activities for the years then ended. The Organization operates on a 52/53-week fiscal year, with the fiscal year end on the Friday nearest December 31. The accompanying financial statements cover the period from January 3, 2015 through January 1, 2016 (2015), and January 4, 2014 through January 2, 2015 (2014). The Organization utilizes two different funds to account for its activities: an enterprise fund, which reports information about the general operations of the Organization, and a fiduciary fund, which reports information about the OPEB Trust Fund (the Plan). For information regarding the fiduciary fund of the Organization, see the statements of plan net position OPEB trust fund and the statements of changes in plan net position OPEB trust fund in the financial statements. The OPEB trust fund does not issue separate annual audited financial statements. The following discussion should be read in conjunction with the financial statements and notes to the financial statements. The enterprise fund financial statements presented were prepared in accordance with Governmental Accounting Standards Board (GASB) Statement No. 34, Basic Financial Statements and Management s Discussion and Analysis for State and Local Governments, as amended by GASB Statement No. 37, Basic Financial Statements and Management s Discussion and Analysis for State and Local Governments: Omnibus, and GASB Statement No. 38, Certain Financial Statement Note Disclosures. The financial statements presented focus on the financial condition, the changes in net position, and cash flows of the Organization. There are three financial statements presented: the statements of net position; the statements of revenues, expenses, and changes in net position; and the statements of cash flows. These statements present financial information in a form similar to that used by private-sector corporations. The Organization s net position (total assets minus total liabilities) is an indicator of the Organization s current financial condition, while the changes in net position and the cash flow statements are indicators of whether the Organization s financial condition has improved or worsened during the year. This discussion and analysis of the Organization s financial statements provides an overview of its activities for the year. As discussed in Note 2 to the financial statements, in 2015, the Institute adopted the provisions of GASB Statement No. 75, Accounting and Financial Reporting for Postemployment Benefits Other Than Pensions, which required the Institute to record its obligation (asset) for postemployment benefits other than pensions (OPEB). This standard has been applied retrospectively, resulting in the restatement of beginning net position. 4

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) STATEMENTS OF NET POSITION The statements of net position present the financial position of the Organization at the end of the fiscal year and include all assets and liabilities recorded on the accrual basis of accounting. As stated above, the difference between total assets and total liabilities (net position) is one indicator of the financial condition of the Organization at year end. A summarized comparison of the Organization s assets, liabilities, and net position at January 1, 2016 and January 2, 2015, is as follows: 2015 2014 (Restated) Change % Change Current assets $ 82,978,571 $ 96,909,449 $ (13,930,878) (14%) Capital assets 61,278,984 69,778,971 (8,499,987) (12%) Deferred outflows 534,634 3,023,299 (2,488,665) (82%) Total assets and deferred outflows $ 144,792,189 $ 169,711,719 $ (24,919,530) (15%) Current liabilities $ 17,825,203 $ 25,658,545 $ (7,833,342) (31%) Noncurrent liabilities 17,666,458 18,403,516 (737,058) (4%) Total liabilities $ 35,491,661 $ 44,062,061 $ (8,570,400) (19%) Net position: Net investment in capital assets $ 43,388,984 $ 51,378,971 $ (7,989,987) (16%) Restricted: Expendable 10,844,784 13,874,062 (3,029,278) (22%) Unrestricted 55,066,760 60,396,625 (5,329,865) (9%) Total net position $ 109,300,528 $ 125,649,658 $ (16,349,130) (13%) Net position decreased from $125.6 million at January 2, 2015, to $109.3 million at January 1, 2016, a decrease of $16.3 million. This decrease reflects the losses the Organization has incurred for the year ended January 1, 2016. Total assets and deferred outflows decreased by approximately 15% during 2015, with a 14% decrease in current assets, a 12% decrease in capital assets, and an 82% decrease in deferred outflows. The change in current assets comprised: Investments (restricted and unrestricted) decreased from $57.2 million at January 2, 2015, to $56.4 million at January 1, 2016, due to interest and dividend income reinvested of $1.1 million, market losses of $2.0 million, and net transfers from operations of $0.1 million. Cash and cash equivalents decreased from $1.2 million at the beginning of the year to $0.3 million at year end due to cash flows from operations of $2.9 million, purchases of capital assets of $3.7 million, and other negative cash flows of $0.1 million. 5

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) STATEMENTS OF NET POSITION CONTINUED Accounts receivable increased by 26%, with the 2015 year-end balance of $17.0 million representing 98 days of sales outstanding for contract revenues compared to 76 days of sales outstanding for contract revenues at January 2, 2015. The increase in accounts receivable was related to certain projects with significant increases and closeouts of government contracts. Other receivables decreased 84% from the January 2, 2015, balance of $22.5 million, resulting principally from an intellectual property milestone of $20.0 million earned in the fourth quarter of 2014 and received in 2015, and an insurance receivable due at January 1, 2016, of $1.4 million. The insurance receivable, non-operating, increased from zero at 2014 year-end to $3.2 million at 2015 year-end. The receivable reflects the amount due based on loss on the disposal of assets for a casualty loss. The Organization invested $3.9 million in capital assets in 2015. After disposals and depreciation/amortization expense, net capital assets decreased during the year from $69.8 million to $61.3 million, a decrease of 12%. Deferred outflows declined by 82% due to a decline in the interest rate swap asset of $0.2 million and a decline in the net other postemployment benefits asset of $2.3 million. Current liabilities decreased by 31% during the year, and noncurrent liabilities decreased by 4%, from beginning balances of $25.7 million and $18.4 million, respectively. The 31% net decrease in total current liabilities comprised a 56% decrease in accounts payable to a year-end balance of $1.6 million, a 43% decrease in accrued liabilities to a year-end balance of $9.6 million, and an increase of $0.8 million in notes payable from a balance of $1.8 million at the beginning of the year. Unearned contract revenues increased by 15% from the beginning balance of $3.0 million. The decrease in accrued liabilities was related primarily to distributions accrued related to the intellectual property income milestone earned in the fourth quarter of 2014 and paid in 2015. The 4% decrease in noncurrent liabilities resulted from current maturities of long-term debt of $0.5 million and a decrease in the interest rate swap liability of $0.2 million. 6

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) STATEMENTS OF NET POSITION CONTINUED A summarized comparison of the Organization s assets, liabilities, and net position at January 2, 2015 and January 3, 2014, is as follows: 2014 (Restated) 2013 (Restated) Change % Change Current assets $ 96,909,449 $ 85,963,406 $ 10,946,043 13% Capital assets 69,778,971 75,515,565 (5,736,594) (8%) Deferred outflows 3,023,299 2,639,327 383,972 15% Total assets and deferred outflows $ 169,711,719 $ 164,118,298 $ 5,593,421 3% Current liabilities $ 25,658,545 $ 18,455,129 $ 7,203,416 39% Noncurrent liabilities 18,403,516 19,132,836 (729,320) (4%) Total liabilities $ 44,062,061 $ 37,587,965 $ 6,474,096 17% Net position: Net investment in capital assets $ 51,378,971 $ 57,182,801 $ (5,803,830) (10%) Restricted: Expendable 13,874,062 13,138,741 735,321 6% Unrestricted 60,396,625 56,208,791 4,187,834 7% Total net position $ 125,649,658 $ 126,530,333 $ (880,675) (1%) Net position decreased from $126.5 million at January 3, 2014, to $125.6 million at January 2, 2015, a decrease of $0.9 million. This decrease reflects the losses the Organization has incurred for the year ended January 2, 2015. Total assets and deferred outflows increased by approximately 3% during 2014, with a 13% increase in current assets, an 8% decrease in capital assets, and a 15% increase in deferred outflows. The change in current assets comprised: Investments (restricted and unrestricted) decreased from $66.7 million at January 3, 2014, to $57.2 million at January 2, 2015, due to interest and dividend income reinvested of $1.2 million, market gains of $1.8 million, and transfers to operations of $12.5 million. Cash and cash equivalents increased from $0.2 million at the beginning of the year to $1.2 million at year end due to negative cash flows from operations of $7.1 million, net funds transferred (to)/from trustee of $0.5 million, purchases of capital assets of $4.7 million, transfers from investments of $12.5 million, and other negative cash flows of $0.2 million. Accounts receivable decreased by 2%, with the 2014 year-end balance of $13.5 million representing 76 days of sales outstanding for contract revenues compared to 75 days of sales outstanding for contract revenues at January 3, 2014. The decrease in accounts receivable is consistent with the decline in contract revenues. Other receivables increased 834% from the January 3, 2014, balance of $2.4 million, resulting principally from an intellectual property milestone earned in the fourth quarter of 2014. 7

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) STATEMENTS OF NET POSITION CONTINUED Funds held by trustee decreased from the beginning of the year balance of $0.5 million to zero at year end, as bond funds were used for qualified capital investments. The Organization invested $4.7 million in capital assets in 2014. After disposals and depreciation/amortization expense, net capital assets decreased during the year from $75.5 million to $69.8 million, a decrease of 8%. The 15% increase in deferred outflows comprises a decrease of $0.2 million in the interest rate swap asset and an increase in the net OPEB asset of $0.6 million. Current liabilities increased by 39% during the year, and noncurrent liabilities decreased by 4%, from beginning balances of $18.5 million and $19.1 million, respectively. The 39% net increase in total current liabilities comprised a 30% decrease in accounts payable to a year-end balance of $3.5 million, a 107% increase in accrued liabilities to a year-end balance of $16.8 million, and an increase of $0.6 million in notes payable from a balance of $1.3 million at the beginning of the year. Unearned contract revenues decreased by 18% from the beginning balance of $3.6 million. The increase in accrued liabilities was related primarily to distributions accrued related to the intellectual property income milestone earned in the fourth quarter. The 4% decrease in noncurrent liabilities resulted from current maturities of long-term debt of $0.5 million and a decrease in the interest rate swap liability of $0.2 million. STATEMENTS OF REVENUES, EXPENSES, AND CHANGES IN NET POSITION The statements of revenues, expenses, and changes in net position present, on an accrual basis, the revenues earned and expenses incurred during the fiscal year. Activities are classified as either operating or nonoperating, depending on whether activities are an integral part of the Organization s operations (operating) or not (nonoperating). The difference between revenues and expenses (change in net position) increases or decreases the net position balance presented in the statements of net position from one year to the next. 8

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) STATEMENTS OF REVENUES, EXPENSES, AND CHANGES IN NET POSITION CONTINUED Operating revenues consist of revenues from contract research and intellectual property revenues, net of direct expenses. Operating expenses are those expenses necessary to conduct contract research, to generate and protect the Organization s intellectual property, and to generate intellectual property income. Comparative statements of revenues, expenses, and changes in net position for 2015 and 2014 are as follows: Year Ended January 1, 2016 Year Ended January 2, 2015 (Restated) Change % Change Operating revenues: Contract revenues $ 63,362,767 $ 65,326,361 $ (1,963,594) (3%) Intellectual property income, net of direct expenses 4,470,005 16,551,805 (12,081,800) (73%) Total operating revenues 67,832,772 81,878,166 (14,045,394) (17%) Operating expenses: Salaries, wages, and benefits 45,198,054 43,729,386 1,468,668 3% Supplies and services 28,539,114 31,448,080 (2,908,966) (9%) Depreciation and amortization 7,750,688 8,064,463 (313,775) (4%) Total operating expenses 81,487,856 83,241,929 (1,754,073) (2%) Operating loss (13,655,084) (1,363,763) (12,291,321) (901%) Nonoperating revenues and expenses: Contributions 159,002 97,552 61,450 63% Investment income (949,539) 2,961,079 (3,910,618) (132%) Interest expense (513,047) (588,610) 75,563 13% Loss on disposal of assets (1,384,161) (1,880,472) 496,311 26% Net nonoperating revenues and expenses (2,687,745) 589,549 (3,277,294) (556%) Loss before other revenues, expenses, gains, and losses (16,342,829) (774,214) (15,568,615) (2,011%) Environmental remediation Loss from discontinued operations - (6,301) 78,016 (184,477) (78,016) 178,176 (100%) 97% Change in net position (16,349,130) (880,675) (15,468,455) (1,756%) Net position at beginning of year, as previously reported 125,649,658 123,676,222 1,973,436 2% Adjustment to adopt new accounting guidance issued by the GASB - 2,854,111 (2,854,111) (100%) Net position at beginning of year, as restated 125,649,658 126,530,333 (880,675) (1%) Net position at end of year $ 109,300,528 $ 125,649,658 $ (16,349,130) (13%) Contract revenues in 2015 were 3% lower than the prior year, with revenues from sales to the U.S. Government generating 68% of the total in 2015 and 71% in 2014. Net intellectual property income decreased from 2014 to 2015 by 73% due to a milestone earned in 2014 and a declining royalty stream for a product approaching its end of patent life. 9

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) STATEMENTS OF REVENUES, EXPENSES, AND CHANGES IN NET POSITION CONTINUED The increase in salaries, wages, and employee benefits of 3% was the net result of nominal merit and market increases, staff reductions, and increased benefit costs. Year-end employee headcounts (full-time equivalents, FTE) for the Organization for 2015 and 2014 were 434 and 460, respectively. Contract revenue per FTE was approximately $146,000 for 2015 and $142,000 in 2014. The 9% decline in expenditures for supplies and services from 2014 to 2015 comprises a 7% decline in directly related project expenditures and 12% decrease in non-labor overhead and general and administrative expenses. The decrease in investment income in 2015 comprises unrealized gains on investments in 2014 of $1.8 million versus unrealized losses of $2.1 million in 2015. Dividend and interest income was $1.2 million in 2014 and $1.1 million in 2015. For 2014 and 2015, loss from discontinued operations is comprised of legal expenses. No contingent consideration was earned in 2014 or 2015. The adjustment to adopt new accounting guidance issued by the GASB is due to the adoption of GASB No. 75, related to the Organization s OPEB plan. 10

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) STATEMENTS OF REVENUES, EXPENSES, AND CHANGES IN NET POSITION CONTINUED Comparative statements of revenues, expenses, and changes in net position for 2014 and 2013 are as follows: Year Ended January 2, 2015 (Restated) Year Ended January 3, 2014 (Restated) Change % Change Operating revenues: Contract revenues $ 65,326,361 $ 67,063,914 $ (1,737,553) (3%) Intellectual property income, net of direct expenses 16,551,805 5,507,147 11,044,658 201% Total operating revenues 81,878,166 72,571,061 9,307,105 13% Operating expenses: Salaries, wages, and benefits 43,729,386 43,701,039 28,347 0% Supplies and services 31,448,080 33,718,079 (2,269,999) (7%) Depreciation and amortization 8,064,463 6,810,380 1,254,083 18% Total operating expenses 83,241,929 84,229,498 (987,569) (1%) Operating loss (1,363,763) (11,658,437) 10,294,674 88% Nonoperating revenues and expenses: Contributions 97,552 135,093 (37,541) (28%) Investment income 2,961,079 8,106,195 (5,145,116) (63%) Interest expense (588,610) (582,727) (5,883) (1%) Loss on disposal of assets (1,880,472) (1,602,035) (278,437) (17%) Net nonoperating revenues and expenses 589,549 6,056,526 (5,466,977) (90%) Loss before other revenues, expenses, gains, and losses (774,214) (5,601,911) 4,827,697 86% Environmental remediation Loss from discontinued operations 78,016 (184,477) - (20,958) 78,016 (163,519) - (780%) Change in net position (880,675) (5,622,869) 4,742,194 84% Net position at beginning of year, as previously reported 123,676,222 129,299,091 (5,622,869) (4%) Adjustment to adopt new accounting guidance issued by the GASB 2,854,111-2,854,111 - Net position at beginning of year, as restated 126,530,333 129,299,091 (2,768,758) (2%) Net position at end of year $ 125,649,658 $ 123,676,222 $ 1,973,436 2% Contract revenues in 2014 were 3% lower than the prior year, with revenues from sales to the U.S. Government generating 71% of the total in 2014 and 71% in 2013. Net intellectual property income increased from 2013 to 2014 by 201% due to a milestone earned in 2014. Salaries, wages, and employee benefits increased modestly, the net result of nominal merit and market increases, and staff reductions. Year-end employee headcounts for the Organization for 2014 and 2013 were 460 and 475, respectively. Contract revenue per employee increased from $141,000 in 2013 to $142,000 in 2014. 11

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) STATEMENTS OF REVENUES, EXPENSES, AND CHANGES IN NET POSITION CONTINUED The 7% decline in expenditures for supplies and services from 2013 to 2014 comprises a 6% decline in directly related project expenditures and an 8% increase in non-labor overhead and general and administrative expenses. The decrease in investment income in 2014 comprises unrealized gains on investments in 2013 of $7.0 million versus unrealized gains of $1.8 million in 2014. Dividend and interest income was $1.2 million in 2013 and 2014. For 2013 and 2014, loss from discontinued operations comprises legal expenses, with the 2013 legal expenses offset by an insurance recovery of $1.0 million. No contingent consideration was earned in 2013 or 2014. The adjustment to adopt new accounting guidance issued by the GASB is due to the adoption of GASB No. 75, related to the Organization s OPEB plan. STATEMENTS OF CASH FLOWS The statements of cash flows present detailed information about the cash activity of the Organization by reporting the sources and uses of cash. The statements of cash flows include cash flows from three sources: operating activities, financing activities, and investing activities. Cash flows from operating activities reflect the cash generated from, or used in, the Organization s operations. Cash flows from financing activities include cash provided by the issuance of debt and cash used to extinguish such debt. Additionally, financing activities include the acquisition and disposal of capital assets. Finally, cash flows from investing activities include cash used to acquire debt and equity securities and to purchase intangible assets. Cash provided by debt and equity securities, such as interest and dividend income, and from the sale of such securities and other investments, is also reported as net cash provided or used by investing activities. 12

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) STATEMENTS OF CASH FLOWS CONTINUED Summary cash flows for 2015 and 2014 are as follows: Year Ended January 1, 2016 Year Ended January 2, 2015 Change % Change Cash flows from operating activities $ 2,872,928 $ (7,088,213) $ 9,961,141 141% Cash flows from noncapital financing activities 159,002 97,552 61,450 63% Cash flows from capital and related financing activities (3,845,069) (4,476,317) 631,248 14% Cash flows from investing activities (94,341) 12,500,739 (12,595,080) (101%) Net change in cash and cash equivalents (907,480) 1,033,761 (1,941,241) (188%) Cash and cash equivalents at beginning of year 1,209,023 175,262 1,033,761 590% Cash and cash equivalents at end of year $ 301,543 $ 1,209,023 $ (907,480) (75%) The significant differences in cash flows in 2015 versus 2014 are: Operating activities: Cash collected from contract revenues decreased by $6.1 million (9%), a 6 percentage point greater decrease than the decline in accrual basis revenues. The difference reflects an increase in days sales outstanding of 76 in 2014 to 98 in 2015. Cash collected from intellectual property income increased by $18.3 million due to a $20.0 million milestone earned in 2014 and collected in 2015, and a decline in the intellectual property royalty payments. Payments to employees increased by $2.1 million in 2015 with an increase of $3.5 million in payments under the intellectual property income sharing policy, merit and market increases, and offsetting costs savings associated with staff reductions. Note that for both years, payments to employees and related benefits include payments made under the Organization s intellectual property income sharing policy. These payments have been netted against intellectual property revenues in the statements of revenues, expenses, and changes in net position. Payments to suppliers increased by $0.2 million due to an increase of $4.2 million in payments to co-developers of intellectual property and offsetting reductions in project related and indirect expenses. Capital and related financing activities: Purchases of capital assets decreased from $4.7 million in 2014 to $3.9 million in 2015. Trust funds of $0.5 million were used to purchase capital assets in 2014 and no trust funds were available for use in 2015. Principal and interest payments on long-term debt were $1.0 million and $1.1 million in 2015 and 2014, respectively. Investing activities: Purchases of investments decreased from $17.1 million in 2014 to $6.7 million in 2015, and proceeds from sales of investments decreased from $28.6 million in 2014 to $5.5 million in 2015. 13

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) STATEMENTS OF CASH FLOWS CONTINUED Expenses from divestiture comprised $6,000 of directly related legal expenditures in 2015, and $149,000 of directly related legal expenditures in 2014. Interest and dividend income was approximately $1.1 million and $1.2 million in 2015 and 2014, respectively. Summary cash flows for 2014 and 2013 are as follows: Year Ended January 2, 2015 Year Ended January 3, 2014 Change % Change Cash flows from operating activities $ (7,088,213) $ (355,702) $ (6,732,511) (1,893%) Cash flows from noncapital financing activities 97,552 135,093 (37,541) (28%) Cash flows from capital and related financing activities (4,476,317) (7,563,950) 3,087,633 41% Cash flows from investing activities 12,500,739 6,914,630 5,586,109 81% Net change in cash and cash equivalents 1,033,761 (869,929) 1,903,690 219% Cash and cash equivalents at beginning of year 175,262 1,045,191 (869,929) (83%) Cash and cash equivalents at end of year $ 1,209,023 $ 175,262 $ 1,033,761 590% The significant differences in cash flows in 2014 versus 2013 are: Operating activities: Cash collected from contract revenues decreased by $4.9 million (7%), 4 percentage points lower than the 3% decrease in accrual basis revenues. The difference reflects stability of days sales outstanding in 2014 as compared to an improvement of 14 days in 2013. Cash collected from intellectual property income decreased by $0.2 million due to a declining royalty stream. Payments to employees increased nominally by $0.2 million in 2014 with a decline in payments under the intellectual property income sharing policy and costs savings associated with staff reductions offset by merit and market increases and strategic new hires. Note that for both years, payments to employees and related benefits include payments made under the Organization s intellectual property income sharing policy. These payments have been netted against intellectual property revenues in the statements of revenues, expenses, and changes in net position. Payments to suppliers increased by 4% due primarily to a 30% decline in accounts payable related to the timing of purchases, the receipt of vendor invoices, and payments. Capital and related financing activities: Purchases of capital assets decreased from $11.6 million in 2013 to $4.7 million in 2014. The Organization issued $0.6 million of self-bought bonds in 2013 with the proceeds placed in trust. No self-bought bonds were issued in 2014. Trust funds of $0.5 million and $4.4 million were used in 2014 and 2013, respectively, to purchase capital assets. Principal and interest payments on long-term debt were $1.1 million in 2013 and 2014. 14

MANAGEMENT S DISCUSSION AND ANALYSIS (Unaudited) STATEMENTS OF CASH FLOWS CONTINUED Investing activities: Purchases of investments increased from $10.4 million in 2013 to $17.1 million in 2014, and proceeds from sales of investments increased from $16.1 million in 2013 to $28.6 million in 2014. Expenses from divestiture comprised $149,000 of directly related legal expenditures in 2014, and $1.0 million of directly related legal expenditures and net insurance proceeds of $1.0 million in 2013. Interest and dividend income was approximately $1.2 million in 2013 and 2014. CAPITAL ASSETS AND DEBT ADMINISTRATION An aspect of the Organization s continued growth is an emphasis on the expansion and maintenance of capital assets. The Organization continues to acquire new capital assets and maintain and upgrade those assets it already possesses, as financial resources allow. At January 1, 2016, capital expenditure commitments were approximately $2.4 million. Capital assets include land, buildings, equipment, and intangibles, such as patent costs. As shown on the statements of cash flows, the Organization invested approximately $3.9 million in capital assets in 2015. All of the long-term debt at January 1, 2016 and January 2, 2015, was related to a $20.0 million Recovery Zone Facility Bond issued on August 30, 2010. During 2015 and 2014, the Organization made long-term debt payments of $510,000 and $480,000, respectively, all of which were for the Recovery Zone Facility Bond. 15

FINANCIAL STATEMENTS

STATEMENTS OF NET POSITION Enterprise Fund ASSETS AND DEFERRED OUTFLOWS OF RESOURCES 2014 2015 (Restated) CURRENT ASSETS Cash and cash equivalents $ 301,543 $ 1,209,023 Investments 45,679,988 45,801,195 Restricted cash and investments 10,686,608 11,414,279 Accounts receivable, net 17,046,403 13,517,190 Other receivables 3,530,451 22,502,617 Insurance receivable, non-operating 3,169,448 - Materials and supplies, net 947,049 923,199 Prepayments and other current assets 1,617,081 1,541,946 Total current assets 82,978,571 96,909,449 NONCURRENT ASSETS Net OPEB asset 158,176 2,459,783 Capital assets: Land and improvements 8,157,347 8,086,347 Buildings and major plant equipment 64,355,578 70,626,838 Laboratory equipment and fixtures 62,171,952 63,091,569 Office furniture and equipment 2,609,539 2,480,925 Intangible assets, net 2,214,834 1,957,006 139,509,250 146,242,685 Less accumulated depreciation 79,783,427 76,940,647 59,725,823 69,302,038 Construction-in-progress 1,553,161 476,933 Total capital assets, net 61,278,984 69,778,971 Total noncurrent assets 61,437,160 72,238,754 TOTAL ASSETS 144,415,731 169,148,203 DEFERRED OUTFLOWS OF RESOURCES Accumulated change in fair value of interest rate swap 376,458 563,516 TOTAL ASSETS AND DEFERRED OUTFLOWS OF RESOURCES $ 144,792,189 $ 169,711,719 See notes to the financial statements. 16

STATEMENTS OF NET POSITION Enterprise Fund LIABILITIES AND NET POSITION 2014 2015 (Restated) CURRENT LIABILITIES Accounts payable $ 1,550,481 $ 3,497,750 Accrued liabilities 9,617,914 16,796,398 Unearned contract revenue 3,387,870 2,955,368 Current maturities of long-term debt and capital lease obligations 600,000 560,000 Note payable 2,668,938 1,849,029 Total current liabilities 17,825,203 25,658,545 NONCURRENT LIABILITIES Long-term debt and capital lease obligations 17,290,000 17,840,000 Derivative instrument interest rate swap 376,458 563,516 Total noncurrent liabilities 17,666,458 18,403,516 NET POSITION Invested in capital assets, net of related debt 43,388,984 51,378,971 Restricted: Expendable 10,844,784 13,874,062 Unrestricted 55,066,760 60,396,625 Total net position 109,300,528 125,649,658 TOTAL LIABILITIES AND NET POSITION $ 144,792,189 $ 169,711,719 See notes to the financial statements. 17

STATEMENTS OF REVENUES, EXPENSES, AND CHANGES IN NET POSITION Enterprise Fund FOR THE YEARS ENDED 2014 2015 (Restated) OPERATING REVENUES Contract revenues $ 63,362,767 $ 65,326,361 Intellectual property revenues, net of direct expenses 4,470,005 16,551,805 Total operating revenues 67,832,772 81,878,166 OPERATING EXPENSES Salaries, wages, and benefits 45,198,054 43,729,386 Supplies and services 28,539,114 31,448,080 Depreciation and amortization 7,750,688 8,064,463 Total operating expenses 81,487,856 83,241,929 OPERATING LOSS (13,655,084) (1,363,763) NONOPERATING REVENUES AND EXPENSES Contributions 159,002 97,552 Investment income (loss) (949,539) 2,961,079 Interest expense (513,047) (588,610) Loss on disposal of assets (1,384,161) (1,880,472) Net nonoperating revenues and expenses (2,687,745) 589,549 LOSS BEFORE OTHER CHANGES (16,342,829) (774,214) See notes to the financial statements. 18

STATEMENTS OF REVENUES, EXPENSES, AND CHANGES IN NET POSITION Enterprise Fund FOR THE YEARS ENDED 2014 2015 (Restated) OTHER CHANGES IN NET POSITION Environmental cleanup $ - $ 78,016 Loss from discontinued operations (6,301) (184,477) CHANGE IN NET POSITION (16,349,130) (880,675) NET POSITION AT BEGINNING OF YEAR, AS PREVIOUSLY REPORTED 125,649,658 123,676,222 ADJUSTMENT TO ADOPT NEW ACCOUNTING GUIDANCE ISSUED BY THE GASB - 2,854,111 NET POSITION AT BEGINNING OF YEAR, AS RESTATED - 126,530,333 NET POSITION AT END OF YEAR $ 109,300,528 $ 125,649,658 See notes to the financial statements. 19

STATEMENTS OF CASH FLOWS Enterprise Fund FOR THE YEARS ENDED 2015 2014 CASH FLOWS FROM OPERATING ACTIVITIES Grants and contracts $ 58,908,035 $ 64,966,430 Intellectual property revenues 27,299,263 8,975,228 Payments to employees and related benefits (47,571,557) (45,483,852) Payments to suppliers (35,762,813) (35,546,019) Net cash provided (used) by operating activities 2,872,928 (7,088,213) CASH FLOWS FROM NONCAPITAL FINANCING ACTIVITIES Contributions 159,002 97,552 Net cash provided by noncapital financing activities 159,002 97,552 CASH FLOWS FROM CAPITAL AND RELATED FINANCING ACTIVITIES Purchases of capital assets (3,714,914) (4,706,297) Funds transferred from trust - 547,236 Net change in note payable 819,909 598,282 Principal payments on long-term debt and capital lease obligations (510,000) (480,000) Interest payments on long-term debt and capital lease obligations (513,047) (588,610) Proceeds from sale of capital assets 72,983 153,072 Net cash used in capital and related financing activities (3,845,069) (4,476,317) CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sales of investments 5,501,047 28,622,321 Proceeds from divestiture of subsidiary, net of related expenses (6,301) (148,820) Purchases of investments (6,739,322) (17,148,450) Interest on cash 8,928 454 Interest and dividend income on investments 1,141,307 1,175,234 Net cash provided (used) by investing activities (94,341) 12,500,739 See notes to the financial statements. 20

STATEMENTS OF CASH FLOWS Enterprise Fund FOR THE YEARS ENDED 2015 2014 NET CHANGE IN CASH AND CASH EQUIVALENTS $ (907,480) $ 1,033,761 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 1,209,023 175,262 CASH AND CASH EQUIVALENTS AT END OF YEAR $ 301,543 $ 1,209,023 RECONCILIATION OF OPERATING LOSS TO NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES Operating loss $ (13,655,084) $ (1,363,763) Adjustments to reconcile operating loss to net cash provided (used) by operating activities: Depreciation and amortization 7,750,688 8,064,463 Noncash adjustment of postretirement benefits 2,301,607 (553,292) Change in accounts receivable, net (3,529,213) 279,277 Change in other receivables 18,797,166 (19,867,335) Change in materials and supplies, net (23,850) 118,636 Change in prepayments and other current assets (75,135) (291,333) Change in accounts payable (1,947,269) (1,533,683) Change in accrued liabilities (7,178,484) 8,698,025 Change in unearned contract revenue 432,502 (639,208) Net cash provided (used) by operating activities $ 2,872,928 $ (7,088,213) SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES Change in fair value of investments $ (2,099,774) $1,785,391 Net book value of impaired assets $ 3,169,447 $ - Other receivable from a related party in exchange for capital assets $ 175,000 $ 225,000 See notes to the financial statements. 21

VEBA TRUST FUND STATEMENTS OF PLAN NET POSITION OPEB TRUST FUND ASSETS 2015 2014 Cash and equivalents $ 4,910 $ 6,317 Investments, at fair value 3,262,031 5,294,286 TOTAL ASSETS $ 3,266,941 $ 5,300,603 LIABILITIES AND NET POSITION NET POSITION RESTRICTED FOR OPEB $ 3,266,941 $ 5,300,603 See notes to the financial statements. 22

VEBA TRUST FUND STATEMENTS OF CHANGES IN PLAN NET POSITION OPEB TRUST FUND FOR THE YEARS ENDED 2015 2014 ADDITIONS Net change in fair value of investments $ (70,464) $ 144,755 Dividends and interest - 124,788 Total additions (70,464) 269,543 DEDUCTIONS Benefit payments 73,259 66,702 Transfer 1,876,015 - Administrative expenses 13,924 10,311 Total deductions 1,963,198 77,013 NET INCREASE (DECREASE) (2,033,662) 192,530 NET POSITION RESTRICTED FOR OPEB AT BEGINNING OF YEAR 5,300,603 5,108,073 NET POSITION RESTRICTED FOR OPEB AT END OF YEAR $ 3,266,941 $ 5,300,603 See notes to the financial statements. 23

NOTES TO THE FINANCIAL STATEMENTS 1. ORGANIZATION AND SCOPE OF STATEMENTS Organization Southern Research Institute (the Organization) is an Alabama not-for-profit, 501(c)(3) corporation. The Organization offers research and technology services to support industry and federal government agencies primarily in the areas of drug discovery and development, environment and energy, and materials and systems engineering. Effective November 24, 1999, the Board of Directors entered into an affiliation agreement with the University of Alabama at Birmingham (UAB). For financial reporting purposes, the Organization is a component unit of UAB. A component unit is a legally separate organization for which the primary government is financially accountable. Governmental Accounting Standards Board (GASB) Statement No. 14, The Financial Reporting Entity, as amended by GASB Statement No. 39, Determining Whether Certain Organizations Are Component Units, states that a primary government is financially accountable for a component unit if it appoints a voting majority of the organization s governing body and (1) it is able to impose its will on that organization or (2) there is a potential for the organization to provide specific financial benefits to, or impose specific financial burdens on, the primary government. In this case, UAB appoints the Organization s Board of Directors and is able to impose its will on the Organization. In evaluating the Organization as a reporting entity, management has determined that the Organization is financially accountable for the Southern Research Institute Health and Welfare Benefit Program (the Plan) and, as such, has included the Plan as an OPEB Trust Fund within the Organization s financial statements. 2. SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The Organization complies with all applicable GASB pronouncements. The Organization s financial statement presentation is prepared in accordance with the provisions of GASB Statement No. 62, Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements. This statement incorporates into GASB s authoritative literature certain accounting and financial reporting guidance that is included in pronouncements issued by certain other authoritative bodies on or before November 30, 1989. 24

NOTES TO THE FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES CONTINUED The operations of the Organization are presented as an enterprise fund following the accrual basis of accounting in order to recognize the flow of economic resources. Under this basis, revenues are recognized in the period in which they are earned, and expenses are recognized in the period in which they are incurred. Net position is classified and reported in three components: net investment in capital assets; restricted; and unrestricted. These classifications are defined as follows: Net investment in capital assets This component of net position consists of capital assets, including restricted capital assets, net of accumulated depreciation and reduced by the outstanding balances of any bonds, mortgages, notes, or other borrowings that are attributable to the acquisition, construction, or improvement of those assets. If there are significant unspent related debt proceeds at year end, the portion of the debt attributable to the unspent proceeds is not included in the calculation of net investment in capital assets. Rather, that portion of the debt is included in the same net position component as the unspent proceeds. Restricted This component of net position includes assets subject to external constraints imposed by creditors (such as through debt covenants), grantors, contributors, laws or regulations of other governments, or constraints imposed by law through constitutional provisions or enabling legislation. Unrestricted This component of net position consists of assets that do not meet the definition of restricted or net investment in capital assets. The operations of the Plan are presented as an OPEB trust fund, which is a type of fiduciary fund, following the accrual basis of accounting in order to recognize the flow of economic resources. Investments are reported at fair value. Fiscal Year The Organization operates on a 52/53-week fiscal year, with the fiscal year end on the Friday nearest December 31. The accompanying financial statements cover the periods from January 3, 2015 through January 1, 2016 (2015), and January 4, 2014 through January 2, 2015 (2014). Cash Equivalents The Organization classifies all highly liquid investments with maturities of three months or less when purchased, not designated as restricted, as cash equivalents. The Organization maintains deposits at financial institutions which, at times, may exceed federally insured limits. The Organization has not experienced any losses in such accounts. Investments Investments are carried at fair value based on quoted market prices with all investment income reported in the statements of revenues, expenses, and changes in net position. 25

NOTES TO THE FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES CONTINUED Accounts Receivable The Organization reports accounts receivable at net realizable value. The allowance for doubtful accounts on accounts receivable is maintained in amounts estimated to provide adequate reserves to cover anticipated losses based on historical bad-debt experience and evaluation of periodic aging of the accounts. On a continuing basis, management analyzes delinquent receivables and, once these receivables are determined to be uncollectible, they are written off through a charge against an existing allowance account. Accrued costs and profits on fixed-price contracts and subcontracts included in unbilled receivables are billed as work is performed and accepted by the customer. Under the contractual arrangements by which progress payments are received, the U.S. Government has a security interest in work-inprogress under fixed-price contracts. The Organization estimates that unbilled receivables will be collectible within one year. Materials and Supplies Materials and supplies are valued at the lower of cost or market, on a first-in, first-out (FIFO) method. Materials and supplies are shown net of reserves of $60,000 for 2015 and 2014. Capital Assets Capital assets, including assets under capital leases, are recorded at cost and are depreciated or amortized using the straight-line method over the following estimated useful lives of the assets or the period of the lease, whichever is shorter: Land improvements Buildings and major plant equipment Laboratory equipment and fixtures Office furniture and equipment 5 years 15-50 years 3-20 years 3-10 years Amortization of assets under capital leases is included in depreciation expense. Expenditures for maintenance and repairs are charged to operations as incurred. Intangibles Intangible assets include the costs of acquiring and defending patents and licenses on technology developed by the Organization. The costs of patents and licenses are being amortized using the straight-line method over their estimated useful lives, approximately 20 years. Impairment of intangible assets is reviewed annually and the carrying value adjusted based on the probability of future benefit. Goodwill and other intangible assets that have indefinite lives are not amortized; however, these assets are evaluated at least annually for impairment. 26

NOTES TO THE FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES CONTINUED Post Employment Benefits Other than Pensions (OPEB) For purposes of measuring the net OPEB liability, deferred outflows of resources and deferred inflows of resources related to OPEB, and OPEB expense, information about the fiduciary net position of the Plan and additions to/deductions from the Plan s net position have been determined on the same basis as they are reported by the Plan. For this purpose, benefit payments (including refunds of contributions) are recognized when due and payable in accordance with the benefit terms. Investments are reported at fair value. Income Taxes The Organization is exempt from federal income tax under Section 501(a) of the United States Internal Revenue Code (IRC) as an organization described in IRC Section 501(c)(3) and is not a private foundation as described in IRC Section 509(a). However, the Organization is required to pay tax on income from activities unrelated to its exempt purposes (unrelated business income). During 2015 and 2014, the Organization did not receive refunds of taxes paid, nor pay/accrue any taxes owed. Restricted Expendable Net Position The Organization reports gifts of cash and other assets as restricted support if they are received with donor stipulations that limit the use of the donated assets. When a donor restriction expires, that is, when a stipulated time restriction ends or purpose restriction is accomplished, restricted expendable net position is reflected as a transfer to unrestricted net position in the statements of revenues, expenses, and changes in net position. The Organization reports gifts of land, buildings, and equipment as unrestricted support unless explicit donor stipulations specify how the donated assets must be used. Gifts of long-lived assets with explicit restrictions that specify how the assets must be used and gifts of cash or other assets that must be used to acquire long-lived assets are reported as restricted support. Absent explicit donor stipulations about how long those long-lived assets must be maintained, the Organization reports the expiration of donor restrictions when the donated or acquired long-lived assets are placed in service. The Organization has received donations with stipulations on how the funds should be used, although none of these donations have permanent legal restrictions. While it is the Organization s present intent to only use the investment income generated from these donations for the stipulated purposes, the Board of Directors has the right to use the donations for the stipulated purposes. The Organization has restricted expendable net position for three endowments with a total balance at January 1, 2016 and January 2, 2015, of $10,686,608 and $11,414,279, respectively. In addition, the Organization s net OPEB asset at January 1, 2016 and January 2, 2015, of $158,176 and $2,459,783, respectively, is reported as restricted expendable net position, as the Board of Directors may use the assets held in trust for benefits provided to employees and retirees. Revenues and Expenses Operating revenues and expenses consist of those revenues and expenses that result from the ongoing principal operations of the Organization. Operating revenues consist primarily of charges for services related to contracts and intellectual property revenue. 27

NOTES TO THE FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES CONTINUED The Organization is involved in various types of research, primarily through contracts with the U.S. Government and industrial companies. Revenues on cost-plus-fee contracts and cost-sharing arrangements are recognized to the extent of reimbursable costs incurred, plus estimated fees earned thereon. Revenues on fixed-price contracts are recognized on the percentage-of-completion method based on cost incurred in relation to total estimated cost. Losses on contracts are recognized in the period in which the losses become known. The Organization receives revenue from the licensing of intellectual property. Revenue is received in the form of license fees and royalties on drug sales. License fees are recognized as revenue when the earnings process is complete, and the Organization has no further continuing performance obligations and has completed its performance under the terms of the agreement. Royalties received on the sale of drugs licensed to third parties are recognized as revenue based on receipt of the quarterly royalty payment and estimated for periods for which the royalty payment has not been received. Nonoperating revenues and expenses consist of those revenues and expenses that are related to financing and investing activities and result from nonexchange transactions or ancillary activities. When an expense is incurred for purposes for which there are both restricted and unrestricted net positions available, it is the Organization s policy to apply those expenses to restricted net position to the extent such is available and then to unrestricted net position. The U.S. Government accounted for approximately 68% of the Organization s contract revenues in 2015 and 71% in 2014. Independent Research and Development Costs Independent research and development (IR&D) is conducted by the Organization under internal projects. IR&D costs incurred were $2,200,280 and $2,702,691 in 2015 and 2014, respectively, and are included in operating expenses in the accompanying statements of revenues, expenses, and changes in net position enterprise fund. Use of Estimates The accompanying financial statements were prepared in conformity with accounting principles generally accepted in the United States of America which require 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Subsequent Events Management has evaluated subsequent events and their potential effects on these financial statements through April 27, 2016, which is the date the financial statements were available to be issued. 28

NOTES TO THE FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES CONTINUED New Accounting Pronouncement In June 2015, GASB issued Statement No. 75, Accounting and Financial Reporting for Postemployment Benefits Other Than Pensions, which is adopted by the Organization for the 2015 fiscal year. GASB Statement No. 75 replaces the requirements of GASB Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions. Among other things, GASB Statement No. 75 requires governments to report a liability, or asset, in the financial statements for the OPEB that they provide and requires governments in all types of OPEB plans to present more extensive note disclosures and required supplementary information about their OPEB liabilities. Net position of the Organization at the beginning of the year ended January 2, 2015, was increased by $2,854,111 as a result of the adoption of the new accounting guidance. 3. CASH AND CASH EQUIVALENTS The carrying amount of cash balances at January 1, 2016, totaled $301,543 ($1,209,023 for 2014), and the bank balance was $197,005 ($1,242,189 for 2014). The bank balances were fully insured at January 1, 2016 and January 2, 2015. 4. INVESTMENTS Unrestricted Investments As of January 1, 2016, the Organization had unrestricted investments in equity mutual funds totaling $21,761,974, unrestricted investments in a private equity fund of $272,192, unrestricted investments in a privately-held company of $361,095, and the following unrestricted fixed-income investments and maturities: Investment Type Investment Maturities of Underlying Securities (in Years) Market Value Less Than 1 1-5 6-10 More Than 10 Mutual funds bonds $ 23,284,727 $ 3,795,750 $ 19,488,977 $ - $ - The carrying amount of the investments shown above equals fair market value. 29

NOTES TO THE FINANCIAL STATEMENTS 4. INVESTMENTS CONTINUED Unrestricted Investments As of January 2, 2015, the Organization had unrestricted investments in equity mutual funds totaling $22,479,770, unrestricted investments in a private equity fund of $272,191, unrestricted investments in a privately-held company of $361,096, and the following unrestricted fixed-income investments and maturities: Investment Type Investment Maturities of Underlying Securities (in Years) Market Value Less Than 1 1-5 6-10 More Than 10 Mutual funds bonds $ 22,688,138 $ 3,308,318 $ 19,379,820 $ - $ - The carrying amount of the investments shown above equals fair market value. Restricted Investments As of January 1, 2016, the Organization had restricted investments in equity mutual funds totaling $6,613,304 and the following restricted cash and fixed-income investments and maturities: Investment Type Investment Maturities of Underlying Securities (in Years) Market Value Less Than 1 1-5 6-10 More Than 10 Money market funds $ 171,325 $ 171,325 $ - $ - $ - Mutual funds bonds 3,901,979 403,112 3,498,867 - - $ 4,073,304 $ 574,437 $ 3,498,867 $ - $ - The carrying amount of the investments shown above equals fair market value. Restricted Investments As of January 2, 2015, the Organization had restricted investments in equity mutual funds totaling $7,287,259 and the following restricted cash and fixed-income investments and maturities: Investment Type Investment Maturities of Underlying Securities (in Years) Market Value Less Than 1 1-5 6-10 More Than 10 Money market funds $ 12,368 $ 12,368 $ - $ - $ - Mutual funds bonds 4,114,652-4,114,652 - - $ 4,127,020 $ 12,368 $ 4,114,652 $ - $ - The carrying amount of the investments shown above equals fair market value. Interest Rate Risk The Organization has investment policy statements that seek to limit its exposure to fair value losses arising from rising interest rates through limiting the duration and maturity of the underlying fixed income investments in the mutual funds it purchases. 30

NOTES TO THE FINANCIAL STATEMENTS 4. INVESTMENTS CONTINUED Credit Risk The Organization has investment policy statements that seek to minimize credit risk through diversification. At January 1, 2016 and January 2, 2015, the Organization had investments in mutual funds which only purchase fixed income securities rated BBB or better. The average credit ratings of holdings is between A and AA. Custodial Credit Risk For an investment, custodial credit risk is the risk that, in the event of the failure of the counterparty, the Organization will not be able to recover the value of its investments or collateral securities that are in the possession of an outside party. The Organization has no formal policy on custodial credit risk. At January 1, 2016, the Organization had uncollateralized restricted cash and investments with Fidelity Investments (Fidelity) of $10,686,608, unrestricted cash and investments with Fidelity of $45,072,470 and other unrestricted investments of $633,287 (discussed below). At January 2, 2015, the Organization had uncollateralized restricted cash and investments with Fidelity Investments (Fidelity) of $11,414,279, unrestricted cash and investments with Fidelity of $46,289,343, and other unrestricted investments of $633,287 (discussed below). During the year ended December 31, 2006, the Organization invested $30,000 and committed to invest an additional $270,000 over the next 10 years in a new private equity fund, Birmingham Technology Fund, LLC (the Fund). The Fund had been formed to provide investors the opportunity to invest in privately-held companies that are commercializing technologies developed at the academic and research institutions in the state of Alabama, with a primary focus on medical and life sciences technology developed at UAB. During 2014 and 2015, no additional investments were made. As the estimated fair value of the investment is approximately equal to the cost basis, no impairment of this investment exists at January 1, 2016 or January 2, 2015. No private company stock was purchased during the years ended January 1, 2016 and January 2, 2015. 5. ACCOUNTS RECEIVABLE The components of accounts receivable at year end were as follows: 2015 2014 Billed $12,584,947 $ 9,717,477 Unbilled 4,547,772 3,846,803 17,132,719 13,564,280 Less allowances 86,316 47,090 $17,046,403 $13,517,190 31

NOTES TO THE FINANCIAL STATEMENTS 6. OTHER RECEIVABLES At January 1, 2016 and January 2, 2015, other receivables consisted primarily of amounts due from the licensing of intellectual property. Revenue is received in the form of license fees, milestone payments, and royalties on drug sales. 7. CAPITAL ASSETS Capital assets activity for the year ended January 1, 2016, is summarized below: Balance at January 2, 2015 Additions Transfers Retirements/ Reimbursements Balance at January 1, 2016 Capital assets not being depreciated: Land $ 6,796,985 $ 6,000 $ - $ - $ 6,802,985 Construction-in-progress 476,933 1,737,089 (660,861) - 1,553,161 7,273,918 1,743,089 (660,861) - 8,356,146 Capital assets being depreciated: Land improvements 1,289,362-65,000-1,354,362 Buildings and major plant equipment 70,626,838 81,004 (28,027) (6,324,237) 64,355,578 Laboratory equipment and fixtures 63,091,569 1,343,208 471,676 (2,734,501) 62,171,952 Office furniture and equipment 2,480,925 87,211 152,212 (110,809) 2,609,539 137,488,694 1,511,423 660,861 (9,169,547) 130,491,431 144,762,612 3,254,512 - (9,169,547) 138,847,577 Less accumulated depreciation (76,940,647) (7,387,625) - 4,544,845 (79,783,427) 67,821,965 (4,133,113) - (4,624,702) 59,064,150 Intangibles 4,107,796 635,402 - (14,511) 4,728,687 Less accumulated amortization (2,150,790) (363,063) - - (2,513,853) 1,957,006 272,339 - (14,511) 2,214,834 $ 69,778,971 $ (3,860,774) $ - $ (4,639,213) $ 61,278,984 32

NOTES TO THE FINANCIAL STATEMENTS 7. CAPITAL ASSETS CONTINUED Capital assets activity for the year ended January 2, 2015, is summarized below: Balance at January 3, 2014 Additions Transfers Retirements/ Reimbursements Balance at January 2, 2015 Capital assets not being depreciated: Land $ 6,796,902 $ - $ 83 $ - $ 6,796,985 Construction-in-progress 4,249,626 2,304,109 (6,076,802) - 476,933 11,046,528 2,304,109 (6,076,719) - 7,273,918 Capital assets being depreciated: Land improvements 1,212,774 76,671 (83) - 1,289,362 Buildings and major plant equipment 75,618,971 218,686 (5,174,075) (36,744) 70,626,838 Laboratory equipment and fixtures 53,656,662 1,603,247 11,250,877 (3,419,217) 63,091,569 Office furniture and equipment 2,487,449 - - (6,524) 2,480,925 132,975,856 1,898,604 6,076,719 (3,462,485) 137,488,694 144,022,384 4,202,713 - (3,462,485) 144,762,612 Less accumulated depreciation (70,316,524) (7,708,180) - 1,084,057 (76,940,647) 73,705,860 (3,505,467) - (2,378,428) 67,821,965 Intangibles 3,604,212 503,584 - - 4,107,796 Less accumulated amortization (1,794,507) (356,283) - - (2,150,790) 1,809,705 147,301 - - 1,957,006 $ 75,515,565 $ (3,358,166) $ - $ (2,378,428) $ 69,778,971 Depreciation expense for the years ended January 1, 2016 and January 2, 2015, was $7,387,625 and $7,708,180, respectively. Amortization expense for the years ended January 1, 2016 and January 2, 2015, was $363,063 and $356,283, respectively. During 2015, the Organization had a weather related event that resulted in a roof collapse at one of its laboratory facilities. The Organization has written off assets with a net book value of $3.2 million and has accrued an insurance receivable for an equivalent amount. Additionally, the Organization received $1.5 million of advances against its claim that the Organization has applied against its business interruption losses. Insurance proceeds for business interruption are reflected in operating income in the accompanying statements of revenues, expenses, and changes in net position. The $3.2 million receivable for the property damage is reflected in the statements of net position enterprise fund as a current asset and as an equivalent reduction to the loss on disposal of assets in the statements of revenues, expenses, and changes in net position enterprise fund. 33

NOTES TO THE FINANCIAL STATEMENTS 7. CAPITAL ASSETS CONTINUED During 2011, the Organization had laboratory equipment irreparably damaged by a vendor-supplied product. The Organization negotiated a settlement in 2012 with the vendor in the amount of $1.5 million, which was reflected in operating income in the statements of revenues, expenses, and changes in net position enterprise fund for 2012. Additionally, the Organization negotiated a further settlement in 2014 with an insurer for $1.5 million. The Organization also received an insurance settlement in 2014 of $564,000 for costs resulting from an equipment failure in a prior year. The settlement amounts are reflected in operating income in the accompanying statements of revenues, expenses, and changes in net position enterprise fund for 2014. 8. ACCRUED LIABILITIES Accrued liabilities are summarized as follows at year end: 2015 2014 Payroll related payables $ 4,598,368 $ 4,276,791 Intellectual property awards accrual 1,382,932 9,798,067 Healthcare obligations 379,500 369,200 Other accrued expenses 3,257,114 2,352,340 $ 9,617,914 $16,796,398 9. SELF-INSURANCE The Organization is self-insured for employees' healthcare and dental coverage with a $1,500 annual maximum per covered employee for dental. The Organization has an excess claims policy for claims exceeding $250,000 annually per covered individual. Provision is made in the financial statements for estimates of both reported claims and claims incurred but not reported. These estimates are provided by the Organization s claims administrator and are determined using details of historical activity. Changes in the total self-insured liabilities for the years ended are presented below: 2015 2014 Beginning of the year accrual $ 369,200 $ 296,900 Claims expense 3,242,838 2,948,388 Claims paid (3,232,538) (2,876,088) End of the year accrual $ 379,500 $ 369,200 34

NOTES TO THE FINANCIAL STATEMENTS 10. LONG-TERM DEBT Long-term debt activity for the year ended January 1, 2016, is summarized as follows: Balance at January 2, 2015 Additions Payments/ Reductions Balance at January 1, 2016 Due Within One Year Recovery Zone Facility Bonds held by BBVA Compass, variable interest rate tied to LIBOR for initial 7-year term starting August 30, 2010 $ 18,400,000 $ - $ 510,000 $ 17,890,000 $ 600,000 Long-term debt activity for the year ended January 2, 2015, is summarized as follows: Balance at January 3, 2014 Additions Payments/ Reductions Balance at January 2, 2015 Due Within One Year Recovery Zone Facility Bonds held by BBVA Compass, variable interest rate tied to LIBOR for initial 7-year term starting August 30, 2010 $ 18,880,000 $ - $ 480,000 $ 18,400,000 $ 560,000 Maturities of long-term debt after 2015 are as follows: Principal Interest Total 2016 $ 600,000 $ 243,608 $ 843,608 2017 17,290,000 177,261 17,467,261 $17,890,000 $ 420,869 $18,310,869 The above schedule is based on the variable rate in effect at January 1, 2016. As discussed below, the Organization entered into an interest rate swap agreement which will effectively fix the rate exposure on the floating rate note to 2.947% for the term of the swap. The Organization paid interest of $513,047 and $588,610 during 2015 and 2014, respectively. The Organization incurred no capital lease obligations during 2015 or 2014 in connection with lease arrangements to acquire equipment. Conduit Debt On August 30, 2010, The Cooperative District of the City of Birmingham Southern Research Institute issued, for the benefit of the Organization as the guarantor, $20 million of Recovery Zone Facility Bonds. These bonds are held by BBVA Compass for an initial term of seven years and bear interest at a variable rate, subject to the interest rate swap discussed below. The bonds can be extended with maturities up to September 1, 2036, and, if renewed, would amortize over this period. The bond proceeds will be used primarily for upgrades to the Organization s laboratory facilities and equipment located in Birmingham, Alabama. 35

NOTES TO THE FINANCIAL STATEMENTS 10. LONG-TERM DEBT CONTINUED Interest Rate Swap Subsequent to the issuance of the bonds, the Organization entered into an interest rate swap agreement with an effective date of September 1, 2011, with BBVA Compass for the purpose of reducing the cash flow impact to the Organization of changes in interest rates on its $20,000,000 floating rate long-term debt issued in 2010. This derivative instrument is designated as a cash flow hedge and had an initial notional amount of $20,000,000, which declines consistent with repayments on the bonds. This interest rate swap agreement effectively changes the Organization s floating interest rate to a fixed rate of 2.947%. Cash flows under the interest rate swap during 2015 and 2014 were net payments made by the Organization in amounts totaling approximately $281,000 and $321,000, respectively. The interest rate swap agreement termination date is September 1, 2017. At January 1, 2016, the interest rate swap had a negative fair value (liability) to the Organization of $376,458 which represents the cost to the Organization at that date if the interest rate swap agreement was terminated. The negative fair value (liability) at January 2, 2015, was $563,516. The fair value is reported in the accompanying financial statements as an asset (deferred outflows interest rate swap) and as a liability (derivative instrument interest rate swap). The fair value represents estimated midmarket valuations, which attempt to approximate the current economic value of a given position using prices and rates at the average of the bid and offer for the respective underlying asset(s) or reference(s) rates and/or mathematical models, as deemed appropriate by the counterparty. The changes in fair value are reported in deferred outflow interest rate swap in the statements of net position enterprise fund. The critical terms of the hedgeable item (debt) and the interest rate swap agreement are the same; therefore, the changes in the cash flows of the interest rate swap agreement substantially offset the changes in cash flows of the debt. Termination Risk The Organization or its counterparty may terminate the derivative instrument if the other party fails to perform under the terms of the contract. If, at the time of termination, the hedging derivative instrument is in a liability position, the Organization would be liable to the counterparty for a payment equal to the liability. The instrument is subject to optional redemption before the scheduled termination date at the direction of the Organization. 11. NOTE PAYABLE On November 30, 2015, the Organization renewed a one-year, $3 million loan agreement with a financial institution. The principal is due upon demand, and variable rate interest payments of LIBOR plus 1.75% (no floor) are due on a monthly basis. The loan is a revolving line of credit that is integrated with the Organization s cash management system provided by a financial institution. The loan is secured by the Organization s trade accounts receivable. As of January 1, 2016 and January 2, 2015, the carrying amount of the note payable was $2,668,938 and $1,849,029, respectively. 36

NOTES TO THE FINANCIAL STATEMENTS 12. OPERATING LEASES The Organization leases office space and equipment under various operating leases. Rental expense under all operating leases for the year ended January 1, 2016, amounted to $205,312 ($412,961 for 2014). Future lease payments required under noncancelable operating leases having initial or remaining terms in excess of one year consisted of the following as of January 1, 2016: 2016 $ 67,742 2017 18,138 2018 5,566 $ 91,446 13. OTHER POSTEMPLOYMENT BENEFITS PLAN (OPEB) General Information about the OPEB Plan Plan description The Organization sponsors a single-employer postretirement welfare benefit plan, entitled Southern Research Institute Health and Welfare Benefit Program (the Plan). In January 2003, the Organization established a trust fund (the Trust) to accumulate funds to pay the costs of benefits for participants covered by the Plan. The Trust and the Plan collectively constitute a "voluntary employee's beneficiary association" (VEBA) to fund benefits to eligible retirees and pay for administration expenses. Benefit provisions are established and may be amended by the Organization's Board of Directors. The Plan does not issue a publicly available report. Benefits provided The Plan provides for medical and dental insurance coverage to eligible retirees and their dependents not eligible for Medicare coverage. Life insurance coverage is available for retirees only, and coverage amount depends on the retiree's age and salary at retirement. The coverage period for medical or dental insurance under the Plan is available from the date of retirement until either the retiree or the spouse reaches age 65 or otherwise becomes eligible for Medicare coverage. The coverage period available for life insurance extends from the date of retirement through the age of 70. Employees covered by benefit terms Participants are eligible to receive benefits under the Plan upon meeting the age and service requirements indicated below: Date of Hire January 1, 2014 and after January 9, 2006 - December 31, 2013 Prior to January 9, 2006 Minimum Age and Service 59.5 with 10 years continuous service; spousal coverage 5 years maximum 55 with 10 or more years continuous service; spousal coverage 10 years maximum 55 with 5 or more years continuous service or 62 with 2 or more years continuous service 37

NOTES TO THE FINANCIAL STATEMENTS 13. OTHER POSTEMPLOYMENT BENEFITS PLAN (OPEB) CONTINUED At January 1, 2015, the most recent actuarial valuation date, the Plan had 38 retirees and beneficiaries receiving benefits. The Plan had a total of 440 active participants. Funding policy The Organization established a VEBA to be used as a conduit to provide for benefit payments under the Plan. Assets have been segregated and restricted to provide for postretirement health and welfare premiums. The Organization has funded the VEBA initially to match the obligation and may provide for additional funding amounts as determined necessary by the Board of Directors. Administrative costs of the Plan are paid from investment earnings. Net OPEB Liability (Asset) The Organization s net OPEB liability (asset) was measured as of January 1, 2015, and the total OPEB liability used to calculate the net OPEB liability (asset) was determined by an actuarial valuation as of that date. Actuarial assumptions The total OPEB liability in the January 1, 2015 actuarial valuation was determined using the following actuarial assumptions, applied to all periods included in the measurement, unless otherwise specified: Actuarial Cost Method Actuarial Value of Assets Amortization Method Mortality Discount Rate/Investment Rate of Return Salary Scale Healthcare Costs Rates Entry Age Normal Method Fair value of cash and investments Level Dollar Method RP-2014 Mortality Table, with separate rates for males and females, annuitant and non-annuitant 6.5% per annum 4% per annum For medical costs, initial rate of 8% graded by 0.5% per year to an ultimate rate of 5.50% (dental costs, rate of 4.0% per year) Withdrawal Rates at sample ages range from 20% at age 20 to 1% at age 60; no withdrawal assumed after attainment of eligibility for retirement Retirement Marital Status Age Difference of Spouses Plan Participation Per Capita Claims Cost 10% at age 55; 5% at ages 55-61; 25% at age 62; 10% at ages 63-64 and 100% at age 65 80% of retirees assumed married at retirement Males are assumed to be 3 years older than females 50% of future retirees are assumed to elect coverage. 60% of retirees electing coverage who have spouses are assumed to elect spousal coverage Developed based on 2015 active rates adjusted to an age 65 cost. Pre-Medicare medical, $11,756, Dental, $616 38

NOTES TO THE FINANCIAL STATEMENTS 13. OTHER POSTEMPLOYMENT BENEFITS PLAN (OPEB) CONTINUED Aging 2.5% per year until age 65 Annual Per Capita Retiree Contributions Medical: single, $3,787; retiree and spouse, $7,574. Dental: single, $198; retiree and spouse $396 Retiree Contribution Increases Retiree contributions are assumed to increase at the same rates as incurred medical or dental claims. Changes in the Net OPEB Liability (Asset) Total OPEB Liability (A) Fiduciary Net Position (B) Net OPEB Liability (Asset) (A) (B) Balances at December 31, 2014 $ 2,839,764 $ 5,300,603 $ (2,460,839) Service cost 150,288-150,288 Interest cost 191,972-191,972 Net investment income - (70,464) 70,464 Benefit payments (73,259) (73,259) - Administrative expense - (13,924) 13,924 Transfer - (1,876,015) 1,876,015 Net change 269,001 (2,033,662) 2,302,663 Balances at December 31, 2015 $ 3,108,765 $ 3,266,941 $ (158,176) Balances at December 31, 2013 $ 3,227,405 $ 5,108,073 $ (1,880,668) Service cost 159,178-159,178 Interest cost 215,791-215,791 Net investment income - 269,543 (269,543) Differences between expected and actual experience (200,674) - (200,674) Change in benefit terms (495,234) - (495,234) Benefit payments (66,702) (66,702) - Administrative expense - (10,311) 10,311 Net change (387,641) 192,530 (580,171) Balances at December 31, 2014 $ 2,839,764 $ 5,300,603 $ (2,460,839) 39

NOTES TO THE FINANCIAL STATEMENTS 13. OTHER POSTEMPLOYMENT BENEFITS PLAN (OPEB) CONTINUED Sensitivity of the Net Pension Liability (Asset) to Changes in the Discount Rate The following information presents the total OPEB liability (asset) calculated using the discount rate of 6.5% as well as what the total OPEB liability (asset) would be if it were calculated using a discount rate that is 1.00% lower or 1.00% higher than the current rate: Current 1% 1% Decrease Discount Rate Increase (5.5%) (6.5%) (7.5%) Total OPEB (Asset) Liability $ 3,323,193 $ 3,108,765 $ 2,915,212 OPEB Expense For the year ended January 1, 2016, the Plan recognized OPEB expense of $11,529. Investments As of January 1, 2016, the Plan had investments in equity mutual funds totaling $1,745,615, restricted cash of $4,910, and the following fixed-income investments and maturities: Investment Type Investment Maturities of Underlying Securities (in Years) Market Value Less Than 1 1-5 6-10 More Than 10 Mutual funds bonds $ 1,516,416 $ 134,834 $ 1,381,582 $ - $ - As of January 2, 2015, the Plan had investments in equity mutual funds totaling $2,856,135, restricted cash of $6,317, and the following fixed-income investments and maturities: Investment Type Investment Maturities of Underlying Securities (in Years) Market Value Less Than 1 1-5 6-10 More Than 10 Mutual funds bonds $ 2,438,151 $ 399,841 $ 2,038,310 $ - $ - The carrying amount of the investments shown above equals fair market value. Interest Rate Risk The assets of the Plan are invested in a diversified manner to provide consistent returns while accepting a moderate level of risk. The primary objective of the account is to generate the actuarial return required to fund future retiree medical benefits. The target asset allocation is reviewed annually with the Organization s Finance Committee and is currently: 33% in domestic stocks, 16% in international stocks, 5% in real estate, 27% in global debt securities, and 19% in short-term debt securities. 40

NOTES TO THE FINANCIAL STATEMENTS 13. OTHER POSTEMPLOYMENT BENEFITS PLAN (OPEB) CONTINUED Credit Risk The Plan has investment policy statements that seek to minimize credit risk through diversification. The Plan had investments in mutual funds which only purchase fixed income securities rated BBB or better at January 1, 2016, and BBB or better as of January 2, 2015. The average credit rating of its holdings is between A and AA. Custodial Credit Risk For an investment, custodial credit risk is the risk that, in the event of the failure of the counterparty, the Plan will not be able to recover the value of its investments or collateral securities that are in the possession of an outside party. The Plan has no formal policy on custodial credit risk. At January 1, 2016, the Plan had uncollateralized cash and investments with Fidelity Investments of $3,266,941 ($5,300,603 at January 2, 2015). 14. OPERATING EXPENSES BY FUNCTION Operating expenses by functional classification for the year ended January 1, 2016, are as follows: Salaries, Wages, and Benefits Supplies and Services Depreciation and Amortization Total Research $ 40,173,826 $ 20,490,180 $ - $ 60,664,006 Institutional support 3,737,083 3,325,538-7,062,621 Operation and maintenance of plant 1,287,145 4,723,396-6,010,541 Depreciation - - 7,750,688 7,750,688 $ 45,198,054 $ 28,539,114 $ 7,750,688 $ 81,487,856 Operating expenses by functional classification for the year ended January 2, 2015, are as follows: Salaries, Wages, and Benefits Supplies and Services Depreciation and Amortization Total Research $ 39,080,125 $ 21,905,399 $ - $ 60,985,524 Institutional support 3,407,699 3,779,221-7,186,920 Operation and maintenance of plant 1,241,562 5,763,460-7,005,022 Depreciation - - 8,064,463 8,064,463 $ 43,729,386 $ 31,448,080 $ 8,064,463 $ 83,241,929 Amounts are allocated based on management's best estimate. 41

NOTES TO THE FINANCIAL STATEMENTS 15. EMPLOYEE BENEFIT PLAN The Organization has a defined contribution retirement plan available to all employees after they have attained certain age and service requirements. The provisions of the plan are established by and may be amended by the Organization. Employees may contribute a percentage of their pretax salary, not to exceed the maximum allowed under the Internal Revenue Code. Contributions by employees are matched in accordance with the plan agreements and totaled $2,442,147 and $2,456,607 for the years ended January 1, 2016 and January 2, 2015, respectively. Total employer contributions for the years ended January 1, 2016 and January 2, 2015, amounted to $2,542,555 and $2,506,405, respectively, for this plan. 16. RELATED PARTY TRANSACTIONS As discussed in Note 1, the Organization is a component unit of UAB. Numerous business arrangements exist between the two entities, including renting space, providing contract or grant support, providing administrative support, and conducting joint research projects. Contract revenue received from UAB totaled $4,894,059 during 2015 and $2,171,303 during 2014. Expenses paid to UAB totaled $1,546,321 during 2015 and $1,776,410 during 2014. Accounts receivable from UAB were $286,894 at January 1, 2016, and $433,106 at January 2, 2015. Accounts payable to UAB were $119,930 at January 1, 2016, and $123,756 at January 2, 2015. 17. COMMITMENTS AND CONTINGENCIES At January 1, 2016, commitments for capital expenditures totaled approximately $2.4 million. 18. LITIGATION The Organization is subject to certain litigation and claims in the normal course of operations. It is the opinion of management that there are no currently outstanding claims for which the ultimate outcome will have a material adverse impact on the Organization s financial position. 42

REQUIRED SUPPLEMENTARY INFORMATION

REQUIRED SUPPLEMENTARY INFORMATION 2015 2014 TOTAL OPEB LIABILITY Service cost $ 150,288 $ 159,178 Interest 191,972 215,791 Differences between expected and actual experience - (200,674) Change in benefit terms - (495,234) Benefit payments (73,259) (66,702) Net change in total OPEB liability 269,001 (387,641) Total OPEB liability beginning 2,839,764 3,227,405 Total OPEB liability ending (A) $ 3,108,765 $ 2,839,764 OPEB FIDUCIARY NET POSITION Contributions $ - $ - Net investment income (70,464) 269,543 Benefit payments (73,259) (66,702) Administrative expense (13,924) (10,311) Other transfer (1,876,015) - Net change in plan fiduciary net position (2,033,662) 192,530 Plan fiduciary net position beginning 5,300,603 5,108,073 Plan fiduciary net position ending (B) 3,266,941 5,300,603 NET PENSION LIABILITY (ASSET) (A) (B) $ (158,176) $ (2,460,839) COVERED EMPLOYEE PAYROLL $ 32,880,000 $ 32,600,000 NET OPEB LIABILITY (ASSET) AS A PERCENTAGE OF COVERED PAYROLL (0.48%) (7.55%) NET POSITION AS A PERCENTAGE OF THE TOTAL OPEB LIABILITY 105.09% 186.62% The Schedule of Changes in Net OPEB Liability (Asset) is not available for years prior to 2014. The reported Covered Employee Payroll during the measurement period is the total payroll paid to covered employees. 43

SUPPLEMENTARY INFORMATION

SCHEDULE OF EXPENDITURES OF FEDERAL AWARDS FOR THE YEAR ENDED JANUARY 1, 2016 Federal Grantor/Pass-Through Grantor CFDA.Identifying Number Federal Expenditures Passed Through to Subrecipients Research and Development Cluster: Department of Defense Direct Department of Defense 12. $ 2,360 $ - Department of Defense 12. 24,939 - Department of Defense 12. 123,336 - Department of Defense 12.FA4819-09-C-0037 928 - Department of Defense 12.FA4819-09-C-0037 447 - Department of Defense 12.FA8650-14-C-2442 107,090 - Department of Defense 12.FA9101-07-C-0004 (5,644) - Department of Defense 12.N00014-10-C-0357 115 - Department of Defense 12.N00167-08-C-0002 523,589 608,298 Department of Defense 12.N00167-16-F-0047 11,296 1,662 Department of Defense 12.N00178-08-C-3041 219 - Department of Defense 12.N00178-11-C-3011 1,100,965 50,490 Department of Defense 12.N00178-15-C-1008 1,560,222 6,600 Department of Defense 12.W58RGZ-14-C-0007 133,460 - Department of Defense 12.W81XWH-10-1-0232 268,638 - Department of Defense 12.W912HQ-09-C-0034 (65) - Department of Defense 12.W912HQ12C0059 289,218 71,001 Pass-Through Aerojet 12.S39697 (6,032) - Aerojet 12.200043048 89,570 - Alion Science & Tech Corp 12.1122008-TO 7 669 - Alliant Techsystems 12.ATK-94348 64,524 - Alliant Techsystems 12.ATK-95084 16,249 - Alliant Techsystems 12.MP00100507 9,747 - Alliant Techsystems 12.SP00070332 12,613 - Alliant Techsystems 12.ATK-98249 84,660 - Analytical Mechanics Asso 12.T00338 586 - Textron Systems Corporation 12.3500003935 16,472 - United Technologies Corp 12.2134916 3,779 - Utron Kinetics, LLC 12.2925 258,639 4,921 Team, Inc 12.3263 18,172 - Lockheed Martin Corp 12.4100602592 28,630 - Lockheed Martin Corp 12.4101543 43,682 - Lockheed Martin Corp 12.41018425 191,104 - Raytheon Company 12.42009781 366,650 1,815 Raytheon Company 12.42010084 723,546 14,685 Rolls-Royce Allison 12.46001578 7,824 - Rolls-Royce Allison 12.46001775 1,847 - Sienna Technologies 12.4635 15,353 - Rolls-Royce Allison 12.5100002599 113,520 - Matech Advanced Materials 12.7716 149,031 665 Boeing 12.797082 126,355 - ARL PENN STATE 12.932696 24,501 - See notes to schedule of expenditures of federal awards. 44

SCHEDULE OF EXPENDITURES OF FEDERAL AWARDS FOR THE YEAR ENDED JANUARY 1, 2016 Passed Federal Grantor/Pass-Through Grantor CFDA.Identifying Number Federal Expenditures Through to Subrecipients Boeing 12.961851 99,857 - Tekla Research, Inc. 12.015-02-002 52,711 - Tekla Research, Inc. 12.015-09-007 29,115 - Leidos Biomedical Research 12.29XS124 387,704 - Leidos Biomedical Research 12.29XS124 3,631 - Pratt & Whitney 12.44-94092/R1 129,450 - GE Aviation 12.500720/500760 122,724 4,522 Plasma Processes, Inc. 12.6012-045-KM-101414 27,050 - ERC, INC. 12.AS060662 3,861 - Alliant Techsystems 12.ATK-88165 5,961 - Alliant Techsystems 12.ATK-89941 58,784 - Alliant Techsystems 12.ATK-91172 950 - Pratt & Whitney 12.BPA F787422 10,460 - DE Technologies, Inc. 12.DET-PO-13-150 5,463 - Dynetics, Inc. 12.DI-SC-12-10 TO1 95,788 - Alion Science & Tech Corp 12.FA4600-06-D-0003 341,363 24,100 Alion Science & Tech Corp 12.FA4600-06-D-0003 111,304 - Alion Science & Tech Corp 12.FA4600-06-D-0003 157,364 - Raytheon Company 12.FA8650-11-C-1162 21,849 - Alliant Techsystems 12.FA8650-14-C-5206 81,259 - Alliant Techsystems 12.FA865014C7421 89,000 - Materials Research & Design 12.FA9101-14-C-0026 109,132 - Maryland Procurement 12.H98230-11-C-0622 28,090 - Black & Veatch 12.HDTRA1-08-D-0007 898 - Black & Veatch 12.HDTRA1-08-D-0007 449,472 64,532 DTRA 12.HDTRA1-13-C-0093 7,488 5,882 Northrop Grumman Corp 12.HDTRA1-14-D-0006 282,066 - Alliant TechSystems 12.HQ0147-11-C-003 20 - Alliant TechSystems 12.HQ0147-12-C-0016 61,140 1,197 Exothermics 12.HQ0147-12-C-7258 28,305 - Ultramet 12.HQ0147-13-C-0014 48,604 - Lockheed Martin Corp 12.HR0011-04-9-0010 24,049 - DARPA 12.HR0011-15-C-0001 1,191,732 10,203 Conrad-E Virginia Med Sch 12.MC-08-500 (15,879) - Alliant Techsystems 12.MP00081843 14,842 - Materials Research & Design 12.N00014-13-P-1108 10,550 - Materials Research & Design 12.N000167-13-C-0003 392,326 22,810 Materials Research & Design 12.N68335-13-C-0348 26,692 - Alliant Techsystems 12.NNJ06tA25C 275,969 8,778 Analytical Mechanics Asso 12.NNL12AA09C (240) - Analytical Mechanics Asso 12.NNL12AA09C (1) - Analytical Mechanics Asso 12.NNL12AA09C 133,654 - Analytical Mechanics Asso 12.NNL12AA09C 3,899 - Johns Hopkins Enterprise 12.NNN06AA01C 349,666 - Trex Enterprises 12.NNX11CB94C (2,146) - SAIC 12.P010096003 460 - Matech Advanced Materials 12.PO7532 21,774 1,197 Aerojet 12.S38006 3,631 - See notes to schedule of expenditures of federal awards. 45

SCHEDULE OF EXPENDITURES OF FEDERAL AWARDS FOR THE YEAR ENDED JANUARY 1, 2016 Passed Federal Grantor/Pass-Through Grantor CFDA.Identifying Number Federal Expenditures Through to Subrecipients Thor Technologies 12.SUBC 0064-SRI (2) - Thor Technologies 12.T14S050 8,104 - Intuitive Research & Tech 12.W31P4Q-09-A-0016 244,118 - Gleason Research Assoc 12.W31P4Q-10-A-0017 322,931 - Torch Technologies, Inc. 12.W31P4Q-14-D-0017 48,878 - Nordic Life Science 12.W81XWH-11-1-0817 69,388 - Ultramet 12.W911QX-13-C-0061 17,305 - Navmar Applied Sciences 12.W911QX13C0181 32,249 - Total Department of Defense 12,527,615 903,358 National Aeronautics and Space Administration Direct National Aeronautics and Space Administration 43. 6,754 - National Aeronautics and Space Administration 43.NNA12AB86B 382,404 - National Aeronautics and Space Administration 43.NNJ11JB28C 2,499,877 888,911 National Aeronautics and Space Administration 43.NNM14AA01B 657,983 280,816 Pass-Through Materials Research & Design 43.NN05-SRI-001 25,332 - Materials Research & Design 43.NN06-SR-001 234 - Materials Research & Design 43.NNX13CA29P 108,434 - Materials Research & Design 43.NNX14CA09C 11,952 - Materials Research & Design 43.NNX15CA57P 26,876 - Plasma Processes, Inc. 43.NNX15CCM51P 6,800 - Total National Aeronautics and Space Administration 3,726,647 1,169,727 Department of Veterians Affairs Direct Department of Veterans Affairs 64.VA247-15-P-0878 27,846 - Total Department of Veterians Affairs 27,846 - Department of Energy Direct Department of Energy 81.DE-EE0006062 69,236 7,500 Department of Energy 81.DE-EE0006535 498,585 50,733 Department of Energy 81.DE-EE0006746 268,602 122,578 Department of Energy 81.DE-EE0006781 453,936 28,309 Department of Energy 81.DE-EE0007116 59,740 - Department of Energy 81.DE-FE0010231 23 - Department of Energy 81.DE-FE0012054 297,995 94,975 Department of Energy 81.DE-FE0024083 1,235,677 255,538 Department of Energy 81.DE-FE0024084 98,955 68,251 Department of Energy 81.DE-FE0026388 156,846 - Pass-Through UT-Battelle, Inc. 81.40001394 94,957 - Southern Company Service 81.ATP DTD 10/17/08 397,019 - RPSEA 81.DE-AC26-07NT42677 832,587 433,439 See notes to schedule of expenditures of federal awards. 46

SCHEDULE OF EXPENDITURES OF FEDERAL AWARDS FOR THE YEAR ENDED JANUARY 1, 2016 Passed Federal Grantor/Pass-Through Grantor CFDA.Identifying Number Federal Expenditures Through to Subrecipients Western Research Institute 81.DE-FC26-08NT43293 3,890 - Southern Company Service 81.DE-NT000749 (13,098) - Techverse, Inc. 81.DE-SC0011869 4,316 - Southern Company Service 81.SCS26649 324,335 - Southern Company Service 81.SCS31511-0008 894,901 - Total Department of Energy 5,678,502 1,061,323 Department of Health and Human Services Direct National Institutes of Health 93.7R01CA183921-02 17,699 - National Institutes of Health 93.HHSN261201100013C 230,494 - National Institutes of Health 93.HHSN261201500022I 2,348 - National Institutes of Health 93.HHSN271201100005I 36,576 - National Institutes of Health 93.HHSN271201100005I (279) - National Institutes of Health 93.HHSN271201100005I 31,127 - National Institutes of Health 93.HHSN271201100005I 70,194 - National Institutes of Health 93.HHSN271201300115P 48,156 - National Institutes of Health 93.HHSN272200700041C (12) - National Institutes of Health 93.HHSN272200700042C 344 - National Institutes of Health 93.HHSN272201000022I 640,043 - National Institutes of Health 93.HHSN272201000022I 267,258 - National Institutes of Health 93.HHSN272201100012I 94,430 - National Institutes of Health 93.HHSN272201100012I 30,946 - National Institutes of Health 93.HHSN272201100013I 312,678 - National Institutes of Health 93.HHSN272201100013I 199,477 137,360 National Institutes of Health 93.HHSN272201400010I 2,450,817 - National Institutes of Health 93.HHSN272211000121 52,108 - National Institutes of Health 93.HHSN273201300010C 3,331,423 - National Institutes of Health 93.R01 AI052019 20,327 - National Institutes of Health 93.R01 CA133093 53,288 - National Institutes of Health 93.R01 DA024675 156,487 - National Institutes of Health 93.R21 AI101924 70,737 43,850 National Institutes of Health 93.R21 DAO29962 157,919 9,726 National Institutes of Health 93.R21CA158560 9,353 - National Institutes of Health 93.R21CA182056 191,262 - National Institutes of Health 93.R21CA182056 1,189,740 215,150 National Institutes of Health 93.R21CA182056 34,081 - National Institutes of Health 93.R21CA182056 101,387 - National Institutes of Health 93.R21CA182056 100,000 - National Institutes of Health 93.R21CA182056 94,149 - National Institutes of Health 93.R21CA182056 231,618 - National Institutes of Health 93.R21CA182056 315,945 55,000 National Institutes of Health 93.R21CA182056 73,880 - National Institutes of Health 93.R21CA182056 26,279 - Pass-Through: Forge Life Science 93. (6,062) - Leidos Biomedial Research 93.151212 5,000 - See notes to schedule of expenditures of federal awards. 47

SCHEDULE OF EXPENDITURES OF FEDERAL AWARDS FOR THE YEAR ENDED JANUARY 1, 2016 Passed Federal Grantor/Pass-Through Grantor CFDA.Identifying Number Federal Expenditures Through to Subrecipients Leidos Biomedial Research 93.12XS448 214,599 - University of Chicago 93.1U01NS069997 65,649 - University of Alabama at Birmingham 93.1U19AI109680-01 4,079,203 - Leidos Biomedial Research 93.29XS124 754,131 235,485 Leidos Biomedial Research 93.29XS124 2,281 - Leidos Biomedial Research 93.29XS124 47,747 - Leidos Biomedial Research 93.29XS124-1,285 Albany Medical College 93.5R01AI100138-03 3,275 - University of Alabama at Birmingham 93.5R01CA175012-01A1 346,574 - University of Alabama at Birmingham 93.5U01E023759-02 122,772 - Battelle Memorial Institute 93.HHSN272201200003I 11,461 - Battelle Memorial Institute 93.HHSN272201200003I 46,244 - Fisher Bioservices, Inc. 93.HHSN272201200022C 222,992 - NANOBIO 93.HHSN272201300028C 4,777 - PFENEX 93.HHSO100201000045C 906,403 - Biomedical Adv Research 93.HHSO100201100007I 369,276 - Vaxinnate Corp 93.HHSO100201100011C 35,567 - SIGA Technologies, Inc. 93.HHSO10020110001C 1,579,559 15,938 University of Alabama at Birmingham 93.R01 CA108886 34,766 - University of Alabama at Birmingham 93.R21 ES025423 33,776 - SIGA Technologies, Inc. 93.R21CA182056 10,488 - University of Alabama at Birmingham 93.R21CA182056 4,288 - Leidos Biomedial Research 93.SUB P010176955 39,056 - Dana Farber Cancer Institute 93.W911NF-10-1-0266 108,391 - Total Department of Health and Human Services 19,684,494 713,794 Classified Classified 99. 50,525 330 Classified 99. 45,613 - Total Classified 96,138 330 Grand Total $ 41,741,241 $ 3,848,532 See notes to schedule of expenditures of federal awards. 48

NOTES TO SCHEDULE OF EXPENDITURES OF FEDERAL AWARDS FOR THE YEAR ENDED JANUARY 1, 2016 1. BASIS OF ACCOUNTING The accompanying schedule of expenditures of federal awards (the Schedule) summarizes the expenditures of Southern Research Institute (the Institute) under direct contracts and subcontracts of the government for the year ended January 1, 2016. Because the Schedule presents only a selected portion of the operations of the Institute, it is not intended to, and does not, present the financial position, results of operations, changes in net position, and cash flows of the Institute. For purposes of the Schedule, federal awards include all grants, contracts, and similar agreements entered into directly between the Institute, the agencies and departments of the federal government, and all subawards to the Institute by nonfederal organizations pursuant to federal grants, contracts, and similar agreements. The information in the Schedule is presented in accordance with the provisions of Title 2 U.S. Code of Federal Regulations (CFR) Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (Uniform Guidance). The Institute has obtained Catalog of Federal Domestic Assistance ( CFDA ) numbers to ensure that all programs have been appropriately identified in the Schedule. CFDA numbers for applicable programs have been appropriately listed by those programs. Certain contracts and grants are not assigned CFDA numbers and, therefore, CFDA numbers are not listed by these programs. For purposes of the Schedule, expenditures for federal awards programs are recognized on the accrual basis of accounting. 2. INDIRECT COST RATE The Institute did not elect to charge a de minimis rate of 10% for all federal awards. 49

INDEPENDENT AUDITORS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING AND ON COMPLIANCE AND OTHER MATTERS BASED ON AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE WITH GOVERNMENT AUDITING STANDARDS The Board of Directors Southern Research Institute We have audited, in accordance with the auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States, the financial statements of Southern Research Institute, a component unit of the University of Alabama at Birmingham, as of and for the year ended January 1, 2016, and its discretely presented component unit as of and for the year ended January 1, 2016, and the related notes to the financial statements, which collectively comprise the Institute s basic financial statements, and have issued our report thereon dated April 27, 2016. Internal Control over Financial Reporting In planning and performing our audit of the financial statements, we considered Southern Research Institute s internal control over financial reporting (internal control) to determine the audit procedures that are appropriate in the circumstances for the purpose of expressing our opinions on the financial statements, but not for the purpose of expressing an opinion on the effectiveness of Southern Research Institute s internal control. Accordingly, we do not express an opinion on the effectiveness of the Institute s internal control. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis. A material weakness is a deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity s financial statements will not be prevented, or detected and corrected, on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. Our consideration of internal control was for the limited purpose described in the first paragraph of this section and was not designed to identify all deficiencies in internal control that might be material weaknesses or significant deficiencies. Given these limitations, during our audit we did not identify any deficiencies in internal control that we consider to be material weaknesses. However, material weaknesses may exist that have not been identified. 50

Compliance and Other Matters As part of obtaining reasonable assurance about whether Southern Research Institute s financial statements are free from material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit and, accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance or other matters that are required to be reported under Government Auditing Standards. Purpose of this Report The purpose of this report is solely to describe the scope of our testing of internal control and compliance and the results of that testing, and not to provide an opinion on the effectiveness of the organization s internal control or on compliance. This report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the organization s internal control and compliance. Accordingly, this communication is not suitable for any other purpose. Birmingham, Alabama April 27, 2016 51

INDEPENDENT AUDITORS REPORT ON COMPLIANCE FOR EACH MAJOR PROGRAM AND ON INTERNAL CONTROL OVER COMPLIANCE REQUIRED BY THE UNIFORM GUIDANCE The Board of Directors Southern Research Institute Report on Compliance for Each Major Federal Program We have audited Southern Research Institute s compliance with the types of compliance requirements described in the OMB Compliance Supplement that could have a direct and material effect on Southern Research Institute s major federal program for the year ended January 1, 2016. Southern Research Institute s major federal program is identified in the summary of auditors results section of the accompanying schedule of findings and questioned costs. Management s Responsibility Management is responsible for compliance with federal statutes, regulations, and the terms and conditions of its federal awards applicable to its federal programs. Auditors Responsibility Our responsibility is to express an opinion on compliance for Southern Research Institute s major federal program based on our audit of the types of compliance requirements referred to above. We conducted our audit of compliance in accordance with auditing standards generally accepted in the United States of America; the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States, and the audit requirements of Title 2 U.S. Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (Uniform Guidance). Those standards and the Uniform Guidance require that we plan and perform the audit to obtain reasonable assurance about whether noncompliance with the types of compliance requirements referred to above that could have a direct and material effect on a major federal program occurred. An audit includes examining, on a test basis, evidence about Southern Research Institute s compliance with those requirements and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion on compliance for each major federal program. However, our audit does not provide a legal determination of Southern Research Institute s compliance. Opinion on Each Major Federal Program In our opinion, Southern Research Institute complied, in all material respects, with the types of compliance requirements referred to above that could have a direct and material effect on its major federal program for the year ended January 1, 2016. 52