YEAR IN REVIEW

Results for the fiscal year were excellent once again. The University's financial strength was augmented by an increasing stream of revenues, superior performance of the endowment, and the continued success of the Capital Campaign. Moody's Investors Service confirmed the University's financial position by upgrading its General Pledge Revenue Bond Issues from an Aa1 to its Aaa rating. The Aaa rating is Moody's highest, denoting the smallest degree of investment risk. Only two other public universities with medical centers have been assigned this superior rating.

Financial Position

The University's strong financial position is evidenced in its balance sheet. Total fund balances increased from $3.1 billion to $3.8 billion, a 20 percent increase. Total assets increased 19 percent to $4.4 billion. From a liquidity perspective, total current fund assets of $473 million are available to cover $187 million of total current fund liabilities.

The endowment comprises almost half of the University's fund balances. It provides the margin of excellence in recruitment and retention of our faculty, and it provides financial stability to the University's diverse operations. While private giving continues to bolster the endowment, the University's investment returns have also contributed to its strong growth. The endowment fund balance increased from $1.3 billion last year to approximately $1.8 billion this year: almost a 38 percent increase.

Examining two debt-related ratios provides another picture of the University's financial strength. The ratio of unrestricted operating resources to debt comes to 224.6 percent. Thus, there are $2.25 of unrestricted resources available to pay each $1 of debt. Unrestricted resources are particularly important since they are available for general use and not restricted to any one type of activity. These are the most flexible funds the University possesses. Examining total resources to debt provides a ratio of 709.6 percent. Thus, total resources cover outstanding debt 7 times over. This is a significant increase from our five-year average of 5.8 times coverage, and illustrates the financial reserve strength of the institution.

Revenue Sources

The University's balanced revenue streams create a stable funding base for its operations. For the academic division, there were four major sources of Educational and General (E&G) funds. Both grants and contracts and state appropriations provided 27 percent; tuition and fees provided 25 percent; and endowment income and private gifts provided 16 percent. (Please note that the numbers for sources and uses exclude the $52.1 million of federal Direct Lending activity for the 1999--00 fiscal year.)

Total tuition and fees declined from the prior fiscal year while state appropriations increased. Why? The Commonwealth chose to reduce in-state tuition for the benefit of its citizens, and then provided additional state appropriations to cover the reduction in tuition revenue. This strategy caused the slight dip in tuition revenue.

The reduction of the in-state tuition rate actually places the University in a stronger competitive position. The University's in-state rate for fiscal year 1999 was $4,866 compared to its national peers' average of $3,844. That was a difference of $1,022 per in-state student. Now the University's rate is $4,130 as compared to its national peers' average of $3,966: only a $164 difference per student. The result? Not only is U.Va. priced more competitively against its national peers, but it has more flexibility in increasing tuition should future increases become necessary.

For out-of-state tuition, the picture is similarly positive. The University's out-of-state rate is $16,603 compared to its private national peers' average of $23,151. The difference of $6,548 per student provides a buffer against future cost increases.

Grants and contracts provided 27 percent of the revenue base. This also reflects a trend of increasing awards over the past five years. For this fiscal year, grant and contract awards increased by another 12 percent. The largest contributor to this growth remains the School of Medicine through its awards from the U.S. Department of Health and Human Services. The School of Medicine provides over 50 percent of total grant and contract revenue.

Uses of Funds

An examination of several categories of Educational and General funds reveals how the University spent its funds and supported its primary programs. In total, expenditures for instruction, research, academic support, and student services increased $30.4 million or 7.2 percent this fiscal year.

Funds spent on instruction increased from $194.5 million to $209.9 million, a $15.4 million or 7.9 percent increase. Research expenditures increased by $9.0 million to a total of $145.9 million, up 6.6 percent. Thus, the University devoted an additional $24.4 million to two of its primary missions of instruction and research.

Smaller, but still significant increases were reflected in academic support and student services. Academic support grew $4.0 million to a total of $78.6 million, while student services increased $2.0 million or 12.7 percent to $18.1 million.

Public service expenditures dropped slightly, by 0.6 percent. The University plans to make substantive improvements in this area. One of the four 2020 Planning Commissions convened by President Casteen has as its focus Public Service and Outreach activities.

Institutional support showed an increase of 8.8 percent to $50.8 million. This increase was due in large part to the University's goal of replacing its outdated administrative systems with an integrated suite of systems from Oracle Corporation. Absent these new integrated systems expenditures, institutional support would have decreased by $3.0 million this year, a 6.4 percent decline.

These figures demonstrate the University's continued commitment to holding down administrative costs and increasing support of its primary missions. The investment in the new integrated systems, while significant, is consistent with the University's pursuit of and commitment to using new technologies.

Meeting Future Challenges

"For here we are not afraid to follow the truth wherever it may lead, nor to tolerate any error so long as reason is left free to combat it." -- Thomas Jefferson, 1820

The words of the University's founder still ring true into the new millennium. We must continue our commitment to the same sound financial practices the University has employed over time, and that commitment must be combined with an open-minded willingness to examine new tools and employ new technology in order to meet the University's future challenges. A simple list of future capital projects is illustrative of the challenges before us: renovations to academic buildings and dormitories; additions to a professional school complex and intramural facilities; and new construction of vivarium facilities and parking garages. Then there are the recommendations emanating from the 2020 Planning Commissions, such as fulfilling the critical demand for additional research space and creating a new arts precinct. The growing list is daunting.

To meet these future needs the University will require ongoing state support, the continued generosity of donors and alumni, and close attention to its bottom line. As stated in the beginning, Moody's Investors Service upgraded the University's bond rating to Aaa status. This upgrade was based on sound financial management over an extended period of time, not just the result of one or two year's growth. For example, our required debt service payments represent only 3 percent of annual operating expenditures. And expendable funds are more than five times the level of outstanding debt.

Some level of additional bond financing will be required to meet the University's capital needs. But for each capital project, the University will require a significant initial gift and a dedicated revenue stream to meet the cost of the debt. This prudent strategy will ensure that the required debt service payments remain low and that expendable funds are sufficient to cover outstanding balances. For example, the University's Debt Advisory Committee adopted a 4 percent debt service to revenue ratio. Of particular note is that this ratio is more conservative than the 5 percent limit adopted by the Commonwealth of Virginia Debt Capacity Advisory Committee.

Medical Center

Note that this review of the Medical Center's financial results is based on the reporting standards as prescribed by the AICPA's audit and accounting guide entitled Health Care Organizations. Certain reporting standards are different than the reporting standards upon which the University's consolidated financial statements are based. The University's consolidated financial statements are based on the audit guide, Audits of Colleges and Universities.

To maintain its financial strength in a competitive health care market, Medical Center management continues to improve patient services while controlling costs. As a result of these efforts, the Medical Center increased its operating income from $10.1 million net income in 1999 to $21.9 million in 2000. Net revenue after non-operating gains and losses increased from $5.7 million in 1999 to $24.9 million in 2000. This increase resulted from the Medical Center's ability to increase its total revenue by 3 percent while holding growth in expenses to less than 1 percent. Although there was modest growth in revenue from inpatient services, the Medical Center's shift in services to the outpatient area is evidenced by a 15 percent growth in outpatient revenue.

The portion of gross revenue actually collected increased as a result of improved payments from third parties; however, these gains were partially offset by continued decreases in Medicare reimbursement. The Balanced Budget act reduced Medicare reimbursement by $3.6 million during 2000 and is expected to further reduce Medicare revenue by $4.2 million in 2001. An increased level of third-party coverage for our patients, and therefore a decline in the number of patients eligible for indigent care or on a "self-pay" status, can be attributed to the current strong economy.

The negligible growth in operating costs resulted from two factors: a continuing labor shortage and associated staff vacancies, and effective resource management. The labor shortage will likely continue for nurses and various technical positions until at least 2004. This shortage has and will continue to drive up labor costs for these employees. Resource management has been particularly important in the area of pharmaceutical costs. With the rapid growth in the number of new drugs and the continued rise in drug costs, new techniques have been implemented to control drug costs. A greater emphasis on medical management is designed to ensure that the proper drug is prescribed for each patient, while new robotic technologies are being employed in the pharmacy to fill prescriptions in a more cost-effective manner.

As a result of the increase in revenues and leveling of expenses, the Medical Center had a 4.4 percent operating margin, which compares favorably with that of other academic medical centers around the country. The principal source of non-operating gains was investment income derived from the Medical Center's investment of its depreciation reserve fund with the State Treasurer. The non-operating loss from investments in affiliated companies of $1.5 million includes operating losses incurred by the Blue Ridge Health Alliance, which provides health plans to employers in Virginia under the name of QualChoice of Virginia, and Health South, which operates an acute rehabilitation hospital.

Hospital admissions decreased by 2.5 percent during 2000. During this same period, length of stay decreased from 5.4 days to 5.3 days. As a result of these decreases, patient days declined by 3.0 percent to 149,861. During this same period, outpatient visits, including visits to the emergency room, grew by 2.1 percent to 543,047 visits.