Our operations and financial results are subject to various risks and uncertainties that could adversely affect our business, financial condition, results of operations and cash flows. Here, we provide a broad overview of the chief external factors that influence, and in some cases govern, operations and financial results, briefly discussing their specific impacts in 2009 as well as their anticipated near-term effects. The remainder of this report, notably the sections entitled “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” provides a further understanding of the risks and uncertainties we confront.
Adverse changes in the economy directly impact our business, negatively affecting our results of operations.
The demand for postal services is heavily influenced by the economy. We are now in the early stages of a recovery, though most economists believe that it will be slow and prolonged. However the nature of the recovery is not universal. U.S. national unemployment, on the increase since January 2008, reached 9.8% by the close of our fiscal year on September 30, 2009, and 10.2% in October, the highest level since 1983. Unemployment may continue to rise for the next several quarters in spite of the anticipated growth in gross domestic product (GDP). The lingering effects of turmoil in the financial markets have resulted in a crisis of confidence among consumers, which raises economic risk significantly. Uncertain market conditions are expected to have an adverse impact on retail sales, investment, consumer spending and consumer confidence. Negative trends in these areas are likely to depress the demand for postal services.
Our ability to generate sufficient cash flows is substantially dependent on our ability to execute strategies to increase efficiency, reduce costs and generate revenue.
The Postal Service incurred a net loss of $3,794 million for the year ended September 30, 2009. This followed a net loss of $2,806 million for the year ended September 30, 2008. A significant portion of the 2009 loss is attributed to the unprecedented decline in mail volume, which fell by 25.6 billion pieces, resulting in a $6,842 million or 9.1% decrease in revenue, compared to 2008. The decline in mail volume is primarily attributable to the breadth and depth of the economic recession, which has affected all sectors of the economy and all classes of mail. In fact, while electronic diversion of mail is a long-established trend that is expected to continue to depress annual mail volumes, there is some evidence that the recession has accelerated the diversion of First-Class Mail, overnight documents and direct mail advertising. Looking ahead to 2010, we expect mail volume to further decline. While forecasting in this recession has become extremely difficult, our operational plan in 2010 predicts a mail volume decline by another 10-15 billion pieces from 2009 levels, and we foresee a net loss of over $7 billion. It is possible that mail volumes could decrease at a rate greater than this projection.
We experienced negative cash flow from operations in two of the past three years. In 2009, we were able to fund obligations, through increased debt and a $4 billion reduction to our PSRHBF payment that passed Congress on September 30, 2009, and was signed into law by the President on October 1. Our annual net increase in debt is limited by statute to $3 billion, and total outstanding debt is capped at $15 billion. Our debt at September 30, 2009, was $10.2 billion. We currently project net debt outstanding at the end of 2010 to increase by $3 billion, but this may not be sufficient to fund all obligations. If significant losses continue in 2011, the overall $15 billion debt limitation will likely become insufficient.
We believe that, while there are sufficient cash flows for ongoing operations, there is considerable uncertainty as to whether we will have sufficient cash on September 30, 2010, to fund our required $5.5 billion PSRHBF payment. If we cannot fund this payment on September 30, 2010, we will experience a cash shortfall. There is also uncertainty as to what the legal and/or regulatory consequences would be to the Postal Service if we cannot fund this PSRHBF payment. We will continue to inform the Congress on our financial outlook and on legislative changes that would help ensure the availability of cash at year-end. However, there can be no assurance that adjustments to the PSRHBF payment schedule will be granted by September 30, 2010, or at all.
In light of these liquidity issues, in July 2009, the Government Accountability Office (GAO) listed the Postal Service as one of its “high risk” government agencies. In its report, Restructuring the U.S. Postal Service to Achieve Financial Viability, GAO recognized what we have been reporting. GAO cited our mounting losses, increasing debt levels and inability to cut costs fast enough to offset the accelerated declines in mail volume and revenue. To achieve financial viability, GAO suggested that the Postal Service develop and implement a broad restructuring plan, noting that many initiatives would require Congressional support.
The Postal Service in 2010 will continue actions to increase efficiency, reduce costs and generate new revenue. These activities will include reducing additional workhours and headcount, maximizing operational efficiencies, renegotiating contracts with major suppliers, continuing the freeze on construction of most new facilities and initiating revenue generation efforts using the increased pricing flexibility available under P.L. 109-435.
Seeking to avert a potential cash shortfall, early in 2009 we requested that Congress restructure our payments for retiree health benefits and grant the flexibility to suspend the legislative requirement that we deliver mail six days a week. Specifically, we requested that Congress restructure the retiree health benefit payments it mandated in the 2006 Postal Reform Act. Public Law 111-68, Making appropriations for the Legislative Branch for the fiscal year ending September 30, 2010, and for other purposes (P.L. 111-68), addressed the 2009 payment to the PSRHBF. While Congress did provide us with a necessary $4 billion reduction of the PSRHBF payment scheduled for 2009, P.L. 111-68 did not restructure PSRHBF payments beyond 2009. Neither did it act to relax Congress’ current requirement that we adhere to a six-day delivery schedule. We will continue to provide information and updates to Congress on these outstanding issues.
Lifting the six-day delivery requirement and allowing the Postal Service to adjust delivery days to match the requirements of actual mail volumes would provide us with critical cost-savings opportunities. However, should this proposal become law in fiscal year 2010, no savings would likely be realized from the delivery schedule change until 2011 since multiple operational, contractual and customer issues would need to be resolved before actual implementation of a five-day delivery schedule.
Our ability to generate sufficient cash flows to meet obligations is substantially dependent on the strength and speed of the economic recovery and on our ability to execute strategies to increase efficiency, reduce costs and generate incremental revenue. Although each cost reduction and revenue generation initiative is expected to positively impact cash flow in the future, in the aggregate, they may be insufficient to offset a potential September 30, 2010, cash shortfall if the economy worsens or we are unable to meet expectations. Further, there can be no assurance that Congress will enact additional legislation that impacts 2010, or at all.
Expanding use of electronic communications methods and other commercial services competes with some of our principal services. Our business and results of operations will be adversely affected by electronic diversion. If we do not compete effectively with these services, or grow marketing mail, package services or revenues from other sources, this adverse impact will be substantial over time.
The Postal Service product mix is shifting away from transactions, correspondence and periodicals mail toward advertising and shipping services which are highly correlated with economic expansions and contractions. This year’s revenue and volume clearly show the effect of that changing product mix. Over the past fifteen years transaction mail, such as bill payment, has been eroded by competition from electronic media, primarily the Internet. It is expected that over time bills and statements will continue to follow payments online, and there is evidence that the recent recession has accelerated that movement. Factors underlying this trend include growing Internet access in homes, increased availability of broadband service, falling personal computer prices, expansion of mobile Internet access, increasing familiarity and comfort with the Internet and the growing trend by businesses to incent or require their customers to use alternatives to mail for payments and statement receipt.
Correspondence mail has long been a declining part of mail volume. With the availability of inexpensive telephone service, e-mail and other Internet-based forms of communication such as e-cards and social networking, there is little chance that the trend in correspondence mail will change.
Periodicals in the mail continue to decline as people read less and increasingly use electronic media for news and information. A steep decline in periodicals advertising has amplified the impact of the recession and electronic competition.
The recession of 2007–2009 hit the advertising industry exceptionally hard, especially in 2009. Even Internet advertising was adversely affected. Direct mail advertising fared better than some media — national television newspapers, magazines and print advertising in particular. Trends in advertising appear to be favoring media that can be measured and targeted, two traits that have long set direct mail advertising apart. In the future it is expected that media that share these characteristics will prosper. It is possible that as the Internet continues to become part of daily life, it will make inroads on advertising by mail.
While the Postal Act of 2006 limited 90% of our price increases to the rate of inflation, our costs are not similarly limited. Accordingly, we may not be able to increase prices sufficiently to offset increased costs, which would adversely affect our results of operations.
Postal costs are heavily concentrated in wages, employee and retiree benefits and transportation. They are significantly impacted by wage inflation, health benefit premium increases, retirement and workers’ compensation program, cost of living allowances (COLAs) and the continuous expansion of our delivery network. We believe that recovery in volume and associated revenue growth, along with continuing productivity improvements, will be required to address the challenge presented by our current financial situation and the regulatory price cap.
The contracts with our four largest unions currently include provisions granting COLAs, which are linked to the Consumer Price Index — Urban Wage Earners and Clerical Workers (CPI-W). The COLA effective in September 2008 conferred an annual pay increase of nearly $1,500 on each career employee covered by collective bargaining agreements. The combined impact of that COLA and the carry-over from the March 2008 COLA represented an additional $1.1 billion in expenses for the Postal Service in 2009. Although the CPI-W has thus far stayed below its July 2008 high point, a resurgence of consumer inflation could have a significant adverse impact on our financial position. We estimate that each 1% increase in the CPI-W results in more than $200 million increase in annual Postal Service expenses. In addition, the valuation of our workers’ compensation liability is highly influenced by expectations of inflation and interest rates. A 1% change in the interest rates assumptions produces an approximately $900 million change in the liability. While these interest rate assumptions do not effect our annual cash payment, the CPI-W does affect the COLA payments received by claimants with compensation claims.
Current labor agreements with the two largest unions expire in November 2010 and November 2011. The ability to negotiate fair contracts that reflect the state of the economy and current and future mail revenues is essential to maintaining our financial stability. Failure to do so, or an adverse decision by an arbitrator should we not be able to agree to terms with the unions, could have significant adverse consequences on our ability to meet our obligations.
Adverse events may call into question our reputation for quality and reliability, which could diminish the value of the Postal Service brand and potentially adversely affect our business and results of operations.
We serve every American household and business nearly every day. For the fifth year in a row, the Ponemon Institute named the Postal Service the most trusted government agency and sixth most trusted of all organizations. The Postal Service brand represents quality and reliable service and therefore is a valuable asset. We use our brand extensively in sales and marketing initiatives, and take care to defend and protect it. Any event that calls into question this quality and reliability could diminish the value of our brand and potentially adversely affect our business and reputation.
Fuel expenses are a material part of our operating costs. A significant increase in fuel prices could adversely affect our costs and results of operations.
We are exposed to changes in commodity prices primarily for diesel fuel, unleaded gasoline, aircraft fuel for transportation of the mail and natural gas for heating facilities. A 1% increase in fuel costs would result in a $22 million increase in expense. We did not use derivative commodity instruments to manage the risk of changes in energy prices during the periods covered by this report.
We are subject to Congressional oversight, regulation by other government agencies and also oversight by various other organizations and the public. If we cannot successfully address the various, and sometimes conflicting, concerns of regulators, we may be subject to greater regulation, which could increase costs or otherwise place additional burdens on our operations.
This is an outgrowth of our unique status as a provider of a fundamental service to the American people. We attempt to balance the interests of all groups with the need for operational efficiency. Efforts to be responsive to these various stakeholders sometimes adversely impact the speed with which we are able to respond to changes in mail volumes or other operational needs. Any limitations on our ability to take management action could adversely affect our operating and financial results.
Our customers are potentially subject to various state legislative proposals which could reduce our revenues, increase costs or otherwise place additional burdens on our operations.
Do Not Mail bills are designed to limit or stop advertising mail from being mailed to households. In the past few years, several states have introduced Do Not Mail legislation. While no state bills have passed, there continues to be activity. In 2009, three states introduced Do Not Mail bills — Connecticut, Florida and New York. The Connecticut and Florida bills expired at the end of the 2009 legislative session. However, the New York bills are still active and will carry over into the 2010 legislative session. Similar proposals also have surfaced in city governments.
The Postal Service opposes legislation that would limit mailing or that would interfere with the availability of an affordable, universal postal system. The Postal Service will continue to communicate the value of the mail by building upon its strong environmental record and its work with mailers to offer consumers choices on how to manage their mail. By working aggressively with mailers, marketers and advertisers, the Postal Service can continue to improve the quality and relevancy of advertising mail.
The Postal Service continues to work closely with the mailing industry to promote and implement best practices for address management and anticipates that the implementation of the Intelligent Mail Barcode will be an additional tool to ensure that mail is deliverable as addressed. In addition, through its environmental stewardship, the Postal Service continues to promote programs such as recycling mail in postal lobbies to make it even easier for customers to make environmentally friendly choices.
Should a state pass Do Not Mail legislation, it would result in lost revenue for the Postal Service. A Postal Service financial analysis estimated that a national implementation of Do Not Mail legislation would place approximately $6 billion of revenue at risk annually.
We rely extensively on technology to operate our systems. A significant failure in a material system could impair our reputation for reliable service and adversely affect our results of operations.
We rely extensively on technology to operate systems for processing and delivering mail. Our intranet is one of the largest maintained by any organization in the world. Any significant failure of these systems could cause delays in the processing and delivering of mail, which could damage our reputation, result in loss of business and increase costs of operation.
A failure on our part to protect the privacy of information we obtain from customers could damage our reputation and result in a loss of business.
We receive a variety of private information from customers, such as address change data. We have implemented a number of safeguards intended to protect the confidentiality of data that we obtain.
We are subject to the risk of biohazards and other threats placed in the mail.
Although we have implemented extensive emergency preparedness measures to keep the mail, employees and customers safe from harm due to biohazards or other threats that could be introduced into the mailstream, there continues to be a risk of possible biohazard or other threats. If new biohazards or other threats were to arise and measures were not sufficient to contain or mitigate the threat, our services could be disrupted. This could adversely affect revenues, require substantial expenditures to address the threat and adversely affect our operations and financial condition.
We are also subject to risks and uncertainties that affect many other businesses, including:
