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 2010 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 results of operations.
The demand for postal services is heavily influenced by the economy. We are now more than a year into an economic recovery that most economists believe will be slow and prolonged. Though the U.S. national unemployment rate has improved modestly since the beginning of 2010, it remained high at 9.6% in September 2010. The lingering effects of turmoil in the financial markets continue to impact consumer confidence, raising economic risk significantly. Uncertain market conditions caused by the recent recession are expected to have a continuing adverse impact on retail sales, investment, consumer spending, consumer confidence and ultimately use of the mail. 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 increase efficiency, reduce costs, and generate revenue, as well as on legislative change.
The Postal Service incurred a net loss of $8,505 million for the year ended September 30, 2010. This followed net losses of $3,794 million in 2009 and $2,806 million in 2008. A significant portion of these losses are attributed to the unprecedented declines in mail volume in 2008, 2009, and 2010, combined with the cost of pre-funding retiree health benefits as mandated by P.L. 109-435.
Mail volume fell by 6.2 billion pieces in 2010, resulting in a $1,038 million, or 1.5%, decrease in revenue compared to 2009. In 2009, mail volume decreased 26.0 billion pieces, resulting in a $6,842 million, or 9.1%, decrease in revenue compared to 2008. The declines in mail volume that began in 2008 are primarily the result of the economic recession that began in December 2007, combined with the long-term trend of hard copy correspondence and transactions migrating to electronic media. This migration to electronic media accelerated during the recession and is expected to continue. The trend is especially concerning because First-Class Mail, our most profitable service, is expected to continue to decline in 2011 and for the foreseeable future. It is possible that mail volume, and therefore revenue, could decrease at a rate greater than currently projected.
We are mandated by P.L. 109-435 to pre-fund retiree health benefits for a period of 10 years (2006-2016), including a payment of $5.5 billion in 2011. This is a requirement not faced by other public or private entities. We cannot change the benefit formula or the payment schedule without legislation. In 2010 despite our request for Congress to change the payment schedule for this long-term obligation, no modifications were made.
Due largely to the decline in mail volume and the retiree health benefit pre-funding requirement, we experienced negative cash flow from operations in two of the past three years. During the three years ended September 30, 2010, we were able to fund obligations through increased debt and, in 2009, a $4 billion reduction to the scheduled PSRHBF payment that was due on September 30, 2009. Debt at September 30, 2010, was $12 billion. We forecast debt outstanding at the end of 2011 to increase by $3 billion to $15 billion, the maximum allowable by law. Our forecasts indicate that cash generated in 2011 from operating activities, plus the September 30, 2010 cash of $1,161 million and borrowings of an additional $3.0 billion will be insufficient to allow the Postal Service to meet all of its financial obligations in 2011.
We project that, while there will be sufficient cash flows for routine, ongoing operations, we will have insufficient cash on hand and borrowing capacity at September 30, 2011, to fully fund the scheduled $5.5 billion PSRHBF payment, or other obligations due on the date. The legal and/or regulatory consequences to the Postal Service if it cannot fund the PSRHBF payment or other financial obligations are unknown.
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, citing mounting losses, increasing debt levels, and an inability to cut costs fast enough to offset volume and revenue declines. To achieve financial viability, GAO suggested that the Postal Service develop and implement a broad restructuring plan. Ensuring a Viable Postal Service for America, our action plan for the next decade which was issued in March 2010, provides a fundamental framework to address financial viability issues for the longer-term.
Early in 2009, seeking to avert a potential cash shortfall, we requested that Congress restructure the pre-funding payments for retiree health benefits mandated by P.L. 109-435 and suspend the requirement for six-day per week mail delivery. Public Law 111-68, Making Appropriations for the Legislative Branch for the Fiscal Year-Ending September 30, 2010, and for other purposes, addressed the September 30, 2009 payment to the PSRHBF, reducing it from the scheduled $5.4 billion to $1.4 billion. P.L. 111-68 did not, however, restructure future PSRHBF payments, nor did it alter Congress’ requirement that we adhere to a six-day delivery schedule. Congress did not pass similar legislation in 2010, and the Postal Service therefore paid the $5.5 billion mandated retiree health benefits pre-funding payment at September 30, 2010.
Allowing the Postal Service to adjust delivery days to match mail volume would provide critical cost savings. Significant cost savings from changing the delivery schedule would not be realized until 6-12 months after approval of the change. This provides time for customer notifications and changes to internal systems and operations that would be required in order to achieve the expected cost savings. Thus, due to legal and practical constraints, it is unlikely that full savings from altering the delivery schedule could be achieved before 2012, at the earliest.
In July 2010, the Postal Service filed a request with the PRC seeking an exigent price increase as allowed by P.L. 109-435. This request for a price increase for Mailing Services that exceeded the increases tied to the Consumer Price Index was denied by the PRC. On October 22, 2010 the Postal Service filed a petition in the U.S. Court of Appeals for the District of Columbia Circuit seeking a review of the PRC’s interpretation of the law that governs how prices can be set under extraordinary and exceptional circumstances. The Postal Service believes that the PRC misread the statute and applied an incorrect standard in evaluating the request for an exigent price increase. No decision is likely to occur in time to impact 2011.
The ability to generate sufficient cash flows to meet obligations is also substantially dependent on the continuance, strength, and speed of the economic recovery and the execution of operational strategies available under current law to increase efficiency and generate incremental revenue. We will continue to inform Congress and other stakeholders of our financial condition and outlook and pursue legislative changes, cost reductions, and additional ways to generate revenues that would help ensure the availability of adequate cash at the end of 2011. Although the Postal Service’s cost reduction and revenue generation initiatives are expected to positively impact cash flow, we project that they will not, in the aggregate, be sufficient to offset the expected September 30, 2011 cash shortfall. Many of the structural reforms needed to ensure long-term viability, such as adjustments to the PSRHBF payment schedule, can only be achieved with legislative change. There can be no assurance that Congress will enact additional legislation that impacts 2011 or future years.
Our business and results of operations are adversely affected by electronic diversion. If we do not compete effectively with electronic communications services, or grow marketing mail, package services, or revenue from other sources, this adverse impact will become more substantial over time.
Customer usage of postal services continues to shift away from transactions, correspondence, and Periodicals Mail toward advertising and Shipping Services. Advertising and Shipping Services are highly correlated with economic activity. Over the past 15 years, transactional mail, such as bill payments, has been eroded by competition from electronic media, primarily the internet. It is expected that, over time, bills and statements will increasingly follow payments to online services, and we believe 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 decline in correspondence mail will be reversed.
Periodicals in the mail continue to decline as people increasingly use electronic media for news and information. The impact of the recession and electronic competition has amplified the steep decline in periodicals advertising.
The recession of 2007–2009 negatively impacted the advertising industry, 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 favored direct mail. In the future, it is expected that media sharing these characteristics will continue to be an important medium. It is possible that as internet usage grows, it will gain market share on advertising by mail. While Standard Mail did rebound modestly in the second half of 2010, it is too early in the economic cycle to determine whether a resurgent trend has been established in this mail category.
While the Postal Act of 2006 (P.L. 109-435) limited price increases on our Mailing Services 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. This would adversely affect our results of operations.
Postal costs are heavily concentrated in wages, employee and retiree benefits, and transportation. These costs are significantly impacted by wage inflation, health benefit premium increases, retirement and workers’ compensation programs, cost of living allowances (COLAs), fuel prices, and the continuous expansion of our delivery network. We believe that growth in volume and associated revenue, along with continuing productivity improvements, will not be sufficient to address the challenge presented by our current financial situation and the regulatory price cap.
The contracts with the four largest unions representing the majority of our employees currently include provisions granting COLAs, which are linked to the Consumer Price Index — Urban Wage Earners and Clerical Workers (CPI-W). The most recent 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. There were no COLA payments in 2010.
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 labor costs. We estimate that each 1% increase in the CPI-W results in more than $200 million increase in annual expenses. The determination of the workers’ compensation liability is also highly influenced by the CPI-W, and medical inflation, and interest rates. Changes in CPI and medical inflation increase the liability while interest rates have an inverse relationship. An increase of 1% in the interest rate would decrease our estimate of the liability by approximately $1.0 billion. A decrease of 1% in the interest rate would increase our estimate of the liability by approximately $1.3 billion. While these interest rate assumptions do not affect our annual cash payment, the CPI-W and medical cost increases do affect the payments made to claimants.
Our current labor agreements 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 revenue is essential to maintaining financial stability. Failure to do so, or an adverse decision by an arbitrator should we be unable to agree to terms with the unions, could have significant adverse consequences on our ability to meet financial 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 business and results of operations.
We serve almost every American household and business six days a week. For the sixth 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 operating costs. A significant increase in fuel prices could adversely affect costs and results of operations.
We are exposed to changes in commodity prices primarily for diesel fuel, unleaded gasoline and aircraft fuel for transportation of the mail, and natural gas and heating oil for facilities. A 1% increase in fuel costs would result in a $23 million increase in expense. We do not use derivative commodity instruments to mitigate the financial risk of changes in energy prices during the periods covered by this report.
We are subject to Congressional oversight and regulation by the Postal Regulatory Commission and other government agencies. We have a wide variety of stakeholders whose interests and needs are sometimes in conflict. If we cannot successfully address the various, and sometimes conflicting, concerns of our stakeholders, we may be subject to greater legislation and regulation, which could increase costs or otherwise place additional burdens on 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 parties. Efforts to be responsive to various stakeholders sometimes adversely impact the speed with which we are able to respond to changes in mail volume or other operational needs. Any limitations on our ability to take management action could adversely affect operating and financial results.
We rely extensively on technology. A significant failure in a material system could impair our reputation for reliable service and adversely affect results of operations.
We rely extensively on technology to manage and operate systems for payment, processing, and delivery of mail. Our operational and administrative information systems are among the largest and most complex systems maintained by any organization in the world. We have a number of systems that are nearing the end of their useful lives. Replacing these systems will require substantial investments. Any significant systems failure could cause delays in the processing and delivering of mail or result in the inability to process operational and financial data. This could damage our reputation, result in loss of business, and increase costs.
A failure 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. Should these safeguards be breached, however, our reputation could be damaged with a resultant loss of business.
We are subject to the risk of biohazards and other threats placed in the mail.
Two Postal employees died from exposure to anthrax in 2001. 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 mail, this risk cannot be completely mitigated. If new threats were to arise and measures were not sufficient to contain or mitigate the threat, services could be disrupted. This could adversely affect mail volumes, revenue, require substantial expenditures to address the new threat, and adversely affect our operations and financial condition.
We may be adversely impacted by the legal or regulatory responses to actual or perceived global climate change.
Concerns about climate change, particularly global warming, have resulted in significant discussions in the scientific community, domestic and international governments, and environmental organizations about the effects of greenhouse gases on the environment. These discussions may result in new laws or regulations that regulate greenhouse gas emissions into the environment and, as a result, our operating costs may increase. The costs that we believe are likely to increase as a result of any new environmental laws or regulations could include: diesel fuel, unleaded gasoline, the cost of retrofitting existing vehicles, and other petroleum-related products, such as tires. In addition, the utility costs associated with the operation of facilities may increase as a result of new environmental laws and regulations. Finally, since we also use contracted carriers to transport the mail, we anticipate that increased operating costs for these independent carriers, including increased costs resulting from new laws or regulations, may ultimately be passed through to the Postal Service.
We are also subject to risks and uncertainties that affect many other businesses, including:
