Inflation rates have been low, with the Consumer Price Index averaging around 2% in 2002 and 2003. We expect inflation to remain low in 2004, possibly lower than the recent average, as the increases in energy prices that occurred earlier this year work their way out of the economic system. A rapid run-up in inflation could significantly affect our expenses because our cost of living adjustments (COLAs) for our bargaining employees are linked to changes in the Consumer Price Index for Urban and Clerical Workers.

     In reducing the number of our career employees by 24,000 in 2003, following similar reductions in the past three years, we reduced work hours by 54 million hours below 2002. We plan an additional reduction of 25 million work hours in 2004, which translates to as many as 11,000 fewer career positions.We have reduced positions through attrition, by not filling certain vacancies and reassigning employees. While we will continue to reduce positions through attrition, we will also continue to offer the voluntary early retirement packages that we offered in 2003 to certain employees, including clerks and mail handlers. These retirement packages allow employees to retire early with reduced annuities, but do not offer incentive payments. We will not incur restructuring expenses in connection with these voluntary early retirements.

     These reductions are achieved through our cost savings initiatives that fall into two general categories: cost savings programs and increases in operational efficiency. We have developed plans to continue productivity increases and control expense growth using both types of initiatives, but the majority of our savings will come from increases in operational efficiency.

     The Postal Civil Service Retirement System Funding Reform Act of 2003 (Act) was signed into law by the President on April 23, 2003. This Act, PL 108-18, changed our funding requirements for CSRS retiree benefits and the related Postal Service payment schedules. The Office of Personnel Management (OPM) projected that without this reform, we had overfunded our pension obligations and, ultimately, would do so by $105 billion over the life

of the system. The Act refers to these averted overpayments as "savings", which the Act defines as the difference between the contributions the Postal Service would have made if this Act had not been enacted and the contributions made by the Postal Service under the Act. OPM estimated that these "savings" would be $3.4 billion for 2003, $2.7 billion for 2004 and $3.1 billion for 2005.

     As directed by the Act, we are using the "savings" in 2003, 2004 and 2005 to reduce outstanding debt to the U. S. Treasury and to hold postal rates steady until 2006. The Act also requires any "savings" after 2005 be placed in an "escrow" account and counted as operating expenses for rate-making purposes until otherwise provided for by law.

In 2003 we added 1.9 million new addresses. That's like adding two cities, one the size of Chicago, and one the size of Baltimore.

     As required by the Act, we have submitted reports giving our recommendations on two issues. First, we recommended that the obligation to fund the military service costs of postal employees' CSRS retirement benefits revert to the Department of the Treasury. Second, we recommended that the escrow provisions of the Act be eliminated and that the "savings" be used to fund retiree health care benefits, retire debt or fund capital expenditures. We do not know what actions, if any, will be taken regarding these proposals. Any of these issues could materially affect our financial results in 2004 and beyond.

     In 2002, at the direction of Congress, we developed an Emergency Preparedness Plan to protect our employees and our customers from exposure to infectious biohazard agents, to screen and sanitize the mail, to decontaminate two mail processing plants that handled anthrax-laden letters and to repair or replace postal facilities affected by the September 11, 2001 terrorist attacks on New York City.