As a part of our continuing evaluation of estimates required in the preparation of management's financial statements, we recorded a $104 million decrease in the contingent liabilities balance in 2004, compared to a decrease of $92 million in 2003 and a $187 million increase in 2002. We recognized settlements, payments and changes in estimates of claims and lawsuits in our changes in contingent liabilities. Management and General Counsel believe that we have made adequate provision for the probable amounts due under the suits, claims and proceedings we have discussed here.

Note 11 - emergency preparedness funding

In FY 2002, the United States was subjected to biological terrorism, utilizing the mail as the delivery medium. In response, we implemented process changes and technology applications to reduce the risk to both our employees and our customers. The President of the United States and Congress authorized funding of $762 million in 2002 to assist in paying for some of these safety measures, and to replace or repair postal facilities damaged or destroyed on September 11, 2001.

In 2002 and 2003, the majority of our emergency preparedness expenses were for one-time activities, such as plant decontamination. We recognized these expenses as nonoperating expenses and the corresponding revenue offset as non-operating revenue. Due to the ongoing nature of the remaining expenses, such as depreciation, supplies, and maintenance, beginning in 2004 all emergency preparedness items are treated as operating expenses and the associated revenue as operating revenue.

Our emergency preparedness expenditures are not all covered by the appropriations we received. The emergency preparedness expenses and capital equipment commitments for the years ended September 30 are as follows:

As of September 30, 2004, all emergency preparedness appropriations have been fully expended or committed. We recognize these appropriations as revenue in the year in which the related expenditure is recognized as an expense, or when the government approves the reimbursement of a previously

incurred expense. The emergency preparedness appropriations revenues recognized during the years ended September 30 were $92 million in 2004, $177 million in 2003 and $179 million in 2002. They are reflected in the 2004 and 2003 Statements of Cash Flows as a financing activity.

The capital funds spent in 2002 ($38 million) were spent on irradiation equipment that did not meet our needs. With the approval of OMB, the eight machines valued at $24 million were transferred to other government and public agencies, and the manufacturer provided us with a stronger machine at no additional cost. This new machine is valued at $14 million and is not yet deployed.

Appropriations that had not been recognized as revenue as of September 30, 2004 and 2003, were $314 million and $406 million, respectively. The balance was recorded as an accrued expense until spent. Amounts spent on capital equipment are deferred as a non-current liability and amortized to offset depreciation expense of the related equipment.