A Message from the Chief Financial Officer and Executive Vice President

As is widely recognized, the price-volume challenges we are experiencing today were not anticipated in the business model that was designed in 1970. The premise of that model with its letter mail monopoly was that moderate volume growth and postage rate increases at or below the economy’s rate of inflation would finance universal service and the ever-expanding delivery network. However, since 1998, the volume of single piece First-Class letters has declined by 10.9 billion, or 20 percent, severely stressing the business model.

Our service to customers, our financial results, and continued improvements in our workplace environment and safety efforts were all outstanding in 2005. These achievements are amply described in this report. Some further reflection on the year, however, may provide insight useful to understanding future challenges.

Robust growth in the first quarter (October—December 2004) provided a jump start to revenue for the year as election mailings boosted Standard Mail volume and mailings by financial institutions increased First-Class Mail volume. Across all operations, our employees absorbed the surge in volume of almost 3 billion additional pieces, producing a high gain in total factor productivity. With volume then growing more than twice as fast as the growth in delivery addresses, we captured economies in our delivery network. In the remaining three quarters, volume growth was less than half of the first quarter rate and was not conducive to similar productivity gains.

An encouraging development was the slight growth in the year’s total First-Class Mail volume after three years of volume decline. The decline of 1.8 billion single-piece-rate envelopes (37 cents) was offset by growth of 1.7 billion workshare-rate pieces. Total revenue for First-Class Mail did decline $300 million due to the mix change. As had been forecasted, Standard Mail volume grew 5.4 billion pieces, to 100.9 billion to exceed total First-Class Mail volume for the first time. Standard Mail volumes are becoming more volatile with time, affected as they are by economic conditions, the comparative price points of Standard Mail, and rapidly evolving alternative media.

Historically, First-Class Mail with its high volumes and higher dollar contribution over variable costs has financed the greatest part of the institutional costs of our nationwide Post Office and delivery network. As electronic diversion of First-Class Mail continues, Standard Mail’s share in the mail mix will grow. Under the current business model, this alteration in the mail mix will result in postal revenues not keeping pace with ongoing inflation in costs and will intensify both our revenue volatility and postal vulnerability to business cycles.

As is widely recognized, the price-volume challenges we are experiencing today were not anticipated in the business model that was designed in 1970. The premise of that model with its letter mail monopoly was that moderate volume growth and postage rate increases at or below the economy’s rate of inflation would finance universal service and the ever-expanding delivery network. However, since 1998, the volume of single piece First-Class letters has declined by 10.9 billion, or 20 percent, severely stressing the business model. While 2005’s volume set a new record of 212 billion pieces, the shifting mix of the mail has affected revenues substantially. At 2005 postage rates, the lower volume and the specific mail mix of 2000 would have generated $3.3 billion more revenue.