Financial Section Part II

Outlook

The long-predicted slowdown in macroeconomic growth arrived in 2007 with gross domestic product (GDP) growth of 2.1%. The outlook for 2008 calls for continued sluggish growth. Though still a minority, a growing number of economists are predicting a recession. This concern is fueled by continuing high energy prices, prolonged weakness in the housing market, and tighter credit. Virtually all economists are anticipating weak growth. Based on Global Insight’s forecast, we anticipate that GDP growth will be around 2.0% in 2008.

Several other factors also weigh heavily on the business outlook of the Postal Service. Growth in retail sales, employment, and investment, all drivers of mail demand, is expected to be weak in 2008.

We project revenue to increase by $3.2 billion, or 4.3% to $78.2 billion in 2008 on a slight volume increase. This expected revenue increase is due primarily to the May 2007 price increase.

As a result of the May 2007 price increase, First-Class Mail revenue is expected to rise between 2% and 3% while volume is expected to decline less than 1% during 2008. Electronic alternatives to mail will continue to decrease First-Class Mail volume. We expect single-piece First-Class Mail letters and flats will once again decline by more than one billion pieces. This may be offset to some degree by growth in First-Class Mail workshare letters and flats. The outlook for single-piece First-Class Mail is less robust because of the expected slowdown in retail sales.

Standard Mail revenue is expected to grow between 6% and 7% while volume grows by less than 1%. Though less profitable than First-Class Mail, we believe that Standard Mail revenue and volume will continue to increase. In particular, automated regular bulk rate mail should see healthy increases while Enhanced Carrier Route mail will have only modest increases.

Package Services volume is expected to decline by less than 1% in 2008 while revenue grows by 6% to 8%. Although the component mix of this product is changing, we do not anticipate any significant changes of the product volume in the foreseeable future.

Periodicals revenue is projected to increase in the 10% range on a volume decline of 2% to 3% in 2008. We expect the modest year-over-year declines in Periodicals volume to continue. In addition to the effects of the economy mentioned above, the reading habits of Americans are changing. The decline in Periodicals volume, in conjunction with population growth, is a clear indicator of the effect of electronic media.

The competitive landscape for postal services is increasingly global in terms of customer choices and service providers. International Mail volume in 2008 will be affected by both the 2007 rate simplification and new rate implementation. We anticipate these two revenue-enhancing strategies may combine for a revenue increase of up to 5%.

Network Growth

We estimate that network growth in 2008 will continue at the 2007 level of 1.8 million delivery points per year. Expansion of the delivery network, while increasing the number of customers served, also causes continuing upward cost pressures.

Despite the recent slowdown in the housing market, long-term trends for housing can be expected to track long-term trends in population. Household growth will translate into a continuing expansion of our delivery network. As the population and delivery network continue to grow, we expect First-Class Mail volume to continue to decline. This combination of trends will continue to challenge us to build other postal business and increase productivity to continue to finance the nation’s universal delivery system.

Expense Growth

Total expenses for 2008 are estimated at $78.8 billion, a 1.6% reduction from 2007 expenses of $80.1 billion. This reduction in expenses is primarily due to the effects of legislation P.L.109-435 that occurred in 2007. P.L.109-435 increased expenses by $6.8 billion in 2007, as we began funding the PSRHBF. This impact included the $2.958 billion payment from escrow, which was expensed in 2007 and placed into the PSRHBF. Excluding this one time escrow payment, personnel costs in 2008 are estimated to increase by approximately $700 million or 1.2%, primarily driven by cost-of-living adjustments, contractual pay increases, and increases in health benefits costs. This will be offset by a planned reduction of 28 million work hours. This work-hour reduction target is equal to approximately 14,000 full-time equivalent employees. Contract agreements are in place with all unions through at least 2010 except the NRLCA. Personnel costs in 2008 including retiree health benefits are expected to account for 79% of total expenses.

Nonpersonnel costs, excluding transportation, are estimated to increase by about $550 million, a 6.0% increase primarily driven by projected inflation. Transportation costs are also estimated to increase by $400 million, or 6.0%, compared with 2007, due to contractual obligations and expected increases in energy prices.

We cannot estimate the additional costs associated with modifying any of our systems that will be required to separately report the financial activity of shipping services at this time. Additional costs as a result of the new financial reporting requirements, costs of complying with new PRC regulations, and the cost of compliance with the requirements of Section 404 of the Sarbanes-Oxley Act have not yet been determined.