Financial Section Part I
Economic Risk
The demand for all postal services is heavily influenced by changes in the economy. A slowdown in the economy would impact nearly every class of mail negatively. In recent months a steep slump in housing prices, challenging conditions in the financial and credit markets, and a recent rise in oil prices have driven down consumer confidence. These conditions may have an adverse impact on retail sales, investment, and employment. Growth in retail sales, investment spending, and employment are all drivers of mail demand.
Impact of Inflation on Revenue and Expense
P.L.109-435 is intended to benefit both residential and business customers by seeking to achieve predictable price increases tied to the rate of inflation for services defined as mailing services (primarily First-Class Mail, Standard Mail, and Periodicals). These services represent about 90% of total revenues and about 86% of our attributable costs.
While the majority of our rates are now linked directly to general inflation, our costs are not. In 2007, general inflation as measured by CPI-U was 2.8% compared with postal resource price inflation of 3.7%. Postal costs are heavily concentrated in wages, employee and retiree benefits, and transportation. They are significantly impacted by legislatively-imposed expenses and by the continuous expansion of our delivery network. Under current conditions, we believe that both volume and revenue growth, along with increasing productivity improvements, will be required to address the challenge presented by the regulatory price cap.
The labor contracts with three of our four largest unions currently include provisions granting a cost of living allowances (COLAs). These recently negotiated contracts expire in 2010 or 2011. One contract with the NRLCA is in interest arbitration. Under current contract provisions, COLAs are linked to the Consumer Price Index (CPI) and are granted semiannually. Employee compensation represents a significant portion of our annual expenses; therefore, an increase in the CPI greater than had been incorporated into our financial plans could adversely affect financial results.
We estimate that an increase in the CPI of 0.5% would cause an annualized increase in our COLAs of about $100 million.
Fuel Price Risk
Fuel prices are a significant part of our expenses. 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 for heating facilities. A 1.0% change in fuel and natural gas costs would result in a $24 million increase in expense. We currently do not use derivative commodity instruments to manage the risk of changes in energy prices.
Technology
We rely extensively on technology to operate our systems for processing and delivering mail. Our intranet is the largest maintained by any organization in the world. Any significant failure of these systems could cause delays in the processing and delivering mail, which could damage our reputation, result in loss of business and increase our costs of operation.
Privacy
We receive a variety of private information from our customers, such as address change data. We have implemented a number of safeguards intended to protect the confidentiality of data that we obtain. Any significant violation of the privacy of our data could damage our reputation and result in loss of business.
Biohazards
Although we have implemented extensive emergency preparedness measures to keep the mail, postal employees and postal customers safe from harm due to biohazards that could be introduced into the mailstream, we must continue to be vigilant about possible biohazard threats. If a new biohazard were to arise and our measures were not sufficient to contain or otherwise mitigate the threat, our services could be disrupted. This could adversely affect our revenues, and we could be required to make substantial expenditures to address the threat, which could also adversely affect our costs of operation and financial condition.
Security
We may be required to comply with additional security requirements contained in legislation and regulations adopted to address threats to national security. For example, on August 3, 2007, the Implementing Recommendations of the 9/11 Commission Act of 2007 (P.L.110-53) became effective. This Act requires the Transportation Security Administration (TSA) to impose additional screening requirements for cargo transported on passenger aircraft. The TSA has not yet made clear whether or how it will apply to the transportation of mail. Accordingly, we cannot predict the impact of the Act. Depending upon how the Act and other security requirements are implemented, we could be required to make significant expenditures, which could have a material adverse effect on our results of operation and/or financial condition.