The financial outlook for the Postal Service is closely linked to the outlook for the U.S. economy and changes in the use of the mail. In the past two years, the American economy experienced its worst economic downturn since the Great Depression and mail volume fell precipitously. We saw a gradual economic recovery in 2010, but lingering high unemployment remains a major concern. It is estimated that GDP growth will be less than 1.5% in the final quarter of 2010. Growth in consumer spending is estimated at 2% for the fourth quarter while business investment should grow approximately 10%, which is less than previously forecast. The consumer spending and estimated business investment trends do not provide the growth stimulus necessary to return to significantly higher mail volumes.

IHS Global Insight, an economic and forecasting consulting firm, is forecasting positive year-over-year growth in the economy as measured by real GDP throughout 2011 and growth of 3% in 2012.

Mail volume, however, has become only weakly correlated with GDP. Trends in employment, investment expenditures, and retail sales are better indicators of mail volume trends. Weak growth in employment and retail sales is predicted for 2011. Recovery in employment is expected to lag the broader economic recovery, just as it did in the recession of 2001. Business investment is the sole bright spot in these indicators, fueled by healthy corporate balance sheets, low financing costs, and the need to replace aging equipment.

In the longer term, economic growth as measured by all these statistics is expected to continue, but at growth rates below those of the late 1990s and early 2000s. The slower long-term growth trend is expected to suppress long-term growth in mail volume.

These economic indicators suggest that the worst is over in terms of the precipitous volume decline the Postal Service has experienced and that volume and revenue in 2011 should be relatively flat.

Revenue Outlook

The revenue outlook for 2011 is worsened after the PRC’s rejection of the Postal Service’s request for an exigent price increase. This increase, if approved, would have generated approximately $2 billion in additional revenue in 2011. Although the Postal Service has decided to appeal this ruling, no decision is likely to occur in time to impact 2011. Thus, the revenue outlook for 2011 is largely dependent on the course of the economy and to a lesser extent, revenue initiatives.

Although the economy is largely responsible for the recent revenue and volume decrease, electronic diversion presents an ongoing, long-term challenge, particularly with respect to First-Class Mail.

First-Class and Standard Mail account for 94% of total mail volume. First-Class Mail volume is expected to continue its long-term decline, while Standard Mail is expected to grow slowly. Total mail volume is expected to be virtually flat in 2011 and then show steady growth beginning in 2012 as the economy continues to recover, but is unlikely to ever return to the peak 2006 levels.

For 2011, we project revenue to be flat versus 2010. Revenue will see a small boost from the recently announced Shipping Services price increases offset by First-Class Mail declines.

First-Class Mail volume is expected to decline during 2011. Even when employment, consumer spending, and capital investment recover, the growing use of the internet and other electronic means of communication will continue to suppress mail growth. First-Class single-piece letters have been in decline for more than a decade and are expected to continue to decline in both the short- and long-term.

Standard Mail volume has fallen by approximately 20% since peaking in 2007. For 2011, Standard Mail revenue and volume are expected to begin a slow rebound.

Periodicals volume is projected to decrease modestly in 2011. While the projected declines in Periodicals are not as dramatic as some other mail categories, they represent the continuation of a long-term trend.

Shipping Services revenue and volume are expected to increase in 2011. This entire group is influenced by competitors’ prices, which often include fuel surcharges and by our own advertising and promotional initiatives.

Expense Outlook

Total expenses for 2011, excluding retiree health benefits, are expected to increase, as planned cost reductions are outweighed by the impact of contractual wage and benefit increases and inflation.

Plans are to aggressively reduce costs wherever possible, while maintaining high levels of service. We are projecting more than $2 billion in cost savings including over 40 million in work hour reductions in 2011.

A continuing challenge that must be overcome in order to achieve these work hour savings targets will be our ability to reduce employee complement to fully capture the savings generated by these initiatives.

Beginning in 2011, the Postal Service will be required to increase the employer’s share of retirement contributions for employees under the FERS program by 0.5%, from 11.2% to 11.7%. This will add approximately $130 million to 2011 compensation and benefit expenses. In addition, we are currently negotiating new contracts with the APWU and the NRLCA because current agreements expire on November 20, 2010. The financial impact of the new labor contracts cannot be determined at this time.

In addition, it should be noted that the outlook for non-cash workers’ compensation expenses cannot be predicted because these changes are largely dependent on the level of interest rates. A 1% increase or decrease in interest rates could decrease or increase workers’ compensation expense by over $1 billion.

Finally, the 2011 financial outlook remains clouded by continuing uncertainty regarding the unsupportable large PSRHBF pre-funding contribution required in 2011, and the continuing need for structural reform.