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Executives

John Welch - President and CEO

John Barpoulis - SVP and CFO

Robert Van Namen - SVP, Uranium Enrichment

Philip Sewell - SVP, American Centrifuge and Russian HEU

J. Tracy Mey - VP and CAO

Steven Wingfield - Director, Investor Relations

Analysts

Laurence Alexander - Jefferies & Company

Jason Adler - GMP Securities

USEC (USU) Q4 2012 Results Earnings Call February 26, 2013 8:30 AM ET

Operator

Greetings, and welcome to the USEC Incorporated fourth quarter and 2012 year-end conference call. [Operator instructions.] It is now my pleasure to introduce your host, Steven Wingfield, Director of Investor Relations for USEC Inc. Thank you Mr. Wingfield. You may now begin.

Good morning and thank you for joining us for the USEC conference call regarding the fourth quarter and year-end review of 2012. With me today are John Welch, President and Chief Executive Officer; John Barpoulis, Senior Vice President and Chief Financial Officer; Bob Van Namen, Senior Vice President; Philip Sewell, Senior Vice President; and Tracy Mey, Vice President and Chief Accounting Officer.

Before turning the call over to John Welch, I’d like to welcome all of our callers as well as those listening to our webcast. This conference call follows our earnings news release issued yesterday afternoon. That news release is available on many financial websites and our corporate website, usec.com. All of our news releases and SEC filings, including our annual report on form 10-K, which was filed yesterday, are also available on our website. A replay of this call also will be available later today on the USEC website.

I’d like to remind everyone that certain of the information that we may discuss on this call today may be considered forward-looking information that involves risks and uncertainty, including assumptions about the future performance of USEC. Our actual results may differ materially from those in our forward-looking statements. Additional information concerning factors that could cause actual results to materially differ from those in our forward-looking statements is contained in our filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q.

Finally, the forward-looking information provided today is time sensitive and is accurate only as of today, March 19, 2013. This call is the property of USEC. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of USEC is strictly prohibited. Thank you for your participation.

Now I’d like to turn the call over to John Welch.

John Welch

Good morning, and thank you for joining us today to discuss our fourth quarter and full year 2012 results. I’d like to begin by discussing the current status of USEC’s business and the American Centrifuge, as well as the important initiatives we have underway. I’ll then hand the call over to John Barpoulis for a more complete report on our financial reports.

Let me start by addressing the writeoff we have announced for the American Centrifuge costs that were capitalized through late 2011. First and foremost, this is a noncash charge that does not reflect any problems for the plant equipment or the AC100 centrifuges or the manufacturing infrastructure we’ve developed for these precision machines.

Equally important, no taxpayer funds are at risk, and we have sufficient liquidity and cash to meet our current obligations. Today, the centrifuge machines and plant systems assets we’ve built continue to operate. This was an accounting determination only, and we remain confident about the technology. The ongoing research, development, and demonstration, or RD&D program, continues to demonstrate that the technology is robust.

With that said, let me take a minute to walk you through the process we followed to evaluate our American Centrifuge investment. Each year, we conduct the year-end review of the carrying value of our long-lived capital assets as part of the preparation of our financial statements. As part of this review, we look at the significant capital that would be required to complete the project. We also looked at the anticipated sources for that capital, including a potential DOE loan guarantee and Japanese export credit agency financing in our ability to provide the remaining capital needed.

Based on the cash flow from operations that we anticipate having available for investment in the project during that timeframe, we expect additional third-party investment in ACP at the project level will be necessary. As a result, our ownership in the project will likely be reduced. The conclusion that our ultimate ownership share of ACP will likely be reduced affects the likelihood of recovering our previous investment. Therefore, under GAAP rules, we took a noncash charge of $1.1 billion against 2012 earnings.

Bottom line, the charge to expense resulted in a full year net loss for the year of $1.2 billion, or $9.84 per share. That also resulted in a balance sheet impact of creating a stockholder deficit. I want to make clear that this charge against 2012 earnings does not affect our current operations, and again it does not have any impact on the RD&D program with the Department of Energy. And it certainly does not affect our commitment to move forward with commercialization of the American Centrifuge technology, which we believe provides the best long term value proposition for our stakeholders.

This past week, we concluded several important agreements that have also been included in our year-end filing. First, we reached an agreement with a group of banks led by JPMorgan to amend our credit facility and extend it through September. The amended revolving credit facility totals $110 million, which is adequate to meet our working capital needs during that period.

We have a constructive working relationship with our lender group, and we expect to successfully extend our credit facility by September, based on our anticipated working capital needs as we transition away from Paducah enrichment operations. In connection with the amended credit facility, we paid off the outstanding balance of our term loan, which was $78.1 million.

On Friday, we closed on the sale of our subsidiary, NAC International, from which we expect to net about $42.4 million. The new owner, Hitachi Zosen, has been a key fabricator for NAC dry cask storage technology for many years. We have a great deal of respect for Hitachi Zosen, and know that our former employees who will be staying on under the new management will do well there.

Also on Friday, we signed an amendment to our agreement with the Department of Energy for $44 million in additional incremental funding of the cooperative RD&D program. This brings total Department of Energy support for the RD&D program to date to $178 million and will fund the program through mid-June. Separately, congress is considering legislation that would fund the government’s share of the RD&D program through late 2013.

Turning to more specific details on the research, development, and demonstration, we have been successfully executing the program with the Department of Energy and it remains unscheduled and on budget. Legacy equipment in the plant has been removed, and new redundant plant support systems have been installed. We are also in the process of installing the 120 AC100 machines that will make up the demonstration commercial cascade.

It’s rather remarkable to see all the craft workers, the construction activity, and the transformation of this section of the plant. We are looking forward to demonstrating the first commercially configured cascade later this summer. There is a new video on our website that was recorded in recent weeks that shows this work in great detail.

There are several performance milestones and test programs for the research, development, and demonstration programs slated for the second half of the year, including three technical, specific tests that were added under the revised agreement signed last Friday. Assuming continued financial support for DOE’s share of the program cost, we are confident of meeting the milestones by the end of 2013.

As provided for under our agreement with DOE, the RD&D program has oversight by a very strong board of managers. In addition to two USEC members, this board includes representatives from leaders in the nuclear industry, including Babcock and Wilcox, Exelon, and Toshiba, as well as two independent members with strong industry credentials. The board’s chairman is Luis Reyes, retired executive director for operations at the Nuclear Regulatory Commission.

We continue to confirm the technical readiness to proceed with commercial deployment, and we expect to update our pending application for a loan guarantee from DOE later this year. Data acquired during the RD&D program, testing information, and more than a million machine hours of run time should provide empirical strength to our application. While we’ve been given no assurances by DOE regarding a loan guarantee, we believe that all of the actions we are taking on both the technical and financial front should make for a stronger application.

Indeed, we are working hard to prepare a comprehensive update to our loan guarantee application, including updating the costs and schedule for the project. We continue to look for ways to improve our credit profile, strengthen our balance sheet, and prepare to successfully finance the project.

I want to leave no doubt in anyone’s mind that USEC remains committed to commercializing the American Centrifuge technology. We firmly believe that this is the path to USEC’s long term competitiveness in the uranium enrichment business, and that it is the best way to maximize value for all of our stakeholders, including the government’s national security requirements.

Now, I’d like to provide a short update on the tails enrichment operations at the Paducah plant. Under a multipart agreement, USEC is feeding depleted uranium tails into the Paducah plant rather than the usual method of using natural uranium as feed stock.

These tails are from the DOE enrichment operations prior to 1993. The government considered this depleted uranium to be a liability to be disposed of sometime in the future. Our product from enriching these depleted tails is the same low enriched uranium that Paducah has been delivering to customers for decades. Thus, we are taking a waste stream and producing a valuable nuclear fuel.

This agreement also has national security benefits. This nuclear fuel will go into Tennessee Valley Authority reactors under a special program that provides DOE with tritium, a radioactive isotope essential to our nascent national security defense programs. This program assures DOE will have a secure source of sufficient quantities of tritium to meet our national security needs until the American Centrifuge plant can serve that role.

Our one-year agreement continues commercial enrichment at Paducah through May 2013. Our employees continue to operate the plant at a very high level of efficiency. We are in discussions regarding the potential for continuing enrichment at Paducah for several months beyond the completion of the current arrangement. However, we believe it will be difficult to continue commercial enrichment beyond the end of the current arrangement in May 2013 and any short term follow on arrangement.

We are planning for the transition of Paducah. The Paducah plant is owned by DOE, and USEC has leased portions of the Paducah site since the 1990s. We are meeting frequently with DOE officials to anticipate and address a wide range of issues as we transition the plant back to DOE.

Once we cease enrichment at the Paducah gaseous diffusion plant, we will still need to lease, for a limited period of time, certain areas for ongoing operations such as shipping and handling, inventory management, and site services.

An important topic in these discussions with DOE is the timing of our delease of the site. We are seeking to minimize our transitions costs, which could be substantial. We expect to delease the site and return it to DOE in 2014.

This month marks the the second anniversary of the horrific earthquake and tsunami that struck Japan. In the aftermath of that tragedy, roughly 50 nuclear reactors were shut down in Japan and Germany. This has resulted in an oversupply of low enriched uranium and lower market prices for our product.

We had planned to continue enrichment at Paducah as we built the American Centrifuge plant. That would have been an important source of cash generation to help finance construction of the plant. However, current market conditions and our production costs at Paducah make that an uneconomic option.

Consequently, there will be a transition period of several years when we will no longer be enriching uranium at Paducah, but instead we expect to make sales from our existing inventory and purchases from Russia under our transitional supply agreement.

But that’s the short term view of what is generally a very long term market. The United States has the largest fleet of reactors in the world, that produces nearly 20% of our nation’s electricity. The World Nuclear Association tracks global reactor construction and they report more than 60 reactors currently being built. Most of these new plants will be online by the end of the decade and many more reactors are in advanced planning.

Since it will take about five years for the American Centrifuge to ramp up to its initial commercial capacity, today’s oversupply should become a market in better supply and demand alignment. That’s the key reason why we believe deploying the American Centrifuge is the path for USEC’s long term competitiveness in the uranium enrichment business and the best way to maximize value for all stakeholders.

In summary, despite the accounting driven net loss for 2012, we continue to execute our plan to transition from the enrichment at Paducah to construction of the American Centrifuge plant. And so let me close with three points. The tails enrichment program at Paducah is going very well, and I am confident that we will successfully meet the terms of the multiparty agreements. I am proud of our Paducah employees that have operated the plant at peak efficiency.

Second, we are on a path to meet the objectives of the RD&D program during 2013 and we appreciate the cost-sharing support for the program provided by congress and the administration. And finally, we remain absolutely committed to the commercialization of the American Centrifuge technology.

Now I’d like to turn the call over to John Barpoulis for a more detailed report on our financial results. John?

John Barpoulis

Thanks, John, and good morning everyone. In order to get to your questions this morning, we want to keep our prepared remarks brief. I will shorten my usual analysis of revenue and cost of sales trends and stay at a high level.

We reported revenue of nearly $2 billion, an increase of nearly a quarter billion over 2011. SWU prices in 2012 were 5% higher compared with the year before, and SWU sales volumes increased by 31%. SWU sales accounted for 95% of our 2012 revenue, as uranium available for sale continues to decline and we have significantly ramped down our contract services work for the government.

Since sales by NAC made up most of our contract services revenue, the recent sale of the NAC subsidiary means contract service segment revenue is expected to decline significantly going forward.

Switching to the cost side of the ledger, our two largest cost components are electric power and the price we pay Russia to purchase SWU. The cost of power is about 70% of our cost of production. During 2012, the average cost per megawatt hour of electricity declined 3% compared to the prior year, reflecting lower costs under our revised contract with the Tennessee Valley Authority.

SWU production increased by 1% year over year, and the unit production cost declined 4%, reflecting the economics of the depleted uranium enrichment program that began in June 2012. Purchase costs for the SWU component of LEU purchased from Russia under the Megatons to Megawatts program increased $13 million in 2012, compared to the year before, due to a 2% year over year increase in the price we pay under the market based pricing formula.

Gross profit for the year was $138 million, an increase of about $54 million, or 64%, compared to 2011. Our gross profit margin in 2012 was 7.2%, compared to 5% in 2011. Below the gross profit line, we had several significant expenses as well as offsetting other income for DOE’s pro rata share of the RD&D program.

Selling, general, and administrative expense was $56 million in 2012, a decrease of $6 million compared to the prior year. The lower expense reflects reductions in consulting costs and salary savings that resulted from actions implemented as part of our review of our organizational structure in 2012. Related charges for advisory support for this organizational structure review, other advisors, and workforce reduction severance totaled $12.3 million in 2012.

There are a number of elements related to the advanced technology expense, but the $1.3 billion total is dominated by the expense of $1.1 billion of costs capitalized prior to late 2011. Also included in advanced technology expense is $45 million related to the title transfer of previously capitalized American Centrifuge machinery and equipment to DOE earlier in 2012, as provided for in our RD&D cooperative agreement.

We have shared the RD&D program costs with the DOE since the agreement became effective last June 1. DOE’s share of 80% of these program costs, which is reported as other income, was $92 million during 2012.

At the bottom line, we reported a net loss of $1.2 billion in 2012. On a per share basis, that is $9.84. Because this net loss was largely due to the noncash charge, it had no effect on cash flow from operations. During 2012, we generated $143 million compared to $56 million in 2011. You can see the impact of this cash generation as our cash balance grew to $293 million as of December 31 from $38 million at the end of 2011.

Throughout our 10-K and earnings news release, we referenced a number of issues we will be confronting in the next year as we go through a period of transition. Given this uncertainty, we are limiting our guidance for financial results in 2013 to the first half of the year. The exception to this limited guidance is that we expect the volume of SWU delivered for the total year in 2013 will decline by about one-third compared to 2012. We expect revenue from the LEU segment to be approximately $1.4 billion for the full year, with about $50 million of that attributable to uranium sales.

In the contract services segment, NAC International accounted for most of the revenue. As John noted, we completed the sale of NAC last week.

We are in the second year of the RD&D program, but the federal funds for cost sharing the expense of the program have been incremental. We reached agreement with the DOE regarding $44.4 million of funding last week that will continue to keep the RD&D program moving ahead through about mid-June. There is legislation pending that could provide significant additional funding, but we have no assurance that the funds will be appropriated.

Given that uncertainty, we are not providing guidance on advanced technology expense or other income from DOE that reimburses the government share. We have additional information in our 10-K, including further information on our 2013 outlook and important factors that could affect our actual results.

That concludes our prepared remarks this morning. Operator, we are ready to take questions from our callers.

Question-and-Answer Session

Operator

[Operator instructions.]

John Welch

While we’re waiting for questions to get into queue, I’d like to ask Bob Van Namen to address a question we’ve heard from investors. Bob, what’s the status of nuclear reactors in Japan and how does this temporary oversupply in the marketplace for nuclear fuel effect the commercial prospects for output of the American Centrifuge plant?

Robert Van Namen

Thank you, John. As of now, only two of Japan’s 54 reactors are currently operating. Japan does have in place its new regulatory authority, the nuclear regulatory authority, that is going to be putting forward new rules and regulations regarding the restart of these reactors. We do expect that process to be wrapped up over the summer, leading to further restarts as we go through the rest of the year.

We do see, in the long run, a large number of these reactors restarting, but that will take time. Just like many other countries, you do see Japan being reliant and needing nuclear power and the clean energy that it provides to help fuel its economy. We do see Japan restarting these reactors. It’s just going to take time to do so.

We’ve recently had a management transition where Phil Sewell has picked up responsibility for marketing and sales, and so Phil, if you could comment on the market impacts of that?

Phillip Sewell

Sure. Having recently returned from a trip to Asia, and in particular China, it’s interesting to note the positive reaction that the market is having to the emergence of American Centrifuge plants in meeting future nuclear power needs. China has, obviously, a very large growth program, looking to increase their nuclear capacity to 200 gigawatts by the year 2030. Presently, with 28 reactors under construction, they’re interested in the enrichment market, and in particular, the suppliers that will be available to meet their needs.

Their reaction to the American Centrifuge plant is similar to many others, in that they see that it plays an important role in terms of provide supply diversity and ensuring a market with price competitiveness. Stability, reliability, assurance that fuel will be there is key, and having met with the China National Nuclear Corporation and the China Nuclear Energy Industry Corporation, both of which are responsible for enrichment and nuclear power plants in China, they have expressed an interest in engaging with USEC to look at how ACP can play a role in meeting their future nuclear fuel needs.

So that is symbolic of many of the conversations that we’re having in the market, and we find that it’s interesting that American Centrifuge is emerging with planned production at about the time when people will be looking very, very carefully at how they can secure their nuclear fuel needs.

Now, operator, I think we’re ready for questions. Thank you very much.

Operator

You’re welcome. Our first question is from the line of Laurence Alexander of Jefferies & Company. Please proceed with your question.

Laurence Alexander - Jefferies & Company

First question is, has there been a formal process to evaluate either sale of the company or an auction of the ACP technology?

John Barpoulis

I would say that that would be a bit of speculation, down a different path of discussions, but I think the answer to that is no.

Laurence Alexander - Jefferies & Company

And secondly, is there any impact from a balance sheet restructuring on your DOE licenses, either your ongoing operation licenses or your viability for the DOE loan guarantee program?

John Barpoulis

I think the answer to that is also no, but I would also add that everything that we are looking to accomplish this year in 2013 in our core business and with respect to our various creditors and lenders is all about positioning USEC as a stronger sponsor of ACP as we go back for the loan guarantee and financing for the commercial deployment.

Laurence Alexander - Jefferies & Company

And can you put some bounds around the financial criteria that the government has given you as part of the DOE loan guarantee progress, so people can model out what you’re trying to get to as an end state?

John Barpoulis

I think the aspects of the DOE loan guarantee remain similar, or at least out understanding is similar, to the work that we did earlier in the loan guarantee process. We continue to pursue a $2 billion loan guarantee from DOE and up to $1 billion of Japanese export credit agency funding. The additional quantitative parameter that we put out is that we, in addition to those two elements of the financing, we are looking for likely at least $1 billion dollars of additional equity capital to complete the commercial deployment. And so with respect to the loan guarantee program, again, we’re looking to update our loan guarantee later this year and reengage with the process.

Laurence Alexander - Jefferies & Company

Can you also game out how your other business activities… At one point you discussed exploring being a sourcing agent or selling SWU in the U.S. Can you just discuss what other revenue opportunities you might be developing at this point, apart from the ACP?

John Welch

We previously revealed that there’s a transitional supply agreement that we entered into with Russia. I think March of 2011. And that has started, it ramps up to a level that’s about half of what we do today under the Megatons to Megawatts program. And it certainly has options where we could increase it in future years, up to the full level of the Megatons to Megawatts program. 2013 represents the first year that we’re selling output from that transitional supply. That’s obviously a very valuable piece of business as we transition from Paducah operations to American Centrifuge, and basically exiting the Paducah operations sooner than we would have liked to when we looked at our whole business strategy going from one source to another several years ago. That transitional supply agreement is a very valuable piece of business.

Laurence Alexander - Jefferies & Company

And for modeling purposes, once Paducah is transitioned, what would be the margin or cash flow profile of the Russian agreement on a standalone basis?

John Barpoulis

I don’t think that we are at a point to provide specific gross profit margin guidance on the TSA. What I would add to John’s comments is we have provided the guidance in 2013 volumes of sales. Again, while healthy, we expect to be about one-third lower than compared to last year. And we do have a significant amount of inventory on hand. Again, we are looking to meet all of our customers obligations and we expect that to be used to satisfy our customers’ needs over the next several years. So we will see a blend of all of our sources of supply over the next few years. And again, we’re looking to, I’d say [unintelligible], to the TSA supply over time.

Laurence Alexander - Jefferies & Company

If you look at the agreements you have in hand, not specific to the Russian agreement, but all of your agreements that you have, to the term of those agreements, do you have any sense of what the total embedded cash flow or free cash flow could be from those agreements? Would you have a range over the next several years, the cumulative free cash flow opportunity that you can generate from your existing agreement?

John Barpoulis

I think as you’d expect, we certainly have many internal scenarios that will very much be affected by market conditions over the time period. Slightly but more importantly, our Paducah transition. So at this point, not looking to provide specific cumulative guidance around cash flow.

Robert Van Namen

Laurence, if I could add one more comment on the TSA, we do have market related provisions in the TSA that will adapt over time to the changes in the market that we’re seeing that we discussed earlier on the call. So we do have the ability to sell that material into our backlog, both domestically and internationally, and we have the ability to kind of go through the ups and downs in the markets with the gross profit embedded in that TSA.

Operator

[Operator instructions.] Gentlemen, we have the next question coming from the line of Jason Adler with GMP Securities. Please proceed with your question.

Jason Adler - GMP Securities

I know we’ve talked about this in the past, but if you don’t mind, can you just review the production capacity for ACP through the five-year ramp up that you talked about?

Robert Van Namen

We do expect to see production from the ACP reaching $3.8 million SWUs. It will be starting in 2016/2017, and then ramping up from there to a full capacity about two years later. So a reasonably linear buildup of capacity from zero to 3.8 million SWUs. One thing about the ACP is that once you begin bringing these cascades online, you will be able to get usable product and you will be able to create revenue through the startup process. So you do not have to wait until the end of the buildout to be able to start getting the revenues from the plant.

Jason Adler - GMP Securities

And from a gross margin perspective, is that linear, or does gross margin get wider as the capacity ramps up?

John Welch

I think very much a function of our startup cost and profile. Again, we don’t provide specific guidance around gross profit expectations for ACP. We point people to public comparisons that we certainly look to achieve, and the one public marker that’s out there certainly are Urenco’s public figures that provide for what a centrifuge-based business could achieve.

Jason Adler - GMP Securities

The other question I have, in terms of the expenditure of the $350 million for the RD&D, are there certain components of the project that DOE pays for and you pay for? Or do you spend all DOE’s money first and then yours? How does that work? And I guess what I’m getting at ultimately is how much of the $70 million of your component is left to spend?

Robert Van Namen

We will go forward with spending on the project that is in parity with us spending DOE’s money as well as our money on the same pace. So there is no breakdown with specific scopes that are provided by government money.

John Barpoulis

Total allowable costs under the program, they are looked at in total, and again, we are looking at an 80-20 breakdown of funding between the government and USEC, and that funding is done on a pro rata basis over time.

Operator

There are no further questions at this time. I will now turn the floor back to management for closing comments.

John Welch

We greatly appreciate the questions and comments from all of you this morning. You should know that we understand your concerns about the business, especially with regard to the accounting action for 2012 and what it means for the future of the American Centrifuge. Please know that we are as committed as ever to moving forward with commercialization of the American Centrifuge and continue to believe that it is the path to USEC’s long term competitiveness in the uranium enrichment business and the best way to maximize value for all stakeholders. Thank you again, and good day.

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