Steven Wingfield - Director, Investor Relations
John Welch - President and Chief Executive Officer
John Barpoulis - Senior Vice President and Chief Financial Officer
Bob Van Namen - Senior Vice President
Gabriela Bis - Goldman Sachs
USEC Inc. (USU) Q3 2009 Earnings Call November 3, 2009 8:30 AM ET
Good day and welcome everyone to the USEC Incorporated third quarter 2009 earnings results conference call. This call is being recorded.
With us today from the company is Mr. John Welch, President and Chief Executive Officer and Mr. Steven Wingfield, the Director of Investor Relations. Management will make opening remarks, which will be followed by a question-and-answer period.
At this time, I'd like to turn the call over to Mr. Steve Wingfield. Please go ahead, sir.
Good morning. Thank you for joining us for USEC's conference call regarding the third quarter of 2009, which ended September 30.
With me today are John Welch, President and Chief Executive Officer; John Barpoulis, Senior Vice President and Chief Financial Officer; Phil Sewell, Senior Vice President; Bob Van Namen, Senior Vice President; and Tracy Mey, Controller and Chief Accounting Officer.
Before turning the call over to John Welch, I want to welcome all of our callers as well as those listening to our webcast via the Internet. This conference call follows our earnings news release issued yesterday after the market's close. That news release is available on many financial websites, as well as our corporate website, usec.com. I want to inform all of our listeners that our news releases and SEC filings, including our 10-K, 10-Qs and 8-Ks are available on our website. We expect to file our quarterly report on Form 10-Q later today. A replay of this call also will be available later this morning 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 risk 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, November 3, 2009. This call is the property of USEC. Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of USEC is strictly prohibited.
Thank you for your participation. And now I'd like to turn the call over to John.
Good morning. Thank you for joining us this morning to discuss our third quarter results. The third quarter was challenging and intense for the economy, our electric utility customers and certainly for USEC.
During the next few minutes, I will address recent developments regarding our efforts to deploy the American Centrifuge technology and to obtain funding through the Department of Energy Loan Guarantee Program. I will briefly discuss our results at a higher level, and John Barpoulis will provide more details during his report. We will also leave sufficient time for your questions.
Taking a look at the bottom line, we recorded a loss of $6.2 million in the third quarter, compared to net income of $8.4 million in the same quarter last year. SWU sales volumes were lower and our unit cost of sales increased reducing our gross profit margins. In addition, advanced technology expenses were $31.7 million or $2.6 million more than the same period last year. As you know, we began demobilizing construction activities for the American Centrifuge plant in August, but the impact of that cost cutting will not be seen in our results until the fourth quarter and beyond.
Our view of expected operating results for the full year remains positive, particularly our cash flow generated by operations. With several caveats, we provided guidance to investors that we expect net income of $50 million to $65 million and cash flow from operations of $360 million to $375 million for year-end. Investors who have followed USEC know that our results can swing significantly from quarter-to-quarter. We've certainly seen that this year. As a reminder, we had a small loss in the first quarter, a good second quarter. The loss we are reporting today for the third quarter and our expectation for a strong finish in the fourth quarter.
Let me say at the outset that for a variety of policy reasons, we believe the Department of Energy wants the American Centrifuge project to succeed. They have told us that. And if we did not believe that was the case, we would not still be pursuing the loan guarantee. We think that preserving the value of our substantial investment in the American Centrifuge technology is important to enhance long-term shareholder value. Therefore, we are continuing to invest in certain ACP activities as we work to address DOE's concerns and determine the most cost-effective deployment plan.
Let me bring you up-to-date on what we've been working on recently and our path forward. In late July, DOE decided not to proceed to the next step in the loan guarantee process, a conditional commitment for $2 billion in financing for the American Centrifuge Plant. DOE raised technical and financial concerns. As a result, DOE and USEC agreed to delay final review of our loan guarantee application for at least six months from August. At that time, DOE pledged to provide $45 million over an 18-month period to support continued development activities. We took the necessary steps to demobilize construction of the plant and scale back many other development activities, as we focused on addressing DOE's concerns.
By the end of September, most construction activities have been demobilized and we stopped work on the plant design, which we estimate to be 80% complete. Approximately, 1,300 jobs were lost across the full project with the majority of those coming in Ohio and Tennessee. That's what we've stopped doing. Let me tell you what we are still doing and the list is long.
We have revised our technology and demonstration program to fully address the concerns and issues identified in the independent engineer's report on the project. That report is DOE's report. It contains export-controlled information and USEC proprietary information that cannot be made public.
I can tell you, however, that the report concludes that the American Centrifuge technology and design have been proven sound and robust. Independent engineer's found that our current AC100 design and the plant technologies are ready for USEC to transition to production.
The report notes concerns about quality assurance and quality control on the manufacturing process. The engineers want to see the production-ready machines operate in a commercial cascade configuration. And they expressed concern about the impact of the demobilization on project schedule and ultimate cost to complete. The report concludes that the biggest threat to successfully completing the plant is the uncertainty of financing.
I'd say that nothing in report came as a surprise to us, and we generally agree with its findings. We are aggressively working to address the concerns they've raised. In the weeks, since our quality control stand down in August, we moved to resume demonstrating the performance availability and manufacturability of production-ready centrifuge technology included in the AC100 machines. Our engineers in Oak Ridge are continuing development work to optimize operating characteristics for performance and reliability. They are also proceeding with value engineering improvements and performance enhancement features. Importantly, this cadre of scientists and engineers are the leading centrifuge experts in America who are working to preserve U.S. leadership in centrifuge technology.
Although, operation and production-ready machines on a commercial plant cascade configuration will not resume until early next year, we are making solid progress. We have reassembled about a dozen AC100 machines and have 10 of them spinning in the ACP's lead cascading area.
We expect to have about two dozen machines assembled by the end of November. We are addressing initial start-up issues that surfaced during earlier lead cascade testing. We have instituted more rigorous quality procedures and practices as we reassembled the AC100 machines.
We took advantage of the fact that we have disassembled many of the machines during the quality stand down. We are installing updated components as they are reassembled to bring these machines up to the latest design. When our testing program resumes, we'll have approximately two dozen machines in the lead cascade.
Another concern we are addressing is how best the manufacture of the machines in the high volumes needed to populate the ACP when we remobilized the project. We've spent significant time and resources to resurrect the manufacturing infrastructure in the United States, needed to build these precision machines. We want to keep that manufacturing infrastructure warm by having our strategic suppliers build a limited number of additional machines with the latest components.
Moreover, the additional machines will be installed and operated as part of the Lead Cascade test program, providing more hours of AC100 machine run-time. We think this additional demonstration on manufacturability makes great business sense.
As you may have read, the White House submitted the $30 million budget amendment to Congress for the program, as a result of the DOE's August funding commitment. While we appreciated the Department of Energy's effort, unfortunately the funding was not provided in the 2010 Energy and Water Conference report.
We've seen a great deal of support for the American Centrifuge program on Capitol Hill and believe the effort was not successful due to the timing on the amendment and the appropriations process, and different views for how to offset the cost of the proposed amendment.
We believe there are still alternative means to provide the necessary cost sharing. We are continuing to work with DOE and Congress on alternative approaches for obtaining this funding.
I've talked about the steps we are taking to address technical concerns. In addition, there are also financial issues and risks that we are addressing. A substantial portion of our recent effort has been to focus on ways to mitigate cost risk for the project and our ability to manage that risk.
We are working to provide a revised and much improved capital structure as part of our updated submission to DOE. We are addressing these financial concerns in several ways and to some extent this effort is interwoven with our technical work.
For example, under the Loan Guarantee Program, DOE will charge a risk premium or credit subsidy upfront to provide financing. As we reduce manufacturing risk by improving our quality assurance program or reduce operations risks with our Lead Cascade testing program, we would hope to lower the risk premium.
We continue to work with Babcock & Wilcox to form a joint venture to manufacture AC100 machines in 2010. The value here is that the joint venture would provide a single point of accountability for machine manufacturing, which we expect will be more than half of the total costs of deploying the American Centrifuge.
A single point of accountability is essential in our goal to have high-quality centrifuges delivered to the ACP for installation startup and operation. We would expect that B&W's extensive experience would help to reduce ACP cost risk.
In parallel, we are working to establish an updated baseline, ACP budget and schedule for remobilizing the project, assuming future funding under the Loan Guarantee Program.
We are working with our suppliers to restructure our contractual agreements to convert them to fixed cost contracts along with other steps to enhance our project management. Taken together, these steps should reduce our risk profile.
We continue to see great interests by our customers in completing the ACP. Clearly, the industry knows that additional capacity will be needed in the next decade to meet a growing demand for low enriched uranium fuel. The nuclear utilities want diversity of supply and they want to see a U.S. owned and operated enrichment plant.
Our customers have committed to buy a substantial portion of the output from the plant and the largest nuclear utility in the United States, signed the contract in September to buy over $1 billion worth of fuel from the ACP. We are working hard to provide our customers with a long-term competitive supply of nuclear fuel.
We remain focused on delivering value to our shareholders. And as previously disclosed, we have engaged an outside adviser to solicit project investors and evaluate our strategic alternatives. We are considering all options, including a possible sale of the company or another business combination transaction. I can't say much more about this effort from a confidentiality standpoint.
In closing, let me emphasize three things. We have a clear go-forward strategy for the American Centrifuge project and we are focused on addressing DOE's concerns before resubmitting our application early next year.
Our core business today is profitable and generates significant cash to fund our current operations, and we never lose sight of who we work for everyday. While there is no guarantee that our exploration of strategic alternatives will result in transaction or agreement, I give you my assurance that the Board is focused on delivering value to the shareholders.
Now, I'd like to turn the call over to John Barpoulis to report on the third quarter financials. John?
Thanks, John, and good morning, everyone. Let me say upfront that for our practice, we expect to issue our 10-Q report later today, which has significant additional detail.
Starting at the top line for the quarter, revenue was $549 million, a decrease of $41 million or 7% from the same quarter last year. As is USEC's normal pattern, SWU sales made up the majority of revenue at $467 million, a decline of 5% compared to the third quarter of 2008. SWU sales in the third quarter reflected a 10% decrease in sales volume and a 6% increase in the average price billed to customers.
We are seeing the higher prices in contracts that we've signed in recent years representing a larger portion in our mix of customer deliveries, which is helping to bolster the average price billed to customers.
The uranium revenue is $26 million, which was a decrease of $23 million over the same quarter last year. The average price billed to customers was up sharply year-over-year, but uranium sales volume was 75% lower due to the mix, timing and terms of the sales contracts.
Although the spot market prices for uranium have increased recently due to a production problem at a large mine in Australia, uranium prices have generally declined in the past year.
The economics of underfeeding the enrichment process to obtain uranium for resale are affected by uranium prices and the cost for electric power. Uranium prices remain volatile and we will continue to monitor and optimize the economics of our production based on the cost of power and market conditions for SWU and uranium. As uranium prices increased, the economics of underfeeding clearly improve.
Turning back to the quarter, the U.S. government contracts segment revenue was $56 million, an increase of about $5 million from the same quarter last year. The drivers here are billings under a new contract for work at the gas plant and higher revenue for our subsidiary NAC.
Looking at the year-to-date, we had total revenue of $1.57 billion with $1.27 billion coming from the SWU sales. That's an increase of 47% in SWU revenue compared to the same nine-month period of 2008.
Revenue from uranium sales accounted for $150 million, which was 3% lower than the same period last year. The government contracts segment had revenue of $153 million, a decline of about $14 million compared to the same period of 2008.
On the cost side of the ledger, our two largest cost components are electric power and the price we pay Russia to purchase SWU.
We have a power contract until mid 2012 with the Tennessee Valley Authority, or TVA. That agreement provides moderate annual increases to the base price we pay, plus an adjustment up or down based on TVA’s cost of fuel and purchase power.
This fuel cost adjustment resulted in a 15% increase in fuel costs in 2008, as the price of generating fuels particularly coal and natural gas spiked in early 2008. Thus far in 2009, abundant rain in the Tennessee Valley had increased availability of hydropower and lower natural gas prices have helped to keep fuel costs to a more modest 7% over our base cost.
In fact, the average cost per megawatt hour declined by 6% in the nine-month period compared to the same period of 2008. The purchase price paid to Russia is 11% higher in 2009 than in 2008, which is the same increase that we also saw last year.
We purchased about half of our SWU supply from Russia, so these increases have a significant effect on our cost of sales.
That leads me to the cost of sales for the LEU segment for the nine-month period. The cost of sales for SWU and uranium was $1.27 billion, which was $374 million or 42% more than the same period in 2008. Most of the increase was due to the 37% increase in SWU sales volume and the higher SWU unit costs partially offset by lower uranium sales volume.
Cost of sales per SWU was 14% higher than in the nine-month period of 2008, reflecting changes in our monthly moving average inventory costs.
So, although, unit production costs were flat in the nine months ended September 30, 2009, cost of sales per SWU was negatively impacted by higher purchase costs from Russia, higher unit production costs last year and a greater allocation of production costs to SWU inventory due to declines in uranium values so far this year.
As you will recall, under our monthly moving average inventory methodology, cost of sales reflects changes in production and purchase costs.
Our production volume declined 4%, and the cost of electric power declined by $44 million in the nine-month period compared to the same period last year due to a decline in megawatt hours purchased and a lower price paid for megawatt hour. We continue to buy 2,000 megawatts of power during non-summer months for our Paducah plant.
The additional power is used to maintain efficient SWU production, while taking advantage of the economics of underfeeding the enrichment process. As a reminder, underfeeding requires less uranium feedstock that uses additional electric power to produce the same amount of low enriched uranium.
The quantity of uranium that is added to uranium inventory from underfeeding is accounted for as a byproduct of the enrichment process. Production costs are allocated to the uranium obtained from underfeeding based on the net realizable value of the uranium and the remainder of production costs is allocated to SWU inventory costs.
Because uranium prices have fallen in recent months, the net realizable value of the uranium obtained from underfeeding has declined resulting in a lower allocation of production costs to uranium. Cost of sales in the government contracts segment increased almost $5 million during the nine-month period, compared to the same period last year, primarily due to higher benefit costs resulting from a decline in 2008 of the value of pension and post-retirement benefit plan assets.
Gross profit for the third quarter was $39 million, a decline of $9 million from the same quarter of 2008. The gross profit increased slightly for our government services segment, but fell 23% in our larger LEU segment.
For the nine-month period, our gross profit was $159 million, an increase of 5%. The primary contributor was gross profit for the LEU segment, which was up 22% compared to the same period in 2008, driven by higher SWU volume and higher uranium prices.
Our gross profit margin was 7% for the third quarter, compared to 8% in the same quarter of 2008. For the nine-month period, the gross profit margin was 10% compared to almost 13% in the same period last year.
The impact of higher inventory costs for purchases from Russia and the cost of electric power for SWU production were the largest factors in the profit margin decline as the average price billed to customers for both SWU and uranium were higher.
On gross profit, we have expenses for advanced technology, primarily the continued demonstration and development costs of American Centrifuge. During the quarter, we began to demobilize the project, but the impact of the reduced spending will not be seen in our results until the fourth quarter and beyond.
We were also involved with preparing for the next phase in the Lead Cascade testing program as our crews have disassembled and began reassembling and installing the AC100 series machines in Piketon.
The amount of American Centrifuge spending expensed during the third quarter was about $32 million, compared to $29 million in the same period last year.
Through nine months, advanced technology expense totaled $94 million, an increase of $13 million over 2008.
In addition to the advanced technology expenses, $327 million of ACP related activities were capitalized in the nine-month period compared to $320 million in the same period of 2008.
Selling, general and administrative expense increased by $4 million in the nine-month period compared to the same period last year. There were increases in compensation and benefit expenses related to last year’s decline in the value of pension assets, as well as consulting expense.
In addition, the 2008 period included a $1 million credit for stock-based compensation due to a decline in the stock price in the first quarter of 2008.
We also saw a decrease of almost $15 million in interest expense in the nine-month period as we capitalized more of the interest paid and repaid the remaining principal balance on our senior notes redeemed in January 2009.
Also below the line, we reported a special charge of $2.5 million for a one-time termination benefits related to the demobilization of the ACP. The related cash expenditures are expected primarily in the fourth quarter.
Going to the bottom line, we recorded a net loss of $6.2 million in the third quarter compared to net income of $8.4 million in the same quarter last year. The diluted EPS was a loss of $0.06 per share for the 2009 quarter versus earnings of $0.06 per diluted share for the same quarter of 2008.
For the nine-month period, we had earnings of $9 million compared to $23.6 million in the same period of 2008. The diluted EPS was $0.06 per share in 2009 compared to $0.18 per diluted share in the same period last year.
Turning next to cash, we ended the quarter with $69 million in cash compared to $78 million at June 30, and $249 million on December 31, 2008. The major draws on cash so far this year were the repayment of senior notes due in January 2009 of $96 million, and capital expenditures mostly related to ACP of $401 million.
Cash flow from operations through the third quarter was $319 million compared to cash flow used in operations of $184 million in the same period last year. That $503 million improvement is primarily from monetizing inventory that we billed in 2008.
We have an extensive discussion of our liquidity in the 10-Q, but the summary is this; USEC anticipates that its cash expected internally generated cash flow from operations, the expected receipt of $70 million from the trade case settlement and available borrowings under its revolving credit facility are sufficient to meet its cash needs for at least 12 months. This assumes renewal of our credit facility that expires next August.
As noted in our news release, we are providing annual guidance of net income of 50 to $65 million in 2009 on a gross profit margin of approximately 10%. We also continue to expect cash flow from operations in the range of $360 million to $375 million.
An important assumption in this guidance relates to the settlement we reached earlier this year between USEC and Eurodif regarding a long-standing trade case. As a result of that settlement, we expect to receive approximately $70 million pre-tax in the current quarter, but not likely before December. Please note that there are a number of additional factors listed in the outlook section of the news release that could affect net income and cash flow.
To summarize, financial results for the third quarter reflect a decline in SWU and uranium sales volume that wasn’t offset by the higher prices billed to customers and the impact of higher ACP expense. We are profitable for the nine-month period, and looking ahead, we see our fourth quarter that should be our best quarter of 2009.
Our cash flow from operations is very strong and we have significantly increased our guidance for cash generation from earlier this year.
And to echo John, we are vigorously addressing DOE’s concerns so that we will be in position to update our application to the Loan Guarantee office in 2010.
And operator, we are now ready to take questions from our callers.
Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions). Our first question comes from Laurence Alexander with Jefferies & Company.
This is [Amanda] for Laurence. A quick question first around the comment that the business should provide sufficient cash to meet your needs for the next 12 months; I know that’s through the cash from ops settlement in your credit facility, does this take into account sort of a minimum cash burn rate over the next 12 months? Or is there any more color you could give us on that?
Hi. Yes, it does. I mean it does take into account an overall expectation and view on overall project spending. But I would also say it takes into account two aspects. First, with respect to that potential burn rate on ACP, I think the best information that we can provide at this point is really on the expense side of ACP expenditures. As you saw on our release, the ACP expense year-to-date is approximately $94 million. And in our guidance, we mentioned that we expect total year expense to be between $115 million and $120 million. So if you do the math that equates to an average monthly rate of about $7 million to $9 million per month in the fourth quarter. Obviously, we’re continuing to work through our demobilization and the capital expenditure side of that equation.
I think more importantly, it gets to our overall view on liquidity and recognition that as we look forward, as we have, we will continue to take steps to ensure that we have adequate liquidity for our ongoing operations.
Okay. And then just as you look at spending priorities for the ACP over the next several months and I know that the amount you spend will depend on the available funds, but how would you rank some of the priorities that you mentioned?
Well, it’s difficult to rank. Clearly, our focus is to fully address the technical issues that have been identified by the Department of Energy and Parsons. And so the activity associated with operating Lead Cascade is certainly right at the top. We need to get the machines back and operating and running. Operating Lead Cascades demonstrates all of our assembly processes, validates all of the improvements to our quality procedures.
We will be continuing to manufacture machines during that period of time, so that we can keep the industrial base for the manufacturing warm, have it in a good position to remobilize, and then we are continuing our development and test activities in Oak Ridge that allows us to continue to validate the machine that will be the baseline machine that will go in a Lead Cascade, also gives us the ability to work on the value engineering and the continued performance improvement.
So it’s hard to prioritize clearly those things that directly tied to the technical issues that DOE has addressed, that allows us to get a run time to get a reliability of those (inaudible) and then you bring the manufacturing right after that. Those are all things that decrease project risk which will decrease credit subsidy cost.
And then, we will continue the development activities as well, because that really becomes the future of the machine and the potential improvements that can be realized over the full deployment of the plant.
(Operator Instructions). Our next question comes from Gabriela Bis with Goldman Sachs.
Gabriela Bis - Goldman Sachs
Can you give us a sense of the level of CapEx you will be spending in the fourth quarter and for the full year? And kind of how you see the breakdown of CapEx going forward, capitalized versus expense? I’m trying to get a sense of sort of the run rate that you will be seeing. I know that you guys are demobilizing and spending a little bit less, but trying to get a sense of what that means going forward and especially into 2010?
Again Gabby, unfortunately I think the best guidance that we can provide is really on the expense side of the equation, looking at that average spend in the fourth quarter, between $7 million and $9 million per month. We’ve recognized that our level of capital expenditures will be ramping down, and are much lower like a hole in 2009 compared to our original expectations, if you go back to look at the initial guidance we provided at the beginning of the year with respect to total CapEx.
As you know, from our practice, we’ll be providing outlook and guidance. We would expect to do that early in 2010 or late in 2010. I think that’s the best answer I can provide at this point.
Gabriela Bis - Goldman Sachs
Okay, thank you. And second question I have is regarding uranium sales. And I know you mentioned that, uranium prices have come down and that’s why we saw a decrease in uranium sales. Can you give us a sense of what you’re really seeing in the market right now, and what you’re thinking in terms of when prices will stabilize?
Bob Van Namen
This is Robert Van Namen. The prices definitely have firmed since there was an accident at an Olympic Dam facility that took out about 80% of the production from this very large, very important mine. So we did see prices tick back up fairly consistently. The major caveat there is the Department of Energy and their plans to pay for additional shutdown work and decontamination and decommissioning work by selling uranium into the market. They have an obligation to do an adverse impact assessment on the impact on the uranium and other domestic markets, and they’re doing so now.
So what we see is, again, a shortfall in production in the market, which would generally tend to push prices up, somewhat countered by secondary supplies. We see the market being fairly reasonably stable and firm now, again in the $130 a kilogram range. It does have the potential to move up somewhat, because of the Olympic Dam situation, but we and others in the market are keeping a careful eye on DOE’s actions.
(Operator Instructions). There are no other questions coming in the queue at this time. I’ll turn it back over for any closing remarks.
Well, thank you all for your questions. I think in summary, although recent events have been challenging, we are clearly focused on addressing the issues ahead. Significant progress is being made on a number of fronts as we talk to you. I look forward to bringing you report on our annual performance in February and we continue to appreciate your support, your interest and your investment in USEC. Thank you.
This concludes today’s conference call. Thank you for your participation.
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