USEC Inc. Q1 2010 Earnings Call Transcript

May. 5.10 | About: Centrus Energy (LEU)

USEC Inc. (USU) Q1 2010 Earnings Call Transcript May 5, 2010 8:30 AM ET

Executives

Steve Wingfield – Director, IR

John Welch – President and CEO

John Barpoulis – SVP and CFO

Bob Van Namen – SVP, Uranium Enrichment

Analysts

Laurence Alexander – Jefferies

Gabriela Bis – Goldman Sachs

Baker Burleson – Fox Point Capital

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2010 USEC, Inc. earnings conference call. My name is Diana and I'll be your operator for today. (Operator Instructions) Now, I'd like to turn the conference over to your host for today, Mr. Steve Wingfield, Director of Investor Relations. Please proceed.

Steve Wingfield

Good morning. Thank you for joining us for USEC's conference call, regarding first quarter of 2010, which ended March 31st.

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 I turn 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 markets closed. 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 10-Q later today. A replay of this call will also 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 May 5, 2010. This call is the property of USEC. Any redistribution, re-transmission 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.

John Welch

Good morning and thank you for joining us this morning to discuss our first quarter results. Over the course of the next few minutes, I will address our progress on the American Centrifuge technology since the first of the year. I will also briefly discuss our financial results for the first quarter, our outlook for 2010 and provide sufficient time for your questions.

Taking a look at the bottom line, we reported a net loss for the quarter of $9.7 million compared to a net loss of $2.1 billion in the first quarter of 2009. Our results in the 2010 first quarter were significantly affected by a one-time charge of $6.5 million related to a change in tax treatment of Medicare reimbursements resulting from the recently enacted healthcare legislation.

Many of the activities we are working on to address DOE's concerns about technical aspects of the American Centrifuge are expensed under accounting rules and the $25.7 million in advanced technology expenses in the first quarter also had the effect of reducing our earnings.

Absent the Advanced Technology expense and the one time tax related charge, we would have reported positive earnings for the quarter. And despite reporting a loss, our revenue of $345 million was on target and the gross profit margin of 7.7% was higher than our expectations for the quarter.

As you will recall, we began de-mobilizing and reducing construction and machine manufacturing activities for the American Centrifuge project in August 2009. Although, Advanced Technology expense was significant in the first quarter, it was approximately $6 million less than the same quarter last year and capitalized spending in the first quarter was $93 million less than in the same period of 2009.

So although, we reduced construction and machine manufacturing activities, there continues to be spending related to the project as we work further to advance the project and address DOE's concerns. A significant portion of the spending was to assemble the AC100 machines in our Lead Cascade testing program, which began operations in March.

Turning next to our 2010 outlook, in our news release, we reiterated our revenue guidance for the year and our expectation for our gross profit margin of 5% to 6%. However, given the substantial uncertainty regarding our spending pattern for the American Centrifuge project, we did not provide guidance for the bottom line.

We did, however, provide guidance for total project spending through June 30, 2010. Be assured, as we gain clarity on our project spending as the year goes on, along with other factors, we will revisit our guidance.

Preserving the value of our substantial investment in the American Centrifuge technology has been a key element of our plan to enhance long-term shareholder value. We've made significant progress during the first four months of 2010 to address DOE's technical and financial concerns, which has been detailed in various communications, so I won't repeat them here. We appreciate your patience as we go through the process of addressing those concerns and we are working hard to bring the effort to a successful conclusion.

A key element to addressing the technical concerns was the start-up and operation of a Lead Cascade of AC100 centrifuge, our production ready machines. During December and January, approximately 2000 AC100 machines were assembled, installed and operated individually. We spent several weeks conditioning the machines for the uranium gas, building up the inventory of gas to commercial levels.

In late March, we began operating in a cascade and a commercial plant configuration. That was a very important step because it demonstrates our production ready AC100 machine and machine-to-machine interaction. The cascade has been operating successfully since it came online.

Also during March we reached an agreement with the Department of Energy for a $90 million cost sharing program with each side making $45 million available. As you can see from the earnings news release, this cost sharing has already been implemented.

We've said that we're keeping the manufacturing infrastructure of the American Centrifuge machines warm by building a limited number of additional machines. Our suppliers have now assembled approximately 20 additional AC100 machines that are operating individually. We may elect to add these machines to the AC100 cascade later this year, but in the meantime we will still be gaining experience and machine runtime as they operate.

We believe we can enhance our centrifuge technology further, allowing us to develop more productive machines that can be introduced as appropriate. In Oak Ridge our engineers are continuing development work to optimize the operating characteristics of the AC100 for performance and reliability. They are also moving forward with value engineering the machine to help reduce its manufacturing costs.

In closing, let me emphasize three things. We are executing on our strategy for the American Centrifuge project and we are focused on addressing DOE's concerns. We are targeting to update our loan guarantee application with DOE this summer. We remain sharply focus on our current operations and as we have said before, we are evaluating our strategic alternatives and that process is continuing.

Now I'd like to turn the call over to John Barpoulis for a report on first quarter financial results. John?

John Barpoulis

Thanks, John and good morning, everyone. Starting with revenue for the quarter, total revenue was $345 million, a decrease of $161 million or 32% from the same quarter last year. SWU sales made up the majority of revenue and totaled $267 million. That was also $161 million lower than the same period last year.

Those who have followed USEC for a while know that our revenues can swing significantly from quarter-to-quarter and in some cases year-to-year. In 2009, SWU volume increased 30% compared to 2008 due to the timing of utility customer refuelings.

In the first quarter, SWU volume was 41% lower than the same quarter of 2009, but for the year we have reiterated our guidance that SWU volume will be just 15% lower in 2010 compared to last year. As SWU contracts that we have signed in recent years at higher prices and with price adjusters become a larger portion of our backlog, we are seeing an increase in average prices billed to customers.

In the first quarter, average prices billed to customers rose 5% year-over-year. Uranium revenue was $16 million in the first quarter, which was a decrease of $13 million, compared to the same quarter of 2009. Both uranium prices and volumes sold declined. Uranium market prices declined in 2009 and have been trading in the low $40 a pound.

As a short bit of background for anyone who is new to USEC, we underfeed the enrichment process when it makes economic sense. We can obtain uranium for resale by using more electric power and using less natural uranium feedstock. The economics of underfeeding the enrichment process, however, are affected by uranium prices and the cost of electric power.

Turning back to revenue, the U.S. government contract segment revenue for the quarter was $63 million, an increase of $13 million or 27% from the same quarter of last year. The higher revenue reflects fee recognition on certain contracts with DOE and additional decontamination and decommissioning work in Ohio. This segment also includes our subsidiary, NAC International.

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.

During the first quarter, our power costs increased by $20 million compared to the same quarter last year. The average cost of power per megawatt hour increased 7%, which includes the effect of the power contracts fuel cost adjustment, but we also bought more electricity in 2010 than last year when in January 2009 an ice storm temporarily reduced power consumption in our enrichment capacity.

Due to winter ice near Russia and the shipping schedule, we did not receive any deliveries under the Megatons to Megawatts program in the first quarter of 2010. Those shipments have started and we expect the price paid to Russia will be 8% higher in 2010 compared to last year. The purchase price paid to Russia was 11% higher in each of the last two years and these increases had a significant effect on the cost of sales embedded in our inventory costs.

These higher purchase and production cost components affect our cost of sales for the LEU segment. The cost of sales for SWU and uranium was $267 million, which was $148 million or 36% less than in 2009. This change was due in large part to the 41% decrease in SWU volume but also reflects higher SWU unit costs.

Cost of sales in the government contract segment was $51 million, an increase of $2 million compared to the same quarter in 2009, reflecting costs associated with the expanded scope of work at the Portsmouth plant in Ohio. Gross profit was $27 million for the first quarter compared to $42 million in the same period last year.

Our gross profit margin was 7.7% for the first quarter compared to 8.3% in the same quarter of 2009. Even though the average price build to customers for SWU is 5% higher, the impact of higher inventory costs for purchases from Russia and the cost of electric power for SWU production in earlier periods caused the profit margin to decline.

As John mentioned earlier, we reiterated our guidance on gross profit margin of 5% to 6% for the full year. Below the gross profit line, we have expenses for Advanced Technology, primarily related to the American Centrifuge. We have substantially demobilized and reduced project construction and machinery manufacturing activities, but our continued demonstration and development efforts to address DOE's concerns resulted in significant but lower expense.

The demonstration expense relates to assembling machines and startup activities in the Lead Cascade testing program. The amount of advanced technology expense in the quarter primarily related to the American Centrifuge project was about $26 million compared to $31 million in the first quarter of 2009. Also, included in the expense was approximately $0.5 million of work by NAC on a transportation version of the magna store technology.

The reduction in spending on the project is even clearer when you look at capital spending. In addition to Advanced Technology expenses, $37 million of ACP related activities were capitalized in the first quarter of 2010 compared to $130 million in the same period last year.

Selling, general and administrative expense was $15 million during the first quarter and was fairly flat compared to the same period last year with a slight increase due to an increase in stock-based compensation. In other income there is a new item that will likely affect each quarter in 2010.

In March, DOE and USEC agreed to a cost sharing arrangement regarding certain American Centrifuge activities. DOE has made $45 million available for project activities by taking the disposal obligation for a specific quantity of depleted uranium from USEC, which will release cash that had been posted for future depleted uranium disposition.

During the quarter USEC made qualifying American Centrifuge expenditures of $19.4 million. DOE's contribution on a 50-50 cost sharing arrangement is $9.7 million and is recognized as other income during the first quarter.

We also had a one time charge to our income tax provision of $6.5 million related to the change in tax treatment of Medicare Part D reimbursements that were an outcome of the new healthcare legislation signed into law in March. Under the legislation tax deductibles prescription drug costs will be reduced by the amount of the federal subsidy.

Looking at the bottom line, we reported a net loss of $9.7 million for the first quarter compared to a net loss of $2.1 million in the same quarter of 2009. The diluted and basic loss per share are the same $0.09 in the first quarter of 2010 and $0.02 in the same quarter of 2009.

Turning next to cash, we ended the quarter with $32 million in cash compared to $131 million on December 31, 2009. The major draws on cash for the quarter were payment of an Accounts Payable balance of $135 million to Russia and capital expenditures of $49 million primarily related to the American Centrifuge plan.

Cash flow used in operations for the first quarter was $43 million compared to cash flow from operations of $24 million in the same period last year. That $67 million difference was primarily due to a larger monetization of inventory to meet higher SWU sales in the first quarter of 2009 compared to the first quarter of 2010.

We had no borrowings under the revolving credit facility during the first quarter, but we expect to borrow on the facility from time to time beginning in the second quarter based on working capital needs.

As noted earlier, we have reiterated our revenue and gross profit margin guidance for 2010. One item that we updated is our spending on the American Centrifuge project. We expect to invest $110 million to $120 million both expensed and capitalized on the project through June 30, 2010.

We will, of course review our plan for the American Centrifuge project throughout the year. If we are unsuccessful in expanding our credit facility in the near-term, our ability to invest in ACP will be limited by our credit facility covenants.

Advanced Technology expense for the project has a very direct effect on net income and at this point uncertainty on spending levels beyond the second quarter have led us to refrain from bottom line guidance.

This uncertainty on ACP investment levels also affects cash flow from operations and so we have not provided specific guidance. However, we have said that we expect to build inventory in 2010 in anticipation of future sales, which is a draw on cash. 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 quickly summarize, we recorded a loss for the quarter, but the loss was affected by a one time income tax provision adjustment and expenses related to the American Centrifuge project. And to echo John, we are targeting to update our applications to the loan guarantee office during the summer.

We have more than 40 AC100 machines spinning, including approximately two dozen in a cascade and a commercial plant configuration, which we believe will go a long way toward addressing DOE's technical concerns. We are also continuing to address the financial strength of USEC to successfully construct the ACP.

And with that operator, we're now ready to take questions from our callers.

Question-and-Answer Session

Operator

(Operator Instructions). The first question will come from the line of Laurence Alexander. Please proceed.

Laurence Alexander – Jefferies

Good morning.

John Barpoulis

Good morning, Laurence.

Laurence Alexander – Jefferies

I guess just a couple of questions. First of all, could you elaborate a little bit on whether there is any constraint in your credit agreements on the ACP investments that you need to do this year. And give us an update on how much flexibility you have on that?

John Barpoulis

Sure, Laurence. Yes, there are – there is a covenant in our credit facility and we're very cognizant of the spending limitations within the credit agreement. The intent of this covenant is an effect to preserve an adequate portion of the revolving credit facility for the working capital needs of our existing operations, something we are clearly aligned with our lenders. And with this in mind, the ACP spending covenant provides for certain flexibility.

First, for each additional dollar of lender commitments that we receive through an accordion feature within the credit facility, we can increase the spending basket dollar for dollar up to a maximum of $165 million under the credit facility.

In addition, the recently executed DOE cooperative agreement, which provides $45 million available for the project, that is not restricted by the credit facility covenant. And in addition, there are additional long-term cap – any additional long-term capital raised can also be invested in ACP but subject to the credit facility provisions.

Ultimately, we recognize that we cannot continue at our existing rate of investment in the project without near term progress in each of those areas. The current limitation in the covenant is $90 million and again, we are looking to increase that, raise capital or utilize the DOE cooperative agreement to provide for some flexibility around that.

Laurence Alexander – Jefferies

And I guess, secondly on the TVA, could you give us an update on your thoughts about, sort of, extending our supply agreement and whether or not they will be giving you flexibility around the amount of power supplied to Paducah?

Bob Van Namen

Yes. This is Bob Van Namen. We are in discussions with TVA and we'll continue to do, so probably over the next six to nine months. Just a reminder that the current contract with TVA has firm pricing out through May 2012 and at that point we would engage in an extension depending on several factors, including the power costs, the market prices for enrichment and the demand we see out in the market.

And I think it will be a good conversation with TVA. Clearly the economy has taken a downturn across the country and in the Tennessee Valley and I think that are load is very important to them. We do see it being a good robust discussion and we are also looking at alternate suppliers for power in addition to TVA.

Laurence Alexander – Jefferies

And then, I guess, lastly if I may, could you address, sort of, the trends in the realized margins on the Russian contract, with respect on the last couple of years and how you think it is going to play out over the next couple? And also whether Paducah on a standalone basis is free cash flow positive enough to cover your debt?

John Barpoulis

Laurence its John Barpoulis. Let me address the first half and then I'll turn it over to Bob for any commentary on Paducah.

Recalling again from our standpoint, we do not look at allocating per se gross profit margin by production source. Our inventory is combined and we look at our collective sources and our collective sales., but specifically we do analyze clearly cost trends on that side of the ledger and to that extent I know that we've described that in the past two years the cost under the Russian purchase – Russian HEU agreement did increase about 11% in each of the prior two years, but we're expecting about 8% this year.

And that was very much the result of the negotiations that Phil Sewell and this team undertook last year with the Russians to come up with a mutually agreeable modification to the overall pricing mechanism. And so it was through those negotiations, which again mutually agreeable and accepted by both sides, that provides for greater certainty from our perspective around the future costs of the Russian purchases and aligns those better with our anticipated revenue pricing over the coming years. Bob?

Bob Van Namen

Just a couple of comments on Paducah. As John said, we do not look at the margin on a source specific basis, but a couple of comments on the trends. We are operating the Paducah facility at an all time peak in efficiency with a lot of equipment online allowing us to very efficiently utilize the power that we get from TVA.

Power costs have taken a turn down compared – or at least the fuel cost adjusters have compared to where we were anticipating them to be given plentiful rainfall and lower commodity costs in the energy markets. So the power outlook definitely is better than we would have thought. And Paducah continues to benefit from its ability to underfeed and to create uranium which gives us extra ways to monetize the power and to be able to get the economic benefits out of the operation of the plant.

So we are pleased with the way Paducah is operating. We believe that again given the constraints we have on power cost and market availability and SWU prices that we can continue to operate the plant well into the future, as long as the market needs it. So it is still a very valuable asset for the company and for the country.

Laurence Alexander – Jefferies

Thank you.

John Barpoulis

Thanks, Laurence.

Operator

And the next question will come from the line of Gabriela Bis with Goldman Sachs. Please proceed.

Gabriela Bis – Goldman Sachs

Good morning.

John Barpoulis

Good morning, Gabi.

Gabriela Bis – Goldman Sachs

So two questions. First, would be with the exception of the additional machine hours on the Lead Cascade that you're completing right now, are there any other technical hurdles you're aware of that you need to meet before being able to reapply for the loan guarantee this summer?

John Welch

This is John. I think, as you know, there were a series, that we've described the series of technical issues that were recorded in the Parsons report and that we are addressing the – many of them are addressed by the operation of Lead Cascade, because the operation of Lead Cascade has demonstrated the production of – as we've said, about two dozen AC100 machines. So that is continuing to flex our supplier base.

The $90 million cost sharing will continue that process with an overall average of about eight machines per month that we will continue to build out. So a lot of the issues associated with supplier base readiness, quality assurance, running the machines effectively all get tied up into the operation of Lead Cascade.

There are some other costs modeling type of issues that are reflective of how we estimate to operate the plant and then actually do flow of materials, things like that. But the majority of them are wrapped up in that Lead Cascade operation.

Gabriela Bis – Goldman Sachs

Great. Thank you for that color. And then a second point is relating to your $90 million cost share program with the DOE. I was wondering, if you can provide us a little bit more color on how it is reflected in your P&L and balance sheet. I know that the reimbursement from the government is reflected in other income, but USEC's share of the agreement, the $45 million that they are going to be able to spend, how does that get reflected? Is it something that's reflected in the APC costs, on the income statement or is it more CapEx in the cash flow statement?

John Barpoulis

I think under – this is John Barpoulis, Gabi. Under the cooperative agreement, the bulk of the qualifying expenditures are captured in the ACP expense side and so there are some, I believe that may filter into capital expenditures, but the bulk are related to ACP expense.

Gabriela Bis – Goldman Sachs

That'd be helpful. And then on the balance sheet side, can you walk us through how that gets reflected?

John Barpoulis

Balance sheet – on the balance sheet, what you will see in the 10-Q will be a reduction in our depleted uranium liability, but you'll also see an increase in our advances from customer. So we've got an advance from DOE to provide that funding.

Gabriela Bis – Goldman Sachs

Okay. Great. And lastly, if I may, do you know when you think you will be ready to provide investors with an update on the cost of the ACP? Is it around the time of when you're going to be refiling your loan application?

John Welch

I think that's a pretty fair assessment. To be able to update the application of the loan guarantee, there will be a whole new update on cost based on what we know at that point in time and we will be disclosing that around that timeframe.

John Barpoulis

And just to clarify, we are updating our application in the process. We are not resubmitting, but it will be a fulsome update to the application.

Gabriela Bis – Goldman Sachs

Got it. Thank you very much.

Operator

(Operator Instructions). Your next question will come from the line of Baker Burleson with Fox Point Capital. Please proceed.

Baker Burleson – Fox Point Capital

Hey, guys. Good morning.

John Barpoulis

Good morning.

John Welch

Good morning.

Baker Burleson – Fox Point Capital

Kind of, following up on what Gabby was asking there – I know you cannot get too far into the details, being that you have the strategic review going on and what not, but as we think through in the update for ACP last night you mentioned needing more capital in excess of the $2 billion.

Can you just walk us through timing? Does that come before you update the application or is that part of the update of the application? Just, kind of, the timing of how that's going to play out maybe over the course of the year.

John Barpoulis

It's John Barpoulis. And let me address that in a couple of ways. I think with respect to the loan guarantee application, clearly, as we are providing that information, we'll be working with the loan guarantee office to provide a sense of certainty and predictability around the capital required in order to complete the plant.

And so, as we've described the overall sources for deployment of ACP, it is through cash generated by USEC operations. It will be loan guarantee debt funding, as well as indicated here additional capital required for deployment.

The amount timing of that will be very much a function of our work on the cost side and the determination – one of Gabi's questions getting to the timing around when we would expect to have a much better view of an update on the cost side. And so that's the first part.

The second part, we have described in the past that we are evaluating our strategic alternatives. That is specifically with respect to that capital and as I'm sure you can appreciate, there's not much that I can say on that front.

Baker Burleson – Fox Point Capital

Maybe just as a follow-up, can I ask is having the additional capital secured a requirement of updating the DOE application?

John Barpoulis

That will very much be a function of our discussions with the loan guarantee office. It's ultimately providing additional comfort to DOE around the timing and amounts of capital required to complete the plan.

Baker Burleson – Fox Point Capital

Okay. Thanks very much.

John Welch

Okay. Thank you.

Operator

We do have a follow-up question from the line of Gabriela Bis. Please proceed.

Gabriela Bis – Goldman Sachs

Hi. Just to follow-up on timing of the loan guarantee application. If you do provide the update in the summer, do you know how long the process will take for the DOE to review that and provide some sort of resolution or decision?

John Welch

Well, this is John again. We would not presume to speak for the loan guarantee office regarding schedule for review. But, again, I would say that it is an update rather than a new application and the office is certainly familiar with our program. We hope to work with the office to move forward as expeditiously as possible.

Gabriela Bis – Goldman Sachs

So your understanding is it wouldn't be necessarily as long of a process as it was last time, it might be more of an expedited process?

John Welch

We hope so.

Gabriela Bis – Goldman Sachs

Thank you.

Operator

There are no more questions in the queue. I'd now like to turn the call over to John Welch, CEO for closing remarks.

John Welch

Thank you all for participating in the call this morning. I think, clearly, you can see that we have made significant progress in recent months and we're working hard to continue that progress as we prepare to update our bigger application to the loan guarantee office this summer. We appreciate your support; we'll keep you up-to-date as everything evolves. And your interest and investment is appreciated. Thank you.

Operator

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect and have a great day.

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