USEC Inc. (USU) Q4 2011 Earnings Call March 14, 2012 8:30 AM ET
Steven Wingfield - Director, IR
John Welch - President & CEO
John Barpoulis - SVP & CFO
Bob Van Namen - SVP, Uranium Enrichment
Philip Sewell - SVP, American Centrifuge and Russian HEU
George Caffrey - JMP Securities
Lucy Watson - Jefferies
Greetings and welcome to USEC Inc’s fourth quarter and year-end 2011 earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the prepared remarks. (Operator Instructions)
As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Steven Wingfield, Director of Investor Relations for USEC Inc. Thank you, Mr. Wingfield. You may begin.
Good morning. Thank you for joining us for USEC’s conference call regarding the fourth quarter and year end review for 2011, which ended December 31st. With me today are John Welch, President and Chief Executive Officer; John Barpoulis, Senior Vice President and Chief Financial Officer; Philip Sewell, Senior Vice President; Bob Van Namen, 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 earlier today. 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 intend to file our annual report on Form 10-K 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 risks and uncertainties, 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 our quarterly reports on Form 10-Q. Finally, the forward-looking information provided today is time sensitive and is accurate only as of today, March 4th, 2012. 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 and now, and now I’d like to turn the call over to John Welch.
Good morning and thank you for joining us today. Earlier this morning, we reported our fourth quarter and yearend results. At the bottom line, we reported a substantial net loss. The net loss of $540.7 million for the full year was a result of a confluence of several factors including non cash write-offs. John Barpoulis will have a more detailed discussion on these factors in his report, but let me address them at a high level.
First the expense for Advanced Technology was higher than in prior years because of the impact of write-offs associated with the American Centrifuge project and because of changes and how we accounting for American Centrifuge spending. For the last several years we have been capitalizing spending on the project for activities that were intended to be part of our commercial plan.
Beginning in the fourth quarter, we are now expensing all project spending because the work we expect to do over the next two years will be related primarily to the Research, Development and Demonstration programs or RD&D. Expense for Advanced Technology for the full year totaled $273 million including $127 million of previously capitalized spending related to earlier centrifuge machines that were determined to no longer be compatible with the commercial plant design.
Those American Centrifuge expenses more than offset our $84 million gross profit. From an income tax viewpoint that caused a substantial cumulative loss for the past several years that makes it difficult to assume we can use our tax benefit going forward. Therefore USEC recorded a full valuation allowance for the net deferred tax assets of $369 million.
From an operation standpoint, our gross profit was lower due to lower sales volume of our products, uranium and separate work units or SWU and higher cost. While much of our loss was due to expense related to the American Centrifuge project, we also have high production costs at Paducah that are making profitable operations difficult going forward.
Last summer we said that there were three key factors that would drive our decision to operate our Paducah plant beyond May 2012. First we need sufficient demand for Paducah’s output of low-enriched uranium. Second we need a program to re-enrich uranium tails stored at Paducah or find other demand for enrichment that would load the plant sufficiently to keep it economic.
Finally we need attractive power pricing and supply to extend operations beyond the May 31 expiration date of our power contract with TVA. At this point we do not have three elements in place. The earthquakes, tsunami and nuclear event in Japan a year ago has led to virtually all of Japan's reactors being temporarily shut down for inspections and refueling.
It is uncertain how long these outages may extend and our competitors have been left with significant supplies of low-enriched uranium to sell in the near term. Our current view is that we do not see sufficient commercial demand to support Paducah production of LEU for utility customers after the TVA contract expires.
Recently there have been discussions about the potential for Bonneville Power Administration, a federal agency within DoE to purchase a sufficient amount of SWU that could lead to continued operation at Paducah perhaps for a year. However these discussions may not be successful and we could decide to cease enrichment at Paducah after our power contract with TVA expires.
Therefore we are simultaneously conducting a full review of our options going forward. Let me take a few minutes to update you on the American Centrifuge project. As you know USEC applied for a loan guarantee from DoE in 2008, but it became apparent last summer that we had not addressed some technical and financial issues to DoE’s satisfaction.
Rather than move forward with the conditional commitment DoE suggested a cost sharing, research, development and demonstration program or RD&D. DoE’s interest in the RD&D program reflects their support for the American Centrifuge technology and a recognition by the administration regarding the essential national security role of an indigenous capacity to enrich uranium.
The cost sharing RD&D program will retire remaining technical risk that DoE foresees and provides the basis to move forward and obtain a loan guarantee for the American Centrifuge plant. However funding for this fiscal year for the RD&D program must be finalized in the very near future.
We are placed to be included in the President's Budget for 2013. We have begun work on the RD&D program and funded it through March 2012. We are working with DoE and the Congress on government funding for the program for the rest of the year. We have been encouraged by the administration’s increasingly vocal support for the essential national security role that the American Centrifuge project could play in providing an indigenous source of enriched uranium.
A clear expression of the administration's viewpoint was voiced earlier this month by Thomas D'Agostino, Administrator of the National Nuclear Security Administration during congressional testimony. To quote him directly, “What we believe is that, it is very important for the United States to maintain indigenous US capability to enrich fissile material. It is important on a number of fronts”. He went on to detail the need for domestic enrichment to provide nuclear fuel to keep carriers and submarines operating to maintain the nation's tritium supply for strategic weapons and to support America's position as a leader in nonproliferation efforts.
The reason I am bringing that testimony to our attention is that we do see support for the American Centrifuge from the administration and the RD&D program is a bridge to a DoE loan guarantee and to commercial deployment of the technology. If we didn't see that support, we would not still be spending money on the program.
We have about three dozen machines in our Lead Cascade Test Program today and under the RD&D program we would build a full commercial cascade of a 120 AC100 machines along with related infrastructure. As you can see, there are a number of moving pieces and a fair amount of uncertainty. But one thing that seems certain to me is that 2012 will be a year of transition for USEC. We began that transition last year as we concluded our cold shutdown work for DoE at the former Portsmouth plant.
Based on our view of the near-term market for SWU, we are moving away from commercial production at Paducah. We are also focused on the RD&D program which we see as a necessary demonstration of the technology which will provide a bridge to deploying American Centrifuge.
Frankly speaking USEC is likely to be a smaller company. We’ve started that process for the Contract Services Segment. We have 1000 fewer employees today than a year ago. At my direction, the management team initiated a review of our organizational structure in early 2012 and we have engaged a management consulting firm to support this review.
We expect the outcome of this review will result in a smaller workforce over time and we expect to begin taking actions that will affect employees in the second quarter.
In closing let me emphasize three things. We still believe in the value to shareholders for our American Centrifuge technology. We were disappointed that we were unable to achieve a conditional commitment into 2011, but we see the RD&D program as a bridge to a loan guarantee and deployment of the technology commercially.
Second 2012 will be a year of transition for USEC. We are taking steps to evolve from our legacy operations that have defined us in the past to a company that is appropriately sized for the work we will do in the future.
We will align our staffing and our cost structure with the realities of our business. And finally we have a positive long-term outlook for the enrichment market. And we are seeking to build on our strengths. We have substantial inventory assets that can be sold along with the material we buy from Russia.
We have a ten-year supply contract with Russia after the Megatons to Megawatts program expires at the end of 2013. Or subsidiary, NAC’s dry cask storage business has very good growth potential and our American Centrifuge technology has value for both shareholders and the United States government.
Now I would like to turn the call over to John Barpoulis for a more detailed report on our financial results. John?
Thanks John and good morning everyone. I will go through our operational results for the year and then address the factors that were responsible for the substantial net loss we reported. I will have only limited comments on the fourth quarter.
Starting at revenue for the year, total revenue was $1.67 billion with SWU revenues making up $1.33 billion or approximately 80% of that total. SWU volume declined 15% year over year reflecting the variability of utility orders and refueling cycles. The average price billed to customers increased 3% compared to 2010, reflecting higher prices included in contracts signed in recent years.
Uranium revenue for the year was $132 million compared to $236 million in 2010. The average price billed to customers increased by 20%, but the volume of uranium sold declined 53% reflecting declines in uranium inventory per sale. We continue to transition in our contract services segment in 2011 as we concluded the long-standing cold shutdown contract with the Department of Energy in September.
This segment also includes revenues for our subsidiary NAC International. Revenue from contract services totaled $209 million compared to $278 million in 2010. The lower revenue was due primarily to the completion of the Cold Shutdown contract in September at the former Portsmouth plant.
Switching to the cost side of the ledger, our two largest cost components, our electric power and the price we pay Russia to purchase SWU. We have a power contract through May 2012 with the Tennessee Valley Authority or TVA. That agreement provides moderate annual increases to the base price we pay, plus an adjustment based on TVA’s cost of fuel and purchase power.
During 2011, our power costs declined because we purchased 11% fewer megawatt hours of electricity compared to 2010. Under our TVA contract we reduced our non-summer month purchases from 2000 MW to 1650 MW beginning in September of 2010.
However the average cost per megawatt hour increased by 3% in 2011 reflecting TVA’s fuel cost adjustment as well as the fixed annual increase. The cost of power is about 70% of our cost of production. Production costs in 2011 declined $57 million or 7% compared to 2010 due to a 10% reduction in overall production volume partially offset by a 4% increase in unit production costs.
Purchase costs of SWU from Russia under the Megatons to Megawatts program increased $20.5 million in 2011 compared to 2010 due to a 3% price increase year over year. These higher purchase and production cost components affect our cost of sales for the LEU segment. The cost of sales for SWU and uranium in 2011 was $1.39 billion which was $232 million or 14% lower than in 2010. This change was due to the reduced volume of SWU and uranium sold that reflects the higher purchase costs from Russia, higher unit production costs and the effective higher inventory costs from prior periods.
Cost of sales in the Contract Services Segment during 2011 was $197 million, a decrease of $57 million or 23% compared to 2010. As noted earlier, this reflects completion of the work at the Portsmouth plant in Ohio.
Gross profit for 2011 was $84 million compared to $158 million in 2010. Our gross profit margin was 5% for 2011 compared to 7.8% in 2010. I want to focus on two items below the gross profit line. Advanced technology and income tax. Nearly all of the expense in Advanced Technology is related to the demonstration of the American Centrifuge technology. In January, we issued an 8-K disclosing that we would expense previously capitalized, work in progress costs related to centrifuge machines that we are determined to no longer be compatible with the commercial plant design.
Earlier in 2011, we expensed the cost of centrifuge machines that had been damaged and were no longer usable. Together these two items totaled approximately $137 million. We also expensed about $10 million for previously capitalized amounts related to prepayments made to a supplier for the ACP.
Our contract with this supplier could not be extended and the $10 million represents the remaining balance of prepayments for materials we will not purchase under the contract. Beginning with the start of the fourth quarter, all American centrifuge project costs has been expensed including interest expense that we would have previously capitalized.
We have reduced the level of spending and the project is focused on the RD&D program rather than activities that would create capital assets. Therefore we do not expect to capitalize spending related to the ACP until commercial plant deployment resumes.
For the full year, Advanced Technology expense totaled $273 million compared to $110 million in 2010, a difference of $163 million. The other line item I want to discuss is income tax. In the same 8-K issued in January, we said we expected to record a full valuation allowance for the net deferred tax asset created by expensing the previously capitalized ACP spending as well as all other previously recorded net deferred assets.
We took that action as we completed our financial review of the fourth quarter. As we evaluated the likelihood that the tax asset could be realized in the future, we looked into many factors. We have a cumulative loss over the past three years due to a significant loss incurred in 2011. This cumulative loss is a significant piece of negative evidence in the evaluation and one that is very difficult to overcome.
In 2011 the net increase of $369 million in the valuation allowance reduces the net deferred tax assets to the realizable value as of December 31st. The ultimate realization of the net deferred tax assets is dependent upon generating sufficient taxable income in future years when deferred tax assets are recoverable or are expected to reverse.
These two factors, expenses and charge related to the American Centrifuge project and the tax-related valuation allowance were the main drivers for our net loss of $540.7 million. These factors did not affect our cash flow from operations which was $56.3 million.
Earlier this week, USEC and a group of lenders agreed to an extension of a credit facility that replaces a facility that was set to expire on May 31st, 2012. The amended agreement provides for a credit facility of up to $235 million that will mature on May 31st, 2013.
The new facility includes a revolving credit facility of $150 million including upto $75 million in letters of credit and a term loan of $85 million. The prior facility also included a term loan of $85 million. The facility is secured by assets of the USEC Inc and its subsidiaries. Additional details regarding the facility were included in an 8-K filing made Tuesday and in our annual report on Form 10-K which we expect to issue as soon as possible.
Normally USEC provides annual guidance regarding a number of financial metrics with our year-end report. This year however our guidance will be limited. As noted in the earnings news release, there are a number of uncertainties that would make providing earnings and cash flow guidance subject to such a wide range that we believe it would be of little value.
In the next few weeks for example we will be making decisions regarding whether to cease enrichment at the Paducah plant. That decision will have an impact on cost of production. We are also subject to uncertainty regarding funding for the RD&D program which affect spending levels for advanced technology after the first quarter. We did however provide guidance for revenue. Regardless of any decision on continued operations of Paducah, we have significant sales of SWU in our backlog for delivery in 2012.
We expect revenue from SWU sales of $1.45 billion to $1.5 billion which is $100 million to $150 million more than in 2011. At December 31st, 2011 we had a net inventory of SWU and uranium of $882 million.
We will continue to buy 5.5 SWU annually from Russia through the end of the Megatons to Megawatts program, in December 2013. In 2011, we signed a commercial contract with TENEX to continue purchasing SWU from Russia over the next decade.
We expect to remain an important supplier of low enriched uranium for nuclear reactors. After we made decision regarding whether to extend or cease enrichment at Paducah, you will revisit our financial metrics with an intent to provide additional guidance later in the year.
And with that operator, we’re now ready to take questions from our callers.
Thank you. We will now be conducting a question-and-answer session. (Operator Instructions)
Well allowing the callers to queue up for questions, I know there were some developments last evening with respect to on the senate side for RD&D program. And perhaps we can touch on those developments.
Sure. I will be glad to update folks. I think as most of you know, we’re currently pursuing both the legislative path and the non-legislative path for the RD&D funding. We’re continuing to work very hard with DOE and members of the Congress to provide DOE with the necessary transfer authority to utilize funding for the RD&D program from its existing FY2012 budget, prior to March 31 and we know that was going to be difficult.
Progress has been made in terms of the inclusion of an amendment for funding this authority and the Senate version of the surface transportation bill. However, there is no assurance at this time that that will be passed by the house and enacted. Therefore, we continue to work on a non-legislative path, and believe progress is being made and Congress towards support for DoE’s use of existing authorities, to make funding available via transfer of depleted uranium. Conversations on both these paths the Hill, USEC and DOE are ongoing.
Operator, we’re ready for questions.
Thank you. Our first question comes from the line of George Caffrey with JMP Securities. Please proceed with your question.
George Caffrey - JMP Securities
Couple of questions, first of all, with respect to Paducah; could you talk a little bit about, little bit more in terms of what the drivers of the decision, whether to shutdown or not shutdown Paducah and if you were to cease say, producing SWU there, would there be other activities that you might do to generate additional income?
Bob Van Namen
George. This is Bob Van Namen and I hit on a couple of the key points drivers. First one would be the necessary economic equation for us to continue production. The plant is operating at its all time most efficient level. We were operating very solidly with very high power utilization. So we’re very pleased with the current operation.
What we really need to make the plan economical going forward is sufficient volume going through the facility. So we like to operate the plant between five and six million SWUs on an annual basis and as John touched on with the events at Fukushima, we’re seeing a lot of challenges in being able to place that in to the commercial market. So finding the ability to produce that five million SWUs to use some of that capacity, to enrich high assay tails from the Department of Energy. And then the third key component to that is the power cost that we would see.
That probably would have been the biggest challenge. If you ask me two years ago what we’re facing now with natural gas prices at all time lows, we’re really seeing very good buying opportunities for power, the volume is the biggest challenge. We do see the opportunities, John mentioned with the Bonneville Power Administration to be able to place the output through the BPA, have them purchase the low enriched uranium and then use that to continue the operations of the plant. But as you know, it’s now middle of March and we’re on a fairly short time frame to be able to make this decision. If we don’t go forward with the operation of the plant, again, the Department of Energy would be taking back certain facilities under our lease and we would look at doing work for them, if that is what they wanted to do, for preparing the facility for decontamination, decommissioning.
George Caffrey - JMP Securities
Okay. And assuming that were to occur, is there any residual value, which you might realize from the facility or in essence is there nothing of value that you could realize there?
Bob Van Namen
Yeah, we would continue to use certain of the facilities for shipping and transfer for processing our inventories that would remain at the site and then distributing that to our customers. And then also the Paducah facility is a key element of the Megatons to Megawatts program, which would wrap up at the end of 2013. So we would continue to use those facilities for inventory and for shipping and transfer for the HEU deal.
George Caffrey - JMP Securities
Next question, with the current softness in demand, which is an important driver of your decision on Paducah, do you see that changing anytime over the course of the next couple of years or will take a longer period of time for demand to improve?
Very good question. Absolutely we do see that changing. In Japan, right now, 52 out of the 54 reactors that support the Japanese Electric Grid are now down for refueling and inspections. That is what is causing the majority of the hole in the market. We do see that changing. They will be trying to get through the summer with limited power production capability and we do see that potentially being the driver and bringing some of those units back on line.
At the same time, you see worldwide demand continuing to grow. We have 26 reactors under construction in China. We have, I think, total of 62 worldwide under construction. So as those units come online, they will be adding to the demand. We see continued production from the U.S. fleet, solidly with continued upgrades and we’ve had good news and the reason past with NRC is showing a combined operating license for the Southern Company. So, with demand being solid. I think it will take several years to work off the effects from Fukushima, but the fundamentals for nuclear power is still very solid worldwide.
George Caffrey - JMP Securities
Turning a little bit to ACP, and the RD&D program that you talked about, assuming everything was to go as you would like it to go, could you walk through with what the timeline and funding would look like over the course of the next couple of years with the RD&D, but then you know, what it would look like beyond that and while you’re talking about that, could you also touch upon, the status if you will of Toshiba at this point?
Sure, George. This is John Barpoulis. I will touch on the first part with respect to the overall profile and I think the project team is scoping the nature of the end profile of RD&D program now. But as an additional detail is provided in our 10-K, the total program as we described in general is a two-year program, totaling $375 million in total, with the government’s portion being capped at $300 million and so really, if you take a look at that profile for rough purposes, we certainly look at that amount spread over two years.
Yeah, and I also would add George, that just both are mutual objectives of ourselves and the government that the RD&D program leads to commercial deployment of the technology. They’re very high on the technology. They want to see it deployed. They know that they need an indigenous source of supply. So in parallel with the RD&D program, would be our whole thought process for coming back at the loan guarantees. So that when you finish the RD&D process and you retire, any technical issues, project execution issues, then you’re in the middle of the loan guarantee review process, as you go forward with a commercial deployment.
George Caffrey - JMP Securities
And that would be in 2014 theoretically?
Theoretically in that time frame, I think would make sense.
But certainly look to re-engage in 2013.
And certainly the issues near-term are very much, as you can imagine we are very much focused on the end of March funding. So that we can get the balance of the FY2012 funding. So we know what path we are executing on. We are very encouraged by the FY2013 money being included in the President’s budget but there is a process we have to go through on that. And so that becomes the short-term slug-it-out on the hill to get the necessary authority, for the government to transfer money and move on. But the RD&D program, it helps de-risk the project; it provides a path ultimately to come back at the loan guarantee and for commercial deployment.
Now very solid support from our partners in this process for Babcock & Wilcox, and Toshiba. As you know Toshiba’s involvement potentially also includes the export credit agencies from Japan as part of the total debt draw that we would want to achieve. Their support has been very strong for the deployment of ACP. They are very much encouraged by the U.S. government’s position and desire to deploy ACP. And if you look back at it, all three of us, USEC, Toshiba and B& have fully have the right to walk away from this thing at this point in time and none of us have done it because we still see that path to deployment and the strong support from the government for going forward with that. I hope that answered all your questions.
George Caffrey - JMP Securities
It does, with one more and then I will get back in the queue. When we look forward to CapEx over the next couple of years, it sounds like the unfunded portion of the 375 for the program, will give 75, which you would need to come out of pocket for in terms of CapEx for ACP. Is that all there is over the course of next two years and what are the CapEx beyond there that might there be?
I think that that is certainly in our plan in terms of additional investment just from a GAAP standpoint. We do not expect that to be capitalized. We expect all of the RD&D program funding ultimately its liked to be expensed. While we had had a cooperative agreement in the past, we are also evaluating the nature of how we will be accounting for that, as we have a clear view on our accounting for it. We will provide that in updated guidance.
Thank you. Our next question comes from the line of Laurence Alexander with Jefferies & Co. Please proceed with your question.
Lucy Watson - Jefferies
Good morning, this is Lucy Watson on for Laurence today. I guess going back to your comments on the resizing of USEC for different scenarios, may be if we could look at it from a cost-perspective, would it be possible to walk through the gives and takes in your contingency plan around firstly, the RD&D funding agreement and then secondly the potential continuation of production at Paducah once the TVA contract expires?
Lucy, may be just to clarify the question, is it around anticipated total size of the business volumes that we would expect to see over that time period or were you looking at a different perspective?
Lucy Watson - Jefferies
Looking from a cost perspective, so you had mentioned you resized the government contract segment already. Just wondering if you have sort of a range of expectations in your contingency plan based on those other two events?
Bob Van Namen
This is Bob Van Namen, May be just a couple of comments on that. We are looking at those scenarios as John said. We have engaged the outside consultant now to look at the resources required to execute what would our corporate structure look like, what would the infrastructure need to be under those different scenarios. That is work that is going on right now. We don’t have any conclusions at this point but again expect to wrap that up by the end of the second quarter.
Lucy Watson - Jefferies
Okay. And moving to the ACP expense run rate, it looks like you back out the non-capitalized or un-capitalized expenses from 2011. You are operating it around $34 million a quarter run rate for advanced technology expense. Will that be a reasonable expectation in Q1?
Lucy I think that sounds a bit high from total ACP run rate, from a quarterly standpoint. We will have additional detail in the 10K. What you will see in the fourth quarter is we believe that $190 million or so of total ACP expense but again in the first quarter, if you take out the non-cash components of that and again you will see more detail in our 10-K. You will see that we are in the $40 million to $50 million run rate and expect in the first quarter that we will be around the $44 million run rate. But again for the quarter and again we will have more information in our 10Q on that.
Lucy Watson - Jefferies
Okay. And acknowledging that you haven’t provided a full year outlook for 2012 and understandably so, how are you thinking about the cash flow outlook for 2012 at least given what you know now and what would be your confidence in that range?
I think again 2012 very important indicator in spite of the significant net loss, our core operations continue to produce positive cash flow in 2011 at $56 million. Again, I think that given the uncertainty around the decisions regarding the Paducah facility and the nature of and timing of RD&D funding, both very much will affect our cash outlook for the year. So unfortunately we can’t provide more specific guidance at this time but again as we indicated, as those decisions become clearer, and as the range narrows, we will certainly look to provide that kind of information.
Lucy, the other think I would add is, again from our standpoint within that range of scenarios we see having more than adequate liquidity to support our ongoing operations for at least one year.
Lucy Watson - Jefferies
Okay. And in terms of negotiations with ACP suppliers, could you just provide an update on the status of those?
Sure. This is Philip Sewell. We have agreements with the suppliers to support the ongoing ACP program and the RD&D program that we are going to be working with the government, involves the suppliers continuing, to provide the components necessary to build out a 120 machine cascade over the next years and operating that cascade in order to determine, I will say validation of the reliability, availability in a commercial environment. So we have ongoing of contracts. They are meeting those contracts and we will be working with them over this two year time period and updating a loan guarantee for the purpose of supporting the financial conditions, under which they will be supplying the machines and building out the plan. So we will be working in two different areas. One is supporting the technical verification under the RD&D program and two, looking and updating our cost and schedule for the commercial plan for the purposes of a loan guarantee.
And Lucy let me add that one of the, joint objective between our sales and department of energy is that this RD&D program is retiring risk and positioning everybody for commercial deployment. So the use of our suppliers that would be there to build the whole plan and maintaining a critical capability with those suppliers as we go through this demonstration period is a priority of both of us. So we are looking at how best, to keep them engaged on the best position possible for re-mobilization, as we go through the loan guarantee process.
Lucy Watson - Jefferies
Okay. And then any visibility on gross margins embedded in your SWU backlog?
Again at this point we are comfortably providing the revenue guidance Lucy, that we laid out but again given the uncertainty and things that could impact our cost of production, cost of sales at this point we are not able to provide clear guidance on that for the year.
Our next question comes from the line of [Bob Cuttlebug with Cuttlebug Capital Management].
Just hopefully, it will be a very familiar theme from us; but John, back in August when we asked the question and I still recall it, as to what you talked the timing of the definitive agreement would be with the DOE whether it be weeks or months or quarters?
And John you stated at that time it may be a matter of weeks so you know not months. So for the record we did a little research yesterday, its been actually 30 weeks seven months and now we are into the third quarter. And given that we would like to make just two observations and just ask you two questions and please stop us if you disagree and the great news is we feel that its quite apparent and I think this echoes your comments that you've just made in the call today that the DOE and Secretary too and the Administration and Congress for that matter are all extraordinarily strongly in support of the ACP project.
The bad news is we believe over the last several months its become abundantly clear that a huge stumbling block to that is the size, you know I guess you could probably say that or the lack thereof of USEC. So given that we have two questions and again this should be familiar questions to you, would you please explain why a sale of USEC to a larger concern would not be in the absolute best interest of we feel the ACP project, the DOE for that matter, national security and defense and I think most obviously importantly, the stakeholders of USEC both equity and debt? And number two why sale to a larger concern should be completed in a matter of weeks and not months or quarters?
Bob I would have been disappointed if you hadn't continued up on your theme and you know we have a Paducah-sharing duty and both the management and the Board’s very serious about what that duty is. They continue to analyze potential value maximizing strategies for our stakeholders and that includes strategic options.
I think one of the real challenges that we have today is that research, development and demonstration program is an absolute necessity. It is a necessary bridge to commercial deployment for the plant whether its USEC’s doing it or whether it’s anybody else doing it. And so the, again we believe the best value for the shareholders is to go down the ACP path and we see the support for that, but the RD&D program is an absolutely essential element to having that nailed down to the greatest degree that we can and that really becomes the funding sources for it and so now you have the bridge and a path to the deployment. We will consider all options in doing that.
The second half of your question is one of timing. I think without that bridge firmly in place some of those strategic options aren't going to happen. Those discussions aren't going to happen until you have that. So I think that's about as far as I can go in being comfortable in answering that question, but the ACP and affordable enrichment technology is the key of the future and we have very strong support for doing that. The RD&D program and having that solidified is the necessary bridge. Then we need to get back out.
You are coming back at a loan guarantee and you have to maximize the financial strength for the project and going after that loan guarantee and that's where we have to look at how we improve our own balance sheet and our own credit rating and heading into that and that's a lot of what we've talked about that we are going to go do and then we have to look at what is the right structure with strategic partners for being able to put the project in its best like and going back for the loan guarantee.
Well, I appreciate the answer and by the way, let's keep our fingers crossed big plus being on the Senate Transportation Bill and see if we can get it through the House.
Thank you. Our next question comes from the line of [Richard Howard with Prospective Partners]. Please proceed with your question.
I have two questions. If we had gotten the loan guarantee in 2008 would we have built centrifuges that in fact would not have been optimal?
No. I mean it has certainly from the department standpoint it’s their comfort to demonstrate reliability and availability. No one has the question will the machines work, will they provide the separative capacity that's there and so we -- in putting together our process that we laid down in 2008, we had gates that we would come through from a technical demonstration standpoint before we would go into the full rate production.
The department’s concern was, hey they wanted to see more of those risks retire before they would commit to go do it. So I think the department has taken a conservative and prudent position on that and we've certainly have been able to move forward. The write-off for the machines, we've learnt things in the incident that we had last year that told us that we were going to have to make some improvements to the machine. We have done that. That meant that we had to write off the machines that were damaged last year and that some of the earliest machines that we had built, it just didn't make economic sense to modify them.
And those early machines were not designed or planned to be in a commercial plant. If we got the loan guarantee for the purpose of moving forward, so they were going to be I will say initially used and we have a unique characteristic with the centrifuge technology and that you can replace individual machines and you can put machines in and operate them and then as you see improvements then you can adjust and put those improvements in.
But clearly the machines that were capitalized were clearly intended to see a part in the commercial plant?
Yeah they were originally planned and then but the idea is you can replace components and improve it.
The second question concerns the $85 million bank facility. How much of the $882 million net SWU inventory is pledged as collaterals to that loan?
The lenders have a security interest in our SWU and LEU inventory.
The entire inventory?
The entire inventory, but also of note obviously the facility size is $235 million, the funded term loan is $85 million dollars and the revolving piece is $150 million.
Can you give me a feel for how much the potential collateral value is; I mean that seems like a very small amount given the clear ability to liquidate that inventory?
That inventory is accounted for the lower cost to market and so we see that as the minimum value of the gross inventory.
But you couldn’t borrow $ 880 million against it, but could you borrow $500 million against it?
The revolving credit facility is again its $235 million and so that’s the maximum amount and it also includes a block built into that and so we are limited at $235 million.
And you feel that’s all it could be in fact borrowed against it under any circumstance?
The revolving credit facility yes; but it is clear that additional collateral or the lenders enjoy a significant amount of collateral.
And sorry to get focused on that, but do you see and I lost your last name ask a reasonable question, the gross margin embedded in the SWU inventory is there any reason to think it’s any different than the gross margin of about 20% on your sales?
Rich again I think the cause of the uncertainty and the cost of production this year, that will affect cost of sales and it could be impacted by one-time items related to the Paducah plant, so those may impact a gross profit for the business in 2012.
One other comment, I would certainly hope that we wouldn’t sell the company at this point in time as reflected by the prior question?
Thank you. Our next question comes from the line of [Ben Lewis], a Private Investor. Please proceed with your question.
Slightly I don’t know if it’s a technical question or what but depending on peoples estimates there is about I think 93 nuclear reactors that are supposedly going to be online by 2021 and 63 in construction today. I think utilities are well sort of stocked in the near-term at least on the U308 side and China came in 2010; I think 50 million pounds from Canada and secured some more from France.
Now I think in the near term everyone is well stocked and you could have some deferrals or you have seen, but what lead time you need as you take 2021 as a dropped date how many as prior to 2021 do you have to start gearing up for enrichment need of at least the mining companies talk about demand going from 180 million pounds to 220 in that timeframe. So how do we think about this and how do we think about enrichment capacity now that AREVA has sort of stalled their plants in Idaho?
Bob Van Namen
Yeah Ben, this Bob Van Namen and complicated question and let me try and step you through it in a couple of bites. The first piece is the transformation that the current industrial bases undergoing. You are seeing the AREVA gaseous diffusion plant come off line middle of 2012. They recently made that announcement as they are coming up on a new centrifuge facility using the URENCO technology.
We will also again as we have talked about extensively here in the next several years be taking off the Paducah facility which removes 5 to 6 millions SWUs of capacity and then by the end of 2013 you will be seeing the end of the highly enriched uranium the mega tons to mega watts deal with the Russians.
So with those three capacity coming our of the market those are being replaced by new projects such as the American centrifuge by the URENCO technology expansions and by the Russians selling more commercial SWUs into the market. So you have a near term transition going on and then you are going to have capacity being built to meet the demands of the new reactors.
Generally, you are looking at an eight to 10 year lead time for putting the new reactor in place. We look at again, after we would deploy the first 3.8 million SWUs of American Centrifuge; we are at looking somewhere along the lines of three to four years to put additional capacity into place. And so we can very much build-out additional capacity to meet the demands of the new reactors.
One reminder is that the initial cores of these reactors are substantially larger than the reload requirements and so you do see in 2015 to 2020 timeframe a large volume of new core production needing to happen from the existing infrastructure. This is one of the areas we think that the Paducah plant could be very valuable and why we are trying to as best we can extend the life of that plant to be able to provide the flexibility to meet some of the initial core demands.
Our next question comes from the line of [Amaretto Ono] with CRT Capital. Please proceed with your question.
I have a question regarding the RD&D program. You said that essentially there are two packs or one is the legislative pack and the other is the non-legislative pack. In the non-legislative pack you mentioned that you still require Congress approval how does that work?
The close working relationship with DoE has had with the Congress on their RD&D program anything that they would do is on a non-legislative pack. They would probably run by the Congress. I think most people agree and the department has the capability, the authority to go do a non-legislative exchange, but they are not going to do that without support from the grant from the Congress.
And do you think that there is ability to do that up to lets say $300 million worth of or in the amount of $300 million dollars.
The way the government is currently planning it is the FY12 issue would be $150 million in total. But the second incremental funding is contained in the FY13 budget and then that is something that will be debated in the Congress and ultimately improved with the FY13 budget.
So if you want a non-legislative pack and you been looking for building that bridge for the remainder of the fiscal year as you get to the FY2013 funding. The government also has some limited reprogramming they could do as part of that, but clearly everybody is preferred path is to come up with a legislative solution that would support the anticipated FY12 funding which is a $ 150 million from the government.
Thank you. Mr. Welch, there are no further question at this time. I would like to turn the floor back over to you for closing comments.
Well, thank you all for joining us this morning. We appreciate your attendance especially on short notice. We expect to file our 10-K later today and I certainly encourage you to call Steve Wingfield with any questions you might have.
Needless to say, we expect 2012 to be a very challenging year, but the USEC management team is focused on meeting those challenges and having further calls with you all to update you on how we are doing on that. Good day and thanks very much for your participation
Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.
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