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Executives

Steven Wingfield - Director, IR

John Welch - President and CEO

John Barpoulis - SVP and CFO

Bob Van Namen - SVP of Uranium Enrichment

Analysts

Albert Kabili - Goldman Sachs

Lucy Watson - Jefferies & Company

Roger Reed - Natiexis Bleichroeder

Baker Burleson - Fox Point Capital

Roy Adams - Lehman Brothers

USEC Inc. (USU) Q2 2008 Earnings Call Transcript August 6, 2008 8:30 AM ET

Operator

Good day and welcome everyone to the USEC Inc.’s Second Quarter 2008 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 session period.

At this time, I would like to turn the call over to Steve Wingfield. Please go ahead, sir.

Steven Wingfield

Good morning. Thank you for joining us for USEC’s conference call regarding the second quarter, which ended June 30th, and our update on the American Centrifuge project.

With me today are John Welch, President and Chief Executive Officer; John Barpoulis, Senior Vice President and Chief Financial Officer; Bob Van Namen, Senior Vice President; 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 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, 8-Ks are available on our website. We expect to file our first quarter 10-Q later today. A replay of this call 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 maybe 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 10-K and subsequent quarterly 10-Qs.

Finally, the forward-looking information provided today is time-sensitive and is accurate only as of today, August 6th, 2008. This call is the property of USEC. Any redistribution, retransmission or re-broadcast of this call in any form without the expressed written consent of USEC is strictly prohibited.

So, thank you for your participation, and now I’d like to turn the call over to John Welch.

John Welch

Good morning. Thank you for joining us to discuss our second quarter 2008 results. John Barpoulis will provide a detailed review of those financial results in just a moment. I’ll start with a high-level review of our earnings for the quarter and then provide a status report on the American Centrifuge project.

We have affirmed our budget of $3.5 billion to build the American Centrifuge and I will review that process in my remarks. Taking a look at the bottom line, we earned $10.8 million in the second quarter compared to a loss of $13.4 million in the same quarter last year.

For the first six months, we earned $15.2 million compared to $25.9 million in the same period last year. That continues to track to our expectations for the year. As we noted in our 2008 financial outlook issued in February, reiterated in April and again today, our sales volume will be about 20% in ‘08 than in 2007 due to the timing of our customers’ refueling schedules.

A majority of the reactors served by USEC are refueled on an 18 to 24 months cycle, and we have seen last year’s higher than average volume reduced our customers’ refueling requirements in 2008. And the same cycle, however, will swing back in 2009 to SWU volumes similar to what we saw in ‘07.

Midway through the year we have a better view of how customer orders for the rest of the year should track and we are reiterating our guidance for ‘08. We expect net income in a range of $25 million to $45 million and cash flow used in operations of $60 million to $80 million.

As you drilldown, there is some movement within the numbers, but we expect to remain within those ranges. An important factor in this year’s draw on cash is that we are building inventories for deliveries that we will make later this year. Looking ahead to 2009, we expect cash flow from operations to improve.

Yesterday we also provided a wide-ranging update on our progress to build the American Centrifuge plant. There were several major takeaways in the release that I want to emphasize to our investors. First, we affirmed our comprehensive budget of $3.5 billion in line with our previously disclosed estimate for building the plant. This includes approximately $875 million spent through June 30th, but does not include financing cost or financial assurance.

As time has passed, maturity of our centrifuge plant design has improved. Based on this maturity we have undergone a rigorous process over the several months to develop the budget, to challenge our suppliers’ cost estimates, and to create detailed work breakdown structure activities that reflect extensive input from our suppliers.

Second, we have submitted our application for a DOE loan guarantee. We believe USEC is the first company to apply for the loan guarantee after the solicitation was issued on June 30th, and we’re well ahead of the September deadline. The application is a two-part process and we plan to submit part two later this month.

We believe the American Centrifuge is ideally suited for the loan guarantee program and that our project is tightly aligned with the criteria that DOE has established for the program. For example, DOE seeks projects that will result in lower emissions of air pollutants and greenhouse gases.

The American Centrifuge technology requires 95% less electricity than the gaseous diffusion technology used today to create the same amount of low-enriched uranium, thereby, reducing our carbon footprint. By substantially cutting the energy required to enrich uranium we will further enhance nuclear power power’s green story as an emissions free energy source.

Because we are well underway in a construction of our plant and we have a strongest desire to stay on our current schedule, we will be working closely with DOE to keep the review process for the application moving forward. We are actively seeking a prompt review of our application and a commitment from DOE. Since the timing of the review by DOE for loan guarantees is uncertain, we continue to evaluate alternative sources of capital on a parallel path.

We must maintain adequate liquidity for our ongoing operations. If we are not able to obtain timely action from DOE or obtain an alternative capital commitment, we will be forced to slow spending on the project or take other actions.

A third point of emphasis would be that we have released the design drawings for the AC100 machines to our strategic suppliers. This allows them to initiate manufacturing of components for the 40 to 50 AC100 machines that will be installed in the Lead Cascade in Piketon. We expect our suppliers to build these AC100 series machines by the end of this year.

Fourth, the Lead Cascade integrated testing that has been underway for the past year continues to provide us with important information. We have logged more than 1,000 machine hours since the Lead Cascade operations began last August and the results are increasing confidence about the reliability and performance of the American Centrifuge.

Next, we have been testing centrifuges with AC100 components at our facilities in Oak Ridge, Tennessee, and we have seen SWU performance beyond the 350 SWU per machine per year than as our current target.

That strengthens our conviction that we have a very good centrifuge design with potential to have even better performance in the future. I can confidently say at an appropriate time we will deploy a higher performing machine in this first 3.8 million SWU plant.

Sixth, the build-out of the balance of plant for American Centrifuge continues on schedule. We continue to refurbish existing buildings and prepare the floor of the production building for machine months, axillary structures, such as boiler buildings are going up. Later this year, we expect to begin to install the service that provide the piping and electrical connections for the centrifuges.

The final point I’ll make about the manufacturing infrastructure is really to focus in on that manufacturing infrastructure that we are creating. An important focus this year has been in recreating the industrial base to build these sophisticated machines here in the United States. Over the next few months, many components of the American Centrifuge will be built or assembled in over a dozen states.

In March, we purchased a facility in Oak Ridge built in the 1980s specifically for manufacturing centrifuges. Our strategic supplier, The Babcock & Wilcox Company will use the facility for centrifuge machine manufacturing, balancing and testing. We have renamed the facility the American Centrifuge Technology and Manufacturing Center or TMC. We are spending more than $50 million on machines and equipment to make it a state-of-the-art manufacturing centre. We expect to use the centre to build components for the AC100 centrifuge machines being built this year which will be assembled and installed at site.

The TMCs were a key compound for the AC100 machines will be manufactured and assembled over the next few years to complete the ACP build out. We recently held a Board of Directors meeting in Oak Ridge and the board received a full tour of this impressive facility and its very reflective of the re-industrialization of our manufacturing base that is going on. Now, I would like to turn the call over to John Barpoulis who will report on the second quarter financials. I will come back and address some other areas in a moment. John?

John Barpoulis

Thank you, John and good morning everyone. We want to get to your questions quickly, and so I will keep my reports to the key points. We expect to issue our 10-Q report later today and it has substantial detail. Starting at the topline for the quarter, revenue is $249 million, an increase of 18% or $38 million over the same last year. As you would expect, SWU sales made up the majority of revenue at $126. What is unusual for this quarter, however, is that although total revenue was up SWU revenue was down by $20 million. SWU sales in the second quarter reflected a 20% decline in sales volume, but a 7% increase in the average price billed customers. This fits in with our guidance SWU sales volume will likely be down 20% this year compared to 2007.

Last year was a record year for revenue in sales volume of SWU in the 18 to 24-month refueling cycle for reactors means that we will have lower deliveries in 2008. Uranium revenue was $58 million which is more than double the revenue from uranium recorded in the same quarter last year. Both volume and average price billed to customers increased significantly. The US government contract segment contributed $65 million, an increased of about $16 million. The increase was due to the revolution of concerns regarding billable incurred costs for DOE contract work from fiscal 2002, increased contract work related to coal shutdown efforts of the Portsmouth Gaseous Diffusion Plant and to a lesser extent the timing of sales for NAC. Looking briefly of revenue from the six-month period total revenue was down 12%. The timing of reactor refueling can be clearly seen in this period as SWU volume was down 32% year-over-year.

Due to the mix of customers, average SWU price billed customers was down about 2% compared to the same six-month period last year. Uranium revenue was more than 200% higher due in part to recognition of previously deferred revenues.

Turning next to cost of sales for the LEU segment for the first half of the year, cost of sales for SWU and uranium was $396 million, which was $100 million or 20% less than the same period a year ago. That’s mainly due to the decline in SWU sales volume. As you know, under our monthly moving average inventory methodology cost of sales reflects changes in production and purchase cost. Our production cost increased 19% during the six-month period due to a 25% increase in the amount of power purchased and quantities produced. You will recall, that we are now buying 200 megawatts of power 24x7 during the non-summer months from TBA. That translates into 1.6 million more megawatt hours of electricity being purchased during the first half of this year compared to the same time frame in 2007.

The additional power is used to increase food production and to underfeed the enrichment process. Production volume is up by 22% as we are building inventory in advance of higher anticipated sales in the second half of 2008, as well as, taking advantage of the economics of under [PA]. The quantity of uranium that is added to uranium inventory from underfeeding is accounted for as a by-product 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 the production cost is allocated through inventory costs. Our overall unit production cost declined 2%. We continue to see the impact of higher prices paid to Russia. In 2008, the price we were paying Russia under the market based pricing formula is 11% higher than in 2007. Cost of sales in the government contract segment increased $15 million during the six month period compared to the same period last year. The margins for this segment as higher revenue more than offset higher cost.

Gross profit for the quarter was $64 million, that’s more than double the gross profit in the same quarter of last year. Our gross profit margin was almost 26% for the quarter compared to 13% in the same quarter of 2007. For the six month period, the gross profit was $102 million, which is nearly unchanged from last year’s results.

The gross profit margin was 17% for the six months of 2008 compared to 15% in the same period last year. As you can see in our outlook, we still expect our gross profit margin for the year to be 13% to 14%. So the margins in the second half of the year are expected to be a bit tighter. Below gross profit margin, we have expenses for the continued demonstration and development costs of American Centrifuge. Compared to last year, expenses charged to the project are 21% and 25% lower in the quarter and six months period respectively.

The reduction in advance technology expense is due to reduced activities associated with assembling and testing centrifuges and equipment at our test facilities in Oak Ridge, Tennessee. More of our spending in 2008 is related to the construction of the American Centrifuge Plant and is being capitalized. Our numbers tell the story here. During the first six months of 2008, $179 million of spending was capitalized compared to $26 million in the first half of last year. As we move forward with the commercial deployment of the American Centrifuge, most of our spending will be capitalized.

Expenditures in the six-month period on ACP were $259 million, the spent profile for the rest of 2008 were ratchet higher as construction continues in the first AC100 machines are built by our strategic suppliers.

Selling, general and administrative expense increased by $4 million over the six-month period compared to last year, but last year’s expense benefited from a reversal of a previously accrued tax penalty of more than $3 million. Nevertheless, we are keeping a sharp eye on the SG&A line to avoid creep in our overhead exposure. For comparison to last year, I am going to focus on non-diluted earnings per share to keep the comparison even. On that basis, going to the bottom line we recorded net income of $10.8 million or $0.10 per share for the second quarter of 2008, compared to a net loss of $13.4 million or $0.15 per share in the same quarter of 2007.

In the six-month period we reported net income of $15.2 million or $0.14 per share compared to $25.9 million in the same period of 2007. Earnings per share in 2008 include the impact of the additional 23 million shares issued at the end of 2007 in September. I would also point out that the results in 2007 benefited from almost $21 million from the non-cash reversal of previously recorded accruals for taxes and interest associated with the accounting standards known as 1048. Turning next to cash, we had $504 million in cash on hand as of June 30, 2008 compared to $886 million on December 31, 2007. Cash flow used in operations in the six-month period was $170 compared to the cash flow used in operation was about $83 in the first half of 2007.

The reduction in cash flow from operations was primarily the results of a $350 million billed in net inventory year-over-year. The other drawn on our cash balance was the higher level of capital expenditures related to the American Centrifuge project. Our cash balance along with access to $400 million credit facility and anticipated cash generated by operation should provide us with sufficient liquidity into 2009 and the ability to pay off our maturing bonds in January 2009.

As John noted earlier, we still need to raise a significant amount of capital to complete the American Centrifuge project. We have submitted part I of our application under the DOE loan guarantee program and will work diligently to keep the review process moving forward in a timely manner. However, we have no assurance that the ACP will be selected to move forward in the program and it could take an extended period for a guarantee and related funding to be finalized. Accordingly, we continue to evaluate alternative sources of capital on a parallel path.

In the yesterday’s news release we also reiterated our net income and cash flow guidance for 2008. As noted in the news release, our guidance is subject to a number of assumptions and uncertainties that could affect results. To summarize our guidance we expect revenue for 2008 to be $1.7 billion, with SWU revenue making up $1.3 billion of that total. We expect Uranium revenue to approximately $190 million but that is subject to the timing of revenue recognition. US government contracts and others expected to be approximately $230 million.

Although our base cost for power is set under a five year contract with TBA, we expect a fuel cost and purchase power cost adjustment in that contract to increase our cost. This will negatively affect our production cost and cash flow from operations for the rest of 2008. Therefore, although our gross profit margin was 17% in the first half of 2008, we expect that margin to pull back due to these higher cost and come in at 13% to 14% over the full year.

Below the gross profit line our guidance didn’t change. We still anticipate expenses related to the American Centrifuge to be $125 million, total spending on the project should be in the range of $600 million to $650 million this year.

We reiterated our net income expectation in a range of $25 million to $45 million. Cash flow used in operation is expected to be in a range to $60 million to $80 million as we build SWU inventory in advance of 2009 when sales volume is expected to rebound to level seen in 2007.

To quickly summarize, financial results for the second quarter and for the first half of the year were inline with our expectation. We have reiterated our annual guidance for net income and cash flow. Looking ahead we see stronger sales in 2009 and improving cash flow from operations. We also have a challenge ahead of raising the substantial capital we need to complete the American Centrifuge project under our schedule.

Now I would like to turn the call back to John for some final comments.

John Welch

Before we go to your questions, I want to provide an update on the market for nuclear fuel. We continue to see more support for nuclear power than we have seen in decades and that interest in building new power plants is continuing to show up an improved pricing for our product. Just here in the United States, 11 nuclear utilities have applied for construction and operating licenses from the nuclear regulatory commission for a total of 18 new reactors.

Bob Van Namen here can answer more detailed questions on the market, but I want to make a couple of points. Our marketing and sales staff has been meeting with customer to discuss selling the output at the American Centrifuge for months. Preliminary discussions have been underway and we have now begun negotiating and funding long-term contracts for deliveries beginning in 2013.

The price indicators has published in news, letters covering our industry have continued to firm particularly for long-term commitment by enrichers. At the end of July the price indicator for SWU was $150 per SWU compared to $143 at the end of 2007. Going back to the end of 2005 the price was $113 per SWU.

There are some who have questioned why we did not fill up our order book a couple of year's ago. I believe that by waiting until now to sell this product we are in a better position, with much better visibility into the cost of building the plant and in improving marketplace for selling the plant output. We are now structuring proposals for long-term contracts and ways that will provide stronger support for our financing and earn an appropriate return on capital. We have received accepted offer from customers that should lead to signing long-term contracts from commitments totaling approximately $900 million. Our sales group will continue to sell the output of the plant during up coming months.

So to sum up, our financial results came in pretty much as we expected for the second quarter and the first half of 2008. We released drawings for the initial design for the AC100, we are moving forward to build these individual machines in the second half of this year and conduct an integrated testing program with a cascade of 40 to 50 AC100 machines by the end of the first quarter in 2009.

The current lead cascade integrated testing program is provided us with over a 100,000 hours of machine operation since last August, these machines have been put through their paces under a tougher operating environment that is likely to occur in normal plant operations. The test results have added to our compliments and the performance and reliability of the technology. Last but certainly not least we completed our comprehensive $3.5 billion budget for the project. This budget includes a bottom-up rollup detailed work break down structure that reflects extensive input from our suppliers. The controls and processes are in place to manage to this estimate.

Operator we are now ready to take questions from our callers.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). We will take our first question from Al Kabili with Goldman Sachs.

Albert Kabili - Goldman Sachs

Hi, good morning guys.

John Welch

Hi Al.

Albert Kabili - Goldman Sachs

I appreciate some of the additional disclosure that you had in the ACP cost update particularly on the sensitivities. The one question I have though is, 1% rise in raw materials would change the budget by 10 million is what you disclosed which just thinking about that that would assume $1 billion exposure to raw materials and 100 million to labor which would be less than I would have expected. Can you just walk me through how to think about that?

John Welch

Sure Al. It was reverse, the sensitivity was 8 million for materials, 10 million for labor with respect to a 1% increase in total cost. I think your question is a good one and we last year as we talked about earlier this year we saw significant pressure in all elements of the cost estimate and that included labor hours, rates, administrative costs, overhead materials etcetera. And so as we said in the release based on the maturity of the AC100 and plant design we have gone through this rigorous process to develop the budget. We also recognized that we are subject to cost risk, but not all elements of cost risk lend themselves to a straight forward sensitivity. But we wanted to provide our investors with this material price labor rate escalation sensitivity to provide some additional insight.

Albert Kabili - Goldman Sachs

Okay. Has that changed dramatically to sensitivity since the beginning of the year, because based on the number we are talking about. I mean beginning of the year you had a roughly you call it $800 million jump in the estimate, when looked at the budget, to get $800 million based on the sensitivities here that would suggest dramatic escalation in raw materials and labor. And so I am just trying to reconcile that as well.

John Barpoulis

Okay Al, this is John. Not that much from what we anticipated back in that timeframe. We have long-term contracts for certain aspects of the project already in place. There are escalation expectations in that, so anything that’s beyond that would be subject to this factor of 1% and $8 million. We actually think that we pretty well have the commodity escalation bracketed especially with what we have seen in the markets, now it tend to hit a peak, but that’s not to say that something else might happen and we are subject to it. But we build this plant out pretty quickly and so as these contracts are finalized and a lot of material contracts tend to be certainly much more fixed price, we were in a transition period to that, I mean the factors appropriate for what we think we can deal with in that arena and yet at the same time we think we have that pretty well bracketed.

Albert Kabili - Goldman Sachs

Okay. And relative to the budget that $3.5 billion, what type of contingency, what level of magnitude are you assuming in there in terms of escalation of labor rates and raw material prices versus today’s level. Is that $3.5 billion using today’s level or do you have contingencies build in there in that $3.5 billion that assumes further escalation?

John Barpoulis

I think we said before there is a degree of contingence already built into that estimate. Now, the -- in establishing a management reserve, now we put in place a very strict and formal change control process. And that whether you're looking at trends at one line item versus another you're going to take a look at that trend and say, is that a cost issue that we can mitigate? Is it something that's going to carry through the full length of the program or not. But you'll go through that strict review process of trends and determine, do we need to release part of that management reserve to account for that?

So you take yourself through a strict process there. You also take yourself -- that's the same process that any sort of engineering change proposal that would come up in the process to either -- okay, we've got to do something different to account for something we hadn't anticipated, or that might be additional value engineering changes that say, hey we believe you can save money by doing this now. You still go through a formal configuration control, change control type process to control that.

So that's basically -- one of the reasons I might feel, hey, John, how do you feel about all of this estimate? I feel a hell of a lot better about it because of our design maturity, the level of involvement from our suppliers in getting to this point, and the processes and controls that are in place to manage to this budget. That doesn't mean you're not going to come up with issues you've got to deal with, but you have a management reserve to address those and we certainly -- our ultimate -- one of the items that we ultimately can play with on this thing is how big a plant do we build? It's modular in nature. Do you scale back maybe number of machines to live within that cost target? Again, if you scale back a number of machines that may not mean that it's less capacity if we choose to deploy that additional capability in the $3.8 in the initial plant deployment.

So I think that in that regard we have a couple of other levers that we can play with, but you can be assured that what we've got in place today is to go manage to that $3.5 billion number, and control it as tightly as we can.

Albert Kabili - Goldman Sachs

Okay, and John, you highlighted -- you've been highlighting for awhile now the potential for the ACP to actually exceed the 350 SWU per machine target. Any thoughts in terms of what level of magnitude we're talking about there? I know it's early and you don't want to commit anything here, but I want to get at least some framework for the potential opportunity for upside.

John Welch

Well, we're not going to provide you a number, but there's certainly -- and there are lots of things that come into that. Some things you might say are easier than others. If you can get additional output from the machine without a major design change to the process, boy, you're going to grab that one because it means you can probably get it fairly quickly with very little risk. But we would certainly pick a point in time that's appropriate. I mean, on one hand I want to tell you that that's there because that's probably part of our cost mitigation strategy at some point in the deployment of the plant. On the other hand, you can be assured that the guys that are working today are focused on a 350 SWU machine and getting that thing out into production, getting the production machine into test, getting the value engineer machine into test, all of that. And then we'll pick an appropriate time to do it so as not to create disruption because that's -- this gets to be a pretty high volume manufacturing activity, and if you're going to do something different you've got to pick the point to do it.

Albert Kabili - Goldman Sachs

Okay, and then two final questions if I may. On the long-term contracts for ACP capacity, question on, I guess, pricing. How is -- how are you guys thinking of pricing structure generally? Are you looking at a kind of fixed price with cost escalators? Or is there a heavy component that's going to be driven by market rates at the time of ACP production? And what percentage of capacity are you expecting to fill by the end of the year?

Bob Van Namen

Sure, Bob Van Namen here. I can answer that kind of. We are in the midst of a discussions with the customers and so I'm not going to really be able to talk about any of the specifics of those negotiations. In general, I would be able to say that we're looking at getting a -- the optimal mix of risks, and the appropriate sharing of upside and downside price movements in the markets with our -- in our discussions with the customers. Our customers definitely are focused on reliability and certainty of supply as they sign these 10 to 15 year contracts to support the centrifuge deployment. And we are focused on assembling a portfolio contracts to get the desired return and to support the financing needs for the plant. We've had discussions with the customers on both market related pricing as well as firm prices escalated by factors such as inflation, and labor, and we're seeking to create a balanced portfolio of contracts with a very strong credit profile.

Albert Kabili - Goldman Sachs

Okay, great. I will jump back into queue. Thank you, guys.

John Barpoulis

Thanks, Al.

Operator

We will take our next question from Laurence Alexander from Jefferies & Company.

Lucy Watson - Jefferies & Company

Hi, this is Lucy Watson speaking for Laurence.

John Barpoulis

Good morning.

Lucy Watson - Jefferies & Company

Good morning. I just actually had a follow-up question on the ACP contracts. You mentioned getting closer to an acceptable return on capital. I was wondering if you might be able to give us any color on -- I see you're getting to closer to a certain range.

John Barpoulis

Well, I think as we've said previously, we're -- and as Bob articulated, we're seeking to structure our long-term contracts ultimately that support a very strong credit profile, and that meet our return targets. I think as we've discussed earlier, we don't disclose our return targets, but what I always like to reinforce is that we are seeking returns on our investments that meet or exceed our weighed average cost to capital. And so we are -- we're very focused on structuring them to support the business in this initial phase, as well as with an eye toward expansions. But at this point we're not looking to further refine that target.

Lucy Watson - Jefferies & Company

Okay, great, and it also looks as if the completion date might be moving a little bit toward the end of 2012. Just wondering what your confidence level is on finishing in 2012 rather than maybe 2013?

John Barpoulis

There were a couple -- you're correct in that we -- one, we still very good. We're still at 2012. It did move a little bit because we gave our self more time in some of the design test -- design development and testing that's going on with AC100, and the value engineered design activities. As confident as I can be with what I know today. I mean, there's clearly -- there's a large manufacturing ramp up that is a challenge, and yet in some areas we're looking much better than what we had projected there. So we're working the critical path aspect of that. But we got a lot of machines to build, and we're going to work to that schedule, but today I'm as confident as I can be based -- given what I know today.

Lucy Watson - Jefferies & Company

Okay, great, and just one more question, when you look at the Paducah orders that will be coming on stream in 20-10 to 20-12, how did the gross margin from those orders compare with those that have been delivered in the last two years.

Bob Van Namen

Bob Van Names here, we don’t comment on gross margin for say, but I’ll say may be a couple of comments on the contracting strategy for that. Over the last several years as we were hit with the higher power prices, we have begun contracting for Paducah output and HEU output with price indicators in our contracts that reflect both in movements in power prices, and movements in market prices which then tieback to the HEU deal. So we do see maintaining an alignment between our cost and our revenue side. We are fazing those in as quickly as we can as the older contracts roll off, and we do sign new contracts, and we're being successful and sharing those risks with our customers.

Lucy Watson - Jefferies & Company

Okay, thank you.

John Barpoulis

The one thing I comeback to on your comment on 20-12, is let's not forget that we run an integrated enrichment business, and so how we go through that transition period with GDP as a backstop during deployment of ACP gives us some flexibility there in how we go do that. So we'll clearly manage into the current schedule. We'll go at that as aggressively as we can, but we will certainly put it in the context of the entire business as we come through that transition

Lucy Watson - Jefferies & Company

Thanks.

John Barpoulis

Thank you.

Operator

Our next question comes from the Roger Reed with Natiexis Bleichroeder.

Roger Reed - Natiexis Bleichroeder

Hey, good morning gentleman.

John Welch

Good morning Roger.

Roger Reed - Natiexis Bleichroeder

Just, kind of quick question on the DOE loan guarantee Any idea what the timing is, or if not specifically when they'll get back and give you a thumbs up or a thumbs down, kind of the process you need to go through. What sort of timing I should expect you might hear this, you might get a comment from them, you would go back to them. Just maybe a little more specificity on that if you could.

John Welch

I think that the specificity that we can provide is really embedded within the solicitation that the milestones that we see is that all Part I applications, or applicancy to submit part I of their application by September 29 of this year for the financial cycles facioliies and they need to submit part II by December second and so, while it is not clear the timing that we may take around those dates, I think those are two milestones that we certainly out there with respect to additional information coming out.

Roger Reed - Natiexis Bleichroeder

Okay, and then, in terms of -- and I know Congress can change their minds on a whim a lot of times, but relative to the experience you've had, the guaranteed program looks pretty solid I mean, it's funded. There not some other vote that would have to occur in Congress. They in other words, have to vote against doing it as opposed to having to vote again for it.

John Barpoulis

That’s correct.

Roger Reed - Natiexis Bleichroeder

Okay.

John Barpoulis

And then to reinforce the long guarantee the loan guarantee office I would say is staffed by product finance professionals with SM Bank, and other experience, and I would characterize the process as being very similar and having many parallels to other government programs, but also a traditional credit approach. The other element of review that I would add is we've talked about as applications come in, I think we certainly expect that they'll be reviewing those applications, asking questions along the way, and starting due diligence as prudent.

Roger Reed - Natiexis Bleichroeder

Okay, and then just a couple of more I guess, you'd call near-term modeling questions. The difference in the second half of the year to kind of stick with your net income guidance of $25 million to $45 million would be kind of $10 million to $30 million if I've done my math correctly Is that difference of $20 million affectively just what uranium sales go out the door at this point. I mean, or the vast majority of it has to be uranium sales?

John Barpoulis

Not necessarily, I mean, ultimately it is the mix of our expected customer delivery on SWU, uranium, anticipated the potential recognition of uranium revenues. Again, depending on when that may flow out door, and also the contributions from our government contract services. So it isn't necessarily just uranium. It really is across the board. Bob, I don't know if there’s anything else to add.

Bob Van Namen

Yes, the other part of that is we are anticipating higher power costs at the Paducah plant which will be rolling through cost of production due to higher gas and coal prices. So that's reflected in the projection as well.

Roger Reed - Natiexis Bleichroeder

Okay, and that actually goes to my next question. As you look to 2009 as just a general thought process, knowing your costs for power are likely be higher, and in terms of adjusting your pricing on your contracts, you talked about 20-10 to 20-12; 2009, are we pretty well dialed in at this point on the pricing front? Or do you have some ability to put through some costs escalators on the fuel side?

John Barpoulis

We have two ways of being able to handle that. One is under a lot the newer existing contracts we do have a power price modifier in that pricing section that correlates with the fuel cost, adjuster that we think we'll be seeing. Again, we are in the process of phasing that in, so as we get farther out in time, more of our backload -- more of our backlog will have the market and the power price adjuster. Number two is we still have some new sales that we're looking to make into the market in 2009, and We’d be able to put through higher cost in higher market prices for those new sales.

Roger Reed - Natiexis Bleichroeder

Can you give me an idea of maybe what percentage of new sales for '09? In other word, how much is backlog, how much would be where I can be pretty confident you will be able to put the power cost through?

John Barpoulis

In general, I would say we are in a long-term commitment market, and generally our stock sales are a very small percentage of our overall sales. So that's probably as far as I can go.

Roger Reed - Natiexis Bleichroeder

Okay, thank you.

John Barpoulis

Thank you.

Operator

We'll hear next from Baker Burleson with Fox Point Capital.

Baker Burleson - Fox Point Capital

Hey guys, good morning.

John Welch

Good morning.

Baker Burleson - Fox Point Capital

Thanks, I wanted to just echo the thanks for all the additional detail on the cost assessments and sensitivities on ACP, always helpful to have more data for us. Just a question on the loan guarantee. I think most of it was hit on the last question, but how do the mechanics of this work? You guys get the loan guarantee, how does that kind of in--flow through to you going out and securing capital? You've got a piece of paper you can show to lenders that says the government's behind us, and so that makes it easier to get money, I imagine, but there's probably--it's probably a little more complicated than that. I'd just love to get some color around how it actually works once you get the guarantee.

John Barpoulis

Sure, good question. As the loan guarantee program rules and regulations have evolved this very much came out of the rules established last fall. That if an applicant is seeking to have more than 90% of the debt guaranteed, which is the avenue that we would be pursuing. I think it is most optimal under the program that that funding would actually be provided through the Federal Financing Bank which is part of the Department of Treasury. So the guarantee program really has to elements. In some cases it could be a guarantee that you go out and secure funding in the capital markets with that government backing. But again, for projects that are seeking guarantees of more than 90% of the debt which is our case, we would be seeking funding through the Federal Financing Bank so that the guaranteed program in effect becomes a part of the funding mechanism and just to reinforce the FFB is – it would be providing for 100% government supported debt.

Baker Burleson - Fox Point Capital

Got you. So the government will actually be the lender.

John Barpoulis

That’s correct.

Baker Burleson - Fox Point Capital

Any idea what kind of terms you get when the government is your lender?

John Barpoulis

No, at this point we -- obviously we’ve not been selected. We have not necessarily seen any specific term sheets to be shared publicly, and so I think it’s kind of premature at this point to speculate on specific terms and condition.

Baker Burleson - Fox Point Capital

Sure, understood. Great, thanks a lot.

John Barpoulis

No problem.

Operator

Next we’ll take a question from Roy Adams with Lehman Brothers.

Roy Adams - Lehman Brothers

Thank you. This question is for Bob. As we see SWU prices pickup a bit here, as your Russian peers have trouble entering into the US market, how exactly are your sales and marketing teams gearing to take advantage of that in terms of selling and pre selling perhaps capacity on the ACP project. And another question on that theme is are you considering selling (inaudible) of the project to customers who in fact as we all know are very keen on securing SWU supplies for their aggressive new build plants.

Bob Van Namen

Sure, good questions, and I – let me take them one at a time. The first one is I would say that the current market is not necessary influenced as much by Russian supply as it is by the dynamics of higher power prices associated with gaseous diffusion plant production. Clearly the Russians do present a downside, but I think that that has been accounted for in the trade actions that are going on, and I think the market has assimilated the Russian presence into the pricing. So I would say it’s much more dominated by gaseous diffusion plant and power cost. As we’re looking to the ACP contracting, clearly it gives us a good tailwind to sell ACP contracts with the price movements in the market. The customers are again focused on long-term dynamics which are the relative efficiencies of the different centrifuge projects, cost of capital associated with constructing new facilities and the need for security and diversity of supply. So I think all those factors really come together in a very favorable climate for us to be able to do the ACP contracting.

Roy Adams - Lehman Brothers

Okay, thank you.

John Barpoulis

Okay, thank you.

Operator

We’ll take our final question from Al Kabili with Goldman Sachs.

Albert Kabili - Goldman Sachs

Hi guys. My follow-up questions have actually been answered.

John Barpoulis

Okay. Thank you, Al.

John Welch

Well, thank you all for your questions this morning. Again, a little bit of summary. We’ve made substantial progress on many fronts in the projects during the quarter. We are also keeping very sharp focus on our current operations. We thank you for your interest and certainly your investment in USEC. We have a vision for delivering long-term shareholder value, and you can be assured we remain focused on executing that plan. Thank you very much.

Operator

That concludes today’s conference. Thank you for joining us, and have a great day.

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Source: USEC Inc. Q2 2008 Earnings Call Transcript
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