10-Q 1 form10-q.htm QUARTERLY REPORT form10-q.htm





UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
 

ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-14287
 
USEC Inc.
(Exact name of registrant as specified in its charter)

Delaware
52-2107911
(State of incorporation)
(I.R.S. Employer Identification No.)

Two Democracy Center
6903 Rockledge Drive, Bethesda, Maryland 20817
(301) 564-3200

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes ý   No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
o
 
Accelerated filer
ý
Non-accelerated filer
o
 
Smaller reporting company
o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

As of July 25, 2012, there were 124,082,753 shares of the registrant’s Common Stock issued and outstanding.
 
 
 
 
 


 
 
 

 
 
TABLE OF CONTENTS
   
Page
 
PART I – FINANCIAL INFORMATION
 
   
Item 1.
Financial Statements:
 
 
 
 
 
 
 
 
PART II – OTHER INFORMATION
 
   
 
 

This quarterly report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2, contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934 – that is, statements related to future events. In this context, forward-looking statements may address our expected future business and financial performance, and often contain words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “will” and other words of similar meaning. Forward-looking statements by their nature address matters that are, to different degrees, uncertain. For USEC, particular risks and uncertainties that could cause our actual future results to differ materially from those expressed in our forward-looking statements include, but are not limited to: risks related to the ongoing transition of our business, including uncertainty regarding the transition of the Paducah gaseous diffusion plant and uncertainty regarding continued funding for the American Centrifuge project and the impact of decisions we may make in the near term on our business and prospects; our dependency on the multi-party arrangement with Energy Northwest, the Bonneville Power Administration, the Tennessee Valley Authority and the U.S. Department of Energy (“DOE”) to support continued enrichment operations at the Paducah gaseous diffusion plant; risks related to Energy Northwest obtaining the financing needed to complete the multi-party arrangement and the potential for termination of the agreement if such financing is not secured on terms acceptable to Energy Northwest; risks related to the performance of each of the parties under the multi-party arrangement, including the obligations of DOE to timely deliver depleted uranium to Energy Northwest; the impact of the March 2011 earthquake and tsunami in Japan on the nuclear industry and on our business, results of operations and prospects;  the impact and potential duration of the current supply/demand imbalance in the market for low enriched uranium; the potential impacts of a decision to cease enrichment
 
 
2

 

operations at Paducah; uncertainty regarding the timing, amount and availability of additional funding for the research, development and demonstration (“RD&D”) program and the dependency of government funding on Congressional appropriations; restrictions in our credit facility on our spending on the American Centrifuge project and the potential for us to demobilize the project;  limitations on our ability to provide any required cost sharing under the RD&D program; the ultimate success of efforts to obtain a DOE loan guarantee and other financing for the American Centrifuge project, including the ability through the RD&D program or otherwise to address the concerns raised by DOE with respect to the financial and project execution depth of the project, and the timing and terms thereof; potential changes in our anticipated ownership of or role in the American Centrifuge project; the impact of actions we have taken or may take to reduce spending on the American Centrifuge project, including the potential loss of key suppliers and employees, and impacts to cost and schedule; the impact of delays in the American Centrifuge project and uncertainty regarding our ability to remobilize the project; the potential for DOE to seek to exercise its remedies under the June 2002 DOE-USEC agreement; risks related to the completion of the remaining two phases of the three-phased strategic investment by Toshiba Corporation (“Toshiba”) and Babcock & Wilcox Investment Company (“B&W”), including the potential for immediate termination of the securities purchase agreement governing their investments; changes in U.S. government priorities and the availability of government funding, including loan guarantees; uncertainty regarding the continued capitalization of certain assets related to the American Centrifuge Plant and the impact of a potential impairment of these assets on our results of operations; our ability to extend, renew or replace our credit facility that matures on May 31, 2013 and the impact of a failure to timely renew on our ability to continue as a going concern; restrictions in our credit facility that may impact our operating and financial flexibility; our ability to actively manage and enhance our liquidity and working capital and the potential adverse consequences of any actions taken on the long term value of our ongoing operations; our dependence on deliveries of LEU from Russia under a commercial agreement (the “Russian Contract”) with a Russian government entity known as Techsnabexport (“TENEX”) and on a single production facility and the potential for us to cease commercial enrichment of uranium in the event of a decision to shut down Paducah enrichment operations; limitations on our ability to import the Russian LEU we buy under the new supply agreement into the United States and other countries; our inability under many existing long-term contracts to directly pass on to customers increases in our costs; the decrease or elimination of duties charged on imports of foreign-produced low enriched uranium; pricing trends and demand in the uranium and enrichment markets and their impact on our profitability; movement and timing of customer orders; changes to, or termination of, our contracts with the U.S. government, risks related to delays in payment for our contract services work performed for DOE; our subsidiary NAC may not perform as expected; the impact of government regulation by DOE and the U.S. Nuclear Regulatory Commission; the outcome of legal proceedings and other contingencies (including lawsuits and government investigations or audits); the competitive environment for our products and services; changes in the nuclear energy industry; the impact of volatile financial market conditions on our business, liquidity, prospects, pension assets and credit and insurance facilities; risks related to the underfunding of our defined benefit pension plans and the impact of the potential requirement to accelerate the funding of these obligations on our liquidity; the impact of a potential de-listing of our common stock on the NYSE; the impact of potential changes in the ownership of our stock on our ability to realize the value of our deferred tax benefits; the timing of recognition of previously deferred revenue; and other risks and uncertainties discussed in this and our other filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2011 (“10-K”). Revenue and operating results can fluctuate significantly from quarter to quarter, and in some cases, year to year. For a discussion of these risks and uncertainties and other factors that may affect our future results, please see Item 1A entitled “Risk Factors” and the other sections of this report and our 10-K, which are available on our website at www.usec.com.  Readers are urged to carefully review and consider the various disclosures made in this report and in our other filings with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business. We do not undertake to update our forward-looking statements to reflect events or circumstances that may arise after the date of this quarterly report on Form 10-Q except as required by law.
 
 
 
 
3

 
 
USEC Inc.
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
(millions)
 
 
   
June 30,
2012
   
December 31,
2011
 
ASSETS
           
Current Assets
           
Cash and cash equivalents
  $ 229.0     $ 37.6  
Accounts receivable, net
    173.4       162.0  
Inventories
    1,924.4       1,752.0  
Deferred costs associated with deferred revenue
    130.8       175.5  
Other current assets
    67.2       64.8  
Total Current Assets
    2,524.8       2,191.9  
Property, Plant and Equipment, net
    1,130.6       1,187.1  
Other Long-Term Assets
               
Deposits for surety bonds
    107.5       151.3  
Deferred financing costs, net
    11.2       12.2  
Goodwill
    6.8       6.8  
Total Other Long-Term Assets
    125.5       170.3  
Total Assets
  $ 3,780.9     $ 3,549.3  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current Liabilities
               
Accounts payable and accrued liabilities
  $ 111.3     $ 120.1  
Payables under Russian Contract
    141.7       206.9  
Inventories owed to customers and suppliers
    1,382.8       870.1  
Deferred revenue and advances from customers
    178.9       205.2  
Credit facility term loan
    85.0       85.0  
Convertible preferred stock
    94.4       88.6  
Total Current Liabilities
    1,994.1       1,575.9  
Long-Term Debt
    530.0       530.0  
Other Long-Term Liabilities
               
Depleted uranium disposition
    71.7       145.2  
Postretirement health and life benefit obligations
    213.2       207.8  
Pension benefit liabilities
    252.5       258.3  
Other liabilities
    76.8       79.7  
Total Other Long-Term Liabilities
    614.2       691.0  
Commitments and Contingencies (Note 12)
               
Stockholders’ Equity
    642.6       752.4  
Total Liabilities and Stockholders’ Equity
  $ 3,780.9     $ 3,549.3  

See notes to consolidated condensed financial statements.



 
4

 

USEC Inc.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
(millions, except per share data)

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Revenue:
                       
Separative work units
  $ 347.2     $ 330.3     $ 885.1     $ 638.8  
Uranium
    3.6       67.8       3.6       81.8  
Contract services
    14.0       56.3       37.6       114.3  
Total Revenue
    364.8       454.4       926.3       834.9  
Cost of Sales:
                               
Separative work units and uranium
    340.4       368.6       841.6       675.8  
Contract services
    12.1        52.6       33.6       112.0  
Total Cost of Sales
    352.5       421.2       875.2       787.8  
Gross profit
    12.3       33.2       51.1       47.1  
Advanced technology costs
    85.7       33.5       122.5       60.2  
Selling, general and administrative
    14.8       16.7       29.7       32.2  
Special charge for workforce reductions and advisory costs
    3.2       -       9.6       -  
Other (income)
    (10.0 )      -       (10.0 )     (3.7 )
Operating (loss)
    (81.4 )     (17.0 )     (100.7 )     (41.6 )
Interest expense
    12.7       0.1       25.4       0.1  
Interest (income)
    (0.1 )      (0.1 )     (0.2 )     (0.3 )
(Loss) before income taxes
    (94.0 )     (17.0 )     (125.9 )     (41.4 )
Provision (benefit) for income taxes
    (2.0 )     4.2       (5.1 )     (3.6 )
Net (loss)
  $ (92.0 )   $ (21.2 )   $ (120.8 )   $ (37.8 )
Net (loss) per share – basic
  $ (.76 )   $ (.18 )   $ (.99 )   $ (.31 )
Net (loss) per share – diluted
  $ (.76 )   $ (.18 )   $ (.99 )   $ (.31 )
Weighted-average number of shares outstanding:
                               
Basic
    121.7       121.1       122.0       120.3  
Diluted
    121.7       121.1       122.0       120.3  


See notes to consolidated condensed financial statements.


 
5

 

USEC Inc.
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
(millions)

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Net (loss)
  $ (92.0 )   $ (21.2 )   $ (120.8 )   $ (37.8 )
Other comprehensive income, before tax:
                               
Amortization of prior service costs (Note 8)
    0.4       0.4       0.8       0.8  
Amortization of actuarial losses (Note 8)
    6.0       2.8       12.0       6.0  
Other comprehensive income, before tax
    6.4       3.2       12.8       6.8  
Income tax (expense) benefit related to items of other comprehensive income
    (2.3 )     (1.2 )     (4.6 )     (2.5 )
Other comprehensive income, net of tax
    4.1       2.0       8.2       4.3  
Comprehensive (loss)
  $ (87.9 )   $ (19.2 )   $ (112.6 )   $ (33.5 )

See notes to consolidated condensed financial statements.

 
6

 

USEC Inc.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
(millions)

   
Six Months Ended
June 30,
 
   
2012
   
2011
 
Cash Flows from Operating Activities
           
Net (loss)            
  $ (120.8 )   $ (37.8 )
Adjustments to reconcile net (loss) to net cash provided byoperating activities:
               
Depreciation and amortization        
    19.5       30.2  
Transfer of machinery and equipment to U.S. Department of Energy
    44.6       -  
Deferred income taxes       
    (4.6 )     7.3  
Other non-cash income on release of disposal obligation       
    (10.0 )     (0.6 )
Capitalized convertible preferred stock dividends paid-in-kind      
    5.8       5.1  
Gain on extinguishment of convertible senior notes   
    -       (3.1 )
Changes in operating assets and liabilities:
               
Accounts receivable – (increase) decrease   
    (11.4 )     174.6  
Inventories, net – decrease     
    340.3       173.9  
Payables under Russian Contract – (decrease)           
    (65.2 )     (56.0 )
Deferred revenue, net of deferred costs – increase   
    27.1       10.2  
Accrued depleted uranium disposition – increase (decrease)      
    (73.5 )     9.9  
Accounts payable and other liabilities – increase (decrease)    
    3.6       (8.2 )
Other, net                                                                                                   
    6.7       (19.9 )
Net Cash Provided by Operating Activities                                                                                                               
    162.1       285.6  
                 
Cash Flows Provided by (Used in) Investing Activities
               
Capital expenditures                                                                                                               
    (4.1 )     (91.0 )
Deposits for surety bonds - decrease                                                                                                               
    43.8       -  
Net Cash Provided by (Used in) Investing Activities      
    39.7       (91.0 )
                 
Cash Flows Used in Financing Activities
               
Borrowings under revolving credit facility      
    123.6       -  
Repayments under revolving credit facility        
    (123.6 )     -  
Payments for deferred financing costs               
    (9.8 )     (3.7 )
Common stock issued (purchased), net              
    (0.6 )     (1.7 )
Net Cash (Used in) Financing Activities        
    (10.4 )     (5.4 )
Net Increase                                                                                                               
    191.4       189.2  
Cash and Cash Equivalents at Beginning of Period       
    37.6       151.0  
Cash and Cash Equivalents at End of Period                                                                                                               
  $ 229.0     $ 340.2  
Supplemental Cash Flow Information:
               
Interest paid, net of amount capitalized    
  $ 13.2     $ -  
Income taxes paid, net of refunds         
    0.5       2.1  

See notes to consolidated condensed financial statements.

 
7

 

USEC Inc.
CONSOLIDATED CONDENSED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)
(millions)

   
Common Stock,
Par Value
$.10 per Share
   
Excess of
Capital over
Par Value
   
Retained
Earnings
(Deficit)
   
Treasury
Stock
   
Accumulated
Other Comprehensive Income (Loss)
   
Total
 
Six Months Ended June 30, 2011
                               
Balance at December 31, 2010
  $ 12.3     $ 1,172.8     $ 329.9     $ (57.1 )   $ (144.1 )   $ 1,313.8  
Amortization of actuarial losses and prior service costs, net of tax
    -       -       -       -       4.3       4.3  
Common stock issued in exchange for convertible senior notes
    0.7       40.5       -       -       -       41.2  
Restricted and other common stock issued, net of amortization
    -       (2.9 )     -       6.5       -       3.6  
Net (loss)
    -       -       (37.8 )     -       -       (37.8 )
Balance at June 30, 2011
  $ 13.0     $ 1,210.4     $ 292.1     $ (50.6 )   $ (139.8 )   $ 1,325.1  
                                                 
Six Months Ended June 30, 2012
                                         
Balance at December 31, 2011
  $ 13.0     $ 1,212.5     $ (210.8 )   $ (49.4 )   $ (212.9 )   $ 752.4  
Amortization of actuarial losses and prior service costs, net of tax
    -       -       -       -       8.2       8.2  
Restricted and other common stock issued, net of amortization
    -       (13.7 )     -       16.5       -       2.8  
Net (loss)
    -       -       (120.8 )     -       -       (120.8 )
Balance at June 30, 2012
  $ 13.0     $ 1,198.8     $ (331.6 )   $ (32.9 )   $ (204.7 )   $ 642.6  

See notes to consolidated condensed financial statements.

 
8

 

USEC Inc.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)


1. BASIS OF PRESENTATION

The unaudited consolidated condensed financial statements as of and for the three and six months ended June 30, 2012 and 2011 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. The unaudited consolidated condensed financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the financial results for the interim period. Certain information and notes normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) have been omitted pursuant to such rules and regulations.

Operating results for the three and six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. The unaudited consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and related notes and management's discussion and analysis of financial condition and results of operations included in the annual report on Form 10-K for the year ended December 31, 2011.

New Accounting Standards

In May 2011, the Financial Accounting Standards Board (“FASB”) amended its guidance on fair value measurements and related disclosures. The amendments represent the converged guidance of the FASB and the International Accounting Standards Board and provide a consistent definition of fair value and common requirements for measurement and disclosure of fair value between GAAP and International Financial Reporting Standards (“IFRS”). The new amendments also change some fair value measurement principles and enhance disclosure requirements related to activities in Level 3 of the fair value hierarchy. The new provisions are effective for fiscal years and interim periods beginning after December 15, 2011 and are applied prospectively. The implementation of the amended guidance in the first quarter of 2012 did not have an effect on USEC’s results of operations, cash flows or financial position.

In June and December 2011, the FASB issued guidance on the presentation of comprehensive income. The new guidance requires companies to present the components of net income and other comprehensive income either in a single statement below net income or in a separate statement of comprehensive income immediately following the income statement. The provisions of this new guidance are effective for fiscal years and interim periods beginning after December 15, 2011 and are applied retrospectively for all periods presented. The implementation of the new guidance in the first quarter of 2012 was reflected in USEC’s consolidated condensed financial statements and did not have an effect on USEC’s results of operations, cash flows or financial position.

In September 2011, the FASB amended its guidance on testing goodwill for impairment. Under the revised guidance, companies testing goodwill for impairment have the option of first performing a qualitative assessment to determine whether further quantitative assessments are warranted. In assessing qualitative factors, companies are to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test prescribed in the existing guidance. The provisions of this new guidance are effective for fiscal years and interim periods beginning after December 15, 2011.  USEC evaluates the carrying value of goodwill by performing an impairment test on an annual basis in the fourth quarter or whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. USEC expects the adoption of the new guidance will not have a material effect on its results of operations, cash flows or financial position.
 
 
 
9

 

 
2.  ACCOUNTS RECEIVABLE
   
June 30,
2012
   
December 31,
2011
 
   
(millions)
 
Accounts receivable (1):
     
Utility customers:
           
Trade receivables
  $ 82.8     $ 124.2  
Uranium loaned to customer (2)
    53.6        -  
      136.4       124.2  
Contract services, primarily Department of Energy (3):
               
Billed revenue
    34.8       18.8  
Unbilled revenue
    2.2       19.0  
      37.0       37.8  
    $ 173.4     $ 162.0  
 
(1)  
Accounts receivable are net of valuation allowances and allowances for doubtful accounts totaling $14.1 million at June 30, 2012 and $13.7 million at December 31, 2011.
 
(2)  
The loan period ends in the third quarter of 2012 under the agreement with the investment grade-rated utility customer.
 
(3)  
Billings for contract services related to the U.S. Department of Energy (“DOE”) are generally invoiced based on provisional billing rates approved by DOE. Unbilled revenue represents the difference between actual costs incurred, prior to incurred cost audit and notice by DOE authorizing final billing, and provisional billing rate invoiced amounts. USEC expects to invoice and collect the unbilled amounts as billing rates are revised, submitted to and approved by DOE. USEC has also invoiced certain amounts and subsequently submitted certified claims under the Contract Disputes Act for breach-of-contract amounts equaling unreimbursed costs. USEC believes DOE has breached its agreement by failing to establish appropriate provisional billing and final indirect cost rates on a timely basis.
 

3. INVENTORIES

USEC is a supplier of low enriched uranium (“LEU”) for nuclear power plants. LEU consists of two components: separative work units (“SWU”) and uranium. SWU is a standard unit of measurement that represents the effort required to transform a given amount of natural uranium into two components: enriched uranium having a higher percentage of U235 and depleted uranium having a lower percentage of U235. The SWU contained in LEU is calculated using an industry standard formula based on the physics of enrichment. The amount of enrichment deemed to be contained in LEU under this formula is commonly referred to as its SWU component and the quantity of natural uranium deemed to be used in the production of LEU under this formula is referred to as its uranium component.

USEC holds uranium, principally at the Paducah gaseous diffusion plant (“GDP”), in the form of natural uranium and as the uranium component of LEU. USEC holds SWU as the SWU component of LEU. USEC may also hold title to the uranium and SWU components of LEU at fabricators to meet book transfer requests by customers. Fabricators process LEU into fuel for use in nuclear reactors.


 
10

 

Components of inventories follow (in millions):

   
June 30, 2012
   
December 31, 2011
 
   
Current
Assets
   
Current
Liabilities
   
Inventories, Net
   
Current
Assets
   
Current
Liabilities
   
Inventories, Net
 
         
(a)
               
(a)
       
Separative work units
  $ 969.0     $ 547.5     $ 421.5     $ 1,048.6     $ 334.7     $ 713.9  
Uranium
    945.5       835.3       110.2       690.0       535.4       154.6  
Materials and supplies
    9.9        -       9.9       13.4        -       13.4  
    $ 1,924.4     $ 1,382.8     $ 541.6     $ 1,752.0     $ 870.1     $ 881.9  

(a)  
Inventories owed to customers and suppliers, included in current liabilities, relate primarily to SWU and uranium inventories owed to fabricators. Fabricators process LEU into fuel for use in nuclear reactors. Under inventory optimization arrangements between USEC and domestic fabricators, fabricators order bulk quantities of LEU from USEC based on scheduled or anticipated orders from utility customers for deliveries in future periods. As delivery obligations under actual customer orders arise, USEC satisfies these obligations by arranging for the transfer to the customer of title to the specified quantity of LEU at the fabricator. USEC’s balances of SWU and uranium vary over time based on the timing and size of the fabricator’s LEU orders from USEC. Balances can be positive or negative at the discretion of the fabricator. Fabricators have other inventory supplies and, where a fabricator has elected to order less material from USEC than USEC is required to deliver to its customers at the fabricator, the fabricator will use these other inventories to satisfy USEC’s customer order obligations on USEC’s behalf. In such cases, the transfer of title of LEU from USEC to the customer results in quantities of SWU and uranium owed by USEC to the fabricator. The amounts of SWU and uranium owed to fabricators are satisfied as future bulk deliveries of LEU are made.

The decrease in net inventories in the six months ended June 30, 2012, reflects the high volume of SWU sales during the first quarter of 2012, including orders that USEC and customers have advanced from later in 2012 and from 2013.  On March 13, 2012, USEC entered into an agreement with DOE pursuant to which DOE acquired U.S. origin LEU from USEC in exchange for the transfer of quantities of USEC’s depleted uranium tails to DOE. This transaction also had the effect of reducing inventory levels. The advancement of orders may increase SWU and uranium inventories owed to fabricators to the extent that fabricators do not accelerate their bulk delivery orders from USEC to a corresponding degree, thereby using their other inventories to satisfy USEC’s customer order obligations until future bulk deliveries of LEU from USEC to the fabricators are made.

Uranium Provided by Customers and Suppliers

USEC held uranium with estimated values of approximately $2.2 billion at June 30, 2012, and $2.9 billion at December 31, 2011, to which title was held by customers and suppliers and for which no assets or liabilities were recorded on the balance sheet. The reduction reflects a 24% decline in quantities and a 3% decline in the uranium spot price indicator. Utility customers provide uranium to USEC as part of their enrichment contracts. Title to uranium provided by customers generally remains with the customer until delivery of LEU at which time title to LEU is transferred to the customer, and title to uranium is transferred to USEC.

 
11

 

4. PROPERTY, PLANT AND EQUIPMENT

A summary of changes in property, plant and equipment follows (in millions):

   
December 31,
2011
   
Capital Expenditures
(Depreciation)
   
Transfers
and
Retirements
   
June 30,
2012
 
Construction work in progress
  $ 1,111.2     $ 1.0     $ (47.0 )   $ 1,065.2  
Leasehold improvements                                          
    182.9       -       0.6       183.5  
Machinery and equipment
    251.2       0.9       (5.1 )     247.0  
      1,545.3       1.9       (51.5 )     1,495.7  
Accumulated depreciation and amortization
     (358.2 )     (13.8 )      6.9        (365.1 )
    $ 1,187.1     $ (11.9 )   $ (44.6 )   $ 1,130.6  

Capital expenditures include items in accounts payable and accrued liabilities at June 30, 2012 for which cash is paid in subsequent periods.

USEC is working to deploy the American Centrifuge technology at the American Centrifuge Plant (“ACP”) in Piketon, Ohio. Capital expenditures related to the ACP, which are primarily included in the construction work in progress balance, totaled $1.1 billion at June 30, 2012 and December 31, 2011. Capitalized asset retirement obligations included in construction work in progress totaled $19.3 million at June 30, 2012 and December 31, 2011.

Instead of moving forward with a conditional commitment for a loan guarantee for the American Centrifuge project through the DOE Loan Guarantee Program, in the fall of 2011, DOE proposed a two-year cost share research, development and demonstration (“RD&D”) program for the American Centrifuge project. Additional details are provided in Note 12 under “American Centrifuge Plant – Project Funding.” As a result of the shift in focus of the American Centrifuge project, beginning in the fourth quarter of 2011, USEC began spending on the American Centrifuge technology at reduced levels with activities concentrating on development and demonstration. As a result, all project costs incurred since the fourth quarter of 2011 have been expensed, including interest expense that previously would have been capitalized. Capitalization of expenditures related to the ACP has ceased until commercial plant deployment resumes.

On June 12, 2012, USEC through its subsidiary entered into a contract with DOE to transfer to DOE title to the centrifuge machines and equipment produced or acquired under the RD&D program. The transferred property for research, development and demonstration activities include specified existing machines and equipment having a cost of $44.6 million that were transferred in the second quarter of 2012.

USEC believes that future cash flows from the ACP will exceed its capital investment. Since USEC believes its capital investment is fully recoverable, no impairment of the balance of capitalized costs is anticipated at this time. USEC will continue to evaluate this assessment as conditions change, including as a result of activities conducted as part of the RD&D program.


 
12

 

5. DEFERRED REVENUE AND ADVANCES FROM CUSTOMERS

   
June 30,
2012
   
December 31,
2011
 
   
(millions)
 
Deferred revenue
  $ 139.4     $ 181.5  
Advances from customers
    39.5       23.7  
    $ 178.9     $ 205.2  
                 
Deferred costs associated with deferred revenue
  $ 130.8     $ 175.5  

 
Advances from customers included $21.2 million as of June 30, 2012 and $22.3 million as of December 31, 2011 for services to be provided to DOE or to be applied to existing receivables balances due from DOE in USEC’s contract services segment. DOE funded this work through an arrangement whereby DOE transferred uranium to USEC which USEC immediately sold in the market.

Advances from customers as of June 30, 2012 include $16.4 million representing the balance of $26.4 million of initial funding from DOE under the RD&D program. DOE made the $26.4 million available by taking the disposal obligation for a specific quantity of depleted uranium from USEC, which will enable USEC to release encumbered funds for investment in the American Centrifuge technology that USEC had otherwise committed to future depleted uranium disposition obligations. The $26.4 million in encumbered funds are reflected in other long-term assets as deposits for surety bonds as of June 30, 2012. In the third quarter of 2012, surety bonds and related cash deposits are expected to be reduced at which time USEC will receive the cash. As of June 30, 2012, USEC made qualifying American Centrifuge expenditures under the RD&D program of $12.5 million. DOE’s pro-rata share of 80%, or $10.0 million, is recognized as other income in the three and six months ended June 30, 2012.

6. DEBT

Credit Facility

On March 13, 2012, USEC amended and restated its existing $310.0 million credit facility, scheduled to mature on May 31, 2012, to a $235.0 million credit facility that matures on May 31, 2013. The amended and restated credit facility includes a revolving credit facility of $150.0 million (including up to $75.0 million in letters of credit) and a term loan of $85.0 million. The interest rate on the term loan as of June 30, 2012 was 10.5%. Under the amended and restated credit facility, commencing December 3, 2012, the aggregate revolving commitments and term loan principal will be reduced by $5.0 million per month through the expiration of the credit facility.

Utilization of the current credit facility at June 30, 2012 and the former credit facility at December 31, 2011 follows:
   
June 30,
   
December 31,
 
   
2012
   
2011
 
   
(millions)
 
Borrowings under the revolving credit facility
  $ -     $ -  
Term loan due May 31, 2013                                                                       
    85.0       -  
Term loan due May 31, 2012                                                                       
    -       85.0  
Letters of credit                                                                       
    10.8       19.6  
Available credit                                                                       
    94.2       205.4  
 
 
 
13

 
The revolving credit facility contains various reserve provisions that reduce available borrowings under the facility periodically including a permanent availability block under the new amended and restated credit facility equal to $45.0 million. Borrowings under the credit facility are subject to limitations based on established percentages of eligible accounts receivable and USEC-owned inventory pledged as collateral to the lenders. Available credit reflects the levels of qualifying assets at the end of the previous month less any borrowings or letters of credit and reduced by the availability block.

As with the former facility, the amended and restated credit facility is secured by assets of USEC Inc. and its subsidiaries, excluding equity in, and assets of, subsidiaries created to carry out future commercial American Centrifuge activities. The amended and restated credit facility includes various operating and financial covenants that restrict USEC’s ability and the ability of its subsidiaries, to, among other things, incur or prepay other indebtedness, grant liens, sell assets, make investments and acquisitions, consummate certain mergers and other fundamental changes, make certain capital expenditures and declare or pay dividends or other distributions.

The credit facility, as further amended on June 1, 2012, imposes limitations and restrictions on our ability to invest in the American Centrifuge project. Under the amended credit facility, we can invest our 20% share of the costs under the RD&D program (up to $75 million) as long as the amount of expenditures reimbursable to USEC under the RD&D program that have not yet been reimbursed does not exceed $50 million. Aggregate American Centrifuge project expenditures from and after June 1, 2012 may not exceed $375 million and the aggregate amount of American Centrifuge project expenditures from and after June 1, 2012 for which USEC is not entitled to reimbursement under the RD&D program may not exceed $75 million (except for spending needed to carry out a project demobilization or to maintain compliance with legal and regulatory requirements under certain circumstances).

Convertible Senior Notes due 2014

Convertible senior notes amounted to $530.0 million as of June 30, 2012 and December 31, 2011. The convertible senior notes are due October 1, 2014. Interest of 3.0% is payable semi-annually in arrears on April 1 and October 1 of each year. The notes were not eligible for conversion to common stock as of June 30, 2012 or December 31, 2011.

Deferred Financing Costs

Financing costs are generally deferred and amortized over the life of the instrument. A summary of deferred financing costs for the six months ended June 30, 2012 follows (in millions):

   
December 31, 2011
   
Additions
   
Reductions
   
June 30,
 2012
 
Other current assets:
                       
Bank credit facilities
  $ 2.4     $ 9.2     $ (5.0 )   $ 6.6  
                                 
Deferred financing costs (long-term):
                               
Convertible notes
  $ 5.5     $ -     $ (0.9 )   $ 4.6  
ACP project
    6.7       -       (0.1 )     6.6  
Deferred financing costs
  $ 12.2     $ -     $ (1.0 )   $ 11.2  


 
14

 

7. FAIR VALUE MEASUREMENTS

Pursuant to the accounting guidance for fair value measurements, fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, consideration is given to the principal or most advantageous market and assumptions that market participants would use when pricing the asset or liability.

Fair Value Hierarchy

The accounting guidance for fair value measurement also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard establishes a fair value hierarchy based on the level of independent, objective evidence surrounding the inputs used to measure fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is as follows:

Level 1 – quoted prices in active markets for identical assets or liabilities.
•   
Level 2 – inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3 – unobservable inputs in which little or no market data exists.

Financial Instruments Recorded at Fair Value

   
Fair Value Measurements
(in millions)
 
   
June 30, 2012
   
December 31, 2011
 
   
Level 1
   
Level 2
   
Level 3
   
Total
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Assets:
                                               
Cash equivalents (a)
    -     $ 228.6       -     $ 228.6       -     $ 37.4       -     $ 37.4  
Deferred compensation asset (b)
    -       2.6       -       2.6       -       2.3       -       2.3  
                                                                 
Liabilities:
                                                               
Deferred compensation obligation (b)
    -       2.9       -       2.9       -       2.6       -       2.6  
 

(a)   Cash equivalents consist of funds invested in institutional money market funds. These investments are classified within Level 2 of the valuation hierarchy because unit prices of institutional funds are not quoted in active markets.
(b)   The deferred compensation obligation represents the balance of deferred compensation plus net investment earnings. The deferred compensation plan is informally funded through a rabbi trust using variable universal life insurance. The cash surrender value of the life insurance policies is designed to track the deemed investments of the plan participants. Investment crediting options consist of institutional and retail investment funds. The deemed investments are classified within Level 2 of the valuation hierarchy because (i) of the indirect method of investing and (ii) unit prices of institutional funds are not quoted in active markets.
 
 
 

 
15

 

Other Financial Instruments

As of June 30, 2012 and December 31, 2011, the balance sheet carrying amounts for accounts receivable and accounts payable and accrued liabilities (excluding the deferred compensation obligation described above), and payables under the commercial agreement (the “Russian Contract”) with a Russian government entity known as Techsnabexport (“TENEX”) approximate fair value because of the short-term nature of the instruments.

The balance sheet carrying amounts and estimated fair values of USEC’s debt follow (in millions):
 
   
June 30, 2012
   
December 31, 2011
 
   
Carrying Value
   
Fair
Value
   
Carrying Value
   
Fair
Value
 
Credit facility term loan due May 31, 2013
  $ 85.0     $ 87.2       -       -  
Credit facility term loan due May 31, 2012
    -       -     $ 85.0     $ 72.8  
Convertible preferred stock
    94.4       94.4       88.6       88.6  
3.0% convertible senior notes, due October 1, 2014
    530.0       259.7       530.0       246.1  

The estimated fair values of the term loans are based on the change in market value of an index of loans of similar credit quality based on published credit ratings, and are classified as using Level 2 inputs in the fair value measurement.

The convertible preferred stock can be converted or sold at the holder’s option and is classified as a current liability at the redemption value. The estimated fair value of the convertible preferred stock is based on a market approach using a discount rate of 12.75%, which is unobservable (Level 3) since the instruments do not trade. Dividends on the convertible preferred stock are paid (or accrued and are added to the liquidation preference of the convertible preferred stock) as additional shares of convertible preferred stock on a quarterly basis at an annual rate of 12.75%, which is consistent with current market prices and other market benchmarks. The estimated fair value equals the redemption value of $1,000 per share. If a share issuance limitation were to exist at the time of share conversion or sale, any preferred stock shares subject to the share issuance limitation would be subject to optional or mandatory redemption for, at USEC's option, cash or SWU consideration. However, USEC’s ability to redeem may be limited by Delaware law, and if not limited may result in mandatory prepayment of USEC’s credit facility.

The estimated fair value of the convertible notes is based on the trading price as of the balance sheet date, and is classified as using Level 1 inputs in the fair value measurement.


 
16

 

8. PENSION AND POSTRETIREMENT HEALTH AND LIFE BENEFITS

The components of net benefit costs for pension and postretirement health and life benefit plans were as follows (in millions):
 
 
 
Defined Benefit Pension Plans
   
 Postretirement Health and Life Benefits Plans
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
   
2012
   
2011
   
2012
   
2011
 
Service costs
  $ 3.7     $ 3.2     $ 7.3     $ 8.0     $ 0.9     $ 1.4     $ 1.8     $ 2.7  
Interest costs
    12.0       12.5       24.1       25.1       2.8       3.1       5.6       6.1  
Expected return on plan assets
(gains)
    (13.0 )     (13.5 )     (26.0 )     (26.9 )     (0.7 )     (0.9 )     (1.4 )     (1.8 )
Amortization of prior service costs
    0.4       0.4       0.8       0.8       -       -       -       -  
Amortization of actuarial losses
    4.9       2.2       9.8       4.7       1.1       0.6       2.2       1.3  
Curtailment losses
    -       -       -       3.2       -       1.9       -       1.9  
Net benefit costs
  $ 8.0     $ 4.8     $ 16.0     $ 14.9     $ 4.1     $ 6.1     $ 8.2     $ 10.2  

USEC expects to contribute $15.9 million to the defined benefit pension plans in 2012, consisting of $12.5 million of required contributions under the Employee Retirement Income Security Act (“ERISA”) and $3.4 million to non-qualified plans. USEC has contributed $11.2 million in the six months ended June 30, 2012. These expected contribution amounts reflect the recently enacted Moving Ahead for Progress in the 21st Century Act (MAP-21) which reduced the required contributions under ERISA in 2012 by an estimated $10.7 million.

There is no required contribution for the postretirement health and life benefit plans under ERISA and USEC expects to contribute $1.4 million later in 2012. Certain contributions to the plans are recoverable under USEC’s contracts with DOE. USEC receives federal subsidy payments for sponsoring prescription drug benefits that are at least actuarially equivalent to Medicare Part D.

Prior to the start of 2012, a significant portion of the costs related to pension and postretirement health and life benefit plans were attributed to Portsmouth contract services, based on the employee base performing contract services work. Starting in 2012, ongoing pension costs related to our former Portsmouth employees are charged to the LEU segment rather than the contract services segment based on our continuing enrichment operations that support our active and retired employees. These net benefit costs totaled $6.6 million for the six months ended June 30, 2012 and are directly charged to cost of sales rather than production.

 
17

 

9. STOCK-BASED COMPENSATION

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(millions)
 
Total stock-based compensation costs:
                       
Restricted stock and restricted stock units
  $ 1.3     $ 2.1     $ 2.5     $ 4.4  
Stock options, performance awards and other
    0.2       0.3       0.5       0.8  
Less: costs capitalized as part of inventory
    (0.1 )     (0.1 )     (0.1 )     (0.4 )
Expense included in selling, general and administrative and advanced technology costs
  $ 1.4     $ 2.3     $ 2.9     $ 4.8  
Total recognized tax benefit
  $ -     $ 0.8     $ -     $ 1.7  

The total recognized tax benefit is reported at the federal statutory rate net of the tax valuation allowance in 2012.

Stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized over the requisite service period, which is either immediate recognition if the employee is eligible to retire, or on a straight-line basis until the earlier of either the date of retirement eligibility or the end of the vesting period. As of June 30, 2012, there was $4.3 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based payments granted, of which $3.9 million relates to restricted shares and restricted stock units, and $0.4 million relates to stock options. That cost is expected to be recognized over a weighted-average period of 1.7 years.

On February 15, 2012, USEC’s Board of Directors voted to discontinue USEC’s employee stock purchase plan effective immediately. Given the recent volatility of USEC stock and the holding requirement for all shares purchased through the plan, the Board determined that it was prudent to discontinue the Program and refund all amounts credited to participants’ accounts to date for the offering period January 1, 2012 through June 30, 2012.



 
18

 

10. NET INCOME (LOSS) PER SHARE

Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period, excluding any unvested restricted stock. In calculating diluted net income (loss) per share, the numerator is increased by interest expense on the convertible notes, net of amount capitalized and net of tax, and the denominator is increased by the weighted average number of shares resulting from potentially dilutive securities, assuming full conversion, consisting of stock compensation awards, convertible notes, convertible preferred stock and warrants. No dilutive effect is recognized in a period in which a net loss has occurred.
 

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(millions)
 
Numerator:
                       
Net (loss)      
  $ (92.0 )   $ (21.2 )   $ (120.8 )   $ (37.8 )
Net interest expense on convertible notes and convertible preferred stock dividends (a)
 
(b)
   
(b)
   
(b)
   
(b)
 
Net (loss) if-converted                                                                         
  $ (92.0 )   $ (21.2 )   $ (120.8 )   $ (37.8 )
                                 
Denominator:
                               
Weighted average common shares       
    124.3       122.8       123.7       122.1  
Less: Weighted average unvested restricted stock
    2.6       1.7       1.7       1.8  
Denominator for basic calculation         
    121.7       121.1       122.0       120.3  
                                 
Weighted average effect of dilutive securities:
                               
Stock compensation awards         
    -       0.1       -       3.1  
Convertible notes        
    44.3       44.3       44.3       44.6  
Convertible preferred stock:
                               
Equivalent common shares (c)       
    76.7       17.4       22.8       15.5  
Less: share issuance limitation (d)    
    53.9       -       -        -  
Net allowable common shares       
    22.8       17.4       22.8       15.5  
Subtotal                                                                         
    67.1       61.8       67.1       63.2  
Less: shares excluded in a period of a net loss 
    67.1       61.8       67.1       63.2  
Weighted average effect of dilutive securities  
    -       -       -        -  
Denominator for diluted calculation       
    121.7       121.1       122.0       120.3  
                                 
Net (loss) per share – basic                                                                             
  $ (.76 )   $ (.18 )   $ (.99 )   $ (.31 )
Net (loss) per share – diluted                                                                             
  $ (.76 )   $ (.18 )   $ (.99 )   $ (.31 )

(a)  
Interest expense on convertible notes and convertible preferred stock dividends net of amount capitalized and net of tax. The total recognized tax benefit is reported at the federal statutory rate net of the tax valuation allowance in 2012. See note (b) below.
 
(b)  
No dilutive effect is recognized in a period in which a net loss has occurred. Net interest expense on convertible notes and convertible preferred stock dividends was $4.8 million in the three months ended June 30, 2012 and $9.5 million in the six months ended June 30, 2012. There was no net interest expense in the three and six months ended June 30, 2011.
 
(c)  
The number of equivalent common shares for the convertible preferred stock is based on the arithmetic average of the daily volume weighted average prices per share of common stock for each of the last 20 trading days, and is determined as of the beginning of the period for purposes of calculating diluted net income (loss) per share.
 
(d)  
Prior to obtaining shareholder approval, the preferred stock may not be converted into an aggregate number of shares of common stock in excess of 19.99% of the shares of our common stock outstanding on May 25, 2010 (approximately 22.8 million shares), in compliance with the rules of the New York Stock Exchange. If a share issuance limitation were to exist at the time of share conversion or sale, any preferred stock shares subject to the share issuance limitation would be subject to optional or mandatory redemption for, at USEC's option, cash or SWU consideration. However, USEC’s ability to redeem may be limited by Delaware law, and if not limited may result in mandatory prepayment of USEC’s credit facility.
 
 
 
19

 
 
Options and warrants to purchase shares of common stock having an exercise price greater than the average share market price are excluded from the calculation of diluted net income (loss) per share (options and warrants in millions):
 
Three Months Ended June 30,
Six Months Ended June 30,
 
2012
2011
2012
2011
Options excluded from diluted net (loss) per share
2.9
2.2
2.9
2.2
Warrants excluded from diluted net (loss) per share
6.3
6.3
6.3
6.3
Exercise price of excluded options
$3.72 to
$5.00 to
$3.72 to
$5.00 to
 
$14.28
$14.28
$14.28
$14.28
Exercise price of excluded warrants
$7.50
$7.50
$7.50
$7.50


11. WORKFORCE REDUCTIONS AND ADVISORY COSTS

USEC’s business is in a state of significant transition. In early 2012, USEC initiated an internal review of its organizational structure and engaged a management consulting firm to support this review. Costs for the management consulting firm and other advisors totaled $1.5 million in the second quarter of 2012 and $6.0 million in the six months ended June 30, 2012, and was mostly paid as of June 30, 2012.

Actions taken to-date related to USEC’s organizational structure resulted in workforce reductions at the American Centrifuge design and engineering operations in Oak Ridge, Tennessee, at the headquarters operations located in Bethesda, Maryland and at the central services operations located in Piketon, Ohio. The reductions to-date involved 45 employees including two senior corporate officers. A charge of $1.9 million was incurred in the first quarter of 2012 and $1.7 million in the second quarter of 2012 for one-time termination benefits consisting of severance payments, short-term health care coverage and immediate vesting of restricted stock for certain employees. Related cash expenditures of $0.7 million were incurred in the first quarter of 2012 and $2.2 million were incurred in the second quarter of 2012. The remaining cash expenditures are expected primarily in the latter half of 2012. Additional actions affecting employees to align the organization with our evolving business environment are expected.

12. COMMITMENTS AND CONTINGENCIES

Power Contract

On May 15, 2012, the power purchase agreement with TVA was amended to extend its term and TVA and USEC entered into a supplemental confirmation agreement pursuant to the amended power purchase agreement for USEC to purchase the power needed to operate the Paducah GDP during the one-year term of the depleted uranium enrichment agreement with Energy Northwest.  Under this supplemental agreement, USEC has a take or pay obligation to purchase electricity during June - September 2012 at monthly amounts increasing from approximately 750 to 1,250 megawatts and then at 1,500 megawatts for the remaining months of the contract, less a 25% reduction in May 2013 to provide a transition in power delivery. As of June 30, 2012, USEC is obligated to make minimum payments under the supplemental agreement and the amended power purchase agreement of approximately $0.5 billion through May 2013. USEC’s costs are subject to monthly fuel cost adjustments to reflect changes in TVA's fuel costs, purchased power costs, and related costs. However, these fuel cost adjustments are passed through to Energy Northwest under the depleted uranium enrichment agreement.  USEC has the right to terminate its power purchase obligations under the supplemental agreement if Energy Northwest terminates the depleted uranium enrichment agreement, or fails to deliver depleted uranium or to meet its payment obligations, and USEC ceases enrichment operations at Paducah as a result. In such a case, USEC will agree with TVA on a schedule to reduce to zero over a period of thirty days all power purchases in a manner that ensures safe and reliable operation of Paducah.

 
 
20

 
 
American Centrifuge Plant

Project Funding

USEC needs significant additional financing in order to complete the American Centrifuge Plant (“ACP”). USEC believes a loan guarantee under the DOE Loan Guarantee Program, which was established by the Energy Policy Act of 2005, is essential to obtaining the funding needed to complete the ACP. In July 2008, USEC applied under the DOE Loan Guarantee Program for $2 billion in U.S. government guaranteed debt financing for the ACP.  As discussed in Note 4, instead of moving forward with a conditional commitment for a loan guarantee, in the fall of 2011, DOE proposed a two-year RD&D program for the project. DOE indicated that USEC’s application for a DOE loan guarantee would remain pending during the RD&D program but has given USEC no assurance that a successful RD&D program will result in a loan guarantee. Additional capital beyond the $2 billion of DOE loan guarantee funding that USEC has applied for and USEC’s internally generated cash flow will be required to complete the project. USEC has had discussions with Japanese export credit agencies regarding financing up to $1 billion of the cost of completing the ACP. Additional capital will also be needed and the amount of additional capital is dependent on a number of factors, including the amount of any revised cost estimate and schedule for the project, the amount of contingency or other capital DOE may require as part of a loan guarantee, and the amount of the DOE credit subsidy cost that would be required to be paid in connection with a loan guarantee.  USEC has no assurances that it will be successful in obtaining this financing and that the delays it has experienced will not adversely affect these efforts. If conditions change and deployment of the ACP becomes no longer probable or becomes delayed significantly from USEC’s current expectations, USEC could expense up to the full amount of previously capitalized costs related to the ACP of up to $1.1 billion. Events that could impact USEC’s views as to the probability of deployment or USEC’s projections include progress in meeting the technical milestones of the RD&D program, the status of continued DOE funding for the RD&D program, changes in USEC’s anticipated ownership of or role in the project, changes in the cost estimate and schedule for the project, and prospects for obtaining a loan guarantee and other financing needed to deploy the project.

The objectives of the RD&D program are (1) to demonstrate the American Centrifuge technology through the construction and operation of a cascade of 120 commercial centrifuge machines and (2) to sustain the domestic U.S. centrifuge technical and industrial base for national security purposes and potential commercialization of the American Centrifuge project. This includes activities to reduce the risks and improve the future prospects of deployment of the American Centrifuge technology. USEC intends to meet these objectives through the construction and operation of one complete demonstration cascade of 120 commercial centrifuge machines and supporting infrastructure. This will enable us to demonstrate redundancy of the primary cascade support systems for commercial plant operation and to complete integrated testing against operational requirements.

USEC began funding the RD&D program in January 2012 and has been building machines and parts for the demonstration cascade. On June 12, 2012, USEC and DOE entered into a cooperative agreement to provide funding for the RD&D program. The cooperative agreement provides for 80% DOE and 20% USEC cost sharing for work performed during the period June 1, 2012 through December 31, 2013 with a total estimated cost of $350 million. DOE’s total contribution would be up to $280 million and USEC’s contribution would be up to $70 million. USEC’s 20% contribution will include investments made by USEC commencing June 1, 2012.  DOE’s contribution will be incrementally funded and is limited to $87.7 million until DOE provides authorization for additional funding.  DOE funding through July 31, 2012 was $26.4 million. On July 31, 2012, DOE authorized an additional $61.3 million of funding (for a total of $87.7 million).  The remaining funding of $192.3 million from DOE has not yet been authorized and is subject to Congressional appropriations, Congressional transfer or reprogramming authority to permit the use by DOE of funds previously appropriated for other programs, or other sources available to DOE and therefore it is possible that this additional funding may not be made available.

 
 
21

 
DOE provided the initial $87.7 million of funding by accepting title to quantities of depleted uranium that will enable USEC to release encumbered funds for approximately 80% of the allowable costs of the RD&D program up to $87.7 million. As described in Note 5, USEC receives the cash when the surety bonds and related cash deposits providing the financial assurance for disposition of this depleted uranium are reduced.

Under the cooperative agreement, USEC and USEC’s newly created subsidiary American Centrifuge Demonstration, LLC (“ACD”) will carry out the RD&D program. ACD is putting in place a program management and enhanced program execution structure as required by the cooperative agreement.  On July 23, 2012, USEC entered into a limited liability company agreement for ACD which, among other things, establishes a board of managers in accordance with the enhanced program execution structure. The seven-person board is comprised of two independent managers, two managers appointed by USEC, and one manager appointed by each of Babcock & Wilcox Technical Services Group, Inc., Toshiba America Nuclear Energy Corporation and Exelon Generation Company, LLC.

The cooperative agreement also includes five technical milestones for the RD&D program. On June 27, 2012, USEC achieved the first technical milestone related to the finalization of a test program plan for the remaining technical milestones and for full system reliability and plant availability.  Submittal of a more detailed cost and schedule for the RD&D program, including the dates for the technical milestones, was also a condition to DOE providing funding beyond the initial $26.4 million of funding. On July 24, 2012, USEC submitted the required information.  DOE has the right to terminate the cooperative agreement if any of these technical milestones are not met on or before the agreed date for such milestones. DOE also has the right to terminate the cooperative agreement if USEC materially fails to comply with the other terms and conditions of the cooperative agreement.  Failure to meet the technical milestones under the cooperative agreement could provide a basis for DOE to exercise its remedies under the 2002 DOE-USEC Agreement (as defined below).

On June 12, 2012, USEC through its subsidiary also entered into a contract with DOE to transfer to DOE title to the centrifuge machines and equipment produced or acquired under the RD&D program. The transferred property includes some existing machines and equipment and, at DOE’s option, the machines and equipment produced or acquired under the cooperative agreement. As compensation for the sale of the transferred property, (1) DOE will make the transferred property available for no additional fee as leased personal property under the lease agreement between DOE and USEC for the facilities at Piketon, Ohio for the American Centrifuge Plant, and (2) at financial closing on the financing for the construction of the American Centrifuge Plant, title to the transferred property will transfer to the lessee under and in accordance with the terms of the lease agreement.  If USEC abandons the centrifuge technology and returns the premises leased under the DOE lease agreement, DOE will keep the transferred property and would be responsible for its disposal.


 
22

 

Milestones under the 2002 DOE-USEC Agreement

On June 12, 2012, USEC and DOE entered into an amendment to the agreement dated June 17, 2002 between DOE and USEC (such agreement, as amended, the “2002 DOE-USEC Agreement”). Under the 2002 DOE-USEC Agreement, USEC and DOE made long-term commitments directed at resolving issues related to the stability and security of the domestic uranium enrichment industry.
The agreement provides that USEC will develop, demonstrate and deploy the American Centrifuge technology in accordance with milestones and provides for remedies in the event of a failure to meet a milestone under certain circumstances. The June 2012 amendment adds two new milestones related to the RD&D program and revises the remaining four milestones under the 2002 agreement relating to the financing and operation of the American Centrifuge Plant to be aligned with the RD&D program.

USEC also granted to DOE an irrevocable, non-exclusive right to use or permit third parties on behalf of DOE to use all American Centrifuge technology intellectual property (“Centrifuge IP”) royalty free for U.S. government purposes (which includes completion of the cascade demonstration test program and national defense purposes, including providing nuclear material to operate commercial nuclear power reactors for tritium production).  USEC also granted an irrevocable, non-exclusive license to DOE to use such Centrifuge IP developed at USEC’s expense for commercial purposes (including a right to sublicense), which may be exercised only if USEC misses any of the milestones under the 2002 DOE-USEC Agreement or if USEC (or an affiliate or entity acting through USEC) is no longer willing or able to proceed with, or has determined to abandon or has constructively abandoned, the commercial deployment of the centrifuge technology.  Such commercial purposes licenses are subject to payment of a reasonable royalty to USEC, which shall not exceed $665 million.

The 2002 DOE-USEC Agreement provides DOE with specific remedies if USEC fails to meet a milestone that would materially impact USEC’s ability to begin commercial operations of the American Centrifuge Plant on schedule and such delay was within USEC’s control or was due to USEC’s fault or negligence. These remedies could include terminating the 2002 DOE-USEC Agreement, revoking USEC’s access to DOE’s U.S. centrifuge technology that USEC requires for the success of the American Centrifuge project and requiring USEC to transfer certain of its rights in the American Centrifuge technology and facilities to DOE, and to reimburse DOE for certain costs associated with the American Centrifuge project. DOE could also recommend that USEC be removed as the sole U.S. Executive Agent under the nonproliferation program between the United States and the Russian Federation known as “Megatons to Megawatts,” which could affect USEC’s access to Russian LEU under the Megatons to Megawatts program in 2013.  Any of these remedies under the 2002 DOE-USEC Agreement could have a material adverse impact on USEC’s business.

The 2002 DOE-USEC Agreement provides that if a delaying event beyond the control and without the fault or negligence of USEC occurs which would affect USEC’s ability to meet an ACP milestone, DOE and USEC will jointly meet to discuss in good faith possible adjustments to the milestones as appropriate to accommodate the delaying event.

USEC’s right to continue operating the Paducah GDP under its lease with DOE is not subject to meeting the ACP milestones. In addition, the new 10-year commercial supply agreement entered into on March 23, 2011 with TENEX is not subject to any of the remedies related to the ACP under the 2002 DOE-USEC Agreement.


 
23

 

NYSE Listing Notice

On May 8, 2012, USEC received notice from the New York Stock Exchange (“NYSE”) that the average closing price of its common stock was below the NYSE’s continued listing criteria relating to minimum share price.  Rule 802.01C of the NYSE’s Listed Company Manual requires that a company’s common stock trade at a minimum average closing price of $1.00 over a consecutive 30 trading-day period.  In accordance with the NYSE’s rules, on May 14, 2012, USEC provided written notice to the NYSE of its intent to cure this deficiency. USEC is evaluating its options to cure the price deficiency, including a reverse stock split, which would require shareholder approval at or prior to USEC’s next annual meeting of shareholders. USEC has six months from receipt of the notice to regain compliance with the NYSE’s price criteria (or by no later than USEC’s next annual meeting of shareholders if shareholder approval is required). Subject to the NYSE’s rules, during the cure period, USEC’s common stock will continue to be listed and trade on the NYSE, subject to its continued compliance with the NYSE’s other applicable listing rules. USEC is currently in compliance with all other NYSE listing rules.

USEC can regain compliance at any time during the six-month cure period if on the last trading day of a calendar month during the cure period, USEC has a closing share price of at least $1.00 and an average closing share price of at least $1.00 over the 30 trading-day period ending on the last trading-day of that month or on the last day of the cure period.  If USEC effectuates a reverse stock split vote by no later than the next annual meeting of shareholders to cure the condition, the condition will be deemed cured if the price promptly exceeds $1.00 per share, and the price remains above the level for at least the following 30 trading days.

Legal Matters

USEC is subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, USEC does not believe that the outcome of any of these legal matters will have a material adverse effect on its results of operations, cash flows or financial condition.

On June 27, 2011, a complaint was filed in the United States District Court for the Southern District of Ohio, Eastern Division, against USEC by a former Portsmouth GDP employee claiming that USEC owes severance benefits to him and other similarly situated employees that have transitioned or will transition to the DOE decontamination and decommissioning (“D&D”) contractor. The plaintiff amended its complaint on August 31, 2011 and February 10, 2012, among other things, to limit the purported class of similarly situated employees to salaried employees at the Portsmouth site who transitioned to the D&D contractor and are allegedly eligible for or owed benefits. USEC believes it has meritorious defenses against the suit and has not accrued any amounts for this matter. An estimate of the possible loss or range of loss from the litigation is difficult to make because, among other things, (i) the plaintiff has failed to state the amount of damages sought, (ii) the plaintiff purports to represent a class of claimants the size and composition of which remains unknown and (iii) the certification of the class is uncertain. However, USEC estimates that the total severance liability for the approximately 400 salaried employees at the Portsmouth site that transitioned to the DOE D&D contractor would have been approximately $14 million if severance was required to be paid to all of these employees. In such an event, DOE would have owed a portion of this amount, estimated at approximately $9 million, assuming DOE was responsible for periods both during which it operated the facility and under which USEC was a direct contractor to DOE.


 
24

 

13. SEGMENT INFORMATION

USEC has two reportable segments:  the LEU segment with two components, SWU and uranium, and the contract services segment.  The LEU segment is USEC’s primary business focus and includes sales of the SWU component of LEU, sales of both the SWU and uranium components of LEU, and sales of uranium. The contract services segment includes nuclear energy services and technologies provided by NAC International Inc. as well as work performed for DOE and DOE contractors at the Portsmouth site and the Paducah GDP.  Gross profit is USEC’s measure for segment reporting. Intersegment sales were less than $0.1 million in each period presented below and have been eliminated in consolidation.

   
Three Months Ended
  June 30,
   
Six Months Ended
 June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(millions)
 
Revenue
                       
LEU segment:
                       
Separative work units
  $ 347.2     $ 330.3     $ 885.1     $ 638.8  
Uranium
    3.6       67.8       3.6       81.8  
      350.8       398.1       888.7       720.6  
Contract services segment
    14.0       56.3       37.6       114.3  
    $ 364.8     $ 454.4     $ 926.3     $ 834.9  
                                 
Segment Gross Profit
                               
LEU segment
  $ 10.4     $ 29.5     $ 47.1     $ 44.8  
Contract services segment
    1.9       3.7       4.0       2.3  
Gross profit
    12.3       33.2       51.1       47.1  
Advanced technology costs
    85.7       33.5       122.5       60.2  
Selling, general and administrative
    14.8       16.7       29.7       32.2  
Special charge for workforce reductions and advisory costs 
    3.2       -       9.6       -  
Other (income) (a)
    (10.0 )     -       (10.0 )     (3.7 )
Operating (loss)
    (81.4 )     (17.0 )     (100.7 )     (41.6 )
Interest expense (income), net
    12.6       -       25.2       (0.2 )
(Loss) before income taxes
  $ (94.0 )   $ (17.0 )   $ (125.9 )   $ (41.4 )


(a)  
Other income in the three and six months ended June 30, 2012 consists of pro-rata cost sharing support from DOE of $10.0 million for partial funding of American Centrifuge activities. See Note 5.

Other income in the six months ended June 30, 2011 includes a gain on debt extinguishment of $3.1 million in connection with USEC’s exchange with a noteholder whereby USEC received convertible notes with a principal amount of $45 million in exchange for 6,952,500 shares of common stock and cash for accrued but unpaid interest on the convertible notes.


 
25

 

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with, and is qualified in its entirety by reference to, the consolidated condensed financial statements and related notes set forth in Part I, Item 1 of this report as well as the risks and uncertainties presented in Part II, Item 1A of this report and Part I, Item IA of the annual report on Form 10-K for the year ended December 31, 2011.


Overview

USEC, a global energy company, is a leading supplier of low enriched uranium (“LEU”) for commercial nuclear power plants. LEU is a critical component in the production of nuclear fuel for reactors to produce electricity. We:
 
·  
supply LEU to both domestic and international utilities for use in about 150 nuclear reactors worldwide;
 
·  
enrich uranium at the Paducah gaseous diffusion plant (“GDP”) that we lease from the U.S. Department of Energy (“DOE”);
 
·  
are the exclusive executive agent for the U.S. government under a nuclear nonproliferation program with Russia, known as Megatons to Megawatts;
 
·  
are working to deploy what we believe is the world’s most advanced uranium enrichment technology, known as the American Centrifuge;
 
·  
provide transportation and storage systems for spent nuclear fuel and provide nuclear and energy consulting services; and
 
·  
perform limited contract work for DOE and its contractors at the Paducah and Portsmouth sites.
 

LEU consists of two components: separative work units (“SWU”) and uranium. SWU is a standard unit of measurement that represents the effort required to transform a given amount of natural uranium into two components: enriched uranium having a higher percentage of U235 and depleted uranium having a lower percentage of U235. The SWU contained in LEU is calculated using an industry standard formula based on the physics of enrichment. The amount of enrichment deemed to be contained in LEU under this formula is commonly referred to as its SWU component and the quantity of natural uranium deemed to be used in the production of LEU under this formula is referred to as its uranium component.

We produce or acquire LEU from two principal sources. We produce about half of our supply of LEU at the Paducah GDP in Paducah, Kentucky, and we acquire the other portion under a contract with Russia (the “Russian Contract”) under the Megatons to Megawatts program. Under the Russian Contract, we purchase the SWU component of LEU derived from dismantled nuclear weapons from the former Soviet Union for use as fuel in commercial nuclear power plants.

Our View of the Business Today

The aftermath of the March 2011 earthquake and tsunami in Japan that irreparably damaged four nuclear reactors at Fukushima continues to affect our business. Although long-term forecasts continue to suggest growth in uranium enrichment demand, the impact of Fukushima has resulted in excess supply. Although two reactors have been restarted in Japan, the process of restarting reactors has taken longer than expected and more than 50 reactors were off-line in Japan and Germany during the second quarter.  Japan has significantly increased its purchases of fossil fuels, primarily oil and liquefied natural gas, to offset a portion of its unavailable nuclear power capacity, but concerns about a severe power shortage during the summer remain. These prolonged outages have resulted in excess SWU supply in the market, and this imbalance between supply and demand for LEU could increase over time depending on the length and severity of delays or cancellations of deliveries. In addition to the shutdown of reactors in Japan, following the events at Fukushima, Germany shut down eight of its reactors and announced that it will be phasing out all 17 nuclear reactors by 2022. Although we do not serve any of the German reactors, our European competitors that serve the German reactors now have excess nuclear fuel available to sell, further adding to the excess supply in the market. Based on the current lack of near-term demand, excess supply in the market and uncertainty regarding the pace of restarting reactors in Japan, we foresee an unfavorable imbalance between supply and demand for LEU until at least the second half of the decade.

 
 
26

 
 
These market conditions have challenged our efforts to continue enrichment operations at the Paducah GDP. On May 15, 2012, we entered into a multi-party arrangement with Energy Northwest, the Bonneville Power Administration, the Tennessee Valley Authority and DOE to support a one-year extension of enrichment operations at the Paducah plant. Additional details are provided below under “Paducah Gaseous Diffusion Plant.”

We believe that nuclear power is an essential component of the world’s electricity generation mix. There is a global fleet of approximately 430 nuclear reactors that provide about 14% of the world’s electricity. The United States has the largest number of reactors with 104 operating units that provide approximately 20% of the nation’s electricity. We see continued growth in the number of nuclear power reactors internationally, but that growth may be at a slower pace than previously anticipated and much of the anticipated growth is in emerging markets that may be more difficult for us to enter. According to the World Nuclear Association, six new reactors went on line in 2011 and more than 60 reactors are currently under construction, including 26 that are expected to be operational by the end of 2013. Completing all of the reactors currently under construction would add about 7 million SWU of annual demand, or a 14% increase to annual demand for enrichment. Another 500 reactors have been ordered, planned or proposed to be in operation by 2030. In China alone, two dozen new units are being built and another 50 reactors are in the planning stage.

We have been working to deploy a highly efficient centrifuge plant in Piketon, Ohio to meet the global need for nuclear fuel, provide a path to long-term profitability for our shareholders and assure that the United States has a domestically owned and operated source of uranium enrichment. We are working on a research, development and demonstration (“RD&D”) program proposed by DOE for our American Centrifuge technology. We have been funding the RD&D program on our own since January as we worked to secure DOE funding for the program and on June 12, 2012, we finalized a cooperative agreement with DOE to provide the initial phase of this funding. However, DOE has not yet authorized funding for the RD&D program beyond November 2012 and we could demobilize the American Centrifuge project if additional funding for the RD&D program is not obtained this year. We could also take actions to restructure the project that could result in changes in our anticipated ownership of or role in the project. Additional details are provided below under “The American Centrifuge Plant.”

By the end of 2013, we will also be completing the highly successful 20-year Megatons to Megawatts program which has provided half of our LEU supply in recent years. In 2011, we entered into a 10-year contract to maintain access to Russian LEU supplies and to assist in the transition from the Paducah GDP to the American Centrifuge Plant ("ACP"). Additional details are provided below under “Russian Supply Transition.”

This period of transition from the gaseous diffusion technology used at the Paducah plant to the American Centrifuge technology will be challenging for USEC as we face significant competitive and cost pressures. As we cease enrichment operations at Paducah, we need to attract and retain highly skilled workers to deploy the American Centrifuge technology but we must also address the size of our support structure as we expect to sell significantly less SWU during this transition period. We are evaluating our corporate organizational structure and have taken initial steps to reduce costs.  We are also evaluating how best to manage the potential costs associated with a shutdown of Paducah operations, including how to address our pension and post-retirement health and life benefit plan funding obligations and how to minimize other ongoing costs.  In light of the uncertainties and challenges facing us and our desire to improve our credit profile and our ability to successfully finance the American Centrifuge project, we may pursue discussions with certain creditors and key stakeholders regarding ways to improve our capital structure, including the potential restructuring of our balance sheet.
 

 
 
27

 
Organizational Structure Review

During 2011, the company reduced the number of total employees by approximately one-third as we concluded much of the contract services work being performed at the former Portsmouth gaseous diffusion plant and most of these employees transitioned to DOE’s decontamination and decommissioning contractor at the site.

In early 2012, we initiated an internal review of our organizational structure and engaged a management consulting firm to support the review. We expect to reduce significantly the size of our workforce and corporate-wide organization costs over time. Actions taken to-date related to our organizational structure resulted in workforce reductions at the American Centrifuge design and engineering operations in Oak Ridge, Tennessee, at the headquarters operations located in Bethesda, Maryland and at the central services operations located in Piketon, Ohio. The reductions to-date involved 45 employees including two senior corporate officers. A charge of $1.9 million was incurred in the first quarter of 2012 and $1.7 million in the second quarter of 2012 for one-time termination benefits consisting of severance payments and short-term health care coverage.

Additional actions affecting employees to align the organization with our evolving business environment are expected, which could result in additional charges. We continue to evaluate opportunities to streamline corporate overhead and anticipate potential workforce reductions at our Paducah site as our operations transition over time. We will also be working to assure that the company has adequate resources to execute and complete the RD&D program, and that we are positioned for commercial deployment of our American Centrifuge technology.

Paducah Gaseous Diffusion Plant

Delays in financing construction of the American Centrifuge Plant have made continued efficient operation of our current enrichment plant an important element of our business as we transition to centrifuge production. Without enrichment operations at Paducah, we will cease commercial enrichment of uranium during this transition period and our supply of LEU will be limited to inventory on hand and Russian commercial supply under the commercial agreement we entered into in March 2011 for the supply of commercial Russian LEU (the “Russian Supply Agreement”) and inventories of Russian LEU delivered to us under the Russian Contract prior to its completion. As we look to transition Paducah operations, we are seeking to minimize the amount of time we will be without a source of domestic U.S. enrichment production. Absent a definitive timeline for ACP deployment, this could adversely affect our efforts to pursue the American Centrifuge project, to implement the Russian Supply Agreement or to pursue other options, and could threaten our overall viability.

On May 15, 2012, we entered into a multi-party arrangement with (1) Energy Northwest, a West Coast power supplier, (2) the Bonneville Power Administration (“BPA”), a federal agency within DOE, (3) the Tennessee Valley Authority (“TVA”), a federally owned corporation and supplier of power to the Paducah plant, and (4) DOE to enrich depleted uranium.  The volume of enrichment under this arrangement is sufficient to support a one-year extension of enrichment operations at the Paducah GDP through May 31, 2013.  Under the agreements that are part of this arrangement, DOE will provide high-assay depleted uranium hexafluoride, also known as tails, to Energy Northwest. Energy Northwest has contracted with USEC to enrich the tails into low enriched uranium. We have received approximately 50% of the tails at the Paducah GDP as of the end of July 2012. Energy Northwest will use a portion of the low enriched uranium for its Columbia Nuclear Generating Station and will sell the remainder of the U.S.-origin low enriched uranium to TVA. The fuel will be used in TVA’s reactors, including reactors that are used to produce tritium, a vital component for maintaining the U.S. nuclear deterrent. TVA will supply the power for the enrichment under a supplemental confirmation agreement pursuant to the existing USEC-TVA power contract.
 

 
 
28

 
During the remainder of 2012, we expect to continue discussions with DOE regarding the future of the Paducah GDP and the transition of Paducah operations. Although we will continue to look for ways to economically extend Paducah enrichment operations, our contract with Energy Northwest under the multi-party arrangement expires on May 31, 2013 and we believe it will be difficult to continue enrichment operations at the Paducah GDP beyond the term of this contract.  The plant continues to operate at a very high level of efficiency, but the technology uses significant amounts of electric power and as a result is at an operating cost disadvantage compared to the gas centrifuge plants operated by our competitors. We will be working with DOE to achieve an orderly transition of Paducah operations, as described below under “LEU Segment–Paducah GDP Transition”.

We have already made some regulatory submittals to the NRC to support the de-lease of a portion of the Paducah GDP and return of facilities to DOE and expect to be taking additional actions throughout 2012 as our planning continues. Under our lease, DOE has the obligation for decontamination and decommissioning of the Paducah plant. Ceasing enrichment operations at the Paducah GDP could have a material adverse effect on our business and prospects. For a discussion of the potential implications of a shutdown of Paducah enrichment operations, see Item 1A, “Risk Factors” of this report and our 2011 Annual Report on Form 10-K.

The American Centrifuge Plant
 
We are working to deploy the American Centrifuge technology, a highly efficient uranium enrichment gas centrifuge technology. The American Centrifuge technology requires 95% less electricity to produce low enriched uranium on a per SWU unit basis than our existing gaseous diffusion technology. The deployment of this technology would significantly reduce both our production costs and our exposure to price volatility for electricity, the largest production cost component of our current gaseous diffusion technology. We are working to deploy this technology in the ACP in Piketon, Ohio. This new facility would modernize our production capacity and position us to be competitive in the long term.

As of June 30, 2012, we have invested approximately $2.3 billion in the American Centrifuge program, which includes $1.2 billion charged to expense over several years for technology development and demonstration. We began construction on the ACP in May 2007 after being issued a construction and operating license by the NRC. We have operated centrifuges as part of our lead cascade test program for more than 100 machine years since August 2007. This experience gives us confidence in the performance of our technology, and provides operating data and expertise for future commercial deployment. The American Centrifuge technology is a disciplined evolution of classified U.S. centrifuge technology originally developed by DOE and successfully demonstrated during the 1980s.

We need significant additional financing in order to complete the ACP.  We applied for a $2 billion loan guarantee under the DOE Loan Guarantee Program in July 2008.  Instead of moving forward with a conditional commitment for a loan guarantee, in the fall of 2011, DOE proposed a research, development and demonstration (“RD&D”) program. DOE indicated that our application for a DOE loan guarantee would remain pending during the RD&D program but has given us no assurance that a successful RD&D program will result in a loan guarantee. Additional capital beyond the $2 billion of DOE loan guarantee funding that we have applied for and our internally generated cash flow will be required to complete the project. We have had discussions with Japanese export credit agencies regarding financing up to $1 billion of the cost of completing the ACP. Additional capital will also be needed and the amount of additional capital is dependent on a number of factors, including the amount of any revised cost estimate and schedule for the project, the amount of contingency or other capital DOE may require as part of a loan guarantee, and the amount of the DOE credit subsidy cost that would be required to be paid in connection with a loan guarantee. However we have no assurances that we will be successful in obtaining this financing and that the delays we have experienced will not adversely affect these efforts.
 

 
 
29

 
The objectives of the RD&D program are (1) to demonstrate the American Centrifuge technology through the construction and operation of a cascade of 120 commercial centrifuge machines and (2) to sustain the domestic U.S. centrifuge technical and industrial base for national security purposes and potential commercialization of the American Centrifuge project. This includes activities to reduce the risks and improve the future prospects of deployment of the American Centrifuge technology. USEC intends to meet these objectives through the construction and operation of one complete demonstration cascade of 120 commercial centrifuge machines and supporting infrastructure. This will enable us to demonstrate redundancy of the primary cascade support systems for commercial plant operation and to complete integrated testing against operational requirements.

June 2012 Cooperative Agreement with DOE

We began funding the RD&D program in January 2012 and have been building machines and parts for the demonstration cascade.  On June 12, 2012, we and DOE entered into a cooperative agreement to provide funding for the RD&D program. The agreement provides for 80% DOE and 20% USEC cost sharing for work performed during the period June 1, 2012 through December 31, 2013 having a total estimated cost of $350 million. DOE’s total contribution would be up to $280 million and our contribution would be up to $70 million. The cooperative agreement will be incrementally funded and DOE funding is limited to $87.7 million until DOE provides authorization for additional funding.  DOE funding through July 31, 2012 was $26.4 million. On July 31, 2012, DOE authorized an additional $61.3 million of funding (for a total of $87.7 million). The remaining funding of $192.3 million from DOE has not yet been authorized and is subject to Congressional appropriations, Congressional transfer or reprogramming authority to permit the use by DOE of funds previously appropriated for other programs, or other sources available to DOE and therefore it is possible that this additional funding may not be made available. We will provide cost sharing equal to 20% of the allowable costs of $109.6 million of the RD&D program, or $21.9 million through November 30, 2012.  Our 20% contribution will include investments made by us commencing June 1, 2012.  DOE provided the initial $87.7 million of funding by accepting title to quantities of depleted uranium that will enable us to release encumbered funds for approximately 80% of the allowable costs of the RD&D program up to $87.7 million. We receive the cash when the surety bonds and related cash deposits providing the financial assurance for disposition of this depleted uranium are reduced.

Under the cooperative agreement, we and our newly created subsidiary American Centrifuge Demonstration, LLC (“ACD”) will carry out the RD&D program. ACD is putting in place a program management and enhanced program execution structure as required by the cooperative agreement.  On July 23, 2012, we entered into a limited liability company agreement for ACD which, among other things, establishes a board of managers in accordance with the enhanced program execution structure.  The seven-person board is comprised of two independent managers, two managers appointed by USEC, and one manager appointed by each of Babcock & Wilcox Technical Services Group, Inc., Toshiba America Nuclear Energy Corporation and Exelon Generation Company, LLC.

 
30

 

The cooperative agreement also includes the following five technical milestones for the RD&D program:
 
·  
Milestone 1: DOE and USEC jointly agree upon a test program for the remaining milestones and for full system reliability and plant availability that takes into account human factors, upgraded Lower Suspension Drive Assembly (“LSDA”) and overall AC100 reliability, and full cascade separative performance, so as to achieve an overall plant availability and confidence level needed to support commercial plant operations;
 
·  
Milestone 2: Confirm the reliability of the LSDA by accumulating 20 machine years of operation at target speed using AC100 centrifuges with upgraded LSDAs with no more than the projected number of LSDA failures;
 
·  
Milestone 3: Demonstrate AC100 manufacturing quality by operating the commercial demonstration cascade for a minimum of 20 machine years to provide the confidence level needed to support commercial plant operations;
 
·  
Milestone 4: Demonstrate AC100 reliability by accumulating 20 machine years at target speed and design condition with no more than the expected number of infant, steady-state and electronic recycles; and
 
·  
Milestone 5: Demonstrate sustained production from a commercially-staged, 120-centrifuge demonstration cascade configuration for 60 days (approximately 20 machine years) in cascade recycle mode with production availability needed during commercial plant operations using an average AC100 centrifuge production of 340 SWU per centrifuge year.

We achieved the first technical milestone related to the finalization of a test program plan for the remaining technical milestones and for full system reliability and plant availability. Submittal of a more detailed cost and schedule for the RD&D program, including the dates for the technical milestones, was also a condition to DOE providing funding beyond the initial $26.4 million of funding. On July 24, 2012, we submitted the required information. We also believe we have met the technical conditions for the achievement of the second milestone, however, certification of achievement is subject to verification by DOE.  The remaining three milestones are tied to the completion of the RD&D program and so we have proposed to DOE milestone dates of December 31, 2013 for these milestones.  We are awaiting DOE’s acceptance of these proposed milestone dates.  In addition, we have also agreed to non-binding performance indicators with DOE that are designed to be achieved throughout the RD&D program and ensure that the RD&D program is on track to achieve the remaining three milestones and other program objectives.

DOE has the right to terminate the Cooperative Agreement if any of these technical milestones are not met on or before the agreed date for such milestones. DOE also has the right to terminate the cooperative agreement if we materially fail to comply with the other terms and conditions of the cooperative agreement.  Failure to meet the technical milestones under the cooperative agreement could provide a basis for DOE to exercise its remedies under the 2002 DOE-USEC Agreement (as defined below).  Additional information regarding the remedies under the 2002 DOE-USEC Agreement can be found below and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

On June 12, 2012, through our subsidiary we also entered into a contract with DOE to transfer to DOE title to the centrifuge machines and equipment produced or acquired under the RD&D program. The transferred property includes some existing machines and equipment and, at DOE’s option, the machines and equipment produced or acquired under the cooperative agreement.  As compensation for the sale of the transferred property, (1) DOE will make the transferred property available for no additional fee as leased personal property under the lease agreement between DOE and USEC for the facilities at Piketon, Ohio for the American Centrifuge Plant, and (2) at financial closing on the financing for the construction of the American Centrifuge plant, title to the transferred property will transfer to the lessee under and in accordance with the terms of the lease agreement.  If we abandon the centrifuge technology and return the premises leased under the DOE lease agreement, DOE will keep the transferred property and would be responsible for its disposal.
 

 
 
31

 
Amendment to the June 2002 DOE-USEC Agreement

On June 12, 2012 USEC and DOE entered into an amendment (the “2002 Agreement Amendment”) to the Agreement dated June 17, 2002 between DOE and USEC, as amended (the “2002 DOE-USEC Agreement”).  The 2002 DOE-USEC Agreement provides that we will develop, demonstrate and deploy the American Centrifuge technology in accordance with milestones and provides for remedies in the event of a failure to meet a milestone under certain circumstances. The 2002 Agreement Amendment adds two new milestones and revises the remaining four milestones under the 2002 DOE-USEC Agreement relating to the financing and operation of the American Centrifuge Plant. These milestone dates are not intended to be representative of management’s view of an updated schedule for deployment of the American Centrifuge plant but are a result of negotiations with DOE. During the RD&D program, we will be developing a comprehensive cost estimate and revised schedule for the American Centrifuge project that would form the basis for an update to our loan guarantee application to DOE. The 2002 Agreement Amendment provides that we will submit a revised plan to DOE covering the milestones after November 2014 on or before the date we submit a notice of commitment to proceed with commercial operations, and DOE and USEC will discuss adjustment of these remaining milestones as may be appropriate based on this revised plan.

·  
The following two new milestones are added:
 
May 2014 – Successful completion of the American Centrifuge Cascade Demonstration Test Program
 
June 2014 – Commitment to proceed with commercial operation

·  
The remaining milestones were extended as follows:
 
November 2014 – Secure firm financing commitment(s) for the construction of the commercial American Centrifuge Plant with an annual capacity of approximately 3.5 million separative work units (“SWU”) per year
 
July 2017 – Begin commercial American Centrifuge Plant operations
 
September 2018 – Commercial American Centrifuge Plant annual capacity at 1 million SWU per year
 
September 2020 – Commercial American Centrifuge Plant annual capacity of approximately 3.5 million SWU per year;

·  
A portion of our obligations under Article 3 of the 2002 DOE-USEC Agreement (relating to deployment of advanced enrichment technology) may be carried out by ACD as appropriate for ACD in implementing the RD&D program;

·  
We also granted to DOE an irrevocable, non-exclusive right to use or permit third parties on behalf of DOE to use all American Centrifuge technology intellectual property (“Centrifuge IP”) royalty free for U.S. government purposes (which includes completion of the cascade demonstration test program and national defense purposes, including providing nuclear material to operate commercial nuclear power reactors for tritium production); and

 
32

 
·  
We also granted an irrevocable, non-exclusive license to DOE to use such Centrifuge IP developed at our expense for commercial purposes (including a right to sublicense), which may be exercised only if we miss any of the milestones under the 2002 DOE-USEC Agreement or if we (or an affiliate or entity acting through us) is no longer willing or able to proceed with, or has determined to abandon or has constructively abandoned, the commercial deployment of the centrifuge technology.  Such commercial purposes licenses are subject to payment of a reasonable royalty to us, which shall not exceed $665 million.

Project Spending

During the first six months of 2012, our spending on the American Centrifuge project has been approximately $12 million per month. This is a reduction from our average monthly rate of spending during most of 2011 of approximately $17 million per month.  During October 2011, we suspended a number of contracts with suppliers and contractors involved in the American Centrifuge and adjusted our activities to conserve available resources while we negotiated the RD&D program budget and scope.

The execution of the cooperative agreement in June 2012 satisfies the requirement of our credit facility that we shall have entered into a definitive agreement with DOE for the RD&D program in order to continue spending on the American Centrifuge project.  Under the credit facility, we can invest our 20% share of the costs under the RD&D program as long as the amount of expenditures reimbursable to us under the RD&D program that have not yet been reimbursed does not exceed $50 million. In addition to restrictions under our credit facility, continued spending on the ACP remains subject to our available liquidity, additional DOE funding under the RD&D program, our willingness to invest further in the project absent funding commitments to complete the project, our ability following the RD&D program to obtain a DOE loan guarantee and additional capital, and other risks related to the deployment of the ACP.

Beginning with the fourth quarter of 2011, with the shift in focus to the RD&D program, all project costs incurred have been expensed, including interest expense that previously would have been capitalized. Our spending beginning in the fourth quarter of 2011 relates primarily to development and maintenance activities rather than capital asset creation. We also are expensing costs under the RD&D program as incurred. Capitalization of expenditures related to the ACP has ceased until commercial plant deployment resumes.

Research, Development and Demonstration Activities

The lead cascade test program in Piketon, Ohio began operations in August 2007 and has accumulated over 100 machine years of runtime. Through the lead cascade test program, we demonstrate the performance of centrifuge machines, demonstrate the reliability of machine components, obtain data on machine-to-machine interactions, verify cascade performance models under a variety of operating conditions, and obtain operating experience for our plant operators and technicians. Data from this testing program has provided valuable assembly, operating and maintenance information, as well as operations experience for the American Centrifuge Plant staff.

Based on data gained during the lead cascade test program, we have modified existing AC100 machines to install a safety enhancement. In April 2012, we notified the NRC that we resumed normal lead cascade operations with UF6 gas. Under the terms of the RD&D program, we have begun manufacturing and operating additional AC100 machines and expect to complete and operate a 120-machine cascade in a commercial plant configuration in 2013.  As of July 31, 2012, we have approximately 50 machines built and conditioned with uranium gas, and we continue to build new AC100 machines for the RD&D program’s demonstration cascade of commercial centrifuge machines and supporting infrastructure. We have begun installing service modules and other control equipment to support the RD&D commercial cascade.

 
33

 
Continued lead cascade operations will accomplish two of the primary objectives of the RD&D program. The first objective is to demonstrate sufficient run time on the AC100 centrifuges to establish the high confidence level in cascade reliability required by DOE to support loan guarantee financing for the commercial plant. A second objective is to build out and demonstrate the full level of balance of plant system redundancy designed for the commercial plant.

Russian Supply Transition

Our purchases under the 20-year Megatons to Megawatts program are expected to be completed in 2013. After that time, the limited quotas imposed under terms of an international agreement with Russia and U.S. law will increase so that Russia will be able to sell LEU directly into the United States equal to approximately 20% of the U.S. demand from 2014 through 2020, with additional quantities eligible to be imported for use in the initial fueling of new U.S. reactors.

Under the terms of our 2011 supply agreement with TENEX, we will purchase Russian LEU over a 10-year period commencing in 2013. Unlike the Megatons to Megawatts program, the quantities supplied under the 2011 supply agreement will come from Russia’s commercial enrichment activities rather than from down blending of excess Russian weapons material. Under the terms of the supply agreement, the supply of LEU to USEC will increase until it reaches a level in 2015 that includes a quantity of SWU equal to approximately one-half the level currently supplied by TENEX to USEC under the Megatons to Megawatts program. Beginning in 2015, TENEX and USEC also may mutually agree to increase the purchases and sales of SWU by certain additional optional quantities of SWU up to an amount equal to the amount we now purchase each year under the Megatons to Megawatts program. The LEU that we obtain from TENEX under the 2011 supply agreement will be subject to quotas and other restrictions applicable to commercial Russian LEU that do not apply to LEU supplied to USEC under the Megatons to Megawatts program, which could adversely affect our ability to sell the commercial Russian LEU that we purchase under the new agreement, and absent amendments to the quotas, most of the LEU supplied to us by TENEX under the new agreement will have to be supplied to foreign customers for fabrication into fuel outside the United States. Deliveries under the supply agreement are expected to continue through 2022.  We will purchase the SWU component of the LEU and deliver natural uranium to TENEX for the LEU’s uranium component. The pricing terms for SWU under the supply agreement are based on a mix of market-related price points and other factors. 

The 2011 supply agreement provides us continued access to an important part of our existing supply mix. As we continue to work towards building the ACP, we continue to review structuring options and strategic alternatives to realize long-term shareholder value. In that context and subject to compliance with applicable laws and regulations, we and TENEX have agreed to conduct a feasibility study to explore the possible deployment of an enrichment plant in the United States employing Russian centrifuge technology. Any decision to proceed with such a project would depend on the results of the feasibility study and would be subject to further agreement between the parties and their respective governments.


 
34

 

LEU Segment

Revenue from Sales of SWU and Uranium

Revenue from our LEU segment is derived primarily from:
 
·  
sales of the SWU component of LEU,
·  
sales of both the SWU and uranium components of LEU, and
·  
sales of uranium.

The majority of our customers are domestic and international utilities that operate nuclear power plants, with international sales constituting 23% of revenue from our LEU segment in 2011. Our agreements with electric utilities are primarily long-term, fixed-commitment contracts under which our customers are obligated to purchase a specified quantity of SWU from us or long-term requirements contracts under which our customers are obligated to purchase a percentage of their SWU requirements from us. Under requirements contracts, a customer only makes purchases when its reactor has requirements for additional fuel. Our agreements for uranium sales are generally shorter-term, fixed-commitment contracts.

Our revenues and operating results can fluctuate significantly from quarter to quarter, and in some cases, year to year. Revenue is recognized at the time LEU or uranium is delivered under the terms of contracts with domestic and international electric utility customers. Customer demand is affected by, among other things, reactor operations, maintenance and the timing of refueling outages. Utilities typically schedule the shutdown of their reactors for refueling to coincide with the low electricity demand periods of spring and fall. Thus, some reactors are scheduled for annual or two-year refuelings in the spring or fall, or for 18-month cycles alternating between both seasons.

Customer payments for the SWU component of LEU typically average approximately $20 million per order. As a result, a relatively small change in the timing of customer orders for LEU due to a change in a customer’s refueling schedule may cause operating results to be substantially above or below expectations. Customer orders that are related to their requirements for enrichment may be delayed due to outages, changes in refueling schedules or delays in the initial startup of a reactor. Customer requirements and orders are more predictable over the longer term, and we believe our performance is best measured on an annual, or even longer, business cycle. Our revenue could be adversely affected by actions of the NRC or nuclear regulators in foreign countries issuing orders to modify, delay, suspend or shut down nuclear reactor operations within their jurisdictions, including in response to the March 2011 events in Japan.

In order to enhance our liquidity and manage our working capital in light of anticipated sales and inventory levels and to respond to customer-driven changes, we have been working with customers regarding the timing of their orders, in particular the advancement of those orders. Rather than selling material into the limited spot market for enrichment, USEC has advanced orders from 2012 into 2011 and orders from 2013 into 2012. If customers agree to advance orders without delivery, a sale is recorded as deferred revenue. Alternatively, if customers agree to advance orders and delivery, revenue is recorded in an earlier than originally anticipated period. The advancement of orders has the effect of accelerating our receipt of cash from such advanced sales, although the amount of cash and profit we receive from such sales may be reduced as a result of the terms mutually agreed with customers in connection with advancement.

As a result of the lack of near-term demand due to the impacts of the events in Japan on the market, we have not been able to replace many of the order advancements that we have done in the past with additional sales, which has the effect of reducing our sales backlog. Uncertainty regarding the continuation of Paducah plant operations and the American Centrifuge project have also had a negative effect on our backlog as our sales are a function of our future supply, including potential supply from Paducah plant operations and from the American Centrifuge Plant. Looking out into the second half of this decade and beyond, we expect an increase in uncommitted demand that could provide the opportunity to make additional sales to supplement our backlog. However, the amount of any demand and our ability to capture that demand is uncertain.

 
35

 
Our financial performance over time can be significantly affected by changes in prices for SWU and uranium.  The long-term SWU price indicator, as published by TradeTech, LLC in Nuclear Market Review, is an indication of base-year prices under new long-term enrichment contracts in our primary markets. Since our backlog includes contracts awarded to us in previous years, the average SWU price billed to customers typically lags behind the current price indicators by several years. Following are TradeTech’s long-term SWU price indicator, the long-term price for uranium hexafluoride (“UF6”), as calculated by USEC using indicators published in Nuclear Market Review, and TradeTech’s spot price indicator for UF6:

   
June 30,
   
December 31,
   
June 30,
 
   
2012
   
2011
   
2011
 
Long-term SWU price indicator ($/SWU)
  $ 140.00     $ 148.00     $ 158.00  
UF6:
                       
Long-term price composite ($/KgU)
    176.13       176.13       193.67  
Spot price indicator ($/KgU)                                                      
    139.00       143.25       145.50  

Uranium can be acquired for sale by underfeeding the production process at the Paducah GDP. We may also purchase uranium from suppliers in connection with specific customer contracts, as we have in the past. Underfeeding is a mode of operation that uses or feeds less uranium but requires more SWU in the enrichment process, which requires more electric power. In producing the same amount of LEU, we may vary our production process to underfeed uranium based on the economics of the cost of electric power relative to the prices of uranium and enrichment, resulting in excess uranium that we can sell.

Most of our inventories of uranium available for sale have been sold in prior years as reflected in decreased uranium sales in the six months ended June 30, 2012 as compared to the prior period, and we expect uranium sales to have less of an impact on earnings going forward. Our average unit cost for uranium inventory has risen over the past several years as production costs are allocated to uranium from underfeeding based on its net realizable value.

In a number of sales transactions, title to uranium or LEU is transferred to the customer and USEC receives payment under normal credit terms without physically delivering the uranium or LEU to the customer. This may occur because the terms of the agreement require USEC to hold the uranium to which the customer has title, or because the customer encounters brief delays in taking delivery of LEU at USEC’s facilities. In such cases, recognition of revenue does not occur at the time title to uranium or LEU transfers to the customer but instead is deferred until LEU to which the customer has title is physically delivered. The proportion of uranium sales to SWU sales comprising the deferred revenue balance has declined as uranium sales are declining.

Cost of Sales for SWU and Uranium

Cost of sales for SWU and uranium is based on the amount of SWU and uranium sold and delivered during the period and is determined by a combination of inventory levels and costs, production costs, and purchase costs. Under the monthly moving average inventory cost method that we use, an increase or decrease in production or purchase costs will have an effect on inventory costs and cost of sales over current and future periods.

 
36

 
We produce about one-half of our SWU supply at the Paducah GDP. Production costs consist principally of electric power, labor and benefits, long-term depleted uranium disposition cost estimates, materials, depreciation and amortization, and maintenance and repairs.

The NRC requires that we guarantee the disposition of our depleted uranium with financial assurance (refer to “Liquidity and Capital Resources – Financial Assurance and Related Liabilities”).  However, under the depleted uranium enrichment agreement entered into with Energy Northwest to re-enrich DOE’s depleted uranium tails commencing June 1, 2012, we do not take title to the depleted uranium generated from the re-enrichment of DOE’s depleted uranium and therefore do not incur costs for its disposition and do not need to provide any financial assurance. In addition, under the cooperative agreement with DOE for the RD&D program, DOE’s cost-share is provided by DOE accepting title to quantities of our depleted uranium tails, which enables us to reduce our financial assurance and release encumbered funds.

The gaseous diffusion process uses significant amounts of electric power to enrich uranium. Costs for electric power are approximately 70% of production costs at the Paducah GDP. We purchase most of the electric power for the Paducah GDP under a power purchase agreement with TVA. The monthly quantities of power purchased by USEC under the TVA power contract for the months of January through May for both 2011 and 2012 were fixed at 1,650 megawatts. In addition, we purchased some supplemental power during the period February – May 2012 that was deferred from 2011, and we deferred a small quantity of power that was to be consumed prior to May 31, 2012 to the summer months of 2012.

On May 15, 2012, as part of the multi-party arrangement with Energy Northwest, BPA, TVA and DOE, the power purchase agreement with TVA was amended to extend its term and TVA and USEC entered into a supplemental confirmation agreement pursuant to the amended power purchase agreement for us to purchase the power needed to operate the Paducah GDP during the one-year term of the depleted uranium enrichment agreement.  Under this supplemental agreement, we have a take or pay obligation to purchase electricity during June - September 2012 at monthly amounts increasing from approximately 750 to 1,250 megawatts and then at 1,500 megawatts for the remaining months of the depleted uranium enrichment contract, less a 25% reduction in May 2013 to provide a transition in power delivery. We have the right to terminate these power purchase obligations under the supplemental agreement if Energy Northwest terminates the depleted uranium enrichment agreement, or fails to deliver depleted uranium or to meet its payment obligations, and we cease enrichment operations at Paducah as a result.

Our purchase costs under the TVA power contract are subject to monthly fuel cost adjustments to reflect changes in TVA’s fuel costs, purchased-power costs, and related costs. The impact of the fuel cost adjustment has imposed an average increase over base contract prices of about 9% in the first six months of 2012, 12% in 2011, 10% in 2010, and 6% in 2009. Effective June 1, 2012, although our purchase costs under the amended TVA contract continue to be subject to a fuel cost adjustment, the fuel cost adjustment is included in the power price component of our sales price billed to Energy Northwest under the depleted uranium enrichment agreement.

Any quantity of uranium that is added to uranium inventory from underfeeding is accounted for as a byproduct of the enrichment process. Production costs are allocated to the uranium added to inventory based on the net realizable value of the uranium, and the remainder of production costs is allocated to SWU inventory costs.

We purchase about one-half of our SWU supply under the Russian Contract. Prices under the contract are determined using a discount from an index of published price points, including both long-term and spot prices, as well as other pricing elements. The pricing methodology, which includes a multi-year retrospective view of market-based price points, is intended to enhance the stability of pricing and minimize the disruptive effect of short-term market price swings. The price per SWU under the Russian Contract for 2012 is 2% higher compared to 2011.

 
37

 
Paducah GDP Transition

As described above under “Paducah Gaseous Diffusion Plant,” we believe it will be difficult to continue enrichment operations at the Paducah GDP beyond the one-year term of the depleted uranium enrichment arrangement and are working with DOE to plan for the transition of the Paducah GDP. The current lease for the Paducah GDP expires in 2016. However, under the terms of the lease, we can terminate the lease prior to expiration upon two year’s prior notice. We can also de-lease portions of the property under lease to meet our changing requirements upon 60 days prior notice with DOE’s consent, which cannot be unreasonably withheld. 

If we do not continue enrichment operations at the plant beyond May 31, 2013 or continue enrichment for only a short period of time, we would accelerate expenses for certain assets such as previously capitalized leasehold improvements and machinery and equipment related to the Paducah enrichment operations. As of June 30, 2012, net book value of property, plant and equipment included in our consolidated balance sheet was approximately $60 million related to our Paducah operations. These assets are currently being depreciated over their estimated life based on the lease term through 2016. A decision to cease enrichment prior to the end of 2016 would accelerate depreciation and increase our cost of sales, negatively impacting our gross profit in our LEU segment.

We also have significant inventories of SWU and uranium at the Paducah GDP and these inventories are valued at the lower of cost or market. We compare our inventory cost against market prices and if our inventory costs were to exceed market prices, we could be required to record an inventory impairment.

In addition, as of June 30, 2012, we have accrued liabilities for lease turnover costs related to the Paducah GDP of approximately $43 million included in our other long-term liabilities. The lease turnover could be accelerated, depending on the transition schedule, and considered as a current liability if we were to terminate the lease prior to the current expiration date.  

Depending on the finalization of a transition plan with DOE, we could also expect to incur significant costs in connection with a shutdown of Paducah enrichment operations, including potential severance costs and curtailment charges related to our defined benefit pension plan and postretirement health and life benefit plans. These costs could place significant demands on our liquidity and we are evaluating alternatives to manage these potential costs.

Depending on the transition of Paducah enrichment operations, we could de-lease the Paducah GDP except for certain facilities used for ongoing operations such as shipping and handling, inventory management and site services, including deliveries to customers of our inventory of LEU and handling of Russian material through 2013 under the Russian Contract, or beyond under the Russian Supply Agreement. We are currently evaluating what facilities would be needed for ongoing operations if we do not continue enrichment operations and the most cost-effective manner of conducting those operations to minimize our ongoing maintenance costs.  However, we may not be able to achieve the desired cost savings in the timeframe we expect.  For example, we must factor in the need and cost of maintaining facilities in order to handle our inventory in how we plan to transition Paducah operations.  As of June 30, 2012, these inventories include approximately $1.4 billion of inventories owed to customers and suppliers that relate primarily to inventories owed to fabricators.  These inventories are awaiting delivery to fabricators under deliver optimization arrangements between USEC and domestic fabricators, the timing of transfer of which is uncertain.  These inventories have been increasing and could continue to increase to the extent that fabricators continue to use their other inventories to satisfy our customer order obligations.  In addition, we have no assurance that DOE would accept facilities that we wish to de-lease in the timeframe desired or on a schedule that would be cost efficient. 

 
38

 
Contract Services Segment

Revenue from Contract Services

We perform services and earn revenue from contract work through our subsidiary NAC and from contract work for DOE and DOE contractors at the Paducah GDP and the Portsmouth site. USEC ceased uranium enrichment at the Portsmouth GDP, located in Piketon, Ohio, in 2001. Over the past decade, we maintained the Portsmouth site and performed services under contract with DOE. On September 30, 2011, contracts for maintaining the Portsmouth facilities and performing services for DOE at Portsmouth expired and we completed the transition of facilities to the decontamination and decommissioning (“D&D”) contractor selected by DOE for the site. Consequently, on September 30, 2011, we ceased providing government contract services at the portion of the Portsmouth site related to the former GDP. We will continue to provide some limited services to DOE and its contractors at the Paducah site and at the Portsmouth site related to facilities we continue to lease for the American Centrifuge Plant. Revenue from our contract services segment, however, has decreased significantly and is now comprised primarily of revenue generated by NAC. 

Revenue from U.S. government contracts is based on allowable costs for work performed in accordance with government cost accounting standards (“CAS”). Allowable costs include direct costs as well as allocations of indirect plant and corporate overhead costs and are subject to audit by the Defense Contract Audit Agency (“DCAA”), or such other entity that DOE authorizes to conduct the audit. As a part of performing contract work for DOE, certain contractual issues, scope of work uncertainties, and various disputes arise from time to time. Issues unique to USEC can arise as a result of our history of being privatized from the U.S. government and our lease and other contracts with DOE.

DOE funded a portion of the now-completed work at Portsmouth through an arrangement whereby DOE transferred uranium to us which we immediately sold. We completed six competitive sales of uranium between the fourth quarter of 2009 and the first quarter of 2011. Our receipt of the uranium was not considered a purchase by us and no revenue or cost of sales was recorded upon its sale. This is because we had no significant risks or rewards of ownership and no potential profit or loss related to the uranium sale. The value of the contract work is based on the cash proceeds from the uranium sales less our selling and handling costs. The net cash proceeds from the uranium sales were recorded as deferred revenue, and (a) revenue is recognized in our contract services segment as services are provided or (b) is to be applied to existing receivables balances due from DOE in our contract services segment.

Contract Services Receivables

Payment for our contract work performed for DOE is subject to DOE funding availability and Congressional appropriations. DOE historically has not approved our provisional billing rates in a timely manner. DOE has approved provisional billing rates for 2004, 2006 and 2010 based on preliminary budgeted estimates even though updated provisional rates had been submitted based on more current information. In addition, we have finalized and submitted to DOE the Incurred Cost Submissions for Portsmouth and Paducah contract work for the six months ended December 31, 2002 and the years ended December 31, 2003, 2004, 2005, 2006, 2007, 2008, 2009 and 2010. DCAA historically has not completed their audits of our Incurred Cost Submissions in a timely manner. DCAA has been periodically working on audits for the six months ended December 31, 2002 and the year ended December 31, 2003 since May 2008. In June 2011, a new DOE contractor began an audit for the year ended December 31, 2004. There is the potential for additional revenue to be recognized, based on the outcome of DOE reviews and audits, as the result of the release of previously established receivable related reserves. However, because these periods have not been audited, uncertainty exists and we have not yet recognized this additional revenue.
 

 
 
39

 
Our consolidated balance sheet includes receivables, net of valuation allowances, from DOE or DOE contractors of $37.0 million as of June 30, 2012. Of the $37.0 million, $2.2 million represents revenue recorded for amounts not yet billed due to the absence of approved billing rates referenced above (referred to as unbilled receivables). Past due receivables from DOE or DOE contractors were $46.6 million at June 30, 2012. As of June 30, 2012, we have submitted certified claims totaling $38.0 million related to these past due receivables and are in the process of submitting the balance. We believe DOE has breached its agreement by failing to establish appropriate provisional billing and final indirect cost rates on a timely basis.

On December 2, 2011, we submitted a certified claim for $11.2 million under the Contract Disputes Act (“CDA”) for payment of breach-of-contract amounts equaling unreimbursed costs for the periods through December 31, 2009. In a letter dated June 1, 2012, DOE’s Contracting Officer denied this claim and we have until May 31, 2013 to appeal the denial to the U.S. Court of Federal Claims. In addition, on February 16, 2012, we submitted a second certified claim for $9.0 million under the CDA related to the 2010 historical period. On May 8, 2012, we submitted a third certified claim for $17.8 million under the CDA related to the 2011 historical period. In a letter response dated June 28, 2012, DOE informed us that it will provide a written decision on or before August 15, 2012 related to the second and third claims.

Portsmouth Contract Closeout Costs

Contract closeout related costs, as defined by applicable federal acquisition regulations and government cost accounting standards, are anticipated to be billed to DOE and recorded as revenue when contract closeout occurs and amounts are deemed probable of recovery. Our current estimate for these billable costs is approximately $10 million or more, which includes an estimate to complete outstanding DOE audits within a reasonable period of time. Additionally, we believe DOE is responsible for approximately $45 million to $125 million of costs related to pension and postretirement health and life benefit plans. These estimates of contract closeout costs do not include ongoing cost reimbursable work being performed and amounts already included in our receivable balances. The actual amounts of contract closeout costs are subject to a number of factors and therefore subject to significant uncertainty including uncertainty concerning the amount of such costs and the amount that may be reimbursable under contracts with DOE.

Advanced Technology Costs

American Centrifuge

USEC is working to deploy the American Centrifuge technology at the ACP in Piketon, Ohio. Costs relating to the American Centrifuge technology are charged to expense or capitalized based on the nature of the activities and estimates and judgments involving the completion of project milestones. As of June 30, 2012, cumulative project costs totaled $2.3 billion.

Costs relating to the demonstration of American Centrifuge technology are charged to expense as incurred. Demonstration costs historically have included NRC licensing of the American Centrifuge Demonstration Facility in Piketon, Ohio, engineering activities, and assembling and testing of centrifuge machines and equipment at centrifuge test facilities located in Oak Ridge, Tennessee and at the American Centrifuge Demonstration Facility. As of June 30, 2012, cumulative project costs charged to expense totaled $1.2 billion.

 
40

 
Capitalized costs relating to the American Centrifuge technology have included NRC licensing of the commercial plant, engineering activities, construction of AC100 centrifuge machines and equipment, process and support equipment, leasehold improvements and other costs directly associated with the commercial plant. As of June 30, 2012, cumulative project costs capitalized totaled $1.1 billion, including capitalized interest of $100.5 million, prepayments to suppliers for services not yet performed of $21.7 million, accrued asset retirement obligations of $19.3 million and $7.7 million of accrued costs.

In addition, we have deferred financing costs of approximately $6.6 million for costs related to the ACP project, such as loan guarantee application fees paid to DOE and third-party costs. Deferred financing costs related to the DOE Loan Guarantee Program will be amortized over the life of the loan or, if USEC does not receive a loan, charged to expense.

Instead of moving forward with a conditional commitment for a loan guarantee for the American Centrifuge project through the DOE Loan Guarantee Program, in the fall of 2011, DOE proposed a two-year cost share research, development and demonstration (“RD&D”) program for the American Centrifuge project. Additional details are provided above under “The American Centrifuge Plant.”   As a result of the shift in focus of the American Centrifuge project, beginning in the fourth quarter of 2011, USEC began spending on the American Centrifuge technology at reduced levels with activities concentrating on development and demonstration. As a result, beginning in the fourth quarter of 2011, all project costs incurred have been expensed, including interest expense that previously would have been capitalized. Capitalization of expenditures related to the ACP has ceased until commercial plant deployment resumes.

We believe that future cash flows generated by the ACP will exceed our capital investment and our capital investment is more likely than not to be fully recoverable. We will continue to evaluate this assessment as conditions change, including as a result of activities conducted as part of the RD&D program. If conditions change, including if the current path to commercial deployment were no longer probable or our anticipated role in the project were changed, we could expense up to the full amount of previously capitalized costs related to the ACP of up to $1.1 billion. Events that could impact our views as to the probability of deployment or our projections include an unfavorable determination in any phase of the RD&D program regarding the commercial deployment of the ACP.

Risks and uncertainties related to the financing, construction and deployment of the American Centrifuge Plant and the continued capitalization of the ACP capital investment and potential for a valuation allowance are described in Item 1A, “Risk Factors” of our 2011 Annual Report on Form 10-K.
 
MAGNASTOR®
 
Advanced technology costs also include research and development efforts undertaken by NAC, relating primarily to its MAGNASTOR dual-purpose spent fuel dry storage and transportation technology. NAC continues to seek license amendments for the expanded use of the storage technology and is pursuing NRC certification of the counterpart transportation cask system, MAGNATRAN.



 
41

 

Results of Operations – Three and Six Months Ended June 30, 2012 and 2011

Segment Information

We have two reportable segments measured and presented through the gross profit line of our income statement: the LEU segment with two components, SWU and uranium, and the contract services segment. The LEU segment is our primary business focus and includes sales of the SWU component of LEU, sales of both SWU and uranium components of LEU, and sales of uranium. The contract services segment includes nuclear energy services and technologies provided by NAC as well as limited work performed for DOE and its contractors at Paducah and Portsmouth. Intersegment sales between our reportable segments were less than $0.1 million in each period presented below and have been eliminated in consolidation.

The following table presents elements of the accompanying consolidated condensed statements of operations that are categorized by segment (dollar amounts in millions):

   
Three Months Ended June 30,
             
   
2012
   
2011
   
Change
   
%
 
LEU segment
                       
Revenue:
                       
   SWU revenue
  $ 347.2     $ 330.3     $ 16.9       5 %
Uranium revenue
    3.6       67.8       (64.2 )     (95 )%
Total
    350.8       398.1       (47.3 )     (12 )%
Cost of sales
    340.4       368.6       28.2       8 %
Gross profit
  $ 10.4     $ 29.5     $ (19.1 )     (65 )%
                                 
Contract services segment
                               
Revenue
  $ 14.0     $ 56.3     $ (42.3 )     (75 )%
Cost of sales
    12.1       52.6       40.5       77 %
Gross profit (loss)
  $ 1.9     $ 3.7     $ (1.8 )     (49 )%
                                 
Total
                               
Revenue
  $ 364.8     $ 454.4     $ (89.6 )     (20 )%
Cost of sales
    352.5       421.2       68.7       16 %
Gross profit
  $ 12.3     $ 33.2     $ (20.9 )     (63 )%


 
42

 



   
Six Months Ended
June 30,
             
   
2012
   
2011
   
Change
   
%
 
LEU segment
                       
Revenue:
                       
SWU revenue
  $ 885.1     $ 638.8     $ 246.3       39 %
Uranium revenue
    3.6       81.8       (78.2 )     (96 )%
Total
    888.7       720.6       168.1       23 %
Cost of sales
    841.6       675.8       (165.8 )     (25 )%
Gross profit
  $ 47.1     $ 44.8     $ 2.3       5 %
                                 
Contract services segment
                               
Revenue
  $ 37.6     $ 114.3     $ (76.7 )     (67 )%