Centrus Energy Corp (LEU) 2006 Q3 法說會逐字稿

Good day, and welcome, everyone, to the USEC, Inc. Third Quarter 2006 Earnings Conference Call. This call is being recorded. With us today from the Company is Mr. John Welch, President and Chief Executive Officer, and Mr. Steven Wingfield, the Director of Investor Relations. Management will make opening remarks, which will be followed by a question and answer period. At this time, I would like to turn the call over to Steve Wingfield. Please go ahead, sir.

Good morning. Thank you for joining us for USEC's conference call regarding its third quarter, which ended September 30, 2006. With me today are John Welch, President and Chief Executive Officer, John Barpoulis, Senior Vice President, Chief Financial Officer and Treasurer, and Bob Van Namen, Senior Vice President, Uranium Enrichment.

Before I turn--before turning the call over to John, I want to welcome all of our callers, as well as those listening to our webcast via the Internet. This conference call follows our earnings news release issued yesterday after the markets closed. USEC is making reference to non-GAAP financial information in both our earnings news release and on this conference call. A reconciliation of those non-GAAP financial measures to the comparable GAAP financial measures is contained in the earnings news release. That news release is available on many financial websites, as well as our corporate website, USEC.com.

Third, I want to inform all of our listeners that our news releases and SEC filings, including our 10-Ks, 10-Qs, and 8-Ks, are available on our website. A replay of this call also will be available later this morning on the USEC website.

I'd like to remind everyone that certain of the information that we may discuss on this call today may be considered forward-looking information and involves risk and uncertainty, including assumptions about the future performance of USEC. Our actual results may differ materially from those forward-looking statements. Additional information concerning factors that could cause actual results to materially differ from those in our forward-looking statements is contained in our SEC filings, including our annual report on Form 10-K and subsequent quarterly 10-Qs.

Finally, the forward-looking information provided today is time sensitive and is accurate as of today, November 3, 2006. This call is the property of USEC. Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of USEC is strictly prohibited.

Thank you for your participation. And now I'd like to turn the call over to John Welch.

Thank you, Steve, and good morning to you all. Welcome to USEC's conference call to discuss our third quarter 2006 results. John Barpoulis will provide a detailed review of those financial results in just a moment. Before we get to John's report, I want to give you an update of our business, particularly the status of our demonstration program, American Centrifuge.

Turning first to our results, revenue in 2006 continues to outpace what we saw in the first nine months of 2005. For the third quarter, revenue was slightly lower compared to last year, but during the first nine months of 2006, revenue was up 29%. And even though revenue was $3 million lower in the quarter than the same period last year, net income was almost $10 million compared to a loss of $5 million in the third quarter of 2005.

The improved results were a result of higher SWU revenue on higher average prices billed to customers that helped to improve the overall gross profit margin. And while expenses for the American Centrifuge increased by $3.5 million compared to the same quarter of last year, lower interest expense more than offset that higher advanced technology spending. Looking back over the first nine months, our net income was $66 million, a substantial improvement over last year's loss of $7 million. John Barpoulis will have more details on our financial performance in a few minutes.

These results were the result of hard work to lower our cost structure over the last several years and to improve prices for our products. Despite that effort, the 50% increase in power prices we now pay TVA will begin to have a more significant impact on our results in the fourth quarter and even more so next year. This will significantly reduce our gross margins going forward.

We continue to seek ways to mitigate the substantial change in the cost structure of our domestic production. And while we are looking for additional efficiencies in all aspects of our operations, electricity is such a big portion of our cost structure, almost 70%, that nearly everything else on the cost side has a limited impact.

In the past several months, Bob Van Namen and I have been meeting with many of our customers to discuss our situation. These discussions are ongoing, but our customers have given us solid feedback that they want to see us and the American Centrifuge succeed. It is clear they want a strong domestic enrichment industry that provides them reliable and competitive supply in the long run, which is one of their key objectives.

We also believe that the U.S. Government is committed to maintaining a viable domestic enrichment capability. Support for nuclear power is growing in this country and around the world because nuclear power is one of the leading choices for environmentally responsible electricity generation.

We are working to focus this stakeholder support for deployment of the American Centrifuge and the long-term viability of the domestic enrichment industry. Our goal is to convert this tacit support into arrangements that can help mitigate our squeeze on gross margins as we transition to what we believe will be solid financial foundation based on future production from the American Centrifuge plant.

Let me turn next to our progress on the American Centrifuge. Our investors requested more details about the demonstration of the American Centrifuge technology, and recently we issued an update as part of our effort to provide more information.

There is an inherent tension here, however. Investors want as much information as possible and we want to provide it, so that you can evaluate the potential of our leading edge enrichment technology. On the flip side, it is a top secret technology owned by the government, which is concerned, with good reason, about proliferation of uranium enrichment. So please understand that we want to help you evaluate the value proposition for USEC, but we have an obligation and a duty to the government to protect their technology.

With that said, the Department of Energy has allowed USEC to provide more information about the performance levels seen in recent tests at the American Centrifuge. We have been testing individual machines for a number of months at our Oak Ridge, Tennessee facility. As early as April, we achieved performance essentially at our target level of about 320 SWUs per machine per year under suboptimal conditions.

Recently, the USEC project team tested a centrifuge machine under more optimal conditions that demonstrated 350 SWUs per machine. These performance levels have been reaffirmed in subsequent testing. This is exciting news because these test results validate our decision to spend additional time optimizing the centrifuge machines before building our Lead Cascade.

Each incremental SWU that our machines produce help improve the economics of the project. That will become increasingly important because it is becoming apparent, given the run up in commodity prices and other factors, that the American Centrifuge plant will cost significantly more than our previous projection of $1.7 billion.

As we've said a couple of times recently, we are seeing a number of upward cost pressures on components and commodities - steel, carbon fiber, and construction labor are all substantially higher than when we made our previous estimate. Those increases, combined with the impact of our previously announced one-year schedule change for Lead Cascade operations, will significantly increase the cost of the project.

We are still working on our evaluation of the costs and schedule and we expect to be able to talk about an updated estimate by the end of the year or early 2007. As part of that evaluation, we are looking at steps we can take to reduce the unit costs of the machines through value engineering. We are aggressively pursuing ways to optimize the American Centrifuge machine because gains in performance can offset cost increases and continue to improve the economics of the project.

I can also tell you that we are working diligently to identify ways to lower our expected costs. Let me provide one example. We are using a large facility built by the Department of Energy in Piketon, Ohio in the 1980s for our American Centrifuge plant. Although the building is in place, the balance of the plant - the systems, piping, and support facilities - are part of the plant construction that must still be done.

We are working with our engineering and procurement firm, Fluor, Incorporated, to evaluate ways that we can refurbish existing equipment and systems, rather than installing new equipment. Given the substantial run up in commodity and steel prices, using what we have will likely result in savings of tens of millions of dollars.

We will continue to look for ways that we can seek further performance optimization and value engineering to achieve lower unit costs for the centrifuge machines that will be used in the commercial plant.

In 2002, we signed a wide ranging agreement with the Department of Energy regarding many facets of our relationship. One section covers the American Centrifuge and contains a number of milestones to track our progress in demonstrating and deploying the technology. There are 15 milestones in all, and up to now, we have been on or ahead of schedule.

The milestones were intended to assure that USEC stays intently focused on moving this important project forward. The further you get into a project, however, the more opportunities there are for unexpected events and delays to occur. We decided earlier this year to delay the start of the Lead Cascade until 2007, and that has an impact on the October 2006 milestone.

We are in the process of discussing with DOE our progress towards the milestone of obtaining satisfactory reliability and performance data from the--from Lead Cascade operations. We believe that USEC has more than substantial progress towards meeting this milestone, having obtained substantial satisfactory performance and reliability data from our tests of centrifuges and related systems. Clearly, we will continue to obtain more data over the coming months.

We are also discussing with DOE our January 2007 milestone for securing a commitment for financing the first 1 million SWU of production. We think the financing milestone could be achieved on schedule, but the reality is that we will not need this financial commitment in January of next year. We also think USEC is likely to get more attractive financing terms if we wait until after we have verified performance data from the Lead Cascade later in 2007. By that time, we will also have a more concrete estimate of the cost of the commercial plant and the project schedule as well as more definitive feedback from customers to our proposed pricing for SWU produced at the new plant.

When we look at the progress that we've made toward a successful deployment of the American Centrifuge and our continuing strong commitment to the project, we expect to reach a mutually acceptable agreement with the Department of Energy regarding these two milestones. We do not expect that the DOE will take any of the punitive actions that are available to the Department under the terms of the 2002 agreement. This is their technology that we're working hard to deploy commercially, and based on our conversations, we believe they want USEC to succeed.

On a parallel path, the process of obtaining a license to operate the American Centrifuge plant from the Nuclear Regulatory Commission is moving ahead. All indications are that the license will be issued in early 2007. The Environmental Impact Statement was issued in May and the Safety Evaluation Report was issued in September. A public hearing on these two key elements was held early this month and a site visit is scheduled for December the Atomic Safety and Licensing Board.

In August, another regulatory step, the Nuclear Regulatory Commission assumed oversight for the American Centrifuge Demonstration Facility in Piketon. This transition from DOE to the NRC allows us to operate centrifuge machines on uranium hexafluoride gas. We have a small number of machines installed at the Piketon facility that will help verify cascade configurations and support system functionality, and we expect to have those machines on gas later this month.

To sum up, we expect to operate a small number of centrifuges this year as we finalize the machine design for the initial Lead Cascade. We plan to install and operate centrifuges for the Lead Cascade by mid-2007. I want to emphasis that the data we have gathered so far gives us confidence that the centrifuges we plan to deploy commercially may well operate better than we had initially targeted. We also recognize that the delays over the past year have impacted our near term schedule for the program, and we are assessing the impact of these delays on our project cost and overall schedule.

I want to assure our shareholders, as well as our other stakeholders, that our priority is to execute our deployment plan in the most cost effective manner. We believe this will maximize shareholder value over the long term, and give our customers a long term reliable supply of enriched uranium.

Now, I want to ask John Barpoulis to report on our financial results for the quarter and year-to-date. John?

Thank you, John. Good morning, everyone. Starting with the top line, revenue in the third quarter was $418 million, or about $3 million less than the third quarter of 2005. Revenue for the first nine months of the year was $1.3 billion, or about $300 million more than the same period last year.

Now, let's get to the details for the quarter. Revenue from SWU sales increased $30 million, or about 10% from the same quarter a year before. SWU sales volume was 3% higher, and the average price billed to customers improved by 7% compared to the same period last year. Revenue from sales of uranium was $34 million, a decrease of $26 million, or 43%, from the third quarter of 2005.

Looking at the year-to-date, total revenue was $1 billion, 304 million, or about $295 million more than the same period last year. SWU revenue totaled $975 million, an increase of $261 million. We saw a 28% volume growth for SWU, and a 7% increase in prices billed to customers. Uranium was also strong, with a 30% increase in uranium revenue year-to-date, due entirely to higher prices billed to customers as sales volume was lower. We are seeing uranium sales volume begin a pattern of gradual decline as we finish selling our uranium inventory in 2007.

Revenue from our second business segment, U.S. Government Contracts and Other, was about $8 million lower in both the quarter and the nine-month period at $47 million and $148 million, respectively. The decline is due to a smaller scope of contracts and other work for the Department of Energy, but the related costs were also lower.

Uranium revenue includes amounts of previously deferred revenue that were recognized during the quarter. As we've disclosed before, USEC transfers title and collects cash from customers for uranium sales, but does not recognize the revenue until the low enriched uranium is physically delivered. USEC continues to show a substantial amount of deferred revenue on the balance sheet related mainly to uranium sales.

As of September 30, $118 million in deferred revenue, with an expected gross profit of about $40 million, has been deferred until subsequent quarters. At June 30 and March 31, this deferred revenue amount was $108 million.

So you can see we have been adding deferred revenue at roughly the same pace as we have been recognizing revenue deferred from previous quarters. The timing of recognition of this revenue cannot be determined, as it is often dependent upon the sale of uranium by a broker to a utility and the utility's ultimate purchase and shipment of SWU from USEC.

In recent quarters, USEC has been able to underfeed the enrichment process to obtain additional uranium supplies. While we are still obtaining uranium from underfeeding, a combination of factors will sharply limit new uranium supplies we have going forward to sell into the market. First, our customers are requesting lower tails assays when they place their order for low enriched uranium. Although we sell more SWU when customers use contractual flexibility to order lower tails assays, we lose out on the opportunity to obtain higher margin uranium by underfeeding the enrichment process.

Second, our contract with Russia is based on a transaction tails level of 0.3%. That is, we return uranium feed supplies to Russia as if all of our customer contracts are being fulfilled at a tails assay level of 0.3%. For example, when a customer orders LEU with a tails assay of 0.25%, if we use Russian LEU, USEC must make up the difference in natural uranium feed returned to Russia. As the tails assay goes down, the amount of feed goes up that USEC must obtain through underfeeding, from its own inventory, or potentially, by buying supplies in the marketplace.

If customers continue to request lower tails assays, our opportunity to benefit from underfeeding the Paducah plant's enrichment process will be reduced. The benefits of underfeeding are also reduced by higher power prices. In the future, we may need to buy natural uranium supplies in the market or seek alternate sources to supplement our inventory.

Switching to the cost side of the business, for the nine-month period, cost of sales for the LEU segment was 28% higher, in line with the increase in the volume of SWU delivery. The average unit cost of sales pursued for the period was 2% higher than in 2005. The increase to unit cost of sales was due to higher starting inventory costs, higher unit production costs, and higher purchase prices paid to Russia under the Megatons to Megawatts program.

The purchase price paid to Russia is set by a market-based pricing formula that reflects increasing global food prices in recent years. The cost of sales for U.S. Government contracts in the nine-month period declined $12 million as the scope of contract work was reduced.

Looking at the entire enterprise, the gross profit for the nine-month period was $224 million, an increase of $97 million, or 77%, over the same period last year. This improvement reflects higher SWU volume and prices billed to customers, as well as continued sales of uranium. The gross profit margin was 17% for the nine months, reflecting the impact of an unusually high margin in the first quarter.

For the third quarter, the gross profit was $52 million, an increase of $16 million, or 43%, over the same quarter in 2005. The gross profit margin for the quarter was almost 13%, which improved on last year's margin of about 9% in the third quarter of 2005.

Below the gross profit line are the expenses for selling, general, and administrative, or SG&A, and the American Centrifuge project. SG&A for the first nine months was $37 million, a 12% reduction year-over-year, and is a direct result of our organizational restructuring last fall. Salaries and related employee benefits expenses and office rent were all lower.

USEC continues to make a substantial investment in the American Centrifuge technology - $70 million during the nine-month period, which is about 4 million more than was expensed in the same period of 2005. Total spending related to the American Centrifuge during the nine-month period was about $91 million, including capitalized costs of $22 million. That compares to $78 million in the same period last year, of which $12 million was capitalized.

In addition, we have spent about $1 million this year on advanced technology related to NAC International's Magnastor spent fuel storage technology that is currently being reviewed by the NRC. This investment in American Centrifuge had the effect of reducing net income by approximately $44 million in the nine-month period, assuming a 37% statutory tax rate.

To help investors evaluate the impact of this adjustment to current financial results, we reported pro forma net income before American Centrifuge expenses, which is a non-GAAP financial measure. USEC reported pro forma net income before American Centrifuge expenses of $110 million in the first nine months of 2006, compared to $33 million for the same period in 2005. For the third quarter, pro forma net income before American Centrifuge expenses was $25 million, compared to $7 million in the same quarter last year.

On a GAAP basis, we reported net income of $66 million for the first nine months of 2006, compared to a loss of about $7 million in the same period last year. For the quarter, net income was about $10 million, compared to a loss of $5 million in the third quarter of 2005. I refer you to our earnings release for a detailed schedule reconciling pro forma net income to net income.

Turning next to cash, our cash flow from operating activities for the nine-month period was $153 million, compared to $20 million in 2005. Operations generated more cash thus far in 2006 than in the same period last year due to higher customer collections and a net reduction in uranium and SWU inventories. One element that improved cash flow is due to customer collections that are more balanced this year between quarters, compared to 2005, when a higher proportion of cash was collected in the fourth quarter.

This year's improved cash inflow is partially offset by higher payments for electric power due to three payments to TVA under the new contract and higher tax payments. We ended the quarter with a cash balance of $96 million and no short term borrowing under our bank credit facility.

The largest change to our December 31, 2005 cash position was the $289 million repayment of the senior notes that matured in January of 2006. After that repayment, our interest expense has been more than cut in half, $11 million in the nine-month period, compared to $27 million in the same period last year. And our debt to total capitalization ratio is 13%.

In yesterday's new release, we updated our earnings and cash flow guidance for 2006. Starting at the top, we reiterated guidance for revenue of approximately $1.8 billion, and a gross profit margin of approximately 16%. The major change to our outlook is in the amounts of spending on the American Centrifuge project that will be expensed. Total spending is expected to decline $25 million to $160 million for the year.

We now project that spending will be split - approximately $110 million expensed and $50 million capitalized. The change in spending pattern is due to our previously announced delay in deploying the Lead Cascade. We expect that our substantial spending on the American Centrifuge will have the effect of reducing net income in 2006 by approximately $69 million.

Our revised earnings guidance is for a range of $65 to $75 million, therefore, pro forma net income before American Centrifuge expenses is expected to be in the range of $134 to $144 million. Again, please refer to our earnings release for a reconciliation of these pro forma numbers. We expect to generate approximately $150 to $160 million in cash flow from operations in 2006.

We expect to provide 2007 annual guidance early next year. The higher cost of electricity we are now paying will have a substantial impact on our financial results in 2007 and beyond. We will provide more details in February when we report our year-end results.

So to summarize, we have continued to show good results this year, with improved revenue from strong SWU volumes and higher prices billed to customers for both SWU and uranium, resulting in higher gross margin and net income. However, we still have much to do over the next several months in testing our American Centrifuge technology and working to mitigate the higher power prices in 2007 and beyond that will have a substantial impact on our gross profit. We are sharply focused on these areas and look forward to providing an update when we report our year-end results.

And with that, Operator, we are now ready to take questions from our callers.

Thank you. (Operator Instructions.) And we will go first to Laurence Alexander from Jefferies and Company.

Good morning.

Good morning.

Good morning, Larry.

I guess just to sort of--a somewhat theoretical question. And this is--I don't want to sort of get into--just assuming costs for uranium SWU energy are at current levels. If your--if a generic customer moves from a 0.3% tail to a .25% tail, is that--does your EBIT margin or your EBITDA go up or down?

Bob Van Namen here. That's a very complicated question.

[I was afraid so.]

What we look at--let me see what's--the best way to handle that. The--when our customer lowers his tails assay, he obviously buys more SWU from us and gives us less uranium. What that does with our plant and with other enrichers is to have us produce more and for gaseous diffusion plant operations that means perhaps we need to buy more expensive power to do so. So, it's really hard to say. It depends on the circumstances of how much power we have to buy, what our other contracts are doing, and how much other demand we have to meet.

Okay, fair enough. Can we get a little bit more clarity on the outlook for the government contract? Should we take the--this quarter's performance as an ongoing run rate, or is there going to be another swing going in the next couple of quarters?

I don't think that we would be providing any further detail on the outlook for government contracts. But again, I think there's--you will see additional information in the 10-Q reflecting our past performance that may help you.

And, again, were the milestones--clearly, the DOE probably is not going to be adopting the cumulative measures. But could you clarify what they are, so that [you] can assess sort of what the hierarchy of risks are?

The punitive measures?

Yes.

I mean, that can take a very wide range of activities--that certainly could go at the basic heart of the whole agreement. I believe that's laid out in the--.

--10-K.

The 10-K. And that will cover each and every one of those.

And then, finally, on the deferred revenue from uranium sales in prior periods, could you quantify the EPS impact, if any, for this quarter?

The EPS impact is something that, again, we do not provide a further breakdown or forecast for that deferred revenue. But again, I think you can take the deferred revenue that we've said was recognized for the quarter, or for the year-to-date thus far, and do a calculation based on the information that we'll provide in the Q with respect to total shares outstanding.

Fair enough. I'll hop back in queue. Thank you.

And we'll go next to Paul Clegg with Natexis.

Hey. Good morning, guys. Nice quarter.

Good morning, Paul. Thank you.

Good morning, Paul.

A question on guidance. It looks like you changed several items, mostly related to the postponement of the Lead Cascade. But you also took down pre-centrifuge net income guidance by about 6 million. Can we talk about what's driving that?

Pre-centrifuge net income guidance.

Yes. It went from I think 140 to 150 down to 134 to 144 from the second quarter to the third quarter. So, you're sort of lowering and--lowering the range.

Right. Ultimately, with the pro forma analysis, we really are working backward from net income. So, I think it really is a result of the range that we updating for our 2006 guidance. And so, I think that the range that we have moved up is reflective of what we're expecting in terms of our--again, our expenses for American Centrifuge, and that really is the key driver for the change in the forecast. I don't think there is anything significant or material driving anything, if you're looking at it on that pro forma basis.

Okay. But on a--if we were to eliminate the spending altogether from American Centrifuge and just look at the core earnings potential, are we seeing anything sort of shift to a later quarter? I mean, in the past, you guys have talked a lot about the ability of customer deliveries of both Uranium and SWU actually to be hard to target, so to speak.

Right. And, no, I wouldn't point to any single factor. And clearly, the timing of customer deliveries is much more important from our cash outlook standpoint. And I know that we qualify--that we're expecting--we have some significant cash inflows in the fourth quarter that are subject to some timing risks. So, it is--it's more an impact on the cash side.

Okay. And can you tell us whether or not any--there's any components to your guidance that includes deferred revenues from uranium sales coming into the income statement?

Again, we wouldn't break out our guidance in that factor. But in our guidance and in our expectations we are always factoring into that our overall performance, including recognition of deferred revenue.

Okay. And if--I'll just do one follow-up and then jump back in the queue. A question about the amendment to the credit agreement and how that affects your outlook for liquidity into 2007. Now, of course, you've gained back 150 million that was restricted previously from that reserve. What--how would you characterize your ability to get through 2007 without accessing the capital markets? Do you think it's likely now that you don't access the capital markets at all until you've got the Lead Cascade up and running?

Well, I think the amendment to our credit facility clearly has increased our flexibility. And so, I really do thank our lenders, our agent, JPMorgan Chase, and our other leading institutions for working with us to amend that credit facility. Clearly, it provides us with that additional liquidity. It has that immediate $150 million impact. And so, I won't forecast the timing or how or what we may intend to do next year from a capital markets perspective, but clearly, it improves our flexibility.

Okay. Thanks.

Sure.

And we'll go next to Fadi Shadid with Friedman Billings Ramsey.

Hey. Good morning.

Good morning, Fadi.

Good morning.

A question on the kind of contracts you're signing now for future SWU deliveries. In terms of potential pricing, if SWU prices keep rising, and we're looking like 2009, 2010, if they hit much higher numbers where they are now, how much of it will you realize on any business that you're signing now that hasn't been priced, per se? Just in general terms, what kind of contracts are you--terms are you signing and potentially how much of a price appreciation could you realize?

The answer is a pretty complex one. It really depends on the individual contracts, and the details of those we don't really go into. But what we have been doing is signing contracts in 2006 that will allow us to hedge market, power prices, and inflation risks much better than we have in the past. When you look at our supply mix, we get about half of the enriched uranium from Russia under the Megatons to Megawatts program, and the price we pay for that is on a market basis. And the market-based formula that we use in our contracts generally reflect trends in the overall market.

The cost of power is, again, one of our other big drivers in our cost of production, and about 70% of our production cost is directly related to electricity. So, the power price component of the formula in our contract help us--helps us to hedge that risk as well. We also have general inflation numbers included in our contracts.

So, when you look at the combination, going forward, we would expect to take and benefit from increases in market prices, as well as covering ourselves for any volatility in the electricity market. And we do see those contracts as being much more dynamic going forward.

Is it like a cost plus a margin type idea, or is it just whatever the market bears to some extent? If SWU prices hit 200 or something, whether electricity prices go up that much or not, could you still fetch market prices?

Maybe if I could--where we were several years ago was that we would start with a base price in a contract that was generally reflective of the market at that time. And then, forward deliveries would be escalated by inflation only. So, when you conclude components for market and for electricity, you can expect a higher price out of current contract if we do see volatility in either one of those components.

So, we would be closer to 200 than we otherwise would have been had we been under a base escalated formula in your scenario.

Okay. So, I mean, it's not only tied to your costs, it's also tied to just general market prices?

Absolutely.

Okay. Another question on the issue of we're losing benefit from underfeeding. But if uranium prices--I mean, given uranium prices at $60 a pound now, potentially going higher, would it make sense for you to reenrich depleted uranium, reenriching tails?

That is something we've--Bob Van Namen, again. That's something we look at on an ongoing basis. It makes sense to reenrich tails whenever we see the economics of the Paducah plant, the optimum tails assay of our Paducah production being less than .3 where the vast majority of our tails are at .3. And we have been doing so, and we will continue to do so in the future.

Is there like a breakeven uranium price where the economics favor reenriching tails?

The more uranium enriched tails, the more you're pushing into summertime power. And so, you do get to the point where, when you start eating into summertime power, that's pretty expensive. So, we right now have not seen the economic breakeven for buying more summertime power, but we're probably approaching that faster than we thought we would have been six months ago.

Okay. Thank you.

Sure.

And we'll go next to Tom Lewis with Century Management.

Yes. Good morning.

Good morning, Tom.

Good morning.

Yes. Could you tell us what has driven this item on the balance sheet of inventories owed to customers up to a number that looms large relative to your shareholders equity here? Never really noticed it before, but what's that all about?

It really is the--right. It's based on the inventory that we hold versus what's held at our fabricators--held between the two sites.

I don't understand.

That's why the number looks better--.

--Right. Bob Van Namen here. I think what you're seeing is that while inventories of natural uranium--our customers continue to put inventories of natural uranium at our facilities, that natural uranium has gone up in its valuation based on the market. And so, that pushes up that overall valuation.

So, you're pricing that as--I mean, normally on the asset side, you price at the lower cost of market. You're pricing that at a higher cost of market because it's on the other site? Because it's a liability?

It is the customer's feed. It is not our asset I guess, so that would be priced at the market value.

All right.

That's right.

All right. Okay. Thank you.

(Operator Instructions.) And we'll go next to Anthony Webster with West End Advisors.

Hi. Thanks very much for taking my questions today. I apologize that I got on the call a little late, so let me know if anything that I am asking has already been asked and answered. The first question is, are you still forecasting that your gross margins may go down around 5% in 2007?

We are not restating or updating that information that we had provided earlier. Clearly, what we have been saying is that we do expect that higher power prices will have a substantial impact to our gross profit next year. And that we continue to work with all of our stakeholders, customers--U.S. Government and other stakeholders, about how we can mitigate that squeeze on our gross profit margins.

Okay. And one thing I'm a little confused about is that your energy prices have gone up as of June quite substantially. And I'm wondering--and you say the full effect of that will hit the P&L in 2007. Can you walk me through the accounting of that, the lag?

Sure. I think what's important to recognize there is that, first, the cash impact is immediate and we do see that in 2006, albeit on a half year basis compared to our previous year. But from a GAAP standpoint in net income we do have our monthly rolling average inventory method in recognizing the impact of that cost of sales or cost of production.

And so, that is something that rolls through our inventory and would become more readily apparent in 2007 as that cost increase rolls through.

I see. Okay. And two more quick questions. What's the SWU capacity of your existing gaseous diffusion plant?

It has a nameplate capacity of 11. It realistically now probably has an upward capacity of about eight and probably in the 5 to 6 million range is where we prefer to operate it.

Okay. And you're shooting for American Centrifuge to start out commercially at something like one?

Yes. Starting at--well, ramping up from one to an eventual capacity, depending on the final output of the machine of 3.5 to 4 million.

Right. Okay. And one final thing. Given that it looks like you have something on the order of just using very round numbers, a $2 billion project, and looking at your balance sheet, et cetera, and need to raise, again, very rough numbers--something like a billion. Your new plant's coming online in 2011. You have a competitor centrifuge plant using existing technology coming on in 2009. And in the meantime, you have this huge cash burn from your operations, if you're assuming you've got these 5% margins.

Have you considered shutting down the existing plant and outsourcing current contractual needs to make the financing look better between now and 2011?

I think--this is John Barpoulis. Two points. First, we are--obviously, we are always looking at operating opportunities and otherwise. What's very important to recognize is that under our various agreements with the U.S. Government, we are--we have obligations to run the gas distribution plant at a minimum 3.5 million SWU level. And from a supply/demand standpoint in the market, I think that's important as we look forward in total capacity and how we operate and plan our operations and capacity. And we are always keeping that balance in mind, both within our own customer contracts and supplies, and internationally what the market looks like.

So, I'll answer the question in a more general way. And just jumping back to the anticipated production capacity for American Centrifuge. Again, at this point, we are looking at a 3.5 million SWU plant. But as the performance in our rotor testing indicates, some improvement--above 320 SWU per machine, that 3.5 million could change as well.

Right. Okay, thank you.

We'll go next to Baker Burleson with Fox Point Capital.

Hi. Good morning. I was wondering, on your income statement you break out the revenue from SWUs and revenue from uranium. But then, the cost side those are lumped together. Given the fact that you've referenced in the last couple of statements--earnings statements that uranium inventories are on their way down, could you give us some guidance on what we could expect for a gross margin just from the SWU piece?

No. The reason we do not break out the cost side of that is, again, uranium from our perspective is a by-product of our enrichment business. And so, that is why you don't see further information there. And again, we're at this point not providing further guidance on 2007 at this point. What we have said, again, is that our--we do expect our inventories to be depleted by the end of 2007, early 2008. And so, you should expect to see a trend downward of the uranium revenue.

Right. But it would be helpful, to me, at least, in evaluating the Company to understand. I understand the uranium is a bit of a byproduct as a result of the underfeeding process. But it would be very helpful to understand how much of the gross profit is provided by that byproduct as we evaluate the prospects of the Company going forward.

Okay. Well, thank you for that comment and we will take that feedback into account as we evaluate how we provide information going forward.

But you're not willing to help us understand it right now.

No.

Okay, thanks.

Sure.

And we'll go next to Terence Ortslan from TSO Associates.

Could you remind me again how many megawatts of power do you need for the process?

We generally in the--Bob Van Namen here. In the non-summer months, we will use anywhere from 1,600 megawatts to 2,000 megawatts. And then, during the summer, we'll operate somewhere from 300 to 900 megawatts of power.

That's a lot of power.

Yes, it is. I think we are the single largest consumer in the United States. It's--.

--Industrial.

Industrial consumer.

And the centrifuge process, how much would that take in terms of power?

It is about 5% of the quantity on an equivalent SWU production basis, so 95% less.

I see. All right. Thank you. [Indiscernible-accented.] Thanks.

And we'll go next to Paul Clegg with Natexis.

Hi, guys. Just a quick follow-up on the TVA contract as you roll forward into 2007. As I recall, I think the contract that you have signed today comes up for renegotiation, or the pricing on that comes up for renegotiation in May, if I'm not mistaken, or perhaps it's June. But TVA is bringing on Brown's Ferry next year and natural gas prices are not what they were when you signed this contract.

Can you kind of comment on how you think the--a renegotiated contract would work directionally? And is it your intention at this point to lock in for a longer period of time than one year when you renegotiate that?

Yes. This is John Welch. Let me take the first half, then I'll turn it over to Bob since he owns that responsibility. Clearly, we would like a longer term contract just because it gives us much more certainty going forward, and especially as we head out into debt and equity markets. So, we would like longer term. The trends that you're talking about we think would help us heading into that thing--heading into that.

And yet, if you look at the volatility that's occurred in the energy market over the last two years, you can expect that volatility to be covered somehow in any of those aspects going forward and people are going to want to protect themselves.

Okay.

Bob, you want to comment in more detail?

Yes. Just a couple of additional thoughts. It's still very early in our negotiation process for TVA. We are looking at--we're currently covered through May of 2007 and looking for June 2007 and beyond pricing. While it is true that the natural gas prices have declined from where we were last year with Hurricane Katrina, you do see natural gas is making up a very small component of the TVA's generation. The return of Brown's Ferry I, which they do have scheduled I think for May of 2007, should definitely help their cost position since nuclear is going to be some of their lowest operating cost.

We've maintained the position that we are a very large and very unique customer for TVA. And we really should be paying less than we are today, in addition to the commodity price decreases that we've seen in the market. So, we are going to see those discussions play out for the next several months, and we'll let you know as we go forward.

Okay. And, if I may, one quick follow-up related to that. Was--did the--you have these sort of riders - cost adjustment riders - in the contract. Were any of those a sort of negative surprise, if you will, in the third quarter or in--going into the fourth quarter? Are you starting to see that bite a little bit more than what you were expecting?

Paul, I think any information related to that would appear in the Q.

Okay. I'll look for that. Thank you. Thanks, guys.

And we'll take a follow-up from Fadi Shadid with Friedman Billings Ramsey.

Yes, hi. Could you also just comment in general about the SWU market in terms of supply/demand, available capacity. And is--are customers changing sort of their outlook or procurement behavior as a function of rising uranium prices? Just kind of what you're seeing out there in terms of market balances/imbalances.

Sure. Bob Van Namen here. It's a good question. We continue to see strong demand for SWU going forward. We do see changes in the way utilities are looking at the SWU market, some of which are based on the behavior they've seen in the uranium market. They are going much longer term on their contract duration. They're doing higher prices. They're more focused on reliability and supply. So, the dynamics we're seeing from the customers overall reflect a very positive trend in the market.

We are seeing, again, on the international market the potential for new demand coming on with new reactors in China, in India, and in many other countries which have announced an intent to go forward with new nuclear generation. The long term dynamics are great. The intermediate supply/demand picture is one that really speaks for a very solid position for the American Centrifuge project at 3.5 million and perhaps even more than that.

Okay. If I could also go back to my earlier question on re-enriching tails. What does the math work out in terms of carry or breakeven uranium price for it to make sense economically to re-enrich tails at Paducah?

Again, as I said before, and I'm not trying to dodge your question. It's a question that we reevaluate constantly. But it depends on when--at what point you push into summertime power. And at that point, it's a question of overall SWU supply as well as re-enriching tails and producing uranium. So, we're still not seeing the point where it makes sense economically for us to buy summertime power to re-enrich tails. As we do have opportunities to do in the non-summer months, and we're able to procure the power at an attractive price, we are doing so.

But we're still not there. We're probably--.

--Are we far or are we close or--like $100 per pound, or--?

--I mean--.

--Or is that too high?

Well, it's approaching it. I mean, I don't know the exact numbers and because the summer power market is so volatile, it's very tough to speculate on that one.

All right. Thank you much.

Sure, buddy.

And we'll take a follow-up from Laurence Alexander with Jefferies and Company.

Just a directional question. As you're thinking about the 3.5 million SWU target for the American Centrifuge and you're already signing longer term contracts with your customers, is the--do you--are you nearing the point where your past--say halfway through filling up the capacity on the American Centrifuge as it ramps up? And are your customers looking at the longer term SWU landscape with the same perspective you are, and encouraging you to move beyond the 3.5 million target? Or do they think that that's just right at sort of the Goldilocks target?

Yes. We are having discussions with the customers, as John mentioned, at all levels within their organizations, about the appropriate size and contract duration and other aspects of the contract. We are looking to go out and actually firm up those contracts next year. We're having conceptual discussions now based on what we're seeing in the marketplace. But we're really looking to get the Lead Cascade data, contracts with the fabricators and the suppliers for the centrifuge project, before we go out and actually lock up that long term supply.

Yes. Our discussions with the utilities, which you--what I said earlier was they clearly want us to be successful. They want a competitive strong domestic market from which to buy enriched uranium. But they're asking all the kinds of questions that you ask, relative--okay, how's the performance of the machine going, what's that mean for the plant, how--what's the impact on economics. So, they're watching our progress as closely as you are, believe me.

The--a more optimal time for us to enter into those longer term contracts is as we come through our costs rebaselining and we have data coming out the cascade, and we've signed fixed price contracts with the vendors for the manufacture of 11,000-plus machines. The utilities would like to enter into a long term contract. And so, we're starting the discussions now, because there becomes an optimal point, a point at which we're both comfortable that we're meeting their demands, they have a reliable supply, and we're assured that we can get the necessary return for the investment that's being made.

And I guess on--I guess related to that, has the utility's tone been affected much by the news flow coming out of Russia over the last three to six months? Has that changed their stance at all?

We do see the utility--Bob Van Namen here. We do see the utilities very focused on reliable supply. And I think they've observed some of the Russian behavior as they look at using energy as an extension of their--energy commodities as an extension of their policy in international politics. And so, they are concerned about reliable supply. So, it has been a factor in many of our discussions, both domestically and internationally.

And finally, you went out of your way to highlight the potential for needing to buy uranium in the spot market to satisfy the Russian requirements. Can you give us some sense of what the possible magnitudes might be, so that people don't exaggerate the impact?

Laurence, I don't think we're prepared to provide specific guidance, again, until early next year when we'll be providing guidance with--for 2007. But on the whole, this is just a topic that we're raising for people's awareness. And it is likely something that's more of a longer term impact that we see, based on the dynamics that we see in the SWU and uranium markets.

Yes. But qualitatively, it's a longer term issue versus a shorter term issue or--.

--Yes, that is correct.

Okay.

And that concludes the question and answer session today. At this time, I'd like to turn the conference back over to Management for any additional or closing remarks.

I think one of the things that I wanted to talk to is just a little bit about--since this is my one-year anniversary of giving these calls is that what this Management Team has been focused on in the last year has really been how to pull our focus together, how to bring the team together, such that we can adequately execute this business in the near term, while we're making such a significant transition to a whole new way of doing business.

It was important for us to establish a baseline for this project that we could manage to and report against, so that we could give you and the rest of the stakeholders confidence that we're moving in the right direction. Again, I would tell you that this is a complex project that we're undertaking and there are many challenges ahead of us. But I feel a heck of a lot better today for where our baseline is, and I'm confident that the efforts and extra time that we're taking in the near term will provide significant benefits over the long term deployment of the plant.

We appreciate your questions and your continued probing on how we're doing in that process. And we look forward to continued communications with you, so thanks very much.

That concludes the conference today, ladies and gentlemen. Again, thank you for your participation, and you may now disconnect.