Filed Pursuant to

Rule 424(b)(5)

 

A filing fee of $15,887 calculated in accordance with Rule 457(r), is payable to the SEC in connection with the offering of convertible notes from the Registration Statement (File 333-146063) by means of this prospectus Supplement and the accompanying prospectus. Also registered is an indeterminate number of shares of common stock into which the convertible notes may be converted. Pursuant to Rule 457(i), no separate registration fee is payable where securities and securities into which conversion is offered are registered at the same time and no additional consideration is payable upon conversion. The proposed maximum aggregate offering price is based on a maximum aggregate principal amount of convertible notes to be sold of $517.5 million including amounts that may be purchased by the underwriters pursuant to their option to purchase additional convertible notes.

Subject to Completion. Dated September 14, 2007

 

Prospectus Supplement to Prospectus dated September 14, 2007.

 

$450,000,000

 

  % Convertible Senior Notes due 2014

 

 

 

 

The notes will bear interest at a rate of  % per annum. We will pay interest on the notes on April 1 and October 1 of each year. The first such payment will be made on April 1, 2008. The notes will mature on October 1, 2014.

 

Holders may convert their notes at their option on any day prior to the close of business on the scheduled trading day (as defined herein) immediately preceding August 1, 2014 only under the following circumstances: (1) during the five business day period after any five consecutive trading day period in which the price per note for each trading day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such day; (2) during any calendar quarter (and only during such quarter) after the calendar quarter ending September 30, 2007, if the last reported sale price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 120% of the conversion price in effect on the last trading day of the immediately preceding calendar quarter; or (3) upon the occurrence of specified corporate events. The notes will be convertible, regardless of the foregoing circumstances, at any time from, and including, August 1, 2014 through the scheduled trading day immediately preceding the maturity date of the notes.

 

Upon conversion, for each $1,000 in principal amount outstanding, we will deliver a number of shares of our common stock equal to the conversion rate. The initial conversion rate for the notes will be     shares of common stock per $1,000 in principal amount of notes, equivalent to an initial conversion price of approximately $        per share of common stock. The conversion rate will be subject to adjustment in some events but will not be adjusted for accrued interest. In addition, if a make-whole fundamental change (as defined herein) occurs prior to the maturity date of the notes, we will in some cases increase the conversion rate for a holder that elects to convert its notes in connection with such make-whole fundamental change.

 

Subject to certain exceptions, holders may require us to repurchase for cash all or part of their notes upon a fundamental change (as defined herein) at a price equal to 100% of the principal amount of the notes being repurchased plus any accrued and unpaid interest up to, but excluding, the relevant repurchase date. We may not redeem the notes prior to maturity.

 

The notes will be our senior unsecured obligations and will rank equally with all of our existing and future senior unsecured debt and senior to all of our subordinated debt. The notes will be structurally subordinated to all existing and future liabilities of our subsidiaries and will be effectively subordinated to our existing and future secured indebtedness to the extent of the value of the collateral. As of June 30, 2007, we had indebtedness of $150 million, none of which was secured, and letters of credit of $33.4 million outstanding under our credit facility. For a more detailed description of the notes, see “Description of Notes” beginning on page S-105.

 

We do not intend to apply for a listing of the notes on any securities exchange or for inclusion of the notes in any automated quotation system. Shares of our common stock are traded on the New York Stock Exchange under the symbol “USU”. The closing sale price of our common stock on the New York Stock Exchange on September 13, 2007 was $13.14 per share.

 

Concurrently with this offering notes, we are offering 18,000,000 shares of common stock (or 20,700,000 shares if the underwriters exercise their option to purchase additional shares with respect to that offering in full).

 

See “Risk Factors” beginning on page S-20 to read about important factors you should consider before buying the notes.

 

Our certificate of incorporation contains significant restrictions on foreign ownership of shares of our common stock. See “Description of Indebtedness and Capital Stock — Description of Capital Stock — Foreign Ownership Restrictions”.

 

 

 

 

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus supplement or the accompanying prospectus. Any representation to the contrary is a criminal offense.

 

 

 

 

 

The initial public offering price set forth above does not include accrued interest, if any. Interest on the notes will accrue from September   , 2007 and must be paid by the purchasers if the notes are delivered after September   , 2007.

 

To the extent that the underwriters sell more than $450,000,000 principal amount of notes, the underwriters have the option to purchase up to $67,500,000 principal amount of notes at the initial price to public less the underwriting discount.

 

 

 

 

The underwriters expect to deliver the notes through the facilities of The Depository Trust Company against payment in New York, New York on September  , 2007.

 

 

 

 

Merrill Lynch & Co.

 

 

 

 

Prospectus Supplement dated September  , 2007.

 

ABOUT THIS PROSPECTUS SUPPLEMENT

 

This prospectus supplement and the accompanying prospectus are part of a registration statement that we filed with the Securities and Exchange Commission, or SEC, utilizing a “shelf” registration process. This prospectus supplement provides you with the specific details regarding this offering, including the principal amount, conversion ratio and ranking of our notes, and the risks of investing in our notes. The accompanying prospectus provides you with more general information, some of which does not apply to the offering of our notes. To the extent information in this prospectus supplement is inconsistent with the accompanying prospectus or any of the documents incorporated by reference into this prospectus supplement and the accompanying prospectus, you should rely on this prospectus supplement.

 

You should rely only on the information contained or incorporated by reference in this prospectus supplement, the accompanying prospectus and any free writing prospectus that we authorize to be distributed to you. We have not, and the underwriters have not, authorized anyone to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus supplement, the accompanying prospectus, the documents incorporated by reference in this prospectus supplement and the accompanying prospectus, and any free writing prospectus is accurate only as of the date on those respective documents. Our business, financial condition, results of operations and prospects may have changed since those dates. You should read this prospectus supplement, the accompanying prospectus, the documents incorporated by reference in this prospectus supplement and the accompanying prospectus, and any free writing prospectus when making your investment decision. You should read and consider the information in this prospectus supplement, the accompanying prospectus and any free writing prospectus, together with the additional information described under the headings “Where You Can Find Additional Information” and “Incorporation by Reference” in the accompanying prospectus.

	•	supply LEU to both domestic and international utilities for use in approximately 150 nuclear reactors worldwide,
	•	are in the process of demonstrating, and expect to deploy, what we anticipate will be the world’s most efficient uranium enrichment technology, known as the American Centrifuge,
	•	are the exclusive executive agent for the U.S. government for a nuclear nonproliferation program with Russia, known as Megatons to Megawatts,
	•	perform contract work for the U.S. Department of Energy (“DOE”) and DOE contractors at the Paducah and Portsmouth gaseous diffusion plants, and
	•	provide transportation and storage systems for spent nuclear fuel and provide nuclear and energy consulting services, including nuclear materials tracking.

	•	sales of the SWU component of LEU,
	•	sales of both the SWU and uranium components of LEU and
	•	sales of uranium.

	•	demonstrating the capability of the cascade to generate product assays in a range useable by commercial nuclear power plants,
	•	providing information on machine-to-machine interactions and integrated efficiency of the full cascade,
	•	confirming the design and performance of the centrifuge machine and cascade support systems,
	•	verifying cascade performance models under various operating conditions,

	•	providing information on the performance of centrifuge components over time, and
	•	giving operators and technicians hands-on experience assembling, operating and maintaining the machines.

Strategic Supplier		Responsibility
Honeywell International		Rotor assembly, balancing and final machine assembly
Alliant Techsystems Inc.		Fabricating carbon fiber rotor tubes
BWX Technologies, Inc.		Classified machining and unclassified part procurement
Fluor Corporation		Managing commercial plant engineering, procurement and construction activities

	•	American Centrifuge.  We are deploying the American Centrifuge Plant to replace our gaseous diffusion uranium enrichment operations and to be well positioned to meet utility demand for LEU. We believe that the centrifuge machine that we will deploy in the ACP will have an output much greater than the next best competitor’s machine and will be the most efficient uranium enrichment machine in the world.
	•	Underfeeding.  Our existing gaseous diffusion plant has the ability to use, or feed less uranium but utilize more electric power in our enrichment process, which we refer to as underfeeding, and gives us the ability to obtain uranium that can be potentially resold at attractive prices and higher profit margins. We have purchased additional electricity to take advantage of underfeeding the enrichment process for the next three years and potentially have the opportunity to do so beyond that time.
	•	Pre-sold Capacity through Long-Term Supply Contracts.  Our long-term contracts with our electric utility customers provide us with predictable sales, although the timing and amounts of these sales can vary based on customer requirements. As we deploy the ACP, we anticipate signing additional long-term contracts to maintain a predictable sales level. By pre-selling LEU to be delivered at a later time, we try to minimize customer demand risk.
	•	Domestic Producer.  We are currently the only domestic uranium enricher. As a result, USEC-sourced supplies of LEU carry fewer geopolitical risks.
	•	Established Relationships.  We have an extensive base of existing domestic and international customers and support them with reliable supply and flexible logistics.
	•	Megatons to Megawatts.  We are the exclusive executive agent for the United States under the Megatons to Megawatts program with the Russian Federation under which we purchase from Russia the SWU component of LEU derived from dismantled Soviet nuclear weapons. Although the Russian government has indicated that it will not renew the program after it expires in 2013, we are currently able to supplement the Paducah GDP production with this additional source of LEU.

	•	Pursuing Next Generation Technology.  We are in the process of demonstrating and expect to deploy the American Centrifuge technology, which we believe will be the world’s most efficient uranium enrichment technology. Deploying the American Centrifuge technology will drastically reduce our power costs and modernize our production capacity.
	•	Pursuing Sales Opportunities.  With an expected increase in the global demand for LEU to supply nuclear reactors, we are focusing on retaining existing customers and attracting new

	•	Improving Operating Efficiencies.  We deploy continuously improved systems and tools to enhance our operating efficiencies and productivity. The implementation of the ACP will dramatically reduce our power utilization and we are making every effort to optimize the performance of the centrifuge machine design for the ACP.

	•	Redemption price or exchange value:  Generally the redemption price or exchange value for any shares of our common stock redeemed or exchanged would be their fair market value. However, if we redeem or exchange shares held by foreign persons, including shares acquired by foreign persons after the conversion of notes acquired in this offering, and our Board in good faith determines that such foreign person knew or should have known that the foreign ownership restrictions in our certificate of incorporation were violated at the time of their

		purchase, the redemption price or exchange value is required to be the lesser of fair market value and the foreign person’s purchase price for the shares redeemed or exchanged.

	•	Form of payment:  cash, securities or a combination, valued by our Board in good faith.
	•	Notice:  at least 30 days’ notice of redemption is required, however, if we have deposited the cash or securities for the redemption or exchange in trust for the benefit of the relevant foreign holders, we may redeem shares held by such holders on the same day that we provide notice (which we refer to as the “trust redemption right”).

	1.	Unless the Board determines that the further exercise of rights under our certificate of incorporation is necessary to maintain our regulatory compliance (whether as a result of a request or order of a regulatory authority or otherwise), the Board will seek to maintain our regulatory compliance by first limiting the voting rights of any such foreign person.
	2.	To the extent that the Board determines that the exercise of our right of redemption or exchange is necessary to maintain our regulatory compliance (whether as a result of a request or order of a regulatory authority or otherwise), such redemption or exchange shall be taken only to the extent necessary, in the judgment of the Board, to maintain such regulatory compliance or comply with such request or order, shall be settled only in cash and in no event will we avail ourselves of the trust redemption right (unless otherwise required by law or to maintain our regulatory compliance).
	3.	In no event will we exercise our right of redemption or exchange if the Board determines that such redemption or exchange is required to be made at the lesser of fair market value and the foreign person’s purchase price for the shares redeemed or exchanged.

Issuer		USEC Inc.
Notes Offered		$450,000,000 in aggregate principal amount of   % Convertible Senior Notes due 2014, which may be increased to up to $517,500,000 in principal amount of the notes if the underwriters exercise their option to purchase additional notes in full.
Maturity Date		October 1, 2014, unless earlier repurchased or converted.
Interest		% per year payable semiannually in arrears in cash on April 1 and October 1 of each year, beginning on April 1, 2008.
Ranking		The notes will be our senior unsecured obligations and will rank equally with all of our existing and future senior unsecured debt and senior to all of our subordinated debt. The notes will be structurally subordinated to all existing and future liabilities of our subsidiaries and will be effectively subordinated to our existing and future secured indebtedness to the extent of the value of the collateral. As of June 30, 2007, we had indebtedness of $150 million, none of which was secured, and letters of credit of $33.4 million outstanding under our credit facility.
		The indenture for the notes does not restrict us or our subsidiaries from incurring debt or other liabilities, including secured debt. Our subsidiaries will not guarantee any of our obligations under the notes.
Conversion Rights		Holders may convert their notes prior to the close of business on the “scheduled trading day” (as defined herein) immediately preceding August 1, 2014 in multiples of $1,000 in principal amount, at the option of the holder, under the following circumstances:
		• during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price per note for each trading day of such measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the notes on each such day;
		• during any calendar quarter (and only during such calendar quarter) after the calendar quarter ending September 30, 2007, if the last reported sale price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 120% of the applicable

		conversion price in effect for the notes on the last trading day of the immediately preceding calendar quarter; or
		• upon the occurrence of specified events described below under “Description of Notes — Conversion Rights — Conversion upon Specified Corporate Events”.
		At the option of the holder, regardless of the foregoing circumstances, holders may convert their notes, in multiples of $1,000 in principal amount, at any time on or after August 1, 2014 through the scheduled trading day immediately preceding the maturity date of the notes.
		The initial conversion rate for the notes will be    shares of common stock per $1,000 in principal amount of notes, which is equivalent to an initial conversion price of approximately $   per share of common stock, subject to adjustment. The conversion rate may be adjusted under certain circumstances. See “Description of Notes — Conversion Rights — Conversion Rate Adjustments”.
		In addition, if a “make-whole fundamental change” (as defined herein) occurs prior to the maturity date of the notes, we will in some cases increase the conversion rate for a holder that elects to convert its notes in connection with such fundamental change as described under “Description of Notes — Conversion Rights — Adjustment to Shares Delivered upon Conversion upon a Make-Whole Fundamental Change”. No adjustment to the conversion rate will be made if the stock price is less than $    per share or if the stock price exceeds $    per share (in each case, subject to adjustment).
		The holder will not receive any additional cash payment or additional shares representing accrued and unpaid interest upon conversion of a note, except in limited circumstances. Instead, interest will be deemed paid by the shares of our common stock delivered to the holder upon conversion.
Settlement Upon Conversion		Upon conversion we will deliver, on the third business day following the relevant conversion date, a number of shares of our common stock equal to the conversion rate on the relevant conversion date for each $1,000 principal amount of notes. We will deliver cash in lieu of any fractional shares of our common stock based on the last reported sale price of our common stock on the relevant conversion date (or, if the conversion date is not a trading day, the next succeeding trading day).
Sinking Fund		None.
Optional Redemption by the Company		The notes may not be redeemed by us prior to the maturity date.
Fundamental Change Repurchase Right of Holders		Subject to certain exceptions, if we undergo a “fundamental change” (as defined herein) you will have the option to require

		us to repurchase all or any portion of your notes. The fundamental change repurchase price will be 100% of the principal amount of the notes to be purchased plus any accrued and unpaid interest to but excluding the fundamental change repurchase date. We will pay cash for all notes so repurchased.
Events of Default		Except as noted below, if an event of default on the notes occurs and is continuing, the principal amount of the notes, plus accrued and unpaid interest thereon, if any, may be declared immediately due and payable, subject to certain conditions set forth in the indenture. If the event of default relates to our failure to comply with the reporting obligations in the indenture, at our option, the sole remedy for the first 90 days following such event of default consists exclusively of the right to receive additional interest on the notes at a rate of 0.50% per annum. The notes will automatically become due and payable in the case of certain types of bankruptcy or insolvency events of default involving us.
Absence of an Established Market for the Notes		The notes are new securities and there is currently no established market for the notes. Accordingly, we cannot assure you as to the development or liquidity of any market for the notes. The underwriters have advised us that they currently intend to make a market in the notes. However, they are not obligated to do so, and they may discontinue any market making with respect to the notes without notice.
		We do not intend to apply for a listing of the notes on any securities exchange or any automated dealer quotation system.
Form of the Notes		We will issue the notes in book-entry form through The Depository Trust Company. The notes will be evidenced by one or more global notes. We will issue the notes only in registered form, without interest coupons and in denominations of $1,000 in principal amount and multiples of $1,000.
NYSE Symbol for Our Common Stock		Our common stock is listed on the New York Stock Exchange under the symbol “USU”.
Concurrent Common Stock Offering		Concurrently with this offering, we are offering 18,000,000 shares (20,700,000 shares if the underwriters exercise their option to purchase additional shares in full) of our common stock. We refer to the concurrent offering of our common stock and this offering as the “offerings”.
Use of Proceeds		We estimate the net proceeds to us from the sale of the notes will be approximately $438.8 million (or approximately $504.8 million if the underwriters exercise their option to purchase additional notes in full) and the net proceeds from the concurrent common stock offering will be approximately $225.3 million, based on an assumed public offering price of

		$13.14 per share, the closing price of our common stock on September 13, 2007 (or approximately $259.2 million if the underwriters exercise their option to purchase additional shares in full) in each case after deducting aggregate estimated offering expenses of approximately $1.7 million as well as discounts and commissions. All of the net proceeds from these offerings will be applied to the development, demonstration and deployment of the American Centrifuge project and our general operating expenses and working capital requirements.
		See “Sources and Uses of Funding for the American Centrifuge Project” for a further discussion of the estimated sources and uses of funds for the deployment of the American Centrifuge Project.
U.S. Federal Tax Considerations		You should consult your tax advisor with respect to the U.S. federal income tax consequences of owning the notes and the common stock into which the notes may be converted in light of your own particular situation and with respect to any tax consequences arising under the laws of any state, local, foreign or other taxing jurisdiction. See “Certain Material United States Federal Income Tax Considerations”.

														Six Months Ended
														June 30,
		Years Ended December 31,												(Unaudited)
		2006				2005				2004				2007				2006
		(In millions, except per share data)
Revenue:
Separative work units		$	1,337.4			$	1,085.6			$	1,027.3			$	550.9			$	638.3
Uranium			316.7				261.3				224.0				32.0				146.8
U.S. government contracts and other			194.5				212.4				165.9				93.2				101.5
Total revenue			1,848.6				1,559.3				1,417.2				676.1				886.6
Cost of sales:
Separative work units and uranium			1,349.2				1,148.4				1,071.6				496.0				630.2
U.S. government contracts and other			162.5				181.4				151.5				79.2				84.8
Total cost of sales			1,511.7				1,329.8				1,223.1				575.2				715.0
Gross profit			336.9				229.5				194.1				100.9				171.6
Special charges (credits), net			3.9	(1)			7.3	(2)			—				—				1.5
Advanced technology costs			105.5				94.5				58.5				69.3				47.1
Selling, general and administrative			48.8				61.9				64.1				24.0				25.8
Other (income) expense, net			—				(1.0	)(3)			(1.7	)(4)			—				—
Operating income			178.7				66.8				73.2				7.6				97.2
Interest expense			14.5				40.0				40.5				5.9				8.2
Interest (income)			(6.2	)			(10.5	)			(3.9	)			(17.8	)			(2.3	)
Income before income taxes			170.4				37.3				36.6				19.5				91.3
Provision (benefit) for income taxes			64.2				15.0				13.1				(6.4	)			35.1
Net income		$	106.2			$	22.3			$	23.5			$	25.9			$	56.2
Net income per share — basic and diluted		$	1.22			$	.26			$	.28			$	.30			$	.65
Dividends per share		$	—			$	.55			$	.55			$	—			$	—

														As of June 30,
		As of December 31,												(Unaudited)
		2006				2005				2004				2007				2006
		(In millions)
Balance Sheet Data:
Cash, cash equivalents and short-term investments		$	171.4			$	259.1			$	174.8			$	48.3			$	21.6
Inventories:
Current			900.0				974.3				1,009.4				1,062.3				899.9
Long-term			24.2				71.4				156.2				—				89.5
Total assets			1,861.4				2,080.8				2,003.4				1,850.7				1,855.8
Current portion of long-term debt			—				288.8				—				—				—
Long-term debt			150.0				150.0				475.0				150.0				150.0
Other long-term liabilities			300.3				270.2				244.4				325.3				280.1
Stockholders’ equity			986.0				907.6				918.7				989.4				967.6

(1)		Special charges of $3.9 million in 2006 include a $2.6 million impairment of an intangible asset established in 2004 relating to the acquisition of NAC, $1.5 million related to consolidation of office space in connection with the 2005 restructuring plan, and special credits totaling $0.2 million representing changes in estimate of costs for termination benefits charged in 2005.
(2)		The plan to restructure headquarters and field operations resulted in special charges of $7.3 million in 2005 related to termination benefits, principally consisting of severance benefits.
(3)		Other income in 2005 includes $1.0 million from customs duties paid to USEC as a result of trade actions.
(4)		Other income in 2004 includes income of $4.4 million from customs duties paid to USEC as a result of trade actions, partly offset by an expense of $2.7 million for acquired-in-process research and development expense relating to the acquisition of NAC.

														Six Months Ended
		Years Ended December 31,												June 30,
		2006				2005				2004				2007				2006
Other Financial Data (Unaudited):
Gross profit margin			18.2	%			14.7	%			13.7	%			14.9	%			19.4	%
Increase in average SWU price billed to customers compared to prior year or corresponding six-month period in prior year			5	%			2	%			0	%			10	%			7	%
American Centrifuge expenditures (in millions):
Expensed		$	103.3			$	92.7			$	58.1			$	68.6			$	46.2
Capitalized		$	41.2			$	16.0			$	6.1			$	25.6			$	11.7
Total		$	144.5			$	108.7			$	64.2			$	94.2			$	57.9

		December 31,												June 30,
		2006				2005				2004				2007				2006
Other Market Data (Unaudited)(1):
Long-term SWU price indicator ($/SWU)		$	136.00			$	113.00			$	107.00			$	140.00			$	128.00
Uranium hexafluoride:
Long-term price composite ($/KgU)		$	192.54			$	106.06			$	75.32			$	260.47			$	135.05
Spot price indicator ($/KgU)		$	199.00			$	106.00			$	63.00			$	358.00			$	132.00

(1)		This data has been calculated using indicators published in Nuclear Market Review and the spot price indicator for uranium hexafluoride. This is an indication of base-year prices under new long-term SWU contracts in our primary markets. However, 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.

														Six Months Ended
														June 30,
		Years Ended December 31,												(Unaudited)
		2006				2005				2004				2007				2006
Cash Flow Data:
Net cash provided by (used in) operating activities		$	278.1			$	188.9			$	52.6			$	(82.8	)		$	39.7
Net cash (used in) investing activities			(79.6	)			(26.3	)			(34.3	)			(41.4	)			(16.1	)
Net cash provided by (used in) financing activities			(286.2	)			(78.3	)			(57.6	)			1.1				(261.1	)
Credit Statistics (Unaudited):
Debt to total capitalization at period end(1)			13	%			33	%			34	%			13	%			15	%
Ratio of earnings to fixed charges(2)			11.4	x			2.0	x			2.0	x			3.2	x			11.2	x

(1)		On an as adjusted basis after giving effect to our issuance and sale of $450.0 million principal amount of the notes offered hereby and our concurrent issuance and sale of 18,000,000 shares of common stock in the concurrent common stock offering at an assumed price to the public of $13.14 per share, our June 30, 2007 debt to total capitalization would have been 33%.
(2)		For purposes of these calculations, “earnings” represents income (loss) before income taxes and those fixed charges impacting earnings and “fixed charges” consist of interest expense related to indebtedness, amortization of deferred financing costs and discount, and capitalized interest.

 

FORWARD-LOOKING STATEMENTS

 

This prospectus supplement and the documents incorporated by reference in this prospectus supplement contain “forward-looking statements” — 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: the success of the demonstration and deployment of our American Centrifuge technology including our ability to meet our performance targets, target cost estimate and schedule for the American Centrifuge Plant and our ability to secure required external financial support; the cost of electric power used at our gaseous diffusion plant; our dependence on deliveries under the Russian Contract and on a single production facility; our inability under most existing long-term contracts to pass on to customers increases in SWU prices under the Russian Contract resulting from significant increases in market prices; changes in existing restrictions on imports of Russian enriched uranium, including the imposition of duties on imports of enriched uranium under the Russian Contract; the elimination of duties charged on imports of foreign-produced low enriched uranium; pricing trends in the uranium and enrichment markets and their impact on our profitability; changes to, or termination of, our contracts with the U.S. government and changes in U.S. government priorities and the availability of government funding; the impact of government regulation; the outcome of legal proceedings and other contingencies (including lawsuits, government investigations or audits and government/regulatory and environmental remediation efforts); the competitive environment for our products and services; changes in the nuclear energy industry; 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. We do not undertake to update our forward-looking statements except as required by law.

 

RISK FACTORS

 

Any investment in our notes or our common stock involves a high degree of risk. You should consider the risks described below carefully and all of the information contained in this prospectus supplement before deciding whether to purchase our notes or to convert the notes into common stock. The risks and uncertainties described below are not the only risks and uncertainties we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition and results of operations could suffer materially. In that event, the price of the notes and our common stock could decline, and you could lose all or part of your investment in the notes and our common stock. The risks discussed below also include forward-looking statements and our actual results may differ substantially from those discussed in these forward-looking statements. See “Forward-Looking Statements”.

 

Risks Related to Our Business

 

The long-term viability of our business depends on our ability to replace our current enrichment facility with the American Centrifuge Plant.

 

We currently depend on our gaseous diffusion facility in Paducah, Kentucky for approximately one-half of the LEU that we need to meet our delivery obligations to our customers and to generate uranium through underfeeding to satisfy our obligations under the Russian Contract. The gaseous diffusion technology that we use at the Paducah GDP is an older, high operating-cost technology that requires substantially greater amounts of electric power than the centrifuge technology used by our competitors. Due to significant increases in our power costs during recent periods and the possibility of additional power cost increases in the future, the production of LEU using gaseous diffusion technology is becoming increasingly uneconomic. We are focused on developing and deploying an advanced uranium enrichment centrifuge technology, which we refer to as American Centrifuge technology, as a replacement for our gaseous diffusion technology. The American Centrifuge technology is more advanced and expected to operate substantially more cost-efficiently than gaseous diffusion. The American Centrifuge technology, however, has substantial capital costs and risks as further described below. We are not currently pursuing any strategies to replace the Paducah GDP with alternatives other than the American Centrifuge Plant. As a result, if we are unable to successfully and timely demonstrate and deploy the American Centrifuge Plant on a cost-effective basis, due to the risks and uncertainties described in this section or for any other reasons, our gross profit margins, cash flows, liquidity and results of operations would be materially and adversely affected and our business may not remain viable.

 

We face a number of risks and uncertainties associated with the successful and timely demonstration, construction and deployment of the American Centrifuge technology.

 

The American Centrifuge technology is expected to be more operationally cost-efficient than our gaseous diffusion technology that we currently depend on for LEU production at the Paducah GDP. However, the demonstration, construction and deployment of the American Centrifuge technology is a large and capital-intensive undertaking that is subject to numerous risks and uncertainties.

 

We are in the process of demonstrating the American Centrifuge technology and are working toward beginning commercial plant operations in late 2009 and having approximately 11,500 centrifuge machines deployed in 2012. However, to date we have experienced substantial delays in demonstrating the American Centrifuge technology and these delays have impacted our construction and deployment schedule and increased the overall costs of the project. The delays we have experienced to date resulted from a variety of factors including the failure of certain materials to meet specifications, performance problems with, and failures of, certain centrifuge components and the time-consuming process of ensuring compliance with new regulatory requirements.

In the beginning of 2007, we revised our deployment schedule and cost estimate to take account of the effect of delays experienced through the end of 2006. While the revised schedule takes into account the lessons we have learned in our efforts to deploy the American Centrifuge Plant to date, it is nevertheless ambitious. To maintain the revised schedule, we have made, and expect to continue to make, key decisions, including decisions to expend or commit to expend large amounts of capital and resources, before we have received all relevant centrifuge machine performance data and confirmation of the American Centrifuge project’s costs, schedule and overall viability.

 

Additionally, our ability to meet the revised schedule depends on a number of factors that are outside of our control, including our reliance on third party suppliers for American Centrifuge components. The failure of any of our suppliers to provide their respective components as scheduled or at all could result in substantial delays in, or otherwise materially hamper, the deployment of the American Centrifuge Plant. There are a limited number of potential suppliers for these key components and finding alternate suppliers could be difficult, time consuming and costly. In addition, because such suppliers are few and due to our dependence on them for key components, our ability to obtain favorable contractual terms with these suppliers is limited. We have entered into and expect to enter into future agreements with suppliers in which we bear certain cost, schedule and performance risk. Although we will seek to address these risks, we cannot provide any assurance that we will be able to, which could result in cost increases and unanticipated delays. Our inability to effectively integrate these suppliers and other key third party suppliers could also result in delays and otherwise increase our costs.

 

As a result of these and other factors, including factors and circumstances similar to those that have delayed us in the past, we may be unable to meet our revised schedule. Delays in our revised schedule could:

 

 

Any of these outcomes could substantially reduce our revenues, gross profit margins, liquidity and cash flows and adversely affect the overall economics, ability to finance and the likelihood of successful deployment of the American Centrifuge Plant. This would have a material adverse impact on our business and prospects because we believe the long-term viability of our business depends on the successful deployment of the American Centrifuge Plant.

 

We are required to meet certain milestones under the 2002 DOE-USEC Agreement and our failure to meet these milestones or disagreements with DOE as to whether we met a milestone in a timely manner could cause DOE to exercise one or more remedies under the 2002 DOE-USEC Agreement.

 

The 2002 DOE-USEC Agreement contains specific project milestones relating to the American Centrifuge Plant. In March 2007 we received approval from DOE to revise and extend the October 2006 milestone by one year and to extend the January 2007 financing milestone by one year. In approving these extensions, DOE reserved its rights and remedies under the 2002 DOE-USEC Agreement.

After the revision, four mandatory milestones and one optional milestone remain:

 

 

Our revised schedule for deploying the American Centrifuge Plant is later than the schedule established by the January 2009, March 2010 and September 2011 milestones above. While we believe that we will reach a mutually acceptable agreement with DOE regarding rescheduling of these milestones, we cannot assure you that we will reach such an agreement.

 

If DOE determines that we failed to comply with the terms of the 2002 DOE-USEC Agreement, including if DOE determines we did not meet one or more of the milestones that we believe we have already met, then, unless such failure is determined to arise from causes beyond our control and without our fault or negligence, DOE could exercise one or more remedies under the 2002 DOE-USEC Agreement. These remedies could include terminating the 2002 DOE-USEC Agreement, revoking our access to DOE’s U.S. centrifuge technology that we require for the success of the American Centrifuge project and requiring us to transfer our rights in the American Centrifuge technology and facilities to DOE, and requiring us to reimburse DOE for certain costs associated with the American Centrifuge project. DOE could also recommend that we be removed as the sole Executive Agent under the Megatons-to-Megawatts program. Any of these actions could have a material adverse impact on our business and prospects. Once we have secured (and demonstrated to DOE) firm financing commitments for the construction of a one million SWU per year centrifuge plant, DOE’s ability to take these actions is limited to circumstances in which failure to meet a milestone is attributable to our gross negligence in project planning or execution or where we constructively or formally abandon the project.

 

Deployment of the American Centrifuge technology will require additional external financial and other support that may be difficult to secure.

 

We will require a significant amount of capital to achieve commercial deployment of the American Centrifuge Plant. Under our revised deployment schedule, spending on the American Centrifuge project will increase substantially after 2007, with spending in 2008 currently projected to be approximately double the level of 2007.

 

Given the declining level of cash generated by our existing operations caused by higher power costs incurred since June 2006, the expected cost to complete the American Centrifuge project and the risk associated with the project, we may need participation by third parties and/or the U.S. government to finance and complete the project under our revised deployment schedule. We cannot assure you that we will be able to obtain sufficient additional external financing and we cannot predict the cost or terms on which such financing will be available, if at all, to continue our operations and deployment of the American Centrifuge Plant. We also cannot assure you that we will be able to attract third party and/or U.S. government participation.

Factors that could affect our ability to obtain financing, the cost of any financing or that could affect our ability to successfully attract the third party and/or U.S. government investment or participation that we may need to raise capital could include:

 

 

We cannot assure you that we will attract the capital we need to complete the American Centrifuge project in a timely manner or at all. If we do not, we might be forced to slow or stop spending on the project, which could result in delays and increased costs, and potentially make the project uneconomic. This would have a material adverse impact on our business and prospects because we believe the long-term viability of our business depends on the successful deployment of the American Centrifuge project.

 

Our estimates of the costs of the American Centrifuge project are subject to significant uncertainties that could adversely affect our ability to finance and deploy the American Centrifuge Plant.

 

In early 2007, we completed a comprehensive review of the cost of deploying the American Centrifuge Plant and established a target cost estimate of $2.3 billion. That target cost estimate includes amounts spent on the project through early 2007 and estimates for cost escalation, but does

not include financing costs or a reserve for general contingencies. Our target cost estimate assumes that we will be successful in reducing the capital cost per machine over time based on value engineering the design of centrifuge machines for high-volume manufacturing.

 

Our cost estimates for the American Centrifuge project are based on many assumptions that are subject to change as new information becomes available or as unexpected events occur. For example, spending to date, combined with commitments we have made and anticipate making in the near future for components of the American Centrifuge Plant exceed the corresponding amounts included in our target cost estimate by approximately $150 million, or 15%. Some of the key variables in our estimates are difficult to quantify with certainty at this stage of the project. Further, several key variables such as the cost of raw materials to build the plant and general inflation, are outside our control. It is also difficult to quantify with certainty at this stage the cost of manufacturing complex centrifuge machine components on a commercial scale. This manufacturing will be done by third parties and while our cost estimates reflected preliminary input from our project suppliers, we will not know the actual cost until we finalize the design of the centrifuge machines and enter into contractual arrangements with these project suppliers.

 

Based on information currently available to us, including costs incurred since establishing the target cost estimate in early 2007, initial bids and procurements from suppliers, feedback from consultants and other third parties, and our analysis of material, commodity and labor cost trends, we believe that our cost of deploying the American Centrifuge Plant is likely to be higher than provided for in our target cost estimate, particularly as a result of higher costs associated with the centrifuge machines being manufactured by our suppliers during the initial stage of deployment. Working closely with key suppliers, we are seeking to reduce the capital cost per machine while maintaining performance objectives to help achieve our target cost estimate. We continue to simplify the design of the centrifuge machines in order to reduce costs as well as to take advantage of technological advancements to improve performance. We believe that success in these value engineering efforts by our project team and our strategic suppliers may help to offset higher materials costs seen in some of the initial American Centrifuge project procurements, but we cannot assure you that such offsets will be achieved or that we will otherwise meet our target cost estimate.

 

In addition, our current target estimate for the deployment of the American Centrifuge Plant of $2.3 billion assumes that we are able to comply with an ambitious schedule for demonstration and deployment activities and achieve certain costs savings in 2007 and beyond. We may not be able to maintain this schedule or achieve these cost savings.

 

We expect to complete a comprehensive review and update of our target cost estimate for deployment of the American Centrifuge Plant in the first quarter of 2008. The cost estimate resulting from that review will take into account the costs and the cost trends we have experienced during our initial procurements as well as our evaluation of material, commodity and labor cost trends. Given the approximately 15% variance in spending to date and commitments as compared with our target cost estimate, unless we can identify further cost savings, including through the contracts that we are negotiating with our key suppliers, the target cost estimate we expect to establish in the first quarter of 2008 will be greater than the $2.3 billion target cost estimate established in early 2007.

 

The target cost update will also for the first time include a reserve for general contingencies that will reflect the maturity of the project. The reserve for general contingencies, which is not included in our target cost estimate of $2.3 billion, will take into account potential variations in the project plans and uncertainty regarding associated costs that we cannot specifically identify at the time the estimate is prepared. We expect that the information available to us when we calculate the reserve for general contingencies in 2008 will allow us to develop a risk-based estimate at that time. Based on the limited information currently available to us, including cost data, initial bids and procurements from suppliers, feedback from consultants and other third parties, and our analysis of material, commodity and labor cost trends, we believe that a reserve for general contingencies of approximately 15% to 20% is reasonable at this time in addition to our current target cost estimate of $2.3 billion. Nevertheless,

given the uniqueness of the American Centrifuge project, we cannot assure investors that the actual amount eventually required for general contingencies will be within this range.

 

In addition to providing a reserve for general contingencies, our overall financing needs for the American Centrifuge project will also include additional costs not covered by our target cost estimate, such as financing costs, financial assurance requirements and operating costs related to commercial plant initial operations. In our pre-application for a loan guarantee under DOE’s loan guarantee program, we requested a proposed loan guarantee amount based on our target cost estimate plus amounts for contingency, financing, financial assurance costs and operating costs related to commercial plant initial operations.

 

We cannot assure investors that costs associated with the American Centrifuge Plant will not be materially higher than anticipated or that efforts that we take to mitigate cost increases will be successful or sufficient. Regardless of our success in demonstrating the technical viability of the American Centrifuge technology, uncertainty surrounding our ability to accurately estimate costs or to limit potential cost increases could jeopardize our ability to successfully finance and deploy the American Centrifuge Plant. Our inability to finance and deploy the American Centrifuge Plant would have a material adverse impact on our business and prospects because we believe the long-term viability of our business depends on the successful deployment of the American Centrifuge project.

 

Significant increases in the cost of the electric power supplied to the Paducah GDP have materially increased our overall production costs and may, in the future, increase our cost of sales to a level above the average prices we bill our customers.

 

Dramatically higher costs for power are putting significant pressure on our business and will continue to do so unless and until we are able to replace our existing production with more efficient centrifuge technology. The gaseous diffusion enrichment process that we use to produce LEU at the Paducah GDP requires significant amounts of electric power. After an approximately 50% increase in 2006 in our costs for electric power under our power contract with the Tennessee Valley Authority (“TVA”), electric power constitutes approximately 70% of the production cost at the Paducah GDP. We amended our power contract with TVA effective June 1, 2007 to provide capacity and prices from June 2007 through May 2012. While this contract provides some stability and assurances regarding power costs for the next five years, the costs of electric power under this 2007 amendment are at prices generally similar to those implemented in 2006, and our price of power under the contract increases each year through 2012. Our power costs are also subject to monthly adjustments to account for changes in TVA’s fuel and purchased-power costs, which means that our actual power costs could be greater than we anticipate. We also purchase additional power during the summer months at market prices, which is the time of the year when market prices are the highest, and which are subject to volatility.

 

Capacity and prices under the TVA contract are only agreed upon through May 2012 and we have not yet contracted for power for periods beyond that time. If we want to purchase power to operate the Paducah GDP beyond May 2012, we may be unable to reach an acceptable agreement and we are at risk for additional power cost increases in the future.

 

Although we are currently signing new contracts with customers in which prices for future deliveries are adjusted, in part, on the basis of changes in a power cost index, most of our sales contracts do not include provisions that permit us to pass through increases in power prices to our customers. As a result, our gross profit margin and cash flow under these sales contracts will be significantly reduced by the higher power costs under the amended TVA contract since June 2006. Additionally, if our power costs rise unexpectedly, profit margins under new sales contracts that we are entering into may be similarly impacted to the extent the adjustments in the power cost index are not sufficient to account for increases in our power costs. Accordingly, if our power costs continue to rise and mitigating steps are unavailable or insufficient, production at the Paducah GDP will become

increasingly uneconomic at existing contract prices, which will adversely affect the long-term viability of our business.

 

In accordance with the TVA power contract, we provide financial assurance to support our payment obligations to TVA, including providing an irrevocable letter of credit and making weekly prepayments based on the price and usage of power. Effective September 2007, because of the increased volume of power we have contracted for, the amount required for the letter of credit and weekly prepayments will increase. These financial requirements will increase again in October 2007. A significant increase in the price we pay for power could further increase the amount of this financial assurance, which could adversely affect our liquidity and reduce capital resources otherwise available to fund the American Centrifuge project.

 

Deliveries of LEU under the Russian Contract account for approximately 50% of our supply mix and a significant delay or stoppage of deliveries could affect our ability to meet customer orders and could pose a significant risk to our continued operations.

 

A significant delay in, or stoppage or termination of, deliveries of LEU from Russia under the Russian Contract or a failure of the LEU to meet the Russian Contract’s quality specifications, could adversely affect our ability to make deliveries to our customers. A delay, stoppage or termination could occur due to a number of factors, including logistical or technical problems with shipments, commercial or political disputes between the parties or their governments, or our failure or inability to meet the terms of the Russian Contract. Further, because our annual LEU production capacity is less than our total delivery commitments to customers, an interruption of deliveries under the Russian Contract could, depending on the length of such an interruption, threaten our ability to fulfill these delivery commitments with adverse effects on our reputation, costs, results of operations, cash flows and long-term viability. Depending upon the reasons for the interruption and subject to limitations of liability under our sales contracts, we could be required to compensate customers for a failure or delay in delivery.

 

The appointment of a substitute or additional executive agent pursuant to the U.S. government’s compliance with the terms of the Executive Agent MOA would require that all or part of the fixed quantity of LEU available each year under the Russian Contract be provided to the substitute or additional executive agent. This would not only reduce our access to LEU under the Russian Contract, but would also create a significant new competitor, which could impair our ability to meet our existing delivery commitments while reducing our ability to bid for new sales. Reduced access to LEU under the Russian Contract would also increase our costs and reduce our gross profit margins.

 

Changes in, or termination of, the Russian Suspension Agreement, or an inability to apply the limitations under the Russian Suspension Agreement to imports of Russian LEU, could lead to significantly increased competition from Russian LEU or, if replaced with tariffs, could increase our costs under the Russian Contract.

 

The Russian Suspension Agreement is a 1992 agreement between the U.S. and Russia that today precludes Russian LEU from being sold for consumption in the U.S. except under the Russian Contract. The agreement could be terminated (1) unilaterally by the Russian government upon 60 days notice or (2) as a result of periodic administrative procedures under U.S. international trade laws. For example, a “sunset review” of the Russian Suspension Agreement is conducted every five years by the Department of Commerce (“DOC”) and the U.S. International Trade Commission. Final determinations in the latest sunset review were made in May and July of 2006 and were in favor of maintaining the existing suspension agreement. However, interested parties who participated in the sunset review have appealed the decisions of DOC and the U.S. International Trade Commission to the Court of International Trade and, if unsuccessful at that court, could pursue such appeals to higher Federal courts. Such appeals could result in a reversal of either or both of these decisions, which ultimately could lead to termination of the Russian Suspension Agreement, without any offsetting restraints on increases in imports of Russian LEU.

Officials of the Russian and U.S. governments are currently engaged in discussions regarding a possible amendment to the Russian Suspension Agreement that would permit Russia to sell LEU in the United States in future years in addition to the sales currently made by Russia under the Russian Contract. The details of these intergovernmental discussions are confidential and it is unclear whether the Russians might take action to terminate the Russian Suspension Agreement if they are dissatisfied with the results of these discussions.

 

Unless the U.S. government secures reasonable limits on Russian imports, discussions could result in an agreement between the Russian and U.S. governments that allows Russia to make significant sales of LEU in the U.S. market in future years. Depending upon a number of factors, including the amount of LEU the Russians are permitted to offer, the years in which such sales are permitted, the amounts available from other suppliers for delivery in such years, the level of market demand for LEU, and the manner in which the limits on Russian sales are implemented, the availability of Russian LEU could result in a decline in market prices and a decrease in our sales, which could adversely affect our revenues, gross profit margins and cash flows and jeopardize our ability to secure the long-term sales contracts we need to continue operating our existing enrichment plant and pursue the deployment of the American Centrifuge Plant, including our ability to secure financing for the American Centrifuge project.

 

If the Russian and U.S. governments fail to reach agreement on modifications to the Russian Suspension Agreement that are satisfactory to Russia, or if, after reaching agreement, Russia becomes dissatisfied with the benefits of the agreement, Russia could elect to terminate the Russian Suspension Agreement. Unless accompanied by equivalent limitations on imports or unless other steps are taken by the U.S. government to limit the impact on us, a termination of the Russian Suspension Agreement could result in a significant increase in sales of Russian-produced LEU in the United States. This could depress prices and undermine our ability to sell the large quantity of LEU that we are committed to purchase under the Russian Contract. This could substantially alter the economics of the American Centrifuge project and our ability to obtain financing for it, reduce our revenues, gross profit margins and cash flows and jeopardize our ability to secure the long-term sales contracts we need to continue operating our existing enrichment plant and pursue the deployment of the American Centrifuge Plant.

 

If the Russian Federation unilaterally terminated the Russian Suspension Agreement, DOC would be required to recommence its antidumping investigation. Unless waived, DOC would require importers of Russian LEU, including us under the Russian Contract, to post bonds to cover estimated duties on imports subject to that investigation that would likely exceed 100% of the value of the imports. Further, if the investigation resulted in an antidumping order, we would have to pay estimated duties on future imports of Russian LEU in cash. Because we have a fixed commitment to purchase the Russian LEU under the Russian Contract and must continue to import the Russian LEU in order to meet our obligations to customers, we may not have any alternative to posting the bonds or paying these duties. Depending on the cost of the bonds and the magnitude of the duties imposed, the increase in our costs could materially and adversely affect our gross profit margins, cash flows, liquidity and results of operations and as a result, our business may not remain viable.

 

Any limitations imposed on imports of Russian LEU under the Russian Suspension Agreement or under an order resulting from a recommenced antidumping investigation following the termination of the Russian Suspension Agreement could be circumvented if Russia elects to sell only the SWU component of Russian LEU in a manner that DOC or U.S. courts consider to be a sale of services that is outside the scope of U.S. antidumping law. In that case, Russia would be free to sell SWU without regard to any limitations under the Russian Suspension Agreement or any duties imposed under an antidumping order. Such unrestricted sales also could result in a decline in market prices and a loss of sales by us, which could adversely affect our revenues, gross profit margins and cash flows and jeopardize our ability to secure the long-term sales contracts we need to continue operating our existing enrichment plant and pursue the deployment of the American Centrifuge Plant, including our ability to secure financing for the American Centrifuge project.

We depend on a single production facility in Paducah, Kentucky for approximately 50% of our LEU supply and significant or extended unscheduled interruptions in production could affect our ability to meet customer orders and pose a significant risk to, or could significantly limit, our continued operations and profitability.

 

Our annual imports of Russian LEU account for only approximately one-half of the total amount of LEU that we need to meet our delivery obligations to customers. In addition, some customers do not permit us to deliver Russian LEU to them under their contracts with us. Accordingly, our production at the Paducah GDP is needed to meet our annual delivery commitments. An interruption of production at the Paducah GDP would result in a drawdown of our inventories of LEU and, depending on the length and severity of the production interruption, we could be unable to meet our annual delivery commitments, with adverse effects on our reputation, costs, results of operations, cash flows and long-term viability. Depending upon the reasons for the interruption and subject to limitations on our liability under our sales contracts, we also could be required to compensate customers for our failure to deliver on time.

 

Production interruptions at the Paducah GDP could be caused by a variety of factors, such as:

 

 

The Paducah GDP is owned by the U.S. government. Our rights to the plant are defined under a lease agreement with DOE and the law that the lease agreement implements. Under the 2002 DOE-USEC Agreement, we could lose our right to extend the lease of the Paducah GDP and could be required to waive our exclusive right to lease the facility if we fail on more than one occasion within specified periods to meet certain production thresholds and fail to cure the deficiency. In addition, DOE could assume responsibility for operation of the Paducah GDP if we cease production at the Paducah GDP and fail to recommence production within time periods specified in the 2002 DOE-USEC Agreement. Without a lease to the Paducah GDP and absent access to other sources of LEU, we would be unable to meet our annual delivery commitments to customers once our available inventories were exhausted.

 

Our ability to retain key executives and managers is critical to the success of our business.

 

The success of our business depends on our key executives, managers and other skilled personnel, some of whom were involved in the development of our American Centrifuge technology and many of whom have security clearances. We do not have employment agreements with our corporate executives or American Centrifuge project managers nor do we have key man insurance policies for them. If our executives, managers or other skilled personnel resign, retire or are terminated, or their service is otherwise interrupted, we may not be able to replace them in a timely manner and we could experience significant declines in productivity and delays in the deployment of our American Centrifuge project, on which the viability of our business depends.

The rights of our creditors under the documents governing our indebtedness may limit our operating and financial flexibility.

 

Our revolving credit facility includes various operating and financial covenants that restrict our ability, and the ability of our 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. Complying with these covenants may make it more difficult for us to successfully execute our business strategy. For example, these covenants could limit the amount of cash we can use to finance the American Centrifuge Plant. The revolving credit agreement also requires that we maintain a minimum level of available borrowings and contains reserve provisions that may reduce the available borrowings under the credit facility periodically.

 

Our failure to comply with obligations under the revolving credit facility or other agreements such as the indenture governing the notes offered hereby and the 2002 DOE-USEC Agreement, or the occurrence of a “fundamental change” as defined in the indenture governing the notes offered hereby, could result in an event of default under the credit facility. A default, if not cured or waived, could permit acceleration of our indebtedness. We cannot be certain that we will be able to remedy any default. If our indebtedness is accelerated, we cannot be certain that we will have funds available to pay the accelerated indebtedness or that we will have the ability to refinance the accelerated indebtedness on terms favorable to us or at all.

 

Changes in the price for SWU or uranium could affect our gross profit margins and ability to service our indebtedness and finance the American Centrifuge project.

 

Changes in the price for SWU and uranium are influenced by numerous factors, such as:

 

 

The long-term nature of our contracts with customers may prolong any adverse impact of low market prices on our gross profit margins. For example, even as prices increase and we secure new higher-priced contracts, we are contractually obligated to deliver LEU and uranium at lower prices under contracts signed prior to the increase. A decrease in the price for SWU could also affect our future ability to service our indebtedness and finance the American Centrifuge project because the economics of the American Centrifuge Plant are dependent upon a minimum SWU sales price to finance future American Centrifuge operations and service our indebtedness.

 

Additionally, an increase in the price for SWU could result in an increase in the price that we pay for the SWU component of Russian LEU because the price we are charged for the SWU component of Russian LEU under the Russian Contract is determined by a formula that employs an index of international and U.S. price points, which in turn reflects market prices. Although any increase may be moderated by the retrospective nature of the formula, a significant increase in the prices Russia charges us as a result of increasing price points due to significant increases in market prices would substantially increase our costs of sales and inventories. This increase, if not offset by increases in our sales prices, would adversely affect our cash flows and results of operations.

The release of excess government stockpiles of enriched uranium into the market could depress market prices and reduce demand for LEU from our company.

 

The U.S. and foreign governments have stockpiles of LEU that they could sell in the market. In addition, LEU may be produced by downblending stockpiles of highly enriched uranium owned by the U.S. and foreign governments. The release of these stockpiles into the market can depress prices and reduce demand for LEU from us, which could adversely affect our revenues, cash flows and results of operations.

 

The long-term nature of our customer contracts could adversely affect our results of operations in current and future years.

 

As is typically the case in our industry, we sell nearly all of our LEU under long-term contracts. The prices that we charge under many of our existing contracts (particularly those reflecting terms agreed to prior to 2006) only increase based on an agreed upon inflation index. Therefore, these contracts do not allow us to pass along increases in our actual costs, such as increased power costs or increases in the prices we pay under the Russian Contract, or to take advantage of market increases in the price of SWU. We anticipate that these limitations, combined with our cost-structure and our sensitivity to increased power costs due to the power-intensive gaseous diffusion technology that we currently depend on, will reduce our ability to cover our cost of sales with revenues earned under our customer contracts and will materially and adversely impact our gross profit margins and cash flows in current and future periods.

 

In addition, our older contracts give customers the flexibility to determine the amounts of natural uranium that they deliver to us, which can result in our receiving less uranium from customers than we transferred from our inventory to the Russian Federation under the Russian Contract. Over time, to the extent our inventory, including uranium generated through underfeeding, is insufficient to absorb the difference, we could be required to purchase uranium to continue to meet our obligations to the Russian Federation, which, depending on the market price of uranium, could have an adverse impact on our gross profit margins, cash flows, results of operations and liquidity.

 

We face significant competition from three major producers who may be less cost sensitive or may be favored due to national loyalties and from emerging competitors in the domestic market.

 

We compete with three major producers of LEU, all of which are wholly or substantially owned by governments: AREVA (France), TENEX (Russia) and Urenco (Germany, Netherlands and the United Kingdom). Currently, these competitors utilize or are in the process of transitioning to more efficient and cost-effective technology to enrich uranium than we use at the Paducah GDP. In addition, Louisiana Energy Services, a group controlled by Urenco, has started to construct a uranium enrichment plant in New Mexico, and AREVA recently announced that it is preparing to build a proposed centrifuge uranium enrichment plant in the United States. We also face potential competition from General Electric’s nuclear energy business, which has signed an agreement with Silex Systems Limited, an Australian company, to license Silex’s uranium enrichment technology and begin a phased development process and potential future construction of a uranium enrichment plant in the United States.

 

Our competitors have greater financial resources, including access to below-market financing terms and our foreign competitors enjoy support from their government owners, which may enable them to be less cost- or profit-sensitive. In addition, decisions by our foreign competitors may be influenced by political and economic policy considerations rather than commercial considerations. For example, our foreign competitors may elect to increase their production or exports of LEU, even when not justified by market conditions, thereby depressing prices and reducing demand for our LEU, which could adversely affect our revenues, cash flows and results of operations. Similarly, the elimination or weakening of existing restrictions on imports from our competitors could adversely affect our revenues, cash flows and results of operations.

Our dependence on our largest customers could adversely affect us.

 

Our 10 largest customers (other than the U.S. government) represented 53% of our revenue in 2006, and our three largest customers represented 22% of our revenue in 2006. To the extent our existing contracts with these customers include prices that are greater than or equal to market prices, a reduction in purchases from these customers, whether due to their decision to increase purchases from our competitors or for other reasons, including a disruption in their operations that reduces their need for LEU from us, could adversely affect our business and results of operations. Conversely, to the extent that our contracts with these customers include prices that are lower than market prices, a decision by these customers to exercise options under these contracts to purchase more from us also could adversely affect our business and results of operations.

 

We are seeking to improve the pricing under our long-term contracts with our customers, including our largest customers, as these contracts expire. However, because price is a significant factor in a customer’s choice of a uranium enricher, when contracts come up for renewal, customers may reduce their purchases from us if we attempt to increase our prices in order to offset increases in our costs, resulting in the loss of the contracts. Moreover, once lost, customers may be difficult to regain because they typically purchase LEU under long-term contracts. Therefore, given the need to maintain existing customer relationships, particularly with our largest customers, our ability to raise prices in order to respond to increases in costs or other developments may be limited. In addition, because we have a fixed commitment to order LEU derived from at least 30 metric tons of highly enriched uranium each year under the Russian Contract and to purchase the approximately 5.5 million SWU deemed to be contained in such material, any reduction in purchases by our customers below the level required for us to resell both our own production and the Russian material could adversely affect our revenues, cash flows and results of operations.

 

Our ability to compete in certain foreign markets may be limited for political, legal and economic reasons.

 

Agreements for cooperation between the U.S. government and various foreign governments control the export of nuclear materials from the United States. If any of the agreements with countries in which our customers are located were to lapse, terminate or be amended, it is possible we would not be able to make sales or deliver LEU to customers in those countries. This could adversely affect our results of operations.

 

Purchases of SWU by customers in the European Union are subject to a policy of the Euratom Supply Agency that seeks to limit foreign enriched uranium to no more than 20% of European Union consumption per year. Further, we are precluded from selling LEU in the Russian Federation by the absence of an agreement for cooperation that permits exports to Russia.

 

Recent court decisions may reduce our ability to protect ourselves from unfairly priced imports, which could adversely affect our results of operations.

 

Recent decisions of the U.S. Court of International Trade and the U.S. Court of Appeals for the Federal Circuit could preclude DOC from imposing antidumping and countervailing duties to offset unfairly-priced LEU imported from foreign countries. Under these rulings, we would be unable to use certain U.S. trade laws to protect us from unfairly priced LEU in the future, thereby increasing the possibility that our competitors will seek to increase market share by reducing prices to unfair levels. An increase in our competitors’ market share and the accompanying reduction in market prices could adversely affect our results of operations.

Our future prospects are tied directly to the nuclear energy industry worldwide.

 

Potential events that could affect either nuclear reactors under contract with us or the nuclear industry as a whole, include:

 

 

These events could adversely affect us to the extent they result in a reduction or elimination of customers’ contractual requirements to purchase from us, the suspension or reduction of nuclear reactor operations, the reduction of supplies of raw materials, lower demand, burdensome regulation, disruptions of shipments or production, increased operational costs or difficulties or increased liability for actual or threatened property damage or personal injury.

 

Changes to, or termination of, any of our agreements with the U.S. government, or deterioration in our relationship with the U.S. government, could adversely affect our results of operations.

 

We, or our subsidiaries, are a party to a number of agreements and arrangements with the U.S. government that are important to our business, including:

 

 

Termination or expiration of one or more of these agreements, without replacement with an equivalent agreement or arrangement that accomplishes the same objectives as the terminated or expired agreement(s), could adversely affect our results of operations. In addition, deterioration in our relationship with the U.S. agencies that are parties to these agreements could impair or impede our ability to successfully implement these agreements, which could adversely affect our results of operations.

 

Our existing U.S. government contracts are subject to continued appropriations by Congress and may be terminated if future funding is not made available.

 

Approximately 10% of our revenues are from U.S. government contracts. All contract work for DOE, including cold standby or cold shutdown of the Portsmouth GDP, cleanup of out-of-specification uranium and certain NAC consulting and transportation activities, is subject to the availability of DOE funding and congressional appropriations. If funds were not available, we could be required to

terminate these operations and incur related termination costs. In addition, the criteria for awarding contracts to us may change such that we would not be eligible to compete for such contracts, which could adversely affect our results of operations.

 

Revenue from U.S. government contract work is based on cost accounting standards and allowable costs that are subject to audit by the Defense Contract Audit Agency. Allowable costs include direct costs as well as allocations of indirect plant and corporate overhead costs. Audit adjustments could reduce the amounts we are allowed to bill for DOE contract work or require us to refund to DOE a portion of amounts already billed.

 

Our operations are highly regulated by the NRC and DOE.

 

Our operations, including the Paducah and Portsmouth GDPs and NAC, are regulated by the NRC. In addition, the American Centrifuge Demonstration Facility and the construction and operation of the American Centrifuge Plant are licensed by the NRC, which regulates our activities at those facilities.

 

Our gaseous diffusion plants are required to be recertified every five years and the term of the current certification expires on December 31, 2008. The NRC could refuse to renew either or both of the certificates if it determines that: (1) we are foreign owned, controlled or dominated; (2) the issuance of a renewed certificate would be inimical to the maintenance of a reliable and economic domestic source of enrichment services; (3) the issuance of renewed certificate would be adverse to U.S. defense or security objectives; or (4) the issuance of a renewed certificate is otherwise not consistent with applicable laws or regulations in effect at the time of renewal. The same requirements apply to NRC’s issuance of the 30 year license for the American Centrifuge Plant. If the certificate for the Paducah GDP were not renewed, we could no longer produce LEU at the Paducah GDP, which would threaten our ability to make deliveries to customers and meet the minimum production requirements under the 2002 DOE-USEC Agreement, jeopardize our cash flows, and subject us to various penalties under our customer contracts and the 2002 DOE-USEC Agreement.

 

The NRC has the authority to issue notices of violation for violations of the Atomic Energy Act of 1954, NRC regulations and conditions of licenses, certificates of compliance, or orders. The NRC has the authority to impose civil penalties or additional requirements and to order cessation of operations for violations of its regulations. Penalties under NRC regulations could include substantial fines, imposition of additional requirements or withdrawal or suspension of licenses or certificates. Any penalties imposed on us could adversely affect our results of operations. The NRC also has the authority to issue new regulatory requirements or to change existing requirements. Changes to the regulatory requirements could also adversely affect our results of operations.

 

Our American Centrifuge facilities in Oak Ridge and certain of our operations at our other facilities are subject to regulation by DOE. DOE has the authority to impose civil penalties and additional requirements which could adversely affect our results of operations.

 

Our operations require that we maintain security clearances that are overseen by the NRC and DOE in accordance with the National Industrial Security Program Operating Manual (“NISPOM”). These security clearances require that we provide a certification regarding foreign ownership, control or influence (“FOCI”), and the security clearances could be suspended or revoked based upon material changes to our FOCI certification, or other concerns that we might be subject to FOCI. Under the NISPOM and applicable DOE and NRC regulations and guidance, aggregate foreign ownership of our common stock exceeding 10% would not, in and of itself, result in a material change to our FOCI certification. Rather, reporting pursuant to our FOCI certification would be required if a foreign person or group under common control reported ownership of more than 5%, or any foreign person or group individually or collectively exercised control or influence through the entitlement to control the appointment and tenure of any management position or similar entitlement indicating control or influence. The NRC staff has previously concluded that its NISPOM FOCI requirements are more comprehensive and prescriptive than the statutory prohibition of foreign ownership and that information

sufficient to make a FOCI determination should be sufficient to enable NRC to satisfy its statutory responsibility to assure that we are not owned, controlled or dominated by an alien, a foreign company, or a foreign government.

 

Our certificate of incorporation gives us certain rights with respect to common stock held (beneficially or of record) by foreign persons. If levels of foreign ownership set forth in our certificate of incorporation are exceeded, we have the right, among other things, to redeem or exchange common stock held by foreign persons, and in certain cases, the applicable redemption price or exchange value may be equal to the lower of fair market value or a foreign person’s purchase price.

 

Our certificate of incorporation gives us certain rights with respect to shares of our common stock held (beneficially or of record) by foreign persons. Specifically, if “foreign persons” (as defined in our certificate of incorporation to include, among others, individuals who are not a U.S. citizen, entities that are organized under the laws of non-U.S. jurisdictions and entities that are controlled by individuals who are not a U.S. citizen or by entities that are organized under the laws of non-U.S. jurisdictions) beneficially own in the aggregate more than 10% of our common stock, or if persons having a significant commercial relationship with a foreign uranium enrichment provider or a foreign competitor own any shares of our common stock, we may exercise certain rights. These rights include requesting information from holders (or proposed holders) of our securities, refusing to permit the transfer of securities to foreign persons, suspending or limiting voting rights of shares of stock held by foreign persons, redeeming or exchanging shares of our stock owned by foreign persons on terms set forth in our certificate of incorporation, and taking other actions that we deem necessary or appropriate to ensure compliance with the foreign ownership restrictions. See “Description of Indebtedness and Capital Stock — Description of Capital Stock — Foreign Ownership Restrictions” for a complete discussion of the foreign ownership restrictions included in our certificate of incorporation.

 

In order to monitor and estimate the amount of our common stock held by foreign persons, we regularly review Schedule 13D and 13G filings with the SEC with respect to our common stock and other information available to us including monthly and quarterly reports listing major institutional holders of our common stock. However, it is very difficult to determine our level of foreign ownership as of any particular date due to a variety of factors including: the complexities associated with identifying whether a particular beneficial holder is a foreign person; the significant volume of our common stock that changes hands daily; and the fact that a number of our stockholders are under no obligation to report their ownership to us or to otherwise make such information public. Our ability to accurately assess our level of foreign ownership is further complicated as a result of the issuance of an additional 18,000,000 shares of common stock in the concurrent common stock offering (or 20,700,000 shares of common stock if the underwriters exercise their option to purchase additional notes in full). As a result, we cannot assure you that on any given day, including immediately after the consummation of the concurrent common stock offering, the aggregate ownership of our common stock by foreign persons will not exceed the foreign ownership restrictions.

 

The terms and conditions of our rights with respect to our redemption or exchange right in respect of shares held by foreign persons, including shares acquired by foreign persons after conversion of notes acquired in this offering, are as follows:

 

 

 

While our Board has adopted a policy applicable to foreign persons owning (beneficially or of record) shares of our common stock that we believe reduces the risks posed to foreign stockholders under our certificates of incorporation, which are discussed in “Summary — Matters Affecting our Foreign Stockholders”, there remain situations in which foreign stockholders could lose the right to vote their shares or in which we may redeem or exchange shares held by foreign persons and in which such redemption or exchange could be at the lesser of fair market value and the foreign person’s purchase price for the shares redeemed or exchanged, which could result in a significant loss for that foreign person.

 

Our operations are subject to numerous federal, state and local environmental protection laws and regulations.

 

We incur substantial costs for compliance with environmental laws and regulations, including the handling, treatment and disposal of hazardous, low-level radioactive and mixed wastes generated as a result of our operations. Unanticipated events or regulatory developments, however, could cause the amount and timing of future environmental expenditures to vary substantially from those expected.

 

Under a cleanup agreement with the Environmental Protection Agency (“EPA”), we removed certain material from a site in South Carolina previously operated by Starmet CMI, one of our former contractors, that was attributable to quantities of depleted uranium we had sent there under a 1998 contract. In June 2007, we were contacted by the EPA concerning costs incurred by the EPA for additional cleanup at the Starmet site. We are currently in discussions with the EPA regarding these costs. At June 30, 2007, we had an accrued current liability related to these costs that is less than the amount spent by the EPA for the cleanup. The amount of this accrual could be insufficient. In addition, we could incur additional costs associated with our share of costs for cleanup of the Starmet site, resulting from a variety of factors, including a decision by federal or state agencies to recover costs for prior cleanup work or require additional remediation at the site.

 

Pursuant to numerous federal, state and local environmental laws and regulations, we are required to hold multiple permits. Some permits require periodic renewal or review of their conditions, and we cannot predict whether we will be able to renew such permits or whether material changes in permit conditions will be imposed. Changes in permits could increase costs of producing LEU and reduce our profitability. An inability to secure or renew permits could prevent us from producing LEU needed to meet our delivery obligations to customers, which would threaten our ability to make deliveries to customers and meet the minimum production requirements under the 2002 DOE-USEC Agreement, adversely affect our reputation, costs, cash flows, results of operations and long-term viability, and subject us to various penalties under our customer contracts and the 2002 DOE-USEC Agreement.

 

Our operations involve the use, transportation and disposal of toxic, hazardous and/or radioactive materials and could result in liability without regard to our fault or negligence.

 

Our plant operations involve the use of toxic, hazardous and radioactive materials. A release of these materials could pose a health risk to humans or animals. If an accident were to occur, its severity could be significantly affected by the volume of the release and the speed of corrective action taken by plant emergency response personnel, as well as other factors beyond our control, such as weather and wind conditions. Actions taken in response to an actual or suspected release of these materials, including a precautionary evacuation, could result in significant costs for which we could be legally responsible. In addition to health risks, a release of these materials may cause damage to, or the loss of, property and may adversely affect property values.

We lease facilities from DOE for the Paducah and Portsmouth GDPs, the ACP and centrifuge test facilities in Piketon, Ohio and Oak Ridge, Tennessee. Pursuant to the Price-Anderson Act, DOE has indemnified us against claims for public liability arising out of or in connection with activities under those leases resulting from a nuclear incident or precautionary evacuation. If an incident or evacuation is not covered under the DOE indemnification, we could be financially liable for damages arising from such incident or evacuation, which could have an adverse effect on our results of operations and financial condition. In connection with international transportation of LEU, it is possible for a claim related to a nuclear incident occurring outside the United States to be asserted that would not fall within the DOE indemnification under the Price-Anderson Act.

 

While DOE has provided indemnification pursuant to the Price-Anderson Act, there could be delays in obtaining reimbursement for costs from DOE and DOE may determine that not all costs are reimbursable under the indemnification.

 

We do not maintain any nuclear liability insurance for our operations at the gaseous diffusion plants. Further, American Nuclear Insurers, the only provider of nuclear liability insurance, has declined to provide nuclear liability insurance to the American Centrifuge Plant due to past and present DOE operations on the site.

 

NAC’s business involves providing products and services for the storage and transportation of toxic, hazardous and radioactive materials, which, if released or mishandled, could cause personal injury and property damage (including environmental contamination) or loss and could adversely affect property values. NAC obtains nuclear liability insurance to protect against third party liability resulting from a nuclear incident, but this insurance contains exclusions and limits and there is no assurance that this insurance would cover all potential liabilities.

 

In our contracts, we seek to protect ourselves from liability, but there is no assurance that such contractual limitations on liability will be effective in all cases or that, in the case of NAC’s contracts, NAC’s insurance will cover all the liabilities NAC has assumed under those contracts. The costs of defending against a claim arising out of a nuclear incident or precautionary evacuation, and any damages awarded as a result of such a claim, could adversely affect our results of operations and financial condition.

 

The dollar amount of our sales backlog, as stated at any given time, is not necessarily indicative of our future sales revenues.

 

Backlog is the aggregate dollar amount of SWU and uranium that we expect to sell under contracts with utilities. As of June 30, 2007, our sales backlog was an estimated $6.9 billion through 2015 ($6.5 billion through 2012, including $1.0 billion expected to be delivered during the period from July 1 to December 31, 2007). There can be no assurance that the revenues projected in our backlog will be realized, or, if realized, will result in profits. Backlog is partially based on customers’ estimates of their fuel requirements and certain other assumptions, including our estimates of selling prices and inflation rates. Such estimates are subject to change. For example, some of our contracts include pricing elements based on market prices prevailing at the time of delivery. We use an external composite forecast of future market prices in estimating the price that we will be entitled to charge under such contracts in the future. These forecasts may not be accurate, and therefore our estimate of future prices could be overstated. Pricing under some new contracts is subject, in part, to escalation based on a broad power price index. For purposes of the backlog, we assume increases to the power price index in line with overall inflation rates. However, because the index is not geared to general inflation rates, our estimates of future prices under these contracts could be inaccurate. Any inaccuracy in our estimates of future prices would add to the imprecision of our backlog estimate.

 

For a variety of reasons, the amounts of SWU and uranium that we will sell in the future under our existing contracts, or the timing of customer purchases under those contracts, may differ from our estimates. Customers may not purchase as much as we predicted, or at the times we anticipated, as result of operational difficulties, changes in fuel requirements or other reasons. Reduced purchases

would reduce the revenues we actually receive from contracts included in the backlog. For example, our revenue could be reduced by actions of the NRC or nuclear regulators in foreign countries issuing orders to delay, suspend or shut down nuclear reactor operations within their jurisdictions. Increases in our costs of production or other factors could cause sales included in our backlog to be at prices that are below our cost of sales, which could adversely affect our results of operations, and customers may purchase more under lower priced contracts than we predicted.

 

We use estimates in accounting for the future disposition of depleted uranium and changes in these estimates or in actual costs could affect our future financial results and liquidity.

 

We currently store depleted uranium at the Paducah GDP and accrue estimated costs for its future disposition. The long-term liability for depleted uranium is dependent upon the volume of depleted uranium generated and estimated processing, transportation and disposal costs, which involves many assumptions. Our estimated cost and accrued liability are subject to change as new information becomes available, and an increase in the estimate would have an adverse effect on our results of operations.

 

We anticipate that we will send most or all of our depleted uranium to DOE for disposition unless a more economic disposal option is available. DOE is constructing facilities at the Paducah and Portsmouth GDPs to process large quantities of depleted uranium owned by DOE. Under federal law, DOE would also process our depleted uranium if we provided it to DOE. If we were to dispose of our uranium in this way, we would be required to reimburse DOE for the related costs of disposal, including our pro rata share of capital costs.

 

The NRC requires that we guarantee the disposition of our depleted uranium with financial assurance. Our estimate of the unit disposition cost for accrual purposes is approximately 35% less than the unit disposition cost for financial assurance purposes, which includes contingencies and other potential costs as required by the NRC. Any increase in our estimated unit cost of disposal will require us to provide additional financial assurance and could adversely affect our liquidity. The amount of future depleted uranium disposal costs could also vary substantially from amounts accrued and an increase in our actual cost of disposal could have a material adverse impact on our results of operations in future years.

 

Financial assurances are also provided for the ultimate decontamination and decommissioning of the American Centrifuge facilities to meet NRC and DOE requirements. The amount of these decontamination and decommissioning costs could vary from the amounts accrued.

 

Deferral of revenue recognition could result in volatility in our quarterly and annual results.

 

We do not recognize revenue for sales of uranium or LEU until the uranium or LEU is physically delivered. Consequently, in sales transactions where we have received payment and title has transferred to the customer but delivery has not occurred because the terms of the agreement require us to hold the uranium to which the customer has title or because a customer encounters delays in taking delivery of LEU at our facilities, recognition of revenue is deferred until the uranium or LEU is physically delivered. This deferral can potentially be over an indefinite period and is outside our control and can result in volatility in our quarterly and annual results. If, in a given period, a significant amount of revenue is deferred or a significant amount of previously deferred revenue is recognized, earnings in that period will be affected, which could result in volatility in our quarterly and annual results. Additional information on our deferred revenue is provided in note 8 to our consolidated financial statements incorporated by reference in this prospectus supplement.

 

Our operating results may fluctuate significantly from quarter to quarter, and even year to year, which could have an adverse effect on our cash flows.

 

Under customer contracts with us for the supply of LEU to meet requirements for specific time periods or specific reactor refuelings, our customers order LEU from us based on their refueling

schedules for nuclear reactors, which generally range from 12 to 18 months, or in some cases up to 24 months. Customer payments for the SWU component of such LEU typically average $12 million per order. As a result, a relatively small change in the timing of customer orders due to a change in a customer’s refueling schedule may cause operating results to be substantially above or below expectations, which could have an adverse effect on our cash flows.

 

The levels of returns on pension and post-retirement plan assets, changes in interest rates and other factors affecting the amounts we have to contribute to fund future pension liabilities could adversely affect our earnings in future periods.

 

Our earnings may be positively or negatively impacted by the amount of expense we record for our employee benefit plans. This is particularly true with expense for our pension plans. Generally Accepted Accounting Principles in the United States (“GAAP”) require that we calculate expense for the plans using actuarial valuations. These valuations are based on assumptions that we make relating to financial market and other economic conditions. Changes in key economic indicators can result in changes in the assumptions we use. The key year-end assumptions used to estimate pension expense for the following year are the discount rate, the expected rate of return on plan assets, healthcare cost trend rates and the rate of increase in future compensation levels. For additional information and a discussion regarding how our financial statements can be affected by pension plan accounting policies, see Critical Accounting Estimates in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and note 12 to our consolidated financial statements incorporated by reference in this prospectus supplement.

 

Anti-takeover provisions in Delaware law and in our certificate of incorporation, bylaws and shareholder rights plan could delay or prevent an acquisition of our company.

 

We are a Delaware corporation, and the anti-takeover provisions of Delaware law impose various impediments to the ability of a third party to acquire control of our company, even if a change of control would be beneficial to our existing shareholders. Other provisions of our certificate of incorporation and bylaws may make it more difficult for a third party to acquire control of us without the consent of our board of directors. We also have adopted a shareholder rights plan, which could increase the cost of, or prevent, a takeover attempt. These various restrictions could deprive shareholders of the opportunity to realize takeover premiums for their shares.

 

Risks Related to the Notes

 

Our increased indebtedness as a result of this offering may harm our financial condition and results of operations.

 

On a pro forma basis after giving effect to the offering of the notes and the concurrent offering of common stock, our total consolidated long-term debt as of June 30, 2007 would have been approximately $600 million and would have represented approximately 33% of our total capitalization. In addition, the indenture for the notes will not restrict our ability to incur additional indebtedness.

 

Our level of indebtedness could have important consequences to you, because:

 

 

 

Our operations may not generate sufficient cash to enable us to service our debt. If we fail to make a payment on the notes, we could be in default on the notes, and this default could cause us to be in default on our other indebtedness outstanding at that time. Conversely, a default on our other outstanding indebtedness may cause a default under the notes.

 

We may be unable to pay interest or principal on the notes or to repurchase the notes upon a fundamental change.

 

The notes bear interest semi-annually at a rate of     % per annum. Holders of notes also have the right to require us to repurchase all or a portion of their notes for cash upon the occurrence of a fundamental change. We may not have sufficient funds to pay interest or principal on the notes or make the required repurchase of the notes at the applicable time and, in such circumstances, may not be able to arrange the necessary financing on favorable terms, if at all. In addition, our ability to pay interest or principal on the notes or make the required repurchase, as the case may be, may be limited by law or the terms of other debt agreements or securities. We anticipate that our revolving credit facility will be amended prior to the consummation of the offering of the notes to facilitate the issuance of the notes, see “Description of Indebtedness and Capital Stock — Description of Indebtedness — Revolving Credit Facility”. We expect the amendment to specify that the occurrence of a fundamental change under the indenture governing the terms of the notes will constitute an event of default with respect to the revolving credit facility subject to the expiration of any applicable grace or cure periods set forth in the indenture. Absent a waiver or further amendment thereof, the amended revolving credit facility will restrict our ability to pay the principal amount of the notes in cash and will constitute an event of default under the amended revolving credit facility, which would permit our revolving lenders to accelerate the maturity of our indebtedness thereunder. Our failure to pay such cash amounts to holders of notes or make the required repurchase, as the case may be, however, would constitute an event of default under the indenture governing the notes which, in turn, could constitute an event of default under other debt agreements or securities, thereby resulting in their acceleration and required prepayment and further restrict our ability to make such payments and repurchases. See “Description of Notes — Interest”, and “Description of Notes — Fundamental Change Permits Holders to Require Us to Repurchase Notes”.

 

Provisions in the indenture for the notes may deter or prevent a business combination that may be favorable to you.

 

If a fundamental change occurs prior to the maturity date of the notes, holders of the notes will have the right, at their option, to require us to repurchase all or a portion of their notes. In addition, if a make-whole fundamental change occurs prior to the maturity date of the notes, we will in some cases increase the conversion rate for a holder that elects to convert its notes in connection with such make-whole fundamental change. In addition, the indenture governing the notes prohibits us from engaging in certain mergers or acquisitions unless, among other things, the surviving entity assumes our obligations under the notes. These and other provisions could prevent or deter a third party from acquiring us even where the acquisition could be beneficial to you.

 

There is currently no trading market for the notes and an active trading market for the notes may not develop or, if it develops, may not be maintained.

 

The notes will be new securities for which there is currently no existing trading market. We do not intend to apply for listing of the notes on any securities exchange or for quotation of the notes on any automated dealer quotation system. Although the underwriters have informed us that they may make a market in the notes, they are not obligated to do so, and may discontinue market-making at any time without notice. Accordingly, an active trading market may not develop for the notes and, even if one develops, such market may not be maintained. If an active trading market for the notes does

not develop or is not maintained, the market price and liquidity of the notes are likely to be adversely affected and holders may not be able to sell their notes at desired times and prices or at all. If any of the notes are traded after their purchase, they may trade at a discount from their purchase price.

 

The liquidity of the trading market, if any, and future trading prices of the notes will depend on many factors, including, the market price of our common stock, prevailing interest rates, our financial condition, results of operations, business, prospects and credit quality relative to our competitors, the market for similar securities and the overall securities market, and may be adversely affected by unfavorable changes in any of these factors, some of which are beyond our control and others of which would not affect debt that is not convertible into capital stock. Historically, the market for convertible debt has been volatile. Market volatility could materially and adversely affect the notes, regardless of our financial condition, results of operations, business, prospects or credit quality.

 

The notes have a number of features that may adversely affect their value and trading price, including conversion conditions and the lack of financial covenants. Furthermore, even if the conversion conditions are met, since the value of the shares of common stock into which the notes are convertible is dependent on the price of our common stock, volatile or depressed market prices for our common stock are likely to have a similar effect on the trading prices of the notes. We cannot assure you that the price of our common stock in the future will not have an adverse effect on the trading prices of the notes.

 

Our stock price could continue to be volatile and therefore, it may be difficult for you to resell the shares of common stock issuable upon conversion of your notes at prices you find attractive.

 

Our stock price has been volatile. For example, during the eight-month period ended August 31, 2007, the market price for our common stock fluctuated between $12.13 and $25.65 per share. The following factors, among others, could have a significant impact on the market for our common stock:

 

 

Many of the factors listed above are beyond our control. These factors may cause the market price of our common stock to decline, regardless of our financial condition, results of operations, business or prospects. It is impossible to assure converting holders that the market price of our common stock will not fall in the future. Therefore, holders who receive our common stock upon the conversion of their notes will be subject to the risk of volatile and depressed market prices of our common stock and it may be difficult for such holders to resell those shares of common stock at prices they find attractive.

The conditional conversion feature of the notes may prevent the conversion of the notes prior to August 1, 2014.

 

The notes are convertible prior to the close of business on the scheduled trading day prior to the maturity date at any time on or after August 1, 2014. Prior to August 1, 2014, the notes are convertible only under the following conditions: (1) during the five business-day period after any five consecutive trading day period, which we refer to as the measurement period, in which the price per note for each trading day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such day; (2) during any calendar quarter (and only during such quarter) after the calendar quarter ending September 30, 2007, if the last reported sale price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 120% of the applicable conversion price in effect on the last trading day of the immediately preceding calendar quarter; or (3) upon the occurrence of specified corporate events. See “Description of Notes — Conversion Rights” in this prospectus supplement. If these conditions to conversion are not met, holders of the notes will not be able to convert their notes prior to August 1, 2014 and, therefore, may not be able to receive the value of the consideration into which the notes would otherwise be convertible. In addition, for these and other reasons, the trading price of the notes could be substantially less than the value of the shares of common stock into which the notes are convertible.

 

We have made only limited covenants in the indenture for the notes, and these limited covenants may not protect your investment.

 

The indenture governing the notes does not:

 

 

Furthermore, the indenture governing the notes contains only limited protections in the event of a change in control and similar transactions. We could engage in many types of transactions, such as acquisitions, refinancings or recapitalizations, that could substantially affect our capital structure and the value of the notes and our common stock but may not constitute a fundamental change that permits holders to require us to repurchase their notes. For these reasons, you should not consider the covenants in the indenture or the repurchase features of the notes as a significant factor in evaluating whether to invest in the notes.

 

The additional shares by which the conversion rate will be increased for notes converted in connection with certain make-whole fundamental change transactions may not adequately

compensate holders for the lost option time value of their notes as a result of any such make-whole fundamental change.

 

If certain transactions that constitute a make-whole fundamental change occur, under certain circumstances, we will increase the conversion rate by a number of additional shares of our common stock. This increased conversion rate will apply only to holders who convert their notes in connection with any such transaction. The number of additional shares of our common stock will be determined based on the date on which the transaction becomes effective and the price paid per share of our common stock in such transaction, as described under “Description of Notes — Conversion Rights — Adjustment to Shares Delivered upon Conversion upon a Make-Whole Fundamental Change” in this prospectus supplement. While the number of additional shares of common stock is designed to compensate holders for the lost option time value of the notes as a result of such transaction, the amount of such additional shares is only an approximation of such lost value and may not adequately compensate holders for such loss. In addition, notwithstanding the foregoing, if the price paid per share of our common stock in the transaction is less than $      per share or in excess of $      per share, the conversion rate will not be increased. In no event will the conversion rate exceed     per $1,000 principal amount of notes, subject to adjustment under certain circumstances, regardless of when the transaction becomes effective or the price paid per share of our common stock in the transaction.

 

Furthermore, a holder will not receive the additional consideration payable as a result of the increase in the conversion rate until the effective date of such make-whole fundamental change, or even later, which could be a significant period of time after the date the holder has tendered its notes for conversion. Our obligation to increase the conversion rate as described above also could be considered a penalty, in which case its enforceability would be subject to general principles of reasonableness of economic remedies.

 

The conversion rate of the notes may not be adjusted for all dilutive events.

 

The conversion rate of the notes is subject to adjustment for certain events, including, but not limited to, certain dividends on our common stock, the issuance of certain rights, options or warrants to holders of our common stock, subdivisions or combinations of our common stock, certain distributions of assets, debt securities, capital stock or cash to holders of our common stock and certain tender or exchange offers, as described under “Description of Notes — Conversion Rights — Conversion Rate Adjustments” in this prospectus supplement. The conversion rate will not be adjusted for other events, such as an issuance of our common stock for cash or certain repurchases of our common stock, that may adversely affect the trading price of the notes and our common stock. If we engage in any of these types of transactions for which there is no adjustment to the conversion rate, the value of the common stock into which your notes may be convertible may be diluted. There can be no assurance that an event will not occur that is adverse to the interests of the holders of the notes and their value, but does not result in an adjustment to the conversion rate.

 

Holders of the notes will not be entitled to any rights with respect to our common stock, but will be subject to all changes made with respect to them.

 

Holders of the notes will not be entitled to any rights with respect to our common stock (including voting rights and rights to receive any dividends or other distributions on our common stock), but holders of the notes will be subject to all changes affecting our common stock. Holders of the notes will be entitled to the rights afforded our common stock only if and when our common stock is delivered to them upon the conversion of their notes. For example, if an amendment is proposed to our certificate of incorporation or bylaws requiring stockholder approval and the record date for determining the stockholders of record entitled to vote on the amendment occurs prior to a holder’s receipt of our common stock upon the conversion of their notes, such holder will not be entitled to vote on the amendment, although such holder will nevertheless be subject to any changes affecting

our common stock. In addition, because of the contingent conversion, you may not be able to convert your notes until August 1, 2014.

 

The definition of a fundamental change requiring us to repurchase the notes is limited and, therefore, the market price of the notes may decline if we enter into a transaction that is not a fundamental change under the indenture.

 

The term “fundamental change” requiring us to repurchase the notes at your option is limited to specified corporate transactions and may not include other events that might adversely affect our financial condition. In addition, the requirement that we offer to repurchase the notes upon a fundamental change may not protect holders in the event of a highly leveraged transaction, reorganization, merger or similar transaction involving us.

 

Future sales of our common stock in the public market or the issuance of securities senior to our common stock could adversely affect the trading price of our common stock and the value of the notes and our ability to raise funds in new securities offerings.

 

Future sales of our common stock, the perception that such sales could occur or the availability for future sale of shares of our common stock or securities convertible into or exercisable for our common stock could adversely affect the market prices of our common stock and the value of the notes prevailing from time to time and could impair our ability to raise capital through future offerings of equity or equity-related securities. In addition, we may issue common stock or equity securities senior to our common stock in the future for a number of reasons, including to finance our operations and business strategy, to adjust our ratio of debt to equity, to satisfy our obligations upon the exercise of options or for other reasons.

 

As of June 30, 2007, we had outstanding options to purchase approximately 1,371,000 shares of our common stock at a weighted average exercise price of $10.32 per share (approximately 501,000 of which have not yet vested) issued to employees, directors and consultants pursuant to our 1999 Equity Incentive Plan, as amended. In order to attract and retain key personnel, we may issue additional securities, including stock options, restricted stock grants, restricted stock units and shares of common stock in connection with our employee benefit plans or may lower the price of existing stock options. No prediction can be made as to the effect, if any, that the sale, or the availability for sale, of substantial amounts of common stock by our existing stockholders pursuant to an effective registration statement or under Rule 144, through the exercise of any registration rights agreements that we may enter into or the issuance of shares of common stock upon the exercise of stock options, or the perception that such sales or issuances could occur, could adversely affect the prevailing market prices for our common stock and the value of the notes.

 

Conversion of the notes will dilute the ownership interest of existing stockholders, including holders who had previously converted their notes.

 

To the extent we issue any shares of our common stock upon conversion of the notes, the conversion of some or all of the notes will dilute the ownership interests of existing stockholders, including holders who have received shares of our common stock upon prior conversion of the notes. Any sales in the public market of the common stock issuable upon such conversion could adversely affect prevailing market prices of our common stock. In addition, the existence of the notes may encourage short selling by market participants because the conversion of the notes could depress the price or our common stock.

 

The notes may not be rated or may receive a lower rating than anticipated.

 

We do not intend to seek a rating on the notes.  However, if one or more rating agencies rates the notes and assigns the notes a rating lower than the rating expected by investors, or reduces or

indicates that they may reduce their rating in the future, the market price of the notes and our common stock could be harmed.

 

The effective subordination of the notes to our secured indebtedness to the extent of the collateral securing such indebtedness may limit our ability to satisfy our obligations under the notes.

 

The notes will be our senior unsecured obligations and rank equally with any of our existing or future senior debt and senior to any of our future subordinated debt. However, the notes will be effectively subordinated to any secured indebtedness to the extent of the value of the collateral securing such indebtedness. As of June 30, 2007, we had no secured indebtedness outstanding, however, we expect to place increasing reliance on our credit facility in the future, which is secured. The provisions of the indenture governing the notes do not prohibit us from incurring secured indebtedness in the future. Consequently, in the event of a bankruptcy, liquidation, dissolution, reorganization or similar proceeding with respect to us, the holders of any secured indebtedness will be entitled to proceed directly against the collateral that secures such secured indebtedness. Therefore, such collateral will not be available for satisfaction of any amounts owed under our unsecured indebtedness, including the notes, until such secured indebtedness is satisfied in full.

 

The structural subordination of the notes to our secured liabilities and all liabilities and preferred equity of our subsidiaries may limit our ability to satisfy our obligations under the notes.

 

The notes will be structurally subordinated to all unsecured and secured liabilities and preferred equity of our subsidiaries. In the event of a bankruptcy, liquidation, dissolution, reorganization or similar proceeding with respect to any such subsidiary, we, as a common equity owner of such subsidiary, and, therefore, holders of our debt, including holders of the notes, will be subject to the prior claims of such subsidiary’s creditors, including trade and other payables, but excluding intercompany indebtedness. As of June 30, 2007, our subsidiaries had an accounts payable and accrued liabilities balance of approximately $80.7 million. The provisions of the indenture governing the notes do not prohibit our subsidiaries from incurring additional liabilities or issuing preferred equity in the future.

 

We may incur indebtedness ranking equal to the notes.

 

If we incur debt that ranks equal to the notes, including trade payables, the holders of that debt will be entitled to share ratably with you in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding-up of us. This may have the effect of reducing the amount of proceeds paid to you, if any.

 

USE OF PROCEEDS

 

We estimate the net proceeds to us from the sale of the notes will be approximately $438.8 million (or approximately $504.8 million if the underwriters exercise their option to purchase additional notes in full) and the net proceeds from the concurrent common stock offering will be approximately $225.3 million, based on an assumed public offering price of $13.14 per share, the closing price of our common stock on September 13, 2007 (or approximately $259.2 million if the underwriters exercise their option to purchase additional shares in full) in each case after deducting aggregate estimated offering expenses of approximately $1.7 million as well as discounts and commissions. All of the net proceeds from these offerings will be applied to the development, demonstration and deployment of the American Centrifuge project and our general operating expenses and working capital requirements.

 

See “Risk Factors — Risks Related to our Business — Our estimates of the costs of the American Centrifuge project are subject to significant uncertainties that could adversely affect our ability to finance and deploy the American Centrifuge Plant” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview — Our View of the Business Today” for a further discussion of the financing of the American Centrifuge project.

 

PRICE RANGE OF OUR COMMON STOCK AND DIVIDEND POLICY

 

Our common stock, par value $0.10 per share, is currently traded on the New York Stock Exchange under the symbol “USU”. As of August 31, 2007, there were approximately 87,444,000 shares of our common stock outstanding. The following table sets forth, for the periods indicated, the last reported high and low trading prices of our common stock on the New York Stock Exchange.

 

 

We currently do not pay dividends and have not paid a dividend since the fourth quarter of 2005. In February 2006, our Board of Directors voted to discontinue paying a common stock dividend in order to redirect those funds to reduce the level of external financing needed for construction of the American Centrifuge Plant. Accordingly, we have no intention to pay cash dividends in the foreseeable future. Additionally, the agreement governing our revolving credit facility contains, and the indenture governing the notes offered hereby will contain, restrictions on our ability to pay dividends in certain circumstances.

 

CAPITALIZATION

 

The following table sets forth our (1) cash and cash equivalents and (2) capitalization as of June 30, 2007:

 

 

The information in this table should be read in conjunction with “Selected Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements, including the related notes, incorporated by reference in this prospectus supplement.

 

 

 

SELECTED FINANCIAL DATA

 

This selected financial data should be read in conjunction with the consolidated financial statements and related notes incorporated by reference in this prospectus supplement and management’s discussion and analysis of financial condition and results of operations. Selected financial data as of and for the years ended December 31, 2006, 2005, 2004 and 2003, the six-month period ended December 31, 2002, and the fiscal year ended June 30, 2002, have been derived from our audited annual consolidated financial statements. The audited consolidated financial statements for the years ended December 31, 2006, 2005 and 2004 are incorporated by reference in this prospectus supplement. In 2002, the Board of Directors approved a change in fiscal year end from June 30 to December 31, effective December 31, 2002. The statement of operations data for the six-month periods ended June 30, 2006 and June 30, 2007 and as of June 30, 2007 are derived from our unaudited consolidated condensed financial statements and accompanying notes incorporated by reference in this prospectus supplement and, in the opinion of our management, include all normal recurring adjustments necessary for a fair presentation of the results for the unaudited interim periods. The historical financial information presented below may not be indicative of our future performance.

 

 

 

 

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 financial statements and related notes incorporated into this prospectus supplement by reference as well as the risks and uncertainties incorporated by reference and included in this prospectus supplement under the heading “Risk Factors”.

 

Overview

 

We are a leading supplier of low enriched uranium, or LEU, for commercial nuclear power plants. LEU is a critical component in the production of nuclear fuel for reactors to produce electricity. We, either directly or through our subsidiaries United States Enrichment Corporation and NAC International Inc.:

 

 

Low Enriched Uranium

 

LEU consists of two components: 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 contained in LEU under this formula is commonly referred to as the SWU component.

 

We produce or acquire LEU from two principal sources. We produce LEU at the gaseous diffusion plant in Paducah, Kentucky, and we acquire LEU from Russia under a contract, which we refer to as the “Russian Contract”, to purchase the SWU component of LEU recovered from dismantled nuclear weapons from the former Soviet Union for use as fuel in commercial nuclear power plants.

 

Our View of the Business Today

 

During the first half of 2007, we have been sharply focused on addressing significant pressure on our gross profit margins and cash flow from operations caused by higher power costs incurred since June 2006. These efforts have shown early signs of success, as our financial forecasts for the full year 2007, while still below 2006 results, are substantially better than our original guidance for net losses and negative cash flow. However, we continue to foresee challenges through the rest of 2007 and over the next several years as we work to finance and build a new commercial uranium enrichment plant that we call the American Centrifuge Plant to replace our aging gaseous diffusion plant in Paducah, Kentucky. We believe that over the long-term, the deployment of the American Centrifuge Plant will provide our customers with an efficient and reliable source of LEU and that our production costs will be more predictable and less affected by changes in power costs. In addition, we

believe that the American Centrifuge Plant will provide the United States with energy security for nuclear fuel and will provide substantial national security benefits.

 

Our cost of sales increased during the first half of 2007 and will continue to increase during the second half of the year as a result of a significant increase beginning in June 2006 in the cost of electric power used by the Paducah GDP. Because of our average inventory method of accounting, the impact of the 2006 power cost increase is reflected in our cost of sales over time. We expect the high cost of power to continue to adversely affect our gross profit margin until the American Centrifuge Plant is complete. Our cost of sales also increased in the first half of 2007 as a result of increases in the purchase price for LEU delivered under the Russian Contract. Purchases under the Russian Contract account for approximately 50% of our supply mix and our costs under this contract are increasing at a faster rate than price increases under our existing customer contracts. This price increase under the Russian Contract without associated price increases under most of our existing customer contracts has had and will continue to have a negative impact on our gross profit margin.

 

During the second quarter of 2007 we reached a new five-year power agreement with the Tennessee Valley Authority (“TVA”), which supplies most of the power for the Paducah GDP. The new agreement went into effect June 1, 2007 and is expected to result in a modest decrease in our power cost during the first year of the agreement, followed by moderate annual increases over the remainder of the contract. As we had sought, the new agreement provides that we will receive up to 2,000 megawatts of electricity during non-summer months during the first three years, an approximately 25% increase in the amount of electricity provided under the contract. The additional power gives us added production, while providing additional stability and predictability in our power costs over the next five years.

 

The market price for our product increased during the first half of the year and, absent an increase in sales of unfairly priced SWU by our foreign competitors, we believe market fundamentals suggest that SWU prices will likely remain firm as supply and demand for LEU needed to fuel a growing number of reactors worldwide seeks a balance. We believe that a stable domestic enrichment market is essential to the successful financing and deployment of the American Centrifuge technology.

 

The Russian government has said it will not extend the current Megatons to Megawatts program beyond 2013 and has been negotiating with the U.S. government regarding direct sales of Russian LEU to U.S. utilities after that date. Given the high priority that the Bush Administration has placed on ensuring a secure domestic nuclear fuel supply, we believe that the U.S. government will seek reasonable limits on Russian imports. We support a balanced approach that will provide the market with fairly priced Russian LEU while sustaining a stable domestic enrichment market that can support investment in new uranium enrichment facilities. If Russia is permitted to begin selling substantial quantities of LEU before we have secured an adequate backlog of sales to cover our production from the American Centrifuge Plant, the impact of this additional supply in the enrichment market could be significant, and long-term SWU prices could drop to a level where we could not justify further investment in the American Centrifuge Plant.

 

We have recently moved into the next phase of integrated testing of the American Centrifuge technology involving multiple machines in a cascade configuration. We refer to this phase as the Lead Cascade test program. In a centrifuge enrichment facility, a cascade is a group of centrifuge machines connected in a series and parallel arrangement to achieve an intended isotope separation capability. A uranium enrichment facility that uses gas centrifuge technology is made up of hundreds of cascades. The number and arrangement of centrifuge machines in a cascade can vary. The cascades tested during our Lead Cascade test program will consist of fewer than 20 prototype machines, including spare machines, and will be located within an existing building that will ultimately house the full-scale commercial plant.

 

In early 2007, we completed a comprehensive review of the cost of deploying the American Centrifuge Plant and established a target cost estimate of $2.3 billion. This target cost estimate includes amounts spent on the project through early 2007 and estimates for cost escalation, but does

not include financing costs or a reserve for general contingencies. Our target cost estimate assumes that we will be successful in reducing the capital cost per machine over time based on value engineering the design of centrifuge machines for high-volume manufacturing. As of June 30, 2007, we had spent approximately $465 million on the American Centrifuge project.

 

Based on information currently available to us, including costs incurred since establishing the target cost estimate in early 2007, initial bids and procurements from suppliers, feedback from consultants and other third parties, and our analysis of material, commodity and labor cost trends, we believe that our cost of deploying the American Centrifuge Plant is likely to be higher than provided for in our target cost estimate, particularly as a result of higher costs associated with the centrifuge machines being manufactured by our suppliers during the initial stage of deployment. Spending to date, combined with commitments we have made and anticipate making in the near future for components of the American Centrifuge Plant exceed the corresponding amounts included in our target cost estimate by approximately $150 million, or 15 percent.

 

Working closely with key suppliers, we are seeking to reduce the capital cost per machine while maintaining performance objectives to help achieve our target cost estimate. We continue to simplify the design of the centrifuge machines in order to reduce costs as well as to take advantage of technological advancements to improve performance. We are also contracting for the manufacture of the centrifuge machines in stages so that contracts for machines manufactured in later stages can benefit from the reduced costs we expect to realize over time. We believe that success in these value engineering efforts by our project team and our strategic suppliers may help to offset higher materials costs seen in some of the initial American Centrifuge project procurements.

 

Using information collected from our efforts and further progress toward freezing the design of the AC100 machine, we expect to complete a comprehensive review and update of our target cost estimate for deployment of the American Centrifuge Plant in the first quarter of 2008. The cost estimate resulting from that review will take into account the costs and the cost trends that we have experienced during our initial procurements as well as our evaluation of material, commodity and labor cost trends. Given the approximately 15% variance in spending to date and commitments as compared with our target estimate, unless we can identify further cost savings, including through the contracts that we are negotiating with our key suppliers, the target cost estimate we expect to establish in the first quarter of 2008 will be greater than the $2.3 billion target cost estimate established in early 2007.

 

The target cost update will also include for the first time a reserve for general contingencies that will reflect the maturity of the project. The reserve for general contingencies, which is not included in our target cost estimate of $2.3 billion, will take into account potential variations in the project plans and uncertainty regarding associated costs that we cannot specifically identify at the time the estimate is prepared. We expect that the information available to us when we calculate the reserve for general contingencies in 2008 will allow us to develop a risk-based estimate at that time. Based on the limited information currently available to us, including cost data, initial bids and procurements from suppliers, feedback from consultants and other third parties, and our analysis of material, commodity and labor cost trends, we believe that a reserve for contingencies of approximately 15% to 20% is reasonable at this time, in addition to our current target cost estimate of $2.3 billion.

 

We expect to continue to periodically review and update our target cost estimate throughout the duration of the project.

 

In addition to providing for a reserve for general contingencies, our overall financing needs for the American Centrifuge project will also include additional costs not covered by our target cost estimate, such as financing costs, financial assurance requirements and operating costs related to commercial plant initial operations. See “Business — The American Centrifuge Plant — American Centrifuge Asset Retirement Obligation” for a discussion of our financial assurance requirements, currently estimated to be approximately $345.3 million in 2006 dollars, and associated asset retirement obligations. See “Risk Factors — Our estimates of the costs of the American Centrifuge

project are subject to significant uncertainties that could adversely affect our ability to finance and deploy the American Centrifuge Plant”.

 

We have spent approximately $465 million on the American Centrifuge project through June 30, 2007. Based on our current deployment schedule, we expect to spend approximately $225 million on the American Centrifuge project in the remainder of 2007 (for total spending of approximately $320 million in 2007) and about double the 2007 amount in 2008. Approximately $376 million of our spending through June 30, 2007 has been for demonstration, including costs relating to NRC licensing of our American Centrifuge Demonstration Facility in Piketon, Ohio, engineering activities, and assembly and testing of centrifuge machines and equipment at test facilities in Oak Ridge and the American Centrifuge Demonstration Facility. We are shifting to increased spending directly relating to the American Centrifuge Plant and manufacturing infrastructure. Manufacturing of the plant production machines represents approximately 50% of our target cost estimate, with the remainder consisting of engineering, procurement and construction of the American Centrifuge Plant infrastructure, program management and demonstration costs.

 

We anticipate that following the consummation of the offerings, our cash, together with our expected internally generated cash flow from operations and available borrowings under our revolving credit facility will provide us with sufficient capital and liquidity to advance the project to the point where we will have frozen the design of the AC100 machine, entered into additional agreements with key suppliers, begun contracting with customers for time periods in which production from the American Centrifuge Plant will be used to satisfy all or part of our delivery obligations and have substantially more information that will support an updated target cost estimate.

 

Even if we raise the net proceeds contemplated by this offering together with the net proceeds from our concurrent common stock offering, we will still need to raise a significant amount of additional capital to complete the American Centrifuge project. Under our current schedule and anticipating the additional maturity and progress of the project described above, we expect that we will seek to raise significant additional capital in the second half of 2008. We also continue to pursue potential participation by third parties and/or support from the U.S. government in financing the American Centrifuge project.

 

We have been seeking the support of the U.S. government in two principal ways. We have been pursuing the possibility of U.S. government loan guarantees under authorized programs. We submitted a pre-application for a loan guarantee under DOE’s loan guarantee program in December 2006 and also provided feedback to DOE in response to its Notice of Proposed Rulemaking for the loan guarantee program. We believe we are well qualified for loan guarantees under criteria related to energy conservation and nuclear power. However, DOE is still developing regulations for this program and additional Congressional action may be required before any meaningful loan guarantees could be offered. We do not expect to hear about potential awards before late 2007 or early 2008, at which time potential participants would be invited to submit a formal loan application. In our pre-application, we requested a proposed loan guarantee amount based on a preliminary cost estimate plus amounts for contingency, financing, financial assurance costs and operating costs related to commercial plant initial operations. Our pre-application was based on limited information known at the time. We expect to have more accurate information as part of our update of our target cost estimate for deployment of the American Centrifuge Plant and this information would form the basis for any loan application we might be asked by DOE to submit.

 

The second principal way that we have been seeking the support of the U.S. government is through discussions we have had with DOE regarding the potential for us to re-enrich uranium contained in cylinders of depleted uranium, also known as “tails”. These tails were generated during the several decades that the U.S. government operated its gaseous diffusion plants in Kentucky, Ohio and Tennessee. These cylinders are owned by the U.S. government and represent an obligation of the U.S. government for their ultimate disposal. Because the market price of uranium has increased dramatically over the past three years, it now makes economic sense to reclaim more of the U²³⁵

content remaining in these byproduct cylinders. We have the only domestic enrichment plant capable of processing and reclaiming the U²³⁵ content from these cylinders, so we believe we are ideally suited to this task. We have been discussing with DOE the potential for us to re-enrich the uranium contained in these cylinders for our benefit, and the benefit of our customers and the U.S. government. At the request of several congressmen and senators, the Government Accountability Office is reviewing current law to determine DOE’s authority to transfer this material to us for additional processing, with a report expected by year end. Any agreement for the re-enrichment of DOE’s tails will require action by the U.S. government, and the nature and the timing of any action is uncertain.

 

If we can reach agreement with the government regarding the tails, we will seek to generate additional cash flows from operations to help offset the higher cost of electric power at the Paducah GDP and to reinvest in the American Centrifuge Plant. Our electric utility customers would also benefit from additional uranium supply in the marketplace. The U.S. government could gain a uranium supply that it could hold as a strategic reserve similar to the national petroleum strategic reserve, and provide an assurance of uranium supply for new nuclear power reactors being proposed in the U.S. The U.S. government would also benefit from a smaller disposal liability because fewer cylinders of tails will remain after the re-enrichment process.

 

Additional funds may be necessary sooner than we currently anticipate in the event of changes in schedule, increases above our target cost estimate, unanticipated prepayments to suppliers, increases in financial assurance, cost overruns or any shortfall in our estimated levels of operating cash flow, or to meet other unanticipated expenses. We cannot assure you that we will be able to obtain additional financing on a timely basis, on acceptable terms or at all. See Risk Factors — “Deployment of the American Centrifuge technology will require additional external financial and other support that may be difficult to secure”. Additionally, proceeds from the offerings will not be segregated in a manner that limits their use for any particular purpose. As a result, we cannot assure you that proceeds from the offerings that we currently expect will be available for the demonstration and deployment of the American Centrifuge project will not instead be used to fund our operating expenses and working capital requirements or for other purposes.

 

We are focused on meeting these substantial challenges, and we are encouraged about the prospects for the nuclear power industry and the important role that we will play in fueling that future.

 

Revenue from Sales of SWU and Uranium

 

Our revenue is derived primarily from:

 

 

The majority of our customers are domestic and international utilities that operate nuclear power plants, with international sales constituting approximately 40% of revenue in 2006. 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 or uranium from us or long-term requirements contracts under which our customers are obligated to purchase a percentage of their SWU or uranium requirements from us. Under requirements contracts, customers are not obligated to make purchases if the reactor does not have requirements. The timing of requirements is associated with reactor refueling outages.

 

Our revenues and operating results can fluctuate significantly from quarter to quarter, and in some cases, year to year. 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 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 delay, suspend or shut down nuclear reactor operations within their jurisdictions.

 

Our financial performance over time can be significantly affected by changes in prices for SWU. The SWU price indicator for new long-term contracts, as published by TradeTech in Nuclear Market Review, is an indication of base-year prices under new long-term SWU 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. Following are the long-term SWU price indicator, the long-term price for uranium hexafluoride, as calculated using indicators published in Nuclear Market Review, and the spot price indicator for uranium hexafluoride:

 

 

A substantial portion of our earnings and cash flows in recent years has been derived from sales of uranium and, as a result, our inventory of uranium available for sale has been reduced. We will continue to supplement our supply of uranium by underfeeding the production process at the Paducah GDP and by purchasing uranium from suppliers in connection with specific customer contracts. 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 vary our production process to underfeed uranium based on the economics of the cost of electric power relative to the price of uranium. Uranium prices in the market have continued to make underfeeding economical despite increases in power costs. Under the June 2007 amendment to the TVA power contract, we have a greater supply of electric power available to underfeed the production process and increase our SWU production.

 

We supply uranium to the Russian Federation for the LEU we receive under the Russian Contract. We replenish our uranium inventory with uranium supplied by customers under our contracts for the sale of SWU and through underfeeding our production process. Our new SWU sales contracts and certain of those contracts that we have renegotiated require customers to deliver a greater amount of natural uranium to us relative to the quantity of LEU product delivered. Although this means we will sell less SWU under these contracts, the natural uranium delivered to us by customers is approaching the amounts we utilize in our production process and must deliver under the Russian Contract.

 

Although we have reduced supplies of uranium available for sale compared with prior years, we expect to opportunistically sell uranium inventory in excess of internal needs. We intend to use the proceeds to pay for increased costs under the TVA power contract and to invest in the American Centrifuge technology. The recognition of revenue and earnings for uranium sales is deferred until uranium or LEU to which the customer has title is physically delivered rather than at the time title transfers to the customer. The timing of revenue recognition for uranium sales is uncertain.

 

Revenue from U.S. Government Contracts

 

We perform and earn revenue from contract work for DOE and DOE contractors at the Paducah and Portsmouth GDPs, including contracts for cold standby or cold shutdown and processing out-of-specification uranium at the Portsmouth GDP. DOE and USEC have periodically extended the cold standby program, and we anticipate continued funding through 2008. The program was redefined

beginning in 2006 to include actions necessary to prepare for a DOE decontamination and decommissioning program, which we refer to as “cold shutdown”. Processing of USEC-owned out-of-specification uranium under contract with DOE was completed in October 2006, and we expect that the processing of DOE-owned out-of-specification uranium for DOE will continue through September 2008. Continuation of U.S. government contracts is subject to DOE funding and Congressional appropriations, and the processing of out-of-specification uranium is currently funded through February 2008.

 

Revenue from U.S. government contracts is based on allowable costs determined under government cost accounting standards. 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 is in the process of reviewing the final settlement of allowable costs proposed by us for the twelve months ended June 2002, the six months ended December 2002, the twelve months ended December 2003, and the twelve months ended December 2004. Also refer to “Business — Legal Proceedings — DOE Contract Services Matter” and “Business — Legal Proceedings — Defense Contract Audit Agency Matter”. Revenue from U.S. government contracts includes revenue from NAC.

 

Cost of Sales

 

Cost of sales for SWU and uranium is based on the amount of SWU and uranium sold during the period and is determined by a combination of inventory levels and costs, production costs and purchase costs. 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. Under the monthly moving average inventory cost method coupled with our inventories of SWU and uranium, 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.

 

We have agreed to purchase approximately 5.5 million SWU each calendar year for the remaining term of the Russian Contract through 2013. Purchases under the Russian Contract are approximately 50% of our supply mix. Prices are determined using a discount from an index of international and U.S. price points, including both long-term and spot prices. A multi-year retrospective of the index is used to minimize the disruptive effect of short-term market price swings. Increases in these price points in recent years have resulted, and likely will continue to result, in increases to the index used to determine prices under the Russian Contract. Officials of the Russian government have announced that Russia will not extend the Russian Contract or the government-to-government agreement it implements, beyond 2013. Accordingly, we do not anticipate that we will purchase significant quantities of Russian SWU after 2013.

 

We provide for the remainder of our supply mix from the Paducah GDP. The gaseous diffusion process uses significant amounts of electric power to enrich uranium. In 2006, the power load at the Paducah GDP averaged 1,370 megawatts and we expect the average power load at the Paducah GDP to increase in 2007. We purchase electric power for the Paducah GDP under a power purchase agreement signed with TVA in 2000. On June 1, 2006, fixed, below market prices under the 2000 TVA power contract expired and a one-year pricing agreement went into effect. Costs for electric power increased from approximately 60% of production costs at the Paducah GDP under the pre-2006 agreement to approximately 70%. Pricing for the one-year term ending May 2007 was about 50% higher than the pre-2006 pricing, and was also subject to a fuel cost adjustment to reflect changes in TVA’s fuel costs, purchased power costs and related costs. Upon the expiration of this one-year pricing agreement, effective June 1, 2007, we amended the TVA power contract to provide for the quantity and pricing of power purchases for the five-year period June 1, 2007 through May 31, 2012, extending the overall term of the power contract by two additional years to May 31, 2012.

 

Pricing under the five-year agreement continues to consist of a summer and a non-summer base energy price through May 31, 2008. Beginning June 1, 2008, the price consists of a year-round base energy price that increases moderately based on a fixed, annual schedule. All years remain subject to

a fuel cost adjustment provision. The initial power price under the 2007 amendment represents a modest reduction from the actual price paid under the previous one-year pricing, in each case after taking into account the fuel cost adjustment. The impact of future fuel cost adjustments is uncertain and our cost of power could fluctuate in the future.

 

The increase in electric power costs from the pre-2006 pricing has significantly increased overall LEU production costs and reduced cash flows, and will increasingly reduce our gross profit margin as higher production costs are reflected in cost of sales under our monthly moving average cost of inventory.

 

The quantity of power purchases under the 2007 amendment generally ranges from 300 megawatts in the summer months (June — August) to up to 2,000 megawatts in the non-summer months. This is an increase from previous quantities in the non-summer months. During the last two years of the contract, the quantity of non-summer power purchases will be reduced to a maximum of 1,650 megawatts at all hours. This is designed to provide a transition down for the TVA power system because of the significant amount of power being purchased by us. Consistent with past practice, we also purchased from TVA and another third party, at market-based prices, an additional 600 megawatts of power during the summer months of 2007.

 

Because of the increased quantities in the non-summer months, the 2007 amendment also provides for an increase in the amount of financial assurances we provide to TVA to support our payment obligations. These include a letter of credit and weekly prepayments based on the price and usage of power.

 

We store depleted uranium at the Paducah and Portsmouth GDPs and accrue estimated costs for its future disposition. We anticipate that we will send most or all of our depleted uranium to DOE for disposition unless a more economic disposal option becomes available. DOE is constructing facilities at the Paducah and Portsmouth GDPs to process large quantities of depleted uranium owned by DOE. Under federal law, DOE would also process our depleted uranium if we provided it to DOE for disposal. If we were to dispose of our depleted uranium in this way, we would be required to reimburse DOE for the related disposition costs of our depleted uranium, including our pro rata share of DOE’s capital costs. Our estimate of the unit disposal cost is based primarily on estimated cost data obtained from DOE without consideration given to contingencies or reserves, and was increased by 2% in the first quarter of 2007 as a result of our review of current data available. The NRC requires that we guarantee the disposition of our depleted uranium with financial assurance (refer to “Liquidity and Capital Resources — Financial Assurances and Related Liabilities”). Our estimate of the unit disposition cost for accrual purposes is approximately 35% less than the unit disposition cost for financial assurance purposes, which includes contingencies and other potential costs as required by the NRC. Our estimated cost and accrued liability, as well as financial assurance we provide for the disposition of depleted uranium, are subject to change as additional information becomes available.

 

Government Investigation of Imports from France

 

In 2002, the DOC imposed antidumping and countervailing duty (anti-subsidy) orders on imports of LEU produced in France. The orders were imposed in response to unfair trading practices by our French competitors in connection with imports of LEU into the United States. Since 2002, these orders have been challenged and impacted by further judicial and administrative actions.

 

 

 

Critical Accounting Estimates

 

Our significant accounting policies are summarized in note 1 to our consolidated financial statements, which were prepared in accordance with generally accepted accounting principles and are incorporated by reference in this prospectus supplement. Included within these policies are certain policies that require critical accounting estimates and judgments. Critical accounting estimates are those that require management to make assumptions about matters that are uncertain at the time the estimate is made and for which different estimates, often based on complex judgments, probabilities and assumptions that we believe to be reasonable, but are inherently uncertain and unpredictable, could have a material impact on our operating results and financial condition. It is also possible that other professionals, applying their own judgment to the same facts and circumstances, could develop and support a range of alternative estimated amounts. We are also subject to risks and uncertainties that may cause actual results to differ from estimated amounts, such as the healthcare environment, legislation and regulation.

 

The sensitivity analyses used below are not intended to provide a reader with our predictions of the variability of the estimates used. Rather, the sensitivities used are included to allow the reader to understand a general cause and effect of changes in estimates.

 

We have identified the following to be our critical accounting estimates:

 

Pension and Postretirement Health and Life Benefit Costs and Obligations

 

We provide retirement benefits under defined benefit pension plans and postretirement health and life benefit plans. The valuation of benefit obligations and costs is based on provisions of the plans and actuarial assumptions that involve judgments and estimates. Changes in actuarial assumptions could impact benefit obligations and benefit costs, as follows:

 

 

 

Costs for the Future Disposition of Depleted Uranium and Plant Lease Turnover Costs

 

SWU and uranium inventories include estimates and judgments for production quantities and production costs. Production costs include estimates of future expenditures for the conversion, transportation and disposition of depleted uranium, the treatment and disposal of hazardous, low-level radioactive and mixed wastes, and plant lease turnover costs. Lease turnover costs are estimated and are accrued over the expected productive life of the plant. An increase or decrease in production costs has an effect on inventory costs and cost of sales over current and future periods.

 

We store depleted uranium generated from our operations at the Paducah and Portsmouth GDPs and accrue estimated costs for its future disposition. We anticipate that we will send most or all of our depleted uranium to DOE for disposition unless a more economic disposal option becomes available. DOE is constructing facilities at the Paducah and Portsmouth GDPs to process large quantities of depleted uranium owned by DOE. Under federal law, DOE would also process our depleted uranium if we provided it to DOE for disposal. If we were to dispose of our depleted uranium in this way, we would be required to reimburse DOE for the related costs of disposing our depleted uranium, including our pro rata share of DOE’s capital costs. Processing DOE’s depleted uranium is expected to take about 25 years. The timing of the disposal of our depleted uranium has not been determined. The long-term liability for depleted uranium disposition is dependent upon the volume of depleted uranium that we generate and estimated processing, transportation and disposal costs. Our estimate of the unit disposal cost is based primarily on estimated cost data obtained from DOE without consideration given to contingencies or reserves. Our estimate of the unit cost is periodically reviewed as additional information becomes available, and was increased by 2% in the first quarter of 2007 as a result of our review of current data then available.

 

The NRC requires that we guarantee the disposition of our depleted uranium with financial assurance. Our estimate of the unit disposition cost for accrual purposes is approximately 35% less than the unit disposition cost for financial assurance purposes, which includes contingencies and other potential costs as required by the NRC. Our estimated cost and accrued liability, as well as financial assurance we provide for the disposition of depleted uranium, are subject to change as additional information becomes available.

 

The amount and timing of future costs could vary from amounts accrued. Accrued liabilities for depleted uranium and lease turnover costs are $71.5 million and $55.5 million, respectively, as of December 31, 2006 and $82.6 million and $56.6 million, respectively, as of June 30, 2007.

American Centrifuge Technology Costs

 

Costs relating to the demonstration and deployment of 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. Centrifuge costs relating to the demonstration of American Centrifuge technology are charged to expense as incurred. Demonstration costs include 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. Capitalized costs relating to the American Centrifuge technology include or will include NRC licensing, engineering activities, construction of centrifuge machines and equipment, leasehold improvements and other costs directly associated with the American Centrifuge Plant. Capitalized centrifuge costs are recorded in property, plant and equipment as part of construction work in progress. The continued capitalization of such costs is subject to ongoing review and successful project completion, including NRC licensing, financing, and installation and operation of centrifuge machines and equipment.

 

During the second quarter of 2007 and in prior periods we were principally in a demonstration phase of the American Centrifuge project and, as a result, the majority of our expenditures on the project were expensed. We are now moving into a commercial plant phase where an increasing amount of costs will be capitalized as part of the American Centrifuge Plant. Our ability to move from a demonstration phase to a commercial plant phase is based on management’s judgment that the technology has a high probability of commercial success and meets internal targets related to physical control, technical achievement and economic viability. If conditions change and deployment were no longer probable, costs that were previously capitalized would be charged to expense.

 

Expenditures related to American Centrifuge technology for the six months ended June 30, 2007, the year ended December 31, 2006 and cumulative expenditures as of June 30, 2007, follow (in millions):

 

 

 

Income Taxes

 

During the ordinary course of business, there are transactions and calculations for which the ultimate tax determination is uncertain. As a result, we recognize tax liabilities based on estimates of whether additional taxes and interest will be due. To the extent that the final tax outcome of these matters is different than the amounts that were initially recorded, such differences will impact the income tax provision in the period in which such determination is made. To the extent that the provision for income taxes increases/decreases by 1% of income from continuing operations, net income would have declined/improved by $1.7 million in 2006.

Accounting for income taxes involves estimates and judgments relating to the tax bases of assets and liabilities and the future recoverability of deferred tax assets. In assessing the realization of deferred tax assets, we determine whether it is more likely than not that the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon generating sufficient taxable income in future years when deferred tax assets are recoverable or are expected to reverse. Factors that may affect estimates of future taxable income include, but are not limited to, competition, changes in revenue, costs or profit margins, market share and developments related to the American Centrifuge technology. We have determined that it is more likely than not that deferred tax assets will be realized.

 

Determining the need for or amount of a valuation allowance involves judgments, estimates and assumptions. We review historical results, forecasts of taxable income based upon business plans, eligible carryforward periods, periods over which deferred tax assets are expected to reverse, developments related to the American Centrifuge technology, tax planning opportunities and other relevant considerations. The underlying assumptions may change from period to period. In the event we were to determine that it is more likely than not that all or some of the deferred tax assets will not be realized in future years, a valuation allowance would result.

 

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). This interpretation clarifies the accounting for income taxes by prescribing a minimum recognition threshold that a tax position is required to meet before the related tax benefit may be recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.

 

We adopted the provisions of FIN 48 effective January 1, 2007. As a result of implementing FIN 48, we recognized a $31.1 million increase in the liability for unrecognized tax benefits. This increase resulted in a $7.5 million decrease in the January 1, 2007 retained earnings balance and a $23.6 million increase in the deferred tax assets. Implementation of FIN 48 also resulted in an additional $11.4 million decrease in the January 1, 2007 retained earnings balance for accrued interest and penalties. The liability for unrecognized tax benefits was $38.5 million at January 1, 2007, of which $19.5 million would impact the effective tax rate, if recognized.

 

We and our subsidiaries file income tax returns with the U.S. government and various states and foreign jurisdictions. The Internal Revenue Service (“IRS”) has been examining our federal income tax returns from 1998 through 2003. In addition, in the second quarter of 2007, the IRS commenced an examination of our 2004 and 2005 federal income tax returns. For tax return years 1998 through 2003, we reached agreement with the IRS during the first quarter of 2007 on all matters except for one remaining issue described below. With the exception of the one issue described below, the applicable U.S. federal statute of limitations expired on March 31, 2007 with respect to tax return years 1998 through 2002. The liability for unrecognized tax benefits decreased $15.4 million and the tax provision decreased $12.7 million in the first quarter of 2007, primarily as a result of the expiration of the statute of limitations.

 

The remaining issue in the IRS examination related to $50.2 million of expenditures incurred at the Paducah GDP during tax return years 1998 through 2000. We incurred these expenditures to improve the stability of several structures at the site in the event of an earthquake. The IRS challenged the timing of deductibility of these costs. During the second quarter of 2007, we reached agreement with the IRS on this issue, which resulted in a decrease to the liability for unrecognized tax benefits of $15.9 million, a tax payment to the IRS of $8.6 million and a decrease in deferred tax assets. At June 30, 2007, the liability for unrecognized tax benefits, included in other long-term liabilities, was $7.9 million. In addition, we currently anticipate that the applicable federal statute of limitations with respect to tax return year 2003 will expire in the third quarter of 2007. As of June 30, 2007, the applicable Kentucky and Ohio statutes of limitations for tax return years 2002 forward and 2003

forward, respectively, have not yet expired. We believe that it is reasonably possible that the liability for unrecognized tax benefits could decrease by up to $2.0 million in the next 12 months.

 

We recognize accrued interest as a component of interest expense and accrued penalties as a component of selling, general and administrative expense in the consolidated statement of income, which is consistent with the reporting in prior periods for these items. After implementation of FIN 48, our balance of accrued interest and penalties was $19.5 million as of January 1, 2007. Expenses for accrued interest and penalties recorded during the second quarter of 2007 were $0.6 million for a year to date amount as of June 30, 2007 of $2.0 million. In addition, on March 31, 2007, as a result of the expiration of the applicable U.S. federal statute of limitations with respect to tax return years 1998 through 2002, $6.6 million of previously accrued interest was reversed and was recorded as interest income in the consolidated statement of income. Also, during the second quarter of 2007, as a result of resolving the remaining issue with the IRS as described above, $6.9 million of previously accrued interest and penalties was reversed and recorded as interest income and as a reduction to selling, general and administrative expense in the consolidated statement of income. As of June 30, 2007, accrued interest and penalties totaled $8.0 million.

 

Results of Operations

 

Comparison of the Six Months Ended June 30, 2007 and 2006

 

The following tables show for the six months ended June 30, 2007 and 2006, certain items from the consolidated condensed statements of income incorporated by reference in this prospectus supplement detailed by reportable segments and in total.

 

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 U.S. government contracts 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 U.S. government contracts segment includes work performed for DOE and DOE contractors at the Portsmouth and Paducah GDPs as well as nuclear energy services and technologies provided by NAC. Intersegment sales between our reportable segments were less than $0.1 million in each period presented below and have been eliminated in consolidation.

 

Segment information for the six months ended June 30, 2007 and 2006 follows (in millions):

 

Revenue

 

Total revenue declined $210.5 million (or 24%) in the six months ended June 30, 2007 compared to the corresponding period in 2006. Revenues from the LEU segment are presented in the following table (in millions, except percentage change):