============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------- FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended June 30, 2003 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from _____to_____ Commission Registrant, State of Incorporation, I.R.S. Employer File Number Address and Telephone Number Identification No. - ------------- ------------------------------------- ------------------ 1-3526 The Southern Company 58-0690070 (A Delaware Corporation) 270 Peachtree Street, N.W. Atlanta, Georgia 30303 (404) 506-5000 1-3164 Alabama Power Company 63-0004250 (An Alabama Corporation) 600 North 18th Street Birmingham, Alabama 35291 (205) 257-1000 1-6468 Georgia Power Company 58-0257110 (A Georgia Corporation) 241 Ralph McGill Boulevard, N.E. Atlanta, Georgia 30308 (404) 506-6526 0-2429 Gulf Power Company 59-0276810 (A Maine Corporation) One Energy Place Pensacola, Florida 32520 (850) 444-6111 001-11229 Mississippi Power Company 64-0205820 (A Mississippi Corporation) 2992 West Beach Gulfport, Mississippi 39501 (228) 864-1211 1-5072 Savannah Electric and Power Company 58-0418070 (A Georgia Corporation) 600 East Bay Street Savannah, Georgia 31401 (912) 644-7171 333-98553 Southern Power Company 58-2598670 (A Delaware Corporation) 270 Peachtree Street, N.W. Atlanta, Georgia 30303 (404) 506-5000 =============== =========================================== ==================
Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes X No____ Indicate by check mark whether the registrants are accelerated filers as defined by Rule 12b-2 of the Securities Exchange Act of 1934. Yes X (except for Southern Power Company) No ___ Description of Shares Outstanding Registrant Common Stock at July 31, 2003 - ---------- --------------- ----------------- The Southern Company Par Value $5 Per Share 728,512,169 Alabama Power Company Par Value $40 Per Share 6,625,000 Georgia Power Company No Par Value 7,761,500 Gulf Power Company No Par Value 992,717 Mississippi Power Company Without Par Value 1,121,000 Savannah Electric and Power Company Par Value $5 Per Share 10,844,635 Southern Power Company Par Value $0.01 Per Share 1,000 This combined Form 10-Q is separately filed by The Southern Company, Alabama Power Company, Georgia Power Company, Gulf Power Company, Mississippi Power Company, Savannah Electric and Power Company and Southern Power Company. Information contained herein relating to any individual company is filed by such company on its own behalf. Each company makes no representation as to information relating to the other companies. 2
<TABLE> <CAPTION> INDEX TO QUARTERLY REPORT ON FORM 10-Q June 30, 2003 Page Number <S> <C> DEFINITIONS........................................................................................................ 5 PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition The Southern Company and Subsidiary Companies Condensed Consolidated Statements of Income........................................................ 8 Condensed Consolidated Statements of Cash Flows.................................................... 9 Condensed Consolidated Balance Sheets.............................................................. 10 Condensed Consolidated Statements of Comprehensive Income and Accumulated Other Comprehensive Income......................................................... 12 Management's Discussion and Analysis of Results of Operations and Financial Condition.............. 13 Alabama Power Company Condensed Statements of Income..................................................................... 24 Condensed Statements of Cash Flows................................................................. 25 Condensed Balance Sheets........................................................................... 26 Condensed Statements of Comprehensive Income and Accumulated Other Comprehensive Income......................................................... 28 Management's Discussion and Analysis of Results of Operations and Financial Condition.............. 29 Georgia Power Company Condensed Statements of Income..................................................................... 38 Condensed Statements of Cash Flows................................................................. 39 Condensed Balance Sheets........................................................................... 40 Condensed Statements of Comprehensive Income and Accumulated Other Comprehensive Income......................................................... 42 Management's Discussion and Analysis of Results of Operations and Financial Condition.............. 43 Gulf Power Company Condensed Statements of Income..................................................................... 52 Condensed Statements of Cash Flows................................................................. 53 Condensed Balance Sheets........................................................................... 54 Condensed Statements of Comprehensive Income and Accumulated Other Comprehensive Income......................................................... 56 Management's Discussion and Analysis of Results of Operations and Financial Condition.............. 57 Mississippi Power Company Condensed Statements of Income..................................................................... 65 Condensed Statements of Cash Flows................................................................. 66 Condensed Balance Sheets........................................................................... 67 Management's Discussion and Analysis of Results of Operations and Financial Condition.............. 69 Savannah Electric and Power Company Condensed Statements of Income..................................................................... 77 Condensed Statements of Cash Flows................................................................. 78 Condensed Balance Sheets........................................................................... 79 Management's Discussion and Analysis of Results of Operations and Financial Condition.............. 81 Southern Power Company Condensed Statements of Income..................................................................... 88 Condensed Statements of Cash Flows................................................................. 89 Condensed Balance Sheets........................................................................... 90 Condensed Statements of Comprehensive Income and Accumulated Other Comprehensive Income......................................................... 92 Management's Discussion and Analysis of Results of Operations and Financial Condition.............. 93 Notes to the Condensed Financial Statements........................................................... 101 Item 3. Quantitative and Qualitative Disclosures about Market Risk............................................ 22 Item 4. Controls and Procedures............................................................................... 22 </TABLE> 3
<TABLE> <CAPTION> INDEX TO QUARTERLY REPORT ON FORM 10-Q June 30, 2003 Page Number PART II - OTHER INFORMATION <S> <C> Item 1. Legal Proceedings......................................................................................... 116 Item 2. Changes in Securities and Use of Proceeds................................................................. Inapplicable Item 3. Defaults Upon Senior Securities........................................................................... Inapplicable Item 4. Submission of Matters to a Vote of Security Holders....................................................... 116 Item 5. Other Information......................................................................................... Inapplicable Item 6. Exhibits and Reports on Form 8-K.......................................................................... 119 Signatures ............................................................................................... 124 </TABLE> 4
<TABLE> <CAPTION> DEFINITIONS TERM MEANING <S> <C> Alabama Power............................... Alabama Power Company Clean Air Act .............................. Clean Air Act Amendments of 1990 Dynegy...................................... Dynegy, Inc. ECO Plan.................................... Environmental Compliance Overview Plan Energy Act.................................. Energy Policy Act of 1992 EPA......................................... U. S. Environmental Protection Agency FASB........................................ Financial Accounting Standards Board FERC........................................ Federal Energy Regulatory Commission Form 10-K................................... Combined Annual Report on Form 10-K of Southern Company, Alabama Power, Georgia Power, Gulf Power, Mississippi Power, Savannah Electric and Southern Power for the year ended December 31, 2002 Georgia Power............................... Georgia Power Company Gulf Power.................................. Gulf Power Company IRS......................................... Internal Revenue Service LIBOR....................................... London Interbank Offered Rate Mirant...................................... Mirant Corporation Mississippi Power........................... Mississippi Power Company Mobile Energy............................... Mobile Energy Services Company, L.L.C. and Mobile Energy Services Holdings, Inc. Moody's..................................... Moody's Investors Service, Inc. NRC......................................... Nuclear Regulatory Commission operating companies......................... Alabama Power, Georgia Power, Gulf Power, Mississippi Power and Savannah Electric PEP......................................... Performance Evaluation Plan PPA......................................... Purchase Power Agreement PSC......................................... Public Service Commission PUHCA....................................... Public Utility Holding Company Act of 1935, as amended RTO......................................... Regional Transmission Organization S&P......................................... Standard and Poor's, a division of The McGraw-Hill Companies Savannah Electric........................... Savannah Electric and Power Company SCS......................................... Southern Company Services, Inc. SEC......................................... Securities and Exchange Commission SeTrans..................................... A proposed regional transmission organization consisting of public and private companies, including Southern Company, located in eight southeastern states Southern Company............................ The Southern Company Southern Company GAS........................ Southern Company Gas LLC Southern Company system..................... Southern Company, the operating companies, Southern Power and other subsidiaries Southern LINC............................... Southern Communications Services, Inc. Southern Power.............................. Southern Power Company Super Southeast............................. Southern Company's traditional service territory, Alabama, Florida, Georgia and Mississippi plus the surrounding states of Kentucky, Louisiana, North Carolina, South Carolina, Tennessee and Virginia TVA......................................... Tennessee Valley Authority </TABLE> 5
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This Quarterly Report on Form 10-Q contains forward-looking and historical information. Forward-looking information includes, among other things, statements concerning capital requirements, expected capacity payments, the Atlanta one-hour ozone nonattainment classification and Southern Power's commercial paper balances and scheduled completion of new generating facilities. In some cases, forward-looking statements can be identified by terminology such as "may," "will," "could," "should," "expects," "plans," "anticipates," "believes," "estimates," "projects," "predicts," "potential" or "continue" or the negative of these terms or other comparable terminology. The registrants caution that there are various important factors that could cause actual results to differ materially from those indicated in the forward-looking statements; accordingly, there can be no assurance that such indicated results will be realized. These factors include the impact of recent and future federal and state regulatory change, including legislative and regulatory initiatives regarding deregulation and restructuring of the electric utility industry and also changes in environmental and other laws and regulations to which Southern Company and its subsidiaries are subject, as well as changes in application of existing laws and regulations; current and future litigation, including the pending EPA civil actions against certain Southern Company subsidiaries; the effects, extent and timing of the entry of additional competition in the markets in which Southern Company's subsidiaries operate; the impact of fluctuations in commodity prices, interest rates and customer demand; state and federal rate regulations; political, legal and economic conditions and developments in the United States; the performance of projects undertaken by the non-traditional business and the success of efforts to invest in and develop new opportunities; internal restructuring or other restructuring options that may be pursued; potential business strategies, including acquisitions or dispositions of assets or businesses, which cannot be assured to be completed or beneficial to Southern Company or its subsidiaries; the ability of counterparties of Southern Company and its subsidiaries to make payments as and when due; the effects of, and changes in, economic conditions in the areas in which Southern Company's subsidiaries operate, including the current soft economy; the direct or indirect effects on Southern Company's business resulting from the terrorist incidents on September 11, 2001, or any similar such incidents or responses to such incidents; financial market conditions and the results of financing efforts; the timing and acceptance of Southern Company's new product and service offerings; the ability of Southern Company and its subsidiaries to obtain additional generating capacity at competitive prices; weather and other natural phenomena; and other factors discussed elsewhere herein and in other reports (including the Form 10-K) filed from time to time with the SEC. 6
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES 7
<TABLE> <CAPTION> THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, --------------------- --------------------- 2003 2002 2003 2002 ------ ------ ------ ------ (in thousands) (in thousands) Operating Revenues: <S> <C> <C> <C> <C> Retail sales $2,175,706 $2,185,048 $4,149,550 $4,028,767 Sales for resale 338,071 293,475 677,232 526,154 Other electric revenues 227,921 84,447 319,798 149,258 Other revenues 117,525 67,802 265,545 140,181 ---------- ---------- ---------- ---------- Total operating revenues 2,859,223 2,630,772 5,412,125 4,844,360 ---------- ---------- ---------- ---------- Operating Expenses: Fuel 732,245 686,544 1,442,572 1,260,737 Purchased power 135,575 123,644 272,677 191,261 Other operations 570,193 522,704 1,064,059 967,956 Maintenance 238,954 247,019 468,664 475,809 Depreciation and amortization 258,297 254,271 503,285 499,906 Taxes other than income taxes 142,737 137,877 291,563 277,724 ---------- ---------- ---------- ---------- Total operating expenses 2,078,001 1,972,059 4,042,820 3,673,393 ---------- ---------- ---------- ---------- Operating Income 781,222 658,713 1,369,305 1,170,967 Other Income and (Expense): Allowance for equity funds used during construction 4,173 3,505 12,024 10,592 Interest income 20,589 4,141 25,087 8,944 Equity in losses of unconsolidated subsidiaries (26,276) (25,751) (53,443) (41,655) Leveraged lease income 15,698 14,753 33,413 29,454 Interest expense, net of amounts capitalized (134,188) (123,219) (257,949) (243,772) Distributions on capital and preferred securities of subsidiaries (39,951) (43,649) (79,537) (86,176) Preferred dividends of subsidiaries (5,472) (4,396) (10,222) (8,777) Other income (expense), net 1,855 2,176 (2,428) (17,880) ---------- ---------- ---------- ---------- Total other income and (expense) (163,572) (172,440) (333,055) (349,270) ---------- ---------- ---------- ---------- Earnings Before Income Taxes 617,650 486,273 1,036,250 821,697 Income taxes 185,763 154,881 306,931 266,019 ---------- ---------- ---------- ---------- Earnings Before Cumulative Effect of Accounting Change 431,887 331,392 729,319 555,678 Cumulative effect of accounting change -- less income taxes of $231 - - 367 - ---------- ---------- ---------- ---------- Consolidated Net Income $ 431,887 $ 331,392 $ 729,686 $ 555,678 ========== ========== ========== ========== Common Stock Data: Consolidated basic earnings per share $0.60 $0.47 $1.01 $0.79 Consolidated diluted earnings per share $0.59 $0.46 $1.00 $0.78 Average number of basic shares of common stock outstanding (in thousands) 724,627 706,181 721,785 703,596 Average number of diluted shares of common stock outstanding (in thousands) 730,286 712,165 727,139 709,137 Cash dividends paid per share of common stock $0.343 $0.335 $0.685 $0.670 The accompanying notes as they relate to Southern Company are an integral part of these condensed financial statements. </TABLE> 8
<TABLE> <CAPTION> THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Six Months Ended June 30, 2003 2002 ------ ----- (in thousands) Operating Activities: <S> <C> <C> Consolidated net income $729,686 $555,678 Adjustments to reconcile consolidated net income to net cash provided from operating activities -- Depreciation and amortization 585,381 551,663 Deferred income taxes and investment tax credits 199,776 22,729 Equity in losses of unconsolidated subsidiaries 53,443 41,655 Leveraged lease income (33,413) (29,454) Pension, postretirement, and other employee benefits (13,540) (29,632) Other, net 21,791 15,952 Changes in certain current assets and liabilities -- Receivables, net (30,305) (38,478) Fossil fuel stock (28,952) 20,027 Materials and supplies (13,401) 12,806 Other current assets (117,251) (70,190) Accounts payable (251,300) (78,416) Taxes accrued 160,320 92,725 Other current liabilities (110,334) (25,671) ---------- ---------- Net cash provided from operating activities 1,151,901 1,041,394 ---------- ---------- Investing Activities: Gross property additions (1,071,142) (1,409,984) Cost of removal net of salvage (35,941) (56,779) Change in construction payables (66,025) (65,109) Other (21,309) (49,871) ---------- ---------- Net cash used for investing activities (1,194,417) (1,581,743) ---------- ---------- Financing Activities: Increase (decrease) in notes payable, net 477,254 (247,899) Proceeds -- Senior notes 1,970,000 1,473,992 Other long-term debt 75,495 3,299 Capital and preferred securities - 475,000 Preferred stock 125,000 - Common stock 291,076 247,830 Redemptions -- First mortgage bonds (33,350) (7,444) Long-term senior notes (1,617,465) (381,030) Other long-term debt (526,605) (160,662) Capital and preferred securities (240,000) (35,000) Payment of common stock dividends (493,069) (470,426) Other (48,213) (36,618) ---------- ---------- Net cash provided from (used for) financing activities (19,877) 861,042 ----------- ---------- Net Change in Cash and Cash Equivalents (62,393) 320,693 Cash and Cash Equivalents at Beginning of Period 273,032 354,015 ---------- ---------- Cash and Cash Equivalents at End of Period $ 210,639 $ 674,708 ========== ========== Supplemental Cash Flow Information: Cash paid during the period for -- Interest (net of $31,176 and $28,108 capitalized for 2003 and 2002, respectively) $247,444 $213,496 Income taxes (net of refunds) ($1,680) $241,385 The accompanying notes as they relate to Southern Company are an integral part of these condensed financial statements. 9 </TABLE>
<TABLE> <CAPTION> THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Assets 2003 2002 - ------ ------------- --------------- (in thousands) Current Assets: <S> <C> <C> Cash and cash equivalents $ 210,639 $ 273,032 Receivables Customer accounts receivable 745,372 709,878 Unbilled revenues 294,924 277,105 Under recovered regulatory clause revenues 167,717 174,362 Other accounts and notes receivable 365,861 370,021 Accumulated provision for uncollectible accounts (35,941) (25,546) Fossil fuel stock, at average cost 327,906 298,955 Materials and supplies, at average cost 552,860 539,459 Other 328,957 299,743 ----------- ----------- Total current assets 2,958,295 2,917,009 ----------- ----------- Property, Plant, and Equipment: In service 39,617,006 37,485,853 Less accumulated depreciation 15,254,464 15,448,850 ----------- ----------- 24,362,542 22,037,003 Nuclear fuel, at amortized cost 196,637 222,676 Construction work in progress 1,403,638 2,382,287 ----------- ----------- Total property, plant, and equipment 25,962,817 24,641,966 ----------- ----------- Other Property and Investments: Nuclear decommissioning trusts, at fair value 725,987 639,167 Leveraged leases 806,908 790,767 Other 225,199 243,353 ----------- ----------- Total other property and investments 1,758,094 1,673,287 ----------- ----------- Deferred Charges and Other Assets: Deferred charges related to income taxes 889,272 897,777 Prepaid pension costs 841,318 786,115 Unamortized debt issuance expense 127,705 121,008 Unamortized premium on reacquired debt 329,189 313,057 Other 426,604 398,581 ----------- ----------- Total deferred charges and other assets 2,614,088 2,516,538 ----------- ----------- Total Assets $33,293,294 $31,748,800 =========== =========== The accompanying notes as they relate to Southern Company are an integral part of these condensed financial statements. 10 </TABLE>
<TABLE> <CAPTION> THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Liabilities and Stockholders' Equity 2003 2002 - ------------------------------------ ------------ ---------------- (in thousands) Current Liabilities: <S> <C> <C> Securities due within one year $ 698,846 $ 1,679,489 Notes payable 1,443,369 972,459 Accounts payable 657,820 985,660 Customer deposits 177,036 168,952 Taxes accrued -- Income taxes 202,149 62,571 Other 207,230 218,967 Interest accrued 174,085 158,196 Vacation pay accrued 128,463 130,015 Other 456,410 592,531 ------------ ----------- Total current liabilities 4,145,408 4,968,840 ------------ ----------- Long-term debt 9,525,874 8,692,962 ------------ ----------- Deferred Credits and Other Liabilities: Accumulated deferred income taxes 4,398,899 4,214,471 Deferred credits related to income taxes 431,602 449,816 Accumulated deferred investment tax credits 593,072 606,779 Employee benefits provisions 645,229 614,239 Asset retirement obligations 839,643 - Other 892,831 813,464 ------------ ----------- Total deferred credits and other liabilities 7,801,276 6,698,769 ------------ ----------- Company or subsidiary obligated mandatorily redeemable capital and preferred securities 2,180,000 2,380,000 ------------ ----------- Cumulative preferred stock of subsidiaries 423,126 298,126 ------------ ----------- Common Stockholders' Equity: Common stock, par value $5 per share -- Authorized -- 1 billion shares Issued -- June 30, 2003: 727,821,192 shares; -- December 31, 2002: 716,548,526 shares 3,639,106 3,582,743 Paid-in capital 572,734 337,670 Treasury, at cost -- June 30, 2003: 160,935 shares; -- December 31, 2002: 147,021 shares (3,409) (2,815) Retained earnings 5,110,814 4,874,375 Accumulated other comprehensive loss (101,635) (81,870) ------------ ----------- Total common stockholders' equity 9,217,610 8,710,103 ------------ ----------- Total Liabilities and Stockholders' Equity $ 33,293,294 $31,748,800 ============ =========== The accompanying notes as they relate to Southern Company are an integral part of these condensed financial statements. 11 </TABLE>
<TABLE> <CAPTION> THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, -------------------------- -------------------------- 2003 2002 2003 2002 -------- ------- -------------------------- (in thousands) (in thousands) <S> <C> <C> <C> <C> Consolidated Net Income $ 431,887 $ 331,392 $ 729,686 $ 555,678 Other comprehensive loss: Changes in fair value of marketable securities (16) 431 96 291 Changes in fair value of qualifying hedges, net of tax of $(9,458), $(22,990), ($14,962), $(18,945), respectively (12,351) (35,941) (20,692) (29,692) Less: Reclassification adjustment for amounts included in net income, net of tax of $29, $24, $195, $24, respectively 574 38 831 38 ------------ ---------- --------- --------- Total other comprehensive loss $ (11,793) $ (35,472) $ (19,765) $ (29,363) ------------ ---------- ---------- --------- CONSOLIDATED COMPREHENSIVE INCOME $ 420,094 $ 295,920 $ 709,921 $ 526,315 ============ ========== ========= ========= THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES CONDENSED CONSOLIDATED STATEMENTS OF ACCUMULATED OTHER COMPREHENSIVE LOSS (UNAUDITED) At June 30, At December 31, 2003 2002 ------------ --------------- (in thousands) Balance at beginning of period $ (81,870) $ 7,148 Change in current period (19,765) (89,018) ---------- --------- BALANCE AT END OF PERIOD $ (101,635) $ (81,870) ---------- --------- The accompanying notes as they relate to Southern Company are an integral part of these condensed financial statements. 12 </TABLE>
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION SECOND QUARTER 2003 vs. SECOND QUARTER 2002 AND YEAR-TO-DATE 2003 vs. YEAR-TO-DATE 2002 RESULTS OF OPERATIONS Southern Company is focusing on three main businesses in the Southeast: its traditional business, represented by its five operating companies providing regulated retail electric service in four states; a growing competitive generation business in the Super Southeast; and energy-related products and services for its retail customers. For additional information on these businesses, see Item 1 - BUSINESS - "Operating Companies," "Southern Power" and "Other Business" in the Form 10-K. Earnings Southern Company's second quarter and year-to-date 2003 earnings were $432 million ($0.60 per share) and $730 million ($1.01 per share), respectively, compared with $331 million ($0.47 per share) and $556 million ($0.79 per share) in the second quarter and year-to-date 2002. The second quarter and year-to-date 2003 earnings include a one-time after-tax gain of $88 million associated with the termination in May 2003 of all PPAs between Southern Company subsidiaries, Mississippi Power and Southern Power, and subsidiaries of Dynegy. Reference is made to Note (M) to the Condensed Financial Statements herein for additional information. Earnings in the second quarter 2003 increased despite mild weather. As a result of the mild weather, second quarter demand for electricity in the retail service territory declined; however, the availability of low-cost generation for the wholesale market resulted in increased sales to other utilities and strong performance by Southern Company's competitive generation business. Year-to-date 2003 earnings were also positively impacted by increased demand for electricity in the first quarter 2003 and the overall impact of regulatory rate proceedings in Alabama and Florida. <TABLE> <CAPTION> Significant income statement items appropriate for discussion include the following: Increase (Decrease) ------------------------------- ------------------------------- Second Quarter Year-To-Date ------------------------------- ------------------------------- (in thousands) % (in thousands) % <S> <C> <C> <C> <C> Retail sales..................................... $ (9,342) (0.4) $ 120,783 3.0 Sales for resale................................. 44,596 15.2 151,078 28.7 Other electric revenues.......................... 143,474 169.9 170,540 114.3 Other revenues................................... 49,723 73.3 125,364 89.4 Fuel expense..................................... 45,701 6.7 181,835 14.4 Purchased power expense.......................... 11,931 9.6 81,416 42.6 Other operations expense......................... 47,489 9.1 96,103 9.9 Equity in losses of unconsolidated subsidiaries.................................. 525 2.0 11,788 28.3 Interest income.................................. 16,448 N/M 16,143 180.5 Interest expense, net of amounts capitalized................................... 10,969 8.9 14,177 5.8 N/M Not meaningful </TABLE> 13
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Retail sales. Excluding fuel revenues, which generally do not affect net income, retail sales revenue decreased by $17.5 million, or 1.1%, in the second quarter 2003 and increased by $40 million, or 1.4%, year-to-date 2003 when compared to the same periods in 2002. Kilowatt-hour energy sales to residential, commercial and industrial customers were down 4.1%, 1.3% and 1.1%, respectively, for the second quarter 2003 primarily due to milder-than-normal temperatures and the sluggish economy in the service territory. Year-to-date 2003 earnings increased due to colder weather in the first quarter 2003 and customer growth when compared to the corresponding periods in the prior year. Sales for resale. The second quarter and year-to-date 2003 increases are primarily attributed to increases of 27% and 33.3%, respectively, in wholesale capacity and energy sales to these customers due to commercial operation of new plants placed into service in June 2002 and June 2003 when compared to the same periods in 2002. In addition, milder-than-normal weather in the retail service territory resulted in additional available capacity for the wholesale markets. Increased demand for energy as well as higher sales prices also contributed to the increases in both of these reporting periods in 2003. Other electric revenues. Other electric revenues were higher in the second quarter and year-to-date 2003 when compared to the same periods in 2002 primarily due to $144 million in revenues recorded upon the termination of Dynegy's PPAs. See Note (M) to the Condensed Financial Statements herein for further information. Other revenues. The second quarter and year-to-date 2003 increases in other revenues are primarily attributed to revenues from Southern Company GAS, which began operations in August 2002, as well as increases in revenues from Southern LINC and from a subsidiary that provides services related to alternative fuel products, when compared to the same periods in 2002. Fuel expense. In the second quarter and year-to-date 2003, fuel expense increased as a result of an increase in the average cost of fuel; commercial operation of Southern Power's new units in June 2002 and June 2003 and fuel expenses associated with Southern Company GAS. Increases in fuel expense at the operating companies are generally offset by fuel revenues and do not affect net income. Purchased power expense. This expense increased in the second quarter and year-to-date 2003 mainly due to the availability of power at prices lower than the cost of self-generation and the Southern Company system power pool when compared to the same periods in 2002. Increases in purchased power expenses at the operating companies are generally offset by fuel revenues and do not affect net income. Other operations expense. The increases in other operation expense for the second quarter and year-to-date 2003 are primarily attributed to higher administrative and general expenses related to commercial operation of Southern Power's new units in June 2002 and June 2003; costs incurred in conjunction with restructuring Mississippi Power's lease agreement for the combined cycle generating units at Plant Daniel; property insurance and employee benefits and operations at Southern Company GAS. Southern Company GAS began operations in August 2002. Reference is made to Note (R) to the Condensed Financial Statements herein for additional information on Mississippi Power's restructured lease agreement. 14
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Equity in losses of unconsolidated subsidiaries. Losses from unconsolidated subsidiaries remained stable in the second quarter 2003 but increased year-to-date 2003 when compared to the corresponding period in the prior year due to higher operating losses from Southern Company's investments in entities that produce synthetic fuel. These losses are offset by income tax credits generated by such entities. See Note (D) to the Condensed Financial Statements herein for further information on Southern Company's investments in these entities and IRS reviews of the related tax credits. Interest income. The second quarter and year-to-date 2003 increases when compared to the same periods in 2002 are primarily a result of a favorable tax settlement related to IRS audits for the years 1988 through 1999, excluding 1993 through 1995. Interest expense, net of amounts capitalized. The increases in this expense in the second quarter and year-to-date 2003 are mainly attributed to issuances, net of redemptions, of $353 million in senior notes by the operating companies since the corresponding periods in 2002. Future Earnings Potential The results of operations discussed above are not necessarily indicative of future earnings potential. The level of future earnings depends on numerous factors. The two major factors are the ability of the operating companies to maintain a stable regulatory environment and achieve energy sales growth while containing costs and the profitability of the competitive market-based wholesale generating business. For additional information relating to these issues, see Item 1 - BUSINESS - "Risk Factors" and Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential" of Southern Company in the Form 10-K. Reference is made to Note 11 to the financial statements of Southern Company in Item 8 and MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential" in Item 7 of the Form 10-K and to Note (B) to the Condensed Financial Statements herein for information relating to Mirant. On July 14, 2003, Mirant filed for voluntary reorganization under Chapter 11 of the Federal Bankruptcy Code. Southern Company has various contingent liabilities associated with Mirant, including guarantees, litigation and joint and several liabilities in connection with the consolidated federal income tax return, as well as related indemnifications under the separation agreement. The ultimate outcome of such contingent liabilities cannot now be determined. Furthermore, the impact of Mirant's bankruptcy filing on its related indemnity obligations, if any, cannot now be determined. On April 30, 2003, Mirant filed its Annual Report on Form 10-K for the year ended December 31, 2002, which included its restated financial statements for the years ended December 31, 2001 and 2000. The effect of these restatements on Southern Company's financial statements, if any, cannot be determined until Mirant's 2001 revised quarterly financial statements are filed. The impact of the bankruptcy filing on the timing of filing 2001 revised quarterly financial statements, if any, cannot now be determined. However, Southern Company's management does not currently anticipate that a reaudit of Southern Company's 2000 or 2001 financial statements will be necessary. Southern Company's business activities are subject to extensive governmental regulation related to public health and the environment. Litigation over environmental issues and claims of various types, including property damage, personal injury and citizen enforcement of environmental requirements, has increased generally throughout the United States. In particular, personal injury claims for damages caused by alleged exposure to hazardous materials have become more frequent. The ultimate outcome of such litigation currently 15
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION filed against Southern Company and its subsidiaries cannot be predicted at this time; however, after consultation with legal counsel, management does not anticipate that the liabilities, if any, arising from such proceedings would have a material adverse effect on Southern Company's financial position, results of operations or cash flows. Reference is made to Note (D) to the Condensed Financial Statements herein for information regarding Southern Company's investments in two entities that produce synthetic fuel and receive tax credits pursuant to Section 29 of the Internal Revenue Code. On June 30, 2003 the IRS issued an announcement that suspended the issuance of new private letter rulings upon its initiation of additional reviews of the significant chemical change requirement for such tax credits. The IRS has notified both of the entities in which Southern Company holds investments of related reviews. From the date of Southern Company's investments in these entities through June 30, 2003, Southern Company has recognized approximately $219 million of these synthetic fuel tax credits through income. The ultimate outcome of the IRS reviews cannot be determined at this time. Compliance costs related to the Clean Air Act and other environmental regulations could affect earnings if such costs cannot be recovered. For additional information about these issues, including the EPA litigation, see Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Environmental Matters" and Note 3 to the financial statements of Southern Company in Item 8 of the Form 10-K. Reference is made to Note (E) to the Condensed Financial Statements herein for information regarding a recent ruling by the U.S. Court of Appeals for the Eleventh Circuit. Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS - "Environmental Matters" in Item 7 of the Form 10-K. The Atlanta area is currently classified as a "serious" nonattainment area for the one-hour ozone standard under Title I of the Clean Air Act. All "serious" areas were required to attain the one-hour ozone standard by November 1999. The EPA provided an extension of the area's compliance deadline to 2004, but on June 16, 2003, the Eleventh Circuit Court of Appeals held the EPA's extension policy to be invalid and remanded the matter back to the EPA. In response, the EPA is expected to re-classify Atlanta as a "severe" nonattainment area with respect to the one-hour standard. If the Atlanta area fails to comply with the one-hour standard by November 2005, all major sources of nitrogen oxides and volatile organic compounds located in the nonattainment area, including Georgia Power's Plants McDonough and Yates, could be subject to payment of emissions fees currently estimated at $7,800-$8,000 per ton, of nitrogen oxides emitted above 80% of the baseline period. Based on average emissions at these units over the past three years, such fees could potentially reach $23 million annually. However, Georgia Power does not anticipate exceeding 80% of the baseline and, therefore, does not anticipate incurring any such fees. The final outcome of this matter will depend on the development and implementation of applicable regulations. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - FERC Matters" of Southern Company in the Form 10-K for information on the formation of an RTO as ordered by the FERC and the notice of proposed rulemaking regarding open access transmission service and standard electricity market design. In April 2003, the FERC issued a White Paper related to its proposed rulemaking regarding open access transmission service and standard electricity market design in an effort to respond to certain of the public comments received on the standard market design proposal. Reactions to the White Paper by Southeastern state regulators reflect significant continuing differences in opinion between the FERC and various state regulatory commissions over questions of jurisdiction and protection of retail customers. These significant differences between state and federal regulators create substantial uncertainty related to the ultimate approval of SeTrans because state commission approval of the transfer of operational control of the transmission assets of Southern Company and its subsidiaries is a prerequisite to the formation of SeTrans. Pending energy legislation may also impact these issues. Any impact of the other FERC proposals on Southern Company and its subsidiaries 16
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION will depend on the form in which final rules may be ultimately adopted; however, Southern Company's revenues, expenses, assets and liabilities could be adversely affected by changes in the transmission regulatory structure in its regional power market. Reference is made to Note (M) to the Condensed Financial Statements herein for information regarding a one-time gain of $88 million upon the amendment and termination of PPAs between Dynegy and Mississippi Power and Southern Power. In accordance with the amended PPA, Mississippi Power will recognize capacity revenues totaling approximately $8.8 million for the period from June through October 2003. Under the original terms of the PPAs, Mississippi Power and Southern Power would have recognized revenue of approximately $1.8 million and $5.9 million, respectively, for the remaining period of 2003 following the terminations. Additionally, Mississippi Power and Southern Power are evaluating options for their existing capacity. Southern Power has suspended construction of Plant Franklin Unit 3. The final outcome of these matters cannot now be determined. Reference is made to Notes (A) through (I), (L) through (N) and (R) to the Condensed Financial Statements herein for discussion of various contingencies and other matters which may affect future earnings potential. Accounting Policies Critical Policy Southern Company's significant accounting policies are described in Note 1 to the financial statements of Southern Company in Item 8 of the Form 10-K. Southern Company's critical accounting policy involves rate regulation. The operating companies are subject to the provisions of FASB Statement No. 71, "Accounting for the Effects of Certain Types of Regulation." In the event that a portion of a company's operations is no longer subject to these provisions, the company would be required to write off related regulatory assets and liabilities that are not specifically recoverable and determine if any other assets, including plant, have been impaired. New Accounting Standards Reference is made to Note (J) to the Condensed Financial Statements herein for information regarding the adoption of FASB Statement No. 143, "Accounting for Asset Retirement Obligations" effective January 1, 2003. Statement No. 143 establishes new accounting and reporting standards for legal obligations associated with the ultimate cost of retiring long-lived assets. The present value of the ultimate costs for an asset's future retirement must be recorded in the period in which the liability is incurred. The cost must be capitalized as part of the related long-lived asset and depreciated over the asset's useful life. Additionally, Statement No. 143 does not permit non-regulated companies to continue accruing future retirement costs for long-lived assets that they do not have a legal obligation to retire. Prior to January 2003, Southern Company accrued for the ultimate cost of retiring most long-lived assets over the life of the related asset through depreciation expense. In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," which requires classification of certain financial instruments within its scope, including shares that are mandatorily redeemable, as liabilities. Statement No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise on July 1, 2003 for calendar year companies. In accordance with Statement No. 150, Southern Company and the operating companies reclassified $2.2 billion of mandatorily redeemable preferred securities as liabilities effective July 1, 2003. The implementation of Statement No. 150 did not have a material effect on Southern Company's Statements of Income and Cash Flows. 17
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" requires the primary beneficiary of a variable interest entity to consolidate the related assets and liabilities. On July 1, 2003, Southern Company adopted Interpretation No. 46 with no financial statement impact following completion of restructuring Mississippi Power's lease arrangement for the combined cycle generating units at Plant Daniel. See Financial Condition - "Off-Balance Sheet Financing Arrangements" below and Note (R) to the Condensed Financial Statements herein for further information on the lease restructuring. FINANCIAL CONDITION Overview Major changes in Southern Company's financial condition during the first six months of 2003 included $1.1 billion used for gross property additions to utility plant. The funds for these additions and other capital requirements were primarily obtained from operating activities, issuances of senior notes and other long-term debt. See Southern Company's Condensed Consolidated Statements of Cash Flows herein for further details. Off-Balance Sheet Financing Arrangements In May 2001, Mississippi Power began the initial 10-year term of an operating lease agreement with Escatawpa Funding, Limited Partnership ("Escatawpa"), a special purpose entity, to use a combined-cycle generating facility located at Mississippi Power's Plant Daniel. The facility cost approximately $370 million. Reference is made to Note 9 to the financial statements of Southern Company in Item 8 of the Form 10-K for additional information. In June 2003, Escatawpa sold its ownership interests in the facility to Juniper Capital L.P. ("Juniper"). Simultaneously, Juniper entered into a restructured lease agreement with Mississippi Power. The terms of the lease with Juniper are substantially the same as the lease with Escatawpa. In accordance with Interpretation No. 46, Mississippi Power is not required to consolidate the leased assets and related liabilities. Furthermore, the restructured lease agreement is an operating lease under FASB Statement No. 13, "Accounting for Leases." Reference is made to Note (R) to the Condensed Financial Statements herein for additional information. Credit Rating Risk Southern Company and its subsidiaries do not have any credit agreements that would require material changes in payment schedules or terminations as a result of a credit rating downgrade. There are certain contracts that could require collateral -- but not accelerated payment -- in the event of a credit rating change to below investment grade. These contracts are primarily for physical electricity purchases and sales, fixed-price physical gas purchases and agreements covering interest rate swaps. At June 30, 2003, the maximum potential collateral requirements under the electricity purchase and sale contracts and financial instrument agreements were approximately $382 million. Generally, collateral may be provided for by a Southern Company guaranty, letter of credit or cash. At June 30, 2003, there were no material collateral requirements for the gas purchase contracts. 18
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Exposure to Market Risks Southern Company's market risk exposures relative to interest rate changes have not changed materially compared with the December 31, 2002 reporting period. In addition, Southern Company is not aware of any facts or circumstances that would significantly affect such exposures in the near term. Due to cost-based rate regulations, the operating companies have limited exposure to market volatility in interest rates, commodity fuel prices and prices of electricity. To mitigate residual risks relative to movements in electricity prices, the operating companies and Southern Power enter into fixed price contracts for the purchase and sale of electricity through the wholesale electricity market and, to a lesser extent, similar contracts for gas purchases. Also, the operating companies have each implemented fuel-hedging programs at the instruction of their respective PSCs. The fair value of derivative energy contracts at June 30, 2003 was as follows: Second Quarter 2003 Year-to-Date Changes Changes ---------------------------------- ---------------------------------------- Fair Value ---------------------------------- ---------------------------------------- (in thousands) Contracts beginning of period $47,228 $47,335 Contracts realized or settled (23,235) (37,955) New contracts at inception - - Changes in valuation techniques - - Current period changes 2,690 17,303 ---------------------------------- ------------------------ --------------- Contracts at June 30, 2003 $26,683 $26,683 ================================== ======================== =============== Source of June 30, 2003 Valuation Prices -------------------------------- ------------ --------------------------- Total Maturity ---------------------------- Fair Value Year 1 1-3 Years -------------------------------- -------------------------------------- (in thousands) Actively quoted $26,683 $32,620 $(5,937) External sources - - - Models and other methods - - - -------------------------------- ------------ -------------- ------------- Contracts at June 30, 2003 $26,683 $32,620 $(5,937) ================================ ============ ============== ============= Unrealized gains and losses from mark to market adjustments on contracts related to the PSC-approved fuel hedging programs are recorded as regulatory assets and liabilities. Realized gains and losses from these programs are included in fuel expense and are recovered through the operating companies' fuel cost recovery clauses. In addition, unrealized gains and losses on electric and gas contracts used to hedge anticipated purchases and sales are deferred in Other Comprehensive Income. Gains and losses on contracts that do not represent hedges are recognized in the Statements of Income as incurred. At June 30, 2003, the fair value of derivative energy contracts reflected in the financial statements was as follows: 19
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Amounts --------------------------------------- ------------------------- (in thousands) Regulatory liabilities, net $24,110 Other comprehensive income 862 Net income 1,711 --------------------------------------- ------------------------- Total fair value $26,683 ======================================= ========================= For the three months and six months ended June 30, 2003, approximately $1 million and $0.5 million, respectively, of gains were recognized in income, compared to $3.7 million and $(6.1) million, respectively, of gains (losses) recognized in income during the three months and six months ended June 30, 2002. Southern Company is exposed to market price risk in the event of nonperformance by the parties to the derivative energy contracts. Southern Company's policy is to enter into agreements with counterparties that have investment grade credit ratings by Moody's and S&P or that provide adequate collateral; therefore, Southern Company does not anticipate nonperformance by the counterparties. For additional information, reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Market Price Risk" of Southern Company in the Form 10-K, Note 1 to the financial statements of Southern Company in Item 8 of the Form 10-K and Note (L) to the Condensed Financial Statements herein. Financing Activities During the first half of 2003, Southern Company subsidiaries issued $1,970 million of senior notes, $125 million of preferred stock and $75 million of other long-term debt. The issuances were used to refund long-term senior notes and other long-term debt. The remainder was used to reduce short-term debt and fund ongoing construction programs. Reference is made to Southern Company's Condensed Consolidated Statements of Cash Flows herein for further details on financing activities during the first half of 2003. In July 2003, Gulf Power issued $60 million of Series G 4.35% Senior Notes due July 15, 2013 and $60 million of Series H 5.25% Senior Notes due July 15, 2033. The proceeds of the Series G Senior Notes were used to pay at maturity the $60 million outstanding principal amount of Series C 4.69% Senior Notes due August 1, 2003. The proceeds of the Series H Senior Notes will be used to redeem in August 2003 the $46.7 million outstanding principal amount of the Series A 6.70% Senior Insured Quarterly Notes due June 30, 2038. The remainder will be used to repay a portion of Gulf Power's short-term indebtedness. In July 2003, Southern Power issued $575 million of 4.875% Senior Notes, Series C due July 15, 2015. The proceeds from the sale were used to repay a substantial portion of existing short-term indebtedness; to settle interest rate hedges associated with this financing; and for general corporate purposes. In July 2003, Alabama Power entered into swaps to hedge interest payments associated with an anticipated debt issuance planned in December 2003. The swaps are for a notional amount of $250 million at a fixed interest rate of 2.35% and mature in December 2006. 20
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION In July 2003, Georgia Power entered swaps to hedge interest payments associated with variable rate pollution control bonds. The swaps are for a notional amount of $873.3 million at an average fixed interest rate of 1.388% and mature in December 2004. Also in July 2003, Georgia Power entered a swap to hedge interest payments associated with a variable rate note with a coupon of LIBOR plus 10 basis points. The swap is for a notional amount of $50 million at a fixed interest rate of 1.5625% and matures in January 2005. Further in July 2003, Georgia Power entered a U.S. Treasury lock to hedge interest payments associated with a 10-year debt issuance planned in August 2003. The swap is for a notional amount of $100 million at a fixed interest rate of 4.465%. In July 2003, Savannah Electric entered a swap to hedge interest payments associated with an anticipated debt issuance planned in December 2003. The swap is for a notional amount of $25 million at a fixed interest rate of 5.025% and matures in December 2013. The market price of Southern Company's common stock at June 30, 2003 was $31.16 per share and the book value was $12.67 per share, representing a market-to-book ratio of 246%, compared to $28.39, $12.16 and 233%, respectively, at the end of 2002. The dividend for the second quarter 2003 was $0.343 per share compared to $0.335 per share in the second quarter 2002. In July 2003, Southern Company increased the dividend to $0.35 per share for the third quarter 2003. Capital Requirements Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Capital Requirements for Construction," "Other Capital Requirements" and "Environmental Matters" of Southern Company in the Form 10-K for a description of the Southern Company system's capital requirements for its construction program, sinking fund requirements, maturing debt and environmental compliance efforts. Approximately $699 million will be required by June 30, 2004 for redemptions and maturities of long-term debt. Also, Southern Company and its subsidiaries plan to continue, to the extent possible, a program to retire higher-cost debt and replace these securities with lower-cost capital. Sources of Capital In addition to the financing activities previously described, Southern Company may require additional equity capital over the next several years. The amounts and timing of additional equity capital to be raised will be contingent on Southern Company's investment opportunities. The operating companies and Southern Power plan to obtain the funds required for construction and other purposes from sources similar to those used in the past, which were primarily internal sources and the issuances of new debt and preferred equity securities, term loans and short-term borrowings. However, the amount, type and timing of any financings -- if needed -- will depend upon market conditions and regulatory approval. See Item 1 - BUSINESS - "Financing Programs" of Southern Company in the Form 10-K for additional information. Southern Company's current liabilities exceed current assets because of the continued use of short-term debt as a funding source to meet cash needs as well as scheduled maturities of long-term debt. 21
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION To meet short-term cash needs and contingencies, the Southern Company system had at June 30, 2003 approximately $211 million of cash and cash equivalents and approximately $3.2 billion of unused credit arrangements with banks, of which $76 million expire in 2003, $2.5 billion expire in 2004 and $665 million expire in 2005 and beyond. Of the facilities maturing in 2003 and 2004, $2.2 billion contain provisions allowing two-year term loans executable at the expiration date. These unused credit arrangements also provide liquidity support to variable rate pollution control bonds and commercial paper programs. Due to a reduction of commercial paper and variable rate pollution bonds requiring liquidity support, the Southern Company system reduced its credit arrangements from $4.3 billion at March 2003 to $3.2 billion by the end of June 2003. The operating companies may also meet short-term cash needs through a Southern Company subsidiary organized to issue and sell commercial paper and extendible commercial notes at the request and for the benefit of each of the operating companies. At June 30, 2003, the Southern Company system had extendible commercial notes outstanding of zero, short-term notes payable outstanding of $32 million and commercial paper outstanding of $1.4 billion. Management believes that the need for working capital can be adequately met by utilizing lines of credit without maintaining large cash balances. PART I Item 3. Quantitative And Qualitative Disclosures About Market Risk. Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS - "Market Price Risk" herein for each registrant and Note 1 to the financial statements of each registrant in Item 8 of the Form 10-K. Reference is also made to Note (L) to the Condensed Financial Statements herein for information relating to derivative instruments. Item 4. Controls and Procedures. (a) Evaluation of disclosure controls and procedures. As of the end of the period covered by this quarterly report, Southern Company, the operating companies and Southern Power conducted separate evaluations under the supervision and with the participation of each company's management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the disclosure controls and procedures (as defined in Sections 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). Based upon those evaluations, the Chief Executive Officer and the Chief Financial Officer, in each case, concluded that the disclosure controls and procedures are effective in alerting them in a timely manner to material information relating to each company (including its consolidated subsidiaries) required to be included in periodic filings with the SEC. (b) Changes in internal controls. There have been no significant changes in Southern Company's, the operating companies' or Southern Power's internal controls or in other factors that could significantly affect these internal controls subsequent to the date each company carried out its evaluation. 22
ALABAMA POWER COMPANY 23
<TABLE> <CAPTION> ALABAMA POWER COMPANY CONDENSED STATEMENTS OF INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, 2003 2002 2003 2002 ------ ------ ------ ------ (in thousands) (in thousands) Operating Revenues: <S> <C> <C> <C> <C> Retail sales $748,906 $736,174 $1,419,735 $1,368,071 Sales for resale -- Non-affiliates 130,621 119,540 254,343 214,163 Affiliates 54,741 42,497 116,728 97,174 Other revenues 30,288 26,132 68,311 47,184 --------- -------- ---------- --------- Total operating revenues 964,556 924,343 1,859,117 1,726,592 --------- -------- ---------- --------- Operating Expenses: Operation -- Fuel 234,988 233,536 474,732 443,833 Purchased power -- Non-affiliates 41,886 20,413 75,156 36,184 Affiliates 58,416 41,913 99,912 74,643 Other 159,642 141,510 294,185 261,572 Maintenance 81,646 77,701 156,221 154,515 Depreciation and amortization 104,505 98,934 204,716 197,209 Taxes other than income taxes 56,482 54,103 116,567 111,603 --------- --------- ---------- --------- Total operating expenses 737,565 668,110 1,421,489 1,279,559 --------- --------- ---------- --------- Operating Income 226,991 256,233 437,628 447,033 Other Income and (Expense): Allowance for equity funds used during construction 3,062 2,869 7,799 5,876 Interest income 4,270 3,190 7,546 6,352 Interest expense, net of amounts capitalized (58,941) (58,568) (113,514) (114,217) Distributions on preferred securities of subsidiary (3,939) (5,995) (7,380) (12,014) Other income (expense), net (4,315) (4,461) (10,034) (16,026) --------- --------- --------- -------- Total other income and (expense) (59,863) (62,965) (115,583) (130,029) --------- ------- --------- -------- Earnings Before Income Taxes 167,128 193,268 322,045 317,004 Income taxes 55,758 73,884 114,831 121,424 --------- ---------- ---------- --------- Net Income 111,370 119,384 207,214 195,580 Dividends on Preferred Stock 4,747 3,671 8,772 7,327 ---------- ---------- ---------- --------- Net Income After Dividends on Preferred Stock $ 106,623 $ 115,713 $ 198,442 $ 188,253 ========== ========== ========== ========== The accompanying notes as they relate to Alabama Power are an integral part of these condensed financial statements. </TABLE> 24
<TABLE> <CAPTION> ALABAMA POWER COMPANY CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Six Months Ended June 30, 2003 2002 ------ -------- (in thousands) Operating Activities: <S> <C> <C> Net income $ 207,214 $ 195,580 Adjustments to reconcile net income to net cash provided from operating activities -- Depreciation and amortization 236,633 232,518 Deferred income taxes and investment tax credits, net 32,712 (19,574) Pension, postretirement, and other employee benefits (18,924) (18,521) Other, net 6,116 29,684 Changes in certain current assets and liabilities -- Receivables, net (24,466) 6,172 Fossil fuel stock (7,857) 13,166 Materials and supplies (2,899) 4,950 Other current assets (50,549) (61,860) Accounts payable (65,279) (60,648) Taxes accrued 60,963 57,455 Other current liabilities (13,840) 16,920 ----------- --------- Net cash provided from operating activities 359,824 395,842 ----------- --------- Investing Activities: Gross property additions (359,735) (345,823) Cost of removal net of salvage (17,752) (15,287) Other 16,488 (8,902) ----------- --------- Net cash used for investing activities (360,999) (370,012) ----------- --------- Financing Activities: Increase in notes payable, net 33,940 134,651 Proceeds -- Senior notes 1,065,000 350,000 Preferred stock 125,000 - Common stock 25,000 - Capital contributions from parent company 8,162 2,396 Redemptions -- First mortgage bonds - (4,498) Senior notes (1,000,800) (840) Other long-term debt (472) (434) Payment of preferred stock dividends (8,659) (7,219) Payment of common stock dividends (215,100) (215,500) Other (24,524) 4,959 ----------- --------- Net cash provided from financing activities 7,547 263,515 ----------- --------- Net Change in Cash and Cash Equivalents 6,372 289,345 Cash and Cash Equivalents at Beginning of Period 22,685 35,756 ----------- --------- Cash and Cash Equivalents at End of Period $ 29,057 $ 325,101 =========== ========= Supplemental Cash Flow Information: Cash paid during the period for -- Interest (net of $3,953 and $3,531 capitalized for 2003 and 2002, respectively) $85,222 $86,015 Income taxes (net of refunds) $48,385 $121,615 The accompanying notes as they relate to Alabama Power are an integral part of these condensed financial statements. </TABLE> 25
<TABLE> <CAPTION> ALABAMA POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Assets 2003 2002 - ---- ------------- ----------------- (in thousands) Current Assets: <S> <C> <C> Cash and cash equivalents $ 29,057 $ 22,685 Receivables -- Customer accounts receivable 266,581 240,052 Unbilled revenues 95,757 89,336 Other accounts and notes receivable 44,107 47,535 Affiliated companies 69,043 74,099 Accumulated provision for uncollectible accounts (4,142) (4,827) Fossil fuel stock, at average cost 81,600 73,742 Materials and supplies, at average cost 190,494 187,596 Other 131,245 110,035 ------------ ----------- Total current assets 903,742 840,253 ------------- ----------- Property, Plant, and Equipment: In service 14,057,392 13,506,170 Less accumulated provision for depreciation 5,390,833 5,543,416 ------------ ----------- 8,666,559 7,962,754 Nuclear fuel, at amortized cost 84,130 103,088 Construction work in progress 335,200 478,652 ------------ ----------- Total property, plant, and equipment 9,085,889 8,544,494 ------------ ----------- Other Property and Investments: Equity investments in subsidiaries 47,378 45,553 Nuclear decommissioning trusts, at fair value 338,386 292,297 Other 16,717 16,477 ------------ ----------- Total other property and investments 402,481 354,327 ------------ ----------- Deferred Charges and Other Assets: Deferred charges related to income taxes 328,308 327,276 Prepaid pension costs 415,768 389,793 Unamortized debt issuance expense 7,946 4,361 Unamortized premium on reacquired debt 115,137 103,819 Department of Energy assessments 17,144 17,144 Other 111,465 104,539 ------------- ------------ Total deferred charges and other assets 995,768 946,932 ------------- ------------ Total Assets $ 11,387,880 $ 10,686,006 ============= ============ The accompanying notes as they relate to Alabama Power are an integral part of these condensed financial statements. </TABLE> 26
<TABLE> <CAPTION> ALABAMA POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Liabilities and Stockholder's Equity 2003 2002 - ------------------------------------ ------------- ---------------- (in thousands) Current Liabilities: <S> <C> <C> Securities due within one year $ 507,177 $ 1,117,945 Notes payable 70,931 36,991 Accounts payable -- Affiliated 106,946 109,790 Other 86,921 150,195 Customer deposits 46,202 44,410 Taxes accrued -- Income taxes 80,948 80,438 Other 59,698 20,561 Interest accrued 49,915 36,344 Vacation pay accrued 33,901 33,901 Other 80,729 114,870 ------------ ------------- Total current liabilities 1,123,368 1,745,445 ------------ ------------- Long-term debt 3,536,617 2,851,562 ------------ ------------- Deferred Credits and Other Liabilities: Accumulated deferred income taxes 1,502,600 1,436,559 Deferred credits related to income taxes 166,446 177,205 Accumulated deferred investment tax credits 221,789 227,270 Employee benefits provisions 148,200 141,149 Deferred capacity revenues 29,165 33,924 Asset retirement obligations 346,809 - Asset retirement obligation regulatory liability 96,369 - Other 150,356 147,640 ------------ ------------- Total deferred credits and other liabilities 2,661,734 2,163,747 ------------ ------------- Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding company junior subordinated notes 300,000 300,000 ------------ ------------- Cumulative preferred stock 372,512 247,512 ------------ ------------- Common stockholder's equity: Common stock, par value $40 per share -- Authorized - 15,000,000 shares Outstanding - 6,625,000 shares Par value 265,000 240,000 Paid-in capital 1,908,626 1,900,464 Premium on preferred stock 99 99 Retained earnings 1,232,291 1,250,594 Accumulated other comprehensive loss (12,367) (13,417) ------------ ------------- Total common stockholder's equity 3,393,649 3,377,740 ------------ ------------- Total Liabilities and Stockholder's Equity $ 11,387,880 $ 10,686,006 ============ ============= The accompanying notes as they relate to Alabama Power are an integral part of these condensed financial statements. </TABLE> 27
<TABLE> <CAPTION> ALABAMA POWER COMPANY CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, ---------------------------------- --------------------------- 2003 2002 2003 2002 ---------------- ----------- -------- -------- (in thousands) (in thousands) <S> <C> <C> <C> <C> Net Income After Dividends on Preferred Stock $ 106,623 $ 115,713 $ 198,442 $ 188,253 Other comprehensive income (loss): Changes in fair value of qualifying hedges, net of tax of $265, $(312), $221, $(312), respectively 1,122 (514) 1,050 (514) ---------- ---------- ---------- ---------- COMPREHENSIVE INCOME $ 107,745 $ 115,199 $ 199,492 $ 187,739 ========== =========== =========== =========== ALABAMA POWER COMPANY CONDENSED STATEMENTS OF ACCUMULATED OTHER COMPREHENSIVE LOSS (UNAUDITED) At June 30, At December 31, 2003 2002 ------------ ----------------- (in thousands) Balance at beginning of period $ (13,417) $ - Change in current period 1,050 (13,417) ----------- ------------- BALANCE AT END OF PERIOD $ (12,367) $ (13,417) ============ ============= The accompanying notes as they relate to Alabama Power are an integral part of these condensed financial statements. </TABLE> 28
ALABAMA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION SECOND QUARTER 2003 vs. SECOND QUARTER 2002 AND YEAR-TO-DATE 2003 vs. YEAR-TO-DATE 2002 RESULTS OF OPERATIONS Earnings Alabama Power's net income after dividends on preferred stock for the second quarter and year-to-date 2003 was $106.6 million and $198.4 million, respectively, compared to $115.7 million and $188.3 million, respectively, for the corresponding periods of 2002. Earnings decreased $9.1 million, or 7.9%, in the second quarter of 2003 primarily due to higher operating expenses that were partially offset by the favorable settlement of income tax audits. Earnings year-to-date 2003 increased by $10.1 million, or 5.4%, principally due to the effect of increased market based prices in sales for resale - non-affiliates and the favorable effect of the settlement of income tax audits. Significant income statement items appropriate for discussion include the following: <TABLE> <CAPTION> Increase (Decrease) --------------------------------------------------------------- Second Quarter Year-To-Date ------------------------------- ------------------------------- (in thousands) % (in thousands) % <S> <C> <C> <C> <C> Retail sales..................................... $ 12,732 1.7 $ 51,664 3.8 Sales for resale - non-affiliates................ 11,081 9.3 40,180 18.8 Sale for resale - affiliates..................... 12,244 28.8 19,554 20.1 Other revenues................................... 4,156 15.9 21,127 44.8 Fuel expense..................................... 1,452 0.6 30,899 7.0 Purchased power - non-affiliates................. 21,473 105.2 38,972 107.7 Purchased power - affiliates..................... 16,503 39.4 25,269 33.9 Other operation expense.......................... 18,132 12.8 32,613 12.5 Depreciation and amortization.................... 5,571 5.6 7,507 3.8 Distributions on preferred securities of subsidiary.................................. (2,056) (34.3) (4,634) (38.6) Income taxes..................................... (18,126) (24.5) (6,593) (5.4) </TABLE> Retail sales. Excluding energy cost recovery revenues and revenues from Rate CNP, Certificated New Plant, associated with PPAs certificated by the Alabama PSC which generally do not affect net income, retail sales revenues decreased by $7.6 million, or 1.4%, for the second quarter 2003, but increased $12.9 million, or 1.2%, year-to-date 2003, when compared to the same periods in the prior year. Reference is made to Note (F) to the Condensed Financial Statements herein for additional information. During the second quarter 2003, retail energy sales were impacted by milder-than-normal temperatures and as a result decreased slightly when compared to the corresponding period in 2002. The year-to-date 2003 increase can primarily be attributed to favorable weather conditions and slight sales growth in the first three months of this year, as well as a 2 percent increase in retail base rates that went into effect in April 2002 as a result of Rate RSE, Rate Stabilization and Equalization. 29
ALABAMA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Sales for resale - non-affiliates. During the second quarter 2003, the revenues associated with sales for resale to non-affiliates increased due to an 11.8% increase in market based prices even though overall sales of energy for the quarter decreased 2.4% when compared to the corresponding period in 2002. The year-to-date increase in sales for resale to non-affiliates in 2003 is due to a 7.6% increase in energy sold and a 10.3% increase in price when compared to the corresponding period in 2002. Sales of energy will vary depending on demand, market based prices and the availability of Southern Company system generation. Sales for resale - affiliates and Purchased power - affiliates. Revenues from sales for resale to affiliated companies within the Southern Company system, as well as purchases of energy, will vary depending on demand and the availability and cost of generating resources at each company. These transactions did not have a significant impact on earnings since the related energy is sold at marginal cost, and energy purchases are generally offset by energy revenues through Alabama Power's energy cost recovery clause. Other revenues. During the second quarter 2003, other revenues increased primarily due to a $3.8 million increase in revenues from Alabama PSC-approved fees charged to customers for connection, reconnection and collection when compared to the same period in 2002. The year-to-date 2003 increase is primarily due to an $11.7 million increase in revenues from cogeneration steam facilities due to higher gas prices, a $7.3 million increase in revenues from fees charged to customers for connection, reconnection and collection and a $5.7 million increase in revenues from transmission for others when compared to the same period in 2002. Since cogeneration steam revenues are generally offset by fuel expenses, these revenues do not have a significant impact on earnings. Fuel expense. During the second quarter 2003, fuel expense remained flat because generation decreased 8.5% compared to the corresponding period in 2002 while the price of fuel increased 9.9%. However, year-to-date 2003 fuel expense increased when compared to the corresponding period in 2002 mainly due to a 10.3% increase in fuel prices while generation remained relatively flat. Since energy expenses are generally offset by energy revenues, these expenses did not have a significant impact on earnings. Purchased power - non-affiliates. In the second quarter and year-to-date 2003, purchased power from non-affiliates increased when compared to the same periods in the prior year. The second quarter and year-to-date 2003 increases are primarily attributed to a 103.9% and 119.1% increase in price, respectively. These expenses do not have a significant impact on earnings since energy expenses are generally offset by energy revenues through Alabama Power's energy cost recovery clause. Other operation expense. The increase in other operation expense for the second quarter 2003 is mainly a result of a $10.9 million increase in administrative and general expenses. The increase in administrative and general expenses primarily relates to a $5.5 million increase in property insurance and a $3.4 million increase in employee benefits. The year-to-date 2003 increase in other operation expense when compared to the same period in 2002 is primarily due to a $20.3 million increase in administrative and general expenses, a $3.4 million increase in nuclear expense and a $2.9 million increase in steam expense. The increase in administrative and general expenses mainly relates to a $7.7 million increase in property insurance, a $7.3 million increase in employee benefits and a $2.2 million increase in injuries and damages expense. Depreciation and amortization. The increases for the second quarter and year-to-date 2003 are attributed to an increase in utility plant-in-service when compared to the same periods in 2002. 30
ALABAMA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Distributions on preferred securities of subsidiary. Refinancing of higher distribution rate trust preferred securities in the fourth quarter 2002 led to decreases in this item in the second quarter and year-to-date 2003. Income taxes. The second quarter and year-to-date 2003 decreases in income tax expenses are primarily attributed to the tax settlement related to tax audits covering the years 1988 through 1999, excluding the years 1993 through 1995, which increased net income by $4.7 million. Future Earnings Potential The results of operations discussed above are not necessarily indicative of future earnings potential. The level of future earnings depends on numerous factors including Alabama Power's ability to achieve energy sales growth while containing costs and maintaining a stable regulatory environment. Growth in energy sales is subject to a number of factors. These factors include weather, competition, new short- and long-term contracts with neighboring utilities, energy conservation practiced by customers, the elasticity of demand and the rate of economic growth in Alabama Power's service area. For additional information relating to these issues, see Item 1 - BUSINESS - "Risk Factors" and Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential" of Alabama Power in the Form 10-K. Alabama Power's business activities are subject to extensive governmental regulation related to public health and the environment. Litigation over environmental issues and claims of various types, including property damage, personal injury and citizen enforcement of environmental requirements, has increased generally throughout the United States. In particular, personal injury claims for damages caused by alleged exposure to hazardous materials have become more frequent. Compliance costs related to the Clean Air Act and other environmental regulations could affect earnings if such costs cannot be recovered. For additional information about these issues, including the EPA litigation, see Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Environmental Matters" and Note 3 to the financial statements of Alabama Power in Item 8 of the Form 10-K. Reference is made to Note (E) to the Condensed Financial Statements herein for information regarding a recent ruling by the U.S. Court of Appeals for the Eleventh Circuit. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "FERC Matters" of Alabama Power in the Form 10-K for information on the formation of an RTO as ordered by the FERC and the notice of proposed rulemaking regarding open access transmission service and standard electricity market design. In April 2003, the FERC issued a White Paper related to its proposed rulemaking regarding open access transmission service and standard electricity market design in an effort to respond to certain of the public comments received on the standard market design proposal. Reactions to the White Paper by Southeastern state regulators reflect significant continuing differences in opinion between the FERC and various state regulatory commissions over questions of jurisdiction and protection of retail customers. These significant differences between state and federal regulators create substantial uncertainty related to the ultimate approval of SeTrans because state commission approval of the transfer of operational control of the transmission assets of Southern Company and its subsidiaries is a prerequisite to the formation of SeTrans. Pending energy legislation may also impact these issues. Any impact of the other FERC proposals on Southern Company and its subsidiaries will depend on the form in which final rules may be ultimately adopted; however, Alabama Power's revenues, expenses, assets and liabilities could be adversely affected by changes in the transmission regulatory structure in its regional power market. 31
ALABAMA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION In June 2003, during a special session of the State of Alabama Legislature, a tax reform package was passed subject to approval by the voters of Alabama on September 9, 2003. If the tax reform package passes, the impact to Alabama Power's overall tax liability should not be significant. Reference is also made to Notes (A), (E), (F), (H), (L) and (N) to the Condensed Financial Statements herein for discussion of various contingencies and other matters which may affect future earnings potential. Accounting Policies Critical Policy Alabama Power's significant accounting policies are described in Note 1 to the financial statements of Alabama Power in Item 8 of the Form 10-K. Alabama Power's critical accounting policy involves rate regulation. Alabama Power is subject to the provisions of FASB Statement No. 71, "Accounting for the Effects of Certain Types of Regulation." In the event that a portion of Alabama Power's operations is no longer subject to these provisions, Alabama Power would be required to write off related regulatory assets and liabilities that are not specifically recoverable and determine if any other assets, including plant, have been impaired. New Accounting Standards Reference is made to Note (J) to the Condensed Financial Statements herein for information regarding the adoption of FASB Statement No. 143, "Accounting for Asset Retirement Obligations" effective January 1, 2003. Statement No. 143 establishes new accounting and reporting standards for legal obligations associated with the ultimate cost of retiring long-lived assets. The present value of the ultimate costs for an asset's future retirement must be recorded in the period in which the liability is incurred. The cost must be capitalized as part of the related long-lived asset and depreciated over the asset's useful life. Additionally, Statement No. 143 does not permit non-regulated companies to continue accruing future retirement costs for long-lived assets that they do not have a legal obligation to retire. Prior to January 2003, Alabama Power accrued for the ultimate cost of retiring most long-lived assets over the life of the related asset through depreciation expense. In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," which requires classification of certain financial instruments within its scope, including shares that are mandatorily redeemable, as liabilities. Statement No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise on July 1, 2003 for calendar year companies. In accordance with Statement No. 150, Alabama Power reclassified $300 million of mandatorily redeemable preferred securities as liabilities effective July 1, 2003. The implementation of Statement No. 150 did not have a material effect on Alabama Power's Statements of Income and Cash Flows. 32
ALABAMA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION FINANCIAL CONDITION Overview Major changes in Alabama Power's financial condition during the first six months of 2003 included the addition of approximately $360 million to utility plant. The funds for these additions and other capital requirements were derived primarily from operating activities. See Alabama Power's Condensed Statements of Cash Flows herein for further details. Credit Rating Risk Alabama Power does not have any credit agreements that would require material changes in payment schedules or terminations as a result of a credit rating downgrade. Exposure to Market Risks Alabama Power's market risk exposures relative to interest rate changes have not changed materially compared with the December 31, 2002 reporting period. In addition, Alabama Power is not aware of any facts or circumstances that would significantly affect such exposures in the near term. Due to cost-based rate regulations, Alabama Power has limited exposure to market volatility in interest rates, commodity fuel prices and prices of electricity. To mitigate residual risks relative to movements in electricity prices, Alabama Power enters into fixed price contracts for the purchase and sale of electricity through the wholesale electricity market and, to a lesser extent, similar contracts for gas purchases. Alabama Power has also implemented a retail fuel hedging program at the instruction of the Alabama PSC. The fair value of derivative energy contracts at June 30, 2003 was as follows: Second Quarter 2003 Year-to-Date Changes Changes ------------------------------------------------------------------------- Fair Value -------------------------------- ---------------------------------------- (in thousands) Contracts beginning of period $24,276 $21,402 Contracts realized or settled (11,624) (18,780) New contracts at inception - - Changes in valuation techniques - - Current period changes 3,035 13,065 -------------------------------- ------------------------ --------------- Contracts at June 30, 2003 $15,687 $15,687 ========================================================= =============== 33
ALABAMA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Source of June 30, 2003 Valuation Prices ------------------------------- ------------ ---------------------------- Total Maturity ---------------------------- Fair Value Year 1 1-3 Years ------------------------------- ----------------------------------------- (in thousands) Actively quoted $15,687 $20,487 $(4,800) External sources - - - Models and other methods - - - ------------------------------- ------------ -------------- ------------- Contracts at June 30, 2003 $15,687 $20,487 $(4,800) =============================== ============ ============== ============= Unrealized gains and losses from mark to market adjustments on contracts related to the retail fuel hedging programs are recorded as regulatory assets and liabilities. Realized gains and losses from these programs are included in fuel expense and are recovered through Alabama Power's fuel cost recovery clause. Gains and losses on contracts that do not represent hedges are recognized in the Statements of Income as incurred. At June 30, 2003, the fair value of derivative energy contracts reflected in the financial statements was as follows: Amounts --------------------------------------- -------------------- (in thousands) Regulatory liabilities, net $15,892 Other comprehensive income - Net loss (205) --------------------------------------- --------------------- Total fair value $15,687 ======================================= ===================== For the three months ended June 30, 2003 and 2002, approximately $(0.1) million and $1 million, respectively, of (losses) gains were recognized in income. For the six months ended June 30, 2003 and 2002, approximately $0.3 million and $2.4 million, respectively, of losses were recognized in income. For additional information, reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Exposure to Market Risk" of Alabama Power in the Form 10-K and Note 1 to the financial statements of Alabama Power in Item 8 of the Form 10-K and to Note (L) to the Condensed Financial Statements herein. Financing Activities Alabama Power issued a total of $620 million of Senior Notes in the first quarter 2003. The proceeds of these issues were used to redeem $557 million of Senior Notes and for other general corporate purposes. In addition, Alabama Power redeemed $194 million of Senior Notes in the first quarter 2003 from proceeds obtained from a December 2002 issuance of $200 million of Senior Notes. Also in the first quarter 2003, Alabama Power issued 1,250 shares ($125 million) of Preferred Stock. The proceeds of this issue were used to repay a portion of Alabama Power's outstanding short-term indebtedness and for other general corporate purposes. 34
ALABAMA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION In April 2003, Alabama Power issued $195 million of Series W Floating Rate Extendible Senior Notes due April 23, 2006, the initial maturity date, unless the maturity of all or a portion of the principal amount is extended by investors to April 23, 2007. The proceeds from the sale were used by Alabama Power for general corporate purposes, including Alabama Power's continuous construction program. In May 2003, Alabama Power issued $250 million of Series X 3.125% Senior Notes due May 1, 2008. The proceeds from this sale were used to repay at maturity $250 million in aggregate principal amount of the Series M 7.85% Senior Notes due May 15, 2003. In the second quarter 2003, Alabama Power issued a total of 625,000 shares of common stock to Southern Company at $40.00 a share ($25,000,000 aggregate purchase price). The proceeds from the sale were used by Alabama Power for general corporate purposes. In July 2003, Alabama Power entered into swaps to hedge interest payments associated with an anticipated debt issuance planned in December 2003. The swaps are for a notional amount of $250 million at a fixed interest rate of 2.35% and mature in December 2006. Alabama Power plans to continue, when economically feasible, a program to retire higher-cost debt and replace these obligations with lower-cost capital if market conditions permit. Capital Requirements Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS of Alabama Power under "Capital Requirements," "Other Capital Requirements" and "Environmental Matters" in the Form 10-K for a description of Alabama Power's capital requirements for its construction program, maturing debt and environmental compliance efforts. Sources of Capital In addition to the financing activities previously described herein, Alabama Power plans to obtain the funds required for construction and other purposes from sources similar to those used in the past. The amount, type and timing of any financings -- if needed -- will depend upon maintenance of adequate earnings, regulatory approval, prevailing market conditions and other factors. See Item 1 - BUSINESS - "Financing Programs" in the Form 10-K for additional information. Alabama Power's current liabilities exceed current assets because of scheduled maturities of long-term debt. To meet short-term cash needs and contingencies, Alabama Power had at June 30, 2003 approximately $29.1 million of cash and cash equivalents, unused committed lines of credit of approximately $619 million (including $454 million of such lines which are dedicated to funding purchase obligations relating to variable rate pollution control bonds) and an extendible commercial note program. These lines of credit, unless extended, will expire at various times during 2004. Alabama Power may also meet short-term cash needs through a Southern Company subsidiary organized to issue and sell commercial paper and extendible commercial notes at the request and for the benefit of Alabama 35
ALABAMA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Power and other Southern Company subsidiaries. Alabama Power has regulatory authority for up to $1 billion of short-term borrowings. At June 30, 2003, Alabama Power had $59 million outstanding in commercial paper and $12 million outstanding in notes payable to banks. Management believes that the need for working capital can be adequately met by utilizing lines of credit without maintaining large cash balances. 36
GEORGIA POWER COMPANY 37
<TABLE> <CAPTION> GEORGIA POWER COMPANY CONDENSED STATEMENTS OF INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, 2003 2002 2003 2002 ------ ------ ------ ------ (in thousands) (in thousands) Operating Revenues: <S> <C> <C> <C> <C> Retail sales $ 1,041,604 $ 1,062,070 $ 2,007,311 $ 1,966,984 Sales for resale -- Non-affiliates 59,452 72,322 133,438 122,372 Affiliates 46,365 25,282 93,851 41,789 Other revenues 42,672 44,811 81,931 80,103 ----------- ----------- ----------- ----------- Total operating revenues 1,190,093 1,204,485 2,316,531 2,211,248 ----------- ----------- ----------- ----------- Operating Expenses: Operation -- Fuel 271,428 255,792 513,931 483,169 Purchased power -- Non-affiliates 62,052 65,280 134,088 103,070 Affiliates 121,605 98,716 235,448 157,496 Other 199,487 204,694 385,477 378,514 Maintenance 107,628 108,461 218,572 212,315 Depreciation and amortization 86,003 101,206 171,745 197,003 Taxes other than income taxes 49,290 49,857 102,465 99,432 ----------- ----------- ----------- ----------- Total operating expenses 897,493 884,006 1,761,726 1,630,999 ----------- ----------- ----------- ----------- Operating Income 292,600 320,479 554,805 580,249 Other Income and (Expense): Interest expense, net of amounts capitalized (47,925) (41,453) (92,288) (82,048) Distributions on preferred securities of subsidiaries (14,919) (15,647) (29,838) (30,423) Other income (expense), net 25,169 8,519 31,152 6,158 ----------- ----------- ----------- ----------- Total other income and (expense) (37,675) (48,581) (90,974) (106,313) ----------- ----------- ----------- ----------- Earnings Before Income Taxes 254,925 271,898 463,831 473,936 Income taxes 96,231 100,933 171,699 176,058 ----------- ----------- ----------- ----------- Net Income 158,694 170,965 292,132 297,878 Dividends on Preferred Stock 167 167 335 335 ----------- ----------- ----------- ----------- Net Income After Dividends on Preferred Stock $ 158,527 $ 170,798 $ 291,797 $ 297,543 =========== =========== =========== =========== The accompanying notes as they relate to Georgia Power are an integral part of these condensed financial statements. </TABLE> 38
<TABLE> <CAPTION> GEORGIA POWER COMPANY CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Six Months Ended June 30, 2003 2002 ------ ------- (in thousands) Operating Activities: <S> <C> <C> Net income $ 292,132 $ 297,878 Adjustments to reconcile net income to net cash provided from operating activities -- Depreciation and amortization 204,286 195,235 Deferred income taxes and investment tax credits, net 108,809 22,448 Pension, postretirement, and other employee benefits (17,372) (27,239) Other, net 8,167 15,817 Changes in certain current assets and liabilities -- Receivables, net 33,395 56,317 Fossil fuel stock (22,658) 19,988 Materials and supplies (8,000) 7,625 Other current assets 31,641 9,869 Accounts payable (141,009) (75,937) Taxes accrued 16,600 26,551 Other current liabilities 2,201 6,829 ----------- ---------- Net cash provided from operating activities 508,192 555,381 ----------- ---------- Investing Activities: Gross property additions (370,727) (434,403) Cost of removal net of salvage (10,786) (32,826) Sales of property - 387,212 Change in construction payables (63,893) (30,131) Other 2,104 8,606 ----------- ---------- Net cash used for investing activities (443,302) (101,542) ----------- ---------- Financing Activities: Increase (decrease) in notes payable, net (17,633) 85,407 Proceeds -- Senior notes 700,000 - Preferred securities - 440,000 Capital contributions from parent company 9,748 5,397 Redemptions -- First mortgage bonds - (1,860) Pollution control bonds - (7,800) Senior notes (465,000) (300,000) Capital distributions to parent company - (200,000) Payment of preferred stock dividends (393) (344) Payment of common stock dividends (282,900) (271,450) Other (14,786) (15,276) ----------- ---------- Net cash used for financing activities (70,964) (265,926) ----------- ---------- Net Change in Cash and Cash Equivalents (6,074) 187,913 Cash and Cash Equivalents at Beginning of Period 16,873 23,260 ----------- ---------- Cash and Cash Equivalents at End of Period $ 10,799 $ 211,173 =========== ========== Supplemental Cash Flow Information: Cash paid during the period for -- Interest (net of $2,852 and $5,344 capitalized for 2003 and 2002, respectively) $107,940 $79,084 Income taxes (net of refunds) ($21,958) $95,482 The accompanying notes as they relate to Georgia Power are an integral part of these condensed financial statements. </TABLE> 39
<TABLE> <CAPTION> GEORGIA POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Assets 2003 2002 - ------ -------------- ----------------- (in thousands) Current Assets: <S> <C> <C> Cash and cash equivalents $ 10,799 $ 16,873 Receivables -- Customer accounts receivable 279,288 302,995 Unbilled revenues 132,307 104,454 Under recovered regulatory clause revenues 125,052 117,580 Other accounts and notes receivable 74,943 122,585 Affiliated companies 38,691 40,501 Accumulated provision for uncollectible accounts (5,825) (5,825) Fossil fuel stock, at average cost 142,705 120,048 Materials and supplies, at average cost 271,364 263,364 Other 62,396 96,922 ------------ ------------ Total current assets 1,131,720 1,179,497 ------------ ------------ Property, Plant, and Equipment: In service 17,894,675 17,222,661 Less accumulated provision for depreciation 7,183,011 7,333,529 ------------ ------------ 10,711,664 9,889,132 Nuclear fuel, at amortized cost 112,508 119,588 Construction work in progress 403,677 667,581 ------------ ------------ Total property, plant, and equipment 11,227,849 10,676,301 ------------ ------------ Other Property and Investments: Equity investments in unconsolidated subsidiaries 38,095 36,167 Nuclear decommissioning trusts, at fair value 387,601 346,870 Other 29,480 28,612 ------------ ------------ Total other property and investments 455,176 411,649 ------------ ------------ Deferred Charges and Other Assets: Deferred charges related to income taxes 516,618 524,510 Prepaid pension costs 370,464 341,944 Unamortized debt issuance expense 75,344 67,362 Unamortized premium on reacquired debt 177,496 178,590 Asset retirement obligation regulatory asset 11,901 - Other 151,220 162,686 ------------ ------------ Total deferred charges and other assets 1,303,043 1,275,092 ------------ ------------ Total Assets $ 14,117,788 $ 13,542,539 ============ ============ The accompanying notes as they relate to Georgia Power are an integral part of these condensed financial statements. </TABLE> 40
<TABLE> <CAPTION> GEORGIA POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Liabilities and Stockholder's Equity 2003 2002 - ------------------------------------ ------------- ---------------- (in thousands) Current Liabilities: <S> <C> <C> Securities due within one year $ 2,215 $ 322,125 Notes payable 340,044 357,677 Accounts payable -- Affiliated 115,804 135,260 Other 259,774 445,220 Customer deposits 99,418 94,859 Taxes accrued -- Income taxes 104,794 20,245 Other 91,031 134,269 Interest accrued 65,900 59,608 Vacation pay accrued 40,844 42,442 Other 102,134 112,131 ------------ ------------ Total current liabilities 1,221,958 1,723,836 ------------ ------------ Long-term debt 3,663,476 3,109,619 ------------ ------------ Deferred Credits and Other Liabilities: Accumulated deferred income taxes 2,238,686 2,176,438 Deferred credits related to income taxes 200,822 208,410 Accumulated deferred investment tax credits 318,750 324,994 Employee benefits provisions 247,634 236,486 Asset retirement obligations 484,323 - Other 336,897 373,740 ------------ ------------ Total deferred credits and other liabilities 3,827,112 3,320,068 ------------ ------------ Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding company junior subordinated notes 940,000 940,000 ------------ ------------ Preferred stock 14,569 14,569 ------------ ------------ Common Stockholder's Equity: Common stock, without par value-- Authorized - 15,000,000 shares Outstanding - 7,761,500 shares 344,250 344,250 Paid-in capital 2,165,789 2,156,040 Premium on preferred stock 40 40 Retained earnings 1,954,417 1,945,520 Accumulated other comprehensive loss (13,823) (11,403) ------------ ------------ Total common stockholder's equity 4,450,673 4,434,447 ------------ ------------ Total Liabilities and Stockholder's Equity $ 14,117,788 $ 13,542,539 ============ ============ The accompanying notes as they relate to Georgia Power are an integral part of these condensed financial statements. </TABLE> 41
<TABLE> <CAPTION> GEORGIA POWER COMPANY CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, ------------------------- ---------------------- 2003 2002 2003 2002 ----------- ----------- --------- -------- (in thousands) (in thousands) <S> <C> <C> <C> <C> Net Income After Dividends on Preferred Stock $ 158,527 $ 170,798 $ 291,797 $ 297,543 Other comprehensive income (loss): Changes in fair value of qualifying hedges, net of tax of $(380), $(37), $(1,346), $120, respectively (1,015) (58) (2,547) 190 Less: Reclassification adjustment for amounts included in net income, net of tax of $79, $0, $79, $0, respectively 134 - 127 - ---------- ----------- ---------- ---------- COMPREHENSIVE INCOME $ 157,646 $ 170,740 $ 289,377 $ 297,733 ========== =========== ========== ========== GEORGIA POWER COMPANY CONDENSED STATEMENTS OF ACCUMULATED OTHER COMPREHENSIVE LOSS (UNAUDITED) At June 30, At December 31, 2003 2002 ------------ ----------------- (in thousands) Balance at beginning of period $ (11,403) $ (153) Change in current period (2,420) (11,250) ---------- ---------- BALANCE AT END OF PERIOD $ (13,823) $ (11,403) ========== ========= The accompanying notes as they relate to Georgia Power are an integral part of these condensed financial statements. </TABLE> 42
GEORGIA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS RESULTS OF OPERATIONS AND FINANCIAL CONDITION SECOND QUARTER 2003 vs. SECOND QUARTER 2002 AND YEAR-TO-DATE 2003 vs. YEAR-TO-DATE 2002 RESULTS OF OPERATIONS Earnings Georgia Power's net income after dividends on preferred stock for the second quarter and year-to-date 2003 was $158.5 million and $291.8 million, respectively, compared to $170.8 million and $297.5 million for the corresponding periods in 2002. Earnings were down by $12.3 million, or 7.2%, for the second quarter 2003 primarily due to lower operating revenues. Year-to-date 2003 earnings were down slightly by $5.7 million, or 1.9%, as a result of higher non-fuel operating expenses and lower retail base revenues. Significant income statement items appropriate for discussion include the following: <TABLE> <CAPTION> Increase (Decrease) --------------------------------------------------------------- Second Quarter Year-To-Date ------------------------------- ------------------------------- (in thousands) % (in thousands) % <S> <C> <C> <C> <C> Retail sales..................................... $ (20,466) (1.9) $ 40,327 2.1 Sales for resale - non-affiliates................ (12,870) (17.8) 11,066 9.0 Sale for resale - affiliates..................... 21,083 83.4 52,062 124.6 Fuel expense..................................... 15,636 6.1 30,762 6.4 Purchased power - non-affiliates................. (3,228) (4.9) 31,018 30.1 Purchased power - affiliates..................... 22,889 23.2 77,952 49.5 Depreciation and amortization.................... (15,203) (15.0) (25,258) (12.8) Interest expense, net of amounts capitalized..... 6,472 15.6 10,240 12.5 Other income (expense), net...................... 16,650 195.4 24,994 N/M N/M Not meaningful </TABLE> Retail sales. Excluding fuel revenues, which generally do not affect net income, retail sales revenue decreased by $30 million, or 4%, in the second quarter 2003 and $7.3 million, or 0.5%, year-to-date 2003 when compared to the corresponding periods in 2002. During the second quarter 2003, energy sales to residential, commercial and industrial customers were down by 6%, 1.5% and 3.5%, respectively, when compared to the same period in the prior year. Milder-than-normal temperatures and a sluggish economy during the second quarter 2003 are the primary causes for these reductions in energy sales. Year-to-date 2003, energy sales to residential, commercial and industrial customers remained relatively flat. Sales for resale - non-affiliates. The decrease in the second quarter 2003 and the increase year-to-date 2003 in sales for resale to non-affiliates is related to the demand for energy by these customers. In the second quarter 2003, the demand for energy by non-affiliates was down by 17.8%. Year-to-date 2003, the demand for energy by non-affiliates was up by 9.0%. These transactions did not have a significant impact on earnings since the energy is usually sold at variable cost. 43
GEORGIA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS RESULTS OF OPERATIONS AND FINANCIAL CONDITION Sales for resale - affiliates. Revenues from sales for resale to affiliated companies within the Southern Company system will vary depending on demand and the availability and cost of generating resources at each company. During the second quarter and year-to-date 2003, energy sales to affiliates increased 83.4% and 124.6%, respectively, when compared to the corresponding periods in 2002. These transactions did not have a significant impact on earnings since this energy is generally sold at marginal cost. Fuel expense. In the second quarter and year-to-date 2003, fuel expense was higher primarily due to increases of 9.1% and 7.1%, respectively, in the average cost of fuel. These expenses do not have a significant impact on earnings since energy expenses are generally offset by energy revenues through Georgia Power's fuel cost recovery clause. Purchased power - non-affiliates. Purchased power from non-affiliates was down in the second quarter 2003 when compared to the same period in the prior year principally due to lower demand for energy. Year-to-date 2003, these purchases were higher due mainly to increased demand for energy and the higher average unit cost of energy purchased by Georgia Power. These expenses do not have a significant impact on earnings since energy expenses are generally offset by energy revenues through Georgia Power's fuel cost recovery clause. Purchased power - affiliates. During the second quarter and year-to-date 2003, purchased power from affiliates increased as a direct result of PPAs between Georgia Power and Southern Power that began in June 2002 and June 2003. The capacity component of these transactions increased $13.2 million in the second quarter 2003 and $36.8 million year-to-date 2003 as compared to the same periods in 2002. The energy component of power purchased from affiliated companies within the Southern Company system will vary depending on demand and the availability and cost of generating resources at each company and will have no significant impact on earnings since energy expenses are generally offset by energy revenues through Georgia Power's fuel cost recovery clause. Depreciation and amortization. The decreases in the second quarter and year-to-date 2003 are attributed to lower regulatory charges necessary to levelize purchased power costs under the terms of the retail rate order effective January 1, 2002. These decreases are offset by an increase in purchased power costs discussed above. All purchased power costs will be reflected in rates evenly from 2002 through 2004 under the retail rate order effective January 1, 2002. Interest expense, net of amounts capitalized. This item increased during the second quarter and year-to-date 2003 mainly as a result of the issuances of $1.2 billion in senior notes since the same periods in 2002. Other income (expense), net. The second quarter and year-to-date 2003 increases are primarily attributed to increased income related to a new electricity pricing program and $14.5 million of interest on a favorable tax settlement as compared to the same periods in 2002. The new electricity pricing program contributed $7.2 million and $10.1 million to the increase for the second quarter and year-to-date 2003, respectively. 44
GEORGIA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Future Earnings Potential The results of operations discussed above are not necessarily indicative of future earnings potential. The level of future earnings depends on numerous factors including regulatory matters and the effect of weather and the economy on energy sales. For additional information relating to these issues, see Item 1 - - BUSINESS - "Risk Factors" and Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential" of Georgia Power in the Form 10-K. In January 2002, Georgia Power began operating under a three-year retail rate order. Under the terms of the order, earnings will be evaluated annually against a retail return on common equity range of 10 percent to 12.95 percent. Two-thirds of any earnings above the 12.95 percent return will be applied to rate refunds, with the remaining one-third retained by Georgia Power. Retail rates were decreased by $118 million effective January 1, 2002. Purchases under PPAs will be reflected in rates evenly over the next three years under the retail rate order effective January 1, 2002. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential" and Note 3 to the financial statements of Georgia Power in Item 8 of the Form 10-K for additional information. On May 23, 2003, Georgia Power filed for a fuel cost recovery rate increase. Reference is made to Note (G) to the Condensed Financial Statements herein for additional information. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - FERC Matters" of Georgia Power in the Form 10-K for information on the formation of an RTO as ordered by the FERC and the notice of proposed rulemaking regarding open access transmission service and standard electricity market design. In April 2003, the FERC issued a White Paper related to its proposed rulemaking regarding open access transmission service and standard electricity market design in an effort to respond to certain of the public comments received on the standard market design proposal. Reactions to the White Paper by Southeastern state regulators reflect significant continuing differences in opinion between the FERC and various state regulatory commissions over questions of jurisdiction and protection of retail customers. These significant differences between state and federal regulators create substantial uncertainty related to the ultimate approval of SeTrans because state commission approval of the transfer of operational control of the transmission assets of Southern Company and its subsidiaries is a prerequisite to the formation of SeTrans. Pending energy legislation may also impact these issues. Any impact of the other FERC proposals on Southern Company and its subsidiaries will depend on the form in which final rules may be ultimately adopted; however, Georgia Power's revenues, expenses, assets and liabilities could be adversely affected by changes in the transmission regulatory structure in its regional power market. In June 2002, Georgia Power entered into a fifteen-year PPA beginning in June 2005 with Southern Power to purchase 1,040 megawatts of capacity from the planned combined-cycle plant at Plant McIntosh to be built and owned by Southern Power. The annual capacity cost is expected to be approximately $72 million. Reference is made to Note (P) to the Condensed Financial Statements herein for information regarding the FERC approval process for this PPA. Additionally, Georgia Power has entered into a seven-year PPA beginning in June 2005 with Duke Energy Trading & Marketing to purchase 620 megawatts with an average annual capacity cost of approximately $48 million. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential" and Note 4 under "Purchased Power Commitments" to the financial statements of Georgia Power in Item 8 of the Form 10-K. 45
GEORGIA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Compliance costs related to the Clean Air Act and other environmental regulations could affect earnings if such costs cannot be recovered. For additional information, including information on the EPA litigation, see Item 7 - - MANAGEMENT'S DISCUSSION AND Analysis - "Environmental Matters" of Georgia Power and Note 3 to the financial statements of Georgia Power in Item 8 of the Form 10-K. Reference is made to Note (E) to the Condensed Financial Statements herein for information regarding a recent ruling by the U.S. Court of Appeals for the Eleventh Circuit. Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS - "Environmental Matters" in Item 7 of the Form 10-K. The Atlanta area is currently classified as a "serious" nonattainment area for the one-hour ozone standard under Title I of the Clean Air Act. All "serious" areas were required to attain the one-hour ozone standard by November 1999. The EPA provided an extension of the area's compliance deadline to 2004, but on June 16, 2003, the Eleventh Circuit Court of Appeals held the EPA's extension policy to be invalid and remanded the matter back to the EPA. In response, the EPA is expected to re-classify Atlanta as a "severe" nonattainment area with respect to the one-hour standard. If the Atlanta area fails to comply with the one-hour standard by November 2005, all major sources of nitrogen oxides and volatile organic compounds located in the nonattainment area, including Georgia Power's Plants McDonough and Yates, could be subject to payment of emissions fees currently estimated at $7,800-$8,000 per ton, of nitrogen oxides emitted above 80% of the baseline period. Based on average emissions at these units over the past three years, such fees could potentially reach $23 million annually. However, Georgia Power does not anticipate exceeding 80% of the baseline and, therefore, does not anticipate incurring any such fees. The final outcome of this matter will depend on the development and implementation of applicable regulations. Georgia Power's business activities are subject to extensive governmental regulation related to public health and the environment. Litigation over environmental issues and claims of various types, including property damage, personal injury and citizen enforcement of environmental requirements, has increased generally throughout the United States. In particular, personal injury claims for damages caused by alleged exposure to hazardous materials have become more frequent. The ultimate outcome of such litigation currently filed against Georgia Power cannot be predicted at this time; however, after consultation with legal counsel, management does not anticipate that the liabilities, if any, arising from such proceedings would have a material adverse effect on Georgia Power's financial statements. Reference is made to Notes (A), (E), (G) through (I), (L) and (P) to the Condensed Financial Statements herein for discussion of various contingencies and other matters which may affect future earnings potential. Accounting Policies Critical Policy Georgia Power's significant accounting policies are described in Note 1 to the financial statements of Georgia Power in Item 8 of the Form 10-K. Georgia Power's critical accounting policy involves rate regulation. Georgia Power is subject to the provisions of FASB Statement No. 71, "Accounting for the Effects of Certain Types of Regulation." In the event that a portion of Georgia Power's operations is no longer subject to these provisions, Georgia Power would be required to write off related regulatory assets and liabilities that are not specifically recoverable and determine if any other assets, including plant, have been impaired. 46
GEORGIA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION New Accounting Standards Reference is made to Note (J) to the Condensed Financial Statements herein for information regarding the adoption of FASB Statement No. 143, "Accounting for Asset Retirement Obligations" effective January 1, 2003. Statement No. 143 establishes new accounting and reporting standards for legal obligations associated with the ultimate cost of retiring long-lived assets. The present value of the ultimate costs for an asset's future retirement must be recorded in the period in which the liability is incurred. The cost must be capitalized as part of the related long-lived asset and depreciated over the asset's useful life. Additionally, Statement No. 143 does not permit non-regulated companies to continue accruing future retirement costs for long-lived assets that they do not have a legal obligation to retire. Prior to January 2003, Georgia Power accrued for the ultimate cost of retiring most long-lived assets over the life of the related asset through depreciation expense. In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," which requires classification of certain financial instruments within its scope, including shares that are mandatorily redeemable, as liabilities. Statement No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise on July 1, 2003 for calendar year companies. In accordance with Statement No. 150, Georgia Power reclassified $940 million of mandatorily redeemable preferred securities as liabilities effective July 1, 2003. The implementation of Statement No. 150 did not have a material effect on Georgia Power's Statements of Income and Cash Flows. FINANCIAL CONDITION Overview The major change in Georgia Power's financial condition during the first six months of 2003 was the addition of approximately $371 million to utility plant. The funds for these additions and other capital requirements were derived primarily from operations. See Georgia Power's Condensed Statements of Cash Flows herein for further details. Credit Rating Risk Georgia Power does not have any credit agreements that would require material changes in payment schedules or terminations as a result of a credit rating downgrade. There are certain physical electricity sales contracts that could require collateral -- but not termination -- in the event of a credit rating change to below investment grade. Generally, collateral may be provided for by a Southern Company guaranty, letter of credit or cash. At June 30, 2003, the maximum potential collateral requirements were approximately $228 million. Exposure to Market Risks Georgia Power's market risk exposures relative to interest rate changes have not changed materially compared with the December 31, 2002 reporting period. In addition, Georgia Power is not aware of any facts or circumstances that would significantly affect such exposures in the near term. 47
GEORGIA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Due to cost-based rate regulations, Georgia Power has limited exposure to market volatility in interest rates, commodity fuel prices and prices of electricity. To mitigate residual risks relative to movements in electricity prices, Georgia Power enters into fixed price contracts for the purchase and sale of electricity through the wholesale electricity market and, to a lesser extent, similar contracts for gas purchases. Georgia Power has also implemented a retail fuel hedging program at the instruction of the Georgia PSC. The fair value of derivative energy contracts at June 30, 2003 was as follows: Second Quarter 2003 Year-to-Date Changes Changes --------------------------------- ---------------------------------------- Fair Value --------------------------------- ---------------------------------------- (in thousands) Contracts beginning of period $ (839) $ 89 Contracts realized or settled (4) (4) New contracts at inception - - Changes in valuation techniques - - Current period changes (1,191) (2,119) --------------------------------- ------------------------ -------------- Contracts at June 30, 2003 $ (2,034) $ (2,034) ================================= ======================== ================ All of these contracts are actively quoted and mature within one year. At June 30, 2003, the fair value of derivative energy contracts reflected in the financial statements was as follows: Amounts --------------------------------------- ------------------------- (in thousands) Regulatory assets, net $(1,785) Other comprehensive income - Net loss (249) --------------------------------------- ------------------------- Total fair value $(2,034) ======================================= ========================= Realized gains and losses are recognized in the Statements of Income as incurred. For the three months ended June 30, 2003 and 2002, approximately $(0.1) million and $1.3 million of (losses) gains, respectively, were recognized in income. For the six months ended June 30, 2003 and 2002, approximately $0.3 million and $1.2 million of losses, respectively, were recognized in income. For additional information, reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Exposure to Market Risks" of Georgia Power in the Form 10-K and Note 1 to the financial statements of Georgia Power in Item 8 of the Form 10-K. Financing Activities In February 2003, Georgia Power issued $250 million of Series L Floating Rate Senior Notes due February 18, 2005. The proceeds from this issuance were used to repay a portion of Georgia Power's outstanding short-term indebtedness. Also in February 2003, Georgia Power issued $150 million of Series M 5.40% Senior Insured Quarterly Notes due March 1, 2033. A portion of the proceeds was used to redeem in March 2003 the $145 million outstanding principal amount of Georgia 48
GEORGIA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Power's Series A 6 7/8% SeniorPublic Income Notes due December 31, 2047 and the balance of the proceeds was used for general corporate purposes. During March 2003, Georgia Power elected to change the interest rate mode on $316 million of variable rate pollution control bonds. Georgia Power changed $255 million of the bonds from the "daily rate mode," which required backup bank credit facilities, to the "auction rate mode." In addition, Georgia Power changed $61 million of the bonds from the "daily rate mode" to the "long-term interest rate mode." In April 2003, Georgia Power issued $100 million of Series N 5.750% Senior Notes due April 15, 2023, $150 million of Series O 5.90% Senior Notes due April 15, 2033 and $50 million of Series P Floating Rate Senior Notes due April 15, 2005. The proceeds from these sales were used to repay a portion of Georgia Power's outstanding short-term indebtedness and to repay at maturity all of Georgia Power's Series I 5.25% Senior Notes due May 8, 2003. In July 2003, Georgia Power entered swaps to hedge interest payments associated with variable rate pollution control bonds. The swaps are for a notional amount of $873.3 million at an average fixed interest rate of 1.388% and mature in December 2004. Also in July 2003, Georgia Power entered a swap to hedge interest payments associated with a variable rate note with a coupon of LIBOR plus 10 basis points. The swap is for a notional amount of $50 million at a fixed interest rate of 1.5625% and matures in January 2005. Further in July 2003, Georgia Power entered a U.S. Treasury lock to hedge interest payments associated with a 10-year debt issuance planned in August 2003. The swap is for a notional amount of $100 million at a fixed interest rate of 4.465%. Georgia Power plans to continue, when economically feasible, a program to retire higher-cost debt and replace these obligations with lower-cost capital if market conditions permit. Capital Requirements Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS of Georgia Power under "Financing Activities," "Liquidity and Capital Requirements" and "Environmental Matters" in the Form 10-K for a description of Georgia Power's capital requirements for its construction program, maturing debt and environmental compliance efforts. Sources of Capital Georgia Power plans to obtain the funds required for construction and other purposes from sources similar to those used in the past. The amount, type and timing of any financings -- if needed -- will depend upon maintenance of adequate earnings, regulatory approval, prevailing market conditions and other factors. See Item 1 - BUSINESS - "Financing Programs" in the Form 10-K for additional information. Georgia Power's current liabilities exceed current assets because of the continued use of short-term debt as a funding source to meet cash needs. 49
GEORGIA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION To meet short-term cash needs and contingencies, Georgia Power had at June 30, 2003 approximately $10.8 million of cash and cash equivalents and approximately $725 million of unused credit arrangements with banks. These credit arrangements expire in June 2004 and contain provisions allowing two-year term loans executable at the expiration date and represent a reduction in the previous level of credit arrangements due to reduced liquidity support requirements as outlined in "Financing Activities" above. The credit arrangements provide liquidity support to Georgia Power's obligations with respect to variable rate pollution control bonds and commercial paper. Georgia Power may also meet short-term cash needs through a Southern Company subsidiary organized to issue and sell commercial paper and extendible commercial notes at the request and for the benefit of Georgia Power and other Southern Company subsidiaries. At June 30, 2003, Georgia Power had outstanding $340 million of commercial paper. Management believes that the need for working capital can be adequately met by utilizing lines of credit without maintaining large cash balances. 50
GULF POWER COMPANY 51
<TABLE> <CAPTION> GULF POWER COMPANY CONDENSED STATEMENTS OF INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, 2003 2002 2003 2002 ------- ------ ------ -------- (in thousands) (in thousands) Operating Revenues: <S> <C> <C> <C> <C> Retail sales $175,669 $172,781 $335,462 $306,275 Sales for resale -- Non-affiliates 17,908 18,684 36,633 36,118 Affiliates 12,414 7,514 22,631 10,095 Other revenues 9,218 11,008 18,321 18,432 -------- -------- -------- -------- Total operating revenues 215,209 209,987 413,047 370,920 -------- -------- -------- -------- Operation -- Fuel 77,798 70,142 141,065 106,897 Purchased power -- Non-affiliates 3,929 6,848 9,885 12,652 Affiliates 5,079 13,130 17,666 30,191 Other 33,426 30,985 63,437 57,910 Maintenance 17,257 23,749 33,837 41,938 Depreciation and amortization 20,324 19,083 40,576 36,374 Taxes other than income taxes 16,728 14,876 33,116 29,291 -------- -------- -------- -------- Total operating expenses 174,541 178,813 339,582 315,253 -------- -------- -------- -------- Operating Income 40,668 31,174 73,465 55,667 Other Income and (Expense): Interest expense, net of amounts capitalized (8,252) (8,146) (16,307) (15,132) Distributions on preferred securities of subsidiary (1,894) (2,103) (3,922) (4,206) Other income (expense), net (256) 185 (679) 1,961 --------- --------- -------- --------- Total other income and (expense) (10,402) (10,064) (20,908) (17,377) -------- -------- -------- -------- Earnings Before Income Taxes 30,266 21,110 52,557 38,290 Income taxes 11,427 7,569 19,692 12,978 -------- -------- -------- -------- Net Income 18,839 13,541 32,865 25,312 Dividends on Preferred Stock 54 54 108 108 -------- -------- -------- -------- Net Income After Dividends on Preferred Stock $ 18,785 $ 13,487 $ 32,757 $25,204 ======== ======== ======== ======== The accompanying notes as they relate to Gulf Power are an integral part of these condensed financial statements. </TABLE> 52
<TABLE> <CAPTION> GULF POWER COMPANY CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Six Months Ended June 30, 2003 2002 ------ -------- (in thousands) Operating Activities: <S> <C> <C> Net income $ 32,865 $ 25,312 Adjustments to reconcile net income to net cash provided from operating activities -- Depreciation and amortization 43,247 38,700 Deferred income taxes (112) (4,049) Other, net 917 (25) Changes in certain current assets and liabilities -- Receivables, net (7,598) (27,336) Fossil fuel stock (2,822) (12,757) Materials and supplies (2,797) (465) Other current assets 12,241 5,281 Accounts payable (19,713) 2,200 Taxes accrued 17,002 13,545 Other current liabilities 14,065 (144) --------- --------- Net cash provided from operating activities 87,295 40,262 --------- --------- Investing Activities: Gross property additions (40,654) (67,948) Cost of removal net of salvage (4,842) (1,672) Other (6,652) (16,305) --------- --------- Net cash used for investing activities (52,148) (85,925) --------- --------- Financing Activities: Increase (decrease) in notes payable, net 23,227 (3,187) Proceeds -- Pollution control bonds 61,625 - Senior notes 65,000 44,803 Capital contributions from parent company 11,612 37,782 Redemptions -- Pollution control bonds (61,625) - Senior notes (45,037) - Other long-term debt (20,000) - Preferred securities (40,000) - Payment of preferred stock dividends (108) (108) Payment of common stock dividends (35,100) (32,750) Other (4,504) (594) --------- --------- Net cash provided from (used for) financing activities (44,910) 45,946 --------- --------- Net Change in Cash and Cash Equivalents (9,763) 283 Cash and Cash Equivalents at Beginning of Period 13,278 2,244 --------- --------- Cash and Cash Equivalents at End of Period $ 3,515 $ 2,527 ========= ========= Supplemental Cash Flow Information: Cash paid during the period for -- Interest (net of $66 and $1,391 capitalized for 2003 and 2002, respectively) $18,525 $19,999 Income taxes (net of refunds) ($5,393) $2,503 The accompanying notes as they relate to Gulf Power are an integral part of these condensed financial statements. </TABLE> 53
<TABLE> <CAPTION> GULF POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Assets 2003 2002 - ------ ----------- ----------------- (in thousands) Current Assets: <S> <C> <C> Cash and cash equivalents $ 3,515 $ 13,278 Receivables -- Customer accounts receivable 55,611 48,609 Unbilled revenues 32,171 28,077 Under recovered regulatory clause revenues 27,970 29,549 Other accounts and notes receivable 5,954 6,618 Affiliated companies 7,730 8,678 Accumulated provision for uncollectible accounts (1,197) (889) Fossil fuel stock, at average cost 40,013 37,191 Materials and supplies, at average cost 37,637 34,840 Prepaid taxes - 12,704 Prepaid service agreement 4,547 4,535 Other 10,051 9,599 ----------- ---------- Total current assets 224,002 232,789 ----------- ---------- Property, Plant, and Equipment: In service 2,280,852 2,248,156 Less accumulated provision for depreciation 974,598 946,408 ----------- ---------- 1,306,254 1,301,748 Construction work in progress 32,426 35,708 ----------- ---------- Total property, plant, and equipment 1,338,680 1,337,456 ----------- ---------- Other Property and Investments 11,318 10,157 ----------- ---------- Deferred Charges and Other Assets: Deferred charges related to income taxes 18,182 18,798 Prepaid pension costs 38,788 36,298 Unamortized debt issuance expense 4,947 3,900 Unamortized premium on reacquired debt 17,418 14,052 Other 24,037 20,379 ----------- ----------- Total deferred charges and other assets 103,372 93,427 ----------- ----------- Total Assets $ 1,677,372 $ 1,673,829 =========== =========== The accompanying notes as they relate to Gulf Power are an integral part of these condensed financial statements. </TABLE> 54
<TABLE> <CAPTION> GULF POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Liabilities and Stockholder's Equity 2003 2002 - ------------------------------------ ------------- --------------- (in thousands) Current Liabilities: <S> <C> <C> Securities due within one year $ 60,000 $ 100,000 Notes payable 51,706 28,479 Accounts payable -- Affiliated 23,037 26,395 Other 17,707 39,685 Customer deposits 17,227 16,047 Taxes accrued -- Income taxes 19,671 10,718 Other 15,040 9,170 Interest accrued 7,055 7,875 Vacation pay accrued 5,044 5,044 Other 14,344 3,933 ------------ ----------- Total current liabilities 230,831 247,346 ------------ ----------- Long-term debt 453,345 452,040 ------------ ----------- Deferred Credits and Other Liabilities: Accumulated deferred income taxes 169,347 167,689 Deferred credits related to income taxes 27,808 29,692 Accumulated deferred investment tax credits 21,308 22,289 Employee benefits provisions 42,259 39,656 Other 56,735 46,376 ------------ ----------- Total deferred credits and other liabilities 317,457 305,702 ------------ ----------- Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding company junior subordinated notes 115,000 115,000 ------------ ----------- Preferred stock 4,236 4,236 ------------ ----------- Common Stockholder's Equity: Common stock, without par value-- Authorized - 992,717 shares Outstanding - 992,717 shares 38,060 38,060 Paid-in capital 361,380 349,769 Premium on preferred stock 12 12 Retained earnings 160,055 162,398 Accumulated other comprehensive loss (3,004) (734) ------------ ----------- Total common stockholder's equity 556,503 549,505 ------------ ----------- Total Liabilities and Stockholder's Equity $ 1,677,372 $ 1,673,829 ============ =========== The accompanying notes as they relate to Gulf Power are an integral part of these condensed financial statements. </TABLE> 55
<TABLE> <CAPTION> GULF POWER COMPANY CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, ---------------------- ------------------------ 2003 2002 2003 2002 --------- -------- ---------- ------- (in thousands) (in thousands) <S> <C> <C> <C> <C> Net Income After Dividends on Preferred Stock $ 18,785 $ 13,487 $ 32,757 $ 25,204 Other comprehensive income: Changes in fair value of qualifying hedges, net of tax of $(1,426), $0, $(1,426), $0, respectively (2,270) - (2,270) - ---------- --------- ---------- --------- COMPREHENSIVE INCOME $ 16,515 $ 13,487 $ 30,487 $ 25,204 ========== ========= ========== ========= GULF POWER COMPANY CONDENSED STATEMENTS OF ACCUMULATED OTHER COMPREHENSIVE LOSS (UNAUDITED) At At June 30, December 31, 2003 2002 ----------- --------------- (in thousands) Balance at beginning of period $ (734) $ - Change in current period (2,270) (734) -------- ------- BALANCE AT END OF PERIOD $ (3,004) $ (734) ======== ======= The accompanying notes as they relate to Gulf Power are an integral part of these condensed financial statements. </TABLE> 56
GULF POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION SECOND QUARTER 2003 vs. SECOND QUARTER 2002 AND YEAR-TO-DATE 2003 vs. YEAR-TO-DATE 2002 RESULTS OF OPERATIONS Earnings Gulf Power's net income after dividends on preferred stock for the second quarter and year-to-date 2003 was $18.8 million and $32.8 million, respectively, compared to $13.5 million and $25.2 million for the corresponding periods in 2002. Earnings in the second quarter and year-to-date 2003 increased by $5.3 million, or 39.3%, and $7.6 million, or 30%, respectively, as a result of higher operating revenues that were only partially offset year-to-date 2003 with higher operating expenses. Significant income statement items appropriate for discussion include the following: <TABLE> <CAPTION> Increase (Decrease) -------------------------------------------------------------------- Second Quarter Year-To-Date ------------------------------------ ------------------------------- (in thousands) % (in thousands) % <S> <C> <C> <C> <C> Retail sales........................ $2,888 1.7 $29,187 9.5 Sale for resale - affiliates........ 4,900 65.2 12,536 124.2 Other revenues...................... (1,790) (16.3) (111) (0.6) Fuel expense........................ 7,656 10.9 34,168 32.0 Purchased power - non-affiliates.... (2,919) (42.6) (2,767) (21.9) Purchased power - affiliates........ (8,051) (61.3) (12,525) (41.5) Other operation expense............. 2,441 7.9 5,527 9.5 Maintenance expense................. (6,492) (27.3) (8,101) (19.3) Depreciation and amortization....... 1,241 6.5 4,202 11.6 Taxes other than income taxes....... 1,852 12.4 3,825 13.1 Other income (expense), net......... (441) (238.4) (2,640) (134.6) </TABLE> Retail sales. Excluding the recovery of fuel expense and certain other expenses that do not affect net income, retail sales increased by $8.3 million, or 8.7%, for the second quarter 2003 and by $21.3 million, or 12.2%, year-to-date 2003 when compared to the corresponding periods in 2002. For both of the above reporting periods, retail sales revenues were higher than the corresponding periods in 2002 primarily due to an increase in the number of customers and the retail rate increase which went into effect in June 2002. During the second quarter 2003, retail energy sales to residential and industrial customers increased by 1.2% and 8.1%, respectively, while energy sales to commercial customers decreased by 1% as compared to the same period in 2002. For year-to-date 2003 as compared to 2002, retail energy sales to residential, commercial and industrial customers increased by 0.2%, 0.6% and 8.2%, respectively. Sales for resale - affiliates and Purchased power - affiliates. Revenues from sales for resale to affiliated companies and purchases of energy within the Southern Company system will vary depending on demand and the availability and cost of generating resources at each company. Gulf Power increased its generating resources with commercial operation of Plant Smith in April 2002 and thus had greater generation resources to sell to affiliates. These 57
GULF POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION transactions do not have a significant impact on earnings since this energy is generally sold at marginal cost and energy purchases are generally offset by energy revenues through Gulf Power's fuel cost recovery mechanism. Other revenues. The second quarter 2003 decrease in other revenues when compared to the same period in 2002 is primarily due to a $1.7 million settlement, recorded in 2002, related to a PPA. Fuel expense. During the second quarter 2003, fuel expense increased from the corresponding period in the prior year mainly due to a 78.5% increase in natural gas prices and increased generation to meet demand. Year-to-date 2003, fuel expense was higher because of commercial operation of Plant Smith Unit 3 in April 2002, a 60.4% increase in natural gas prices and increased generation to meet additional demand for energy. Since energy expenses are generally offset by energy revenues through Gulf Power's fuel cost recovery mechanism, these expenses do not have a significant impact on net income. Purchased power - non-affiliates. The decreases in the second quarter and year-to-date 2003 when compared to the corresponding periods in 2002 are directly related to commercial operation of Plant Smith Unit 3 which began commercial operation in April 2002. Other operation expense. A number of factors caused the increases in other operation expense in the second quarter and year-to-date 2003 as compared to the same periods in the prior year. Customer accounts expenses increased $0.5 million and $1.3 million; distribution expenses increased $0.5 million and $0.6 million; and administrative and general expenses increased $0.5 million and $2.2 million, respectively, for the second quarter and year-to-date 2003. Increased relocation expenses and severance costs caused the change in the administrative and general expenses. Maintenance expense. The decreases in maintenance expense during the second quarter and year-to-date 2003 were primarily due to a decrease in planned turbine and boiler inspections and repairs in 2003 compared to the same periods in 2002. Depreciation and amortization. Depreciation and amortization was higher in the second quarter and year-to-date 2003 and was directly related to an increase in utility plant-in-service, including Plant Smith Unit 3, when compared to the corresponding periods in the prior year. Taxes other than income taxes. The increases in this item for the second quarter and year-to-date 2003 are primarily attributed to property taxes on Plant Smith Unit 3 and revenue taxes related to the 2002 base rate increase. Other income (expense), net. The decreases in this item during the second quarter and year-to-date 2003 as compared to the same periods in the prior year were primarily a result of reductions in Allowance for Equity Funds Used During Construction following the completion of Plant Smith Unit 3. Future Earnings Potential The results of operations discussed above are not necessarily indicative of future earnings potential. The level of future earnings depends on numerous factors. The major factors include regulatory matters and the ability to achieve energy sales growth. For additional information relating to these issues, see Item 1 - BUSINESS - "Risk Factors" and Item 7 - MANAGEMENT'S DISCUSSION AND 58
GULF POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION ANALYSIS - "Future Earnings Potential" of Gulf Power in the Form 10-K. Gulf Power is subject to certain claims and legal actions arising in the ordinary course of business. Gulf Power's business activities are subject to extensive governmental regulation related to public health and the environment. Litigation over environmental issues and claims of various types, including property damage, personal injury and citizen enforcement of environmental requirements, has increased generally throughout the United States. In particular, personal injury claims for damages caused by alleged exposure to hazardous materials have become more frequent. The ultimate outcome of such litigation currently filed against Gulf Power cannot be predicted at this time; however, after consultation with legal counsel, management does not anticipate that the liabilities, if any, arising from such proceedings would have a material adverse effect on Gulf Power's financial statements. Compliance costs related to the Clean Air Act and other environmental regulations could affect earnings if such costs are not fully recovered through Gulf Power's Environmental Cost Recovery Clause. For additional information about these issues, including the EPA litigation, see Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Environmental Matters" and Note 3 to the financial statements of Gulf Power in the Form 10-K. Reference is made to Note (E) to the Condensed Financial Statements herein for information regarding a recent ruling by the U.S. Court of Appeals for the Eleventh Circuit. In 2002, the Florida PSC approved an annual base rate increase for Gulf Power of $53.2 million which became effective in June 2002. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential" of Gulf Power in the Form 10-K for additional information. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - FERC Matters" of Gulf Power in the Form 10-K for information on the formation of an RTO as ordered by the FERC and the notice of proposed rulemaking regarding open access transmission service and standard electricity market design. In April 2003, the FERC issued a White Paper related to its proposed rulemaking regarding open access transmission service and standard electricity market design in an effort to respond to certain of the public comments received on the standard market design proposal. Reactions to the White Paper by Southeastern state regulators reflect significant continuing differences in opinion between the FERC and various state regulatory commissions over questions of jurisdiction and protection of retail customers. These significant differences between state and federal regulators create substantial uncertainty related to the ultimate approval of SeTrans because state commission approval of the transfer of operational control of the transmission assets of Southern Company and its subsidiaries is a prerequisite to the formation of SeTrans. Pending energy legislation may also impact these issues. Any impact of the other FERC proposals on Southern Company and its subsidiaries will depend on the form in which final rules may be ultimately adopted; however, Gulf Power's revenues, expenses, assets and liabilities could be adversely affected by changes in the transmission regulatory structure in its regional power market. Reference is made to Notes (A), (E), (H), (I) and (L) to the Condensed Financial Statements herein for discussion of various contingencies and other matters which may affect future earnings potential. 59
GULF POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Accounting Policies Critical Policy Gulf Power's significant accounting policies are described in Note 1 to the financial statements of Gulf Power in Item 8 of the Form 10-K. Gulf Power's critical accounting policy involves rate regulation. Gulf Power is subject to the provisions of FASB Statement No. 71, "Accounting for the Effects of Certain Types of Regulation." In the event that a portion of Gulf Power's operations is no longer subject to these provisions, Gulf Power would be required to write off related regulatory assets and liabilities that are not specifically recoverable and determine if any other assets, including plant, have been impaired. New Accounting Standards Reference is made to Note (J) to the Condensed Financial Statements herein for information regarding the adoption of FASB Statement No. 143, "Accounting for Asset Retirement Obligations" effective January 1, 2003. Statement No. 143 establishes new accounting and reporting standards for legal obligations associated with the ultimate cost of retiring long-lived assets. The present value of the ultimate costs for an asset's future retirement must be recorded in the period in which the liability is incurred. The cost must be capitalized as part of the related long-lived asset and depreciated over the asset's useful life. Additionally, Statement No. 143 does not permit non-regulated companies to continue accruing future retirement costs for long-lived assets that they do not have a legal obligation to retire. Prior to January 2003, Gulf Power accrued for the ultimate cost of retiring most long-lived assets over the life of the related asset through depreciation expense. In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," which requires classification of certain financial instruments within its scope, including shares that are mandatorily redeemable, as liabilities. Statement No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise on July 1, 2003 for calendar year companies. In accordance with Statement No. 150, Gulf Power reclassified $115 million of mandatorily redeemable preferred securities as liabilities effective July 1, 2003. The implementation of Statement No. 150 did not have a material effect on Gulf Power's Statements of Income and Cash Flows. FINANCIAL CONDITION Overview Major changes in Gulf Power's financial condition during the first six months of 2003 included the addition of approximately $40.7 million to utility plant. The funds for these additions and other capital requirements were derived primarily from operations. See Gulf Power's Condensed Statements of Cash Flows herein for further details. Credit Rating Risk Gulf Power does not have any credit agreements that would require material changes in payment schedules or terminations as a result of a credit rating downgrade. 60
GULF POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Exposure to Market Risks Gulf Power's market risk exposures relative to interest rate changes have not changed materially compared with the December 31, 2002 reporting period. In addition, Gulf Power is not aware of any facts or circumstances that would significantly affect such exposures in the near term. Due to cost-based rate regulations, Gulf Power has limited exposure to market volatility in interest rates, commodity fuel prices and prices of electricity. To mitigate residual risks relative to movements in electricity prices, Gulf Power enters into fixed price contracts for the purchase and sale of electricity through the wholesale electricity market and, to a lesser extent, similar contracts for gas purchases. Gulf Power has received approval from the Florida PSC to recover prudently incurred costs related to its fuel hedging program through the fuel cost recovery mechanism. The fair value of derivative energy contracts at June 30, 2003 was as follows: Second Quarter 2003 Year-to-Date Changes Changes --------------------------------- ---------------------------------------- Fair Value --------------------------------- ---------------------------------------- (in thousands) Contracts beginning of period $3,955 $ 2,336 Contracts realized or settled (2,369) (2,860) New contracts at inception - - Changes in valuation techniques - - Current period changes (568) 1,542 --------------------------------- ------------------------ --------------- Contracts at June 30, 2003 $1,018 $1,018 ================================= ======================== =============== Source of June 30, 2003 Valuation Prices -------------------------------- --------------- ----------------------- Total Maturity ----------------------- Fair Value Year 1 1-3 Years -------------------------------- --------------------------------------- (in thousands) Actively quoted $1,018 $1,858 $(840) External sources - - - Models and other methods - - - -------------------------------- --------------- ----------------------- Contracts at June 30, 2003 $1,018 $1,858 $(840) ================================ =============== ======================= Unrealized gains and losses from mark to market adjustments on contracts related to fuel hedging programs are recorded as regulatory assets and liabilities. Realized gains and losses from these programs are included in fuel expense and are recovered through Gulf Power's fuel cost recovery clause. Gains and losses on contracts that do not represent hedges are recognized in the income statement as incurred. At June 30, 2003, the fair value of derivative energy contracts was reflected in the financial statements as follows: 61
GULF POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Amounts - ----------------------------------------------------------------------------- (in thousands) Regulatory liabilities, net $1,059 Other comprehensive income - Net income (41) - ----------------------------------------------------------------------------- Total fair value $1,018 ============================================================================= For the quarter and year-to-date periods ended June 30, 2003 and 2002, the realized gains and losses recognized in income were immaterial. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Exposure to Market Risks" of Gulf Power in the Form 10-K and Note 1 to the financial statements of Gulf Power in Item 8 of the Form 10-K for additional information. Financing Activities In January 2003, Gulf Power redeemed $40 million of 7.625% trust preferred securities using the proceeds of $40 million in trust preferred securities issued in December 2002 at a five-year initial fixed rate of 5.60%. In March 2003, Gulf Power issued $65 million of Series F Senior Insured Quarterly Notes due April 1, 2033. The proceeds from this issue were used to redeem, in April 2003, the $20 million Series B 7.50% Junior Subordinated Notes due June 30, 2037 and, in May 2003, the $45 million of Series E Senior Notes due January 30, 2012. In April 2003, Gulf Power sold through public authorities $29.075 million of variable rate pollution control revenue refunding bonds due February 1, 2026 and $32.55 million of variable rate pollution control refunding bonds due June 1, 2023. The proceeds were used to redeem (1) $7.875 million aggregate principal amount of water pollution control revenue refunding bonds, Series 1993; (2) $21.2 million of pollution control revenue refunding bonds, Series 1996 and (3) the outstanding amount of pollution control revenue refunding bonds, Series 1993. Both pollution control bonds issued in April 2003 will bear interest at a rate to be determined by the auction rate process. In July 2003, Gulf Power issued $60 million of Series G 4.35% Senior Notes due July 15, 2013 and $60 million of Series H 5.25% Senior Notes due July 15, 2033. The proceeds of the Series G Senior Notes were used to pay at maturity the $60 million outstanding principal amount of Series C 4.69% Senior Notes due August 1, 2003. The proceeds of the Series H Senior Notes will be used to redeem in August 2003 the $46.7 million outstanding principal amount of the Series A 6.70% Senior Insured Quarterly Notes due June 30, 2038. The remainder will be used to repay a portion of Gulf Power's short-term indebtedness. Gulf Power plans to continue, to the extent possible, a program to retire higher-cost securities and replace these obligations with lower-cost capital if market conditions permit. 62
GULF POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Capital Requirements Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS of Gulf Power under "Capital Requirements for Construction," "Other Capital Requirements" and "Environmental Matters" in the Form 10-K for a description of Gulf Power's capital requirements for its construction program, maturing debt and environmental compliance efforts. Sources of Capital In addition to the financing activities previously described herein, Gulf Power plans to obtain the funds required for construction and other purposes from sources similar to those used in the past. The amount, type and timing of any financings -- if needed -- will depend upon maintenance of adequate earnings, regulatory approval, prevailing market conditions and other factors. See Item 1 - - BUSINESS - "Financing Programs" in the Form 10-K for additional information. To meet short-term cash needs and contingencies, Gulf Power had at June 30, 2003 approximately $3.5 million of cash and cash equivalents and $66.3 million of unused committed lines of credit with banks that expire in 2004. The credit arrangements provide liquidity support to Gulf Power's obligations with respect to variable rate pollution control bonds and commercial paper. Gulf Power may also meet short-term cash needs through a Southern Company subsidiary organized to issue and sell commercial paper and extendible commercial notes at the request and for the benefit of Gulf Power and other Southern Company subsidiaries. At June 30, 2003, Gulf Power had outstanding $20 million of notes payable and $31.7 million of commercial paper. Management believes that the need for working capital can be adequately met by utilizing lines of credit without maintaining large cash balances. 63
MISSISSIPPI POWER COMPANY 64
<TABLE> <CAPTION> MISSISSIPPI POWER COMPANY CONDENSED STATEMENTS OF INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, 2003 2002 2003 2002 ------- ------ ------ ------ (in thousands) (in thousands) <S> <C> <C> <C> <C> Retail sales $134,058 $138,601 $248,028 $257,068 Sales for resale -- Non-affiliates 59,320 52,182 129,745 104,334 Affiliates 5,665 10,456 11,888 20,069 Contract termination 62,111 - 62,111 - Other revenues 3,206 4,139 6,474 6,965 -------- -------- -------- -------- Total operating revenues 264,360 205,378 458,246 388,436 -------- -------- -------- -------- Operating Expenses: Operation -- Fuel 55,596 66,772 106,720 126,974 Purchased power -- Non-affiliates 4,511 4,416 11,328 7,257 Affiliates 17,755 10,387 38,087 17,793 Other 49,743 37,103 84,906 72,464 Maintenance 18,751 20,606 33,011 41,277 Depreciation and amortization 13,902 13,918 26,975 28,430 Taxes other than income taxes 13,716 13,719 27,083 26,911 -------- -------- -------- -------- Total operating expenses 173,974 166,921 328,110 321,106 -------- -------- -------- -------- Operating Income 90,386 38,457 130,136 67,330 Other Income and (Expense): Interest expense (3,767) (4,279) (7,537) (9,325) Distributions on preferred securities of subsidiary (630) (1,022) (1,260) (1,770) Other income (expense), net 753 1,152 765 1,345 -------- -------- -------- -------- Total other income and (expense) (3,644) (4,149) (8,032) (9,750) -------- -------- -------- -------- Earnings Before Income Taxes 86,742 34,308 122,104 57,580 Income taxes 33,179 13,016 46,642 21,803 -------- -------- -------- -------- Net Income 53,563 21,292 75,462 35,777 Dividends on Preferred Stock 504 504 1,007 1,007 -------- -------- -------- -------- Net Income After Dividends on Preferred Stock $ 53,059 $ 20,788 $ 74,455 $ 34,770 ======== ========= ======== ========= The accompanying notes as they relate to Mississippi Power are an integral part of these condensed financial statements. </TABLE> 65
<TABLE> <CAPTION> MISSISSIPPI POWER COMPANY CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Six Months Ended June 30, 2003 2002 ----- ----- (in thousands) Operating Activities: <S> <C> <C> Net income $ 75,462 $ 35,777 Adjustments to reconcile net income to net cash provided from operating activities -- Depreciation and amortization 31,046 30,486 Deferred income taxes and investment tax credits, net 1,623 (6,021) Other, net 12,676 5,953 Changes in certain current assets and liabilities -- Receivables, net 12,950 3,463 Fossil fuel stock (6,723) (1,768) Materials and supplies 143 (1,092) Other current assets (484) (5,487) Accounts payable (40,330) (13,723) Taxes accrued 14,463 7,666 Other current liabilities (16,025) 8,500 --------- --------- Net cash provided from operating activities 84,801 63,754 --------- --------- Investing Activities: Gross property additions (26,566) (36,813) Other (1,317) (10,713) --------- --------- Net cash used for investing activities (27,883) (47,526) --------- --------- Financing Activities: Increase (decrease) in notes payable, net - 9,922 Proceeds -- Senior notes 90,000 80,000 Preferred securities - 35,000 Capital contributions from parent company 1,956 682 Redemptions -- First mortgage bonds (33,350) (650) Pollution control bonds (850) - Senior notes (86,628) (80,190) Preferred securities - (35,000) Payment of preferred stock dividends (1,007) (1,007) Payment of common stock dividends (33,000) (31,750) Other (1,185) 106 --------- --------- Net cash used for financing activities (64,064) (22,887) --------- --------- Net Change in Cash and Cash Equivalents (7,146) (6,659) Cash and Cash Equivalents at Beginning of Period 62,695 18,950 --------- --------- Cash and Cash Equivalents at End of Period $ 55,549 $ 12,291 ========= ========= Supplemental Cash Flow Information: Cash paid during the period for -- Interest $10,413 $7,490 Income taxes (net of refunds) $6,073 $7,231 The accompanying notes as they relate to Mississippi Power are an integral part of these condensed financial statements. </TABLE> 66
<TABLE> <CAPTION> MISSISSIPPI POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Assets 2003 2002 - -------- ------------ --------------- (in thousands) Current Assets: <S> <C> <C> Cash and cash equivalents $ 55,549 $ 62,695 Receivables -- Customer accounts receivable 38,151 31,136 Unbilled revenues 21,215 18,434 Under recovered regulatory clause revenues 14,695 27,233 Other accounts and notes receivable 6,112 8,056 Affiliated companies 12,596 20,674 Accumulated provision for uncollectible accounts (902) (718) Fossil fuel stock, at average cost 34,026 27,303 Materials and supplies, at average cost 21,920 22,063 Assets from risk management activities 9,568 13,061 Deferred income tax assets 15,174 18,675 Other 11,445 7,469 ----------- ----------- Total current assets 239,549 256,081 ----------- ----------- Property, Plant, and Equipment: In service 1,800,392 1,786,378 Less accumulated provision for depreciation 740,374 722,231 ----------- ----------- 1,060,018 1,064,147 Construction work in progress 37,246 34,065 ----------- ----------- Total property, plant, and equipment 1,097,264 1,098,212 ----------- ----------- Other Property and Investments 1,809 1,768 ----------- ----------- Deferred Charges and Other Assets: Deferred charges related to income taxes 12,332 12,617 Prepaid pension costs 16,243 14,993 Unamortized debt issuance expense 2,503 4,304 Unamortized premium on reacquired debt 10,617 7,776 Other 39,063 16,415 ----------- ----------- Total deferred charges and other assets 80,758 56,105 ----------- ----------- Total Assets $ 1,419,380 $ 1,412,166 =========== =========== The accompanying notes as they relate to Mississippi Power are an integral part of these condensed financial statements. </TABLE> 67
<TABLE> <CAPTION> MISSISSIPPI POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Liabilities and Stockholder's Equity 2003 2002 - ------------------------------------ ------------- ----------------- (in thousands) Current Liabilities: <S> <C> <C> Securities due within one year $ 80,000 $ 69,200 Accounts payable -- Affiliated 17,679 22,396 Other 58,217 91,710 Customer deposits 7,307 6,855 Taxes accrued -- Income taxes 44,938 12,042 Other 23,031 41,464 Interest accrued 3,561 6,562 Vacation pay accrued 5,782 5,782 Regulatory clauses over recovery 24,397 35,680 Deferred revenue 14,052 - Other 8,607 8,504 ----------- ----------- Total current liabilities 287,571 300,195 ----------- ----------- Long-term debt 202,483 243,715 ----------- ----------- Deferred Credits and Other Liabilities: Accumulated deferred income taxes 144,937 146,631 Deferred credits related to income taxes 24,340 20,798 Accumulated deferred investment tax credits 20,448 21,054 Employee benefits provisions 51,076 49,869 Residual value guarantee 15,699 - Other 44,653 45,142 ----------- ----------- Total deferred credits and other liabilities 301,153 283,494 ----------- ----------- Company obligated mandatorily redeemable preferred securities of subsidiary trust holding company junior subordinated notes 35,000 35,000 ----------- ----------- Preferred stock 31,809 31,809 ----------- ----------- Common Stockholder's Equity: Common stock, without par value -- Authorized - 1,130,000 shares Outstanding - 1,121,000 shares 37,691 37,691 Paid-in capital 287,236 285,280 Premium on preferred stock 326 326 Retained earnings 237,375 195,920 Accumulated other comprehensive loss (1,264) (1,264) ----------- ----------- Total common stockholder's equity 561,364 517,953 ----------- ----------- Total Liabilities and Stockholder's Equity $ 1,419,380 $ 1,412,166 =========== =========== The accompanying notes as they relate to Mississippi Power are an integral part of these condensed financial statements. </TABLE> 68
MISSISSIPPI POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION SECOND QUARTER 2003 vs. SECOND QUARTER 2002 AND YEAR-TO-DATE 2003 vs. YEAR-TO-DATE 2002 RESULTS OF OPERATIONS Earnings Mississippi Power's net income after dividends on preferred stock for the second quarter and year-to-date 2003 was $53.1 million and $74.5 million, respectively, compared to $20.8 million and $34.8 million for the corresponding periods of 2002. Earnings increased by $32.3 million, or 155.2%, in the second quarter 2003 and $39.7 million, or 114.1%, year-to-date 2003 due primarily to a pre-tax gain of $62 million related to the termination of a PPA with Dynegy. Reference is made to Note (M) to the Condensed Financial Statements herein for additional information regarding the termination of this PPA. Significant income statement items appropriate for discussion include the following: <TABLE> <CAPTION> Increase (Decrease) -------------------------------------------------------------------- Second Quarter Year-To-Date ------------------------------------ ------------------------------- (in thousands) % (in thousands) % <S> <C> <C> <C> <C> Retail sales.................................. $ (4,543) (3.3) $ (9,040) (3.5) Sales for resale - non-affiliates............. 7,138 13.7 25,411 24.4 Sale for resale - affiliates.................. (4,791) (45.8) (8,181) (40.8) Contract termination.......................... 62,111 N/M 62,111 N/M Fuel expense.................................. (11,176) (16.7) (20,254) (16.0) Purchased power - non-affiliates.............. 95 2.2 4,071 56.1 Purchased power - affiliates.................. 7,368 70.9 20,294 114.1 Other operation expense....................... 12,640 34.1 12,442 17.2 Maintenance expense........................... (1,855) (9.0) (8,266) (20.0) N/M Not meaningful </TABLE> Retail sales. Retail sales revenue decreased by $4.5 million, or 3.3%, in the second quarter 2003 and $9 million, or 3.5%, year-to-date 2003 when compared to the same periods in 2002. During the second quarter and year-to-date 2003, retail sales revenues were down due mainly to decreased energy sales to residential and industrial customers. The primary reasons for these decreases in energy sales were milder weather and the continued economic slowdown in Mississippi Power's service area. Sales for resale - non-affiliates. In the second quarter and year-to-date 2003, sales for resale to non-affiliates increased when compared to the same periods in 2002 mainly due to increased prices associated with non-territorial energy sales. 69
MISSISSIPPI POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Sales for resale - affiliates and Purchased power - affiliates. Revenues from sales for resale to affiliated companies, as well as purchases of energy, within the Southern Company system will vary depending on demand and the availability and cost of generating resources at each company. These transactions do not have a significant impact on earnings since the energy is generally sold at marginal cost and energy purchases are generally offset by energy revenues through Mississippi Power's retail and wholesale fuel cost recovery clauses. Contract termination. In the second quarter and year-to-date 2003, this item reflects the $62 million of revenues recorded upon the termination of a PPA with Dynegy. Reference is made to Note (M) to the Condensed Financial Statements herein for additional information. Fuel expense and Purchased power - non-affiliates. During the second quarter and year-to-date 2003, fuel expense decreased and purchased power from non-affiliates increased when compared to the same periods in 2002 due to opportunities to purchase some power more economically than to generate it and due to a 1.5% reduction in demand for energy on a year-to-date basis. Since energy expenses are generally offset by energy revenues through Mississippi Power's retail and wholesale fuel cost recovery clauses, these expenses do not have a significant impact on earnings. Other operation expense. The increases in this item during the second quarter and year-to-date 2003 when compared to the corresponding periods in 2002 were caused primarily by the costs incurred in conjunction with restructuring the lease agreement for the combined cycle generating units at Plant Daniel. Reference is made to Note (R) to the Condensed Financial Statements herein for additional information. Maintenance expense. In the second quarter and year-to-date 2003, maintenance expenses were down when compared to the same periods in 2002 primarily due to scheduled maintenance performed at Plant Watson and Plant Daniel in 2002. Future Earnings Potential The results of operations discussed above are not necessarily indicative of future earnings potential. The level of future earnings depends on numerous factors including regulatory matters and the effect of weather and the economy on energy sales. For additional information relating to these issues, see Item 1 - - BUSINESS - "Risk Factors" and Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential" of Mississippi Power in the Form 10-K. Mississippi Power's business activities are subject to extensive governmental regulation related to public health and the environment. Litigation over environmental issues and claims of various types, including property damage, personal injury and citizen enforcement of environmental requirements, has increased generally throughout the United States. In particular, personal injury claims for damages caused by alleged exposure to hazardous materials have become more frequent. The ultimate outcome of such litigation currently filed against Mississippi Power cannot be predicted at this time; however, after consultation with legal counsel, management does not anticipate that the liabilities, if any, arising from such proceedings would have a material adverse effect on Mississippi Power's financial statements. 70
MISSISSIPPI POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Mississippi Power's 2003 ECO Plan filing was approved, as filed, by the Mississippi PSC on March 18, 2003 and resulted in a slight increase in rates effective April 2003. Compliance costs related to the Clean Air Act and other environmental regulations could affect earnings if such costs cannot continue to be recovered. For additional information about these issues, including the EPA litigation, see Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Environmental Matters" and Note 3 to the financial statements of Mississippi Power in the Form 10-K. Reference is made to Note (E) to the Condensed Financial Statements herein for information regarding a recent ruling by the U.S. Court of Appeals for the Eleventh Circuit. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - FERC Matters" of Mississippi Power in the Form 10-K for information on the formation of an RTO as ordered by the FERC and the notice of proposed rulemaking regarding open access transmission service and standard electricity market design. In April 2003, the FERC issued a White Paper related to its proposed rulemaking regarding open access transmission service and standard electricity market design in an effort to respond to certain of the public comments received on the standard market design proposal. Reactions to the White Paper by Southeastern state regulators reflect significant continuing differences in opinion between the FERC and various state regulatory commissions over questions of jurisdiction and protection of retail customers. These significant differences between state and federal regulators create substantial uncertainty related to the ultimate approval of SeTrans because state commission approval of the transfer of operational control of the transmission assets of Southern Company and its subsidiaries is a prerequisite to the formation of SeTrans. Pending energy legislation may also impact these issues. Any impact of the other FERC proposals on Southern Company and its subsidiaries will depend on the form in which final rules may be ultimately adopted; however, Mississippi Power's revenues, expenses, assets and liabilities could be adversely affected by changes in the transmission regulatory structure in its regional power market. Reference is made to Note (M) to the Condensed Financial Statements herein for information regarding a one-time gain of $38 million upon the amendment and termination of a PPA between Dynegy and Mississippi Power. In accordance with the amended PPA, Mississippi Power will recognize capacity revenues totaling approximately $8.8 million for the period from June through October 2003. Under the original terms of the PPAs, Mississippi Power would have recognized revenue of approximately $1.8 million for the remaining period of 2003 following the termination. Also as a result of this PPA termination, Mississippi Power continues to review alternatives for remarketing this capacity. The final outcome of this matter cannot now be determined. Reference is made to Notes (A), (E), (H), (M), (Q) and (R) to the Condensed Financial Statements herein for discussion of various contingencies and other matters which may affect future earnings potential. Accounting Policies Critical Policies Mississippi Power's significant accounting policies are described in Note 1 to the financial statements of Mississippi Power in Item 8 of the Form 10-K. Mississippi Power's critical accounting policies involve rate regulation and lease accounting. 71
MISSISSIPPI POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Mississippi Power is subject to the provisions of FASB Statement No. 71, "Accounting for the Effects of Certain Types of Regulation." In the event that a portion of Mississippi Power's operations is no longer subject to these provisions, Mississippi Power would be required to write off related regulatory assets and liabilities that are not specifically recoverable and determine if any other assets, including plant, have been impaired. Additionally, Mississippi Power accounts for its lease of two generating units at Plant Daniel totaling 1,064 megawatts of capacity as an operating lease. Reference is made to Note (R) of the Condensed Financial Statements herein for an explanation of the restructuring activity that took place during the second quarter of 2003 to allow for continued off-balance sheet accounting treatment. Effective July 1, 2003, FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" would have required Mississippi Power to consolidate the assets and liabilities of Escatawpa Funding, Limited Partnership ("Escatawpa"), the special purpose entity, from which Mississippi Power leased the units. Under the restructured lease with Juniper Capital, consolidation is not required. New Accounting Standards Reference is made to Note (J) to the Condensed Financial Statements herein for information regarding the adoption of FASB Statement No. 143, "Accounting for Asset Retirement Obligations" effective January 1, 2003. Statement No. 143 establishes new accounting and reporting standards for legal obligations associated with the ultimate cost of retiring long-lived assets. The present value of the ultimate costs for an asset's future retirement must be recorded in the period in which the liability is incurred. The cost must be capitalized as part of the related long-lived asset and depreciated over the asset's useful life. Additionally, Statement No. 143 does not permit non-regulated companies to continue accruing future retirement costs for long-lived assets that they do not have a legal obligation to retire. Prior to January 2003, Mississippi Power accrued for the ultimate cost of retiring most long-lived assets over the life of the related asset through depreciation expense. FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This interpretation applies to guarantees issued or modified after December 31, 2002. In accordance with FASB Interpretation No. 45, Mississippi Power has recorded a $16 million liability for the fair value of its residual value guarantee associated with the lease of two generating units at Plant Daniel. FASB Interpretation No. 46 requires the primary beneficiary of a variable interest entity to consolidate the related assets and liabilities. On July 1, 2003, Mississippi Power adopted Interpretation No. 46 with no financial statement impact following the completion of restructuring the lease arrangement for the combined cycle generating units at Plant Daniel. See Financial Condition - - "Off-Balance Sheet Financing Arrangements" and Note (R) to the Condensed Financial Statements herein for further information on the lease restructuring. 72
MISSISSIPPI POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," which requires classification of certain financial instruments within its scope, including shares that are mandatorily redeemable, as liabilities. Statement No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise on July 1, 2003 for calendar year companies. In accordance with Statement No. 150, Mississippi Power reclassified $35 million of mandatorily redeemable preferred securities as liabilities effective July 1, 2003. The implementation of Statement No. 150 did not have a material effect on Mississippi Power's Statements of Income and Cash Flows. FINANCIAL CONDITION Overview Major changes in Mississippi Power's financial condition during the first six months of 2003 included the addition of approximately $26.6 million to utility plant. The funds for these additions and other capital requirements were derived primarily from operating activities. See Mississippi Power's Condensed Statements of Cash Flows herein for further details. Off-Balance Sheet Financing Arrangements In May 2001, Mississippi Power began the initial 10-year term of an operating lease agreement with Escatawpa, a special purpose entity, to use a combined-cycle generating facility located at Mississippi Power's Plant Daniel. The facility cost approximately $370 million. Reference is made to Note 8 to the financial statements of Mississippi Power in Item 8 of the Form 10-K under "Lease Agreements", "Critical Policies" above and Note (R) to the Condensed Financial Statements herein for additional information. In June 2003, Escatawpa sold its ownership interests in the facility to Juniper Capital L.P. ("Juniper"). Simultaneously, Juniper entered into a restructured lease agreement with Mississippi Power. The terms of the lease with Juniper are substantially the same as the lease with Escatawpa. In accordance with FASB Interpretation No. 46, Mississippi Power is not required to consolidate the leased assets and related liabilities. Furthermore, the restructured lease agreement is an operating lease under FASB Statement No. 13, "Accounting for Leases." Accordingly, the lease is not reflected on the condensed balance sheet of Mississippi Power. Credit Rating Risk Mississippi Power does not have any credit agreements that would require material changes in payment schedules or terminations as a result of a credit rating downgrade. There are certain fixed-price physical gas purchase contracts that could require collateral -- but not accelerated payment -- in the event of a credit rating change to below investment grade; however, at June 30, 2003, this exposure was immaterial. Exposure to Market Risks Mississippi Power's market risk exposures relative to interest rate changes have not changed materially compared with the December 31, 2002 reporting period. In addition, Mississippi Power is not aware of any facts or circumstances that would significantly affect such exposures in the near term. 73
MISSISSIPPI POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Due to cost-based rate regulation, Mississippi Power has limited exposure to market volatility in interest rates, commodity fuel prices and prices of electricity. To mitigate residual risks relative to movements in electricity prices, Mississippi Power enters into fixed price contracts for the purchase and sale of electricity through the wholesale electricity market and, to a lesser extent, similar contracts for gas purchases. Mississippi Power has also implemented retail fuel hedging programs at the instruction of its PSC and wholesale fuel hedging programs under agreements with wholesale customers. The fair value of derivative, fuel and energy contracts was as follows: Second Quarter 2003 Year-to-Date Changes Changes ---------------------------------- ---------------------------------------- Fair Value ---------------------------------- ---------------------------------------- (in thousands) Contracts beginning of period $13,306 $12,864 Contracts realized or settled (5,176) (9,327) New contracts at inception - - Changes in valuation techniques - - Current period changes 579 5,172 ---------------------------------- ------------------------ --------------- Contracts at June 30, 2003 $8,709 $8,709 ================================== ======================== =============== Source of June 30, 2003 Valuation Prices --------------------------- --------------- --------------------------- Total Maturity --------------------------- Fair Value Year 1 1-3 Years --------------------------- ------------------------------------------- (in thousands) Actively quoted $8,709 $8,646 $63 External sources - - - Models and other methods - - - --------------------------- --------------- ------------- ------------- Contracts at June 30, 2003 $8,709 $8,646 $63 =========================== =============== ============= ============= Unrealized gains and losses from mark to market adjustments on contracts related to the retail and wholesale fuel hedging programs are recorded as regulatory assets and liabilities. Realized gains and losses from these programs are included in fuel expense and are recovered through Mississippi Power's energy cost management clauses. Reference is made to Note 1 to the financial statements of Mississippi Power under "Financial Instruments" in Item 8 of the Form 10-K regarding the respective approvals of the retail and wholesale energy cost management clauses. Gains and losses on contracts that do not represent hedges are recognized in the Statements of Income as incurred. At June 30, 2003, the fair value of derivative energy contracts reflected in the financial statements was as follows: Amounts --------------------------------------- -------------------- (in thousands) Regulatory liabilities, net $8,752 Other comprehensive income - Net loss (43) --------------------------------------- ------------------------- Total fair value $8,709 ======================================= ========================= 74
MISSISSIPPI POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION For the quarter and year-to-date periods ended June 30, 2003 and 2002, the realized gains and losses recognized in income were immaterial. For additional information, reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Market Price Risk" of Mississippi Power in the Form 10-K and Note 1 to the financial statements of Mississippi Power in Item 8 of the Form 10-K. Financing Activities In April 2003, Mississippi Power issued $90 million of Series E 5-5/8% Senior Notes due May 1, 2033. The proceeds from this sale were used to repay at maturity $35 million of Mississippi Power's Series B 6.05% Senior Notes due May 1, 2003, to redeem the $51.6 million outstanding principal amount of Mississippi Power's Series A 6.75% Senior Insured Quarterly Notes due June 30, 2038 and to repay a portion of Mississippi Power's outstanding short-term indebtedness. Mississippi Power plans to continue, to the extent possible, a program to retire higher-cost debt and replace these securities with lower-cost capital. Capital Requirements Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS of Mississippi Power under "Capital Requirements for Construction," "Environmental Matters" and "Other Capital Requirements" and Note 3 to the financial statements in the Form 10-K for a description of Mississippi Power's capital requirements for its construction program, environmental compliance efforts and maturities of long-term debt. Sources of Capital In addition to the financing activities previously described herein, Mississippi Power plans to obtain the funds required for construction and other purposes from sources similar to those used in the past. The amount, type and timing of any financings -- if needed -- will depend upon maintenance of adequate earnings, regulatory approval, prevailing market conditions and other factors. See Item 1 - BUSINESS - "Financing Programs" in the Form 10-K for additional information. Mississippi Power's current liabilities exceed current assets due to scheduled maturities of long-term debt. To meet short-term cash needs and contingencies, Mississippi Power had at June 30, 2003 approximately $55.5 million of cash and cash equivalents and $99.5 million of unused committed credit arrangements with banks that expire in 2003 and 2004. Approximately $37 million of these credit arrangements contain provisions allowing two-year term loans executable at expiration date. The credit arrangements provide liquidity support to Mississippi Power's obligations with respect to variable rate pollution control bonds and commercial paper. Mississippi Power may also meet short-term cash needs through a Southern Company subsidiary organized to issue and sell commercial paper and extendible commercial notes at the request and for the benefit of Mississippi Power and other Southern Company subsidiaries. At June 30, 2003, Mississippi Power had no outstanding commercial paper. Management believes that the need for working capital can be adequately met by utilizing lines of credit without maintaining large cash balances. 75
SAVANNAH ELECTRIC AND POWER COMPANY 76
<TABLE> <CAPTION> SAVANNAH ELECTRIC AND POWER COMPANY CONDENSED STATEMENTS OF INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, 2003 2002 2003 2002 ------- ------ ----- ------ (in thousands) (in thousands) Operating Revenues: <S> <C> <C> <C> <C> Retail sales $75,468 $74,293 $139,014 $129,240 Sales for resale -- Non-affiliates 1,773 2,097 3,807 3,030 Affiliates 912 1,264 3,236 2,162 Other revenues 757 706 1,835 1,306 ------- ------- -------- -------- Total operating revenues 78,910 78,360 147,892 135,738 ------- ------- -------- -------- Operating Expenses: Operation -- Fuel 12,594 14,148 24,019 23,076 Purchased power -- Non-affiliates 1,390 2,067 3,402 3,134 Affiliates 22,080 17,396 41,093 29,523 Other 13,882 12,926 26,981 25,998 Maintenance 6,689 7,447 12,599 12,772 Depreciation and amortization 5,088 6,079 10,149 12,588 Taxes other than income taxes 3,652 3,703 7,099 7,188 ------- ------- -------- -------- Total operating expenses 65,375 63,766 125,342 114,279 ------- ------- -------- -------- Operating Income 13,535 14,594 22,550 21,459 Other Income and (Expense): Interest expense, net of amounts capitalized (2,473) (2,705) (5,094) (5,474) Distributions on preferred securities of subsidiary (685) (685) (1,370) (1,370) Other income (expense), net (361) 93 (570) (533) ------- ------- -------- -------- Total other income and (expense) (3,519) (3,297) (7,034) (7,377) ------- ------- -------- -------- Earnings Before Income Taxes 10,016 11,297 15,516 14,082 Income taxes 3,720 4,262 5,711 5,245 ------- --------- -------- -------- Net Income $ 6,296 $ 7,035 $ 9,805 $ 8,837 ======= ========= ======== ======== The accompanying notes as they relate to Savannah Electric are an integral part of these condensed financial statements. </TABLE> 77
<TABLE> <CAPTION> SAVANNAH ELECTRIC AND POWER COMPANY CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Six Months Ended June 30, 2003 2002 -------- -------- (in thousands) Operating Activities: <S> <C> <C> Net income $ 9,805 $ 8,837 Adjustments to reconcile net income to net cash provided from operating activities -- Depreciation and amortization 11,197 12,968 Deferred income taxes and investment tax credits, net 521 (6,056) Pension, postretirement, and other employee benefits 3,203 3,153 Other, net 4,085 (3,188) Changes in certain current assets and liabilities -- Receivables, net (3,986) 2,207 Fossil fuel stock (1,951) 1,056 Materials and supplies (278) 3,712 Other current assets 2,469 (3,150) Accounts payable (4,168) 4,120 Taxes accrued 2,044 (561) Other current liabilities (5,808) 2,067 --------- -------- Net cash provided from operating activities 17,133 25,165 --------- -------- Investing Activities: Gross property additions (19,557) (20,432) Other 298 510 --------- -------- Net cash used for investing activities (19,259) (19,922) --------- -------- Financing Activities: Increase in notes payable, net 29,054 4,351 Proceeds -- Pollution control bonds 13,870 - Other long-term debt - 159 Capital contributions from parent company 5,860 1,267 Redemptions -- First mortgage bonds - (436) Pollution control bonds (13,870) - Senior notes (20,000) - Other long-term debt (463) - Payment of common stock dividends (11,500) (11,350) Other (149) (25) --------- -------- Net cash provided from (used for) financing activities 2,802 (6,034) --------- -------- Net Change in Cash and Cash Equivalents 676 (791) Cash and Cash Equivalents at Beginning of Period 3,978 2,391 --------- -------- Cash and Cash Equivalents at End of Period $ 4,654 $ 1,600 ========= ======== Supplemental Cash Flow Information: Cash paid during the period for -- Interest (net of $113 and $148 capitalized for 2003 and 2002, respectively) $5,946 $5,536 Income taxes (net of refunds) $403 $15,148 The accompanying notes as they relate to Savannah Electric are an integral part of these condensed financial statements. </TABLE> 78
<TABLE> <CAPTION> SAVANNAH ELECTRIC AND POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Assets 2003 2002 - ------ ---------- --------------- (in thousands) Current Assets: <S> <C> <C> Cash and cash equivalents $ 4,654 $ 3,978 Receivables -- Customer accounts receivable 24,264 22,631 Unbilled revenues 13,474 11,531 Other accounts and notes receivable 1,711 2,937 Affiliated companies 2,792 1,102 Accumulated provision for uncollectible accounts (735) (682) Fossil fuel stock, at average cost 10,280 8,328 Materials and supplies, at average cost 9,864 9,586 Prepaid taxes 22,385 24,414 Other 2,522 2,066 --------- --------- Total current assets 91,211 85,891 --------- --------- Property, Plant, and Equipment: In service 894,856 880,604 Less accumulated provision for depreciation 428,014 416,232 --------- --------- 466,842 464,372 Construction work in progress 11,722 6,082 --------- --------- Total property, plant, and equipment 478,564 470,454 --------- --------- Other Property and Investments 2,117 3,648 --------- --------- Deferred Charges and Other Assets: Deferred charges related to income taxes 10,886 11,692 Cash surrender value of life insurance for deferred compensation plans 22,147 21,943 Unamortized debt issuance expense 3,767 3,757 Unamortized premium on reacquired debt 7,835 8,103 Other 15,117 11,717 --------- --------- Total deferred charges and other assets 59,752 57,212 --------- --------- Total Assets $ 631,644 $ 617,205 ========= ========- The accompanying notes as they relate to Savannah Electric are an integral part of these condensed financial statements. </TABLE> 79
<TABLE> <CAPTION> SAVANNAH ELECTRIC AND POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Liabilities and Stockholder's Equity 2003 2002 - ------------------------------------ ------------ --------------- (in thousands) Current Liabilities: <S> <C> <C> Securities due within one year $ 875 $ 20,892 Notes payable 31,951 2,897 Accounts payable -- Affiliated 11,172 7,889 Other 7,122 15,769 Customer deposits 6,882 6,781 Taxes accrued -- Income taxes 1,311 311 Other 4,361 3,317 Interest accrued 3,039 3,268 Vacation pay accrued 2,481 2,427 Other 9,499 15,233 --------- --------- Total current liabilities 78,693 78,784 --------- --------- Long-term debt 167,606 168,052 --------- --------- Deferred Credits and Other Liabilities: Accumulated deferred income taxes 80,933 78,970 Deferred credits related to income taxes 11,093 12,445 Accumulated deferred investment tax credits 8,957 9,289 Employee benefits provisions 36,821 33,619 Other 23,572 16,242 --------- --------- Total deferred credits and other liabilities 161,376 150,565 --------- --------- Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding company junior subordinated notes 40,000 40,000 --------- --------- Common Stockholder's Equity: Common stock, par value $5 per share -- Authorized - 16,000,000 shares Outstanding - 10,844,635 shares Par value 54,223 54,223 Paid-in capital 22,637 16,776 Retained earnings 108,353 110,049 Accumulated other comprehensive loss (1,244) (1,244) --------- --------- Total common stockholder's equity 183,969 179,804 --------- --------- Total Liabilities and Stockholder's Equity $ 631,644 $ 617,205 ========= ========= The accompanying notes as they relate to Savannah Electric are an integral part of these condensed financial statements. </TABLE> 80
SAVANNAH ELECTRIC AND POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION SECOND QUARTER 2003 vs. SECOND QUARTER 2002 AND YEAR-TO-DATE 2003 vs. YEAR-TO-DATE 2002 RESULTS OF OPERATIONS Earnings Savannah Electric's net income for the second quarter and year-to-date 2003 was $6.3 million and $9.8 million, respectively, compared to $7 million and $8.8 million for the corresponding periods of 2002. Earnings in the second quarter were down $0.7 million, or 10.5%, due primarily to higher operating expenses. Year-to-date 2003 earnings were up by $1 million, or 11%, as a result of higher operating revenues and lower interest expenses, which were partially offset by higher operating expenses. Significant income statement items appropriate for discussion include the following: <TABLE> <CAPTION> Increase (Decrease) -------------------------------------------------------------------- Second Quarter Year-To-Date ------------------------------------ ------------------------------- (in thousands) % (in thousands) % <S> <C> <C> <C> <C> Retail sales.................................. $ 1,175 1.6 $ 9,774 7.6 Sales for resale - non-affiliates............. (324) (15.5) 777 25.6 Sale for resale - affiliates.................. (352) (27.8) 1,074 49.7 Fuel expense.................................. (1,554) (11.0) 943 4.1 Purchased power - non-affiliates.............. (677) (32.8) 268 8.6 Purchased power - affiliates.................. 4,684 26.9 11,570 39.2 Other operation expense....................... 956 7.4 983 3.8 Maintenance expense........................... (758) (10.2) (173) (1.4) Depreciation and amortization................. (991) (16.3) (2,439) (19.4) Interest expense, net of amounts capitalized................................ (232) (8.6) (380) (6.9) </TABLE> Retail sales. Excluding fuel revenues, which do not affect net income, retail sales revenue decreased by $0.5 million, or 1.1%, in the second quarter 2003 and increased by $2.2 million, or 2.7%, year-to-date 2003 when compared to the corresponding periods in 2002. The second quarter 2003 decrease is primarily due to a 5.8% decrease in energy sales to retail customers. Residential and commercial energy sales were down by 8.8% and 6.4%, respectively, reflecting milder-than-normal temperatures and industrial energy sales were up 3.6% when compared to the same period in 2002. The year-to-date 2003 increase is primarily a result of the base rate increase that took effect in June 2002. Year-to-date 2003, energy sales to industrial customers were higher by 10.2% in contrast to energy sales to residential and commercial customers that were down by 0.3% and 2.5%, respectively. The increases in energy sales to the industrial sector are attributed to increased usage by several industrial customers. Residential and commercial energy sales were down slightly reflecting milder than normal weather. 81
SAVANNAH ELECTRIC AND POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Sales for resale - non-affiliates. The decrease in the second quarter 2003 is mainly due to lower demand for energy by these non-affiliated customers when compared to the same period in 2002. Year-to-date 2003 sales for resale to non-affiliates increased when compared to the same period in 2002 primarily due to increased demand for energy by non-affiliates. These transactions do not have a significant impact on earnings since the energy is usually sold at marginal cost. Sales for resale - affiliates. Revenues from sales for resale to affiliated companies within the Southern Company system will vary depending on demand and the availability and cost of generating resources at each company. These transactions do not have a significant impact on earnings since the energy is generally sold at marginal cost. Fuel expense. The second quarter 2003 decrease in fuel expense is primarily due to lower demand as compared to the corresponding period in 2002. Fuel expense increased year-to-date 2003 due primarily to increased generation related to the higher demand for energy in the first quarter 2003. Since fuel expenses are generally offset by fuel revenues through Savannah Electric's fuel cost recovery clause, these expenses do not have a significant impact on net income. Purchased power - non-affiliates. In the second quarter 2003, purchased power from non-affiliates decreased due to reduced demand for energy from non-affiliates. Year-to-date 2003 purchased power from non-affiliates increased because of the opportunity to purchase this energy at a cost lower than self-generation in the first quarter 2003 as compared to the same period in 2002. These transactions do not have a significant impact on earnings, as energy costs are generally recovered through Savannah Electric's fuel cost recovery clause. Purchased power - affiliates. The increases in purchased power from affiliates in the second quarter and year-to-date 2003 were directly related to the new PPA with Southern Power which became effective June 2002. The annual capacity costs of this PPA are approximately $14.0 million. Capacity costs of purchased power are generally recovered through base rates and the energy component is recovered through the fuel cost recovery clause. Purchased power from affiliates also includes energy purchases which will vary depending on demand and cost of generation resources at each company. These energy costs are recovered through the fuel cost recovery clause and have no significant impact on earnings. Other operation expense. The increases for the second quarter and year-to-date 2003 are attributed to an increase in administrative and general expenses primarily relating to employee benefits and to new marketing programs when compared to the same periods in the prior year. Maintenance expense. The decreases in the second quarter and year-to-date 2003 are related to scheduled maintenance outages at one of Savannah Electric's steam plants. Depreciation and amortization. During the second quarter and year-to-date 2003, this item decreased mainly due to discontinued accelerated depreciation and the amortization of the related regulatory liability that began in June 2002, in accordance with the 2002 base rate order. Interest expense, net of amounts capitalized. This expense decreased in the second quarter and year-to-date 2003 as a result of a lower amount of debt outstanding and lower interest rates when compared to the corresponding periods in 2002. 82
SAVANNAH ELECTRIC AND POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Future Earnings Potential The results of operations discussed above are not necessarily indicative of future earnings potential. The level of future earnings depends on numerous factors which include maintaining a stable regulatory environment and achieving energy sales growth while containing costs. For additional information relating to these issues, reference is made to Item 1 - BUSINESS - "Risks Factors" and Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential" of Savannah Electric in the Form 10-K. Savannah Electric's business activities are subject to extensive governmental regulation related to public health and the environment. Litigation over environmental issues and claims of various types, including property damage, personal injury and citizen enforcement of environmental requirements, has increased generally throughout the United States. In particular, personal injury claims for damages caused by alleged exposure to hazardous materials have become more frequent. The ultimate outcome of such litigation currently filed against Savannah Electric cannot be predicted at this time; however, after consultation with legal counsel, management does not anticipate that the liabilities, if any, arising from such proceedings would have a material adverse effect on Savannah Electric's financial position, results of operations or cash flows. Compliance costs related to the Clean Air Act and other environmental regulations could affect earnings if such costs cannot be recovered. For additional information about these issues, including the EPA litigation, see Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Environmental Matters" and Note 3 to the financial statements of Savannah Electric in the Form 10-K. Reference is made to Note (E) to the Condensed Financial Statements herein for information regarding a recent ruling by the U.S. Court of Appeals for the Eleventh Circuit. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - FERC Matters" of Savannah Electric in the Form 10-K for information on the formation of an RTO as ordered by the FERC and the notice of proposed rulemaking regarding open access transmission service and standard electricity market design. In April 2003, the FERC issued a White Paper related to its proposed rulemaking regarding open access transmission service and standard electricity market design in an effort to respond to certain of the public comments received on the standard market design proposal. Reactions to the White Paper by Southeastern state regulators reflect significant continuing differences in opinion between the FERC and various state regulatory commissions over questions of jurisdiction and protection of retail customers. These significant differences between state and federal regulators create substantial uncertainty related to the ultimate approval of SeTrans because state commission approval of the transfer of operational control of the transmission assets of Southern Company and its subsidiaries is a prerequisite to the formation of SeTrans. Pending energy legislation may also impact these issues. Any impact of the other FERC proposals on Southern Company and its subsidiaries will depend on the form in which final rules may be ultimately adopted; however, Savannah Electric's revenues, expenses, assets, and liabilities could be adversely affected by changes in the transmission regulatory structure in its regional power market. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential" of Savannah Electric in the Form 10-K for information on plans to retire a 102 megawatt peaking facility in May 2005 and a fifteen-year PPA with Southern Power to purchase 200 megawatts of capacity beginning in June 2005 from the planned combined-cycle plant at Plant McIntosh to be built and owned by Southern Power. The annual capacity cost is expected to be approximately $14.5 million. Reference is made to Note (P) to the Condensed Financial Statements herein for information regarding the FERC approval process for this PPA. 83
SAVANNAH ELECTRIC AND POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Reference is made to Notes (A), (E), (H) and (P) to the Condensed Financial Statements herein for discussion of various contingencies and other matters which may affect future earnings potential. Accounting Policies Critical Policy Savannah Electric's significant accounting policies are described in Note 1 to the financial statements of Savannah Electric in Item 8 of the Form 10-K. Savannah Electric's critical accounting policy involves rate regulation. Savannah Electric is subject to the provisions of FASB Statement No. 71, "Accounting for the Effects of Certain Types of Regulation." In the event that a portion of Savannah Electric's operations is no longer subject to these provisions, Savannah Electric would be required to write off related regulatory assets and liabilities that are not specifically recoverable and determine if any other assets have been impaired. New Accounting Standards Reference is made to Note (J) to the Condensed Financial Statements herein for information regarding the adoption of FASB Statement No. 143, "Accounting for Asset Retirement Obligations" effective January 1, 2003. Statement No. 143 establishes new accounting and reporting standards for legal obligations associated with the ultimate cost of retiring long-lived assets. The present value of the ultimate costs for an asset's future retirement must be recorded in the period in which the liability is incurred. The cost must be capitalized as part of the related long-lived asset and depreciated over the asset's useful life. Additionally, Statement No. 143 does not permit non-regulated companies to continue accruing future retirement costs for long-lived assets that they do not have a legal obligation to retire. Prior to January 2003, Savannah Electric accrued for the ultimate cost of retiring most long-lived assets over the life of the related asset through depreciation expense. In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," which requires classification of certain financial instruments within its scope, including shares that are mandatorily redeemable, as liabilities. Statement No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise on July 1, 2003 for calendar year companies. In accordance with Statement No. 150, Savannah Electric reclassified $40 million of mandatorily redeemable preferred securities as liabilities effective July 1, 2003. The implementation of Statement No. 150 did not have a material effect on Savannah Electric's Statements of Income and Cash Flows. FINANCIAL CONDITION Overview Major changes in Savannah Electric's financial condition during the first six months of 2003 included the addition of approximately $19.6 million to utility plant. The funds for these additions and other capital requirements were derived primarily from operations and the issuance of securities. See Savannah Electric's Condensed Statements of Cash Flows herein for further details. 84
SAVANNAH ELECTRIC AND POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Credit Rating Risk Savannah Electric does not have any credit agreements that would require material changes in payment schedules or terminations as a result of a credit rating downgrade. Exposure to Market Risks Savannah Electric's market risk exposures relative to interest rate changes have not changed materially compared with the December 31, 2002 reporting period. In addition, Savannah Electric is not aware of any facts or circumstances that would significantly affect such exposures in the near term. Due to cost-based rate regulations, Savannah Electric has limited exposure to market volatility in interest rates, commodity fuel prices and prices of electricity. To mitigate residual risks relative to movements in electricity prices, Savannah Electric enters into fixed price contracts for the purchase and sale of electricity through the wholesale electricity market and, to a lesser extent, similar contracts for gas purchases. Savannah Electric has also implemented a retail fuel hedging program at the instruction of the Georgia PSC. The fair value of derivative energy contracts at June 30, 2003 was as follows: Second Quarter 2003 Year-to-Date Changes Changes --------------------------------- ---------------------------------------- Fair Value --------------------------------- ---------------------------------------- (in thousands) Contracts beginning of period $1,270 $ 626 Contracts realized or settled (1,130) (1,130) New contracts at inception - - Changes in valuation techniques - - Current period changes 37 681 --------------------------------- ------------------------ --------------- Contracts at June 30, 2003 $177 $177 ================================= ======================== =============== Source of June 30, 2003 Valuation Prices ------------------------------ ------------- ----------------------------- Total Maturity ----------------------------- Fair Value Year 1 1-3 Years ------------------------------ ------------------------------------------- (in thousands) Actively quoted $177 $537 $(360) External sources - - - Models and other methods - - - ------------------------------ ------------- -------------- -------------- Contracts at June 30, 2003 $177 $537 $(360) ============================== ============= ============== ============== Unrealized gains and losses from mark to market adjustments on contracts related to the retail fuel hedging programs are recorded as regulatory assets and liabilities. At June 30, 2003, Savannah Electric had approximately $0.2 million in regulatory liabilities related to unrealized gains on mark to market derivative contracts associated with its fuel hedging programs. Gains and losses on contracts that do not represent hedges are recognized in the Statements of Income as incurred. For the three months and six months ended June 30, 2003 and 2002, these amounts were not material. 85
SAVANNAH ELECTRIC AND POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION For additional information, reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Exposure to Market Risks" of Savannah Electric in the Form 10-K and Note 1 to the financial statements of Savannah Electric in Item 8 of the Form 10-K. Financing Activities In February 2003, Savannah Electric sold through a public authority an aggregate principal amount of $13.87 million of variable rate Pollution Control Revenue Bonds, Series 2003 due February 1, 2038. The proceeds from this sale, together with any investment proceeds and other moneys of Savannah Electric, were used to redeem $13.87 million aggregate principal amount of Pollution Control Revenue Bonds, Series 1997. The 2003 bonds will bear interest at a rate to be determined by the auction rate process. In July 2003, Savannah Electric entered a swap to hedge interest payments associated with an anticipated debt issuance planned in December 2003. The swap is for a notional amount of $25 million at a fixed interest rate of 5.025% and matures in December 2013. Savannah Electric plans to continue, to the extent possible, a program to retire higher-cost debt and replace these securities with lower-cost capital. Capital Requirements Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS of Savannah Electric under "Capital Requirements for Construction," "Other Capital Requirements" and "Environmental Matters" in the Form 10-K for a description of Savannah Electric's capital requirements for its construction program, maturing debt and environmental compliance efforts. Sources of Capital Savannah Electric plans to obtain the funds required for construction and other purposes from sources similar to those used in the past. The amount, type and timing of any financings -- if needed -- will depend upon maintenance of adequate earnings, regulatory approval, prevailing market conditions and other factors. See Item 1 - BUSINESS - "Financing Programs" in the Form 10-K for additional information. To meet short-term cash needs and contingencies, Savannah Electric had at June 30, 2003 approximately $4.7 million of cash and cash equivalents and $55 million of unused committed credit arrangements with banks, of which $31 million expires in 2003 and $24 million expires in 2004 and beyond. Of the unused credit arrangements expiring in 2003 and 2004, $30 million includes either one or two year term loan options executable at the expiration date. The credit arrangements provide liquidity support to some of Savannah Electric's obligations with respect to its variable rate debt and its commercial paper. Savannah Electric may also meet short-term cash needs through a Southern Company subsidiary organized to issue and sell commercial paper and extendible commercial notes at the request and for the benefit of Savannah Electric and other Southern Company subsidiaries. At June 30, 2003, Savannah Electric had $32 million of outstanding commercial paper. Since Savannah Electric has no major generating plants under construction, management believes that the need for working capital can be adequately met by utilizing lines of credit. 86
SOUTHERN POWER COMPANY 87
<TABLE> <CAPTION> SOUTHERN POWER COMPANY CONDENSED STATEMENTS OF INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, 2003 2002 2003 2002 ----- ------ ----- ------- (in thousands) (in thousands) Operating Revenues: Sales for resale -- <S> <C> <C> <C> <C> Non-affiliates $ 68,997 $ 25,355 $119,266 $ 42,842 Affiliates 86,079 32,337 141,369 34,147 Contract termination 80,000 - 80,000 - Other revenues 3,205 85 5,085 87 --------- --------- -------- --------- Total Operating Revenues 238,281 57,777 345,720 77,076 Operating Expenses: Operation -- Fuel 35,198 19,173 55,236 21,165 Purchased power -- Non-affiliates 16,237 7,611 31,560 10,725 Affiliates 31,670 3,421 49,602 4,791 Other 12,327 6,213 18,235 8,402 Maintenance 303 801 2,480 871 Depreciation and amortization 8,062 3,484 14,606 5,485 Taxes other than income taxes 2,063 802 3,363 1,503 --------- --------- -------- --------- Total operating expenses 105,860 41,505 175,082 52,942 --------- --------- -------- --------- Operating Income 132,421 16,272 170,638 24,134 Other Income and (Expense): Interest expense, net of amounts capitalized (2,944) (1,195) (4,343) (1,195) Other income (expense), net (174) (624) 129 (1,220) --------- --------- -------- --------- Total other income and (expense) (3,118) (1,819) (4,214) (2,415) --------- --------- -------- --------- Earnings Before Income Taxes 129,303 14,453 166,424 21,719 Income taxes 50,013 5,595 64,376 8,406 --------- --------- -------- --------- Earnings Before Cumulative Effect of Accounting Change 79,290 8,858 102,048 13,313 Cumulative effect of accounting change -- less income taxes of $231 thousand - - 367 - --------- --------- -------- --------- Net Income $ 79,290 $ 8,858 $102,415 $ 13,313 ========= ========= ======== ========= The accompanying notes as they relate to Southern Power are an integral part of these condensed financial statements. </TABLE> 88
<TABLE> <CAPTION> SOUTHERN POWER COMPANY CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Six Months Ended June 30, 2003 2002 ----- ------ (in thousands) Operating Activities: <S> <C> <C> Net income $ 102,415 $ 13,313 Adjustments to reconcile net income to net cash provided from operating activities -- Depreciation and amortization 13,924 6,871 Deferred income taxes and investment tax credits, net 10,514 (1,888) Deferred capacity revenues (10,159) 4,309 Other, net 878 2,671 Changes in certain current assets and liabilities -- Receivables, net (34,680) (37,958) Fossil fuel stock 4,678 342 Materials and supplies (324) 663 Other current assets (7,287) 109 Accounts payable 23,023 17,126 Taxes accrued 46,627 10,780 Interest accrued (3,781) 1,198 Other current liabilities - (631) ----------- --------- Net cash provided from operating activities 145,828 16,905 ----------- --------- Investing Activities: Gross property additions (231,396) (853,256) Change in construction related payables (19,587) (20,390) Other 1,079 (333) ----------- --------- Net cash used for investing activities (249,904) (873,979) ----------- --------- Financing Activities: Increase in notes payable, net 488,326 185,392 Proceeds -- Senior notes - 574,189 Capital contributions from parent company 385 253,772 Redemptions -- Other long-term debt (380,163) (135,000) Other (2,540) (19,629) ----------- --------- Net cash provided from financing activities 106,008 858,724 ----------- --------- Net Change in Cash and Cash Equivalents 1,932 1,650 Cash and Cash Equivalents at Beginning of Period 19,474 3,711 ----------- --------- Cash and Cash Equivalents at End of Period $ 21,406 $ 5,361 ----------- --------- Supplemental Cash Flow Information: Cash paid during the period for -- Interest (net of $23,890 and $13,436 capitalized for 2003 and 2002, respectively) $- $- Income taxes (net of refunds) $10,831 $724 The accompanying notes as they relate to Southern Power are an integral part of these condensed financial statements. </TABLE> 89
<TABLE> <CAPTION> SOUTHERN POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Assets 2003 2002 - ----- ------------ --------------- (in thousands) Current Assets: <S> <C> <C> Cash and cash equivalents $ 21,406 $ 19,474 Receivables -- Customer accounts receivable 8,350 6,609 Affiliated companies 44,494 11,555 Accumulated provision for uncollectible accounts (350) (350) Fossil fuel stock, at average cost 6,353 11,031 Materials and supplies, at average cost 6,877 6,553 Prepayments 11,419 8,796 Assets from risk management activities 5,601 8,386 Other 6,232 1,568 ---------- ------------ Total current assets 110,382 73,622 ---------- ------------ Property, Plant, and Equipment: In service 1,668,361 896,163 Less accumulated provision for depreciation 35,514 21,590 ` ---------- ------------ 1,632,847 874,573 Construction work in progress 555,136 1,082,987 ---------- ------------ Total property, plant, and equipment 2,187,983 1,957,560 ---------- ------------ Deferred Charges and Other Assets: Accumulated deferred income taxes 36,362 38,591 Unamortized debt issuance expense 15,086 12,177 Other 2,931 4,026 ---------- ------------ Total deferred charges and other assets 54,379 54,794 ---------- ------------ Total Assets $2,352,744 $ 2,085,976 ========== ============ The accompanying notes as they relate to Southern Power are an integral part of these condensed financial statements. </TABLE> 90
<TABLE> <CAPTION> SOUTHERN POWER COMPANY CONDENSED BALANCE SHEETS (UNAUDITED) At June 30, At December 31, Liabilities and Stockholder's Equity 2003 2002 - ------------------------------------ ----------- -------------- (in thousands) Current Liabilities: <S> <C> <C> Securities due within one year $ 200 $ 200 Notes payable 492,351 - Notes payable to parent 16,663 210,488 Accounts payable -- Affiliated 36,881 37,748 Other 8,825 4,522 Taxes accrued -- Income taxes 47,046 3,915 Other 7,809 4,313 Interest accrued 16,932 20,713 Other 6,305 3,484 ----------- ----------- Total current liabilities 633,012 285,383 ----------- ----------- Long-Term Debt: Senior notes 575,000 575,000 Other long-term debt 1,685 382,089 Unamortized debt (discount) premium, net (1,170) (1,210) ----------- ----------- Long-term debt 575,515 955,879 ----------- ----------- Deferred Credits and Other Liabilities: Obligations under risk management activities 92,983 63,191 Deferred capacity revenues-- Affiliated 8,290 13,075 Other 607 3,147 Other-- Affiliated 15,451 15,644 Other 765 3,053 ----------- ----------- Total deferred credits and other liabilities 118,096 98,110 ----------- ----------- Common Stockholder's Equity: Common stock, par value $.01 per share -- Authorized - 1,000,000 shares Outstanding - 1,000 shares - - Paid-in capital 921,615 731,230 Retained earnings 164,892 62,477 Accumulated other comprehensive loss (60,386) (47,103) ----------- ----------- Total common stockholder's equity 1,026,121 746,604 ----------- ----------- Total Liabilities and Stockholder's Equity $ 2,352,744 $ 2,085,976 =========== =========== The accompanying notes as they relate to Southern Power are an integral part of these condensed financial statements. </TABLE> 91
<TABLE> <CAPTION> SOUTHERN POWER COMPANY CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) For the Three Months For the Six Months Ended June 30, Ended June 30, ---------------------------- ------------------------- 2003 2002 2003 2002 ---- ---- ---- ---- (in thousands) (in thousands) <S> <C> <C> <C> <C> Net Income $ 79,290 $ 8,858 $ 102,415 $ 13,313 Other comprehensive loss: Changes in fair value of qualifying hedges, net of tax of $(6,164), $(20,285), $(8,564), $(16,397), respectively (10,154) (32,194) (13,987) (26,192) Less: Reclassification adjustment for amounts included in net income, net of tax of $(50), $24, $116, $24, respectively 440 38 704 38 --------- --------- --------- --------- COMPREHENSIVE INCOME $ 69,576 $ (23,298) $ 89,132 $ (12,841) ========= ========= ========= ========= SOUTHERN POWER COMPANY CONDENSED STATEMENTS OF ACCUMULATED OTHER COMPREHENSIVE LOSS (UNAUDITED) At At June 30, December 31, 2003 2002 ----------- -------------- Balance at beginning of period $ (47,103) $ 6,689 Change in current period (13,283) (53,792) ---------- --------- BALANCE AT END OF PERIOD $ (60,386) $ (47,103) ========== ========= The accompanying notes as they relate to Southern Power are an integral part of these condensed financial statements. </TABLE> 92
SOUTHERN POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION SECOND QUARTER 2003 vs. SECOND QUARTER 2002 AND YEAR-TO-DATE 2003 vs. YEAR-TO-DATE 2002 RESULTS OF OPERATIONS Earnings Southern Power's net income for second quarter and year-to-date 2003 was $79.3 million and $102.4 million, respectively, compared to $8.9 million and $13.3 million for the corresponding periods of 2002. The increases in earnings of $70.4 million for the second quarter 2003 and $89.1 million year-to-date 2003 can be attributed primarily to an after-tax gain of approximately $50 million related to the termination of PPAs with Dynegy related to Plant Dahlberg Units 8 through 10 and Plant Franklin Unit 3. Reference is made to Note (M) to the Condensed Financial Statements herein for additional information regarding the termination of these PPAs. The other significant factor contributing to increased earnings is the sale of wholesale capacity and energy to affiliated and non-affiliated companies from Plant Wansley Units 6 and 7 and Plant Franklin Unit 1 beginning in June 2002, and Plant Franklin Unit 2 and Plant Harris Units 1 and 2, beginning in June 2003, along with the initiation of PPAs for those units with Alabama Power, Georgia Power and Savannah Electric. Significant income statement items appropriate for discussion include the following: <TABLE> <CAPTION> Increase (Decrease) -------------------------------------------------------------- Second Quarter Year-To-Date ------------------------------- ------------------------------ (in thousands) % (in thousands) % <S> <C> <C> <C> <C> Sales for resale - non-affiliates................ $43,642 172.1 $ 76,424 178.4 Sale for resale - affiliates..................... 53,742 166.2 107,222 N/M Contract termination............................. 80,000 N/M 80,000 N/M Other revenues................................... 3,120 N/M 4,998 N/M Fuel expense..................................... 16,025 83.6 34,071 161.0 Purchased power - non-affiliates................. 8,626 113.3 20,835 194.3 Purchased power - affiliates..................... 28,249 N/M 44,811 N/M Other operation expense.......................... 6,114 98.4 9,833 117.0 Depreciation and amortization.................... 4,578 131.4 9,121 166.3 Interest expense, net of amounts capitalized..... 1,749 146.4 3,148 263.4 N/M Not meaningful </TABLE> Sales for resale - non-affiliates. During the second quarter and year-to-date 2003, sales for resale to non-affiliates increased as a result of additional wholesale capacity and energy sales to non-affiliates that resulted from commercial operation of Plant Franklin Unit 1, which was not fully obligated under a long-term PPA until June 2003, and test period energy transactions for Plant Franklin Unit 2 and Plant Harris Units 1 and 2 which were placed into commercial operation in June 2003. 93
SOUTHERN POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Sales for resale - affiliates. Energy and capacity sales through PPAs with Alabama Power, Georgia Power and Savannah Electric for the full six months of 2003 caused the majority of the increase in the second quarter and year-to-date 2003 when compared to the same periods in 2002. Revenues from sales to affiliated companies through the Southern Company system power pool ("Southern Pool") and energy sales under PPAs will vary depending on demand and the availability and cost of generating resources at each company within the Southern Pool. Contract termination. For the second quarter and year-to-date 2003, this revenue results from the $80 million received from Dynegy in May 2003 to terminate PPAs related to Plants Dahlberg and Franklin. Reference is made to Note (M) to the Condensed Financial Statements herein for further information. Other revenues. The increases in the second quarter and year-to-date 2003 are primarily due to scheduling and administrative fees on wholesale contracts that were not in place during the first six months of 2002. Fuel expense. The second quarter and year-to-date 2003 increases are primarily attributed to the full period commercial operation of units at Plant Wansley and Plant Franklin Unit 1 as well as commercial operation of new units at Plant Franklin and Plant Harris as mentioned above. Purchased power - non-affiliates. During the second quarter and year-to-date 2003, purchased power from non-affiliates were higher than in the same periods in 2002 mainly due to the availability of power at prices lower than Southern Power's self generation or the Southern Pool and the effects of purchase power provisions in the contracts with the electric membership cooperatives, the City of Dalton, Georgia and the North Carolina Municipal Power Authority 1. Purchased power - affiliates. In the second quarter and year-to-date 2003, purchased power from affiliates increased primarily due to the availability of power at prices lower than Southern Power's self-generation. Expenses from purchased power transactions will vary depending on demand, availability and the cost of generating resources accessible throughout the Southern Company system. Other operation expense. The second quarter and year-to-date 2003 increases result from higher administrative and general expenses due to commercial operation of Plant Wansley Units 6 and 7 and Plant Franklin Unit 1, beginning in June 2002, and Plant Franklin Unit 2 and Plant Harris Units 1 and 2, beginning in June 2003, when compared to the corresponding periods in 2002. Depreciation and amortization. During the second quarter and year-to-date 2003, the increases in depreciation and amortization are primarily attributed to the generating units that were placed into service in June 2002 and 2003 as compared to the same periods in the prior year. Interest expense, net of amounts capitalized. The increases in interest expense, net of amounts capitalized for the second quarter and year-to-date 2003, when compared to the corresponding periods in 2002 are due to the lower percentage of interest costs subject to capitalization as projects have reached completion. 94
SOUTHERN POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Effects of Inflation Southern Power is subject to long-term contracts and income tax laws that are based on the recovery of historical costs. While the inflation rate has been relatively low in recent years, it continues to have an adverse effect on Southern Power because of the large investment in generating facilities with long economic lives. Conventional accounting for historical cost does not recognize this economic loss nor the partially offsetting gain that arises through financing facilities with fixed-money obligations such as long-term debt. Future Earnings Potential The results of operations are not necessarily indicative of future earnings. The level of future earnings depends on numerous factors including completion of construction on new generating facilities, regulatory matters, energy sales, creditworthiness of customers, total generating capacity available in the Super Southeast and the remarketing of capacity. For additional information relating to these issues, see Item 1 - BUSINESS - "Risk Factors" and Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential" of Southern Power in the Form 10-K. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - General" and to Note 5 to the financial statements of Southern Power in Item 8 of the Form 10-K for additional information on long-term power sales agreements and PPAs. Southern Power's PPAs with non-affiliated counterparties have provisions that require the posting of collateral or an acceptable substitute guarantee in the event that S&P or Moody's downgrades the credit ratings of such counterparty to below-investment grade, or, if the counterparty is not rated, fails to maintain a minimum coverage ratio. The PPAs are expected to provide Southern Power with a stable source of revenue during their respective terms. In June 2003, Southern Power placed Plant Franklin Unit 2 and Plant Harris Units 1 and 2 into commercial operation. Southern Power expects Plant Stanton A to be completed and placed into commercial operation during the third quarter 2003. In 2004, Southern Power's PPA with Georgia Power will begin for Plant Harris Unit 2. PPAs for the other units become effective upon commercial operation. Southern Power also has Plant McIntosh Units 10 and 11 under construction. Reference is made to Note (M) to the Condensed Financial Statements herein for information regarding a one-time gain of $50 million upon the termination of PPAs between Dynegy and Southern Power. Under the original terms of the PPAs, Southern Power would have recognized revenue of approximately $5.9 million for the remaining period of 2003 following the terminations. Because of the termination of these PPAs, Southern Power is exploring alternatives for remarketing its existing capacity and has suspended construction of Plant Franklin Unit 3. Southern Power may complete limited construction activities as needed to preserve the long-term viability of the project. Reference is also made to Note (P) to the Condensed Financial Statements herein for information regarding the FERC approval process for Southern Power's PPAs with Georgia Power and Savannah Electric for Plant McIntosh Units 10 and 11. The final outcome of these matters cannot now be determined. In July 2003, Southern Power entered into a five-year contract with Piedmont Municipal Power Authority (PMPA) beginning January 1, 2006. PMPA is a full requirements provider to 10 South Carolina cities. The contract is projected to yield sales of 135 megawatts in 2006, growing to 181 megawatts in the fifth year of the contract. 95
SOUTHERN POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Environmental Matters" of Southern Power in the Form 10-K for information on the development by federal and state environmental regulatory agencies of additional control strategies for emission of air pollution from all major sources of air pollution, particularly electric generating facilities. Compliance costs related to current and future environmental laws and regulations could affect earnings if such costs are not fully recovered. Southern Power's business activities are subject to extensive governmental regulation related to public health and the environment. Litigation over environmental issues and claims of various types, including property damage, personal injury and citizen enforcement of environmental requirements, has increased generally throughout the United States; in particular, personal injury claims for damages caused by alleged exposure to hazardous materials have become more frequent. Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - FERC Matters" of Southern Power in the Form 10-K for information on the formation of an RTO as ordered by the FERC and the notice of proposed rulemaking regarding open access transmission service and standard electricity market design. In April 2003, the FERC issued a White Paper related to its proposed rulemaking regarding open access transmission service and standard electricity market design in an effort to respond to certain of the public comments received on the standard market design proposal. Reactions to the White Paper by Southeastern state regulators reflect significant continuing differences in opinion between the FERC and various state regulatory commissions over questions of jurisdiction and protection of retail customers. These significant differences between state and federal regulators create substantial uncertainty related to the ultimate approval of SeTrans because state commission approval of the transfer of operational control of the transmission assets of Southern Company and its subsidiaries is a prerequisite to the formation of SeTrans. Pending energy legislation may also impact these issues. Any impact of the other FERC proposals on Southern Company and its subsidiaries will depend on the form in which final rules may be ultimately adopted. Reference is also made to Notes (A), (E), (L), (M) and (P) to the Condensed Financial Statements herein for discussion of various contingencies and other matters which may affect future earnings potential. Accounting Policies Critical Policies Southern Power's significant accounting policies are described in Note 1 to the financial statements of Southern Power in Item 8 of the Form 10-K. Southern Power has three critical accounting policies that require a significant amount of judgment and are considered to be the most important to the presentation of Southern Power's financial position and results of operations. The first critical policy is the recognition of capacity revenues from long-term contracts at the lesser of the levelized basis or the cash collected over the contract periods. Second, Southern Power designates qualifying derivative instruments as cash flow or fair value hedges and marks such derivative instruments to market based primarily on quoted market prices. The unrealized changes in fair value of qualifying cash flow hedges are deferred in Other Comprehensive Income. Any ineffectiveness in those hedges and changes in non-qualifying positions are reported as a component of current period income. Finally, Southern Power uses flow-through accounting for state manufacturer's tax credits. This means that Southern Power recognizes the credit as a reduction of tax expense when it is more likely than not to be allowed by the Georgia Department of Revenue. 96
SOUTHERN POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION New Accounting Standards Reference is made to Note (J) to the Condensed Financial Statements herein for information regarding the adoption of FASB Statement No. 143, "Accounting for Asset Retirement Obligations" effective January 1, 2003. Southern Power has no legal liability for asset retirement obligations as defined by FASB Statement No. 143. Upon adoption, Southern Power recorded a cumulative effect of change in accounting principle of $0.6 million, representing previously accrued removal costs. FINANCIAL CONDITION Overview The major change in Southern Power's financial condition during the first six months of 2003 was the addition of approximately $231.4 million to utility plant related to on-going construction of Southern Power's combined-cycle units. The funds for these additions were provided by Southern Power's credit facility, commercial paper program and subordinated loans from Southern Company. See Southern Power's Condensed Statements of Cash Flows herein for further details. Credit Rating Risk Southern Power does not have any credit agreements that would require material changes in payment schedules or terminations as a result of a credit rating downgrade. There are certain physical electricity sale contracts, fixed-price physical gas purchases and agreements covering interest rate swaps and currency swaps that could require collateral -- but not accelerated payment -- in the event of a credit rating change to below investment grade. Generally, collateral may be provided for by a Southern Company guaranty, letter of credit or cash. At June 30, 2003, the maximum potential collateral requirements under the electricity sale contracts and financial instrument agreements were approximately $154 million. At June 30, 2003, there were no material collateral requirements for the gas purchase contracts. Exposure to Market Risks Southern Power is exposed to market risks, including changes in interest rates, currency exchange rates and certain commodity prices. To manage the volatility attributable to these exposures, Southern Power nets the exposure to take advantage of natural offsets and enters into various derivative transactions for the remaining exposure pursuant to approved risk management policies in areas such as counterparty exposure and hedging practices. Southern Power's policy is that derivatives are to be used primarily for hedging purposes. Derivative positions are monitored using techniques that include market valuation and sensitivity analysis. 97
SOUTHERN POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Southern Power has no outstanding variable rate long-term debt. To mitigate Southern Power's exposure to interest rates, it entered into interest rate swaps that were designated as cash flow hedges of interest expenses arising from the 2003 planned debt issuances. Changes in the fair values of these swaps are deferred in Other Comprehensive Income. Upon the issuance of the debt in July 2003, the swaps were settled at a loss of approximately $93.3 million that will be amortized to expense over the appropriate periods. Reference is made to Note (L) to the Condensed Financial Statements herein for additional information. Based on Southern Power's overall interest rate exposure at June 30, 2003, including derivative and other interest-rate sensitive instruments, a near-term 100 basis-point change in interest rates would not materially affect Southern Power's financial statements. In addition, Southern Power is not aware of any facts or circumstances that would significantly affect such exposures in the near term. Because energy from Southern Power's facilities is primarily sold under long-term contracts with tolling agreements and provisions shifting substantially all of the responsibility for fuel cost to the PPA counterparties, Southern Power's exposure to market volatility in commodity fuel prices and prices of electricity is limited. To mitigate residual risks in those areas, Southern Power enters into fixed-price contracts for the purchase or sale of fuel and electricity. In connection with the transfers of Plant Franklin in 2001 and Plant Wansley in 2002 to Southern Power, Georgia Power transferred approximately $5.6 million and $1.6 million, respectively, in derivative assets relating to electric and gas forward contracts in effect at the date of the transfers. These contracts were recorded at fair value on the date of the transfer, which was equal to Georgia Power's carrying amount. Following the transfer, these contracts are being marked to market through income until completely realized and settled in August 2003. Southern Power had firm purchase commitments that required payment in Euros. As a hedge against fluctuations in the exchange rate for Euros, Southern Power entered into forward contracts to purchase Euros and had designated these contracts as fair value hedges of an unrecognized firm commitment. Since the terms of these Euro contracts mirrored the purchase commitment terms, there was no ineffectiveness recognized in income. All Euro payments have been made and the gains associated with the hedges effectively reduced the purchase price of the equipment, which is included in construction work in progress. As of June 30, 2003, there were no additional Euro hedges outstanding. Unrealized gains and losses on electric and gas contracts used to hedge anticipated purchases and sales are deferred in Other Comprehensive Income. Gains and losses on contracts that do not represent hedges are recognized in the Statements of Income as incurred. The fair values of derivative energy contracts at June 30, 2003 were as follows: Second Quarter 2003 Year-to-Date Changes Changes ----------------------------------- ---------------------------------------- Fair Value ----------------------------------- ---------------------------------------- (in thousands) Contracts beginning of period $1,875 $3,864 Contracts realized or settled (2,825) (3,490) New contracts at inception - - Changes in valuation techniques - - Current period changes 246 (1,078) ----------------------------------- ------------------------ --------------- Contracts at June 30, 2003 $ (704) $ (704) =================================== ======================== =============== 98
SOUTHERN POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION At June 30, 2003, all of these contracts are based on actively quoted market prices. Realized gains and losses on hedged transactions are recognized in revenues and/or fuel expense in the Statements of Income as incurred. For the three months ended June 30, 2003 and 2002, approximately $0.2 million and $1.3 million of losses, respectively, were recognized in Other Income in the Statements of Income. For the six months ended June 30, 2003 and 2002, approximately $0.1 million of gains and $2.6 million of losses, respectively, were recognized in Other Income in the Statements of Income. Financing Activities During the first six months of 2003, Southern Company made subordinated loans to Southern Power of approximately $3.8 million, net of repayments. In March 2003, $190 million of notes payable to Southern Company were converted to a capital contribution from Southern Company. Equity contributions and subordinated loans from Southern Company are projected to total approximately $900 million to Southern Power by the end of 2003. No dividends are projected to be paid in 2003. In July 2003, Southern Power issued $575 million of 4.875% Senior Notes, Series C due July 15, 2015. The proceeds from the sale were used to repay a substantial portion of existing short-term indebtedness, to settle interest rate hedges associated with this financing and for general corporate purposes. Reference is made to Note (L) to the Condensed Financial Statements herein for information regarding these hedges. Capital Requirements Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Capital Requirements for Construction" and "Other Capital Requirements" of Southern Power in the Form 10-K for a description of Southern Power's capital requirements for its construction program, maturing debt, purchase commitments and long-term service agreements. Sources of Capital Southern Power's current liabilities exceed current assets because of the continued use of short-term debt as an interim funding source for Southern Power's ongoing construction program. Southern Power's strategy is to refinance most of such short-term borrowings with long-term securities following commercial operation of the generating facilities. In February 2003, Southern Power initiated a commercial paper program to fund a portion of the construction costs of new generating facilities. The amount of commercial paper will initially represent about 45% of total debt, but is forecasted to decline to about 7% at year-end 2005 as more construction projects are completed and refinanced with long-term securities. At June 30, 2003, Southern Power had outstanding $492.4 million in commercial paper. Reference is made to Note 7 to the financial statements of Southern Power in Item 8 of the Form 10-K for additional information relating to the commercial paper program. To meet short-term cash needs and contingencies, Southern Power had at June 30, 2003 approximately $21.4 million of cash and cash equivalents. To meet liquidity and capital resource requirements, Southern Power had at June 30, 2003 approximately $650 million of unused committed credit arrangements with banks 99
SOUTHERN POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION expiring in 2006. This line also provides liquidity support for Southern Power's commercial paper program (as discussed above). Amounts drawn under the arrangements are used to finance acquisition and construction costs related to gas-fired electric generating facilities and for general corporate purposes, subject to borrowing limitations for each generating facility. The arrangements permit Southern Power to fund construction of future generating facilities upon meeting certain requirements. Financing of construction at the McIntosh facility is subject to FERC approval of the related PPAs. Reference is made to Note (P) to the Condensed Financial Statements herein for information regarding the FERC approval process for Southern Power's PPAs with Georgia Power and Savannah Electric for Plant McIntosh Units 10 and 11. Southern Power also has access to loans from Southern Company to meet any additional Plant McIntosh funding needs should other funding sources not be adequate. 100
NOTES TO THE CONDENSED FINANCIAL STATEMENTS FOR THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES ALABAMA POWER COMPANY GEORGIA POWER COMPANY GULF POWER COMPANY MISSISSIPPI POWER COMPANY SAVANNAH ELECTRIC AND POWER COMPANY SOUTHERN POWER COMPANY INDEX TO APPLICABLE NOTES TO FINANCIAL STATEMENTS BY REGISTRANT Registrant Applicable Notes Southern Company A, B, C, D, E, F, G, H, I, J, K, L, M, N, R, S Alabama Power A, E, F, H, J, L, N Georgia Power A, E, G, H, I, J, L, N, O, P Gulf Power A, E, H, I, J, L Mississippi Power A, E, H, J, M, Q, R Savannah Electric A, E, H, J, P Southern Power A, E, J, L, M, O, P 101
THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES ALABAMA POWER COMPANY GEORGIA POWER COMPANY GULF POWER COMPANY MISSISSIPPI POWER COMPANY SAVANNAH ELECTRIC AND POWER COMPANY SOUTHERN POWER COMPANY NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (A) The condensed financial statements of the registrants included herein have been prepared by each registrant, without audit, pursuant to the rules and regulations of the SEC. In the opinion of each registrant's management, the information regarding such registrant furnished herein reflects all adjustments necessary to present fairly the results of operations for the periods ended June 30, 2003 and 2002. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although each registrant believes that the disclosures regarding such registrant are adequate to make the information presented not misleading. Disclosure which would substantially duplicate the disclosure in the Form 10-K and details which have not changed significantly in amount or composition since the filing of the Form 10-K are omitted from this Form 10-Q. Therefore, these condensed financial statements should be read in conjunction with the financial statements and the notes thereto included in the Form 10-K. Certain prior period amounts have been reclassified to conform to current period presentation. Due to seasonal variations in the demand for energy, operating results for the periods presented do not necessarily indicate operating results for the entire year. (B) Reference is made to Note 11 to the financial statements of Southern Company in Item 8 and MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - General" of Southern Company in Item 7 of the Form 10-K for information on the spin-off of Mirant from Southern Company. On July 14, 2003, Mirant filed for voluntary reorganization under Chapter 11 of the Federal Bankruptcy Code. Southern Company has certain contingent liabilities associated with Mirant. Reference is made to Note 9 under "Guarantees" to the financial statements of Southern Company in Item 8 of the Form 10-K for information regarding Southern Company's guarantees of contractual commitments made by Mirant's subsidiaries. At July 31, 2003, the total notional amount of guarantees outstanding was less than $30 million. Reference is also made to Note (E) herein for information regarding various lawsuits related to Mirant and guarantees related to Mobile Energy. Reference is also made to Note 6 to the financial statements of Southern Company in Item 8 of the Form 10-K for information regarding joint and several liability with Mirant in connection with the joint consolidated federal income tax return. As discussed in Note (C) below, the IRS has completed its audits of the consolidated federal income tax returns through 1999. Under the terms of the separation agreement, Mirant agreed to indemnify Southern Company for costs associated with these lawsuits, Mobile Energy guarantees and additional IRS assessments. The impact of Mirant's bankruptcy filing on Mirant's indemnity obligations, if any, cannot now be determined. 102
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) On April 30, 2003, Mirant filed its Annual Report on Form 10-K for the year ended December 31, 2002. This filing included Mirant's restated financial statements for the years ended December 31, 2001 and 2000. Mirant's restated net income for 2001 and 2000 decreased by $159 million and $29 million, respectively. Mirant also announced that it is preparing revised quarterly financial statements for 2001 and expects to provide the quarterly results as soon as possible. Southern Company owned 100% of Mirant through September 2000 and 80% between October 2000 and April 2, 2001. Due to Southern Company's spin-off of Mirant on April 2, 2001, Southern Company's financial statements reflect its share of Mirant's net income as discontinued operations. The effect of these restatements on Southern Company's financial statements, if any, cannot be determined until Mirant's 2001 revised quarterly financial statements are filed. The impact of the bankruptcy filing on the timing of filing 2001 revised quarterly financial statements, if any, cannot now be determined. (C) Reference is made to Note 1 under "Leveraged Leases" and Note 6 to the financial statements of Southern Company in Item 8 and MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - General" in Item 7 of the Form 10-K. As a large corporate taxpayer, Southern Company undergoes audits by the IRS for each of its tax years. The IRS has completed its audits of Southern Company's consolidated federal income tax returns for all years through 1999. As part of the audit for the 1996-1999 tax years, the IRS reviewed Southern Company's four international leveraged lease transactions. Based on its review, the IRS proposed to disallow the tax losses associated with one of these transactions, resulting in an additional tax payment of approximately $30 million, including interest, to the IRS. To finalize the audit and eliminate any additional interest charges, Southern Company made this payment to the IRS in May 2003 and intends to pursue a refund claim for this amount. Notwithstanding the position taken by the IRS, Southern Company continues to believe that the transaction remains a valid lease for U.S. tax purposes and, accordingly, will vigorously contest the proposed disallowance. Southern Company has accounted for the payment as a deposit. If Southern Company is not successful in its defense of the tax treatment for this transaction, it would also affect the timing of the related revenue recognition for book purposes. A cumulative effect adjustment would be required to reduce net income based on the revised cash flows as a result of the changes in the allowed tax deductions. The IRS did not disallow any tax losses or make any other adjustments for the 1996-1999 period with respect to any of Southern Company's other lease transactions. However, there can be no assurance that subsequent IRS audits would not raise similar disallowance issues. The ultimate outcome of these matters cannot now be determined. 103
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) (D) On June 30, 2003, the IRS issued an announcement suspending the issuance of new private letter rulings on tax credits for synthetic fuels pursuant to Section 29 of the Internal Revenue Code upon its initiation of a review of the scientific validity of test procedures and results that have been presented as evidence that a significant chemical change occurred in such synthetic fuel. In addition, the IRS indicated that it may revoke existing private letter rulings that relied on the procedures and results under review if it determines that those test procedures and results do not demonstrate that a significant chemical change has occurred. Southern Company has investments in two entities that produce synthetic fuel and receive tax credits. In April 2001, Southern Company acquired a 30% membership interest in Alabama Fuel Products, LLC (AFP). In 1998, Southern Company acquired a 24.975% limited partnership interest in Carbontronics Synfuels Investors, L.P. (Carbontronics). At June 30, 2003, Southern Company's investments in AFP and Carbontronics totaled $25 million and $8 million, respectively. Carbontronics has informed Southern Company that, on August 5, 2003, the IRS communicated plans to perform an examination of the partnership for the years 2000 and 2001. From the inception of Southern Company's investment in Carbontronics through June 30, 2003, Southern Company has recognized approximately $90 million in tax credits through income related to its share of Carbontronics' synthetic fuel production. The IRS is currently auditing AFP for tax years 1999 and 2000. Based on a conversation between the IRS field agent and the tax matters partner for AFP on July 31, 2003, there is an expectation that the IRS may challenge the existence of significant chemical change at AFP. A written report is expected, but has not yet been received. From the inception of Southern Company's investment in AFP through June 30, 2003, Southern Company has recognized approximately $129 million in tax credits through income related to its share of AFP's synthetic fuel production. Both entities have private letter rulings from the IRS that concluded significant chemical change occurred based on the procedures and results submitted. In addition, both entities regularly use independent laboratories and experts to test for chemical change. These tests replicated significant chemical changes consistent with the procedures submitted with the private letter rulings. Southern Company has relied on these private letter rulings and believes that the test results presented in connection with such private letter rulings are valid, and that the entities have operated in compliance with their respective private letter rulings and Section 29 of the Internal Revenue Code. The ultimate outcome of this matter cannot now be determined. (E) Reference is made to Note 3 to the financial statements of Southern Company, the operating companies and Southern Power in Item 8 and to "Legal Proceedings" in Item 3 of the Form 10-K for information relating to various lawsuits and other contingencies. MIRANT ERISA LITIGATION On April 17, 2003, a retired employee of Mirant filed a complaint in the United States District Court for the Northern District of Georgia alleging violations of the Employee Retirement Income Security Act and naming as defendants Mirant, Southern Company, several current and former directors and officers of Mirant and/or Southern Company, and "Unknown Fiduciary Defendants 1-100." The plaintiff seeks to represent a purported class consisting of individuals who were participants in or beneficiaries of two Mirant employee benefit plans and their predecessor plans (the "Plans") at any time between January 1, 2000, and the filing of the complaint whose plan accounts included investments in Mirant common stock or the "Mirant Corporation Stock 104
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) Fund." The complaint alleges that the defendants misled participants in the Plans by concealing Mirant's alleged "participation in the illegal manipulation of energy prices in California during 2000 and 2001 as well as other irregular and unlawful accounting manipulations tied to energy trading." On June 3, 2003, a substantially similar complaint was filed in the United States District Court for the Northern District of Georgia. Neither complaint contains any specific allegations of wrongdoing with respect to Southern Company. It is expected that these suits will be consolidated. Southern Company denies any wrongdoing and intends to defend this action. The final outcome of this matter cannot now be determined. NEW SOURCE REVIEW ENFORCEMENT ACTIONS Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS - "Environmental Matters" in Item 7 and Note 3 to the financial statements of each registrant (except Southern Power) under "New Source Review Enforcement Actions" in Item 8 of the Form 10-K. On June 24, 2003, the U.S. Court of Appeals for the Eleventh Circuit ("Court of Appeals") ruled that it did not have jurisdiction to decide the TVA appeal because the challenged Administrative Compliance Order ("ACO") did not constitute final agency action. The Court of Appeals held that the Clean Air Act's statutory scheme for enforcement of the ACO is unconstitutional and that the EPA must prove any Clean Air Act violations by TVA in federal district court. Until that time, the Court of Appeals ruled, TVA is free to ignore the ACO without penalty. On July 3, 2003, Alabama Power and the EPA jointly notified the Alabama district court of the ruling of the Court of Appeals and requested that the stay in that case be continued until expiration of the period in which the EPA can request a rehearing. The district court granted the parties' request on July 10, 2003. On August 8, 2003, the EPA filed a petition for rehearing en banc with the Court of Appeals. At this time, no party to the case in federal district court in Atlanta against Georgia Power, which was administratively closed two years ago, has asked the court to reopen that case. The final outcome of these matters cannot now be determined. MOBILE ENERGY BANKRUPTCY PETITION Reference is made to Note 3 to the Southern Company financial statements in Item 8 of the Form 10-K. In July 2003, Mobile Energy received the necessary approval of its plan of reorganization under PUHCA. Mobile Energy currently anticipates the U.S. Bankruptcy Court will also approve the plan of reorganization in September 2003. The reorganization will not impact Southern Company's outstanding guarantees of certain potential obligations of Mobile Energy that represent a maximum contingent liability of $19 million at June 30, 2003. PLANT WANSLEY ENVIRONMENTAL LITIGATION Reference is made to Item 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS - "Environmental Matters" of Georgia Power in the Form 10-K and to Note 3 to the financial statements of Southern Company and Georgia Power under "Plant Wansley Litigation" in Item 8 of the Form 10-K. On June 19, 2003, the court granted Georgia Power's motion to dismiss the allegations regarding hazardous air pollutants and denied Georgia Power's motion to dismiss the allegations regarding emission offsets. Discovery is ongoing and no trial date has been set. The final outcome of this matter cannot now be determined. 105
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) MIRANT SECURITIES LITIGATION Reference is made to Note 3 under "Mirant Securities Litigation" of Southern Company in Item 8 of the Form 10-K. On July 14, 2003, the U.S. District Court for the Northern District of Georgia dismissed all claims based on Mirant's alleged improper trading and marketing activities in the California energy market; however, the Court did not dismiss the claims based on alleged false statements and omissions in Mirant's prospectus for its initial public offering and accounting-related issues previously disclosed by Mirant. Such claims seek to impose liability on Southern Company based on allegations that Southern Company was a "control person" as to Mirant prior to the spin-off date. Mirant's bankruptcy filing imposes an automatic stay of this action as to Mirant and may affect the proceedings as to Southern Company and other parties in this lawsuit. Southern Company's answer to the consolidated amended complaint is due on September 3, 2003, and discovery begins on that date. Under certain circumstances, Southern Company will be obligated under its Bylaws to indemnify the four current and/or former Southern Company officers who served as directors of Mirant at the time of its initial public offering through the date of the spin-off and are also named as defendants in this lawsuit. The final outcome of this matter cannot now be determined. RACE DISCRIMINATION LITIGATION Reference is made to Note 3 under "Race Discrimination Litigation" of Southern Company and Georgia Power in Item 8 of the Form 10-K. On March 31, 2003, the United States District Court for the Northern District of Georgia granted summary judgment in favor of the defendants on all claims raised by all of the seven named plaintiffs. On April 28, 2003, plaintiffs filed an appeal to the United States Court of Appeals for the Eleventh Circuit challenging these adverse summary judgment rulings, as well as the District Court's October 2001 ruling denying class certification. In addition, plaintiffs appealed some adverse rulings on discovery issues. Both parties have filed their respective briefs with the Eleventh Circuit Court of Appeals, and they are awaiting the determination of the Court of Appeals. The final outcome of the case cannot now be determined. (F) Reference is made to Note 3 to the financial statements of Southern Company and Alabama Power in Item 8 of the Form 10-K for information relating to Alabama Power's retail rate adjustment procedures. In June 2003, Alabama Power began buying power under a seven-year PPA with Southern Power for 615 megawatts of capacity annually from Plant Harris. In addition, Alabama Power also began buying power under a seven-year PPA with a third party for 630 megawatts; one-half of which became available in June 2003, with the remainder scheduled to be available beginning in 2004. Both PPAs have been certificated by the Alabama PSC. As a result, Alabama Power's retail rates were adjusted by approximately 2.6% under Rate CNP (Certificated New Plant), which allows Alabama Power to recover costs associated with certificated PPAs. 106
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) (G) On May 23, 2003, Georgia Power filed for a fuel cost recovery rate increase. The increase will allow for the recovery of fuel costs based on an estimate of future fuel costs, as well as the collection of the existing under recovery of fuel expenses. The Georgia PSC held hearings on July 31, 2003. A final decision from the Georgia PSC is expected on August 19, 2003 with an effective date of September 1, 2003. The outcome of the filing cannot be determined at this time. (H) Reference is made to Note 1 under "Regulatory Assets and Liabilities" to the financial statements of Southern Company and each of the operating companies in Item 8 of the Form 10-K. The operating companies are subject to the provisions of FASB Statement No. 71, "Accounting for the Effects of Certain Types of Regulation." In the event that a portion of a company's operations is no longer subject to these provisions, the company would be required to write off related regulatory assets and liabilities that are not specifically recoverable and determine if any other assets have been impaired. (I) Reference is made to Note 9, Note 4 and Note 4 under "Guarantees" to the financial statements of Southern Company, Georgia Power and Gulf Power, respectively, in Item 8 of the Form 10-K for information regarding guarantees of loans to residential customers for heat pump purchases. As of June 30, 2003, the total outstanding loans guaranteed by all of the operating companies was $14.3 million, of which Georgia Power is responsible for $11.5 million and Gulf Power is responsible for $0.8 million. Total loan loss reserves of $4 million ($2.4 million for Georgia Power and $0.2 million for Gulf Power) have been recorded. (J) Effective January 1, 2003, Southern Company adopted FASB Statement No. 143, "Accounting for Asset Retirement Obligations." Statement No. 143 establishes new accounting and reporting standards for legal obligations associated with the ultimate cost of retiring long-lived assets. The ultimate costs for an asset's future retirement must be recorded in the period in which the liability is incurred. The cost must be capitalized as part of the related long-lived asset and depreciated over the asset's useful life. Additionally, Statement No. 143 does not permit the continued accrual of future retirement costs for long-lived assets which the company does not have a legal obligation to retire. However, the operating companies have discussed the financial statement impacts of Statement No. 143 with their respective PSCs and will continue to recognize the accumulated removal costs for other obligations as part of accumulated depreciation. As of June 30, 2003, amounts recorded in Accumulated Depreciation that represent regulatory liabilities related to such removal costs totaled $1.2 billion, consisting of $562 million, $416 million, $146 million, $75 million and $34 million for Alabama Power, Georgia Power, Gulf Power, Mississippi Power and Savannah Electric, respectively. The operating companies had no cumulative effect to net income resulting from the adoption of Statement No. 143. As a result, Alabama Power, Georgia Power, Gulf Power, Mississippi Power and Savannah Electric recorded regulatory assets (liabilities) of $(71) million, $21 million, $0.9 million, $0.6 million and $2.4 million, respectively, as of January 1, 2003. At June 30, 2003, the regulatory liability for Alabama Power is reflected in the balance sheets under "Asset retirement obligation regulatory liability." The regulatory assets of the other operating companies are reflected in the balance sheets under either "Asset retirement obligation regulatory asset" or in "Other" under "Deferred Charges and Other Assets." Southern Power recorded a cumulative effect adjustment to income upon adoption of $0.6 million, representing removal costs previously accrued. 107
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) The liability recognized to retire long-lived assets primarily relates to Southern Company's nuclear facilities, which include Alabama Power's Plant Farley and Georgia Power's ownership interests in Plants Hatch and Vogtle. The fair value of assets legally restricted for settling retirement obligations related to these assets as of June 30, 2003 is $338 million, $388 million and $726 million for Alabama Power, Georgia Power and Southern Company, respectively. In addition, the operating companies have retirement obligations related to various landfill sites, ash ponds and underground storage tanks. The operating companies have also identified retirement obligations related to certain transmission and distribution facilities. However, liabilities for the removal of these transmission and distribution assets will not be recorded because no reasonable estimate can be made regarding the timing of the obligations. The operating companies will continue to recognize in the income statement their ultimate removal costs in accordance with each company's respective regulatory treatment. Any difference between costs recognized under Statement No. 143 and those reflected in rates will be recognized as either a regulatory asset or liability. Alabama Power has revised the estimated cost to retire Farley Nuclear Plant as a result of a new site-specific decommissioning study completed in April 2003. The effect of the revision is an increase of $34.5 million for the Statement No. 143 liability included in "Asset retirement obligations" with a corresponding increase in property, plant and equipment. Based on the new study, the estimated site study decommissioning costs are $955 million ($892 million for radiated structures plus $63 million for non-radiated structures) and the ultimate decommissioning costs are $2,529 million ($2,349 million for radiated structures plus $180 million for non-radiated structures). For additional information, see Note 1 to the financial statements of Alabama Power in Item 8 of the Form 10-K. The following table reflects the details of the Asset Retirement Obligations included in the balance sheets. <TABLE> <CAPTION> Balance at Liabilities Liabilities Cash Flow Balance at 12/31/02 Incurred Settled Accretion Revisions 06/30/03 -------- -------- ------- --------- --------- -------- (in millions) <S> <C> <C> <C> <C> <C> <C> Alabama Power $ - $301.0 $ - $11.3 $34.5 $346.8 Georgia Power - 469.1 - 15.2 - 484.3 Gulf Power - 4.0 - 0.1 - 4.1 Mississippi Power - 1.0 - - - 1.0 Savannah Electric - 3.2 - 0.1 - 3.3 Southern Company $ - $778.3 $ - $26.7 $34.5 $839.5 </TABLE> The following table represents pro-forma asset retirement obligations as if Statement No. 143 had been adopted on January 1, 2002. At December 31, ----------------------------------- 2002 2001 ---- ---- (in millions) Alabama Power $301.0 $281.3 Georgia Power 469.1 440.1 Gulf Power 4.0 3.7 Mississippi Power 1.0 0.9 Savannah Electric 3.2 2.7 Southern Company $778.3 $728.7 108
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) The adoption of FASB Statement No. 143 has been treated as a non-cash transaction for purposes of the Statements of Cash Flows. (K) Reference is made to Note 1 under "Stock Options" and Note 7 under "Stock Option Plan" to the financial statements of Southern Company in Item 8 of the Form 10-K for information regarding non-qualified employee stock options provided by Southern Company. Southern Company accounts for options granted in accordance with Accounting Principles Board Opinion No. 25; thus, no compensation expense is recognized because the exercise price of all options granted equaled the fair market value on the date of the grant. The estimated fair values of stock options granted during the three-month and six-month periods ending June 30, 2003 and 2002 have been derived using the Black-Scholes stock option pricing model. The following table shows the assumptions and the weighted average fair values of these stock options: <TABLE> <CAPTION> Three Months Three Months Six Six Ended Ended Months Months June 30, 2003 June 30, 2002 Ended Ended June 30, 2003 June 30, 2002 -------------- -------------- --------------- -------------- <S> <C> <C> <C> <C> Interest Rate 2.6% 4.2% 2.7% 4.0% Average expected life of stock options (in years) 4.3 4.3 4.3 4.3 Expected volatility of common stock 22.7% 26.2% 23.6% 26.1% Expected annual dividends on common stock $1.37 $1.34 $1.37 $1.34 Weighted average fair value of stock options granted $3.51 $4.08 $3.59 $3.37 </TABLE> The pro forma impact of fair-value accounting for options granted on net income is as follows: <TABLE> <CAPTION> As Reported Pro Forma --------------------- ------------------------- Three Months Ended June 30, 2003 <S> <C> <C> Net income (in millions) $432 $427 Earnings per share (dollars): Basic $0.60 $0.60 Diluted $0.59 $0.59 Three Months Ended June 30, 2002 Net income (in millions) $332 $326 Earnings per share (dollars): Basic $0.47 $0.47 Diluted $0.46 $0.46 Six Months Ended June 30, 2003 Net income (in millions) $730 $721 Earnings per share (dollars): Basic $1.01 $1.00 Diluted $1.00 $0.99 Six Months Ended June 30, 2002 Net income (in millions) $556 $546 Earnings per share (dollars): Basic $0.79 $0.78 Diluted $0.78 $0.77 </TABLE> 109
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) <TABLE> <CAPTION> Diluted Earnings Per Share Three Months Ended Three Months Ended Six Months Six Months June 30, 2003 June 30, 2002 Ended Ended (in thousands) June 30, 2003 June 30, 2002 ----------------------------------- ------------------- ------------------- ------------------ ------------------- <S> <C> <C> <C> <C> As Reported Shares 724,627 706,181 721,785 703,596 Effect of options 5,659 5,984 5,354 5,541 Diluted Shares 730,286 712,165 727,139 709,137 </TABLE> (L) In addition to the fixed price electric and gas contracts used to mitigate exposure to volatile energy prices (see "Exposure to Market Risks" in MANAGEMENT'S DISCUSSION AND ANALYSIS herein), Southern Company and certain of its subsidiaries enter into interest rate swaps to hedge exposure to interest rate changes. Swaps related to fixed rate securities are accounted for as fair value hedges; swaps related to variable rate securities or forecasted transactions are accounted for as cash flow hedges. The swaps are generally structured to mirror the terms of the hedged debt instruments; therefore, no material ineffectiveness has been recorded in earnings. As of June 30, 2003, the following swaps were outstanding: Fair Value Hedges <TABLE> <CAPTION> --------------- -------------- ------------------ ---------------- -------------------------- Notional Fixed Rate Variable Rate Maturity Fair Value Amount Received Paid Date June 30, 2003 ------------------------ --------------- -------------- ------------------ ---------------- -------------------------- <S> <C> <C> <C> <C> <C> Southern Company $400 million 5.3% 6-month LIBOR February 2007 $46.1 million (in arrears) less 0.103% </TABLE> <TABLE> <CAPTION> Cash Flow Hedges ---------------- -------------- ------------------ ----------------- -------------------- Weighted Average Variable Rate Fixed Rate Notional Received Paid Maturity Fair Value Amount Date June 30, 2003 ----------------------- ---------------- -------------- ------------------ ----------------- -------------------- Variable Rate Securities ----------------------- ---------------- -------------- ------------------ ----------------- -------------------- <S> <C> <C> <C> <C> <C> Southern Company $200 million 1-month LIBOR 3.1975% June 2004 $(4.0) million Alabama Power $350 million 3-month 3.015% December 2003 $(3.2) million LIBOR plus 0.12% Alabama Power $486 million BMA Index 1.6254% January 2004 $(1.6) million Alabama Power $486 million BMA Index 1.9923% January 2007 $2.3 million Alabama Power $195 million 3-month LIBOR 1.89% April 2006 $0.8 million Georgia Power $250 million 3-month 1.96% February 2005 $(2.0) million LIBOR plus 0.125% ----------------------- ---------------- -------------- ------------------ ----------------- -------------------- </TABLE> 110
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) <TABLE> <CAPTION> ----------------------- ---------------- -------------- ------------------ ----------------- -------------------- Forecasted Transactions ----------------------- ---------------- -------------- ------------------ ----------------- -------------------- <S> <C> <C> <C> <C> <C> Gulf Power $60 million 3-month LIBOR 4.5975% July 2013 $(3.7) million Southern Power $350 million 1-month LIBOR 6.2348% June 2013 $(73.1) million Southern Power $150 million 1-month LIBOR 5.4792% June 2008 $(19.8) million </TABLE> In May 2003, Alabama Power completed the issuance of $250 million of senior notes due May 1, 2008. In connection with the issuance of these notes, Alabama Power settled a related interest rate swap and incurred a loss of $10.2 million. Including the effect of this settlement, for the twelve month period ended June 30, 2004, a total of $2.8 million will be reclassified from Other Comprehensive Income to Interest Expense for Alabama Power. In July 2003, Southern Power completed the issuance of $575 million of 4.875% senior notes due July 15, 2015. In connection with the issuance of these notes, Southern Power settled the interest rate swaps above and incurred a loss of $93.3 million. Including the effect of this settlement, for the twelve month period ended June 30, 2004, a total of approximately $9.8 million will be reclassified from Other Comprehensive Income to Interest Expense for Southern Power. Also in July 2003, Gulf Power completed the issuance of $60 million of 4.35% senior notes due July 15, 2013. In connection with the issuance of these notes, Gulf Power settled the interest rate swaps above and incurred a loss of $3.3 million. For the twelve month period ended June 30, 2004, a total of approximately $0.3 million will be reclassified from Other Comprehensive Income to Interest Expense for Gulf Power. (M) Reference is made to Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - General" and to Note 5 to the financial statements in Item 8 of the Form 10-K for Southern Company, Mississippi Power and Southern Power for information regarding PPAs between subsidiaries of Dynegy and Mississippi Power and Southern Power and related letters of credit. On May 21, 2003, Mississippi Power and Southern Power entered into agreements with Dynegy (the "Agreements") to resolve all outstanding matters related to Dynegy, the PPAs and the related letters of credit. Under the terms of the Agreements, (1) Dynegy made a cash payment of $75 million to Mississippi Power and $80 million to Southern Power; (2) the PPAs between Southern Power and Dynegy were terminated, with no party having any remaining obligations under such PPAs thereafter; (3) Dynegy and Mississippi Power amended their PPA so that no capacity payments are due from Dynegy to Mississippi Power for capacity made available under the PPA from June 2003 through October 2003 (but other obligations and payments by Dynegy under such PPA are not affected during such time) and the PPA will terminate effective October 31, 2003, with neither party having any remaining obligations under the PPA after October 31, 2003; (4) Dynegy paid all amounts for which it was obligated under the PPAs up to their time of cancellation or amendment; (5) Southern Power and Mississippi Power returned the existing letters of credit in support of Dynegy's obligations under the PPAs; and (6) Dynegy deposited $7 million with Mississippi Power as collateral for Dynegy's potential energy purchases under the PPA through October 31, 2003. 111
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) The termination payments from Dynegy resulted in a one-time gain to Southern Company of approximately $88 million after tax ($38 million for Mississippi Power and $50 million for Southern Power). Because of the terminations of these PPAs, Southern Power has suspended construction of Plant Franklin Unit 3. Southern Power may complete limited construction activities as needed to preserve the long-term viability of the project. The length of the deferral period will depend on forecasted capacity needs and other wholesale market opportunities. Mississippi Power and Southern Power are also continuing to explore alternatives for their existing capacity. The final outcome of these matters cannot now be determined. After giving effect to the termination of these PPAs, total expected capacity payments from non-affiliates are as follows (in millions): Southern Mississippi Southern Year Power Power Company ----------------------- ------------ ----------------- -------------- 2003 $43.3 $17.6 $ 60.9 2004 64.1 - 64.1 2005 30.5 - 30.5 2006 30.2 - 30.2 2007 30.1 - 30.1 2008 and thereafter 171.4 - 171.4 ----------------------- ------------ ----------------- -------------- Total $369.6 $17.6 $387.2 ======================= ============ ================= ============== (N) Reference is made to Note 10, Note 9, and Note 5 for Southern Company, Alabama Power and Georgia Power, respectively, in Item 8 of the Form 10-K for information regarding a mandatory program of deferred premiums which could be assessed after a nuclear incident against all owners of nuclear reactors to cover third-party liability claims. On or about August 20, 2003, the NRC will increase the maximum retrospective premium for each licensed reactor operated from $88 million to $100 million per incident. The maximum assessment, excluding any applicable state premium taxes, for Alabama Power and Georgia Power - based on its ownership and buyback interests -- is $200 million and $203 million, respectively, per incident. The annual retrospective limit of $10 million per incident for each licensed reactor will not change. (O) Reference is made to Note 3 to the financial statements under "Construction Program" of Southern Power and to Note 4 to the financial statements under "Construction Program" of Georgia Power in Item 8 of the Form 10-K for information regarding Southern Company keep-wells covering the transfer of specific vendor contracts from Georgia Power to Southern Power for the operation of Plant Dahlberg and construction at the Plant Franklin and Plant Stanton sites. As of June 30, 2003, Southern Power has no remaining purchase obligations to equipment vendors under these contracts. (P) Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - General" in Item 7 and Note 4 under "Purchased Power Commitments" and "Fuel and Purchased Power Commitments" to the financial statements of Georgia Power and Savannah Electric, respectively, and Note 5 to the financial statements of Southern Power in Item 8 of the Form 10-K for information regarding PPAs between Southern Power and Georgia Power and Savannah Electric for Plant McIntosh capacity. Such PPAs were certified by the Georgia PSC in December 2002 after a competitive bidding process. 112
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) The Electric Power Supply Association and Calpine Corporation have made filings in this proceeding in opposition to the FERC's acceptance of the PPAs, alleging that the PPAs do not meet the applicable standards for PPAs between affiliates. In April 2003, Southern Power applied for FERC approval of these PPAs. In July 2003, the FERC accepted the PPAs to become effective June 1, 2005, subject to refund, and ordered that hearings be held to determine: (a) whether, in the design and implementation of the Georgia PSC competitive bidding process, Georgia Power and Savannah Electric unduly preferred Southern Power; (b) whether the analysis of the competitive bids unduly favored Southern Power, particularly with respect to evaluation of non-price factors; (c) whether Georgia Power and Savannah Electric selected their affiliate, Southern Power, based upon a reasonable combination of price and non-price factors; (d) whether Southern Power received an undue preference or competitive advantage in the competitive bidding process as a result of access to its affiliate's transmission system; (e) whether and to what extent the PPAs impact wholesale competition; and (f) whether the PPAs are just and reasonable and not unduly discriminatory. Hearings are scheduled to commence on March 1, 2004. Management believes that the PPAs should be approved by the FERC; however, the ultimate outcome of this matter cannot now be determined. In March 2003, Savannah Electric transferred to Southern Power 58 acres of land to facilitate construction at Plant McIntosh. The transfer was made at Savannah Electric's book value of approximately $16,500 in accordance with PUHCA and the related SEC order (Release No. 35-27322) dated December 27, 2000, which authorized the formation of Southern Power and the transfer of assets thereto. On July 17, 2003, the Georgia PSC issued an order requiring that Savannah Electric record the transfer of this land at the higher of net book value or fair market value based on an appraisal by an appraiser selected by the Georgia PSC staff. Based on an appraisal performed in November 2002, the estimated fair market value of the land is approximately $200,000. The outcome of this matter cannot now be determined. (Q) Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS - "Future Earnings Potential - FERC Matters" in Item 7 and Note 3 under "Transmission Facilities Agreement" to the financial statements of Mississippi Power in Item 8 of the Form 10-K for information regarding the FERC's investigation related to a transmission facilities agreement with Entergy Corporation. On July 9, 2003, the FERC approved a settlement between Mississippi Power and the FERC Staff. The impact of the settlement provides for no refund of prior revenues collected. (R) Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS - "Accounting Policies - Critical Policies" and "Financial Condition - Off-Balance Sheet Financing Arrangements" of Mississippi Power and "Financial Condition - Off-Balance Sheet Financing Arrangements" of Southern Company in Item 7 and Note 8 under "Lease Agreements" and Note 9 under "Operating Leases" to the financial statements of Mississippi Power and Southern Company, respectively, in Item 8 of the Form 10-K for information regarding Mississippi Power's lease of two generating units totaling 1,064 megawatts at Plant Daniel from Escatawpa Funding, Limited Partnership ("Escatawpa"), which began in 2001. Escatawpa raised a total of approximately $370 million to finance these generating units. Escatawpa was not consolidated by Mississippi Power pursuant to accounting guidance then in effect. On June 27, 2003, the generating units owned by Escatawpa and the related debt were acquired by Juniper Capital L.P. ("Juniper"), a limited partnership unaffiliated with Mississippi Power. Simultaneously, Juniper entered into a restructured lease agreement with Mississippi Power. Juniper has also entered into leases with third parties unrelated to Mississippi Power. The assets leased by Mississippi Power comprise less than half of Juniper's assets. In accordance with FASB Interpretation No. 46, Mississippi Power is not 113
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) required to consolidate the leased assets and related liabilities. Furthermore, the new lease agreement is an operating lease under FASB Statement No. 13. Principal terms of the Juniper lease remain essentially the same as those in the Escatawpa lease. The initial lease term ends in 2011. Like the Escatawpa lease, the Juniper lease also includes a purchase and renewal option based on the cost of the facility, which was $368.7 million at the inception of the Juniper lease. Mississippi Power is required to amortize approximately 4% of the initial acquisition cost over the initial lease term, which is less than the 10% provided for under the Escatawpa lease. Eighteen months prior to the end of the initial lease, Mississippi Power may elect to renew for 10 years. If Mississippi Power elects to renew the lease, the agreement calls for Mississippi Power to amortize an additional 17% of the initial completion cost over the renewal period. Upon termination of the lease, at Mississippi Power's option, it may either exercise its purchase option or the facility can be sold to a third party. For each of the six month periods ended June 30, 2003 and 2002, Mississippi Power recognized approximately $13 million in lease expenses, including approximately $1.6 million related to the amortization of the initial acquisition cost. In addition, $10.6 million in lease termination costs are included in other operation expenses for the three months ended June 30, 2003. The Juniper lease provides for a residual value guarantee (approximately 73% of the acquisition cost) by Mississippi Power that is due upon termination of the lease in the event that Mississippi Power does not renew the lease or purchase the assets and the fair market value is less than the unamortized cost of the asset. In accordance with FASB Interpretation No. 45, Mississippi Power has recognized a liability of approximately $16 million for the fair market value of this residual value guarantee in its June 30, 2003 balance sheet. 114
NOTES TO THE CONDENSED FINANCIAL STATEMENTS: (Continued) (S) Southern Company's reportable business segment is the sale of electricity in the Southeast by the operating companies and Southern Power. The All Other category includes parent Southern Company, which does not allocate operating expenses to business segments, and segments below the quantitative threshold for separate disclosure. These segments include telecommunications, energy products and services, and leasing and financing services. Intersegment revenues are not material. Financial data for business segments for the periods covered in the Form 10-Q are as follows: <TABLE> <CAPTION> Electric All Reconciling Utilities Other Eliminations Consolidated --------------------------------------------------- -------------------------------------------------------------- (in millions) <S> <C> <C> <C> <C> Three Months Ended June 30, 2003: Operating revenues $ 2,742 $ 123 $ (6) $ 2,859 Segment net income (loss) 423 9 - 432 Six Months Ended June 30, 2003: Operating revenues 5,147 276 (11) 5,412 Segment net income (loss) 710 20 - 730 Total assets at June 30, 2003 $31,962 $ 1,743 $ (412) $33,293 --------------------------------------------------- ------------- ------------- ---------------- ----------------- Three Months Ended June 30, 2002: Operating revenues $ 2,563 $ 74 $ (7) $ 2,630 Segment net income (loss) 341 (11) 2 332 Six Months Ended June 30, 2002: Operating revenues 4,704 150 (10) 4,844 Segment net income (loss) 573 (19) 2 556 Total assets at December 31, 2002 $30,409 $1,881 $ (541) $31,749 --------------------------------------------------- ------------- ------------- ---------------- ----------------- </TABLE> Products and Services <TABLE> <CAPTION> Electric Utilities Revenues Period Retail Wholesale Other Total ------ ---------- --------------- ------------ ------------ <S> <C> <C> <C> <C> Three Months Ended June 30, 2003 $2,176 $338 $228 $2,742 Three Months Ended June 30, 2002 2,185 294 84 2,563 Six Months Ended June 30, 2003 4,150 677 320 5,147 Six Months Ended June 30, 2002 4,029 526 149 4,704 </TABLE> 115
PART II -OTHER INFORMATION Item 1. Legal Proceedings. Reference is made to the Notes to the Condensed Financial Statements herein for information regarding certain legal and administrative proceedings in which Southern Company and its reporting subsidiaries are involved. Item 4. Submission of Matters to a Vote of Security Holders. Southern Company Southern Company held its annual meeting of shareholders on May 28, 2003. Each nominee for director of Southern Company received the requisite plurality of votes for election. The vote tabulation was as follows: <TABLE> <CAPTION> Nominees Shares For Shares Withhold Vote <S> <C> <C> Daniel P. Amos 536,000,477 10,523,799 Dorrit J. Bern 531,823,380 14,700,896 Thomas F. Chapman 532,249,344 14,274,932 Allen Franklin 533,727,210 12,797,066 Bruce S. Gordon 535,628,816 10,895,460 L. G. Hardman III 532,082,468 14,441,808 Donald M. James 530,981,255 15,543,021 Zack T. Pate 532,098,196 14,426,080 J. Neal Purcell 531,979,230 14,545,046 Gerald J. St. Pe 535,764,375 10,759,901 </TABLE> In addition, at the annual meeting, shareholders were asked to vote for the ratification of by-laws amendments permitting book-entry shares. The vote tabulation was 528,295,086 shares for, 9,409,288 shares against and 8,819,889 shares abstaining. As a result of this vote the by- laws amendments were adopted. Shareholders were also entitled to vote on a stockholder proposal on providing an environmental report. The vote tabulation was 91,215,426 shares for, 293,556,756 shares against and 45,455,923 shares abstaining. As a result of this vote, the stockholder proposal was rejected. 116
Item 4. Submission of Matters to a Vote of Security Holders. (Continued) Alabama Power Alabama Power held its annual meeting of common shareholders and preferred shareholders on April 25, 2003, and the following persons were elected to serve as directors of Alabama Power: Whit Armstrong Charles D. McCrary David J. Cooper, Sr. Malcolm Portera Allen Franklin Robert D. Powers R. Kent Henslee C. Dowd Ritter Carl E. Jones, Jr. James H. Sanford Patricia M. King William F. Walker James K. Lowder John Cox Webb, IV Wallace D. Malone, Jr. James W. Wright All 6,000,000 of the then outstanding shares of Alabama Power's common stock are owned by Southern Company and were voted in favor of the nominees for directors. In addition, at the annual meeting, shareholders were asked to vote for an amendment to Alabama Power's Articles of Incorporation that would increase Alabama Power's authorized common stock from 6,000,000 shares to 15,000,000 shares. All 6,000,000 of the then outstanding shares of Alabama Power's common stock are owned by Southern Company and were voted in favor of this amendment. None of the shares of preferred stock or Class A preferred stock were voted. Georgia Power Georgia Power held its annual meeting of common shareholders and preferred shareholders on May 21, 2003, and the following persons were elected to serve as directors of Georgia Power: Juanita P. Baranco David M. Ratcliffe Robert L. Brown, Jr. D. Gary Thompson Anna R. Cablik Richard W. Ussery Allen Franklin William Jerry Vereen L. G. Hardman III Carl Ware G. Joseph Prendergast E. Jenner Wood, III All of the 7,761,500 outstanding shares of Georgia Power's common stock are owned by Southern Company and were voted in favor of the nominees for directors. None of the shares of preferred stock were voted. 117
Item 4. Submission of Matters to a Vote of Security Holders. (Continued) Gulf Power Gulf Power held its annual meeting of common shareholders and preferred shareholders on May 21, 2003, and the following persons were elected to serve as directors of Gulf Power: C. LeDon Anchors Allen Franklin William C. Cramer, Jr. William A. Pullum Fred C. Donovan, Sr. Susan N. Story All of the 992,717 outstanding shares of Gulf Power's common stock are owned by Southern Company and were voted in favor of the nominees for directors. None of the shares of preferred stock were voted. Mississippi Power Mississippi Power held its annual meeting of common shareholders and preferred shareholders on May 21, 2003, and the following persons were elected to serve as directors of Mississippi Power: Tommy E. Dulaney Aubrey K. Lucas Michael D. Garrett George A. Schloegel Linda T. Howard Philip J. Terrell Robert C. Khayat N. Eugene Warr All of the 1,121,000 outstanding shares of Mississippi Power's common stock are owned by Southern Company and were voted in favor of the nominees for directors. None of the shares of preferred stock were voted. Savannah Electric By written consent, in lieu of the annual meeting of stockholders of Savannah Electric, effective May 2, 2003, the following persons were elected to serve as directors of Savannah Electric: Gus H. Bell, III Anthony R. James Archie H. Davis Robert B. Miller, III Walter D. Gnann Arnold M. Tenenbaum All of the 10,844,635 outstanding shares of Savannah Electric's common stock are owned by Southern Company and were voted in favor of the nominees for directors. 118
Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. -------- (3) Articles of Incorporation and By-Laws Southern Company (a) 1 - By-Laws of Southern Company as amended effective February 17, 2003, and as presently in effect. (4) Instruments Describing Rights of Security Holders, Including Indentures Southern Power (g) 1 - Second Supplemental Indenture dated as of July 8, 2003 between Southern Power and The Bank of New York, as Trustee. (10) Material Contracts Southern Company (a) 1 - Southern Company Change in Control Severance Plan, Amended and Restated effective May 1, 2003. (a) 2 - Southern Company Executive Change in Control Severance Plan, Amended and Restated effective May 1, 2003. (a) 3 - Southern Company Senior Executive Change in Control Severance Plan effective May 1, 2003. (a) 4 - First Amendment as adopted July 9, 2003, to The Southern Company Pension Plan, as amended and restated effective January 1, 2002. Alabama Power (b) 1 - Amended and Restated Supplemental Pension Agreement among SCS, Southern Nuclear, Alabama Power and James H. Miller III. (24) Power of Attorney and Resolutions Southern Company (a) 1 - Power of Attorney and resolution. (Designated in the Form 10-K for the year ended December 31, 2002, File No. 1-3526 as Exhibit 24(a) and incorporated herein by reference.) (a) 2 - Power of Attorney for Thomas A. Fanning. (Designated in the Form 10-Q for the Quarter ended March 31, 2003, File No. 1-3526 as Exhibit 24(a)2 and incorporated herein by reference.) 119
Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. (Continued) -------- Alabama Power (b) 1 - Power of Attorney and resolution. (Designated in the Form 10-K for the year ended December 31, 2002, File No. 1-3164 as Exhibit 24(b) and incorporated herein by reference.) Georgia Power (c) 1 - Power of Attorney and resolution. (Designated in the Form 10-K for the year ended December 31, 2002, File No. 1-6468 as Exhibit 24(c) and incorporated herein by reference.) (c) 2 - Power of Attorney for C. B. Harreld. Gulf Power (d) 1 - Power of Attorney and resolution. (Designated in the Form 10-K for the year ended December 31, 2002, File No. 0-2429 as Exhibit 24(d) and incorporated herein by reference.) (d) 2 - Power of Attorney for Susan N. Story. (Designated in the Form 10-Q for the Quarter ended March 31, 2003, File No. 0-2429 as Exhibit 24(d)2 and incorporated herein by reference.) Mississippi Power (e) 1 - Power of Attorney and resolution. (Designated in the Form 10-K for the year ended December 31, 2002, File No. 001-11229 as Exhibit 24(e) and incorporated herein by reference.) Savannah Electric (f) 1 - Power of Attorney and resolution. (Designated in the Form 10-K for the year ended December 31, 2002, File No. 1-5072 as Exhibit 24(f) and incorporated herein by reference.) Southern Power (g) 1 - Power of Attorney and resolution. (Designated in the Form 10-K for the year ended December 31, 2002, File No. 333-98553 as Exhibit 24(g) and incorporated herein by reference.) (31) Section 302 Certifications Southern Company (a) 1 - Certificate of Southern Company's Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. 120
Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. (Continued) -------- (a) 2 - Certificate of Southern Company's Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. Alabama Power (b) 1 - Certificate of Alabama Power's Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. (b) 2 - Certificate of Alabama Power's Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. Georgia Power (c) 1 - Certificate of Georgia Power's Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. (c) 2 - Certificate of Georgia Power's Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. Gulf Power (d) 1 - Certificate of Gulf Power's Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. (d) 2 - Certificate of Gulf Power's Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. Mississippi Power (e) 1 - Certificate of Mississippi Power's Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. (e) 2 - Certificate of Mississippi Power's Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. Savannah Electric (f) 1 - Certificate of Savannah Electric's Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. (f) 2 - Certificate of Savannah Electric's Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. 121
Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. (Continued) -------- Southern Power (g) 1 - Certificate of Southern Power's Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. (g) 2 - Certificate of Southern Power's Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002. (32) Section 906 Certifications Southern Company (a) - Certificate of Southern Company's Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002. Alabama Power (b) - Certificate of Alabama Power's Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002. Georgia Power (c) - Certificate of Georgia Power's Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002. Gulf Power (d) - Certificate of Gulf Power's Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002. Mississippi Power (e) - Certificate of Mississippi Power's Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002. Savannah Electric (f) - Certificate of Savannah Electric's Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002. Southern Power (g) - Certificate of Southern Power's Chief Executive Officer and Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002. 122
(b) Reports on Form 8-K. ------------------- The registrants collectively and separately filed Current Reports on Form 8-K dated April 30, 2003: Item reported: Items 9 and 12 Financial statements filed: None Southern Company filed Current Reports on Form 8-K dated April 17, 2003, April 21, 2003 and May 21, 2003: Item reported: Item 5 Financial statements filed: None Alabama Power filed Current Reports on Form 8-K dated April 15, 2003 and May 1, 2003: Item reported: Items 5 and 7 Financial statements filed: None Georgia Power filed a Current Report on Form 8-K dated April 10, 2003: Item reported: Items 5 and 7 Financial statements filed: None Mississippi Power filed Current Reports on Form 8-K dated April 21, 2003 and May 21, 2003: Item reported: Item 5 Financial statements filed: None Mississippi Power filed a Current Report on Form 8-K dated April 24, 2003: Item reported: Items 5 and 7 Financial statements filed: None Southern Power filed Current Reports on Form 8-K dated April 21, 2003 and May 21, 2003: Item reported: Item 5 Financial statements filed: None 123
THE SOUTHERN COMPANY SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. THE SOUTHERN COMPANY By Allen Franklin Chairman and Chief Executive Officer (Principal Executive Officer) By Thomas A. Fanning Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) By /s/ Wayne Boston (Wayne Boston, Attorney-in-fact) Date: August 13, 2003 124
ALABAMA POWER COMPANY SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. ALABAMA POWER COMPANY By Charles D. McCrary President and Chief Executive Officer (Principal Executive Officer) By William B. Hutchins, III Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) By /s/ Wayne Boston (Wayne Boston, Attorney-in-fact) Date: August 13, 2003 125
GEORGIA POWER COMPANY SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. GEORGIA POWER COMPANY By David M. Ratcliffe President and Chief Executive Officer (Principal Executive Officer) By C. B. Harreld Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) By /s/ Wayne Boston (Wayne Boston, Attorney-in-fact) Date: August 13, 2003 126
GULF POWER COMPANY SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. GULF POWER COMPANY By Susan N. Story President and Chief Executive Officer (Principal Executive Officer) By Ronnie R. Labrato Vice President, Chief Financial Officer and Comptroller (Principal Financial and Accounting Officer) By /s/ Wayne Boston (Wayne Boston, Attorney-in-fact) Date: August 13, 2003 127
MISSISSIPPI POWER COMPANY SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. MISSISSIPPI POWER COMPANY By Michael D. Garrett President and Chief Executive Officer (Principal Executive Officer) By Michael W. Southern Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) By /s/ Wayne Boston (Wayne Boston, Attorney-in-fact) Date: August 13, 2003 128
SAVANNAH ELECTRIC AND POWER COMPANY SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. SAVANNAH ELECTRIC AND POWER COMPANY By A. R. James President and Chief Executive Officer (Principal Executive Officer) By Kirby R. Willis Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) By /s/ Wayne Boston (Wayne Boston, Attorney-in-fact) Date: August 13, 2003 129
SOUTHERN POWER COMPANY SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. SOUTHERN POWER COMPANY By William P. Bowers President and Chief Executive Officer (Principal Executive Officer) By Cliff S. Thrasher Senior Vice President, Comptroller and Chief Financial Officer (Principal Financial and Accounting Officer) By /s/ Wayne Boston (Wayne Boston, Attorney-in-fact) Date: August 13, 2003 130