Southern Company - 10-Q quarterly report FY

 

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

     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. Yesþ No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Securities Exchange Act of 1934).

     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.

 

 

     This Quarterly Report on Form 10-Q contains forward-looking statements. Forward-looking statements include, among other things, statements concerning the strategic goals for Southern Company’s wholesale business, retail sales growth, storm damage cost recovery, environmental regulations and expenditures, financing activities, completion of construction projects, impacts of adoption of new accounting rules, and estimated construction and other expenditures. 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 similar terminology. There are various factors that could cause actual results to differ materially from those suggested by the forward-looking statements; accordingly, there can be no assurance that such indicated results will be realized. These factors include:

THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

The accompanying notes as they relate to Southern Company are an integral part of these condensed financial statements.

THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

The accompanying notes as they relate to Southern Company are an integral part of these condensed financial statements.

THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

The accompanying notes as they relate to Southern Company are an integral part of these condensed financial statements.

THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

The accompanying notes as they relate to Southern Company are an integral part of these condensed financial statements.

THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

The accompanying notes as they relate to Southern Company are an integral part of these condensed financial statements.

SECOND QUARTER 2005 vs. SECOND QUARTER 2004
AND
YEAR-TO-DATE 2005 vs. YEAR-TO-DATE 2004

Discussion of the results of operations is focused on Southern Company’s primary business of electricity sales in the Southeast by the retail operating companies — Alabama Power, Georgia Power, Gulf Power, Mississippi Power, and Savannah Electric — and Southern Power. Southern Power is an electric wholesale generation subsidiary with market-based rate authority. Southern Company’s other business activities include investments in synthetic fuels and leveraged lease projects, telecommunications, energy-related services, and natural gas marketing. For additional information on these businesses, see BUSINESS — The SOUTHERN System — “Retail Operating Companies,” “Southern Power,” and “Other Business” in Item 1 of the Form 10-K. Also see Note (P) to the Condensed Financial Statements herein for information on a letter of intent signed in July 2005 to sell the assets of Southern Company GAS, the natural gas marketing business.

     Southern Company continues to focus on several key performance indicators. These indicators include customer satisfaction, peak season equivalent forced outage rate, return on equity, and earnings per share. For additional information on these indicators, see MANAGEMENT’S DISCUSSION AND ANALYSIS — OVERVIEW — “Key Performance Indicators” of Southern Company in Item 7 of the Form 10-K.

Southern Company’s second quarter and year-to-date 2005 earnings were $387 million ($0.52 per share) and $710 million ($0.95 per share) compared with $352 million ($0.48 per share) and $683 million ($0.93 per share), respectively, for the corresponding periods in 2004. Increases in earnings in the second quarter and year-to-date 2005 primarily resulted from sustained economic strength and customer growth in the Southern Company service area, as well as a base rate increase at Georgia Power. These increases were partially offset by mild weather, the expiration of certain provisions of Georgia Power’s three-year retail rate plan ending December 31, 2004 (2001 Retail Rate Plan), and higher maintenance costs as compared to the corresponding periods in 2004.

     Significant income statement items appropriate for discussion include the following:

     Retail revenues. The chart below reflects the primary drivers of the 3.1% and 4.4% increases in retail revenues in the second quarter and year-to-date 2005 when compared to the prior year. Changes in revenue related to cost recovery mechanisms such as fuel and environmental have no effect on net income. In the second quarter and year-to-date 2005, retail kilowatt-hour energy sales decreased by 1.8% and 1.3%, respectively, from the same periods a year ago, primarily due to milder weather. The decrease was partially offset by continued customer and demand growth due to sustained economic growth in the Southeast. The number of retail customers increased by 1.5% and weather-adjusted average consumption by retail customers increased by 0.5% and 0.7%, respectively, in the second quarter and year-to-date 2005 when compared with the second quarter and year-to-date 2004.

     Details of retail revenues are as follows:

     Sales for resale. In the second quarter and year-to-date 2005, sales for resale increased $41.1 million, or 12.0%, and $37.4 million, or 5.4%, respectively, over the same periods in 2004. The increases reflect a rise in fuel revenues due to the higher cost of fuel and new wholesale contracts between Georgia Power and 30 electric membership cooperatives (EMCs) and Flint EMC, both beginning in January 2005. In addition, Southern Power entered into new wholesale contracts with Flint EMC in January 2005 and added additional wholesale revenues through its acquisition of Oleander Power Project, L.P. (Oleander) and assumption of associated PPAs in June 2005. See FUTURE EARNINGS POTENTIAL — “Other Matters” herein for additional information on the Oleander acquisition.

     Other electric revenues. In the second quarter and year-to-date 2005, when compared to the same periods in 2004, other electric revenues increased $15.1 million, or 16.1%, and $22.7 million, or 12.1%, respectively. These increases were primarily due to higher transmission revenues of $6.1 million and $8.5 million, and increased outdoor lighting revenues of $1.7 million and $3.2 million in the second quarter and year-to-date 2005, respectively, as compared to the same periods in 2004. In addition, customer fees increased $1.3 million and $2.4 million in the second quarter and year-to-date 2005, respectively, over the corresponding periods in 2004. Other electric revenues also increased by $1.5 million in the second quarter and year-to-date 2005 when compared to the same periods in 2004 as the result of an Alabama Power customer’s early termination of a contract.

     Fuel expense. Fuel expense was higher in the second quarter and year-to-date 2005 due to increases of 19.0% and 15.0%, respectively, in the average unit cost of fuel per net kilowatt-hour generated when compared to the same periods in the prior year. Increases in fuel expense at the retail operating companies are generally offset by fuel revenues and do not affect net income. Fuel expenses incurred under Southern Power’s PPAs are generally the responsibility of the counterparties, and do not significantly affect net income.

     Purchased power expense. The 43.3% and 34.3% decreases in purchased power expense in the second quarter and year-to-date 2005, respectively, compared with the same periods in the prior year are primarily a result of lower kilowatt-hour purchases resulting from milder weather reducing demand and a decrease in the cost of purchased power per kilowatt-hour. Since these expenses are offset by energy revenues, they generally do not have a significant impact on earnings.

     Maintenance expense. The $48.1 million increase in maintenance expense year-to-date 2005 is mainly attributable to $45 million of expenses recorded by Alabama Power in accordance with an accounting order approved by the Alabama PSC to offset the costs of Hurricane Ivan and restore the natural disaster reserve. In accordance with the accounting order, Alabama Power also returned certain regulatory liabilities related to deferred taxes to its retail customers; therefore, the combined effects of this accounting order had no impact on net income. See Note 3 to the financial statements of Southern Company under “Gulf Power and Alabama Power Storm Damage Recovery” in Item 8 of the Form 10-K and “Income taxes” below for additional information.

     Depreciation and amortization expense. The $54.4 million and $106.4 million increases in depreciation and amortization in the second quarter and year-to-date 2005, respectively, when compared to the prior year are due to the expiration in 2004 of certain provisions in Georgia Power’s 2001 Retail Rate Plan. In accordance with the 2001 Retail Rate Plan, Georgia Power amortized an accelerated cost recovery liability equally as a credit to amortization expense and recognized new Georgia PSC-certified purchased power costs in rates evenly over the three years ended December 31, 2004. This treatment resulted in a credit to amortization expense of $47 million and $94 million during the second quarter and year-to-date 2004, respectively. See Note 3 to the financial statements of Southern Company under “Georgia Power Retail Rate Activity” in Item 8 of the Form 10-K for additional information.

     Allowance for equity funds used during construction. The $13.2 million increase in AFUDC equity year-to-date 2005 compared to the same period in the prior year relates primarily to construction of the McIntosh combined cycle units 10 and 11 by Georgia Power and Savannah Electric. See Note 3 to the financial statements of Southern Company under “Plant McIntosh Construction Project” in Item 8 of the Form 10-K for further information. AFUDC equity is non-taxable. See Note (H) to the Condensed Financial Statements herein for information on the impact on Southern Company’s 2005 annual effective tax rate.

     Interest expense, net of amounts capitalized. The $15.6 million and $24.0 million increases in interest expense, net of amounts capitalized, in the second quarter and year-to-date 2005, respectively, when compared to the same periods in 2004 are mainly attributed to an increase in the amount of senior notes outstanding and lower amounts of interest capitalized as projects have reached completion, partially offset by refinancing with lower interest-rate long-term debt. See MANAGEMENT’S DISCUSSION AND ANALYSIS — FINANCIAL CONDITION AND LIQUIDITY — “Financing Activities” of Southern Company in Item 7 of the Form 10-K and herein for additional information.

     Other income (expense), net. The increases in other income (expense), net, of $13.4 million and $15.8 million in the second quarter and year-to-date 2005, respectively, when compared to the same periods in the prior year, are a result of $5.5 million and $6.2 million increases in flat bill revenues for the second quarter and year-to-date 2005, respectively, and a $4.9 million increase for the second quarter and year-to-date 2005, related to the timing of the employee stock ownership plan contribution when compared to the prior year periods.

     Income taxes. The $13.8 million decrease in income taxes in the second quarter 2005 compared to the prior year is primarily due to a $8.8 million increase in tax benefits received related to higher production at synfuel production facilities. The $57.6 million decrease in year-to-date 2005 income taxes over the prior year is primarily the result of the impact of the Alabama PSC accounting order discussed under “Maintenance expense” above and, along with other items, is expected to result in an annual effective income tax rate of

approximately 27% for Southern Company in 2005. See Note 5 to the financial statements of Southern Company in Item 8 of the Form 10-K and Note (H) to the Condensed Financial Statements herein for additional information.

The results of operations discussed above are not necessarily indicative of future earnings potential. The level of Southern Company’s future earnings depends on numerous factors that affect the opportunities, challenges, and risks of Southern Company’s primary business of selling electricity. These factors include the retail operating companies’ ability to maintain a stable regulatory environment, to achieve energy sales growth while containing costs, and to recover costs related to growing demand and increasingly stringent environmental standards. Another major factor is the profitability of the competitive market-based wholesale generating business and federal regulatory policy, which may impact Southern Company’s level of participation in this market. Future earnings for the electricity business in the near term will depend, in part, upon growth in energy sales, which is subject to a number of factors. These factors include weather, competition, new energy contracts with neighboring utilities, energy conservation practiced by customers, the price of electricity, the price elasticity of demand, and the rate of economic growth in the service area. For additional information relating to these issues, see BUSINESS — The SOUTHERN System — “Risk Factors” in Item 1 and MANAGEMENT’S DISCUSSION AND ANALYSIS — FUTURE EARNINGS POTENTIAL of Southern Company in Item 7 of the Form 10-K.

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 certain environmental litigation, see MANAGEMENT’S DISCUSSION AND ANALYSIS — FUTURE EARNINGS POTENTIAL — “Environmental Matters” of Southern Company in Item 7 and Note 3 to the financial statements of Southern Company under “Environmental Matters” in Item 8 of the Form 10-K.

On June 3, 2005, the U.S. District Court for the Northern District of Alabama issued its decision in favor of Alabama Power on two primary legal issues in the case: (1) the scope of the routine maintenance repair and replacement exclusion under the New Source Review rules and (2) the proper test for calculating emissions increases under those rules. The court decided that routine maintenance repair and replacement must be defined with reference to what is routine in the industry as opposed to what is routine at an individual unit and emissions increases must be measured against the maximum hourly emission rate. The decision does not resolve the case, nor does it address other legal issues associated with the EPA’s allegations involving Plant Miller Units 3 and 4. In separate orders, the court dismissed Alabama Power’s motion for summary judgment on the other claims, stayed the entire case, and referred the parties to mediation to be completed by September 9, 2005. Alabama Power may refile its motion for summary judgment if the mediation proves unsuccessful. The Georgia Power and Savannah Electric case, which is pending in federal district court in Georgia, remains administratively closed. The ultimate outcome of these matters cannot now be determined. See MANAGEMENT’S DISCUSSION AND ANALYSIS — FUTURE EARNINGS POTENTIAL — “Environmental Matters — New Source Review Actions” of Southern Company in Item 7 and Note 3 to the financial statements of Southern Company under “Environmental Matters — New Source Review Actions” in Item 8 of the Form 10-K and Note (B) to the Condensed Financial Statements herein under “New Source Review Actions” for additional information.

In March 2005, the U.S. Court of Appeals for the Eleventh Circuit accepted Georgia Power’s petition for review of the U.S. District Court for the Northern District of Georgia’s December 15, 2004 order related to the Plant Wansley environmental litigation. Oral argument on that appeal has not been scheduled. The ultimate outcome of this matter cannot now be determined. See MANAGEMENT’S DISCUSSION AND ANALYSIS — FUTURE EARNINGS POTENTIAL — “Environmental Matters — Plant Wansley Environmental Litigation” of Southern Company in Item 7 and Note 3 to the financial statements of Southern Company under “Environmental Matters — Plant Wansley Environmental Litigation” in Item 8 of the Form 10-K and Note (B) to the Condensed Financial Statements herein under “Plant Wansley Environmental Litigation” for additional information.

The EPA issued the final Clean Air Interstate Rule on March 10, 2005. The rule addresses sulfur dioxide (SO₂) and nitrogen oxide (NO_x) emissions that contribute to nonattainment of the eight-hour ozone and fine particulate matter National Ambient Air Quality Standards. Twenty-eight eastern states, including each of the states within Southern Company’s service area, are subject to the fine particulate and/or the eight-hour ozone requirements set forth within the rule. The rule may require additional reductions of NO_x and/or SO₂ to be achieved by the installation of additional controls at Southern Company facilities or through the purchase of allowances. The impact of this final rule on Southern Company will, however, depend on the outcome of legal challenges and development and implementation of applicable state regulations and therefore cannot be determined at this time.

     On March 15, 2005, the EPA announced the final Clean Air Mercury Rule, selecting a cap-and-trade approach to be implemented in two phases, 2010 and 2018. The rule sets a permanent cap on emissions at the 2018 level and provides for an emissions allowance trading market. The impact of this final rule on Southern Company will depend on the outcome of legal challenges and development and implementation of applicable state regulations and therefore cannot be determined at this time.

     On June 15, 2005, the EPA issued final rules addressing Best Available Retrofit Technology (BART) standards under the Regional Haze Program. States must develop regulations to implement the federal regional haze requirements, including BART standards, by December 17, 2007. The impact of the final BART rules on Southern Company will depend on the outcome of any litigation over the final rules and the development and implementation of the applicable state regulations and therefore cannot be determined at this time.

     On June 14 and 15, 2005, the EPA published final rules approving the redesignation of the Atlanta metro area to “attainment” under the one-hour ground-level ozone standard.

See MANAGEMENT’S DISCUSSION AND ANALYSIS — FUTURE EARNINGS POTENTIAL — “FERC and State PSC Matters — Market-Based Rate Authority” of Southern Company in Item 7 and Note 3 to the financial statements of Southern Company under “Market-Based Rate Authority” in Item 8 of the Form 10-K for information on the FERC’s April 2004 order adopting a new interim analysis for measuring generation market power and a proceeding initiated by the FERC in December 2004 to assess Southern Company’s generation dominance within its retail service territory. Each of the retail operating companies and Southern Power has authorization from the FERC to sell power to non-affiliates at market-based prices. The retail operating companies and Southern Power also have FERC authority to make short-term opportunity sales at

market rates. Specific FERC approval must be obtained with respect to a market-based contract with an affiliate. On February 15, 2005, Southern Company submitted additional information related to generation dominance in its retail service territory. On July 8, 2005, the FERC initiated a hearing before an administrative law judge to review the generation market power issues. Any new market-based rate transactions in its retail service territory entered into after February 27, 2005 will be subject to refund to the level of the default cost-based rates, pending the outcome of the proceeding. In the event that the FERC’s default mitigation measures are ultimately applied, the retail operating companies and Southern Power may be required to charge cost-based rates for certain wholesale sales in the Southern Company retail service territory, which may be lower than negotiated market-based rates. The impact of such sales through June 30, 2005 is not material to Southern Company’s net income. The final outcome of this matter will depend on the form in which the final methodology for assessing generation market power and mitigation rules may be ultimately adopted and cannot be determined at this time.

     In addition, on May 5, 2005, the FERC issued an order expanding the generation market power proceeding initiated in December 2004 to include an investigation of whether Southern Company satisfies the other three parts of the FERC’s market-based rate analysis: transmission market power, barriers to entry, and affiliate abuse or reciprocal dealing. The FERC established a new refund period related to this expanded investigation. Any and all new market-based rate transactions involving any Southern Company subsidiary will be subject to refund to the extent the FERC orders lower rates beginning July 19, 2005. The FERC also directed that this expanded proceeding be held in abeyance pending the outcome of the proceeding on the IIC discussed below.

     Southern Company and its subsidiaries believe that there is no meritorious basis for these allegations and intend to vigorously defend themselves in the proceeding. However, the final outcome of this matter, including any remedies to be applied in the event of an adverse ruling in this proceeding, cannot now be determined.

Also, on May 5, 2005, the FERC initiated a new proceeding to examine (1) the provisions of the IIC among Alabama Power, Georgia Power, Gulf Power, Mississippi Power, Savannah Electric, Southern Power, and SCS, as agent, under the terms of which the power pool of Southern Company is operated, and, in particular, the propriety of the continued inclusion of Southern Power as a party to the IIC, (2) whether any parties to the IIC have violated the FERC’s standards of conduct applicable to utility companies that are transmission providers, and (3) whether Southern Company’s code of conduct defining Southern Power as a “system company” rather than a “marketing affiliate” is just and reasonable. In 2000, in connection with the formation of Southern Power, the FERC authorized Southern Power’s inclusion in the IIC. The FERC also previously approved Southern Company’s code of conduct. The FERC order directs that the administrative law judge who presided over the McIntosh PPA proceeding be assigned to preside over the hearing in this proceeding and that the testimony and exhibits presented in that proceeding be preserved to the extent appropriate. See Note 3 to the financial statements of Southern Company under “Plant McIntosh Construction Project” in Item 8 of the Form 10-K for further information on the McIntosh PPA proceeding. Effective July 19, 2005, revenues from transactions under the IIC involving any Southern Company subsidiaries will be subject to refund to the extent the FERC orders any changes to the IIC.

     Southern Company and its subsidiaries believe that there is no meritorious basis for these allegations and intend to vigorously defend themselves in the proceeding. However, the final outcome of this matter, including any remedies to be applied in the event of an adverse ruling in this proceeding, cannot now be determined.

See MANAGEMENT’S DISCUSSION AND ANALYSIS — FUTURE EARNINGS POTENTIAL — “FERC and State PSC Matters — Generation Interconnection Agreements” of Southern Company in Item 7 of the Form 10-K for information on the FERC’s Order 2003 related to standardization of generation interconnection agreements and procedures. The FERC has indicated that Order 2003, which was effective January 20, 2004, is to be applied prospectively to interconnection agreements. Subsidiaries of Tenaska, Inc., as counterparties to three previously executed interconnection agreements with subsidiaries of Southern Company, have filed complaints at the FERC requesting that the FERC modify the agreements and that Southern Company refund a total of $19 million previously paid for interconnection facilities, with interest. Southern Company has also received similar requests from other entities totaling approximately $14 million. Southern Company has opposed such relief, and the proceedings are still pending. The impact of Order 2003 and its subsequent rehearings on Southern Company and the final results of these matters cannot be determined at this time.

The retail operating companies each have established fuel cost recovery rates approved by their respective state PSCs. In recent quarters, the retail operating companies have experienced higher than expected fuel costs for coal and gas. These higher fuel costs have increased the under recovered fuel costs included in the balance sheets. The retail operating companies will continue to monitor the under recovered fuel cost balance in light of these higher fuel costs.

     Alabama Power fuel costs are recovered under Rate ECR (Energy Cost Recovery), which provides for the addition of a fuel and energy cost factor to base rates. Alabama Power’s under-recovered fuel costs as of June 30, 2005 totaled $127.4 million as compared to $101.6 million at December 31, 2004. Alabama Power increased its fuel billing factor in April 2005. Alabama Power will continue to monitor the under-recovered fuel cost balance to determine if an additional adjustment to billing rates should be requested from the Alabama PSC. See Note 3 to the financial statements of Southern Company under “Alabama Power Retail Regulatory Matters” in Item 8 of the Form 10-K and Note (I) to the Condensed Financial Statements herein for additional information.

     On May 17, 2005, the Georgia PSC voted to allow Georgia Power to increase customer fuel rates to recover estimated under-recovered fuel costs of approximately $508 million as of May 31, 2005 over the period from June 1, 2005 through May 31, 2009, as well as future projected fuel costs based on a June 2005 through May 2006 test period. The new fuel rate became effective June 1, 2005 and represents an average annual increase in revenues of approximately 9.5%, or approximately $473 million. Based on the order, a portion of the under-recovered regulatory clause revenues was reclassified from current to long-term on the balance sheet. At June 30, 2005, Georgia Power’s under-recovered fuel costs totaled $516 million, of which $363 million is classified as long-term. See Note 3 to the financial statements of Southern Company under “Georgia Power Retail Rate Activity” in Item 8 of the Form 10-K and Note (J) to the Condensed Financial Statements herein for additional information.

See MANAGEMENT’S DISCUSSION AND ANALYSIS — FUTURE EARNINGS POTENTIAL — “FERC and State PSC Matters - - Storm Damage Cost Recovery” of Southern Company in Item 7 and Notes 1 and 3 to the financial statements of Southern Company under “Storm Damage Reserves” and “Gulf Power and Alabama Power Storm Damage Recovery,” respectively, in Item 8 of the Form 10-K. Each retail operating company maintains a reserve for property damage to cover the cost of damages from major storms to its transmission and distribution lines and the cost of uninsured damages to its generation facilities and other property.

     Hurricane Ivan hit Gulf Power’s service territory in September 2004. In March 2005, the Florida PSC approved a Stipulation and Settlement between Gulf Power, the Office of Public Counsel for the State of Florida, and the Florida Industrial Power Users Group which allows Gulf Power to recover the retail portion of $51.7 million, the projected reserve deficiency, plus interest and revenue taxes, from customers over a 24-month period beginning in April 2005. In connection with the Stipulation, Gulf Power has agreed that it will not seek any additional increase in its base rates and charges to become effective on or before March 1, 2007.

     On July 10, 2005, Hurricane Dennis hit Gulf Power’s service territory. Approximately 242,000, or 60%, of Gulf Power’s customers were without electrical service immediately after the hurricane struck. More than 98% of those without power had service restored in six days. Based on current projections, retail sales revenues lost as a result of power outages from Hurricane Dennis are not expected to have a material impact on the net income of Gulf Power. Gulf Power maintains an accumulated provision for property damage to cover the cost of damages from major storms and other uninsured damages to its property. Due to the damages incurred in 2004 related to Hurricane Ivan (Ivan), the accumulated reserve had a deficit balance of $42 million at June 30, 2005, including the Ivan deficit. The Ivan deficit at June 30, 2005 was $44.4 million, which is currently being recovered from retail customers through a surcharge on the customer’s bill over a two-year recovery period. The current preliminary estimate of Hurricane Dennis restoration costs are approximately $60 million. The established policy of the Florida PSC, as recently reaffirmed by its decisions following the 2004 hurricane experience of Florida’s investor owned electric utilities, provides for recovery of these costs through the mechanism of the property insurance reserve and, where necessary, through a special recovery surcharge. In 2005, the Florida legislature authorized securitized financing as an additional mechanism available to the Florida PSC and electric utilities in Florida for addressing the extraordinary costs associated with hurricanes. Based upon the additional costs related to Hurricane Dennis, this option, along with other alternatives, is being evaluated to allow a more rapid recovery of these costs. See Note (K) to the Condensed Financial Statements herein for additional information.

     Hurricane Dennis also impacted the Gulf Coast of Alabama and continued north through the state of Alabama, causing significant damage in parts of the service territory of Alabama Power. Approximately 241,000 of Alabama Power’s 1,390,000 customer accounts were without electrical service immediately after the hurricane. The total operation and maintenance costs associated with repairing the damage to facilities and restoring service to customers are preliminarily estimated to be approximately $30 million. The June 30, 2005 balance of $4.2 million in the natural disaster reserve is not sufficient to cover these costs. Alabama Power has requested clarification from the Alabama PSC concerning an October 2004 order that allows the natural disaster reserve to carry a negative balance and to defer such costs for recovery in future periods to be determined by the Alabama PSC. If this request is not approved, Alabama Power would be required to expense the costs in excess of the reserve balance in the third quarter of 2005. See Note (I) to the Condensed Financial Statements herein for additional information.

See MANAGEMENT’S DISCUSSION AND ANALYSIS — FUTURE EARNINGS POTENTIAL — “Other Matters” of Southern Company in Item 7 and Note 3 to the financial statements of Southern Company under “Mirant Related Matters” in Item 8 of the Form 10-K and Note (B) to the Condensed Financial Statements herein under “Mirant Related Matters.” In July 2003, Mirant filed for voluntary reorganization under Chapter 11 of the U.S. Bankruptcy Code. In June 2004, Mirant’s bankruptcy counsel notified Southern Company that it was investigating, on behalf of a committee of independent Mirant directors, potential claims against Southern Company.

     In June 2005, Mirant, as a debtor in possession, and The Official Committee of Unsecured Creditors of Mirant Corporation filed a complaint against Southern Company in the U.S. Bankruptcy Court for the Northern District of Texas and filed an amended complaint on July 6, 2005. The complaint alleges that Southern

Company caused Mirant to engage in certain fraudulent transfers and to pay illegal dividends to Southern Company in 1999 and 2000 with actual intent to hinder, delay or defraud creditors or, alternatively, when Southern Company knew or should have known that Mirant was allegedly insolvent, undercapitalized or unable to pay its debts. The alleged fraudulent transfers and/or illegal dividends include: (1) certain dividends from Mirant to Southern Company in the aggregate amount of $668 million, (2) the repayment of certain intercompany loans and accrued interest in an aggregate amount of $1.035 billion, and (3) the dividend distribution of one share of Series B Preferred Stock and its subsequent redemption in exchange for Mirant’s 80% interest in a holding company which owned SE Finance Capital Corporation and Southern Company Capital Funding, Inc., which transfer Mirant asserts is valued at $247.9 million. The complaint also seeks to recharacterize certain advances from Southern Company to Mirant for investments in energy facilities from debt to equity. The complaint further alleges that Southern Company is liable to Mirant’s creditors for the full amount of Mirant’s liability under an alter ego theory of liability and that Southern Company caused Mirant to breach its fiduciary duty of loyalty to its creditors. The complaint seeks monetary damages in excess of $2 billion plus interest, punitive damages, attorneys fees, and costs. Finally, Mirant objects to Southern Company’s claims against Mirant in the Bankruptcy Court (which, in the aggregate, currently total approximately $70 million) and seeks equitable subordination of Southern Company’s claims to the claims of all other creditors. Southern Company believes there is no meritorious basis for Mirant’s claims and intends to vigorously defend itself in this action.

     On July 13, 2005, The Official Committee of Unsecured Creditors of Mirant Corporation, on behalf of Mirant, as a debtor in possession, and its creditors, filed a complaint in the Bankruptcy Court against certain former officers and directors of Mirant and/or Southern Company. The complaint alleges that the defendants breached their fiduciary duties of loyalty and care owed to Mirant and its creditors by allowing Mirant to overpay for certain acquisitions of utility assets in 1997, 1998, and 1999, and by authorizing or participating in certain transfers from Mirant to Southern Company in 1999 and 2000 as described above when Mirant was allegedly insolvent, undercapitalized, or unable to pay its debts. Specifically, the complaint alleges that the defendants lacked independence in judgment and failed to act in the best interest of Mirant and its creditors when they authorized or participated in these acquisitions and transfers. The complaint seeks to recover damages in excess of $1.9 billion for such transfers. Under certain circumstances, Southern Company may be obligated under its Bylaws to indemnify the individuals named as defendants in the complaint.

     The ultimate outcome of these matters cannot be determined at this time.

     Southern Company has various other contingent liabilities associated with Mirant, including guarantees of contractual commitments, litigation, and joint and several liabilities in connection with the consolidated federal income tax return. The ultimate outcome of such contingent liabilities cannot now be determined.

See MANAGEMENT’S DISCUSSION AND ANALYSIS — FUTURE EARNINGS POTENTIAL — “Income Tax Matters - Leveraged Lease Transactions” of Southern Company in Item 7 and Note 3 to the financial statements of Southern Company under “Income Tax Matters — Leveraged Lease Transactions” in Item 8 of the Form 10-K and Note (B) to the Condensed Financial Statements herein under “Income Tax Matters” for information regarding IRS challenges to Southern Company’s transactions related to international leveraged leases that could have material impacts on Southern Company’s financial statements. The ultimate outcome of these matters cannot now be determined.

As discussed in Note 3 to the financial statements of Southern Company under “Income Tax Matters — Synthetic Fuel Tax Credits” in Item 8 of the Form 10-K, Southern Company has investments in two entities that produce synthetic fuel and receive tax credits under Section 29 of the IRC. In accordance with Section 29 of the IRC, these tax credits are subject to limitation as the annual average price of oil (as determined by the DOE) increases over a specified, inflation-adjusted dollar amount published in the spring of the subsequent year. Southern Company, along with its partners in these investments, will continue to monitor oil prices. Any indicated potential limitation on these credits could affect either the timing or the amount of the credit recognition and could also require an impairment analysis of these investments by Southern Company. In April 2005, Southern Company entered into a derivative transaction designed to reduce its exposure to the potential phase-out of these credits in 2005. The purchased option, which had an initial fair value of approximately $7 million, is being marked to market over the remainder of the year through other income (expense), net. See Note (F) to the Condensed Financial Statements herein for additional information.

On June 7, 2005, Southern Power, through certain of its wholly-owned subsidiaries, acquired all of the outstanding general and limited partnership interests of Oleander from Constellation Power, Inc. and certain other subsidiaries of Constellation Energy Group, Inc. Southern Power’s acquisition of the general and limited partnership interests in Oleander was pursuant to a Purchase and Sale Agreement dated April 8, 2005, for an aggregate purchase price of approximately $206 million, plus approximately $12 million of working capital and other adjustments. The purchase was for a dual-fueled generating plant in Brevard County, Florida with a nominal installed capacity of 680 MW. The entire output of the plant is sold under separate PPAs with Florida Power & Light Company and Seminole Electric Cooperative, Inc. The PPAs expire in 2007 and 2009, respectively.

     In July 2005, the U.S. Congress passed the Energy Policy Act of 2005 (Energy Act), which President Bush is expected to sign into law in early August 2005. Among other things, the Energy Act includes various tax subsidies for electric utilities and provisions repealing the PUHCA. The Energy Act also amends federal energy laws and provides the FERC with new oversight responsibilities for the electric utility industry. The implementation of the Energy Act requires proceedings at the state level and the development of regulations by the FERC, as well as other federal agencies. Southern Company is still reviewing the legislation; however, its impacts will depend on the promulgation and implementation of final rules and cannot be determined at this time.

     Southern Company is subject to certain claims and legal actions arising in the ordinary course of business. In addition, 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 against Southern Company and its subsidiaries cannot be predicted at this time; however, management does not anticipate that the liabilities, if any, arising from such current proceedings would have a material adverse effect on Southern Company’s financial statements.

     See the Notes to the Condensed Financial Statements herein for discussion of various contingencies and other matters which may affect future earnings potential.

Southern Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States. Significant accounting policies are described in Note 1 to the financial statements of Southern Company in Item 8 of the Form 10-K. In the application of these policies,

certain estimates are made that may have a material impact on Southern Company’s results of operations and related disclosures. Different assumptions and measurements could produce estimates that are significantly different from those recorded in the financial statements. Also see MANAGEMENT’S DISCUSSION AND ANALYSIS — ACCOUNTING POLICIES — “Application of Critical Accounting Policies and Estimates” of Southern Company in Item 7 of the Form 10-K for a complete discussion of Southern Company’s critical accounting policies and estimates related to Electric Utility Regulation, Contingent Obligations, and Unbilled Revenues.

FASB Statement No. 123R, Share-Based Payments, was issued in December 2004. This statement requires that compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant date fair value of the equity instruments issued. In April 2005, the SEC amended the compliance dates for FASB Statement No. 123R. For Southern Company, this statement is now effective beginning January 1, 2006. Although the compensation expense calculation required under the revised statement differs slightly, the impacts on Southern Company’s financial statements are expected to be similar to the pro forma disclosures included in Note 1 to the financial statements of Southern Company under “Stock Options” in Item 8 of the Form 10-K and in Note (C) to the Condensed Financial Statements herein.

     FASB Interpretation No. 47 (FIN 47), Accounting for Conditional Asset Retirement Obligations, was issued in March 2005. This interpretation requires that asset retirement obligations be recorded when a legal obligation exists even though the timing and/or the method of settlement are conditional on a future event. For Southern Company, FIN 47 is effective no later than December 31, 2005. Southern Company is currently assessing the impact of FIN 47 on its balance sheet; however, adoption is not currently expected to have a material impact on Southern Company’s income statement.

     In December 2004, the FASB issued Staff Position No. 109-1 (FSP 109-1), Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities provided by the American Jobs Creation Act of 2004, which requires that the generation deduction for utilities be accounted for as a special tax deduction rather than as a tax rate reduction. Southern Company adopted FSP 109-1 in the first quarter of 2005 with no material impact on its financial statements.

Southern Company’s financial condition continued to be strong at June 30, 2005. Net cash flow from operating activities totaled $792 million for first six months of 2005, compared to $901 million for the corresponding period in 2004. The $109 million decrease in 2005 resulted primarily from higher fuel costs at the retail operating companies. Those costs are recoverable in future periods and are reflected on the balance sheets as under recovered regulatory clause revenues. Gross property additions to utility plant were $1.2 billion in the first six months of 2005. The majority of funds needed for gross property additions since 2000 has been provided from operating activities.

     Significant balance sheet changes include a $240 million increase in long-term debt for the first half of 2005 due to the replacement of short-term financing with long-term debt, consistent with Southern Company’s finance policy, and an increase of $534 million in property, plant, and equipment.

     The market price of Southern Company’s common stock at June 30, 2005 was $34.67 per share and the book value was $14.13 per share, representing a market-to-book ratio of 245%, compared to $33.52, $13.86, and 242%, respectively, at the end of 2004. The dividend for the second quarter 2005 was $0.3725 per share compared to $0.35 per share in the second quarter 2004.

     The retail operating companies, Southern Power, and SCS have each maintained investment grade ratings from the major rating agencies.

See MANAGEMENT’S DISCUSSION AND ANALYSIS — FINANCIAL CONDITION AND LIQUIDITY —“Capital Requirements and Contractual Obligations” of Southern Company in Item 7 of the Form 10-K for a description of Southern Company’s capital requirements for its construction program and other funding requirements associated with scheduled maturities of long-term debt, as well as the related interest, preferred stock dividends, leases, trust funding requirements, and other purchase commitments. Approximately $1.2 billion will be required by June 30, 2006 for redemptions and maturities of long-term debt.

Southern Company intends to meet its future capital needs through internal cash flow and external security issuances. The amounts and timing of additional equity capital to be raised will be contingent on Southern Company’s investment opportunities. The retail 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 from operating cash flows, security issuances, and term loan and short-term borrowings. However, the amount, type, and timing of any financings, if needed, will depend upon market conditions and regulatory approval. See MANAGEMENT’S DISCUSSION AND ANALYSIS — FINANCIAL CONDITION AND LIQUIDITY — “Sources of Capital” of Southern Company in Item 7 of the Form 10-K for additional information.

     To meet short term cash needs and contingencies, the Southern Company system had at June 30, 2005 approximately $237 million of cash and cash equivalents and approximately $3.1 billion of unused credit arrangements with banks, of which $238 million expire in 2005 and $2.8 billion expire in 2006 and beyond. Of the facilities maturing in 2005 and 2006, $168 million contain provisions allowing two-year term loans executable at the expiration date and $275 million contain provisions allowing one-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. Southern Company expects to renew its credit facilities, as needed, prior to expiration. The retail 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 retail operating companies. At June 30, 2005, the Southern Company system had outstanding commercial paper of $893.1 million and extendible commercial notes of $24.3 million. Management believes that the need for working capital can be adequately met by utilizing commercial paper programs and lines of credit without maintaining large cash balances.

See MANAGEMENT’S DISCUSSION AND ANALYSIS — FINANCIAL CONDITION AND LIQUIDITY — “Off-Balance Sheet Financing Arrangements” of Southern Company in Item 7 and Note 7 to the financial statements of Southern Company under “Operating Leases” in Item 8 of the Form 10-K for information related to Mississippi Power’s lease of a combined cycle generating facility at Plant Daniel.

Southern Company does not have any credit arrangements 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 BBB- or Baa3 or below. These contracts are primarily for physical electricity purchases and sales. At June 30, 2005, the

maximum potential collateral requirements at a BBB- or Baa3 rating were approximately $51.8 million. The maximum potential collateral requirements at a rating below BBB- or Baa3 were approximately $353.8 million. In addition, through the acquisition of Oleander, Southern Power assumed a PPA with Seminole Electric Cooperative, Inc. that could require collateral, but not accelerated payment, in the event of a credit rating change to BBB- or Baa3 or below. The amount of this collateral cannot be determined at this time. Generally, collateral may be provided for by a Southern Company guaranty, letter of credit, or cash. Southern Company is also party to certain derivative agreements that could require collateral and/or accelerated payment in the event of a credit rating change to below investment grade. These agreements are primarily for natural gas price and interest rate risk management activities. At June 30, 2005, Southern Company and its subsidiaries had no material exposure under these contracts.

Southern Company’s market risk exposures relative to interest rate changes have not changed materially compared with the December 31, 2004 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 retail operating companies have limited exposure to market volatility in interest rates, commodity fuel prices, and prices of electricity. In addition, Southern Power’s exposure to market volatility in commodity fuel prices and prices of electricity is limited because its long-term sales contracts shift substantially all fuel cost responsibility to the purchaser. To mitigate residual risks relative to movements in electricity prices, the retail 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, into similar contracts for gas purchases. The retail operating companies have implemented fuel hedging programs at the instruction of their respective state PSCs. Southern Company GAS also has in place a risk management program to substantially mitigate its exposure to price volatility for its natural gas purchases.

     The fair value of derivative energy contracts at June 30, 2005 was as follows:

     For additional information, see MANAGEMENT’S DISCUSSION AND ANALYSIS — FINANCIAL CONDITION AND LIQUIDITY — “Market Price Risk” of Southern Company in Item 7 and Notes 1 and 6 to the financial statements of Southern Company under “Financial Instruments” in Item 8 of the Form 10-K and Note (F) to the Condensed Financial Statements herein.

In the first six months of 2005, Southern Company and its subsidiaries issued $655 million of senior notes and $149 million of common stock through employee and director stock plans and incurred obligations in connection with the issuance of $185 million of pollution control revenue bonds. The proceeds were primarily used to refund senior notes, obligations incurred in connection with pollution control revenue bonds, and other long-term debt and to fund ongoing construction projects. The remainder was used to repay short-term indebtedness. See Southern Company’s Condensed Consolidated Statements of Cash Flows herein for further details on financing activities during the first six months of 2005.

     In June 2005, Southern Company started repurchasing shares of stock to offset issuances under the Southern Company’s stock compensation plans. The total number of shares repurchased during the first six months of 2005 was 1.8 million at a cost of $62.3 million.

     In addition to any financings that may be necessary to meet capital requirements and contractual obligations, Southern Company and its subsidiaries plan to continue, when economically feasible, a program to retire higher-cost securities and replace these obligations with lower-cost capital if market conditions permit.

See MANAGEMENT’S DISCUSSION AND ANALYSIS — FINANCIAL CONDITION AND LIQUIDITY — “Market Price Risk” herein for each registrant and Notes 1 and 6 to the financial statements of each registrant under “Financial Instruments” in Item 8 of the Form 10-K. Also, see Note (F) to the Condensed Financial Statements herein for information relating to derivative instruments.

     (a) Evaluation of disclosure controls and procedures.

     As of the end of the period covered by this quarterly report, Southern Company, the retail 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 design and operation 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 these 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 their company (including its consolidated subsidiaries, if any) required to be included in periodic filings with the SEC.

     (b) Changes in internal controls.

     There have been no changes in Southern Company’s, the retail operating companies’, or Southern Power’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) during the second quarter of 2005 that have materially affected or are reasonably likely to materially affect Southern Company’s, the retail operating companies’, or Southern Power’s internal control over financial reporting.

ALABAMA POWER COMPANY
CONDENSED STATEMENTS OF INCOME (UNAUDITED)

CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

The accompanying notes as they relate to Alabama Power are an integral part of these condensed financial statements.

ALABAMA POWER COMPANY
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)

The accompanying notes as they relate to Alabama Power are an integral part of these condensed financial statements.

ALABAMA POWER COMPANY
CONDENSED BALANCE SHEETS (UNAUDITED)

The accompanying notes as they relate to Alabama Power are an integral part of these condensed financial statements.

ALABAMA POWER COMPANY
CONDENSED BALANCE SHEETS (UNAUDITED)