Southern Company - 10-Q quarterly report FY

 

 

     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 þ 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).

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

     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 and repairs, environmental regulations and expenditures, financing activities, completion of construction projects, impacts of adoption of new accounting rules, access to sources of capital, 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

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

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

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.

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.

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.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

THIRD QUARTER 2005 vs. THIRD 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.

     Hurricanes Dennis and Katrina hit Southern Company’s service territory in July and August 2005, respectively. As a result of these storms, as well as Hurricane Ivan in September 2004, Southern Company has incurred significant restoration costs. In addition, fuel costs at each of the retail operating companies have risen significantly during 2005. Southern Company will continue to work with its regulators to develop methods to enable the timely recovery of these costs.

     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 third quarter and year-to-date 2005 earnings were $722 million ($0.97 per share) and $1.43 billion ($1.92 per share) compared with $644 million ($0.87 per share) and $1.33 billion ($1.80 per share), respectively, for the corresponding periods in 2004. Increases in earnings in the third quarter and year-to-date 2005 primarily resulted from warmer weather in September 2005, 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 the expiration of certain provisions of Georgia Power’s three-year retail rate plan that ended December 31, 2004 (2001 Retail Rate Plan), and higher other operations expenses as compared to the corresponding periods in 2004. 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 on Georgia Power’s 2005 rate increase and 2001 Retail Rate Plan.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     Significant income statement items appropriate for discussion include the following:

     Retail revenues. The chart below reflects the primary drivers of the 26.0% and 12.7% increases in retail revenues in the third quarter and year-to-date 2005 when compared to the prior year. 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 information on Georgia Power’s retail base rate increase that became effective January 1, 2005. Changes in revenue related to cost recovery mechanisms such as fuel, environmental, and storm damage have no effect on net income. In the third quarter and year-to-date 2005, retail kilowatt-hour energy sales increased by 5.6% and 1.2%, respectively, from the same periods a year ago, primarily due to warm weather in September 2005 and continued customer and demand growth from sustained economic growth in the Southeast. Even after the effects of Hurricane Katrina, the number of retail customers increased by 1.1% and weather-adjusted average consumption by retail customers increased by 1.2% for both the third quarter and year-to-date 2005 when compared with the third quarter and year-to-date 2004. See FUTURE EARNINGS POTENTIAL – “FERC and State PSC Matters – Storm Damage Cost Recovery” herein for additional information on the effects of Hurricane Katrina.

     Details of retail revenues are as follows:

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     Sales for resale. In the third quarter and year-to-date 2005, sales for resale increased $162.5 million, or 47.3%, and $200 million, or 19.3%, respectively, over the same periods in 2004. The increases reflect a rise in fuel revenues due to increases of 39.2% and 20.9%, respectively, in the average unit cost of fuel per net kilowatt-hour generated when compared to the same periods in the prior year, 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 third quarter and year-to-date 2005, when compared to the same periods in 2004, other electric revenues increased $11.0 million, or 11.0%, and $33.6 million, or 11.7%, respectively. These increases were primarily due to higher transmission revenues of $8.8 million and $18.4 million, respectively, and increased outdoor lighting revenues of $1.2 million and $4.4 million, respectively, in the third quarter and year-to-date 2005, respectively, as compared to the same periods in 2004. Customer fees increased $1.5 million and $4.1 million in the third quarter and year-to-date 2005, respectively, over the corresponding periods in 2004. Other electric revenues also increased by $2.8 million year-to-date 2005 when compared to the same period in 2004 as the result of early terminations of customer contracts at Alabama Power and Mississippi Power.

     Fuel expense. Fuel expense was higher in the third quarter and year-to-date 2005 due to increases of 39.2% and 20.9%, 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. See FUTURE EARNINGS POTENTIAL – “FERC and State PSC Matters – Fuel Cost Recovery” herein for additional information. 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 $159.6 million and $43.6 million increases in purchased power expense in the third quarter and year-to-date 2005, respectively, compared with the same periods in the prior year are primarily a result of higher fuel prices and higher kilowatt-hour purchases resulting from increased demand due to warmer weather. Since these expenses generally are offset by energy revenues, they generally do not have a significant impact on earnings.

     Other operations expense. The $106.1 million and $132.4 million increases in other operations expense in the third quarter and year-to-date 2005, respectively, compared with the same periods in the prior year are primarily a result of higher salaries and benefits costs of $62.1 million and $47.1 million, respectively. For the third quarter and year-to-date 2005, fossil generation operations expense increased $12.0 million and $22.4 million, respectively, and year-to-date transmission and distribution operations expense increased $48.6 million in each case when compared to the same periods in the prior year. These increases are due to a return to normal spending levels when compared to the prior year. Also in the third quarter and year-to-date 2005, insurance and workers compensation expenses increased $21.4 million and $12.0 million, respectively, over the corresponding periods in 2004.

     Maintenance expense. The $45.4 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

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Power Storm Damage Recovery” in Item 8 of the Form 10-K and “Income taxes” below for additional information.

     Depreciation and amortization expense. The $58.8 million and $165.1 million increases in depreciation and amortization in the third quarter and year-to-date 2005, respectively, when compared to the prior year are primarily 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 $140 million during the third 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.

     Taxes other than income taxes. The $17.9 million and $30.7 million increases in taxes other than income taxes in the third quarter and year-to-date 2005, respectively, compared with the same periods in the prior year are primarily a result of increases in franchise and gross receipts taxes associated with increases in revenues from energy sales.

     Allowance for equity funds used during construction. The $8.9 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.

     Equity in losses of unconsolidated subsidiaries. The $13.0 million and $14.9 million increases in equity in losses of unconsolidated subsidiaries in the third quarter and year-to-date 2005, respectively, compared with the same periods in the prior year reflect increased production at synfuel production facilities that generate operating losses. These partnerships also claim federal income tax credits that offset these operating losses and make the projects profitable. See FUTURE EARNINGS POTENTIAL – “Income Tax Matters – Synthetic Fuel Tax Credits” herein for further information.

     Interest expense, net of amounts capitalized. The $29.4 million and $53.4 million increases in interest expense, net of amounts capitalized, in the third quarter and year-to-date 2005, respectively, when compared to the same periods in 2004 are mainly attributed to $11.0 million and $24.2 million, respectively, associated with issuance of new long-term and short-term debt, and $11.2 million and $18.2 million, respectively, resulting from higher interest rates on variable rate 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 $14.4 million and $30.3 million in the third quarter and year-to-date 2005, respectively, when compared to the same periods in the prior year, are primarily a result of $13.5 million in realized gains on gas hedges at Georgia Power and Savannah Electric, under programs approved by the Georgia PSC. Also contributing to the year-to-date 2005 increases over the prior year were a $2.4 million increase in gains on the sale of certain investments, and a $4.9 million decrease in charitable contributions.

     Income taxes. The $40.2 million increase in income taxes in the third quarter 2005 when compared to the prior year is primarily due to taxes associated with higher net income in 2005, offset by a $18.6 million increase

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

in tax benefits received related to higher production at synfuel production facilities. The $17.3 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 a $27.9 million increase in tax benefits received related to higher production at synfuel production facilities. The year-to-date 2005 decrease over 2004 is partially offset by higher net income in 2005. Southern Company’s annual effective income tax rate is expected to be approximately 27% for 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 Southern Company’s 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 fully recovered in rates on a timely basis. 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 (NSR) 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 Plant Miller claims, stayed the entire case, and referred the parties to mediation. Alabama Power may refile its motion for summary judgment if the mediation proves unsuccessful. At the request of the mediator, the deadline for completing the mediation has been extended from September 9, 2005 to November 30, 2005. 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

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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.

     On June 24, 2005, the U.S. Court of Appeals for the District of Columbia Circuit upheld, in part, the EPA’s December 2002 revisions to its NSR regulations, which included changes to the regulatory exclusions and methods of calculating emissions increases. However, the court vacated portions of those revisions, including those addressing the exclusion of certain pollution control projects. On October 20, 2005, the EPA published a proposed rule clarifying the test for determining when an emissions increase is subject to the NSR requirements. The impact of the proposed rules will depend on adoption of the final rules by the EPA and the individual state implementation of such rules, as well as the outcome of any additional legal challenges, and, therefore, cannot be determined at this time.

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 is scheduled for early 2006. 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.

See MANAGEMENT’S DISCUSSION AND ANALYSIS — FUTURE EARNINGS POTENTIAL – “Environmental Matters – Carbon Dioxide Litigation” of Southern Company in Item 7 of the Form 10-K for information on a complaint filed by attorneys general from eight states, each outside of Southern Company’s service territory, and the corporation counsel for New York City in July 2004 against Southern Company and four other electric power companies alleging that the companies’ emissions of carbon dioxide, a greenhouse gas, contribute to global warming, which the plaintiffs assert is a public nuisance. A nearly identical complaint was filed by three environmental groups in the same court. In September 2005, the U.S. District Court for the Southern District of New York dismissed these cases. The plaintiffs filed an appeal on October 19, 2005. The ultimate outcome of this matter cannot be determined at this time.

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 matter 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’s coal-fired facilities or through the purchase of allowances.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     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.

     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.

     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. On June 15, 2005, the EPA revoked the one-hour ground-level ozone standard, in connection with the implementation of its new eight-hour ozone standard.

     On September 8, 2005, the EPA proposed a rule for the implementation of the fine particulate matter air quality standard. Several areas within Southern Company’s service area in Alabama and Georgia were previously designated by the EPA as “nonattainment” for the standard. The EPA plans to finalize the proposed implementation rule in 2006.

     The impact of these rules 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.

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. Through SCS, as agent, 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 Southern Company’s retail service territory. A hearing before an administrative law judge to review the February filing is scheduled for March 2006. 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 September 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, in May 2005, the FERC started an investigation to determine 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

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

subsidiary will be subject to refund to the extent the FERC orders lower rates as a result of this new investigation, with the refund period 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. The impact of such sales through September 30, 2005 is not material to Southern Company’s net income.

     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, in May 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 connection with the formation of Southern Power, the FERC authorized Southern Power’s inclusion in the IIC in 2000. 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. The hearing is scheduled for June 2006. 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.

On October 5, 2004, the Alabama PSC approved a specific rate mechanism for the recovery of Alabama Power’s retail costs associated with environmental laws, regulations, or other such mandates. The rate mechanism began operation in January 2005 and provides for the recovery of these costs pursuant to a factor

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

that will be calculated annually. Environmental costs to be recovered include operation and maintenance expenses, depreciation, and a return on invested capital. Retail rates increased 1% in January 2005, which should yield an annual recovery of approximately $33 million, and are expected to increase approximately 1% in 2006. In conjunction with the Alabama PSC’s approval, Alabama Power agreed to a moratorium until 2007 on any retail rate increase under its previously approved Rate Stabilization and Equalization Plan (Rate RSE). See “Alabama Power Base Rates” below for further information on Rate RSE.

See Note 3 to the financial statements of Southern Company under “Alabama Power Retail Regulatory Matters” in Item 8 of the Form 10-K for information on Alabama Power’s Rate RSE. On October 4, 2005, the Alabama PSC approved a revision to Rate RSE requested by Alabama Power. Rate RSE adjustments can be made effective January 2007 and annually thereafter and will be based on forward-looking information for the applicable upcoming calendar year. Rate adjustments for any two-year period, when averaged together, cannot exceed 4% per year and any annual adjustment is limited to 5%. The range of return on common equity, on which such adjustments are based, remains unchanged. If Alabama Power’s actual retail return on common equity is above the allowed equity return range, customer refunds will be required; however, there is no provision for additional customer billings should the actual retail return on common equity fall below the allowed equity return range. Alabama Power will make its initial submission of projected data for calendar year 2007 by December 1, 2006.

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 to approximately $985 million at September 30, 2005. Operating revenues are adjusted for differences in actual recoverable fuel costs and amounts billed in current regulated rates. Accordingly, changes to the billing factors will have no significant effect on Southern Company’s revenues or net income, but will affect annual cash flow. The retail operating companies will continue to monitor the under recovered fuel cost balance in light of these higher fuel costs.

     On October 19, 2005, Alabama Power filed with the Alabama PSC for a fuel cost recovery increase under the provisions of its energy cost recovery rate (Rate ECR). An approval of this filing would result in an increase of the energy billing factor for retail customers from 1.788 cents per kilowatt-hour to 2.650 cents per kilowatt-hour and would become effective December 3, 2005. This change represents an $8.62 per month increase for an average residential customer billing of 1,000 kilowatt-hours. The requested increase is intended to allow for the recovery of energy costs based on an estimate of future energy costs, as well as the collection of the existing under recovered energy costs by the end of 2006. Alabama Power’s under recovered retail energy costs as of September 30, 2005 totaled $182.4 million. Under the terms of Rate ECR, the increase will be effective 45 days after the filing unless modified by the Alabama PSC following a public hearing. The final outcome of this filing cannot be determined at this time. 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 customer billings 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 assets to deferred charges and other assets

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

on the balance sheet. Under recovered fuel amounts for the period subsequent to June 1, 2005 totaled $198.3 million through September 30, 2005. In accordance with the Georgia PSC’s order, such amounts will be reviewed semi-annually beginning February 2006. If the amount under or over recovered exceeds $50 million at the evaluation date, Georgia Power will be required to file for a temporary fuel rate change. However, Georgia Power has agreed with a Georgia PSC staff recommendation to suspend the temporary fuel rate provision and, instead, will file a request no later than April 2006 to increase its fuel cost recovery rate. Fuel cost recovery revenues as recorded on the financial statements are adjusted for differences in actual recoverable costs and amounts billed in current regulated rates. Accordingly, any increase in the billing factor would have no significant effect on Georgia Power’s revenues or net income, but would increase annual cash flow. 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.

Hurricane Ivan hit the Gulf coast of Florida and Alabama in September 2004, causing significant damage to the service areas of both Gulf Power and Alabama Power. 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 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 for additional information. 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. The agreement allows Gulf Power to recover approximately $51.7 million in storm damage costs, plus interest and revenue taxes, from customers over a 24-month period that began in April 2005. Gulf Power also agreed that it will not seek any additional increase in its base rates and charges to become effective on or before March 1, 2007.

     In July and August 2005, Hurricanes Dennis and Katrina, respectively, hit the Gulf Coast of the United States and caused significant damage within Southern Company’s service area, including portions of Gulf Power, Alabama Power, and Mississippi Power. Hurricane Dennis and Katrina restoration costs are currently estimated to total approximately $425 million to $475 million, of which approximately $230 million to $250 million relates to operation and maintenance expenditures. Such cost estimates exclude approximately $60 million expected to be covered through external insurance. Restoration efforts following Hurricane Katrina are ongoing for approximately 19,200 Mississippi Power customers who remain unable to receive power, as well as to make permanent improvements in areas where temporary emergency repairs were necessary. In addition, business and governmental authorities are still reviewing redevelopment plans for portions of the most severely damaged areas along the Mississippi shoreline. Until such plans are complete, Mississippi Power cannot determine the related electric power needs or associated cost estimates. The ultimate impact of redevelopment plans in these areas on the cost estimates cannot now be determined.

     Each retail operating company maintains a reserve 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. In addition, each of the affected retail operating companies has been authorized by their respective state PSCs to defer the portion of the Hurricane Dennis and Katrina restoration costs that exceeded the balance in their storm damage reserve accounts. As of September 30, 2005, the deficit balance in Southern Company’s storm damage reserve accounts totaled approximately $308 million, of which approximately $36 million and $272 million, respectively, is included in the Condensed Balance Sheets herein under “Other Current Assets” and “Other Regulatory Assets.”

     The recovery of these deferred costs is subject to the approval of the respective state PSCs. On November 1, 2005, Alabama Power requested the Alabama PSC to approve a separate rate rider to recover its $69 million

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

of deferred Hurricane Dennis and Katrina operation and maintenance costs over a two-year period and to replenish the reserve to a target balance of $75 million over a five-year period. In December 2005, Mississippi Power expects to file additional details of its $245 million to $295 million of Hurricane Katrina restoration costs with the Mississippi PSC, as required, and to establish a method to recover such costs from customers. In 2005, the Florida legislature authorized securitized financing for hurricane costs. Gulf Power is currently evaluating this option, along with other alternatives, to allow a more rapid recovery of its total deferred costs of approximately $58 million.

     See Notes (I), (K), and (L) to the Condensed Financial Statements herein and Note 1 to the financial statements of Southern Company under “Storm Damage Reserves” in Item 8 of the Form 10-K for additional information. The estimates of storm damage restoration costs and expected external insurance recoveries are subject to change. The ultimate impact of these matters cannot now be determined.

See Note 3 to the financial statements of Southern Company under “Mirant Related Matters – Mirant Bankruptcy” in Item 8 of the Form 10-K for information regarding Southern Company’s 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.

     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 that 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. Southern Company filed an answer to the amended complaint in August 2005, and has filed motions to transfer the case from the Bankruptcy Court to the U.S. District Court for the Northern District of Georgia. The ultimate outcome of this matter cannot be determined at this time.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     In July 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 alleged 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 the transfers described above from Mirant to Southern Company in 1999 and 2000 when Mirant was allegedly insolvent, undercapitalized, or unable to pay its debts. In August 2005, the lawsuit was dismissed without prejudice. The ultimate outcome of this matter cannot be determined at this time.

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 FASB has recently proposed changes to the accounting for both leveraged leases and uncertain tax positions that may be effective as early as December 31, 2005. If approved as proposed, these changes could require Southern Company to reflect the tax deductions that the IRS is challenging as currently payable on the balance sheet and to change the timing of income recognized under the leases, including a cumulative effect upon adoption of the change. For the lease settled with the IRS in February 2005, Southern Company estimates such cumulative effect would reduce Southern Company’s net income by approximately $11 million. The impact of these proposed changes related to the remaining three lease transactions would be dependent on the outcome of ongoing negotiations with the IRS, but could be significant, and potentially material, to Southern Company’s net income. 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

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 signed into law in 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. 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 other contingencies, regulatory matters, and other matters being litigated 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

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 of FASB Statement No. 143, Accounting for Asset Retirement Obligations (FAS No. 143), 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. As required under FAS No. 143, the present value of the ultimate cost of retiring long-lived assets is recorded in the period in which the liability is incurred. The costs are capitalized as part of the related long-lived asset and depreciated over the asset’s useful life. For Southern Company, FIN 47 is effective no later than December 31, 2005. Southern Company currently expects to record additional asset retirement obligations (and plant in service) of less than $200 million, primarily related to asbestos removal and disposal of polychlorinated biphenyls in certain transformers. However, Southern Company has not concluded its assessment of FIN 47 and other potential obligations are still being evaluated. The adoption of FIN 47 is not expected to have any effect 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 stable at September 30, 2005. Net cash flow from operating activities totaled $2.1 billion for first nine months of 2005, compared to $2.1 billion for the corresponding period in 2004. Gross property additions to utility plant were $1.7 billion in the first nine 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 $406 million increase in long-term debt for the first nine months of 2005 primarily due to an increase of $711 million in property, plant, and equipment.

     The market price of Southern Company’s common stock at September 30, 2005 was $35.76 per share and the book value was $14.59 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 third quarter 2005 was $0.3725 per share compared to $0.3575 per share in the third 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

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 $919 million will be required by September 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 prevailing market conditions, regulatory approval, and other factors. 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 September 30, 2005 approximately $416 million of cash and cash equivalents and approximately $3.1 billion of unused credit arrangements with banks, of which $24.0 million expire in 2005 and $3.1 billion expire in 2006 and beyond. Of the facilities maturing in 2005 and 2006, $296 million contain provisions allowing one-year term loans executable at the expiration date and $168 million 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. Southern Company expects to renew its credit facilities, as needed, prior to expiration. In October 2005, additional credit facilities totaling $340 million were signed. A portion of these facilities will be used to fund costs related to Hurricanes Ivan, Dennis, and Katrina, with the remainder used to support obligations with respect to variable rate pollution control bonds and commercial paper. 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 September 30, 2005, the Southern Company system had outstanding commercial paper of $816.8 million, $20 million borrowed under revolving lines of credit, and extendible commercial notes of $16.2 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 September 30, 2005, the maximum potential collateral requirements at a BBB- or Baa3 rating were approximately $61 million. The maximum potential collateral requirements at a rating below BBB- or Baa3 were approximately $354 million. In addition, through the acquisition of Oleander, Southern Power assumed a PPA with Seminole

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 risk management activities. At September 30, 2005, Southern Company and its subsidiaries had no material exposure related to these agreements.

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 September 30, 2005 was as follows:

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     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 nine months of 2005, Southern Company and its subsidiaries issued $715 million of senior notes and $209 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 nine months of 2005.

     Subsequent to September 30, 2005, Southern Company entered into an interest rate swap related to the anticipated issuance of $250 million in senior notes. The interest rate swap has a notional amount of $125 million. It is anticipated that the senior notes will be issued in the fourth quarter of 2005.

     In June 2005, Southern Company started a program to repurchase shares of stock to offset issuances under the Southern Company’s stock compensation plans. Approximately 9.7 million shares have been repurchased through September 30, 2005 at a total cost of $340.3 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.

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.

CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)

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

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)