Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2006, for The Southern Company and its subsidiary operating companies: Alabama Power, Georgia Power, Gulf Power, Mississippi Power, and Southern Power. The filing includes a combined report for these entities. A significant corporate event occurred effective July 1, 2006, when Savannah Electric and Power Company was merged into Georgia Power Company; Savannah Electric's results for the second quarter are included in the consolidated Southern Company figures but will be reflected in Georgia Power's standalone statements beginning in the third quarter.
Key Financial Metrics (Six Months Ended June 30, 2006)
| Metric | 2006 (in millions) | 2005 (in millions) |
|---|---|---|
| Total Operating Revenues | $6,654.8 | $5,906.7 |
| Consolidated Net Income | $646.8 | $709.8 |
| Earnings Per Share (Diluted) | $0.87 | $0.95 |
| Operating Cash Flow | $743.6 | $796.2 |
| Property Additions (Investing) | ($1,167.7) | ($1,141.8) |
| Long-Term Debt (Balance Sheet) | $11,297.0 | $10,957.9 |
| Cash and Cash Equivalents | $262.9 | $202.1 |
Material Changes vs. Prior Period
- Revenue Growth: Total operating revenues increased 12.7% year-to-date, driven by a 12.8% increase in retail revenues. This growth was primarily due to warmer weather in the second quarter, customer growth, and sustained economic strength in the Southeast.
- Earnings Decline: Consolidated net income decreased 8.9% year-to-date. The decline was primarily caused by higher other operations and maintenance expenses, a reduction in tax credits and impairments associated with synthetic fuel investments, and higher interest expense.
- Expense Increases: Fuel expense increased 26.8% year-to-date due to higher coal and natural gas prices. Interest expense increased 21.8% due to higher variable interest rates and increased debt outstanding.
- Impairment Loss: The company recorded a $15.3 million impairment loss on equity method investments related to synthetic fuel entities, which were considered fully impaired due to high oil prices and the projected phase-out of tax credits.
Guidance, Outlook, and Risks
- Storm Damage Recovery: Significant restoration costs were incurred from Hurricanes Dennis, Katrina, and Ivan.
- Mississippi Power: The Mississippi PSC certified $302.4 million in storm restoration costs. Recovery is expected through Community Development Block Grants (CDBG) and a state bond program.
- Gulf Power: The Florida PSC approved an extension of the storm recovery surcharge for 27 months to recover costs associated with Hurricanes Ivan, Dennis, and Katrina, rather than issuing securitized bonds.
- Fuel Cost Recovery: Under-recovered fuel costs totaled approximately $1.3 billion system-wide. Georgia Power received approval for a $400 million increase in annual fuel billings effective July 1, 2006.
- Regulatory and Legal Risks:
- FERC Proceedings: Ongoing investigations regarding market-based rate authority and the Intercompany Interchange Contract (IIC). A settlement offer regarding the IIC was filed in April 2006 and is pending FERC approval.
- Environmental Litigation: Alabama Power entered a consent decree with the EPA regarding New Source Review (NSR) violations at Plant Miller, resolving the claim for a $100,000 penalty and requiring a donation of $4.9 million in emission allowances.
- Income Tax Matters: The IRS challenged deductions related to leveraged lease transactions. Southern Company plans to pay the disputed tax ($79 million) plus interest in the third quarter of 2006 and file a claim for refund.
- Acquisitions: Southern Power acquired Plant DeSoto in June 2006 for $79.2 million and entered into an agreement to acquire Rowan County Power for $325 million, expected to close in the third quarter.
Investor Verification Checklist
- Synthetic Fuel Impairment: Verify the full extent of the $15.3 million write-off and the termination of ownership in synthetic fuel entities due to oil price sensitivity.
- Storm Cost Recovery Mechanisms: Confirm the status of CDBG grant applications for Mississippi Power and the implementation of the extended surcharge for Gulf Power.
- FERC Settlement Status: Monitor the FERC's decision on the Intercompany Interchange Contract (IIC) settlement offer filed in April 2006.
- Georgia Power Merger: Review the financial impact of the Savannah Electric merger on Georgia Power's third-quarter reporting and the transition of fuel cost recovery rates.
- Interest Rate Exposure: Assess the impact of rising variable interest rates on future interest expense, particularly for pollution control bonds and commercial paper.