SO

Business Context and Reporting Period

This Form 10-Q is a combined quarterly report filed by The Southern Company and its subsidiary operating companies (Alabama Power, Georgia Power, Gulf Power, Mississippi Power, Savannah Electric, and Southern Power) for the period ended September 30, 2004. The Southern Company operates as a holding company for retail electric utilities in the Southeast and a wholesale generation subsidiary, Southern Power. The report covers the third quarter and the nine months ended September 30, 2004, comparing results to the same periods in 2003.

Key Financial Metrics (Consolidated)

Amounts in millions, except per share data.

Material Changes vs. Prior Period

• Earnings: Q3 2004 earnings increased 4.1% to $644 million, driven by increased electricity consumption and customer growth despite mild weather. YTD 2004 earnings decreased 1.6% to $1.33 billion, primarily due to a one-time after-tax gain of $88 million in Q2 2003 from the termination of capacity sales contracts with Dynegy.
• Revenues: Retail sales revenues increased 5.7% in Q3 and 9.1% YTD. Sales for resale decreased in Q3 due to reduced uncontracted capacity following new Power Purchase Agreements (PPAs), though YTD sales were flat.
• Expenses: Fuel expenses increased 4.9% in Q3 and 12.8% YTD due to higher unit costs. Purchased power expenses rose 36.2% in Q3 and 36.5% YTD, largely due to increased demand and off-system sales commitments.
• Depreciation: Depreciation and amortization decreased 7.5% in Q3 and 6.4% YTD, primarily due to increased amortization of regulatory liabilities at Georgia Power and Mississippi Power.

Guidance, Outlook, Risks, and Unusual Items

• Hurricane Ivan Impact: Hurricane Ivan caused substantial damage in September 2004. Alabama Power estimated $52 million in restoration costs, deferring a $41 million negative balance in its natural disaster reserve for future recovery. Gulf Power charged $75.5 million to its property damage reserve, exceeding its balance by $47.5 million, which was deferred for recovery.
• Regulatory Matters:
  • Georgia Power: Filed a request for a ~7% retail revenue increase effective Jan 1, 2005. A final order is expected in December 2004.
  • Alabama Power: Approved a new rate mechanism for environmental cost recovery effective Jan 2005, expected to increase rates by ~1% in 2005 and 2006.
  • Mississippi Power: Approved reclassification of Plant Daniel capacity, resulting in a $60 million regulatory liability amortization that will boost earnings over 2004-2007.
• Plant McIntosh: Southern Power transferred the Plant McIntosh construction project to Georgia Power and Savannah Electric. The Georgia PSC is reviewing the valuation; full cost recovery is not guaranteed, and a write-off may be required if costs exceed market value.
• Legal & Environmental Risks:
  • New Source Review (NSR): Litigation regarding Clean Air Act violations remains active for Alabama Power. Penalties could be substantial if violations are deemed continuing.
  • Global Warming Litigation: Lawsuits filed in July 2004 allege CO2 emissions constitute a public nuisance. Southern Company intends to vigorously defend these claims.
  • Mirant Bankruptcy: Southern Company faces potential contingent liabilities related to Mirant's bankruptcy and tax audits.
• Accounting Changes: Adopted FASB Interpretation No. 46R (deconsolidating certain trusts) and FSP 106-2 (Medicare drug subsidy), which reduced post-retirement benefit obligations by approximately $182 million.

Investor Verification Checklist

• Storm Cost Recovery: Verify the regulatory approval status and recovery timeline for the deferred hurricane costs at Alabama Power and Gulf Power.
• Plant McIntosh Valuation: Monitor the Georgia PSC's final order on the Plant McIntosh project valuation to assess potential asset write-offs.
• Rate Case Outcomes: Track the final decisions on Georgia Power's rate increase and Alabama Power's environmental cost recovery mechanism.
• Environmental Litigation: Review developments in the New Source Review litigation and global warming lawsuits for potential penalty exposures.
• Wholesale Market Power: Assess the outcome of FERC's market power analysis, which could force a shift from market-based to cost-based rates for wholesale sales.