SO

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2007, for The Southern Company and its subsidiary operating companies: Alabama Power, Georgia Power, Gulf Power, Mississippi Power, and Southern Power. The Southern Company is a holding company for these vertically integrated utilities and a wholesale generation subsidiary. The primary business involves the sale of electricity in the Southeastern United States.

Key Financial Metrics (Consolidated)

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased by 11.3% ($345.4 million). Retail revenues rose 11.0% driven by fuel cost recovery provisions ($193.6 million), rate increases at Alabama Power, and sales growth. Wholesale revenues increased 15.9% due to higher fuel costs and favorable market conditions.
• Profitability: Net income increased 29.5% ($77.1 million). This was primarily due to higher revenues, improved earnings in the synthetic fuel business, and a retail base rate increase at Alabama Power. These gains were partially offset by higher interest expense and lower market-based rates for large commercial customers.
• Expense Trends: Fuel expenses increased 25.6% ($268.0 million) due to higher unit costs and volume. Purchased power expenses decreased 38.6% ($40.3 million). Interest expense increased 10.0% ($17.6 million) due to higher debt levels and variable rates.
• Cash Flow: Operating cash flow improved significantly by $203.5 million, largely due to higher net income and reduced cash outflows for accounts payable related to gas purchases.

Guidance, Outlook, and Risks

Management Commentary: Management notes that results are not necessarily indicative of future earnings. Future performance depends on regulatory environments, weather, economic growth, and fuel costs. The company continues to focus on customer satisfaction, plant availability, and system reliability.

Key Risks and Contingencies:

• Environmental Litigation: Pending EPA civil actions regarding New Source Review (NSR) provisions at Alabama Power and Georgia Power facilities. A Supreme Court decision in a similar Duke Energy case (April 2007) impacts the timeline for resolution. Plant Wansley litigation is nearing a consent decree with no expected material financial impact.
• Regulatory Matters: FERC proceedings regarding the Intercompany Interchange Contract (IIC) and the status of Southern Power as a "system company" were approved with modifications in April 2007, requiring functional separation.
• Income Tax Uncertainties: Adoption of FIN 48 and FSP 13-2 resulted in a $125 million reduction to beginning retained earnings (non-cash) related to leveraged lease transactions (SILO/LILO). The company is litigating IRS challenges to these transactions.
• Fuel Cost Recovery: Under-recovered fuel costs totaled approximately $1.3 billion across traditional operating companies. While these are recoverable through rate adjustments, timing of recovery affects cash flow.
• Mirant Matters: Ongoing litigation related to the former subsidiary Mirant, including securities litigation and asset recovery suits, remains unresolved.

Investor Verification Checklist

• Regulatory Approvals: Verify the status of pending rate cases, specifically the Georgia Power general rate case due July 2007 and fuel cost recovery adjustments.
• Environmental Compliance Costs: Monitor the final resolution of NSR litigation and the impact of new EPA fine particulate matter regulations on capital expenditures.
• Debt Maturities: Review the schedule for approximately $1.5 billion in long-term debt redemptions and maturities due by March 31, 2008.
• Accounting Adjustments: Assess the long-term impact of the $125 million retained earnings adjustment related to leveraged lease tax positions and the ongoing litigation with the IRS.
• Construction Projects: Track the cost overruns and funding status of the Integrated Gasification Combined Cycle (IGCC) project in Orlando, Florida.