Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 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 all registrants. A significant corporate event during the period was the merger of Savannah Electric and Power Company into Georgia Power, effective July 1, 2006, accounted for as a pooling of interests.
Key Financial Metrics (Consolidated)
Figures are for the nine months ended September 30, 2006, unless otherwise noted.
- Revenue: Total operating revenues were $11.20 billion, an increase of 9.2% compared to $10.26 billion in the prior year period. Retail revenues increased 9.4% to $9.30 billion.
- Profit: Consolidated Net Income was $1.38 billion ($1.86 per diluted share), a decrease of 3.3% from $1.43 billion ($1.92 per diluted share) in the prior year.
- Cash Flow: Net cash provided from operating activities was $1.98 billion, down slightly from $2.08 billion in the prior year. Net cash used for investing activities was $2.15 billion, driven by property additions of $2.11 billion.
- Debt: Long-term debt totaled $10.99 billion at September 30, 2006. Total liabilities were $30.15 billion.
- Liquidity: Cash and cash equivalents were $418 million. The company maintained approximately $3.4 billion in unused credit arrangements.
- Margins: Operating income was $2.76 billion. The effective tax rate increased due to reduced synthetic fuel tax credits.
Material Changes vs. Prior Period
- Revenue Growth: Driven by a 2.4% increase in retail KWH sales, customer growth, and warmer weather. Fuel cost recovery revenues also contributed significantly to the top-line increase.
- Expense Increases: Fuel expense rose 21.9% year-to-date due to higher fuel costs and increased generation. Maintenance expense increased 4.3% due to transmission and distribution projects. Interest expense increased 19.1% due to higher debt levels and rising interest rates.
- Acquisitions: Southern Power acquired Plant DeSoto (June 2006) and Plant Rowan (September 2006), adding significant generating capacity and increasing depreciation expense.
- Synthetic Fuel Impairment: The company recorded a $16 million impairment loss on equity method investments in synthetic fuel entities due to high oil prices phasing out tax credits. Production at one facility was idled, and the company terminated its interest in the other.
- Storm Recovery: Continued recovery from Hurricanes Dennis, Katrina, and Ivan. Mississippi Power received a $276.4 million Community Development Block Grant (CDBG) for storm restoration. Gulf Power secured a surcharge extension to recover storm costs.
Guidance, Outlook, and Risks
- Regulatory Environment: Future earnings depend heavily on the ability to recover prudently incurred costs through regulated rates. Key pending matters include fuel cost recovery filings with state Public Service Commissions (PSCs) and FERC proceedings regarding market-based rate authority and the Intercompany Interchange Contract (IIC).
- Environmental Compliance: Significant spending is anticipated for Clean Air Act compliance. New EPA rules regarding fine particulate matter and New Source Review (NSR) could increase costs. Alabama Power resolved NSR violations at Plant Miller via a consent decree but faces appeals on other plants.
- Storm Damage: While recovery mechanisms are in place for recent hurricanes, the company faces ongoing restoration costs and the need to replenish property damage reserves.
- Tax Matters: The company faces IRS challenges regarding leveraged lease transactions (SILOs), with a potential liability of approximately $107 million recorded for tax years 2002-2003. New accounting standards (FIN 48) regarding uncertain tax positions will be adopted in 2007.
- Outlook: Management expects continued growth in energy sales driven by economic strength in the Southeast, though results are subject to weather, fuel prices, and regulatory outcomes.
Investor Verification Checklist
- Storm Cost Recovery: Verify the status of regulatory approvals for storm damage cost recovery, specifically the implementation of the Mississippi state bond program and the Florida PSC surcharge extension for Gulf Power.
- Fuel Cost Recovery: Monitor upcoming PSC rulings on fuel cost recovery rate filings, particularly for Georgia Power (ruling expected February 2007) and Alabama Power, to ensure timely cash flow recovery for under-recovered fuel costs (approx. $1.4 billion system-wide).
- Synthetic Fuel Tax Credits: Assess the impact of oil price fluctuations on the phase-out of Section 45K tax credits and the potential for further impairments or changes in derivative hedging strategies.
- FERC Proceedings: Track the outcome of the FERC investigation into market-based rate authority and the IIC, as adverse rulings could require refunds or a shift to cost-based rates for wholesale sales.
- Environmental Litigation: Monitor the status of appeals regarding NSR violations at Alabama Power plants (Barry, Gaston, Gorgas, Greene County) and Plant Wansley opacity litigation.
- Acquisition Integration: Review the financial performance and integration of the newly acquired DeSoto and Rowan plants by Southern Power.