SO

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2005, for The Southern Company and its subsidiary operating companies: Alabama Power, Georgia Power, Gulf Power, Mississippi Power, Savannah Electric and Power, and Southern Power. The Southern Company operates as a holding company for these vertically integrated electric utilities and a competitive wholesale generation subsidiary. The primary business involves the sale of electricity in the Southeastern United States.

Key Financial Metrics (Consolidated)

Figures are for the six months ended June 30, 2005, unless otherwise noted. Amounts in millions.

Margin Analysis: Operating income for the six months ended June 30, 2005, was $1,287 million, a decrease of approximately 2.3% compared to $1,318 million in the prior year period. This decline was primarily due to the expiration of certain provisions in Georgia Power's 2001 Retail Rate Plan which previously provided credits to amortization expense.

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 4.7% year-over-year. Retail revenues rose 4.4%, driven by customer growth and base rate increases at Georgia Power, partially offset by milder weather reducing kilowatt-hour sales.
• Expense Increases:
  • Fuel Expense: Increased 13.2% to $1,934 million due to higher average unit costs for coal and natural gas. These costs are largely recoverable through regulatory clauses.
  • Depreciation and Amortization: Increased 22.4% to $580 million, primarily due to the expiration of amortization credits under Georgia Power's 2001 Retail Rate Plan.
  • Maintenance Expense: Increased 9.5% to $554 million, largely attributable to $45 million in expenses recorded by Alabama Power to restore its natural disaster reserve following Hurricane Ivan.
• Acquisition: Southern Power acquired the Oleander Power Project (680 MW) in June 2005 for approximately $206 million, adding to its wholesale generation capacity.

Guidance, Outlook, and Risks

Management Commentary: Management attributes earnings growth to sustained economic strength and customer growth in the service area. However, they note that results are subject to weather variations, regulatory changes, and fuel cost volatility.

Regulatory and Legal Risks:

• FERC Proceedings: The Federal Energy Regulatory Commission (FERC) initiated proceedings regarding Southern Company's generation market power and the Intercompany Interchange Contract (IIC). New market-based rate transactions entered into after February 27, 2005, are subject to refund pending the outcome. An expanded investigation into affiliate abuse and transmission market power began July 19, 2005.
• Environmental Litigation: Significant litigation remains pending regarding New Source Review (NSR) rules (EPA vs. Alabama Power, Georgia Power, Savannah Electric) and Plant Wansley environmental compliance. A federal court decision in June 2005 favored Alabama Power on two primary legal issues, but the case remains stayed for mediation.
• Mirant Bankruptcy: Mirant Corporation and its creditors have filed complaints alleging fraudulent transfers and illegal dividends totaling over $2 billion. Southern Company intends to vigorously defend these claims.

Storm Damage: Hurricane Dennis (July 2005) caused significant damage to Gulf Power and Alabama Power facilities. Preliminary restoration costs are estimated at $60 million for Gulf Power and $30 million for Alabama Power. Recovery mechanisms are being evaluated with state Public Service Commissions.

Investor Verification Checklist

• Regulatory Recovery: Verify the status of fuel cost recovery filings, particularly for Georgia Power ($516 million under-recovered) and Alabama Power ($127.4 million under-recovered), and the approval of storm damage recovery surcharges.
• FERC Outcomes: Monitor the FERC hearings on generation market power and the IIC, as adverse rulings could require refunds of market-based revenues or force a shift to cost-based rates.
• Environmental Compliance Costs: Assess the potential financial impact of the Clean Air Interstate Rule, Clean Air Mercury Rule, and Regional Haze Program (BART) on future capital expenditures.
• Mirant Litigation: Track the progress of the Mirant bankruptcy proceedings and the potential for indemnification obligations regarding former officers and directors.
• Storm Reserve Adequacy: Confirm the sufficiency of natural disaster reserves for Alabama Power and Gulf Power following Hurricane Dennis and the regulatory approval for cost recovery.