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 June 30, 2004. The Southern Company operates as a holding company for regulated electric utilities in the Southeast and a wholesale generation subsidiary, Southern Power. The report covers the three and six months ended June 30, 2004, compared to the same periods in 2003.

Key Financial Metrics (Consolidated)

Material Changes vs. Prior Period

• Earnings Decline: Consolidated net income decreased by approximately 18.5% in the second quarter and 6.4% year-to-date compared to 2003. The primary driver was a one-time after-tax gain of $88 million recorded in the second quarter of 2003 from the termination of capacity sales contracts with Dynegy.
• Revenue Growth: Excluding the Dynegy impact, earnings increased due to customer growth, increased electricity consumption, favorable weather conditions, and new generating capacity available for wholesale sales.
• Expense Increases: Fuel expenses increased 17.9% (Q2) and 18.0% (YTD) due to higher average unit costs. Purchased power expenses rose significantly (90.1% Q2, 36.6% YTD) due to increased demand and off-system sales commitments.
• Depreciation: Depreciation and amortization expenses decreased (9.6% Q2, 5.8% YTD) primarily due to increased amortization of regulatory liabilities at Georgia Power and Mississippi Power.
• Capital Expenditures: Gross property additions totaled approximately $1.0 billion for the first six months of 2004.

Guidance, Outlook, and Risks

• Regulatory Matters:
  • FERC Market Power: The FERC adopted new interim tests for measuring generation market power. Southern Company believes it can rebut the presumption of market power, but default cost-based mitigation measures could apply if rebuttal fails, potentially lowering wholesale rates.
  • Georgia Power Rate Case: Filed July 1, 2004, requesting a ~7% revenue increase effective Jan 1, 2005, to cover higher costs and investments. Final order expected in December 2004.
  • Mississippi Power: The Mississippi PSC approved the reclassification of Plant Daniel capacity to jurisdictional cost of service, resulting in a $60 million regulatory liability amortization that will increase earnings over 2004-2007.
  • Alabama Power: Filed August 2, 2004, for a specific rate mechanism to recover environmental compliance costs, potentially increasing rates by ~1% in 2005 and 2006.
• Environmental Litigation:
  • New Source Review (NSR): Cases against Alabama Power, Georgia Power, and Savannah Electric were stayed pending the TVA case resolution. The stay was lifted for Alabama Power in June 2004. An adverse outcome could require substantial capital expenditures and penalties.
  • Global Warming: Lawsuits filed in July 2004 by eight states and environmental groups alleging CO2 emissions constitute a public nuisance. Plaintiffs seek injunctive relief to cap and reduce emissions. Southern Company intends to vigorously defend these claims.
• Plant McIntosh Project: Southern Power transferred the construction project for Units 10 and 11 to Georgia Power and Savannah Electric in May 2004. Full cost recovery depends on the Georgia PSC's review of the affiliate transaction.
• Mirant Contingencies: Southern Company faces contingent liabilities related to Mirant's bankruptcy, including potential tax challenges and litigation regarding the Employee Savings Plan.

Investor Verification Checklist

• Regulatory Approvals: Verify the outcome of the Georgia Power rate case (expected Dec 2004) and the Alabama Power environmental cost recovery mechanism.
• Environmental Litigation Status: Monitor the status of the New Source Review cases, particularly the Alabama Power case which is back on the active docket, and the global warming lawsuits filed in July 2004.
• FERC Market Power Determination: Track the submission of analyses to FERC (due Aug 9, 2004) and the final methodology for assessing generation market power to assess potential impacts on wholesale revenue.
• Plant McIntosh Cost Recovery: Confirm the Georgia PSC's decision on the cost recovery for the Plant McIntosh construction project transferred to Georgia Power and Savannah Electric.
• Mirant Tax and Legal Exposure: Review updates on the IRS audit regarding Mirant-related tax deductions and the Mirant bankruptcy examiner's investigation into potential claims against Southern Company.