SO

Business Context and Reporting Period

Company: The Southern Company (SOUTHERN) and its five operating subsidiaries (Alabama Power, Georgia Power, Gulf Power, Mississippi Power, Savannah Electric) and Southern Power.

Reporting Period: Fiscal year ended December 31, 2001.

Business Overview: SOUTHERN is a holding company providing electric service in Alabama, Georgia, Florida, and Mississippi. A major strategic shift occurred in 2001 with the completion of the tax-free spin-off of Mirant Corporation on April 2, 2001. Consequently, Mirant's results are reported as discontinued operations. The company is also developing a new competitive wholesale business through its subsidiary, Southern Power, which had 800 MW in commercial operation and 3,900 MW under construction at year-end.

Key Financial Metrics (2001)

Material Changes vs. Prior Period

• Mirant Spin-Off: The distribution of Mirant shares resulted in charges of approximately $3.2 billion to paid-in capital and $0.4 billion to retained earnings. Mirant's financials are now presented as discontinued operations.
• Revenue Growth: Operating revenues increased slightly by $89 million (0.9%) to $10.155 billion. This growth was driven by a 39% increase in sales for resale outside the service area, offset by a 3.2% decline in total retail sales due to mild weather and an economic downturn.
• Earnings Increase: Net income from continuing operations rose to $1.12 billion, driven by cost containment and lower interest rates, despite the decline in retail energy sales.
• Capital Structure: The company issued $1.2 billion in senior notes in 2001, primarily to retire higher-cost debt. The market-to-book value ratio was 222% at year-end.

Guidance, Outlook, and Risks

• Construction Program: Estimated capital expenditures are $2.8 billion for 2002, $2.1 billion for 2003, and $2.3 billion for 2004. Approximately 4,500 MW of new generating capacity is scheduled for service by 2003.
• Dividend Policy: Management maintains a goal of a 75% dividend payout ratio and targets earnings per share growth of 5% or more annually.
• Environmental Risks: Significant capital expenditures are required for compliance with the Clean Air Act (Acid Rain and Ozone non-attainment). Estimated remaining costs for ozone compliance are $520 million. The EPA has brought civil actions against Alabama Power, Georgia Power, and Savannah Electric regarding New Source Review provisions; these cases are stayed pending a ruling on a similar case against the Tennessee Valley Authority (TVA).
• Regulatory Risks: The company faces potential restructuring and deregulation in its service territories. While no retail deregulation has been enacted in its primary states, the industry is evolving toward competition.
• Legal Contingencies: Pending litigation includes race discrimination claims against Georgia Power (class certification denied) and environmental remediation liabilities.

Investor Verification Checklist

• Mirant Spin-Off Impact: Verify the treatment of Mirant as discontinued operations and the specific charges to equity ($3.6 billion total) to understand the baseline for future growth.
• Environmental Compliance Costs: Review the estimated $940 million total cost for ozone non-attainment compliance and the status of the EPA New Source Review litigation, as an adverse outcome could require substantial, unrecoverable capital expenditures.
• Southern Power Growth: Assess the progress of the 3,900 MW under construction for Southern Power, as this is the primary engine for future competitive wholesale earnings.
• Rate Regulation: Monitor the status of rate cases in Georgia (new 3-year order approved Dec 2001) and Alabama (Rate Stabilization Equalization Plan) to ensure cost recovery for new investments.
• Debt Maturities: Review the $1.1 billion in debt maturities and sinking fund requirements due in 2003 and the company's ability to refinance at favorable rates.