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Annual Submission Reports
	ML071220226
Person / Time
Site:	Farley
Issue date:	04/24/2007
From:	Derieux J; Alabama Power Co
To:	; Document Control Desk, NRC/NRR/ADRO
References
	Download: ML071220226 (422)
	v • d • e

[[:#Wiki_filter:J. Randy DeRieux 600 North 18th Street Assistant Treasurer and Past Office Box 2641 Manager - Birmingham, Alabama 35291-0040 Treasury/Finance Tel 205.257.2454 Fax 205.257.1023 ALABAMAAN.. POWER Always on.' A SOUTHERN COMPANY April 24, 2007 100 Years. Lighting the way. U. S. Nuclear Regulatory Commission Attn: Document Control Desk Washington, D. C. 20555-0001 Joseph M. Farley Nuclear Plant Annual Submission Reports Re: Docket Nos.: 50-348 50-364 Ladies & Gentlemen: Enclosed is the annual submission of Alabama Power Company with respect to the retrospective premium guarantee required under the Price Anderson Act, as amended, applicable to its Joseph M. Farley Nuclear Plant. We have elected to satisfy this guarantee requirement by submitting annual certified financial statements and cash projections, showing that a cash flow can be generated and would be available for payment of retrospective premiums up to $30,000,000 within three months after submission of the statement. In this connection, enclosed are the following:

1. 2006 Annual Report (10-K) which includes financial statements for the calendar year 2006, together with the report on such statements by Deloitte & Touche LLP, independent public accountants;

2. Unaudited Financial Statements for the quarter ended March 31, 2007;

3. Cash Flow Projections for the period January 1, 2007 through December 31, 2007, showing that cash flow of $30,000,000 can be generated and would be available for payment of retrospective premiums within three months after submission of the statement.

Please acknowledge receipt of the enclosures by signing and returning the enclosed copy of this letter. Very truly yours, JRD:jm Enclosures cc: w/enclosures Southern Nuclear Operating Company Mr. J. T. Gasser, Executive Vice President Mr. J. R. Johnson, Vice President - Plant Farley U. S. Nuclear Regulatory Commission Dr. W. D. Travers, Regional Administrator Mr. R. E. Martin, NRR Project Manager - Farley Mr. E.L. Crowe, Senior Resident Inspector - Farley

ALABAMA POWER COMPANY STATEMENT OF INCOME (THOUSANDS OF DOLLARS) 3 Months Ended 3/31/2007 OPERATING REVENUES: Revenues $ 1,197,202 OPERATING EXPENSES: Operation - Fuel 386,072 Purchased & interchange power, net 77,352 Other 171,403 Maintenance 118,762 Depreciation & amortization 115,943 Taxes other than income taxes 72,718 Federal and State income taxes 72,544 Total Operating Expenses 1,014,794 OPERATING INCOME 182,408 OTHER INCOME (EXPENSES): Allowance for equity funds used during construction 6,586 Income from subsidiary 979 Other, net 212 INCOME BEFORE INTEREST CHARGES 190,185 INTEREST CHARGES: Interest on long-term debt 63,282 Allowance for debt funds used during construction (3,346) Amortization of debt discount, premium and expenses, net 3,531 Other interest charges 3,602 Net Interest Charges 67,069 NET INCOME 123,116 DIVIDENDS ON PREFERRED STOCK 8,182 NET INCOME AFTER DIVIDENDS ON PREFERRED STOCK $ 114,934 This statement reflects the usual accounting practices of the Company on the basis of interim figures and is subject to audit and end of year adjustments.

This statement reflects the usual ALABAMA POWER COMPANY accounting practices of the Company BALANCE SHEET on the basis of interim figures and CONSOLIDATED WITH ALABAMA POWER CAPITAL TRUSTS IV & V is subject to audit and end of year (Stated in Thousands of Dollars) adjustments. At At ASSETS March 31, 2007 March 31, 2006 UTILITY PLANT: Plant in service, at original cost ........................................................ $ 16,167,367 $ 15,451,825 Less - Accumulated provision for depreciation and amortization.................... $ 6,320,416 $ 5,997,337

                                                                                                             $              9,846,951   $        9,454,488 Nuclear fuel, at amortized cost ........................................................                   $                139,202   $          126,078 Construction work in progress..........................................................                     $                622,445   $          523,939
                                                                                                             $             10,608,598   $       10,104,505 OTHER PROPERTY AND INVESTMENTS:

Equity investments in subsidiaries...................................................... $ 50,036 $ 48,901 Investment in unconsolidated subsidiaries............................................. $ 9,279 $ 9,279 Nuclear decommissioning trusts....................................................... $ 518,629 $ 476,264 Miscellaneous............................................................................ $ 24,991 $ 22,742

                                                                                                             $                602,935   $          557,186 CURRENT ASSETS:

Cash ..................................................................................... $ 16,073 $ 12,651 Special Deposits ........................................................................ $ 20 $ Temporary cash investments........................................................... $ $ 110,000 Investment securities ................................................................... $ $ Receivables - Customer accounts receivable ...................................................... $ 725,417 $ 603,125 Other accounts and notes receivable ................................................ $ 44,046 $ 43,230 Affiliated companies ................................................................... $ 55,497 $ 59,560 Accumulated provision for uncollectible accounts.................................. $ (9,416) $ (8,157) Refundable income taxes............................................................... $ $ 3,408 Fossil fuel stock, at average cost....................................................... $ 162,059 $ 134,612 Materials and supplies, at average cost............................................... $ 257,739 $ 224,597 Allowance Inventory..................................................................... $ 4,735 $ 12,659 Prepayments - Income taxes .......................................................................... $ 25,244 Other .................................................................................. $ 96,006 $ 94,388 Other current assets - SFAS 133 ...................................................... $ 7,809 $ 24,652 Vacation pay deferred.................................................................. $ 46,415 $ 44,985

                                                                                                             $              1,431,644   $        1,359,710 Debt expense, being amortized ........................................................                      $                 44,908   $           38,924 Debt redemption expense, being amortized..........................................                          $                 91,778   $           99,576 Accumulated miscellaneous operating provisions................................                                                         $             4,658 Prepaid pension cost....................................................................                    $                731,311   $          521,211 Regulatory assets.......................................................................                    $                992,683   $          851,587 Miscellaneous............................................................................                   $                115,2566  $          106,903
                                                                                                             $              1,975,936   $        1,622,859 TOTAL ASSETS ..........................................................................                       $             14,619,113   $       13,644,260 4123/2007 +

This statement reflects the usual ALABAMA POWER COMPANY accounting practices of the Comnpany BALANCE SHEET on the basis of interim figures and CONSOLIDATED WITH ALABAMA POWER CAPITAL TRUSTS IV & V is subject to audit and end of year (Stated inThousands of Dollars) adjustments. CAPITAUIZATION AND UABILFTES At At March 31, 2007 March 31, 2006 CAPITALIZATION: Common stock equity.................................................................. $ 4,105,416 $ 3,769,305 Preferred stock .......................................................................... $ 612,272 $ 465,047 Company obligated mandatonly redeemable preferred securities *................. $ 309,279 $ 309,279 Long-term debt .......................................................................... $ 4,038,399 $ 4,356,731

                                                                                                             $                      9,065,366      $        8,900,362 CURRENT LIABILITIES:

Preferred stock due or to be redeemed within one year............................. $ $ Long-term debt due or to be redeemed within one year............................. $ 668,648 $ 376,645 Notes payable to banks ................................................................ $ $ Commercial paper ...................................................................... $ 74,794 $ Accounts payable - Affiliated companies................................................................... $ 128,392 $ 115,264 Other .................................................................................. $ 203,123 $ 187,639 Customer deposits ..................................................................... $ 62,735 $ 58,877 Taxes accrued - Federal and state income ............................................................ $ 51,249 $ 124,1866 Other .................................................................................. $ 49,675 $ 50,371 Interest accrued ......................................................................... $ 53,051 $ 53,383 Accrued Interest Payable to Unconsolidated Subs................................ $ 8,119 $ 8,119 Vacation pay accrued................................................................... $ 38,645 $ 37,646 Miscellaneous............................................................................ $ 66,948 $ 105,598

                                                                                                             $                      1,405,379      $        1,117,728 DEFERRED CREDITS AND OTHER LIABILITIES:

Accumulated deferred income taxes ................................................... $ 2,137,888 $ 2,052,072 Accumulated deferred investment tax credits......................................... $ 186,581 $ 194,584 Asset Retirement Obligations.......................................................... $ 483,660 $ 453,459 Prepaid capacity revenues, net ........................................................ $ Regulatory liabilities ..................................................................... $ 283,506 $ 100,744 Accumulated miscellaneous operating provisions ................................ $ Natural disaster reserve ................................................................ $ 16,957 $ 3,698 Miscellaneous............................................................................ $ 1,039,776 $ 821,613

                                                                                                             $                      4,148,368      $        3,626,170 TOTAL CAPITALIZATION AND LIABILITIES ...........................................                              $                     14,619,113      $      13,644,260
*Substantially all assets of AJabama Power Capital Trust IV & Verre junior subordinate notes issued by the company. Upon redemption of such notes, the Trust securities will be mandatorily redeemable. See Notel7to the financial statements of Alabamia Power Company of the 2002 Form 10-K for further details.

4/232007 +

ALABAMA POWER COMPANY Internal Cash Flow for Joseph M. Farley Nuclear Power Station (Thousands of Dollars) 2006 2007 Actual Projections Net Income $ 542,464 $ 597,170 Less Dividends Paid 464,918 497,034 Retained Earnings 77,546 100,136 Adjustments: Depreciation and Amortization 524,313 540,724 Deferred Income Taxes and Investment Tax Credits (27,562) 39,976 Allowance for Equity Used During Construction (18,253) (41,525) Total Adjustments 478,498 539,175 Internal Cash Flow $ 556,044 $ 639,311 Average Quarterly Cash Flow $ 139,011 $ 159,828 Percentage Ownership in all Operating Nuclear Units: Joseph M. Farley Units 1 and 2 100% Maximum Total Contingent Liability $ 30,000 Filename:PriceAnderson\nfcashfl

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2006 OR ()TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from to Commission Registrant, State of Incorporation, I.R.S. Employer File Number Address and Telephone Number Identification No. 1-3526 The Southern Company 58-0690070 (A Delaware Corporation) 30 Ivan Allen Jr. Boulevard, N.W. Atlanta, Georgia 30308 (404) 506-5000 1-3164 Alabama Power Company 63-0004250 (An Alabama Corporation) 600 North 18th Street Birmingham, Alabama 35291 (205) 257-1000 1-6468 Georgia Power Company 58-0257110 (A Georgia Corporation) 241 Ralph McGill Boulevard, N.E. Atlanta, Georgia 30308 (404) 506-6526 0-2429 Gulf Power Company 59-0276810 (A Florida Corporation) One Energy Place Pensacola, Florida 32520 (850) 444-6111 001-11229 Mfississippi Power Company 64-0205820 (A Mississippi Corporation) 2992 West Beach Gulfport, Mississippi 39501 (228) 864-1211 333-98553 Southern Power Company 58-2598670 (A Delaware Corporation) 30 Ivan Allen Jr. Boulevard, N.W. Atlanta, Georgia 30308 (404) 506-5000

Securities registered pursuant to Section 12(b) of the Act:' Each of the following classes or series of securities registered pursuant to Section 12(b) of the Act is listed on the New York Stock Exchange. Title of each class Registrant Common Stock, $5 par value The Southern Company Mandatorily redeemable preferred securities, $25 liquidation amount 2 7.125% Trust Preferred Securities Class A preferred, cumulative, $25 stated capital Alabama Power Company 5.20% Series 5.83% Series 5.30% Series Senior Notes 5%% Series AA 5.875% Series II 57/% Series GG 6.375% Series JJ Class A Preferred Stock, non-cumulative, Georgia Power Company par value $25 per share 6Y8% Series Senior Notes 5.90% Series 0 - 6% Series R 5.70% Series X 5.75% Series T 6% Series W 5.75% Series G5 Mandatorily redeemable preferred securities, $25 liquidation amount 3 7Y8% Trust Preferred Securities 4 57%% Trust Preferred Securities Senior Notes Gulf Power Company 5.25% Series H 5.75% Series I 5.875% Series J 1 2 As of December 31, 2006. Issued by Southern Company Capital Trust VI and guaranteed by The Southern Company. 3 Issued by Georgia Power Capital Trust V and guaranteed by Georgia Power Company. 4 Issued by Georgia Power Capital Trust VII and guaranteed by Georgia Power Company. 5 Assumed by Georgia Power Company in connection with its merger with Savannah Electric and Power Company, effective July 1, 2006.

Senior Notes Mississippi Power Company 5%% Series E Depositary preferred shares, each representing one-fourth of a share of preferred stock, cumulative, $100 par value 5.25% Series Mandatorily redeemable preferred securities, $25 liquidation amount 6 7.20% Trust Originated Preferred Securities 7 Securities registered pursuant to Section 12(g) of the Act: Title of each class Registrant Preferred stock, cumulative, $100 par value Alabama Power Company 4.20% Series 4.60% Series 4.72% Series 4.52% Series 4.64% Series 4.92% Series Class A Preferred Stock, cumulative, $100,000 stated capital Flexible Money Market (Series 2003A) Preferred stock, cumulative, $100 par value Mississippi Power Company 4.40% Series 4.60% Series 4.72% Series 6 Issued by Mississippi Power Capital Trust II and guaranteed by Mississippi Power Company. 7 As of December 31, 2006.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities .Act. Registrant Yes No The Southern Company x Alabama Power Company x Georgia Power Company x Gulf Power Company x Mississippi Power Company x Southern Power Company x Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes __ No X (Response applicable to all registrants.) Indicate by check mark whether the registrants'(1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes X No.- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants' knowledge, in definitive proxy or information statements incorporated by reference in Part Ul of this Form 10-K or any amendment to this Form 10-K. (X) Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Accelerated Non-accelerated Registrant Filer Filer Filer The Southern Company X Alabama Power Company X Georgia Power Company X Gulf Power Company X Mississippi Power Company X Southern Power Company X Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes _ No X (Response applicable to all registrants.)

Aggregate market value of The Southern Company's common stock held by non-affiliates of The Southern Company at June 30, 2006: $23.8 billion. All of the common stock of the other registrants is held by The Southern Company. A description of each registrant's common stock follows: Description of Shares Outstanding Registrant Common Stock at January 31, 2007 The Southern Company Par Value $5 Per Share 748,594,220 Alabama Power Company Par Value $40 Per Share 12,250,000 Georgia Power Company Without Par Value 9U261,500 Gulf Power Company Without Par Value 1,792.717 Mississippi Power Company Without Par Value 1,121,000 Southern Power Company Par Value $0.01 Per Share 1,000 Documents incorporated by reference: specified portions of The Southern Company's Proxy Statement relating to the 2007 Annual Meeting of Stockholders are incorporated by reference into PART III. In addition, specified portions of the Information Statements of Alabama Power Company, Georgia Power Company and Mississippi Power Company relating to each of their respective 2007 Annual Meetings of Shareholders are incorporated by reference into PART 111. Southern Power Company meets the conditions set forth in General Instructions 1(l)(a) and (b) of Form 10-K and is therefore filing this Form 10-K with the reduced disclosure format specified in General Instructions I(2)(b) and (c) of Form 10-K. This combined Form 10-K is separately filed by The Southern Company, Alabama Power Company, Georgia Power Company. Gulf Power Company, Mississippi Power Company and Southern Power Company. Information contained herein relating to any individual company is filed by such company on its own behalf. Each company makes no representation as to information relating to the other companies.

Table of Contents Page PART I Item 1 B usiness ................................................................... I-I The Southern Company System .................................................. 1-2 Construction Programs ........................................................ 1-3 Financing Programs .......................................................... 1-3 Fuel Supply ................................................................ 1-4 Territory Served by the Utilities.................................................. 1-5 Com petition ................................................................ 1-7 Seasonality ................................................................. 1-8 Regulation .............................. . ................................. 1-8 Rate M atters ......................................................... ....... 1-10 Employee Relations .......o. .. o......,...........,.....+......... ..................... 1-12 1-1 Item lA It m Ii c o s . Riskk FFactors

1-12 Item lB Unresolved Staff Coomments ........... ....................................... 1-21 Item 2 Properties ..... ....................... I.................................... 1-22 Item 3 Legal Proceedings......................... ................................... 124 Item 4 Submission of Matters to a Vote of Security Holders'................................... 1-25 Executive Officers of Southern Company ........................................... 1-26 Executive Officers of Alabama Power.......... .................................. .1.27 Executive Officers of Georgia Power ........ 1-28

                                                                                                                 ..................................                                                     1-29 Executive Officers of Mississippi Power. ........

PART I1 Item 5 Market for Registrants' Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ...... ..................................................... I-1 Item 6 Selected Financial Data............... . .................................. 11-2 Item 7 Management's Discussion and Analysis of Finaticial Condition and Results of Operations ........ I-2 Item 7A Quantitative and Qualitative Disclosures about Market Risk .............................. 1-2 Item 8 Financial Statements and Supplementary Data ........................................ 11-3 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ....... U-4 Item 9A Controls and Procedures ............................................. .......... 1-5 Item 9B Other Information .................... ............. ........... ............... . I-5 PART III Item 10 Directors, Executive Officers and Corporate Governance ............................... III-I Item 11 Executive Compensation .............................................. ......... 1-1 Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters... . ........................................................... 111-3 Item 13 Certain Relationships and Related Transactions and Director Independence.................. III-1 Item 14 Principal Accountant Fees and Services ............................................ 111-4 PART IV Item 15 Exhibits and Financial Statement Schedules......................................... IV-I Signatures .................................................................. IV-2 i

DEFINITIONS When used in Items 1 through 5 and Items 9A through 15, the following terms will have the meanings indicated. Term Meaning AEC ............................. Alabama Electric Cooperative, Inc. AFUDC ........................... Allowance for Funds Used During Construction Alabama Power ..................... Alabama Power Company AM EA ........................... Alabama Municipal Electric Authority. Clean Air Act ...................... Clean Air Act Amendments of 1990 Dalton ............................ City of Dalton, Georgia DO E ............................. United States Department of Energy Duke Energy ....................... Duke Energy Corporation Energy Act of 1992 .................. Energy Policy Act of 1992 Energy Act of 2005 .................. Energy Policy Act of 2005 Energy Solutions .................... Southern Company Energy Solutions, Inc. EPA ............................. United States Environmental Protection Agency FA SB ............................ Financial Accounting Standards Board FERC ............................ Federal Energy Regulatory Commission FM PA ............................ Florida Municipal Power Agency FP&L ............................ Florida Power & Light Company Gas South ......................... Gas South, LLC, an affiliate of Cobb Electric Membership Corporation Georgia Power ...................... Georgia Power Company Gulf Power ........................ Gulf Power Company Hampton .......................... City of Hampton, Georgia Holding Company Act ................ Public Utility Holding Company Act of 1935, as amended IBEW ............................ International Brotherhood of Electrical Workers IIC .............................. Intercompany Interchange Contract IPP .............................. Independent powei producer IRP .................. ........ Integrated Resource Plan IRS. .............................. Internal Revenue Service, JEA................... ........... Jacksonville Electric Authority KU A ............................. Kissimmee Utility Authority MEAG ..................... ... Municipal Electric Authority of Georgia M irant ............................ Mirant Corporation Mississippi Power ................... Mississippi Power Company Moody's .......................... Moody's Investors Service NRC ......................... Nuclear Regulatory Commission O PC ............................. Oglethorpe Power Corporation O UC ............................. Orlando Utilities Commission PPA .............................. Power Purchase Agreement Progress Energy Carolinas ............. Carolina Power & Light Company, d/b/a Progress Energy Carolinas, Inc. Progress Energy Florida ............... Florida Power Corporation, d/b/a Progress Energy Florida, Inc. PSC ............................. Public Service Commission registrants ......................... The Southern Company, Alabama Power Company, Georgia Power Company, Gulf Power Company, Mississippi Power Company and Southern Power Company ii

DEFINITIONS

                                                                  . (continued)

RFP .... ... ; . . , ... . - ."- . Request for Proposal 1 ....

RTO ...................... .. Regional Transmission Organization RUS ............... Rural Utility Service (formerly Rural Electrification Administration)' Companies "4! S& P ........ .... .... .. ..... Staiidard and Poor's, a division of The McGraw-Hill (merged into Georgia Power on Savannah Electric ................ -,Savanniah Electric'ind Power Company

                                                             -July 1, 2006)

S CS . . . . . . 7, .. :' ' Southern Company Services, Inc. (the system service company) SEC .............. ..... ....... Securities and Exchange Commission SEGCO............ Southern Electric Generating Company SEPA .......................... Southeastern Power Administration SERC '......... ...... .... ;. .... ' Southeastern Electric Reliability Council SMEPA ........................... South Mississippi Electric Power Association Southern Company..... .. The Southern Company" Southern Company Gas ............... ,Southern CompanyGas LLC Southern Company system ............. Southern Company, the traditional operating companies, Southern Power, SEGCO, Southern Nuclear, SCS, SouthernLINC Wireless and other subsidiaries Southern Holdings ................... Southern Company Holdings, Inc. SouthernLINC Wireless ............... Southern Communications Services, Inc. Southern Nuclear .................... Southern Nuclear Operating Company, Inc. Southern Power ..................... Southern Power Company Southern Telecom .......... :........ Southern Telecom" Inc. traditional operating companies ... .. Alabama Power Company, Georgia Power Company, Gulf Power Company and Mississippi Power Company TVA ............................. Tennessee Valley Authority 1, . ,ii iii

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This Annual Report on Form 10-K contains forward-looking statements. Forward-looking statements include, among other things, statements concerning the strategic goals for Southern Company's wholesale business, retail sales growth, customer growth, storm damage cost recovery and repairs, fuel cost recovery, environmental regulations and expenditures, eamings. growth, dividend payout ratios, access to sources of capital, projections for postretirement benefit trust contributions, synthetic fuel investments, financing activities, completion of construction projects, impacts of the adoption of new accounting rules, and estimated construction and other expenditures. In some cases, forward-looking statements can be identified by terminology such as "may," "will," "could," "should,: "expects," "plans," "anticipates," "believes," "estimates," "projects," "predicts," "potential" or "continue" or the negative of these terms or other similar terminology. There are various factors that could cause actual results to differ materially from those suggested by the forward-looking statements; accordingly, there can be no assurance that such indicated results will be realized. These factors include:

the impact of recent and future federal and state regulatory change, including legislative and regulatory initiatives regarding deregulation and restructuring of the electric utility industry, implementation of the Energy Act of 2005, and also changes in environmental, tax and other laws and regulations to which Southern Company and its subsidiaries are subject, as well as changes in application of existing laws and regulations;

" current and future litigation, regulatory investigations, proceedings or inquiries, including the pending EPA civil actions against certain Southern Company subsidiaries, FERC matters, IRS audits, and Mirant matters; " the effects, extent, and timing of the entry of additional competition in the markets in which Southern Company's subsidiaries operate; " variations in demand for electricity, including those relating to weather, the general economy and population, and business growth (and declines);

available sources and costs of fuels;
ability to control costs;

" investment performance of Southern Company's employee benefit plans;

advances in technology;

" state and federal rate regulations and the impact of pending and future rate cases and negotiations, including rate actions relating to fuel and storm restoration cost recovery; " the performance of projects undertaken by the non-utility businesses and the success of efforts to invest in and develop new opportunities; " fluctuations in the level of oil prices;

the level of production, if any, by the synthetic fuel operations at Carbontronics Synfuels Investors LP and Alabama Fuel Products, LLC for fiscal year 2007;
internal restructuring or other restructuring options that may be pursued;

" potential business strategies, including acquisitions or dispositions of assets or businesses, which cannot be assured to be completed or beneficial to Southern Company or its subsidiaries; " the ability of counterparties of Southern Company and its subsidiaries to make payments as and when due;

the ability to obtain new short- and long-term contracts with neighboring utilities;

" the direct or indirect effect on Southern Company's business resulting from terrorist incidents and the threat of terrorist incidents; " interest rate fluctuations and financial market conditions and the results of financing efforts, including Southern Company's and its subsidiaries' credit ratings; " the ability of Southern Company and its subsidiaries to obtain additional generating capacity at competitive prices;

catastrophic events such as fires, earthquakes, explosions, floods, hurricanes, pandemic health events such as an avian influenza, or other similar occurrences;

" the direct or indirect effects on Southern Company's business resulting from incidents similar to the August 2003 power outage in the Northeast; " the effect of accounting pronouncements issued periodically by standard setting bodies; and " other factors discussed elsewhere herein and in other reports filed by the registrants from time to time with the SEC. The registrants expressly disclaim any obligation to update any forward-looking statements. iv

                                                             .PART I Item 1. BUSINESS                                                     market. Southern Power is a corporation organized under the laws of Delaware on January 8, 2001 and was Southern Company was incorporated under the laws of                  admitted to do business in the States of Alabama, Florida Delaware on November 9, 1945. Southern Company is and Georgia on January 10, 2001 and in the State of domesticated under the laws of Georgia and is qualified to do business as a foreign corporation under the laws of            Mississippi on January 30, 2001.

Alabama. Southern Company owns all the outstanding Southern Company also owns all the outstanding common stock of Alabama Power, Georgia Power, Gulf Power and Mississippi Power, each of which is an common stock or membership interests of SouthemLINC operating public utility company. The traditional operating Wireless, Southern Company Gas, Southern Nuclear, SCS, companies supply electric service in the states of Southern Telecom, Southern Holdings and other direct Alabama, Georgia, Florida and Mississippi. More and indirect subsidiaries. SouthernLINC Wireless provides particular information relating to each of the traditional digital wireless communications services to the traditional operating companies is as follows: operating companies and also markets these services to Alabama Power is a corporation organized under the the public within the Southeast. Southern Nuclear laws of the State of Alabama' on November 10, 1927, provides services to Alabama Power's and Georgia by the consolidation of a predecessor Alabama Power's nuclear plants. SCS is the system service Power Company, Gulf Electric Company and company providing, at cost, specialized services to Houston Power Company. The predecessor Alabama Southern Company and its subsidiary companies. Power Company had been in continuous existence Southern Telecom provides wholesale fiber optic solutions since its incorporation in 1906. to telecommunication providers in the Southeast. Southern Georgia Power was incorporated under the laws of Holdings is an intermediate holding subsidiary for ý the State of Georgia on June 26, 1930, and admitted Southern Company's investments in synthetic fuels and to do business in Alabama on September 15, 1948. leveraged leases and various other energy-related Effective July 1, 2006, Savannah Electric, formerly a businesses. wholly-owned subsidiary of Southern Company, was merged with and into Georgia Power. Alabama Power and Georgia Power each own 50% of the outstanding common stock of SEGCO. SEGCO is Gulf Power is a Florida corporation 'that has had a an operating public utility company that owns electric continuous existence since it was originally generating units with an aggregate capacity 'of 1,019,680 organized under the laws of the State of Maine on November 2, 1925. Gulf Power was admitted to do' kilowatts at Plant Gaston on the Coosa River near business in Florida on January 15, 1926, in Wilsonville, Alabama. Alabama Power and Georgia Mississippi on October 25, 1976, and in Georgia on Power are each entitled to one-half of SEGCO's capacity November 20, 1984. Gulf Power became a Florida and energy. Alabama Power acts as SEGCO's agent in the corporation after being domesticated under the laws operation of SEGCO's units and furnishes coal to SEGCO of the State of Florida on November 2, 2005. as fuel for its units. SEGCO also owns three 230,000 volt transmission lines extending from Plant Gaston to the Mississippi Power was incorporated under the laws of the State of Mississippi on July,12, 1972, was admitted Georgia state line at which point connection is made with to do business in Alabama on November 28, 1972, and the Georgia Power transmission line system. effective December 21, 1972, by the merger into it of the predecessor Mississippi Power Company, succeeded See Note 10 to the financial statements of Southern to the business and properties of the latter company. Company in Item 8 herein for additional information The predecessor Mississippi Power Company was regarding Southern Company's segment and related incorporated under the laws of the State of Maine on information. November 24,41924, and was admitted to do business in Mississippi on December 23, 1924, and in Alabama The registrants' Annual Report on Form 10-K, on December 7, 1962.. Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports are made In addition, Southern Comrpany owns all of the common stock of Southern Power, which is also an available on Southern Company's website, free of charge, operating public utility company. Southern Power as soon as reasonably practicable after such material is constructs, acquires and-manages generation assets and electronically filed with or furnished to the SEC. Southern sells electricity at market-based rates in the wholesale Company's internet address is www.southemcompany.com. I-1

The Southern Company System Item 8 herein for information on the settlement of the FERC proceeding related to the IIC. Traditional operating companies Southern Company, each traditional operating The transmission facilities of each of the traditional company, Southem, Power, Southern Nuclear, SEGCO and operating companies are connected to the respective' other subsidiaries. have contracted with SCS to furnish, at company's own generating plants and other sources of direct or allocated cost and upon request,, the, following power and are interconnected with the transmission services: general and design engineering, purchasing, facilities of the other traditional operating companies and accounting and statistical analysis, finance and treasury, SEGCO by means of heavy-duty high voltage lines. For tax, information resources, marketing, auditing, insurance in.formation on Georgia Power's integrated transmission and pensiont administration, human resources, systems and system, see "Territory Served by the Utilities" herein for procedures and other. services with respect, to business and additional information. operations, and, power pool transactions. Southern Power, SouthernLINC Wireless and Southern Telecom have also Operating contracts covering arrangements in effect secured from the traditional operating companies certain with principal neighboring utility systems provide for services which are furnished at cost. capacity exchanges, capacity purchases and, sales, Alabama Power, and Georgia Power each have a transfers of economy energy and other similar contract with Southern Nuclear to operate Plant Farley transactions. Additionally, the traditional operating and Plants Hatch and Vogtle, respectively. See companies have entered into voluntary reliability "Regulation - Atomic Energy. Act of 1954" herein for agreements with' the subsidiaries of Entergy Corporation, additional information. Florida Electric Power Coordinating Group and TVA and with Progress Energy Carolinas, Duke Energy South Carolina Electric & Gas Company and Virginia Electric Southern Power and Power Company, each of which provides for the. Southern Power is an electric wholesale generation establishment and periodic review of principles 'and subsidiary with market-based rate authority from the procedures for planning and operation of generation and FERC. Southern Power constructs, acquires and, manages transmission facilities, maintenance schedules, load generating facilities and sells the output under long-term, retention programs, emergency operations and other fixed-price capacity contracts both tounaffiliated matters affecting the reliability of bulk power supply. The wholesale purchasers as well 'as to the traditional traditional operating companies have joined with other operating companies (under PPAs approved by the utilities in the Southeast (including those referred to respective state PSCs). Southern Power's business above) to form the SERC to augment further the activities are not subject to traditional state regulation of reliability and adequacy of bulk power supply. Through utilities but are subject to regulation by the FERC. the SERC, the traditional operating companies are Southern Power has attempted to insulate itself from represented on the National Electric Reliability Council. significant fuel supply, fuel transportation and electric The IIC provides for coordinating operations of the transmission risks by making such risksthe responsibility of the counterparties to the PPAs. However, Southern power producing facilities of the traditional operating Power's overall profit will depend on, the parameters of companies.and Southern Power and the capacities available to such companies from non-affiliated sources the wholesale market and its efficient operation of its wholesale generating assetS. At December 31, 2006, and for the pooling of surplus energy available for interchange. Coordinated operation of the entire Southern Power had 6,731 megawatts of nameplate' interconnected system is conducted through a central capacity in commercial operation. ' power supply coordination office maintained by SCS. The available sources of energy are allocated to the traditional Other Business operating companies and Southern Power to provide the In January 2006, Southern Company Gas sold most economical sources of power consistent with reliable substantially all of its'assets, including natural gas. operation. The resulting benefits and savings are inventory, accounts receivable and customer list to Gas apportioned among each of the companies. See South. See Note 3 to the financial statementsof Southern MANAGEMENT'S DISCUSSION AND ANALYSIS - Company under "Southern Company Gas Sale" in Item 8 FUTURE EARNINGS POTENTIAL - "FERC Matters - herein for additional information. Intercompany Interchange Contract" of each of the registrants in Item 7 herein and Note 3 to the financial Southern Holdings is. an intermediate holding. statements of Southern Company, each of the traditional subsidiary for Southern Company's investments in operating companies and Southern Power, all under synthetic fuels and leveraged leases and various other: "FERC Matters - Intercompany Interchange Contract" in energy-related businesses. Southern Company's interest in 1-2

one of the synthetic fuel entities was terminated in 2006. push to talk, cellular service, text messaging, wireless Synthetic fuel tax credits will no longer be available after internet access and wireless data. Its system covers December 31, 2007. , ! approximately 128,000 square miles in the Southeast.

  , SouthernLlNC Wireless serves Southern Company's                       These continuing efforts to invest in and develop new traditional operating companies and markets its services to          business opportunities offer potential returns exceeding non-affiliates within the Southeast. SouthemLINC Wireless            those of rate-regulated operations. However, these delivers multiple wireless communication options including           activities also involve a higher degree of risk.

Construction Programs The subsidiary companies of Southern Company are engaged in continuous construction programs to accommodate existing and estimated future loads on their respective systems. For estimated construction and environmental expenditures for the periods 2007 through 2009, see Note 7.to the financial statements of Southern Company, each traditional operating company and Southern Power all under "Construction Program" in Item 8 herein. Estimated construction costs in 2007 are expected to be apportioned approximately as follows: (in millions) Southern Company Alabama Georgia Gulf Mississippi Southern System* Power Power Power Power Power' New generation $ 172 $- $172 Environmental 1,661 505 955 171 Other generating facilities, 21 including associated 21 plant substations 441 175 167 30 47 New business 406 159- 201 29 17. Transmission 447 104 293 11 28 Joint line and substation 5 5 Distribution; '321 143 136 13 30 Nuclear fuel 116 48 68 General plant 342 84 103 19 29 22

                                              $3,911          $1,218          $1,923        $278            $146             $241
       *These amounts include the traditional operating              "Rate Matters - Integrated Resource Planning" herein for companies and Southern Power (as detailed in the table               additional information.

above) as well as -the amounts for the other subsidiaries. See "Regulation - Environmental Statutes and See "Other Business" herein for additional information. Regulations" herein for additional information with The construction programs are subject to periodic respect to certain existing and proposed environmental review and revision, and actual construction costs may requirements and PROPERTIES.- "Jointly-Owned vary from the above estimates because of numerous Facilities" in Item 2 herein for additional information factors. These factors include: changes in business " concerning :Alabama Power's, Georgia Power's and conditions; acquisition of additional generating assets; Southern Power's joint ownership of certain generating revised load growth estimates;. changes in environmental units and related facilities with certain non-affiliated regulations; changes in existing nuclear plants to meet utilities. new regulatory requirements;, changes in FERC rules and regulations; increasing costsý of labor, equipment and Financing Programs materials; and cost of capital. In addition, there can be no assurance that costs related, to capital expenditures will be See each of the registrant's MANAGEMENT'S fully recovered. DISCUSSION AND ANALYSIS - FINANCIAL CONDITION AND LIQUIDITY in Item 7 herein and Under Georgia law, Georgia Power is required to file Note 6 to the financial statements of Southern Company, an IRP for approval by the Georgia PSC. Through the each traditional operating company and Southern Power IRP process, the Georgia PSC must pre-certify the in Item 8 herein for information concerning financing construction of new power plants and new PPAs. See programs. 1-3

Fuel Supply For the traditional operating companies and SEGCO, the average costs of fuel in cents per net kilowatt-hour The traditional operating companies' and SEGCO's generated for 2004 through 2006 are shown below: supply of electricity is derived predominantly from coal. Southern Power's supply of electricity is primarily fueled 2004 2005 2006 by natural gas. The sources of generation for the years Alabama Power 1.69. 2.02 2.27 2004 through 2006 are shown below: Georgia Power 1.58 2.12 2.39 Coal Nuclear Hydro Gas Oil Gulf Power 2.32 2.77 3.27

                                % %           %     %          Mississippi Power                  2.50       3.11       3.34 SEGCO                              1.60       1.69       2.12 Alabama Power Southern Company 2004        65      19        6      10 system - weighted 2005        67      19        6        8            average                         1.89       2.39       2.64 2006        68      19        4        9 Georgia Power                                                         The traditional operating companies have long-term 2004        76      22        2                  agreements in place from which they expect to receive approximately 89% of their coalburn requirements in 2005        75      18        2        4 1                  2007. These agreements cover remaining terms up to nine 2006        75      18                 6         years. In 2006, the weighted average sulfur content of all Gulf Power                                                      coal burned by the traditional operating companies was 2004        84                       16          0.86% sulfur. This sulfur level, along with banked and 2005        86                       14          purchased sulfur dioxide allowances, allowed the 2006        87                       13          traditional operating companies to remain within limits set by the Phase II acid rain requirements of the Clean Mississippi Power Air Act. In 2006, Southern Company purchased 2004        69                       31          approximately $50.8 million of sulfur dioxide and 2005        70                       30          nitrogen oxide emission allowances to be used in current 2006        71                       29          and future periods. As additional environmental SEGCO                                                           regulations are proposed that impact the utilization of 2004       100

coal, the traditional operating companies' fuel mix will be
monitored to ensure that the traditional operating 2005 100

                                          **      10

companies remain in compliance with applicable laws and 2006 100 regulations. Additionally, Southern Company and the Southern Power traditional operating companies will continue to evaluate 2004 ** ** the need to purchase additional emission allowances and

                                          **      100 2005        **      **

the timing of capital expenditures for emission control

                                          **      100 2006       **      **

equipment. See MANAGEMENT'S DISCUSSION AND ANALYSIS - FUTURE EARNINGS POTENTIAL -

Southern Company system - weighted average "Environmental Matters - Environmental Statutes and 2004 69 16 3 12 Regulations" of Southern Company and each of the 2005 71 15 3 11

traditional operating companies in Item 7 herein for 2006 70 15 2 13
information on the Clean Air Act.
Less than 0.5%. ** Not applicable. The Southern Company system has long-term agreements in place for its natural gas bum requirements.

For 2007, the Southern Company system has contracted for 176 billion cubic feet of natural gas supply. These agreements cover remaining terms up to 12 years. In addition to gas supply, the Southern Company system has contracts in place for both firm gas transportation and storage. Management believes that these contracts provide sufficient natural gas supplies, transportation and storage: to ensure normal operations of the Southern Company system's natural gas generating units. Changes in fuel prices to the traditional operating companies are 'generally reflected in fuel adjustment 1-4

clauses contained in rate schedules. See "Rate Matters - Alabama Power is engaged, within the State of Rate Structure" herein for additional information. Alabama, in the generation and purchase of electricity and Southern Power's PPAs generally provide that the the distribution and sale of such electricity at retail in counterparty is responsible for substantially all 'of the cost over 1,000 communities (including Anniston, of fuel. Birmingham, Gadsden, Mobile, Montgomery and Tuscaloosa) and at wholesale to 15 municipally-owned Alabama Power and Georgia Power have, numerous electric distribution systems, 11 of which are served contracts covering a portion of their nuclear fuel needs for indirectly.through sales to AMEA, and two rural uranium, conversion services, enrichment services and distributing cooperative associations. Alabama Power also fuel fabrication. These contracts have varying expiration supplies steam service in downtown Birmingham. dates and most are short to medium term (less, than Alabama Power owns coal reserves near its Plant Gorgas 10 years). Management believes that sufficient capacity and uses the output of coal from the reserves in its for nuclear fuel supplies and processing exists to preclude generating plants. Alabama Poweralso sells, and the impairment of normal operations of the Southern cooperates with dealers in promoting the sale of, electric Company system's nuclear generating units. appliances. Alabama Power and Georgia' Power have contracts with the' DOE tliat provide for the permanent disposal of Georgia Power is engaged in the generation and spent nuclear fuel. The DOE failed to begin disposing of purchase of electricity and the transmission, distribution spent fuel in 1998, as required by the contracts, and and sale of such electricity within the State of Georgia at Alabama Power and Georgia Power are pursuing legal retail in over 600 communities (including Athens, Atlanta, remedies against the government for breach of contract. Augusta, Columbus, Macon and Rome), as well as in At Plants Farley and Hatch, on-site dry storage facilities rural areas, and at wholesale currently to OPC, MEAG, are operational and can'be expanded to accommodate Dalton and Hampton. This territory also includes the five-spent fuel through the life of each plant. Sufficient pool county area in eastern Georgia formerly served by storage capacity for spent fuel is available' at Plant Vogtle Savannah Electric. See Note 3 to the financial statements to maintain full-core discharge capability for both units of Georgia Power under "Merger" in Item 8 herein for into 2014. Construction of an on-site dry storage facility information on the merger of Savannah Electric with and at Plant Vogtle is expected to begin in sufficient time to into. Georgia Power. maintain pool full-core discharge capability. Gulf Power is engaged, within the northwestern The Energy Act of 1992 established a Uranium portion of Florida, in the generation and purchase of Enrichment Decontamination and Decommissioning Fund, electricity and the distribution and sale of such electricity which is funded in part by a special assessment on at retail in 71 communities (including Pensacola, Panama utilities with nuclear plants, including Alabama Power City and Fort Walton Beach), as well as in rural areas, and Georgia Power. This assessment was paid over a and at wholesale to a non-affiliated utility and a 15-year period that ended in 2006. This fund will be used municipality. by the DOE for the decontamination and decommissioning of its nuclear fuel enrichment facilities. J. Mississippi Power is engaged in the generation and The law provides that utilities will recover-these payments purchase of electricity and the distribution and sale of in the same manner as any other fuel expense. See Note 1 such energy within the 23 counties of southeastern to the financial statements of Southern Company, Mississippi, at retail in 123 communities (including Alabama Power and Georgia Power under "Nuclear Fuel Biloxi, Gulfport, Hattiesburg, Laurel, Meridian and' Disposal Costs" in Item 8 herein forladditional Pascagoula),,as well as in rural areas, and at wholesale to information. one municipality, six rural electric distribution cooperative associations and one generating and transmitting Territory Served by the -Utilities cooperative. The territory in which the traditional operating companies provide electric service comprises most of the states of For information relating to kilowatt-hour sales by Alabama and Georgia together' with the northwestern classification for the traditional operating companies, see portion of Florida and southeastern'Mississippi. In this MANAGEMENT'S DISCUSSION AND ANALYSIS - territory there are non-affiliated electric 'distribution RESULTS OF OPERATIONS of each of the traditional systems which obtain -some Or all 'of their power operating companies in Item 7 herein. Also, for requirements either directly or indirectly from the information relating to the sources of revenues for the traditional operating companies. The territory has an area Southern Company system, each of the traditional of approximately 120,000 square miles and an estimated operating companies and Southern Power, reference is population of approximately 11 million. made to Item 6 herein. ' I-5

A portion of the area served by the traditional 15-year agreement which began in January 2005 and one operating companies adjoins the area served by TVA and from other sources. OPC has a wholesale power contract its municipal and cooperative distributors. An Act of with the remaining 38 of these cooperative organizations, Congress limits the distribution of TVA power, unless OPC and these cooperative organizations utilize self-otherwise authorized by Congress, to specified areas or owned generation, some of which is acquired and jointly-customers which generally were those served on July 1, owned with Georgia Power, megawatt capacity purchases 1957. from Georgia Power under power supply agreements and other arrangements to meet their power supply The RUS has authority to make loans to cooperative obligations. Georgia Power, OPC and Georgia Systems associations or corporations to enable them to provide Operations Corporation entered into a new control area electric service to customers in rural sections of the compact agreement effective March 2005 which replaced country. There are 71 electric cooperative organizations previous coordination service agreements. operating in the territory in which the traditional operating companies provide electric service at retail or In April 2006, AEC began purchasing 250 megawatts wholesale. of capacity from Georgia Power for a 10-year term. In January 2005, 29 electric cooperative organizations served One of these organizations, AEC, is a generating and by OPC' and one served by Southern Power began transmitting cooperative selling power to several purchasing a total of 700 megawatts of capacity from distributing cooperatives, municipal systems and other Georgia Power under individual contracts for 10-year customers in south Alabama and northwest Florida. AEC terms. Also, in January' 2005, the electric cooperative owns generating units with approximately 1,776 served by Southern Power began purchasing 25 megawatts megawatts of nameplate capacity, including an undivided of peaking capacity from Georgia Power under a 10-year 8.16% ownership interest in Alabama Power's Plant contract. This electric cooperative began purchasing Miller Units I and 2. AEC's facilities were financed with 50 megawatts of coal-fired capacity from Georgia Power RUS loans secured by long-term contracts requiring beginning on April 1, 2006 and ending on December 31, distributing cooperatives to take their requirements from 2014 and will purchase another 75 megawatts of coal-AEC to the extent such energy is available. fired capacity from Georgia Power beginning June 1, Four electric cooperative associations, financed by 2010 and ending December 31, 2019. See the RUS, operate within Gulf Power's service area. These PROPERTIES - "Jointly-Owned Facilities" in Item 2 cooperatives purchase their full requirements from AEC herein for additional information. and SEPA (a federal power marketing agency). A There are 65 municipally-owned electric distribution non-affiliated utility also operates within Gulf Power's systems operating in the territory in which the traditional service area and purchases its full requirements from Gulf operating companies provide electric service at retail or Power. wholesale. Alabama Power and Gulf Power have entered into AMEA was organized under an act of the Alabama separate agreements with AEC involving interconnection legislature and is comprisedof 11 municipalities. In between their respective systems. The delivery of capacity December 2001, Alabama Power entered into a power and energy from AEC to certain distributing cooperatives sales agreement with AMEA which began on January 1, in the service areas of Alabama Power and Gulf Power is 2006. Under this contract, AMEA supplies 70 to governed by the Southern Company/AEC Network 95 megawatts of power from its combustion turbine plant Transmission Service Agreement. The rates for this and Alabama Power serves the remainder of its member service to AEC are on file with the FERC. See needs through 2010. Beginning in 2011, the amount of PROPERTIES - "Jointly-Owned Facilities" in Item 2 power supplied to AMEA by Alabama Power is fixed at herein for details of Alabama Power's joint-ownership 2010 levels and AMEA has the option to seek other with AEC of a portion of Plant Miller. suppliers for its incremental growth needs through 2015, Mississippi Power has an interchange agreement with at which time the contract terminates. SMEPA, a generating and transmitting cooperative, Forty-eight municipally-owned electric distribution pursuant to which various services are provided, including systems and one county-owned system receive their the furnishing of protective capacity by Mississippi Power to SMEPA. requirements through MEAG, which was established by a Georgia state statute in 1975. MEAG serves these There are 43 electric cooperative organizations requirements from self-owned generation facilities, some operating in, or in areas adjoining, territory in the State of of which are acquired and jointly-owned with Georgia Georgia in which Georgia Power provides electric service Power, power purchased from Georgia Power and, at retail or wholesale. Three of these organizations obtain purchases from other resources. In 1997, a pseudo their power from TVA, one from Southern Power under a scheduling and services agreement was implemented 1-6

between Georgia Power and MEAG., Since 1977, Dalton having aconnected load of at least 900 kilowatts may has filled its requirements from self-owned generation, receive electric service from the supplier of its choice. facilities, some of which are acquired and jointly-owned See "Competition" herein for additional information. with Georgia Power, and through purchases from Georgia Under the provisions of its franchises and Power pursuant to their partial requirements tariff. concessions and the 1973 State Territorial Electric Service Beginning January 1, 2003, Dalton entered into a power Act, and pursuant to the merger with Savannah Electric, supply agreement with Georgia Power and Southern Georgia Power now has the full but nonexclusive right to Power pursuant to which it will purchase 134 megawatts serve the City of Savannah, the Towns of Bloomingdale,. from Georgia Power and the balance of its requirements, Pooler, Garden City, Guyton, Newington, Oliver, Port !. net of self-owned generation, from Southern Power for a Wentworth, Rincon, Tybee Island, Springfield, 15-year term. In addition, Georgia Power serves the full Thunderboltvand Vernonburg, and in conjunction with a requirements of Hampton's electric distribution system secondary supplier, the-Town of Richmond Hill. In under a market-based contract. See PROPERTIES - addition, Savannah Electric was assigned certain "Jointly-Owned Facilities" in Item 2 herein for additional unincorporated areas in Chatham, Effingham, Bryan, information. . Bulloch and Screven Counties by the Georgia PSC. In Georgia Power has entered into substantially similar connection with the merger of Savannah Electric with and agreements with Georgia Transmission. Corporation intodGeorgia Power, the Georgia PSC approved the (formerly OPC's transmission division), MEAG and. transfer of Savannah Electric's 'service territory to Georgia Dalton providing for the establishment of an integrated Power at the effective time 'of merger. See "Comletition" transmission system to carry., the power and energy of. herein for additional information. each. The agreements require an investment by each party Pursuant to the 1956 Utility Act, the Mississippi PSC in the integrated transmission system in proportion to its issued "Grandfather Certificates" of public convenience,' respective share of the aggregate system load. See and necessity to Mississippi Power and to six distribution PROPERTIES - "Jointly-Owned Facilities" in, tem 2 rural cooperatives operating in southeastern Mississippi, herein for additional information. then served in whole or in part by Mississippi Power, See MANAGEMENT'S DISCUSSION AND authorizing them to distribute electricity in certain ANALYSIS - FUTURE EARNINGS POTENTIAL - specified geographically described areas of the state. The "Power Sales Agreements" of Southern Power in Item 7 six co6peratives'serve approximately'375,000 retail! herein for information concerning its PPAs. customers in a certificated area of approximately , 10,300 hquare miles. In areas included in a"'Grandfather SCS, acting on behalf of the traditional operating Certificate," the utility holding such certificate may, companies, also has a contract with SEPA providing for without further certification, extend its lines up to five the use of the traditional operating companies' facilities at miles;' oher extensions within that area by such utility, or government expense to deliver to certain cooperatives and by 6thei utilities, may not be made except upon a municipalities, entitled by federal statute to preference in showing of, and a grant of a certificate of, public the purchase of power from SEPA, quantities of power convenience'and necessity. Areas included in such a equivalent to the amounts of power allocated to them by certificate which are subsequently annexed to SEPA from certain United States government municipalities may continue to be served by the holder of hydroelectric projects. . the -certificate, irrespective of whether it has a franchise in The retail service rights of all electric suppliers in the annexing municipality. On the other hand, the holder of the municipal franchise may not extend service into the State of Georgia are regulated by the 1973 State such, newly. annexed area without authorization by the Territorial Electric Service Act. Pursuant to ithe provisions Mississippi PSC. of this, Act; all areas within, existing municipal limits were assigned to the primary electric supplier therein, (451 ,municipalities, including Atlanta, Columbus, Macon, Competition Augusta, Athens, Rome and Valdosta, to Georgia:Power; The electric utility industry in the-United States is 115 to electric cooperatives; and 50 to publicly-owned continuing to evolve as a result of regulatory and systems). Areas outside of such municipal limits were, competitive factors. Among the early primary agents of either to be assigned or to -beAdeclared open for customer: change was the Energy Act of 1992. The Energy Act of choice of upplier by action of the Georgia PSC pursuant 1992-allowed IPPs to access a utility's transmission to standards set forth in this Act. Consistent with such network in orderto sell electricity to other utilities. standards, the Georgia PSC has assigned substantially all of the land area in the state to a supplier.: Notwithstanding Alabama Power currently has cogeneration contracts such assignments, this Act provides that any new -, in effect with 10 industrial customers. Under the terms of customer locating outside of 1973 municipal limits and these contracts, Alabama Power purchases excess 1-7

generation of such companies. During 2006, Alabama Southeastern United States wholesale market. The needs Power purchased approximately 78 million kilowatt-hours of this market are driven by the demands of end users in from such companies at a cost of $3.9 million. the Southeast and the generation available. Southern Power's success in wholesale energy sales is influenced Georgia Power currently has contracts in effect with by various factors including reliability and availability of 10 small power producers whereby Georgia Power Southern Power's plants, availability of transmission to purchases their excess generation. During 2006, Georgia serve the demand, price and Southern Power's ability to Power purchased 11I million kilowatt-hours from such contain costs. companies at a cost of $2.4 million. Georgia Power has PPAs for electricity with two cogeneration facilities. Payments are subject to reductions for failure to meet Seasonality minimum capacity output. During 2006, Georgia Power Electric power gener-ation is a seasonal business. At the purchased 356 million kilowatt-hours at a cost of traditional operating companies and Southern Power, the $70.6 million from these facilities. demand for power peaks during the hot summer months, with market prices also peaking at that time. Power Also during 2006, pursuant to the merger with demand peaks can also be recorded during the winter. As Savannah Electric, Georgia Power purchased energy from a result, the overall operating results of Southern seven customer-owned generating facilities. Six of the Company, the traditional operating companies and seven customers provide only energy to Georgia Power. Southern Power in the future may fluctuate substantially These six customers make no capacity commitment and on a seasonal basis. In addition, Southern Company, the are not dispatched by Georgia Power. Georgia Power does traditional operating companies and Southern Power have have a contract with the remaining customer for eight historically sold less power, and consequently earned less megawatts of dispatchable capacity and energy. During income, when weather conditions are milder. 2006, Georgia Power purchased a total of 48.6 million kilowatt-hours from the seven suppliers at a cost of approximately $1.9 million. Regulation State Commissions Gulf Power currently has agreements in effect with various industrial, commercial and qualifying facilities The traditional operating companies are subject to the pursuant to which Gulf Power purchases "as available" jurisdiction of their respective state PSCs, which have energy from customer-owned generation. During 2006, broad powers of supervision and regulation over public Gulf Power purchased 9.3 million kilowatt-hours from utilities operating in the respective states, including their such companies for approximately $0.5 million. rates, service regulations, sales of securities (except for the Mississippi PSC) and, in the cases of the Georgia PSC Mississippi Power currently has a cogeneration and the Mississippi PSC, in part, retail service territories. agreement in effect with one of its industrial customers. See 'Territory Served by the Utilities" and "Rate Matters" Under the ternms of this contract, Mississippi Power herein for additional information. purchases any excess generation. During 2006, this customer had no excess generation. Federal Power Act The competition for retail energy sales among In July 2005, the U.S. Congress passed the Energy Act of competing suppliers of energy is influenced by various 2005 which repealed the Holding Company Act effective factors, including price, availability, technological February 8, 2006. The traditional operating companies, advancements and reliability. These factors are, in turn, Southern Power and its generation subsidiaries and affected by, among other influences, regulatory, political SEGCO are all public utilities engaged in wholesale sales and environmental considerations, taxation and supply. of energy in: interstate commerce and therefore remain Generally, the traditional operating companies have subject to the rate, financial and accounting jurisdiction of experienced, and expect to continue to experience, the FERC under the Federal Power Act. Certain financing competition in their respective retail service territories in approvals which would have been obtained from the SEC varying degrees as the result of self-generation (as under the repealed Holding Company Act now must be described above) and fuel switching by customers and obtained from the FERC. In implementing repeal of the other factors. See also "Territory Served by the Utilities" Holding Company Act, the FERC sought to minimize herein for additional information concerning suppliers of unnecessary administrative burdens and decided to retain electricity operating within or near the areas served at an "at cost standard" for services rendered by system retail by the traditional operating companies. service companies such as SCS, to permit certain existing financing authorizations to remain effective without Southern Power competes with investor owned further action by the FERC and to reduce reporting utilities, IPPs and others for wholesale energy sales in the requirements. In addition to its repeal of the Holding 1-8

Company Act, the Energy Act of 2005 authorized the Upon or after the expiration of each license, the FERC to establish regional reliability organizations United States Government, by act of Congress, may take authorized to enforce reliability standards, established a over the project or the FERC may relicense the project process for the FERC to address impediments to the either to the original licensee or to a new licensee. In the construction of transmission and established clear event of takeover or relicensing to another, the original responsibility for the FERC to prohibit manipulative licensee is to be compensated in accordance with the energy trading practices. provisions of the Federal Power Act, such compensation to reflect the net investment of the licensee in the project, Alabama Power and Georgia Power are also subject not in excess of the fair value of the property taken, plus to the provisions of the Federal Power Act or the earlier reasonable damages to other property of the licensee Federal Water Power Act applicable to licensees with resulting from the severance therefrom of the property respect to their hydroelectric developments. Among the taken. If the FERC does not act on the new license hydroelectric projects subject to.licensing by the FERC application prior to the expiration of the existing license, are 14 existing Alabama Power generating stations having the FERC is required to issue annual licenses, under the an aggregate installed capacity of 1,662,400 kilowatts and same terms and conditions of the existing license,- until a 18 existing Georgia Power generating stations having an new license is issued. aggregate installed capacity of 1,074,696 kilowatts. In' 2003, Georgia Power started the relicensing Atomic Energy Act of 1954 process for the Morgan Falls project which is located on the Chattahoochee River near Atlanta, Georgia and Alabama Power, Georgia Power and Southern Nuclear are submitted the final license application for this facility to subject to the provisions of the Atomic Energy Act of the FERC in February 2007. The current license for the 1954, as amended, which vests jurisdiction in the NRC Morgan Falls project expires in 2009. In 2007, Georgia over the construction and operation of nuclear reactors, Power expects to begin the relicensing process for particularly with regard to certain public health and safety Bartlett's Ferry which is located on the Chattahoochee and antitrust matters. The National Environmental Policy River near Columbus, Georgia. The current Bartlett's Act has been construed to expand the jurisdiction of the Ferry license expires in 2014 and the application for a NRC~to consider the environmental impact of a facility new license is expected to be submitted to the FERC in licensed under the Atomic Energy Act of 1954, as 2012. In July 2005, Alabama Power filed two applications amended. with the FERC for new 50-year licenses for its seven hydroelectric developments on the Coosa River (Weiss, The NRC operating licenses for Plant Vogtle units 1 Henry, Logan Martin, Lay, Mitchell, Jordan and B ouldin) and 2 currently expire in January .2027 and February and for the Lewis Smith and Bankhead developments on 2029, respectively. In January 2002, the NRC granted the Warrior River. The FERC licenses for all of these nine Georgia Power a 20-year extension of the licenses for developments expire in July and August of 2007. In 2006, both units at Plant Hatch which permits the operation of Alabama Power initiated the process of developing an units 1 and'2 until 2034 and 2038, respectively. Georgia application to relicense the'Martin hydroelectric project Power plans to file an application with the NRC in June located on the Tallapoosa River. The current Martin 2007 to extend the licenses for Plant Vogtle units 1 and 2 license will expire in 2013 and the application for a new for an additional 20 years. In May 2005, the NRC granted license is expected to be filed with the FERC in 2011. Alabama Power a 20-year extension of the licenses for See MANAGEMENT'S DISCUSSION AND both units at Plant Farley which permits operation of units ANALYSIS - FUTURE EARNINGS POTENTIAL - I and 2 until 2037 and 2041, respectively.

 "FERC Matters - Hydro Relicensing" of Alabama Power in Item 7 herein for additional information.                           See Notes 1 and 9 to the financial statements of Southern Company, Alabama Power and Georgia Power Georgia Power and OPC also have a license,                 in Item 8 herein for information 'on nuclear expiring in 2027, for the Rocky Mountain Plant, a pure           decommissioning costs and nuclear insurance.

pumped storage facility of 847,800 kilowatt capacity. See PROPERTIES - "Jointly-Owned Facilities" in Item 2 herein for additional information. FERC Matters Licenses for all projects, excluding those discussed See MANAGEMENT'S DISCUSSION AND] above, expire in the period 2013-1033 in the case of ANALYSIS - FUTURE EARNINGS POTENTIAL - Alabama Power's projects and'in the period 2014-2039 in "FERC Matters" of each of the registrants in Item 7 the case of Georgia Power's projects. herein for information on matters regarding the FERC. 1-9

Environmental Statutes and Regulations Rate Matters Southern Company's operations are subject to extensive *Rate Structure regulation by state and federal environmental agencies under a variety of statutes and regulations governing The rates and service regulations of the traditional environmental media, including air, water and land operating companies are uniform for each class of service resources. Compliance with these environmental throughout their respective service areas. Rates for requirements involves significant capital and operating residential electric service are generally of the block type costs, a major portion of which is expected to be based upon kilowatt-hours used and include minimum recovered through existing ratemaking provisions. There charges. Residential and other rates contain separate is no assurance, however, that all such costs will be customer charges. Rates for commercial service are recovered. presently of the block type and, for large customers, the billing demand is generally used to determine capacity Compliance with the federal Clean Air Act and and minimum bill charges. These large customers' rates resulting regulations has been, and will continue to be, a are generally based upon usage by the customer and significant focus for Southern Company, each traditional include rates with special features to encourage off-peak operating company and SEGCO. See MANAGEMENT'S usage. Additionally, Alabama Power, Gulf Power and DISCUSSION AND ANALYSIS - FUTURE EARNINGS Mississippi Power are generally allowed by their POTENTIAL - "Environmental Matters" of Southern respective state PSCs to negotiate the terms and cost of Company and each of the traditional operating companies service to large customers. Such terms and cost of in Item 7 herein for additional information about the service, however, are subject to final state PSC approval. Clean Air Act and other environmental issues, including the litigation brought by the EPA under the New Source Fuel and net purchased energy costs are recovered Review provisions of the Clean Air Act. through specific fuel cost recovery provisions at the traditional operating companies. These fuel cost recovery Additionally, each traditional operating company and provisions are adjusted to reflect increases or decreases in SEGCO has incurred costs for environmental remediation such costs as needed. Gulf Power's and Mississippi of various sites. See MANAGEMENT'S DISCUSSION Power's fuel cost recovery provisions are adjusted AND ANALYSIS - FUTURE EARNINGS annually to reflect increases or decreases in such costs. POTENTIAL - "Environmental Matters - Environmental Georgia Power is currently required to file for an Statutes and Regulation - Environmental Remediation" of adjustment to its fuel cost recovery rate no later than Southern Company and each of the traditional' operating March 1, 2008. Alabama Power's fuel clause is adjusted companies in Item 7 herein for information regarding as required. Revenues are adjusted for differences environmental remediation efforts. Also, see Note 3 to the between recoverable costs and amounts actually recovered financial statements of Southern Company, Georgia in current rates. Power, Gulf Power and Mississippi Power under "Environmental Matters - Environmental Remediation" in Approved environmental compliance and storm Item 8 herein for information regarding the identification damage costs are recovered at Alabama Power, Gulf of sites that may require environmental remediation. Power and Mississippi Power through cost recovery provisions approved by their respective state PSCs. The traditional operating companies, Southern Power Within limits approved by their respective PSCs, these and SEGCO are unable to predict at this time what rates are adjusted to reflect increases or decreases in such additional steps they may be required to take as a result costs as required. Alabama Power recovers the cost of of the implementation of existing or future quality control new plant and Gulf Power recovers purchased power requirements for air, water and hazardous or toxic capacity and conservation costs through cost recovery materials, but such steps could adversely affect system provisions which are adjusted as required to reflect operations and result in substantial additional costs. increases or decreases in such costs as needed. Georgia Power continues to recover environmental compliance, The outcome of the matters mentioned above under storm damage and new plant costs through its base rates., "Regulation" cannot now be determined, except that these Revenues are adjusted for differences between recoverable developments may result in delays in obtaining costs and amounts actually recovered in current rates. appropriate licenses for generating facilities, increased construction and operating costs or reduced generation, See MANAGEMENT'S DISCUSSION AND the nature and extent of which, while not determinable at ANALYSIS - FUTURE EARNINGS POTENTIAL-, this time, could be substantial. "PSC Matters" of Southern Company and each of the 1-10

traditional operating companies in Item 7 herein and Following the Georgia PSC's approval of the 2004 Note 3 to the financial statements of Southern Company IRP, Georgia Power de-certified the Atkinson combustion under "Alabama Power Retail Regulatory Matters" and turbine units 5A and 5B totaling approximately "Georgia Power Retail Regulatory Matters" and Note 3 to 80 megawatts ofcapacity and extended the life of the the financial statements of each of the traditional Kraft combustion turbine unit until such time as its operating companies under "Retail Regulatory Matters" in retirement is warranted. Item 8 herein for a discussion of rate matters. Also, see Georgia Power received certification of its RFP for Note 1 to the financial statements of Southern Company approximately 1,000 megawatts to meet its future supply-and each of the traditional operating companies in Item 8 side capacity needs for 2009 and beyond. herein for a discussion of recovery of fuel costs and environmental compliance 'costs through rates. In January 2006, Georgia Power filed an application with the Georgia PSC to approve an amendment to Southern Power is authorized by the FERC to sell Georgia Power's IRP in connection with the merger to power to non-affiliates at market-based prices and to add Savannah Electric customers and generating assets. In make short-term opportunity sales at market rates. Special FERC approval must be obtained with respect to a June 2006, the Georgia PSC approved the merger between Georgia Power and Savannah Electric. Also, the Georgia mirket-based contract with an affiliate. See PSC approved the transfer of territory, customers, power MANAGEMENT'S DISCUSSIONAND ANALYSIS - FUTURE EARNINGS POTENTIAL - "FERC Matters - plants and demand-side programs from Savannah Electric to Georgia Power. Market-Based Rate Authority" of Southern Power in Item 7 herein and Note 3 to the financial statements of In March 2006, Georgia Power issued RFPs for Southern Power under "FERC Matters - Market-Based approximately, 2,100 and 1,400 megawatts, respectively, to Rate Authority" in Item 8 herein for a discussion of rate meet its 2010.and 2011 supply-side needs. For the 2011 matters. RFP, Georgia Power submitted self-build proposals that compare to the market. Additionally, Georgia Power will Integrated Resource Planning continue a residential load management program which was certified by the Georgia PSC for up to 40 megawatts Georgia Power must file an IRP with the Georgia PSC of equivalent supply-side capacity. Georgia Power will that specifies how it intends to meet the future electrical continue -to utilize approximately eight megawatts of needs of its customers through a combination of demand- capacity, from existing qualifying facilities under firnn side and supply-side resources. The Georgia PSC must contracts and continue to add additional resources as certify any new demand-side or supply-side resources.' ordered by 'the Georgia PSC. Once certified, the lesser of actual or certified construction costs and purchased power costs will be On January 31, 2007, Georgia Power filed its 2007 recoverable through rates. IRP with the Georgia PSC. With the 2007 IRP and subsequent filings, Georgia Power proposes to: (1) retire In December 2002, the Georgia PSC certified a PPA the coal units at Plant McDonough and replace them with between Duke Energy and Georgia Power for 620 combined-cycle natural gas units; (2) gain approval for megawatts for seven years that began in June 2005. five new energy efficiency pilot programs and request that K-Gen Power, LLC has replaced Duke Energy as a party certified demand-side management programs receive to this contract. similar financial treatment as supply-side options; In May 2004, the Georgia PSC ordered Georgia (3) pursue up to three new renewable generation projects Power and Savannah Electric to purchase the McIntosh with a Georgia Power ownership interest; (4) establish combined cycle generating facility from Southern Power new nuclear units as a preferred option to meet demand in and place it into their respective rate bases. The McIntosh the 201512016 timeframe; and (5) establish policy that resource was previously certified as a PPA by the Georgia baseloaid generating plants should be built by Georgia PSC in the supply-side certification conducted in 2002 Power and, should not be subject to the competitive bid and, at the same time, the Georgia PSC also approved the process. The Georgia PSC decision on this 2007 IRP de-certification of Savannah Electric's Plant Riverside, filing is expected in July 2007. units 4 through 8, effective in May 2005. The McIntosh units produce a combined 1,240 megawatts' and have been Environmental Cost Recovery Plans available since June 2005. Pursuant to-the merger with Savannah Electric, Georgia Power now has 100% See MANAGEMENT'S DISCUSSION AND ownership of the McIntosh units. See Note 3 to the' ANALYSIS - FUTURE EARNINGS POTENTIAL - financial statements of Georgia Power under "Retail "PSC Matters - Alabama Power" and "PSC Matters - Regulatory Matters - Rate Plans". in Item 8 herein for Retail Rate Adjustments," respectively, of Southern additional information.. ' Company 'and Alabama Power in Item 7 herein and Note 3 1-11

to the financial statements of Southern Company and

One of Southern Holdings' subsidiaries has Alabama Power, under "Alabama Power Retail Regulatory 4 employees. Southern Holdings has agreements with Matters" and "Retail Regulatory Matters," respectively, in SCS whereby all other employee services are rendered at Item 8 herein for a discussion on Alabama PSC rate cost.

matters. ** Southern Power has no employees. Southern Power has agreements with SCS and the traditional operating See Note 3 to the financial statements of Gulf Power under "Retail Regulatory Matters - Environmental Cost companies whereby employee services are rendered at Recovery" in Item 8 herein for information on Gulf cost. Power's environmental cost recovery. The traditional operating companies have separate agreements with local unions of the IBEW generally See MANAGEMENT'S DISCUSSION AND covering wages, working conditions and procedures for ANALYSIS - FUTURE EARNINGS POTENTIAL - handling grievances and arbitration. These agreements "PSC Matters - Environmental Compliance Overview apply with certain exceptions to operating, maintenance Plan" of Mississippi Power in Item 7 herein and Note 3 to and construction employees. the financial statements of Mississippi Power under "Retail Regulatory Matters - Environmental Compliance Alabama Power has agreements with the IBEW on a Overview Plan" in Item 8 herein for information on five-year contract extending to August 15, 2009. Upon Mississippi Power's environmental cost recovery. notice given at least 60 days prior to that date, negotiations may be initiated with respect to agreement Storm Damage Cost Recovery terms to be effective after such date. Georgia Power has an agreement with the IBEW See MANAGEMENT'S DISCUSSION AND covering wages and working conditions, which is in effect ANALYSIS - FUTURE EARNINGS POTENTIAL - through June 30, 2008. "PSC Matters - Storm Damage Cost Recovery" of Southern Company, Gulf Power and Mississippi Power Gulf Power has an agreement with the IBEW and "PSC Matters - Natural Disaster Cost Recovery" of covering wages and working conditions, which is in effect Alabama Power in Item 7 herein and Note 3 to the through October 14, 2009. financial statements of Southern Company, Alabama Mississippi Power has an agreement with the IBEW Power, Gulf Power and Mississippi Power under "Storm extending the previous contract for one year to August 16, Damage Cost Recovery," "Retail Regulatory Matters - 2007. Negotiations are expected to begin in July 2007 on Natural Disaster Cost Recovery," "Retail Regulatory a new four-year agreement. Matters - Storm Damage Cost Recovery" and "Retail Regulatory Matters - Storm Damage Cost Recovery," Southern Nuclear has agreements with the IBEW on respectively, in Item 8 herein for a discussion of the a three-year contract extending to June 30, 2008 for impacts and recovery of storm damage costs related to Plants Hatch and Vogtle and a three-year contract which Hurricanes Ivan, Dennis and Katrina. is in effect through August 15, 2009 for Plant Farley. Upon notice given at least 60 days prior to these dates, negotiations may be initiated with respect to agreement Employee Relations terms to be effective after such dates. The Southern Company system had a total of 26,091 The agreements also subject the terms of the pension employees on its payroll at December 31, 2006. plans for the companies discussed above to collective bargaining with the unions at either a five-year or a Employees 10-year cycle, depending upon union and company at actions. December 31, 2006 Alabama Power 6,796 Item 1A. RISK FACTORS Georgia Power 9,278 Gulf Power 1,321 In addition to the other information in this Form 10-K, Mississippi Power 1,270 including MANAGEMENT'S DISCUSSION AND SCS ANALYSIS - FUTURE EARNINGS POTENTIAL in 3,737 Southern Holdings* 4 Item 7 of each registrant, and other documents filed Southern Nuclear 3,216 by Southern Company and/or its subsidiaries with the Southern Power SEC from time to time, the following factors should be Other 469 carefully considered in evaluating Southern Company and its subsidiaries. Such factors could affect actual Total 26,091 results and cause results to differ materially from 1-12

those expressed In any forward-looking statements . The traditional operating companies currently own made by, or on behalf of, Southern Company and/or and operate transmission facilities 'as part of a vertically its subsidiaries. integrated utility. Transmission revenues are not separated from generation and distribution revenues in their approved retail rates. Since 1999, when the FERC issued Risks Related to the Energy Industry final rules on RTOs, there have been a number of Southern Company and its subsidiaries are subject to proceedings at FERC designed to encourage further substantial governmental regulation. Compliance with voluntary formation of RTOs or to mandate their current and future regulatory requirements and formation. Under this new transmission regulatory procurement of necessary approvals, permits and structure, the traditional operating companies could certificates may result in substantial costs to Southern transfer functional control (but not ownership) of their Company and its subsidiaries. transmission facilities to an independent third party. While there are no active proceedings at FERC that Southern Company and its subsidiaries, including the would require Southern Company to participate in a RTO, traditional operating companies and Southern Power, are current FERC efforts that may potentially change the subject to substantial regulation from federal, state and regulatory and/or operational structure of transmission local regulatory agencies. Southern Company and its include rules related to the standardization of generation subsidiaries are required to comply with numerous laws interconnection, as well as an inquiry into, among other and regulations and to obtain numerous permits, approvals things, market power by vertically integrated utilities. The and certificates from the governmental agencies that financial condition, net income and cash flows of regulate various aspects of their businesses, including Southern Company and its utility subsidiaries could be customer rates, service regulations, retail service adversely .affected by future changes in the federal territories, sales of securities, asset acquisitions and sales, regulatory or operational structure of transmission. accounting policies and practices, and the operation of fossil-fuel, hydroelectric and nuclear generating facilities. Certain events in the energy markets that are beyond For example, the rates charged to wholesale customers by the control of Southern Company and its subsidiaries the traditional operating companies and by Southern have increased the level of public and regulatory Power must be approved by the FERC. In addition, the scrutiny in the energy industry and in the capital respective state PSCs must approve the traditional markets. The reaction to these events may result in operating companies' rates for retail -ustomers. While the new laws or regulations related to the business retail rates approved by the respective state PSCs are operations or the accounting treatment of the existing designed to provide for recovery of costs and a return on operations of Southern Company and its subsidiaries invested capital, there can be no assurance that a state which could have a negative impact on the net income PSC will not deem certain costs to be imprudently or access to capital of Southern Company and its incurred and not subject to recovery. subsidiaries. Southern Company and its subsidiaries believe the As a result of the energy crisis in California during necessary permits, approvals and certificates have been the summer of 2001, the Enron' Corporation bankruptcy, obtained for its existing operations and that their investigations by governmental authorities into energy respective businesses are conducted in accordance with trading activities and the August 2003 power outage in applicable laws; however, the impact of any future the Northeast, companies in regulated and unregulated revision or changes in interpretations of existing electric utility businesses have been under an increased regulations or the adoption of new laws and regulations amount of public and regulatory scrutiny with respect to, applicable to Southern Company or any of its subsidiaries among Pther things, accounting practices, financial cannot now be predicted. Changes in regulation or the disclosures and relationships with independent auditors. imposition of additional regulations could influence the This increased scrutiny has led to substantial changes in operating environment of Southern Company and its laws and regulations affecting Southern Company and its subsidiaries and may result in substantial costs. subsidiaries, including, among others, enhanced internal control arid auditor independence requirements, financial statement certification requirements, more frequent SEC General Risks Related to Operation of Southern reviews of financial statements and accelerated and Company's Utility Subsidiaries additional SEC filing requirements. New accounting and The regional power market in which Southern disclosure requirements have changed the way Southern Company and its utility subsidiaries compete may have Company and its subsidiaries are required to record changing transmission regulatory structures, which revenues, expenses, assets and liabilities. Southern could affect the ownership of these assets and related Company expects continued regulatory focus on revenues and expenses. accounting and financial reporting issues. Future 1-13

disruptions in the industry such as those described above any subsidiary of Southern Company in Southern and any additional resulting regulations may have a Company's retail service territory entered into during a negative impact on the net income or access to capital of 15-month refund period beginning February 27, 2005 Southern Company and its subsidiaries. could be subject to refund to the level of the default cost-based rates, pending the outcome of the proceeding. Such Deregulation or restructuring in the electric industry sales through May 27, 2006, the end of the refund period may result in increased competition and unrecovered were approximately $19.7 million for the Southern costs which could negatively impact the net income of Company, system. In the event that FERC's default Southern Company and the traditional operating mitigation measures for entities that are found to have companies and the value of their respective assets. market power are ultimately applied, the traditional Increased competition, which may result from operating companies and Southern Power may be required restructuring efforts, could have'a significant adverse to charge cost-based rates for certain wholesale sales in financial impact on Southern Company and its traditional the Southern Company retail service territory, which may operating companies. Increased competition could result be lower than negotiated market-based rates. in increased pressure to lower the cost of electricity. Any adoption in the territories served by the traditional In addition, in May 2005 the FERC started an operating companies of retail competition and the investigation to determine whether Southern Company unbundling of regulated energy service could have a satisfies the other three parts of FERC's market-based rate significant adverse financial impact on Southern Company analysis: transmission market power, barriers to entry and and the traditional operating companies due to an affiliate abuse or reciprocal dealing. The FERC impairment of assets, a loss of retail customers, lower established a new 15-month refund period related to this profit margins, an inability to recover reasonable costs or expanded investigation. Any new market-based rate sales increased costs of capital. Southern Company and the involving any Southiern Company subsidiary could be traditional operating companies cannot predict if or when subject'to refund to the extent the FERC orders lower they may be subject to changes in legislation or rates as a result of this new investigation. Such sales regulation, nor can Southern Company and the traditional through October 19, 2006, the end of the refund period, operating companies predict the impact of these changes. were approximately $55.4 million for the Southern Company system, of which $15.5 million relates to sales Additionally, the electric utility industry has inside the retail service territory discussed above. experienced a substantial increase in competition at the wholesale level. As a result of changes in federal law and regulatory policy, competition in the wholesale electricity Risks Related to Environmental Regulation market has greatly increased due to a greater participation by traditional electricity suppliers, non-utility generators, Southern Company's and the traditional operating IPPs, wholesale power marketers and brokers and due to companies' costs of compliance with environmental the trading of energy futures contracts on various laws are significant, The costs of compliance with commodities exchanges. In addition, FERC rules on future environmental laws and the incurrence of transmission service are designed to facilitate competition environmental liabilities could negatively impact the in the wholesale market on a nationwide basis by net income and cash flows of Southern Company, the providing greater flexibility and more choices to traditional operating companies or Southern Power. wholesale power customers. Potential changes to the criteria used by the FERC for Southern Company and the traditional operating approval of market-based contracts may negatively companies are subject to extensive federal, state and local impact the traditional operating companies' and environmental requirements which, among other things, Southern Power's ability to charge market-based rates. regulate air emissions, water discharges and the management of hazardous and solid waste in order to. Each of the traditional operating companies and adequately protect the environment. Compliance with Southern Power have authorization from the FERC to sell these legal requirements requires Southern Company and power to nonaffiliates, including short-term opportunity the traditional operating companies to commit significant, sales, at market-based prices. Specific FERC approval expenditures for installation of pollution control must be obtained with respect to a market-based sale to equipment, environmental monitoring, emissions fees and an affiliate. In December 2004, the FERC initiated a permits at all of their respective facilities. These proceeding to assess Southern Company's generation expenditures are significant and Southern Company and'- dominance within its retail service territory. The ability to the traditional operating companies expect that they will-charge market-based rates in other markets is not an issue increase in the future. Through 2006, Southern Company in that proceeding. Any new market-based rate sales by had invested approximately $3.1 billion in capital projects 1-14

to comply with these requirements, with annual totals of Risks Related to Southern Company and its Business $661 million, $423 million and $300 million for 2006, Southern Cpmpany may be unable to meet its ongoing 2005 and 2004, respectively. SouthernCompany expects and future.financial obligations and to pay dividends that capital expenditures to assurecompliance with on its common stock.if its subsidiaries are unable to existing and new regulations will be anfadditional pay upstream dividends or repay funds to Southern $1.66 billion, $1.65 billion and $1.27 billion for 2007, Company. 2008 and 2009, respectively. Because Southern 'Ster" Company.is a holding company and, as Company's compliance strategy islimphcted by changes to existing environmental laws and regulations; the cost, such, Southern Coriipany haý no operations of its own. availability, and existing inventory of emission, Substantially all of Southern Compainy's consolidated allowances, and Southern Company's fuel mix', the assets are'held"by subsidiaries. Southern Company's ultimate outcome cannot be determined dt this time. ability to meet 'its financial obligations and to pay dividends on its common stock' at the current rate is Litigation over environmental: issues and, claims'of primarily dependent on the net income and cash flows of various types, including property damage,- personal injury, its subsidiaieis 'and their ability to'pay 'upstream dividends and citizen enforcement of environmental requirements, or t6 repay funds to Southern Company. Prior to funding such as opacity and other air quality standards, has Southern Company, Southern' Company's subsidiaries increased generally throughout the United States. In, have! inancial obligations that must be. satisfied, including particular, personal injury claims for damages caused by amI ong'otheir,'debt service and preferred and preference subsidiaries are alleged exposure to hazardous materials have become stock dividends. Southern Company's more frequent. separale legal entities and have no obligation to provide South'ern Company with funds for its payment If Southern Company, the traditional operating obligations.. . companies or Southern Power fail to comply with The financial performance of Southern Company and environmental laws and regulations, even if caused by. its subsidiaries may be adversely affected if Its factors beyond their control, that failure may result in the subsidiaries are unable to successfully operate their assessment of civil or criminal penalties and fines. The facilities. EPA has filed civil actions against Alabama Power and Georgia Power alleging violations of the new source ýSouthern Company's financial performance-depends review provisions of the Clean AirAct. Southern on the successful operation of its subsidiaries' electric Company is a party to suits alleging its emissions of generating,'-transmission and distribution facilities. carbon dioxide, a greenhouse gas, contribute to gl6bal Operating'these facilities involves many risks, including:. warming. An adverse outcome in any one of these cases could require substantial capital expenditures that'cannot

operator error and breakdown or failure of be determined at this time 'and could'possibly require the equipment or processes; payment of substantial penalties. This could'affect future
operating limitations that may be imposed by results of operations, cash flows, and possibly financial environmental or other regulatory requirements; condition if such costs are not recovered through * ,labor disputes; .

regulated rates.

terroristattacks; fuel or material supply interruptions; Existing environmental laws and regulations may be
9ompliance with mandatory reliability standards revised or new 'laws and regulations related to global. *if; adopted; and climate change, air quality or other environmental and Scatastrophic events such as fires, earthquakes, health concerns may be adopted or become applicable to exvlosions, q floods, hurricanes, pandemic 4ealth Southern Company, the traditional operating 'companies, events such as an avian influenza or other similar and Southern Power. Revised or additional laws and. occurrences. - t, regulations could result in significant additional expense A decrease or elimination of revenues from power and operating restrictions on the facilities of the produced by the electric generating facilities or an traditional operating companies or Southern Power. or increase in the cost of operating the facilities 'would increased compliance costs which may not be fully reduce the net income and'cash flows and could adversely recoverable from customers and would therefore reduce impact the fmancia condition of .theaffected traditional the net income of Southern Company, the traditional operating conipany or Southern Power and of Southern operating companies or Southern Power. The cost impact Company. ,

of such'legislation would depend upon the specific. requirements enacted and cannot be determined at this The revenues of Southern Company, the traditional time. operating companies and Southern Power depend in I-15

part on sales under PPAs. The failure of a Tightening labor markets in the Southeast and counterparty to one of these PPAs to perform its increasing costs of materials have resulted in increasing obligations, or the failure to renew the PPAs, could cost estimates for Southern Company's subsidiaries' have a negative impact on the net income and cash construction projects. If a traditional operating company flows of the affected traditional operating company or or Southern Power is unable to complete the development Southern Power and of Southern Company. or construction of a facility or decides to delay or cancel construction of a facility, it may not be able to recover its Most of Southern Power's generating capacity has investment in that facility. In addition, construction delays been sold to purchasers under PPAs having initial terms and contractor performance shortfalls can result in the of five to 15 years. In addition, the traditional operating loss of revenues and may, in turn, adversely affect the net companies enter into PPAs with non-affiliated parties. income and financial position of a traditional operating Revenues are dependent on the continued performance by company or Southern Power and of Southern Company. the purchasers of their obligations under these PPAs. Even Furthermore, if construction projects are not completed though Southern Power and the traditional operating according to specification, a traditional operating companies have a rigorous credit evaluation, the failure of company or Southern Power and Southern Company may one of the purchasers to perform its obligations could incur liabilities and suffer reduced plant efficiency, higher have a negative impact on the net income and cash flows operating costs and reduced net income. of the affected traditional operating company or Southern Power and of Southern Company. Although these credit Once facilities come into commercial operation, evaluations take into account the possibility of default by ongoing capital expenditures are required to maintain a purchaser, actual exposure to a default by a purchaser reliable levels of operation. Significant portions of the may be greater than the credit evaluation predicts. Neither traditional operating companies' existing facilities were Southern Power nor the traditional operating companies constructed many years ago. Older generation equipment, can predict whether the PPAs will be renewed at the end even if maintained in accordance with good engineering of their respective terms or on what terms any renewals practices, may require significant capital expenditures to may be made. If a PPA is not renewed, a replacement maintain efficiency, to comply with changing PPA cannot be assured. environmental requirements or to provide reliable operations. Southern Company, the traditional operating Changes in technology may make Southern Company's companies and Southern Power may incur additional electric generating facilities owned by the traditional costs or delays in the construction of new plants or operating companies and Southern Power less environmental facilities and may not be able to recover competitive. their investment. The facilities of Southern Company, the traditional operating companies and Southern A key element of the business model of Southern Power require ongoing capital expenditures. Company, the traditional operating companies and Southern Power is that generating power at central power Certain of the traditional operating companies and plants achieves economies of scale and produces power at Southern Power are in the process of constructing new relatively low cost. There are other technologies that generating facilities and adding environmental controls produce power, most notably fuel cells, microturbines, equipment at existing generating facilities. Southern windmills and solar cells. It is possible that advances in Company intends to continue its strategy of developing technology will reduce the cost of alternative methods of and constructing other new facilities, expanding existing producing power to a level that is competitive with that of facilities and adding environmental control equipment. most central power station electric production. If this The completion of these types of projects without delays were to happen and if these technologies achieved or cost overruns is subject to substantial risks, including: economies of scale, the market share of Southern Company, the traditional operating companies and

      " shortages and inconsistent quality of equipment,         Southern Power could be eroded, and the value of their materials and labor;                                    respective electric generating facilities could be reduced.

work stoppages; Changes in technology could also alter the channels

      " permits, approvals and other regulatory matters;         through which retail electric customers buy or utilize
      " adverse weather conditions;                              power, which could reduce the revenues or increase the
      " unforeseen engineering problems;                         expenses of Southern Company, the traditional operating

environmental and geological conditions; companies or Southern Power.
delays or increased costs to interconnect its facilities to transmission grids; Operation of nuclear facilities involves inherent risks,
unanticipated cost increases; and including environmental, health, regulatory, terrorism
attention to other projects. and financial risks that could result in fines or the 1-16

closure of Southern Company's nuclear units owned The generation and energy marketing operations of by Alabama Power or Georgia Power, and which may Southern Company, the traditional operating companies present potential exposures in excess of insurance and Southern Power are subject to changes in power coverage. prices or fuel costs, which could increase the cost of producing power or decrease the amount Southern Alabama Power owns two nuclear units and Georgia Company, the traditional operating companies and Power holds undivided interests in, and contracts for Southern Power receive from the sale of power. The operation of, four nuclear units. These six units are market prices for these commodities may fluctuate over operated by Southern Nuclear and represent relatively short periods of time. Southern Company, the approximately 3,680 megawatts, or 9.1%, of Southern traditional operating companies and Southern Power Company's generation capacity as of December 31, 2006. attempt to mitigate risks associated with fluctuating fuel These nuclear facilities are subject to environmental, costs by passing these costs on to customers through the health and financial risks such as on-site storage of spent traditional operating companies' fuel cost recovery nuclear fuel, the ability to dispose of such spent nuclear clauses or through PPAs. Among the factors that could fuel, the ability to maintain adequate reserves for influence power prices and fuel costs are: decommissioning, potential liabilities arising out of the

prevailing market prices forcoal; natural gas, operation of these facilities and the threat of a possible uranium, fuel oil and other fuels used in the terrorist attack. Alabama Power and Georgia Power generation facilities of the traditional operating maintain decommissioning trusts and external insurance companies and Southern Power including coverage to minimize the financial exposure to these associated transportation costs, and supplies of risks; however, it is possible that damages could exceed such commodities; the amount of insurance coverage.
demand for energy and the extent of additional supplies of energy available from current or new The NRC has broad authority under federal law to competitors; impose licensing and safety-related requirements for the liquidity in the general wholesale electricity operation of nuclear generation facilities. In the event of market; non-compliance, the NRC has the authority to impose
weather conditions impacting demand for fines or shut down a unit, or both, depending upon its electricity; assessment of the severity of the situation, until
seasonality; compliance is achieved. NRC orders or new regulations
transmission or transportation constraints or related to increased security measures and any future inefficiencies; safety requirements promulgated by the NRC could " availability of competitively priced alternative require Alabama Power and Georgia Power to make energy sources; substantial operating and capital expenditures at their " forced or unscheduled plant outages for the nuclear plants. In addition, although Alabama Power, Southern Company system, its competitors or Georgia Power and Southern Company have no reason to third party providers; anticipate a serious nuclear incident at their plants, if an
the financial condition of market participants; incident did occur, it could result in substantial costs to 0, the economy in the service territory and in Alabama Power or Georgia Power and Southern general, including the impact of economic Company. A major incident at a nuclear facility anywhere conditions on industrial and commercial demand in the world could cause the NRC to limit or prohibit the for electricity; operation or licensing of any domestic nuclear unit.
natural disasters, wars,'embargos; acts of terrorism and other catastrophic events; and In addition, potential terrorist threats and increased.
federal, state and foreign energy and public scrutiny of utilities could resultin increased environmental regulation and legislation.

nuclear licensing or compliance costs that are difficult or impossible to predict... Certain of. these factors could increase the expenses of the traditional operating companies or Southern Power The generation and energy marketing operations of and Southern Company. For the traditional operating. Southern Company, the traditional operating companies;,such increases may not be fully recoverable companies and Southern Power are subject to risks, through rates. Other of these factors could reduce the many of which are beyond their control, including revenues of the traditional operating companies or changes in power prices and fuel costs,'that may Southern Power and Southern Company. reduce Southern Company's, the traditional operating companies' and Southern Power's revenues and As' a result of increasing fuel costs, the traditional increase costs. operating companies have accrued significant 1-17

underrecovered fuel cost balances. In addition, Gulf contracts in place; however, there can be no assurance Power and Mississippi Power have significant deficit that the counterparties to these agreements will fulfill balances in their storm cost recovery reserves as a result their obligations to supply coal to the traditional operating of Hurricanes Ivan, Dennis and Katrina. The traditional companies. The suppliers under these agreements may operating companies may experience similar deficit experience financial or technical problems which inhibit balances following future storms. While the traditional their ability. to fulfill their obligations to the traditional operating companies are generally authorized to recover operating companies. In addition, the suppliers under underrecovered fuel costs through fuel cost recovery these agreements may not be required to supply coal to clauses and storm recovery costs through special rate the traditional operating companies under certain provisions administered by the respective PSCs, recovery circumstances, such as in the event of a natural disaster. If may be denied if costs are deemed to be imprudently the traditional operating companies are unable to obtain incurred and delays in the authorization of such recovery their coal requirements under these contracts, the could negatively impact the cash flows of the affected traditional operating companies may be required to traditional operating companies and Southern Company. purchase their coal requirements at higher prices, which may not be fully recoverable through rates. The use of derivative contracts by Southern Company and its subsidiaries in the normal course of business In addition, Southern Power in particular, and the could result in firancial losses that negatively impact traditional operating companies to a lesser extent, are the net income of Southern Company and its dependent on natural gas for a portion of their electric subsidiaries. generating capacity. Natural gas supplies can be subject to Southern Company and its subsidiaries, including the disruption in the event production or distribution is traditional operating companies and Southern Power, use curtailed. For example, in connection with the 2005 derivative instruments, such as swaps, options, futures and hurricanes in the Gulf of Mexico, production and forwards, to manage their commodity and financial distribution of natural gas was limited for a period of market risks and, to a lesser extent, engage in limited time, resulting in shortages and significant increases in trading activities. Southern Company and its subsidiaries the price of natural gas. In addition, world market could recognize financial losses as a result of volatility in conditions for fuels, including the policies of the the market values of these contracts or if a counterparty Organization of Petroleum Exporting Countries, can fails to perform. In the absence of actively quoted market impact the price and availability of natural gas. prices and pricing information from external sources, the valuation of these financial instruments can involve Demand for power could exceed supply capacity, management's judgment or use of estimates. As a result, resulting in increased costs for purchasing capacity in changes in the underlying assumptions or use of the open market or building additional generation alternative valuation methods could affect the value of the capabilities. reported fair value of these contracts. Through the traditional operating companies and The traditional operating companies and Southern Southern Power, Southern Company is currently obligated Power may not be able to obtain adequate fuel to supply power to retail customers and wholesale supplies, which could limit their ability to 'operate customers under long-term PPAs. At peak times, the their facilities. demand for power required to meet this obligation could exceed Southern Company's available generation capacity. The traditional operating companies and Southern Power purchase fuel, including coal, natural gas, uranium Market or competitive forces may require that the and fuel oil, from a number of suppliers. Disruption in the traditional operating companies or Southern Power delivery of fuel, including disruptions as a result of, purchase capacity on the open market or build additional among other things, transportation delays, weather, labor generation capabilities. Because regulators may not permit relations, force majuere events or environmental the traditional operating companies to pass all of these regulations affecting any of these fuel suppliers, could purchase or construction costs on to their customers, the limit the ability of the traditional operating companies and traditional operating companies may not be able to Southern Power to operate their respective facilities, and recover any of these costs or may have exposure to thus reduce the net income of the affected traditional regulatory lag associated with the time between the operating company or Southern Power and Southern incurrence of costs of purchased or constructed capacity Company. and the traditional operating companies' recovery in customers' rates. Under Southern Power's long-term fixed The traditional operating companies are dependent price PPAs, Southern Power would not have the ability to on coal for much of their electric generating capacity. recover any of these costs. These situations could have Each traditional operating company has coal supply negative impacts on net income and cash flows for the 1-18

affected traditional operating company or Southern Power and costs. Finally, the complaint includes an objection to and Southern Company. Southern Company's pending claims against Mirant in the Bankruptcy Court (which relate to reimbursement under The operating results of Southern Company, the the separation agreements of payments -such as income traditional operating companies and Southern Power taxes, Interest, legal fees, and other guarantees described are affected by weather conditions and may fluctuate in Note 7' to the financial statements of Southern on a seasonal and quarterly basis. Company in Item 8 herein) and seeks equitable subordination of Southern Company's claims to the Electric power generation is generally a seasonal claims of all other creditors.' Southern Company served an business. In many parts of the'country, demand for power answer to the complaint in June 2006. peaks'during the hot summer months, with market prices also peaking at that time. In other areas, power demand On January 10, 2006, the U.S. District Court for the peaks during the winter. As a result, the overall operating Northern District of Texas 'granted Southern Company's. results of Southern Company, the traditional operating motion to withdraw this action from the Bankruptcy Court companies and Southern Power in the future' may and, on 'February 15, 2006, granted Southern Company's fluctuate substantially on a seasonalba'sis. In addition, motion to transfer the case to the U.S. District Court for Southern Company, the traditional 0oler.ating'companies the Northern District of Georgia. On May 19, 2006, r and Southern Power have historically siold less power, and Southern Company filed a motion for summary judgment consequently earned less inco'me, when, 'weather seeking entry of judgment against the plaintiff as to all conditions are milder. Unusually mild weather 'in the counts of the complaint. On December 11, 2006, the future could reduce the revenues, 'netincome,- available U.S. District Court for the Northern District of Georgia cash and borrowing ability of Southern Company, the granted in part and denied in part the motion. As a result, traditional operating companies and Southern Power. certain breach of fiduciary duty claims are barred; all other claims in the complaint may proceed. Southern Mirant and The Official Commttee of Unsecured Company believes there is no meritorious basis for the Creditors of Mirant Corporation have filed a claim claims in the complaint and is vigorously defending itself against Southern Company sIeeking substantial in this action. However, the final outcome of this matter monetary damages in connection with transfers made cannot now be determined. by Mirant to Southern Company prlir to the Mirant spin-off. IRS challenges to Southern Company's income tax deductions taken In connection with four international In July 2003, Mirant filed for voluntary leveraged lease transactions could result in the reorganization under Chapter I I of the Bankruptcy Code. payment of substantial additional interest and In January 2006, Mirant's plan of reorganization became penalties and could materially impact Southern effective, and Mirant emerged from bankruptcy. Company's cash flow and net Income. In 2005, Mirant, as debtor in possession, and The Southern Company participates in four international Official Committee of Unsecured Creditors of Mirant leveraged lease transactions and receives federal income Corporation filed a complaint against Southern Company tax deductions for depreciation and amortization, as well in the U.S. Bankruptcy Court for' the Northern District of as interest on related debt. In connection with its audit of Texas, which was amended in July 2005, February 2006 Southern Company's tax returns for 1996 through 2001, and May 2006. The third amended complaint (the the IRS proposed to disallow. Southern Company's tax complaint) alleges that Southern Company caused Mirant losses related to one international leveraged lease (a to engage in certain fraudulent transfers and to pay 'illegal lease-in-lease-out, or LILO) transaction. In February dividends to Southern Company prior to the spin-off. The 2005, Southern Company reached a negotiated settlement complaint also seeks to recharacterize certain advances with the IRS relating to this matter, which is now final. from Southern Company to Mirant for investments in energy facilities from debt to equity. The complaint In connection with its audit of 2000 and 2001, the further alleges that Southern Company isbliable to IRS also challenged Southern Company's deductions Mirant's creditors for thefull amount of Mirant's liability related to three other international lease (sale-in-lease-out, and that Southern Company breached its fiduciary duties or SILO) transactions. In the third quarter 2006, Southern to Mirant and its creditors, caused Mirant to breach Com*pany aid the full amount of the disputed tax 'and the fiduciary duties .to its creditors, and aided and abetted applicable interest on the SILO issue for tax years breaches of fiduciary duties by Mirant's directors and 2000-2001 'and filed a claim for irefund which has been officers. The complaint also seeks recoveries under denied'by the IRS. The disputed tax amount is $79 million theories of restitution, unjust enrichment, and alter ego. and the related interest is approximately $24 million for The complaint seeks monetary damages in excess of these tax years. This payment, and the subsequent IRS

 $2 billion plus interest, punitive damages, attorneys', fees,        disallowance of the refund claim, closed the issue with 1-19

the IRS and Southern Company plans to proceed with Southern Company, the traditional operating litigation. The IRS has also raised the SILO issues for tax companies and Southern Power rely on access to both years 2002 and 2003. The estimated amount of disputed short-term money markets and longer-term capital tax and interest for these years is approximately markets as a significant source of liquidity for capital $83 million and $15 million, respectively. The tax and requirements not satisfied by the cash flow from their interest for these tax years was paid to the IRS in the respective operations. If Southern Company, any fourth quarter 2006. Southern Company has accounted for traditional operating company or Southern Power is not both payments in 2006 as deposits, as management able to access capital at competitive rates, its ability to believes no additional tax or interest liabilities have been implement its business plan or pursue improvements and incurred. make acquisitions that Southern Company, the traditional operating companies or Southern Power may otherwise Although the payment of the tax liability did not rely on for future growth will be limited. Each of affect Southern Company's results of operations under Southern Company, the traditional operating companies accounting standards in effect through December 31, and Southern Power believes that it will maintain 2006, it did impact cash flow. For tax years 2000 through sufficient access to these financial markets based upon 2006, Southern Company has claimed $284 million in tax current credit ratings. However, certain market disruptions benefits related to these SILO transactions challenged by or a downgrade of the credit rating of Southern Company, the IRS. Southern Company believes these transactions any traditional operating company or Southern Power may are valid leases for U.S. tax purposes and thus the related increase its cost of borrowing or adversely affect its deductions are allowable. Southern Company will ability to raise capital through the issuance of securities continue to defend this position through administrative or other borrowing arrangements. Such disruptions could appeals or litigation. The ultimate outcome of these include: matters cannot now be determined.

                                                                       "   an economic downturn; In July 2006, the FASB released new interpretations               "   the bankruptcy of an unrelated energy company; for the accounting for both leveraged leases and uncertain              "   capital market conditions generally; tax positions that were adopted January 1, 2007. For the                "   market prices for electricity and gas; LILO transaction settled with the IRS in February 2005,

terrorist attacks or threatened attacks on Southern the leveraged leases accounting interpretation requires that Company's facilities or unrelated energy Southern Company recognize a cumulative effect companies; reduction to beginning 2007 retained earnings of
war or threat of war; or approximately $17 million at adoption and change the " the overall health of the utility industry.

timing of income recognized under the lease. Southern Company, the traditional operating For the SILO transactions which are the subject of companies and Southern Power are subject to risks pending litigation, Southern Company is continuing to associated with a changing economic environment, evaluate the impact of the new interpretations but including their ability to obtain insurance, the estimates that the reduction to retained earnings in 2007 financial stability of their respective customers and could be approximately $115 million to $135 million. The their ability to raise capital. impact on Southern Company's net income of these accounting interpretations would also be dependent on the The threat of terrorism and the related military action outcome of the pending litigation or changes in by the United States continue to affect the nation's assumptions related to uncertain tax positions but could economy and financial markets. The insurance industry be significant and potentially material. has also been disrupted by these events as well as recent hurricane activity on the Gulf Coast. The availability of Risks Related to Market and Economic Volatility insurance covering risks Southern Company, the traditional operating companies, Southern Power and their The business of Southern Company, the traditional respective competitors typically insure against may operating companies and Southern Power is dependent decrease, and the insurance that Southern Company, the on their ability to successfully access capital markets. traditional operating companies and Southern Power are The inability of Southern Company, any traditional able to obtain may have higher deductibles, higher operating company or Southern Power to access premiums and more restrictive policy terms. Any capital may limit its ability to execute its business plan economic downturn or disruption of financial markets or pursue improvements and make acquisitions that could constrain the capital available to Southern Southern Company, the traditional operating Company's, the traditional operating companies' and companies or Southern Power may otherwise rely on Southern Power's industry and could reduce access to for future growth. funding for the respective operations of Southern 1-20

Company, the traditional operating companies and Southern Power, as well as the financial stability of thCWf respective customers and counterparties. These factors could adversely affect Southern Company's subsidiaries' ability to achieve energy sales growth, thereby decreasing Southern Company's level of future net income. Certain of the traditional operating companies have substantial investments in the Gulf Coast region which can be subject to major storm activity. The ability of the traditional operating companies to recover costs and replenish reserves in the event of a major storm, other natural disaster, terrorist attack or other catastrophic event generally will require regulatory action. Additionally, storm damage may affect the availability and cost of insurance to these traditional operating companies. Each traditional operating company maintains a reserve for property damage to cover the cost of damages from major storms to its transmission and distribution. lines and the cost of uninsured damages to its generating facilities and other property. In September 2004, Hurricane Ivan hit the Gulf coast of Florida and Alabama, causing significant damage to the service areas of Alabama Power and Gulf Power. In July and August 2005, Hurricanes Dennis and Katrina, respectively, hit the Gulf coast of the United States and caused significant damage in the service areas of Gulf Power, Alabama Power and Mississippi Power. In each case, Costs to the respective traditional operating companies exceeded their respective storm cost reserves and insurance coverage'and were subsequently approved for recovery by their respective state PSCs. In the event a traditional operating company experiences a natural disaster, terrorist attack or other catastrophic event, recovery of costs in excess of reserves and insurance coverage is subject to the approval of its state PSC. While the traditional operating companies generally are entitled to recover prudently incurred costs incurred in connection with'such an event, any denial by the applicable'state PSC or delay in recovery of any portion of such costs could have a material negative impact on a traditional operating company's results of operations and/or cash flows. Item lB. UNRESOLVED STAFF COMMENTS. None. 1-21

Item 2. PROPERTIES Nameplate Electric Properties - The Electric Utilities Generating Station Location Capacity (1) (Kilowatts) The traditional operating companies, Southern Power and COMBUSTION TURBINES SEGCO, at December 31, 2006, owned and/or operated Greene County Demopolis, AL 34 hydroelectric generating stations, 34 fossil fuel Alabama Power Total 720,000 generating stations, three nuclear generating stations and 12 combined cycle/cogeneration stations. The amounts of Boulevard Savannah, GA 59,100 capacity for each company are shown in the table below. Bowen Cartersville, GA 39,400 Intercession City Intercession City, FL 47,667 (10) Nameplate Kraft Port Wentworth, GA 22,000 Generating Station Location Capacity (1) McDonough Atlanta, GA 78,800 McIntosh Units (Kilowatts) 1 through 8 Effingham County, GA 640,000 FOSSIL STEAM McManus Brunswick, GA 481,700 Gadsden ( iadsden, AL 120,000 Mitchell Albany, GA 118,200 Gorgas J asper, AL 1,221,250 Robins Warner Robins, GA 158,400 Barry N/lobile, AL 1,525,000 Wansley Carrollton, GA 26,322 Greene County E)emopolis, AL 300,000(2) Wilson Augusta, GA 354,100 Gaston Unit 5 Vilsonville, AL 880,000 Georgia Power Total 2,025,689 Miller E3irmingham, AL 2,532,288 (3) Alabama Power Total 6,578,538 Lansing Smith Unit A Panama City, FL 39,400 Bowen C artersville, GA 3,160,000 Pea Ridge Branch Nlilledgeville, GA 1,539,700 Units 1-3 Pea Ridge,. FL 15,000 Hammond Ftome, GA 800,000 Gulf Power Total 54,400 Kraft P'ort Wentworth, GA 281,136 McDonough A tlanta, GA 490,000 Chevron McIntosh F*ffingham County, GA 163,117 Cogenerating McManus Brunswick, GA 115,000 Station Pascagoula, MS 147,292(11) Mitchell Albany, GA 125,000 Sweatt Meridian, MS 39,400 Scherer 4acon, GA 750,924(4) Watson Gulfport, MS 39,360 Wansley C arrollton, GA 925,550 (5) Mississippi Power Total 226,052 Yates lewnan, GA 1,250,000 Georgia Power Total 9,600,427 Dahlberg Jackson County, GA 756,000 DeSoto Arcadia, FL 343,760 Crist Pensacola, FL 970,000 Oleander Cocoa, FL 628,400 Daniel Pascagoula, MS 500,000(6) Rowan Salisbury, NC 455,250 Lansing Smith Panama City, FL 305,000 Southern Power Totb 2,183,410' Scholz Chattahoochee, FL 80,000 Scherer Unit 3 Macon, GA 204,500(4) Gaston (SEGCO) Wilsonville, AL 19,680 (7) Gulf Power Total 2,059,500 Total Combustion Turbines 5,229,231 Daniel Pascagoula, MS 500,000 (6) Eaton Hattiesburg, MS 67,500 COGENERATION Greene County Demopolis, AL 200,000 (2) Washington County Washington County, AL 123,428 Sweatt Meridian, MS 80,000 GE Plastics Project Burkeville, AL 104,800 Watson Gulfport, MS 1,012,000 Theodore Theodore, AL 236,418 Mississippi Power Total 1,859,500 Alabama Power Total 464,646 Gaston Units 1-4 Wilsonville, AL COMBINED CYCLE SEGCO Total 1,000,000 (7) Barry Mobile, AL Total Fossil Steam 21,097,965 Alabama Power Total 1,070,424 McIntosh Units NUCLEAR STEAM 10&l1 Effingham County, GA Farley Dothan, AL Georgia Power Total 1,318,920 Alabama Power Total 1,720,000 Smith Lynn Haven, FL Hatch Baxley, GA 899,612 (8) Gulf Power Total 545,500 Vogtle Augusta, GA 1,060,240 (9) Daniel (Leased) Pascagoula, MS Georgia Power Total 1,959,852 Mississippi Power Total 1,070,424 Total Nuclear Steam 3,679,852 1-22

(3) Capacity shown is Alabama Power's portion (91.84%) of Nameplate Generating Station Location Capacity (1) total plant capacity. (4) Capacity shown for Georgia Power is 8.4% of Units 1 and (Kilowatts) 2 and 75% of Unit 3. Capacity shown for Gulf Power is Franklin Smiths, AL 1,198,360 25% of Unit 3. Harris Autaugaville, AL 1,318,920 (5) Capacity shown is Georgia Power's portion (53.5%) of Rowan Salisbury, NC 530,550 total plant capacity. Stanton Unit A Orlando, FL 428,649 (12) (6) Represents 50% of the plant which is owned as tenants in Wansley Carrollton, GA 1,073,000 common by Gulf Power and Mississippi Power. Southern Power Total 4,549,479 (7) SEGCO is jointly-owned by Alabama Power and Georgia Total Combined Cycle 8,554,747 Power. See BUSINESS in Item 1 herein for additional information. HYDROELECTRIC FACILITIES (8) Capacity shown is Georgia Power's portion (50.1%) of Bankhead Holt, AL 53,985 total plant capacity. Bouldin Wetumpka, AL 225,000 (9) Capacity shown is Georgia Power's portion (45.7%) of Harris Wedowee, AL 132,000 total plant capacity. Henry Ohatchee, AL 72,900 (10) Capacity shown represents 33%% of total plant capacity. Holt Holt, AL 46,944 Georgia Power owns a 1/3 interest in the unit with 100% Jordan Wetumpka, AL 100,000 use of the unit from June through September. Progress Lay Clanton, AL 177,000 Energy Florida operates the unit. Lewis Smith Jasper, AL 157,500 (11) Generation' is dedicated to a single industrial customer. Logan Martin Vincent, AL 135,000 Martin Dadeville, AL 182,000 (12) Capacity' shown is Southern Power's portion (65%) of Mitchell Verbena, AL 170,000 total plant capacity. Thurlow Tallassee, AL 81,000 (13) Capacity shown is Georgia Power's portion (25.4%) of Weiss Leesburg, AL 87,750 total plant capacity. OPC operates the plant. Yates Tallassee, AL 47,000 Except as discussed below under "Titles to Property," Alabama Power Total 1,668,079 the principal plants and other important units of the Barnett Shoals traditional operating companies, Southern Power and (Leased) Athens, GA 2,800 SEGCO are owned in fee by the respective companies. It Bartletts Ferry Columbus, GA 173,000 is the opinion of management of each such company that Goat Rock Columbus, GA 38,600 Lloyd Shoals Jackson, GA 14,400 its operating properties are adequately maintained and are Morgan Falls Atlanta, GA 16,800 substantially in' good operating condition. North Highlands Columbus, GA 29,600 Oliver Dam Columbus, GA 60,000 Mississippi Power owns a 79-mile length of Rocky Mountain Rome, GA 215,256 (13) 500-kilovolt transmission line which is leased to Entergy Sinclair Dam Milledgeville, GA 45,000 Gulf States. Theline, completed in 1984, extends from Tallulah Falls Clayton, GA 72,000 Plant Daniel to the Louisiana state line. Entergy Gulf Terrora Clayton, GA 16,000 States is paying a use fee over a 40-year period covering Tugalo Clayton, GA 45,000 Wallace Dam Eatonton, GA 321,300 all expenses and the amortization of the original Yonah Toccoa, GA 22,500 $57 million cost of the line. At December 31, 2006, the 6 Other Plants 18,080 unamortized portion of this cost was approximately Georgia Power Total 1,090,336 $26.2 million. Total Hydroelectric Facilities , JJO,,+J The all-time maximum demand on the traditional Total Generating Capacity 41,784,856 operating companies, Southern Power and SEGCO was 35,889,900 kilowatts and occurred on August 7, 2006. This amount excludes demand served by capacity retained Notes: (I) See !"Jointly-Owned Facilities" herein for addi tional by MEAG, OPC and SEPA. The reserve margin for the information. traditional operating companies, Southern Power and (2) Owned by Alabama Power and Mississippi Poower as SEGCO at that time was 17. 1%. See SELECTED tenants in common in the proportions of 60% and 40%, FINANCIAL DATA in Item 6 herein for additional respectively. information Ion peak demands. 1-23

Jointly-Owned Facilities Alabama Power, Georgia Power and Southern Power have undivided interests in certain generating plants and other related facilities to or from non-affiliated parties. The percentages of ownership are as follows: Percentage Ownership Progress Total Alabama Georgia Energy Southern Capacity Power AEC Power OPC MEAG DALTON Florida Power OUC FMPA KUA (Megawatts) Plant Miller Units I and 2 1,320 91.8% 8.2% -% -% -% -% -% -% -% -% Plant Hatch 1,796 - 50.1 30.0 17.7 2.2 Plant Vogtle 2,320 - 45.7 30.0 22.7 1.6 Plant Scherer Units I and 2 1,636 - 8.4 60.0 30.2 1.4 Plant Wansley 1,779 - 53.5 30.0 15.1 1.4 Rocky Mountain 848 - 25.4 74.6 - Intercession City, FL 143 - 33.3 66.7 .- - Plant Stanton A 660 - 65% 28% 3.5% 3.5% Alabama Power and Georgia Power have contracted statements of Mississippi Power under "Operating to operate and maintain the respective units in which each Leases - Plant Daniel Combined Cycle Generating Units" has an interest (other than Rocky Mountain and in Item 8 herein for additional information. The Intercession City) as agent for the joint owners. SCS traditional operating companies own the fee interests in provides operation and maintenance services for Plant certain of their principal plants as tenants in common. See Stanton A. "Jointly-Owned Facilities" herein for additional information. Properties such as electric transmission and In addition, Georgia Power has commitments distribution lines and steam heating mains are constructed regarding a portion of a five percent interest in Plant principally on rights-of-way which are maintained under Vogtle owned by MEAG that are in effect until the later franchise or are held by easement only. A substantial of retirement of the plant or the latest stated maturity date portion of lands submerged by reservoirs is held under of MEAG's bonds issued to finance such ownership flood right easements. interest. The payments for capacity are required whether any capacity is available. The energy cost is a function of each unit's variable operating costs. Except for the portion Item 3. LEGAL PROCEEDINGS of the capacity payments related to the Georgia PSC's (1) United States of America v. Alabama Power disallowances of Plant Vogtle costs, the cost of such (United States District Court for the Northern capacity and energy is included in purchased power from District of Alabama) non-affiliates in Georgia Power's statements of income in Item 8 herein. United States of America v. Georgia Power and Savannah Electric (United States District Court for the Northern Titles to Property District of Georgia) The traditional operating companies', Southern Power's See "Environmental Matters - New Source Review and SEGCO's interests in the principal plants (other than Actions" in Note 3 to Southern Company's and each certain pollution control facilities, one small hydroelectric traditional operating company's financial statements generating station leased by Georgia Power, combined in Item 8 herein for information. cycle units at Plant Daniel leased by Mississippi Power and the land on which five combustion turbine generators (2) Environmental Remediation of Mississippi Power are located, which is held by See "Environmental Matters - Environmental easement) and other important units of the respective Remediation" in Note 3 to the financial statements companies are owned in fee by such companies, subject of Southern Company, Georgia Power and only to the liens pursuant to pollution control bonds of Mississippi Power and "Retail Regulatory Matters - Alabama Power and Gulf Power and to excepted Environmental Remediation" in Note 3 to the encumbrances as defined therein. At December 31, 2006, financial statements of Gulf Power in Item 8 herein Gulf Power's interest in its principal plants was subject to for information related to environmental a lien under a mortgage indenture. The mortgage remediation. indenture and the lien were discharged effective January 26, 2007. See Note 6 to the financial statements (3) In re: Mirant Corporation, et al. of Southern Company, Alabama Power and Gulf Power (United States Bankruptcy Court for the Northern under "Assets Subject to Lien" and Note 7 to the financial District of Texas) 1-24

See "Mirant Matters - Mirant Bankruptcy" in Note 3 to Southern Company's financial statements in Item 8 herein for information. (4) MC Asset Recovery, LLC v. Southern Company (United States District Court for the Northern District of Georgia) (formerly styled In re: Mirant Corporation,et al. in the United States Bankruptcy Court for the Northern District of Texas) - - See "Mirant Matters - MC Asset Recovery Litigation" in Note 3 to Southern Company's financial statements in Item'8 herein for information. (5) In re: Mirant Corporation Securities Litigation (United States District Court for the Northern District of Georgia) See "Mirant Matters - Mirant Securities Litigation" in Note 3 to Southern Company's financial statements in Item 8 herein. for information. (6) In re: Mirant Corporation ERISA Litigation (United States District Court for the Northern District of Georgia) See "Mirant Matters - Southern Company Employee Savings Plan Litigation" in Note 3 to Southern Company's financial statements -in Item 8 herein for information. (7) Sierra Club, et al. v. Georgia Power (United States District Court for the Northern District of Georgia) in See "Plant Wansley Environmental Litigation" Note 3 to Southern Company's and Georgia Power's financial statements in Item 8 herein for information. (8) Right of Way Litigation. See "Right of Way Litigation" in Note 3 to Southern Company's, Georgia Power's, Gulf Power's anid Mississippi Power's financial statements in Item 8 herein for information. See Note 3 to each iegistrant's financial statements in Item 8 herein for descriptions of additional legal and administrative proceedings discuissed therein. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Southern Company, Alabama Power, Georgia Power, Gulf Power, Mississippi Power and Southern Power None. 1-25

EXECUTIVE OFFICERS OF G. Edison Holland, Jr. SOUTHERN COMPANY Executive Vice President, General Counsel. and Secretary Age 54 (Identification of executive officers of Southern Company Elected in 2001. Executive Vice President and General is inserted in PartI in accordance with Regulation S-K, Counsel since 2001. Item 401(b), Instruction 3.) The ages of the officers set forth below are as of December 31, 2006. Anthony, R. James David M. Ratcliffe Executive Vice President Chairman, President, Chief Executive Officer and Director Age 56 Age 58 Elected in 2005. Executive Vice President of Southern Elected in 1999. President since April 2004; Chairman Company since December 2005. Previously served as and Chief Executive Officer since July 2004. Previously Chairman. of Savannah Electric from December 2005 served as Chief Executive Officer of Georgia Power from through January 2006 and President and Chief Executive June 1999 to April 2004; and President of Georgia Power Officer of Savannah Electric from April 2001 to from June 1999 to December 2003. December 2005. Andrew J.

Dearman,

III Executive Vice President Charles D. McCrary Age 53 Executive Vice President Elected in 2005. Executive Vice President since Age 55 - December 2005. Previously served as Senior Vice Elected in 1998. Executive Vice President of Southern President from December 2000 until December 2005. Company since February 2002; President and Chief Executive Officer of Alabama Power since October 2001'. Dwight H. Evans Executive Vice President W. Paul Bowers Age 58 Executive Vice President of SCS Elected in 2001. Executive Vice President since May Age 50. 2001. Elected in 2001. Executive Vice President of SCS since May 2001 and previously served as President and Chief Thomas A. Fanning Executive Officer of Southern Power from May 2001 to Executive Vice President, Chief Financial Officer and March 2005. Treasurer Age 49 Elected in 2003. Executive Vice President, Chief J. Barnie Beasley Financial Officer and Treasurer since April 2003. President and Chief Executive Officer of Southern Previously served as President, Chief Executive Officer Nuclear and Director of Gulf Power from 2002 to April 2003; and Age 55 Executive Vice President, Treasurer and Chief Financial Elected in 2004. President and Chief Executive Officer of Officer of Georgia Power from 1999 to 2002. Southern Nuclear since September 2004. Previously served as Executive Vice President of'Southern Nuclear Michael D. Garrett from January 2004 to September 2004; and Vice President Executive Vice President from July 1998 through December 2003. Age 57 Elected in 2004. Executive Vice President since January 1, The officers of Southern Company were elected for a 2004. He also serves as President and Director of Georgia term running from the first meeting of the directors Power since January 1, 2004 and Chief Executive Officer following the last annual meeting (May, 24, 2006) for one. of Georgia Power since April 2004. Previously served as year until the first board meeting after the next annual President, Chief Executive Officer and Director of meeting or until their successors are elqcted and have Mississippi Power from 2001 to 2003. qualified. 1-26

EXECUTIVE OFFICERS OF C. Alan Martin ALABAMA POWER I Executive Vice President Age 58 (Identtifcation.of executive officers,of Alabama Power is Elected in -1999. Executive Vice President of the inserted in Part I in accordance with Regulation S-K, Customer Service Organization since 2001. Item 401(b), Instruction 3.) The ages of the officers set forth below are as of December .31, 2006. Steven R. Spencer Executive Vice President Charles D. McCrary Age 51 President, Chief Executive Officer andDirector Elected in 2001. Executive Vice President of External Age 55 Affairs since 2001. Elected in 2001. President, Chief Executive Officer, and Director since October 2001; Executive Vice President of Jerry L. Stewart Southern Company since February 2002. Senior Vice President Age 57 Art P. Beattie Elected in 1999. Senior Vice President of Fossil and Executive Vice President, Chief Financial Officer and Hydro Generation since 1999. Treasurer Age 52

I" The officers of Alabama Power were elected for a Elected in 2004. Executive Vice President, Chief term running from the last annual organizational meeting Financial :Officer and Trpasurer, since February 2005. of the directors (April 28, 2006) for one year until the Previously served as Vice President and Comptroller of next annual meeting or until their successors are elected Alabama Power-from 1994 throughJanuary 2005.: and have qualified..

r, - i

                                                                   .,     l ! ,] '

L. ,

le" * * * ,

I, -, .-.- I , 1-27

EXECUTIVE OFFICERS OF Christopher C. Womack GEORGIA POWER Executive Vice President Age 48 (Identification of executive officers of Georgia Power is Elected in 2001. Executive Vice President of External inserted in Part I in accordance with Regulation S-K, Affairs since March 2006. Previously served as Senior Item 401(b), Instruction 3.) The ages of the officers set Vice President of Fossil and Hydro Generation and Senior forth below are as of December 31, 2006. Production Officer from December 2001 to February 2006. Michael D. Garrett Judy M. Anderson President, Chief Executive Officer and Director Senior Vice President Age 57 Age 58 Elected in 2003. President and Chief Executive Officer of Elected in 2001. Senior Vice President of Charitable Georgia Power since April 2004. Previously served as Giving since 2001. President of Georgia Power from January 2004 to April 2004; President and Chief Executive Officer and Director. Douglas E. Jones of Mississippi Power from May 2001 to December 2003. Senior Vice President Age 48 Elected in 2005. Senior Vice President of Fossil and Mickey A. Brown Hydro Generation since March 2006. Previously served as Executive Vice President Senior Vice President of Customer Service and Sales from Age 59 January 2005 to February 2006; Executive Vice President Elected in 2001. Executive Vice President of the of Southern Power from January 2004 to January 2005; Customer Service Organization since January 2005. Senior Vice President of SCS from December 2001 to Previously served as Senior Vice President of Distribution January 2004. from May 2001 to December 2005. James H. Miller, III Senior Vice President and General Counsel Cliff S. Thrasher Age 57 Executive Vice President, Chief Financial Officer and Elected in 2004. Senior Vice President and General Treasurer Counsel since March 2004. Previously served as Vice Age 56 President and Associate General Counsel for SCS and Elected in 2005. Executive Vice President, Chief Senior Vice President, General Counsel and Assistant Financial Officer and Treasurer since March 2005. Secretary of Southern Power from 2001 to 2004. Previously served as Senior Vice President, Comptroller and Chief Financial Officer of Southern Power from Each of the above is currently an executive officer of November 2002 to March 2005 and Vice President of Georgia Power, serving a term running from the last SCS from June 2002 to March 2005; and Vice President, annual organizational meeting of the directors (May 17, Comptroller and Chief Accounting Officer of Georgia 2006) for one year until the next annual meeting or until Power from September 1995 to June 2002. their successors are elected and qualified. 1-28

EXECUTIVE OFFICERS OF Kimberly D. Flowers MISSISSIPPI POWER Vice President Age 42 (Identification of executive officers of Mississippi Power is Elected in 2005. Vice President and Senior Production inserted in PartI in accordance with Regulation S-K, Officer since March 2005. Previously served as Plant Item 401(b), Instruction 3.) The ages of the officers set Manager, Plant Bowen, Georgia Power from November forth below are as of December 31, 2006. 2000 until March 2005. Donald R. Horsley Anthony J. Topazi Vice President President, Chief Executive Officer and Director Age 52 Age 56 Elected in 2006. Vice President of Customer Services and Elected in 2003. President, Chief Executive Officer and Retail Marketing since April 2006. Previously served as Director since January 1, 2004. Previously served as Vice President of Transmission at Alabama Power from Executive Vice President of Southern Company March 2005 to March 2006 and Manager, Transmission Generation and Energy Marketing from November 2000 Lines at Alabama Power from February 2001 to March to December 2003; Senior Vice President of Southern 2005. Power from November 2002 to December 2003; and Vice President of Southern Power from 2001 until November Frances V. Turnage 2002. Vice President, Treasurer and Chief Financial Officer Age 58 John W. Atherton Elected in 2005. Vice President, Treasurer and Chief Vice President Financial Officer since March 2005. Previously served as Age 46 Comptroller from 1993 to March 2005. Elected in 2004. Vice President of External Affairs since January 2005. Previously served as the Director of The officers of Mississippi Power were elected for a Economic Development from September 2003 to January term running from the last annual organizational meeting 2005; Manager, Sales and Marketing Services from April of the directors (April 12, 2006) for one year until the 2002 to August 2003; and Manager, State Legislative next annual meeting or until their successors are elected Affairs from August 1996 to April 2002. and have qualified. 1-29

(This page intentionally left blank) PART II Item 5. MARKET FOR REGISTRANTS' (3) Dividends on each registrant's common stock COMMON EQUITY, RELATED are payable at the discretion of their respective board of directors. The dividends on common STOCKHOLDER MATTERS AND stock declared by Southern Company and the ISSUER PURCHASES OF EQUITY traditional operating companies to their SECURITIES stockholder(s) for the past two years were as follows: (a)(1) The common stock of Southern Company is listed and traded on the New York Stock Registrant Quarter 2006 2005 Exchange. The commron stock is also traded on (in thousands) regional exchanges across- the United States. The high and low stock prices for each quarter Southern First $276,442 $265,958 of the past two years were'as follows: Company Second 287,704 277,679 High Low Third 287,845 277,625 Fourth 288,440 276,306 2006 First Quarter $35.89 $32.34 Alabama Power First 110,150 102,475 Second Quarter 33.25 30.48 102,475 Second 110,150 Third Quarter 35.00 32.01 Third . 110,150 102,475 Fourth Quarter 37.40 34.49 Fourth 110,150 102,475 2005 First 157,500 145,700 Georgia Power First Quarter $34.34 .$31.14 145,700 Second 157,500 Second Quarter 35.00 31.60 36.47 33.24 Third 157,500 145,700 Third Quarter Fourth Ouarter 36.33. 32.76 Fourth 157,500 145,700 There is no market for the other registrants' Gulf Power First 17,575 17,100 common stock, all of which is owned by Second 17,575 17,100 Southern Company. Third 17,575 17,100 Fourth 17,575 17,100 (2) Number of Southern Company's common stockholders of record at'December 31, 2006: Mississippi First 16,300 15,500 110,259 Power Second 16,300 15,500 Each of the other registrants have one common Third 16,300 15,500 stockholder, Southern Company. Fourth 16,300 15,500 In 2005 and 2006, Southern Power paid dividends to Southern Company as follows: Registrant Quarter 2006 2005 (in millions)

Southern Power First $ -I $-

Second 38.9 Third 19.4' 36.2 Fourth 19.4 36.2 The dividend paid per share of Southern Company's common stock was 35.750 for first quarter of 2005 and 37.25¢ for the remaining quarters of.2005 and the first quarter of 2006. For the second,. third and fourth quarters of I1-1

2006, the dividend paid per share of Southern Item 7. MANAGEMENT'S DISCUSSION Company's common stock was 38.75¢. AND ANALYSIS OF FINANCIAL Southern Power's credit facility contains CONDITION AND RESULTS OF potential limitations on the payment of OPERATIONS common stock dividends. At December 31, Southern Company.w See "MANAGEMENT'S 2006, Southern Power was in compliance with DISCUSSION ANDT ANALYSIS OF FINANCIAL the conditions of this credit facility and thus CONDITION AND RESULTS OF OPERATIONS," had no restrictions on its ability to pay contained herein at pages I-10,throughl-37. common stock dividends. See Note 8 to the financial statements of Southern Company Alabama Power. See "MANAGEMENT'S' under "Common Stock Dividend Restrictions" DISCUSSION AND ANALYSIS OF FINANCIAL I OF OPERATIONS:' and Note 6 to the financial statements of CONDITION AND RESULTS Southern Power under "Dividend Restriction" contained herein at p~ges 11-84 through 11-103. in Item 8 herein for additional information Georgia Power. See "MANAGEMENT'S regarding these restrictions. DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," (4) Securities authorized for issuance under equity contained herein at-pages 11-140 through 1I-159. compensation plans. Gulf Power. See "MANAGEMENT'S DISCUSSION See Part III, Item 12. Security Ownership of AND ANALYSIS OF FINANCIAL CONDITION AND Certain Beneficial Owners and Management RESULTS OF OPERATIONS," contained herein at and Related Stockholder Matters under the pages 11-196 through 11-214. heading "Equity Compensation Plan Information" herein. Mississippi Power. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL (b) Use of Proceeds CONDITION AND RESULTS OF OPERATIONS," contained herein at pages 11-246 through 11-265. Not applicable. Southern Power. See "MANAGEMENT'S (c) Issuer Purchases of Equity Securities DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF'OPERATIONS;" None. contained herein at pages 11-298 through 11-311. Item 6. SELECTED FINANCIAL DATA Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES Southern Company. See "SELECTED ABOUT MIARKET RISK CONSOLIDATED FINANCIAL AND OPERATING DATA:' contained herein at pages 11-80 and 11-81. See MANAGEMENT'S DISCUSSION AND ANALYSIS - FINANCIAL CONDITION AND LIQUIDITY.- "Market Alabama Power. See "SELECTED FINANCIAL Price Risk" of each of the registrants in.Item 7 herein and AND OPERATING DATA:' contained herein at pages Note 1 of each of the registrant's financial statements 11-136 and 11-137. under "Financial Instruments" in Item 8 herein. See also Note 6 to the financial statements of Southern Company, Georgia Power. See "SELECTED FINANCIAL AND each traditional operating company and Southern Power OPERATING DATA:' contained herein at pages 11-192 under "Financial Instruments" in Item 8 herein. and 11-193. Gulf Power. See "SELECTED FINANCIAL AND OPERATING DATA," contained herein at pages 11-242 and 11-243. Mississippi Power. See "SELECTED FINANCIAL AND OPERATING DATA," contained herein at pages 11-294 and 11-295. Southern Power. See "SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA," contained herein at page 11-326. 11-2

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO 2006 FINANCIAL STATEMENTS Page The Southern Company and Subsidiary Companies: Management's Report on Internal Control Over Financial Reporting ................................ -7 Reports of Independent Registered Public Accounting Firm - " Internal Control over Financial Reporting .................. ............ ....... . , -8 Consolidated Financial Statements .......... ............ .. ........... 1-9 Consolidated Statements of Income for the Years Ended December 31; 2006, 2005, and 2004 ................ 1-38 Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005, and 2004........... 11-39 Consolidated Balance Sheets at December 31, 2006 and 2005 ........................................ 11-40 Consolidated Statements of Capitalization at December 31, 2006 and 2005_. .......... ..... .1-42 1 Consolidated Statements of Common Stockholders' Equity for the Years Ended December 31, 2006, 2005, and 2004 ......................................... -144 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2006, 2005, and 2004 ...................................... ................. 11-44 Notes to Financial Statements ........................................................ 11-45 Alabama Power: , i

 ;Report of Independent   Registered   Public     Accounting          Firm            ..........                ..                   ............                             11-83 Statements of Income for the Years Ended December 31, 2006, 2005, and, 2004. ..........                                                           .....                    11-104 Statements of Cash Flows for the Years Ended, December 31, 2006, 2005i and 2004                                                    ................                    ,  11-105 Balance Sheets at December 31, 2006 and 2005 .........                           .................                                                           r'..
                                                                                                                                                                  ....       I-106
 'Statements  of Capitalization at December         31,   2006      and    2005     .... ...              ..........                           .................             11-108 Statements of Common Stockholder's Equity for' the Years Ended December 31, 2006, 2005, and 2004 ................................................                                                                                      11-110
 'Statements of Comprehensive Income for the Years Ended                                                                                                         . .

December 31, 2006, 2005, and 2004 ...................................................... 11-110 Notes t6 Financial Statements' ............................... . ... ... ... 1111 Georgia Power: Report of Independent Registered Public Accounting Firm ........................................ 11-139 Statements of Income for the Years Ended December 31, 2006, 2005, and 2004 ........................ 11-160 Statements of Cash Flows for the Years Ended December 31, 2006, 2005, and 2004 ..................... 11-161 Balance Sheets at December 31, 2006 and 2005 ................................................ 11-162 Statements of Capitalization at December 31, 2006 and 2005 ...................................... 11-164 Statements of Common Stockholder's Equity for the Years Ended December 31, 2006, 2005, and 2004 ...................................................... 11-165 Statements of Comprehensive Income for the Years Ended December 31, 2006, 2005, and 2004 ...................................................... II-165 Notes to Financial Statements ............................................................. 11-166 Gulf Power: Report of Independent Registered Public Accounting Firm ........................................ 11-195 Statements of Income for the Years Ended December 31, 2006, 2005, and 2004 ........................ 11-215 Statements of Cash Flows for the Years Ended December 31, 2006, 2005, and 2004 ..................... II-216 Balance Sheets at December 31, 2006 and 2005 ................................................ 11-217 Statements of Capitalization at December 31, 2006 and 2005 ...................................... 11-219 11-3

Page Statements of Common Stockholder's Equity for the Years Ended December 31. 2006, 2005, and 2004 ...................................................... II-220 Statements of Comprehensive Income for the Years Ended December 31. 2006, 2005, and 2004 ...................................................... 11-220 Notes to Financial Statements ............................................................. 11-221 Mississippi Power: Report of Independent Registered Public Accounting Firm ........................................ 11-245 Statements of Income for the Years Ended December 31, 2006, 2005, and 2004 ........................ 11-266 Statements of Cash Flows for the Years Ended December 31, 2006, 2005, and 2004 ..................... 11-267 Balance Sheets at December 31, 2006 and 2005 ................................................. 11-268 Statements of Capitalization at December 31, 2006 and 2005 ...................................... 11-270 Statements of Common Stockholder's Equity for the Years Ended December 31, 2006, 2005, and 2004 ...................................................... 11-271 Statements of Comprehensive Income for the Years Ended December 31, 2006, 2005, and 2004 ...................................................... 11-271 Notes to Financial Statements ............................................................. 11-272 Southern Power and Subsidiary Companies: Report of Independent Registered Public Accounting Firm ........................................ 11-297 Consolidated Statements of Income for the Years Ended December 31, 2006, 2005, and 2004 .............. 11-312 Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005, and 2004 ........... 11-313 Consolidated Balance Sheets at December 31, 2006 and 2005 ..................... I................ 11-314 Consolidated Statements of Common Stockholder's Equity for the Years Ended December 31, 2006, 2005, and 2004 ...................................................... 11-316 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2006, 2005, and 2004 ...................................................... 11-316 Notes to Financial Statements ............................................................. 11-317 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 11-4

Item 9A. CONTROLS AND PROCEDURES Disclosure Controls And Procedures. As of the end of the period covered by this annual report, Southern Company, the traditional operating companies and Southern Power conducted separate evaluations under the supervision and with the participation of each company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the disclosure controls and procedures (as defined in Sections 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). Based upon these evaluations, the Chief Executive Officer and the Chief Financial Officer, in each case, concluded that the disclosure controls and procedures are effective in alerting them in a timely manner to material information relating to their company (including its consolidated subsidiaries, if any) required to be included in periodic filings with the SEC. Internal Control Over Financial Reporting. (a) Management's Annual Report on Internal Control Over Financial Reporting. (1) Southern Company Southern Company's Management's Report on Internal Control Over Financial Reporting is included on page 11-7 of this Form 10-K. (2) Traditional operating companies and Southern Power Not applicable because these companies are not accelerated filers. (b) Attestation Report of the Registered Public Accounting Firm. (1) Southern Company The report of Deloitte & Touche LLP, Southern Company's independent registered public accounting firm, regarding management's assessment of Southern Company's internal control over financial reporting and the effectiveness of Southern Company's internal control over financial reporting is included on page HI-8 of this Form 10-K. (2) Traditional operating companies and Southern Power Not applicable because these companies are not accelerated filers. (c) Changes in internal controls. There have been no changes in Southern Company's, Alabama Power's, Georgia Power's, Gulf Power's, Mississippi Power's or Southern Power's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) during the fourth quarter 2006 that have materially affected or are reasonably likely to materially affect Southern Company's, Alabama Power's, Georgia Power's, Gulf Power's, Mississippi Power's or Southern Power's internal control over financial reporting. Item 9B. OTHER INFORMATION None. 11-5

(This page intentionally left blank) THE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES FINANCIAL SECTION 11-6

MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Southern Company and Subsidiary Companies 2006 Annual Report Southern Company's management is responsible for Deloitte & Touche LLP, an independent registered establishing and maintaining an adequate system of public accounting firm, as auditors of Southern internal control over financial reporting as required by the Company's financial statements, has issued an attestation Sarbanes-Oxley Act of 2002 and as defined in ExchangeF report on management's assessment of the effectiveness of Act Rule 13a-15(f). A control system can provide only: Southern Company's internal control over financial reasonable, not absolute, assurance that ihe 'objectives of reporting as of December 31, 2006. Deloitte & Touche the control systemare met. LLP's report, 'which expresses unqualified opinions on management's assessment and on the effectiveness of Under management's supervision, an evaluation of Southern Company's internal control over financial the design and effectiveness of Southern Company's reporting, is included herein. internal control over financial reporting was conducted based on the framework in Internal(Cohtrol-Integrated Framework issued by'the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management concluded that Southern Company's internal controloover financial reporting was effective as of Deceifiber'31, 2006. David M. Ratcliffe Chairman, President, and Chief Executive Officer Thomas A. Fanning Executive Vice President, Chief Financial Officer, and Treasurer February 26,- 2007 11-7

Internal Control Over Financial Reporting REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Southern Company We have audited management's assessment, included in being made only in accordance with authorizations of the accompanying Management's Report on Internal management and directors of the company; and (3) provide Control Over Financial Reporting (page 117), that reasonable assurance regarding prevention or timely Southern Company (the "Company") maintained effective detection of unauthorized acquisition, use, or disposition of internal control over financial reporting as of the company's assets that could have *amaterial effect on December 31, 2006, based on criteria established in the financial statements. Internal Control-IntegratedFramework issued by the Because of the inherent limitations of internal control Committee of Sponsoring Organizations of the Treadway over financial reporting, including the possibility of Commission. The Company's management is- responsible collusion or improper management override of controls, for maintaining effective internal control over financial material misstatements due to error or fraud may not, be.. reporting and for its assessment of the effectiveness of prevented or detected on a timely basis. Also, projections internal control over financial reporting. Our of any evaluation of the effectiveness of the internal responsibility is to express an opinion on management's control over financial reporting to future periods are assessment and an opinion on the effectivenless of the subject to the risk that the controls may become inadequate Company's internal control over financial reporting based because of changes in conditions, or that the degree of on our audit. compliance with the policies or procedures may deteriorate. We conducted our audit in accordance with the In our opinion, management's assessment that the standards of the Public Company Accounting Oversight Company maintained effective internal control over Board (United States). Those standards require that we financial reporting as of December 31, 2006, is fairly plan and perform the audit to obtain reasonable assurance stated, in all material respects, based on the criteria about whether effective internal control over financial established in Internal Control-IntegratedFramework reporting was maintained in all material respects. Our issued by the Committee of Sponsoring Organizations of audit included obtaining an understanding of internal the Treadway Commission. Also in our opinion, the control over financial reporting, evaluating management's Company maintained, in all material respects, effective assessment, testing and evaluating the design and internal control over financial reporting as of operating effectiveness of internal control, and performing December 31, 2006, based on the criteria established in such other procedures as we considered necessary in the Internal Control-IntegratedFramework issued by the circumstances. We believe that our audit provides a Committee of Sponsoring Organizations of the Treadway reasonable basis for our opinions. Commission. We have also audited, in accordance with the A company's internal control over financial reporting standards of the Public Company Accounting Oversight is a process designed by, or under the supervision of, the Board (United States), the consolidated financial company's principal executive and principal financial statements as of and for the year ended December 31, officers, or persons performing similar functions, and 2006 of the Company and our report dated February 26, effected by the company's board of directors, management, 2007 expressed an unqualified opinion on those financial and other personnel to provide reasonable assurance statements and included an explanatory paragraph regarding the reliability of financial reporting and the regarding a change in the method of accounting for the preparation of financial statements for external purposes in funded status of defined benefit pension and other accordance with generally accepted accounting principles. postretirement plans. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as Atlanta, Georgia necessary to permit preparation of financial statements in February 26, 2007 accordance with generally accepted accounting principles, and that receipts and expenditures of the company are 11-8

Consolidated Financial Statements REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Southern Company We have audited the accompanying consolidated balance As discussed in Note 2 to the financial statements, in sheets and consolidated statements of capitalization of 2006 the Company changed its method of accounting for Southern Company and Subsidiary Companies (the' the funded status of defined benefit pension and other "Company") as of December 31, 2006 and 2005, and the postretirement plans. related consolidated statements of income, comprehensive We have also audited, in accordance with the income, common stockholders' equity, and cash flows for standards oif 'the Public Company Accounting Oversight each of the three years in the period ended December 31, Board.(United States), the effectiveness of the Company's 2006. These financial statements are the responsibility of internal control over financial reporting as of the Company's management. Our responsibility is to December 31, 2006, based on the.criteria established in express an opinion on these financial statements based on Interal nControl-IntegratedFramework issued by the our audits. Committee of Sponsoring Organizations of the Treadway We conducted our audits in accordance with the Commission and our report dated February 26, 2007 standards of the Public Company Accounting Oversight expressed. an unqualified opinion on management's Board. (United States). Those standards require that we assessment -of the -effectiveness of the Company's internal plan and perform the audit to obtain reasonable assurance control over financial reporting and an unqualified about whether the financial statements. are free of material opinion on the effectiveness of the Company's internal misstatement. An audit includes examining, on a test control over. financial reporting. basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

                                                                                   " i7~                   i In our opinion, such consolidated financial statements (pages 11-38 to 11-79) present fairly, in all material respects, the financial position of Southern..           Atlanta, Georgia Company and Subsidiary Companies at December 31,                  February 26, 2007 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.               '         . .

11-9

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Southern Company and Subsidiary Companies 2006 Annual Report OVERVIEW Business Activities The primary business of Southern Company (the telecommunications, and energy-related services. Company) is electricity sales in the Southeast by the Management continues to evaluate the contribution of traditional operating companies - Alabama Power, each of these activities to total shareholder return and Georgia Power, Gulf Power, and Mississippi Power - and may pursue acquisitions and dispositions accordingly. The Southern Power. Savannah Electric and Power Company synthetic fuel tax credits will no longer be available after (Savannah Electric) was also a traditional operating December 31, 2007. In January 2006, the sale of the company subsidiary of Southern Company until being Company's natural gas marketing business was merged with and into Georgia Power effective July 1, completed. 2006. Southern Power constructs, acquires, and manages generation assets and sells electricity at market-based Key Performance Indicators rates in the wholesale market. In striving to maximize shareholder value while providing Many factors affect the opportunities, challenges, and cost-effective energy to more than four million customers, risks of Southern Company's electricity business. These Southern Company continues to focus on several key factors include the traditional operating companies' ability indicators. These indicators include customer satisfaction, to maintain a stable regulatory environment, to achieve plant availability, system reliability, and earnings per energy sales growth, and to effectively manage and secure share (EPS), excluding earnings from synthetic fuel timely recovery of rising costs. These costs include those investments. Southern Company's financial success is related to growing demand, increasingly stringent directly tied to the satisfaction of its customers. Key environmental standards, fuel prices, and storm restoration elements of ensuring customer satisfaction include following multiple hurricanes. Since the beginning of outstanding service, high reliability, and competitive 2004, each of the traditional operating companies prices. Management uses customer satisfaction surveys completed successful retail base rate proceedings. These and reliability indicators to evaluate the Company's regulatory actions have provided earnings stability and results. enabled the recovery of substantial capital investments to Peak season equivalent forced outage rate (Peak facilitate the continued reliability of the transmission and Season EFOR) is an indicator of fossil/hydro plant distribution network and to continue environmental improvements at the generating plants. During 2005 and availability and efficient generation fleet operations during the months when generation needs are greatest. 2006, each of the traditional operating companies The rate is calculated by dividing the number of hours of completed proceedings as necessary to address fuel and forced outages by total generation hours. The 2006 Peak storm damage cost recovery. Appropriately balancing Season EFOR of 1.11 percent is better than the target and environmental expenditures with customer prices will continue to challenge the Company for the foreseeable a significant improvement over 2005 Peak Season EFOR. Transmission and distribution system reliability future. performance is measured by the frequency and duration of Another major factor is the profitability of the outages. Performance targets for reliability are set competitive market-based wholesale generating business internally based on historical performance, expected and federal regulatory policy, which may impact Southern weather conditions, and expected capital expenditures. Company's level of participation in this market. Southern The performance for 2006 exceeded most targets on these Power continued executing its regional strategy in 2006 reliability measures. through the acquisition of power plants in North Carolina Southern Company's synthetic fuel investments and Florida. Consistent with prior acquisitions, the newly generate tax credits as a result of synthetic fuel acquired plants have associated power purchase production. Due to higher oil prices in 2006, these tax agreements (PPAs) in place. The Company continues to credits were partially phased out and one synfuel face regulatory challenges related to transmission and investment was terminated. As a result, Southern market power issues at the national level. Company's synthetic fuel investments did not contribute Southern Company's other business activities include significantly to earnings and EPS during 2006. These tax an investment in a synthetic fuel producing entity (which credits will no longer be available after December 31, claims federal income tax credits designed to offset its 2007. Southern Company management uses EPS, operating losses), leveraged lease projects, excluding synfuel earnings, to evaluate the performance 11-10

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report of Southern Company's ongoing business activities. Dividends Southern Company believes the presentation of earnings Southern Company has paid dividends on its common and EPS excluding the results of the synthetic fuel stock since 1948. Dividends paid per share of common investments also is useful for investors because it provides stock were $1.535 in 2006, $1.475 in 2005, and $1.415 in investors with additional information for purposes of 2004. In January 2007, Southern Company declared a comparing Southern Company's performancefor such quarterly dividend of 38.75 cents per share. This is the periods. The presentation of this additional information is 237th consecutive quarter that Southern Company has not meant to be considered a substitute for financial paid a dividend equal to or higher than the previous measures prepared in accordance with generally -accepted quarter. The Company targets a dividend payout ratio of accounting principles. approximately 70 to 75 percent of net income, excluding earnings from synthetic fuel businesses. For 2006, the Southern Company's 2006 results compared With' its actual payout ratio was 73 percent, excluding synthetic targets for some of these key indicators are reflected in fuel earnings,, and 72.5 percent overall. the following chart: RESULTS OF OPERATIONS Key Performance 2006 Target 2006 Actual' Electricity Businesses Indicator Performance Performance Southern Company's electric utilities generate and sell Customer Top quartile in electricity to retail and wholesale customers in the Satisfaction customer surveys Top quartile Southeast. A condensed income statement for the Peak Season electricity business is as follows: EFOR 2.75% or less 1.11% Increase (Decrease) Basic EPS $2.15 -$2.20, J, $2.12 Amount from Prior Year EPS, excluding 2006 2006 2005 2004 synfuel (in millions) earnings $2.03- $2.08 $2.10 Electric operating revenues $14,088 $ 810 $1,813 $718 See RESULTS OF OPERATIONS her-ein for Fuel 5,143 655 1,089 400 additional information on the Company's financial Purchased power 543 (188) 88 170 performance. The financial performance achieved in 2006 Other operations and reflects the continued emphasis that management places. maintenance 3,290 70 215 148 on these indicators as well as the commitment shown by Depreciation and employees in achieving or exceeding management's amortization 1,164 27 229 (64) expectations. Taxes other than income taxes 715 39 52 40 Total electric operating Earnings 10,855 603 1,673 694 expenses., Southern Company's net income was $1.57 billion in Operating income 3,233 207 140 24 Other income, fiet 53 (9) 38 22 2006, a decrease of 1,.1 percent fipm the prior year. The - Interest expenses 751 75 62 19 lower earnings compared with theprior year were Income taxes 949 50 24 '30 primarily the result of a reduction of tax credits related to Net income $ 1,586 '$ 73 $ 92 $ (3) the production of synthetic fuels. This decrease was largely offset by continued economic strength and a growing customer base. Net income was $1.59 billion in 2005 and $1.53 billion in 2004, reflecting increases over the prior year of 3.8 percent and 4.0 percent, respectively. Basic EPS, including discontinued operations, was $2.12 in 2006, $2.14 in 2005, and $2.07 in 2004. Diluted EPS, which factors in additional shares related to stock options, was 2 cents lower than basic EPS for 2006 and 1 cent lower for each of 2005 and 2004. II-11

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report Revenues Capacity revenues under unit power sales contracts, principally sales to Florida utilities, reflect the recovery of Details of electric operating revenues are as follows: fixed costs and a return on investment, and energy is 2006 2005 2004 generally sold at variable cost. Unit power kilowatt-hour (in millions) (KWH) sales increased 0.2 percent, 1.7 percent, and 1.9 percent in 2006, 2005, and 2004, respectively. Retail - prior year $11,165 $ 9,732 $ 8,875 Fluctuations in oil and natural gas prices, which are the Change in - primary fuel sources for unit power sales customers, Base rates 72 236 41 influence changes in these sales. However, because the Sales growth 40 184 216 energy is generally sold at variable cost, these fluctuations Weather 35 34 48 have a minimal effect on earnings. The capacity and Fuel and other cost energy components of the unit power sales contracts were recovery clauses 489 979 552 as follows: Retail - current year 11,801 11,165 9,732 2006 2005 2004 Sales for resale 1,822 1,667 1,341 Other electric operating (in millions) revenues 465. 446 392 Unit.power - Electric operating revenues $14,088 $13,278 $11,465 Capacity $208 $201, $185 Energy 274 237 213 Percent change 6.1% 15.8% 6.7% Total $482 $438 $398 Retail revenues increased $636 million, $1.4 billion, In 2006, sales for resale revenues increased and $857 million in 2006, 2005, and 2004, respectively. The significant factors driving these changes are shown in $155 million as a result of a 10.5 percent increase in the the preceding table. The increase in base rates in 2005 is average cost of fuel per net KWH generated, as well as revenues resulting from new PPAs in 2006. In addition, primarily due to approval by the Georgia Public Service Commission (PSC) of a retail base rate increase at Southern Company assumed four PPAs through the acquisitions of Plants DeSoto and Rowan in June and Georgia Power. Electric rates for the traditional operating companies include provisions to adjust billings for September 2006, respectively. The 2006 increase was partially offset by. a decrease in opportunity sales. fluctuations in fuel costs, including the energy component of purchased power costs. Under these provisions, fuel In 2005, sales for resale revenues increased revenues generally equal fuel expenses, including the fuel $326 million primarily due to a 26.5 percent increase in component of purchased power, and do not affect net the average cost of fuel per net KWH generated. In : income. Certain of the traditional operating companies addition, Southern Company entered into new PPAs with also have clauses to recover other costs, such as 30 electric membership cooperatives (EMCs) and Flint environmental, storm damage, new plants, and PPAs. EMC, both beginning in January 2005, and assumed two PPAs in June 2005 in connection with the acquisition of Sales for resale revenues consist of PPAs with Plant Oleander. investor-owned utilities and electric cooperatives, short-term opportunity sales, and unit power sales contracts. In 2004, sales for resale revenues decreased Southern Company's average wholesale contract extends $17 million primarily due to a lower price differential more than 10 years and, as a result, the Company has between market prices and the Company's marginal cost significantly limited its remarketing risk. Short-term that reduced the availability of short-term opportunity opportunity sales are made at market-based rates that sales. Milder summer weather throughout the Southeastýil generally provide a margin above the Company's variable also reduced demand. cost to produce the energy. Revenues associated with PPAs and opportunity sales were as follows: 2006 2005 2004 (in millions) Other power sales - Capacity and other $ 499 $ 430 $308 Energy 841 799 635 Total $1,340 $1,229 $943 11-12

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report Energy Sales units. Details of Southern Company's generation, fuel, and purchased power are as follows: Changes in revenues are influenced heavily by the volume 2006 2005 2004 of energy sold each, year. KWH sales. for 2006. and the percent change by year were as follows: Total generation".. (billions-fKWH) - " ' 201 195 188 KWH Percent Change Total purchased power', 2006 2006 2005 2004 (billions of KWH) ' 10 11 , 15 (in billions) 5.A1,r~e* nff o.pnprninn ' ' Residential 52.4 2.5% 2 .8% 3.9% (percent) . - Commercial '53.0 2.2 3.6 3.4 Coal 70% 71% '69% Industrial 55.0 (0.2) (2.2) 3.6 Nuclear 15 15 16 0.8 Gas ;,. .13. .11, 12 Other 0.9 (7.6)" (0.9) 161.3 1.4 1.2 3.6 Hvdro 2 3 3 Total retail Sales for resale 40.1 6.1 7.3 (13.0) Cost of fuel, generated (cents per net KWH)- Total 201A4 2.3. 2.3 0.1 Coal' ' 2.40 1.93 1.75 N{fuciear 0.47 0.47 0.46 Retail energy sales in 2006 increased2.3 billion Gas ' 6.63 8.52 4.90 KWH as a result of customer grov~th of 1.7 percent,' Average cost of fuel, generated sustained economic growth primarily 'in the residential' (cents per net KWH) 2.64 2.39 1.89 and commercial customer classes, arid warmer weather in Average cost of purchased power 2006 when compared to 2005. Retail-'energy sales in:2005 (cents per net KWH) ' 5.64 ' 7.14 4.48 increased 1.9 billion KWH as a *'esult- of sustained economic groWith and customer growth of 1.2 percent. Fuel and purchased power expenses were $5.7 billion Hurricane Katrina dampened' custoimer growth from in 2006, ,an increase of $467. million or 8.9 percent above previous years and was the primary contributor-to the" the prior year costs. This increase was the result of a decrease in industrial sales in 2005. Inwaddition,'u 2005, $319 -million increase in the cost of fuel and purchased some Georgia Power industrial cisitomners 'were- power and $148 million related to an increase in total reclassified from industrial to comniici~il to be consistent KWH. generated and purchased. with the rate structure approved by'the Georgia PSC resulting in higher commercial sales ýand lower industrial In'-005,'-fueliand purchased -power expenses were sales in 2005 when compared, with 2004. l etaIl energy $5.2 fiiliin, an increase of $1.2 billion or 29.1 percent'," sales in 2004 were strong across all customer classes as, a above 20b4 costs. This increase Was the result of a' result of an improved economrn minthe Southeast and $1.2 billihn increase in the 'cost of fuel and purchased customer growth of 1.5 percent. - power, patially offset by $47,',million related to a decrease in total KWH generated and purchased; Energy sales for resale increased by 2.3 billion KWH

                                                                            -,-Fuel and purchased power expenses were $4.0 billion in 2006, increased by 2.6 billion KWH in 2005, and in  2004,    an increase of $570 million or 16.4 percent decreased by 5.3 billion KWH in 204. The increases in, above 2003'costs. This increase was the result of a sales for resale in 2006 and 2005'are related primarily to
                                                                        $473 million, inprpase in the cost -of fuel and purchased the new PPAs discussed above. Theý decrease in 2004.

power and$97 milion related to an increLse in total compared with 2003 is primarily due to a lower price KWH generated and purchased. differential between market'prices2'arid the Comptany's' marginal cost that reduced the availability of short-termn "-Whileprices have moderated somewhat in 2006, a% opportunity, sales. Milder summer -weather throughout the significant upward trend in the cost of coal and natural Southeast also reduced demand. ,-. ' gas has, enierged'sinee 2003, and 'volatility 'in these' markets:is ýxpected to continue. Increased'coal prices Fuel and PurchasedPowe'r kxpenses have been influenced by a worldwide increase in demand as a result of-rap'id economic growth in China, as well as' Fuel costs constitute the 7singlE largest expense for the by increases.in minfing and fuel transportation costs. electric utilities. The miu of fuel sources for generation of Higher natural gas prices in the United States are the electricity is determined primarily by demand, the unit. - result of increased'demand and Slightly lower gas supplies cost of fuel consumed, and the ,availability of generating - despite increased drilling' activity. Natural gas production 11-1.3

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report and supply interruptions, such as those caused by the the combined effect of the accounting order had no 2004 and 2005 hurricanes, result in an immediate market impact on net income. See Note 3 to the financial response; however, the long-term impact of this price statements under "Storm Damage Cost Recovery" for volatility may be reduced by imports of liquefied natural additional information. Transmission and distribution gas if new liquefied gas facilities are built. Fuel expenses expenses fluctuate from year to year due to variations in generally do not affect net income, since they are offset maintenance schedules, flexible spending projects, and by fuel revenues under the traditional operating normal increases in costs and are the primary basis for the companies' fuel cost recovery provisions. Likewise, 2004 increase. Southern Power's PPAs generally provide that the purchasers are responsible for substantially all of the cost The 2004 increase in other operations and of fuel. maintenance expenses was partially offset by a $60 million regulatory liability related to Plant Daniel that was Other Operationsand Maintenance Expenses expensed in 2003. Other operations and maintenance expenses were Depreciationand Amortization Expenses $3.3 billion, $3.2 billion, and $3.0 billion, increasing $70 million, $215 million, and $148 million in 2006, Depreciation and amortization expenses increased 2005, and 2004, respectively. Other production expenses $27 million in 2006 as a result of the acquisitions of at fossil, hydro, and nuclear plants increased $3 million, Plants DeSoto, Rowan, and Oleander in June 2006, $58 million, and $53 million in 2006, 2005, and 2004, September 2006, and June 2005, respectively, and a respectively. Production expenses fluctuate from year to reduction in the amortization of the Plant Daniel year due to variations in outage schedules, flexible regulatory liability. An increase in depreciation rates at spending projects, and normal increases in costs. Southern Power associated with adoption of a new, depreciation study also contributed to the 2006 increase. Administrative and general expenses increased Partially offsetting the 2006 increase was the amortization $29 million in 2006 as a result of a $17 million increase of a Georgia Power regulatory liability related to the in salaries and wages and a $24 million increase in levelization of certain purchased power capacity costs as pension expense, partially offset by a $16 million ordered by the Georgia PSC under the terms of the retail reduction in medical expenses. Administrative and general rate order effective January 1, 2005. See Note 3 to the expenses increased $73 million in 2005 related to a financial statements under "Georgia Power Retail $33 million increase in employee benefits; a $22 million Regulatory Matters" for additional information. increase in shared service expenses, primarily increases in Sarbanes-Oxley Act compliance costs, legal costs, and Depreciation and amortization expenses increased other corporate expenses; and a $9 million increase in $229 million in 2005 as a result of additional plant in property damage. Administrative and general expenses service and from the expiration in 2004 of certain increased $106 million in 2004 primarily related to a provisions in Georgia Power's retail rate plan for the three $41 million increase in employee benefits, a $23 million years ended December 31, 2004 (2001 Retail Rate Plan). increase in shared service expenses, primarily nuclear In accordance with the 2001 Retail Rate Plan, Georgia security, and a $13 million increase in property insurance. Power amortized an accelerated cost recovery liability as a credit to amortization expense and recognized new Transmission and distribution expenses increased Georgia PSC-certified purchased power capacity costs in $30 million, $60 million, and $49 million in 2006, 2005, rates evenly over the three years ended December 31, and 2004, respectively. Transmission and distributio'n 2004. See Note 3 to the financial statements under expenses increased in 2006 primarily due to expenses "Georgia Power Retail Regulatory Matters" for additional associated with recovery of prior year storm costs through information. natural disaster recovery clauses and additional investment in distribution to meet customer growth. Transmission and Depreciation and amortization expenses declined by distribution expenses increased in 2005 primarily as a $64 million in 2004 primarily as a result of amortization result of $48 million of expenses recorded by Alabama of the Plant Daniel regulatory liability and a Georgia Power in accordance with an accounting order approved Power regulatory liability related to the levelization of by the Alabama PSC primarily to offset the costs of certain purchased power capacity costs that reduced Hurricane Ivan and restore the natural disaster reserve. In amortization expense by $17 million and $90 million, accordance with the accounting order, Alabama Power respectively, from the prior year. See FUTURE : also returned certain regulatory liabilities related to EARNINGS POTENTIAL - "PSC Matters -Mississippi deferred income taxes to its retail customers; therefore, Power" herein and Note 3 to the financial statements 11-14

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report under "Georgia Power Retail Regulatory'Matters" for and levetaged lease'projects, telecommunications, and more information on these regulatory adjustments. These energy-related services. These businesses are classified in reductions were partially offset by a higher depreciable general categories 'and may comprise one or more of the plant base. following subsidiaries: Southern Company Holdings invests in various energy-related projects, including Taxes Other Than Income Taxes synthetic' fuels and leveraged lease projects that receive tax benefits', Which contribute significantly to the Taxes other than income taxes increased by $39 million in economic results of these investments; SouthernLINC 2006 primarily as a result of increases in franchise and. Wireless provides digital wireless communications municipal gross receipts taxes associated with increases in services to the traditional operating companies and also revenues from energy sales as well as increases in markets these Services to the public within the Southeast; property taxes associated with additional plant in service. Southern Telecom provides fiber optics services in the Taxes other than income. taxes increased by $52 million in Southeast; and Southern Company Gas was a retail gas 2005 primarily as a result of increases in franchise and marketer serving customers in the State of Georgia. On municipal gross receipts taxes associated with increases in January 4, 2Q06, Southern Company Gas completed the revenues from energy sales. In 2004, taxes other than sale of subsiantially all of its assets and is reflected in the income taxes 'increased by $40 million primarily as a condensed income statement below as discontinued result of additional plant in service aand a higher property operation. See'eNote 3 to the financial statements under, tax base. "Southern Company Gas Sale"' for additional information. A condensed income statement for Southern Company's Interest Expenses . other business activities follows: Total interest charges and other financing costs increased Increase (Decrease) by $75 million in 2006 due to a $78 million increase Amount from Prior Year associated with $708 million in additional debt outstanding at December 31, 2006 compared to 2006 2006 2005 2004 December'31, 2005 and a $7 million increase associated . ,(in millions) with an increase in average interest rates on variable rate Operatingrevenues $ 268 $ (8) $ 12. $ (7) debt, partially offset by a $6 million increase in ' Other operationsý:and capitalized interest associated with construction projects Aiaaintenance 238 (59) 12 '28 and a $3 million reduction in other interest costs. Total Depreciation and interest charges and other financing costs increased by 36 (3) (2) (9) amortization ' ' -

$62 million in 2005 associated with an~additional "                  Taxes;other than income
$863 million in debt outstanding at December 31, 2005 as                                               . 3        (1)         1        1 taxes compared to December 31, 2004 and an increase in Totaloperating expenses             277        (63)        11       20 average interest rates on variable rate debt. Variable rates on pollution control bonds are highly correlated With the            Operating, income/(loss)              (9)        55          1    (27)

Bond Market Association (BMA)'Municipal Swap Index, Equity in 10stes of which averaged 2.5 percent in 2005 hnd '1.2 percent in unconsolidated 2004. Variable rates on commercial paper and senior

subsidiaries ' (60) 62 (25) ' 3 notes are highly correlated with the one-month 'London Leveraged lease income 69 (5) 4 -4 Interbank Offer Rate (LIBOR), which averaged 3.4 percent Other income,, net (31) (18) (6) (15) in 2005 and 1.5 percent in -2004. An additional $17 million Interest expenses 149 48 18 (21) increase in 2005 was the result of a lower percentage of Income -taxes Q(68) 136 (14) (63) interest costs capitalized as construction projects reached Discontinued operations, completion. The '$19 million increase in interest charges net of tax, (1) (1) (3) 12 and other financing costs in 2004 Was also the result of a, Net income/(loss) $ (13) $(91) $(33) $ 61 lower percentage of interest costs capitalized as construction projects reached completion. Southern Company's non-electric operating revenues decreased $8,million in '2006 primarily as a result of a Other Business Activities $21*million decrease in revenues'at SouthernLINC Southern Company's other business activities include the' Wireless related to lower average tevenue per subscriber' parent company (which does not allocate operating-- - and lower equipment and accessory sales. The 2006 expenses to business units), investments in synthetic fuels decrease -was partially offset by a $12 million increase in 11-15

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report fuel procurement service revenues. Higher production and September 2006 due to higher oil prices. The increase in increased fees in the synthetic fuel business contributed to equity in losses of unconsolidated subsidiaries in 2005 the $12 million increase in 2005. The $7 million decrease reflects the results of additional production expenses at in 2004 was primarily due to lower operating revenues in the synthetic fuel production facilities. The 2004 decrease one of the Company's energy-related services businesses, in equity in losses of unconsolidated subsidiaries when partially offset by an increase in SouthernLINC Wireless compared to the prior year was not material. The federal revenues as a result of increased wireless subscribers. income tax credits resulting from these investments totaled $65 million in 2006, $177 million in 2005, and Other operations and maintenance expenses for these

                                                                  $146 million in 2004. In 2004, a $37 million reserve other businesses declined $59 million in 2006 primarily as related to these tax credits was reversed following the a result of $32 million of lower production expenses settlement of an Internal Revenue Service (IRS) audit.

related to the termination of Southern Company's See FUTURE EARNINGS POTENTIAL - "Income Tax membership interest in one of the synthetic fuel entities, Maters - Synthetic Fuel Tax Credits" herein for further $13 million attributed to the wind-down of one of the information. Company's energy-related services businesses, and $7 million of lower expenses resulting from the March The $18 million decrease in other income in 2006 as 2006 sale of a subsidiary that provided rail car compared with 2005 resulted from a $25 million decrease maintenance services. Other operations and maintenance related to changes in the value of derivative transactions expenses increased by $12 million in 2005 as a result of in the synthetic fuel business and a $16 million decrease $9 million of higher losses for property damage, related to the impairment of investments in the synthetic $2 million in higher network costs at SouthemLINC fuel entities, partially offset by the release of $6 million Wireless, and an $11 million increase in shared service in certain contractual obligations associated with these expenses, partially offset by the $12.5 million bad debt investments. The 2005 decrease in other income when reserve irn 2004 discussed below. Other operations and compared to the prior year was not material. The decrease maintenance expenses increased $28 million in 2004 in other income in 2004 as compared with 2003 reflects a primarily due to a $3 million increase in advertising, a $15 million gain for a Southern Telecom contract $5 million increase in shared services expenses, and a settlement during 2003. $12.5 million bad debt reserve related to additional Total interest charges and other financing costs federal income taxes and interest Southern Company paid increased by $48 million in 2006 due to a $19 million on behalf of Mirant Corporation (Mirant). See FUTURE increase associated with $149 million in additional debt EARNINGS POTENTIAL - "Mirant Matters" herein and Note 3 to the financial statements under "Mirant outstanding at December 31, 2006 as compared to December 31, 2005, a $12 million increase associated Matters - Mirant Bankruptcy" for additional information. with an increase in average interest rates on variable rate - The 2006 and 2005 decreases in depreciation and debt, a $6 million loss on the early redemption of long-amortization expenses when compared to the prior years term debt payable to affiliated trusts in January 2006, and were not material. Depreciation and amortization a $16 million loss on the repayment of long-term debt expenses decreased $9 million in 2004 primarily as a payable to affiliated trusts in December 2006. The 2006 result of $10 million of expenses associated with the increase is partially offset by a $4 million reduction in repurchase of debt at Southern Company Holdings in other interest costs. Interest expense increased by 2003. $18 million in 2005 associated with an additional

                                                                  $283 million in debt outstanding and a 164 basis point Southern Company made investments in two increase in average interest rates on variable rate debt.

synthetic fuel production'facilities that generaie operating Interest expense decreased $21 million in 2004 as a result losses. These investments also allow Southern, Company of the parent company's redemption of preferred , to claim federal income tax credits that offset these securities in 2003. This decrease was partially offset by operating losses and make the projects profitable. The an increase in outstanding long-term debt in 2004. decrease in equity in losses of unconsolidated subsidiaries in 2006 reflects the result of terminating Southern The $136 million increase in income taxes in ý2006 Company's membership interest in one of the synthetic as compared with 2005 resulted from an $80 million fuel entities which reduced the amount of Southern decrease in synthetic fuel tax credits as a result of Company's share of the losses and, therefore, the funding terminating the Company's membership' interest in one of obligation for the year. The decrease also resulted from the synthetic fuel entities and curtailing production at the lower operating expenses while the production facilities at other synthetic fuel entity from May towSeptember 2006. the other synthetic fuel entity were idled from May to In addition, $32 million of tax credit reserves were 11-16

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report recorded in 2006 due to an anticipated phase-out of Accounting Policies and Estimates - Electric Utility synthetic fuel tax credits due to higher oil prices. See Regulation" herein and Note 3 to the financial statements FUTURE EARNINGS POTENTIAL - "Income Tax for additional information about regulatory matters. Matters - Synthetic Fuel Tax Credits" herein for further information. The 2005 decrease in income taxes when The results of operations for the past three years are compared to the prior year was not material. The not necessarily indicative of future earnings potential. The $63 million decrease in income taxes in 2004 as level of Southern Company's future earnings depends on compared with 2003 resulted from a $19 million increase numerous factors that affect the opportunities, challenges, in synthetic fuel tax credits as a result of increased and risks of Southern Company's primary business of production and a $44 million change in a reserve recorded selling electricity. These factors include the traditional. related to these tAx credits. operating companies' ability to maintain a stable regulatory environment that continues to allow for the. Effects of Inflation recovery of all prudently incurred costs during a time of increasing costs. Another major factor is the profitability The traditional operating companies and Soithern Power of the competitive market-based wholesale generating are Subject to rate regulation and party i6 long-term business and federal regulatory .policy, which may impact: contracts that are generally based on the recovery of Southern Company's lqvel of participation in this market. historical costs. When historical 'costs areminclutded, or Future earnings for the electricity business in the near when'inflation exceeds projected costs used 'in rate regulation, the effects of inflation can create an economic term'will depend, in part, upon growth in'energy sales, loss since the recovery of costs could be in dollars that which is subject to a number of factors. These factors have less purchasing power. In addition, the income tax include weather, competition, new energy contracts with laws are based on historical costs. While the inflation rate neighboring futilities, energy conservation practiced by has *been relatively low in recent years, it continues to customers, the price of electricity, the price elasticity of have, an adverse effect on Southern Company because of demand, and the rate of economic growth in the service the large investment in utility, plant with long economic area., lives. Conventional accounting for~historical cost does not recognize this economic loss nor the partially offsetting Southern Company system generating capacity gain that arises through financing facilities with fixed- increased 1,276 megawatts in 2006.. The acquisition by money obligations such as long-term debt and preferred. Southern Powerof Plants DeSoto andRowan added securities. Any recognition of inflation by regulatory 1,330 megawatts to the fleet while generating capacity authorities is reflected in the rate of return allowed in the was reduced by 54 megawatts due to'the retirement of traditional operating companies' approved electric rates. two fossil units and the re-rating of one hydro unit. In general, Southern Company .has constructed or acquired FUTURE EARNINGS POTENTIAL, new generating capacity only after entering into long-term capacity contracts for the new facilities or to meet General requirements of Southern Company's regulated retail markets, both of which are optimized by limited energy, The four traditional operating companies operate as trading activities. vertically integrated utilities providing el~ctricity to customers within their service areas in the southeastern To adapt to Aless regulated, more competitive United States. Prices for electricity provided to retail environment, Southern Company continues to evaluate customers are set by state PSCs under cost-based and consider,a ,wide array of potential business strategies. regulatory principles. Retail rates and earnings are reviewed and may be adjusted p'eriodically within certain. These strategiesmay include business combinations, limitations. Southern Power continues to focus on long- acquisitions involving other utility or non-utility term capacity contracts, optimized by limited energy businesses or properties, internal restructuring, disposition trading activities. The level of future earnings depends on of certain assets, or some combination thereof. numerous factors: including the FederalEnergy Regulatory Furthermore, Southern Company may engage in new Commission's (FERC) market-based rate investigation, business ventures that arise from competitive and . creditworthiness 'of cuslomers, total generating capacity regulatory changes in the utility industry. Pursuit .of any available in the Southeast, -and the successful reniarketing of the above strategies, or any combination thereof, may of capacity as current contracts expire.-See significantly 'affect the 'business operations and financial ACCOUNTING POLICIES - "Application of Critical condition of Southern Company.: , 11-17

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report Environmental Matters plaintiffs' request to stay the appeal, pending the U.S. Supreme Court's ruling in a similar NSR case filed Compliance costs related to the Clean Air Act and other by the EPA against Duke Energy. The action against environmental regulations could affect earnings if such Georgia Power has been administratively closed since the costs cannot be fully recovered in rates on a timely basis. spring of 2001, and none of the parties has sought to Environmental compliance spending over the next several reopen the case. years may exceed amounts estimated. Some of the factors driving the potential for such an increase are higher Southern Company believes that the traditional commodity costs, market demand for labor, and scope operating companies complied with applicable laws and additions and clarifications. The timing, specific the EPA regulations and interpretations in effect at the requirements, and estimated costs could also change as time the work in question took place. The Clean Air Act environmental regulations are modified. See Note 3 to the authorizes maximum civil penalties of $25,000 to financial statements under "Environmental Matters" for $32,500 per day, per violation at each generating unit, additional information. depending on the date of the alleged violation. An adverse outcome in any one of these cases could require New Source Review Actions substantial capital expenditures that cannot be determined at this time and could possibly require payment of In November 1999, the Environmental Protection Agency substantial, penalties. Such expenditures could affect (EPA) brought a civil action in the U.S. District Court for future results of operations, cash flows, and financial the Northern District of Georgia against certain Southern condition if such costs are not recovered through Company subsidiaries, including Alabama Power and regulated rates. Georgia Power, alleging that these subsidiaries had violated the New Source Review (NSR) provisions of the The EPA has issued a series of proposed and final Clean Air Act and related state laws at certain coal-fired revisions to its NSR regulations under the Clean Air Act, generating facilities. Through subsequent amendments and many of which have been subject to legal challenges by other legal procedures, the EPA filed a separate action in environmental groups and states. On June 24, 2005, the January 2001 against Alabama Power in the U.S. District U.S. Court of Appeals for the District of Columbia Court for the Northern District of Alabama after Alabama Circuit upheld, in part, the EPA's revisions to NSR Power was dismissed from the original action. In these regulations that were issued in December 2002 but lawsuits, the EPA alleged that NSR violations occurred at vacated portions of those revisions addressing the eight coal-fired generating facilities operated by Alabama exclusion of certain pollution control projects. These Power and Georgia Power (including a facility formerly regulatory revisions have been adopted by each of the owned by Savannah Electric). The civil actions request states within Southern Company's service territory. On penalties and injunctive relief, including an order March 17, 2006, the U.S. Court of Appeals for the' requiring the installation of the best available control District of Columbia Circuit also vacated an EPA rule technology at the affected units. which sought to clarify the scope of the existing Routine Maintenance, Repair, and Replacement exclusion. In On June 19, 2006, the U.S. District Court for the October 2005 and September 2006, the EPA also Northern District of Alabama entered a consent decree published proposed rules clarifying the test for between Alabama Power and the EPA, resolving the determining when an emissions increase subject to the alleged NSR violations at Plant Miller. The consent NSR permitting requirements has occurred. The impact of decree required Alabama Power to pay $100,000 to these proposed rules will depend on adoption of the final resolve the government's claim for a civil penalty and to rules by the EPA and the individual state implementation donate $4.9 million of sulfur dioxide emission allowances of such rules, as well as the outcome of any additional to a nonprofit charitable organization and formalized legal challenges, and, therefore, cannot be determined at specific emissions reductions to be accomplished by this time. Alabama Power, consistent with other Clean Air Act programs that require emissions reductions. On August 14, Carbon Dioxide Litigation 2006, the district court in Alabama granted Alabama Power's motion for summary judgment and entered final In July 2004, attorneys general from eight states, each judgment in favor of Alabama Power on the EPA's claims outside of Southern Company's service territory, and the related to Plants Barry, Gaston, Gorgas, and Greene corporation counsel for New York City filed a complaint County. The plaintiffs have appealed this decision to the in the U.S. District Court for the Southern District of New U.S. Court of Appeals for the Eleventh Circuit and, on York against Southern Company and four other electric November 14, 2006, the Eleventh Circuit granted power companies. A nearly identical complaint was filed 11-18

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report by three environmental groups in the same court. The environmental media, including air, water, and land complaints allege that the companies' emissions of carbon resources. Applicable statutes. include the Clean Air Act; dioxide, a greenhouse gas, contribute to global warming, the Clean Water Act; the Comprehensive Environmental which the plaintiffs assert is a public nuisance. Under Response, Compensation, and Liability Act; the Resource common law public and private nuisance theories, the Conservation and Recovery Act; the Toxic Substances plaintiffs seek a judicial order (1) holding each defendant Control Act; the Emergency Planning & Community jointly and severally liable for creating, contributing to, Right-to-Know Act; and the Endangered Species Act. and/or maintaining global warming and (2) requiring each Compliance with these environmental requirements of the defendants to cap its emissions of carbon dioxide involves significant capital and operating -costs, a major and then reduce those emissions by a specified percentage portion of which is expected to be recovered through each year for at least a decade. Plaintiffs havelnot, existing ratemaking provisions. Through 2006, Southern however, requested that damages be awarded in Company had invested approximately $3.1 billion in connection with their claims. Southern Company believes capital -projects to comply with these requirements, with these claims are without merit and notes that the annual totals of $661 million, $423 million, and complaint cites no statutory or regulatory basis for the $300 million for 2006, 2005, and 2004, respectively. The claims. In September 2005, the U.S. District Court for the Company expects that capital expenditures to assure Southern District of New York granted Souihern compliance with existing and new regulations will be an Company's and the other defendants' motions to dismiss additional $1.66 billion, $1.65 billion, and $1.27 billion these cases. The plaintiffs filed an appeal to the U.S. Court for 2007, 2008, and 2009, respectively. Because the of Appeals for the Second Circuit in October,2005. The Company's compliance *strategy is impacted by changes to ultimate outcome of these matters cannot be determined existing environmental laws and regulations, the cost, at this time. availability, and existing inventory of emission allowances, and the Company's fuel mix, the ultimate Plant Wansley EnvironmentalLitigation outcome cannot be determined at this time. Environmental costs that are known and estimable at this In December 2002, the Sierra Club, Physicians for Social time are included in capital expenditures discussed under Responsibility, Georgia Forestwatch, and one individual FINANCIAL CONDITION AND LIQUIDITY - "Capital filed a, civil suit in the U.S. District Court for the Requirements and Contractual Obligations" herein. Northern District of Georgia against Georgia Power for Compliance with possible additional federal or state alleged violations of the Clean Air Act at four of the units legislation or regulations related to global climate change, at Plant Wansley. The civil action requested injunctive air quality, or other environmental and health concerns. and declaratory relief, civil penalties, a supplemental could also significantly affect Southern Company. New environmental project, .and attorneys' fees. In January environmental legislation or regulations, or changes to 2007, following the March 2006 reversal and remand by existing statutes or regulations, could affect many areas of the U.S. Court of Appeals for the Eleventh Circuit, the Southern Company',s operations; however, the full impact district court ruled for Georgia Power on all remaining of ýny such changes cannot be determined at this time. allegations in this case. The only issue remaining for resolution by the district court is the appropriate remedy for two isolated, short-term, technical violations of the Air Quality plant's Clean Air Act operating permit. The court has Compliance with the Clean Air Act and resulting asked the parties to submit a joint proposed remedy or regulations has been and will continue to be a significant individual proposals in the event the parties cannot agree. focus for Southern Company. Through 2006, the Although the ultimate outcome of this matter cannot Company had spent approximately $2.5 billion in currently be determined, 'the resulting liability associated reducing sulfur dioxide (SO 2) and nitrogen oxide (NO.) with'the two events is not expected to have a material emissions and in monitoring emissions pursuant to the impact on the Company's financial statements. Clean Air Act. Additional controls have been announced and are currently being installed at several plants to EnvironmentalStatutes and Regulations further lieduce S02, NO,, and mercury emissions, maintain 'ompliance with existing regulations, and meet General new requirements. Southern Company's operations are subject to extensive Approximately $1.3 billion of the expenditures regulation by state and federal environmental agencies related to reducing NOx emissions pursuant to state and under a variety of statutes and regulations governing federal requirements were in connection with the EPA's 11-19

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report one-hour ozone air quality standard and the 1998 regional nonattainment areas based on the new standard by NO,, reduction rules. In addition, in 2006, Gulf Power December 2009. The final outcome of this matter cannot completed implementation of the terms of a 2002 be determined at this time. agreement with the State of Florida to help ensure The EPA issued the final Clean Air Interstate Rule in attainment of the ozone standard in the Pensacola, Florida March 2005. This cap-and-trade rule addresses power area. The conditions of the agreement; which required installing additional controls on certain units and retiring plant SO 2 and NO,, emissions that were found to three older units at a plant near Pensacola, totaled contribute to nonattainment of the eight-hour ozone and fine particulate matter standards in downwind states. approximately $133.8 million, and have been approved Twenty-eight eastern states, including each of the states under Gulf Power's environmental cost recovery clause. within Southern Company's service area, are subject to In 2005, the EPA revoked the one-hour ozone air the requirements of the rule. The rule calls for additional quality standard and published the second of two sets of reductions of NO,, and/or S02 to be achieved in two final rules for implementation of the new, more stringent phases, 2009/2010 and 2015. These reductions will be eight-hour ozone standard. Areas within Southern accomplished by the installation of additional emission Company's service area that were designated as controls at Southern Company's coal-fired facilities or by nonattainment under the eight-hour ozone standard the purchase of emission, allowances from a cap-and-trade included Macon (Georgia), Jefferson and Shelby Counties, program. near and including Birmingham (Alabama), and a The Clean Air Visibility Rule (formerly called the 20-county area within metropolitan Atlanta. Macon is in Regional Haze Rule) was finalized in July 2005. The goal the process of seeking redesignation by the EPA as an of this rule is to restore natural visibility conditions in attainment area and is preparing a maintenance plan for certain areas (primarily national parks and wilderness approval. The Birmingham area was redesignated to areas) by 2064. The rule involves (1) the application of attainment with the eight-hour, ozone standard by the EPA Best Available Retrofit Technology (BART) to certain on June 12, 2006, and the EPA subsequently approved a sources built between 1962 and 1977 and (2) the maintenance plan for the area to address future application of any additional emissions reductions which exceedances of the standard. On December 22, 2006, the may be deemed necessary for each designated area' to U.S. Court of Appeals for the District of Columbia achieve reasonable progress toward the natural Conditions Circuit vacated the first set of implementation rules goal by 2018. Thereafter, for each 10-year planning adopted in 2004 and remanded the rules to the EPA for period, additional emissions reductions will be required to further refinement. The impact of this decision, if any, continue to demonstrate reasonable progress in each area cannot be determined at this time and will depend on during that period. For power plants, the Clean Air subsequent legal action and/or rulemaking activity. State Visibility Rule allows states to determine that the Clean implementation plans, including new emission control Air Interstate Rule satisfies BART requirements for SO 2 regulations necessary to bring ozone nonattainment areas and NO,,. However, additional BART requirements for into attainment, are currently required for most areas by particulate matter could be imposed, and the reasonable June 2007. These state implementation plans could progress provisions could result in requirements for require further reductions in NO, emissions from power additional SO 2 controls. By December 17, 2007, states plants. must submit implementation plans that contain strategies for BART and any other control measures required to During 2005, the EPA's fine particulate matter achieve the first phase of reasonable progress. nonattainment designations became effective for several areas within Southern Company's service area in Alabama In March 2005, the EPA published the final Clean and Georgia, and the EPA proposed a rule for the Air Mercury Rule, a cap-and-trade program for the, implementation of the fine particulate matter standard. reduction of mercury emissions from coal-fired power. The EPA is expected to publish its final rule for plants. The rule sets caps on mercury emissions to be implementation of the existing fine particulate .matter implemented in two phases, 2010 and 2018, and provides standard in early 2007. State plans for addressing the for an emission allowance trading market. The Company nonattainment designations under the existing standard are anticipates that emission controls installed to achieve required by April 2008 and could require further compliance with the Clean Air Interstate Rule and the reductions in SO2 and NO,, emissions from power plants. eight-hour ozone and fine-particulate air quality standards On September 21, 2006, the EPA published a final rule will also result in mercury emission reductions. However, lowering the 24-hour fine particulate matter air quality the long-term capability of emission control equipment to standard even further and plans to designate reduce mercury emissions is still being evaluated, and the 11-20

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report installation of additional control technologies may be Environmental Remediation required., Southern Company must comply with other environmental The impacts of the eight-hour ozone and the fine laws and regulations that cover the handling and disposal particulate matter nonattainment designations, the Clean of waste and release of hazardous substances. Under these Air Interstate Rule, the Clean Air Visibilit' Rule, and the various laws and regulations, the traditional operating Clean Air Mercury Rule on the Company Will depend on companies could incur substantial costs to clean up the development and implementation of rules at the state propertile's. The irdditional operating companies conduct level.' States implementing the Clean Air Mercury Rule studies 'to dtermuine the extent of any required cleanup and the Clean Air Interstate Rule,* in partiu'lar, have the and have'rece6kiized in' their respective financial option not to participate in tlie national' cap-and-trade -... statements the costs to clean up known sites. Amounts for programs and could require reductions greater than those cleanup and ongoing monitoring costs were not material mandated by the federal rules. Impacts will also depend for any year presented. The traditional operating on resolution of pending legal challenges to these rules. companies may be liable for some or all required cleanup Therefore', the full effects of these regulations on the costs for additional sites that may require, environmental Company cannot be determined at this ,time'. Tie remediation. See Note 3 to the financial statements under Company has developed' and contiiiualfy updates a "Environrp.ental Matters - Environmental Remediation" comprehensive environmental compliance strategy to for additional .information. comply with the continuing and new Ieovironmental requirements discussed above.' As part od* ;. Ithis i strategy,

g. the h

GlobalClimate Issues Company plans to install additional SOý, NO., and mercury emission controls within'the next Se-eival years'to Domestic efforts to limit greenhouse gas emissions have assure continued compliance with applicable air quality been spurred by international negotiations ,under the requirements. Framework Convention on Climate Change and specifically the Kyoto Protocol, which proposes a binding limitation on the emissions of greenhouse gases for Water Quality ,, industrialized countries. The Bush Administration has not In Juiy 2004, the EPA published its final technology- supported U.S. ratification of the Kyoto .Protocol orother mandatory carbon Olioxide reduction legislation; however, based regulations under the Clean Water Act for the. purpose of reducing impingement and entrainment of fish, in 2002, it did announce a goal to reduce the greenhouse gas intensity of the U.S. economy, the ratio of greenhouse shellfish, and other forms of aquatic life at existing power gas emissions to the value of U.S. economic output, by plant cooling -water intake structures. The rules require baseline biological information and, perhaps, installation 18 percent by 2012. Southern Company is participating in of fish protection technology near some intake structures the voluntary electric utility sector climate change at existing power plants. On January 25,(2007, the initiative, known as Power Partners, under the Bush Administration's Climate VISION program. The utility U.S. Court of Appeals for the*Second Circtit overturned and remanded several provisionrs of the rule'to the EPA sector pledged to reduce its greenhouse gas emissions rate for revisions. Among other things, the court rejected the by 3 percent to'5 percent by 2010-2012. The Company EPA's use of "cost-benefit". analysis and suggested some continues to evaluate future energy 'and emission profiles ways to incorporate cost considerations. The full impact relative'to the Povwe'r Partners program and is participating in voluntary programs to support the industry 'initiative. In of these regulations will depend on subsequent legal addition, ihe Cormipany is participating in the Bush proceedings, further rulemaking by the EPA, the results of studies and analyses performed as part of the rules' ,, Administration's'Asia Pacific Partnership on'Clean requirements established Developmenit and Climate, a public/private partnership to' imllementation, and the actual work-together to meet goals for energy security, national by state regulatory agencies and, ;therefore,, Cannot now' be determined. air pollution' reduction, and climate change in'ways that promote sustainable economic growth and poverty Georgia Power is retrofitting a closed-loop reduction. Legislativie'proposals that would impose recirculating cooling tower at one facility- under the Clean, mandatory restrictiohs on carbon dioxide -emissions Water Act to cool water prior to discharge and is continue to be considered in 'Congress. The ultimate considering undertaking similar-work at an additional outcome cannot be 'determined at-this time; however, facilityý The total estimated capiial 'cost for this project is' mandatory restrictions on the Company's carbon dioxide

 $96 million. Southern Company is als6 considering                          emissions Could result in significant additional compliance similar projects at other facilities.      '     ,I.                      costs that could iffect future results of operations, cash I1-21

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report flows, and financial condition if such costs are not below. On January 3, 2007, the FERC issued an order recovered through regulated rates. noting settlement of the IIC proceeding and seeking comment identifying any remaining issues and the proper FERC Matters procedure for addressing any such issues. Market-Based Rate Authority Southern Company and its subsidiaries believe that there is no meritorious basis for these proceedings and are Each of the traditional operating companies and Southern vigorously defending themselves in this matter. However, Power has authorization from the FERC to sell power to the final outcome of this matter, including any remedies non-affiliates, including short-term opportunity sales, at to be applied in the event of an adverse ruling in these market-based prices. Specific FERC approval must be proceedings, cannot now be determined. obtained with respect to a market-based contract with an affiliate. Intercompany Interchange Contract In December 2004, the FERC initiated a proceeding The Company's generation fleet in its retail service to assess Southern Company's generation dominance territory is operated under the IIC, as approved by the within its retail service territory. The ability to charge FERC. In May 2005, the FERC initiated a new market-based rates in other markets is not an issue in that proceeding to examine (1) the provisions of the IIC proceeding. Any new market-based rate sales by any among Alabama Power, Georgia Power, Gulf Power, subsidiary of Southern Company in Southern Company's Mississippi Power, Savannah Electric, Southern Power, retail service territory entered into during a 15-month and Southern Company Services, Inc. (SCS), as agent, refund period beginning February 27, 2005 could be under the terms of which the power pool of Southern subject to refund to the level of the default cost-based Company is operated, and, in particular, the propriety of rates, pending the outcome of the proceeding. Such sales the continued inclusion of Southern Power as a party to through May 27, 2006, the end of the refund period, were the IIC, (2) whether any parties to the IIC have violated approximately $19.7 million for the Southern Company the FERC's standards of conduct applicable to utility system. In the event that the FERC's default mitigation companies that are transmission providers, and (3) whether measures for entities that are found to have market power Southern Company's code of conduct defining Southern are ultimately applied, the traditional operating companies Power as a "system company" rather than a "marketing and Southern Power may be required to charge cost-based affiliate" is just and reasonable. In connection with the rates for certain wholesale sales in the Southern Company formation of Southern Power, the FERC authorized retail service territory, which may be lower than Southern Power's inclusion in the IIC in 2000. The FERC negotiated market-based rates. The final outcome of this also previously approved Southern Company's code of matter will depend on the form in which the final conduct. methodology for assessing generation market power and mitigation rules may be ultimately adopted and cannot be On October 5, 2006, the FERC issued an order determined at this time. accepting a settlement resolving the proceeding subject to Southern Company's agreement to accept certain In addition, in May 2005, the FERC started an modifications to the settlement's terms. On October 20, investigation to determine whether Southern Company 2006, Southern Company notified the FERC that it satisfies the other three parts of the FERC's market-based accepted the modifications. The modifications largely rate analysis: transmission market power, barriers to entry, involve functional separation and information restrictions and affiliate abuse or reciprocal dealing. The FERC related to marketing activities conducted on behalf of established a new 15-month refund period related to this Southern Power. Southern Company filed with the FERC expanded investigation. Any new market-based rate sales on November 6, 2006 an implementation plan to comply involving any Southern Company subsidiary could be with the modifications set forth in the order. The impact subject to refund to the extent the FERC orders lower of the modifications is not expected to have a material rates as a result of this new investigation. Such sales impact on Southern Company's financial statements. through October 19, 2006, the end of the refund period, were approximately $55.4 million for the Southern Generation Interconnection Agreements Company system, of which $15.5 million relates to sales inside the retail service territory discussed above. The In July 2003, the FERC issued its final rule on the FERC also directed that this expanded proceeding be held standardization of generation interconnection agreements in abeyance pending the outcome of the proceeding on and procedures (Order 2003). Order 2003 shifts much of the Intercompany Interchange Contract (IIC) discussed the financial burden of new transmission investment from 11-22

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report the generator to the transmission provider, The FERC has PSC Matters indicated that Order 2003, which was effective January 20, 2004, ,is to be applied prospectively to new generating Alabama:Power facilities interconnecting to a transmission system. Order 2003 was affirmed by the U.S. Court of Appeals for the In October -2005, the Alabama PSC approved a revision to District of Columbia Circuit on January 12, 2007. The the Rate Stabilization and Equalization Plan (Rate RSE) cost impact resulting from Order 2003 will vary on a requested -by Alabama Power. Effective January 2007, case-by-case basis for each new generator interconnecting RateRSE adjustments are based on forward-looking to the transmission system. information for the applicable upcoming calendar year. Rate adjustments for any two-yeaw period, when averaged On November 22, 2004, generator company together, cannot exceed 4 percent per year and any annual subsidiaries of Tenaska, Inc. (Tenaska), as counterparties adjustment is limited to 5 percent. Rates remain to three previously executed interconnection agreements unchanged when the projected return on common equity with subsidiaries of Southern Company, filed complaints (ROE) ranges between 13 percent and 14.5 percent. If at the FERC requesting that the FERC modify the Alabama Power's actual retail ROE is above the allowed agreements and that those Southern Company subsidiaries equity return range, customer refunds will be required; refund a total of $19 million previously paid for however, there is no provision for additional customer interconnection facilities, with interest. Southern billings should the actual retail return on common equity Company has also received requests for similar fall below the allowed equity return range. Alabama modifications from other entities, though no other Power made its initial submission of projected data for complaints are pending with the FERC. On January 19, calendar year 2007 on December 1, 2006. The Rate RSE 2007, the FERC issued an order granting Tenaska's increase for 2007 is.4.76 percent, or $193 million requested relief. Although the FERC's order requires the annually and, became effective in January 2007. See modification of Tenaska's interconnection agreements, the Note 3 to the financial statements under "Alabama Power order reduces the amount of the refund that had been Retail Regulatory Matters" for further information. requested by Tenaska. As a result,,Southern Company estimates indicate that no refund is due Tenaska. Southern Georgia Power Company has requested rehearing of the FERC's order. The final outcome of this matter cannot now be In December 2004, the Georgia PSC approved the three-determined. year retail rate plan ending December 31, 2007 (2004 Retail Rate Plan) for Georgia Power. Under the terms of the 2004 Retail Rate Plan, Georgia Power's earnings are Transmission evaluated against a retail ROE range of 10.25 percent to 12.25 percent. Two-thirds of any earnings ab*ve In December 1999, the FERC issued its final rule on 12.25 percent are applied to rate refunds, with the Regional Transmission Organizations (RTOs). Since that remaining one-third retained by Georgia Power. Retail time, there have been a number,of -additional proceedings rates' and cist6&ner fees were increased by 'approximately at the FERC designed to encourage further voluntary $203 million 'in January 2005 to cover the higher costs of formation of RTOs or to mandate their formation. purchased power, operations and maintenance expenses, However, at the current time, there are no active, ý! environmental compliance, and continued investment in proceedings that would require Southern Company to new generation, transmission,' and distribution facilities to participate in an RTO. Current FERC efforts that may support growth and ensure reliability. potentially change the regulatory and/or operational structure of transmission include rules related to the Georgia:Power is required to file a general rate case standardization of generation interconnection, as well as on or about July 1, 2007, in response to which the an inquiry into, among other things, market power by Georgia PSC would be expected to determine whether the vertically integrated utilities. See "Market-Based Rate 2004 Retail Rate Plan should be continued, modified, or Authority" and "Generation Interconnection Agreements" discontinued. See Note 3 to the financial statements under above for additional information. The final outcome of "Georgia Power Retail Regulatory Matters" for additional these proceedings cannot now be determined. However, information. Southern Company's .financial condition, results of operations, and cash flows could be, adversely, affected by Effective July 1, 2006, Savannah Electric was future changes in the federal regulatory or operational merged into Georgia Power. See "Fuel Cost Recovery" structure of transmission. herein for additional information. 11-23

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report Mississippi Power recovered fuel costs: included in the balance sheets to

                                                                   $1.3 billion at December 31, 2006. The traditional In February 2007, Mississippi Power filed with the operating companies continuously monitor the under Mississippi PSC its annual Environmental Compliance recovered fuel cost balance in light of-these higher fuel Overview (ECO) Plan evaluation for 2007. Mississippi costs. Each of the traditional operating companies Power requested an 86 cent per 1,000 KWH increase for               received approval in 2005 and/or 2006 to increase its fuel retail customers. This increase represents approximately cost recovery factors to recover existing under recovered

$7.5 million per year in annual revenues for Mississippi amounts as well as projected future costs. Power. Hearings with the Mississippi PSC are expected to be held in April 2007. The outcome of the 2007 filing Alabama Power fuel costs are recovered under Rate cannot now be determined. In April 2006, the Mississippi ECR (Energy Cost Recovery),, which provides for the PSC approved Mississippi Power's 2006 ECO Plan, which addition of a fuel and energy cost factor to base rates. In included a 12 cent per 1,000 KWH reduction for retail December 2005, the Alabama PSC approved an increase customers. This decrease represented a reduction of that allows for the recovery of approximately $227 million approximately $1.3 million per year in annual revenues in existing under recovered fuel costs over a two-year for Mississippi Power. The new rates were effective in period. As of December 31, 2006, Alabama Power had an April 2006. under recovered fuel balance of approximately

                                                                    $301 million.

In December 2006, Mississippi Power submitted its annual Performance Evaluation Plan (PEP) filing for In March 2006, Georgia Power and Savannah 2007, which resulted in no rate change. Pursuant to the Electric filed a combined request for fuel cost recovery rate schedule, an order is not required from the rate changes with&the Georgia PSC to be effective July 1, Mississippi PSC for Mississippi Power to continue to bill 2006, the effective date of the merger of Savannah the filed rate in effect. In March 2006, the Mississippi Electric into Georgia Power. On June 15, 2006, the PSC approved Mississippi Power's 2006 PEP filing, Georgia PSC ruled on the request and approved an which included an annual retail base rate increase of increase in 'Georgia Power's total annual fuel billings of 5 percent, or $32 million that was effective in April 2006. approximately $400 million. The Georgia PSC order Ordinarily, PEP limits annual rate increases to 4 percent; provided for a combined ongoing fuel forecast but' however, Mississippi Power had requested that the reduced the requested increase related to, such forecast by Mississippi PSC approve a temporary change to allow it $200 million. The order also 'required Georgia Power to to exceed this cap as a result of the ongoing effects of file for a new fuel cost recovery rate on a semi-annual Hurricane Katrina. basis, beginning in September 2006. Accordingly, on September 15, 2006, Georgia Power filed a request to In May 2004, the Mississippi PSC approved recover fuel costs incurred through August 2006 by Mississippi Power's request to reclassify to jurisdictional increasing the fuel cost recovery rate. cost of service the 266 megawatts of Plant Daniel unit 3 and 4 capacity, effective January 1, 2004. The Mississippi On November 13, 2006, under an agreement with the PSC authorized Mississippi Power to include the related Georgia PSC staff, Georgia Power filed a supplementary costs and revenue credits in jurisdictional rate base, cost request reflecting a forecast of annual fuel costs, as well' of service, and revenue requirement calculations for as updated information for previously incurred fuel costs. purposes of retail rate recovery. Mississippi Power is On February 6, 2007, the Georgia PSC ruled on the amortizing the regulatory liability established pursuant to request and approved an increase in Georgia Power's total the Mississippi PSC's order to earnings as follows: annual billings of approximately $383 million. The $16.5 million in 2004, $25.1 million in 2005, Georgia PSC order reduced Georgia Power's requested $13.0 million in 2006, and $5.7 million in 2007, resulting increase in the forecast of annual fuel costs by $40 million in expense reductions in each of those years. and disallowed $4 million of previously incurred fuel costs. The order also requires Georgia Power to file for a Fuel Cost Recovery new fuel cost recovery rate no later than March 1, 2008. The new rates will become effective on March 1, 2007. The traditional operating companies each have established Estimated under recovered fuel costs are to be recovered fuel cost recovery rates approved by their respective state through May 2009 for customers in the former Georgia PSCs. Over the past two years, the traditional operating Power territory and through November 2009 for companies have continued to experience higher than customers in the former Savannah Electric territory. As of expected fuel costs for coal, natural gas, and uranium. December 31, 2006, Georgia Power had an under These higher fuel costs have increased the under recovered fuel balance of approximately $898 million. 11-24

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report Fuel cost recovery revenues as recorded on the Mississippi Development Authority (MDA) for a financial statements are adjusted for differences in actual Community Development Block Grant (CDBG). recoverable costs and amounts billed in current regulated Mississippi' Power filed the CDBG application with the rates. Accordingly, changing the billing factor has no MDA in September 2006. On October 30, 2006, significant effect on the Company's revenues or net Mississippi Power received from'the MDA a CDBG in income, but does impact annual cash flow. Based on their the amount of $276.4 million. Mississippi Power has respective state PSC orders, a portion of the under ' appropriaiely allocated and applied these CDBG proceeds recovered regulatory clause revenues for Alabama Power to both ietail and wholesale storm restoration cost and Georgia Power was reclassified from current assets to recovery. deferred charges and other assets in thebalance sheet. See Mississippi Power filed an application for a financing Note 1 to the financial statements under "Revenues" and order with the Mississippi PSC on July 3, 2006 for Note 3 to the financial statements under "Alabamna Power restoration costs under the state bond program. On Retail Regulatory Matters" and "Georgia Power Retail October 27, 2006, the Mississippi PSC issued a financing Regulatory Matters" for additional information. order that authorizes the issuance of $121.2 million of system restoration bonds. This amount includes Storm Damage Cost Recovery $25.2 nmillion for the retail storm recovery costs not covered by the CDBG, $60 million for a property damage In July 2005 and August 2005, Hurricanes Dennis and reserve, andS36 million for the retail portion of the Katrina, respectively, hit the Gulf Coast of the. United constructdion of.the storm operations facility. The bonds States and caused significant damage within Slouthern will be issued by the Mississippi Development Bank on Company's service area, including portions ýof the service behalf of the State of Mississippi and will be reported as areas of Gulf Power, Alabama Power, and Mississippi liabilities by the State of Mississippi. Periodic true-up Power. In addition, Hurricane Ivan hit the Gulf Coast of mechanisms will be structured to comply with terms and Florida and Alabama in September 2004, causing requirements of the legislation. Details regarding the significant damage to the service areas of both Gulf issuance of the bonds have not been finalized. The final Power and Alabama Power. Each retail operating i outcome, of this matter cannot now be determined. company maintains a reserve to cover the cost of damages from major storms to its transmission and distribution As of December 31, 2006, Mississippi Power's under lines and the cost of uninsured damages to its generation recovered balance in the property damage reserve account facilities and other property. In addition, each of the totaled approximately $4.7 million which is included in affected traditional operating companies 'has been the balance sheets herein under "Current Assets." . authorized by its state PSC to defer the poortion of the In July 2006, the Florida PSC issued its order hurricane restoration costs that exceeded the balance in its approvinga stipulafion and settlement between Gulf storm damage reserve account. As of December 31, 2006, Power and several consumer groups that resolved all the under recovered balance in Southern Company's storm matters relating to Gulf Power's request for recovery of, damage reserve accounts totaled approximately:' incurred costs for storm-recovery activities and the

$89 million, of which approximately $57 million-and replenishment of"Gulf Power's property damage reserve.
$32 million, respectively, are included in the balance The order provides for an extension of the storm-recovery sheets herein under "Other Current Assets" and "Other surcharge currently being collected by Gulf Power for an Regulatory Assets."

additional 27 months, expiring in. June 2009. According to In June 2006, the Mississippi PSC: issued an order the stipulation, the funds resulting from the extension of based upon a stipulation ,between Mississippi Power and the current surcharge will first ,be credited to the the Mississippi Public Utilities Staff. The stipulation and unrecovered balance of storm-recovery costs associated the associated order certified actualistorm restoration with Hurricane Ivan until these costs have been fully costs relating to Hurricane Katrina through April 30, 2006 recovered. The funds will then be credited to the property of $267.9 million and affirmed estimated additional costs* reserve for recovery of the storm-recovery costs of through December 31, 2007 of $34.5 million,, for total $52.6 million associated with Hurricanes Dennis and storm restoration costs of.$302.4 millioni -which was net Katrina that were previously charged to the reserve. of insurance proceeds of approximately $77 million,: Should revenues ,collected by Gulf Power through the without offset for the property damage reserve of '. extension of the storm-recovery surcharge exceed the

 $3.0 million. Of the total amount, '$292.8 million applies         storm-recovery costs associated with Hurricanes Dennis to Mississippi Power's retail jurisdiction. The order              and Katrinal, the excess revenues will be credited to the directed Mississippi Power to file an application with the         reserve. The annual accrual to the reserve of $3.5 million 11-25

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report and Gulf Power's limited discretionary authority to make the balance sheets herein under "Current Assets:' The additional accruals to the reserve will continue as remaining $15.0 million collected was used to establish previously approved by the Florida PSC. Gulf Power the target reserve for future storms. The balance in the made discretionary accruals: to the reserve of $3 million, target reserve,, reduced for current year activity, was $6 million, and $15 million in 2006, 2005, and 2004, $13.2 million at December 31, 2006 and is included in respectively. As part of a March 2005 agreement the balance sheets herein under "Other Regulatory regarding Hurricane Ivan costs that established the Liabilities." existing surcharge, Gulf Power agreed that it would not seek any additional increase in its base rates and charges See Notes 1 and 3 to the financial statements under to become effective on or before March 1, 2007. The "Storm Damage Reserves" and "Storm Damage Cost, terms of the stipulation do not alter or affect that portion Recovery," respectively, for additional information on these reserves. The final outcome of these matters cannot of the prior agreement. According to the order, in the case of future storms, if Gulf Power incurs cumulative costs now be determined. for storm-recovery activities in excess of $10 million during any calendar year, Gulf Power will be permitted to Mirant Matters file a streamlined formal request for an interim surcharge. Mirant was an energy company with businesses that Any interim surcharge would provide for the recovery, included independent power projects and energy trading subject to refund, of up to 80 percent of the claimed costs and risk management companies in the U.S. and selected for storm-recovery activities. Gulf Power would then other countries. It was a wholly-owned subsidiary of petition the Florida PSC for full recovery through.an Southedr Company until its initial public offering in additional surcharge or other cost recovery mechanism. October 2000. In April 2001, Southern Company, As of December 31, 2006, Gulf Power's unrecovered completed a spin-off to its shareholders of its'remaining balance in the property damage reserve totaled ownership and Mirant became an independent corporate approximately $45.7 million, of which approximately entity. $28.8 million and $16.9 million, respectively, are included In July 2003, Mirant and certain of its affiliates filed in the balance sheets herein under "Current Assets" and for voluntary reorganization under Chapter 11 of the "Deferred Charges and Other Assets." Bankruptcy Code. In January 2006, Mirant's plan of. At Alabama Power, operation and maintenance reorganization became effective, and Mirant emerged expenses associated with Hurricane Ivan were from bankruptcy. As part of the plan, Mirant transferred; $57.8 million. In 2005, Alabama Power received Alabama substantially all of its assets and its restructured debt to a PSC approvals to return certain regulatory liabilities to the new corporation that adopted the name Mirant retail customers. These orders also allowed Alabama Corporation (Reorganized Mirant). Southern Company has Power to simultaneously recover from customers accruals certain contingent liabilities associated with guarantees of of approximately $48 million primarily to offset the costs contractual, commitments made by Mirant's subsidiaries. of Hurricane Ivan and restore a positive balance in the discussed in Note 7 to the financial statements under natural disaster reserve. The combined effect of these "Guarantees" and with various lawsuits discussed in orders had no impact on net income in 2005. Note 3 to the financial statements under "Mirant Matters." In December 2005. the Alabama PSC approved a In December 2004, as a result of concluding an IRS separate rate rider to recover Alabama Power's $51 million audit for the tax years 2000 and 2001, Southern Company of deferred Hurricane Dennis and Katrina operation and paid $39 million in additional tax and'interest for issues maintenance costs over a two-year period and to replenish related to Mirant tax items. Under the terms of the. .,,- its reserve to a target balance of $75 million over a five- separation agreements entered into in connection- with the year period.' spin-off, Mirant agreed to indemnify Southern Company for costs associated with these tax items and additional As of December 31, 2006, Alabama Power had IRS assessments. However, as a result of Mirant's " recovered $49.5 million of the costs allowed for storm- bankruptcy, Southern Company sought reimbursement as recovery activities, of which $34.5 million was a an unsecured creditor in the Chapter II proceeding. , reduction in the deficit balance in the natural disaster Based on management's assessment of the collectibility of reserve account related to costs deferred from previous the $39 million receivable, Southern Company has storms. The remaining under recovered balance in the reserved approximately $13.7 million. In December 2006, property damage reserve account totaled approximately Southern Company received approximately $23 million in $16.8 million at December 31, 2006 and is included in tax refunds from the IRS related to Mirant tax items. 11-26

I MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report Additional, refunds are expected. The amount of any

as to all counts in the complaint. On December 11; 2006, unsecured, claim ultimately allowed with respect to Mirant the U.S. DistrictCourt for the Northern District of tax items is expected to be reduced dollar-for-dollar by Georgia granted in part and denied in part the motion.,As the amount of all -refunds received from the, IRS by . a result, certain breach of fiduciary duty claims were, Southern Company, barred;'all other.claims in the complaint may proceed.

Southern Company believes there is no meritorious basis If Southern Company is ultimatel1y requiredto make for the claims in the, complaint and is vigorously any additional payments either with respect to the IRS defending itself in this action. See Note 3 to the financial audit or its contingent obligations dnder'guarantees of" statements under "Mirant Matters - MC Asset Recovery Mirant subsidiaries, -Mirant's indeninifkation obligation to Litigation" for additional information. The ultimate Southen Compan for these additionalf ayrnents, if outcome of these matters cannot be determined at this allowed, would constitute unsecured claimns against time. Mirant, entitled to stbck 'in Reorganized Mirant. See Note 3 to the financialgtatements uinder 'Mirant Income Tax Matters y ' " Matters"-- Mirant IBankruptcy' Leveraged Lease Transactions In June 2005, Mirant, as a debtor in .possession, and The Official Committee of Unsecured Creditors of Mirant Southern Company undergoes audits by the IRS for pach Corporation filed a complaint against Southern Company of its tax years. The IRS has completed its audits of in the U.S. Bankruptcy Court for the Northern District of Southern Company's consolidated federal income tax, Texas, which was amended in July 2005; February 2006, returns for all years through 2003. Southern Company and May 2006. The third amended complaint (the- ,.. participates in four, international leveraged lease complaint) alleges that Southern Company caused Mirant transactionis and receives federal income tax deductions. to engage in certain fraudulent transfers and to pay illegal for depreciation and amortization, as well as interest on dividends to Southern Company prior to the spin-off. The related debt. The IRS proposed to disallow' the taxlo'sses complaint also seeks to recharacterize certain advances for one of these leases (a lease-in-lease-out, or LILO)' in fromn Southern Company to Mirant for investments in connection with its audit of 1997 through 2001. In '2" energy facilities from debt. to equity. 'The complaint October 2004, Southern Company submitted the issue to further alleges; that Southern Company is liable to the IRS 'appeals division and in February 2005 reached a Mirant's creditors for the full amount of Mirant's liability, negotiated settlement with the IRS, which is now final: and that Southern Company breached-its fiduciary duties to Mirant and its creditors, caused Mirant to breach In connection with its audit of 2000 and 2001, the fiduciary duties to its creditors, and aided and abetted IRS also challenged Southern Company's deductionsf breaches of fiduciary duties by Mirant's directors and related to three other international: lease (sale-in-lease-out,. officers. The complaint also seeks recoveries under or SILO) transactions. In the third quarter 2006, Southern theories of restitution, unjust enrichment, and alter ego. Company paid the full amount of the disputed tax and the The complaint seeks monetary dan*ages in excess of applicable interest on the SILO issue for tax years

$2 billion plus interest,' punitive damajes', attormneys' fees, 2000-2001' an d filed a claim for refund which has' been and costs. Finally,. the complaint incplddgS'an objection to denied byI the IRS. The. disputed tax amount is $79 million Southern Company's pendirig claihs against Mirant in the and the rhlated interest is approximately $24 million for Bankruptcy Court (which relate 'to reimbursement under these tax yeý. This payment, and the subsequent IRS the separation agreements of pay1ments stich as income disallowance of the refund claim,' closed the issue with taxes, interest, legal fees, and oýihr' g'ualrtees described the IRS and Southern Company plans to proceed with in Note 7 to the financial sttemefits) and seeks equitable litigation. The IRS has also raised the SILO issues for tax subordination of Southern 'Comhp'any's 'claims to the years 2002`and 2003. The estimated amount ofdisputd' claims of all other creditors. Southern Comlpany served an tax and interest for these years is ajpproximately answer to the complaint in June 2006. $83 millioin and $1*5 million, respectively. The tax and" interest foi these tax years was paid'io the IRS in the In January 2006, MC Asset Recovery, a special. fourth quaiter 2006. Southern Company has accounted 'for purpose subsidiary of Reorganized Mirant, :was substituted both paymenis in 2006 as deposits; 's management as plaintiff. In February 2006, the Company's motion to believes no Iadditiofial tax or interest liabilities have been transfer the case to the U.S.- District Court for the .i, ie incl~rd* ,::

Northern District of Georgia was granted. On May 19, 2006, Southern Company filed. a motion for summary, Although the payment of the tax liability did not judgment seeking entry of judgment against the plaintiff affect Southern Company's results of operations under 11-27

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report accounting standards in effect through December 31, In May 2006, production at one of the synthetic fuel 2006, it did impact cash flow. For tax years 2000 through investments was idled due to continued uncertainty over 2006, Southern Company has claimed $284 million in tax the value of tax credits. In addition, Southern Company benefits related to these SILO transactions challenged by entered into an agreement in June 2006 which terminated the IRS. See Note I to the financial statements under its ownership interest in its other synthetic fuel "Leveraged Leases" for additional information. Southern investment, effective July 1, 2006. Also, during 2006, Company believes these transactions are valid leases for Southern Company entered into derivative transactions U.S. tax purposes and thus the related deductions are designed to reduce its exposure to changes in the value of allowable. The Company will continue to defend this tax credits associated with its synthetic fuel investments. position through administrative appeals or litigation. The These derivative transactions were marked to market ultimate outcome of these matters cannot now be through other income (expense), net. As a result of these determined. actions and the projected continued phase out of tax credits because of high oil prices,. the investments in these In July 2006, the Financial Accounting Standards two synthetic fuel entities were considered fully impaired Board (FASB) released new interpretations for the and approximately $16 million was written off and is accounting for both leveraged leases and uncertain tax reflected in the line item "Impairment loss on equity positions that were adopted January 1, 2007. For the method investments" on the statements of income herein. LILO transaction settled with the IRS in February 2005, In September 2006, due to reduced oil prices in the third the leveraged leases accounting interpretation requires that quarter, production was restarted at the synthetic fuel Southern Company recognize a cumulative effect facility in which Southern Company still has an reduction to beginning 2007 retained earnings of ownership interest. In October 2006, Southern Company approximately $17 million at adoption and change the entered into additional derivative transactions to reduce its timing of income recognized under the lease. exposure to the potential phase-out of these income tax For the SILO transactions which are the subject of credits in 2007. Subsequent to December 31, 2006, the pending litigation, Southern Company is continuing to Company entered into additional derivative transactions to evaluate the impact of the new interpretations but further reduce its exposure to potential phase-out of tax estimates that the reduction to retained earnings in 2007 credits in 2007, See Note 6 to the financial statements could be approximately $115 million to $135 million. The under "Financial Instruments" for additional information impact on Southern Company's net income of these regarding the impact of these derivatives. The final accounting interpretations would also be dependent on the outcome of these matters cannot now be determined. outcome of the pending litigation or changes in assumptions related to uncertain tax positions but could Construction Projects be significant, and potentially material. Integrated Coal Gasification Combined Cycle Synthetic Fuel Tax Credits In December 2005, Southern Power and the Orlando Southern Company had investments in two entities that Utilities Commission (OUC) executed definitive produce synthetic fuel and receive tax credits under agreements for development of an integrated coal Section 45K (formerly Section 29) of the Internal gasification combined cycle (IGCC) 285-megawatt project Revenue Code of 1986, as amended (Internal Revenue in Orlando, Florida. The definitive agreements provide Code). During 2006, as discussed below, Southern that Southern Power will own at least 65 percent of the Company's interest in one of the synthetic fuel entities gasifier portion of the IGCC project. OUC will own the was terminated. In accordance with Section 45K of the remainder of the gasifier portion and 100 percent of the Internal Revenue Code, these tax credits are subject to combined cycle portion of the IGCC project. OUC will limitation as the annual average price of oil (as purchase all of the gasifier capacity from Southern Power determined by the U.S. Department of Energy (DOE)) once the plant is in commercial operation. Southern increases over a specified, inflation-adjusted dollar Power will construct the project and manage its operation amount published in the spring of the subsequent year. after construction is completed. In February 2006, Southern Company, along with its partners in these Southern Power signed a cooperative agreement with the investments, has continued to monitor oil prices. Reserves DOE that provides up to $235 million in grant funding against these tax credits of $32 million were recorded in for the gasification portion of this project. The IGCC 2006 due to projected phase-outs of the credits in 2006 as project is subject to National Environmental Policy Act a result of higher oil prices. Synthetic fuel tax credits will review as well as state environmental review, requires end December 31, 2007. certain regulatory approvals, and is expected to begin 11-28

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report commercial operation in 2010. The total cost related to At this point, no final 'decision has been made regarding the IGCC project is currently being reviewed, and may be actual construction. Any new generation resource must be higher than earlier estimates .due to increases in certified by the Georgia PSC in a' separate proceeding. commodity costs and increased market demand for labor. On March 16, 2006, a subsidiary of Southern Southern Power had spent $7.8 million as of December 31,

                                                          .       Company entered into a develhpment agreement with 2006. Southern Power has the option under the Duke Energy Corporation (Duke Energy) to evaluate the agreements to end its participation in the IGCC project at potential construction of a new two-unit nuclear plant at a the end of the.project definition phase which is expected jointly.owned site in Cherokee County, South Carolina. If to be during 2007..

constructed, 'Southern Company would own an interest in In Junie 2006, Mississippi Power filed an application Unit 1, representing approximately 500 megawatts. Duke with the DOE for certain tax credits available to projects Energy will be the developer and licensed operator of any using clean coal technologies under the ,Energy Policy Act plant built at'the site. of 2005. The proposed project is anadvancedcoal Southern Company also is participating in NuStart gasification facility located in Kemper County, Energy Development, LLC (NuStart Energy), a broad-Mississippi that would use locally mined lignite coal. The based nuclear industry consortium formed' to share the proposed 693 megawatt plant, excluding the mine cost, is cost of developing a COL and the related 'NRC reyiew. expected to require an approximate investment of NuStart Energy plans to complete detailed engineering: $1.5 billion and is expected to be completed in 2013. The design wo6k anq to prepare COL applications for two DOE subsequently certified the project and in November advanced reactor designs, then to choose one of the 2006 the IRS allocated Internal Revenue Code:.... applications and file it for NRC review and approval. The Section 48A tax credits to Mississippi Power of COL ultimately .is expected to be transferred to one or $133 million. The uilhizatiorn of ithese credits is dependent more of the consortium companies; however, at this time, upon meeting the certification requtrcrnents for the project none of them have committed to build a new nuclear under the Internal Revenue Code. Teplant would use an plant. air-blown IGCC technology that generates'poWer from low-rank coals and coals with high moisture Or highý ash Southern Company 'is also exploring'other' content. These coals, whichinclude lignite, make up half possibilities relating,-to nuclear power projects, both on its the proven U.S. and worldwide coal reserves. Mississippi own or in partfiership with other utilities. The final Power is still undergoing a feasibilty 4ssessment of the outcome of these matters cannot now be determined. project which could take up to two years. Approval by various, regulatory. agencies,. including the Mississippi Other Matters PSC, will also be required if the project proceeds. Southern Cdompany is involved in various 'other matters The final outcome of these matters cannot now be being litigated, regulatory matters, and certain tax-related determined. issues that could affect future earnings. See Note 3 to the financial statements for information iegarding material Nuclear issues.,' On August 15,' 2006, as part of a potential expansion of Plant Vogtle, Georgia Power and S6dthern Nuclear ACCOUNTING POLICIES Operating Company, Inc. (SNC)Q. filed an application with Application of Critical Accounting Policies and , the Nuclear Regulatory Commission (NRC):for an early Estimates site permit (ESP) on behalf of, the owners of Plant Vogtle. In addition, Georgia'Power and SNC notified the NRC of Southern Company prepares its consolidated financial their intent to apply for a combined, constructibn and statements in accordance with accounting .princples operating license (COL) in 2008.' Ownership 'agreements generally accepted in the United States. Significant have been signed with each of the existing Plant Vogtle accounting policies are described in Note .1 to the co-owners. See Note 4 to the financial statements for financial statements. In the application of these policies, additional information on these co-owners. In June 2006, certain estimates are made that may haye.a material the Georgia PSC approved Georgia Power's request to impact on Southern Company's results of operations and establish an'accounting order that would allow Georgia related disclosures. Different assumptions and Power to defer for future recovery the ESP and COL measurements -could produce estimates that are costs, of which Georgia Power's portion ig estimated to significantly' different' from those recorded in the financial total approximately $51 million over the next four years. statements. 'Senior management has discussed the 11-29

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report development and selection of the critical accounting regarding certain of these contingencies. Southern policies and estimates described below with the Audit Company periodically evaluates its exposure to such risks Committee of Southern Company's Board of Directors. and records reserves for those matters where a loss is considered probable and reasonably estimable in Electric Utility Regulation accordance with generally accepted accounting principles. The adequacy of reserves can be significantly affected by Southern Company's traditional operating companies, external events or conditions that can be unpredictable; which comprise approximately 93 percent of Southern thus, the ultimate outcome of such matters could Company's total earnings for 2006, are subject to retail materially affect Southern Company's financial regulation by their respective state PSCs and wholesale statements. These events or conditions include the regulation by the FERC. These regulatory agencies set the following: rates the traditional operating companies are permitted to charge customers based on allowable costs. As a result, " Changes in existing state or federal regulation by the traditional operating companies apply FASB governmental authorities having jurisdiction over air Statement No. 71, "Accounting for the Effects of Certain quality, water quality, control of toxic substances, Types of Regulation" (SFAS No. 71), which requires the hazardous and solid wastes, and other environmental financial statements to reflect the effects of rate matters. regulation. Through the ratemaking process, the regulators may require the inclusion of costs or revenues in periods " Changes in existing income tax regulations or changes different than when they would be recognized by a non- in IRS or state revenue department interpretations of regulated company. This treatment may result in the existing regulations. deferral of expenses and the recording of related

                                                                   " Identification of additional sites that require regulatory assets based on anticipated future recovery through rates or the deferral of gains or creation of                  environmental remediation or the filing of other liabilities and the recording of related regulatory                    complaints in which Southern Company or its liabilities. The application of SFAS No. 71 has a further              subsidiaries may be asserted to be a potentially effect on the Company's financial statements as a result               responsible party.

of the estimates of allowable costs used in the ratemaking " Identification and evaluation of other potential lawsuits process. These estimates may differ from those actually or complaints in which Southern Company or its incurred by the traditional operating companies; therefore, subsidiaries may be named as a defendant. the accounting estimates inherent in specific costs such as depreciation, nuclear decommissioning, and pension and " Resolution or progression of existing matters through postretirement benefits have less of a direct impact on the the legislative process, the court systems, the IRS, or Company's results of operations than they would on a the EPA. non-regulated company. As reflected in Note I to the financial statements, Unbilled Revenues significant regulatory assets and liabilities have been recorded. Management reviews the ultimate recoverability Revenues related to the sale of electricity are recorded when electricity is delivered to customers. However, the of these regulatory assets and liabilities based on determination of KWH sales to individual customers is applicable regulatory guidelines and accounting principles based on the reading of their meters, which is performed generally accepted in the United States. However, adverse on a systematic basis throughout the month. At the end of legislative, judicial, or regulatory actions could materially impact the amounts of such regulatory assets and each month, amounts of electricity delivered to customers, but not yet metered and billed, are estimated. Components liabilities and could adversely impact the Company's of the unbilled revenue estimates include total KWH financial statements. territorial supply, total KWH billed, estimated total electricity lost in delivery, and customer usage. These Contingent Obligations components can fluctuate as a result of a number of Southern Company and its subsidiaries are subject to a factors including weather, generation patterns, and power number of federal and state laws and regulations, as well delivery volume and other operational constraints. These as other factors and conditions that potentially subject factors can be unpredictable and can vary from historical them to environmental, litigation, income tax, and other trends. As a result, the overall estimate of unbilled risks. See FUTURE EARNINGS POTENTIAL herein and revenues could be significantly affected, which could have Note 3 to the financial statements for more information a material impact on the Company's results of operations. 11-30

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report New Accounting Standards year retained earnings. The provisions of SAB 108 were effective for the Southern Company for the year ended Stock Options' December 31, 2006. The adoption of SAB 108 did not On January 1, 2006, Southern Company adopted FASB have a material impact on Southern Company's financial Statement No. 123(R), "Share-Based Payment," using the statements. modified prospective method. This statement requires that compensation cost relating to share-based payment transactions be recognized in financial statements. That Income Taxes: cost is measured based on the grant date fair value of the In July 2006, the FASB issued Interpretation No. 48, equity or liability instruments issued. Although the "Accounting for Uncertainty in Income Taxes" (FIN 48). compensation expense required under the revised This interpietation requires that tax benefits rdust be statement differs slightly, the impacts on the Company's "more likely than not" of being sustained in order to be financial statements are similar to the-pro forma recognized. Southern Company adopted FIN 48 effective disclosures included in Note 1 to the financial statements January 1, 2007. The impact on Southern Company's under "Stock Options." financial statements is estimated to be a reduction to retained earnings of $15 million to $25 million. Pensions and Other PostretirementPlans On December 31, 2006, Southern Company adopted FASB Statement No. 158, "Employers' Accounting for Leveraged Leases Defined Benefit Pension and Other Postretirement Plans" (SFAS No. 158), which requires recognition of the funded In July 2006, the FASB issued FASB Staff Position status of its defined benefit postretirement plans in its No. FAS 13-2, "'Accounting for a Change or Projected, balance sheet. With the adoption of SFAS No. 158, Change in the Timing of Cash Flows Relating -to Income Southern Company recorded an additional prepaid Taxes Generated by a Leveraged Lease Transaction" (FSP pension asset of $520 million with respect to its - 13-2). This staff position amends FASB Statement No. 13, overfunded defined benefit plan and additional liabilities "Accounting for Leases" to require recalculation of the of $45 million and $553 million, respectively, related to rate of return and the allocation of income whenever the its underfunded non-qualified pension'pltans and retiree projected timing of the income tax cash flows generated benefit plans. Additionally, SFAS No. 158 will require by a leveraged lease is revised. Southern Company Southern Company to change the measurement date for adopted FSP 13-2 effective January 1, 2007. This its defined benefit postretirement plan assets and adoption required Southern Company to recognize a obligations from September 30 to December 31 beginning cumulative effect bf an approximate $17 million decrease with the year ending December 31, 2008. See Note 2 to to retained eamings related to the'LILO transaction' the financial statements for additional information. settled with the IRS in February 2005. The estimated impact of the adoption 'related to the SILO transactions is a reduction to retained earnings of approximately Guidance on Consideringthe Materiality of

                                                                        $100 million to $115 million. See FUTURE EARNINGS Misstatements POTENTIAL -- "Income Tax Matters - Leveraged Lease In September 2006, the Securities and Exchange                         Transactions" above and Note 3 to the financial Commission (SEC) issued Staff Accounting                               statements under "Income Tax Matters" herein for further Bulletin No. 108, "Considering the Effects of Prior Year               details about the effect of FSP 13-2.

Misstatements when Quantifying Misstatements in Current Year Financial Statements" (SAB 108). SAB 108 addresses how the effects of prior year uncorrected Fair Value Measurement misstatements should be considered when quantifying misstatements in current year financial statements. The FASB issued FASB Statement No. 157, "Fair Value SAB 108 requires companies to quantify misstatements Measurements" (SFAS No. 157) in September 2006. using both a balance sheet and an income statement SFAS No. 157 provides guidance on how to measure fair approach and to evaluate whether either approach results value where it is permitted or required under other, in quantifying an error that is material in light of relevant accounting pronouncements. SFAS No. 157 also requires quantitative and qualitative factors. When the effect of additional disclosures about fair value measurements. initial adoption is material, companies will record the Southern Company plans to adopt SFAS No. 157 on effect as a cumulative effect adjustment to beginning of January 1, 2008 and is currently assessing its impact. 11-31

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report Fair Value Option grade ratings from the major rating agencies with respect to debt, preferred securities, preferred stock, and/or In February 2007, the FASB issued FASB Statement preference stock. SCS has an investment grade corporate No. 159, "Fair Value Option for Financial Assets and credit rating. Financial Liabilities - Including an Amendment of FASB Statement No. 115" (SFAS No. 159). This standard permits an entity to choose to measure many financial Sources of Capital instruments and certain other items at fair value. Southern Company plans to adopt SFAS No. 159 on January 1, Southern Company intends to meet its future capital 2008 and is currently assessing its impact. needs through inaternal cash flow and external security issuances. Equity capital can be provided from any FINANCIAL CONDITION AND LIQUIDITY combination of the Company's stock plans, private placements, or public offerings. The amount and timing of Overview additional, equity capital to be raised in 2007, as well as Southern Company's financial condition remained stable in subsequent years, will be contingent on Southern at December 31, 2006. Net cash flow from operations Company's investment opportunities. The Company does increased from 2005 by $290 million. The increase was not currently anticipate any equity offerings in 2007 primarily the result of decreases in under recovered fuel outside of its existing stock option plan, the employee cost receivables due to higher allowed fuel recovery rates, savings plan, and the Southern Investment Plan. decreases in under recovered storm restoration costs, and decreases in accounts payable from year-end 2005 The traditional operating companies and Southern amounts that included substantial hurricane-related Power plan to obtain the funds required for construction expenditures, partially offset by increases in fossil fuel and other purposes from sources similar to those used in inventory. The $165 million decrease from 2005 to 2004 the past, which were primarily from operating cash flows, resulted primarily from higher fuel costs at the traditional security issuances, term loans, and short-term borrowings. operating companies, partially offset by increases in base See Note 3 to the financial statements under "Storm rates and fuel recovery rates. See FUTURE EARNINGS Damage Cost Recovery" for information regarding POTENTIAL - "PSC Matters - Fuel Cost Recovery" additional options that Mississippi Power may pursue for and "Storm Damage Cost Recovery" for additional recovering storm damage costs. However, the type and information.' timing of any financings, if,needed, will depend upon prevailing market conditions, regulatory approval, and Significant balance sheet changes include an increase other factors. The issuance of securities by the traditional in notes payable of $683 million primarily to meet operatingcompanies is generally subject to the approval Southern Company's short-term financing needs until of the applicable state PSC. In addition, the issuance of longer term financing is secured, an increase in securities all securities by Mississippi Power and Southern Power due within one year of $517 million for debt maturing and short-term securities by Georgia Power is generally within the next year, and an increase in property, plant, subject to regulatory approval by the FERC. Additionally, and equipment of $t.6 billion. The majority of funds with respect to the public offering of securities,. Southern needed for property additions were provided from Company and certain of its subsidiaries file registration operating activities. The implementation of SFAS No. 158 statements with the SEC under the Securities Act of 1933, resulted in significant balance sheet changes and accounts as amended (1933 Act). The amounts of securities for a large portion of the increases in prepaid pension authorized by the appropriate regulatory authorities, as assets of $527 million, other regulatory assets of well as the amounts, if any, registered under the 1933 Act, $417 million, employee benefit obligations of are continuously monitored and appropriate filings are $637 million, and other regulatory liabilities of made to ensure flexibility in the capital markets. $471 million. At the close of 2006, the closing price of Southern Southern Company, each traditional operating Company's common stock was $36.86 per share, company, and Southern Power obtain financing separately without credit support from any affiliate. See Note-6 tof compared with book value of $15.24 per share. The the financial statements under "Bank Credit: market-to-book value ratio was 242 percent at the end of Arrangements" for additional information. The Southern 2006, compared with 240 percent at year-end 2005. Company system does not maintain a centralized cash or Southern Company, each of the traditional operating money pool. Therefore, funds of each company are not companies, and Southern Power, have received investment commingled with funds of any other company. 11-32

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report Southern Company's current liabilities frequently December 31, 2006, Georgia Power entered into interest exceed current assets because of the continued use of rate swap transactions with a notional amount of short-term debt as a funding source to meet cash needs as $375 million, in order to reduce exposure to interest rate well as scheduled maturities of long-term debt. To meet risk, The transactions will be settled over the next two short-term cash needs and contingencies,, Southern years as the underlying debt is issued, and any-resulting Company has substantial cash flow from operating gain or loss will be amortized over a 10-year period. activities and access to the capital markets, including On January 19, 2007, Gulf Power issued to Southern commercial paper programs, to meet liquidity needs. Company. 800,000 shares of Gulf Power's common stock, At December 31, 2006, Southern Company' and its without paý value, for $80 million. The proceeds were subsidiaries had approximately $167 million 'of cash and used by Gulf Power to repay short-term indebtedness and cash equivalents and $3.3 billion of unused credit for other general c0rporate purposes. On February 6, arrangements with banks, of which $656 iiiillion expire in 2007, Alabama Power issued $200 million in senior notes. 2007 and $2.7 billion expire in 2008 and beyond. Of the' The proceeds from the sale of the senior notes were used $2.7 billion expiring in 2008 and beyond',$2.4' billion to repay a portion of Alabama Power's outstanding short-does not expire until 2011. Approximately $79. million of term debt and.for other general corporate purposes. the credit facilities expiring in 2007 allow for the execution of term loans for an additional two-year period, Off-Balance Sheet Financing Arrangements and $343 million allow for the execution of one-year term In 2001, Mississippi Power began the initial 10-year term loans. Most of these arrangements contain covenants that of a lease agreement for a combined cycle generating limit debt levels and typically contain cross default facility built at Plant Daniel for approximately provisions that are restricted only to the indebtedness- of $370 million. In 2003, the generating facility was' the individual company. Southern Company and its acquired by Juniper Capital L.P. (Juniler),' a limited subsidiaries are currently in compliance with all such partnership whose investors are unaffiliated with covenants. See Note 6 to the financial statements under Mississippi Power. Simultaneously, Juniper entered into a:' "Bank Credit Arrangements" for additional information. restructured lease agreement with Mississippi Power. Juniper has also entered into leases with other parties Financing Activities unrelated to Mississippi Power. The assets leased by During 2006, Southern Company and its subsidiaries Mississippi Power comprise less than 50 percent of issued $1.4 billion of senior notes, $154 million of Juniper's assets. Mississippi Power is not required to obligations related to pollution control revenue bonds, and consolidate the leased assets and related liabilities, and

$150' million of preference stock. Interest rate hedges of         the lease with Juniper is considered an operating lease.
$1.1 billionnotional amount were settled at a gain of              The lease also provides for a residual value guarantee,
$2.7 million related to the issuances, The security                approximately 73 percent of the acquisition cost, by.

issuances were used to redeem or extinguish $1.2 billion Mississippi Power that is due upon termination of the of long-term debt, to redeem $169 million of obligations lease in the event that Mississippi Power does not renew related to pollution control revenue bonds, to redeem the lease or -purchase the assets and that the fair market

$15 million of preferred stock, to fund Southern                   value is less than the unamortized cost of the assets. See Company's ongoing construction program, and for general            Note 7 to the financial statements under "Operating corporate purposes. In the second and fourth quarters of           Leases" for additional information.

2006, Alabama Power issued to Southern Company a total of 3 million shares of Alabama Power common stock at Credit Rating Risk

$40.00 per share. The proceeds of $120 million -were used          Southern Company does not have any credit.arrangements by Alabama Power to repay short-term indebtedness and              that would require material changes in payment schedules for other general corporate purposes.                              or terminations as a result of a credit rating downgrade.

Subsequent to December 31, 2006, Southern There are certain contracts that could require collateral, Company issued $500 million of senior notes. The but not accelerated payment, in the event of a credit proceeds from the sale of the senior notes were used by rating change to BBB- or Baa3 or below. These contracts the Company to repay a portion of its outstanding short- are primarily for physical electricity purchases and sales. term indebtedness, a portion of which was incurred to At December 31, 2006, the maximum potential collateral extinguish the 8.19% and 8.14% Southern Company requirements at a BBB- or Baa3 rating were Capital Funding Junior Subordinated Notes, and for other approximately $291 million. The maximum potential general corporate purposes. Also subsequent to collateral requirements at a rating below BBB- or Baa3 11-33

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report were approximately $711 million. Generally, collateral Due to cost-based rate regulations, the traditional may be provided by a Southern Company guaranty, letter operating companies have limited exposure to market of credit, or cash. Southern Company's operating volatility in interest rates, commodity' fuel prices, and subsidiaries are also party to certain derivative agreements* prices. of electricity.' In addition, Southern Power's ' that could require collateral and/or accelerated payment in exposure to market volatility in commodity fuel prices. the event of a credit rating change to below investment and prices of electricity is limited because its long-term, grade for Alabama Power and/or Georgia Power. These sales contracts generally shift substantially all fuel cost"., agreements are primarily for natural gas and power price responsibility to the purchaser. To mitigate residual risks - risk management activities. At December 31, 2006, relative to movements in electricity prices, the traditional Southern Company's total exposure to these types of operating companies and Southern Power enter into fixed-agreements was approximately $27.4 million. price contracts for ihe purchase and sale of electricity through the wh0lesale electricity market and, to a lesser Market Price Risk extentinto simlar contracts for natural gas purchases. The traditional operating companies have implemented Southern Company is exposed to market risks, primarily fuel-hedging programs at the instructiorn of their commodity price risk and interest rate risk. To manage respective state PSCs. the volatility attributable to these exposures, the Company nets the exposures to take advantage of natuial offsets and Thechanges in fair value of energy-related deriVative enters into various derivative transactions for the contracts and year-end valuations were asfollows at remaining exposures pursuant to the Company's policies December 31: in areas such as counterparty exposure and risk management practices. Company policy is that derivatives Changes in Fair Value are to be used primarily for hedging purposes and /.2006 .2005 mandates strict adherence to all applicable risk (in millions) management policies. Derivative positions are monitored Contracts beginning of year $101 $ 11 using techniques including, but not limited to, market Contracts realized or settled 93 (106) valuation, value at risk, stress testing, and sensitivity New contracts at inception analysis. Changes in valuation techniques - - To mitigate future exposure to change in interest Current period changes(a) (276) 196 rates, the Company enters into forward starting interest Contracts end of year -$ (82) $ 101. rate swaps that have been designated as hedges. The (a) Current period changes also include the changes in fait swaps outstanding at December 31, 2006 have a notional amount of $725 million and are related to anticipated debt value of new contracts enteredinto during the period. issuances over the next year. The weighted average Source of 2006 Year-End Valuation Prices interest rate on $1.7 billion of long-term variable interest rate exposure that has not been hedged at January 1, 2007 Total Maturity was 5.1 percent. If Southern Company sustained a Fair Value 2007 2008-2009 100 basis point change in interest rates for all unhedged (in millions) . variable rate long-term debt, the change would affect Actively quoted , $(86) $(79) $(7) annualized interest expense by approximately External 'sources 4 4 - $17.9 million at January 1, 2007. For further information, Models and other-see Notes I and 6 to the financial statements under "Financial Instruments." Contracts end of year $(82) $(75) $(7) 11-34

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report Unrealized gains and losses from mark-to-market income as incurred. For 2006 and 2005, the fair value: adjustments on derivative contracts related to the losses recognized in income to mark the transactions to traditional operating companies' fuel hedging programs market were $32 million and $7 million, respectively. In are recorded as regulatory assets and -liabilities. Realized January 2007, Southern Company entered into additional gains and losses from these programs are included in fuel derivative transactions with net initial premiums paid of expense and are recovered through the traditional $3 million to further reduce its exposure to the potential operating companies' fuel cost re'or'ery clauses'. In phase-out of these income tax credits in 2007. For fuither addition, unrealized'gains and losses on energy-related information, see Notes 1 and 6 to the financial statements derivatives used by Southern Power to hedge anticipated under "Financial Instruments." purchases and sales are deferred in other comprehensive income. Gains and losses on derivative contracts that are Capital Requirements and Contractual Obligations not designated as hedges are recognized in the statements The construction program of Southern Company is, of income as incuirred. At December 31, 2006, the fair currently estimated to be $3.9 billion for 2007, $4.5 billion value gains/(losses) of energy-related derivative contracts for 2008, and $4.8 billion for 2009. Environmental was reflected in the financial statements as follows: expenditures included in these amounts are $1.66 billion,

                                    .                     - "Amounts              $1.65 billion, and $1.27 billion for 2007, 2008, and 2009,

(* n millions) respectively. Actual construction costs may vary from'this

                                                                 $(85)            estimate because of changes in such factors as:, business Regulatory assets, net                                   -

Accumulated other comprehensive income 3 conditions; environmental regulations; nuclear plant regulations; FERC rules and regulations; load projections; Net income the cost and efficiency of construction ýabor, equipment, Total fair value ' $(82) and materials; and the cost of capital. In addition, there-can be no assurance that costs related to capital

Unrealized pre-tai gains and losses from energy- expenditures will be fully recovered. - -

related derivative contracts recognized in income were not material for any year presented. As a result of NRC requirements,! Alabama Power and Georgia Power have external trust funds for nuclear Southern Company is exposed to market :price risk in decommissioning costs; however, Alabama Power the event of nonperformance by ,counterparties to the currenily his no additional funding requirements. For energy-related derivative contracts.' Southern Company's additional ififormation, see Note 1 to the financial policy is to enter into agreements with counterparties that, statements ninder "Nuclear Decommissioning.Y have investment grade credit rating§ by Moody's and Standard & Poor's or with counterparties who have posted In addition, as discussed in Note 2 to the financial collateral to cover potential credit exposure. Tlherefore, statements, Southern Company provides postretirement Southern Company does not anticip'ate market'risk benefits to substantially all employees and funds trusts to exposure from nonperformance by the counterparties. For the extent required by the traditional operating, additional information, see Notes 1 6 to' thefin.ancial`

                                               'd                                  companies respective'regulatory commissions.

statements !under"'Financial instrýumeris." Other 'funding 'requirements related to obligations To reduce Southern Company's exposure to changes associated with scheduled maturities of long-term debt in the value of synthetic fuel tax credits, which are and preferred isecurities,, as well as the related interest, impacted by changes in oil prices, the Company has 'derivative'obligations, preferred and preference stock entered into derivative transactions. indexed to oil prices. dividends, leases, and other purchase commitments are as Because thesetransactions are notdesignated as hedges,.: follows. See Notes 1, 6, and 7 to the financial statements the gains and lodges'are recognized *inthe'statements of for additional information.

                      ,!, , -I . _. i '. ) 1  , J..

11-35

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Company and Subsidiary Companies 2006 Annual Report Contractual Obligations 2008- 2010- After 2007 2009 2011 2011 Total (in millions) Long-term debt(a)- Principal $ 1,418 $ 1,103 $ 615 $10,803 $13,939 Interest 738 1,307 1,205 10,572 13,822 Other derivative obligations(b)- Commodity 119 10 129 Interest 6 6 Preferred and preference stock dividends(c) 41 81 81 203 Operating leases 135 224 160 186 705 Purchase commitments(d) Capital(e) 3,790 9,050 12,840 Coal 3,294 4,329 1,644 2,221 11,488 Nuclear fuel0 120 231 305 236 892 Natural gasf 1,347 1,902 809 2,740 6,798 Purchased power 173 374 351 890 1,788 Long-term service agreements 74 156 193 1,231 1,654 Trusts - Nuclear decommissioning 7 14 14 110 145 Postretirement benefits(g) 41 91 - 132 Total $11,303 $18,872 $5,377 $28,989 $64,541 (a) All amounts are reflected based on final maturity dates. On February 1, 2007, $400 million aggregate principal amount of long-term debt matured. The maturity was funded with short-term borrowings. Southern Company and its subsidiaries plan to continue to retire higher-cost securities and replace these obligations with lower-cost capital if market conditions permit. Variable rate interest obligations are estimated based on rates as of January 1, 2007, as reflected in the statements of capitalization. Fixed rates include, where applicable, the effects of interest rate derivatives employed to manage interest rate risk. (b) For additional information, see Notes 1 and 6 to the financial statements. (c) Preferred and preference stock do not mature; therefore, amounts are provided for the next five years only. (d) Southern Company generally does not enter into non-cancelable commitments for other operations and maintenance expenditures. Total other operations and maintenance expenses for 2006, 2005, and 2004 were $3.5 billion, $3.5 billion, and $3.3 billion, respectively. (e) Southern Company forecasts capital expenditures over a three-year period. Amounts represent current estimates of total expenditures excluding those amounts related to contractual purchase commitments for uranium and nuclear fuel conversion, enrichment, and fabrication services. At December 31, 2006, significant purchase commitments were outstanding in connection with the construction program. (f) Natural gas purchase commitments are based on various indices at the time of delivery. Amounts reflected have been estimated based on the New York Mercantile Exchange future prices at December 31, 2006. (g) Southern Company forecasts postretirement trust contributions over a three-year period. No contributions related to Southern Company's pension trust are currently expected during this period. See Note 2 to the financial statements for additional information related to the pension and postretirement plans, including estimated benefit payments. Certain benefit payments will be made through the related trusts. Other benefit payments will be made from Southern Company's corporate assets. 11-36

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) '*1 Southern Company and Subsidiary Companies 2006 Annual Report Cautionary Statement Regarding Forward-Looking " state And federal rate regulations and the impact of Statements pending and future rate cases and negotiations, including rate actions relating to fuel and storm Southern Company's 2006 Annual Report contains restoration cost recovery; forward-looking statements. Forward-looking statements include,' among other things, statements concerning the " the performance of projects undertaken by the non-strategic goals for 'the wholesale business, retail sales utility businesses and the success of efforts to invest in growth, customer growth, storm damage cost recovery and and develop new opportunities; repairs, fuel cost recovery, environmental regulations and " fluctuations in the level of oil prices; expenditures, earnings growth, dividend payout ratios, access to sources of capital, projections for postretirement " the level of production, if any, by the synthetic fuel benefit trust contributions, synthetic fuel investments, operations at Carbontronics Synfuels Investors LP and financing activities, completion of construction projects, Alabama Fuel Products, LLC for fiscal year, 2007; impacts of adoption of new accounting rules, and

                                                                   " internal restructuring or other restructuring options that estimated construction and other expenditures. In some cases, forward-looking statements can be identified by                 may be pursued; terminology such as "may,' "will," "could:' "should," -

potential business strategies, including acquisitions or "expects," "plans,"- "anticipates," "believes" "estimates," dispositions-of assets or businesses, which cannot be "projects,' "predicts," "potential," or "continue" or the assured to be completed or beneficial to Southern negative of these terms or other similar terminology. Company or its subsidiaries; There are various factors that could cause actual results to differ materially from those suggested by the forward-
the ability of counterpartiesof Southern Company and looking statements; accordingly, there can be no its subsidiaries to make payments as and when due;,

assurance that such indicated results will be realized. " the ability'to btain new short- and lonig-ermn These factors include: contracts with neighboring utilities;'

the impact of recent and future federal and state
the direct or indirect effect on Southern Company's§
regulatory change, including legislative and regulatory business resulting from terroristincidents and ihe initiatives regarding deregulation and restructuring of threat of terrorist incidents; the electric utility industry, implementation of the Energy Policy Act of 2005, and also changes in
interest rate fluctuations and fiinancial market environmental, tax, and other laws -and regulations to condition's and the results of hnancing efforts,

   -which Southern Company and'itý subsidiaries are                   -including-Southern Company's and its subsidiaries' subject, as well as-changes in application of existing             credit ratings; laws and regulations;

the ability-of Southern Company and its subsidiaries to
current and future litigation, regulatory investigations, obtain additional generating capacity at competitive proceedings or inquiries, including the'pending EPA prices; .

civil actions against certain Southern Company catastrophic &vents such as fires, earthquakes, subsidiaries, FERC matters, IRS audits, and Mirant explosions, floods, hurricanes, pandemic health events matters; such as an avian influenza, or other similar

the effects, extent, and timing of the entry of occurrences; additional competition in the markets in which Southern Company's subsidiaries operate; " the direct or indirect effects on Southern Company's business resulting from incidents similar to the August
variations in demand for electritity, including those 2003 power outage in the Northeast; irelating to weather, the general economy and population, and business growth (and declines); " the effect of accounting, pronouncements issued periodically by standard setting bodies; and available sources and costs of fuels;

                                                                    " other factors discussed elsewhere herein and in other

ability to control costs; reports (including the Form 10-K) filed by the
investment performance of Southern Company's Company from time to time with the SEC.

employee benefit plans; Southern Company expressly disclaims any obligation

advances in technology; to update any forward-looking statements.

11-37

CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 2006, 2005, and 2004 Southern Company and Subsidiary Companies 2006 Annual Report 2006 2005 2004 (in millions) Operating Revenues: Retail revenues $11,801 $11,165 $ 9,732 Sales for resale 1,822 1,667 1,341 Other electric revenues 465 446 392 Other revenues 268 276 264 Total operating revenues 14,356 13,554 11,729 Operating Expenses: Fuel 5,152 4,495 3,399 Purchased power 543 731 643 Other operations 2,423, 2,394 2,263 Maintenance 1,096 1,116 1,027 Depreciation and amortization 1,200 1,176 949 Taxes other than income taxes 718 680 627 Total operating expenses 11,132 10,592 8,908 Operating Income 3,224 2,962 2,821 Other Income and (Expense): Allowance for equity funds used during construction 50 51 47 Interest income 41 36 27 Equity in losses of unconsolidated subsidiaries (57) (119) (95) Leveraged lease income 69 74 70 Impairment loss on equity method investments (16) Interest expense, net of amounts capitalized (744) (619) (540) Interest expense to affiliate trusts (122) (128) (100) Distributions on mandatorily redeemable preferred securities (27) Preferred and preference dividends of subsidiaries (34) (30) (30) Other income (expense), net (56) (41) (59) Total other income and (expense) (869) (776) (707) Earnings From Continuing Operations Before Income Taxes 2,355 2,186 2,114 Income taxes 781 595 585 Earnings From Continuing Operations 1,574 1,591 1,529 Earnings from discontinued operations, net of income taxes of $(I),$,

-and $2 for 2006, 2005, and 2004, respectively                                              ()-3 Consolidated Net Income                                                                $ 1,573      $ 1,591     $ 1,532 Common Stock Data:

Earnings per share from continuing operations - Basic $ 2.12 $ 2.14 $ 2.07 Diluted 2.10 2.13 2.06 Earnings per share including discontinued operations - Basic $ 2.12 $ 2.14 $ 2.07

-Diluted                                                                                  2.10          2.13        2.06 Average number of shares of common stock outstanding                  -  (in millions)

Basic 743 744 739

-Diluted                                                                                   748          749         743 Cash dividends paid per share of common stock                                          $ 1.535      $ 1.475     $ 1.4 15 The accompanying notes are an integral part of these financial statements.

11-38

CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2006, 2005, and 2004 Southern Company and Subsidiary Companies 2006 Annual Report 2006 -2005 2004 (in millions) Operating Activities: Consolidated net income $ 1,573 $ 1,591, $ 1,532 Adjustments to reconcile consolidated net income to net cash provided from operating activities -- Depreciation and amortization 1,421 1,398 1,161 Deferred income taxes and investment tax credits 202 499 559 Allowance for equity funds used during construction (50) (51) (47) Equity in losses of unconsolidated subsidiaries 57 119 - 95 Leveraged lease income ,(69) (74) (70) Pension, postretirement, and other employee benefits 46 .(6) (22) Stock option expense 28 Tax benefit of stock options 4 50 31 Derivative fair value adjustments 32 8 2 Hedge settlements 13 (19) (10) Storm damage accounting order 48 Other, net . 46 (30) 35 Changes in certain current assets and liabilities -- Receivables (69) (1,045). (392) Fossil fuel stock (246) (110) (8) Materials and supplies 7 (78) (31) Other current assets 73 '(1) 9 Accounts payable (173) 71 29 Hurricane Katrina grant proceeds 120 Accrued taxes (103) 28 (109) Accrued compensation (24) 13 (23) (68) 119 (46) Other current liabilities Net cash provided from operating activities 2,820 2,530 - 2,695 Investing Activities: Property additions (2,994) (2,370) (2,022) Nuclear decommissioning trust fund purchases (751) (606) (810) Nuclear decommissioning -trust fund sales 743 596 781 Proceeds from property sales 150 10 6 Hurricane Katrina capital grant proceeds 153 - Investment in unconsolidated subsidiaries (64) (115) (97) Cost of removal net of salvage (90) (128) (75) Other 19 (16) (41) Net cash used for investing activities (2,834) (2,629) - (2,258) Financing Activities: Increase (decrease) in notes payable, net 683 831 (141) Proceeds -- Long-term debt 1,564 1,608 1,861 Mandatorily redeemable preferred securities - 200 Preferred and preference stock 150 55 175 Common stock 137 213 124 Redemptions -- Long-term debt (967) (1,285) (1,246) Long-term debt to affiliate trusts (399) - Mandatorily redeemable preferred securities - (240) Preferred and preference stock (15) (4) (28) Common stock repurchased - (352) - Payment of common stock dividends (1,140) (1,098) (1,045) Other (34) (35) (40) Net cash (used for) provided from financing activities (21) (67) (380) Net Change in Cash and Cash Equivalents (35) (166) 57 Cash and Cash Equivalents at Beginning of Year 202 368 311 Cash and Cash Equivalents at End of Year $ 167 $ 202 $ 368 The accompanying notes are an integral part of these financial statements. II-39

CONSOLIDATED BALANCE SHEETS At December 31, 2006 and 2005 Southern Company and Subsidiary Companies 2006 Annual Report Assets 2006 2005 (in millions) Current Assets: Cash and cash equivalents $ 167 $ 202 Receivables -- Customer accounts receivable 943 868 Unbilled revenues 283 304 Under recovered regulatory clause revenues 517 755 Other accounts and notes receivable 330 410 Accumulated provision for uncollectible accounts (35) (38) Fossil fuel stock, at average cost 675 403 Materials and supplies, at average cost 648 666 Vacation pay 121 117 Prepaid expenses 128 129 Other 242 389 Total current assets 4,019 4,205 Property, Plant, and Equipment: In service 45,486 43,578 Less accumulated depreciation 16,582 15,727 28,904 27,851 Nuclear fuel, at amortized cost 317 262 Construction work in progress 1,871 1,367 Total property, plant, and equipment 31,092 29,480 Other Property and Investments: Nuclear decommissioning trusts, at fair value 1,058 954 Leveraged leases 1,139 1,082 Other 296 337 Total other property and investments 2,493 2,373 Deferred Charges and Other Assets: Deferred charges related to income taxes 895 937 Prepaid pension costs 1,549 1,022 Unamortized debt issuance expense 172 162 Unamortized loss on reacquired debt 293 309 Deferred under recovered regulatory clause revenues 845 531 Other regulatory assets 936 519 Other 564 339 Total deferred charges and other assets 5,254 3,819 Total Assets $42,858 $39,877 The accompanying notes are an integral part of these financial statements. 11-40

CONSOLIDATED BALANCE SHEETS At December 31, 2006 and 2005 Southern Company and Subsidiary Companies 2006 Annual Report Liabilities and Stockholders' Equity 2006 . 2005 (in millions) Current Liabilities: Securities due within one year $ 1,418 $ 901 Notes payable 1,941 1,258 Accounts payable 1,081 1,229 Customer deposits 249 220 Accrued taxes -- Income taxes 110 104 Other 391 319 Accrued interest 184 204 Accrued vacation pay 151 144 Accrued compensation 444 459 Other 384 402 Total current liabilities 6,353 5,240 Long-term Debt (See accompanying statements) 10,942 10,958 Long-term Debt Payable to Affiliated Trusts (See accompanying statements) 1,561 1,888 Deferred Credits and Other Liabilities: Accumulated deferred income taxes 5,989 5,736 Deferred credits related to income taxes 291 311 Accumulated deferred investment tax credits 503 527 Employee benefit obligations 1,567 930 Asset retirement obligations 1,137 1,117 Other cost of removal obligations 1,300 1,295 Other regulatory liabilities 794 323 Other 306 267 Total deferred credits and other liabilities 11,87 10,506 Total Liabilities 30,743 28,592 Preferred and Preference Stock of Subsidiaries (See accompanying statements) 744 596 Common Stockholders' Equity (See accompanying statements) 11,371 10,689 Total Liabilities and Stockholders' Eouitv $42,858 $39i877 Commitments and Contingent Matters (See notes) The accompanying notes are an integral part of these financial statements. 11-41

CONSOLIDATED STATEMENTS OF CAPITALIZATION At December 31, 2006 and 2005 Southern Company and Subsidiary Companies 2006 Annual Report 2006 2005 2006 2005 (in millions) (percent of total) Long-Term Debt of Subsidiaries: First mortgage bonds - Maturity Interest Rates 2006 6.50% to 6.90% $ $ 45 Total first mortgage bonds 45 Long-term senior notes and debt - Maturity Interest Rates 2006 2.65% to 6.20% 674 2007 3.50% to 7.13% 1,204 1,207 2008 2.54% to 6.55% 460 461 2009 4.10% to 7.00% 127 128 2010 4.70% 102 102 2011 4.00% to 5.10% 302 102 2012 through 2046 4.35% to 8.12% 6,730 5,535 Adjustable rates (at 1/1/07): 2006 2.11% 27 2007 5.624% 169 265 2009 5.54% to 5.55% 440 440 2010 6.23% 221 154 Total long-term senior notes and debt 9,755 9,095 Other long-term debt - Pollution control revenue bonds - Maturity Interest Rates 2006 5.25% 12 2024 5.50% 3 Variable rates (at 1/1/06): 2015 through 2017 2.01% to 2.16% - 90 2012 through 2036 2.83% to 5.45% 812 850 Variable rates (at 1/1/07): 2011 through 2041 3.50% to 4.07% 1,714 1,586 Total other long-term debt 2,526 2,541 Capitalized lease obligations 97 110 Unamortized debt (discount), net (18) (19) Total long-term debt (annual interest requirement - $643 million) 12,360 11,772 Less amount due within one year 1,418% 814 Long-term debt excluding amount due within one year 10,942- 10,958 44.5% 45.4% 11-42

CONSOLIDATED STATEMENTS OF CAPITALIZATION (continued) At December 31, 2006 and 2005 Southern Company and Subsidiary Companies 2006 Annual Report 2006 2005 2006 2005 (in millions) (percent of total) Long-term Debt Payable to Affiliated Trusts: Maturity . Interest Rates 2027 through 2044 . 4.75% to-8.19% - (annual interest requirement -- $95 million) 1,561 1,960 Less amfiount due Within one year - 72 Total long-term debt payable to affiliated trusts excluding amount due within one year '. - 1,561 1,888 6.3 7.8 'Preferred and Preference Stock of Subsidiaries: Cumulative preferred stock -.. . .... ....

   $100 par or stated value --. .20% to 5.44%

Authorized - 10 million shares Outstanding - 1 million shares 81 96

   $1 par value -- 4.95% to 5.83%

Authorized - 2006: 28 million shares Outstanding - 12 million shares: $25 stated value, .294 294 Outstanding - 1,250 shares: $100,000 stated value 123., 123. . Non-cumulative preferred stock

      $25 par value -- 6.00% to 6.13%

Authorized - 2006: 50 million shares

                     - 2005: 4 million shares Outstanding - 2 million shares                                                                .45                    44 Preference stock Authorized - 2006: 50 million shares
                     - 2005:10 million shares'. ,

Outstanding - $1 par Value -- 5.63% 147

                      - 2006: 6 million shares (non-cumulative)
                      - 2005: 0 shares
                      - $100 par or stated value-- 6.00%                    "
                                                                            --             " .;                            54
                      - 2006: 1 million shares (non-cumulative)
                      - 2005: 1 million shares (non-cumulative)                              -

Total preferred and preference stock of subsidiaries (annual dividend requirement-- $41 million) . 744 611 Less amount due within one year 15 Preferred and preference stock of subsidiaries 2.. excluding amount due within one year 744' 596 3.0 2.5 Common Stockholders' Equity: Common stock, par value $5 per share 3,759; 3,759 Authorized - I billion shares Issued -- 2006:752 million shares

             -   2005: 752 million shares                                                 ' .-            .

Treasury -- 2006: 5.6 million shares

              ,- 2005:- 10.4 million- shargs Paid-in capital --..                                                                            1,096                  1,085.

Treasury, at cost (359) Retained earnings 6,765 6,332 Accumulated other comprehensive income (loss) i i (57) - " (128) Total common stockholders' equity ....

                                                   -              .                            11,371                 10,689    46.2               44.3 Total Capitalization -                              -12              -                 -        4,618               $24,131   100.0%            100.0%

The accompanying notes are an integral pail of these financial statements. 11-43

CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY For the Years Ended December 31, 2006, 2005, and 2004 Southern Company and Subsidiary Companies 2006 Annual Report Accumulated Other Comprehensive Common Stock Income (Loss) Par Paid-In Retained Continuing Discontinued Value Capital Treasury Earnings Operations Operations Total (in millions) Balance at December 31, 2003 $3,675 $ 747 $ (4) $ 5,343 $(115) $ 2 $ 9,648 Net income - - - 1,532 - - 1,532 Other comprehensive income (loss) - - - - (16) (4) (20) Stock issued 34 122 - - - 156 Cash dividends - - - (1,044) (1,044) Other - - (2) 8 6 Balance at December 31, 2004 3,709 869 (6) 5,839 (131) (2) 10,278 Net income - - - 1,591 - - 1,591 Other comprehensive income - - - 3 2 5 Stock issued 50 216 - - - 266 Stock repurchased, at cost - - (352) (352) Cash dividends - (1,098) (1,098) Other - (1) - - (1) Balance at December 31, 2005 3,759 1,085 (359) 6,332 (128) - 10,689 Net income - - 1,573 - - 1,573 Other comprehensive income - - - 19 - 19 Adjustment to initially apply FASB Statement No. 158, net of tax - - - 52 - 52 Stock issued - 11 168 - - 179 Stock repurchased, at cost -- - Cash dividends - (1,140) (1,140) Other (1) (1) Balance at December 31, 2006 $3,759 $1,096 $(192) $ 6,765 $ (57) $ - $11,371 The accompanying notes are an integral part of these financial statements. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the Years Ended December 31, 2006, 2005, and 2004 Southern Company and Subsidiary Companies 2006 Annual Report 2006 2005 2004 (in millions) Consolidated Net Income $1,573 $1,591 $1,532 Other comprehensive income (loss) - continuing operations: Change in additional minimum pension liability, net of tax of $10, $(6), and $(11), respectively 18 (11) (20) Change in fair value of marketable securities, net of tax of $4, $(2) and $4, respectively 8 (4) 6 Changes in fair value of qualifying hedges, net of tax of $(5), $7, and $(11), respectively (8) 12 (16) Less: Reclassification adjustment for amounts included in net income, net of tax of $-, $4, and $8, respectively 1 6 14 Total other comprehensive income (loss) -- continuing operations 19 3 (16) Other comprehensive income (loss) -- discontinued operations: Changes in fair value of qualifying hedges, net of tax of $4 and $(1), respectively - 6 (2) Less: Reclassification adjustment for amounts included in net income, net of tax of $(3) and $(I), respectively - (4) (2) Total other comprehensive income (loss) -- discontinued operations - 2 (4) Consolidated Comprehensive Income $1,592 $1,596 $1,512 The accompanying notes are an integral part of these financial statements. 11-44

NOTES TO FINANCIAL STATEMENTS Southern Company and Subsidiary Companies 2006 Annual Report

1.

SUMMARY

OF SIGNIFICANT ACCOUNTING The traditional operating companies, Southern Power, POLICIES and certain of their subsidiaries are subject to regulation by the Federal Energy Regulatory Commission (FERC) General and the traditional operating companies are also subject to regulation by their respective state public service Southern Company (the Company) is the parent company commissions (PSC). The companies follow accounting of four traditional operating companies, Southern Power principles generally accepted in the United States and Company (Southern Power), Southern Company Services comply with the accounting policies and practices (SCS), Southern Communications Services (SouthernLINC prescribedby their respective commissions. The Wireless), Southern Company Holdings (Southern preparation of finiancial statements in conformity with Holdings), Southern Nuclear Operating Company (Southern account"ng principles generally accepted in the United Nuclear), Southern Telecom, and other direct and indirect, States requires the use of estimates, and the actual results subsidiaries. The traditional operating companies, Alabama may differ from those estimates. Power, Georgia Power, Gulf Power, and Mississippi Power are vertically integrated utilities providing electric service Related Party'-Tiansactions in four Southeastern states. Southern Power constructs, acquires, and manages generation assets and sells Alabama'Power and Georgia Power purchase synthetic electricity at market-based rates'iii' ihe vholesale market.' fuel from Alabahia Fuel Products, LLC (AFP), an entity

SCS; the system service company, provides, at cost, in which Southern Holdings held a 30 percent ownership interest until July 2006, when its ownership interest was specialized services to Southern Company and 'the subsidiary companies. SoiuthernLINC Wireless provides terminated. Total fuel purchases through June 2006 and digital wireless communications services to thedtladitional for the years 2005 and 2004 were $354 million, operating companies and also markets thies6'services to the $507 million, and $409 million, respectively. Synfuel public within the Southeast. Southern Telecom provides Services, Inc. (SSI), another subsidiary of Southern fiber cable services within the Southeast. Southern.- Holdings, proVided fuel transportation services to AFP Holdings is an intermediate holding'cofnpany subsidiary that were ultimately reflected in the cost of the synthetic for Southern Company's investments in synthetic fuels and fuel billed to Alabama Power and Georgia Power. In leveraged leases and various other energy-related connection with these services, the related revenues of businesses. Southern Nuclear operates'and provides approximately $62 million, $83 million, and $82 million services to Southern Company's nuclde~rpower plants. through June 2006 and for the years 2005 and 2004, respectively, have been eliminated against fuel expense in On January 4, 2006, Southern Company completed the financial statements. SSI also provided additional the sale of substantially all of the assets of Southern services to AFp, as well as to a related party of AFP.

Company Gas, its competitiye retail natural gas marketing Revenues from, these transactions totaled approximately, subsidiary, including natural gas inventory, accounts $24 million, $40 million, and $24 million through June receivable, and customer list, to Gas South, LLC, an 2006 and for the years .2005 and 2004, respectively. affiliate of Cobb Electric Membership Corporation. As a Subsequent to the termination of Southern result of the sale, Southern Company's financial Company.'s membership interest in AFP, Alabama Power statements and related information reflect Southern and Georgia Power continued t9 purchase an additional Company Gas as discontinued operations for all periods $384 million in fuel from AFP in 2006. SSI continued to presented. For additional information, see Note 3 under provide. fuel transportation services of $62 million, which "Southern Company Gas Sale.", were eliminated against fuel expense in the financial The financial statements reflect Southern Company's statements, In*.2006, SSI also provided other additional services to AFP and a related party of AFP totaling investments in the subsidiaries on a consolidated basis. $21 million. The equity method is used for subsidiaries in which the Company has significant influence but does not control Regulatory Assets and Liabilities and for variable interest entities where the Company is not the primary beneficiary. All material intercompany The traditional operating companies are subject to the items have been eliminated, in consolidation. Certain prior provisions of Financial Accounting .Standards Board years' data presented in the financial statements have (FASB) Statement No. 71, "Atcounting for the Effects of been reclassified to conform with the Current year Certain Types of Regulation" (SFAS No. 71). Regulatory presentation. assets represent probable future revenues associated with 1145

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report certain costs that are expected to be recovered from In the event that a portion of a traditional operating customers through the ratemaking process. Regulatory company's operations is no longer subject to the liabilities represent probable future reductions in revenues provisions of SFAS No. 71, such company would be associated with amounts that are expected to be credited required to write off related regulatory assets and to customers through the ratemaking process. Regulatory liabilities that are not specifically recoverable through assets and (liabilities) reflected in the balance sheets at regulated rates. In addition, the traditional operating December 31 relate to: company would be required to determine if any impairment to other assets, including plant, exists and 2006 2005 Note write down the assets, if impaired, to their fair value. All (in millions) regulatory assets and liabilities are to be reflected in rates. See Note 3 under "Alabama Power Retail Regulatory Deferred income tax charges $ 896 $ 937 (a) Matters," "Georgia Power Retail Regulatory Matters," and Asset retirement obligations-asset 61 81 (a)

                                                                               "Storm Damage Cost Recovery" for additional Asset retirement obligations-liab                 (155) (139)         (a) information.

Other cost of removal obligations (1,300) (1,295) (a) Deferred income tax credits (293) (313) (a) Revenues Loss on reacquired debt 293 309 (b) Vacation pay 121 117 (c) Wholesale capacity revenues are generally recognized on Under recovered regulatory clause a levelized basis over the appropriate contract periods. revenues 411 351 (d) Energy and other revenues are recognized as services are Building lease 51 52 (d) provided. Unbilled revenues related to retail sales are Generating plant outage costs-asset 56 54 (d) accrued at the end of each fiscal period. Electric rates for Under recovered storm damage costs 89 366 (d) the traditional operating companies include provisions to Fuel hedging-asset 115 24 (d) adjust billings for fluctuations in fuel costs, fuel hedging, Fuel hedging-liability (13) (127) (d) the energy component of purchased power costs, and Other assets 55 56 (d) certain other costs. Revenues are adjusted for differences Environmental remediation-asset 57 58 (d) between these actual costs and amounts billed in current Environmental remediation-liab. (32) (36) (d) regulated rates. Under or over recovered regulatory clause Deferred purchased power (38) (52) (d) revenues are recorded in the balance sheets and are Other liabilities (50) (32) (d) recovered or returned to customers through adjustments to Plant Daniel capacity (6) (19) (e) the billing factors. Overfunded retiree benefit plans (508) (f) Retail fuel cost recovery mechanisms vary by each Underfunded retiree benefit plans 697 (f) retail operating company, but in general, the process Total $ 507 $ 392 requires periodic filings with the appropriate state PSC. Alabama Power continuously monitors the under/over Note: The recovery and amortization periods for these recovered balance and files for a revised fuel rate when regulatory assets and (liabilities) are as follows: (a) Asset retirement and removal liabilities' are recorded, management deems appropriate. Georgia Power is deferred income tax assets are recovered, and deferred required to file a new fuel case no later than March 1, tax liabilities are amortized over the related property 2008. Gulf Power is required to notify the Florida PSC if lives, which may range up to 60 years. Asset retirement the projected fuel revenue over or under recovery exceeds and removal liabilities will be settled and trued up 10 percent of the projected fuel costs for the period and following completion of the related activities. indicate if an adjustment to the fuel cost recovery factor (b) Recovered over either the remaining life of the original is being requested. Mississippi Power is required to file issue or, if refinanced, over the life of the new issue, for an adjustment to the fuel cost recovery factor which may range up to 50 years. annually. See "Alabama Power Retail Regulatory Matters" (c) Recorded as earned by employees and recovered as paid, and "Georgia Power Retail Regulatory Matters" in Note 3 generally within one year. for additional information. (d) Recorded and recovered or amortized as approved by the appropriate state PSCs. Southern Company has a diversified base of (e) Amortized over a four-year period ending in 2007. customers. No single customer or industry comprises (f) Recovered and amortized over the average remaining 10 percent or more of revenues. For all periods presented, service period which may range up to 21 years. See uncollectible accounts averaged less than I percent of Note 2 under "Retirement Benefits.' revenues. 11-46

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report Fuel Costs .Southern Company's property, plant, and equipment consisted of the following at December 31: Fuel costs are expensed as the fuel is used. Fuel expense 2006 2005 generally includes the cost of purchased emission (in millions) allowances as they are used. Fuel expense also includes the amortization of the cost of nuclear fuel and a charge, Generation $23,355 $22,490 Transmission 6,352 6,031 based on nuclear generation, for the permanent -disposal Distribution 12,484 11,894 of spent nuclear fuel. Total charges for nuclear fuel General' 2,510 2,393 included in fuel expense amounted to $137 million in 41 Plant acquisition adjustment 40 2006, $134 million in 2005, and $134 million in 2004. Utility plant'in service 44,741 42,849 IT equipment and software ' 226 211 Nuclear Fuel Disposal Costs Communications equipment 445 431 Other, 74 87 Alabama Power and Georgia Power have contracts with Other plant in service 745 729 the U.S. Department of Energy (DOE) that provide for $45,486 $43,578 Total plant in service the permanent disposal of spent nuclear fuel. The DOE failed to begin disposing of spen't nuclear fuel in 1998 as The cost 'of replacements of property, exclusive of required by the contracts, and Alabama Power and minor items of property, is capitalized. The cost of Georgia Power are pursuing legal remedies against the maintenance, repairs, and replacement of minor items of government for breach of contract. Sufficient, pool storage property is charged to maintenance expense is incurred or capacity for spent fuel is available at Plant Vogtle to pefformied with the exception of nuclear refueling costs, maintain full-core discharge capability for both units into which are recorded in accordance with specific state PSC 2014. Construction of an on-site dry storage facility at orders. Alabama Power accrues estimated nuclear Plant Vogtle is expected to begin in sufficient time to refueling costs in advance of the unit's next refueling maintain pool full-core discharge capability. At Plants outage. Georgia Power defers and amortizes nuclear Hatch and Farley, on-site dry storage facilities are refueling costs 6ver the unit's operating cycle before the operational and can be expanded to accommodate spent next refueling. The refueling cycles for Alabama Power fuel through the expected life of each plant. and Georgia Power range from 18 to 24 months for each uni&t.n accordance with a Georgia PSC order, Georgia Also, the Energy Policy Act of 1992 established a Power, also defers 'the costs of certain significant Uranium Enrichment Decontamination and , inspection costs for the combustion turbines at Plant Decommissioning Fund, which has been funded in part by McIntosli-and amortizes such costs over 10 years, which, a special assessment on utilities with nuclear plants. This approximates the expected maintenance cycle. assessment was paid over a 15-year period; the final' installment occurred in 2006. This fund will be used by Income and Other Taxes the DOE for the decontamination and decommissioning of Southern Company uses he liability method of its nuclear fuel enrichment facilities. The law provides accounting for deferred income, taxes and provides that utilities will recover these payments in the same deferred income taxes for all significant income, tax manner as any other fuel expense., temporary, differences. Investment tax credits utilized are deferred and amortized to income over the average life of the related property. Taxes that are collected from Property, Plant, and Equipment customers on behalf of governmental agencies to be remitted to these agencies are presented net on the Property, plant, and equipment is stated atporiginal cost statements of income. less regulatory disallowances and. impairments. Original cost includes: materials; labor; minor items of property; Depreciation and Amortization appropriate administrative and general costs; payroll-related costs such as taxes, pensions, and other benefits; Depreciation of the original cost of utility plant in service and the interest capitalized and/or cost of funds used is provided primarily by using composite straight-line during construction. rates, which approximated 3.0 percent in 2006, 2.9 percent 11-47

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report in 2005, and 3.0 percent in 2004. Depreciation studies are estimated useful lives ranging from 3 to 25 years. conducted periodically to update the composite rates. Accumulated depreciation for other plant in service These studies are filed with the respective state PSC for totaled $405 million and $378 million at December 31, the traditional operating companies. Accumulated 2006 and 2005, respectively. depreciation for utility plant in service totaled $16.2 billion and $15.3 billion at December 31, 2006 and Asset Retirement Obligations 2005, respectively. When property subject to composite and Other Costs of Removal depreciation is retired or otherwise disposed of in the normal course of business, its original cost, together with Effective January 1, 2003, Southern Company adopted the cost of removal, less salvage, is charged to FASB Statement No. 143, "Accounting for Asset accumulated depreciation. For other propertydispositions, Retirement Obligations" (SFAS No. 143), which the applicable cost and accumulated depreciation is established new accounting and reporting standards for removed from the balance sheet accounts and a gain or legal obligations associated with the ultimate costs of loss is recognized. Minor items of property included in retiring long-lived assets. The present value of the the original cost of the plant are retired when the related ultimate costs for an asset's future retirement is recorded property unit is retired. in the period in which the liability is incurred. The costs are capitalized as part of the related long-lived asset and Under the three-year retail rate plan for Georgia depreciated over the asset's useful life. In addition, Power ending December 31, 2007 (2004 Retail Rate effective December 31, 2005, Southern Company adopted Plan), Georgia Power was ordered to recognize Georgia the provisions of FASB Interpretation No. 47, PSC-certified capacity costs in rates evenly over the three "Conditional Asset Retirement Obligations" (FIN 47), years covered by the 2004 Retail Rate Plan. As a result of which requires that an asset retirement obligation be the regulatory adjustment, Georgia Power recognized recorded even though the timing and/or method of $33 million in increased depreciation and amortization settlement are conditional on future events. Prior to expense in 2005. Georgia Power recorded a credit to December 2005, the Company did not recognize asset amortization of $14 million in 2006. Under its 2001 rate retirement obligations for asbestos removal and, disposal order, the Georgia PSC ordered Georgia Power to of polychlorinated biphenyls in certain transformers amortize $333 million, the cumulative balance of because the timing of their retirements was dependent on accelerated depreciation and amortization previously future events. The Company has received accounting expensed, equally over three years as a credit to guidance from the various state PSCs allowing the depreciation and amortization expense beginning January continued accrual of other future retirement costs for 2002. Georgia Power also was ordered to recognize new long-lived assets that the Company does not have a legal certified capacity costs in rates evenly over the same obligation to retire. Accordingly, the accumulated removal three-year period under the 2001 rate order. As a result of costs for these obligations will continue to be reflected in this regulatory adjustment, Georgia Power recorded a the balance sheets as a regulatory liability. Therefore, the reduction in depreciation and amortization expense of Company had no cumulative effect to net income $77 million in 2004. See Note 3 under "Georgia Power resulting from the adoption of SIAS No. 143 or FIN 47. Retail Regulatory Matters" for additional information. The liability recognized to retire long-lived assets In May 2004, the Mississippi PSC approved primarily relates to the Company's nuclear facilities, Mississippi Power's request to reclassify 266 megawatts Plants Farley, Hatch, and Vogtle. The fair value of assets of Plant Daniel units 3 and 4 capacity to jurisdictional legally restricted for settling retirement obligations related cost of service effective January 1, 2004 and authorized Mississippi Power to include the related costs and revenue to nuclear facilities as of December 31, 2006 was

                                                                  $1.1 billion. In addition, the Company has retirement credits in jurisdictional rate base, cost of service, and revenue requirement calculations for purposes of retail            obligations related to various landfill sites and rate recovery. Mississippi Power is amortizing the related         underground storage tanks. In connection with the regulatory liability pursuant to the Mississippi PSC's             adoption of FIN 47, Southern Company also recorded additional asset retirement obligations (and assets) of order as follows: $17 million in 2004, $25 million in approximately $153 million, primarily related to asbestos 2005, $13 million in 2006, and $6 million in 2007, removal and disposal of polychlorinated biphenyls in resulting in increases to earnings in each of those years.

certain transformers. The Company also has identified Depreciation of the original cost of other plant in retirement obligations related to certain transmission and. service is provided primarily on a straight-line basis over distribution facilities, co-generation facilities, certain 11-48

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report wireless commurnication towers, and certain structures date of FASB Staff Position FAS 115-1/124-1,- "The authorized by the United States Army Corps of Engineers. Meaning of Oiher-Than-Temporary Impairment and Its However, liabilities for the removal of these assets have Application to Certain Investments" (FSP No. 115-1), the not been recorded because the range of time over which Company considers all unrealized losses to represent the Company may settle these obligations is unknown and other-than-temporary impairments., The adoption of FSP cannot be reasonably estimated. The Company will No. 115-1, had no impact on the results of operations, continue to recognize in the statements of income allowed cash flows,'or financial condition of the Company as all removal costs in accordance with its'regulatory -treatment. losses 'have been and continue to be recorded through a Any differences between costs recognized under " , regulatory liability, whether realized, unrealized, or' SFAS No. 143 and FIN 47 and those reflected in rates are identified as other-than-temporary. Details of'the recognized as either a regulatory asset or liability, as securities held in these irusts at December 31 are as . ordered by the various state PSCs, and are reflected in the follows:* . 1, balance sheets. See "Nuclear Decommissioning" herein Other-than-for further information on amounts included in rates. Unrealized Temporary Fair Details of the asset retirement obligations included in 2006 - -' Gains Impairments Value the balance sheets are as follows: (in millions) 2006 2005 Equity $227.9 .$(10.3) $ 763.1 Debt ,3.7 (2.1) .285.5 (in millions) Other - 8.9 Balance beginning of year $1,117 $ 903 155 Total '$231.6 $(12.4) $1,057.5 Liabilities incurred 8 Liabilities settled . (5) (2)

                                                                                                   -Unrealized Unrealized              Fair Accretion                                          73            61 2005                 . Gains        . :: Losses           Value Cash flow revisions                               (56)

(in millions) Balance end of year $1,137 $1,117 Equity" $155.6' $(14.0) $600.8 Debt '4.1 (2.4) 241.4 Nuclear Decommissioning Other 17.0 111.4 1 The Nuclear Regulatory Commission (NRC) requires Total $176.7 $(16.4) $953.6 licensees of. commercial nuclear power reactors to establish a plan for providing reasonable assurance of The contractual maturities of debt securities at funds for future decommissioning. Alabama Power and December 31, 2006 are as follows: $8.0 million in 2007; Georgia Power have external trust funds to comply with' $70.5 million in 2008-2011; $85.2 million in 2012-2016; the NRC's regulations. Use of the funds is restricted to and $120.4 rmillion thereafter. nuclear decommissioning activities and the funds are Sales of the securities held in the trust funds resulted managed and invested in accordance with applicable in $743.1 million, $596.3 million, and $781.3 million in requirements of various regulatory bodies, including the 2006, 2005,* and 2004, respectively, all of which were re-NRC, the FERC, and state PSCs, as well as the Internal invested. Realized gains and other-than-temporary, Revenue Service (IRS). The triust funds are invested in a impairmentlosses were $39.8 million and $30.3 million, tax-efficient manner in a diversified mix of equity and respectively, in 2006. Net realized gains were fixed income securities and are classified as $22.5 million and $21.6 million in 2005 and 2004,, available-for-sale. respectively. Realized gains and other-than-temporary, The trust funds are included in the balance, sheets at impairment. losses are determined on a specific fair value, as obtained from quoted market prices for the identification basis. In accordance with regulatory, same or similar investments, As the external trust funds guidance, all realized and unrealized gains and losses are are actively managed by unrelated parties with limited included in the regulatory liability for Asset Retirement direction from the Company, the Company does 'not have Obligations in the balance sheets and are not included in the ability to choose to hold, securities with unrealized net income or other comprehensive income. Unrealized losses until recovery. Through 2005, the Company gains and other-than-temporary impairment losses are considered other-than-temporary impairments to be considered non-cash transactions for purposes of the immaterial. However, since'the January 1, 2006 effective statemetits of cash flow. 11-49

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report Amounts previously recorded in internal reserves are NRC generic estimate to decommission the radioactive being transferred into the external trust funds over periods portion of the facilities as of. 2003. Georgia Power will approved by the respective state PSCs. The NRC's include the 2006 study estimates as part of the retail base minimum external funding requirements are based on a rate case to be filed with the Georgia PSC by July 2007. generic estimate of the cost to decommission only the The estimates used in current rates are $421 million and radioactive portions of a nuclear unit based on the size $326 million for Plants Hatch and Vogtle, respectively. and type of reactor. Alabama Power and Georgia Power Amounts expensed in 2006, 2005, and 2004 totaled have filed plans with the NRC designed to ensure that, $7 million, $7 million, and $27 million, respectively. over time, the deposits and earnings of the external trust Significant assumptions used to determine these costs for funds will provide the minimum funding amounts ratemaking were an inflation rate of 4.5 percent and prescribed by the NRC. At December 31, 2006, the 3.1 percent for Alabama Power and Georgia Power, accumulated provisions for decommissioning were as respectively, and a trust earnings rate of 7.0 percent and follows: 5.1 percent for Alabama Power and Georgia Power, respectively. Another significant assumption used was the Plant Plant Plant change in the operating licenses for Plants Farley and Farley Hatch Vogtle Hatch. In January 2002, the NRC granted Georgia Power (in millions) a 20-year extension of the licenses for both units at Plant External trust funds, Hatch, which permits the operation of units 1 and 2 until at fair value $513 $344 $200 2034 and 2038, respectively. In May 2005, the NRC Internal reserves 28 - 1 granted Alabama Power a similar 20-year extension of the Total $541 $344 $201 operating license for both units at Plant Farley. As a result of the license extensions, amounts previously contributed Site study cost is the estimate to decommission a to the external trust funds for Plants Hatch and Farley are currently projected to be adequate to meet the specific facility as of the site study year. The estimated costs of decommissioning based on the most current decommissioning obligations. studies, which were performed in 2003 for Plant Farley and in 2006 for the Georgia Power plants, were as follows Allowance for Funds Used During Construction for Alabama Power's Plant Farley and Georgia Power's (AFUDC) and Interest Capitalized ownership interests in Plants Hatch and Vogtle: In accordance with regulatory treatment, the traditional operating companies record AFUJDC, which represents the Plant Plant Plant estimated debt and equity costs of capital funds that are Farley Hatch Vogtle necessary to finance the construction of new regulated Decommissioning periods: facilities. While cash is not realized currently from such Beginning year 2017 2034 2027 allowance, it increases the revenue requirement over the Completion year 2046 2061 2051 service life of the plant through a higher rate base and (in millions) higher depreciation expense. Interest related to the Site study costs: construction of new facilities not included in the Radiated structures $892 $544 $507 traditional operating companies' regulated rates is Non-radiated structures 63 46 67 capitalized in accordance with standard interest Total $955 $590 $574 capitalization requirements. Cash payments for interest totaled $875 million, The decommissioning cost estimates are based on $661 million, and $551 million in 2006, 2005, and 2004, prompt dismantlement and removal of the plant from respectively, net of amounts capitalized of $27 million, service. The actual decommissioning costs may' vary from $21 million, and $36 million, respectively. the above estimates because of changes in the assumed date of decommissioning, changes in NRC requirements, Impairment of Long-Lived Assets and Intangibles or changes in the assumptions used in making these estimates. Southern Company evaluates long-lived assets for impairment when events or changes in circumstances For ratemaking purposes, Alabama Power's. indicate that the carrying value of such assets may not be decommissioning costs are based on the site study and recoverable. The determination of whether an impairment Georgia Power's decommissioning costs are based on the has occurred is based on either a specific regulatory II-50

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report disallowance or an estimate of undiscountedfuture cash Georgia'PoWer continues to recover environmental flows attributable to the assets, as compared with the costs through, its base rates. Beginning in 2005, such rates carrying value of the assets. If an impairment has include an annual accrual of $5.4 million for occurred, the amount of the impairmen'recognized is environmentai remediation. Environmental remediation determined by either the amount of reguliatry expenditreýs will be charged against the reserve as they disallowance or by estimating the fair' Que 'of the assets" are incurild. The annual accrual amount will be reviewed' and recording a loss if the carrying' value is greater than' and adjusted in future regulatory proceedings. Under the fair value. For assets identified as held for sale, the Georgia PSC ratemaking provisions, $22 million had carrying value is compared to the estimated fair value less previously been deferred in a regulatory liability account the cost to sell in order to determine if an impairment loss for. use in mieeting future environmental remediation costs is required. Until the assets are disposed of, their of $3o6i'*ia7?6wer and is being amortized over a three-estimated fair value is re-evaluated when circumstances or year period that began in January 2005. events change. Gulf Power's environmental remediation liability includes estimated costs~of environmental remediation Storm Damage Reserves projects of approximately $57.2 million as of Deeernb I31,-2006. These estimated costs relate to new' Each traditional operating company maintains a reserve regulaio&ns and more stringent site closure criteria by the for property damage to cover the cost of uninsured Floirida bepartmen'd "ofEnvironmental 'Protection (FDEP) damages from major storms to transmission and for impActslto groundwater from herbicide applications at distribution facilities and to generation facilities and other property.' In accordance with their-respective state PSC Gulf Power substations. The schedule for completion of orders, the traditional operating companies' accrued the remniediation project-s will be' subject to FDEP approval.-The projects have been approved by the Florida

$26 million in 2006 that is recoverable through base'rates.

Alabama Power, Gulf Power, and Mississippi Power also PSC for recovery, as expended, through Gulf Power's, have discretionary authority from their state:PSCs to environmental cost recovery clause; therefore, there was accrue certain additional amounts as circumstances' no impact on net income as a result of these estimates. warrant.. In 2006, 2005, and 2004, puchadditional For Southern Company, the undiscounted accruals .totaled $3 million, $6 million, And $25, million, environmental' remediation liabilities balances as of respectively. In October 2006, the Mississippi PSC December 31, 2006 and 2005 totaled $63 million and ordered Mississippi Power to suspend all accruals to its $62 million, respectively. retail property damage reserve pendingthe establishment of a new reserve limit. Mississippi Power made no teveraged Leases discretionary accruals in 2006 as a result of the order. See Southern Company has several leveraged lease Note 3 under "Storm Damage Cost Recovery" for - agreementl, ranging up to 45 years, which relate to additional information regarding the depletion of these reserves following Hurricanes Ivan, Dennis,'and Katrina international and domestic energy generation, distribution, and the deferral of additional costs, as well as,.additional and transportation assets. Southern Company receives rate riders or other cost recovery mechanisms which have federal iiictme tax deductions for depreciation and been or may be approved by the respective state PSCs to amortization, as well as interest on long-term debt related to these investments. The Company reviews all important replenish these reserves. lease assumnptiorls at least annually, or more frequently if eveints or_¢cihaiges in circumstances -indicate that a change Environmental Remediation Cost Recovery. - inýassumptions has occurred or may occur. These Southern Company must comply witha ihei environmnental assumptions include the effective tax rate, the residual laws and regulations that cover' the handling and disposal value, and le 'c'redit qfiality of ihe lessees. of waste and releases of hazardous substances. Under these various laws and regulations, the subsidiaries may also incur substantial costs to clean up properties. Alabama Power, _Gulf Power, and Mississippi Power have each received authority from their respective state PSCs to recover approved environmental compliance costs through specific retail rate clauses., Within limits approved by the state PSCs, these rates are adjusted annually. 11-51

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report Southern Company's net investment in domestic Materials and Supplies leveraged leases consists of the following at December 31: Generally, materials and supplies include the average 2006 2005 costs of transmission, distribution, and generating plant (in millions) materials. Materials are charged to inventory when Net rentals receivable $ 497 $ 509 purchased and then expensed or capitalized to plant, as Unearned income (261) (280) appropriate, when installed. Investment in leveraged leases 236 229 Fuel Inventory Deferred taxes arising from leveraged leases (133) (59) Fuel inventory includes the average costs of oil, coal, Net investment in leveraged leases $103 $ 170 natural gas, and emission allowances. Fuel is charged to inventory when purchased and then expensed as used and A summary of the components of income from recovered by the traditional operating companies through domestic leveraged leases is as follows: fuel cost recovery rates approved by each state PSC. Emission allowances granted by the Environmental 2006 2005 2004 Protection Agency (EPA) are included in inventory at zero (in millions) cost. Pretax leveraged lease income $20 $ 23 $17 Income tax expense (9) (11) (8) Stock Options Net leveraged lease income $11 $ 12 $ 9 Prior to January 1, 2006, Southern Company accounted for options granted in accordance with Accounting Southern Company's net investment in international Principles Board Opinion No. 25; thus, no compensation leveraged leases consists of the following at December 31: expense was recognized because the exercise price of all options granted equaled the fair market value on the date 2006 2005 of the grant. (in millions) Net rentals receivable $1,299 $1,298 Effective January 1, 2006, the Company adopted the Unearned income (396) (445) fair value recognition provisions of FASB Statement No. 123(R), "Share-Based Payment" (SFAS No. 123(R)), Investment in leveraged leases 903 853 using the modified prospective method. Under that Deferred taxes arising method, compensation cost for the year ended from leveraged leases (492) (351) December 31, 2006 is recognized as the requisite service Net investment in leveraged leases $ 411 $ 502 is rendered and includes: (a) compensation cost for the portion of share-based awards granted prior to and that A summary of the components of income from are outstanding as of January 1, 2006, for which the international leveraged leases is as follows: requisite service had not been rendered, based on the 2006 2005 2004 grant-date fair value of those awards as calculated in (in millions) accordance with the original provisions of FASB Statement No. 123, "Accounting for Stock-based Pretax leveraged lease income $ 49 $ 51 $ 53 Compensation" (SFAS No. 123), and (b) compensation Income tax expense (17) (18) (19) cost for all share-based awards granted subsequent to Net leveraged lease income $ 32 $ 33 $ 34 January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of See Note 3 under "Income Tax Matters" for SFAS No. 123(R). Results for prior periods have not been additional information regarding the leveraged lease restated. transactions. For Southern Company, the adoption of SFAS No. 123(R) has resulted in a reduction in earnings Cash and Cash Equivalents from continuing operations before income taxes and net For purposes of the financial statements, temporary cash income of $28 million and $17 million, respectively, for investments are considered cash equivalents. Temporary the year ended December 31, 2006. Additionally, cash investments are securities with original maturities of SFAS No. 123(R) requires the gross excess tax benefit 90 days or less. from stock option exercises to be reclassified as a 11-52

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report financing cash flow as opposed to an o ~erating cash flow; the used in the pricing model and the weighted average grant-reduction in operating cash flows and increase in financing date fair value of stock options granted: cash flows for the year ended December' 31, .2006 was Period ended December 31 2006 2005 2004 $10 million. Expected volatility 16.9% 17.9% 19.6% The adoption of SFAS No. 123(R) has'also resulted in a reduction in basic and diluted earningsper' share , EKpected term (in years) 5.0 5.0 5.0 from continuing operations of $0.02 and $0.03,1 Interest rate 4.6% 3.9% 3.1% respectively, for the year ended December 31, 2006. Dividend yield 4.4% 4.4% 4.8% For the years prior to the adoption of Weigfited average grant date SFAS No. 123(R), the pro forma impact of fair-value fair value $4.15 $3.90 $3.29 accounting for options granted on earnings, from-continuing operations and basic and diluted earnings per Financial Iinstruments share from continuing operations is as follows: Southern Company uses derivative financial instruments IOptions to limit exposure to fluctuations in interest rates, -the

                                 -As        Impact -     Pro           prices of certain fuel purchases, and electricity purchases Reported    After Taxi  Forma           and sales. All derivative financial instruments are recognized as.,either assets or liabilities (categorized in 2005 Net income                                                         "Other") and'are measured at fair value. Substantially all.

(in millions) $1,591 $(17) $1,574 of Southern Company's bulk energypurchases and sales, Earnings per share contracts that meet the definition of a derivative are' (dollars): exempt from fair value accounting 'requirements-'and are Basic $2.14 "$2.12 accounited for under the accrual method. Other derivative. Diluted $2.13 $2.10 contracts qualify as cash flow hedges of anticipated .', '.I 2004 transactions or are recoverable through the traditional Net income operating companies' fuel hedging programs. This results (in millions) $1,529° $(16). $1,513 in the deferral of related gains and losses in other Earnings per share comprehensive income or regulatory-assets and liabilities; (dollars): Basic $2.07 $2.05 respectively, until the hedged transactions occur. Any

                                                        $2.0$.04       ineffectrveness ansing from cashflow hedges is Diluted                                                      recognized currently in net income. Other derivative Because historical forfeeitures have been insignificant          contracts, incl'uding derivatives related to 'synthetic fuel and are expected to remain insignificant, no forfeitures.              inv'estmiienits,are'marked to market through current period are assumed in the calculati on of compensation expense;               income and are irecorded on a net basis 'in the statements rather they are recognized vvhen they occur.                           of incom'e.

The estimated fair values of stock options granted in Southern Company is exposed to losses related to 2006, 2005, and 2004 were derived using the Black- financial instruments in the event ofcounterparties' Scholes stock option pricing model. Expected ,volatility is nonperformance. The Company has established controls to based on historical volatility of the Company's stock over determine and monitor, the creditworthiness of a period equal to the expected term. Southern Company counterparties in order to mitigate the Company's uses historical exercise data to estimate the expected'term exposure to counterparty credit risk. that represents the period of time that options granted to. employees are expected to be outstanding. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant that covers the expected term of the stock options. The following table shows the assumptions i;1. f*!- * .' ! i 11-53

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report The other Southern Company finnancial instruments 2. RETIREMENT BENEFITS for which the carrying amount did not tlquaI ran vauue at Southern Company has a defined benefit, trusteed, December 31 were as follows: pension plan covering substantially all employees. The Carrying Fair plan is funded in accordance with requirements of the Amount Value Employee Retirement Income Security Act of 1974, as amended (ERISA). No contributions to the plan are expected for the year ending December 31, 2007. Long-term debt: Southern Company also provides certain defined benefit 2006 $13,824 $13,702 pension plans for a selected group of management and 2005 13,623 13,633 highly compensated employees. Benefits under these non-qualified plans are funded on a cash basis. In addition, The fair values were based on either closing market Southern Company provides certain medical care and life prices or closing prices of comparable instruments, insurance benefits for retired employees through other postretirement benefit plans. The traditional operating companies fund related trusts to the extent required by Comprehensive Income their respective regulatory commissions. For the year The objective of comprehensive incon ne is to report a ending December 31, 2007, postretirement trust measure of all changes in common stc k equity of an contributions are expected to total approximately enterprise that result from transactions and other $41 million. economic events of the period other th,an transactions with On December 31, 2006, Southern Company adopted owners. Comprehensive income consis ts of net income, FASB Statement No. 158, "Employers' Accounting for changes in the fair value of qualifying cash flow hedges Defined Benefit Pension and Other Postretirement Plans" and marketable securities, and changess in additional (SFAS No. 158), which requires recognition of the funded minimum pension liability, less incom e taxes and status of its defined benefit postretirement plans in its reclassifications for amounts included in net income, balance sheet. Prior to the adoption of SFAS No. 158, Southern Company generally recognized only the difference between the benefit expense recognized and Variable Interest Entities employer contributions to the plan as either a prepaid asset or as a liability. With respect to each of its The primary beneficiary of a variable i t munderfunded non-qualified pension plans, Southern consolidate the related assets and liabilities. Southern, Company recognized an additional minimum liability Company has established certain whol ly-owned trusts to representing the difference between each plan's issue preferred securities. See Note 6 under "Mandatorily accumulated benefit obligation and its assets. Redeemable Preferred Securities/Long -Term Debt Payable to Affiliated Trusts" for additional infi rmation. However, With the adoption of SFAS No. 158, Southern Southern Company and the traditional operating Company was required to recognize on its balance sheet companies are not considered the primnary beneficiaries of previously unrecognized assets and liabilities related to the trusts. Therefore, the investments n these trusts are unrecognized prior service cost, unrecognized gains or reflected as Other Investments, and the&relatedloans from losses (from changes in actuarial assumptions and the the trusts are reflected as Long-term E)ebt Payable to difference between actual and expected returns on plan Affiliated Trusts in the balance sheets. assets), and any unrecognized transition amounts (resulting from the change from cash-basis accounting to In addition, Southern Company holds an 85 percent accrual accounting). These amounts will continue to be limited partnership investment in an ernergy/technology amortized as a component of expense over the employees' venture capital fund that is consolidat ed in the financial remaining average service life as SFAS No. 158 did not statements. During the third quarter off2004, Southern change the recognition of pension and other Company terminated new investments in this fund; postretirement benefit expense in the statements of however, additional contributions to exxisting investments income. With the adoption of SFAS No. 158, Southern will still occur. Southern Company ha s committed to a Company recorded an additional prepaid pension asset of maximum investment of $46 million, of which $43 million $520 million with respect to its overfunded defined has been funded. Southern Company's investment in the benefit plan and additional liabilities of $45 million and fund at December 31. 2006 totaled $25.6 million. $553 million, respectively, related to its underfunded non-11-54

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report qualified pension plans and retiree benefit plans. The Changes during the year in the projected benefit incremental effect of applying SFAS No. 158 on obligations and.fair,.value of plan assets were as follows: individual line items in the consolidated balance sheet at 2006 2005 December -31, 2006 follows: - (in millions) Before Adjustments After Change in benefit obligation (in millions) Benefit obligation at beginning of Prepaid pension costs $ 1,029 $ 1 520 $ 1,549 year $5,557 $5,075 239 697 936 Service cost 153 138 Other regulatory assets Other property and Interest cost 300 286 2,523 (30) 2,493 Benefits paid'. (230) (214) investments Total assets 41,671 1,187 42,858 Plan amendments 8 32 Accumulated deferred Actuarial (gain) loss (297) 240 income taxes (5,959) (30) (5,989) Balance at end of year' 5,491 5,557 Other regulatory Change in plan assets liabilities (287) (507) (794) Fair, value of plan assets at beginning Employee benefit of year 6,147 5,476 obligations (969) (598) (1,567) Actual return on plan assets 759 866 Total liabilities (29,608) (1,135) (30,743) Employer contributions 17 19 Accumulated other Benefits paid (230) (214) comprehensive Fair value of plan assets at end of income 109 (52) 57 year 'i i 6,693 6,147 Total stockholders' equity (12,063) (52) (12,115) Funded status at end of year 1,202 590 Unrecognized transition amount - (6) Because the recovery of postretirement benefit ' Unrecognized prior service cost - 293 expense through rates is considered probable, Southern Unrecognized net gain - (2) Company recorded offsetting regulatory assets or Fourth quarter contributions . 5 5 regulatory liabilities under the provisions of SFAS No. 71 Prepaid pension asset, net - $1,207 $ 880 with respect to the prepaid assets and the liabilities associated with the Company's traditional operating At December'31, 2006, the projected benefit - companies. With respect to its unregulated subsidiaries, obligations for the qualified and non-qualified pension Southern Company recorded the resulting offset as a plans were $5.1'billion and $0.3 billion, respectively. All component of accumulated other comprehensive income, plan assets are related to the qualified pension'plan. net of tax. Pension-plan assets are managed and invested in The measurement date for plan assets and obligations accordance with all applicable requirements, including is September 30 for each year presented. Pursuant to ERISA and the Internal Revenue Code of 1986, as SFAS No. 158, Southern Company will be required to amended (Internal Revenue Cpode). TheCompany's change the measurement date for its defined benefit investment policy covers a diversified mix of assets, postretirement plans from September 30 to December 31 including equity and fixed income securities, real estate, beginning with the year ending December 31, 2008. and! private equity. Derivative instruments are used., . primarily as hedging tools but may also be used to gain efficient exposure to the various asset classes. The Pension Plans Company primarily minimizes- the risk of large losses The total accumulated benefit obligation for the pension through diversification but also monitors and manages plans was $5.1 billion in 2006 and $5.2 billion in 2005. other aspects of risk. The actual composition of the 11-55

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report Company's pension plan assets as of the end of the year, Components of net periodic pension cost (income) along with the targeted mix of assets, is presented below: were as follows: Target 2006 2005 2006 2005 2004 (in millions) Domestic equity 36%, 38% 40% Service cost $ 153 $ 138 $ 128 International equity 24 23 24 Interest cost 300 286 269 Fixed income 15 16 17 Expected return on plan Real estate 15 16 13 assets (456) (456) (452) Private equity 10 7 6 Recognized net (gain) loss 16 10 (7) Total 100% 100% 100% Net amortization 26 24 18 Net periodic pension cost Amounts recognized in the consolidated balance (income) $ 39 $ 2 $ (44) sheets related to the Company's pension pians consist of the following: Net periodic pension cost (income) is the sum of service cost, interest cost, and other costs netted against 2006 2005 the expected return on plan assets. The expected return on (in millions) plan assets is determined by multiplying the expected rate Prepaid pension costs $1,549 $1,022 of return on plan assets and the market-related value of Other regulatory assets 158 - plan assets. In determining the market-related value of Current liabilities, other (18) - plan assets, the Company has elected to amortize changes Other regulatory liabilities (507) - in the market value of all plan assets over five years Employee benefit obligations (324) (310) rather than recognize the changes immediately. As a. Other property and investments - 43 result, the accounting value of plan assets that is used to Accumulated other comprehensive calculate the expected return on plan assets differs from income - 125 the current fair value of the plan assets. Presented below are the amounts included in Future benefit payments reflect expected future accumulated other comprehensive income, regulatory service and are estimated based on assumptions used to assets, and regulatory liabilities at December 31, 2006, measure the projected benefit obligation for the pension related to the defined benefit pension plans that have, not plans. At December 31, 2006, estimated benefit payments yet been recognized in net periodic pension cost along were as follows: with the estimated amortization of such amounts for the (in millions) next fiscal year: 2007 $ 241 2008 252 Prior Net 2009 263 Service (Gain)/ 2010 277 Cost Loss 2011 294 Balance at December 31, 2006: (in millions) 2012 to 2016 1,786 Accumulated other comprehensive income $ 11 $ (11) Regulatory assets 27 131 Regulatory liabilities 225 (732) Total $263 $(6 12) Estimated amortization in net periodic pension cost in 2007: Accumulated other comprehensive income $ 1 $ 1 Regulatory assets 4 10 Regulatory liabilities 27 Total $32 11-56

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report Other Postretirement Benefits -* benefit plan assets as of the end of the year, along with the targeted mix of assets, is presented below: Changes during the year in the accumulated postretirement benefit obligations (APBO) and in the fair - Target 2006 2005 value of plan assets were as follows: Domestic equity 42% 44% 46% 2006 2005 International equity, 19 20 18 (in millions) Fixed income 29 27 29 Change in benefit obligation Real estate 6 6 5 Benefit obligation at beginning of Private equity 4 3 2 year $ 1,826 $ 1,712. Total 100% 100% 100% Service cost , 30 28 Interest cost 98" 96 Amounts recognized in the, balance sheets related to Benefits paid (79) (78i the Company's other postretirement benefit plans consist Actuarial (gain) loss (49) 68 of the following: Retiree drug subsidy 4 - 2006 2005 Balance at end of year 1,830 1,826 (in millions)

Other regulatory assets $ 538 $ -

Change in plan assets (3) Current liabilities, :other ' - Fair value of plan assets at (1,043) (439) 684 592 Employee benefit obligations beginning of year 78 Accumulated other comprehensive Actual return on plan assets 68 income 14 - Employer contributions 97 92 Benefits paid (118) (78) Presented below are the amounts included in Fair value of plan assets at end of accumulated other comprehensive income and regulatory year 731 684 assets at December, 31, 2006, related to the other Funded status at end of year -(1,099) (1,142) postretirement benefit plans that have not yet been Unrecognized transition amount 114 recognized in net periodic postretirement benefit cost Unrecognized prior service cost . . 121 along with the estimated amortization of such-amounts for Unrecognized net loss 428 thendxt;fiscal year. Fourth quarter contributions " 3 40 Prior Net. Accrued liability (recognized in the Service (Gain)/. Transition balance sheet) $(1,046)' $ (439) Cost Loss Obligation (in millions) Other postretirement benefitsplan assets are Balance at December 31, 2006: managed and invested in accordance with' al applicablk Accumulated Other - requirements, including ERISA and the Internal Revenue' comprehensive income $ 4 $ 10 $ - Code. The Company's investment policy covers a Rigulatory assets 108 332 99 diversified mix of assets,'including equity and fixed Total , $112 $342 $99 income securities, real estate, and private equity. Derivative instruments aresedd'piiriai'ily as hedging' tools but may also be used to gain efficient exposure to the Estimated amortization as net periodic various asset classes. The Company primarily minimizes. postretirement benefit cost in 2007: the risk of large losses through diversification but also monitors and manages other aspects of risk. The actual Accumulated other composition of the Company's other postretirement comprehensive income $ - $ - $ - Regulatory assets 9 ! .14 15 Total . $.9 $ 14 $15 11-57

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report Components of the other postretirement plans' net costs for 2004 were calculated using a discount rate of periodic cost were as follows: 6.00 percent. 2006 2005 2004 2006 2005 , 2004 (in millions) Discount 6.00%i 5.50% 5.75% Service cost $ 30 $ 28 $ 28 Annual salary inbdease 3.50 3.00 3.50 Interest cost 98 .97 93 Lon2-term return on Plan assets 8.50 8.50 8.50 Expected return on plan assets (49) (45) (50) Net amortization 43 38 35 The Company determined the long-term rate of Net postretirement cost $122 $118 $106 return based on historical asset class returns and current market conditions, taking into account the diversification benefits of investing in multiple asset classes. In the third quarter 2004, Southern Company prospectively'adopted FASB Staff Position 106-2, An additional assumption used in measuring the "Accounting and Disclosure Requirements" (FSP 106-2), APBO was a weighted average medical care cost trend related to the Medicare Prescription Drug, Improvement, rate of 9.56 percent for 2007, decreasing gradually to and Modernization Act of 2003 (Medicare Act). The 5.00 percent through the year 2015 and remaining at that Medicare Act provides a 28 percent prescription drug level thereafter. An annual increase or decrease in the subsidy for Medicare eligible retirees. FSP 106-2 requires assumed medical care cost trend rate of 1 percent would recognition of the impacts of the Medicare Act in the affect the APBO and the service and interest cost APBO and future cost of service for postretirement components at December 31, 2006 as follows: medical plan. The effect of the subsidy reduced Southern 1 Percent 1 Percent Company's expenses for the six months ended Increase Decrease, December 31,, 2004 and for the years ended December 31, (in millions) 2005 and 2006 by approximately $11 million, $26 million, and $39 million, respectively, and is expected to have a Benefit obligation $138 $118 similar impact on future expenses. Service and interest costs 9 8 Future benefit payments, including prescription drug Employee Savings Plan benefits, reflect expected future service and are estimated based on assumptions used to measure the APBO for the Southern Company also sponsors a 401(k) defined postretirement plans. Estimated benefit payments are contribution plan covering substantially all employees. reduced by drug subsidy receipts expected as a result of The Company. provides an 85 percent matching the Medicare Act as follows: contribution up tO 6 percent .of an employee's base salary. Prior to November 2006, the Company matched employee Benefit Subsidy contributions at a rate of 75 pecent up to 6 percent of the Payments Receipts Total employee's base salary. Total matching contributions (in millions) made to the plan for 2006, 2005, and 2004 were 2007 $ 82 $ (6) $ 76 $62 million, $58 million, and $56 miillion,'respectively. 2008 91 (7) 84 3. CONTINGENCIES A$D REGULATORY 2009 99 (9) 90 2010 . 107 (10) 97 MATTERS 2011 115 (11) 104 General Litigation Matters 2012 to 2016 667 (81) 586 Southern Company is subject to certain claims and legal actions arising in the ordinary course of business. In Actuarial Assumptions addition, Southern Company's business activities are subject to extensive governmental regulation related to The weighted average rates assumed in the actuarial public health and the environment. Litigation over calculations used to determine both the benefit obligations environmental issues and claims of various types, as of the measurement date and the net periodic costs for including property damage, personal injury, and citizen the pension and other postretirement benefit plans for the enforcement of environmental requirements such as following year are presented below. Net periodic benefit opacity and other air quality standards, has increased 11-58

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report generally throughout the United States. In particular,' refunds from the IRS related to Mirant tax items. personal injury claims for damages caused by alleged Additional refunds -are expected. The amount of any exposure to hezardodLs materials have become more unsecured clain ultimately allowed with respect to 'Mirant frequent The ultimate outc6me of uceh'eding or tax items is expected to be reduced -dollar-for-dollar by. potenuial riti on against Southern Cdmrpany and its the amount Of all refunds received from -the IRS by subsidianes cannot be Ipredicted at this time; however, for Southern Company. currenii'proeedings not specificl'iy'rdlprted herein, UVner the terms of the separation agreements entered management does hot anticipate tht'the liabilities, if any, into connection with the spin-off, Mirant agreed to in arising from suchcuref'it proceedings "Uid have a'. indemnify Southern Company for costs associated with-material adverse effect on :Southern Company's financial these guarantiees, lawsuits,'and additional IRS statements. assessments. However, as a result of Mirants'bankruptcy,

                                                        .           Southern Company sought reimbursement as an unsecured' Mirant Ma/tters                 "                 I, creditor in'Mirant's Chapter'lI proceeding. As part of a Mirant Corporation (Mirant) was an energy company with               complaint fileW'against Southern Company in June 2005 businesses that included independent'power projects and              and amended thereafter, Mirant arid The Official energy trading and risk management companies in the'.                Committee of Unsecured Creditors of Mirant Corporation U.S...and selected other countries,.It wasý a wholly-owned',         (UInsecured Cieditors' Commiiteey)objected to and sought subsidiary of Southern Company until its initial public              equitable sutordination of Southern 'Company s claims, offering in October 2000. In April 2001, Southern                     and Mirant mionved to reject the separation agreements Company completed 'a spin-off ii6'its 'hareholders' "ofits            entered'into in connection with the spin-off. MC Asset remaining ownership, and Mirant bedtie' an independent               Recovery, a special purpose subsidiary of Reorganized' corporate entity.                                                     Mirant, has been substituted as plaintiff in the complaint.

If Southern Company's claims for indemnification with Mirant Bankruptcy . ' " respect to these, or any additional future pdyments, are all6wed,' the'ir Mirant's indemnity oblig'ations to Southerni In July 2003, Mirapt and certain of its affiliates filed Comnpahy'wouild constitute unsedcured claims 'against '"- voluntary petitions for, relief underChapter. 11 of the Bankruptcy Code in the U.S. Bankruptcy-Court for the, Mirant entitl&d t stck in Reorganized Mirafit'. The final' L outcome ot'his' matter cannot now be determined.f Northern District of Texas. The Bankruptcy Court entered an order conf'uming Mirant's plan of reorganization on, December 9, 2005, and Mirant announced. that this, plan MC Asset Recovery Litigation,' became effective on January 3, 2006. As part of the plan; InJune 2005, Mirant, as a debtor i "possesion,'ard the' Mirant transferred substantially all of its assets and its Unsecured Creditors' Commftt&"filed"a' compladnt against restructured debt io a new coiortAdon that *dopted the Southern Company in the U.S. Bankruptcy Coturt for the' name Mirant Corporation' (R Oibgihized Mirant).:' Northern District of Texas, which was amended in July Southern. Company has certain:contingent liabilities 2005,;Febrtdary '2006, and May,_2006. The third 'amended associated with guarantees of contractual commitments comnplaint'(tfie complaiint) allegeg~that Souther-n Company' made by Mirant's subsidiaries discussed in N4qte 7 under daused Mirani'to 6ngage in certain fraudulent transfers:r "Guarantees" and with various lawsuits .1rlated to Mirant and t6 pay' illegal dividends to Southern !Compani? prior. to discussed below. Souther Company has pat

the 'spin-off. The'alleged fraudulent transfeis 'aid illegal '

approximately $1.4 million in, ynnectioi with the dividends'iniclude wiihout limitatiori' (1) certain dividends' guarantees, Also, $.outhem Co,mpany has joint arid sdqeral from Mirint to Southern Company in'the aggregdte,' liability with Mirant regarding the. joint consolidated amount of $668 million, (2)'the repayment of certain 6 s discussed in federal income .tax reumrns through 2001, intercomp6ty loans and accrued interest in an aggregate Note 5. In December.,2004, as,a result of Sopncluding an amount of-$1.035*billion, and (3) the dividend distribution IRS audit'for 'the,tayears ,*000Qand .200!,; .Southemr ofrone'share of Series B Preferred Stockand its Compýay paid $39 million in .addi oal/*¶ nd interest subsequefit redemption in exchange for Mirant's for issues related to Mirant tax items. Bised on 80 percent interest in a holding company that owned management's assessment'of the collectibility of the' SE Finance Capital Corporation and Southern Company

$39 million receivable, Southern Company has reserved                 CapitalFunding, Inc., which transfer plaintiff asserts is approximately $13.37 million. In' December12006, Southern            valued at over $200 million. The -complaint 'also seeks to Company received'approximately $23 million in tax                    recharacterize certain advances from Southern Company 11-59

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report to Mirant for investments in energy facilities from debt to Mirant Securities Litigation equity. The complaint further alleges that Southern Company is liable to Mirant's creditors for the full In November 2002, Southern Company,, certain former and current senior officers of Southern Company, and amount of Mirant's liability under an alter ego theory of recovery and that Southern Company breached its 12 underwriters of Mirant's initial public offering were fiduciary duties to Mirant and its creditors, caused Mirant added as defendants in a class action lawsuit that several Mirant shareholders originally filed against Mirant and to breach its fiduciary duties to creditors, and aided and certain Mirant officers in May 2002. Several other similar abetted breaches of fiduciary duties by Mirant's directors lawsuits filed subsequently were consolidated into this and officers. The complaint also seeks recoveries under litigation in the U.S. District Court for the Northern the theories of restitution and unjust enrichment. The District of Georgia. The amended complaint is based on complaint seeks monetary damages in excess of $2 billion allegations related to alleged improper energy trading and plus interest, punitive damages, attorneys' fees, and costs. marketing activities involving the California energy Finally, the complaint includes an objection to Southern market, alleged false statements and omissions in Mirant's Company's pending claims against Mirant in the prospectus for its initial public offering and in subsequent Bankruptcy Court (which relate to reimbursement under public statements by Mirant, and accounting-related issues the separation agreements of payments such as income previously disclosed by Mirant. The lawsuit purports to taxes, interest, legal fees, and other guarantees described include persons who acquired Mirant securities between in Note 7) and seeks equitable subordination of Southern September 26, 2000 and September 5, 2002. Company's claims to the claims of all other creditors. Southern Company served an answer to the complaint in In July 2003, the court dismissed all claims based on June 2006. Mirant's alleged improper energy trading and marketing activities involving the California energy market. The On December 29, 2005, the Bankruptcy Court remaining claims do not allege any improper trading and entered an order authorizing the transfer of this marketing activity, accounting errors, or material proceeding, along with certain other actions, to MC Asset misstatements or omissions on the part of Southern Recovery, a special purpose subsidiary of Reorganized Company but seek to impose liability on Southern Mirant. Under that order, Reorganized Mirant is obligated Company based on allegations that Southern Company to fund up to $20 million in professional fees in was a "control person" as to Mirant prior to the spin-off connection with the lawsuits, as well as certain additional date. Southern Company filed an answer to the amounts. Any net recoveries from these lawsuits will be consolidated amended class action complaint in distributed to and shared equally by certain unsecured September 2003. Plaintiffs have also filed a motion for creditors and the original equity holders. In January 2006, class certification. the U.S. District Court for the Northern District of Texas During Mirant's Chapter 11 proceeding, the substituted MC Asset Recovery as plaintiff. securities litigation was stayed,,with the exception of limited discovery. Since Mirant's plan of reorganization On January 10, 2006, the U.S. District Court for the has become effective, the stay has been lifted. On Northern District of Texas granted Southern Company's March 24, 2006, the plaintiffs filed a motion for motion to withdraw this action from the Bankruptcy Court reconsideration requesting that the court vacate that and, on February 15, 2006, granted Southern Company's portion of its July 14, 2003 order dismissing the motion to transfer the case to the U.S. District Court for plaintiffs' claims based upon Mirant's alleged improper the Northern District of Georgia. On May 19, 2006, energy trading and marketing activities involving the Southern Company filed a motion for summary judgment California energy market. Southern Company and the seeking entry of judgment against the plaintiff as to all other defendants have opposed the plaintiffs' motion. The' counts of the complaint. On December 11, 2006, the plaintiffs have also stated that they intend to request that U.S. District Court for the Northern District of Georgia the court grant'leave for them to amend the complaint to granted in part and denied in part the motion. As a result, add allegations based upon claims asserted against certain breach of fiduciary duty claims are barred; all Southern Company in the MC Asset Recovery' litigation. other claims in the complaint may proceed. Southern Company believes there is no meritorious basis for the Under certain circumstances, Southern Company will claims in the complaint and is vigorously defending itself be obligated under its Bylaws to indemnify the four in this action. However, the final outcome of this matter current and/or former Southern Company officers who cannot now be determined. served as directors of Mirant at the time of its initial 11-60

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report public offering through the date of the spin-off and who case was pending, and moved to remand the matter. to the are also named as defendants in this lawsuit. The final district court.' The motion.was granted on December 20, outcome of this matter cannot now be determined.. 2006. The settlement term sheet adriits no liability and Southern Company Employee S'agsPlan Litigation provides for a payment of $15.miilion, to be made by the In June 2004, an employee of a-Southern Company Company's insurance carrier, to the Plan, after deduction subsidiary filed a complaint, which was amended in of any award for plaintiff's attorneys fees and certain'. - December 2004 and November 2005 in the U.S. District other expenses if approved by the district court. Because Court for the Northern District of Georgia on behalf of a the case is a putative class action, the settlement requires purported class of participants in or beneficiaries of The court approval.- The district court will consider all matters Southern Company Employee Savings Plan (Plan) at any relited to the settlement. Pending the settlement approval,-. the ultimate outcome of this matter cannot'now be time since April 2, 2001 and whose Plan accounts I -' ` - d etermin ed . I . included investments in Mirant common stock. The complaint asserts claims under ERISA against defendants J)~, Southern Company, SCS, the Employee Savings Plan Environmental Matters Committee, the Pension Fund Investment Review New Source Review Actions Committee, individual members of such commiittees, and the SCS Board of Directors during the putative class In November 1999, the EPA brought a civil action Ln the period."The plaintiff alleges that the 4 ýrious defendants U.S. Dist ict Coirt for the Northern District of Georgia had certain fiduciary duties under ERISAiegardin g the againstcertin Southern Company subsidiaries, including. Mirant shares distributed to Soudtheni Company Alabama Power and Georgia Power, alleging that these shareholders in the spin-off and held in the Mirant Stock subsidiaris -had violated the New Source ReviewV NSR). Fund in the Plan. The plaintiff alleges that the various provisions of the Clean Air Act and related state liws at defendants breached purported fiduciary duties by, among certain coal-fired generating facilities. Through other things, failing to adequately determine wiether subsequent amendments and other legal procedures, the Mirant stock was appropriate to hold in the Plan and EPAfiled a separate action in January 72001 against.. - failingto adequately Inform Plan participants that Mirant Alabama Power. in the U.S. District Court for the -A stock was not an appropriate investmentt forutheir., Northern District of Alabama after Alabama PoWer was;, retirement assets based on Mirant's alleged improper dismissed from the original action. In these. lawsuits; the ..: energy trading and accounting practices, mismanagement, EPA alleged that NSR violations occurred at eight coal-.". and business conditions. The plaintiff also alleges that ý - fired generating facilities operated by Alabama Power and certain defendants failed to monitor.Plan fiduciaries and Georgia !Pcwer (including 'afacility formerly owned by that certain defendant's had conflicting interests regarding Savannah Electric), The civil ;actions request penalties and., Mirant, which prevented them from'afting se i.n the injunctive.relief, Including an order. requiting, the interests of Plan participants and beneficiaries.' The installation of the best available control technology 'at the.: plaintiff seeks class-wide equitable relief 'and an affected units , . - -, . .= . unspecified amount-of'moneta9damages. On June 19, 2006, the U.S. District Court for the: On October 4, 2005, the court dismissed the Northern District of Alabamna 'entered a consent. decree plaintiff's claims for certain types of equitabld relief, but between Alalbama Power and the EPA, resolving"' allowed the remainder of the ERISA-tlaims -toproceed. alleged NSRg violations at Plant Millei. The consent The 'defendants filed answers to the second amended . decree ý.required

                                                                                ý, ý.
                                                                                   <, ," ...Alabama
                                                                                               . I         , , '.,to pay
                                                                                                     - :Power          .,.. $100,0006to
                                                                                                                              ; ,.    . ;l*;,"a lt!

complaint in January 2006 and filed rnotiong for summary resolve me government's clmm for a civil penalty and to.' judgment and to stay discovery in'February 2006. In April donate'$t49 million of sulfur 'dioxide einission allowances 2006, the U.S. District Court for,the-Northern District of to a nonpiofit charitable organization and formalized .... Georgia granted summary judgment in favor of Southern specific ernt.ssions reductions to be accomplished by Company and all other defendants in the case. The-'i, Alabama Power, consistent with other Clean Air Act plaintiff filed an hppeal -of the ruling:On December 19, programs that require emissions reductions. On August 14, 2006, tde parties executed a written settlement term sheet, 2006, the district court in Alabamaa granted Alabama to be followed,.by a formal settlement agreement. On the Power's motion for summary judgment and entered final same day, the parties waived oral argumentlinthe judgment intfavor of Alabama Power on the EPA'sclaims U.S. Court of Appeals for the Eleventh Circuit, where the" related to Plants Barry, Gaston, -Gorgas,,and Greene 11-61

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report County. The plaintiffs have appealed this decision to the Comprehensive Environmental Response, Compensation, U.S. Court of Appeals for the Eleventh Circuit, and on and Liability Act. In 1995, the EPA designated Georgia November 14, 2006, the Eleventh Circuit granted Power and four other unrelated entities as potentially plaintiffs' request to stay the appeal, pending the responsible parties at a site in Brunswick, Georgia, that is U.S. Supreme Court's ruling in a similar NSR case filed listed on the federal National Priorities List. As of by the EPA against Duke Energy. The action against December 31, 2006, Georgia Power had recorded Georgia Power has been administratively closed since the approximately $6 million in cumulative expenses spring of 2001, and none of the parties has sought to associated with its agreed-upon share of the removal and reopen the case. remedial investigation and feasibility study costs for the Brunswick site. Additional claims for recovery of natural Southern Company believes that the traditional resource damages at the site are anticipated. Georgia operating companies complied with applicable laws and Power has also recognized $36 million in cumulative the EPA regulations and interpretations in effect at the expenses through December 31, 2006 for the assessment time the work in question took place. The Clean Air Act and anticipated cleanup of other sites on the Georgia authorizes maximum civil penalties of $25,000 to Hazardous Sites Inventory. $32,500 per day, per violation at each generating unit, depending on the date of the alleged violation. An The final outcome of these matters cannot now be adverse outcome in any one of these cases could require determined. However, based on the currently known substantial capital expenditures that cannot be determined conditions at these sites and the nature and extent of at this time and could possibly require payment of activities relating to these sites, management does not substantial penalties. Such expenditures could affect believe that additional liabilities, if any, at these sites future results of operations, cash flows, and financial would be material to the financial statements. condition if such costs are not recovered through regulated rates. FERC Matters Plant Wansley Environmental Litigation Market-Based Rate Authority In December 2002, the Sierra Club, Physicians for Social Each of the traditional operating companies and Southern Responsibility, Georgia Forestwatch, and one individual Power has authorization from the FERC to sell power to filed a civil suit in the U.S. District Court for the non-affiliates, including short-term opportunity sales, at Northern District of Georgia against Georgia Power for market-based prices. Specific FERC approval must be alleged violations of the Clean Air Act at four of the units obtained with respect to a market-based contract with an at Plant Wansley. The civil action requested injunctive affiliate. and declaratory relief, civil penalties, a supplemental In December 2004, the FERC initiated a proceeding environmental project, and attorneys' fees. In January to assess Southern Company's generation dominance 2007, following the March 2006 reversal and remand by within its retail service territory. The ability to charge the U.S. Court of Appeals for the Eleventh Circuit, the market-based rates in other markets is not an issue in that district court ruled for Georgia Power on all remaining proceeding. Any new market-based rate sales by any allegations in this case. The only issue remaining for subsidiary of Southern Company in Southern Company's resolution by the district court is the appropriate remedy retail service territory entered into during a 15-month for two isolated, short-term, technical violations of the refund period beginning February 27, 2005 could be plant's Clean Air Act operating permit. The court has subject to refund to the level of the default cost-based asked the parties to submit a joint proposed remedy or rates, pending the outcome of the proceeding. Such sales individual proposals in the event the parties cannot agree. through May 27, 2006, the end of the refund period, were Although the ultimate outcome of this matter cannot approximately $19.7 million for the Southern Company currently be determined, the resulting liability associated system. In the event that the FERC's default mitigation with the two events is not expected to have a material measures for entities that are found to have market power impact on the Company's financial statements. are ultimately applied, the traditional operating companies and Southern Power may be required to charge cost-based Environmental Remediation rates for certain wholesale sales in the Southern Company Georgia Power has been designated as a potentially retail service territory, which may be lower than responsible party at sites governed by the Georgia negotiated market-based rates. The final outcome of this Hazardous Site Response Act and/or by the federal matter will depend on the form in which the final 11-62

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report methodology for assessing generation market power and On October 5, 2006, the FERC issued an order mitigation rules may be ultimately adopted and cannot be accepting a settlement resolving the proceeding subject to determined at this time. Southern Company's agreement to accept certain modifications to the settlement's terms. On October 20, In addition, in May 2005, th' FERC started an 2006, Southern Company notified the FERC that it investigation to determine whether Southern Company accepted the modifications. The modifications largely satisfies the other three parts of the FERC's market-based rate analysis- transmission market power, barriers to entry, involve functional separation and information restrictions and affiliate abuse or reciprocal dealing. The FERC related to marketing activities conducted on behalf of established a new 15-month refund peri6d related to this Southern Power. Southern Company :filed with the FERC expanded investigation. Any new hiarket-based rate sales on November 6, 2006 an implementation plan to comply involving any Southern Company subsidiary could be with the modifications set forth in the order. The impact subject to refund to the extent the 'FER orders lower of the modifications is not expected to have a material rates as a result of this new investigation. Such sales impact on Southern Company's financial statements. through October 19, 2006, the end of the refund period, were approximately $55.4 million for the Southern Company system, of which $15.5 million relates to sales Generation Interconnection Agreements inside the retail service territory discussed -above;. The FERC also directed that this expanded proceeding be held In July 2003, the FERC issued its final rule on the in abeyance pending the outcome of the proceeding on standardization of generation interconnection agieements the Intercompany Interchange, Contract (JIC) discussed and procedures (Order 2003). Order 2003 shifts much of below.:On January 3, 2007, the FERC issued an order the financial burden of new transmission investment from noting settlement of the IIC proceeding and seeking the generator to the transmission provider. The FERC has comment identifying any remaining 'issues and the proper indicated that Order 2003, which'was effective January 20, procedure for addressing any such issues. 2004, is to6 be applied prospectively to new generating':, facilities interconnecting to a transmission system. Order Southern Company and its subsidiaries believe that there is no meritorious basis for these proceedings and are 2003 was affirmed by the U.S. Court of Appeals for the vigorously defending themselves in this matter. However, District of Columbia Circuit on January 12, 2007. The the final outcome of this matter, including any remedies cost impact resulting from Order 2003 will vary on a to be applied in the event of.an adverse ruling in these case-by-case basis for each new generator interconnecting proceedings, cannot now be determined. to the transmission system. . . Intercompany Interchange Contract - On, November 22, 2004, generator company subsidiaries of Tenaska, Inc. (Tenaska), as counterparties The Company's generation fleet in its retail service to three previouslyexecuted interconnection agreements territory is operated under the IIC, as approved by the with subsidiaries of Southern Company, filed complaints. FERC. In May 2005, the FERC initiated a new at the FERC requesting that the FERC modify the proceeding to examine (I) the provisions of the IIC agreements and that those Southern Company subsidiaries among Alabama Power, Georgia Power, Gulf Power, refund a total of $19 million previously paid for Mississippi Power, Savannah' Electric, Southern Power, interconnection facilities, with interest. Southern and SCS, as agent, under the terms of which the power Company hlis also received requests for similar pool of Southern Company is operated, and, in particular, modifications from'other entities, though no other the propriety of the continued inclusion of Southern complaints are pending with the FERC. On January 19, Power as a party to the 1iC, (2) whether any parties to 2007, the FERC issued an order granting Tenaska's' the IUC have vi6latedcthe FERC's standards of conduct applicable to utility companies that are transmission requested relief. Although the FERC's order requires the providers, and (3) whether Southern Company's code of modificati6ri"of Tenaska's interconnection agreements, the conduct defining Southern Power as a "system company" order reduces the amount of the refuo'd that had been rather than a "marketing affiliate" is just and reasonable. requested by Tenaska. As a result, Southern Company In connection with the formation of Southern Power, the estimates indicate that norefund is due Tenaska. Southern FERC authorized Southern Power's inclusion in the IIC in Company has requested rehearing of the FERC's order. 2000. The-FERC also previously 1approved Southern The final outcome of this matter cannot now be Company's code of conduct. determined. 11-63

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report Right of Way Litigation judgment claim that the easements do not permit general telecommunications use. The court also dismissed Southern Company and Certain of its subsidiaries, Southern Telecom from this case. Georgia Power including Georgia Power, Gulf Power, Mississippi Power, appealed this ruling to the Georgia Court of Appeals. The and Southern Telecom, have been named as defendants in Georgia Court of Appeals reversed, in part, the trial numerous lawsuits brought by landowners since 2001. court's order and remanded the case to the trial court for The plaintiffs' lawsuits claim that defendants may not the determination of further issues. After the Court of use, or sublease to third parties, some or all of the fiber Appeals' decision, the plaintiffs filed a motion for optic communications lines on the rights of way that cross reconsideration, which was denied, and a petition for the plaintiffs' properties and that such actions exceed the certiorari to the Georgia Supreme Court, which was easements or other property rights held by defendants. denied. On October 10, 2006, the Superior Court of The plaintiffs assert claims for, among other things, Decatur County, Georgia granted Georgia Power's motion trespass and unjust enrichment and seek compensatory for summary judgment. The period during which the and punitive damages and injunctive relief. Management plaintiff could have appealed has expired. This matter is of Southern Company and its subsidiaries believe that now concluded. they have complied with applicable laws and that the plaintiffs' claims are without merit. To date, Mississippi Power has entered into agreements with plaintiffs in approximately 90 percent of In November 2003, the Second Circuit Court in the actions pending against Mississippi Power to clarify Gadsden County, Florida, ruled in favor of the plaintiffs its easement rights in the State of Mississippi. These on their motion for partial summary judgment concerning agreements have been approved by the Circuit Courts'of liability in one such lawsuit brought by landowners Harrison County and Jasper County, Mississippi (First regarding the installation and use of fiber optic cable over Judicial Circuit), and dismissals of the related cases are in Gulf Power rights of way located on the landowners' progress. These agreements have not resulted in any property. Subsequently, the plaintiffs sought to amend material effects on Mississippi Power's financial their complaint and asked the court to enter a final statements. declaratory judgment and to enter an order enjoining Gulf Power from allowing expanded general In addition, in late 2001, certain subsidiaries of telecommunications use of the fiber optic cables that are Southern Company, including Alabama Power, Georgia the subject of this litigation. In January 2005, the trial Power, Gulf Power,' Mississippi Power, Savannah Electric, court granted in part the plaintiffs' motion to amend their and Southern Telecom, were named as defendants in a' complaint and denied the requested declaratory and lawsuit brought by;a telecommunications company that injunctive relief. In November 2005, the trial court ruled uses certain of the defendants' rights of way. This lawsuit in favor of the plaintiffs and against Gulf Power on their alleges, among other things, that the defendants are respective motions for partial summary judgment. In that contractually obligated to indemnify, defend, and hold same order, the trial court also denied Gulf Power's harmless the telecommunications company from any' motion to dismiss certain claims. The court's ruling liability that may be assessed against it in pending and allowed for an immediate appeal to the Florida First future right of way litigation. The Company believes that District Court of Appeal, which Gulf Power filed in the plaintiff's claims are without merit. In the fall of December 2005. On October 26, 2006, the Florida First 2004, the trial court stayed the case until resolution of the District Court of Appeal issued an order dismissing Gulf underlying landowner litigation discussed above. In, Power's December 2005 appeal on the basis that the trial January 2005, the Georgia Court of Appeals dismissed the court's order was a non-final order and therefore not telecommunications company's appeal of the iriai court's. subject to review on appeal at this time. The case is once order for lack of jurisdiction. An adverse outcome in this again pending in the trial court for further proceedings. matter, combined with an adverse outcome against' the The final outcome of this matter cannot now be telecommunications company in one or more of the right determined. In the event of an adverse verdict in this case, of way lawsuits, could result in substantial judgments; Gulf Power could appeal the issues of both liability and however, the final outcome of these matters cannot now damages or other relief granted. be determined. In January 2005, the Superior Court of Decatur Income Tax Matters County, Georgia granted partial summary judgment in another such lawsuit brought by landowners against Southern Company undergoes audits by the IRS for each Georgia Power based on the plaintiffs' declaratory of its tax years. The IRS has completed its audits of 11-64

" r ,

NOTES (continued)

Southern Company and Subsidiary Companies 2006 Annual Report Southern Company's consolidated federal income tax year period, when averaged together, cannot exceed returns for all years through 2003. Southern Company 4 percent per year and any annual adjustment is limited to participates in four international leveraged lease 5 percent. Rates remain unchanged when the projected transactions and receives federal income tax deductions return on common equity (ROE) ranges between for depreciation and amortization, as well as interestuon 13 percent and 14.5 percent. If Alabama Power's actual related debt. The IRS proposed to disallow the tax losses retail ROE is -above the allowed equity return range, for one of these leases (a lease-in-lease-out, or LILO) in customer refunds will be required; however, there is no connection with its audit of 1997 through 2001. In, prbvision for additional customer billings should the October 2004, Southern Company submitted the issue to actual retail return on common equity fall below the the IRS appeals division and in February 20,05 reached'a allowed equity return range. Alabama Power made its negotiated settlement with the IRS which is now final., initial submission of projected data for calendar 'year 2007 on December 1, 2006. The Rate RSE increase for 2007 is In connection with its audits of tat years 2000- 4.76 percent, or $193 million annually, and was effective 2001 and 2002 - 2003 the IRS also challenged Southern in Janiiiary 2007. The ratemaking procedures will remain Company's deductions related to three other international in effect until the Alabama PSC votes to modify or lease (sale-in-lease-out, or SILO) transactions. In the third discontinue them. quarter 2006, Southern Company paid the full amount of the disputed tax and the applicable interest on the SILO The Alabama PSC has also'approved a rate issue for tax years 2000 -2001 and filed a claim for mechanism 'that provides for adjustments to recognize the refund which has now been denied by the IRS. The placing of new generating facilities in retail service and disputed tax amount is $79 million and the, related. interest for the recovery of retail costs associated with certificated is approximately $24 million for these tax years. This purchased power agreements (Rate CNP). An increase of payment, and the subsequent IRS disallowance of the 0.8 percent in retail rates, or $25 million annually, was refund claim, closed the issue with the IRS and Southern effective July. 2004 under Rate CNP for new certificated Company plans to proceed with litigaion. The IRS has power purchase agreements. In April 2005, an adjustment also raised the SILO issues for tax years 2002 and 2003. to Rate CNP decreased retail rates by approximately The estimated amount of disputed tax -and interest for 0.5 percent, or $19 million annually. The annual true-up these years is approximately $83 million and $15 million, adjustment effective in April 2006 increased retail rates respectively. The tax and interest for these tax years was by 0.5,percent, or $19 million annually. The request filed paid to the IRS in the fourth quarter 2006. Southern in February 2007 did not require any, adjustment Company has accpunted for both payments in 2006 as., beginning in April 2007. deposits, as ,management believes no additional tax or interest liabilities have been incurred. Fo* tax years 2000 In October 2004, the Alabama PSC approved ai through, 2006, Southern Company has claimed request by Alabama Power to amend. Rate CNP to also

$284 million in tax benefits related to theseSILO                  provide for the recovery of retail costs associated with.

transactions challenged by the IRS. The ultimate outcome environmental laws and regulations, effective in January of this matter cannot now be determined. See Note 1 2005. The rate mechanism began operation in January under, "Leveraged Leases" for additional information. 2005 and provides for the recovery of these costs pursuant to a factor that will be calculated annually. Environmental Alabama Power Retail Regulatory Matters costs to be recovered include operation and maintenance expenses, depreciation, and a return on invested capital. Alabama Power operates under a Rate Stabilization and Retail rates .increased approximately'1.0 :percent in . Equalization Plan (Rate RSE) approved by the Alabama January 2005, 1.2 percent in January 2006, and 0.6 percent PSC. Rate RSE provides for periodic annual adjustments in January 2007. based upon Alabama! Power's earned. return on end-of-period retail common equity; however, in October 2005, Alabama Power fuel costs are' recovered under Rate Alabama Power and the Alabamfia PSC agreed to a ECR (EnergyCost Recovery), which provides for the moratorium on any rate increase under Rate RSE until addition of a fuel and energy cost factor to base -rates; In'. January 2007. In October 2005, the Alabama PSC December 2005, the Alabama PSC approved an increase approved a revision to Rate RSE requested by Alabama that allows for the recovery of approximately $227 million Power. Effective January' 2007, Rate .RSE adjustments are in existing under recovered fuel costs over a two-year based on forward-looking information for the applicable period. Based on the order, a portion of the under upcoming calendar year. Rate adjustments for any two- recovered iegulatory clause revenues was reclassified 11-65

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report from current assets to deferred charges and other assets in recovery increase in January 2006. In connection with the. the balance sheet. merger of Georgia Power and Savannah Electric, Georgia-Power agreed with a Georgia PSC staff recommendation Georgia Power Retail Regulatory Matters to forego the temporary fuel rate process, and Savannah Electric'. postponed its scheduled filing'. Instead, Georgia! In December 2004, the Georgia PSC approved a three-Power and Savannah Electric filed, a combined request in, year retail rate planending December.31, 2007 (2004 March 2006 to increase the fuel cost recovery rate. Retail Rate Plan) for Georgia Power. Under the terms of the 2004 Retail Rate Plan, Georgia Power's earnings are On June 15, 2006, the Georgia PSC ruled on 'the evaluated against a retail ROE range of 10:25 percent to request and approved an increase in Georgia Power's total 12.25 percent. Two-thirds of any earnings above. annual fuel billimgs of 4approxirnately 4100 million. The 12.25 percent will be applied to rate refunds, with the Georgia PSC order provided for a combined ongoing fuel' remaining one-third retained by Georgia Power.' Retail forecast but reduced the requested increase related to such rates and customer fees were increased by approximately forecast, by $200 million. The order also required. Georgia $203 million effective January 1, 2005., In 2007, Georgia Power, to file for a new fuel cost recovery rate on a semi-; Power will refund 2005 retail earnings in excess of a annual basis, beginning in September 2006. Accordingly, 12.25 percent retail ROE. The refund amouirnt is not on Septemberý:15, 2006, Georgia Power, filed a request to, expected to be material. No refund is anticipated for recover fuel costs incurred through August 2006 by 2006. Georgi4 Power is,required to file a general rate case increasing. the fuel cost recovery rate. byJuly 1, 2007 in response to which the Georgia PSC On. November: 0' , 2006; unrder an Atgreement with the would be expected to determine whether the rate order Georgia PSC staff, Georgia Power filed a supplementary should be continued, modified, or discontinued, request reflecting a forecast of annual'fuel costs, 'as well In December 2001, the Georgia PSC approved a as updated informnation! for previously incurred fiuel costs'. three-year retail rate plan'(2001 Retail Rate Plan) for On February 6, 2ýA7, the'Georgia PSC ruled on the' Georgia' Power ending December 31, 2004. Under the request' and approved an-increase in 'Georgia- Power's. t6tal terms of the 2001 Retail Rate Plan, earnings were annual billings of approxinmately$383' million. The' evaluated hgalnst a retail return on commiion equity range Georgia PSC oirder reduced' Georgia Power's requested' of 10 percent to 12.95 percent. Georgia Power's earnings increase in- the forecast of annual fiel, costs by $40 million in all three years, were within the common equity range. and disallowed $4' million of'pi'vtiusly incurred fuel - Under the! 2001 Retail Rate Plan, Georgia Power costs. The order'als requires Georgia Power'to file tar a amortized a regulatory liability of $333 million, related to new fuel cost recoveIry rate no later thin MarchI 1, 2008. previously recorded accelerated amortization expenses, The new rates wilf bec6me effective'on March 1, 2007. equally over three years beginning in 2002. Also, the Estimated undei irecovered fuel co0ts ,are to be'recoered 2001 Retail Rate Plan irequired Georgih Power to through May 2009 for customers in the' former Georgia recognize capacity arid operating and maintenance costs Power territory'and fthrough Novgmber 2009 for relited to certified purchase power contracts evenly into customers in the former Savannah Electric territory. As of rates ovei a three-year period ended December' 31, 2004. December 31, 2006, Georgia Power had an undci ' recovered fuel 'balance of approximately $898 million.

    .In  May-2005, the Georgia PSC approved Georgia Power's request to increase customer fuel rates by                                                       " , -         . . ... .... .

S torm Da mage C o st Reco v ery approximately 9.5 percent to recover qnder recovered fuel costs of approximately $508 million existing as of Each traditional operating company maintains a reserve to May 31,. 2005 over a four-year period that began June 1, cover the. cost of damages from major storms to its , _,; :! 2005. The Georgia PSC's order instructed that under transmission and distribution facilities and the cost f *ir recovered fuel amounts be reviewed semi-annually uninsured damages to' its 'generation facilities and other s. beginning February 2006. If the amount-under or over property. Following Hurricanes -Ivan, Dennis-, and Katrina' recovered exceeded $50 million at any evaluation date, in September 2004, July 2005,, and August 2005,. Georgia Power was required to file for a temporary fuel respectively, each of'the affected, traditional operating rate change. Under recovered fuel amounts for the period companies has beenv authorized by its respective state PSC subsequent to June 1, 2005 totaled $327.5; million through to defer the portion of the-storm restoration costs incurred December, 31, 2005. In addition, in accordance with a' that exceeded'the balance in its storm damage reserve,, ý separate Georgia PSC order, Savannah Electric was.ý account As of'December. 31, 2006, the under recovered scheduled to file an additional request for a fuel cost balance in Southern Company's storm damage reserve 11-66

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report accounts totaled approxhinately $89xmillioWi, bf which totaled approximately $4.7 million which is included in approximately $57 million and $32 million, respectively, the balance sheets herein under "'Current Assets." . is included in the balancp sheets hre"n under "Other Current Assets" :+`ýdd'0ther Regulator6AWsets I .In July 2006, the Florida .PSC issued its. order. Approximately"$63 million of the uner recovered approyvig a :stipulation and settlement, between Gulf balances are being'recovered throughi separate surcharges, Power and several consumer groups that resolved all. or rate riders approved by tie Floridci and Alabama PSCs, matters *relating to Gulf Power's request for recovery of as discussedfurther below. The recov~rY of the remaining incurred, posts for, storm-recovery activities and the deferred '-osts is' subject t6 the approvaal bf the .`respective replenishrentepf GGulf Power's property damage reserve. state PSC. The order provides for an.extension of the storm-recovery surcharge currently being collected by Gulf Power for an In June.2006, the,.Mississippi-PSC'issued an order, additional 27 months, expiring in June.2009. According to based upon a stipulation between"Mississippi Power and the stiPulati n , te funds resulting from the extension of, the Mississippi Public Utilities Staff. The, stipulation and., the Current surcharge will first be credited to the the associated order certified actual storm restoration .... unrecoyeyrd balance 'of storm-recovery costs associated costs relating to Hurricane Katrina through April 30, 2006 with& riucane Ivan until these costs have been fully' of $267.9 million and affirmed estimated additional costs recoveed . The fuinds will then be credited to the property through December 31, 2007 of $34.5 million, for total . '.. reserve for recovery of the storm-recovery costs of storm restoration costs of $302.4 million which was net $52.6 million associated with Hurricanes Dennis and of insurance proceeds of tpproximately $77 iihilli6n, Katrnaihat were previously charged to the reserve. without offset'for the propetty'damage eseive if Should reveiiies collected by Gulf Power through the, $3.0 million. Of the total am0otint, $292.8 million 'applies' extension of the' storm-recovery surcharge exceedDennis the ' to Mississippi Power's retail jurisdiction. The aorder storm-recover costs associated with Hurricanes M .: ./, Mississippi directed , .. ,be . : 'Power-to

                            ) f ,    file an applicatibn with the       and Kaitna, the excess revenues will' be credited to the Mississipp Development Authority (MDA) for a                             reserve. Thannluial acciual' t6 the reserve of $3.5 million Commuinity Development Block-Grant-(CDBG).                               and GykPIpPw              ienr's discretionary authority 'to make Yited Mississippi Power filed the CDBG application with the                                                                     continue  as previou/sly                          Floridawill
                                                                                       ~appAvedtobythethereserve' additional' a'ccruals'                        PSC.'  Gulf Power MDA in September 2006. On October 30, 2006                    :

Mississippi Power received from the MDA a CDB03 -in made discretionaryi accruals to the reserve of $3 million, the amount of $276.4 million. Mississippi Power has $d millilY,"d $15 'm"iillion in' 2006, 2005, and 2004, appropriately allocated and 'applied these CDBb po&eeds respeectiv'eui. 'ýk part of t'e March e2005 agreement to both retail and wholesale storm restoatioon £*ost. regarding Htiiticane Ivan costs that established the" recovery. existing *utrcarge, Gulf Power agreed that it would not seek any additional increase in its base rates and chiages Mississippi Power filed an application fora financing order with the Mississippi PSC on July 3, 2006 for to become effective on or before March 1, 2007. The terms of the stipulation do not alter or affect that portion restoration costs under the state bond program. On,, October 27, 2006, the Mississippi PSC issued a financing, of the prior agreement. Accoraing , the 'rder,' in the 'ca'e of future storms, if Gulf Power incurs cumulative costs order that authorizes the issuance of $121*.2 million of, system restoration bonds. This amount includes ,., I - :! for kibrm:rto* ry activities 'inýe(cess-of*$10 'million :'+9

$25.2 million for the retail storm recovery costs not;,-                dudlgn y cl.l-nldar                Gulf Pod)er                  "'"to'
                                                                                                                    .ear, will be perrtted" covered by the CDBG, $60 million for a properly. damlage                 file a streaidiiied formal request forar interinm surchafge.'

reserve, and $36 million for the retail portion :ofi the j, Any interim suircharge would provide for the recovery,'" construction of the storm operations facility, The bonds. subjedt to fiKnil', of up to (80 percent of the claimed' costý will be issuedty the Mississippi Development Bank on for storm {cov'ery activities. Gulf Power would then behalf of the State'f Miss ssippi an dvili be reported as petition ihe Florida 'PSC for'full recovery through an liabilities by the State of Mississippi. Periodic true-up additional surcharge or other cost recovery mechanismi. mechanisms will -be structured to comply with: terms and As of December 31, 2006, Gulf ,Power's unrecovered requiremnents'of the lekislation: Details- egarding the, , : , balance in the property damage reserve totaled. issuance of the bonds have not been finalize6d: The finfa-J, of Which'approximately" approximately'$45.7 million, outcome of this matter cannot now be determined.li I 1 $28.8&million and $16.9 million; respectively, are included As of December 31, 2006, iMississippi Power's 'under in the balance sheets 'herein under, "Current Assets", and recovered balance in the property damage reserve account "Deferred' Charges. and Other Assets.": 11-67

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report At Alabama Power, operation and maintenance 4. JOINT OWNERSHIP AGREEMENTS expenses associated with Hurricane Ivan were Alabama Power owns an undivided interest in units I and $57.8 million. In 2005, Alabama Power received Alabama 2 of Plant Miller and related facilities jointly with PSC approvals to return certain regulatory liabilities to the Alabama Electric Cooperative, Inc. Georgia Power owns retail customers. These orders also allowed Alabama' undivided interests in Plants Vogtle, Hatch, Scherer, and Power to simultaneously recover from customers accruals Wansley in varying amounts jointly with Oglethorpe of approximately $48 million primarily to offset the costs Power Corporation (OPC), the Municipal Electric of Hurricane Ivan and restore a positive balance in the Authority of Georgia, the city of Dalton, Georgia, Florida natural disaster reserve. The combined effect of these Power & Light Company, and Jacksonville Electric orders had no impact on net income in 2005. Authority. In addition, Georgia Power has joint ownership agreements with OPC for the Rocky Mountain facilities In December 2005, the Alabama PSC approved a and with Florida Power Corporation for a combustion separate rate rider to recover Alabama Power's $51 million turbine unit at Intercession City, Florida. Southern Power of deferred Hurricane Dennis and Katrina operation and owns an undivided interest in Plant Stanton Unit A and maintenance costs over a two-year period and to replenish related facilities jointly with the Orlando Utilities its reserve to a target balance of $75 million over a five- Commission, Kissimmee Utility Authority, and Florida year period. Municipal Power Agency. As of December 31, 2006, Alabama Power had At December 31, 2006, Alabama Power's, Georgia recovered $49.5 million of the costs allowed for storm- Power's, and Southern Power's ownership and investment recovery activities, of which $34.5 million was a (exclusive of nuclear fuel) in jointly owned facilities with reduction in the deficit balance in the property damage the above entities were as follows: reserve account related to costs deferred from previous storms. The remaining under recovered balance in the Percent Amount of Accumulated property damage reserve account totaled approximately Ownership Investment Depreciation (in millions) $16.8 million at December 31, 2006 and is included in the balance sheets herein under "Current Assets." The Plant Vogtle remaining $15.0 million of the recovered amount was. (nuclear) 45.7% $3,289 $1,857 used to establish the target reserve.for future storms. The Plant Hatch balance in the target reserve for future storms was (nuclear) : 50.1 925 502 $13.2 million at December 31, 2006, and is included in Plant Miller (coal) the balance sheets herein under "Other Regulatory Units I and 2 91.8 958 396 Liabilities." Plant Scherer (coal) Units 1 and 2 8.4 116 60 Plant Wansley Southern Company Gas Sale (coal) 53.5 396 179 Rocky Mountain On January 4, 2006, Southern Company completed the (pumped storage) 25A 170 95 sale of substantially all the assets of Southern Company Intercession City Gas, its competitive retail natural gas marketing (combustion subsidiary, including natural gas inventory, accounts turbine) 33.3 12 2 receivable, and customer list, to Gas South,. LLC, an Plant Stanton affiliate of Cobb Electric Membership Corporation. (combined cycle) Southern Company Gas' sale of such assets was pursuant Unit A .. ... 65.0 155 13 to a Purchase and Sale Agreement dated November 18, At December 31, 2006, the portion of total. 2005 between Southern Company Gas and Gas South. construction work in progress related to Plants Miller, The gross proceeds from the sale were approximately Scherer, and Wansley was $14.9 million, $1.7 million, $126 million. This sale had no material impact on* and $53.1 million, respectively, primarily for Southern Company's net income. As a result of the sale, environmental projects. Southern Company's financial statements and related information reflect Southern Company Gas as Alabama Power, Georgia Power, and Southern Power discontinued operations for all periods presented. have contracted to operate and maintain the jointly owned 11-68

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report facilities, except for Rocky Mountain and Intercession Details of income tax provisions are as follows: City, as agents for.their respective co-owners. The 2006' 2005 2004 companies' proportionate share of their plant operating (in millions) expenses is included in the corresponding operating Total provision for income taxes: expenses in the statements of income., Federal - Current $466 $ 61 $ 14

5. INCOME TAXES 419 482 Deferred 207, Southern Company files a consolidated federal income tax 673 480' 496 return and combined state income tax returns for.the State-"'

Current 110 35 15 States of Alabama,, Georgia, and Mississippi.. Under a joint consolidated incometax allocation agreement, each Deferred' (2) 80 '76 subsidiary's current and deferred taX. expense is computed on a stand-alone basis. In accordance with IRS: 108 115 ,91 regulations, each company is jointly and severally liable Total $781, $595 $587 for the tax liability. . . Net cash payments for income taxes in 2006,: 2005, Mirant was included in the conisolidated federalftax and 2004 were $649 million, $100 million, and return through April 2,'2001 In Decemhber 2004, the qIRS

                                                                    $78 million, respectively.

concluded its audit for the tax years 2000 and 200i, andl Southern Company paid $39.million in additional tax and interest for issues related to Mirant tax items. Underuthe terms.of the separation agreements, Mirant.agreed to. indemnify -Southern Company for subsequent assessment of any additional taxes related to its transactions prior to the spin off., However, as a result of Mirant's bankruptcy, Southern Company sought, reimbursement as an unsecured creditor. Based on management's assessment of the; ;!I . collectibility of this $39 million receivable, Southern 'i Company has reserved approximately $13.7 million. In December 2006, Southern Company received approximately $23 million in tax refunds'fr6m the IRS information, related to Mirant tax items. For additional see Note 3 under "Mirant Makers ý--Mirant Bankruptcy." At December 31, 2006, the tax-related regulatory ,assets and liabilities were $896 million and $293 million, respectively.- These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized interest. These liabilities are attributable to deferred taxes previously recognized at, rates higher than the current enacted, tax law and to unamortized investment tax credits. -. ; ,

                                                                                             ' ' ! 1 I                               '. . I Fl I 11-69

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report The tax effects of temporary differences between the income tax benefit. Beginning in 2002, the State of carrying amounts of assets and liabilities in the financial Georgia allowed the filing of a combined return, which statements and their respective tax bases, which give rise should substantially reduce any additional net operating to deferred tax assets and liabilities, are as follows: loss carryforwards. 2006 200.5 In September 2006, Georgia Power filed its 2005 (in millions) income tax returns, which included certain state income Deferred tax liabilities: tax credits that resulted in a lower effective income tax Accelerated depreciation $4,675 $4,6 13 rate for the year ended December 31, 2006 when Property basis differences 962 99,4 compared to 2005. Georgia Power has also filed similar Leveraged lease basis differences 625 51 9 claims for the years 2001 through 2004. Amounts Employee benefit obligations 530 33 3 recorded in Southern Company's financial statements for Under recovered fuel clause 543 52 8 the year ended December 31, 2006 related to these claims Premium on reacquired debt 120 126 are not material. The Georgia Department of Revenue is Regulatory assets associated with currently reviewing these claims. If approved as filed, employee benefit obligations 362 - such claims could have a significant, and possibly Regulatory assets associated with material, effect on Southern Company's net income. The asset retirement obligations 453 44 *4 ultimate outcome of this matter cannot now be Storm reserve 33 68 determined. Other 126 156 In accordance with regulatory requirements, deferred Total 8.429 7,78 1 investment tax credits are amortized over the lives of the Deferred tax assets: related property with such amortization normally applied Federal effect of state deferred taxes 267 263 as a credit to reduce depreciation in the statements of State effect of federal deferred taxes 63 88 income. Credits amortized in this manner amounted to Employee benefit obligations 615 210 $23 million in 2006, $25 million in 2005, and $27 million Other property basis differences 156 148 in 2004. At December 31, 2006, all investment tax credits Deferred costs 131 126 available to reduce federal income taxes payable had been Unbilled revenue 76 58 utilized. Other comprehensive losses 60 96 The provision for income taxes differs from the Alternative minimum tax amount of income taxes determined by applying the carryforward 202 applicable U.S. federal statutory rate to earnings before Regulatory liabilities associated with income taxes and preferred dividends of subsidiaries, as a employee benefit obligations 196 result of the fl1owing: Asset retirement obligations 453 444 Other 272 247 2006 2005 2004 Total 2,289 1,882 Federal statutory rate 35.0% 35.0% 35.0% Total deferred tax liabilities, net 6,140 5,899 State. income tax, Portion included in prepaid expenses net of federal deduction 2.9 3.4 2.8 (accrued income taxes), net (175) (180) Synthetic fuel tax credits (2.7) (8.0) (8.5) Deferred state tax assets 24 17 Employee stock plans. dividend deduction (1.4) (1.5) -(1.5) Accumulated deferred income taxes in Non-deductible book depreciation 1.0 1.1 1.1 the balance sheets $5,989 $5,736 Difference in prior years' deferred and current tax rate (0.3) (1.8) (0.7) The alternative minimum tax credits do not expire. Other (1.8) (1.4) (0.9) At December 31, 2006, Southern Company also had Effective income tax rate 32.7% 26.8% 27.3% available State of Georgia net operating loss carryforward deductions totaling $1.0 billion, which could result in net state income tax benefits of $59 million, if utilized. These deductions will expire between 2007 and 2021. During 2006, Southern Company utilized $10 million in available net operating losses, which resulted in a $0.6 million state 11-70

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report

6. FINANCING Assets' Subject to Lien' Each of Southern Company's subsidiaries is organized as Mandatorily Redeemable Preferred Securities/ Long- a legal entity, separate and apart from Southern Company Term Debt Payable to Affiliated Trusts and its other subsidiaries. At January 1, 2006, Alabama Power and Gulf Power had mortgages that secured first Southern Company and the' traditional operating companies mortgage bonds they had issued and constituted a direct have each formed certain wholly-owned trust subsidiaries, first lien on substantially all of their respective fixed for the purpose of issuing preferred securities. The property and franchises. Alabama Power discharged its proceeds of the related equity investments and preferred remaining outstanding first mortgage bond obligations and security sales were loaned back to Southern Company or the first mortgage lien was removed in May 2006.

the applicable traditional operating companyt through'the Following the maturity of Gulf Power's remaining issuance of junior subordinated notes totaling $1.6 billion, outstanding f'ist mortgage bonds in November 2006, the which constitute substantially all of the assets of these first mortgage, lien was removed on January 26, 2007. trusts and are reflected in the balance sheets as Long-term The Mississippi Power and Georgia Power first mortgage Debt Payable to Affiliated Trusts (including Securities Due liens were removed in 2005 and 2002, respectively. Within One Year). Southern Company and the traditional Alabama Power and Gulf Power have granted one or operating companies each consider that the mechanisms more liens' on-certain of their respective property in and obligations relating to the preferred securities issued connection with the issuance of ceitain pollution control for its benefit, taken together, constitute a full and bonds with'an outstanding principal ýamounit of unconditional guarantee by it of the respective trusts' $194 miillioii :There are no agreements or other payment obligations with respect to these securities.- At arrangements among the subsidiary companies under December 31, 2006, preferred securities of $1.5 billion which ithe`asietý of one company have 'been pledged or were outstanding. Southern Company guarantees , otherwise made available' to satisty obligations of $206 million of notes related to these securities issued on Southern Company or any of its other subsidiaries. its behalf. See Note 1 under "Variable Interest Entities" for additional information on the accounting treatment for Bank Credit Arrangements these trusts and the related securities. At the beginning of 2007, unused credit arrangements with banks totaled $3.35 billion, of which $656 million Securities Due Within One Year expires during 2007 and $2.7 billion expires in 2008 and beyond'. Of the $2.7 billion expiring in 2008 aand beyond, A summary of scheduled maturities and redemptions of $2.4 billion does not expire 'until 2011. The following; securities due within one year at December 31 is as, follows: table 6uitlines'the credit arrangements by company: -, 2006 2005 Expires

                                               .   '(iA nmillionsy                                                                      2008 &

Capitalized leases $ 13 $ 13 Company - Total Unused 2007 beyond First mortgage bonds ' 45 (in millions) Pollution control bonds - 12 Alabama Po0ker $ 965 $ 965 $365 $ 600 Senior notes , 1,369 697 Georgia Power 910.. 904 40 870 Long-term debt payable to affiliated Gulf Power, 120 120 120 trusts - 72 80 Mississippi Power A'181 181 101 Other long-term debt '36 47 Southern Company 750' 750 750 Preferred stock' - 15 Southern Power 400 400 400 Total $1,418 $901 Other '"30 30 30 Debt and preferred stock redemptions, and/or serial Total . $3,356 $3,350 $656 $2,700 maturities through 2011 applicable to total long-term debt are as follows: $1.4 billion in 2007; $499 million in 2008; Approximately $79 million of the credit facilities

 $604 million in 2009; $286 million in 2010, 'and                             expiring in 2007 allow the execution of term loans for an
 $329 million in 2011. On February 1, 2007, $400 million                      additional two-year period, and $343 million allow execution of one-year term loan&. Most of these                    Z of the 2007 long-term debt principal amount matured. The maturity was funded with short-term borrowings.                              agreements -include stated borrowing rates.

11-71

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report All of the credit arrangements require payment of rate on short-term debt was 5.2 percent for 2006 and commitment fees based on the unused portion of the 3.5 percent for 2005. commitments or the maintenance of compensating balances with the banks. Commitmient fees are one-eighth Financial 1Istruments of 1 percent or less for Souiithen Company, the traditional The traditional operating companies and Southern Power operating companies, and Southern Power. Compensating enter into energy-related derivatives to hedge exposures to balances are not legally restricted from withdrawal. electricity, gas, and other fuel price changes. However, Most of the credit 'arrangements with banks have due to cost-based rate regulations, the traditional covenants that limit debt levels to 65 percent of total operating companies have limited exposure to market capitalization, as defined in the agreements. For purposes volatility in commodity fuel prices and prices of of these definitions, debt excludes the long-term debt electricity. In addition, Southern Power's exposure to payable to affiliated tfrsts. At'December'31, 2006, market volatility in commodity fuel prices and prices of Southern Company, Southern Power, and the traditional electricity is limited because its long-term sales contracts operating companies were each in compliance with their generally shift substantially all fuel cost responsibility to respective debt limit covenants., the purchaser. Each of the traditional operating' companies has implemented fuel-hedging programs at the instruction In addition, the credit arrangements typically contain of their respective state PSCs. Together with Southern cross default provisions that would be triggered if the Power, the traditional operating companies may enter into borrower defaulted on other indebtedness above a hedges of forward electricity sales. specified threshold. The cross default provisions are restricted only to the indebtedness, including any At December 31, 2006, the fair value gains/(losses) guarantee obligations, of the company that has, such credit of energy-related derivative contracts was reflected in the arrangements. Southern Company and its subsidiaries are financial statements as follows: currently in compliance with all such covenants. In the Amounts event of a material adverse change, as defined in Gulf (in millions) Power's credit agreements, Gulf Power would be prohibited from borrowing against unused credit Regulatory assets, net $(85) arrangements' totaling $10 million. Accumulated other comprehensive income 3 Net income A portion of the $3.35 billion unused credit with Total fair value $(82) banks is allocated to provide liquidity support to the traditional operating companies' variable rate pollution The fair value gains or losses for hedges that are control bonds. The amount of variable rate pollution recoverable through the regulatory fuel clauses are control bonds requiring liquidity support as of recorded as regulatory assets and liabilities and are December 31, 2006 was $719 million. recognized in earnings at the same time the hedged items Southern Company, the traditional operating affect earnings. For other hedges qualifying as cash flow companies, and Southern Powrer borrow primarily through hedges, including those of Southern Power,, the fair value commercial paper programs that have the liquidity gains or losses are recorded in other comprehensive income support of committed bank credit arrangements. Southern and are reclassified into earnings at the same time the Company and the traditional operating companies may hedged items affect earnings. For 2006, 2005, and 2004, also borrow through' various other arrangements with the pre-tax gains (losses) reclassified from other banks and extendible commercial note programs. The comprehensive income from continuing operations to fuel amount of commercial paper outstanding and included in expense 'or revenues was not material. For the year 2007, notes payable in the balance sheets at December 31, 2006 approximately $3 million of gains are expected to be and December 31, 2005 was $1.8 billion and $944 million, reclassified from other comprehensive income to revenues. respectively. In addition, the Company and the traditional There was no significant ineffectiveness recorded in operating companies had $30 million of extendible earnings for any period presented. Southern Company has commercial notes and $140 million of short-term bank energy-related hedges in place up to and including 2009. loans outstanding at December 31, 2006. During, 2006, Southern Company entered into During 2006, the peak amount outstanding for short- derivative transactions with net initial premiums paid of term debt was $2.1 billion, and the average amount $20 million to reduce its exposure to a potential phase-out outstanding was $1.6 billion. The average annual interest of certain income tax credits in 2006 and 2007. In 11-72

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report accordance with Section 45K of the Internal Revenue Code, For fair value hedges where the hedged item is an these tax credits.are subject to limitation as the annual asset, liability, or firm commitment, the changes in the fair value of the hedging derivatives are recorded in average price of oil increases. At December 31, 2006, the-fair value of the derivatives was a $12 million net liability. earnings'and are offset by the changes in the fair value of For 2006 and 2005, the fair value loss recognized in other the hedged item. income (expense) to mark the transactions to market was $32 million and $7 million, respectively. The fair value gain or loss for cash flow hedges is recorded 'in other comprehensive income and is Southern Company and-certain subsidiaries also enter reclassified into earnings at the same time the hedged into derivatives to hedge exposure to changes in interest, items affect earnings. In 2006, 2005, and 2004, the rates. Derivatives related to fixed-rate securities are Company incurred net losses of $1 million, $19 million, accounted for as fair value hedges. Derivatives related to and $7 million, respectively, upon termination of certain variable rate securities or forecasted transactions are interest derivatives at the same time it issued debt. These accounted for as cash flow hedges. The derivatives losses have been deferred in other comprehensive income employed as hedging instruments are structured to and will be' amortized to interest expense over the life of minimize ineffectiveness. As such, no material the original interest derivative. For 2006, 2005, and 2004, ineffectiveness has been recorded in earnings. approximately $1 million, $10 million, and $23 million, At December 31, 2006, Southern Company had respectively, of pre-tax losses were reclassified from other $2.4 billion notional amount of interest rate swaps and comprehensiVe inb6me to interest expense. For 2007, pre-options outstanding with net fair value losses of $2 million tax losseg of approximately $15 million areexpected to as follows: be redlassified from other comprehensive' income to interest expense. Fair Value Hedges Variable Fair I Hedge Rate'-ýý- Notional Value 7. COMMITMENTS - Company' Maturity Paid Amount (Loss) (in millions) Construction Program Southern Company 2007 6-month $400 $(0.1) Southeirn Company is engaged in continuous construction LIBOR - 0.10%* programs,cpurrently estimated to total $3.9 billion in 2007, $4.*.billion in 2008, and $4.8 billion in 2009., Cash Flow Hedges These amounts include .$120 million, $109 million, and

                                                                              $122 million in 2007, 2008, and 2009, respectively, for Weighted                       Fair Value          construction expenditures 'related to contractual purchase Average         .,

commimnients for uranium and nuclear fuel conversion, Hedge Fixed Rate, Notional Gain/ Amount (Loss) enrichrnibnt 'aid fabrication servic6s included herein under Company Maturity Paid,:

                                                                               "Fuel and -Purchased Power Commiiitments." The
                                                  ,(in millions) construction programs are subject tto periodic review and Alabama Power                                                                  revision, and actual construction costs may vary from the 2007      '2.01%* *        $536'           $0.8           above estimates because of numerous factors. These 2017       6.15%***:           100           (1.9)        factors include:, changes in business conditions; 2017       6.15%***,           100'         .(1.9)        acquisition. of additional generating assets; revised load Georgia Power,                                                                 growth estimates; changes in environmental regulations; 2007       3,85%***           400             0.1         changes in. existing nuclear plants to meet, new regulatory L2037       5.75%*** " 300                     1.4 requirements; changes in FERC rules and regulations; 2017     -:5.29%              225            (2.0)        increasing costs of labor, equipment, and materials; and.

2007 2.68%, ' J 300 1.4 cost of capital: At December 31, 2006, significant 2007 -2.50%** -14 0.2 purchase commitments were outstanding in connection

London Interbank Offer Rate (LIBOR). with the ongoing, construction program, which includes

** Hedged using the Bond Market-Association Municipal Swap                     new facilities andcapital improvements to transmission, Index.                                                                    distribution, and generation facilities, including those to

Interest rate collar (showing only the rate cap percentage). meet environmental standards.

11-73

NOTES (continued) '4 Southern Company and Subsidiary Companies 2006 Annual Report Long-Term Service Agreements .' Also, Southern Company has entered into various long- term commitments for the purchase of electricity. Total The traditional operating companies 'and Southern Power estimated minimum long-term obligations at December 31, have entered into Long-Term Service Agreements 20Q6 were as follows: (LTSAs) with General Electric (GE) for the purpose of securing maintenance support for the combined cycle and Commitments combustion turbine generating, facilities owned by the Natural Nuclear Purchased subsidiaries, with the exception of newly acquired Plants Gas Coal Fuel Power DeSoto and Rowan. The LTSAS providd that GE will (in imillions) perform all planned inspections on the covered 2007 $1,347.$ 3,294 $120 $ 173 equipment, which includes the cost of all labor and materials. GE is also obligated to .over the costs of 2004- . 1,174 2,609 109- 175 unplanned maintenancei on the covered equipment subject 2009 . 728, 1,720 122 199 to a limit specified in each contract. 2010 454 1,024 160 185. In general, except for Southern Power's Plant, 2011 355 620 -145 166 Dahlberg, these LTSAs are in effect through, two major 2012 and thereafter 2,740 2,221 ' 236 890 inspection cycles per unit. The Dahlberg agrepment is in Total $6,798 $11,488 $892 $1,788 effect through the first major inspection of each unit. Scheduled payments to GE are made at various intervals 'Additional commitments for fuel will be required to based, on-actual operating hours o(the respective units. supply Southern Company's future' needs. Total remaining, payments to GE under these agreements for facilities owned are currently estimated at $1.6 billion Operating Leases over the remaining life of the agreements, which are currently estimated to range up to 30 years. However, the In May 2001, Mississippi Power began the initial 10-year LTSAs contain various cancellation provisions at the, term, of a lease agreement for a combined cycle option of the purchasers. generating facility built at Plant Daniel for approximately,

                                                                  $370 ifiIlio-n. In 2003, 'the generating facility was Georgia Power has also enteredinto an LTSA with acquired by Juniper Capital L.P. (Juniper), whose partners GE through 2014 for neutron monitoring system parts and are. unaffiliated with Mississippi Power. Simultaneously, electronics at Plant Hatch: Total, remaining pbayments'to Juniper entered into a restructured lease agreement with GE under this agreement are cfrrently estirfiated at      -

Mississippi- Power. Juniper has also entered into leases $12.2 million. The 'contract contains cancellation with other parties unrelated to Mississippi Power, The provisions at the option of Georgia Pow'er: . assets leased by Mississippi Power comprise less than Payments made to GE prior to the, performancq. f 50' percent of Juniper's assets. Mississippi Power is not any work are recorded as a prepayment in the balance required to consolidati ýthe leased assets and related sheets. All work performed by GE is capitalized or. liabilities, and' the lease with Juniper is considered an charged to expense (net of any joint owner billings), as operating lease. The initial lease term ends. in-2011.- and appropriate based on tlhe nature of the work. the lease includes a purchase and renewal option based on the cost of the facility at the inception of the lease. Fuel and Purchased Power Commitments . Mississippi Power is required to amortize approximately 4 percent of the initial acquisition cost' over the initial To supply a portion of the fuel requirements of the' lease term. Eighteen months prior to the end of the initial generating plants, Southern Company has 'entered into lease, Mississippi Power may elect to renew for 10 years. various long-term'commitments for the procurement of. If the lease is renewed, the agreement 'calls for fossil and nuclear fuel. In most cases, these contracts'. Mississippi 'Power to amortize an additional 17 percent of contain pro~visions for price escalations, minimum - i:, " the initial completion cost over the'renewal period. Upon purchase levels, and other financial dommitments. Coal termination of the lease, at Mississippi Power's option, it commitments. include! forward contract purchases for' may either exercise its purchase option' or the facility can sulfur dioxide emission allowances. Natural gas purchase, be sold to a third party. commitments' contain fixed volumes with prices based on various indices at the time of delivery., Alounts included The lease, provides for a residual Value guarantee, in the chart below, represent estimates based on New' York approximately 73 percent of the acquisition cost, by, Mercantile Exchange future prices at December 31, 2006. Mississippi Power that is due upon termination of the 11-74

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report lease in the event that Mississippi Power does .noti 1renew amount of guarantees outstanding at December 31. 2006, the lease or purchase the assets. and that the fair market; is less than $20 million, all of which will expire, by:2009. value is less than the unamortized cost of the asset. A As discussede.arlier in this Note under "Operating liability of approximately $9 milli i, for the fair thariket Leases," abalima Power, Georgia Power, and Mississippi value of this residual valu6 guarantee isinclude'd in the' Power have entered into residual Value guarantees. nertan balnce sheet as of December 1, 2606 Southern Company also has other operating'lease SCO*MMON STOCK agreements'With various terms and expiration dates. Total Stock Issued'! ,' operating lease expenses Were $161 rnilli6n' $150 million, and $1B6 million for 2006, 2005, and 2004, respectively. In 2006, Southern Company raised $1 million (53,000 Southern Company includes any step ýrents,'escalations, shares) from heissuance of newcommon shares and. and lease concessions in its computation of minimum $136 million (5 million shares) from the issuance of lease payments, which are recghized' on a -straighi-line' treasury stock under the Company's various stock basis over the minimum lease term. AtDecember3l programns, In;'2005, Ihe Company raised $213 million 2006, estimated mininum lease paymentsbfor.: (10 million shares) from the issuance of new common noncancelable operating leases were as follo~ws:. shares under the Company's various stock programs. Minir inie.aSe Payments Stock] Repurchased Plant Barges&. er Total In early January' 2006, Southern Company discontinued Daniel Rail Cars the common stock repurchase program begun in 2005 (in millions) which was designed primarily 'to offset the shares -of 2007 $'29 $ 53._- $ 53 -,-$135 common stock issued under the Company's various stock 2008 29 48 43 120 programs. IfVJ'anuary 2006, prior to the discontinuance.of 2009 - '29' 39,'! 36 ' 104 the Program, 2S61thern Company repurchased -,..... 2010 .28 30: ,29 -87 approximately 3,000 shares of common stock at a total 28 22 23! :,73 cost of $0.1 _ifiillioi.' During 2005,. Southern Company. 2011 repurchased ý, million shares of common stock at a total, 2012 and thereafter - 62- 124 186 cost of $352 million.' Total .$143 $254 . $308 .$705 SharesReserved ' For the traditional operating companies, the barge At December31, 2006, a total of 88.9. million shares was and rail car lease expenses are recoverable through fuel - reserved for issuance pursuant to the -Southern Investment, cost recovery provisions. 'In addition to the above rental Plan, the Employee Savings Plan, the Outside Directors commitments,' Alabama PoweelandG6_cgia IPowver have StockPlan ':and the'Omnibus Cm'psation "nce:tive obligations'upon expiiation of cet*ileases with*0esect`

                                                                -I         Plani (stock option plan).

to the residual value of the leased property. These' eases expire in 2009, ý010, and 20141, ahd the Mna1imUmn, Stock Option Plan' obligations are $20 million, $62 milioin,;*and $64 ifllion, respectively. At the termination of the leases, the lessee Southern Company provides non-qualified stock options may either exercise its purchase 'optiohi, or the property to a large segment of its employees ranging from line can be sold to .a third party, Alabama P and Georgia awer managerien io'exectitives. As of December 3 1,2006, Power expect that the fair.market value ofthe, leased,1,.(,. 6,509*current afid f6riner employees participated'lih:the' property would substantially.reduce or, eliri'nate. the., sto&k option'plan.i. The: maximum number of shares of payments under the residual value 9bligatios, - common stock that may be issued under these' progratsiS'- may not exceed 57 million. The prices of options'ktanted to date haye been at the fair market value of the shares on Guarantees' 4. I the dates ,o grant. Optionsgranted to date become Prior -to the spin7off, Southern Company made separate exercisable pro rata'over a maximum penrod of( " guarantees to certain counterparties regarding v years from the date of grant. Southern Company generally performance of contractual commitments by. Mirant's' . recognizes stock option expense on a straight-line basis trading and marketing subsidiaries. The total notional. over the vesting period which equates to the requisite., 1-75

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report service period; however, for employees. who are eligible $14 million, $50 million, and $31 million, respectively, for retirement the total cost is expensed at the grant date. for the years ended December 31, 2006, 2005, and 2004. Options outstanding will expire no later than 10 years Southern Company has a policy of issuing shares to. after the date of grant, unless terminated earlier by the satisfy share option exercises. In January 2006, the Southern Company Board of Directors in accordance with Company started reissuing treasury shares that it had the stock option plan. For certain stock option awards, a previously repurchased. The repurchase program ended inr change in control will provide accelerated vesting. As part January 2006. Cash received from issuances related to of the adoption of SFAS No. 123(R), as discussed in option exercises under the share-based payment Note 1 under "Stock Options," Southern Company has not arrangements for the years ended December 31, 2006, modified its stock option plan or outstanding stock 2005, and 2004 was $77 million, $213 million, and options, nor has it changed the underlying valuation

                                                                     $119 million, respectively.

assumptions used in valuing the stock options that were used under SFAS No. 123. Diluted Earnings Per Share Southern Company's activity in the stock option plan For Southern Company, the only difference in computing for 2006 is summarized below: basic and diluted earnings per share is attributable to Weighted outstanding options under the stock option plan. The Shares Average effect of the stock options was determined using the Subject Exercise treasury stock method. Shares used to compute diluted To Option Price earnings per share are as follows: Outstanding at Dec. 31, 2005 31,347,355 $27.13 Average Common Stock Shares Granted 6,656,788 33.81 2006 2005 2004 Exercised (3,239,698) 23.97 (in thousands) Cancelled (155,202) 31.22 As reported shares 743,146 743,927 738,879 Effect of options 4,739 4,600 4,197 Outstanding at Dec. 31, 2006 34,609,243 $28.69 Diluted shares 747,885 748,527 743,076 Exercisable at Dec. 31, 2006 22,045,449 $26.37 The number of stock options vested, and expected to Common Stock Dividend Restrictions vest in the future, as of December 31, 2006 is not The income of Southern Company is derived primarily significantly different from the number of stock options from equity in earnings of its subsidiaries. At outstanding at December 31,42006 as stated above. December 31, 2006, consolidated retained earnings included $4.8, billion of undistributed retained earnings of As of December 31, 2006, thp weighted average the subsidiaries. Southern.Power's credit facility contains remaining contractual term for the, options outstanding potential limitations on the payment of common stock and options exercisable is 6.4 years and 5.2 years, dividends;. as of December 31, 2006, Southern Power was, respectively, and the aggregate intrinsic value for the in compliance with all such requirements.. options outstanding and options exercisable is $283 million and $231 million, respectively.

9. NUCLEAR INSURANCE As of December 31, 2006, there was $10 million of Under the' Price-Anderson Amendments Act (Act),

total unrecognized compensation cost*elated to stock Alabama Power and Georgia Power maintain agreements option awards not yet vested. That cost is expected to be of indemnity' with'the NRC that together with private recognized over a weighted-average perio4 of insurance, cover third-party liability arising from any approximately 11 months. . nuclear incident occurring at the companies' nuclear Th1e total intrinsic value of optio*ns exercised during power plants. The Act provides funds up to $10.76. billion the years ended December 31, 2006, 2005, and;2004 was for public liability claims that could arise from a single $36 million, $130 million, and $81 million, respectively. nuclear incident. Each nuclear plant is insured against this liability to a maximum of $300 million by American The actual tax benefit realized by the Company for Nuclear Insurers (ANI), with the remaining coverage the tax deductions from stock option exercises totaled provided by a mandatory program of deferred premiums 11-76

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report that could be assessed, after a nuclear incident, against all prospective basis to include an industry -aggregate for all owners of nuclear reactors. A company could be assessed "non-certified" terrorist acts, i.e., acts that are not up to $101 million per incident for each licensed reactor certified acts of terrorism pursuant to the Terrorism Risk it operates but not more than an aggregate of $15 million Insurance Act of 2002, which was renewed in 2005. The per incident to be paid in a calendar year for, each reactor. aggregate for all NEIL policies, which applies to non-Such maximum assessment,-excluding aIy applicable certdfied property claims -stemming from terrorism within state premium taxes, for Alabama Power and :Georgia a 12-month duration, is $3.24 billion plus any amounts Power, based on its ownership and buyback interests, is available throUgh reinsurance or indemnity from an $201 million and $203 million, respectively, per incident, outside sourct!The non-certified ANI nuclearliability but not more than an aggregate of $30 million per cap is a $300 million shared industry aggregate during the company to be paid for each incident in hny one year. normal ANI p6licy period. Alabama Power and Georgia Power'are members of For all on-site property damage insurance: policies Nuclear Electric Insurance Limited (NEIL), a mutual, for cdmmercial-nuclear power plants, the NRC 'requires insurer established to provide pioperty damnkge insurance that the prc .Of oedssuch policies shall be dedicated first in an amount up to $500 million for members' nuclear for the sole purpose of placing the reactor in a safe and generating facilities. stable -condition after an accident. Any remaining proceIedhs *fe 'to be. alplied next toward the costs of Additionally, both companies have policies that decontaminatioti and debris removal operations ordered currently provide decontamination, excess property by the NRC. and any further remaining proceeds are to be insurance, and preniature decomnissioninig coverage up to paid either to'the, company or to its bond trustees as may $2.25 billion for losses in excess of the $500 million be appropriate under the policies and applicable trust primary coverage.' This excess irsuranceis. also provided indentures. .'* ., by NEIL. All retrospective assessments, whether generated for NEIL also covers the additional costs that would be liability, proliert, or replacement power, may be subject incurred in obtaining replacerment,powdr during a to applicable'stgte premium taxes. ( -9 prolonged accidental outage at a member's nuclear plant. Members can purchase this coverage, subject to a deductible waiting period of up to_26 W:eki, with a 10. SEGMENT AND RELATED INFORMATION maximum per occurrence per unit limit of $490 million. -_Southmrn Company's reportable business After the deductible period, weekly indemnity payments segment is the would be received until either the unit is operational or sale of electricity fin the Southeast by the traditional until the limit is exhausted in appioximately three years. opertin'g companies and Southern Power. Net income and Alabama Powet and Geoiýga-Powfer -eachpurchase.the' total assets fordiscontinued operations are included in the maximum limit allowed by NEIL, subject to ownership reconciling eliminations column. The "All Other" column limitations. Each facility has elected a !27week waiting includes parent S9uthem Company, which does not, - period. allocate operating expenses to business segments. Also, this category includes segments below the quantitative' Under each of the NEIL policies, members are threshold for separate disclosure. These segments include subject to assessments if losses each year exceed the investments in synthetic fuels and leveraged lease , accumulated funds available to the insurer 4nder that projects, telecommunications, and energy-related services. policy. The current maximum annual assessments for.- Southern Power's revenues from sales to the traditional Alabama Power and Georgia Power under, the NEIL. operating companies were $492 million, $557 ,million.. policies would be $38 million and $49 miillion],- and $425-imi1ion in-2006, 2005, and 2004, respectively. respectively. In addition, see Note 1 under "Related Party Transactions" for information regarding revenues from Following the terrorist attacks of September 2001, services for synthetic fuel production that are included in both ANI and NEIL confirmed that terrorist acts against the cost of fuel purchased by Alabama Power and Georgia commercial nuclear power plants would, subject to the Power. All other intersegment revenues are not material. normal policy limits, be covered under their insurance. Financial data for business segments and products and Both companies, however, revised their policy terms on a services are as follows: 41-77

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report Business Segment Electric Utilities Traditional Operating Southern All Companies Power Eliminations Total Other Eliminations Consolidated 2006 (inmillions) Operating revenues $13,920 $ 777 $(609) $14,088 $ 413 $(145) $14,356 Depreciation and amortization 1,098 -66 1,164 37- (1) 1,200 Interest income 33 2 35 7 (1) 41 Interest expense 637 80 - 717 149 866 Income taxes 867 82 949 (168) - 781 Segment net income (loss) ' 1,462 124 - 1,586 (11) (2) 1,573 Total assets 38,825 2,691 (110) 41,406- .1,933 (481) 42,858 Gross property additions 2,561 501 (16) 3,046 26 - 3,072 Electric Utilities Traditional Operating Southern All Companies Power Eliminations Total Other Eliminations Consolidated 2005 (in millions) Operating revenues $13,157 $ 781 $(660) $13,278 $ 393 $(117) $13,554 Depreciation and amortization 1,083 54 - 1,137 39 - 1,176 Interest income 30 2 - 32 5 (1) 36 Interest expense 567 79 - 646. 101. - 747 Income taxes 827 72 - 899, (304) - 595 Segment net income (loss) 1,398 115 - !,513 80 (2) 1,591 Total assets 36,335 2,303 (179) 38,459 1,751 (333) 39,877 Gross property additions ,2,177 241 - 2,418 58 - 2,476 Electric Utilities Traditional Operating Southern All Companies Power, Eliminations Total, Other Eliminations Consolidated 2004 (in millions) Operating revenues $11,300 $ 701 $(536) $11,465 $ 375 $(111) $11,729 Depreciation and amortization 857 51 - 908 41 - 949 Interest income 24 1 - 25 4 (2) 27 Interest expense 518 66 - 584 83 - 667 Income taxes 802 73 - 875 (290) - 585 Segment net income (loss) 1,309 112 - 1,421 109 2 1,532 Total assets 33,517 2,067 (104) 35,480 1,895 (420) 36,955 Gross property additions 12307 116 (415) 2,008 91 - 2,099 11-78

NOTES (continued) Southern Company and Subsidiary Companies 2006 Annual Report Products and Services Electric Utilities Revenues Year Retail 'Wholesale Other Total (in millions) 2006 $11,801 $1,822 $465 $14,088 2005 11,165 1,667 446 13,278 2004 9,732 1,341 392 11,465

11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Summarized quarterly financial data for 2006 and 2005 - including discontinued operations for net income and earnings per share - are as follows: Per Common Share (Note) Trading Operating Operating Consolidated Basic Price Range Quarter Ended Revenues Income Net Income Earnings Dividends High Low (in millions) March 2006 $3,063 $ 590 $262 $0.35 $0.3725 $35.89 $32.34 June 2006 3,592 807 385 0.52 0.3875 33.25 30.48 September 2006 4,549 1,358 738 0.99 .0.3875 35.00 32.01 December 2006 3,152 469 188 0.25 0.3875 37.40 34.49

                                                                                                                       $34.34     $31.14 March 2005                                  $2,787          $ 560               $323              $0.43       $0.3575 June 2005                                    3,120              721              387               0.52         0.3725  35.00       31.60 September 2005                               4,358            1,277              722               0.97         0.3725  36.47       33.24 December 2005                                3,289              404               159              0.21         0.3725  36.33       32.76 Southern Company's business is influenced by seasonal weather conditions.

I . .,-. , n1-79

SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA For the Periods Ended December 2002 through 2006 Southern Company and Subsidiary Companies 2006 Annual Report 2006 2005 2004 2003 2002 Operating Revenues (in millions) $ 14,356 $ 13,554 $ 11,729 $ 11,018 $ 10,447 Total Assets (in millions) . $ 42,858 $ 39,877 $ 36,955 $ 35,175 $ 33,721 Gross Property Additions (in millions) $ 3,072 $ 2,476 $ 2,099 $ 2,014 $ 2,728 Return on Average Common Equity (percent) 14.26 15.17 15.38 16.05 15.79 Cash Dividends Paid Per Share of Common Stock $ 1.535- $ 1.475 $ 1.415 $ 1.385 $ 1.355 Consolidated Net Income (in millions): Continuing Operations $ 1,574 $ 1,591 $ 1,529 $ 1,483 $ 1,315 Discontinued Operations (1) - 3 (9) '3 Total $ 1,573 $ 1,591 $ 1,532 $ 1,474 $ 1,318 Earnings Per Share From Continuing Operations -- Basic . $ 2.12 $ 2.14 $* 2.07 $ 2.04 .$ 1.86 Diluted 2.10 2.13 2.06 2.03 1.85 Earnings Per Share Including Discontinued Operations -- Basic .. $ 2.12 $ 2.14 $ 2.07 $ 2.03 $ 1.86 Diluted 2.10 2.13 2.06 2.02 1.85 Capitalization (in millions): Common stock equity $ 11,371.; $ 10,689 $ 10,278 $ 9,648 $ 8,710 Preferred and preference stock 744 596 561 423 298 Mandatorily redeemable preferred securities ' - 1,900 2,380 Long-term debt payable to affiliated trusts 1,561 1,888 1,961 - - Long-term debt 10,942 10,958 10,488 10,164 8,714 Total (excluding amounts due within one year. $ 24,618 $ 24,131 $ 23,288 $ 22,135 $ 20,102 Capitalization Ratios (percent): Common stock equity 46.2 44.3 44.1 43.6 43.3 Preferred and preference stock 3.0' 2.5 2.4 1.9 1.5 Mandatorily redeemable preferred securities - - - 8.6 - 11.8 Long-term debt payable to affiliated tirusts 6.3 7.8 8.4 - Long-term debt, ' 44.5 45.4 45.1 45.9 43.4 Total (excluding amounts due within one year) 100.0 ' 100.0 100.0 100.0 100.0 Other Common Stock Data: Book value per share $ 15.24 $ 14.42 $ 13.86 $ 13.13 $ 12.16 Market price per share: High 37.40 36.47 33.96 32.00 31.14 Low 30.48 31.14 27.44 27.00 23.22 Close (year-end) 36.86 34.53 33.52 30.25 28.39 Market-to-book ratio (year-end) (percent) 241.9 239.5 241.8 230.4 233.5 Price-earnings ratio (year-end) (times) 17.4 16.1 16.2 14.8 15.3 Dividends paid (in millions) $ 1,140 $ 1,098 $ 1,044 $ 1,004 $ 958 Dividend yield (year-end) (percent) 4.2 4.3 4.2 4.6 4.8 Dividend payout ratio (percent) 72.4 69.0 68.3 67.7 72.8 Shares outstanding (in thousands): Average 743,146 743,927 738,879 726,702 708,161 Year-end 746,270 741,448 741,495 734,829 716,402 Stockholders of record (year-end) 110,259 118,285 125,975 134,068 141,784 Traditional Operating Company Customers (year-end) (in thousands): Residential 3,706 3,642 3,600 3,552 3,496 Commercial 596 586 578 564 553 Industrial 15 15 14 14 14 Other 5 5 5 6 5 Total 4,322 4,248 4,197 4,136 4,068 Employees (year-end) 26,091 25,554 25,642 25,762 26,178 11-80

SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA For the Periods Ended December 2002 through 2006 Southern Company and Subsidiary Companies 2006 Annual Report 2006 2005 2004 2003 2002 Operating Revenues (inmillions): Residential $ 4,716 $ 4,376 $ 3,848 $ 3,565 $ 3,556 Commercial 4,117 3,904 3,346 3,075 3,007 Industrial 2,866 2,785 2,446 2,146 2,078 Other 102 100 92 89 87 Total retail 11,801 11,165 9,732 8,875 8,728 Sales for resale 1,822 1,667 1,341 1,358 1,168 Total revenues from sales of electricity 13,623 12,832 11,073 10,233 9,896 Other revenues 733 722 656 785 551 Total $ 14,356 $ 13,554 $ 11,729 $ 11,018 $ 10,447 Kilowatt-Hour Sales (in millions): Residential 52,383 51,082 49,702 47,833 48,784 Commercial 52,987 51,857 50,037 48,372 48,250 Industrial 55,044 55,141 56,399 54,415 53,851 Other 920 996 1,005 998 1,000 Total retail 161,334 159,076 157,143 151,618 151,885 Sales for resale 40,089 37,801 35,239 40,520 32,551 Total 201,423 196,877 192,382 192,138 184,436 Average Revenue Per Kilowatt-Hour (cents): Residential 9.00 8.57 7.74 7.45 7.29 Commercial 7.77 7.53 6.69 6.36 6.23 Industrial 5.21 5.05 4.34 3.94 3.86 Total retail 7.31, 7.02 6.19 5.85 5.75 Sales for resale 4.54 4.41 3.81 3.35 3.59 Total sales 6.76 6.52 5.76 5.33 5.37 Average Annual Kilowatt-Hour Use Per Residential Customer 14,235 14,084 13,879 13,562 14,036 Average Annual Revenue Per Residential Customer $ 1,282 $ 1,207 $1,074 $1,011 $ 1,023 Plant Nameplate Capacity Ratings (year-end) (megawatts) 41,785 40,509 38,622 38,679 36,353 Maximum Peak-Hour Demand (megawatts): Winter 30,958 30,384 28,467 31,318 25,939 Summer 35,890 35,050 34,414 32,949 32,355 System Reserve Margin (at peak) (percent) 17.1 14.4 20.2 21.4 13.3 Annual Load Factor (percent) 60.8 60.2 61.4 62.0 51.1 Plant Availability (percent): Fossil-steam 89.3 89.0 88.5 87.7 84.8 Nuclear 91.5 90.5 92.8 94.4 90.3 Source of Energy Supply (percent): Coal 66.7 67.1 64.6 66.4 65.7 Nuclear 13.9 14.0 14.4 14.8 14.7 Hydro 1.9 3.1 2.9 3.8 2.6 Oil and gas 12.7 10.7 10.9 8.8 11.4 Purchased power 4.8 5.1 7.2 6.2 5.6 Total 100.0 100.0 100.0 100.0 100.0 11-8 1

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ALABAMA POWER COMPANY FINANCIAL SECTION 11-82

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING -FRM Alabama Power Company We have audited the accompanying balance sheets and In our opinion, such financial statements statements of capitalization of Alabama Power Company (pages II-104 to 11-134) present fairly, in all material (the "Company") (a wholly owned subsidiary of Southern respects, the financial position of Alabama Power Company) as of December 31, 2006 and 2005,ý andthe Company at December 31, 2006 and 2005, and the results related statements of income, comprehensive income,- of its operations and its cash flows for each of the three common stockholder's equity, and cash flows for each 6f years in the period ended December 31, 2006, in , the three years in the period ended December 31, 2006. conformity with accounting principles generally accepted These financial statements are the responsibility of the in the United States of America. Company's management. Our responsibility is to express As discussed in Note 2 to the financial statements, in an opinion on these financial statements based on our, 2006 Alabama Power Company changed its method of audits. accounting for the funded status of defined benefit We conducted our audits in accordance with the pension and other postretirement plans. standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material 11, i-P misstatement. The Company is not required ýto have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our, audits included Birmingham, Alabama consideration of internal control over financial reporting 1 . February 26,.2007 as a basis for designing audit procedures that are . appropriate in the circumstances, but not for the purpose. of expressing an opinion on the effectiveness of the Company's internal control over financial reporting.. I Ii Accordingly, we express no such opinion. An audit also I-' includes examining, on a test basis, evidence supporting the amounts and disclosures in the finiancial; statements, assessing the accounting principles used 'and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our Opinion.

                                                                        .5,
                                                                              .'.    ,I, 11-83

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Alabama Power Company 2006 Annual Report OVERVIEW Net income is the primary component of the Company's contribution to Southern Company's earnings per share Business Activities goal. The Company's 2006 results compared with its Alabama Power Company (the Company) operates as a targets for each of these indicators are reflected in the vertically integrated utility providing electricity to retail following chart. customers within its traditional service area located within Key 2006 2006 the State of Alabama and to wholesale customers in the Performance Target Actual Southeast. Indicator Performance Performance Many factors affect the opportunities, challenges, and Customer Top quartile in risks of the Company's primary business of selling! Satisfaction customer surveys Top quartile electricity. These factors include the ability to maintain a Peak Season stable regulatory environment, to achieve energy sales EFOR 2.75% or less 0.76% growth, and to effectively manage and secure timely Net Income $502 million $518 million recovery of rising costs. These costs include those related to growing demand, increasingly stringent environmental See RESULTS OF OPERATIONS herein for standards, fuel prices, and restoration following major additional information on the Company's financial storms. performance. The financial performance achieved in 2006 In December 2006, the Company filed for an: reflects the continued emphasis that management places increase in retail base rates under Rate Stabilization and on these indicators, as well as the commitment shown by Equalization Plan (Rate RSE) based on a forward-looking employees in achieving or exceeding management's test period. This increase became effective with billings expectations. beginning in January 2007. This and other regulatory actions are expected to assist the Company's continued Earnings focus on providing reliable electrical service to customers The C2ompany's financial performance remained strong in while maintaining a stable financial position. 2006 despite the challenges of rising costs. The Company's net income after dividends on preferred and Key Performance Indicators preference stock of $518 million in 2006 increased

                                                                   $10 million (1.9 percent) over the prior year. This In striving to maximize shareholder value while providing improvement is primarily due to retail and wholesale.

cost-effective energy to customers, the Company revenue growth offset by higher non-fuel operating continues to focus on several key indicators. These expenses and increased interest expense. indicators include customer satisfaction, plant availability, system reliability, and net income. The Company's The Company's 2005 net income after dividends on financial success is directly tied to the satisfaction of its preferred stock was $508 million, representing a customers. Key elements of ensuring customer satisfaction $27 million (5.6 percent) increase from the prior year. include outstanding service, high reliability, and This improvement was primarily due to retail and competitive prices. Management uses customer wholesale revenue growth and increases in transmission satisfaction surveys and reliability indicators to evaluate revenues, partially offset by higher non-fuel operating the Company's results. expenses. Peak season equivalent forced outage rate (Peak The Company's 2004 net income after dividends on Season EFOR) is an indicator of fossil/hydro plant preferred stock was $481 million, representing an availability and efficient generation fleet operations $8 million (1.8 percent) increase from the prior year. This during the months when generation needs are greatest. improvement was primarily due to retail sales growth, The rate is calculated by dividing the number of hours of increases in other revenues, and lower interest expense, forced outages by total generation hours. Transmission partially offset by higher non-fuel operating expenses. and distribution system reliability performance is measured by the frequency and duration of outages. Performance targets for reliability are set internally based on historical performance, expected weather conditions, and expected capital expenditures. The performance for 2006 exceeded all targets on these reliability measures. 11-84

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report RESULTS OF OPERATIONS Revenues A condensed income statement is as follows: Operating Revenues ITiriease (Decrease) Operating revenues for 2006 were $5.0 billion, reflecting Amount From Prior Year' a $367 million increase from 2005. The following table summarizes the principal factors that have affected 2006 :2006 2005 2004 operating revenues for the past three years: (in millions) Amount Operating revenues $5,015 $367 $412 $276 2006 2005 2004 Fuel 1,673 216 271 119 (in millions) Purchased power 426 (31) 44 98 Retail -- prior year $3,621 $3,293 $3,051 Other operations and Change in - maintenance 1,097 53 97 26 Base rates 43 35 41 Depreciation and Sales growth 42 50 48 amortization 451 24 1 13 Weather 20 18 12 Taxes other than income Fuel cost recovery and other 270 225 141 taxes . 258 9. - 6 14 Retail --' current year 3,996 3,621 3,293 Total operating expenses 3,905 271 - 419 270 Sales for resale-- Non-affiliates 635 551 484 Operating income 1,110 96 (7) 6 289 308 Affiliates ' ' " 216 Total other income and. 851 840 792 6 Total sales for resale (expense) (237)., (40) 46 (29) 23 Other operating revenues 168 187 151 Income taxes 330 Total operating revenues $5,015 $4,648 $4,236 Net income 543 ri0 28 13 Dividends on preferred Percent change 7.9% 9.7% 7.0% and preference stock 25 - 1 5

Retail revenues in 2006 were $4.0 billion. These Net income after revenues increased $375 million (10.3 percent) in 2006, dividends on preferred $328 million (10.0 percent) in 2005, and $242 million and preference stock $ 518 $ 10 $ 27 $ 8 (7.9 percent) in 2004. These increases were primarily due to increased fuel revenue and retail base rate increases of 2.6 percent in January 2006, 1.0 percent in January 2005, and 0.8 percent in July 2004, See FUTURE EARNINGS POTENTIAL - "PSC Matters" herein and Note 3 to the financial statements under "Retail Regulatory Matters" for additional information.

Fuel rates billed to customers are designed to fully recover fluctuating fuel and purchased power costs over a period of time. Fuel revenues generally have no effect on net income because they represent the recording of revenues to offset fuel and purchased power expenses. See FUTURE EARNINGS POTENTIAL - "PSC Matters - Retail Fuel Cost Recovery" herein and Note 3 to the financial statements under "Retail Regulatory Matters - Fuel Cost Recovery" for additional information. Sales for resale lto non-affiliates are predominantly unit power sales under long-term contracts to Florida utilities. Capacity revenues under unit power sales contracts reflect the recovery of fixed costs and a return on investment, and under these contracts, energy is generally sold at variable cost. Fluctuations in oil and natural gas prices, which are the primary fuel sources for unit power sales customers, influence changes in these 11-85

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report sales. However, because energy is generally sold at generally offset by energy reVeriues through the variable cost, these fluctuations have a minimal effect on Company's energy cost recovery clause. earnings. These capacity and energy components of the unit power sales contracts were as follows: Other operating revenues in 2006 decreased

                                                                     $17.6 million (9.5 percent) from 2005 primarily due to a 2006           2005         2004         decrease of $14.6 million in revenues from gas-fueled co-(in thousands)                 generation steam facilities primarily as a result of lower Unit power -                                                          gas prices. In 2005, other operating revenues increased Capacity               $153,581       $147,609     $134,615        $35.0 million (23.2 percent) from 2004 due to an increase Energy                   198,189        169,080      146,809       of $20 million in revenues from gas-fueled co-generation Total                     $351,770       $316,689     $281,424        steam facilities primarily as a result of higher gas prices.

a $7.7 million increase in transmission revenues, and a No significant declines in the amount of capacity $3.9 million increase from rent from associated revenues are scheduled until the termination of the companies primarily related to leased transmission. contracts in May 2010. facilities. Other operating revenues in 2004 increased

                                                                     $7.0 million (4.9 percent) from 2003 due to an increase of Short-term opportunity energy sales are also included           $7.7 million in -revenues from gas-fueled co-generation.

in sales for resale to non-affiliates. These opportunity steam facilities primarily: as a result of higher gas prices,, sales are made at market-based rates that generally and a $2.4 million increase in revenues from rent from provide a margin ab)ove the Company's variable costto electric property offset by a $2.0 million decrease in: produce the energy. Revenues associated with other power transmission revenues. Since co-generation steam sales to non-affiliates were as follows: revenues are generally offset by fuel expense, these 2006 2005 2004 revenues did not have a significant impact on earnings for any year reported. (in thousands) Other power sales - Capacity and other $136,966 $116,181 $ 90,673 Energy Sales Variable cost of Changes in revenues are influenced heavily by the change energy 145,816 118,537 111,742 in volume of energy sold from year to year. KWH sales Total $282,782 $234,718 $202,415 for 2006 and the percent change by year were as follows: Revenues from sales to affiliated companies within KWH Percent Change the Southern Company system will vary from year to year 2006 2006 2005 2004 depending on demand and the availability and cost of (in millions) generating resources at each company. These affiliated Residential 18,633 3.1% 4.1% 2.4% sales and purchases are made in accordance with the Commercial 14,355 2.1 1.7 2.8 Intercompany Interchange Contract (TIC) as approved by Industrial 23,187 (0.7) 2.2 5.8 the Federal Energy Regulatory Commission (FERC). In Other 200 0.4 0.2 (2.4) 2006, sales for resale revenues decreased $72.9 million primarily due to a 16.7 percent decrease in price and a Total retail 56,375 1.2 2.7 3.9 10.3 percent decrease in kilowatt-hour (KWH) sales to Sales for resale - affiliates as a result of a decrease in the availability of the Non-affiliates 15,978 3.5 (0.3) (9.4) Company's generating resources because of an increase in Affiliates 5,145 (10.3) (20.7) (23.2) customer demand within the Company's service territory. Total 77,498 0.8 (0.1) (2.2) In 2005, sales for resale revenues decreased $19.4 million primarily due to a 20.7 percent decrease in KWH sales to Retail energy sales in 2006 were 1.2 percent higher affiliates as a result of a decrease in the availability of the than in 2005. Energy sales in the residential and Company's generating resources due to an increase in commercial sectors led the growth with a 3.1 percent and customer demand within the Company's service territory. a 2.1 percent increase, respectively, in 2006 due primarily Sales for resale revenues increased $31.1 million in 2004 to weather-driven increased demand. Industrial sales due to increases in fuel-related expenses. Excluding the decreased 0.7 percent during the year as several large capacity revenues, these transactions do not have a textile facilities discontinued or substantially reduced their significant impact on earnings since the energy is operations in 2006. In addition, industrial sales decreased generally sold at marginal cost and energy purchases are due to pulp and paper customers utilizing self-generation HI-86

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report as a result of.lower gas prices during .the year compared Fuel and purchased power expenses were $2.1 billion to 2005.. in 2006, an increase of $184.1 million (9.6 percent) above the :prior year costs. This increase was the result of a Retail energy sales in 2005 were 2.7 percent higher $128.7 million increase in the cost of fuel and a than 2004 despite interruptions. during Hurricanes Dennis $55A4 million increase related to total KWH generated and Katrina. Energy sales in the residential sector led the and purchased. growth with a 4.1 percent increase in 2005 due primarily to increased demand. Commercial sales increased Fuel and purchased power expenses were $1.9 billion 1.7 percent jn 2005 primarily due to continued customer in 2005, an increase of $315.4 million (19.7 percent), growth. Industrial sales increased 2.2 percent during the above the prior year costs. This increase was the result of year with chemical, primary metals and automotive a $367.4 million increase in the cost of fuel offset by a-leading the growth in industrial energy consumption. In $52.0 million decrease related to total KWH generated addition, the paper sector chose to purchase rather than and purchased. self-generate which contributed to increised sales. Fuel'and purchased power expenses were $1.6 billion

   - Retail energy sales in the residential sector grew by           in 2004,'an increase of $216.3 million (15.6 percent) 2.4 percent in 2004 primarily due to continued, customer              above the-prior year costs. This increase was the result of growth and a return to normal summer temperatures.                    a $218.4 imfillion increase in the cost of fuel offset by a Commercial sales increased 2.8 per4entin 2004 primarily               $2.1 million decrease related to total KWH generated and due to continued customer growth. Industrial sales                    purchased.

rebounded 5.8 percent during the year with primary Purchased power consists of purchases from affiliates metals, chemical, and paper sectors leading the growth. in the Southern Company system and non-affiliated companies. Purchased power transactions among the Expenses- Company, its:affiliates, and non-affiliates. will vary, from period to period depending on demand and the availability Fuel and PurchasedPower and variable production cost of generating resources at each.company.' Purchased power from non-affiliates Fuel costs constitute the single largest exipnse for the decreased $64.7 million (34.3 percent) in 2006. This Company. The mix' of fuel sources for generation of decrease was due to a 26.8 percent decrease in the electricity is determined primarily by demand, the unit amount of energy purchased and a 10.3 percent decrease cost of fuel consumed, and the availability of generating in purchased power prices over the previous year.. In units. Details of the Company's generati6n, fuel, and 2005, purchased power from non-affiliates increased purchased power are as follows:

                                                                      $2.5 million (1.0 percent) due to a 14.3 percent increase 2006,     2005    2004         in purchased power prices over the previous year. In 2004, purchased power from non-affiliates increased Total generation                                                      $75 million, (68.0. percent) due to a 71.7 percent increase (billions of KWH) --                72.0      71.2    70.2 in energy purchased offset by a 1.9 percent decrease in Total purchased power                                                 purchased power prices compared to 2003.

(billions of KWH)-- 8 8.7 10.2 Sources of generation While pnices have moderated somewhat in 2006, a (percent) -- significant upward trend in the cost of coal and natural Coal 68 67 65 gas has emerged since 2003, and volatility in these Nuclear 19 19 19 markets is expected to continue. Increased coal prices Gas 9, 8 10 have been influenced by a worldwide increase in demand Hydro 4 6 6 as a result of rapid economic growth in China, as well as Average cost of fuel, source by increases in mining and fuel transportation costs. (cents per net KWH) - Higher natural gas prices in the United States are the Coal 2.09 1.85 1.58 result of increased demand and slightly lower gas supplies Nuclear 0.47- 0.46 0.46 despite increased' drilling activity. Natural gas production Gas 7.87. 7.43 4.69 and supply interruptions, such as those caused by the , Average cost of fuel, generated 2004 and 2005 hurricanes, result in an immediate market (cents per net KWH) ... 2.27 -2.02 1.69 responie; however, the long-term impact of this price Average cost of purchased power volatility may be reduced by imports of liquefied natural (cents per net KWH) --.. 5.98 6.49 4.79 gas if new'liquefied gas facilities are built. Fuel expenses 11-87

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report generally do not affect net income, since they are offset offset by the suspension of $18 million in nuclear by fuel revenues under the Company's energy cost decommissioning costs by the Alabama PSC due to the recovery clause. The Company continuously monitors the extension of the operating license for both units at Plant under/over recovered balance and files for a revised fuel Farley. See FUTURE EARNINGS POTENTIAL - rate when management deems appropriate. See FUTURE "Nuclear Relicensing" and Note I to the fin ancial EARNINGS POTENTIAL - "PSC Matters - Retail Fuel statements under "Nuclear Decommissioning" fot ' - Cost Recovery" herein and Note 3 to the financial additional information. In 2004, depreciation and statements under "Retail Regulatory Matters - Fuel Cost amortization expenses increased $13 million (31'percent) Recovery" for additional information. primarily due to an increase in utility plant in iervice. This increase reflects the impact of additions to property, Other OperatingExpenses plant, and equipment. Other Operations and Maintenance Taxes other than Income Taxes In 2006, other operations and maintenance expenses increased $52.8 million (5.1 percent) primarily due to an Taxes other than income taxes increased $9.3 million $18.8 million increase in administrative and general (3.7 percent) in 2006, $6.0 million (2.5 percent) in 2005, expenses related to employee benefits, a $10.1 million and $14.4 million (6.3 percent) in 2004, primaiily due to increase in nuclear production expense related to both increases in state and municipal public utility licenset routine operation and scheduled outage costs, a taxes which are directly related to the increase in retail $9.8 million increase in transmission and distribution revenues. expense related to overhead and underground line costs, and a $5.4 million increase in steam production expense Other Income and (Expense) related to environmental costs. In 2005, other'operations Allowance for Equity Funds Used During Construction, and maintenance expenses increased $96.7 million (10'.2 percent). This increase was primarily due to an Allowance for equity funds used during construction increase in transmission and distribution expense of (AFUDC) decreased $2.0 million (10.01 percent) in 2006 $37.3 million as a result of the Alabama Public Service' primarily due to the timing of construction expenditures Commission (PSC) accounting order to offset the costs of compared to the prior year. AFUDC increased $4.1 million the damage from Hurricane Ivan in September 2004 and (25.6 percent) and $3.5 million (28.2 pertcent), in 2005 and to restore a balance in the natural disaster reserve. See 2004, respectively, primarily due to increases in the Notes 1 and 3 to the financial statements under "Natural amount of construction work in progress over the prior Disaster Reserve" and "Natural Disaster Cost Recovery" year. See Note 1 to the financial, statements under respectively, for additional information. In addition, steam "Allowance for Funds Used During Construction production expense increased $28.1 million related to (AFUDC)" for additional information. scheduled outage costs and administrative and general expenses increased $20.7 million related to employee Interest benefits. In 2004, other operations and maintenance expenses increased $26.6 million (2.9 percent) primarily Interest expense, net of amounts capitalized increased due to an increase in administrative and general expenses $38.7 million (19.6 percent) in 2006 primarily due to related to employee benefits. higher interest rates and an increase in the average debt outstanding during the year. Interest expense, net of Depreciationand Amortization amounts capitalized, increased $3.8 million (2.0 percent) in 2005 due to an increase in average debt outstanding Depreciation and amortization expenses increased during the year. Interest expense, net of amounts $24.5 million (537 percent) in 2006 primarily due to capitalized, decreased $20.7 million (9.7 percent) in 2004 additions to property, plant, and equipment. In 2005, due to refinancing activities. depreciation and amortization expenses remained relatively flat compared to the prior year, increasing only Effects of Inflation $0.6 million (0.1 percent). During 2005, the depreciation rates used by the Company were adjusted based on a The Company is subject to rate regulation that is based on periodic study conducted by external experts that is used the recovery of costs. Rate RSE is based on annual to determine the appropriateness of the rates utilized. Also projected costs, including estimates for inflation. When in 2005, additions to property, plant, and equipment, historical costs are included, or when inflation exceeds - which resulted in increased depreciation expense, were the projected costs used in rate regulation, the effectd of. 11-88

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report inflation can create an economic loss since the recovery driving the potential for such an increase are higher of costs could be in dollars thathave less purchasing commodity costs, market demand for labor, and scope power. In addition, the Income tax laws are based on additions and clarifications. The. timing, specific' historical costs. The inflation rate hasb'een relatively low requirements, and estimated costs could also change as in recent years and any adverse effect of inflation on the environmental regulations are modified. See'Note 3 to the Company has not been substantial., i;:TI financial statements under "Environmental Matters" for

                                         . -,_: 'J
             *' i . . . . . I ' '     ,

additional information. FUTURE EARNINGS POTENTIAL: General New Source Review Actions 1 -1 The Company operates as a vertically integrated utility In ýNgvehai~er 1999, the Environmental Prote~tlon Agency providing electricity to retail custiomers within its (EPA) brought a civil action in the U.S. District Court *or traditional service area located in the State of Alabama, the Northern District of Georgia against certain' Southern and to wholesale customers in the Southeast. Prices for Company'subsidiaries, including i'he Companyi alleging electricity provided by the Company to retail customers that it had violated the New Source Review.(NSR) are set by the Alabama PSC undericbst-bdsed regulatory provisions of 'the Clean Air' Act and related state laws at principles. Prices forielectricity reldting to purchased , certain coal-fired generating facilities. Through power agreements (PPAs), interconnecting transmission subsequent amendments 'and other legal procedures, the lines, and the exchange of electric pow'er are, regulated by EPA filed a' separate action iii'Janu'ary 2001 against the the FERC. Retail rates and earnings are,ieviewed and CompSa, in the U.S. District Court for the Northern may be adjusted periodically 'within certain limitations. District of Alabama after the Company was dismissed See ACCOUNTING POLICIES - "Application Of Critical from the original action. In these lawsuits, the EPA Accounting Policies and Estimates'- Electric Utilityf , alleged that NSR vi6 lations occurred at five coal-fired Regulatibn" herein'and Note 3 to the firtafcial statements generating 'facilities operated by the Company. 'The civil under "FERC Matters" and "Retail 'Regulatory Matters" actions request penaliies and injunctive relief, including for additional information about ke, latory matters. an order re4uiring the installation of the best available', control technology at the affected'units. The results of operations for the past three years are not necessarily indicative of future earings potential. The On June 19, 2006, the U.S. District Court for the - level of the Company's future eam"wgs, depends on Northern Districtbof Alabama entered a consent decree' numerous factors that affect the 9pprtuities, challenges, between the Company and the EPA, 'resolving the alleged and risks of the Company's priniary business of selling NSR violations at Plant Miller. The consent decree electricity. These factors include the Company's ability to required the Company to pay $100,000 to resolve the maintain a stable regulatory environment that continues to government's claim for a civil penalty and to donate allow for the recovery. of all pruently incurred costs $4.9 million of sulfur dioxide emission allowances to a during a time of increasingcps. *Future earnings in the nonprofit charitatile organization and formalized specific near term will depend, in part, upon growth in energy emissi6ns reductions to be accomplished by the Company, sales, which is subje6t tO a number of factors., These consistent With 6ther Clean Air Act programs that require factors include weather, competition, new energy emissions eduictions. On August 14, 2006, the district contracts with neighboring utilities, energy conservation court in -Alabama 'granted the Comnany's motion' for, practiceI by customers., the pric def electricity, the price summaiy judgment and entered final judgment in favor 0f* elasticity. of demand, and the rate of economic growth in the Conihpany.on the EPA's claims related'to Plants .Bar'ry the Company's service area._ Ggston, Gorgos, and Greene County.' The plaintiffs have

     'Assuming' nomial vfeither, Waleg to retail customers              appealed' this decision to the U.S. Court of Appeals for are projected to grow approkimately r1:.'f 'percentannually            the Eleventh Circuit and, on November 14, 2006, the on average during 2007 through 2011                                     Eleventh Ciiruit granted the plaintiffs' request to stay the appeal,'pending the U.S. Supremen Court's ruling in a similar NSR case filed by the EPA against Duke Energy.

Environmental Matters Compliance. costs related to the Clean Air Act and other The Company believes' that it complied with environmental regulations could affect earnings if such'. applicable laws and the EPA regulations and. costs cannot be fully recovered in rates on a timely-basis. interpretations in effect at the time the work in question Environmental compliance spending over the'next several took place. The Clean Air Act authorizes maximum civil' years may exceed amounts estimated. Some of the factors penalties of $25,000 to $32,500 per day, per 'violation at v II-89

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report each generating unit, depending on the date of the alleged these claims are without merit and notes that the violation. An adverse outcome in this matter could require complaint cites no statutory or regulatory basis for the substantial capital expenditures that cannot be determined claims. In September 2005, the U.S. District Court for the at this time and could possibly require payment of Southern District of New York granted Southern, substantial penalties. Such expenditures could affect Company's and the other defendants' motions to dismiss future results of operations, cash flows, and financial these cases. The plaintiffs filed an appeal to the U.S. Court condition if such costs are not recovered through of Appeals for the Second Circuit in October 2005. The regulated rates. ultimate outcome of these' matters cannot'be determined at this time. The EPA has issued a series of proposed and final revisions to its NSR regulations under the Clean Air Act, many of which have been 'subject to legal challenges by EnvironmentalStatutes and Regulations environmental groups and states. On June 24, 2005, the General U.S. Court of Appeals for the District of Columbia Circuit upheld, in part, the EPA's revisions to NSR The Company's operations are subject to extensive regulations that were issued in December 2002 but regulation by state and federal environmental agencies vacated portions of those revisions addressing the under a variety of statutes and regulations governing exclusion of certain pollution control projects. These environmental media, including air, water, and land regulatory revisions have been adopted by the State of resources. Applicable statutes include the Clean Air Act; Alabama. On March 17, 2006, the U.S. Court of Appeals the Clean Water Act; the Comprehensive Environmental for the District of Columbia Circuit' also vacated an EPA Response, Compensation, and Liability Act; the Resource rule which sought to clarify the scope of the existing Conservation and Recovery Act; the Toxic Substances Routine Maintenance, Repair and Replacement exclusion. Control Act; the Emergency Planning & Community In October 2005 and September 2006, the EPA also Right-to-Know Act, and the Endangered Species Act. published proposed rules clarifying the test for Compliance with these environmental requirements determining when an emissions increase subject to the involves significant capital and operating costs, a major NSR permitting requirements has occurred. The impact of portion of which is expected to be recovered through these proposed rules will depend on adoption of the final existing ratemaking provisions. Through 2006, the rules by the EPA and the State of Alabama's Company had invested approximately $1.2 billion in implementation of such rules, as well as the outcome of capital projects to comply with these requirements, with any additional legal challenges, and, therefore, cannot be annual totals of $260 million, $256 million, and determined at this time. $177 million for 2006, 2005, and 2004, respectively. The Company expects that capital 'expenditures to assure Carbon Dioxide Litigation compliance with existing and new regulations will be an additional $505 million, $535' million, and $549 million In July 2004, attorneys general from eight states, each for 2007, 2008, and 2009, i'espectively. Because the outside of Southern Company's service territory, and the Company's compliance strategy is impacted by changes to corporation counsel for New York City filed a complaint existing environmental laws and regulations, the cost, in the U.S. District Court for the Southern District of New availability, and existing inventory of emission York against Southern Company and four other electric allowances, and the Company's fuel mix, the ultimate power companies. A nearly identical complaint was filed impact of compliance cannot be determined at this time.' by three environmental groups in the same court. The Environmental costs that are known and estimable at this complaints allege that the companies' emissions of carbon time are included in capital expenditures discussed tinder dioxide, a greenhouse gas, contribute to global warming, FINANCIAL CONDITION AND LIQUIDITY - "Capital which the plaintiffs assert is a public nuisance. Under Requirements and Contractual Obligations" herein. common law public and private nuisance theories, the plaintiffs seek a judicial order (1) holding each defendant Compliance with possible additional federal or'state jointly and severally liable for creating, contributing to, legislation or regulations related to global climate change, and/or maintaining global warming and (2) requiring each air quality, or other environmental and health concerns of the defendants to cap its emissions of carbon dioxide could also significantly affect the Company. New, . and then reduce those emissions by a specified percentage environmental legislation or regulations, or changes to each year for at least a decade. Plaintiffs have not, existing statutes or regulations could affect many areas of however, requested that damages be awarded in the Company's operations; however, the full impact of connection with their claims. Southern Company believes any such changes cannot be determined at this time. 11-90

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued). Alabama Power Company 2006 Annual Report Air Quality 1 . 1 :" " 1., for addressing the nonattainment designations under the existing standard are required by April 2008 and could Compliance with the Clean Air Act and resulting require further. reductions in SO 2 and NO,, emissions from regulations has been and will continue to.be a significant power plants. On September 21, 2006, the EPA published focus for the Company. Through 2006. the Company had a final rule lowering the 24-hour fine particulate matter spent approximately,.$1.0 billion 'n reducing sulfur air quality standard even further and plans to designate dioxide (SO2) and nitrogen oxide (NO). emissions and in nonattainment areas based on the new standard by , monitoring emissions pursuant Ito the Clean Air Act.. December 2009. The final outcome of this matter cannot Additional controls.have been announced and are be determined at this time. currently being installed at several plants to further reduce SO2, NO,,, and mercury emissions, maintain compliance The EPA issued the final Clean Air Interstate Rule in with existing regulations, and meet newmrequirements. March 2005. This cap-and-trade rule addresses power plantS0 2 'anid NO,, emissions that were found to Approximately $638 million bf these expenditures contribute to norlattainment of the eight-hour ozone' and related to reducing NO,, emissions pursuant to state and fine particulate' matter 'standards 'in downwind states. federal requirements were in connection with the EPA's Twenty-eight eastern states, including the State of one-hour ozone standard and the 199.8 regional NO, Alabama, are subject to the requirements of the rule. The, reduction rules. In 2004, the regionaI NO,, reduction rules rule calls for additional reductions of NO,, and/or SO 2 to were implemented for theporthern two-thirds of be achieved in two phases, 2009/2010 and 201.5. These Alabama. See Note 3 to the financial statements under reductions will be accomplished by the installation of "Retail Regulatory Matteis" for infQrmatioi regarding the additional emission controls rat ,the Company's coal-fired Company's recovery of costs associated with. facilities or by the purchase of emission allowances from. environmental laws and regulations. a cap-and-trade program. In -2005, the EPA revoked the one-hour ozone air The Clean Air Visibility Rule (formerly called the quality standard' and published the 'second of two sets of Regional Haze Rule) was finalized in*July' 2005. The goal final rules for implementation of the new, "morestringent of this rule is to restore'natural Visibility conditions in eight-hour ozone standards. Aieas wiihin- the Company's certain areas (primarily national parks and wilderness servike area that were designated as nbnatuainment under areas) by 2064. The rule involves (1) the application of the eight-hour ozone stanidard included 'J~fferson and Best Available Retrofit Technology: (BART) to certain Shelby Couhties, near and including Bmiringham. The sources built between 1962 and 1977 and (2) the Birmingham area was redesignated to httainment with the application of any additional emissions reductions which eight-hour ozone standard 'by the EPA 6ihJune 12, 2006, may be deemed necessary for each designated area to and the 'EPA 'subsequently' approved a ainteiinance plan achieve reasonable progress toward the natural conditions for 'the area to address future-exceedances of the standard. goal by 2018. Thereafter, for each 10-year planning On December 22, 2006, the U.S. Court of Appeals for the period, additional emissions reductions will be required to District of Columbia Circfit vacated the first'set of continue to demonstrate reasonable progress in each area implementation rules adopted in 2004 and remanded the during that periodi For power plants, the Clean Air rules to the 'EPA for further refinemeit.'-Thie impact of Visibility Rule allows states to determine that the Clean this decisitn,'if any, cannot be detefinied'at this timne Air Interstate 'Rule satisfies.BART requirements for SO:: and 'will depend on subseqtieni legal acfiin and/oi- and NO,,. However, additional BART requirements for. rulemaking actility: State impleenifiatio I plans,ý including particulate matter could be imposed, and the reasonable', new emission control'regulations necessary to bring ozone progress provisions could result in requirements for nonattainmehf 'are as into' ittaihmenit are 'currently, required' additional SO 2 controls. By December 17, 2007,. states for most areas by June 2007. These sitate' implementation must submit implementation plans that contain strategies plans could requiird further feductions'in NO,, emissions for BART and any other control measures required to, from poWer plants. . - achieve the first phase of repsonable progress. During 2005, the EPA's:fine particulate matter- ..InMarch 2005,' the EPA published the final Clean nonattainment designations became effective for several Air Mercury Rule, a cap-and-trade' program for the areas within the Company's service area, and the EPA. reduction of mercury emissions from coal-fired powver" proposed a.rule for the.implementation of the fine plants. The rule sets caps on mercury emissions to be' particulate matter standard. The EPA is expected .to implemented in two phases, 2010 and 2018, and provides publish its final rule for implementation of' the existing for an emission. allowance trading market. The Company fine particulate matter standard in early 2007. State plans anticipates that emission controls installed to achieve . ,- II-91

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report compliance with the Clean Air Interstate Rule and the Environmental Remediation eight-hour ozone and fine-particulate air quality standards will also result in mercury emission reductions. However, The Company must comply with other environmental the long-term capability of emission control equipment to laws and regulations that cover the handling and disposal reduce mercury emissions is still being evaluated, and the of waste and release of hazardous substances. Under these installation of additional control technologies may be various laws and regulations, the Company could incur required. substantial costs to clean up properties. The Company conducts studies to determine the extent of any required The impacts of the eight-hour ozone and the fine cleanup and has recognized in its financial statements the particulate matter nonattainment designations, the Clean costs to clean up known sites. Amounts for cleanup and Air Interstate Rule, the Clean Air Visibility Rule, and the ongoing monitoring costs were not material for any year presented. The Company may be liable for some or all Clean Air Mercury Rule on the Company will depend on required cleanup costs for additional sites that may the development and implementation of rules at the state require environmental remediation. level. States implementing the Clean Air Mercury Rule and the Clean Air Interstate Rule, in particular, have the option not to participate in the national cap-and-trade Global Climate Issues programs and could require reductions greater than those mandated by the federal rules. Impacts will also depend Domestic efforts to limit greenhouse gas emissions have on resolution of pending legal challenges to these rules. been spurred by international negotiations under the Therefore, the full effects of these regulations on the Framework Convention on Climate Change, and Company cannot be determined at this time. The specifically the Kyoto Protocol, which proposes a binding Company has developed and continually updates a limitation on the emissions of greenhouse gases for comprehensive environmental compliance strategy to industrialized countries. The Bush Administration has not comply with the continuing and new environmental supported U.S. ratification of the Kyoto Protocol or other requirements discussed above. As part of this strategy, the mandatory carbon dioxide reduction legislation; however, Company plans to install additional SO 2 , NOR, and in 2002, it did announce a goal to reduce the greenhouse mercury emission controls within the next several years to gas intensity of the U.S. economy, the ratio of greenhouse assure continued compliance with applicable air quality gas emissions to. the value of U.S. economic output, by requirements. 18 percent by 2012. Southern Company is participating in the voluntary electric utility sector climate change initiative, known as Power Partners, under the Bush Water Quality Administration's Climate VISION program. The utility sector pledged to reduce its greenhouse gas emissions rate In July 2004, the EPA published its final technology- by 3 percent to 5 percent by 2010 - 2012. Southern based regulations under the Clean Water Act for the Company continues to evaluate future energy and purpose of reducing impingement and entrainment of fish, emission profiles relative to the Power Partners program and is participating in voluntary programs to support the shellfish, and other forms of aquatic life at existing power industry initiative. In addition,. Southern Company is plant cooling water intake structures. The rules require participating in the Bush Administration's Asia Pacific baseline biological information and, perhaps, installation Partnership on Clean Development and Climate, a public/ of fish protection technology near some intake structures private partnership to work together. to meet goals for at existing power plants. On January 25, 2007, the energy security, national air pollution reduction, and U.S. Court of Appeals for the Second Circuit overturned climate change in ways that promote sustainable and remanded several provisions of the rule to the EPA economic growth and poverty reduction. Legislative for revisions. Among other things, the court rejected the proposals that would impose mandatory restrictions on EPA's use of "cost-benefit" analysis and suggested some carbon dioxide emissions continue to be considered in ways to incorporate cost considerations. The full impact Congress. The ultimate outcome cannot be determined at of these regulations will depend on subsequent legal this time; however, mandatory restrictions on the proceedings, further rulemaking by the EPA, the results of Company's carbon dioxide emissions could result in studies and analyses performed as part of the rules' significant additional compliance costs that could affect implementation, and the actual requirements established future results of operations, cash flows, and financial by state regulatory agencies and, therefore, cannot now be condition if such costs are not recovered through determined. regulated rates. 11-92

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report FERC Matters The Company believes that there is no meritorious basis for these proceedings and is vigorously defending itself in this matter. However, the final outcome of this Market-Based Rate Authority matter, including any remedies to be applied in the event of an adverse ruling in these proceedings, cannot now be The Company has authorization from the FERC to sell determined. power to non-affiliates, including short-term opportunity sales, at market-based prices. Specific FERC approval Intercompany Interchange Contract must be obtained with respect to a market-based contract with an affiliate. The Company's generation fleet is operated under the IIC, as approved by the FERC. In May 2005, the FERC In December 2004, the FERC initiated a proceeding initiated a new proceeding to examine (1) the provisions to assess Southern Company's generation dominance of the IIC among the Company, Georgia Power, Gulf The ability to charge withinits retail service territory. Power, Mississippi Power, Savannah Electric, Southern market-based rates in other markets is not an issue in that Power, and Southern Company Services, Inc. (SCS), as proceeding. Any new mirket-based rate sales by the agent, under the terms of which the power pool of

Company in Southern Company's retail service territory Southern Company is operated, and, in particular, the entered into during a 15-month refund period beginning propriety of the continued inclusion of Southern Power as February 27, 2005 could be subject to refund to the level a party to the IIC, (2) whether any parties to the IIC have of the default cost-based rates, pending the outcome of violated the FERC's standards of conduct applicable to the proceeding. Such sales through May 27, 2006, the end utility companies that are transmission providers, and of the refund period, were approximately $3.9 million for (3) whether Southern Company's code of conduct the Company. In the event that the FERC's default defining Southern Power as a "system company" rather mitigation measures for entities that are found to have than a "marketing affiliate" is just and reasonable. In market power are ultimately applied, the Company may connection with the formation of Southern Power, the be required to charge cost-based rates for certain FERC authorized Southern Power's inclusion in the IIC in wholesale sales in the Southern Company retail service 2000. The FERC also previously approved Southern territory, which may be lower than negotiated market- Company's code of conduct.

based rates. The final outcome of this matter will depend On October 5, 2006,' the FERC issued an order on the form in which -the final methodology for assessing accepting a settlement' resolving the proceeding subject to generation market power and mitigation rules may be Southern Company's agreement to accept certain ultimately adopted and cannot be determined at this time. modifications to the settlement's terms. On October 20, 2006, Southern Company notified the FERC that it In addition, in May 2005, the FERC started an accepted the modifications. The modifications largely investigation to determine whether Southern Company involve functional separation and information restrictions satisfies the other three parts of the FERC's market-based related to marketing activities'conducted on behalf of rate analysis: transmission market power, barriers to entry, Southern Power. Southern Company filed' with the FERC and affiliate abuse or reciprocal dealing. The FERC on November 6, 2006 an implementation plan to comply established a new 15-mofith refund period related to this with the 'modifications set forth in the order. The impact expanded investigation. Any new inarket-based rate sales of the modifications is not expected to have a material involving any Southern Company subsidiary,' including the impact on the Company's financial statements. Company, could be s'ubject to refund to the extent the FERC orders lower rates as a result of this new GenerationInterconnection Agreements investigation. Such sales through October 19, 2006, the end of the refund period, were approximately In July 2003, the FERC issued its final rule on the

$14.6 million for the Company, of which $3.1 million                   standardization of generation interconnection agreements relates to sales inside the retail service 'territory discussed        and procedures (Order 2003). Order 2003 shifts much of above. The FERC also directed that this expanded                      the financial burden of new transmission investment from proceeding be held in abeyance pending the outcome of                 the generator to the transmission provider. The FERC has the proceeding on the IIC discussed below. On January 3,               indicated that Order 2003, which was effective January 20, 2007, the FERC issued an order noting settlement of                   2004, is to be applied 'prospectively to new generating the HC proceeding and seeking comment identifying any                  facilities interconnecting to a transmission system. Order remaining issues and the proper procedure for addressing               2003 was affirmed by the U.S. Court of Appeals for the any such issues.                                                      District of Columbia Circuit on January 12, 2007. The 11-93

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report cost impact resulting from Order 2003 will vary on a the Warrior River. The FERC licenses for all of these nine case-by-case basis for each new generator interconnecting projects expire in July and August of 2007. to the transmission system. - In 2006, the Company initiated the process of On November 22. 2004,. generator company developing an application to relicense the Martin subsidiaries of Tenaska, Inc. (Tenaska), as counterparties hydroelectric project located on the Tallapoosa River. The to two previously executed interconnection agreements current Martin license will expire in 2013 and the with the Company, filed complaints at the FERC application for a new license will be filed with the FERC, requesting that the FERC modify the agreements and that in 2011. th&: Company refund a total of $11 'million previously Upon or after the expiration of each license, the paid for interconnection facilities, with interest. The United States Government, by act of Congress, may take Company has also received requests for similar over the project or the FERC may relicense the project modifications from other entitles, though no other either to the original licensee or to a new licensee. The complaints are pending with the FERC. On January 19, FERC may grant relicenses subject. to certain 2007- the FERC issued- an order granting Tenaska's requirements that could result inladditional costs to the requested relief. Although the FERC's order requires the Company. If the FERC does not act on the Company's, modification of Tenaska's interconnection agreements, the new license. application prior to the expiration of the order reduces the amount of thb refund that had been existing license, then the FERC is required by law to requested by Tenaska. As a result, the'Company estimates issue annual licenses to the Company, under the terms indicate that no refund is due Tenaska. Southern and conditions of the existing license, until a new license Company has requested rehearing of the FERC's order. is issued. The final outcome of this matter cannot now be determined. The timing and final outcome of the Company's relicense applications cannot now be determined. Transmission. Nuclear Relicensing In December 1999, the FERC issued its finai rule on The Company filed an application with the Nuclear, Regional Transmission Organizations (RTOs). Since that time, there have been a number of additional proceedings Regulatory Commission (NRC) in September 2003 to at the FERC designed to encourage further voluntary extend the operating license for Plant Farley. for an formation of RTOs or to mandate their formation. additional 20 years. In May 2005, the NRC, granted the However, at the current time, there are no active Company a 20-year extension of the operating license for proceedings that would require the Company to both units at Plant Farley. As a result of the license participate in an RTO. Current FERC efforts that may extension, amounts previously, contributed to the external potentially change the regulatory and/or operational trust are currently projected to be adequate to meet the structure of transmission include rules related to the decommissioning obligations, Therefore, in June .2005, , standardization of generation interconnIection, as well as the Alabama PSC approved the, Company's request to_ an. inquiry, into, among other things, market power by suspend, effective January 1, 2005, the. inclusion in its vertically integrated utilities. See "Market-Based Rate annual cost of service of $18 million in: decommissioning Authority" and "Generation Interconnection Agreements" costs and to also suspend the associated obligation to ,, above for additional information. The final outcome of make semi-annual contributions to the external trust, See.. these proceedings cannot now be determined. However, Note 1 to the financial statements under "Nuclear the Company's financial condition, results of operations, Decommissioning" for additional information. and cash flows could be adversely affected by future changes in the federal regulatory or operational structure PSC Matters. of transmission. Retail Rate Adjustnzents Hydro Relicensing In October 2005, the Alabama PSC approv~d a revision to the Rate RSE requested by the Company. Effective In July 2005, the Company filed two 'applications with the January 2007 and thereafter, Rate RSE adjustments are FERC for new 50-year licenses for the Company's seven based on forward-looking information for the applicable hydroelectric developments on the Coosa River (Weiss, upcoming calendar year. Rate adjustments for any two-Henry, Logan Martin, Lay, Mitchell, Jordan, and Bouldin) year period, when averaged together, cannot exceed.* and for: the Lewis Smith and Bankhead developments on 4 percent per year and any annual adjustment is limited to 11-94

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report 5 percent. Rates remain unchanged when the projected the Alabama PSC approved an increase of the energy return on retail common equity ranges between billing factor for retail customers from 1.788 cents per 13.0 percent and 14.5 percent. If the c6mpany's actual KWH to 2.400 cents per KWH, effective with billings retail return on common equity is above the allowed beginning January 2006 for the 24-month period ending equity return range,)customer reIfunds will be required; December 31, 2007. Thereafter, the Rate ECR factor will however, there is no provision for additional customer increase absent a contrary order by the Alabama PSC. billings should the actual retail return on common equity This change to the billing factor in 2006 represents on fall below the allowed equity return range. The Company average an increase of approximately, $6.12 per month for made its initial submission of projected data for calendar a customer billing of 1,000 KWH. This approved increase year 2007 on December 1, 2006. The Rate RSE increase was intended to allow for the recovery of energy costs for 2007, effective in January, is 4.76 '%ercent, or based on an estimate of future energy costs, as well as the $193 million annually. Under terms 'of Rate RSE, the collection of the existing under recovered energy costs by maximum increase' for 2008 cannot exceed 3.24 percent. the end -of 2007. In addition, during 2007, the Company See Note 3 to the financial statements under "Retail will be allowed to include a carrying charge associated Regulatory"Matters - Rate RSE" for further'information. with the under recovered fuel costs in the fuel expense calculation. The Company's retail rates, approved by the Alabama PSC, also provide for adjustments to recognize The Company's under recovered fuel costs as of the placing of new generating facilities into retail service December 31, 2006 totaled $301.0 million as compared to and the recovery of retail costs associated with $285.1 million at December 31, 2005. As a result of the certificated PPAs under Rate Certificated New Plant (Rate Alabama PSC order, the Company reclassified CNP). In October 2004, the Alabama PSC amended Rate $301.0 million and $186.9 million ofthe under-recovered CNP to 'also allow for the recovery of the Company's regulatory clause revenues from current assets to deferred. retail costs associated with environnriental laws,' charges and other assets'in the balance sheets as of regulations, or other such mandates. The rate mechanism December 31, 2006 and December .31, 2005, respectively. began operation in January 2005 and provides for the See Note 3. to the financial statements under "Retail recovery of these costs pursuant to a factor that is Regulatory' Matters - Fuel Cost Recovery" for additional calculated annually. Environmental costs to be recovered information. A include operation and maintenance expenses, depreciation, and a return on invested capital. Retail rates increased due Rate ECR reVeriues, as recorded on the financial statements, are 'adjusted for the difference in actual to environmental costs approximately 1.0 percent in recoverable' costs and amounts billed in current regulated' January 2005, 1.2 percent in January 2006, and 0.6 percent rates. Accordingly, this approved increase in the billing in January 2007. It is currently anticipated that retail rates factor will have no significant effect :on the Coipahiy's. will increase approximately 2.5 percent in 2008. revenues or net income, but will increase annual cash Effective July 2004, the Company's retail rates were flow. increased by approximately 0.8 percent, or $25 million annually, under Rate CNP for nrw certificated PPAs. In NaturalDisaster Cost Recovery April 2005, an annual adjustment to Rate CNP decreased retail rates by approximately 0.5 percent,: or $19 million The Company maintains a reserve for operations and annually. The annual true-up adjustment effective in April maintenance expense to cover thd cost of damages froni 2006 increased retail rates by 0.5 -pier nt, 'or $19 million major stbrmis to its transmission and distribution facilities. annually. Based on the Company's Vebruary 2007 filing, On July G,0 2005'and August 29, 2005, Hurricanes - ' there will be no rate adjustment associated with the Dennis and Katrina, respectively, hit 'the coast of Alabama annual true-up adjustment in April 2007.' See Note 3 to and continued north through the' stdate, causing significant the financial statements under "Retail Regulatory dainage'in parts'of the service territory of the Company. Matters - Rate CNP" for additional information. Approximately 241,000 and 637,000 of the Company's 1.4 million customers were' vtithout electrical service Retail Fuel Cost Recovey" immediately after Hurricanes Dennis and Katrina, respectively. The Company sustained significant damage The Company has established fuel cost recovery rates to its distribiution andtransmission facilities during these approved by the Alabama PSC. As a result of increased storms. fuel costs for coal, gas, and uranium,,the Company filed a fuel cost recovery increase under the provisions of its In August 2005, the Company received approval energy cost recovery rate (Rate ECR)., In December 2005, from the Alabama PSC to defer the Hurricane Dennis 11-95

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report storm-related operations and maintenance costs Other Matters, (approximately $28 million), which resulted in a negative In accordance with Financial Accounting Standards Board balance in the natural disaster reserve (NDR). In October 2005, the Company also received similar approval from (FASB) Statement No. 87, Employers' Accounting for Pensions, the Company recorded non-cash prertax pension the Alabama PSC to defer the Hurricane Katrina storm-income of approximately $13 million, $21 million, and related operations and maintenance costs (approximately

$30 million). See Note 1' and Note 3 to the financial
                                                                      $36 million in 2006, 2005, and 2004, respectively.

Postretirement benefit costs for the Company were statements under "Natural Disaster Reserve" and "Natural Disaster Cost Recovery," respectively, for additional $28 million, $28 million, and $22 million in 2006, 2005, information on these reserves. The natural disaster reserve and 2004, respectively. Postretirement benefit costs are, expected to trend upward. Such amounts are dependent on deficit balance at December 31, 2005 was $50.6 million. several factors including trust earnings and changes to the In December 2005, the,Alabama PSC approved a plans. A portion of pension and postretirement benefit request by the Company to replenish the depleted NDR costs is capitalized based on construction-related labor and allow for recovery of future natural disaster costs. charges. Pension and postretirement benefit costs are a The Alabama PSC order gives the Company authority to component of the regulated rates and generally do not record a deficit balance in the NDR when costs of have a long-term effect on-net income. For more uninsured storm damage-exceed any established reserve information regarding pension and postretirement benefits, balance. The order also approved a separate monthly see Note 2 to the. financial statements. NDR charge consisting of two components beginning in The Company is involved in various other matters, January 2006. The first component is intended to establish being litigated and regulatory matters that could affect and maintain a target reserve balance of $75 million for future earnings. See Note 3 to the financial statements for future storms and is an on-going part of customer billing. information regarding material issues. Assuming no additional storms, the Company currently expects that the target reserve balance could be achieved ACCOUNTING POLICIES within five years. The second component of the NDR charge'is intended to allow recovery of the existing Application of Critical Accounting Policies and deferred hurricane related operations and maintenance Estimates costs and any future reserve deficits over a 24-month period. Absent further Alabama PSC approval, the The Company prepares its financial statements in n*aximum total NDR charge consisting of both,-, accordance with accounting principles generally accepted components is $10 per month per non-residential in the United States. Significant accounting policies are customer account and $5 per month per residential, described in Note 1 to the financial statements. In the customer account. application of these policies, certain estimates are made that may have a material impact on the Company's results As of December 31, 2006, the Company had of operations and related disclosures. Different recovered $49.5 million of the costs allowed for storm- assumptions and measurements could produce estimates recovery activities and the 'dficit balafice in the natural that are significantly different from those recorded in the disaster reserve account totaled approximately . financial statements. Senior management has reviewed

$16.8 million, which is included in the balance sheets                 and discussed critical accounting policies and estimates under "Current Assets." Absent any. new storm related                  described below with the Audit Committee of Southern damages, the Company expects to fully recover the                      Company's Board of Directors.,,.

-deferred storm costs by the' middle of 2007. As a result, customer rates would be decreased by this portion of the Electric Utility Regulation, NDR charge. At December 31, 2006, the Company had accumulated a balance of $13.2 million in the target The Company is subject to retail regulation'by the reserve for future storms, which is included in the balance Alabama PSC and wholesale regulation by the FERC. sheets under "Other Regulatory Liabilities.". These regulatory agencies set the rates the Corppagy.is permitted to charge customers based 6n allowable costs. As revenue from the NDR charge is recognized, an As a result, the Company applies' FASB Statement No. 7 1, equal amount of operation and maintenance expense "Accounting for the Effects of CertainITypes of related to the NDR will also be recognized. As a result, Regulation" (SFAS No. 71), which requires the financial this increase in revenue andexpense will not have an statements to reflect the effects of rate regulation. impact on net income but will increase annual cash flow. Through the ratemaking process, the regulators may' 11-96

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report require the inclusion of costs or revenues in periods, ,' 0 Changes in existing income tax regulations or changes different than when they would be recognized by a non- in Internal Revenue Service (IRS) or Alabama regulated company. This treatment rnay result i the Department of Revenue interpretations of existing deferril of expenses and the recordinig of related , regulatioht . - regulatory assets based on anticipated future recovery through'r'tes or the deferral of gains or creation of . Identification of additional sites that require liabilities and the recording of related 'regulatory environmental remediation or the filing of other iiabilities. The application of SFAS No'. 71 has a further complaints -in which the Company may'be asserted to effect on the Company's financial statements as a result be a potentially responsible party... of the estimates of allowable ;costs used in the ratemaking

Identification and evaluation of other potential lawsuits process. These estimates may differ from those actually or conqplaints in which the Company may. be named incurred by the Company; therefore, the aicounting as a defrndanj. - .

estimates inherent in specific costs such as depreciation,:. nuclear decommissioning, and pension and postretirement

Resolutin or-progression of existing matters through benefits have less of a direct impact on the Company's. the legislative process, the court systems, the IRS, or the"EPA.?; i.. ,.. .

results of operations than they would on a nonn-regulated company. As reflected in Note 1 to the financial'statements' Unbilled Revenues under "Regulatory Assets and Liabilities," significant" regulatory assets and liabilities hive b~dn iiecoided. Revenues related to the sale of electricity are recorded Management reviews the ultimate recoverability of these when electricity is delivered to customers.-However, the regulatory assets and liabilities bieýon applicable determination of KWH sales to individual customers is,' regulatory guidelines and accounting principles generally based on the reading of their meters,. which is performed accepted in the United States. However, adverse' " on a syste'natic basis thrpughout the month. At the end of legislative, judicial, or regulatory actions could materially each month, -amounts of electricity delivered to customers, impact the amounts of such regulatory assets and but not yet metered and billed,' nr estimated. Componjents liabilities and could adversely impact the Company's of the urbiikd r&/enue 'estimaies -incluide total"KWH financial statements, territorial supjply, total KWH billed, estinated total electricity lost in'delivery,'and customer usage. These - components can fluctuate as a resuli of a number of Contingent Obligations factors imeldding weather, generation patterns, power delivery volume, and other operational constrants. These The Company is isubject to a number of federal and state factors ciA lie unpredictable and can vary from historical laws and regulations, as well as other factors. and. _.; trends. As i iesult, the overall estimate of udn~lled conditions that potentially subject it to environmental,, reve ,nues couid b6 significantly affected, which could have litigation; income tax, and other risks, See FUTURE a mateiiafimpact on the Company's results of operations'. EARNINGS POTENTIAL herein and Note 3 to the financial statements for more information regarding certain of these contingencies.,The Company periodically New Accounting Standards evaluates its exposure to such risks and records reserves for those matters where a loss is considered probable and Stock Options, . I reasonably estimable in accordance with generally: On January 1, 2006, the Comj'any adopted FASB accepted accounting principles. The adequacy of reserves. Statement No. 123(R), "Share-Based Payment," using the can be significantly affected by external events or conditions that can be unpredictable;.'thus,,the ultimate modified prospective method. This statement requires that compensation cost relating to share-based payment, ,.,>., outcome of such matters could materially affect the transactions be recognized in financial statements. That Company's financial statements. These: events or, conditions include the following: cost is measured based on 'the.grant date fair value of the equity'or liability. instruments issued. Although the , Changes in existing state or federal regulation by' compensation expense required under the revised governmental authorities having'jurisdiction over air statement differs slightly, the impacts on the Company's quality, water quality, control of toxic substances," financial statements are'similar to the pro forma. hazardous and solid wastes, and other environmental disclosures included in Note, 1to the financial statements m atters. . . under "Stock Options:' U1-97

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report Pensions and Other PostretirementPlans Fair Value Measurement On December 31, 2006, the Company adopted FASB The FASB issued FASB Statpment No. 157, "Fair Value Statement No. 158, "Employers' Accounting for Defined Measurements" (SFAS. No. 157) in September 2006. Benefit Pension and Other Postretirement Plans" SFAS No."157 provides guidance on how to measure fair (SFAS No. 158), which requires recognition of the funded value where it is permitted or required under other status of its defined benefit postretirement plans in its accounting pronouncements. SFAS No. 157 also requires balance sheet, With the adoption of SFAS No. 158, the additional disclosures about fair value measuremients. The Company plans to adopt SFAS No. 157 on January 1, Company recorded an additional prepaid pension asset of $183 million with respect to its overfunded defined 2008 and is currently assessing its impact. benefit plan and additional liabilities of $10 million and $147 million, respectively, related to its ýunderfunded non- FairValue Option qualified pension plans and other postretirement benefit In February 2007, the FASB issued FASB Statement plans. Additionally, SFAS No. 158 will require the No. 159, "Faid Value Option for Financial Assets and Company to change the measurement date for its defined Financial Liabilities - Including an Amendment of FASB benefit postretirement plan assets and obligations from September 30 to December 31 beginning with the year Statement No. 115" (SFAS No. 159). This standard ending December 31, 2008. See Note 2 to the financial permits an entity to choose to measure many financial instruments and certain other items at fair value. The statements for additional information. Company plans to adopt SFAS No. 159 on January 1,, 2008 and is currently assessing its impact. Guidance on Considering,the Materiality of Misstatements FINANCIAL CONDITION AND LIQUIDITY In September 2006, the Securities and Exchange Overview Commission (SEC) issued Staff,Accounting Bulletin No. 108, "Considering the Effects of Prior Year The Company's financial condition remained stable at Misstatements when Quantifying Misstatements in December 31, 2006. Net cash flow from operating Current Year Financial Statements" (SAB 108). SAB 108 activities totaled $956 million, $908 million, and addresses how the effects of prior year uncorrected $1,014 million for 2006, 2005, and 2004, respectively. misstatements should be considered when quantifying The $48 million increase for 2006 in operating activities misstatements in current year financial statements. primarily relates to higher recovery rates for fuel and,.-. SAB 108 requires companies to quantify misstatements purchased power partially offset by the timing of using both a balance sheet and an income statement payments for operation expenses. The $106 million approach and, to evaluate whether either approach results decrease for 2005 in operating activities primarily relates in quantifying an error that is material in light of relevant to an increase in under recovered fuel cost and storm quantitative and qualitative factors. When the effect of damage costs"felated to Hurricanes Dennis and Katrina. initial adoption is material, companies will record the These increases were partially offset by the deferral of effect as a cumulative effect adjustment to beginning of income tax liabilities arising from accelerated year retained earnings. The provisions of SAB 108 were depreciation deductions: Fuel and storm damage costs are effective for the Company for the year ended recoverable in future periods. Under recovered fuel cost is December 31, 2006. The adoption of SAB 108 did not included in the balance sheets as under recovered have a material impact on the Company's financial regulatory clause revenue and deferred under recovered statements. regulatory clause revenues. Under recovered storm damage cost is included in the balance sheets as other current assets and other regulatory assets. See FUTURE Income Taxes EARNINGS POTENTIAL - "Retail Fuel Cost Recovery" and "Natural Disaster Cost Recovery" for additional In July 2006, the FASB issued Interpretation No. 48, information. "Accounting for Uncertainty in Income Taxes" (FIN 48). This interpretation requires that tax benefits must be Significant balance sheet changes for 2006 include "more likely than not" of being sustained in order to be an increase of $697 million in gross plant and an increase recognized. The Company adopted FIN 48 effective of $279 million in long-term debt. In 2005, significant January 1, 2007. The adoption of FIN 48 did not have a balance sheet changes included an increase of material impact on the Company's financial statements. $668 million in gross plant. 11-98

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report The Company's ratio of common equityto total The Company. maintains committed lines of credit in capitalization,, including short-term debt, was 42.1 percent the amount of $965 million, of which $365 million will in 2006, 42.2 percent in 2005, and 42.6 percent in .2004. expire at various times during 2007. $198 million of the See Note 6 to the financial statements for additional credit facilities expiring in 2007 allow for the execution information., of term loans for an additional one-year period. The , remaining $600 million of credit facilities expire in 2011. The Company has maintained invest'ient grade See Note 6 to the financial statements under "Bank Credit ratings from the major rating agn'ies'with respect to"" Arrangements" for additional information. debt, preferred securfties,:prefetre~d stok, and preference stock. - The Company may also meet short-term cash needs through a Southern Company subsidiary organized to Sources of Capital issue and sell commercial paper and extendible commercial notes at the request and for the benefit of the The Company plans to obtain the funds required for Company and the other traditional operating companies. construction and other purposes from sources similar to Proceeds from such issuances for the benefit of the those used in, the past, which were primarily from, Company, are loaned .directly to the Company and are not operating cash flows. In recent years, the.Company has commingled with proceeds from such issuances for the primarily utilized unsecured debt, common stock, benefit of any other traditional operating company. The preferred and preference stock, and preferred securities. obligations of each company under these arrangements However, the type and timing of any financimgs, if are several and there is no cross affiliate credit support. needed, will depend, on market conditions, regulatory As of December 31, 2006, the Company had approval, anid other factors.

                                                                    $120 million in commercial paper outstanding, and no Security issuances are subject to regulatory approval         extendible commercial notes outstanding. As of by the Alabama PSC. Additionally, with respect to the                December 31, 2005, the Company had $136 million'in public offering of securities, the' Company files                    commercial papei outstanding, $55 million in extendible registration statements with the SEC under the Securities           commercial notes outstanding, and $125 million in loans"'

Act of 1933, as amended (1933 Act). The amounts of outstanding under an uncommitted credit arrangement. securities authorized by the Alabama PSC, s well 'as the amounts, if any, registered under the 1933 Act, are Finaicing Activities continuously monitored and appropriate filings aremade During 2006, the Company issued $950 million of long-. to ensure flexibility in the capital markets. term debt and six million new shares of preference stock The Company obtains financing separately without at $25.00,stated capital per share and realized proceeds of credit support from any affiliate. See Note 6 to the $150 million. In addition, the Company issued three financial statements under "Bank-Credit Arrangements" million new shares of common stock to Southern - for additional information. The'Southern Company system Company at $40.00 per share and.realized proceeds of does not maintain' a centralizdd cash or money pool. $120 million. The proceeds of these issuances were used Therefore, funds of the Company are not commingled to repay $546.5 million of senior notes and $3.0 million with funds of any:other company. of obligations related to pollution control bonds, toq repay short-term indebtedness, and for other general corporate The Company's current liabilities frequently exceed' purposes. current assets because of the continued use'of short-term debt as a funding source io meet scheduled maturitieS of "On February 6, 2007, the Co'mpany issued, long-term debt is w6ell as casih nieeds which can fluctuate $200 'rillion of long-term senior notes. The proceeds significantly due to the seasonality of the business. were useditd repay short-termn indebtedness and for other' general corporate purposes. To meet short-"tIrm 'cash needs and'contingenciei, the Company has variouisinternal and external sources of Credit Rating Risk . f liquidity. At the begiiining of 2007. .the Company had / .. approximately $16'million of cash and' cash equivalents The Company does not have any credit arrangements that and $965 million of unu:sed'credit arrangements with would require material changes in payment schedules or banks, as described~ below. In additibn, the. Company has terminations as a result of a credit rating downgrade. substantial cash: flow from operating activities and access However,- the Company, along with all members of the, to the capital markets, including commercial'paper Southern Company power pool, is party to certain programs, to meet liquidity needs. derivative agreements that could require collateral' and/or 11-99

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report accelerated payment in the event of a credit rating change In addition, the Company's Rate ECR allows the to below investment grade for the Company and/or recovery of specific costs associated with the sales of Georgia Power. These agreements are primarily for natural gas that become necessary due to operating natural gas and power price risk management activities. considerations at the Company's electric generating At December 31, 2006, the Company's total exposure to facilities. Rate ECR also allows recovery of the cost of these types of agreements was approximately financial instruments used for hedging market price risk $27.4 million. up to 75 percent of the budgeted annual amount of natural gas purchases. The Company may not engage in natural gas hedging activities that extend beyond a rolling Market Price Risk 42-month window. Also, the premiums paid for natural Due to cost-based rate regulations, the Company has gas financial options may not exceed 5 percent of the limited exposure to market volatility in interest rates, Company's natural gas budget for that year. commodity fuel prices, and prices of electricity. To manage the volatility attributable to these exposures, the At December 31, 2006, exposure from these Company nets the exposures to take advantage of natural activities was not material to the Company's finandal offsets and enters into various derivative transactions for position' results of operations, or cash flows. The changes the remaining exposures pursuant to the Company's in fair value of energy-related derivative contracts and policies in areas such as counterparty exposure and risk year-end valuations were as follows at December 31: management practices. Company policy is that derivatives are to be used primarily for hedging purposes and Changes in Fair Value mandates strict adherence to all applicable risk 2006 2005 management policies. Derivative positions are monitored (in thousands) using techniques including, but not limited to, market valuation, value at risk, stress testing, and sensitivity Contracts beginning of year $ 28,978 $ 4,017 analysis. Contracts realized or settled 45,031- (38,320) New contracts at inception - To mitigate future exposure to changes in interest Changes in valuation techniques rates, the Company enters into forward starting interest Current period changes(a) (106,637) 63,281 rate swaps that have been designated as hedges. The Contracts end of year $ (32,628) $ 28,978 weighted average interest rate on $440 million of long- (a) Current period changes also include the changes in fair value of new term variable interest rate exposure that has not been contracts entered into during the period. hedged at January 1, 2007 was 5.50 percent. If the Company sustained a 100 basis point change in interest Source of 2006 Year-End Valuation Prices rates for all unhedged variable rate long-term debt, the Total Maturity change would affect annualized interest expense by approximately $4.4 million at January 1, 2007. Fair Value 2007 2008-2009 Subsequent to December 31, 2006, interest rate swaps (in thousands) hedging approximately $536 million of floating rate Actively quoted $(33,304) $(30,776) $(2,528) pollution control bonds matured, increasing the External sources 676 676 Company's variable rate exposure by $536 million. As a Models and other result, the effect of a 100 basis point change in interest IioiUI)uu - - rates for all currently unhedged variable rate long-term Contracts end of year $(32,628) $(30,100) $(2,528) debt increased to approximately $9.8 million. For further information, see Notes I and 6 to the financial statements Unrealized gains and losses from mark-to-market under "Financial Instruments." adjustments on derivative contracts related to the To mitigate residual risks relative to movements in Company's fuel hedging programs are. recorded as electricity prices, the Company enters into fixed-price regulatory assets and liabilities. Realized gains and losses contracts for the purchase and sale of electricity through from these programs are included in fuel expense and are the wholesale electricity market and, to a lesser extent, recovered through the Company's fuel. cost recovery into similar contracts for gas purchases. The Company clause. Gains and losses on derivative contracts that are has implemented fuel hedging programs at the instruction not designated as hedges are recognized in the statements of the Alabama PSC. of income as incurred. At December 31, 2006, the fair 11-100

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report value gains/(losses) of energy-related derivative contracts conditions; environmental regulations; nuclear plant were reflected in the financial statements as follows: regulations; FERC rules and regulations; load projections; the cost and efficiency of construction labor, equipment,

                                                  'Amounts and materials; and the cost of capital. In addition, there (in thousands) can be no assurance that costs related to capital Regulatory assets, net                              $(33,267)         expenditures will be fully recovered. As a result of NRC Accumulated other comprehensive income                    676         requirements, the Company and Georgia Power have Net income                                                 (37)       external trust funds for nuclear decommissioning costs; Total fair value                                    $(32,628)         however, the Company currently has no additional funding requirements. For additional information, see Unrealized pre-tax gains and losses from energy-                Note 1 to the financial statements under "Nuclear related derivative contracts recognized in income were not            Decommissioning'.

material for any year presented. In addition to the funds required for the Company's The Company is exposed to market price risk in the construction program, approximately $1.3 billion will be event of nonperformance by counterparties to the energy- required by the end of 2009 for maturities of long-term related derivative contracts. The Company's policy is to debt. The Company plans to continue, when economically enter into agreements with counterparties that have feasible, to retire higher cost securities and replace these investment grade credit ratings by Moody's and obligations with lower-cost capital if market conditions Standard & Poor's or with counterparties who have posted permit. collateral to cover potential credit exposure. Therefore,

                                                                           -As discussed in Note 1 to the financial statements the Company does not anticipate market risk exposure from nonperformance by the counterparties. For                         under "Nuclear Fuel Disposal Costs," in 1993 the U.S. Department of Energy implemented a special additional information, see Notes 1 and 6 to the financial statements under "Financial Instruments."                             assessment over a 15-year period on utilities with nuclear plants to be used for the decontamination and Capital Requirements and Contractual Obligations                      decommissioning of its nuclear fuel enrichment facilities.

The final installment occurred in 2006. The construction program of the Company is currently estimated to be $1.2 billion for 2007, $1.3 billion for The Company has also established an external trust 2008, and $1.3 billion for 2009. Environmental fund for postretirement benefits as ordered by the expenditures included in these amounts are $505 million, Alabama PSC. The cumulative effect of funding these

$533 million, and $549 million for 2007, 2008, and 2009,              items over a long period will diminish internally funded respectively (including $202 million on selective catalytic           capital for other purposes and may require the Company reduction facilities and $1.2 billion on scrubbers, which             to seek capital from other sources. For additional reduce SO 2 emissions). In addition, over the next three              information, see Note 2 to the financial statements under years, the Company estimates spending $317 million on                 "Postretirement Benefits."

Plant Farley (including $211 million for nuclear fuel), Other, funding requirements related to obligations

$941 million on distribution facilities, and $405 million             associated with -scheduled maturities of long-term debt on transmission additions. See Note 7 to the financial                and preferred securities, as well as the related interest, statements under "Construction Program" for additional                derivative obligations, preferred and preference stock details.                                                               dividends, leases, and other purchase commitments, are as Actual construction costs may vary from this                    follows. See Notes 1, 6, and 7 to the financial statements estimate because of changes in such factors as: business             for additional information.

11"101

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report Contractual Obligations 2008- 2010- After 2007 2009 2011 2011 Total (in millions) Long-term debt(a) -- Principal $ 669 $ 660 $ 300 $3,191 $ 4,820 Interest 249 413 365 3,315 4,342 Other derivative obligations(b)- Commodity 33 3 - - 36 Interest 4 - - 4 Preferred and preference stock dividends(e) 33 65 65 - 163 Operating leases 28 48 25 26 127 Purchase commitments(d)- Capitale*) 1,191 2,618' - 3,809 Coal - 1,094 10301 1,147 2,145 5,687 Nuclear fuel 26 69 84 67 246 Natural gas0 342 454 99 123 1,018 Purchased power 88 179 37 - 304 Long-term service agreements 17 35 36 67 155 Postretirement benefits~g) 25 47 - - 72 Total $3,799 $5,892 $2,158 $8,934 $20,783 (a) All amounts are reflected based on final maturity dates. The Company plans to continue to retire higher-cost securities and replace these obligations with lower-cost capital if market conditions permit. Variable rate interest obligations are estimated based on rates as of January 1, 2007, as reflected in the statements of capitalization. Fixed rates include, where applicable, the effects of interest rate derivatives employed to manage interest rate risk. (b) For additional information, see Notes I and 6 to the financial statements. (c) Preferred and preference stock do not mature; therefore, amounts are provided for the next five years only. (d) The Company generally does not enter into non-cancelable commitments for other operations and maintenance expenditures. Total other operations and maintenance expenses for 2006, 2005, and 2004 were $1.10 billion, $1.04 billion, and $947 million, respectively. (e) The Company forecasts capital expenditures over a three-year period. Amounts represent current estimates of total expenditures excluding those amounts related to contractual purchase commitments for uranium and nuclear fuel conversion, enrichment, and fabrication services. At December 31, 2006, significant purchase commitments were outstanding in connection with the construction program. (f) Natural gas purchase commitments are based on various indices at the time of delivery. Amounts reflected have been estimated based on the New York Mercantile Exchange future prices at December 31, 2006. (g) The Company forecasts postretirement trust contributions over a three-year period. No contributions related to the Company's pension trust are currently expected'during this period. See Note 2 to the financial statements for additional information related to the pension and postretirement plans, including estimated benefit payments. Certain benefit payments will be made through the related trusts. Other benefit payments will be made from the Company's corporate assets. 11-102

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 2006 Annual Report Cautionary Statement Regarding Forward-Looking

internal restructuring or other restructuring options that Statements may be pursued; The Company's 2006 Annual Report contains forward- 0 potential business strategies, including acquisitions or looking statements. Forward-looking statements include, dispositions of assets or businesses, which cannot be among other things, statements concerning retail sales assured to be completed or beneficial to the Company; growth and retail rates, storm damage cost recovery and
the ability of counterparties of the Company to make repairs, fuel cost recovery, environmental regulations and payments as and when due; expenditures, earnings growth, access tosources of capital, projections for postretirement benefit trust
the ability to obtain new short- and long-term contributions, financing activities, completion of coritracts with neighboring utilities; construction projects, impacts of adoption of new
the direct or indirect effect on the Company's business accounting rules, and estimated construction and other resulting from terrorist incidents and the threat of expenditures. In some cases, forward-looking statements terrorist incidents; can be identified by terminology such as "may:' "will,"

"could," "should:' "expects' "plans," "antiCipates,"

interest rate fluctuations and financial market "believes" "estimates' "projects," "predicts," "potential," conditions and the results of financing efforts, or "continue" or the negative of these terms or other including the Company's credit ratings; similar terminology. There are various factors that could
the ability of the Company to obtain additional cause actual results to differ materially. frbm those generating capacity at competitive prices; suggested by the forward-looking statements; accordingly, there can be no assurance that such indicated results will
catastrophic events such as fires, earthquakes, be realized. These factors include: f explosions, floods, hurricanes, pandemic health events such as an avian influenza, or other similar.
the impact of recent and future federal and state occurrences; regulatory change, including legislative and regulatory initiatives regarding deregulation and restructuring of the direct or indirect effects on the Company's the electric utility industry, implemieIntation of the business resulting from incidents similar to the Energy Policy Act of 2005, and al6'lchanges in August 2003 power outage in the Northeast; environmental, tax, and other laws and regulations to " the-effect of accounting pronouncements issued, which the Company is subject,.as well as changes in -periodically by standard-setting bodies; and application of existing laws and regulations;
other factors discussed elsewhere herein and in other
current and future litigation, regulatory investigations, re*6rts (including the Form 10-K) filed by the proceedings, or inquiries, including FERC matters and Company from time to time with the SEC.

the pending EPA civil action against the Company;

 " the effects, extent, and timing of the .entry of                 The Company expressly disclaims any obligation to additional competition in the markets in which " the"          updateany forward-looking statements.'

Company operates;

variations in demand for electricity, including those relating to weather, the general economy and population, and business growth (and declines);

 " available sources and costs of fuels;
 " ability to control costs;

investment performance of the Company's employee benefit plans;
advances in technology;
state and federal rate regulations and the impact of pending and future rate cases and negotiations, including rate actions relating to fuel and storm restoration cost recovery; 11-103

STATEMENTS OF INCOME For the Years Ended December 31, 2006, 2005, and 2004 Alabama Power Company 2006 Annual Report 2006 2005 2004 (in thousands) Operating Revenues: Retail revenues $3,995,731 $3,621,421 $3,292,828 Sales for resale -- Non-affiliates 634,552 551,408 483,839 Affiliates 216,028 288,956 308,312 Other revenues 168,417 186,039 151,012 Total operating revenues 5,014,728 4,647,824 4,235,991 Operating Expenses: Fuel 1,672,831 1,457,301 1,186,472 Purchased power -- Non-affiliates 124,022 188,733 186,187 Affiliates 302,045 268,751 226,697 Other operations 720,296 682,308 634,030 Maintenance .376,682 361,832 313,407 Depreciation and amortization 451,018 426,506 425,906 Taxes other than income taxes 258,135 248,854 242,809 Total operating expenses 3,905,029 3,634,285 3,215,508 Operating Income 1,109,699 1,013,539 1,020,483 Other Income and (Expense): Allowance for equity funds used during construction 18,253 20,281 16,141 Interest income 20,897 17,144 15,677 Interest expense, net of amounts capitalized (236,045) (197,367) 093,590) Interest expense to affiliate trusts (16,237) (16,237) (16,191) Other income (expense), net (23,758) (20,461) (24,728) Total other income and (expenise) (236,890) (196,640) (202,691) Earnings Before Income Taxes 872,809 816,899 817,792 Income taxes', 330,345 284,715 313,024 Net Income 542,464 532,184 504,768 Dividends on Preferred and Preference Stock 24,734 24,289. 23,597 Net.Income After Dividepds on Preferred and Preference Stock $ 517,730 $ 507,895 $ 481,171 The accompanying notes are an integral part of these financial statements. 11-104

STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2006, 2005, and 2004 Alabama Power Company 2006 Annual Report 2006 2005 2004 (in thousands) Operating Activities: Net income $ 542,464 $ 532,184 . $ .504,768 Adjustments to reconcile net income to net cash provided from operating activities-Depreciation and amortization 524,313 498,914 497,010 Deferred income taxes and investment tax credits, net (27,562) 106,765 252,858 Deferred revenues - (1,274) (12,502) (11,510) Allowance for equity funds used during construction (18,253) (20,281) (16,141) Pension, postretirement, and other employee benefits (15,196) - (22,117) (31,184) Stock option expense ' 4,848 Tax benefit of stock options "IN!Y- 610 17,400 10,672 Hedge settlements 18,006 .(21,445) 2,241 Storm damage accounting order - 48,000 Other, net . 12,832 (15,491).. 26,826 Changes in certain current assets and liabilities -- Receivables (33,260) (255,481) (126,432) Fossil fuel stock .. . (28,179) (44,632) 30,130 Materials and supplies (25,711) (16,935) (26,229) Other current assets 38,645 1,199 7,438 Accounts payable (49,725) 80,951 (31,899) Accrued taxes 1,124 (5,381) (24,568) Accrued compensation. (6,157) 3,273 (7,041) Other current liabilities .. 18,486 33,675 (42,544) Net cash provided from bperating activities 956,011 908,096 1,014,395 Investing Activities: Property additions -.... ... (933,306) 1(860,807) (768,334) Nuclear decommissioning trust fund purchases (286,551) (224,716) (269,277) Nuclear decommissioning trust fund sales . .285,685 223,850 248,992 Cost of removal net of salvage (40,834) (61,314) (37,369) Other . -(1,777) (9,738) (5,008) Net cash used for investing activities '(976,783) (932,725) (830,996) Financing Activities- ' .... Increase (decrease) in notes payable, net (195,609) 315,278 Proceeds -- Senior notes 950,000 - 250,000- 900,000 Preferred and preference siock 150,000 - 100,000 Common stock issued to 'parent 120,000 40,000 40,000 Capital contributions.. :'- -' 27,160 22,473 .. 17,541 Gross excess tax benefit of stock options 1,291 Pollution control bonds - 21,450 Redemptions- ... Senior notes .,(546,500) C (225,000) (725,000) Pollution control bonds .. (2,950) (21,450) Capital leases (5).(,445) (5)- 0 Payment of preferred and preference stock dividends (24,318) (22,759) (23,639) Payment of common stock dividends (440,600) (409,900) (437,300) Other (24,635) (2,697) (16,597) Net cash provided from (used for) financing activities 13,839 (32,610) (146,440) Net Change in Cash and Cash Equivalents (6,933) (57,239) 36,959 Cash and Cash Equivalents at Beginning of Year 22,472 79,711 42,752 Cash and Cash Equivalents at End of Year $ 15,539 $ 22,472 $ 79,711 Supplemental Cash Flow Information: Cash paid during the period for -- Interest (net of $7,930, $8,161, and $6,832 capitalized, respectively) $ 245,387 $ 179,658 $ 188,556 Income taxes (net of refunds) 345,803 159,600 69,068 The accompanying notes are an integral part of these financial statements. 11-105

BALANCE SHEETS At December 31, 2006 and 2005 Alabama Power Company 2006 Annual Report Assets 2006 2005 (in thousands) Current Assets: Cash and cash equivalents $ 15,539 $ 22,472 Receivables -- Customer accounts receivable 323,202 275,702 Unbilled revenues 90,596 :95,039 Under recovered regulatory clause revenues 32,451 132,139 Other accounts and notes receivablet 49,708 50,008 Affiliated companies 70,836 77,304 Accumulated provision for uncollectible accounts (7,091) (7,560) Fossil fuel stock, at average cost 153,120 102,420 Vacation pay 46,465 44,893 Materials and supplies, at average cost 255,664 244,417 Prepaid expenses 76,265 58,845 Other 66,663 98,506 Total current assets 1,173,418 1,194,185 Property, Plant, and Equipment: In service 15,997,793 15,300,346 Less accumulated provision for depreciation 5,636,475 5,313,731 10,361,318 9,986,615 Nuclear fuel, at amortized cost 137,300 127,199 Construction work in progress 562,119 469,018 Total property, plant, and equipment 11,060,737 10,582,832 Other Property and Investments: Equity investments in unconsolidated subsidiaries 47,486 46,913 Nuclear decommissioning trusts, at fair value 513,521 466,963 Other 35,980 41,457 Total other property and investments 596,987 555,333 Deferred Charges and Other Assets: Deferred charges related to income taxes, 354,225 388,634 Prepaid pension costs 722,287 515,281 Deferred under recovered regulatory clause revenues 301,048 186,864 Other regulatory assets 279,661 122,378 Other 166,927 144,400 Total deferred charges and other assets 1,824,148 1,357,557 Total Assets $14,655,290 $13,689,907 The accompanying notes are an integral part of these financial statements. 11-106

BALANCE SHEETS At December 31, 2006 and 2005 Alabama Power Company 2006 Annual Report Liabilities and Stockholder's Equity 2006 2005 (in thousands) Current Liabilities: Securities due within one year $ 668,646 $ 546,645 Notes payable 119,670 315,278 Accounts payable -- Affiliated 12',951 190,744 Other 263,506 266,174 Customer deposits 62,978 56,709 Accrued taxes-- Income taxes .3,120. 63,844 Other 29,696 31,692 Accrued interest 53,573 46,018 Accrued vacation pay 'K. 38,767 37,646 Accrued compensation -,...87,194 92,784 Other .... 79,907 -72,991 Total current liabilities . - - ........ 1370,008

                                                                                                           ;.$                        1,720,525 1

Long-term Debt (See accompanying statements) 3,838,906 3,560,186 Long-term Debt Payable to Affiliated Trusts (See accompanying statements) .309,279 . 309,279 Deferred Credits and Other Liabilities: Accumulated deferred income taxes 2,116,575 .2,070,746 Deferred credits related to income taxes 98,941 101,678 Accumulated deferred investment tax credits 188,582 196,585 Employee benefit obligations . ,,, 375,940-- 208,663 Asset retirement obligations ..................... . ..... .. 476,460 446,268 Other cost of removal obligatiohs', .. 600,278 600,104 Other regulatory liabilities 399,822. 194,135 Other ------- -35,805 - 23,966 Total deferred credits and other liabilities - . ..... - 4,292P,403 '-3,84il45 Total Liabilities 10,010,596 J 9,432,1'35 Preferred and Preference Stock jse. accompanying staiements) 612,407 '465,046 Common Stockholder's Equity (See accompanying statements) . . . 4,032,287

                                                                                                         -....             -   '      3,792,726 Total Liabilities ind Stockholder's Equity                                                             $14,'655,290                  $13,689,907 Commitments and Contingent Matters (See notes)

The accompanying notes are an integral part of these financial statements. 11-107

STATEMENTS OF CAPITALIZATION At December 31, 2006 and 2005 Alabama Power Company 2006 Annual Report 2006 2005 2006 2005 (in thousands) (percent of total) Long-Term Debt: Long-term notes payable - 2.65% to 2.80% due 2006 $ - $ 520,000 Floating rate (2.11% at 1/1/06) due 2006 - 26,500 3.50% to 7.125% due 2007 500,000 500,000 Floating rate (5.624% at 111107) due 2007 168,500 168,500 3.125% to 5.375% due 2008 410,000 410,000 Floating rate (5.55% at 1/1/07) due 2009 250,000 250,000 4.70% due 2010 100,000 100,000 5.10% due 2011 200,000 - 5.125% to 6.375% due 2016-2046 2,325,000 1,575,000 Total long-term notes payable $3,953,500 $3,550,000 Other long-term debt -- Pollution control revenue bonds -- Variable rates (2.01% to 2.16% at 1/1/06) due 2015-2017 - 89,800 5.50% due 2024 - 2,950 Variable rates (3.91% to 4.07% at 1/1/07) due 2015-2031 557,190 467,390 Total other long-term debt 557,190 560,140 Capitalized lease obligations 377 564 Unamortized debt premium (discount), net (3,515) (3,873) Total long-term debt (annual interest requirement --

 $232.9 million)                                            4,507,552             4,106,831 Less amount due within one year                                668,646                546,645 Long-term debt excluding amount due within one year         $3.838.906            $3.560,186    43.6%            43.8%

11-108

STATEMENTS OF CAPITALIZATION (continued) At December 31, 2006 and 2005 Alabama Power Company 2006 Annual Report 2006 2005 2006 2005 (in thousands) (percent of total) Long-term Debt Payable to Affiliated Trusts: 4.75% to 5.5% due 2042 (annual interest requirement -- $16.2 million) 309,279 309,279 3.5 3.8 Preferred and Preference Stock: Cumulative preferred stock

  $100 par or stated value -- 4.20% to 4.92%,

Authorized - 3,850,000 shares Outstanding - 475,115 shares 47,610 47,610

  $1 par value -- 4.95% to 5.83%

Authorized - 27,500,000 shares Outstanding - 12,000,000 shares: $25 stated value 294,105 294,105 Outstanding - 1,250 shares: $100,000 stated, value 123,331 123,331 Preference stock Authorized -40,000,000 shares Outstanding - $1 par value -- 5.63%

                   - 6,000,000 shares (non-cumulative) $25 stated value                               147,361 Total preferred and preference stock (annual dividend
 -requirement -- $32.7 million)                                                   612,407                465,046     7.0                5.7 Common Stockholder's Equity:

Common stock, par value $40 per share - Authorized - 2006: 25,000,000 shares

                - 2005: 15,000,000 shares Outstanding - 2006: 12,250,000 shares                                          490,000,               370,000
                - 2005: 9,250,000 shares Paid-in capital                                                                 2,028,963              1,995,056 Retained earnings                                                               1,516,245              1,439,144 Accumulated other comprehensive income (loss)                                       (2,921)               (11,474)

Total common stockholder's equity 4,032,287 3,792,726 45.9 46.7 Total Cavitalization $8,792,879 $8,127,237 100.0% 100.0' Y1O The accompanying notes are an integral part of these financial statements. 11-109

STATEMENTS OF COMMON STOCKHOLDER'S EQUITY For the Years Ended December 31, 2006, 2005, and 2004 Alabama Power Company 2006 Annual Report

                                     -             .                                                                  Other Common         Paid-In      Retained         Comprehensive Stock        Capital      Earnings          Income (loss)          Total (in thousands)!

Balance at December 31, 2003 $290,000 $1,927,069 $1,291,558 $ (7,967) $3,500,660 Net income after dividends on preferred stock - - 481,171 481,171 Issuance of common stock 40,000 - 40,000 Capital contributions from parent company - 28,213 - " 28,213 Other comprehensive income (loss) - - (8,061) (8,061) Cash dividends on common stock - - (437,300) (437,300) Other - (99) 5,620 - 5,521 Balance at December 31, 2004 330,000 1,955,183 1,341,049 (16,028) 3,610,204 Net income after dividends on preferred stock - - 507,895.. 507,895 Issuance of common stock 40,000 - - 40,000 Capital contributions from parent company - 39,873 "- 39,873 Other comprehensive income (loss) - 4,554 4,554 Cash dividends on common stock - (409,900) - (409,900) Other 100 100 Balance at December 31, 2005 370,000 1,995,056 1,439,144 (11,474) 3,792,726 Net income after dividends on preferred and preference stock - - 517,730 517,730 Issuance of common stock 120,000 - 120,000 Capital contributions from parent company 33,907 33,907 Other comprehensive income (loss) - - .(4,057) (4,057) Adjustment to initially apply FASB Statement ' No. 158, net of tax .. .. . 12,610 12,610 Cash dividends on common stock " - (440,600) - (440,600) Other -.- (29) - (29) Balance at December 31, 2006 $490,000 $2,028,963 $1,516,245 $ (2,921). $4,032,287 The accompanying notes are an integral part of these financial statements. STATEMENTS OF COMPREHENSIVE INCOME For the Years Ended December 31, 2006, 2005, and 2004 Alabama Power Company 2006 Annual Report 2006 2005 2004 (in thousands) Net income after dividends on preferred and preference stock $517,730 $507,895 $481,171 Oth-er comprehensive income (loss): -

Change in additional minimum pension liabilit'y, net of tax of $1,109,

    $(1,422) and $(2,482), respectively                                                                 1,768              (2,338)        (4,083)

Change in fair value of marketable securities, net of tax of $-, $- and $252, respectively - - 414 Changes in fair value of qualifying hedges, net of tax of $155, $5,523 and

    $(4,807), respectively                                                                                255               9,085         (7,906)

Less: Reclassification adjustment for amounts included in net income, net of tax of $(3,696), $(1,333) and $2,136, respectively (6,080) (2,193) 3,514 Total other comprehensive income (loss) (4,057) 4,554 (8,061) Comprehensive Income $513,673 $512,449 $473,110 The accompanying notes are an integral part of these financial statements. 11-110

NOTES TO FINANCIAL STATEMENTS Alabama Power Company 2006 Annual Report

1.

SUMMARY

OF SIGNIFICANT ACCOUNTING preparation of financial statements in conformity with POLICIES accounting principles generally accepted in the United States 'rýquiies the use of estimates, and the actual results General may differ from those estimates. Alabama Power Company (the Company) is a wholly owned subsidiary of Southern Cotnpany, which is the' Affiliate Transactions parent company of four traditional operating companies, The Company has an agreement with SCS under which Southern Power Company (Southern Power), Southern the following services are rendered to the Company at Company Services (SCS), Southern Communications direct or allocated cost: general and design engineering, Services (SouthernLINC Wireless), Southern Company purchasing, accounting and statistical analysis,- finance Holdings (Southern Holdings), Southern Nuclear and treasury, tax, information resources, marketing, Operating Company (Southern Nuclear), Southern auditing, insurance and pension administration, human Telecom, and other direct and indirect Subsidiaries. The resources, systems 'and procedures, and other services traditional operating companies - the Company, Georgia with respect to business and operations and power pool Power Company, Gulf Power Company, and Mississippi transactions. Costs for these services amounted to Power Company - are vertically integrated utilities $266 million, $246 million, and $224 million during providing electric service in four Southeastern states. The 2006, 2005, and 2004, respectively. Cost allocation Company provides electricity to retail customers within methodologies used by SCS were approved by the its traditional service area located within the State of Securities' and Exchange Commission prior to the repeal Alabama and to wholesale customers in the Southeast. of the Public Utility Holding Company Act of 1935, as Southern Power constructs, acquires, and manages amended, and management believes they are reasonable. generation assets, and sells electricity, at market-based The FERC permits services to be rendered at cost by rates in the- wholesale market. SCS, the system service system service companies. company, provides, at cost, specialized services to Southern Company and its subsidiary companies. The Company has an agreement with Southern SouthemL.INC Wireless provides digital wireless Nuclear under which Southern Nuclear operates the communications services to the traditional operating Company's Plant Farley and provides the following companies and also markets these services to the public nuclear-related services at cost: general executive and within the Southeast. Southern Telecom provides fiber advisory services, general operations, management and cable services within the Southeast. Southern Holdings is technical services, administrative services including an intermediate holding company subsidiary for Southern procurement, accounting, statistical analysis, employee.. Company's investments in syntheticjfels and leveraged relations, and other services with respect to business and. leases and various other energy-related businesses. operations. Costs for these services amounted to Southern Nuclear operates and provides services to $162 million,' $157 million, and $169 million during Southern Company's nuclear power plants, including the 2006, 2005, and 2004, respectively. Company's Plant Farley. On January 4, 2006, Southern TheCompany jointly owns Plant Greene County Company completed the sale of substantially all the assets with Mississippi Power.. The Company has an agreement of Southern Company Gas, its competitive retail natural gas marketing subsidiary. with Mississippi Power under which the Company operates Plant Greene County, and Mississippi Power The equity method is used for subsidiaries in which reimburses the Company for its proportionate share of the Company'has significant influence but does not expenses which were $8.6 million 'in 2006, $8.2 million ' control and for variable interest entities where the in 2005, and $7.2 million in 2004. 'See Note 4 for Company is not the primary beneficiary. Certain prior additional information. years' data presented in the financiAlvstatements have -. Southern Company held a 30 percent ownership been reclassified to conform with current year interest. in:Alabama Fuel Products, LLC (AFP), which ' presentation. produces synthetic fuel, until July 2006, when the The Company is subject to regulition by the Federal ownership interestwas terminated. The Company Energy Regulatory Commission (FERC) and the Alabama purchases'synthetic fuel from AFP for use at several of Public Service Commission (PSC). The Company follows the Company's plants. Total fuel purchases through June accounting principles generally accepted in the United 2006 and for the years ended 2005 and 2004 were States and complies with the accounting policies and, $202.2 million, $265.7 million, and $236.9 million, practices prescribed by its regulatory commissions. The respectively Subsequent to the termination of the 1-111

NOTES (continued) Alabama Power Company 2006 Annual Report membership interest in AFP, the Company continued to Power and Gulf Power in 2004 and to Mississippi Power purchase fuel from AFP in the amount of $244.4- million in 2005 was $2.4 million, $2.3 million, and $8.0 million, in 2006. In addition, the Company has an agreement with respectively. In 2004 and 2005, the Company received an indirect subsidiary of Southern Company that provides assistance from affiliated companies inthe amount of services for AFP. Under this agreement, the Company $5.6 million and $5.0 million, respectively, for aid in provides certain accounting functions, including major stormn restoration. These activities were billed at processing and paying fuel transportation invoices, and cost. the Company is reimbursed for its expenses. Amounts billed under this agreement totaled approximately The traditional operating companies, including the $56.5 million, $31.5 million, and $28.7 million in 2006, Company, and Southern Power jointly enter into various 2005, and 2004, respectively. types of wholesale energy, natural gas, and certain other contracts, either directly or through SCS as agent. Each In June 2003, the Company entered into an participating company may be jointly and severally liable agreement with Southern Power under which the for the obligations incurred under these agreements. See Company operates and maintains Plant Harris at cost. In Note 7 under "Fuel Commitments" for additional 2006, 2005, and 2004, the Company billed Southern information. Power $2.2 million, $1.9 million, and $1.8 million, respectively, for operation and maintenance. Under a Revenues power purchase agreement (PPA) with Southern Power, the Company's purchased power costs from Plant Harris Energy and other revenues are recognized as services are in 2006, 2005, and 2004 totaled $61.7 million, provided. Capacity revenues are generaliy'recognized on a $63.6 million, and $59.0 million, respectively. The levelized basis over the appropriate contract periods. Company also provides the fuel, at cost, associated with Unbilled revenues are accrued at the end of each fiscal the PPA and the fuel cost recognized by the Company period. Electric rates for the Company include provisions was $77.8 million in 2006, $81.3 million in 2005, and to adjust billings for fluctuations in fuel costs, fuel' $65.7 million in 2004. Additionally, the Company hedging, the energy component of purchased power costs, recorded $8.3 million of prepaid capacity expenses and certain other costs. Revenues are adjusted for included in other deferred charges and other assets in the differences between these actual costs and amounts billed balance sheets at December 31, 2006 and 2005. See in current regulated rates. Under or over recovered Note 3 under "Retail Regulatory Matters" and Note 7 regulatory clause revenues are recorded in the balance under "Purchased Power Commitments" for additional sheets and are recovered or returned to customers through information. adjustments to the billing factors. The Company continuously monitors the' under/over recovered balances The Company has an agreement with SouthernLINC and files for revised rates as required or when Wireless to provide digital wireless communications management deems appropriate depending on the rate. services to the Company. Costs for these services See "Retail Regulatory Matters - Fuel Cost Recovery" in amounted to $4.9 million, $5.7 million, and $5.3 million Note 3 for additional information. during 2006, 2005, and 2004, respectively. The Company has a diversified base of customers. Also, see Note 4 for information regarding the Company's ownership in and PPA with Southern Electric No single customer comprises 10 percent or more of Generating Company (SEGCO) and Note 5 for revenues. For all periods presented, uncollectible accounts averaged less than one percent of revenues. information on certain deferred tax liabilities due to affiliates. Regulatory Assets and Liabilities The Company provides incidental services to, and receives such services from, other Southern Company The Company is subject to the provisions of Financial subsidiaries which are generally minor in duration and/or Accounting Standards Board (FASB) Statement No. 71, amount. However, with the hurricane damage experienced "Accounting for the Effects of Certain Types of ' by Georgia Power, Gulf Power and Mississippi Power in Regulation" (SFAS No. 71). Regulatory assets represent 2004 and 2005, assistance provided to aid in stormn probable future revenues associated with certain costs that restoration, including Company labor, contract labor, and are expected to be recovered from customers through the materials, has caused an increasein these activities. The' ratemaking process. Regulatory liabilities represent-total amount of storm restoration provided to Georgia probable future reductions in revenues associated with 112

NOTES (continued) Alabama Power Company 2006 Annual Report amounts that are expected to be credited to customers (g) Recovered and amortized over the average remaining through the ratemaking process. .service period which may range up to 15 years. See. Note 2 under "Retirement Benefits." Regulatory assets and (liabilities) reflected in the In the event that a portion of the Company's balance sheets at December 31 relate to: operations is no longer subject to the provisions of; SFAS No. 71, the Company would be required to write 2006 2005 Note off relaied regulatory assets and hiabiities that are not (in millions) specificaliy recoverable through regulated rates. In Deferred income tax charges $354 $3 389 '(a') addition, the Company would be required to determine if Loss on reacquired debt 94 -I.02 (b) any -impaiirment to other assets, including plant, exists and DOE assessments 5 (c) write d Iwn the assets, if impaired, to'their fair values. All Vacation pay 45 (d) regulatory assets and liabilities are f6tbe' reflected in rates. Under recovered regulatory clause revenues 334 3 19 (e) Nuclear Fuel :Disposal Costs , .... Fuel-hedging assets 36 9 (0 6 6 (e) The Company has a contract with the U.S. Department of Other assets ' (152) (139) (a) Energy (DOE) that provides for the permanent disposal of Asset retirement obligations Other cost of removal'obligations (600) (6500) (a) spent nuclear fuel. The DOE failed to begin disposing of

02) (a) spent nuclear fu el in 1998 as required by the contract, and Deferred income tax credits (99) the Company is pursuing legal remedies against the Natural disaster reserve 17 51 '(e) government for breach of contract. An on-site dry spent (prior storms)

Fuel-hedging liabilities (3) 38) (f) fuel -gtorage facility at Plant Farley is operational and can (16) '16) (e) be expanded to accommodate spent fuel ihrough the Mine reclamation and remediation

                                                 "*"(12):                       expected life of.the plant.

Nuclear outage (8) (e) Deferred purchased power (19)Y '19) (e) Also, the Energy Policy Act of 1992 established a Natural disaster reserve Uranium Enrichment Decontamination and

-(e)

(future storms) (13) Decommissioning Fund, which has been funded in part by Other liabilities (3) (3) :(e) a special assessment on utilities with nuclear plants. This Overfunded retiree benefit plans " (183) (g) assessmentW, paid over a 15-year period; the final Underfunded retiree benefit plans 183 (g) instalment occurred in 2006. This fund will be used by Total $ (30)$ t the DOE'for the decontamination and decommissioning of its nuclear fuel enrichment facilities. The law provides Note: The recovery and amortization periods for these regulatory assets and (liabilities) are as follows: that utilities will recover these payments in the same manner as any other fuel expense. (a) Asset retirement and removal liabilities are recorded, deferred income tax assets arejrecovered, and deferred tax Fuel Costs . liabilities are amortized over the related property lives, which may range up to 50 years. Asset retirement and Fuel costs are expensed as the fuel is used. Fuel expense removal liabilities will be settled and trued up following includes the cost of purchased emission allowances as completion of the related activities. I: -: - they are used. Fuel expense also includes the amortization (b) Recovered over the remaining life of the original issue of the cost of nuclear fuel and a charge, based on nuclear which may range up to 50 years. 1 . , generation, for the permanent disposal of spent nuclear (c) Assessments for the decontamination and. , decommissioning of the DOE nuclear.fuel enrichment fuel. Totai charges for nuclear fuel included in fuel facilities are recorded annually from 1993 through 006. expense totaled $66 million in '2006, $64 million in 20O5, (d) Recorded as, earned by employees and recovered as paid,, and $61 :million in 2004. generally within one year. , (e) Rec6rded and recovered or amortized as ap~proved or Inc'loim nd Other Taxes accepted by the Alabama PSC. (f) Fuel-hedging assets and liabilities are recorded over the The Company uses the liability method of accounting for life of the underlying hedged puichase contracts, which deferred income taxes and provides deferred income taxes for all significant income-tax temporary differences. , I generally do not exceed two years. Upon final settlement, actual costs incurred are recovered through the fuel cost Investment tax'credits utilized are deferred and amortized recovery clauses. , ., Z: to income over the average life of the related property. 11-113

NOTES (continued) Alabama Power Company 2006 Annual Report Taxes that are collected from customers on behalf of depreciation is removed from the balance sheet accounts governmental agencies to be remitted to these agencies and a gain or loss is recognized. Minor items of property are presented net on the statements of income: included in the original cost of the plant are retired when the related property unit is retired. Property, Plant, and Equipment Asset Retirement Obligations and Other Costs of Property, plant,. and equipment is stated at original cost Removal less regulatory disallowances and impairments. Original cost includes: materials; labor; minor items of property; Effective January 1, 2003, the Company adopted FASB appropriate administrative and general costs; payroll- Statement No. 143, "Accounting for Asset Retirement related costs such as taxes, pensions, and other benefits; Obligations" (SFAS No. 143), which established new and the interest capitalized and/or cost of funds used accounting and reporting standards for legal obligations during construction. associated with the ultimate costs of retiring long-lived assets. The present value of the ultimate costs of an The Company's property, plant, and equipment asset's future retirement is recorded in the period in consisted of the following at December 31 (in millions): which the liability is incurred. The costs are capitalized as 2006 2005 part of the related long-lived asset and depreciated over the asset's useful life. In addition, effective December 31, Generation $ 8,312 $ 7,971 2005, the. Company adopted the provisions of FASB Transmission 2,308 2,205 Interpretation No. 47, "Conditional Asset Retirement Distribution 4,352 4,115 Obligations" (FIN 47), which requires that an asset General 1,017 1,000 retirement obligation be recorded even though the timing Plant acquisition adjustment 9 9 and/or method of settlement are conditional on future Total plant in service $15,998 $15,300 events. Prior to December 2005, the Company did not recognize asset retirement obligations for asbestos The cost of replacements of property - exclusive of removal and disposal of polychlorinated biphenyls in minor items of property - is capitalized. The cost of certain transformers because the timing of their maintenance, repairs, and replacement of minor items of retirements was dependent on future events. The property is charged to maintenance expense as incurred or Company has received accounting guidance from the performed with the exception of nuclear refueling costs, Alabama PSC allowing the continued accrual of other which are recorded in accordance with specific Alabama future retirement costs for long-lived assets that the PSC orders. The Company accrues estimated nuclear Company does not have a legal obligation to retire. refueling costs in advance of the unit's next refueling Accordingly, the accumulated removal costs for-these outage. The refueling cycle is 18 months for each unit. obligations will continue to be reflected in the balance During 2006, the Company accrued $31.5 million and sheets as a regulatory liability. Therefore, the Company paid $26.7 million for an outage at Unit 1. At had no cumulative effect to net income resulting from the December 31, 2006, the reserve balance totaled adoption of SFAS No. 143 or FIN 47. $12.3 million and is included in the balance sheet in other regulatory liabilities. The liability recognized to retire long-lived assets primarily relates to the Company's nuclear facility, Plant Depreciation and Amortization Farley. The fair value of assets legally restricted for, settling retirement obligations related to nuclear facilities Depreciation of the original cost of utility plant in service as of December 31, 2006 was $513 million. In addition, is provided primarily by using composite straight-line the Company has retirement obligations related to various rates, which approximated 3.1 percent in 2006, 2.9 percent landfill sites and underground storage tanks. In connection in 2005, and 3.0 percent in 2004. Depreciation studies are with the adoption of FIN 47, the Company also recorded conducted periodically to update the composite rates and additional asset retirement obligations (and assets) of the information is provided to the Alabama PSC. When $35 million, related to asbestos removal and disposal of property subject to depreciation is retired or otherwise polychlorinated biphenyls in certain transformers. The disposed of in the normal course.of business, its original Company also has identified retirement obligations related cost, together with the cost of removal, less salvage, is to certain transmission and distribution facilities and charged to accumulated depreciation. For other property certain wireless communication towers. However, dispositions, the applicable cost and accumulated, liabilities for the removal of these assets have not been 11-114

NOTES (continued) Alabama Power Company 2006 Annual Report recorded because the range of time over which the: Company 'considers 11 unrealized losses to represent Company may settle these obligations is unknown and other-than-temiporary impairments. The adoption of FSP cannot be reasonably estimated. The Company will No. 11'*i4had no impact on the results of operations, continue to recognize in the statements of income allowed cash flows, or financial condition' of the Company as all removal costs in accordance with its regulatory treatment. losses hay6 been and continue to be recorded through a Any differences between costs recognized Under .' regulatory liability, whether realized, unrealized, or SFAS No. 143 and FIN 47 and those reflected in rates are identified as other-than-temporary. Details of the recognized as either a regulatory asset or liability, as securities held In these trusts at December 31 are as ordered by the Alabama PSC, and are reflected in the follows: balance sheets. See "Nuclear Decommissioning" for Other-than-further information on amounts included in rates. Unrealized Temporary Fair Details of the asset retirement obligations included in 2006 Gains Impairments Value (in millions) the balance sheets are as follows: Equity'- $121.0 $(5.3) $384.8 2006, 2005 (1.4) 120.1 Debt 0.7 (in millions) Other . . 8.6 Balance beginning of year $446 $384 Total $121.7 $(6.7) $513.5 Liabilities incurred :3' 36 Liabilities settled (3)' - Accretion 30 26 Unrealized Unrealized Fair Cash flow revisions . - - 2005 Gains Losses Value Balance end of year $476 $446 (in millions) Equity $78.9 $(7.7) $275.3 Debt 1.3 (1.6) .106.1 Nuclear Decommissioning 17.0 85.6 Other - The Nuclear Regulatory Commission (NRC) requires Total $97.2 $(9.3) $467.0 licensees of commercial nuclear power reactors to establish a plan for providing reasonable assurance of The contractual maturities of debt securities at funds for future decommissioning. The Company has December 314 2006 are as follows: $1.2 million in 2007; external trust funds to comply with the' NRC's $29.5 million in 2008-2011; $43.2 million in 2012-2016;'- regulations. Use of the funds is restricted to nuclear and $45.1 million thereafter. decommissioning activities and the funds are managed and invested in accordance with applicable requirements Sales of the Securities held in the trust funds resulted of various regulatory bodies, including'the NRC, the in pr ocee of $285.7 million, $223.8 million, and FERC, and the Alabama PSC, as Well as the Internal' $249.0 million in 2006, 2005, and 2004, respectively, all Revenue Service (IRS). The trust funds are invested in a of which were re-invested. Realized gains and tax-efficient manner in a diversified mix of equity and other-than-temporaiy impairment losses were $22.0 million fixed income securities and are classified as and $182 million' respectively, in 2006. Net realized: available-for-sale. gains were $9.9 million 'and $7.5 million in 2005 and 2004, respectively. Realized gains and The trust funds are included in the balance sheets at other-than-temporary impairment losses aredetermined on fair value, as' obtained from quoted market prices for the a speciflc'iddntification basis. In accordance with same or similar investments. As the external trust funds regulatory guidance, all realized and unrealized gains and are actively managed by unrelated parties with limited losses a're' inluded'in theI regulatory liability for Asset direction from the Company, the .Company does not have Reterement Obigations inihe balance sheets and are not the ability to choose to hold securities with unrealized included in net income 6r,other comprehensive income. losses until recovery. Through. 2005, the Company Unrealized' gains and other-than-temporary impairment considered other-than-temporary impairments to be losses are considered non-cash transactions for purposes immaterial. However, since the January 1, 2006 effective of the-statements of cash flow., date of FASB Staff Position FAS 115-1/124-1, "The Meaning of Other-Than-Temporary Impairment and Its -Amounts previously recorded in internal reserves are Application to Certain Investments" (FSP No. 115-1), the being ,iransferred into the external trust funds over periods 11-115

NOTES (continued) Alabama Power Company 2006 Annual Report approved by the Alabama PSC. The NRC's minimum costs and to also suspend the associated obligation to external funding requirements are based on a generic make semi-annual contributions to the external trust. The estimate of the cost to decommission only the radioactive Company will continue to provide site specific estimates portions of a nuclear unit based on the size and type of of the decommissioning costs and related projections of reactor. The Company has filed plans with the NRC funds in the external trust to the Alabama PSC and, if designed to ensure that, over time, the deposits and necessary, would seek the Alabama PSC's approval to earnings of the external trust funds will provide the address any changes in a manner consistent with the NRC minimum funding amounts prescribed by the NRC. At and other applicable requirements. The approved December 31, 2006, the accumulated provisions for suspension does not affect the transfer of internal reserves decommissioning were as follows: (less than $1 million annually) previously collected from customers prior to the establishment of the external trust. External trust funds, at fair value $513 Internal reserves Allowance for Funds Used During Construction 28 (AFUDC) Total $541 In accordance with regulatory treatment, the Company Site study cost is the estimate to decommission the records AFUDC, which represents the estimated debt and facility as of the site study year. The estimated costs of equity costs of capital funds that are necessary to finance decommissioning, based on the most current study the construction of new regulated facilities. While cash is performed in 2003 for Plant Farley were as follows: not realized currently from such allowance, it increases the revenue requirement over the service life of the plant Decommissioning periods: through a higher rate base and higher depreciation Beginning year 2017 expense. All current construction costs are included in Completion year 2046 retail rates. The composite rate used to determine the (in millions) amount of AFUDC was 8.8 percent in 2006, 8.8 percent Site study costs: in 2005, and 8.6 percent in 2004. AFUDC, net of income Radiated structures $892 tax, as a percent of net income after dividends on Non-radiated structures 63 preferred stock was 4.5 percent in 2006, 5.0 percent in Total $955 2005, and 4.2 percent in 2004. The decommissioning cost estimates are based on Impairment of Long-Lived Assets and Intangibles prompt dismantlement and removal of the plant from The Company evaluates long-lived assets for impairment service. The actual decommissioning costs may vary from when events or changes in circumstances indicate that the the above estimates because of changes in the assumed date of decommissioning, changes in NRC requirements, carrying value of such assets may not be recoverable. The determination of whether an impairment has occurred is or changes in the assumptions used in making these based on either a specific regulatory disallowance or an estimates. estimate of undiscounted future cash flows attributable to All of the Company's decommissioning- costs for - the assets, as compared with the carrying value of the ratemaking are based on the site study. Significant assets. If an impairment has occurred, the amount of the assumptions used to determine these costs for ratemaking impairment recognized is determined by either the were an inflation rate of 4.5 percent and a trust earnings amount of regulatory disallowance or by estimating the rate of 7.G percent. Another significant assumption used fair value of the assets and recording a loss if the carrying was the change in the operating license for Plant Farley. value is greater than the fair value. For assets identified as held for sale, the carrying value is compared to the In May 2005, the NRC granted the Company a estimated fair value less the cost to sell in order to 20-year extension of the operating license for both units determine if an impairment loss is required. Until the at Plant Farley. As a result of, the license extension,' assets are disposed of, their estimated fair value is amounts previously contributed to the external trust are currently projected to be adequate to meet the re-evaluated when circumstances or events change. decommissioning obligations. Therefore, in June. 2005, Natural Disaster Reserve the Alabama PSC approved the Company's request to suspend, effective January l; 2005, the inclusion in its In accordance with an Alabama PSC order, the Company annual cost of service of $18 million in, decommissioning has established a natural disaster reserve (NDR) to cover 11-116

NOTES (continued) Alabama Power Company 2006 Annual Report the cost of uninsured damages from major storms to Cash and Cash Equivalents transmission and distribution facilities. The Company For purposes of the financial statements, temporary cash collects a monthly NDR charge per account that consists investments are considered cash equivalents. Temporary of two components which began on January 1, 2006. The cash investiments are s~curities with original maturities of first component is intended to establish and maintain a 90 days or: less'.' reserve for future storms and is an on-going part of customer billing.This plan has a target reserve balance of Materials and Supplies $75 million that could be achieved in five years assuming the Company experiences no additional- storms. The Generally', materials and supplies ihclude the average cost of transm'ission, distribution, and generating plant second component of the NDR charge is intended to allow recovery of the deferred Hurricanes Dennis- and materials. Materials are charged to inventory when Katrina-related operations and maintenance costs and to purchased and then expensed or capitalized toplant, as set in place a mechanism to replenish the NDR should appropriate, when installed. any future storms deplete the natural disasterreserve. The Alabama PSC order gives the Company. authority to have Fuel Inventory a negative NDR balance when costs of uninsured storm Fuel inventory includes the average costs of oil, coal, and damage exceed any established NDR balance. This natural gas. Fuel is charged to inventory when purchased second component allows for the recovery of a negative and then expensed as used andrecovered by the Company balance over a 24-month period. Absent further Alabama through fuel cost recovery rates approved by the Alabama PSC approval, the maximum total NDR charge consisting PSC. Emission allowances granted by the Environmental of both components is $10 per month per account for Protection Agency (EPA) are included in inventory at zero non-residential customers and $5 per month per account cost. for residential customers. Stock Options At December 31, 2006, the Company had accumulated a balance of $13.2 million in the target Soiqthern Corhiany provides non-qualified stock options reserve for future storms, which is included in the balance to a large seginent of the Company's employees ranging sheets under "Other Regulatory Liabilities." Also the from line management to executives. Prior to January 1, Company has recovered $33.8 million of deferred. 2006', th' Company 'accounted for0options granted in Hurricanes Dennis- and Katrina-related operations and accordance with Accounting Principles Board Opinion maintenance costs and the deficit balance in the NDR No. 25; thus, no comp ensation expense was recognized account as of December 31, 2006 totaled approximately because the exercise price of all options granted equaled

 $16.8 million, which is included in the balance sheets           the fair market value on the date of the grant.

under "Current Assets." Absent any new storm-related Effective January 1, 2006, the Company adopted the damages, the Company 'expects to fully recover the fair value recognition provisions of FASB Statement deferred storm costs by the middle of 2007. As a result, No. 123(R), "Share-Based Payment" (SFAS No. 123(R)), customer rates would be decreased 8y this portion of the using the'modified prospective method. Under that NDR charge. - method', comnpensation cost for the year ended As revenue from the NDR charge is recognized, an December 31, 2006 is recognized as the requisite service is rendered and includes: (a) compensation cost for the equal amount of operation and maintenance expense portion of share-based awards granted prior to and that related to the NDR will also be recognized. As a result,, were outstanding as at January 1, 2006, for which the this increase in revenue and explrqse will not have an requisije 'service has not been rendered, based on the impact on net income, but will increase annual cash flow. grant-date fair value of those awards as cilculated in accordance with the original provisions of FASB Environmental Cost Recovery Statement No. 123, "Accounting for Stock-based Compensation" (SFAS No. 123), and (b) compensation The Company has received authority from the Alabama cost for all share-based awards granted subsequent to PSC to recover approved environmental compliance costs January 1, 2006, based on the grant-date fair value through specific retail rate clauses -and are adjusted - - estimated in accordance with the provisions of annually. See Note 3. under "Retail Regulatory Matters - SFAS No. 123(R). Results for prior periods have not been Rate CNP" for additional information. restated. 11-117

NOTES (continued) Alabama Power Company 2006 Annual Report The compensation cost and tax benefits related to the' model and the weighted average grant-date fair value of grant and exercise of Southern Company stock options to stock options granted: the Company's employees are recognized in the Period ended December 31 2006 2005 2004 Company's financial statements with a corresponding credit to equity, representing a capital contribution from Expected volatility 16.9% 17.9% 19.6% Southern Company. Expected term (in years) 5.0 5.0 5.0 Interest rate 4.6% 3.9% 3.1% For the Company, the adoption'of SFAS No, 123(R)' has resulted in a reduction in earnings before income Dividend yield 4.4% 4.4% 4.8% Weighted average grant-date taxes and net income of $4.8 million and $3.0 million, fair value - ý $4.15 $3.90 $3.29 respectively, for the year ended December 31, '2006. Additionally, SFAS No. 123(R) requires the gross excess tax benefit from stock option exercises be reclassified as a Financial Instruments financing cash flow as opposed to an operating cash flow; The Company uses derivative financial instruments to the reduction in operating cash flows and increase in limit exposure to fluctuations in interest rates, the pricesi financing cash flows for the year ended December 31, of certain fuel purchases, and: electricity Ourcha'ses and 2006 was $1.3 million. - sales. All derivative financial instruments are recognized For the years prior to the adoption of as either assets or liabilities and are measured at fair SFAS No. 123(R), the pro forma impact on net income of value. Substantially all of the Company's bulk energy. fair-value accounting for options granted is as follows: purchases and sales contracts that meet the definition of a derivative are exempt from fair value accounting Options requirements and are accounted for under the accrual As Impact Pro method. Other derivative contracts qualify as cash flow Net Income Reported After Tax Forma hedges of anticipated transactions or are recoverable (in thousands) through the Alabama PSC approved fuel-hedging 2005 $507,895 $(2,829) $505,066 program. This results in the deferral of related gains and 2004 481,171 (2,575) 478,596 losses in other comprehensive income or regulatory assets and liabilities, respectively, until the hedged transactions Because historical forfeitures have been insignificant occur. Any ineffectiveness arising from cash flow hedges and are expected to remain insignificant, no forfeitures is recognized currently in net income. Other derivative are assumed in the calculation of compensation expense; contracts are marked to market through current period rather they are recognized when they occur. income and are recorded on a net basis in the statements The estimated fair values of stock options granted in of income. 2006, 2005, and 2004 were derived using the Black-Scholes stock option pricing modeC Expected volatility is The Company is exposed to losses related to based on historical volatility of Southern Company's financial instruments in the event of counterparties' stock over a period equal to the expected term. The nonperformance. The Company has established, controls to Company uses historical exercise data to estimate the determine and monitor the creditworthiness of expected term that represents the period of time that counterparties in order to mitigate the Company's options granted to employees are expected to be exposure to counterparty credit risk. outstanding. The risk-free rate is based on the The Company's other financial instruments for which U.S. Treasury yield curve in effect'at the time of grant the carrying amount did not equal fair value at that covers the expected term of the stock options. The December 31 were as follows: following table shows the assumptions used in the pricing Carrying Fair Amount Value (in millions) Long-term debt: 2006 $4,816 $4,768 2005 4,416 4,403 The fair values were based on either closing market prices or closing prices of comparable instruments. 11-118

NOTES (continued) Alabama Power Company 2006 Annual Report Comprehensive Income On December 31, 2006, the Company adopted FASB Statement No. 158, "Employers' Accounting for Defined The objective' of comprehensive income is to report a Benefit Pension and Other Postretirement Plans" measure of all changes in common stock equity of an (SFAS No. 158), which requires recogmtion of the funded enterprise that result from transactions and other status of its defined benefit postretirement plans in its economic events of the period other than transactions with balance sheet. Prior to the adoption of SFAS No. 158, the owners. Comprehensive income consists of net income, Company generally recognized only the difference,: changes in the fair value of qualifying cash flow hedges between the benefit expense recognized and employer and marketable securities, and changes in additional contributions to the plan as either a prepaid asset or as a minimum pension liability, less income taxes and liability. With respect to its underfunded non-qualified reclassifications for amounts included in net income. pension plan, the'Company recognized an additional minimum liability representing the difference between Variable Interest Entities each plan's acdumulated benefit obligation and its assets. The primary beneficiary of a variable interest entity must With the adoption of SFAS No. 158, the Company. consolidate the related assets and liabilities. The was required to recognize on its balance sheet previously Company has established certain wholly-bwned trusts to unrecognized assets and liabilities related to unrecognized issue preferred securities. See Note 6 under "Mandatorily prior service cost, unrecognized gains or losses (from Redeemable Preferred Securities/Long-Term Debt Payable changes in actuarial assumptions and the difference to Affiliated Trusts" for additional iniformation. However, between actual and expected returns on plan assets), and the Company is not considered the primary beneficiary of any unrecognized transition amounts (resulting from the the trusts.' Therefore, the investments in these trusts are change from cash-basis accounting to accrual accounting). reflected as Other Investments, and the related loans from These amounts will continue to be amortized as a the trusts are reflected as Long-term Debt Payable to.: component-of expense over the employees' remaining Affiliated Trusts in the balance sheets. average service life as SFAS No. 158 did not change the recognition p9f pension and other postretirement benefit Investments expense in the statements of income. With the adoption of SFAS, No.,1 58, the Company recorded an additional.j. The Company maintains an investment in a debt security prepaid pension asset of $183 million with respect to its that matures in 2018 and is classified as available-for-sale. overfunded defined benefit plan and additional liabilities This security is included in the balance sheets under of $10 millioni and $147 millioni, respectively,;elated to Other Property and Investments-Other and totaled its underfunded"non-qualified peniion plitns and retiree

$2.6 million and $4.4 million at December 31, 2006 arid benefit plans: The incremental effecfof applying 2005, respectively. Because the interest rate resets'weekly,:

the carrying value approximates the fai" market value.

2. RETIREMENT BENEFITS The Company has a defined benefit, trusteed, jensi6n' plan covering substantially all employees. The plan i's funded in accordance with reguirements of the Employee Retirement Income Security Act of 0974, as amended (ERISA)ý.No contributions 'to' e plain are expected for the year ending December 31, t2001.' The Comp~any also provides certain defined benefit penIon pans for a, selected group of management and ,iighly'-cpompensated, employees. Benefits under these non-qtialifred plans are funded on a cash basis. In addition, the Company provides certain medical care and life insurance benefits for retired employees through other postretirement benefit plans. The Company funds trusts to the extent required by the Alabama PSC. For the year ending December 31, 2007, postretirement trust contributions are expected to total approximately $24.7 million.

11-119

NOTES (continued) Alabama Power Company 2006 Annual Report SFAS No. 158 on individual line items in the balance Changes during the year in the projected benefit sheet at December 31, 2006 follows: obligations and fair value of plan assets were as follows: Before Adjustments After 2006 2005 (in millions) (in millions) Prepaid pension costs $ 539 $183 $ 722 Change in benefit obligation Other regulatory Benefit obligation at beginning of year $1,421 $1,325 assets 97 183 280 Service cost 37 33 Other property and Interest cost 76 74 investments 603 ,(6) 597 Benefits paid (69) (65) Total assets 14,295 360 14,655 Plan amendments 2 8 Accumulated deferred Actuarial (gain) loss (73) 46 income taxes (2,110) (7) (2,117) Balance at end of year 1,394 1,421 Other regulatory liabilities (217) (183) (400) Change in plan assets Employee benefit Fair value of plan assets at beginning obligations (219) (157) (376) of year 1,875 1,676 Total liabilities (9,664) (347) (10,011) Actual return on plan assets 232 262 Accumulated other Employer contributions 4 4 comprehensive Benefits paid (69) (65) income 16 (13) 3 Employee transfers (4) (2) Total shareholders' Fair value of plan assets at end of year 2,038 1,875 equity (4,631) (13)' (4,644) Funded status at end of year 644 454 Because the recovery of postretirement benefit Unrecognized prior service cost - 79 expense through rates is considered probable, the Unrecognized net (gain) - (54) Company recorded offsetting regulatory assets or Fourth quarter contributions 1 2 regulatory liabilities under the provisions of SFAS No. 71 Prepaid pension asset, net $ 645 $ 481 with respect to the prepaid assets and the liabilities. At December 31, 2006, the projected benefit The measurement date for plan assets and obligations obligations for the qualified and non-qualified pension is September 30 for each year presented. Pursuant to, plans were $1.3 billion and $79 million, respectively. All SFAS No. 158, the Company will be required to change plan assets are related to the qualified pension plan. the measurement date for its defined benefit postretirement plans from September 30 to December 31 Pension plan assets are managed and invested in beginning with the year ending December 31, 2008. accordance with all applicable requirements, including ERISA and the Internal Revenue Code of 1986, as Pension Plans amended (Internal Revenue Code). The Company's investment policy' covers a diversified mix of assets, The accumulated benefit obligation for the pension plans including equity and fixed income securities, real estate, was $1.3 billion in 2006 and $1.3 billion in 2005. and private equity. Derivative instruments are used primarily as hedging tools but may also be used to gain efficient exposure tothe various asset classes. The Company primarily minimizes the risk of large losses through diversification but also monitors and manages other aspects of risk. The actual composition of the 11-120

NOTES (continued) Alabama Power Company 2006 Annual Report Company's pension plan assets as of the end of the year, Components of net periodic pension cost (income) along with the targeted mix of assets, is presented below: were as follows: Target 2006 2005 2006 2005 2004 1(in millions) Domestic equity 36% 38% 40% Service cost $ 37 $ 33 $ 30 International equity 24 23 24 17 Interest cost 77 74 71 Fixed income 15 16 Expected return on plan assets (139)- .(139) (138) Real estate 15 16 13 10 7 6 Recognized net (gain) loss 3 2 . (3) Private equity Net amortization 9 9 4 Total 100% 100% 100% Net periodic pension (income) $ (13) $ (21) $ (36) Amounts recognized in the balance sheets related to Net periodic pension cost (income) is the sum of. the Company's pension plans consist of: service cost, interest cost, and other costs netted against 2006 2005 the expected return on plan assets. The expected return .on (in millions) plan assets is determined by multiplying the expected rate Prepaid pension asset $ 722 $515 of return on plan assets and the market-related value of. Other regulatory assets 36 - plan assets. In determining the market-related value of Current liabilities, other (5) - plan assets, the Company has elected to amortize changes Other regulatory liabilities .,(183) - in the market value of all plan assets over five years Employee benefit obligations (72) (67) rather than recognize the changes immediately. As a. Other property and investments - 10 result, the accounting value of plan assets that is used to Accumulated other comprehensive calculate the expected return on plan assets differs from income - 23 the current fair value of the plan assets. Presented below are the amounts. included in Future benefit payments reflect expected future,- regulatory assets and regulatory liabilities at December 31, service and are estimated based on assumptions used to 2006, related to the defined benefit pension plans that measure the projected benefit obligation for the pension have not yet been recognized in net periodic pension cost plans. At December 31, 2006, estimated benefit payments along with the estimated amortization of such amounts for were as follows: the next fiscal year: Benefit Prior Net Payments (in millions) Service (Gain)/ Cost Loss 2007 *$69 (in millions) 2008 71 2009 73 Balance at December 31, 2006:

                                             $ 6           $    30         2010                                                          77 Regulatory asset 64            (247)         2011                                                          80r Regulatory liability 2012 to 2016                                                467 Total                                      $70            $(217)

Estimated amortization in net periodic pension cost in 2007: Regulatory asset .$1 $3 Regulatory liability 8 - ITotal $9 $3 11-121

NOTES (continued) Alabama Power Company 2006 Annual Report Other Postretirement Benefits benefit plan assets. as of the ,end of the year, along with the targeted mix of assets, is. presented below: Changes during the year in the accumulated postretirement benefit obligations (APBO) and in the fair Target 2006 2005 value of plan assets were as follows: Domestic equity 45% 46% 53% 2006 2005 11 (in millions) International equity 15 16 Fixed income 29 28 28 Change in' benefit obligation Real estate 7 7, 6 Benefit obligation Att beginning of year $ 490 $ 465 Private equity 4 3 - 2" Service cost 7 7 Interest cost 26 26 Total 100% 100% 100% Benefits paid (22) (21) Actuarial (gain) loss (13) 13 Amounts recognized in the balance sheets related, to, Retiree drug subsidy 2 - the Company's other postretirement benefit plans consist Balance at end of year 490 490 of: Change in plan assets, .2006, 2005 Fair value of plan assets at beginning (in millions) of year 245 212 Regulatory assets $147 $ - Actual return on plan assets 23 28 Employee benefit obligations (205) (55) Employer contributions 27 26 Benefits paid (36) (21) Presented below are the amounts included in Fair value of plan assets at end of year 259 245 regulatory assets at December 31, 2006, related to the Funded status at end of year (231) (245) other postretirement benefit plans that have not yet been Unrecognized transition amount - 29 recognized in-.net periodic postretirement benefit cost Unrecognized prior service cost - 64 along with the estimated amortization of such amounts for Unrecognized net loss 85 the next fiscal year. Fourth quarter contributions 26 12 Accrued liability (recognized in the Prior Net balance sheet) $(205) $ (55) Service (Gain)/ Transition Cost Loss Obligation Other postretirement benefit plan assets are managed (in millions) and invested in accordance with all applicable Balance at December 31, 2006: requirements, including ERISA and the Internal Revenue Regulatory asset $59- $63 $25 Code. The Company's investment policy covers a diversified mix of assets, including equity and fixed Estimated amortization as income securities, real estate, and private equity. net periodic Derivative instruments are used primarily as hedging tools postretirement cost in but may also be used to gain efficient exposure to the 2007: various asset classes. The Company primarily minimizes Regulatory asset $ 5 $ 2- $ 4 the risk of large losses through diversification but also monitors and manages other aspects of risk. The actual Components of the postretirement plans' net periodic composition of the Company's other postretirement cost were as follows: 2006 2005 2004

                                                                                                                  --      (in millions)

Service cost $ 7 $ 7 $ 7 Interest cost 26 26 24 Expected return on plan assets (17) (16) (18) Net amortization 12 11 9 Net postretirement cost $ 28 $ 28 $ 22 11-122

NOTES (continued) Alabama Power Company 2006 Annual Report In the third quarter 2004, the Company prospectively An additional assumption used in measuring theý adopted FASB Staff Position 106-2, "Accounting and APBO was a weighted average medical care cost trend Disclosure Requirements" (FSP 106-2), related to the rate of 9.56 percent for 2007, decreasing gradually to Medicare Prescription Drug, Improvement, and 5.00 percent through the -year 2015, and remaining at that Modernization Act of 2003 (Medicare Act). The Medicare level thereafter. An annual increase or decrease in the Act provides a 28 percent prescription drug subsidy for- assumed -medical' care cost trend rate of 1 percent would Medicare eligible retirees. FSP 106-2 requires recognition affect the APBO land the service and interest cost of the impacts of the Medicare Act in the APBO and components at December 31, 2006 as follows: future cost of service for postretirement medical plans. The effect of the subsidy reduced the Company's - I Percent 1 Percent expenses 'for the'six months ended tDecember '31, 2004 Increase Decrease (in millions) and for the years ended Dedeifibeir 31, 2005 anid 2006 by approximately' $3.2 million, $8.7 millibn, and ' Benefit obligation $36 $31 $11.1 million, respectively, and its'expected to have a Service and interest costs 3 2 similar impact on future expenses'.

     .Future benefit payments; including prescription drug Employee Savings Plan benefits, reflect expected future service and are estimated based on assumptions used 'to measure the APBO for the The Comp ny also sponsors a 401(k) defined contribution postretirement plans. Estimated benefit:payments are plan covening substantially all employees. The Company reduced by drug subsidy receipts expected as a result of the Medicare Act as follows:

provides an*85 percent matching contrnbution up to 6 percent of ah employee's base salary. Prior to Benefit Subsidy,, Novemtner 2006, the Company matched employee Payments. Receipts Total contributions at arate of 75 percent up to 6 percent of the (in millions) employee's 'base salary. Total matching contributions

                                  $23             $ (2)     $ 21        made to the',plan for 2006, 2005, and. 2004 were 2007, f25         (2)      23       $14 million, 1$l4  million, and $13 million! respectively.

2008 '. 2009 .' 27 '. (3) 24 2010 . ' '_30 *' (3) 27 2011 32 (4) 28 3. CONTINGENCIES AND REGULATORY 2012 to 2016 ' 181" ' " (26) " 155 MATTERS General Lidigation Matters Actuarial Assumptions The Company is subject to certain claims and legal The weighted average rates assumed in the actuarial actions 'arising in the oidinary course of busines's. In calculations used to determine both the benefit obligations addition, the Company's business activities are subject to as of the measurement date and the net periodic costs for extensive governmental regulation related to public health the pension, and other postretirement benefit plans for the and 'the envirionment. Litigationi over environmental issues following year are presented below. Net periodic benefit and claims of various'types, includinig property damage, costs for 2004 were calculated using a discount rate of personal injury, and citizen enforcement of environmental 6.00 percent. . requirements such as opacity and other air quality , . standards, has increased generally throughout the United 2006 2005 2004 States. In particular, personal injury claims for damages Discount ' .' 6.00% 5.50% 5375% caused by alleged exposure to hazardous: materials have Annual salary increase ' 3.50 3.00 3.50 become inore frequent. The ultimate outcome of such Long-term return on plan assets"' 8.50 8.50 8.50 pending or potential litigation against the Company cannot be predicted at this time; however, for current The Company determined the long-term rate of proceedings not specifically reported herein, management return based on historical asset class returns and current does not anticipate that the liabilities, if any, arising from market conditions, taking into account the diversification such proceedings would have a material adverse effect on benefits of investing in multiple asset classes. the Company's financial statements. 11-123

NOTES (continued) Alabama Power Company 2006 Annual Report Environmental Matters FERC Matters New Source Review Actions Market-Based Rate Authority In November 1999, the EPA brought a civil action in the The Company has authorization from the FERC to sell U.S. District Court for the Northern District of Georgia power to non-affiliates, including short-term opportunity against certain Southern Company subsidiaries, including sales, at market-based prices. Specific FERC approval the Company, alleging that it had violated the New must be obtained with respect to a market-based contract Source Review (NSR) provisions of the Clean Air Act with an affiliate. and related state laws at certain coal-fired generating facilities. Through subsequent amendments and other In December 2004, the FERC initiated a proceeding legal procedures, the EPA filed a separate action in to assess Southern Company's generation dominance January 2001 against the Company in the U.S. District within its retail service territory. The ability to charge Court for the Northern District of Alabama, after it was market-based rates in other markets is not an issue in that dismissed from the original action. In these lawsuits, the proceeding. Any new market-based rate sales by the EPA alleged that NSR violations occurred at five coal- Company in Southern Company's retail service territory fired generating facilities operated by the Company. The entered into during a 15-month refund period beginning civil actions request penalties and injunctive relief, February 27, 2005 could be subject to refund to the level including an order requiring the installation of the best of the default cost-based rates, pending the outcome of available control technology at the affected units. On the proceeding. Such sales through May 27, 2006, the end June 19, 2006, the U.S. District Court for the Northern of the refund period, were approximately $3.9 million for. District of Alabama entered a consent decree between the the Company. In the event that the FERC's default Company and the EPA, resolving the alleged NSR mitigation measures for entities that are found to have violations at Plant Miller. The consent decree required the market power are ultimately applied, the Company may Company to pay $100,000 to resolve the government's be required to charge cost-based rates for certain claim for a civil penalty and to donate $4.9 million of wholesale sales in the Southern Company retail service sulfur dioxide emission allowances to a nonprofit territory, which may be lower than negotiated market-charitable organization and formalized specific emissions based rates. The final outcome of this matter will depend reductions to be accomplished by the Company, consistent on the form in which the final methodology for assessing with other Clean Air Act programs that require emissions generation market power and mitigation rules may be reductions. On August 14, 2006, the district court in ultimately adopted and cannot be determined at this time. Alabama granted the Company's motion for summary In addition, in May 2005, the FERC started an judgment and entered final judgment in favor of the investigation to determine whether Southern Company Company on the EPA's claims related to Plants Barry, satisfies the other three parts of the FERC's market-based Gaston, Gorgas, and Greene County. The plaintiffs have rate analysis: transmission market power, barriers to entry, appealed this decision to the U.S. Court of Appeals for and affiliate abuse or reciprocal dealing. The FERC the Eleventh Circuit, and on November 14, 2006, the established a new 15-month refund period related to this Eleventh Circuit granted the plaintiffs' request to stay the expanded investigation. Any new market-based rate sales appeal, pending the U.S. Supreme Court's ruling in a involving any Southern Company subsidiary, including the similar NSR case filed by the EPA against Duke Energy. Company, could be subject to refund to the extent the The Company believes that it complied with FERC orders lower rates as a result of this new applicable laws and the EPA regulations and investigation. Such sales through October 19, 2006, the interpretations in effect at the time the work in question end of the refund period, were approximately took place. The Clean Air Act authorizes maximum civil $14.6 million for the Company, of which $3.1 million penalties of $25,000 to $32,500 per day, per violation at relates to sales inside the retail service territory discussed each generating unit, depending on the date of the alleged above. The FERC also directed that this expanded violation. An adverse outcome in this matter could require proceeding be held in abeyance pending the outcome of substantial capital expenditures that cannot be determined the proceeding on the Intercompany Interchange Contract at this time and could possibly require payment of (IIC) discussed below. On January 3, 2007, the FERC substantial penalties. Such expenditures could affect issued an order noting settlement of the IIC proceeding future results of operations, cash flows, and financial and seeking comment identifying any remaining issues condition if such costs are not recovered through and the proper procedure for addressing any such issues. regulated rates. 11-124

NOTES (continued) Alabama Power Company 2006 Annual Report The Company believes that there is no meritorious cost impact resulting from Order 2003 will vary on a basis for these proceedings and is'vigorously defending case-by-case basis for each new generator interconnecting itself in this matter. However, the final outcome of this to the transmission system. matter,' including any remedies to. be applied in the event On November 22, 2004, generator company. of an adverse r'uling in these proceedings, cannot now be subsidiaries of Tenaska, Inc. (Tenaska), as counterparties determined. to two previously executed interconnection agreements with the Company, filed complaints at the FERC Intercompany Interchange Contract requesting that the FERC modify the agreements and that The Company's generation fleet is operated under the IIC, the Company refund a total of $11 million previously as approved by the FERC. In May 2005, the FERC paid for interconnection facilities, with interest. The initiated a new' proceeding to examine (1)'the provisions Companylhas also received requests for similar of the IIC among the Company, Georgia Power, Gulf modifications 'from other entities totaling approximately Power, Mississippi Power, Savannah'Electric, Southern $7 million, though no other complaints are pending with Power, and SCS, as agent, under the 'terms 'of which the the FERC. On January 19, 2007, the FERC issued an power pool of Southern Company'is operated, and, in order granting' Tenaska's requested relief. Although the particular, the propriety of the continued inclusion of FERC's order requires the modification of Tenaska's Southern Power as a party to the TIC, (2) whether any interconnection agreements, the order reduces 'the amount parties to the IIC have violated the fERC's standards of of the refund that had been requested by Tenaska. As a conduct applicable to, utility companies that are result, the Company estimates indicate that no refund is. transmission providers, and ,(3) whether Southern due Tenaska. Southern Company has requested rehearing Company's code of conduct defining Southem Power as a of the FERC's order. The final outcome of this matter "system company" rather than a "marketing affiliate" is cannot now be determined. just and reasonable. In connection with the formation of Southern Power, the FERC authorized'Southern Power's Retail Regulatory Matters inclusion in the IIC in 2000. The FERC also previously The following retail ratemaking procedures will remain in approved Southern Company's code of conduct. effect -until the Alabama PSC votes' to modify or On October 5, 2006, the FERC -issued an order discontinue them. accepting a settlement resolving the proceeding subject to Southern Company's agreement to accept. certain Rate RSE' modifications to the settlement's terins. On October 20, The Alabama PSC has adopted a Rate Stabilization and 2006, Southern Company notified the ,FERC that it Equalization plan (Rate RSE) that provides for periodic accepted the modifications. The modifications largely annual adjustments based upon the Company's earned involve functional separation and 1rifonmation restrictions return on retail common equity. Prior~to January 2007, related to marketing activities conducted on behalf of annual adjustments were limited'to 3 percent. Rates Southern Power. Southern Compah' filed with the FERC remain unchanged when the return on common equity on November 6, 2006 an implimeniation'plan to 'comply ranges between 13.0 percent and 14.5 percent. On with the modifications set forth in the order. The impact' October 4, 2005, the Alabama PSC approved a revision to of the modifications is not expected:to have a material Rate RSE. Effective January 2007 and thereafter, Rate impact, on the Company's financial statements. RSE adjustments are made based on forward-looking informatibo*nor the applicable upcoming calendar year. GenerationInterconnection Agreements Rate adjustments for any twoIyear period, when averaged In July 2003, the FERC issued its'finial rule on the together, caniot exceed 4.0 percent per year and any' standardization of generation iterconnection agreements armual adjustmenit is limited to 5.0 p'ercent. The range of and proceduries (Order 2003). Ord1.003 shifts much of return on common equity, on which such adjustments are the financial burden of new transmission investment from based, remains unchanged. If the Company s actual retail the generator to the transmission provider.The FERC has return on common equity is above the allowed equity indicated that Order 2003, which was effective January 20, return range,-customer refunds- will be required; however, 2004,, is to be applied prospectively to new generating there is no provision for additional customer billings facilities interconnecting to 'a transmission system. Order should the actual return on common equity fall below the 2003 was affirmed by the U.S. Court of Appeals for the allowed tquity.return range. The Company made its District of Columbia Circuit on January 12, 2007. The initial -submission of projected data for calendar year 2007 11-125

NOTES (continued) Alabama Power Company 2006 Annual Report on December 1, 2006. The Rate RSE increase for 2007, cost recovery rate factor will increase absent a contrary effective in January, is 4.76 percent, or $193 million order by the Alabama PSC. annually. Under the terms of Rate RSE, the maximum increase for 2008 cannot exceed 3.24 percent. See "Rate The Company's under recovered fuel costs as of CNP" for additional information. December 31, 2006 is $301.0 million and is classified as deferred charges and other assets in the balance sheet as Rate CNP of December 31, 2006. The Alabama PSC has also approved a rate mechanism NaturalDisasterCost Recovery that provides for adjustments to recognize the placing of new generating facilities in retail service and for the In September 2004, Hurricane Ivan hit the Gulf Coast of recovery of retail costs associated with certificated Florida and Alabama and continued north through the purchased power agreements (Rate CNP). In October Company's service territory causing substantial damage. 2004, the Alabama PSC approved a request by the The related costs charged to the Company's NDR were Company to amend Rate CNP to provide for the recovery $57.4 million. During 2004. the Company accrued of retail costs associated with environmental laws and $9.9 million to the reserve and at December 31, 2004, the regulations. Environmental costs to be recovered include reserve balance was a regulatory asset of $37.7 million. operation and maintenance expenses, depreciation and a In February and December 2005, the Company return on invested capital. This component of Rate CNP requested and received Alabama PSC approval of an began operation in January 2005. accounting order that allowed the Company to To recover certificated purchased power costs under immediately return certain regulatory liabilities' to the Rate CNP, increases of 0.8 percent in retail rates, or retail customers. These orders ýlso allowed the Company $25 million annually were effective July 2004. In April to simultaneously recover from customers an accrual of 2005, an adjustment to Rate CNP decreased retail rates by approximately $48 million primarily to offset the costs of approximately 0.5 percent, or $19 million annually. In Hurricane Ivan'and restore a positive balance in the NDR. April 2006, an annual true-up adjustment to Rate CNP; The combined effect of these orders had ho impact on the increased retail rates by approximately 0.5 percent, or Company's net income in 2005. $19 million annually. On July 10, 2005 and August 29, 2005, Hurricanes The retail rates to recover retail costs associated with Dennis and Katrina, respectively, hit the coast of Alabama environmental laws and regulations under Rate CNP are and continued north throdgh the state, causing significant adjusted annually in January. Retail rates increased damage in parts of the service territory of the Company. approximately 1.0 percent in 2005, or $33 million. In Approximately 241,000 and 637,000 of the'Company's 2006, retail rates increased approximately 1.2 percent, or 1.4 million customer accounts were without electrical $43 million, and in 2007 retail rates increased service 'immediately after Hurricanes Dennis aid- Katrina, approximately 0.6 percent, or $23 million. respectively. The Company sustained significant damage to its distribution and transmission facilities during these Fuel Cost Recovery storms. The Company has established fuel cost recovery rates In August 2005, the Company received approval approved by the Alabama PSC. The Company can change from the Alabama PSC to defer the Hurricane Dennis - the retail energy cost recovery rate after submitting to the storm-related operation and maintenance costs Alabama PSC an estimate of future energy costs and the (approximately $28 million). In October 2005, the current over or under recovered balance. In response to Company also received similar approval from the such a request, the Alabama PSC may conduct a public Alabama PSC to defer the' Hurricane Katrina storm-hearing prior to its ruling. Alternatively, the retail energy related operation and maintenance'costs (pp4roximately*, cost recovery rates 'reques'ted by the Company will $30 million). The NDR'balance at December 31, 2005" become effective 45 days after the initial request. was a regulatory asset of $50.6 million. In December 2005, the Alabama PSC approved the In December 2005, the Alabama PSC approved a Company's request to increase the retail energy cost request by the Company to replenish the depleted NDR1 recovery rate to 2.400 cents per kilowatt-hour, effective and allow for recovery of future natural disaster; cosis.i ý with billings that began in January 2006 for the 24-month The Alabama PSC order gives the Company authority to period ending December 31, 2007. Thereafter, the energy record a deficit balance in the NDR when costs of 11-126

NOTES (continued) Alabama Power Company 2006 Annual Report uninsured storm damage exceed any established reserve the statements of income. The Company accounts for balance. The order also approved a separate monthly SEGCO using the equity method. NDR charge consisting of two components which began In addition, the Company has guaranteed in January 2006. The first component is intended to unconditionally the 'obligation of SEGCO under an establish and maintain a target reserve balance of installment sale agreement for the purchIase of certain $75 million for future storms and is an on-going part'bf pollution control facilities at SEGCO's generating units, customer billing' The Company currently expects that the pursuant to which $24:5 million principal amount of' iarget reserve balance could be achieved within five years. pollution control revenue bonds are 0utstanding'."Also, the The second component of the NDR charge is intended to Company h'as 'guaranteed $50 "iilin*p "nci.al.amoin..f allow recovery of the existing deferred hurricane related unsecured ýsenior notes issued by -SEGCO for general operation and maintenance costs and any future reserve corporate purposes. Georgia Power has agre'ed to deficits over a 24-month period. Absent further Alabama reimburse:the Company for' the pro ratA portion of such PSC approval, the maximum total NDR charge consisting obhigations corresponding to its'theri proportionate r. of both componenits-is $10Sper month per non-residential SEGCO if the Company is called ownership of stock of customer account and $5 per month per residential upon to make such payment under its -guaranty. custmer account. At December 31, 2006, the capitalization of SEGCO As of December 31, 2006, the Company had consisted of $60 million of equity ani $88 nulhon of debt recovered $49.5 million of the costs allowed for storm- on which'the annual interest requirement is $3.2 million. recovery activities and the deficit balance in the NDR SEGCO' p4id d'idends totaling $8.5'nillion in 2006, account totaled approximately $16.8 million, which is $7.7 millitoi ".n.2005, and $12.0 millionf in 2004,'of whic6 included in the balance sheets under "Current Assets." one-half 6f each was paid to the Compony. In addition,' Absent any new storm-related damages, the Company the Compainy recognizes 50 perceni of SEGCO's net' expects to fully recover the deferred storm costs by the income. middle of 2007. As a result, customer rates would be decreased by this portion of NDR. At December 31, 2006, In addition-tO the Company's ownership of SEGCO, - the Company had accumulated a balance of $13.2 million the Company's percentage ownership tind investment in", . in the target reserve for future storms, which is included jointly-ownede6alLfired genera'ting plants at December 3i' in the balance sheets under "Other Regulatory Liabilities." 2006 is as'follow s:,l .) " ' ... ..... . . As revenue from the NDR charge is recognized, an Total ., , . equal amount of operation and maintenance expense Megawatt Company, related to the NDR will also be recognized. As a result, Facility .,Capacity Ownership - this increase in revenue and expense will not have an . 60.00% (1) Greene County, 500 impact on net income, but will increase annual cash flow. Plant Miller,!I Units. ! and 2 1,320, 1 91.84%:(2)

4. JOINT OWNERSHIP AGREEMENTS (1) Jointlyiowned with an affiliate, Mississippi'Power. - - , :

(2) Jointly, owned.with Alabama Electric'Cooerative,,lnc., The Company and Georgia Power own equally all of the outstanding capital stock of SEGCO, which owns electric ,Company K Accumulated generating units with a total rated capacity of Facility Investment, *.. Depreciation 1,020 megawatts, as well as associated transmission (In millions) facilities. The capacity of these units is sold equally to the Greene County $118 $ 65 Company and Georgia Power under a contract which, in Plant Miller substance, requires payments sufficient to provide for the Units 1 and 2 958 396 operating expenses, taxes, interest expense and a return on equity, whether or not SEGCO has any capacity and At December 31, 2006, the Company's Plant Miller energy available. The term of the contract extends portion of construction work in progress was automatically for two-year periods, subject to either $14.9 million. party's right to cancel upon two year's notice. The Company's share of purchased power totaled $95 million The Company has contracted to operate and maintain in 2006, $90 million in 2005, and $86 million in 2004 the jointly owned facilities as agent for their co-owners. and is included in "Purchased power from affiliates" in The Company's proportionate share of its plant operating iI-127

NOTES (continued) Alabama Power Company 2006 Annual Report expenses is included in operating expenses in the Details of income tax provisions are as follows: statements of income. 2006 2005 2004 (in millions)

5. INCOME TAXES Federal --

Southern Company files a consolidated federal income tax Current $302 $151 $ 44 return and combined income tax returns for the State of Deferred (25) 81 219 Georgia and the State of Alabama. Under a joint consolidated income tax allocation agreement, each 277 232 263 subsidiary's current and deferred tax expense is computed State -- on a stand-alone basis and no subsidiary is allocated more Current 56 27 16 expense than would be paid if they filed a separate Deferred (3) 26 34 income tax return. In accordance with IRS regulations, 53 53 50 each company is jointly and severally liable for the tax Total $330 $285 $303 liability. In 2004 and 2005, in order to avoid the loss of The tax effects of temporary differences between the certain federal income tax credits related to the carrying amounts of assets and liabilities in the financial production of synthetic fuel, Southern Company chose to defer certain deductions otherwise available to the subsidiaries. The cash flow benefit associated with the utilization of the tax credits was allocated to the subsidiary that otherwise would have claimed the available deductions on a separate company basis without the deferral. This allocation concurrently reduced the tax benefit of the credits allocated to those subsidiaries that generated the credits. As the deferred expenses are deducted, the benefit of the tax credits will be repaid to the subsidiaries that generated the tax credits. At December 31, 2006 and 2005, the Company had $34.9 million and $20.4 million in accumulated deferred income taxes and $3.1 million and $2.0 million in accrued taxes - income taxes, respectively, payable to these subsidiaries, on the balance sheets. At December 31, 2006, the Company's tax-related regulatory assets and liabilities were $354 million and' $99 million, respectively.*These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized interest. These liabilities are attributable to deferred taxes previously recognized at rates higher than the current enacted tax law and to unamortized investment tax credits. 11-128

NOTES (continued) Alabama Power Company 2006 Annual Report statements and their respective tax bases, which give rise A reconciliation of the federal statutory income tax to deferred tax assets and liabilities, are as follows: rate to the effective income tax rate is as follows: 2006 2005 2006 -2005, 2004 (in millions) Federal statutory rate 35.0% 35.0% 35.0% Deferred tax liabilities: State income tax, net of federal Accelerated depreciation $1,651 $1,626 deduction 4.0 4.2 4.0 377 426 1.1 Property basis differences Non-deductible book depreciation 1.0 1.1 Premium on reacquired debt 39- 42 Differences in prior.years' Pension and other benefits 224 148 deferred, and current tax rates (0.3) (4.1) -(0.8) Fuel clause under recovered 137 *.138 (1.0) Other , r (1.8) (1.3) Regulatory assets associated with Effective income tax rate 37.9% 34.9% 38.3% employee benefit obligations 102 Regulatory assets associated with In accordance with Alabama PSC orders, the asset retirement obligations 200 186 Company returned approximately $30 million of excess Storm reserve 10 26 deferred income taxes to its ratepayers in 2005, resulting Other Z .. 4/ in 3.6 percent of the "Difference in prior years' deferred Total 2,797 2,639 and current tax rates" in the table above. See Note 3 to Deferred tax assets: the financial statements under "Retail Regulatory , Federal effect of state deferred taxes. 118 114 Matters -. Natural Disaster Cost Recovery" for additional State effect of federal deferred taxes. 62 87 information. - -,-*- - Unbilled revenue 25 .22 Pension and other benefits 133 . 20 6. FINANCING' Other comprehensive losses 10 .19 Regulatory liabilities associated Mandatorily Redeemable Preferred Securities/ with employee benefit obligations 71 Long-Term Debt Payable to Affiliated Trusts Asset retirement obligations 200 186 The Company has formed certain wholly owned trust Other 83 .56 subsidiaries for the purpose of issuing preferred securities. Total 702 504 The proceeds of the related equity investments and . Total deferred tax.liabilities, net 2,095 2,135 preferred security sales were loaned back to the Company. Portion included in current (liabilities) through the issuance of junior subordinated notes totaling assets, net .22 (64) $309 :million, which constitute substantially all assets of these trusts.and are reflected in the balance sheets as Accumulated deferred income taxes in

                                             $2,117.       $2,071          Long-term Debt Payable to Affiliated Trusts, The the balance sheets Company~considers that the mechanisms and obligations In accordance with regulatory requirements, deferred                 relating to the preferred securities issued for its benefit, investment tax, credits are amortized, over the lives of the               taken together, constitute a full and unconditional relatedproperty with such .amortization: normally applied                  guarantee by it of the respective trusts' payment as a credit to reduce depreciation. in -the statements of                  obligations- with respect to these securities. At income. Credits amortized in this manner amounted,to.                      December 31, 2006, preferred securities of $300 million
$8.0 million in 2006, $8.8 million-in 2005, and                            were outstanding. See Note I under "Variable Interest
$11.0 million in 2004. At December 31, 2006, all                           Entities" for additional information on the accounting investment tax credits available to, reduce federal income                  treatment for these trusts and the related ,securities...

taxes payable had been utilized. Pollution Control Bonds .

                                    - I Pollution co'ntrol obligations represent installment purchases of pollution control facilities financed by 'funds derived from sales, by public authorities of revenue bonds.

The Company is required to make payments sufficient for the authorities to meet principal and interest requirements of such bonds. . - - 11-129

NOTES (continued) Alabama Power Company 2006 Annual Report Senior Notes Assets Subject to Lien The Company issued a total of $950 million of unsecured At January 1, 2006, the Company had a mortgage that senior notes in 2006. The proceeds of these issuances secured first mortgage bonds they had issued and were used to repay short-term indebtedness, and for other constituted a direct fsrSt lien on substantially all of its general corporate purposes., fixed property and franchises. In 2006, the Company At December 31, 2006 and 2005, the Company had discharged its remaining outstanding first mortgage bond $4.0 billion and $3.6 billion of senior notes outstanding, obligations and the lien was removed in May 2006.. The respectively. These senior notes are subordinate to all Company has granted liens on certain property in . secured debt of the Company which amounted, to connection with the issuance of certain series of pollution approximately. $153 million at December 31, 2006. control bondg with an outstanding principal amount of

                                                                  $153 million.

On February 6, 2007, the Company issued $200 million of long-term senior notes. The proceeds Bank Credit Arrangements were used to repay short-term indebtedness and for other general corporate purposes'. The Company maintains committed lines of.credit in the amount of $965 million (including $563 million of such Preference and Common Stock lines which-are dedicated to funding purchase obligations relating to variable rate pollution control bonds), of which In 2006, the Company issued six million new shares of $365 million will expire at various times during 2007. preference stock at $25.00 stated capital per. share and $148 million 'of the-credit facilities expiring in 2007 allow realized proceeds of $150 million. In addition, the for the execution of one-year term loans. The remaining Company issued three million new shares of common $600 million of credit facilities expire in 2011. All of the stock to Southern Company at $40.00 per, share and credit arrangements require payment of a commitment fee realized proceeds of $120 million. The proceeds of these based on thd unused portion of the commitment or the issuances' were used to repay. short-term indebtedness and maintenance of compensating balances with the banks.* for other general corporate purposes.:,1. Commitment fees are less than 1/4 'of percent for the Outstanding'Classes of Capital Stock Comipany. The Company does not consider any of its cash balances to be restricted as of any specific date. The Company currently has preferred' stock, Class A Most of the Company's credit arrangements with preferred stock, preference stock, and common stock batiks have' covenants that limit 'the&Company's debt to outstanding. The Company's preferred stock and Class A 65 percent of total capitalization, as 'defined in 'the preferred stock, without preference between, classes, 'rank arrangements. For purposes of calculating these' senior to the Company's preference stock and common covenants, long-term notes payable to affiliated trusts are stock with respect to payment of dividends and voluntary excluded from debt butincluded in capitalization. or involuntary dissolution. The Company's preference Exceeding this debt level would result in a default under stock ranks senior to the common stock with respect to the credit arrangements. At'December 31, 2006, the' the payment of dividends and voluntary or involuntary Company was In compliance with the debt limit dissolution. Certain series of the preferred stock, Class A covenants. In addition; the credit 'arrangemen&ts typically preferred stock, and preference stock are subject to contain cross' default provisions that Would be triggered if redemption at the option of the Company on or after a the Company defaultedon other indebtednesg (including specified date. guarantee obligations) above' a specified threshold.' None of the arrangementg "contain'material adverse change Securities Due Within One Year clauses at'the time of borrowings. At December 31, 2006 and 2005, the Company had scheduled maturities and redemptions'of senior nbtes due' The Company borrows through commercial paper within one year totaling $669 million and $547 million, i programs that have the liquidity support of committed bank credit arrangements. In addition, the Company respectively. borrows from time to time through extendible commercial Debt maturities through 2011 applicable to total' note programs and uncommitted credit arrangements. As long-term debt are as follows: $669 million in 2007; of December 31, 2006, the Company had $120 million in $410 million in 2008; $250 million in 2009; $100 million commercial paper outstanding and no extendible in 2010; and $200 million in 2011. commercial notes outstanding. As of December 31, 2005, 11-130

NOTES (continued) Alabama Power Company 2006 Annual Report the Company had $136 million in commercial paper minimize ineffectiveness. As such, no material outstanding, $55 million in extendible commercial. notes ineffectiveness has been recorded in earnings.. outstanding, and $125 million in loans outstanding under At*beceiler. 31, 2006, the Company had an uncommitted credit arrangement. During 2006 and

                                                                      $736 million notional amount of interest rate derivatives 2005, the peak amount outstanding for short-term outstanding With net fair value loss of $3.0 million as borrowings was $411 million and $315 million, follows:

respectively. The average amount outstanding in 2006 and 2005 was $45 million and $31 million, respectively. The 'Weighted Average Fair average annual interest rate on short-term borrowings in .. Fixed Value 2006 was 4.76 percent and in 2005 was 4.04 percent. Rate Notional: Gain/ Short-term borrowings are included in notes payable in Maturity :. Paid Amount, (Loss) the balance sheets. (in millions) At December 31, 2006, the Compan hadi'regulatory 2007***" .* 2.01* $536 $ 0.8 20117*i* 6.15"** 100 : :'(1.9) approval to have outstanding up to $1.4 billion of short-2017 6.15"* '100 (1.9) term borrowings.

Hedged using the Bond Market Association Municipal Swap Inddxý':' ; I . ... . .1. I I f,! ,- : ý -

Financial Instruments ** Interest rate collar (showing only the cap rate percentage).

                                                                       *** Matured January 2007.

The Company enters into energy-related derivatives to hedge, exposures to electricity; gas, and other fuel price The fair value gain or loss for cash flow hedges is changes. However, due to cost-based rate.regulations, the recorded in other comprehensive income and is, Company has limited exposure to market volatility in reclassified! into earnings at the same timbe the hedged commodity fuel prices and prices~of electricity. The itenis' affectvearnings. In 2006, 2005, and 2004, the, Company has implemented fuel-hedging programs at the Company settled gains (losses) of $18.0 million, ! instruction ofthe-Alabama PSC. The Company also- $(21.4) million, and $5.5 million, rdspectively, upon enters into hedges of forward electricity sales. There was termination of certain interest derivatives at the same time no material. ineffectiveness recorded in earnings in 2006,,. it issued debt.'These gains (losses) have been deferred in 2005, and 2004.. other comprehensive income and will be amortized to. interest expense over the life of the original interest At December 31, 2006, ihe fair value gains/(losses) derivative, which approximates to the related underlying of derivative energy contracts were reflected in the debt,' financial statements as follows: Itor the years 2006, 2005, and 2004, approximately Amounts $9.8 million. $3.5 million, and $(6.3) million, (in thousands) respecivel*y, of pre-tax gains (losses) were reclassified Regulatory assets, net . $(33,267) from other comprehensive income tointerest expense., For Accumulated other comprehensive income 676 2007, pre-tax losses of approximately $0.1 million are Net income . (37) expeted .to be reclassified from other comprehensive

                                                    $(32,628)          income to interest expense. The Company has interest-.,

Total fair value related fiedges in place through 2017 and has gains, (losses) that are being amortized through 2035.

    , The fair value gain or loss for hedges that are -

recoverable through the regulatory fuel clauses are

7. CoMMITMENTS recorded in the regulatory assets and liabilities and are recognized in earnings at the same time the hedged items Constructiorn Program -

affect earnings. The Company has energy-related hedges in place up to and including 2009. The Company, is engaged in continuous construction programs, currently estimated to total $1.2 billion in 2007, The Company also enters into derivatives to hedge $1.3 billion in 2008, and $1.3 billion in 2009. These exposure to changes in interest ratesý Derivatives related amounts include $26 million, $35 million, and $34 million to variable rate securities or forecasted transactions are in 2007, 2008, and 2009, respectively, for construction accounted for as cash flow hedges. The derivatives expenditures -related to contractual purchase commitments employed as hedging instruments are structured to for uranium and nuclear fuel conversion,- enrichment, and 11-131

NOTES (continued) Alabama Power Company 2006 Annual Report fabrication services included under "Fuel Commitments." estimated minimum long-term obligations at December 31, The construction programs are subject to periodic review 2006 were as follows: and revision, and actual construction costs may vary from the above estimates because of numerous factors. These Commitments factors include: changes in business conditions; revised Non-load growth estimates; changes in environmental Year Affiliated Affiliated Total regulations; changes in existing nuclear plants to meet new (in millions) regulatory requirements; changes in FERC rules and 2007 $ 50 $ 38 $ 88 regulations; increasing costs of labor, equipment, and 2008 50 39 89 materials; and cost of capital. At December 31, 2006, 2009 50 40 90 significant purchase commitments were outstanding in 2010 12 23 35 connection with the construction program. The Company 2011 2 2 has no generating plants under construction. Construction NUIz and merearter - - - of new transmission and distribution facilities and capital Total commitments $162 $142 $304 improvements, including those needed to meet environmental standards for existing generation, transmission, and distribution facilides, will continue. Fuel Commitments To supply a portion of the fuel requirements of its Long-Term Service Agreements generating plants, the Company has entered into-various long-term commitments for the procurement of fossil and The Company has entered into Long-Term Service nuclear fuel. In most cases, these contracts contain Agreements (LTSAs) with General Electric (GE) for the provisions for price escalations, minimum purchase levels, purpose of securing maintenance support for its combined and other financial commitments. Coal commitments cycle and combustion turbine generating facilities. The include forward contract purchases for sulfur dioxide LTSAs, provide that GE will perform all planned emission allowances. Natural gas purchase commitments inspections on the covered equipment, which includes the contain fixed volumes with prices based on various cost of all labor and materials. GE is also obligated to indices at the time of delivery. Amounts included in the cover the costs of unplanned maintenance on the covered chart below represent estimates based on New York equipment subject to a limit specified in each contract. Mercantile Exchange future prices at December 31, 2006. Total estimated minimum long-term commitments at In general, these LTSAs are in effect through two December 31, 2006 were as follows: major inspection cycles per unit. Scheduled payments to Natural Nuclear GE are made at various intervals based on Actual Year Gas Coal Fuel operating hours of the respective units. Total remaining (in millions) payments to GE under these agreements for facilities owned are currently estimated at $155 million over th6 2007 $ 342 $1,094 $ 26 remaining life of the agreements, which are currently' 2008 281 683 35 estimated to range up to 10 years. However, the LTSAs 2009 173 618 34 contain various cancellation provisions at the option of 2010 84 603 39 the Company. 2011 15 544 45 2012 and thereafter 123 2,145 67 Payments made to GE prior to the performance of Total commitments $1,018 $5,687 $246 any planned maintenance are recorded as either prepayments or other deferred charges, and assets in the Additional commitments for fuel will be required to balance sheets. Inspection costs are capitalized or charged supply the Company's future needs. to expense based on the nature of the Work performed. SCS may enter into various types of wholesale energy and natural gas contracts acting as an agent for the Purchased Power Commitments Company and all of the. other Southern Company traditional operating companies and Southern Power. The Company has entered into various long-term Under these agreements, each of the traditional operating commitments for the purchase of electricity. Total companies and Southern Power may be jointly and 11-132

NOTES (continued) Alabama Power Company 2006 Annual Report severally liable. The creditworthiness of Southern Power discussed in Note 4, and to certain residual values of is currently inferior to the creditworthiness of the - leased assets as described above in "'Operating Leases." traditional operating companies. Accordingly, Southern Company has entered into keep-well agreements with the

8. STOCK OPTION PLAN Company and each of the other traditional operating' companies to ensure the Company will not subsidize or Southern Company provides non-qualified stock options be responsible for any costs, losses, liabilities, or danmages to a large segment of the Company's employees ranging resulting from the inclusion of Southern'Powver as a from line management to executives. As of December 31, contracting party under these agreements. 2006, there were 1,108 current and former employees of the Company participating in the stock option plan. The Operating Leases maximum number of shares of Southern Company common stock that may be issued under these programs The Company hag entered into rental agreements for coal may not 6xceed'57 million. The prices of options granted rail cars, vehicles, and other equipmentý wlth'various terms to date'have 'been at the fair market value of the shares on and expiration dates. These expenses totaled $30.3 million the dates of,giirt. 'Options granted to date become in 2006, $27.3 million in 2005, and $28.3 million 'in exercisable pro rata over a maximum period of three 2004. Of these amounts, $21.5 miliion;'$17.8 million, and years from thedate of grant. Theon Company generally

$16.3 million for 2006, 2005, and 2004, respectively,                     recoinizes stock option expense       a straight-line basis relate to the rail car leases and are recoverable through                 over'the vesting period which equates tothe requisite the Company's Rate ECR. At"Decembe'r 31, 2006,                            sev.rice.period- however, for emnployees who are eligible estimated minimum rental commitments for                                  for retirement, the total cost is expensed at the grant 'date.

noncancellable operating leases were as follows: Options outstanding will expire no later than 10 years Rail ,Vhicle' after the date of grant, unless terminated earlier by the Cars " & Other Total Southern Company Board of Directors in accordance with Year S(in millions) the sitck 'option plan. For certain stock option awards a change in 'control will provide accelerated vesting. As part 2007 $20.5 $ 7.6 j$ 28.1 of the adoption of SFAS No. 123(R), as discussed in 2008 19.7 6.4 26.1 Noteý')uider "'Stock Options," Southern Company has not 2009 15.2 6.1 20.3 mbdified its stock option plan or outstanding stock 2010 10.4 5.7. 6. 1 0ptions,, nor has it changed 'the underlying valuation 2011 5.3 3.9 9.2 assumptions used in valuing the stock options that were 2012 and thereafter 22.9 3.0 25.9 used under SFAS No. 123. Total minimum payments $94.0 $32.7 $126.7 The Company's activity in the stock option plan for In addition to the rental commitments above, the 2006 is summarized below: Company has potential obligations upon expiration of Weighted certain leases with respect to the residual value of the Shares Average leased property. These.leases expire ,in 2009iand 2010, Exercise Subject and the Company's maximum obligations are Price to Option

 $19.5 million and $62.3 million, respectively. At the termination of the leases, at the Company's option, the                   Outstanding at Dec, 31, 2005          5,227,985       $27.09 Company may negotiate an extension, exercise its                          Granted.                              1,150,870        33.81 purchase option, or the property can be sold to a third :                 Exercised                              (474,451)       24.28 party. The Company expects that the fair market value of                  Cancelled                                 (9,275)      29.35 the leased property would substantially, eliminate the                    Outstanding at,Dec. 31, 2006          5,895,129       $28.63 Company's payments under the residual: value obligations.

Exercisable at Dec. 31, 2006 3,739,865 $26.26 Guarantees The number of stock options vested and expected to At December 31, 2006, the Company had outstanding Vest in the future, as of December 31, 2006 is not guarantees related to SEGCO's purchase of certain ' significantly different from the number of stock options pollution control facilities and issuance of senior notes, as outstanding -at December 31, 2006 as stated above. 11-133

NOTES (continued) Alabama Power Company 2006 Annual Report As of December 31, 2006, the weighted average for losses in excess of the $500 million primary cov.erage. remaining contractual term for the options outstanding This excess insurance is also provided by NEIL. and options exercisable is 6.6 years and 5.5 years, respectively, and the aggregate intrinsic value for the NEIL also covers the additional costs that would be. options outstanding and options exercisable is incurred in obtaining replacement power during a $48.5 million and $39.7 million, respectively. prolonged, accidental outage at a member's nuclear plant. Members can purchase this coverage, subject to a As of December 31, 2006, there was $1.4 million of deductible waiting, period of up. to 26. weeks, with a total unrecognized compensation cost related to stock maximum per occurrence per unit limit of $490 million. option awards not yet vested. That cost is expected to be After this deductible period, weekly indemnity payments recognized over a weighted-average period of would be received until either the unit is operational or approximately 11 months. until the limit is exhausted in approximately three years. The Company purchases the maximum limit allowed by The total intrinsic value of options exercised during NEIL and has elected a 12-week waiting period. the years ended December 31, 2006, 2005,. and 2004 was $4.9 million, $21.9 million, and $16.1 million, Under each of the NEIL policies, members are respectively. subject to assessments if losses each year exceed the The actual tax benefit realized by the Company .for accumulated funds available to the insurer under that the tax deductions from stock option exercises totaled policy. The current maximum annual assessments for the $1.9 milllon,' $8.5 million, and $6.2 million, respectively, Company under the NEIL policies would be $38 million. for the years ended December 31, 2006,42005, and 2004. Following the terrorist attacks of September 2001, both ANI and NEIL confirmed that terrorist acts against

9. NUCLEAR INSURANCE commercial nuclear power plants would, subject to the normal policy limits, be covered under their insurance; Under the Price-Anderson Amendments Act (Act), the Both companies, however, revised their policy terms on a Company maintains agreements of indemnity with the prospective basis to include an industry aggregate for all NRC that, together with private insurance, cover third-, "non-certified" terrorist acts, i.e., acts that are not party liability arising from any nuclear incident occurring certified acts of terrorism pursuant to the Terrorism Risk at Plant Farley. The Act provides funds up to $10.8 billion Insurance Act of 2002, which was renewed in 2005. The for public liability claims that could arise from a single aggregate for all NEIL policies, which applies to non-nuclear incident. Plant Farley is insured against this certified property claims stemming from terrorism within liability to a maximum' of $300 million by American a' 12 month duration, is $3.2 billion plus any amiounts Nuclear Insurers (ANI), with the remaining coverage available through reinsurance or indemnity from' an provided by a mandatory program of deferred premiums outside source. The non-certified ANI nuclear liability that could be assessed, after a nuclear incident, against all cap is a $300 million shared industry aggregate during the owners of nuclear reactors. The Company could be normal ANI policy period.

assessed up to $101 million per incident for each licensed reactor it operates but not more than an aggregate of For all on-site property damage insurance policies, $15 million per incident to be paid in a calendar year for for commercial nuclear power plants; the NRC requires each reactor. Such maximum assessment, excluding any that the 'proceeds of such policies shall be dedicated first applicable state premium taxes, for the Company is for the sole purpose of placing the reactor in a safe and $201 million per incident but not more than an aggregate stable condition after an accident. Any remaining. "' of $30 million to be paid for each incident in any one proceeds are to be applied next toward the costs of year. decontamination and debris removal operations ordered The Company is a member of Nuclear Electric by the NRC, and any further remaining proceeds are to be Insurance Limited (NEIL), a mutual insurer established to paid either to the Company or to its bond trustees as may provide property damage insurance in an amount up to be appropriate under the policies and applicable trust $500 million for members' nuclear generating facilities. indentures. Additionally, the Company has policies that currently All retrospective assessments, whether generated for' provide decontamination, excess property insurance, and liability, property, or replacement power, may- be subject, premature decommissioning coverage up to $2.25 billion to, applicable state premium taxes. .... - !:. 11-134

NOTES (continued) Alabama Power Company 2006 Annual Report

10. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Summarized quarterl finianciai information foi',006 and 2005 are as follows:

                                             '    Net Income:

After

                                                  '.Dividends on Preferred Quarter        Operating Operating ,andPreference               ,

Ended Revenues Income ?ý.Stock (in millions) March 2006 $1,073 $198 $ 82 i.-1'18 June 2006 1,249 258 September 2006 1,572 '458 r- .238 December 2006 1,121 196 80 March 2005 $ 970. $157 $ 93 June 2005 1,086 253 122 September 2005 1,458 443 ., 236 December 2005 1.134., 161 57 The Company's business is influenced by seasonal weather conditions. I. II-13W

SELECTED FINANCIAL AND OPERATING DATA 2002-2006 Alabama Power Company 2006 Annual Report 2006 2005 2004 2003 2002 Operating Revenues (in thousands) $ 5,014,728 $ 4,647,824 $ 4,235,991 $ 3,960,161 $ 3,710,533 Net Income after Dividends on Preferred and Preference Stock (in thousands) $ 517,730 $ 507,895 $ 481,171 $. 472,810 $ 461,355 Cash Dividends on Common Stock (in thousands) $ 440,600 $ 409,900 $ 437,300 $ 430,200 $ 431,000 Return on Average Common Equity (percent) 13.23 13.72 13.53 13.75 13.80 Total Assets (in thousands) $14,655,290 $13,689,907 $12,781,525 $12,099,575 $11,591,666 Gross Property Additions (in thousands) $ 960,759 $ 890,062 $ 786,298 $ 661,154 $ 645,262 Capitalization (in thousands): Common stock equity $ 4,032,287 $ 3,792,726 $ 3,610,204 $ 3,500,660 $ 3,377,740 Preferred and preference stock 612,407 465,046 465,047 372,512 247,512 Mandatorily redeemable preferred securities - - 300,000 300,000 Long-term debt payable to affiliated trusts 309,279 309,279 309,279 - Long-term debt 3,838,906 3,560,186 3,855,257 3,377,148 2,872,6069 Total (excluding amounts due within one year) $ 8,792,879 $ 8,127,237 $ 8,239,787 $ 7,550,320 $ 6,797,861 Capitalization Ratios (percent): Common stock equity 45.9 46.7 43.8 46.4 49.7 Preferred and preference stock 7.0 5.7 5.6 4.9 3.6 Mandatorily redeemable preferred securities - - - 4.0 4.4 Long-term debt payable to affiliated trusts 3.5 3.8 3.8 - - Long-term debt 43.6 43.8 46.8 44.7. 42.3 Total (excluding amounts due within one year) 100.0 100.0 100.0 100.0 100.0 Security Ratings: First Mortgage Bonds - Moody's - Al Al Al Al Standard and Poor's A+ A A A Fitch AA- AA- A+ A+ Preferred Stock/ Preference Stock - Moody's Baal Baal Baal Baal Baal Standard and Poor's BBB+ BBB+ BBB+ BBB+ BBB+ Fitch A A A A- A-Unsecured Long-Term Debt - Moody's A2 A2 A2 A2 A2 Standard and Poor's A A A A A Fitch A+ A+ A+ A A Customers (year-end): Residential 1,194,696 1,184,406 1,170,814 1,160,129 1,148,645 Commercial 214,723 212,546 208,547 204,561 203,017 Industrial 5,750 5,492 5,260 5,032 4,874 Other 766 759 753 757 789 Total 1,415,935 1,403,203 1,385,374 1,370,479 1,357,325 Employees (year-end) 6,796 6,621 6,745 6,730 6,715 11-136

SELECTED FINANCIAL AND OPERATING DATA 2002-2006 (continued) Alabama Power Company 2006 Annual Report 2006 2005 2004 2003 2002 Operating Revenues (in thousands): Residential $ 1,664,304 $ 1,476,211 $ 1,346,669 $ 1,276,800 $ 1,264,431 Commercial 1,172,436 1,062,341 980,771 913,697 882,669 Industrial 1,140,225 1,065,124 948,528 844,538 788,037 Other 18,766 17,745 16,860 16,428 16,080 Total retail 3,995,731 3,621,421 3,292,828 3,051,463 2,951,217 Sales for resale - non-affiliates 634,552 551,408 483,839 487,456 474,291 Sales for resale - affiliates 216,028 288,956 308,312 277,287 188,163 Total revenues from sales of electricity 4,846,311 4,461,785 4,084,979 3,816,206 3,613,671 Other revenues 168,417 186,039 151,012 143,955 96,862 Total $ 5,014,728 $ 4,647,824 $ 4,235,991 $ 3,960,161 $ 3,710,533 Kilowatt-Hour Sales (in thousands): Residential 18,632,935 18,073,783 17,368,321 16,959,566 17,402,645 Commercial 14,355,091 14,061,650 13,822,926 13,451,757 13,362,631 Industrial 23,187,328 23,349,769 22,854,399 21,593,519 21,102,568 Other 199,445 198,715 198,253 203,178 205,346 Total retail 56,374,799 55,683,917 54,243,899 52,208,020 52,073,190 Sales for resale - non-affiliates 15,978,465 15,442,728 15,483,420 17,085,376 15,553,545 Sales for resale - affiliates 5,145,107 5,735,429 7,233,880 9,422,301 8,844,050 Total 77,498,371 76,862,074 76,961,199 78,715,697 76,470,785 Average Revenue Per Kilowatt-Hour (cents): Residential 8.93 8.17 7.75 7.53 7.27 Commercial .8.17 7.55 7.10 6.79 6.61 Industrial 4.92 4A6 4.15 3.91 3.73 Total retail 7.09 6.50 6.07 5.84 5.67 Sales for resale 4.03 3.97 3.49 2.88 2.72 Total sales 6.25 5.80 5.31 4.85 4.73 Residential Average Annual Kilowatt-Hour Use Per Customer 15,663 15,347 14,894 14,688 15,198 Residential Average Annual Revenue Per Customer $ 1,399 $ 1,253 $1,155 $1,106 $1,104 Plant Nameplate Capacity Ratings (year-end) (megawatts) 12,222 12,216 12,216 12,174 12,153 Maximum Peak-Hour Demand (megawatts): Winter 10,309 9,812 9,556 10,409 9,423 Summer 11,744 11,162 10,938 10,462 10,910 Annual Load Factor (percent) 61.8 63.2 63.2 64.1 62.9 Plant Availability (percent): Fossil-steam 89.6 90.5 87.8 85.9 85.8 Nuclear 93.3 92.9 88.7 94.7 93.2 Source of Energy Supply (percent): Coal 60.2 59.5 56.5 56.5 55.5 Nuclear 17.4 17.2 16.4 17.0 17.1 Hydro 3.8 5.6 5.6 7.0 5.1 Gas 7.6 6.8 8.9 7.6 11.6 Purchased power - From non-affiliates 2.1 3.8 5.4 4.1 4.0 From affiliates 8.9 7.1 7.2 7.8 6.7 Total 100.0 100.0 100.0 100.0 100.0 11-137

(This page intentionally left blank) GEORGIA POWER COMPANY FINANCIAL SECTION 11-138

REPORT OF INDEPENDENT-REGISTERED PUBLIC ACCOUNTING FIRM ', Georgia Power Company Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting We have audited the accompanying balance sheets and the amounts and disclosures in the financial statements, statements of capitalization of Georgia Power Company assessing the accounting principles used and significant (the "Company'"') (a wholly owned subsidiary of Southern estimates made by management, as well as evaluating the Company) as of December 31, 2006 and 2005, and the overall financial statement presentation. We believe that related statements of income, comprehensive income, our audits provide a reasonable basis for our opinion.. common stockholder's equity, and cash flows for each of the three years in the period ended December 31, 2006. -In our opinion, such financial statements (pages II-These financial statements are the responsibility of the 160 to'II-191) present fairly, in all materialrtspects, the Company's management. Our responsibility is to express financial position of Georgia Power Company at " an opinion on these financial statetfents based on our December 31, 2006 and 2005, and the results of its audits. " ', - operations and'its cash flows for.each of the three years in the period ended December 31, 2006, in conformity We. conducted our audits in accordance with the with accounting principles generally. accepted in the standards of the Public Company Accounting Oversight United States of America. Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance, As discussed in Note 2 to the financial statements,' in about whether the financial statements are free of material 2006 Georgia P06ý Company changed its method of misstatement. The Company is not, required to have, nor accotnting for the funded status of defined benefit were we engaged to perform, an audit of its internal pension tand other postretiretnent plans. control over financial reporting. Our audits included. consideration of internal control.over, financial reporting as a basis for designing audit procedures that are appropriate in ihe circumstances, but not for the purpose of expressing an opinion on the efectiveness of the Atlanta, Georgia Company's internal control over financial reporting. Febmar'y 26, 2007 s II ft.. II-139

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF? OPERATIONS Georgia Power Company 2006 Annual Report OVERVIEW availability, system reliability, and net inreome afte ' dividends on pieferred stock. The'Crmpahy s-mancial Business Activities success is diretly tied to ithe satisfacfion of its customers. Key elements of ensuring'custbmer satisfaction include Georgia Power Company (the Comnany) Operates as a outstanding service, high reliability, and competitive' vertically' integrated utility providing electricity to retail prices. Management uses customer satisfaction surveys customers within its traditional service area located within and reliability indicators to evaluate the Company's the State of Georgia and to wholesaler customers in the results. Southeast. Peak season equivalent forced outage rate (Peak Effective July 1, 2006, Savannah Electric and Power Season EFOR) is an indicator of fossil/hydro plant Company (Savannah Electric), which Was also a wholly availability and efficient generation fleet operations owned 'subsidiary of Southern Coinpany, was merged into during t&e months when- generation needs- are greatest. the Company. The Company has accounted for the merger The rate is calculated'by dividing the number of hours of in a manner similar to a pooling of interests, and the* forced otitages by total generationi, hours. The' 2006 Peak Company's financial statements included herein now Season EFOR of 0.99 percent is above target,' a reflect the merger as though it had occurred on January 1, significant improvement over 2005 Peak Season EFOR of 2004. The supplemental selected financial and operating 1.42 percent. Transmission and distribu~iori system data reflect the merger as though it had occurred on reliability performance is"measured by 'the frequency and January 1, 2002. See FUTURE EARNINGS duration of outages. Performance targets for i eiability are POTENTIAL - "Merger" and Note 3 to the financial set intemally based 'on historical performance,' expected statements under "Retail Regulatory Matters - Merger" weather conditions, and expected capital expendituris. for additional information. 2006 performance exceeded all targets on these reliability Many factors affect the opportunities, challenges, and measures. Net income is the primary component of the-risks of the Company's primary business of selling Company's contribution to Southern Company's-earnings electricity. These factors include the ability to maintain a per share goal. stable regulatory environment, to achieve energy sales The Company's 2006 results compared to its targets growth, and to effectively manage and secure timely for some of these indicators are reflected in the following recovery of rising costs. These costs include those related chart. to growing demand, increasingly stringent environmental standards, and fuel prices. In December 2004, the Key 2006 2006 Company completed a major retail rate proceeding (2004 Performance Target Actual Retail Rate Plan) that has provided earnings stability. This Indicator Performance Performance regulatory action also enabled the recovery of substantial Top quartile capital investments to facilitate the continued reliability of Customer Top quartile in in customer the transmission and distribution network and continued Satisfaction customer surveys surveys environmental improvements at the generating plants. Appropriately balancing environmental expenditures with Peak Season customer prices will continue to challenge the Company EFOR 2.75% or less 0.99% for the foreseeable future. The Company is required to Net Income $770 million $787 million file a general rate case by July 1, 2007, which will determine whether the 2004 Retail Rate Plan should be See RESULTS OF OPERATIONS herein for continued, modified, or discontinued. The Company also additional information on the Company's financial received regulatory orders to increase its fuel cost performance. The financial performance achieved in 2006 recovery rate effective June 1, 2005, July 1, 2006, and reflects the continued emphasis that management places March 1, 2007. on these indicators, as well as the commitment shown by employees in achieving or exceeding management's Key Performance Indicators expectations. In striving to maximize shareholder value while providing Earnings cost-effective energy to more than two million customers, the Company continues to focus on several key indicators. The Company's 2006 net income after dividends on These indicators include customer satisfaction, plant preferred stock totaled $787 million representing a 11-140

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report $43 million, or 5.8 percent, increase over 2005. Operating RESULTS OF OPERATIONS income increased in 2006 due to higher base retail A condensed income statement for the Company is as revenues and wholesale non-fuel revenues, partially offset follows:ý by higher non-fuel operating expenses and higher financing costs. The Company's 2005 earnings totaled Increase (Decrease) $744 million representing a $61 million, or 9.0 percent, Amount From Prior Year increase over 2004. Operating income increased in 2005 2006 2006 2005 2004 due to higher base retail revenues resulting from retail (in mnillions) rate increases effective January 1, 2005 and June 1, 2005 Operating revenues $7,246 $170 $1,348 $499 and more favorable weather, as well as higher wholesale 2,233 296 649 129 Fuel revenues resulting from new contracts effective January 1, Purchased power 1,145 (171) 215 237 non-fuel operating 2005, partially offset by increased Other operations expenses.-The Company's 2004 earnings totaled 1,560 (11) .86 154 and maintenance $683 million representing a $29 million, or 4.4 percent, Depreciation and increase over 2003.'Operating income increased in 2004 499 (28) 230 (74) amortization due to higher base retail revenues attributable to more Taxes other than favorable weather and customer. growth during the year, income taxes 299 23 33 16 partially offset by higher non-fuel opetrating expenses. In addition, lower depreciation and amortization expense Total operating expenses 5,736 109 1,213 462 resulting from a three-year retail rate plan approved by the Georgia Public Service Commission (PSC) in 2001 Operating income 1,510 61 '135 37 (2001 Retail Rate Plan) significantly 'offset increased Total other income purchased power capacity expenses. . and (expense) (276) (22) ,(19) 5 Income taxes. 442 (5) 54 12 Net income 792 44 62 30 Dividends on preferred stock 5 1 1 1 Net income after dividends on preferred stock $ 787 $ 43 $ 61 $ 29 I

                                      'J
                                    ,    I I .

11-141.

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report Revenues Wholesale revenues from sales to non-affiliated utilities were: Operating revenues in 2006, 2005, and 2004 and the 2006 2005 2004 percent of change from the prior year are as follows: (in millions) Amount Unit power salesý-- 2006 2005 2004 Capacity $33 $ 33 $ 31 (in millions) Energy ': 38 32 34 Other power sales -- : Retail - prior year $6,065 $5,119 $4,609 Capacity and other 165' 155 75 Change in - Energy 316 305 112 Base rates 3 201 - Sales growth (4) 136 161 Total $552 $525 $252 Weather 7 23 32 Fuel cost recovery 134 586 317 Revnmiis from 'unitpower sales contracts remained relatively con'stant in 2006, 2005, and 2004. Revenues' Retail - current year 6,205 6,065 5,119 from other non-affiliated sales increased $21 million, or Sales for resale - 4.6 percent, ind $273 million, or 146.0 percent, in 2006 Non-affiliates 552 525 252 and 2005, respectively, and decreased $13 million, or Affiliates 253 275 172 6.5 percent, in 2004. The increase in 2006 was due to a Total sales for resale 805 800 424 9.5 percent increase in the demand for kilowatt-hour Other operating revenues 236 211 185 (KWH)-energy sales due to a new contract with an electrical membcrship corporation (EMC) that'went into Total operating revenues $7,246 $7,076 $5,728 effect in April 2006. The increase in 2005 was primarily Percent change 2.4% 23.5% % due to contracts vith 30 EMCs that went into effect in January 2005 which increased the demand for energy. The Retail base revenues of $3.8 billion in 2006 capacity component of these transactions increased increased $7.0 million, or 0.2 percent, from 2005 $1 million and $73.2 million in 2006 and 2005, primarily due to customer growth of 1.9 percent and more respectively. favorable weather, partially offset by lower market-driven Revenues fron sales to affiliated companies within rates to large commercial and industrial customers. Retail the Southern Company system will vary from year to year base revenues of $3.8 billion in 2005 increased by depending on demmd and the availability and cost of $360 million, or 10.6 percent, from 2004 primarily due to generating resource; at each company. These affiliated the retail rate increases effective January 1, 2005 and sales and purchases are made in accordance with the June 1, 2005, sustained economic strength, customer Intercompany Interclange Contract (IIC), as approved by growth, more favorable weather, and generally higher the Federal Energy lRegulatory Commission (FERC). In prices to large business customers. See Note 3 to the 2006 and 2005, KWI energy sales to affiliates increased financial statements under "Retail Regulatory Matters - 9.2 percent and 2.2 porcent, respectively, due to higher Rate Plans" for additional information. Retail base demand. However, reienues from these sales decreased by revenues of $3.4 billion in 2004 increased by 8.3 percent in 2006 doe to reduced cost per KWH $192 million, or 6.0 percent, from 2003 primarily due to delivered. Revenues increased 59.8 percent in 2005 due to an improved economy, customer growth, generally higher higher fuel prices. ln 1004, KWH energy sales to prices to the Company's large business customers, and affiliates decreased 18.3 percent due to lower demand. more favorable weather. However, the decline in associated revenues was only 5.0 percent due to higher fuel prices. These transactions Electric rates include provisions to adjust billings for do not have a significant impact on earnings since this fluctuations in fuel costs, including the energy component energy is generally qld at marginal cost. of purchased power costs. Under these fuel cost recovery Other operating revenues increased $24.6 million, or provisions, fuel revenues generally equal fuel expenses, 11.6 percent, in 200e.primarily due to increased revenues including the fuel component of purchased power, and do of $14.1 million refatqd to work performed for the other not affect net income. See FUTURE EARNINGS owners of the interated transmission system (ITS) in the POTENTIAL - "PSC Matters - Fuel Cost Recovery" State of Georgia, higher customer fees of $4.6 million, herein for additional information. and higher outdoor lighting revenues of $6.1 million due II- 142

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report to a 5.5 percent increase in customers.' Other operating economic strength, customer growth of 1.9 percent, and a revenues increased $26.1 million, or 14.1 percent, in 2005 reclassification bf customers from industrial to'" from 2004, primarily due to higher transmission revenues commercial to be consistent with the rate structure of $16 million related to work performed for the other approved by the Georgia PSC. Industrial sales decreased owners of the ITS, higher revenues under the open access 5.0 percent primarily due to this reclassification of tariff agreement,'higher outdoor lighting revenues of customers. $5.4 million, and higher customer fees that went 'into Residential KWH sales increased 5.5 percent in 2004 effect in .2005 of $5.9-million. The increased transmission from:2003 due to more favorable weather and a revenues in 2006 and 2005 did not have animpact on 1.9 percent increase in residential customers. Commercial earnings since they were offset by associated transmission KWH sales increased 4.1 percent in 2004 due to an. expenses. Other operating revenues increased improved economy and a 3.0 percent increase in $11.6 million,' or 6.7 percenti,"n 2004 over 2003 primarily commercial customers. Industrial sales increased due to higher revenues from outdoor lighting of 2.4 percent in 2004 due to the improved economy. $4.2 million and pole attachment rentals of $4.9 million and higher gains on sales of,emission allowances of $2 million., Fuel and PurchasedPower Expenses Fuel costs constitute the single largest expense for the Energy Sales Company. The mix of fuel source's for generation of Changes in revenues are influenced heavily by the volume electricity is determined primarily by demand, the unit of energy sold each year. KWH sales for 2006 and the cost of fuel consumed, and the availability of generating percent change by year were as follows: units. Details of the Company's generation, fuel, and purchased -power are as follows:

                    ,.,    K"H           Percent Change 2006       2006    2005      2004                                                2006      2005    2004 (in billions)                                 Total generation                                !

Residential 26.2 2.7% 279% 5.5% (billiohs of KWH) 83.7 .82.7 73.6 Commercial 32.1 2.5 6.0 4.1 Total purchased power Industrial '25.6 (1.0)' (5.0) 2.4 (billions of KWH) 23.7 21.7 24.5 Other 0.7 (10.5) (1.0) 1.6 Sources of generation (percent) Total retail 84.6 1.4 ,11.3. 3.9 Coal,; r,' 74.4 75.7 .76.0 Sales for resale . 18.2 21.8 Nuclear 18.2 Non-affiliates -,12.3 8.8 85.5:, (32.2) Gas: 6.2, 3.8 0.3 Affiliates .. 5.5 9.2 2.2 . (18.3) Hydro 1.2 2.3 - 1.9 Total sales for resale 17.8 8.9 48.3 (26.6) Cost of fuel, generated Total sales 102.4' 2.6 6.9 (1.0) (cents pe" het KWH) Coal .2.58 1.91. 1.89 Residential KWH sales increased 2.7 percent in 2006 Nuclear 0.47 0.47 0.46 over 2005 due' to customer growth'0f 1.9 percent and Gas ' 5.76 14.03 8.04 more favorable weather. Comm'ercial KWH 'sales Average ,cost of fuel, generated in6reased 2.5 percent in 2006 over 2005 due to customer (cents per net KWH) 2.39 2.12 1.58 growth' of 2.0 percent and a reclassification of customers Average cost of purchased powerr from industrial to dommercial to'be cohsistent with the (cents per net KWH) 5.90 7.10 5.09 rate structure approved by the "Georgia PSC. Industrial KWH sales decreased 1.0 percent due to a 34 percent Fuel and purchased power expenses were $3.4 billion decrease in the number of customers, as a restilt of this in 2006,'an increase of $124 million, or'3.8 percent, reclassification. above prior yAi" costs. This increase whs driven by a

                                                                      $181 million increase related to total KWH generated and Residential KWH sales increased 2.7 percent in 2005 purchased, partially offset by a $57 million decrease in over 2004 due to more favorable 'weather, customer                     the tost oflfuel.

growth of 1.8 percent, and a 0.9 perceni increase in the average energy onsrnumption per customer. Commercial Fuel and purchased power expenses were $3.3 billion KWH sales increased 6.0 percent in 2005 when conipared in 2005K'an increase of $863 million, or 36.1 percent, to 2004 due to more favorable weather, sustained '" above prior year costs. This increase was the result of an 11-143

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report $868 million increase in the cost of fuel and a $5 million generating plant and transmission and distribution decrease related to total KWH generated and purchased.. increased $27.5 million and $15.9 million, respectively, as a result of scheduled outages and, to a lesser extent, Fuel and purchased power expenses were $2.4 billion certain flexible projects planned for. other periods. in 2004, an increase of $365 million, or 18 percent, above Increased employee benefit expense of $18.9 million. prior year costs. This increase Was' the result of a refai-d t'o pension and medical benefits and higher . $20 million increase in the cost of fuel and a $345 million property insurance costs of $4.6 million resulting from increase related to total KWH generated and purchased. storm-damage also contributed to the, increase. Customer, The Company has entered into three power purchase assistance expense and uncollectible account expense also agreements (PPAs) to purchase a total of approximately increased an, additional $9.3 million in 2005 over 2004, 1,000 megawatts (MW) annually from June 2009 through' primarily as a result of promotional expenses related to an May 2024. These agreements were approved by the' energy efficiency program and an increased number of Georgia PSC on October 2, 2006. These agreements customer bankruptcies. satisfy approximately 550 MW of growth, replace an In 2004, other operations and maintenance expenses existing 450 MW agreement that expires in May 2009, increased $155 million, or 11.6 percent, in part due to the and are expected to result in'higher: bperations and, - timing of generating plant maintenance of $37.6 million maintenance expenses that will be subject to recovery and transmission and distribution maintenance of through future base rates.

                                                                   $39.6 million. Increased employee benefit expense of While prices have moderated somewhat in 2006, a               $30 million related to pension and medical benefits and significant upward trend in the cost of coal and natural            higher workers compensation expense of $8 million also gas has emerged since 2003, and. volatility in these                contributed to the increase.

markets is expected to continue. Increased coal prices have been influenced by a worldwide increase in demand Depreciationand Amortizatio" "' penses as a result of rapid economic growth in China, as well as Depreciation and amortization, decreased $27.9 million, or by increases in mining and fuel transportation costs. 5.3 percent, in 2006 from the prior year due to the Higher natural gas prices in the United States are the amortization of a regulatory liability related to the result of increased demand and slightly lower gas supplies inclusion olT certified PPAs in retail rates as ordered by" despite increased drilling activity. Natural gas production the Georgia PSC under the terms of the 2004 Retail Rate and supply interruptions, such as those caused by the Plan. This' decrease was partially offset by a $15.9 million, 2004 and 2005 hurricanes result in an immediate market or 3.2 percent, increase in depreciation expense in 2006 response; however, the long-term impact of this price over 2005 due to an increase in plant in service.: volatility may be reduced by imports of liquefied natural Depreciation and amortizati6n increased $230 million, or gas if new liquefied gas facilities are built. Fuel expenses 77.5 percent, in 2005 over 2004 primarily due to the generally do not affect net income, since they are offset expiration at the end of 2004 of certain provisions' of the: by fuel revenues under the Company's fuel cost recovery 2001 Retail Rate Plan. In accordance with the 2001 Retail provisions. See FUTURE EARNINGS POTENTIAL Rate Plan, the Company amortized an accelerated cost "PSC MATTERS - Fuel Cost Recovery." recovery liability as a credit to amortization expense and recognized new Georgia PSC-certified purchased power Other Operationsand Maintenance Expenses costs in rates evenly over the three years ended In 2006, other operations and maintenance expenses December 31, 2004. This treatment resulted in a credit to decreased $11 million, or 0.7 percent, from the prior year. amortization expense of $187.1 million in 2004 and a Maintenance for generating plants decreased $20.0 million total decrease in depreciation and amortization of in 2006 as a result of scheduled outages in 2005 offset by $74 million in 2004. See Note 3 to the financial an increase of $18.2.million for transmission and statements under "Retail Regulatory Matters - Rate Plans" distribution expenses related to load dispatching and for additional information. overhead line maintenance. Also contributing to the decrease were decreased employee benefit expenses. Taxes Other Than Income Taxes related to medical benefits and lower workers Taxes other than income taxes increased $22.8 million, or compensation expense of $23.2 million, partially offset by 8.3 percent, in 2006 primarily due to higher property, lower pension income of $13.7 million. taxes of $13.3 million as a result, of an increase in In 2005, other operations and maintenance expenses property, values and higher municipal gross receipts taxes increased $86 million, or 5.8 percent. Maintenance for of $9.1 million as a result of increased retail operating 11-144

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report revenues. Taxes other than incometaxes increased expenses of $2.9 million and $5.0 million related to the $33 million, or 13.6 percent, in 2005 primarily due to employee stock ownership plan and charitable donations, higher municipal gross receipts taxes of $1g.1 million, respectively, and increased revenues of $3.6 million, resulting from increased retail operating-revenues aftd' $5.4 million,t and $'3.millionrelated 'to a residential higher property taxes of $14.0 million'., Taxes other than pricing program, customer contracting, and customer' income taxes increased $15.6 milliori,i or 6.8 percent, 'in facilities tharges, respectively. These increases were 2004 primarily due to higher municipallgross receipts'9 partially offset by net financial gains on gas hedges of taxes associated with increased retail operating revenues. $18.6 million in ý005. Other income and (expense), net increasedI$21ý5 million in 2005. from 2004 primarily due Allowance For Equity Funds Used During Construction to $16.8 million of additional gas hedge gains. Other income and (expense), net decreased in 2004 primarily Allowance for equity funds used during construction - - due to a $15.5, million disallowance of Plant McIntosh (AFUDC) remained relatively constant in 2006 and 2005 construction costs-in December 2004, partially offset by a and increased $18.1 million in 2004, primarily due to the $7.5 million decrease in donations and $3.4 million in construction of the Plant McInt6sh 'combined cycle units increased income from a customer pricing program. See 10 and 11 which were placed in service in Jtine 2005. Note 3, to the financial statements under "Retail Regulatory Matters - Rate Plans" and "- Fuel Hedging Interest Income . Program" for additional information., Interest income decreased $4.1 million in 2006 primarily,, due to interest on a favorable state tax settlement of Effects of Inflation $3.8 million in 2005. Interest income remained relatively constant in 2005. Interest income decreased $9 million in The Company-is subject to rate regulation that is based on 2004 when compared to the prior year primarily due to the recovery of historical costs. When historical costs are interest on a favorable income tax settlement of included, or when inflation exceeds projected costs used $14.5 million in 2003. - , in rate regulation, the effects of inflation can create an economic loss since the recovery of costs could be in Interest Expense dollars that have less purchasing power. In addition, income tax laws are based on historical costs. While the Interest expense increased $22.5 nmilion, or 9.5 percent, inflation rate has been relatively low in recent years, it in 2006 primarily due to generally higher interest rates on continues' to have an adverse effect on the Company variable rate debt and commercial paper, theissuance of because 'of the large' investment in utility plant with long additional senior notes during 2005, and higher average econ6mic lives. Conventional accounting for historical balances on short-term debt. Interest expense increased costdoes not recognize this economic loss nor the $40.6 million, or 15.9 percent, in 2005 from 2004 partially"bffsetting gain that arises through financing primarily due to the issuance of additional senior notes in facilities with fixed-money obligations such as long-term 2005 and generally higher interest rates on variable rate. debt, preferred stock, and preferred securities. Any debt and commercial paper. Variable rates on pollution recognition of inflation by regulatory authorities is control bonds are highly correlated with the Bond Market reflected in the rate of return allowed in the Company's' Association Municipal Swap Index, which averaged approved electric rates. 2.5 percent in 2005 and 1.2 percent in 2004. Variable rates on commercial paper and senior'notes are highly correlated with the one-month. London Interbank' Offer FUTURE EARNINGS POTENTIAL Rate, which averaged 3.4 percent in 2005 ahd 1.5 percent in 2004. Interest expense remained relatively constant in General 2004. The Company refinanced or retired $324 million,' The Company bperates as a vertically integrated utility $635 million, and $470 million of securities in 2006, 2005, and 2004, respectively. Interest capitalized providing electricity to retail customers within its traditioh*l service' territory located within the State of increased in 2005 and 2004 due to the Plant McIntosh construction referenced above. Georgia and to wholesale customers in the Southeast. Prices'for electricity'provided by the Company to retail customers are set by 'the Georgia PSC under cost-based Other Income and (Expense), net regulatory principles. Prices for electricity relating to' Other income and (expense), net increased $1.9 million, PPAs' interconnecting transmission lines, and the or 26.7 percent, in 2006 primarily due to reduced exchange of electric power are set by the FERC. Retail 11-45

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report rates and revenues are reviewed and adjusted periodically Court for the Northern, District of Alabama after Alabama with certain limitations. See ACCOUNTING POLICIES - Power was dismissed from the original action. In these "Application of Critical Accounting Policies and lawsuits, the EPA alleged that NSR violations occurred at Estimates - Electric Utility Regulation" herein and Note 3 eight coal-fired generating facilities operated by Alabama to the financial statements under "Retail Regulatory Power and the Company (including a facility formerly Matters" and "FERC Matters" for additional information owned by Savannah Electric). The civil actions request about regulatory matters. penalties and injunctive relief, including an order requiring the installation of the best available control The results of operations for the past three years are technology at the affected units. not necessarily indicative of future earnings potential. The level of the Company's future earnings depends on On June' 19, 2006, the U-.S. District Court for the numerous factors that affect the opportunities, challenges, Northern District of Alabama entered a consent decree and risks of the Company's business of selling electricity. between Alabama Power and the EPA, resolving the These factors include the ability of the' Company to alleged NSR violations at Plant Miller. The consent maintain a stable regulatory environmetit that continues to decree required Alabama Power to pay $100,000 to allow for the recovery of all'prudently incurred costs resolve the government's claim for a civil penalty and to during a time of increasing costs. Future earnings in the donate $4.9 million of sulfur dioxide emission allowances near term will depend,' in part; upon growth in energy to a nonprofit charitable organization and formalized sales, which is subject to a number of factors. These specific emissions reductions to be accomplished by factors include weather, competition, new energy Alabama Power, consistent with other Clean Air Act contracts with neighboring utilities, energy conservation programs that require emissions reductions. On August 14, practiced by customers, the price of electricity, the price 2006, the district court in Alabama granted Alabama elasticity of demand, and the rate of economic growth in Power's'motion for summary judgment and entered final the Company's service area. Assuming normal weather, judgment in favor of Alabama Power on the EPA's claims retail sales growth is expected to be approximately related to Plants Barry, Gaston, Gorgas, and Greene 2.1 percent on average from 2007 to 2011. County. The plaintiffs have appealed this decision to the U.S. Court of Appeals for the Eleventh Circuit and on Environmental Matters November 14, 2006, the Eleventh Circuit granted plaintiffs' request to stay the, appeal, pending the Compliance costs related to the Clean Air Act and other U.S. Supreme Court's ruling in a similar NSR case filed environmental regulations could affect earnings if such by the EPA against Duke Energy. The action against the costs cannot be fully recovered in rates on a timely basis. Company has been administratively closed since the Environmental compliance spending over the next several spring of 2001, and none of the parties has sought to years may exceed amounts estimated. Some of the factors reopen the case. driving the potential for such an increase are higher commodity costs, market demand for labor, and scope. The Company believes that it complied with additions and clarifications. The timing, specific applicable laws and the EPA regulations and requirements, and estimated costs could also change as interpretations in effect at the time the work in question environmental regulations are modified. See Note 3 to the took place. The Clean Air Act authorizes maximum civil financial statements under "Environmental Matters" for penalties of $25,000 to $32,500 per day, per violation at additional information. each generating unit, depending on the date of the alleged violation. An adverse outcome in this matter could require New Source Review Actions substantial capital expenditures that cannot be determined at this time and could possibly require payment of In November 1999, the Environmental Protection Agency substantial penalties. Such expenditures could affect (EPA) brought a civil action in the U.S. District Court for future results of operations, cash flows, and financial the Northern District of Georgia against certain Southern condition if such costs are not recovered through Company subsidiaries, including the Company and regulated rates. Alabama Power, alleging that these subsidiaries had violated the New Source Review (NSR) provisions of the The EPA has issued a series of proposed and final Clean Air Act and related state laws at certain coal-fired revisions to its NSR regulations under the Clean Air Act, generating facilities, including the Company's Plants many of which have been subject to legal challenges by Bowen and Scherer. Through subsequent amendments and environmental groups and states. On June 24, 2005, the other legal procedures, the EPA filed a separate action in U.S. Court of Appeals for the District of Columbia January 2001 against Alabama Power in the U.S. District Circuit upheld, in part, the EPA's revisions to NSR 11-146

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report regulations that were issued in December 2002 but Northern District of Georgia against the Company for vacated portions of those revisions addressing the6 alleged violations of the Clean Air Act at four of the units exclusion of certain pollution control projects. These at Plant Wansley. The civil action requested injunctive regulatory revisions have been adopted by the State of and declaratory relief, civil penalties, a supplemental Georgia. On March 17, 2006, the U.S., Court of Appeals environmental project, and attorneys' fees. In January for the District of Columbia Circuit also vacated an EPA 2007, following the March 2006 reversal and remand by rule which sought to clarify the scope of the existing the U.S. Court of Appeals for the Eleventh Circuit, the Routine Maintenance,. Repair, and Replacement exclusion. district court ruled for the Company on all remaining In October 2005 and September 2006, the EPA also allegations in this case. The only issue remaining for published proposed rules clarifying the test for resolution by the district court is the appropriate remedy determining when an emissions increase subject to the for two isolated, short-term, technical violations of the NSR permitting requirements has occurred. The impact of plant's Clean Air Act operating permit. The court has these proposed rules will depend on adoption of the final asked 'the parties to submit a joint proposed remedy or rules by the EPA and the' State of Georgia's individualproposals in the event the parties cannot agree. implementation of such rules, as well as the outcome of Although the ultimate outcome of this matter cannot any additional legal chhillenges, and, therefore, cannot be curiently be determined, the resulting liability associated determined at this time. with the two*eients is not expected to have a material impact on 'the Company's financial statements. Carbon Dioxide Litigation,. EnvironmentalStatutes and Regulations In July 2004, attorneys general from eight 'states, each outside of Southern Company's service territory, and the General. corporation counsel for New York City filed a complaint in the U.S. District Court for the Southern District of New The Company's operations are subject to extensive York against Southern Company and four other' electric regu!ation byV state and federal environmental agencies power companies. A nearly identical complaint was filed under a'vanrety of statutes and regulations governing by three environmental groups in the ,same court. The environmental media, including air, water, and land complaints allege that the companies' emissions of carbon resources,, Applicable statutes include the Clean Air Act; dioxide, a greenhouse gas, contribute to global warming, the Clean Water Act; the Comprehensive Environmental which the plaintiffs assert is ,a public nuisance. Under Response, Compensation, and Liability Act; the Resource common law public and private nuisance, theories, the Conservation and Recovery Act; the Toxic Substances plaintiffs seek a judicial order (1) holding each defendant Contorolct; the Emergency Planning & Community jointly and severally liable for creating, contributing to, Right-to-Know Act; and the Endangered Species Act. and/or maintaining global warming and_(2) requiring each Compliance with these environmental requirements of the defendants to cap its emissions of carbon dioxide involves significant capital and operating costs, a major and then reduce those emissions by a specified percentage portion of which is expected to be recovered through each year for at least a decade, Plaintiffs1 hav. not, existing ratemaking provisions. Through .2006, the however, requested that damages be awarded in, Company had invested approximately $1.5 bi'lion in connection with their claims. Southern Compny believes capital projects, to comply with these requirements, with these claims are without merit and notes that the annual totals of $351 million, $117 million, and complaint cites no statutory or regulatory basis for the $47 million for 2006, 2005, and 2004, respectively. The claims. In September 2005, the U.S. District.Court for the Compay expects that capital expenditures to assure Southern District of New Yprk granted Southern- compliance with existing and new regulations will be an Company's and the other defendants' motions to dismiss additional.$955 million, $637 million, and $316 million these cases. The plaintiffs filed an appeal to the U.S. Court for 2007, 2008, and 2009, respectively. Because the of Appeals for the Second Circuit in October 2005. The Company's 0compliance strategy is impacted by changes to ultimate outcome of these matters cannot be determined existing environmental laws and regulations, the cost, at this time. . availability, and existing inventory of emission allowances, and the Company's fue mix, the ultimate outcome cannot be determined at'this time.' Plant Wansley EnvironmentalLitigation Environmental costs that are known and estimable at this In December 2002, the Sierra Club, Physicians for Social time are' included in capital expenditures discussed under Responsibility, Georgia Forestwatch, and one individual FINANCIAL CONDITION AND LIQUIDITY - "Capital filed a civil suit in the U.S. District Court for the Requirements and Contractual Obligations" herein. 11-147

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report Compliance with possible additional federal or state publish its final rule for implementation of the existing legislation or regulations related to global, climate change; fine particulate matter standard in early 2007. State plans air quality, or other environmental and health concerns for addressing the nonattainment designations under the could also significantly affect the Company. New . existing standard are required by April 2008 and could environmental legislation or regulations, or changes to require further reductions in SO 2 and NO. emissions from existing statutes or regulations, could affect many areas of power plants. On September 21, 2006, the EPA published the Company's operations; however, the full impact of a final rule lowering the 24-hour fine particulate matter' any such changes cannot be determined at this time. air quality standard even further and plans to designate nonattainment areas based on the new standard by Air Quality December 2009. The final outcome of this matter cannot be determined at this time. Compliance with the Clean Air Act and resulting regulations has been and will continue to be a significant The EPA issued the final Clean Air Interstate Rule in focus for the Company. Through 2006, the Company had March 2005. This cap-and-trade rule addresses power spent approximately $1.3 billion in reducing sulfur plantSO 2 and NO,,' emissions that were found to dioxide (SO 2) and nitrogen oxide (NO,,) emissions and in contribute to nonattainment of th eight-hour ozone and monitoring emissions pursuant to the Clean Air Act. fine particulate matter standards in downwind states. Additional controls have been announced and are Twenty-eight eastern states, including the State of currently being installed at several plants to further reduce Georgia, are subject to the requirements of the rule. The SO 2, NO, and mercury emissions, maintain compliance rule calls for additional reductiohnsof NO, and/or SO 2' to0 with existing regulations, and meet new requirements. be achieved in two phases, 2009/2010 and 2015. These reductions will be accomplished by the installation of Approximately $700 million of the expenditures additional emission controls at the Company's coal-fired related to reducing NO,, emissions pursuant to state and facilities or by- the purchase of emission allowances from federal requirements were in connection with the EPA's a cap-and-trade program. one-hour ozone air quality standard and the 1998 regional NO,, reduction rules. The Clean Air Visibility Rule (formerly called the Regional Haze Rule) was finalized in July 2005. The goal In 2005, the EPA revoked the one-hour ozone air; of this rule is'to restore natural visibility conditions in quality standard and published the second of two -sets of certain areas,(primarily national parks and wilderness final rules for implementation -of the new, more stringent areas) by 2064. The rule involves (1) the application of eight-hour ozone standard. Areas within the Company's Best Available Retrofit Technology (BART) to certain service area that were designated'as nonattainmenrtunder sources built between 1962 and 1977 and (2) the the eight-hour ozone standard include Macon and a application of'any additional emissions reductions which 20-county area within metropolitan Atlanta. Macon is in may be deemed necessary for each designated area to the process-of seeking redesignation by the EPA as an achieve reasonable progress toward the natural conditions attainment area and is preparing a maintenance plan for goal by 2018. Thereafter, for each 10-year planning approval. On December 22, 2006, the U.S. Court of * . period, additional emiissions reductions will be required to Appeals for the District of Columbia Circuit'vacated the continue to demonistrate reasonable progress in each area first set of implementation rules adopted in 2004 and during that period.' For power plants, the Clean Air remanded the rules to the EPA for'furth'er refinement. The Visibility Rule allows states to determine that the Clean impact of this decision, if any, cannot be determined at Air Interstate Rule satisfies BART requirements for SO 2 this time and will depend on subsequent legalfaction and NO,,. However, additional BART requirements for and/or rulemaking activity. State implementation plans, particulate matter could be imposed and the rdasonable including new emission control regulations necessary to progress provisions could result in requirements for bring ozone nonattainment areas into attainment, are additional SO 2 controls. By December 17, 2007, states currently required for Georgia' by June 2007. These state mustsubmit implementation plans that contain strategies implementation plans could require further reductions in for BART'and any other control measures required to NO,, emissions from power plants. " achieve the first phase of reasonable progress. During 2005, the EPA's fine particulate matter In March 2005, the EPA published the final Clean nonattainment designations became effective for several Air Mercury Rule, a'cap-and-trade program for the areas within the Company's service area andithe EPA reduction of mercury' emissions from coal-fired power proposed a rule for the implementation of the fine plants. The rule sets caps on mercury emissions to be particulate, matter standard. The EPA is expected to implemented in two phases, 2010 and 2018, and provides 11-148

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report for an emission ,allowance trading market. The Company The Company is retrofitting a closed-loop anticipates that emission. controls installed to achieve recirculating cooling tower at one facility under the Clean compliance with the Clean Air Interstate Rule and the Water Act to cool water prior to discharge and is eight-hour ozone and fine-particulate air quality standards considering undertaking similar work at an additional will also result in mercury emission reductions. However, facility. The total estimated capital'cost for this project is the long-term capability of emission control equipment to $96 million. reduce mercury emissions is still being evaluated, and the installation of additional control technologies may be required. EnvironmentalRemediation The impacts of the eight-hour ozone and the fine The Company must comply with other environmental particulate matter nonattainment designations, the Clean laws and regulations that cover the handling and disposal. Air Interstate Rule, the Clean Air Visibility Rule,, and the of waste and release of hazardous substances. Under these Clean Air Mercury Rule on the Company -will depend on various laws and regulations, the Company could incur the development and implementation of rules at the state substantial.costs to clean up properties. The Company level. States implementing the Clean Air Mercury Rule conducts studies to determine the extent of any required and the Clean Air Interstate Rule, in particular, have the cleanup'ýand has recognized in ts 'financial statements the' option not to participate in the national cap-and-trade costs to clean up known sites. Amounts for cleanup and programs and could require reductions greater than those ongoing monitoring costs were not material for any year mandated by the federal rules. Impacts will also depend presented. The Company may be liable for some or all on resolution of pending legal challenges to these rules. required.cleanup costs for.additional sites that may, Therefore, the full effects of these-regulations, on the require environmental remediation. See Note 3 to the Company cannot be determined at.this time. The . financial statements under "Environmental Matters . . Company has developed and. continually, updates a Environmental Remediation" for. additional information. comprehensive environmental compliance strategy to comply with the continuing and newenvironmental Global Climate Issues requirements discussed above. As part of this strategy, the Company plans to install additional SO 2, NO., and Domestic efforts to limit greenhouse gas emissions have mercury emission controls within the next several years to been S.pured by international negotiations, under the assure continued compliance with applicable air quality Framework Convention on Climate Change and, requirements. proposes a binding. specifically'the Kyoto Protocol, which limitation on the emissionI of greenhouse gases for Water Quality ' industrialized countries. The Bush Administration has not supported US ."ratification of the Kyoto Protocol or other In July 20041'the EPA published its final technology- mandatory carbon dioxide reduction legislation; however, based regulations under the Clean Water Act for the in 2002, it did announce a goal' to reduce the greenhouse purpose of 'reducing impingement and entrainment of fish, gas intiisity 6f the U.S. economy, the ratio of greenhouse shellfish, and!other forms of aquatic life at' existing power gas emissions to the value of tj.S. economic output, by plant cooling water intake structuies.* The rules require 18'perceni 1y 2012. Southern Company is participating in baseline biological information and, perhaps, installation the volun'ary electric utility sector climate change of fish protection technology near some intake structures initiative, known as Power Partneris, under the Bush' at existing power plants. On January 25, 2007, the '

Administration's Climate VISION program. The utility U.S. Court of Appeals for the Second Circuit overturned sector pledged to reduce its greenhouse gas emissions rate and remanded several provisions of the rule to, the EPA by 3,percent to 5'iOrcent.by 2010-2012. Southern for revisions. Among other, things, the -court rejected the Company continues to evaluate future energy and EPA's use of "cost-benefit" anialysis and suggested some emission profiles relative to the Power Partners program ways 'to incorporate cost considerations. The full impdct and is participating in voluntary'programs to support the.

of these regulations will depend on subsequent legal industry initiative. In addition, 'Southern Company is proceedings, further rulemaking by' the EPA, results of participating in the Bush Administration's Asia Pacific studies and analyses performed as part of the rules' ; Partnership on Clean Development and Climate, a public/ implementation, and the actual requirements established private partnership to work together to meet goals for by the State of Georgia and therefore, cannot now be energy security, national air pollution reduction, :and' determined. . climate change in ways that promote sustainable '. 11-149

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report economic growth and poverty reduction. Legislative $18.8 million for the Company, of which $3.9 million, proposals that would impose mandatory restrictions on relates to sales inside the retail service territory discussed carbon dioxide emissions~ continue to be considered in above. The FERC also dirdcted that this expanded, .. Congress.: The ultimate outcome cannot be'determined at proceeding be held in abeyance pendihg the outcome of this time; however, mandatory restrictions, on the " ! the proceeding on the IC discussed- below., On January 3, Company's carbon dioxide emissions could result in 2007, the FERC issued an order noting 'settlement of " significant additional compliance costs that could affect the' IIC proceeding and seeking comment identifying any future results of operations, cash flows, and financial remaining issues and the proper procedure for addressing condition if such costs are not recovered through any such issues. regulated rates. The Company believes that there is no meritorious FERC Matters basis for thfese proceedings and is vigorously defending itself iii thi inattewr. However,' the final outcome'of this Market-Based Rate Authority matter, including any remedies to be applied in the event The Company has authorization from theFERC to sell of an 'adverse rulifig' in these proceedinigs, cannot now be' power to non-affiliates, including short-term opportunity deter ed. - sales, at market-based prices. Specific FERC approval must be obtained with respect to a market-based vontract with an affiliate. Inteirompany'Interchange Contract In December 2004, the FERC initiated a proceeding The Company's generation fleet is operated under the IIC,: to assess Southern Company's. generation dominance as approved by the FERC.'In May 2005, the FERC within itS; retail service'territory. The ability to charge initiated a new proceeding to examine (1) the provisions market-based rates in other markets is not an issue in that of the IIC among Alabama Power, the Company, Gulff proceeding. Any new market-based rate sales by the Power, Mississippi Power,' Savannah Electric,, Southern Company in Southern Company's retail service territory Power, and Southern Company Services, Inc. (SCS), as entered into during a 15-month refund period' begiiining agent, undeti the termis of which the power pool of February 27, 2005 could be subject to refund to the level Southern ComIpany iss operated, and, in particular, the of the default cost-based rates, pending the outcome of propriety of-the continied'inclusio of Southern Power as the proceeding. Such, sales through May 27;' 2006,the 'end a party to the IIC, (2)' whether any parties to the IIC hi've of the refund period, were approximately $5.8 million "for violated the FERC's standards of conduct applicabe6 t0' the Company. In the event that the FERC's default utility companies that are transmission providers, and mitigation measures for entities that are found: o have (3) whether Southern Company's code of conduct '. markeipower are ultimately applied, the Company may defining Southern Power as a "system company" rather be required to charge cost-based rates for certain than a "marketing affiliate" is just and reasonable. In wholesale: sales in the Southern Company retýail service connection with the formation of Southern Power, the territory, which may be lower than negotiated market-FERC authorized Southern Power's inclusion in the IIC based rates. The final outcome' of this matter will depend proceeding in 2000. The FERC also previously approved on the form in which the firmal methodology' for assessing Southern Company's code. of conduct, generation market power and mitigation-rules may be ultimately' adopted and c*aot be determined at this time. On October 5, 2006, the FERC .issued an order In addition, in May 2005,' the FERC started an accepting a settlement resolving the proceeding subject- to, investigation to determine whether Southern Company Southern Company's agreement, to accept certain satisfies the other three parts of the FERC's market-based modifications to the settlement's terms. On October 20, rate analysis: transmission market power, barriers to entry, 2006, Southern, Company notified the FERC that it. and affiliate abuse or reciprocal dealing., The FERC accepted the modifications. The modifications -largely.. established a new 15-monthl refund period related to this involve functional separation, and information restrictions expanded investigation. Any new market-based rate sales related to marketing activities conducted- on behalf of involving any Southern Company subsidiary, including the Southern Power. Southern Company filed with the FERC Company, could be subject to refund to the. extent the on November 6,2006 an implementation plan to comply FERC orders lower rates as a result of this new with the modifications set forth. in the order. The impact investigation. Such sales through October 19,. 2006, the of the modifications is not expected to have a material' end of the refund period, were approximately impact on the Company's financial statements. 11-150

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) ' Georgia Power Company 2006 Annual Report GenerationInterconnection Agreements the Company's -financial condition, results of operations, and cash-flows could be adversely affected by future f In July 2003, the 1ERC issued its' fal -rul eon the changes in the federal regulatory or operational structure standardiýzation of generation inie'rconnecflon agreements of transmission. and pr&duires (Oider 2003). Order 2603"shifts much 'of the financial burden of new transmission investment from PSC Matters-the generator to the transmsission provider.The FERC has ifidicated that Order '2003, 'which was'effective January` 20, Merger 2004, is to be applied pro'pec'ive'I to new generating facilities interconinecting to a transmission system. Order EffectiveJuly 1,' 2006, Savannah Electric was merged into 2003 vwas affirmed'by the' U.S.' Courh of, Appeals for the the Company. Prior to, the merger, Southern Cqmpany was District of Columbia'Ciruit on Janu'ary: l1, 2007. The the sole common shareholder of both the Company ands-, cost impact iei'iuiii* frbin Order 2003 ,ill vary 6n a Savannah Electric.. At the time of the merger, each case-by-case basis for each new generator interconnecting outstanding share of Savannah Electric common stock to the transmission system. was cancelled and Southern Company was issued an additional 1,500,000 shares of the Company's common. On Novemb~er 22, 2004, generator company stock, no par value per share. In addition, at the time of subsidiaries of Teniska,'Inc. (Tenaskaj'a*s'c6btiiterparties the meiger,: each outstanding share of Savannah Electric's to three previously e6xecuted 'interc-nhnetion agrieements preferred 'stock',was cancelled 'aid converted 'into the right with subsldiaries of' outhern Coinphhy, inclhiding the to receiveo6'ie share of the Company's 61/s percent Company, filed c6mpiaints-at the FERC'requ'esting that' Series Clas§, A Preferred Stocl, Non-Cumulative," Par the FERC modify the agreements and that the' Company Value $25 Pei Shari,' resulting in the issuance by -the refund 'a total of $7.9 million previously paidlfor; " Companyofl1,800,000 shares of such Class A Preferred -' intercorinection fadilifties; with ihierest. Sodthern Stock in July 2006. Following completion of the merger, Company has also received requests f'r similar the outstanding capital stock ofI the Company consists of modificautions fromdother entities, though no 0ther' 9,261,500 shares of common stiock,'all bf which are hel.d complaints* ae pending' i.ith the FERC.'On Jahiuary 19, by Soiithemr Company, and 1,800,000 shares of (Class A. 2007, the FERC issued "n rider'grantifig' l*naska's - Preferred Stock. requested relief. Altfioigh' th'e'FERO's oidei requires 'the modification of Teniska's iiiteicofiiiectibd agreemnts, the' ,With respect to the merger, the Georgia PSC voted.. order ie6luces the amount of the refund that 'had been- on June 15, 2006 to set aMerger Transition Adjustment requested by Tehaska. As a restilt, the Cqonmpany, estimates (MTA). applicable to customers in the former Savannah - indicate' that nio"iefhd is due Tenasski. Sbuthem-n" Electric service; territory so that the fuel rate that ,became Company has'requested rehearing of the FARC's' or-der. effective pn July, ', 2006 plus the MTA equals the The final 'outcome of this matteri cannot now be applicable fuel, rate paid. by such customers as of June 30, determined. 2006. See "Fuel Cost Recovery" herein for additional information. :Amounts collected under, the MTA are being Transmission credited to customers in the original Georgia Power service te'rititoiry'through a Merger'Transition Credit In December 1999,'"the FERC issubd its final rule on* (MTC). The MTArfnd the MTC will be in effect until' Regional Transmissibn Organiz~ationsý(RtOs). Sirnce that December 31, 2007, when the Coimpany's base rates are time; there have been"a' number of additi6nal-proceedings. scheduled to be adjusted. at the FERC designed to encourage further voluntary ` formation of RTOs or to mandate their formation. Rate'Pldni However, at the current time, tlier hidr&io'active proceedings that wotld require the Company to In December 2004,'the Georgia PSC.approved the 2004 participate in- 'an TO.'Current FERC efforts that may, RetailRate Plan. Under the terms of' the 2004 Retail Rate potentially change the regulatory and/or operational Plan, earnings are being evaluated annually against. a.' structure of transmission include. rules related, to the retail return on common equity (ROE), range of ý. - , standardization of.generation interconnection, as well as. 10.25 percent to -12.25 percent. 'Two-thirds of any , ý i, an inquiry into, among other things, market power by "i earnings above 12,25 percent are. applied to rate refunds,- vertically integrated utilities. See "Market-Based Rate. with the remaining 'one-third retained'by'the Company. Authority" and "Generation Interconnection Agreements": Retail rates increased by approximately $194 million and above for additional information. The final outcome of custombr: fees increased by approximately $9 million these proceedings-.cannot now be determined. However, effective January 1, 2005 to cover the higher costs of 11-151

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report purchased power; operations and maintenance expenses; Fuel cost recovery revenues as recorded on the environmental compliance; and continued investment in financial statements, are adjusted for differences in actual new generation, transmission and distribution facilities to recoverable costs and amounts billed in current regulated support growth and ensure reliability. In 2007, the rates. Accordingly, a change in the billing factor has no Company will refund 2005 earnings above 12.25 percent significant effect on the Company's.reVenues or net retail ROE. No refund is anticipated for 2006. income,, but does impact annual cash flow. In accordance with Georgia PSC order, a portion of the under recovered' The Company is required to file a general rate case regulatory clause revenues for the Company is included in: by July 1, 2007, in response to which the Georgia PSC deferred charges and other assets in the balance sheets. would be expected to determine whether the 2004 Retail See Note 1 to the financial statements under "Revenues" Rate Plan should be continued, modified, or discontinued. and Note 3 to the financial statements under "Retail See Note 3 to the financial statements under "Retail Regulatory Matters" for additional information. Regulatory Matters - Rate Plans" for additional information. Nuclear Fuel Cost Recovery On August 15, 2006, as part of a potential expansion of The Company has established fuel cost recovery rates Plant Vogtle, the Company and Southern Nuclear approved by the Georgia PSC. In March 2006, the Operating Company, Inc. (SNC) filed an application with Company and Savannah Electric filed a combined request the Nuclear Regulatory Commission (NRC) for an early site permit (ESP) on behalf of the owners of Plant Vogte. for fuel cost recovery rate changes with the Georgia PSC to be effective July 1, 2006, concurrent with the merger In addition, the Company and SNC notified the NRC of of the companies. On June 15, 2006, the Georgia PSC their intent to apply for a combined construction and ruled on the request and approved an increase in the operating license (COL) in 2008. Ownership agreements Company's total annual billings of approximately have been signed with each of the existing Plant Vogtle. $400 million. The Georgia PSC order provided for a co-owners. See Note 4 to the financial statements for combined ongoing fuel forecast but reduced the requested additional information on these co-owners. In June 2006, increase related to such forecast by $200 million. The the Georgia PSC approved the Company's request to order also required the Company to file for a new fuel establish an accounting order that would allow the cost recovery rate on a semi-annual basis, beginning in Company to defer for future recovery the ESP and COL September 2006. Accordingly, on September 15, 2006, costs, of which the Company's portion is estimated to. the Company filed a request to recover fuel costs incurred total approximately $51 million over the next four years. through August 2006 by increasing the fuel cost recovery At this point, no final decision hasbeen*.made regarding rate. On November 13, 2006, under agreement with the actual construction. Any new generation resource must be Georgia PSC staff, the Company filed a supplementary certified by the Georgia PSC in a separate proceeding. request reflecting a forecast of annual fuel costs, as well as updated information for previously incurred fuel costs. Other Matters On February 6, 2007, the Georgia PSC approved an The Company is involved in various other matters being increase in the Company's total annual billings of litigated, regulatory matters, and certain tax-related issues approximately $383 million. The order reduced the that could affect future earnings. See Note 3 to the Company's requested increase in the forecast of annual financial statements for information regarding material fuel costs by $40 million and disallowed $4 million of issues. previously incurred fuel costs. The order also requires the Company to file for a new fuel cost recovery rate no later ACCOUNTING POLICIES than, March 1, 2008. The new rates will become effective Application of Critical Accounting Policies and on March 1, 2007. Estimated under recovered fuel costs Estimates through February 2007 are to be recovered through May 2009 for customers in the original Georgia Power territory The Company prepares its financial statements in and through November 2009 for customers in the former accordance with accounting principles generally accepted Savannah Electric'territory. As of December 31, 2006, the in the United States. Significant accounting policies are Company had an under recovered fuel balance of described in Note 1 to the financial statements. In the, approximately $898 million, of which approximately application of these policies, certain estimates are made $544 million is included in deferred charges and other that may have a material impact on the Company's results assets in the balance sheets. of operations and related disclosures. Different H- 152

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report assumptions and measurements could, produce estimates certain of these contingencies. The Company periodically that are significantly different from those recorded in -the evaluates its exposure to such risks and records reserves financial statements. Senior management has reviewed for those matters where a loss is considered pfrobable and and discussed the following critical accounting policies reasonably estimable in accordance with generally and estimates with the Audit Committee of Southern accepted accounting principles. -The adequacy of:reserves Company's Board of Directors. can be significantly affected by external events or conditions that can be unpredictable;, thus, the ultimate Electric Utility Regulation outcome of such matters could materially affect the Company's financial statements, These events or The Company is subject to retail regulation by the conditions include the following: ' Georgia PSC and wholesale regulation bý the FERC." These regulatory agencies set the ratesý the Comapany is

Changes in 'existing state or federal regulation by permitted to charge customers based on allowable costs. governmental authorities having jurisdiction oyer air.,

As a result, the Company, applies'FASB Statement No. 71, quality, water quality, control of toxic substances, "Accounting for the Effects of Certain Types of hazardous and solid .wasies, and other environmental r'. Regulation" (SFAS No. 71), which requires the financial matters. statements to reflect the effects of rate regulation. Through the ratemaking process,'the regulatorsmay Changes in existing income' tax regulations or charieis' require the inclusion of costs or revenues in periods in Internal Revenue Service (IRS) or Georgia different than When they would be 'recognized by Ithe_ a non- Department of Revenue interpretationsof existing regulated 'company. This treatment may result in regulations.,, deferral of expenses and tlhe recording of related regulatory 'assets based ohanticipate'future recovery S'Identification of additional sites ihat'require through rates or the' defeiral of gains orcreation ,fo. environmental remediation or the filing of other liabilities and the recording of related regulatory compfaints in which the Company may be asserted to liabilities. The application of SFAS N. 471 has a further be a potentialy responsible party.. effect on the Company's financial statements as a result of the estimates of allowable costs used in the ratemaking I identificatioi ud evaluation of &therpotentiallawsuits process. These estimates may differ from' those actuidly or complaints in which the Company may be named'as incurred by the Company; therefore, the accounting a defendant. estimates inherent in specific costs such 'as 'depr*eciation,

Resolution or'progression of existing matters through nuclear decommissioning, and pension and postretirement the legislative jrocess, the court systems, the IRS, or benefits have less of a direct Impact on 'the Company's the EPA.' -

results of operations than thiey would on a non-regulated company. ' . . As reflected in Note I to'the 'financial statements Unbilled Revenues significant regulatory assets and liabilities have 'been Revenues related-to the sale of electricity are recorded recorded. Management reviews the ultimate recoverability when electricity is delivered to customers. However, the' of these regulatory assets and liabilities based on., determination of KWH sales to individual customers is ' applicable regulatory guidelines and accounting principles based on the reading of their meters, which is performed generally accepted in the United States. However, adverse ona systematic basis throughout. the month., At the end of legislative, judicial, or regulatory actions could materially each month, amounts of electricity delivered to customers, impact'the 'amounts ofi'ucbh' gulator0 assets and but !not yet metered and billed, are estimated. Components liabilites' and could advefselylimlpact the Co mpany's of the unbilled revenue estimates include total KWH d finanial'statements. territorial 'supply,;total 'KWH billed, estimated total electricity! lost'in delivery,and customer usage. These ContiAgeni Obligations" j'. r' ,. ' , I components can fluctuate as a result of a number of The Company is subject to a number of federal and state factors includingmweather, generation patterns, power laws and regulations, as 'well as ;other factors and delivery volume, and other ,operational constraints. These. conditions that potentially subject it to environmental; factors can be unpredictable and can vary from historical litigation,' income tax, and other risks. See FUTURE trends.; As a result, the overall estimate of unbilled. , EARNINGS POTENTIAL herein and Note 3 to the revenues could be significantly affected, which could have financial statements for more information regarding a material impact on the Company's Yesults of operations. 11-153

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report New Accounting Standards year retained earnings. The provisions of SAB 108 were effective for the Company for the year ended Stock Options December 31, 2006. The adoption of SAB 108 did not On January 1, 2006, the Company adopted FASB have a material impact on the Company's financial Statement No. 123(R), "Share-Based Payment" statements. (SFAS No. 123(R)), using the modified prospective method. As a result, compensation cost relating to share- Income Taxes based payment transactions must now be recognized in the Company's financial statements. That cost is measured In July 2006, the FASB issued Interpretation No. 48, based on the grant date fair value of the equity or liability "Accounting for Uncertainty in Income Taxes" (FIN 48). instruments issued. Although the compensation expense This interpretation requires that tax benefits must be

                                                                    ,'more likely than not" of being sustained in order to be required under the revised statement differs slightly, the impacts on the Company's financial statements are similar            recognized. The Company adopted FIN 48 effective to the pro forma disclosures included in Note I to the               January 1, 2007 with no material impact on the financial statements under "Stock Options."                          Company's financial statements.

Pensions and Other PostretirementPlans Fair Value Measurement On December 31, 2006, the Company adopted FASB The FASB issued FASB Statement No. 157, "Fair Value Statement No. 158, "Employers' Accounting for Defined Measurements" (SFAS No. 157) in September 2006. Benefit Pension and Other Postretirement Plans" SFAS No. 157 provides guidance on how to measure fair (SFAS No. 158), which requires recognition of the funded value where it is permitted or required under other status of its defined benefit postretirement plans in its accounting pronouncements. SIAS No. 157 also requires balance sheet. With the adoption of SIAS No. 158, the additional disclosures about fair value measurements. The Company recorded an additional prepaid pension asset of Company plans to adopt SIAS No. 157 on January 1, $218 million with respect to its overfunded defined 2008 and is currently assessing its impact. benefit plan and additional liabilities and deferred credits of $13 million and $255 million, respectively, related to Fair Value Option its underfunded non-qualified pension plans and retiree benefit plans. Additionally, SFAS No. 158 will require the In February 2007, the FASB issued FASB Statement Company to change the measurement date for its defined No. 159, "Fair Value Option for Financial Assets and benefit postretirement plan assets and obligations from Financial Liabilities - Including an Amendment of FASB September 30 to December 31 beginning with the year Statement No. 115" (SPAS No' 159). This standard ending December 31, 2008. See Note 2 to the financial permits an entity to choose to measure many financial statements for additional information. instruments and certain other items at fair value. The Company plans to adopt SFAS No. 159 on January 1, Guidance on Consideringthe Materiality of 2008 and is currently assessing its impact. Misstatements In September 2006, the Securities and Exchange FINANCIAL CONDITION AND LIQUIDITY Commission (SEC) issued Staff Accounting Overview Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in The Company's financial condition remained stable at Current Year Financial Statements" (SAB 108). SAB 108 December 31, 2006. Cash flow from operations increased addresses how the effects of prior year uncorrected $117 million in 2006, resulting primarily from increased misstatements should be considered when quantifying retail operating revenues partially offset by higher fuel misstatements in current year financial statements. inventories and an increase in under recovered deferred SAB 108 requires companies to quantify misstatements fuel costs. In 2005, cash flow from operations increased using both a balance sheet and an income statement $58 million resulting primarily from increased retail approach and to evaluate whether either approach results operating revenues, partially offset by the increase in in quantifying an error that is material in light of relevant under recovered deferred fuel costs. In 2004, cash flow quantitative and qualitative factors. When the effect of from operations decreased $246 million resulting initial adoption is material, companies will record the primarily from the increase in under recovered deferred effect as a cumulative effect adjustment to beginning of fuel costs. 11-154

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report In 2006, gross property additions were $1.2 billion. $910 million,, of which $904 million was unused, at the, These additions were primarily, related to transmission'i beginning of 2007. See Note 6 tothe financial statements and distribution facilities, nuclear fuel, and equipment to under "Bank Credit Arrangements" for additional comply with environmental standards. The majority of information. funds needed for gross property additions for the last -At the beginning of 2007, bank credit arrangements several years ha'e been provided from operating activities were as follows: 1. and capital contributions from Southern Company and the issuance of short-term debt. The statements of cash flows Expires provide additional details.... .... Total Unused 2007 2008 2011 (in millions) The Company's ratio of comhmon equity to total capitalization - including short-term debt - was $910 $904 $40 $870 48.6 percent in 2006, 47.9 percent in 2005, and The credit arrangements that expire in 2007 allow for 47.5 percent in 2004; The Company has received the execution, of term loans for an additional two-year investment grade ratings from the major rating agencies period. with respect to debt, preferred securities, and preferred stock. The Company may also meet short-term cash needs through a Southern Company subsidiary organized to issue and sell commercial paper and extendible Sources of Capital commercial notes at the request and for the benefit of the The Company plans to obtain the funds required for Company and the other traditional operating companies., construction and other purposes from -sources similar to Proceeds from such issuances for the benefit of the ' those used in the past, which were primarily from Company are' loaned directly to the Company' and are not operating cash flows. However, the type and timing of commingled 'with proceeds frofmi issuances for the benefits any future financings, if needed, will depend on 'market of.any other operating company. The obligations of each conditions, regulatory approvals, and-other factors: comparny under these arrangements are several; there is no cross affiliate c'redit support. As of December 31, 2006, The issuance of long-term securities by the Company the Company' had outstanding $733 million' of commercial is subject to the approval of the Georgia PSC. In addition, paper and no extendible commercial notes. the issuance of short-term debt securities "by the Company is subject to regulatory approval by the FERC. Financing Activities Additionally, with respect to the publi'C offering of securities, the Company files registrati6n statements with During 2006, the Company issued $150 million of senior the SEC under the Securities Act Of 1933, as amended notes and incurred $114 million of obligations related to (1933 Act). The amounts of securiti~es authorized by the the issuance of pollution control bonds. The issuances' Georgia PSC, as well as the amounts, if any, registered were used to reduce the Company's short-term under the 1933 Act, are continuously nmonitbred and indebtedneis and refund $154 million of higher interest appropriate filings are made to ensure' flkibility in ihe rate obligations 'related to pollution control bonds, capital markets. respectively. In addition, $20 million of first mortgage bonds matured. The Company obtains financing separately without credit support from any. affiliate. See, Note 6 to the, Credit Rating Risk-financial statements under "Bank Credit Arrangements" for additional information. The Southern Company system The Company-does not have any credit arrangements that does not maintain a centralized cash or,money pool. . would require material changes in payment schedules or Therefore, funds of the Company are:not commingled. terminations, as a result of a credit rating downgrade. with funds of any other company. There are certain contracts that could require collateral, The Company's current liabilities frquently exceed but not accelerated payment, in the event of a credit rating 'change to BBB- or Baa3 or below. Generally,' current assets'because of the continued use'of short-term collateriai may be provided for by a Southern Company debt as a funding source for under reqovered fuel costs guaranty, letter of Credit, or"cash. These contracts are and to meet cash needs which can fluctuate significantly primarily for physical electricity purchases and sales. At due to the seasonality of the business. December 31, 2006, the maximum potential collateral To meet short-term cash needs and contingencies, the requirements at a BBB- orBaa3 rating were Company had credit arrangements with banks totaling approximately $7.8 million. The maximum potential 11-155

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report collateral requirements. at a rating below BBB- or Baa3 changes' in fair value of eneigy-related derivative were approximately $250 million.' contracts, and year-end valuations were as follows at December 31: The Company is also party to certain derivative agreements that could require collateral and/or accelerated Changes in Fair Value payment in the event of a credit rating change to below 2006 2005 investment grade for the Company and/or Alabama (in millions) Power. These agreements are primarily for natural gas and Contracts beginning of year $ 35.3. $ 7,2 power price risk management activities. At December 31, Contracts realized or settled 40.2 (46.8) 2006, the Company's exposure related to these agreements was approximately $27.4 million. New contracts ,at inception,* Changes in valuation techniques,....... , MN'arket Price Risk Current period changes(a) (113.5) . 74.9 Due to cost-based rate regulation, the C6mpany has Contracts ýend of year $ (38.0) $ 35.3 limited exposure to market rate volatility in interest rates,' commodity fuel prices, and prices of electricity,,To,., (a) Current period change's also include the chahgies- in: fair. manage the volatility attributable to these exposures, the value of new contracts entered into during the period. Company nets the exposures to take advantage of natural Source of 2006 Year-End Valuation Prices offsets and enters into various derivative transactions for Total Maturity the remaining exposures pursuant to the Company's.,. policies in areas such as counterparty exposure and Fair Value Year F 1-3 Years (in millions) hedging practices. The Company's policy is that derivatives are to be used primarily for hedging purposes Actively quoted $(38.9) $(135.9), $(3.0) and mandates strict adherence to all applicable risk External sotuces 0.9 0.9 - management. policies.. Derivative. positions are monitored Models and other methods - . - using techniques including, but not limited to, market Contracts end of,year $(38.0). $(35.0) $(3.0) valuation., value at risk, stress tests, and sensitivity analysis. Unrealized gains and losses from mark to market To mitigate future exposure to changes in interest adjustments on derivative contracts related to the rates, the Company has entered into forward starting Company's fuel hedging programs are recorded as interest rate swaps that havý been designated as hedges. regulatory assets and liabilities. Realized gains and losses These swaps have a notional amount of $525 million and from these programs are included in.fuel expense andare are related to anticipated debt issuances over the next two recovered through the Company's fuelcost recovery years. Subsequent to December 31, 2006, the Company mechanism. Of the net financial gains, the Company was entered,into hedges totaling $375 million, also related to allowed to retain 25 percent in earnings through June 30,, anticipated debt issuances over the next two years. The 2006. In 2005, the Company had a total net gain of weighted average interest rate on outstanding variable $74.6 million of which the Company retained long-term debt that has not been hedged at January 1, $18.6 million. There were no net financial gains in 2006 2007 was 4.6 percent. If the Company sustained a and 2004. Effective July 1- 2006, the Georgia PSC - 100 basis point change in interest rates for all unhedged ordered the suspension of the profit sharing framework variable rate long-term debt, the change would affect related to the fuel hedging program. New'profit sharing' annualized interest expense by approximately $5 million arrangements as well asother charges to the fuel, hedging at Janudry 1, 2007. For further information, see Notes' 1 program are currently under development. See Note 3 to and 6 to the; financial statements under "'Financial the financial statements under "Retail Regulatory Instruments" for additional information. Matters - Fuel Hedging Program" for additional , information. Gains and losses on derivative contracts that To mitigate residual risks relative to movements in are not designated as hedges are recognized in the electricity prices, the Company enters into fixed-price statements of income as incurred, At December 31, 2006, contracts for the purchase and sale of. electricity through the fair value gains/(10sses) of energy-related derivative, the wholesale electricity market' and, to a lesser extent, into similar contracts for gas purchases. The Company has implemented a fuel hedging program at the instruction of the Georgia PSC. The 11-156

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report contracts were reflected in the financial statements as expenditures included in these amounts are $955 million, follows: $637 million, and $316 million for 2007, 2008, and 2009, respectively. Actual construction costs may vary from

                                                 ,Amounts these estimates because of changes in such factors as:

(in millions) business conditions; environmental regulations; nuclear Regulatory assets, net $(38.0) plant regulations; FERC rules and regulations; load Net income projections; the cost and efficiency of construction labor, Total fair value $(38.0) equipment, and materials; and the cost of capital. In addition, there can be no assurance that costs related to Unrealized gains (losses) recognized in income in capital expenditures will be fully recovered. 2006, 2005, and 2004 were not material. The Company is exposed to market price risk in the event of As a result of requirements by the NRC, the nonperformance by counterparties to the derivative energy Company has established external trust funds for nuclear contracts. The Company's policy i's to enter into decommissioning costs. For additional information, see agreements with counterparties that have investment grade Note 1 to the financial statements under "Nuclear credit ratings by Moody's and Stdndard & Poor's or with Decommissioning." counterparties who have posted collateral to cover In addition, as discussed in Note 2 to the financial potential credit exposure. Therefore, the Company does statements, the Company provides postretirement benefits not anticipate market risk exposure from nonperformance to substantially all employees and funds trusts to the, by the counterparties. For additional information, see extent required by the Georgia PSC and the FERC. Notes 1 and 6 to the financial statements under "Financial Instruments." Other funding requirements related to obligations associated with .,heduled maturities of long-term debt Capital Requirements and Contractual Obligations and preferred secyrities and the related interest, preferred The construction program of the Company is currently stock dividends, leases, derivatives, and other purchase estimated to be $1.9 billion for 2007, $1.8 billion for commitments are as follows. See Notes 1, 6, and 7 to the 2008, and $1.8 billion for 2009. Environmental financia! statements for, additional information. II- 157

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report Contractual Obligations 2008- 2010- After 2007 2009 2011 2011 Total (in millions) Long-term debt(a)-. Principal $ 304 $ 328 $ 119 $ 4,768 $ 5,519 Interest 285 537 506 5,411 6,739 Preferred stock dividends~b) 3 6 - - 15 Derivative obligations(c) , 42 4 - 46 Operating leases 32 55. , 44 42 173 Purchase commitments(d),-- . , , -. ;. 266 Capital(>. 1,829 3,437 - Coal 1,638, 2,446 392 44 4,520 Nuclear fuel 94 161 222., 169 .. 646 Natural gast0 647 .76 .464,.1, 1,914. 3,901 Purchased power 355 724 479- 1,255 2,813 Long-term service agreements 12 26 34 139 211 Trusts -- Nuclear decommissioning(g) .7 14 14. 110. 145 Postretirement benefits () .16 .,43 .-. . 59 Total $5,264 $8,657 $2,280 $13,852 $30,053 (a) All amounts are reflected based on finai maturity dates. The Company plans to continue to retire higher-cost securities and replace these obligations with lower-cost capital if market conditions permit. Variable rate interest obligations are estimated based on rates

     .as of January 1, 2007, asL reflected in thd statements' of capitalization. Fixed rates include, where applicable, the effects of interest rate derivatives employed to manage interest rate risk.,

(b) Preferred stock does not mature; therefore, amounts provided are for the next fiv'e' years only. (c) For additional information see Notes 1 and 6 to the financial statements. (d) The Company generally does not enter into non-cancelable commitments for other operations and maintenance expenditures. Total other operations and maintenance expenses for the last three years were $1.6 billion, $1.6 billion, and $1.5 billion, respectively. (e) The Company forecasts capital expenditures over a three-year period. Amounts represent current estimates of total expenditures, excluding those amounts related to contractual purchase commitments for uranium and nuclear fuel conversion, enrichment, and fabrication services. At December 31, 2006, significant purchase commitments were outstanding in connection with the construction program. (f) Natural gas purchase commitments are based on various indices at the time of delivery. Amounts reflected have been estimated based on the New York Mercantile Exchange future prices at December 31, 2006. (g) Projections of nuclear decommissioning trust contributions are based on the 2004 Retail Rate Plan. (h) The Company forecasts postretirement trust contributions over a three-year period. No contributions related to the Company's pension trust are currently expected during this period. See Note 2 to the financial statements for additional information related to the pension and postretirement plans, including estimated benefit payments. Certain benefit payments will be made through the related trusts. Other benefit payments will be made from the Company's corporate assets. 11-158

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 2006 Annual Report Cautionary Statement Regarding Forward-Looking i investment performance of the Company's employee Statements benefit plans; The Company's 2006'Annual' Report contains forward- " advances in technology; looking statements. Forward-looking statements include, " state and federal rate regulations and the impact of among other things, statements concernftig retail sales pending and future rate cases and negotiations, growth, retail rates, fuel cost recovery, environmental including rate cases related to fuel cost recovery; regulations and expenditures, the Comtiy'ýs- rojections for postretirement benefit trust contributfions,financing

internal restructuring or other restructuring options that activities, access to'sources of capital, flue inipacts of the may be pursued; ..

adoption of new accounting rules, completiop'of . potential- business strategies, including acquisitions or*' construction projects, and estimated construction and dispositions of assets or businesses; which cannot be.. other expenditures. In some cases, forward-lo.king assured to be completed or beneficial to the Company, statements can be identified by terminology such as ,"may," "will," "could," "should' "expects,"tplans,"

the ability of counterparties of the Company to make "anticipates," "believes," ."estimates," "projets," payments as and when due; "predicts:' "potential,",or "continue" or the-negative of
the ability to obtain new short- and long-term these terms or other similar terminology, T'here are contracts with neighboring utilities; yarious factors that could cause actual re.sults to differ materially from those suggested by the forward-looking
the direct or indirect effect on the Company's business statements; accordingly, there can be no assurance that .... resulting from-terrorist incidents and the threat of such indicated results-will be realized. l'hese factors terrorist incidents; - -

include: -

interest rate fluctuations and financial market
the impact of regent and future federal and state conditi'ns and the resulis of financing efforts, regulatory change, including legislative and regulatory including the Company's credit ratings;.

initiatives regarding'deregulation andjrestructuring of

the ability of the Company to obtain'additional' -

the electric utility industry, implementop of the generating capacity at Competitive prices;. Energy Policy Act of 2005, and also changes in environmental, tax, and other laws and.regulations to

catastrophic events such as fires, earthquakes, which the Company is subject; as well as -changes in- -explosions,floods, hurricanes, pandemic health events-application of existing laws and regulationg; . - such as -an -avian influenza, or oftier similar ' *- -

occurrences; - ., - .

   .current and future litigation, regulatory investigations, proceedings, or inquiries, including FERC Pmatters and           . the direct or indirect effects on the Company's the pending EPA civil action against:the Company;                     business resulting from incidents similar to the!August
                                                                ...... 2003 power outage in the Northeast;

the effects, extent,-and timing 6f-the-entr-y.of

                                                                      -    the-effectof accounting pronouncements issued
  - additional competition in the markets in which the Company operates;                                                     periodically by standard-setting bodies; and r

variations in demand for electricity, including those
other factors discussed elsewhere herein and in other relating to weather, the general economy and reports (including the Form 10-K) filed by the population, and business growth (and declines); Company from time to time with the SEC.
available sources and costs of fuels; The Company expressly disclaims any obligation to
ability to control costs; update any forward-looking statements.

11-159

STATEMENTS OF INCOME For the Years Ended December 31, 2006, 2005, and 2004 Georgia Power Company 2006 Annual Report 2006 2005 2004 fin thousands) Operating Revenues: Retail revenues $6,205,620 $6,064,363 $5,118,751 Sales for resale . Non-affiliates 551,731 524,800 251,581 Affiliates 252,556 275,525 172,375 Other revenues 235,737 211,149 185,061 Total operating revenues 7,245,644 7,075,837 5,727,768 Operating Expenses: Fuel 2,233,029 1,937,378 1,288,491 Purchased power-- Non-affiliates 332,606 421,033 316,390 Affiliates 812,433 895,243 785,359 Other operations 1,025,848 1,009,993 962,390 Maintenance 534,621- 561,464 522,945 Depreciation and amortization 498,754 526,652 296,740 Taxes other than income taxes 298,824 276,027 243,051 Total operating expenses 5,736,115 5,627,790 4,415,366 Operating Income 1,509,529 1,448,047 1,312,402 Other Income and (Expense): Allowance for equity funds used during construction 31,524 29,145 29,038 Interest income 2,459 6,537 6,865 Interest expense, net of amounts capitalized (258,437) (235,976) (194,415) Interest expense to affiliate trusts (59,510) (59,510) (44,565) Distributions on mandatorily redeemable preferred securities " (15,948) Other income (expense), net 8,833 6,971 (14,512) Total other income and (expense) (275,131) (252,833) (233,537) Earnings Before Income Taxes 1,234,398 1,195,214 1,018,865 Income taxes 442,334 447,448 393,902 Net Income 792,064 747,766 684,963 Dividends on Preferred Stock 4,839 3,393 2,170 Net Income After Dividends on Preferred Stock $ '787,225 - $ 744,373 $ 682,793 The accompanying notes are an integral part of these financial statements. 11-160

STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2006, 2005, and 2004 Georgia Power Company 2006 Annual Report

                                                                                     ......                 2006             .2005                                  2004 (in thousands)

Operating Activities: Net income $ 792,064 $ 747,766 $ 684,963 Adjustments to reconcile net income to net cash provided from operating activities -- Depreciation and amortization 588,428 616,963 385,668 Deferred income taxes and investment tax credits, net 16,159 .257,501 . :, 265,064

     - Deferred expenses -- affiliates                                                                       1,558                    1,268                       (10,563)

Allowance for equity funds used during construction : l(31,524) J.(29,145) (29,038) Pension, postretirement, and other employee benefits 18,604 (03,335) (11,002) Stock option expense 5,805 - - Tax benefit of stock options 1,163 17,263 .10,562 Other, net 1,735 . (8,201) (27,519)

    ' ' Changes in certain current assets and liabilities --

Receivables 1,193 (650,593) (258,737) Fossil fuel stock (194,256) (2,898) (48,668) Materials and supplies.., 31,317 (55,805) (224)

           -   Prepaid income taxes                                                                          1,060                 (38,975)                        10,624 Other current assets "                                                                           774                   3,585            *          (25,263)

Accounts payable - (85,189) 122,117 142,136 Accrued taxes ... . 82,735 77,164 (60,859) Accrued compensation *. . (10,328) 4,162; (6,704) Other current liabilities (21,054) 34,029,. 4,012 Net cash provided from operating activities 1,200,244 1,082,866 1,024,452 Investing Activities: Property additions .- .... ...-.... -. (1,179,498) (891 ,34) (788'828) Nuclear decommissioning trust fund purchases (464,274) (381,235) (541,048) Nuclear decommissioning trust fund sales 457,394 372,536 532,349 Purchase of property from affiliates - (414,582) Cost of removal net of salvage . (33,620)._ (30,764) i (22,642) Change in construction payables, net of jint owner portion 35,075. 4,190 . 1,978 Other .(16,005) (788) (5,101) Net cash used for investing activities (1,240,928) "' (927,375) . (1,237,874) Financing Activities: Increase in notes payable, net 406,768 - 97,713 - 91,523 Proceeds --

      -.-Senior   notes                       .       ......                                            - 150,000                  625,000                        635,060 Preferred stock                                                                                           -        **                                      45,000 Pollution control bonds           ....                                             .       .153,910                       185,000                          -

Gross excess tax benefit of stock options 2,796 .... - S.Mandatorily redeemable preferred securities .. - 200,000

        .Capital contributions from parent company                                                        312,544                   149,475                       307,323 Other long term debt Redemptions...                           "-",                                               ,1       -         ..
                                                                                                                                                  ,    :        , 10,000.

Pollution control bonds . (153,910) (185,000) . Capital leases (136) (1,095) (1,01.4) Senior notes ...... -150,000) - (450,000) (200,000) First mortgage bonds * (20,000) Preferred stock- . . (14,569) ... Mandatorily redeemable prefeired securities - - - (240,000)

   -     Other long term debt                                                                                      -                                               (30,000)

Payment of preferred stock dividends (2,958) (3,246) (1,479) Payment of common stock dividends (630,000) (582,800) (588,700) Other (8,049) (21,760) (18,514) Net cash provided from (used for) financing activities 46,396 (186,713) 209,139 Net Change in Cash and Cash Equivalents 5,712 (31,222) (4,283) Cash and Cash Equivalents at Beginning of Year 11,138 42,360 46,643 Cash and Cash Equivalents at End of Year $ 16,850 $ 11,138 $ 42,360 Supplemental Cash Flow Information: Cash paid during the period for-- Interest (net of $12,530, $11,949, and $10,392 capitalized, respectively) $ 317,536 $ 263,802 $ 238,270 Income taxes (net of refunds) 398,735 196,930 131,696 The accompanying notes are an integral part of these financial statements. 11-161

BALANCE SHEETS At December 31, 2006 and 2005 Georgia Power Company 2006 Annual Report Assets 2006 2005 (in thousands) Current Assets: Cash and cash equivalents $ 16,850 $ 11,138 Receivables - Customer accounts receivable 474,046 447,270 Unbilled revenues 130,585 148,526 Under recovered regulatory clause revenues 353,976 483,673 Other accounts and notes receivable 93,656 112,452 Affiliated companies 21,941 81,474 Accumulated provision for uncollectible accounts (10,030) (9,563) Fossil fuel stock, at average cost 392,011 197,754 Vacation pay 61,907 59,190 Materials and supplies, at average cost 304,514 335,684 Prepaid expenses 74,788 73,216 Other 72,041 59,373 Total current assets 1,986,285 2,000,187 Property, Plant, and Equipment: In service 21,279,792 20,636,505 Less accumulated provision for depreciation 8,343,309 7,972,913 12,936,483 12,663,592 Nuclear fuel, at amortized cost 180,129 134,798 Construction work in progress 923,948 584,470 Total property, plant, and equipment 14,040,560 13,382,860 Other Property and Investments: Equity investments in unconsolidated subsidiaries 70,879 70,664 Nuclear decommissioning trusts, at fair value 544,013 486,591' Other 58,848 73,271 Total other property and investments 673,740 630,526 Deferred Charges and Other Assets:. Deferred charges related to income taxes 510,531 512,337 Prepaid pension costs 688,671 455,514 Deferred under recovered regulatory clause revenues 544,152 343,804 Other regulatory assets 629,003 340,938 Other 235,788 232,279 Total deferred charges and other assets 2,608,145 1,884,872 Total Assets $19,308,730 $17,898,445 The accompanying notes are an integral part of these financial statements. 11- 162

BALANCE SHEETS At December 31, 2006 and 2005 Georgia Power Company 2006 Annual Report Liabilities and Stockholder's Equity 2006 2005 (in thousands) Current Liabilities: Securities due within one year $ 303,906 $ '188,319 Notes payable 733,281 326,513 Accounts payable-- Affiliated 238,093 305,754 Other 402,222 379,810 Customer deposits . 155,763 - 136,360 Accrued taxes .. Income taxes 217,603 128,560 Other 275,098, 206,687 Accrued interest 74,643 92,109 Accrued vacation pay 49,704 48,388 Accrued compensation *,* , 141,356 .143,255 Other 125,494 132,547 Total current liabilities -.. -. 2,717,163 " 2,088,302 Long-term Debt (See accompanying statements) . 4,242,839 4,396,250 Long-term Debt Payable to Affiliated Trusts (See accompanying statements) 969,073 969,073 Deferred Credits and Other Liabilities: Accumulated deferred income taxes j 2,815,724 2,849,727 Deferred credits related to income taxes 157,297 166,736 Accumulated deferred investment tax credits 282,070 295,024 Employee benefit obligations 698,274 391,854 Asset retirement obligations .626,681 634,932 Other cost of removal obligations 436,137 445,189 Other regulatory liabilities 281,391 99,385 Other 80,839 65,981 Total deferred credits and other liabilities 5,378,413 4,948,828 Total Liabilities 13,307,488 .12,02,453 Preferred Stock (See accompanying statements) 44,991 43,909 Common Stockholder's Equity (See accompanying statements) 5,956,251 5,452,083 Total Liabilities and Stockholder's Equity $19,308,730 $17,898,445 Commitments and Contingent Matters (See notes) The accompanying notes are an integral part of these financial statements. ..

Ih163

STATEMENTS OF CAPITALIZATION At December 31, 2006 and 2005 Georgia Power Company 2006 Annual Report 2006 2005 2006 2005 (in thousands) (percent of total) Long-Term Debt: First mortgage bonds -- 6.9% due May 1, 2006 $ $ 20,000 Long-term notes payable -- 6.20% due February 1, 2006 - 150,000 4.875% due July 15, 2007 300,000 300,000 6.55% due May 15, 2008 45,000 45,000 4.10% due August 15, 2009 125,000 125,000

    -Variable rate (5.54% aL 1/1/07) due 2009                                    150,000                 150,000 4.00% due 2011                                                              100,000                 100,000
    .4.90% to 6.00% due 2012-2045                                              2,050,000               1,900,000 Total long-term notes payable'                                                  2,770,000               2,770,000 Other long-term debt --

Pollution control revenuer bonds: 2.83% to 5.45% due 2012-2036 774,370 812,560 Variable rate (3.50% to 4.05% at 1/1/07) due 2011-2041 929,475 891,285 Total other long-term debt 1,703,845 1,703,845 Capitalized lease obligations 76,227 79,564 Unamortized debt premium (discount), net (3,327) (3,449) Total long-term debt (annual interest requirement --

  $225.7 million)                                                              4,546,745               4,569,960 Less amount due within one year                                                   303,906                 173,710 Long-ierm debt excluding aminurt due within one year                                                                     4,242,839               4,396,250     37.9%            40.5%

Long-term Debt Payable to Affiliated Trusts: 4.88% to 7.13% due 204212044 (annual interest requirement -- $59.5 million) 969,073 969,073 8.6 8.9 Preferred Stock: Cumulative preferred stock. $100 stated value at 4.60% Authorized -- 5,000,000 shýares Outstanding -- 2006: 0 shares

               -- 2005: 145,689 shares                                                                     14,609 Non-cumulative preferred stock

$25 par value - 6.125% Authorized -- 50,000,000 shares Outstanding -- 1,800,000 shares 44,991 43,909 (annual dividend requirement -- $2.8 million) Total preferred stock 44,991 58,518 Less amount due within one year -- 14,609 Total preferred stock excluding amount due within one year 44,991 43,909 0.4 0.4 Common Stockholder's Equity: Common stock, without par value - Authorized: 20,000,000 shares Outstanding: 9,261,500 shares 398,473 398,473 Paid-in capital 3,039,845 2,717,539 Retained earnings 2,529,826 2,372,637 Accumulated other comprehensive income (loss) (11,893) (36,566) Total common stockholder's equity 5,956,251 5,452,083 53.1 50.2 Total Capitalization $11,213,154 $10,861,315 100.0% 100.0% The accompanying notes are an integral part of these financial statements., 11-164

STATEMENTS OF COMMON STOCKHOLDER'S EQUITY For the Years Ended December 31, 2006, 2005, and 2004 Georgia Power Company 2006 Annual Report Other Common Paid-In Retained Comprehensive

                                                                -Stock            Capital               Earnings             Income (loss)             Total (in thousands)

Balance at December.31, 2003 $398,473 $2,232,956 -$2,116,949 $(25,079) $4,723,299 Net income after dividends on preferred stock " - 682,793 - 682,793 Capital contributions from parent company. - 317,885 - - 317,885 Other comprehensive income (loss) .- " (11,961) (11,961) Cash dividends on common stock - ' (588,700) - (588,700) Other - (40) - , -,(40) Balance at December 31, 2004 398,473 2,550,801 " 2,211,042 (37,040) 5,123,276 Net income after dividends on preferred stock " 744,373 7 - 744,373 Capital contributions from parent. company - 166,;738 ' - " 166,738 Other comprehensive income (loqs) ' - - 474 474 Cash dividends on common stock (582,800) (582,800) Other ',22 22 Balance at December 31, 2005. 398,473 2,717,539.,, 2,372,637 (36,566) 5,452,083 Net income after dividends on preferred stock. - . 787,225. 787,225 Capital contributions from parent company 32,3066 3- 322,306 Other comprehensive income (loss)', - " 5,184 5,184 Adjustment to initially apply FASB Statement No. 158, net of tax . . .- - - 19,489 19,489 Cash dividends on common stock , - (630,000) - (630,000) Other :.*:- - (36) (36) Balance at December 31, 2006, - $398,473 $3,039,845 $2,529,826 $(11,893) $5,956,251 The accompanying notes are an integral part of these financial statements. STATEMENTS OF COMPREHENSIVE INCOME For the Years Ended December 31,2006, 2005, and 2004 Georgia Power Company 2006 Annual Report . 2006 2005 2004 S" r(in thousands) Net income after dividends on preferied stock" $787,225 $744,373 $682,793 Other comprehensive income (loss): Change in additional minimum pension liability, net of tax of $5,143, $(2,216) and

     $(4,115), respectively..                                                                      I                        8,155       (3,512)          (6,523)

Change in fair value of marketable securities, net of tax of $(494),"$3171and

     $(114), respectively                                                              .                                     (817)           501           (181)

Changes in fair value of qualifying hedges, net of tax of $(935), $1,522 and

     $(4,885), respectively                              '             .            ..                                     (1,454)        2,420          (7,744)

Less: Reclassification adjustment .for amounts included in net income,*net of tax of

     $(441), $861 and $1,568, respectively'                "                                                                 (700)         1,065          2,487 Total other comprehensive income (loss)                                                                          5,184 j          474        (11,961)

Comprehensive Income $792,409- $744,847 $670,832 The accompanying notes are an integral part of these financial statements. 11-165

NOTES TO FINANCIAL STATEMENTS Georgia Power Company 2006 Annual Report

1. .

SUMMARY

OF SIGNIFICANT The Company is subject to regulation by the Federal ACCOUNTING POLICIES Energy Regulatory Commission (FERC) and the Georgia Public Service Commission (PSC). The Company follows General accounting principles generally accepted in the United Georgia Power Company (the Company) is a wholly States and complies with the accounting policies and owned subsidiary of Southern Company, which is the practices prescribed by its regulatory commissions. The parent company of four traditional operating companies, preparation of financial statements in conformity with Southern Power Company (Southern Power), Southern accounting principles generally accepted in the United Company Services (SCS), Southern Communications States requires the use of estimates, and the actual results Services (SouthemLINC Wireless), Southern Company may differ from those estimates. Holdings (Southern Holdings), Southern Nuclear Affiliate Transactions Operating Company (Southern Nuclear), Southern Telecom, and other direct and indirect subsidiaries. The The Company has an agreement with' SCS under which traditional operating companies - Alabama Power, the the following services are rendered to ihe Compahy at Company, Gulf Power, and Mississippi Power - provide direct or allocated cost genei-al and design-engineering, electric service in four Southeastern states. The Company purchasing, accounting and statistical analysis, finance operates as a vertically integrated utility providing and treasury, tax, information resources, marketing, electricity to retail customers within its traditional service auditing, insurance and pension administration, human area located within the State of Georgia and to wholesale resources, systems and procedures, and' other services: customers in the Southeast. Southern Power constructs, with respect to, business and operations and power pool acquires, and manages generation assets and sells' operations. Costs for these services amounted to electricity at market-based rates in the wholesale market. $386 million in 2006, $348 million in 2005, and SCS, the system service company, provides at cost, $310 million' in 2004*. Cost allocation methodologies used sp'ecialized services to Southern Company and its by SCS were approved by the Securitieg and Exchange subsidiary companies. SouthernLINC Wireless provides Commission prior to the repeal of the. Public Utility digital wireless communications serivices to the traditional Holding Company Act of 1935, as amended, and operating companies and also markets. iliese services t6o - management believes they are reasonable. The FERC, the public within the Southeast. Southern Telecom permits services to be rendered at cost by system service provides fiber cable services within the Southeast. companies. Southern Holdings is an intermediate holding company The Company has an agreement with Southern . subsidiary for Southern Company's investments in Nuclear under which the following nuclear-related synthetic fuels and leveraged leases and various other services are rendered to the Company at cost: general energy-related businesses. Southern Nuclear operates and executive and advisory services, general operations, provides services to Southern Company's nuclear power management and technical services, administrative plants. On January 4, 2006, Southern Company completed services including procurement, accounting, employee the sale of substantially all the assets of Southern relations, systems and procedures services, strategic Company Gas, its competitive retail natural gas marketing planning and budgeting services, and other services with subsidiary. respect to business and operations. Costs for these services amounted to $348 million in' 2006, $328 million Effective July 1, 2006, the Company merged with Savannah Electric. The Company has accounted for the in 2005, and $311 million in 2004. merger in a manner similar, to a pooling of interests, and The Company has an agreement with Southern the Company's financial statements now reflect the , Power under which the. Company operates and maintains merger as though it had occurred on January 1, 2004. See Southern Power owned Plants Dahlberg, Franklin,, and Note 3 under "Retail Regulatory Matters -, Merger" for Wansley at cost. Billings under these. agreements with. additional information. Southern Power amounted to $5.4 million in 2006,

                                                                      $5.2 million in 2005, and $4.8 million in 2004.

The equity method is used for subsidiaries in which the Company has significant influence but does not The Company has an agreement with SOuthernLINC control and for variable interest entities wheire-the Wireless under which the Company receives digital Company is not the primary beneficiary. Certain prior wireless conmmunications services and purchases digital years' data presented in the financial statements have equipment. Costs for these services amounted to been reclassified to conform with the current year $7.1 million in 2006, $7.7 million in 2005, and presentation. $8.0 million in 2004. U-166

NOTES (continued) Georgia Power Company 2006 Annual Report I Southern Company's 30 percent ownership interest in "The traditional operating companies, including the> Alabama Fuel Products, LLC (AFP), which produces' Company, and Southern Power may jointly enter into synthetic fuel, was terminated July 1, 2006. The!Company various types of wholesale energy, natural gas, and certain has an agreement with an indirect subsidiary of Southern: other contracts, either directly or through SCS as agent., Company that provides services for AFP. Under this Each participating company may be jointly and, severally agreement, the Company provides certain accounting liable for the obligations incurred under these agreements. functions, including processing and paying fuel See Note 7 under "Fuel Commitments" for additional transportation invoices, and the Company is reimbursed information. for its expenses. Amounts billed under this agreement Regulatory Assets and Liabilities: totaled approximately $76 million idi 2006, $61 million in 2005, 'and $53 million in 2004. In adc1iti6n,ý the Company The Company is subject to the provisions of Financial purchases Synthetic fuel from AFP for use at Plant Accounting Standards Board (FASB) Statement No. 71, Branch. Fuel purchases totaled $146 million lhrough': "Accounting for the Effects of Certain Types~of June 30,'2006, $216 million in 2005, and $163 million in Regulation'! (SFAS No. 71). Regulatory assets represent 2004. - '. . probable future revenues associated with certain costs that are .expected to be recovered from Fustomers through the The Company has entered into sevbral puichased ratemaking process. Regulatory liabilities represent power agreements (PPAs) with Southern Power for probable future reductions in revenues associated with capacity and energy. Expenses associated With these PPAs amounts that gte expected to be credited to customers were $407 million, $469 milliori, and $314 million in through the ratemaking process. T' 2006, 2005, and 2004, respectively. Additionally, the Company had $28 million and $29 '"illion of prepaid' Regulatory assets and (liabilities) reflected in the, capacity expenses included in deferred charges and other Company's balance sheets .at December 31 relate to the follo~wng: o ,, , . :. .* .. . . ..! . assets in the balance, sheets at December 3,1, 2006 and 2005, respectively. See Note 7 under "Purchased Power 2006 2005 Note Commitments" for additional inforpiation.- (in millions) Deferred income tax chargds` $511 '$513 (') The Company has an agreement with Gulf Power 171 177 (b) Premium on reacquired debt under which Gulf Power jointly owns a portion of Plant Vacation pay 62 -59 (c) Scherer. Under this agreement, the Company operates 51 .52,.(d Corporate, building lease !8, (d). Plant Scherer, and Gulf Power reimburses the Company ,51.: Postretirement benefits for its proportionate share of the related ,xpenses which 56, ý...53, (e) Generating plant outage costs,. were $8.0 million in 2006, $4.3 million in 2005, and Underfunded, retiree benefit plans . 310, -

$6.8 million in 2004. See Note 4 for additional                                                                              58       12(g),

Fuel-hedging assets . information. Other :rgulatqry assets . 27., 30.: (d)

                                                                                                                            .5.3 . 7,,l.".(a),

Asset; rtire.,ent obligations (.i436). (45)1 (a) The Company provides incidental pservices to other, Other cost of removal obligations Southern Company subsidiaries which are generally minor in duration and amount. Howeyer, with. te hunqcan~e Deferred income tax credits (157) (167) (a) Envir6nniental remediation -(16) ':(19) (h) damage experienced by Alabama Power, Gulf Power, and -(19). '(33) J'h) Purchased power, Mississippi Power in 2005, assistance provided to aid -in Overfunded retiree' benefit plans (218) -. :' storm, restoration, including company labor, contract Fuel-hedging liabilities ..... ' 7 . (6) (47) (g) labor, and. materials, caused an increase :in these activities. Other regulatory liabilities. (4) (4) (d) The total amount of storm assistance provided .to. Alabama Power, Gulf Power, and Mississippi Power in Total ....... $ 458 $ 270 2005 was $4.3 million, $5.0 million, and $55.2 million, Note::'Tlie recovery and amortization periods for these respectively. These activities were billed at cost. regulatory assets'and (liabilities) are as follows: (a) Asset retirement and removal liabilities are recorded, Also see Note 4 for information'regarding the deferred income tax assets are recovered, and deferred tax Company's' ownership in and PPAwith Southern Electric liabilities are amortized over the related property lives, Generating Company (SEGCO),andNote'5 for; ".: . 1 'ivhich may 'range ul to 60 'years. Asset retirement and information on certain deferred tax liabilities due to removal liabilities will be settled and trued up folloWing affiliates. w'.7. completion of the*related activities. 11-167

NOTES (continued) Georgia Power Company 2006 Annual Report (b) Recovered over either the remaining life of the original of the cost of nuclear fuel and a charge, based on nuclear issue or, if refinanced, over the life of the new issue which generation, for the permanent disposal of spent nuclear may range up to 50 years. fuel. Total charges for nuclear fuel included in fuel (c) Recorded as earned by employees and recovered as paid, expense amounted to:$71 million in 2006, $70 million in

    . generally within one year.                                           2005, and $73 million in 2004.

(d) Recorded and recovered or amortized as approved by the Georgia PSC. Nuclear Fuel Disposal Costs (e) See "Property, Plant, and Equipment" herein. The Company has contracts with the U.S. Department of (f) Recovered and amortized over the average remaining Energy (DOE) that provide for the permanent disposal of service period which may range up to 17 years. See Note 2 spent nuclear fuel. The DOE failed to begin disposing of under "Retirement Benefits.!' spent nuclear fuel in 1998 as required by the contracts, (g) Fuel-hedging assets and liabilities are recorded over the and the Company is pursuing legal remedies against the life of the underlying hedged purchase contracts, which government for breach of contract. Sufficient pool storage generally do not exceed 42 months. Upon final settlement, capacity for spent fuel is available at Plant Vogtle to costs are recovered through the fuel cost recovery clauses. maintain full-core discharge capability for both units into (h) Amortized over a three-year period ending in 2007. See 2014. Construction of an on-site dry storage facility at Note 3 under "Retail Regulatory Matters - Rate Plans." Plant Vogtle is expected to begin in sufficient time to In the event that a portion of the Company's maintain pool full-core discharge capability. At Plant operations is no longer subject to the provisions of. Hatch, an on-site dry storage facility is operational and SFAS No. 71, the Company would be required to write can be expanded to accommodate spent fuel through the off related regulatory assets: and liabilities that are not expected life of the plant. specifically recoverable through regulated rates. In Also, the Energy Policy Act of 1992 established a addition, the Company would be required to determine if Uranium Enrichment Decontamination'and' any impairment to other assets, including plant, exists Decommissioning Fund, which has been funded in part by and, write down the assets, if impaired, to their fair value. a special assessment on utilities with nuclear'plants. This All regulatory assets and liabilities are reflected in rates. assessment was paid over a 15-year period; the final installment occurred in 2006. This fund will be used by, Revenues the DOE for the decontamination and decommissioning of its nuclear fuel enrichment facilities. The law provides Energy and other revenues are recognized as'services are that utilities will recover these payments in the same provided. Unbilled revenues are accrued at the end of manner as any other fuel expense. each fiscal period. Electric rates for the Company include provisions to adjust billings for fluctuations in fuel costs and the energy component of purchased'power costs, and State Tax Credits certain other costs. Revenues are adjusied for'differences The State of Georgia provides a tax credit for qualified between the actual recoverable costs and amounts billed investment property to manufacturing companies that in current regulated rates. construct newý facilities. The credit ranges from 1 percent Retail fuel cost recovery rates require periodic filings to 8 percent of qualified construction expenditures with the Georgia PSC. The Company is required to file its depending upon the county in which the new facility is next fuel case by March 1, 2008. See Note 3 under located. The Company's policy is to recognize these "Retail Regulatory Matters - Fuel Cost Recovery:' credits when management believes that they are more likely than not to be allowed by the Georgia Department The Company has a diversified base of customers. of Revenue. State tax credits of $19.9 million, No single customer or industry comprises 10 percent or $9.4 million, and $13.1 million were recorded in 2006, more of revenues. For all periods presented, uncollectible 2005, and 2004, respectively. accounts averaged less than 1 percent of revenues. Property, Plant, and Equipment Fuel Costs Property, plant, and equipment is stated at original cost, Fuel costs are expensed as the fuel is used. Fuel expense less regulatory disallowances and impairments. Original includes the cost of purchased emission allowances as cost includes: materials; labor; minor items of property; they are used. Fuel expense also includes the amortization appropriate administrative and general costs; payroll-11-168

NOTES (continued) Georgia Power Company 2006 Annual Report related costs such 'as taxes, pensions,%and other benefits; IWhen property subject to depreciation is retired or and the interest capitalized and/or cost of funds used otherwis6 disposed of in the normal course of business, its during construction. original 'costtogether with the cost of removal, less salvage, is charged to accumulated depreciation. Minor The Company's property, plant, and equipment itemjs of property included in the original cost of the plant consisted of the following at December 31 (inmillions): are retired when the related property unit is retired.

                   ),'. [ .;    :'"  ,  .  "L'*   ".      A     'C flt~tt :       "t*r   :

Underbthe Company's retail rate plan for the three Generation $10,064 ,$. 9,988 years ending December 31, 2007 (2004 Retail Rate Plan), Transmission .,: 3,331 3,144 the Companiy was ordered to recognize Georgia PSC - Distribution 6,652 '.6,365 certified'capdcity costs in rates evenly over the three General 1,205 .1,111 years covered by the 2004 Retail Rate Plan. The Plant acquisition adjustment 28 28 Company recorded a credit to amortization of $14 million

                                                                      $20,636             in 2006-as well as $33 million in 2005. Under the retail Total plant in service                                u~$21,280 rate plan'for the Company ending December 31, 2004 (2001 Retail Rate' Plan), the Georgia PSC ordered the The-cost of replacements of property, eXclusive'of Comphny to amortize $333 'million, the cumulative '

minor items of property, ig capitalized: The cost lof * , balance: :Of accelerated depreciation and amortization maintenance, repairs, and replacemenf of rindr'items of previbdily iexplnsed, equally Over three years as a credit property is charged to maintenance -rexpense'as incurred or to depieciatibn and amortization expense beginning performed with the exception of certainigenerating! pla'ntu, Janudry'2002: The 'Company also was ordered to ý maintenance costs. As mandated by Uhe Georgia PSC, the' recognize new certified capacity costs in rates evenly over Company defers and amortizes -nuclear.refueling costs the'sniie three-year period under the 2001 Retail Rate over the unit's*operating cycle before the neit refueling. Pla-hAS. asresult, the Company recorded a reduction in The refueling cycles: are 18 and 24 inonthg for Plants depreciation and: amortization expense'of $77 million in Vogtle and Hitch, respectively. Also, in accordance with 2004. See' Note 3 under "RetailRegulatory Mlatters - Rate the Georgia PSC order, the Company defers the costs of PlansW'6for additional information. certain significant inspection costs for the combustion, -'. turbines at Plant McIntosh and amortizes such costs over 10 years, which approximates the expected maintenance Asset Reti-rement Obligations cycle. and Other"'Costs of Removal EffectiveJaniuary 1, 2003, the Company adopted FASB Income and Other Taxes *. . . . :, . I Statement No.' 143', "Accounting for Asset Retirement' The Company uses the liability method of accounting for Obligatipns" (SFAS No. 143), which established new deferred income taxes and provides deferred income taxes accounting'alid iepor ting standards for legal obligations for all significant income tax temporary differences. ,. associated with the ultimate costs of retiring long-lived Investment tax credits utilized Are deferred and amortized assets. The ,present value of the ultimate costs for an to income over the average lives of the related property. asset's future retirement is recorded in the period in Taxes that are collected from customers on behalf of which the liability is incurred. The costs are capitalized as governmental agencies to be remitted to these agencies part of the related long-lived asset and depreciated over are presented net on the statements.of income. the asset's useful life. In addition, effective December 31, 2005, the Company adopted the provisions of FASB Interpretation No. 47, "Conditional Asset Retirement Depreciation and Amortizaition Obligations'_' (FIN 47), which requires that an asset Depreciation of the original 'cost of utility plant in service retiiement Obligation be recorded even though the timing is provided primarily by using composite straight-line' and/or method of settlement are conditional on future rates, which approximated 2.6 percent in each of 2006,'" events. Prior to December 2005, the Company, did not 2005, and 2004. Depreciation" studies are conducted . . recognize asset retirement obligations for asbestos periodically to update the composite rates that are removal:because the timing of their retirements was approved by the Georgia PSC' Effective January 1,2005, dependent; on' future eVents. The Company has received the Company's depreciation i'ates were revised by the'- approval from the Georgia PSC allowing the continued Georgia PSC. The revised depreciation rates had no accrual ofOther future :retirement costs for long-lived material impact on the Company's financial statements.' assets that the Company'does hot have a legal obligation 11-169

NOTES (continued) Georgia Power Company 2006 Annual Report to retire. Accordingly, the accumulated removal costs for regulations. Use of the funds is restricted to nuclear these obligations will continue to be reflected in the decommissioning activities and the funds are managed balance sheets as a regulatory liability. Therefore, the and invested in accordance with applicable requirements Company had no cumulative effect to net income of various regulatory bodies, including the NRC, the resulting from the adoption of SFAS No. 143 or FIN 47. FERC, and state PSCs, as well as the Internal Revenue Service (IRS). The trust'funds -are invested in a tax-The liability recognized to retire long-lived assets efficient manner in a diversified mix of equity and fixed primarily relates to the Company's nuclear facilities, income securities and are classified as available-for-sale. which include the Company's ownership interests in The trust funds'are included in the balance sheets at fair Plants Hatch and Vogtle. The fair value of assets legally value, as obtained from quoted market prices for the same restricted for settling retirement obligations related to or similar investments. As the external trust funds are nuclear facilities as of December 31, 2006.was actively managed by unrelated parties with limited $544 million. In addition, the Company has retirement direction from the Company, the Company does not have obligations related to various landfill sites, ash ponds, and the ability to choose to hold securities with unrealized underground storage tanks. In connection with the losses until recovery. Through 2005, the Company adoption of FIN 47, the Company also recorded considered other-than-temporary impairments to be additional asset retirement obligations (and assets) of immaterial.. However, since the January 1, 2006 effective approximately $95 million related to asbestos removal... date of FASB Staff Position FAS 115-1/124-1, "The The Company also has identified retirement obligations Meaning of Other-Than-Temporary Impairment and Its related to certain transmission and distribution facilities, Application to Certain Investments" (FSP No. 115-1), the leasehold improvements, equipment on customer property, Company considers all unrealized losses to represent and property associated with the Company's rail lines., other-than-temporary impairments. The adoption of FSP However, liabilities for the removal of these assets have. No. 115-1 had no impact on the results of operations, not been recorded because, no reasonable estimate can be cash flows, or financial condition of the Company as all made regarding the timing of any related retirements. The losses have been and continue to be recorded through a Company will continue to recognize in the statements of regulatory liability, whether realized, unrealized, or income the allowed removal costs in accordance with its identified as other-than-temporary. Details of the regulatory treatment. Any difference between costs securities held in these trusts at December 31 are as recognized under SFAS No. 143 and FIN 47 and those follows: reflected in rates are recognized as either a regulatory asset or liability in the balance sheets as oidered by the Georgia PSC. See "Nuclear Decommissioning" herein for Other-than-further information on amounts included in rates. Unrealized Temporary Fair Details of the asset retirement obligations included in 2006 Gains Impairments Value the balance sheets are as follows: (in millions) Equity $106.9 $(5.0) $378.3 2006 2005 Debt 3.0- (0.7) 165.4 (in millions) Other . 0.3 Balance beginning of year $635 $510 Total $109.9 $(5.7) $544.0 Liabilities incurred 5 95 Liabilities settled (2) (3) Unrealized Unrealized Fair Accretion 41 33 2005 Gains Losses Value Cash flow revisions (52) (in millions) Balance end of year $627 $635 Equity $76.7 $(6.3) $325.5 Debt . 2.8 (0.8) 135.3 Other - 25.8 Nuclear Decommissioning Total $79.5 $(7.1) $486.6 The Nuclear Regulatory Commission (NRC) requires licensees of commercial nuclear power reactors to The contractual, maturities of debt securities at establish a plan for providing reasonable assurance of December 31, 2006 are as follows: $6.8 million in 2007, funds for future decommissioning. The Company has $41.0 million in 2008-2011, $42.0 million in 2012-2016, external trust funds to comply with the NRC's and $75.3 million thereafter. II-170

NOTES (continued) Georgia Power Company 2006 Annual Report Sales of the securities held in the trust funds resulted. The Company's ownership interests in Plants Hatch and in proceeds of $457.4 million', $372.5 million, and Vogtle were as follows: $532.3 million in 2006, 2005, and 2004, respectively, all Plant Plant of which were re-invested. Realized gains and other- Hatch Vogfle than-temporary impairment losses were $17.8 million and $12.1 million, respectively, in 2006. Net realized gains/ Decommissioning periods: (losses) were $12.6 million and $14.1 million in 2005 and Beginning year 2034 2027 2004, respectively. Realized gains and other-than- Completion year 2061 2051 (in millions) temporary impairment losses are determined on a specific Site study-costs: identification basis. In accordance withregulatory Radiated structures $544 $507 guidance, all realized and unrealized gains and losses are 46 67 Non-radiated structures included in the regulatory liability for Asset Retirement Total $590 $574 Obligations in the balance sheets and are not included in net income or other comprehensive income. Unrealized The'decommissioning cost estimates are based on gains and other-than-temporary impairment losses are prompt,dismantlement and removal of the plant from considered non-cash transactions for purposes of the service., The actual decommissioning costs may vary from statements of cash flows. Unrealized losses were'not the above estimates because of changes in the assumed material in any period presented and did not require the date of decommissioning, changes in NRC requirements, recognition of any impairment to ,the underlying or changes in the assumptions used in making these investments. ,, estimates. Amounts previously recorded'in internal reserves are Under the 2004 Retail Rate Plan, effective being transferred into the external trust funds over periods January 1, 2005, the Georgia PSC decreased the annual approved by the Georgia PSC. The NRC's minimum decommissioning costs for ratemaking from $9 million to external funding requirements are based on a generic $7 million. This amount is based on the NRC generic estimate of the cost to decommission only the radioactive estimate to decommission the radioactive portion of the portions of a nuclear unit based on the ,size and tpe of facilities as of 2003. The estimates are $421 million and

                                                                       $326 million for Plants Hatch and Vogtle, respectively.

reactor. The Company has filed plans with the NRC to Significant assumptions used to determine the costs for ensure that, over time - the deposits and earnings of the ratemaking include an estimated inflation rate of external trust funds will provide the minimum funding 3.1 percent and an estimated trust earnings rate of amounts prescribed by the NRC. Annual provisions for 5..1 percent. Another significant assumption used was the' nuclear decommissioning are based on an annuity method change in the operating license for Plant Hatch. In as approved by the Georgia PSC. The amount expensed in January' 2002, the NRC granted the Company a 20-year 2006 and the accumulated provisions for decommissioning extension of the licenses for both units at Plant Hatch at December 31, 2006 were as follows: which permits the operation of units 1 and 2 until 2034 and 2038, respectively. The Company plans to file an Plant Plant application with the NRC in June 2007 to extend the Hatch 'Vogtle licenses for Plant Vogtle units 1 and 2 for an additional (in millions) 20 years,,The Company expects the Georgia PSC to Amount expensed in 2006 $ - $ 6 periodically review and adjust, if necessary, the amounts Accumulated, provisions: collected in rates: for the anticipated cost of External trust funds, at fair value $344 $200 decommissioning.:, Internal reserves . 1 Total $344 $201 Allowance for 'Funds Used During Construction (AFUDC) and Interest Capitalized Site study cost is the estimate to decommission a, In accordance with regulatory treatment, the Company specific facility as of the site study year. The estimated records AFUDC, which represents the estimated debt and costs'of decommissioning .are based on the most current equity costs of capital funds that are necessary to finance study performed in 2006, which will be filed with the the construction of new regulated facilities. While cash is Georgia PSC in 2007 as a part of the, retail base rate case. not realized currently from such allowance, it increases 11-171

NOTES (continued) Georgia Power Company 2006 Annual Report the revenue requirement over the service life of the plant environmental remediation, Environmental remediation through a higher rate base and higher depreciation expenditures will be charged against the reserve as they expense. Interest related to the construction of new are incurred. The annual accrual amount will be reviewed facilities not included in the Company's retail rates is and adjusted in future regulatory proceedings. Under capitalized in accordance with standard interest Georgia PSC ratemaking provisions, $22 million had capitalization requirements. For the years 2006, 2005, and previously been deferred in a regulatory liability account 2004, the average AFUDC rates were 8.3 percent, for use in meeting future environmental remediation costs 8.0 percent, and 8.0 percent, respectively, and AFUDC of the Company and is being amortized over a three-year capitalized was $44.1 million, $41.1 million, and period that began in January 2005. $39.1 million, respectively. AFUDC and interest capitalized, net of taxes, were 5.0 percent, 4.9 percent, Cash and Cash Equivalents and 5.2 percent of net income after dividends on preferred For purposes of the financial statements, temporary cash stock for 2006, 2005, and 2004 respectively. investments ,are considered cash equivalents. Temporary cash investments are securities with original maturities of Impairment of Long-Lived Assets and Intangibles 90 days or less. The Company evaluates long-lived assets for Impairment when events or changes in circumstances indicate that the Materials and Supplies carrying value of such assets may not berecoverable. The Generally, materials and supplies include the average determination of whether an impairment has oCcurred is costs of transmission, distribution, and generating plant based on either a specific regulatory disallowance or an materials. Materials are charged to inventory when estimate of undiscounted future cash flows attributable to purchased and then expensed or capitalized to plant, as the assets, as compared with the carrying value of the appropriate, when installed. assets. If an impairment has occurred, the amount of the impairment recognized is determined by either the Fuel Inventory, amount of regulatory disalowance or by estimating'the fair value of the assets and recording a loss if the carrying Fuel inventory includes the average'costs of oil, coal, value is greater than the fair value. Foi, assets identified as natural gas, and emission allowanices. Fuel is charged to held for sale, the carrying value is compared to the inventory when purchased and thenexpensed as used'and estimated fair value less the cost to sell in order to recovered by ihe Company througlh fuel cost recovery determine if an impairment loss is required. Until the, rates' approved by the Georgia PSC. Emission allowances assets are disposed of, their estimated fair value is re- granted by the Environmental Protection Agency (EPA) evaluated when circumstances, or events change. See ' areincluded in inventory at zero cost. Note 3 under "Retail Regulatory Matters - Rate Plans" for information regarding a regulatory disallowance by the Stock Options Georgia PSC in December 2004. Southem Company provides non-qualified stock options to a large segment of the Company's employees ranging Storm Damage Reserve from line management to executives. Prior to January 1, The Company maintains a reserve for property damage to 2006, the Company accounted for options granted in cover the cost of damages from major storms to its accordance with Accounting Principles Board Opinion transmission and distribution lines and: the cost of No. 25; thus, no compensation expense was recognized uninsured damages to its generation facilities and other because the exercise price of all 6ptions grantede qualed' property as mandated by the Georgia PSC, The Company the fair market value on the date of the grant. accrues $6.6 million annually that is recoyerable through Effective January 1, 2006, the Company adopted the base rates. The Company expects the Georgia PSC to fair value recognition provisions of FASB Statement periodically review and adjust, if necessary, the amountt No6 123(R), "Share-Based Payment" (SFAS No. 123(R)), collected in rates for storm damage costsw using the modified prospective method. Under that method, compensation cost for the year ended Environmental Remediation Cost Recovery December 31, 2006 is recognized as the requisite service The Company continues, to recover environmental costs is rendered and includes: (a) compensation cost for the through its base rates. Beginning in 2005, such rates portion of share-based awards granted prior to and that include an annual accrual of $5.4 million for, were outstanding as of January 1, 2006, for which the 11-172

NOTES (continued) Georgia Power Company 2006 Annual Report requisite service hadnot been rendered, based on the U.S.- Treasury yield curve in effect at the time of grant grant-date fair value of those awards as calculated in that covers the expected term of.the stock options. The accordance with the original provisions of FASB following table shows the assumptions used in the pricing Statement No: 123, "Accounting for Stock-based model and the weighted average grant-date fair value of Compensation" (SFAS No. 123), and (b) compensation stock.optioIns granted: cost for all share-based awards granted subsequent. to Period endedDecember 31 2006 2005 2004 January 1, 2006, based on the grant-date fair value estimated in accordance ,with the provisions of Expected volatility 16.9% 17.9% 19.6% SFAS No. I23(R). Results for prior periods have 'not been, Expected term (inyears) 5.0 5.0 5.0 restated. Interest rate 4.6% 3.9% 3.1% Dividend yield 4.4% 4.4% 4.8% The compensation cost and tax benefits related to the Weighted avierage grant-date grant and exercise of Southern Company stock options to fair value $4.15' $3.90 $3.29 the Company's employees are recognized in the Company's financial statements with a corresponding Financial Instruments credit to equity, representing a capital contribution from Southern Company.' The Company uses derivative financial instruments to limit exposure to fluctuations in interest rates, the prices" For the Company, the adoption of SFAS No. 123(R). of certain fuel purchaseý, and electricity purchases and has resulted in a reduction in earn1ings before income saies. AII derivative financial instruments are recognized taxes and net income of $6 million and $4 million, as either assets or liabilities ac are measured at far respectively, for the year ended December 31, 2006. valute. Subs'tantially all of,thi Company's bulk energy Additionally, SFAS No. 123(R) requires the gross excess purchases and sales contracts that meet the definition of a tax benefit from stock option exercises to be reclassified derivative are exempt from fair value accounting.. as a financing cash flow as opposed to an operating cash requirements and are accounted for under the accrual" flow; the reduction in operating cash flows and increase method. Other derivative contracts qualify as cash flow in financing cash flows for the year ended December 31, hedges of anticipated transactions or are recoverable' 2006 was $3 million. '* -" through the Georgia PSC-approved fuel hedging program. For the years prior to the adoption of This results, in the deferral of related gains and losses in SFAS No. 123(R), the pro forma impact of fair-value other xcornprehensive income or regulatory, assets and accounting for options granted on net income is as liabilities, respectively, until the hedged transactions. follows: occur. Any ineffectiveness arising from cash flow hedges is recognized currently in net income. Other derivative Options contracts are marked to market through current period As impact Pro income And are recorded on a net basis in the statements Net Income Reported 'After Tax Forma of income. (in millionis) 2005 $744 $(3) $741 T'he' Company is exposed to losses related to 2004 $683 $(4) .$679 financial instruments in' the event of counterparties' nonperformance. The Company has established controlg to Because historical forfeitures -have been insignificant determine and monitor the creditworthiness of and are expected to remain insignificant, no forfeitures counterparties in order to mitigate the Company's are assumed in the calculation of compensation expense; exposure to counterparty credit risk. rather they are recognized when they occur. The estimated fair values of stock options granted in 2006, 2005, and 2004 were derived using the Black-Scholes stock option pricing model. Expected volatility is based on historical volatility of Southern Company's stock over a period equal to the expected term. The Company uses historical exercise data to estimate the expected term that represents the period of time that options granted to employees are expected to be outstanding. The risk-free rate is based on the II- 173

NOTES (continued) Georgia Power Company 2006 Annual Report The Company's financial instruments for which the benefits for retired employees through other carrying amounts did not equal fair value at December 31 postretirement benefit plans. The Company funds related were as follows: trusts to the extent required by the Georgia PSC and the FERC. For the year ending December 31, 2007, Carrying Fair postretirement trust contributions are expected to total Amount Value approximately $16 million. (in millions) Long-term debt: On December 31, 2006, the Company adopted FASB 2006 $5,440 $5,376 Statement No. 158, "Employers' Accounting for Defined 2005 $5,460 $5,427 Benefit Pension and dther Postretirement Plans" (SFAS No. 158), which requires recognition of the funded The fair values were based on either closing market status of its defined benefit postretirement plans in its price or closing price of comparable instruments. balance sheet. Prior to the adoption of SFAS No. 158, the Company generally recognized only the difference Comprehensive Income between the benefit expense recognized and employer, contributions to the plan as either a prepaid asset or.as a The objective of comprehensive income is to report a liability. With respect to each of its underfunded non-measure of all'changes in.common stock equity of an qualified pension plans, the Company recognized an enierprise that result from transactions and other additional minimum liability representing the difference economic'events of the penroA other than transactions with between each plan's accumulated benefit obligation and ownrers. Comprehensive income consists ofni'e income, its assets. changes in the fair value of qualifying cash flow hedges and marketable securities, and'chaiges in additi~nal Upon the adoption of SFAS No. 158, the Company minimum-pension liability less income taxes and' was required to recognize on its,balance sheet. assets and. reclassifications for amounts included in'net' income. liabilities related to unrecognized prior service cost, unrecognized gains or losses (from changes in actuarial Variable Interest Entities assumptions, and the difference between actual and , ý; expected returns on plan assets), and any unrecognized The primary beneficiary of a variable interest entity must transition amounts (resulting from the change from cash-consolidate the related assets and liabilities. The - " basis accounting to accrual accounting). These amounts Company has established certain wholly-owned trusts to will continue to be' amortized as a component of expense issue preferred securities.: However, the Company is hot over the employees' remaining average service life. " considered the primary beneficiary of the trusts. ' -, SFAS No. 158 did not change the recognition of pension Therefore,. the investments in these trusts are reflected as and other postretirement benefit expense in the statement Other Investments,; and the related loans from the trusts of income. Upon the adoption of SFAS No. 158, the are reflected as Long-term Debt Payable' to Affiliated. Company recorded an additional prepaid pension asset of' Trusts in the balance sheets. See Note 6 under $218 million with respect to its overfunded defined -----.. "Mandatorily Redeemable Preferred Securities/Long-Term benefit plan and additional liabilities and deferred credits.. Debt Payable to Affiliated Trusts" for additional of $13 million and $255 million, respectively, related to information. its underfunded non-qualified pension plans and retiree benefit plans. The incremental effect of applying

2. RETIREMENT BENEFITS The Company has a defined'benefit, trusteed pension plan covering substantially all employees. The plan is funded in accordance with requirements of the Employee Retirement Income Security Act of 1974, as amended (ERISA). No contributions to the plan are expected for the year ending December 31, 2007. The Company also provides certain defined benefit pension plans for a selected group of management and highly compensated employees. Benefits under these non-qualified pension plans are funded on a cash basis. In addition, the Company provides certain medical care and life insurance II- 174

NOTES (continued) Georgia Power Company 2006 Annual Report SFAS No. 158 on individual line items in the balance obligations and the fair value of plan assets were as sheet at December 31, 2006 follows: "" follows: 2006

                                                                                                                             ...           2005 Before      Adjustments             After                                                            (in millions)
                                       -(in millions)    -

Change In benefit obligation Prepaid pension Benefit obligation at beginning of year $2,172 $1,989 costs $ 471 $ 218 689$ " 53 ' 47 Service cost . Other regulatory 117- 112 Interest ODst assets 319 23107 629 Benefits paid , (95) .(99) Other property and Plan amendments-. 2 - 13 investments - 685 .If) - '674 Actuarial (gain) loss. , (113) 101 Total assets 18,792 -' 19,309

                                                              .517 Balance at end of year                        2,136          2,172 Accumulated deferred- income taxes                                        J(2,803)

(13) .._,.(2,8!6) Change Jn plan assets Fair yalue of plan assets at beginning ... Other regulatory (63), (218)- , .(281) of year - 2,493 2,229 liabilities Actual return on plan assets 308 346 Employee benefit (431) (267) (698) Employe[contributions 6 8 obligations (90) Total liabilities (12,810) (498) (13,308) Benefits paid, (95) Employee transfers .(2) - Accumulated other comprehensive '-'N Fair Value of plan assets at end of year 2,710 2,493 income )1 ~ (6,012 Funded -status at end of year 574 321 Total stockholders' Unrecognized transition amounts - (4) equity (5,982) (19) (6,001) Unrecognized prior service cost - 116 Unrecognize.d net (gain) loss - (27) Because of pension"and postretiremient benefit .' Fourt*i 'quarter cotitributions 2 2 expenses are components of the Company's regulated Prepaid pension asset, net $ 576 $ 408 rates, the Company recorded offsettiing reigulatory assets or regulatory liabilities under the provisions of At December 31, 2006, the projected benefit SFAS No. 71. obligations for the qualified and non-qualified pension plans were $2.0 -billion and $0.1 billion, respectively. All The measurement date for plan assets and obligations plan *ssets are related to the qualified plan. is September 30 for each year presented. Pursuant to -Pension plan assets are managed and invested in SFAS No. 158, the Company will be required to change accordance ,ith:all applicable requirements, including the measurement date for its defined benefit ERISA and flte Internal Revenue Code of 1986, as postretirement plans from September 30 to December 31 amended (Interpal Revenue Code). The Company's beginning with the year ending December 31, 2008. inVestm*nt-policy covers a diversified mix of assets, including equity and fixed income securities, real estate, and private equity. Derivative instruments are used Pension Plans primarily as -hedging tools but MaY-also be used to gain efficient expbsure to the various asset classes. -The The total accumulated benefit obligation for the pension Company primarily minimizes the risk of large losses plans was $2.0 billion in 2006 and $2.0 billion in 2005. through diversification but also monitors and manages, Changes during the year in the projected benefit other asp&-ts f risk. The actutal--6composition of the ' II- 175

NOTES (continued) Georgia Power Company 2006 Annual Report Company's pension plan assets as of the end,of the year, Components of net periodic pension cost (income) along with the targeted mix of assets, is presented below: and other amounts recognized in other comprehensive Target 2006 2005 income were as follows: Domestic equity 36% 38% 40% 2006 2005 2004 International equity 24 23 24 (in millions) Fixed income 15: 16 17 Service cost $ 53 $ 47 $ 44 Real estate 15 16 13 Interest cost 117 112 106 Private equity 10 7 6 Expected return on plan assets (184) (186) (184) Total 100% 100% 100% Recognized net (gain)Iloss 6, 4 (4) Net amortization 8 9 8 Amounts recognized in the balance sheets'related to Net pension (income) $ - $ (14) $ (30) the Company's pension plans consist of the following: Net periodic pension cost (income) is the sum of 2006 2005 service cost, interest cost, and other costs netted against (in millions) the expected return on plan assets. The expected return on Prepaid pension costs $ 689 $ 456 plan assets is determined by multiplying the expected rate Other regulatory assets 56 - of return on plan assets and the market-related value of Current liabilities, other (6) - plan assets. In determining the market-related value of Other regulatory liabilities (218) - pian 'assets, the Company has elected to amortize changes Employee benefit obligations (107) (09) in the market value of all plan assets over five years Other property and investments - 17 rather than recognize the changes immediately.' As a Accumulated other comprehensive result, the accounting value of plan assets that is used to income - 45 calculate the expected return on plan assets differs from the current fair value of the plan assets. Presented below are the amounts included in regulatory assets and regulatory liabilities at December 31, Future benefit payments reflect expected future 2006, related to the defined benefit pension plans that service and are estimated based on assumptions used to have not yet been recognized in net periodic pension cost measure the projected benefit obligation for the pension along with the estimated amortization of such amounts for plans. At December 31, 2006, estimated benefit payments the next fiscal year: were as follows: Prior Net (in millions) Service *(Gain)/ 2007 $101 Cost, Loss 2008 105 2009 110 Balance at December 31, 2006: : (inmillions) 115 2010 Regulatory asset $ 11 $ 45 2011 121 Regulatory liabilities - 92 (310) 2012 to 2016 713 Total $103 $(265) Estimated amortization in net periodic pension cost in 2007: Regulatory assets $. 2 $ 3 Regulatory liabilities 11 - Total $ 13 $ 3 II-176

NOTES (continued) Georgia Power Company 2006 Annual Report Other Postretirement Benefits benefitplan assets as of the end of the year, along with the targeted mixof assets, is presented below: Changes during the year in the accumulated postretirement benefit obligations (APBO) and in the fair .. Target 2006 2005 value of plan assets were as follows: Domestic equity 42% 44% 46% 2006 2005 International equityt. 19 20 18

                                                                                                                                                            .29 (in millions)              Fixed income;                                     29            27 Change in benefit obligation                                                     Real estate -                                       6              6          5 Balance at beginning of year                      $ 812            $ 765         Private. equity                                     4ý             3          2 Service cost                                           11               1i       Total                                           '100%         100%         100%

Interest cost 43 43 Benefits paid. (34) (33) th.Amounts recognized in the balance sheets related .to Actuarial gain (loss) (27) 26 the Company',s other postretirement benefit plans consist Retiree drug subsidy 2. of the following: Balance at end of year 807 812 2006 2005 (in millions) Change in plan assets Other regulatory assets $ 255 $ Fair value of plan assets at beginning' Employee benefit obligations (399) (113) of year 362: 312 Actual return on plan assets 35 40 Presented below are the amounts included in Employer cointributions" ' 48`- 43 regulatory assets at December 31, 2006, related to the Benefits paid (57).' (33) other postretirement benefit plans that have not yet been Fair value of plan assets at end of year, 388 362 recognized in net periodic postretirement benefit cost: Funded status at end of year, , ,(419), (450) Prior Net Unrecognized transition amount,; . . - ." 73 Service (Gain)/ Transition Unrecognized prior service cost, 26 Cost Loss Obligation Unrecognized net (gain) loss - 215 .I I (in millions) Fourth quarter contributions 20 23 Balance at December 31, 2006 Accrued liability (recognized in the " . Regulatory assets -$24:' $166 $64 balance sheet) $(399); -,$(l13) Estimated pmortization In net Other postretirement benefits plan assets are, periodic Po*tretirement . . , .. . 4 managed and invested in accordance with all applicable benefit cost !n 2007: requirements, including ERISA and the Internal Revenue $ 2 $ 8, $ 9 Regulatory assets Code. The Company's investment policy: covers a diversified mix of assets, including equity, and fixed 4 Components of the other postretirement benefit income securities, real estate, and priyate equity. plans' nett periodic cost were as follows: Derivative instruments are used primarily as hedging tools but may also be used to gain efficient exposure to.the 2006 .2005 2004 various,asset classes. The Company primarily minimizes - . . . (in millions) the risk of large losses through diversification but also Service cost $ 11 $ 11 $ 11 monitors and manages other aspects of risk. The actual Interetf . 44 43 43 composition of the Company's other,ppstretirement Eipertd eturn bn plan assets (25) (23) (26) Net irbrtizaiion ' :22 19 19 Net postretirement cost $ 52 $ 50 $ 47 In the third quarter. 2004, the Company prospectively adopted FASB Staff Position 1062; ."Accounting and j4~ Disclosure' Requirements" (FSP 106-2); related to the MedicarePrescription Drug, Improvement, and

                                       .4  -.    .  ,        4~ -                Modernization Act of 2003 (Medicare Act). The Medicare 11-177

NOTES (continued) Georgia Power Company 2006 Annual Report Act provides a 28 percent prescription drug subsidy for affect the APBO and the service and interest cost Medicare eligible retirees. FSP 106-2 requires recognition components at December 31, 2006 as follows: of the impacts of the Medicare Act in the APBO and 1 Percent 1 Percent future cost of service for postretirement medical plan. The Increase Decrease effect of the subsidy reduced the Company's expenses for (in millions) the year ended December 31, 2006, the year ended December 31, 2005, and the six months ended Benefit obligation $67 $57 December 31, 2004 by approximately $16 million, Service and interest costs 5 4 $11 million, and $5 million, respectively, and is expected to have a similar impact on future expenses. Employee Savings Plan Future benefit payments, including prescription drug The Company also sponsors a 401(k) defined contribution benefits, reflect expected future service and are estimated plan covering substantially all employees. The Company based on assumptions used to measure-the APBO for the provides an 85 percent matching contribution up to postretirement plans. Estimated benefit payments are 6 percent of an employee's base salary. Prior to reduced by drug subsidy receipts expected as a result of November 2006, the Company matched employee the Medicare Act as follows: contributions at a rate of 75 percent up to 6 percent of the employee's base salary. Total matching contributions Benefit Subsidy made to the plan for 2006, 2005, and 2004 were Payments Receipts Total $21 million, $20 million, and $19 million, respectively. (in millions) 2007 $ 37 $ 3 $ 34 3. CONTINGENCIES AND REGULATORY 2008 41 3 38 'MATTERS 2009 45 4 41 2010 48 4 44 General Litigation Matters 2011 52 5 47 The Company is subject to certain claims and legal 2012 to 2016 296 33 263 actions arising in the ordinary course of business. In addition, the Company's business activities are subject to Actuarial Assumptions extensive governmental regulation related to public health and the environment. Litigation over environmental issues The weighted average rates assumed in the actuarial and claims of various types, including property damage, calculations used to determine both the benefit obligations personal injury, and citizen enforcement of environmental as of the measurement date and the net periodic costs for requirements such as opacity and other air quality the pension and postretirement benefit plans for the standards, has increased generally throughout the United following year are presented below. Net periodic. benefit States. In particular, personal injury claims for damages costs for 2004 were calculated using a discount rate of caused by alleged exposure to hazardous materials have 6.00 percent. become more frequent. The ultimate outcome of such 2006: 2005 2004 pending or potential litigation against the Company cannot be predicted at this time; however, for current Discount 6.00% 5.50% 5.75% proceedings not specifically reported herein, management Annual salary increase 3.50 3.00 3.50 does not anticipate that the liabilities, if any, arising from Lone-term return on Wlan assets 8.50 8.50 8.50 such current proceedings would have a material adverse effect on the Company's financial statements. The Company determined the long-term rate of return based on historical asset class returns, and current Environmental Matters market conditions, taking into account the diversification benefits of investing in multiple asset classes. New Source Review Actions An additional assumption used in measuring the In November 1999, the EPA brought a civil action in the APBO was a weighted average medical care cost' trend U.S. District Court for the Northern District of Georgia rate of 9.56 percent for 2007, decreasing gradually to against certain Southern Company subsidiaries, including 5.00 percent through the year 2015 and remaining at that Alabama Power and the Company, alleging that these level thereafter. An annual increase or decrease.in the subsidiaries had violated the New Source Review (NSR) assumed medical care cost trend rate of 1 percent would provisions of the Clean Air Act and related state laws at II-178

NOTES (continued) Georgia Power Company 2006 Annual Report certain coal-fired. generating facilities, including the Plant Wansley Environmental Litigation Company's Plants Bowen and Scherer. Through subsequent amendments and other legal procedures, the In December 2002, the Sierra Club,- Physicians for Social EPA filed a separate action in January 2001 against Responsibility, Georgia Forestwatch, and one individual Alabama Power in the U.S. District Court for the filed a civil suit in the U.S. District Court for the Northern District of Alabama after it was dismissed from Northern District of Georgia against the Company for the original action. In these lawsuits, the EPA alleged that alleged violations of the Clean Air Act at four of the units NSR violations occurred at eight coal-fired generating at Plant Wansley. The civil action requested injunctive facilities operated by Alabama Power and the Company and declaratory relief, civil penalties, a supplemental (including a facility formerly owned by Savannah environmental project, and attorneys' fees. In January Electric). The civil actions request penalties and 2007, following the March 2006 reversal and remand by injunctive relief, including an order requiring the the U.S. Court of Appeals for the Eleventh Circuit, the installation of the best available control technology at the district court ruled for the Company on all remaining affected units, On June 19, 2006, the U.S. District Court allegations.in this case. The only issue remaining for resolution by the district court is the appropriate remedy for the Northern District of Alabama entered a consent for two isolated, short-term, technical violations of the decree between Alabama Power and the EPA, resolving plant's Clean Air Act operating permit. The court has, the alleged NSR violations at Plant Miller. The consent asked the parties to submit a joint proposed remedy or decree required Alabama Power to pay $100,000 to -, individual proposals in the event the parties cannot agree. resolve the government's claim for a civil penalty, and to Although the ultimate outcome of this matter cannot-donate $4.9 million of sulfur dioxide emission allowances currently be determined, the resulting liability associated* to a nonprofit charitable organization, and formalized with the two events is not expected to have a material specific emissions reductions to be accomplished by impact on the Company's financial statements. Alabama Power, consistent with other Clean Air Act programs that require emissions reductions. On August 14, 2006, the district court in Alabama granted Alabama EnvironmentalRemediation Power's motion for summary judgment and entered final judgment in favor of Alabama Power on the EPA's claims The Company has been designated as a potentially related to Plants Barry, Gaston, Gorgas, and Greene responsible party at sites governed by the Georgia County. The plaintiffs have appealed this decision to the Hazardous Site Response Act and/or by ýthe federal U.S. Court of Appeals for the Eleventh Circuit, and on Comprehensive. Environmental Response, Compensation, November 14, 2006, the Eleventh Circuit granted. and Liability Act. In 1995, the EPA. designated the plaintiffs' request to stay the appeal, pending the Company and four other unrelated entities as potentially U.S. Supreme Court's ruling in asimilar NSR case filed responsible, parties at a site in Brunswick, Georgia, that is by the EPA against Duke Energy. The action against the listed on the federal National Priorities List. As of, Company has been administratively closed since the: December 31,2006, the Company had recorded spring of 2001, and none of the parties has sought to approximately $6nmillion in cumulative expenses reopen the case. associated with jts agreed-upon share of the removal and. remedial~ investigation and feasibility study. costs for the The Company believes that it complied with Brunswick site. Additional claims for recovery, of natural applicable laws and the EPA regulations and resource damages at the site are anticipated. The interpretations in effect at the time the .work in question Company has also recognized $36 million in cumulative took place. The Clean Air Act authorizes maximum civil expenses -through December 31, 2006 for the assessment penalties of $25,000 to $32,500 per day, per violation at. and anticipated cleanup of other, sites on the Georgia each generating unit, depending on the date of the alleged Hazardous Sites Inventory. , violation. An adverse outcome in this case could require substantial capital expenditures that cannot be determined The final outcome of these matters cannot now be at this time and could possibly require payment of determined,,However, based on the currently known substantial penalties. Such expenditures could affect conditions at these sites and the nature and extent of future results of operations,. cash flows, and financial activities relating to these sites, management does not condition if such costs are not recovered through believe that additional liabilities, if any, at these sites regulated rates. would be material to the Company's financial statements. 11-179

NOTES (continued) Georgia Power Company 2006 Annual Report FERC Matters The Company believes that there is no meritorious basis for these proceedings and is vigorously defending Market-Based Rate Authority itself in this matter. However, the final outcome of this The Company has authorization from the FERC to sell matter, including any remedies to be applied in the 'event power to non-affiliates, including short-term opportunity of an adverse ruling in these proceedings cannot now be, sales, at market-based prices. Specific FERC approval determined.' must be obtained with respect to a market-based contract with an affiliate. IntercompanyInterchange Contract In December 2004, the FERC initiated a proceeding The Company's generation fleet is'operated under the IIC, to assess Southern Company's generation dominance as approved by the FERC. In May 2005, the FERC within its retail service territory. The ability to charge initiated a new proceeding to examine (1)' the provisions' market-based rates in other markets is not an issue in that of the 11C among Alabama Power,' the Company, Gulf' proceeding. Any new market-based rate sales by the Power, Mississippi Power, Savannah Electric, Southern; Company in Southern Company's retail service territory Power, and SCS, as agent, under the terms of which the entered into during a 15-month refund period beginning power pool of Southern Company is operated, and, in February 27, 2005 could be subject to refund to the level particular, the piropriety of the continued inclusion of of the default cost-based rates, pending the outcome of Southern Power as a party to the TIC, (2) whether any the proceeding. Such sales through May, 27, 2006, the end parties to the IIC have violated the FERC's standards of of the refund period, were approximately $5.8 million for conduct applicable to utility companies that are the Company. In the event that the FERC's default transmission providers, and (3) whether Southern mitigation measures for entities, that are found to have Company's code of conduct defining Southern Power as a "system company" rather than a "marketing affiliate" is market power are ultimately applied, the Company may be required to charge cost-based rates for certain just and reasonable. In connection with the formation of wholesale sales in the Southern Company retail service Southern Power, the FERC authorized Southern Power's territory, which may be lower than negotiated market- inclusion in the IIC in 2000. The FERC also previously based rates. The final outcome of this matter will depend approved Southern Company's code of conduct. on the form in which the. final methodology for assessing On October 5, 2006, the FERC issued an order generation market power, and mitigation rules may be accepting a settlement resolving the proceeding subject to' ultimately adopted and cannot be determined at this time. Southern Company's agreement to accept certain Inaddition, in Ma'y 2005,' the FERC started an modifications to the settlemhent's terms. On October 20, 2006, Southern Company notified the FERC that it investigatiot to determine whether Southern Company accepted the modifications. The' modifications largely satisfies the other three parts of the FERC's market-based involve functional separation and information restrictions rate analysis: fransmissiotn market power, barriers to entry, related to marketing activities conducted on 'behalf of and affiliate abuse or reciprocal dealing. The FERC Southern' Power. Southern Company filed with the FERC established a new 15-month refund period related to this' on November 6, 2006 an implementation plan to comply expanded investigation. Any new market-based rate sales with the modifications set forth in the order.. The impact involving any Southern Company subsidiary, including the of the modifications is not expected to have a material Company, could be'subject to refund to the 'extent' the FERC orders lower rates as'a result of this new impact on the Company's financial statements. investigation. Such Wales thrbugh October 19, 2006, the Generation Interconnection Agreements. end of the refund period, were approximately $18.8 million for the Company, of which $3.9 million In July 2003, the FERC issued its final rule on the relates to sales ihside the retail service territory as standardization of generation interconnection agreements discussed above. The FERC also directed that this and procedures (Order 2003). Order 2003 shifts much of expanded proceeding be held in abeyance pending the the financial burden of new transmission' investment from outcome of the proceeding on the Intercompany the generator to the transmission provider. The' FERC has' Interchange Contract (tIC) discussed below. On January 3, indicated that Order 2003, which was effective January 20, 2007, the FERC issued an order noting settlement of t 2004, is to be applied prospectively io new generating the IIC proceeding and seeking comment identifying any facilities interconnecting to a transmission system. Order remaining issues and the proper procedure fot addressing 2003 was'affirmed by the U.S. Court of Appeals for the any such issues. District of Columbia Circuit on January 12, 2007..The 11-180

NOTES (continued) Georgia Power Company 2006 Annual Report cost impact resulting from Order 2003'will vary on a, petition for certiorari to the Georgia Supreme Court, case-by-case basis for each new generator interconnecting which was also denied. On October 10, 2006, the to the transmission system. Superior Court of Decatur County, Georgia granted the Company's motion for summary judgment. The period On November 22, 2004, generator company during which the plaintiff could have appealed has subsidiaries of Tenaska, Inc. (Tenaska), as counterparties expired. This matter is now concluded. 'to three previously executed interconnection agreements with subsidiaries of Southern Company, including the, In addition, in late 2001, certain subsidiaries of. Company, filed complaints at the FERC requesting that Southern Company, including Alabama Power, the the FERC modify the agreements and that the Company Company, Gulf Power, Mississippi Power, Savannah refund a total of $7.9 million previously paid for Electric, and Southern Telecom, were named as interconnection facilities, with interest. Southern defendants ina'lawsuit brought by a telecommunications Company has also received requests for similar. comphotliat uses certain' of the defendants' rights of modifications from other entities, though no other, way. This lawsuit alleges, among other things, that the complaints are pending with the FERC. On January 19, defendants are' contractually obligated to indemnify, 2007, the FERC issued an order granting Tenaska's, defend, and fioId harmless the telecommunications requested relief. Although the FERC's order requires the compafiy' fitm any liability that may be assessed against modification of Tenaska's interconnection agreements, the it in pending and future right bf Way litigation. The order reduces the amount of the refund that had been r Comnpani* believes that the plafintiff's claims are without requested by Tenaska. As a result, the Company estimates merit. In thie fall of '2004, the trial court stayed the case indicate that no refund is due Tenaska. Southern until ri'slution' of the underlying landowner litigation Company has requested rehearing of the FERC's order. discussed abve. IMJanuary 2005, the Georgia Court of The final outcome of this matter cannot now be Appeals dis~iiissed the telecommunications company's determined. appeal of th6 trial court's orderfor lack of jurisdiction. An ad'derse outcome in this matter, cormbned With an Right of Way Litigation adverse bitcome against the telecommumficatifs, company in one ,or more of the right of way laivs~uits, could result Southern Company and certain of its subsidiaries, in substantial judgments; however, the final outcome of including the Company, Gulf Power, Missiisippi Power, these matters cannot now be determined. and Southern Telecom,' have' been ýnamed as defendants in numerous lawsuits brought by laridowners since 2001. Property TakiD1spute The plaintiffs' lawsuits claim, that defendants may not use, or sublease to third parties, t6rne or all of the fiber The Company is involved in a property tax dispute with optic communications lines on the rights of way thiat cross Monroe Cdiunty,- Georgia (Monroe C6unty). The Monroe the plaintiffs' properties and that such actions exceed the County Boad bf Tax Assessors (Monroe Board) has easements or other property rights held by defendanis. issued *ssessments reflecting substantial increases -in the' The plaintiffs assert claims for, among other things, ad valoiem't6 ax valuation of the Coffipafii's 22.95 percent trespass and unjust enrichment, and seek compensatory ownershit interest in Plantý Scherer, which is' located in and punitive damages and injtmýtive-relief. Management Monroe C6unty,1for' tax years 2003,12004, and 2005. The believes that the Company has complied with applicaible Company lkaggirssively pursuing administrative appe'ai'- laws and that the plaintiffs' dlaims are without merit. in Monroe County' and has filed notices 'of arbitration for all three'years. The appeals are currently stayed, pending In January 2005, the Superior Court of Decatur the outfCftie` of the litigation discussed below. County, Georgia granted partial summaryjudgment in a lawsuit brought by landowners against ,the Company, In November p2004,_ the Company filed suit,,on its based on the plaintiffs' declaratory judgment claim that behalf, against the Monroe Board i.m the Superior Courtof the easements do not permit general. telecommunications' Monroe County. The Company requests injunctive relief use. The court also dismissed Southern Telecom from this prohibiting Monroe County and the Monroe Board from, case. The Company appealed this ruling to the Georgia unlawfully changing the value of Plant Scherer and Court of Appeals. The Georgia Court'of Appeals reversed, ultimaiely'lbllecting additional ad valorem taxes from the in part, the trial court's order and remanded 'the case'to Company. On December 22, 2005, the court granted ** the trial court for the determination of further issues. Monroe-County's .motion for summary judgment. The After the Court of Appeals' decision,' the plaintiffs filed a' Company has 'filed'an appeal of the Superior Court's motion for reconsideration, which was denied, and a , decision to the Georgia Supreme Court. .. 1I-181

NOTES (continued) Georgia Power Company 2006 Annual Report If the Company is not successful in its administrative earnings above 12.25 percent will be applied to rate appeals and if Monroe County is successful in defending refunds, with the remaining one-third retained by the the litigation, the Company could be subject to total Company. Retail rates and customer fees increased by additional taxes through December 31, 2006 of up to approximately $203 million effective January 1, 2005 to $18 million, plus penalties and interest. The ultimate cover the higher costs of purchased power, operating and outcome of this matter cannot currently be determined. maintenance expenses, environmental compliance, and continued investment in new generation, transmission, and Retail Regulatory Matters distribution' facilities to support growth and ensure reliability. In 2007, the Company will refund 2005 Merger earnings above 12.25 percent retail ROE. No refunds are Effective July 1, 2006, Savannah Electric was merged into anticipated for 2006. the Company. Prior to the merger, Southern Company was the sole common shareholder of both the Company and In connection with the 2004 Retail Rate Plan, the Savannah Electric. At the time of the merger, each Georgia PSC approved the transfer of the Plant McIntosh outstanding share of Savannah Electric common stock construction project front Southern Power at a total fair was cancelled and Southern Company was issued an market value of approximately $385 million. This value additional 1,500,000 shares of the Company's common reflected an approximate $16 nmillion disallowance and stock, no par value per share. In addition, at the time of reduced the Company's net income by approximately the merger, each outstanding share of Savannah Electric's $9.5 million. The Georgia PSC also certified a total preferred stock was cancelled and converted into the right completion cost not to exceed $547 million for the to receive one share of the Company's 6!/8 percent project. In June 2005, Plant McIntosh units 10 and 11 Series Class A Preferred Stock, Non-Cumulative, Par were placed into service at a total cost that did not exceed Value $25 Per Share, resulting in the issuance by the the certified amount. Under the 2004 Retail Rate Plan, the Company of 1,800,000 shares of such Class A Preferred Plant McIntosh revenue requirements impact is being Stock in July 2006. The exchange of preferred stock was reflected in the Company's rates evenly over the three a non-cash transaction for purposes of the statements of years ending December 31, 2007. cash flows. Following completion of the merger, the In. May 2005, the Georgia PSC approved a new outstanding capital stock of the Company consists of three-year rate plan for the former Savannah Electric 9,261,500 shares of common stock, all of which are held ending May 31, 2008. Under the terms of the plan, by Southern Company, and 1,800,000 shares of Class A earnings were evaluated against a retail ROE range of Preferred Stock. 9.75 percent to 11.75 percent. Retail base revenues With respect to the merger, the Georgia PSC voted increased in June 2005 by approximately. $9.6 million. on June 15, 2006 to set a Merger Transition Adjustment (MTA) applicable to customers in the former Savannah The Company is required' to file a general rate case Electric service territory, so that the fuel rate that became by July 1, 2007, in response to which the*Georgia PSC effective on July 1, 2006 plus the MTA equals the would be expected to determine whether the 2004 Retail applicable fuel rate paid by such customers as of June 30, Rate Plan should be continued, modified, or discontinued. 2006. See "Fuel Cost Recovery" below for additional In connection with this case, the former Savannah information. Amounts collected under the MTA are being Electric's base rate tariffs will be combined with the credited to customers in the original Georgia Power Company's. service territory through a Merger Transition Credit (MTC). The MTA and the MTC will be in effect until ,Under the terms of the 2001 Retail Rate Plan, December 31, 2007, when the Company's base rates are earnings were evaluated against a retail return on common scheduled to be adjusted. equity range of 10 percent to 12.95 percent. The Company's earnings in all three years were within the common equity range. Under the 2001 Retail Rate Plan, Rate Plans the Company amortized a regulatory liability of In December 2004, the Georgia PSC approved the 2004, $333 million, related to previously recorded accelerated Retail Rate Plan for the Company. Under the terms of the amortization expenses, equally over three years beginning 2004 Retail Rate Plan, the Company's earnings are in 2002. Also, the 2001 Retail Rate Plan required the evaluated against a retail return on equity (ROE) range of Company to recognize capacity and operating and 10.25 percent to 12.25 percent. Two-thirds of any maintenance costs related to certified purchase, power 11-182

NOTES (continued) Georgia Power Company 2006 Annual Report contracts evenly into rates over a three-year period ended approximately $71.8 million as of November 30, 2005 December 31, 2004. over an estimated four-year period beginning December 1, 2005, as well as future projected fuel costs. Fuel Cost Recovery Fuel Hedging Program. The Company has established fuel cost recovery rates approved by the Georgia PSC. In March 2006,'the In 2003, the.Georgia PSC approved an order allowing the Company and Savannah Electric filed a combined request Compafiy t6 implement a nratuial gas and oil procurement' for fuel cost recovery rate changes with the Georgia PSC and hedging program. This order allows the Company to to be effective July 1,2006, concurrent with the merger use financial~ istrume~nts to hedge price and commodity of the companies. On June 15, 2006, the Georgii PSC risk associated with these fuels. The order limits the ruled on the request and approved an increase in the program in terms of time, volume, dollars, and physical Company's total annual fuel billings of approximately amounts hedged. The costs of the program, including any $400 million. The Georgia PSC order provided for a - net losses, are recovered as a fuel cost through the fuel combined ongoing fuel forecast but reduced the requested cost recovery clause. Annual net financial gains from the increase related to such forecast by $200 million. The - hedging program, through June: 30, 2006, were shared order also required the Company to file for a new fuel with the retail customers receiving 75 percent and the cost recovery rate on a semi-annual basis, beginning in Company retaining 25 percent of the total net gains. September 2006. Accordingly, on September 15, 2006, Effective July 1, 2006, the Georgia PSC ordered the the Company filed a request to recover fuel costs incurred suspension of the profit sharifig framework related to the through August 2006 by increasing the fuel cost recovery fuel hedging program. New profit sharing arrangements as rate. On November 13, 2006, under agreement* with the well as other changes to the fuel hedging program are Georgia PSC staff, the Company filed a supplementary currently under development. In 2005, the Company had a request reflecting a. forecast of annual fuel costs, as well total net gain of $74.6 million, of which'the Company as updated information for previously incurred fuel costs. retained $18.6 million. The Company had no net gains in 2004 or 2006. On February 6, 2007, the Georgia PSC approved an increase in the Company's total annual billings of - 4. JOINT OWNERSHIP AGREEMENTS approximately $383 million. The.Georgia PSC order. reduced the Company's requested increase in the forecast The Company and an affiliate, Alabama Power, own of annual fuel costs by $40 million and disallowed equally all of the outstanding capital stock of SEGCO $4 million of previously incurred fuel costs. The order which owns electric generating units with a total rated also requires the Company to file, for,a new fuel cost capacity of 1,020 megawatts, as well as associated recovery rate no later than March' 1, 2008. Estimated transmission facilities. The capacity of the units has been under recovered fuel costs through February 2007 are to sold equally to the Company and Alabama Power under a be recovered through May 2009 for customers in the contract which, in substance, requires payments sufficient original Georgia Power territory and through November to provide for the operating expenses, taxes, debt service, 2009 for customers in the former Savannah Electric and return on investment, whether or not SEGCO has any territory. As of December 31, 2006, the Company had an capacity and energy available. The term of the contract under recovered fuel balance of approximately extends automatically for two-year periods, subject to

$898 million, of which approximately $544 million is              either party's right to cancel upon two year's notice.

included in deferred charges and other asseis in the The Company's share of expenses included in balance sheets. purchased power from affiliates in the statements of In May 2005, the Georgia PSC approved the income is as follows: . Company's request to increase customer fuel rates by 2006 2005 2004 approximately .9.5 percent to,recover under recovered fuel (in millions) costs of approximately $508 million existing as of Energy $58 $54 -$51 May 31, 2005 over a four-year period that began June 1, Capacity 38 '38 36 2005. Total .- $96 $92 $87 In November 2005, the Georgia PSC voted to approve Savannah Electric's request to increase customer The Company owns undivided interests in Plants rates to recover estimated under recovered fuel cost of Vogtle, Hatch, iScherer, and Wansley in varying,amounts 11-183

NOTES (continued) Georgia Power Company 2006 Annual Report jointly with Oglethorpe Power Corporation (OPC), the each company is jointly and severally liable for the tax Municipal Electric Authority of Georgia (MEAG), the liability. city of Dalton, Georgia, Florida Power & Light Company, Jacksonville Electric Authority, and Gulf Power. Under In 2004, in order to avoid the loss of certain federal these agreements, the Company has contracted to operate income tax credits related to the production of synthetic and maintain the plants as agent for the co-owners and is fuel, Southern Company chose to defer certain deductions jointly and severally liable for third party claims related otherwise available to the subsidiaries. The cash flow to these plants. In addition, the Company jointly owns the benefit associated with the utilization of the tax credits Rocky Mountain pumped storage hydroelectric plant with was allocated to the subsidiary that otherwise would have OPC who is the operator of the plant. The Company and claimed the available deductions on a separate company Progress Energy Florida, Inc. jointly own a combustion basis without the deferral. This allocation concurrently turbine unit (Intercession City) operated by Progress Energy Florida, Inc. reduced the tax benefit of the credits allocated to those subsidiaries that generated the credits. As the deferred At December 31, 2006, the Company's percentage expenses are deducted, the benefit of the tax credits will ownership and investment (exclusive of nuclear fuel) in be repaid to the subsidiaries that generated the tax credits. jointly owned facilities in commercial operation were as The Company has recorded $9.2 million payable to these follows: subsidiaries in Accumulated Deferred Income Taxes on Company , ,, Accumulated the balance sheets at December 31, 2006. Facility (Type). Ownership Investment Depreciation (in millions) The transfer of the Plant McIntosh construction Plant Vogte (nuclear) 45.7% $3,289 $1,857 project from Southern Power to the Company resulted in Plant Hatch (nuclear) 50.1: 925 502 a deferred gain to Southern Power for federal incolne tax Plant Wansley (coal) 53.5 396 .179 purposes. The Company will reimburse Southern Power Plant Scherer (coal) for the remaining balance of the related deferred taxes of Units 1 and 2 8.4 116 $5.0 million reflected in Southern Power's future taxable Unit 3 75.0 565 income. $4.5 million. of this payable to Southern Power is Rocky Mountain included in Other, Deferred Credits and $0.5 million is (pumped storage) 25.4 170 included in Affiliated Accounts Payable in the balance Intercession City sheets at December 31, 2006. (combustion-turbine)' 33.3 12 2 The transfer of the Dahlberg, Wansley, and Franklin projects to Southern Power from the Company in 2001 At December 31, 2006, the portion of total and 2002 also resulted in a deferred g~iidfor federal construction work in progress related to Plants Wansley, income tax purposes. Southern Power will reimburse the Scherer, and Rocky Mountain was $53.1 million, $8.7 million, and $1.6 million, respectively, primarily for Company for the remaining balance of the ielated environmentallprojects. deferred taxes of $10.0 million reflected in the Company's future taxable income. $8.7 million of this The Company's proportionate share of its plant receivable from Southern Power is included in Other operating expenses is included in the corresponding Deferred Debits and $1.3 million is included in Affiliated operating expenses in the statements of income. Accounts Receivable in the balance sheets at December 31, 2006.

5. LNCOME TAXES At December 31, 2006, tax-related regulatory assets Southem Company files a consolidated federal income tax return and combined income tax returns for the States of were $511 million and tax-related regulatory liabilities

ýdabama, Georgia, and Mississippi. Under a joint were $157 million. The assets are attributable to tax consolidated income.tax allocation agreement, each benefits'flowed through'to customers in prior years and to subsidiary's current and deferred tax expense is computed taxes applicable to capitalized interest. The liabilities are on a stand-alone basis and no subsidiary is allocated more attributable to deferred taxes previously recognized at expense than would be paid if they filed a separate rates higher than current enacted tax law and to income tax return. In accordance with IRS regulations,'. unamortized investment tax credits. 11-184

NOTES (continued) Georgia Power Company 2006 Annual Report Details of the federal and state income tax provisions related property with such amortization normally applied are as follows: as a credit to reduce depreciation in the statements of income. Credits amortized in this manner amounted to 2006 .2005 i-2004

                                                                           $13.0 rnillion in 2006, 2005, and 2004. At December 31, Total provision for income taxes:          -    (in millions)               2006, all investment tax credits available to reduce federal Federal:'                                                                   income taxes' payable had been utilized.

Current $393' $166 $116 77 *233 Deferred 226 A rec6nciliation of the federal statutory income tax 400 392 349 rate to the effective income tax rate is as follows: State: 2005 2004 2006 Current 33 24 13 Deferred 9 32 . 31 Federal statutoryrate . 35.0% 35.0% 35.0% Deferred investment tax credits State income tax, net of federal Total $442 $448 $393 deduction. 2.2. 3.1 2.6 Non-deductible book depreciation 1.1 1.2 1.2 The tax effects of temporary differences between the Other (2.5) (1.8) (2.3) carrying amounts of assets and liabilities, in the financial Effective income tax rate 35.8% 37.5% 36.5% statements and their respective ta. bases, which give rise to deferred tax assets and Iiabiities, are as follows: In 2006, the Company filed its 2005 income tax 2006 2005 returns, which included certain state income tax credits

                                                  -(in millions)            that resulted in a lower effective income tax rate for the Deferred tax liabilities:                                                    year ended December 31, 2006 when compared to 2005.

Accelerated deprec iation $2,ý03 $2,281 The Company has also filed similar claims for the years Property basis differences' 568 558 2001 through 2004. Amounts recorded in the Company's Employee benefit obligations ' 243 163 financial statements for the year ended December 3 1, Fuel clause under recovery ' 365 335 2006 related t6-these claims are not material. The Georgia Premium on reacquired debt' 69 72 Department of Revenue is currently reviewing these Underfunded benefit plans 156 - claims. If approved as filed, such claims could have a Asset retirement obligations 242 246 significant, and possibly material, effect on the Other 75 '87 Company's net income. The ultimate outcome of this Total 4,021 3,742 matter cannot now be determined. Deferred tax assets:; Federal effect of state deferred taxes 123 119

6. FINANCING Other property basis differences 138 139 Other deferred costs 131 126 Outstanding Classes of Capital Stock Employee benefit obligations: '226 73 Other comprehensive income 9 25 The Company currently has preferred stock, Class A Overfunded 'benefii plans 84 preferred stock, preference stock, and common stock, Unbilled revenue " 27 15 authorized. The Company's preferred stock and Class A Asset retirement obligations 242 246 14b preferred. stock, without preference between classes, rank Other 41 senior to the Company's preference stock and common Total 1,021i 783 stock with respect to payment of dividends and voluntary-Total deferred tax liabilities, net 3,000 2,959 or involuntary dissolution. The Company's preference,.

Portion included in current (liabilities) stock ranks senior to the common stock with respect to assets, net :, 0' (185) (110) the paymeritr of dividends and voluntary or involuntary Accumulated deferred income taxes in " , dissolution. No shares of preferred stock or preference the balance sheets :$2,815 $2,849 stock were' outstanding at December 31, 2006.. The-outstanding Class A preferred stock is subject to In accordance with regulatoiy requiriements, deferred redemption at the option of the Company on or after investment tax credits are amortized over the life of the July 1, 2009. 1-185

NOTES (continued) Georgia Power Company 2006 Annual Report Mandatorily Redeemable Preferred Securities/ Senior Notes Long-Term Debt Payable to Affiliated; Trusts The Company issued $150 million aggregate principal The Company has formed certain wholly owned trust amount of unsecured' senior notes in 2006. The proceeds subsidiaries for the purpose of issuing preferred securities. of the issuance were used to repay a portion of. the The proceeds of the related equity investments and Company's short term indebtedness. At December 31, preferred security sales were loaned back to the Company 2006 and 2005, the Company had $2.8 billion and through the issuance of junior subordinated notes totaling $2.8 billion of senior notes outstanding, respectively. $969 million, which constitute substantially all of the These senior notes are effectively subordinated to all assets of these trusts and are reflected in the balance secured debt of the Company. sheets as Long-term Debt Payable to Affiliated Trusts. The Company considers that the mechanisms and obligations relating to the preferred securities issued for Capital Leases its benefit, taken together, constitute a full and Assets acquired under capital leases are recorded in the unconditional guarantee by it of the respective trusts' balance sheets as utility plant in service, and the related payment obligations with respect to. these securities. At obligations are classified as long-term debt. At December 31, 2006, preferred securities of $940 million December 31, 2006 and 2005, the Company had a' were outstanding. See Note 1 under "Variable Interest capitalized lease obligation for its corporate headquarters Entities" for additional information on the accounting building of $72 million and $74 million, respectively, treatment for these trusts and the related securities. with an interest rate of 8.1 percent. For ratemaking purposes, the Georgia PSC has treated the lease as an Securities Due Within One Year operating lease and has allowed only the lease payments A summary of the scheduled maturities and redemptions in cost of service. The difference between the accrued of securities due within one year at December 31 is as expense and~the lease payments allowed for ratemaking follows: purposes has been deferred and is being amortized to expense as ordered by the Georgia PSC. See Note 1 under 2006 2005 "Regulatory Assets and Liabilities." At December 31, (in millions) 2006 and 2005, the Company had capitalized lease Capital lease $ 4 $ 3 obligations for its Plant Kraft coal unloading dock. and its Senior notes 300 150 vehicles of $4.1 million and $5.1 million, respectively. Preferred stock - 15 However, for ratemaking purposes, these obligations are First mortgage bonds - 20 treated as operating leases and, as such, lease payments Total $304 $188 are charged to expense as incurred. The annual expense incurred for these leases in 2006, 2005, and 2004 was Redemptions and/or maturities through 2011 applicable $9.6 million, $9.7 million, and $9.6 million, respectively. to total long-term debt are as follows: $304 million in 2007; $49 million in 2008; $279 million in 2009; $5 million in Bank Credit Arrangements 2010; and $115 million in 2011. At the beginning of 2007, the Company had credit Pollution Control Bonds arrangements with banks totaling $910 million, of which

                                                                          $904 million was unused. Of these facilities, $40 million Pollution control obligations represent loans to the                       expires during 2007, with the remaining $870 million Company from public authorities of funds derived from                      expiring in 2011. The facilities that expire in 2007 sales by such authorities of revenue bonds issued to                       provide the Option of converting borrowings into a two' finance pollution control facilities. The Company is                       year term loan. The Company expects to renew its required to make payments sufficient for the authorities to                facilities, as needed, prior to expiration. The agreements meet principal and interest requirements of such. bonds.                   contain stated borrowing rates. All the agreements require The Company has incurred obligations in connection with                    payment of commitment fees based on the unused portion the sale by public authorities of tax-exempt pollution                     of the commitments or the maintenance of compensating control revenue bonds. The amount of tax-exempt                            balances with the banks. Commitment fees are less than pollution control revenue bonds outstanding at                              1/8 of 1 percent for the Company. Compensating balances December 31, 2006 was $1.7 billion.                                        are not legally restricted from withdrawal.

11-186

NOTES (continued) Georgia Power Company 2006 Annual Report The credit arrangements contain covenants that limit The fair. value gain or loss for hedges that are the level of indebtedness to capitalization'to 65 percent, recoverable through the regulatory fuel clauses are as defined in the arrangements. For purposes of these recorded in regulatory assets and liabilities and are definitions, indebtedness excludes the long-term debt recognized in :earnings at the same time the hedged items payable to affiliated trusts. In addition, the credit affect earnings: The Company has energy-related hedges arrangements contain cross default provisionls that would in place up to and including 2009. trigger an event of default if the Company defaulted on The Company enters into derivatives to hedge other indebtedness above a specified threshold. At exposure to interest rate changes. Derivatives related to December 31, '2006, the "Company was in compliance variable rate securities or forecasted transactions are . with' all such covenants. None of the arrangements accounted for as cash flow hedges. The derivatives contain material adverse change clauses at the time of employed as hedging instruments'are structured to borrowings. minimize ineffectiveness. As such, ho' material Subsequent, The $904 million in unused credit arrangements ineffectiveness has been recorded 'in'earnings. provides liquidity support to the Company's variable rate to December 31, 2006, the Company entered into pollution control bonds.' The amount of variable rate $375 millioh n6tional amounts of interest rate swaps to pollution control bonds outstanding 'requi Aing liquidity hedge unfavorable'changes in interest rates. The hedges support as 6f December 3i, 2006' was $112 million. in will be terminiated at the time 'the underlying' debt is addition, the Company borrows -undera '&cmmercial paper issued. In addition to interest rate swaps, the Company program and an extendible 'commercial dote prograrniThe has also'bntered' into' certain option agreements that amount of commercial paper outstanding at December 31, effectively cap'its interest rate exposure in return for 2006 was $733 million. The amdunt of commercial paper payment of 6 premium. In some cases, costless collars outstanding at December 31, 2005 was $327 million.' have been -ised that effectively establish a floor and a There were no outstanding extencdible commercial notes at ceiling to interest rate expense. December 31, 2006. Commercial 'paper isincluded in ,At December 31, 2006, the Company had $1.2 billion notes-payable on the balance sheets. . notional amounts of interest derivatives accounted for as During 2006, the peak amount of short-term debt cash flow hedges outstanding with net fair value gains as outstanding was $757 million and the average amount follows: 'I' outstanding was $549 million. The average annual interest Weighted rate on short-term debt in 2006 was 5.1 percent. Average Fixed Rate Notional Fair Value Financial Instruments Amount Gain/(Loss) Maturity Paid The Company enters into energy-related derivatives to (in millions) hedge exposures to electricity, gas, and other fuel price 2007 I ' '2.68% .$300 $1.4 changes. However, due to cost-based rate regulations, the 2007 3.85%* 400 0.1 Company has limited exposure to market volatility in 2017 .. 5.29% 225 (2.0) commodity fuel prices'and prices of electricity. See Note 3 2037 i'!',' 5.75%* 300 1.4 under "Retail Regulatory Matters - Fuel Hedging 2007 -. 2.50%** 14 0.2 Program" for information on the Company's fuel hedging

Interest rate collar (showing only the rate cap percentage) program. The Company also enters into hedges of forward **Hedged tising the Bond Market Association Municipal Swap electricity sales. There was no material ineffectiveness Index '

recorded in earnings in 2006, 2005, and 2004. The fair value gain or loss for cash flow hedges is At December 31, 2006, the fair value gains / (losses) recorded in other comprehensive income and is of derivative energy contracts were reflected in the reclassified into earnings at the same time the hedged financial statements as follows: items affect eamings. ,In 2006, 2005, and 2004, the Amounts Company settled gains (losses) totaling $(3.9) million, (in millions) $0.9 million, and $(12.4) million, respectively, upon

                                                        $(38.0)'          termination of certain interest derivatives at the same time Regulatory assets, net      ..

it issued debt., For the years 2006, 2005, and 2004, Net income approximately $1.1 million, $(1.9) million, and Total fair value $(38.0) $(3.9) million, respectively, of pre-tax gains/(losses) were 11-187

NOTES (continued) Georgia Power Company 2006 Annual Report reclassified from other comprehensive income to interest The Company has also entered into an LTSA with expense. For 2007, no material pre-tax losses are expected GE through 2014 for neutron monitoring system parts and to be reclassified from other comprehensive income to electronics at Plant Hatch. Total remaining payments to interest expense. The Company has interest related hedges GE under this agreement are currently estimated at in place through 2037 and has realized gains/(losses) that $12.2 million. The contract contains cancellation, are being amortized through 20171. provisions at the; option of the Company. Payments made to GE prior to the performance of

7. COMMITMENTS any work are recorded 'as a prepayment in the balance Construction Program sheets. Work performed by GE is capitalized or charged to expense as appropriate net of any joint owner billings,'

The Company currently estimates property additions to be based on the nature of the work. approximately $1.9 billion, $1.8 billion, and $1.8 billion in 2007, 2008, and 2009, respectively. These amounts Fuel Commitments . include $94 million, $73 million, and $88 million in 2007, 2008, and 2009, respectively, for construction To supply a portion of the fuel requirements. of its expenditures related to contractual. purchase commitments generating plants, the .Company has entered into various for uranium and nuclear fuel conversion, enrichment, and long.-term commitments for the procurement of fossil and fabrication services included under "Fuel Commitments" nuclear fuel. In most cases, these contracts contain. herein. The construction program is subject to periodic provisions for price escalations, minimum purchase levels, review and revision, and actual construction. costs may and other financial commitments. Coal commitments vary from estimates because of numerous factors, include forward contract purchases for sulfur dioxide including, but not limited to, changes in business, emission 'allowances: Natural gas purchase commitments conditions, changes in FERC rules and regulations, contain fixed volumes with, prices based on various revised load growth estimates, changes in environmental indices at the time of delivery. Amounts included in the regulations, changes in existing nuclear plants to meet chart below represent estimates based on New York new regulatory requirements, increasing costs of labor, Mercantile Exchange future prices at December 31, 2006. equipment, and materials, and cost of capital. At Total estimated minimum long-term obligations at December 31, 2006, significant purchase commitments' December 31, 2006 were as follows: were outstanding in connection with the construction program. Commitments Natural Nuclear Long-Term Service Agreements Gas Coal Fuel (in millions) The Company has entered into a Long-Term Service 2007 $ 647 $1,638 $ 94 Agreement (LTSA) with General Electric (GE) for the 2008 534 1,463 73 purpose of securing maintenance support for the 2009

                                                                                                                           '12188 342         983 combustion turbines at the Plant McIntosh combined                2010                                 202        '330 cycle facility. In summary, the LTSA stipulates that GE           2011                                 262-         62        101 will perform all planned inspections on the covered               2012 and thereafter-              1,914           44'       169 equipment, which includes the cost of all labor and.              Total                  . I      $3,901       $4.520       $646
                                                                                                  . .          . o materials. GE is also obligated to cover the costs of unplanned maintenance on the covered equipment subject                  Additional commitments for fuel will be requirýd to to a limit specified in each contract.                            supply the Company's future needs.

In general, this LTSA is in effect through two major SCS may enter into various types of wholesale inspection cycles per unit. Scheduled payments to GE are energy and natural gas contracts acting as an agent for the made quarterly based on actual operating hours of the Company and all of the other Southern Company respective units. Total payments to, GE, under this traditional operating companies and Southern Power. agreement are currently estimated at $198.5 million over Under these agreements, each of the traditional operating the remaining term of the agreement, which is currently companies and Southern Power may be jointly and projected to be approximately 12 years. However, the severally liable. The creditworthiness of Southern Power LTSA contains various cancellation provisions at the is currently inferior to the creditworthiness of the option of the Company. o traditional operating companies. Accordingly, Southern 11-188

NOTES (continued) Georgia Power Company 2006 Annual Report Company has entered into keep-well agreements -with the Estimated total long-term obligations under these ' Company and each of the other traditional operating commitments at December 31, 2006 were as follows: companies to ensure they will not subsidize or be Commitments responsible for any costs, losses, liabilities, or damages :* i ' '....N on-resulting from the, inclusion of Southern Power as a Affiliated Affiliated contracting _party under these agreements. (in millions) 2007 $220 $86 Purchased Power Commitments 2008 220' 87 The Company has Commitments regarding a portion of a 2009 :'220 94 5 percent interest in'Plant Vogtle owned by MEAG that, 2010 "112 96 are in effect until the latter of the retirement of the plant 2011 z 65. 98 or the latest stated maturity date of MEAG's bonds issued 2012 and thereafter 390 665 to finance such ownership interest. The payments for $1,i27 $i,128 Total capacity are required whether or not any capacity is available. The energy cost is a function, of each unit's variable operating costs. Except as noted below, the cost Operating Leases of such capacity and energy is included in purchased power from non-affiliates in the statements of income. The Company has entered into various operating leases Capacity payments totaled $49 million, $5-4 nmillion, and with various terms and expiration dates. Rental expenses $55 million in 2006, 2005, and 2004, respectively. The related ,to!these operating leases totaled $33 'million for,. current projected Plant Vogtle capacity payments are: 2006, $39 million for 2005, and $39 million for 2004. .

                                                                              " ý'. 1 ;.":*T                   ed miin I fm'"eas;-

Capacity Payments At December 31, 2006, estimated minimum lease

                                                   ,(in millions)       payments for, these noncancelable operating leases were 2007                                                    $;49             as follows: .,

2008 49 Minimum'Lease Payments 2009 54 Rail Cars -Other' Total 2010 54 (ii millions) 2011 " 54 2012 and thereafter 200 2007 $18 $14 $32 2008 18 11.. 29. Total $460 2009 16 ,10 26 2010, 15-, 7 ,22 Portions of the payments noted above relate to costs 2011'.1 .16 06 .,22 in excess of Plant Vogtle's allowed investment for 2012 and thereafter " 2, 10 42 ratemaking purposes. The present Value of these portions at the time, of the disallowance was written off. Total $115 $58 $173 The Company has entered into other various long-In addition to the rental commitments aboVe,,the".ý term commitments for the purchase of electricity. Company has obligations upon expiration of certain rail car leases with respect to the residual "Value.of the leased property. These leases expire in 201 land the Company's maximum obligation is $64 million.!At the'termination of the leases,-at the Company's option, the Company may either exercise its purchase option or the property can be sold to a third party, The Company'expects that the fair,. market value of the leased property:would substantially.. S- reduce or eliminate the Company's payments under the residual value obligation. A portion of the rail car lease obligations is shared with the joint owners of Plants Scherer and Wansley. Rental expenses related to the rail I i -- :, t- car leases are fully recoverable through the fuel cost recovery clause as ordered by the Georgia PSC. U-,189

NOTES (continued) Georgia Power Company 2006 Annual Report Guarantees The Company's activity in the stock option plan for 2006 is summarized below: Alabama Power has guaranteed unconditionally the obligati on of SEGCO under an installment sale agreement Weighted-for the purchase of certain pollution control facilities at Shares Average SEGCO's generating units, pursuant to which Subject to Exercise Option Price $24.5 million principal amount of pollution control revenue bonds are outstanding. Alabama Power has also Outstanding at guaranteed $50 million in senior notes issued by SEGCO. December 31, 2005 7,223,875 $26.87 The Company has agreed to reimburse Alabama Power Granted 1,431,489 33.81, for the pro rata portion of such obligations corresponding Exercised (811,013) 24.02 to the Company's then proportionate ownership of stock Cancelled (13,768) 30.97 of SEGCO if Alabama Power is called upon to make such Outstanding at payment under its guaranty. December 31, 2006 7,830,583 -$28.42 As discussed earlier in this note under "Operating Exercisable at Leases," the Company has entered into certain residual December 31, 2006 5,106,339 $26.14 value guarantees related to rail car leases. The number of stock options vested, and expected to

8. STOCK OPTION PLAN vest in the future, at December 31, 2006 is not significantly different from the number of stock options Southern Company provides non-qualified stock options outstanding at December 31, 2006 as stated above.

to a large segment of the Company's employees ranging from line management to executives. As of December 31, At December 31, 2006, the weighted average 2006, there were 1,651 current and former employees of remaining contractual term for the options outstanding the Company participating in the stock option plan. The and options exercisable is 6.4 years and 5.3 years, maximum number of shares of Southern Company respectively, and the aggregate intrinsic value for the common, stock that may be issued under these programs options outstanding and options exercisable is $66 million may not exceed 57 million, The prices of options granted and $55 million, respectively. to date have been at the fair market value of the shares on As of December 31, 2006, there was $2.5 million of the dates of grant. Options granted to date become total unrecognized compensation cost related to stock exercisable pro rata over a maximum period of three option awards not yet vested. That cost is expected to be years from ihe date of grant. The Company generally recognized over a weighted-average period of recognizes stock option expense on a straight-line basis approximately II months. over the vesting period which equates to the requisite service period; however for employees who are eligibleý The total intrinsic value of options exercised during . for retirement the total cost is expensed at the grant date. the years ended December 31, 2006, 2005, and 2004 was - Options outstanding will expire no later than 10 years $10 million, $24 million, and $16 million, respectively. after the date of grant, unless terminated earlier by the The actual tax benefit realized by the Company for Southern Company Board of Directors in accordance with the tax deductions from stock option exercises totaled the stock option plan. For certain stock option awards a $4 million, $9 million, and $6 million, respectively, for change in control will provide accelerated vesting. As part the years ended December 31, 2006, 2005, and 2004. of the adoption of SFAS No. 123(R), as discussed earlier in Note 1 under "Stock Options," Southern Company has

9. NUCLEAR INSURANCE not modified its stock option plan or outstanding stock options, nor has it changed the underlying valuation Under the Price-Anderson Amendments Act (Act), the assumptions used in valuing the stock options that were Company maintains agreements of indemnity with the used under SFAS No. 123. NRC that, together with private insurance, cover third-party liability arising from any nuclear incident occurring at the Company's nuclear power plants. The Act provides funds up to $10.76 billion for public liability claims that could arise from a single nuclear incident. Each nuclear plant is insured against this liability to a maximum of

                                                                  $300 million by American Nuclear Insurers (ANI), with 11190

NOTES (continued) Georgia Power Company 2006 Annual Report the remaining coverage provided by a mandatory program available through reinsurance or indemnity from an of deferred premiums that could be assessed, after a outside source. The non-certified ANI nuclear liability nuclear incident, against all owners of nuclear reactors. A cap is a $300 million shared industry aggregate during the company could be assessed up to $101 million per normal ANI policy period. incident for each licensed reactor it operates but not more For all on-site property damage insurance policies than an aggregate of $15 million per incident to be paid for commercial nuclear power plants, the NRC requires in a calendar year for each reactor. Such maximum ' that the proceeds of such policies shall be dedicated first assessment for the Company, excluding any applicable for the sole purpose of placing the reactor in a safe and state premium taxes, based on its ownership and buyback stable condition after an accident. Any remaining interests, is $203 million per incident but not more'than proceeds are to be applied next toward the costs of an aggregate of $30 million tQ be paid for each incident decontamination and debris removal operations ordered in any one year. .by the NRC, and any further remaining proceeds are to be The Company is a membei of Nuclear Electric paid either to the Company or to its bond trustees as may Insurance Limited (NEIL), a mutual insurer established to be appropriate under the policies and applicable trust provide property damage insurancein an' amount up to indentures. $500 million for members' nuclear generating facilities. All retrospective assessments, whether generated for Additionally, the Companyýhas policies that currently liability, property, or replacement power, may be subject provide decontamination, excess property insurance, and to applicable state premium taxes. premature decommissioning coverage up to $2.25 billion for losses in excess of the $500 million primary coverage. 10. QUARTERLY FINANCIAL INFORMATION This excess insurance is also provided by NEIL. (UNAUDITED) NEIL also covers additional costs that would be - Summarized quarterly financial information for 2006 and incurred in obtaining replacement power during a 2005 is as follows: prolonged accidental outage at a member's nuclear plant. Net Income Members can purchase this coverage, subject to a After Dividends deductible waiting period of up to 26 weeks, with a Operating Operating on Preferred maximum per occurrence per unit limit of $490 million. Quarter Ended Revenues Income Stock After the deductible period, weekly indemnity payments (in millions) would be received until either the unit is operational or $132 March 2006 $1,584 $288 until the limit is exhausted in approximately 'three years. June 2006 1,808 386 197 The Company purchases the maximum limit allowed by NEIL subject to ownership limitations and has elected a September 2006 2,275 662 382 12-week waiting period. - December 2006 1,579 174 76 Under each of the NEIL policies, members are March 2005 $1,459 $290 $144 subject to assessments if losses each year ex6eed the June 2005 1,554 325 164 accumulated funds available to the insurer under that 375 September 2005 2,369 661 policy. The current maximum annual assessments for the December-2005 1,694 172- 61 Company under the NEIL policies would be $49 million. Following the terrorist attacks of September 200i, The Company's business is influenced by seasonal: both ANI and NEIL confirmed that terrorist acts against weather conditions. commercial nuclear power plants would, subject to the normal policy limits, be covered under their insurance. Both companies, however, revised their policy terms on a prospective basis to include an industry aggregate for all "non-certified" terrorist acts i.e., acts that are not certified acts of terrorism pursuant to the Terrorism Risk Insurance Act of 2002, which was renewed in 2005. The aggregate for all NEIL policies, which applies to non-certified property claims stemming from terrorism within a 12-month duration, is $3.24 billion plus any amounts II-191

SELECTED FINANCIAL AND OPERATING DATA 2002-2006 Georgia Power Company 2006 Annual Report 2006 2005 2004 2003 2002 Operating Revenues (in thousands) $ 7,245,644 $ 7,075,837 $ 5,727,768 $ 5,228,625 $ 5,119,466 Net Income after Dividends on Preferred Stock (in thousands) $ 787,225 .$ 744,373 $ 682,793. $ 654,036 $ 638,948 Cash Dividends on Common Stock (in thousands) $ 630,000 $ 582,800 $ 588,700 $ 588,800 $ 565,600 Return on Average Common Eq1uity (percent) 13.80 14.08 13.87 14.01 13.92 Total Assets (in thousands) $19,308,730 $17,898,445 $16,598,778 $15,527,223 $14,978,520 Gross Property Additions (in thousands) $ 1,276,889 $ 958,563 $ 1,252,197 $ 783,053 $ 916,449 Capitalization (in thousands): , Common stock equity $ 5,956,251 $ 5,452,083 $ 5,123,276 $ 4,723,299 $ 4,610,396 Preferred stock 44,991 43,909 58,547 14,569 14,569 Mandatorily redeemable preferred securities - - 940,000 980,000 Long-term debt payable to affiliated trusts 969,073 969,073 969,073 -- Long-term debt 4,242,839 4,396,250 3,947,621 3,984,825 3,277,671 Total (excluding amounts due within one year) $11,213,154 $10,861,315 $10,098,517 $ 9,662,693 $ 8,882,636 Capitalization Ratios (percent): Common stock equity 53.1 50.2 50.7 48.9 51.9 Preferred stock 0.4 0.4 0.6 0.2 0.2 Mandatorily redeemable preferred securities - - - 9.7 11.0 Long-term debt payable to affiliated,.trusts 8.6 8.9 9.6 - - Long-term debt - 37.9 40.5 39.1 41.2 36.9 Total (excluding amounts due within one year) 100.0 100.0 100.0 100.0 100.0 Security Ratings: Preferred Stock - Moody's Baal Baal Baal Baal Baal Standard and Poor's BBB+ BBB+ BBB+ BBB+ BBB+ Fitch A A A A -A Unsecured Long-Term Debt-. Moody's A2 A2 A2 A2 A2 Standard and Poor's A A A A A Fitch A+ A+ A+ A+ A+ Customers (year-end): Residential 1,998,643 1,960,556 1,926,215 1,890,790 1,854,561 Commercial 294,654 289,009 283,507 275,378 267,505 Industrial 8,008 8,290 7,765 7,989 8,321 Other 4,371 4,143 4,015 - 3,940 3,822 Total 2,305,676 2,261,998 2,221,502 2,178,097 2,134,209 Employees (year-end) 9,278 9,273 - 9,294 9,263 9,385 N/A = Not Applicable... U-192

SELECTED FINANCIAL AND OPERATING DATA 2002-2006 (continued) Georgia Power Company 2006 Annual Report 2006 2005 2004 2003 2002 Operating Revenues (in thousands): Residential $ 2,326,190 $ 2,227,137 $ 1,900,961 $ 1,726,543 $ 1,738,206 Commercial 2,423,568 2,357,077 1,933,004 1,767,487 1,734,423 Industrial 1,382,213 1,406,295 1,217,536 1,051,034 1,036,722 Other 73,649 73,854 67,250 63,715 61,972 Total retail 6,205,620 6,064,363 5,118,751 4,608,779 4,571,323 Sales for resale - non-affiliates 551,731 524,800 251,581 265,029 277,031 Sales for resale - affiliates 252,556 275,525 172,375 181,355 102,398 Total revenues from sales of electricity 7,009,907 6,864,688 5,542,707 5,055,163 4,950,752 Other revenues 235,737 211,149 185,061 173,462 168,714 Total $ 7,245,644 $ 7,075,837 $ 5,727,768 $ 5,228,625 $ 5,119,466 Kilowatt-Hour Sales (inthousands): Residential 26,206,170 25,508,472 24,829,833 23,532,467 23,900,526 Commercial 32,112,430 31,334,182 29,553,893 28,401,764 28,409,596 Industrial 25,577,006 25,832,265 27,197,843 26,564,261 26,531,207 Other 660,285 737,343 744,935 732,900 731,115 Total retail 84,555,891 83,412,262 82,326,504 79,231,392 79,572,444 Sales for resale - non-affiliates 12,314,322 11,318,403 6,101,243 8,998,272 8,220,170 Sales for resale - affiliates 5,494,436 5,033,165 4,925,744 6,029,398 4,088,440 Total 102,364,649 99,763,830 93,353,491 94,259,062 91,881,054 Average Revenue Per Kilowatt-Hour (cents): Residential 8.88 8.73 7.66 7.34 7.27 Commercial 7.55 7.52 6.54 6.22 6.11 Industrial 5.40 5.44 4.48 3.96 3.91 Total retail 7.34 7.27 6.22 5.82 5.74 Sales for resale 4.52 4.89 3.84 2.97 3.08 Total sales 6.85 6.88 5.94 5.36 5.39 Residential Average Annual Kilowatt-Hour Use Per Customer 13,216 13,119 13,002 12,555 12,990 Residential Average Annual Revenue Per Customer $1,173 $1,145 $995 $921 $945 Plant Nameplate Capacity Ratings (year-end) (megawatts) 15,995 15,995 14,743 14,768 14,847 Maximum Peak-Hour Demand (megawatts): Winter 13,528 14,360 13,087 13,929 12,539 Summer 17,159 16,925 16,129 15,575 15,896 Annual Load Factor (percent) 61.8 59.4 61.0 61.6 61.6 Plant Availability (percent): Fossil-steamn 91.4 90.0 87.1 85.9 81.1 Nuclear 90.7 89.3 94.8 94.1 88.8 Source of Energy Supply (percent): Coal 58.0 60.0 57.0 57.9 58.8 Nuclear 14.2 14.4 16.4 16.0 15.4 Hydro, 0.9 1.8 1.5 2.0 0.8 Oil and gas 4.8 3.0 0.1 0.3 0.5 Purchased power - From non-affiliates 6.2 5.6 7.0 7.3 6.2 From affiliates 15.9 15.2 18.0 16.5 18.3 Total 100.0 100.0 100.0 100.0 100.0 11-193

(This page intentionally left blank) GULF POWER COMPANY FINANCIAL SECTION H-194

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Gulf Power Company includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, We have audited the accompanying balance sheets and assessing the accounting principles used and significant statements of capitalization of Gulf Power Company (the estimates made by management, as well as evaluating the "Company") (a wholly owned subsidiai'y f Southern overall financial statement presentation. We believe that Company) as of December 31, .2006 aiid 2005, and the our audits provide a reasonable basis for our opinion. related statements of income, comprehensive income, common stockholder's equity, and cash flows for each of In our opinion, such financial statements (pages II-the three years in the period ended December 31, 2006, - 215 to' II-240) present fairly, in all material respects, the These financial statements are the responsibility of: the. financial' position of Gulf Power Conpany at Company's management. Our responsibility is to express December 31, 2006 and 2005, and the results of its an opinion on these financial statements based on our operations .and its cash flows for each of the three years audits. in the period ended December 31, 2006, in conformity We conducted our audits in accordance with the with accounting principles generally accepted in the standards of the Public Company Accounting Oversight United States of America. Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance As discussed in Note 2 to the financial statements, in about whether the financial statements are free of naterial 2006 Gulf Power Company changed its method of misstatement. The Company is not required to have, nor accounting for the funded status of defined benefit were we engaged to perform, an audit of its 'internal pension and'other postretirement plans. control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the -purpose of expregsing an opinion on the effectiveness of the Company's internal control over financial reporting: Atlanta, Georgia Accordingly, we express no such opinion. An audit also February 26, 2007

                                                ""   '11ý
                                 - ii'.,-,' 'I'   --

I' -' 11-195

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Gulf Power Company 2006 Annual Report OVERVIEW customer satisfaction include outstanding service, high reliability, and competitive prices. Management uses Business Activities customer satisfaction surveys and reliability indicators to evaluate the Company's results. Gulf Power Company (the Company) operates as a vertically integrated utility providing electricity to retail Peak season equivalent forced outage rate (Peak customers within its traditional service area located in Season EFOR) is, an indicator of plant availability and northwest Florida and to wholesale customers in the efficient generation fleet operations during the months Southeast. when generation needs are greatest. The rate is calculated by dividing the number of hours of forced outages by Many factors affect the opportunities, challenges, and total generation hours. Transmission and distribution risks of the Company's business of selling electricity. system reliability performance is measured by the These factors include the ability to maintain a stable frequency and duration of outages. Performance targets regulatory environment, to achieve energy sales growth, for reliability are set internally based on historical and to effectively manage and secure timely recovery of performance, expected weather conditions, and expected rising costs. These costs include those related to growing economic conditions. Net income is the primary demand, increasingly stringent environmental standards,' component of the Company's contribution to Southern fuel prices, and storm restoration costs. Appropriately Company's earnings per share goal. balancing environmental expenditures with customer prices will continue to challenge the Company for the The Company's 2006 results compared with its foreseeable future. targets for some of these key indicators are reflected in the following chart: Hurricanes Dennis and Katrina hit the Gulf Coast of Florida in July 2005 and August 2005, respectively, Key .... , 2006 2006 damaging portions of the Company's service area. In Performance Target Actual September 2004, Hurricane Ivan hit the Gulf Coast of Indicator Performance Performance Florida, causing substantial damage within the Company's service area. In 2005, the Florida Public Service Customer Top quartile Satisfaction performance in Top quartile Commission (PSC) issued an order (2005 Order) that customer surveys approved a stipulation and settlement between the Company and several consumer groups and thereby Peak Season 3.00% 2.57% authorized the recovery of the Company's storm damage EFOR costs related to Hurricane Ivan through a two-year Net Income $76.1 million $76.0 million surcharge that began in April 2005. In July 2006, the Florida PSC issued an order (2006 Order) approving See RESULTS OF OPERATIONS herein for another stipulation and settlement between the Company additional information on the Company's financial and several consumer groups and thereby authorized an performance. The financial performance achieved in 2006 extension of the storm-recovery surcharge currently being reflects the continued emphasis that management places collected by the Company for an additional 27 months, on these indicators, as well as the commitment shown by expiring in June 2009. See Notes I and 3 to the financial employees in achieving or exceeding management's statements under "Property Damage Reserve" and "Retail expectations. Regulatory Matters - Storm Damage Cost Recovery," respectively, for additional information. Earnings Key Performance Indicators The Company's 2006 net income after dividends on preferred and preference stock was $76.0 million, an In striving to maximize shareholder value while providing increase of $0.8 million from the previous year. In 2005, cost-effective energy to over 415,000 customers, the earnings were $75.2 million, an increase of $7.0 million Company continues to focus on several key indicators. from the previous year. In 2004, earnings were These indicators include customer satisfaction, plant $68.2 million, a decrease of $0.8 million from the availability, system reliability, and net income after previous year. The increase in earnings in 2006 is due dividends on preferred and preference stock. The primarily to higher operating revenues partially offset by Company's financial success is directly tied to the higher operating expenses, higher financing costs, and satisfaction of its customers. Key elements of ensuring increases in depreciation expense. The increase in 11-196

MANAGEMENT'S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report earnings in 2005 was due primarily to higher retail sales: Revenues and tower non-fuel operating expenses, excluding Operating revenues increased in 2006 when compared to expenses related to Hurricane Ivan storm damage, which 2005 and 2004. The following table summarizes the are offset by revenues and do not affect earnings. See changes, in, operating revenues for the past three years: FUTURE EARNINGS POTENTIAL - "PSC Matters - Storm Damage Cost Recovery" herein. The decrease in Amount earnings in 2004 was due primarily to higher operating 2006 2005 2004 expenses related to replenishing property damage reserves (in thousands) and increased expenses related to employee benefits. Retail -- prior year $ 864,859 $ 736,870 $699,174 Change in RESULTS OF OPERATIONS Base rates. Sales growth 2,473 11,568 4,896 A condensed statement of income is as follows: Weather 2,443 (4,223) 3,313 Increase (Decrease). Fuel cost recovery Amount From Prior .Year . and other 82,263 120,644 29,487 2006 2006 2005 2004 Retail -- current year 952,038 864,859 736,870 (in thousands) Sales for resale Operating revenues $1,203,914 $120,292 $123,491 $82,434 Non-affiliates 87,142 84,346 73,537 Fuel 534,921- 119,132 48,634 50,652 91,352 110,264 Affiliates 118,097 Purchased power. 73,824 (24,573), 32,500 15,740 Other operation and Total sales for resale 205,239 175,698 183,801 maintenance 259,519 9,749 '20,058 -19,012 Other operating Depreciation and. revenues 46,637 43,065 39,460 amortization 89,170 4,168;, 2,203 477 Taxes other than Total operating income taxes 79,808 3,421 6,531 3,741 revenues $1,203,914 $1,083,622 $960,131 Total operating Percent change 11.1% 12.9% 9.4% expenses 1,037,242 111,897 109,926' 89,622 Operating income 166,672 8,395 13,565 (7,188) Retail revenues increased $87 million, or Total other income and (expense)' (42,090) (4,764) '(749) 5,219 10.1 percent, in 2006, $128.0 million, or 17.4 percent, in Income taxes 45,293 312 5,286 (1,182) 2005, and $37.7 million, or 5.4 percent, in 2004. The Net Income 79,289 3,319 7,530 (787) significant factors driving these changes are shown in the Divi&nds on table above. I Preferred and Preference Stock 3,300 2,539 544 - Fuel and other cost recovery includes recovery provisions for fuel expenses and the energy component of Net Income after F Dividends on .. - . ..... purchased power'costs, energy conservation costs, Preferred and purchased power capacity costs, and environmental Preference Stock $ 75,989 $ 780 $ 6,986' $ (787) compliance costs. Annually, the Company petitions for recovery of projected costs including*any true-up amount from prior periods, and approved rates are implemented each January. Other cost recovery also includes revenues related t6 the recovery of incurred costs for storm damage. activity as approved by the Florida PSC. The recovery provisions generally equal the related expenses and have no material effect on net income. See Note 1 to the financial statements under "Revenues," "Property Damage Reserve," and "Environmental Cost Recovery" and Note 3 to the financial statements under "Retail Regulatory Matters - Environmental Cost Recovery" and "- Storm Damage Cost Recovery" for additional information. Total sales for resale were $205.2 million in 2006, an increase of $29.5 million, or 16.8 percent, compared to 2005, primarily due to increased energy sales to affiliates 11-197

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report to serve their territorial energy requirements. Total sales Energy Sales for resale were $175.7 million in 2005, a decrease of Changes inrevenues are influenced heavily by the volume $8.1 million, or 4.4 percent, compared to 2004, primarily of energy sold each year. Kilowatt-hour (KWH) saies for due to lower energy sales to affiliates resulting from 2006 and the percent changes by year were as follows: decreases in the Company's available generation as a result of outages at Plants Crist and Smith. Total sales for KWH Percent Change , resale were $183.8 million in 2004, an increase of 2006 2006 2005 2004 $43.8 million, or 31.3, percent, compared to 2003, (in millions) primarily due to energy sales. to affiliates at a higher unit Residential 5,426 2.0% 2.0% 2.2% cost resulting from higher incremental fuel prices. Commercial 3,843 2.9 1.1 2.2 Revenue from sales to affiliated companies will vary Industrial 2,136 (1.1) ' 2.3 (P.6) from year to year depending on demand and the Other 24 5.1 0.7 0.4 availability and cost of generating resources at each Total retail 11,429 1.7 1.7 1.5 company. These affiliate sales and purchases are, made in Sales for resale accordance with the Intercompany Interchange Contract Non-affiliates 2,079 (9.4) 1.7 (9.9) (1IC), as approved by the Federal Energy Regulatory Affiliates 2,938 48.6 (36.8) 28.1 Commission (FERC). These transactions do not have a Total 16,446 6.0 (5.6) 3.8 significant impact on eamirigs, since the energy is generally sold at marginal cost and energy purchases are Residential energy sales increased 2.0 percent in' generally offset by revenues through the Company's fuel 2006, compared to 2005, primarily due to more favorable cost recovery clause. weather conditions and customer growth. Residential Sales for resale to non-affiliates are predominantly energy sales increased 2.0 percentvin 2005, compared to unit power sales under long-term contracts to other 2004, primarily due to customer growth offset by Florida utilities. Revenues from contracts have both unfavorable weather conditions. Residential energy sales,' capacity and energy components. Capacity revenues increased 2.2 percent in 2004, compared to 2003, due to reflect the recovery of fixed costs and a return on more favorable weather conditions. and customer growth. investment under the contracts. Energy is generally sold at Commercial energy sales, increased 2.9 percent in variable cost. The capacity and energy components under 2006, compared to 2005, primarily due to more favorable' these unit power sales contracts were as follows: weather conditions and customer growth. Commercial 2006 2005 2004 energy sales increased 1.1 percent in 2005, compared to (in thousands) 2004, primarily due to customer growth offset by unfavorable weather conditions. Commercial energy sales Unit Power-- Capacity $21,477 $20,852 $18,780 increased 2.2 percent in 2004, compared to 2003,

Energy 34,597 33,206 29,360 primarily due to more favorable weather conditions and customer growth. I Total $56,074 $54,058 $48,140 Industrial energy sales decreased 1.1 percent in 2006, Other operating revenues increased.$3.6 million, compared to 2005, due to reduced demand for and

$3.6 million, and $1.0 million in 2006, 2005, and 2004, production of building materials and a conversion project respectively, primarily due to an increase in franchise by a major paper manufacturer. Industrial energy sales fees, which are proportional to changes in revenue. increased 2.3 percent in 2005, compared to 2004, primarily due to additional sales to customers with gas-fired cogeneration resulting from high natural gas prices. Industrial energy sales decreased 1.6 percent in 2004, compared to 2003, primarily due to the short-term outage experienced as a result of Hurricane Ivan in September 2004. Sales for resale to non-affiliates decreased 9.4 percent in 2006, increased 1.7 percent in 2005, and decreased 9.9 percent in 2004, each compared to the prior year primarily as a result of fluctuations in the fuel cost to 11-198

MANAGEMENT'S DISCUSSION AND ANALYSIS OF, FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report produce energy sold to non-affiliated utilities under both related to total KW.H generated. Fuel expense was long-term and short-term contracts..The degree to.which $416 million in 2005, an increase of $48.6 million, or oil and natural gas prices, which are the primary fuel 13.2 percent, above the prior year costs. This increase' was sources for these customers, differ from the Company's the result of:a $67.5 million increase in the cost of fuel fuel costs will influence these changes in sales. The and an $18.9 million decrease related to total KWH fluctuations in sales have a minimal effect on earnings generated. Fuel expense was $367 million in 2004, an because the energy is generally. sold at variable cost. increase of1$50.7 million, or 16 percent, above the prior year costs.,lhis increase was the result of an $32.7 million Sales for resale to affiliates increased 48.6 percent in increase in the cost of fuelland a $18 million increase 2006 compared to 2005, primarily due to increased related -o total KWH generated. territorial energy, requirements of affiliates. Sles for resale to affiliates decreased 36.8 pertieht in 2005 Pu&haised power expense was $73.8 million in 2006, compared to 2004, due to decreases in e Company's a dderas-elof $24.6 milli'on, or 25J0 percent, below the available generation as a result of outages at Plants Crist prior year costs. Thisdecrease was the result of a and Smith. Sales for resale increased 28.1 percent in 2004 $24.9 miltoln !decrease in total KWH purchased and a compared to 2003, primarily to serve affiliates' territorial $0.3 million increase resulting from the higher average, energy requirements. , ,- cost per n)et KWH. .Purchased power expense was I' - -. -

                                                                                  $98.4 ulion in 2005, an increase of $32.5 million, or Expenses                                                                           49.3 7p'ercent, above the prior year costs. This increase was the result of a $7.6 million decrease in total KWH Fuel and Purchased Power                                                           puichased and a $40.1 million increase resulting from the higher average 'c6s;per'net KWH. Purchased power Fuel costs constitute the single largest expense for the                           expense was $65.9 million in 2004, an increase of Company. The mix of fuel sources for generation of                                 $157 mIillion, or 31.4 percent, above the prior year costs..

electricity is determined primarily by, demand, the unit . .'i ,J This increase was the riesuflt of a $6.6 million decrease in cost of fuel consumed, and the availability of generation total KWH purchased and a $22.3 million increase resources. Details of the Company.s amount and sources resulting from the higher average cost per net KWH. of generation, the average cost of fuel per net KWH generated, and the average costs of purchased power were While prices have moderated somewhat in 2006, a as follows: significant upward trend in the cost of coal and natural

                                           -2006            2005: 2004            gas has emerged since 2003, and volatility in these markets is expected to continiue. Increased coal prices .

Total generation have beezt in'fluenced' by a worldwide increase in demand' (millions of KWH) 16,349 15,024 15,841 as a result of rapid economic growth in China, as well 'as Total purchased power by icreaseinmining and fuel transportation 'costs. (millions of KWH) 876 1,172 1,326 Higher :natural'gas prices in ihe United States are the Sources of generation" result-of increased demand and slightly lower gas supplies (percent) - despfie increased drilling activity. Natui.ral gas production' Coal 87% 1; 86% % and supply.inte1rruptions,' such as' those caused by the Gas .- '13 14 16 2004 anid 2005 hurricanes, result in an immediate market Cost of fuel, generation , t response; however, the long-term impact of this price (cents per net KWH)- ', volatility may be reduced by imports:of liquefied natural Coal . 8 2.16 1.83 gas if new liquefied gas facilities are built. Fuel expenses Gas -7.24 '6.48 4.95 A generally do not affect net income, since they are offset Average cost of fuel, generated by fuel revenues under the Company's fuel cost recovery, (cents per' net KWH) ' 321.7. 2.77' 2.32 provisions. See FUTURE EARNINGS POTENTIAL - Average cost of purchased "PSC Matters - Fuel Cost Recovery" herein and -Note 3 to power' ' the financial statements for additional information. (cents per net KWH) &43 8.39 4.97 Other Operations and Maintenance Fuel expense was $535 million in 2006,,.an increase of $119.1 million, or 28.7 percent, above the prior year In 2006, oler operations and maifitenanice expense costs. This increase was the result of an $82A million increased .$9.7million, or 3,9 percent, compared to the increase in the cost of fuel and a $36.7 million increase prior year primarily due to a $4.2 million increase in the 11-199

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report recovery of incurred costs for storm damage activity as 2006 compared to the prior year primarily due to the approved by the Florida PSC, a $1.9 million increase in completion of an environmental control project at Plant employee benefit expenses, and a $1.1 million increase in Crist Unit 7. AFUDC decreased $0.7 million, or property insurance costs. In 2005, other operations and 37.1 percent, in 2005 and increased $1.1 million, or maintenance expense increased $20.1 million, or 160.7 percent, in 2004 compared to the prior year 8.7 percent, compared to the prior year primarily due to primarily :due to the construction and completion of an the recovery of $20.4 million in Hurricane Ivan environmental control project at Plant Crist Unit 7. See restoration costs as approved by the Florida PSC. Since FUTURE EARNINGS POTENTIAL - "Environmental these storm damage expenses are recognized as revenues Matters - Environmental Statutes and Regulations" herein are recorded, there is no impact on net income. See and Note 1 to the financial statements under "Allowance FUTURE EARNINGS POTENTIAL - "PSC Matters - for Funds Used During Constiuction (AFUDC)" for Storm Damage Cost Recovery'* herein and Note '3 'to the additional information. financial statements under "Retail Regulatory Matters - Storm Damage Cost Recovery" for additional ififr0nmation. In 2004, other operations and maintenance expense Interest Income, increased $19.0 million, or 9.0 percent, compared to the Interest income increased $1.4 million, or 37.4 percent, in prior year primarily due to increases of $7.9 million in 2006 compared to the prior year primarily due to interest the property damage reserve, $2.9 million in the accrued received related to the recovery of financing costs expenses for uninsured litigation and workers associated with the fuel clause and incurred costs for compensation claims, $3.4 million for employee benefit storm damage activity as approved, by the Florida PSC. expenses, and $2.5 million for production eipenses. See Interest income increased $2.6 million, or 210.9 percent, Notes 1 and 3 to the financial statements under "Property in 2006 compdred to the prior'year primarily due to Damage Reserve" and "Retail Regulatory Matters - Storm interest received from a tax refund resulting from Damage Cost Recovery," respectively, for additional Hurricane Ivan 'and interest 'received related to the information on the property damage reserve. recovery of fihiancinug costs associated with Hurricane Ivan.: See FUTURE EARNINGS POTENTIAL - "Storm Depreciationand Amortization Damage Cost Recovery" herein and Note 3 to the Depreciation and amortization expense, increased financial statements under "Retail Regulatory Matters - $4.2 million, or 4.9 percent, in 2006 compared to the Storm Damage Cost Recovery" for additional information. prior year primarily due to the construction of Interest income remained relatively flat in 2004 compared environmental control projects at Plants Crist and Daniel to the prior year. that were placed in service in 2005. Depreciation and amortization expense increased $2.2 million, or Interest Expense 2.7 percent, in 2005 compared to the prior year primarily due to the completion of environmental control projects at Interest expense, net of amounts capitalized increased Plant Crist Unit 7. Depreciation and amortization expense $3.9 million, or 10.9 percent, in 2006 compared to the remained relatively flat in 2004 compared to the prior prior year as the result of higher interest rates on variable year due to no significant change in depreciable assets. rate pollution control bonds, increased levels of short-term borrowings at higher interesi rates, and the issuance of Taxes Other Than Income Taxes $60 million in senior notes in August 2005. These increases were partially offset by the maturity of a Taxes other than income taxes increased $3.4 million, or -

                                                                   $100 million bank note in October 2005 and the 4.5 percent, in 2006, $6.5 million, or 9.3 percent, in 2005, extinguishment of $30 million aggregate principal amount and $3.7 million, or 5.7 percent, in 2004 primarily due to          of first mortgage bonds in 2005. Interest expense increases in franchise; and gross receipts taxes, which are         increased $4.2 million, or 13.5 percent, in 2005 compared directly related to the increase in retail revenues.                to the prior year as the result of higher interest rates on variable rate pollution control bonds and an increase in Other Income and (Expense)                                          outstanding short-term indebtedness as a result of hurricane-related costs. Interest expense decreased Allowance for Equity Funds Used During.Construction
                                                                   $2.1 million; or .5.5 percent, in 2004 compared to the Allowance for equity. funds used during construction'               prior year primarily as the result of refinancing higher' (AFUDC) decreased $0.8 million, or 68.9 percent, in                 cost securities.

11-200

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report Other Deductions maintain a stable regulatory- environment that continues to allow for the recovery of all prudently incurred costs Other deductions increased $1.5 million, or 52.9 percent, during a time of increasing environmental and fuel costs. in 2006, decreased $1.4 million,' oI32.2 percent, in 2005, Future earnings in the near term will depend, in part, and $1.5 million, or 25.7 percent, in '2004 compared to upon growth in energy sales, which is subject to a number the prior years as a result of changes in charitable of factors. These factors include weather, competition, contributions. new energy contracts with neighboring utilities, energy conservation practiced by customers, the price'of Effects of Inflation electricity, the price elasticity of demand, and the rate of econbmic'growth in the Company's service area. The Company is subject to rate regulation based on the recovery of historical costs. When historical costs' are included, or when inflation exceeds projected costý used Environ nentai Matters in rate regulation, the effects of inflation can create an Compliance, costs related to the Clean Air Act and other economic loss since the recovery,6f costs could be in environmental regulations could affect earnings if such dollars that have less purchasing power. In addition, the costs cannot be fully recovered'in rates on a timely basis. income tax laws are based on historical costs. While the Envir6rimental compliance spending over the next several inflation rate has been relatively 'low in recent years, it years Imayexceed amounts estimated. Some of the factors continues to have an adverse effect on the 'Company driving the potential for stch an increase are higher because of the large investment 'iiiutility plant with long comnmodity costs, market demand for labor, and -scope economic lives. Conventional accountinig for historical additions and clarifications. The timing, specific cost does not recognize this economic loss nor the requirements, and estimated costs could also change as"' partially offsetting gain that an~ses' through financing environmental regulations are modified. See Note 3 to the facilities with fixed-money obligations such as long-term financial statements under "Environmental Matters" for debt and preferred securities. Any recognition of inflation additional information. by regulatory authorities is reflected in 'the rate' of return allowed in the Company's approved electric rates.' New Source Review Actions* FUTURE EARNINGS POTENTIALJ In November 1999, the Environmental Protection Agency (EPA) brought a civil action in the U.S. District Court for General the Northern District of Georgia against certain Southern Cpmpany subsfdiaries, including Alabama Power and The Company operates as a vertically integrated utility Georgia-Power, alleging that these subsidiaries had providing electricity to retail customers within its violated'the.New Source Review (NSR) provisions of the traditional service area located in:' northwest Florida and to

                                                           '   :       Clean Ar Act and related state laws at certain coal-fired wholesale customers -in the Southeast. Prices for generatihggfacilities. Through 'subsequent amendments and electricity provided by the Company to retail     customers, otIer' legal procedtures, the EPA'filed,'a separate action in' are set by the Florida PSC under cost-based regulatory:                January 20001 against Alabama Power in the U.S. District principles. Prices for electricity 'relating to purchased Courtfof 'the'ortherhI District of Alabama after Alabama power agreements (PPAs), interconnecting transmission                  Power was dismissed from the original action. In these lines, and the exchange of electric, power are regulated by lawsuits, the EPA alleged that NSR 'Violations occurred at the FERC. Retail rates and earnings are reviewed and                  eight coal-fired generating facilities operated by Alabama may be'adjusted periodically within certain limitations.

Power and-Georgia Power (including a facility formerly See ACCOUNTING POLICIES - "Application, of Critical owned by Savannah Electric). The civil actions request Accounting Policies and Estimates - Electric Utility penalties and injunctive relief, including an order Regulation" herein and Note 3 to the financial statements requiring the installation of the best available control for additional information about regulatory matters. technology at the affected units. The EPA concurrently The results of operations for the past three years are issued notices of violation relating to the Company's not necessarily, indicative of future earnings potential.. The Plant Crist and a unit partially owned by the Company at level of the Company's future earnings depends on . Plant Scherer. See Note 4 to the financial statements for numerous factors that affect the opportunities, challenges, information on the Company's ownership interest in Plant and risks of the Company's business of selling, electricity. Scherer Unit 3. In early 2000, the EPA filed a motion to. These factors include the ability of the Company to. amend its complaint to add the allegations in the notices 11-201

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report of violation and to add the Company as a defendant. I for the District of Columbia Circuit also vacated an EPA However, in March 2001, the court denied the motion rule which sought to clarify the scope of the existing , based on lack of jurisdiction, and the EPA has not refiled, Routine Maintenance, Repair and Replacement exclusion. In October 2005 and September 1006, the EPA also, On June. 19, 2006, the U.S. District Court for the published proposed1 rules clarifying the test for Northern District of Alabama entered a consent decree determining when'an emissions increase subject to the between Alabama Power andfthe EPA, resolving the NSR permitting requirements has occurred. The impact of alleged NSR violations at Plant Miller. The consent these proposed rules will depend on adoption of the final decree required Alabama Power to pay $100,000. to rules by the EPA and the State of Florida's resolve the government's claim for a civil penalty and to implementation. of such rules, as well as the outcome of donate $4.9 million of sulfur dioxide emission allowances any additional legal challenges, and, therefore, cannot be to a nonprofit charitable organization and- formalized determined at this time. specific emissions reductions to be accomplished by Alabama Power, consistent with other Clean Air Act programs that require emissions reductions. On August 14, Carbon Dioxide Litigatio.. 2006, the district court in Alabama granted Alabama . In July 2004, attorneys general from eight states, each Power's motion for summary judgment and entered final outside of Southern Company's service territory, and the judgment in favor of Alabama Power on the EPA's claims corporation counsel for New York City filed a complaint related to Plants Barry, Gaston, Gorgas, and Greene in the U.S. District Court for the Southern District of New County. The plaintiffs have.appealed this decision to the York against Southem Company and four other electric' U.S. Court of Appeals for the Eleventh Circuit and, on: power companies. A nearly identical complaint was filed November 14, 2006, the Eleventh Circuit granted the by three, environmental groups in the same court. The plaintiffs' request to stay the appeal, pending the complaiiits'allege .that the companies' emissions of carbon U.S. Supreme Court's ruling in a similar NSR case filed dioxide, a greenhouse gas, contribute to global warming, by the EPA against Duke Energy. The action against which the plaintiffs assert is apublic nuisance. Under Georgia Power has been administratively closed since the common law public and private niuisance' theories, the spring of 2001, and none of the parties has sought to plaintiffs seek a'judicial order (1) holding each defendant reopen the case. jointly and severally liable for creating, contributing to, The Company believes that it complied with and/or maintaining global warmring and (2) requiring each applicable laws and the EPA regulations and. of the defendants to cap its emissions of carbon dioxide interpretations in effect at the time the work in question and then reduce those emissions by a specified percentage took place. The Clean Air Act. authorizes maximum civil each year for at least a decade. Plaintiffs have not, penalties of $25,000 to $32,500, per day, per violation at however, requested that, damages be awarded in each generating unit, depending on the date of the alleged connection with their claims. Southern Company believes violation. An adverse outcome in this matter could require these claims are without merit and notes that the substantial capital expenditures Ithat cannot be determined complaint cites no statutory or regulatory basis for the. at this time and could possibly requi're payment of claims. hA September 2005, the U.S. District Court for the substantial penalties. Such expenditures could affect Southern District of New York granted Southern C future results of operations, cash flows, and financial Company's and the other defendants', motions to dismiss condition if such costs are not recovered through these cases*,Tbe plaintiffs filed an appeal to the U.S. Court regulated rates. of Appeals for the Second Circuit in October 2005. The ultimate outcome of these matters cannot be determined The EPA has issued a series of proposed and final' at this, time. revisions to its NSR regulations under the Clean Air Act, many of which have been subject to legal challenges by Environmental Statutes and Regulations environmental groups and states. On June 24, 2005, the U.S. Court of Appeals for the District of Columbia General Circuit upheld, in part, the EPA's revisions to NSR regulations that were issued in December 2002 but The Company's operations are subject to extensive vacated portions of those revisions addressing the regulation by state and federal environmental agencies exclusion of certain pollution control projects. These under a variety of statutes and regulations governing regulatory revisions have been adopted by the State of environmental media, including air, water', and land Florida. On March 17, 2006, the U.S& Court of Appeals resources. Applicable statutes include the Clean Air Act; 11-202

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report the Clean Water Act; the Comprehensive Environmental dioxide (SO 2 ) and-nitrogen oxide (NOJ)emissions and in Response, Compensation, and Liability Act; the Resource monitoring emissions pursuant to the Clean Air Act. Conservation and Recovery Act; the Toxic Substances Additional controls have been announced and are Control Act; the Emergency Planning '& Community currently being installed at several plants to further reduce Right-to-Know Act; and the Endangered Species Act. - SO2, NO,, and mercury emissions, maintain compliance with existing regulations, and meet new requirements.- Compliance with, these environmental requirements involves significant capital and operating costs, a major In 2006, the Company completed implementation of portion of which is expected to be recovered through the terms of a 2002 agreement wiith the State of Florida to existing ratemaking provisions. Through 2006, the, help ensure attainment of the ozone standard in the Company had invested approximately $299 million in Pensacola, Florida area. The conditions of the agreement, capital projects to comply with these requirements, with which reqirled mistalling additional controls on certain annual totals of $46 million, $45 million, and $67 million units and retiring three older units at a plant near for 2006, 2005, and 2004, respectively. The Company Pensacola, totaled approximately $133.8 million, and have expects that capital expenditures to assure compliance been approved under the Company's environmental cost with existing and new regulations will be an additional,, recovery clause. $171 million, $378 million, and $300 million for 2007, In 2005, the EPA revoked the 'one-hour ozone air, 2008, and 2009, respectively. Because the Cornpany's, quality standard :and published the second of two sets of. compliance strategy is impacted by changes to existing final rules for implementation of the new, more stringent environmental laws and regulations, the cost,. availability, eight-hour.,ozone standard. Macon, Georgia, where Plant and existing inventory of emission allowances, and the Scherer is located, was designated as nonattainment under Company's fuel mix, the ultimate outcome cannot be the. ight-hopr ozone standard. No area within the determined at this time. Environmental costs that are Company's seryjce area -was designated as nonattainment known and estimable at this time are included in capital under the, eight-hour ozone standard. On December 22, expenditures discussed under FINANCIAL CONDITION 2006, the U.S. Court of Appeals for the District of AND LIQUIDITY - "Capital Requirements and Columbia Circuit -vacated the first set of implementation Contractual Obligations" herein. rules. adopted in 2004 and remanded the rules to the EPA The Florida Legis lature has adopted legislation that for further refinement. The impact of this decision, if any, allows a utility to petition the Florida P$C for recovery of cannot be determined at this time and will depend on prudent environmental compliance costs that are not being subsequent legalaction and/or rulemaking activity. State recovered through base rates or any pther,recovery, implementation'-plans, including new emission control mechanism. The legislation is discussed in Note 3 to the regulations necessary to bring ozone nonattainment areas, financial statements under "Retail Regulatory Matters - into attainment, are currently required. for most areas by. Environmental Cost Recovery' Substantially all of the June 2007. These state implementation plans could costs for the Clean Air Act and other new enyironmental. requirefurther reductions in NO. emissions from power legislation discussed below are expected to be ,recovered plants.. ,. through the environmental cost recovery clause., During 2005, the EPA's fine particulate matter Compliance with possible additlbfii' federal or state nonattainment designations became effective for areas legislation or regulations related to global climate change, within Gebfgia,- and the EPA proposed a rule for the air quality, or other environmnental and health concerns implementation of the fine particulate matter standard. could also significantly affect the Company. New The EPA is expected to publish its final rule for environmental legislation or regulations, or chanresito implementation of the existing fine particulate matter existing statutes or regulations, could affect many areas of standard in'early 2007., State plans for addressing the the Company's operations; however, the full impact of nonattainment designations under the existing standard are any such changes cannot be determined at this time. required by April 2008 and could require further reductions in SO 2 and NOx emissions from power plants.' On September 21,2006, the EPA published a final rule Air Quality lowering the 24-hour fine particulate matter air quality' Compliance with the Clean Air Act and resulting standard-even further and plans to designate regulations has been and will continue to'be a significant nonattainment kreas based on the new standard by focus for the Company. Through 2006, the Company had December 2009. The final outcome of this matter cannot spent approximately $153.4 million in reducing sulfur be determined at this time. 11-203

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report The EPA issued the final Clean Air Interstate Rule in The impacts of the eight-hour ozone and the fine March 2005. This cap-and-trade rule addresses power particulate matter nonattainment designations, the Clean plant SO 2 and NO,, emissions that were found to Air Interstate Rule, the Clean Air Visibility Rule, and the, contribute to nonattainment of the eight-hour ozone and Clean Air Mercury Rule on the Company will depend on fine particulate matter standards in downwind states. the development and implementation of rules at the state Twenty-eight eastern states, including Florida, Georgia, level. States implementing the Clean Air Mercury Rule and Mississippi are subject to the requirements of the and the Clean Air Interstate Rule, in particular, have the rule. The rule calls for additional reductions of NO,, option not to participate in the national cap-and-trade and/or S02 to be achieved in two phases, 2009/2010 and programs and could require reductions greater than those 2015. These reductions will be accomplished by the mandated by the federal rules. Impacts will also depend installation of additional emission controls at the on resolution of pending legal challenges to these rules. Company's coal-fired facilities or by the purchase of Therefore, the full effects of these regulations on the emission allowances from a cap-and-trade program. Company cannot be determined at this time. The Company has developed and continually updates a The Clean Air Visibility Rule (formerly called the comprehensive environmental compliance strategy to Regional Haze Rule) was finalized in July 2005. The goal comply with the continuing and new environmental of this rule is to restore natural; visibility conditions in requirements discussed above. As part of this strategy, the certain areas (primarily national parks and~wildemess Company plans to install additional SO2, NO,,, and areas) by 2064. The rule involves (1) the application of mercury emission controls within the next several years to Best Available Retrofit Technology (BART) to certain assure continued compliance with applicable air quality sources built between 1962 and 1977, and (2) the requirements. application of any additional emissions reductioris which may be deemed necessary for each designated area to Water Quality achieve reasonable progress toward the natural conditions In July 2004, the EPA published its final technology-- goal by 2018. Thereafter, for each 10-year planning based regulations: under the Clean Water Act for the period, additional emissions reductions will be required to purpose of reducing impingement and entrainment of fish, continue to demonstrate reasonable progress in each area shellfish, and other forms of aquatic life at existing power during that period. For power' plants, the Clean Air plant cooling water intake structures. The rules require Visibility Rule allows states to determine that the Clean baseline biological information and, perhaps, installation; Air Interstate Rule satisfies BART requirements for S02 of fish protection technology near some intake structures and NO,. However, additional BART requirements for at existing power: plants. On January 25, 2007, the particulate matter could be imposed, and the reasonable U.S. Court of Appeals for the Second Circuit overturned progress provisions could resulf in requirements for and remanded several provisions of the rule to the EPA additional SO 2 controls. By December 17, 2007, states for revisions. Among other things, the court rejected the must submit implementation plans that contain strategies EPA's use of "cost-behefit" analysis and suggested some for BART and any other control measures required to ways to incorporate cost considerations. The full impact achieve the first phase of reasonable progress. of these regulations will depend on subsequent legal proceedings, further rulemaking by the EPA, the results of In March 2005, the EPA published the final Clean studies and analyses performed as part of the rules' Air Mercury Rule, a cap-and-trade program for the implementation,, and the actual requirements established reduction of mercury emissions from coal-fired power by state regulatory agencies and, therefore, cannot now be plants. The rule sets caps on mercury emissions to be. determined. implemented in two phases, 2010 and 2018, and provides for an emission allowance trading market. The Company One facility within the Southern Company system is anticipates that emission controls installed to achieve retrofitting a closed-loop recirculating cooling tower under the Clean Water Act to cool water prior to compliance with the Clean Air Interstate Rule and the discharge and similar projects are being considered at eight-hour ozone and fine-particulate air quality standards will also result in mercury emission reductions. However, other facilities. the long-term capability of emission control equipment to Environmental Remediation reduce mercury emissions is still being evaluated, and the installation of additional control technologies may be The Company must comply with other environmental required. laws and regulations that cover the handling and disposal 11-204

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report of waste and release of hazardous substances. Under these FERC Matters various laws and regulations, the Company could incur substantial costs to clean up properties. The Company, Market-Based Rate Authority conducts studies to determine the extent of any required cleanup and has recognized in its financial statements the The Company has authorization from the FERC -to sell costs to clean-up known sites. Amounts for cleanup &ind power to non-affiliates, including short-term opportunity ongoing monitoring costs were not material for any year sales, at market-based prices. Specific FERC approval presented. The Company may be liable for some"or all must be obtained with respect to a market-based contract required clean up costs for additional sites thIat may with an affiliate. require environmental remediation. See Note 3 to the financial statements under "Environmental Matters, In December 2004, the FERC initiated a proceeding Environmental Remediation" for additional information. to assess Southern Company's generation dominance within its retail service territory. The ability to charge market-based rates in other markets is not an issue in that Global Climate Issues proceeding. Any new market-based rate sales by the Company in Southern Company's retail service territory Domestic efforts to limit greenhou6se gas emissions have entered into during a 15-month refund period beginning been spurred by international negoti~ations under the February 27, 2005 could be subject to refund to the level, Framework Convention on Climate Change and of the default cost-based rates, pending the outcome of specifically the Kyoto Protocol, which proposes a binding the proceeding. Such sales through May 27, 2006, the end limitation on the emissions of greenhouse gases for of the refund period, were approximately $0.8 million for industrialized countries. The Bush Administration has not the Company. In the event that the FERC's default - supported U.S. ratification of the Kyoto Protocol or other mitigation measures for entities that are found to have mandatory carbon dioxide reduction legislation; however, market power are ultimately applied, the Company may in 2002, it did announce a goal to reduce the greenhouse be required to charge cost-based rates for certain gas intensity of the U.S. economy, the ratio of greenhouse wholesale sales in the Southern Company retail service gas emissions to the value of U.S. economic output, by territory, which may be lower than negotiated market-18 percent by 2012. Southern Company is participating in based rates. The final outcome of this matter will depend the voluntary electric utility sector climate change on the form in which the final methodology for-assessing initiative, known as Power Partners, under the Bush generation market power and mitigation rules may be Administration's Climate VISION program. The utility ultimately adopted and cannot be determined at this time. sector pledged to reduce its greenhouse gas emissions rate by 3 percent to 5 percent by 2010-2012. Southern In addition, in May 2005, the' FERC started an Company continues to evaluate'future energy and investigation to determine whether Southern' Company emission profiles relative to the Po~wer Partners program satisfies the other three parts of the FERC's market-:based and is participating in voluntary programs to support the rate analysis: 'transmission market power, barriers to entry, industry'initiative. In addition, Southern Company is and affiliate abuse of reciprocal dealing. The FERC participating in 'the Bush Administration's'Asia Pacific established a new 15-month refund period related to this Partnership on Clean Development and Climate, a public/ expanded in'iestigation, Any new market-based rate sales private'partnership to work together to meet goals for involving any Southern Company subsidiary, including the energy security, national air pollution iýeduction, and Company, could be subject to refund to the extent the climate change in ways that promote sustainable FERC orders lower rates as a result of this new economic growth and poverty reduction. 'Legislative investigation. Such sales thirouih October 19, 2006, the proposals that would impose man'datory restrictions on end of the refund period, were approximately $3 million carbon dioxide emissions continue to'be considered in for the Company, of which $0.6 million relates to sales Congress. the ultimate outcome cannot be determined at inside the retail service territory discussed above. The : this time; however, mandatory restrictions on the FERC also directed that this expanded'proceeding be held Company's carbon dioxide emissions could result in in abeyance pending the outcome of the proceeding on, significant additional compliance costs that could affect the IIC discussed below. On January 3, 2007, the FERC future results of operations, cash flows, and financial issued an order noting settlement of the IIC proceeding condition if such costs are not recovered through and seeking comment identifying any remaining issues regulated rates. and the proper procedure for addressing any such issues. 11-205

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report The Company believes that there is no meritorious District of Columbia Circuit on January 12, 2007. The basis for these proceedings and is vigorously defending cost impact resulting from Order 2003 will vary on a itself in this matter. However, the final outcome of this case-by-case basis for each new generator interconnecting matter, including any remedies to be applied in the event to the transmission system. of an adverse ruling in these proceedings, cannot now be On November 22, 2004, generator company determined. subsidiaries of Tenaska, Inc (Tenaska), as counterparties to three previously executed interconnection agreements Intercompany Interchange Contract with subsidiaries 'of Southerm Company filed complaints The Company's generation fleet is operated under the IIC, at the FERC requesting that the FERC modify the as approved by the FERC. In May 2005, the FERC agreements and that those Southern Company subsidiaries initiated a new proceeding to examine (1) the provisions refund a total of $19 million previously paid for of the IIC among Alabama Power, Georgia Power, the interconnection facilities, with interest. Southern Company, Mississippi Power, Savannah Electric, Southern Company has also received requests for similar Power, and Southern Company Services, Inc. (SCS), as modifications from other entities, though no other agent, under the terms of which the power pool of complaints are pending with the FERC. On January 19, Southern Company is operated, and, in particular, the 2007, the FERC issued an order granting Tenaska's propriety of the continued inclusion of Southern Power as requested relief. Although the FERC's order requires the a party to the IIC, (2) whether any parties to the IIC have modification of Tenaska's' interconnection agreements, Ithe violated the FERC's standards of conduct applicable to order reduces the amount 'of the refund that had been utility companies that are transmission providers, and requested by Tenaska. As a result, Southern Company. (3) whether Southern Company's code of conduct estimates'indicate that no refund is due Tenaska. Southent defining Southern Power as a "system company" rather Company has requested rehearing of the FERC's order.' than a "marketing affiliate" is just and reasonable. In The final outcome of this matter cannot now be connection with the formation of Southern Power, the determined. FERC authorized. Southern Power's inclusion in the IIC in 2000. The FERC also previously approved Southern Transmission Company's code of conduct. In December 1999, the FERC issued its final rule on On October 5, 2006, the FERC issued an order Regional Transmission Organizations (RTOs). Since that accepting a settlement resolving the proceeding subject to time, there have been a number of additional proceedings Southern Company's agreement to accept certain at the FERC designed to encourage further-voluntary modifications to the settlement's terms. On October 20, formation of RTOs or to mandate their formation. 2006, Southern Company notified the FERC that it However, at the current time, there are no active accepted the modifications. The modifications largely proceedings that would require the Company to involve functional separation and information restrictions participate in an RTO. Current FERC efforts that may related to marketing activities conducted on behalf of potentially change the regulatory and/or operational Southern Power. Southern Company filed with the FERC structure of transmission include rules related to the on November 6, 2006 an implementation plan to comply standardization of generation interconnection, as well as with the modifications set forth in the order. Theimpact an inquiry into, among other things, market power by* of the modifications is not expected to have a material vertically integrated utilities. See "Market-Based Rate impact on the Company's' financial statements. Authority" and "Generation Interconnection Agreements" above for additional information. The final outcome of' Generation InterconnectionAgreements these proceedings cannot nowbe determined. However, the Company's financial condition, results of operations, In July 2003, the FERC issued its final rule on the and cash flows could be adversely affected by future standardization of generation interconnection agreements changes in the federal regulatory or operational structure and procedures (Order 2003). Order 2003 shifts much of the financial burden of new transmission investment from of transmission. the generator to the transmission provider. The FERC has indicated that Order 2003, which was effective January 20, 2004, is to be applied prospectively to new generating facilities interconnecting to a transmission system. Order 2003 was affirmed by the U.S. Court of Appeals for the 11-206

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCiAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report PSC Matters collected by the Company for an additional 27 months, expiring in June 2009. " Fuel Cost Recdvery

                                                                         ,According to the 2006 Order, the funds resulting The Company has establisied fuel c"st'recovery rates                from the extension of the current surcharge will first be approved by the' Florida PSC. At DeCemnber 31, 2006 and credited to the unrecovered balance of storm-recovery 2005, the under recovered balance was $77.5 million and             costs associated with Hurricane Ivan until these'costs

$31.6 million, respectively, primarily'due' to increased have beii'fully recovered. The funds will then be credited costs for coal in 2006 and increased costs for coal 'ahd to:tlideproperij reserve for recovery of the storm-recovery natural gas in 200. The Company continuously monitors costs of $52.6 million associated with Hurricanes Dennis the under recovered fuel cost balance in lightfof these' and Kafrina that were previously charged to the reserve. higher fuel costs. If the projected fuel revenue over or Should revenues'collected by the Company through the under recovery exceeds 10 percent of the projected fuel extension, of the storm-recovery surcharge exceed the costs for the period, the Company is required to notify the storm-recovery costs associated with Hurricanes Dennis Florida PSC and indicate 'if an adjustment to the fuel cost and Katrina, the excess revenues will be credited to the recovery factor is being requested. reserve. ' In November 2006, the Florida PSC approved an -The ahnual accrual to the reserve of $3.5 million and increase of approximately 28 percent n the fuel factor for the Comnpany's limited discretionary authority to make retail customers, effective wiWtbillings beginning January additional accruals to the reserve will continue as. 2007. Fuel cost recovery revenues, as recorded on'the previously approved by the Florida PSC. The Company financial statements, are adjusted, for differences in actual made discretionary accruals to the reserve of $3 million,' recoverable costs and amounts billed in c'urrent regulated $6 millioqn, and $15,vnillion in 2006, 2005, and. 2004, rates. Accordingly, any change in the billing factor would respectively. As part of the 2005 Order regarding... have no significant effect on the Companys revenues or Hurricane Ivan costs that established the existing net income, but would impact annual cash flowv. surcharge, 'the Company agreed that it would not seek any additlbrial increase in its base rates and charges to Storm Damage Cost Recovery become effective ,on or before March 1, 2007. The terms of the 2006 Order'd6 not alter or affectl that portion of the Under authority granted by theFlooida PSC, the Company prior agreement. ' maintains a reserve for property damage to cover the cost of uninsured .damages from major storms to its According to the 2006 Order, in the case of future transmission and distribution facilities, generation, stormns, if the. Company incurs cumulative costs for storm-facilities, and 'other property.. recoye.xactivities in excess of $10 million during any.. calendar year, theFCompany will be permitted to file a Hurricanes Dennis and Katrina hit the Gulf Coast"of streamlined formal request for, an interim surcharge. Any Florida in July 2005 and August 2005, respectively,' interii 1 .uprchargewould provide for the recovery, subject damaging portions of the Compiny'" -service area.' In to refund, of up to 80 percent of the claimed costs for September 2004, Hurricane ,Ivan hit the Gulf Coast of storm-recovery activities. The Company would then Florida, 'causing substantial damage within the Company's petition the Florida PSC for full recovery through a final service area. In 2005, the Florida PSC issued the 2005 or non-interim surcharge or other cost recovery Order that-approved a stipulation and iettlement between . me;dhanisiji.- the Company and several consumer groups and thereby authorized the recovery of the Company's storm damage See Notes. 1 and 3,to the financial statements under. costs related to Hurricane Ivan through the tw.o-year "Proprty ,Damage Reserve" and "'Storm Damage. Cost . surcharge that began in April2005.. Recovery,' "espectively,,for additional information..

    "'In July'2006, the Florida PSC Issued the 2006 Order approving another stipulation and settlement between the Other    Matters,.

Company and, several consumer groups that resolved all In 2004, Gedrgia Power and the Company entered into matters relating to the Company's request for recovery of PPAs with Florida Power & Light Company (FP&L) and incurred costs for storm-recovery activities related to the Progress Energy Florida. Under the agreements, Georgia 2005 storms and the replenishment of the Company's Power and-the Company will provide FP&L and Progress property damage reserve.".The 2006 Order provides' for an' Energy Florida With 165 megawatts and 74 megawatts, extension of the storm-recovery surcharge currently being respectively, Obf capacity annually from the jointly owned 11-207

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report Plant Scherer Unit 3 for the period from June 2010 regulatory assets based on anticipated future recovery through December 2015. The contracts provide for fixed through rates or the deferral of gains or creation of capacity payments and variable energy payments based on liabilities and the recording of related regulatory actual energy delivered. The Florida PSC approved the liabilities. The application of SFAS No. 71 has a further contracts in 2005. effect on the Company's financial statements as a result' of the estimates of allowable costs used in the ratemaking Also in 2004, Georgia Power and the Company process. These estimates may differ from those actually entered into a PPA with Flint Electric Membership incurred by the Company; therefore, the accounting Corporation. Under the agreement, Georgia Power and the estimates inherent in specific costs such as depreciation Company will provide Flint Electric Membership and pension and postretirement benefits have less of a Corporation with 75 megawatts of capacity annually from direct impact on the Company's results of operations than the jointly owned Plant Scherer Unit 3 for the period they would on a non-regulated company. from June 2010 through December 2019. The contract provides for fixed capacity payments and variable energy As reflected in Note 1 to the financial statements, payments based on actual energy delivered. significant regulatory assets and liabilities have been recorded. Management reviews the ultimate recoverability The Company is involved in various other matters of these regulatory assets and liabilities based on being litigated and regulatory matters that could affect applicable regulatory guidelines and accounting principles future earnings. See Note 3 to the financial statements. for generally'accepted in the United States. However, adverse information regarding material issues. legislative, judicial, or regulatory actions could materially impact the amounts of such regulatory assets and ACCOUNTING POLICIES liabilities: and could adversely impact the Company's Application of Critical Accounting Policies and financial statements. Estimates Contingent Obligations The Company prepares its financial statements in accordance with accounting principles generally accepted The Company is subject to a number of federal and state in the United States. Significant accounting policies are laws and regulations, as well as other factors and described in Note 1 to the financial statements. In the conditions that potentially subject it to environmental, application of these policies, certain estimates are made litigation, income tax, and other risks. See FUTURE that may have a material impact on the Company's results EARNINGS POTENTIAL herein and Note' 3 to the of operations and related disclosures. Different financial statements for more information regarding' assumptions and measurements could produce estimates certain of these contingencies. The Companyperiodically that are significantly different from'those recorded in the evaluates its exposure to such risks 'and records reserves financial statements. Senior management'has reviewed for those matters where a loss is considered probable and and discussed critical accounting policies and estimates reasonably estimable in accordance with generally described below with the Audit Committee of Southern accepted accounting principles. The adequacy of reserves Company's Board of Directors. can be significantly affected by. external events or conditions that can be unpredictable; thus, the ultimate Electric Utility Regulation outcome of, such matters could materially affect the Company's financial statements. These events or The Company is subject to retail regulation by the Florida conditions include the following: PSC and wholesale regulation by the FERC. These regulatory agencies set the rates the Company is

Changes in existing state or federal regulation by permitted to charge customers based on allowable costs. governmental authorities having jurisdiction over' air As a result, the Company applies FASB Statement No. 71, quality, water quality, control of toxic substances, "Accounting for the Effects of Certain Types of hazardous and solid wastes, and other environmental Regulation" (SFAS No. 71), which requires thd financial matters.

statements to reflect the effects of rate regulation.

Changes in existing income tax regulations or changes Through the ratemaking process, the regulators may in Internal Revenue Service (IRS) or state revenue require.the inclusion of costs or revenues in periods department interpretations of existing regulations.

different than when they would be recognized by a non-regulated company. This treatment may result in the Identification of additional sites that require deferral of expenses and the recording* of related environmental remediation or the filing of other 11-208

MANAGEMENT'S DISCUSSION AND ANALYSIS OF. FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report complaints in which the Company.may be asserted to balance sheet. With the adoption of SFAS No. 158, the be a potentially responsible party., Company recorded an additional prepaid pension asset of

                                                                   $23.5 million with respect to its overfunded defined Identification and evaluation of other potential lawsuits benefit plan and additional liabilities of $2.5 million and or complaints in which the Company may be named                 $12.9 million, respectively, related to its underfunded as a defendant.                                                 non-qualified pension plans and retiree benefit plan.

Resolution or progression of existing matters thrdugh Additionally, SFAS No. 158 will require the Company to the legislative process, the court systems, the IRS, or change the measurement date for its defined benefit the EPA. postretirement plan assets and obligations from September 30 to December 31 beginning with the year Unbilled Revenues ending December 31, 2008. See Note 2 to the financial statements for additional information.' Revenues related to the sale of electricity are recorded when electricity is delivered to customers. However, the Guidance on Consideringthe Materiality of determination of KWH sales to individual customers[ is Misstatements based on the reading of their meters, which is performed on a systematic basis throughout the month. At the end of In September 2006, the Securities and Exchange each month, amounts of electricity delivered to customers, Commission (SEC) issued Staff Accounting but not yet metered and billed, are estimated. Components Bulletin No. 108, "Considering the Effects of Prior Year of the unbilled revenue estimates include total KWH Misstatements when Quantifying Misstatements in territorial supply, total KWH billed, estimated total Current Year Financial Statements" (SAB 108). SAB 108 electricity lost in delivery, and customer usage. These addresses how the effects of prior year uncorrected components can fluctuate as a result of a number of misstatements should be considered when quantifying factors including weather, generation, pattems, 'power misstatements in current year financial statements. delivery volume and other operational constraints. These SAB 108 requires companies to quantify misstatements factors can be unpredictable and can vary from historical using both a balance sheetand an income statement trends. As a result, the overall estimate. of unbilled approach and to evaluate whether either approach results revenues could be significantly affected, which could have in quantifying an error that is material in light of relevant a material.impact on the Company's results of operations. quantitative and qualitative factors. When the effect of initial adoption is material; companies will record the New' Accounting Standards effect as a cumulative effect adjustment to beginning of year retained earnings. The provisions of SAB 108 were Stock Options effective for the Company for the year ended December 31.2006. The adoption of SAB 108 did not On January 1, 2006, the Company 'adopted FASB have a material impact on the Company's financial Statement No. 123(R), "Share-Based Paymient'" using the statements. modified prospective method. This statement requires that compensation cost relating to share-based paynment Income Taxes. transactions be recognized in financial statements. That cost is measured based on the grant-date fair .value of the In July 2006, the FASB issued Interpretation No. 48, equity or liability instruments issued. Although the. "Accounting for Uncertainty in Income Taxes" (FIN 48). compensation expense required under the r evised This interpretation requires that tax benefits must be statement differs slightly, the impacts on the.Company's "more likely than not" of being sustained in order to be financial statements are similar~to the pro forma recognized. The Company adopted FIN 48 effective disclosures included in Note I to the fmancie statements January 1, 2007. The adoption of FIN 48 did not have a under "Stock Options." material impact on the Company's financial statements. Pensions and Other PostretirementPlans Fair Value Measurement On December 31, 2006, the Company adopted FASB The FASB issued FASB Statement No. 157, "Fair Value Statement No. 158, "Employers' Accounting for Defined Measurements" (SFAS No. 157) in September 2006. Benefit Pension and Other Postretirement Plans" SFAS No. 157 provides guidance on how to measure fair (SFAS No. 158), which requires recognition of the funded value-where it is permitted or required under other status of its defined benefit postretirement plans in its accounting pronouncements. SFAS No. 157 also requires 11-209

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report additional disclosures about fair value measurements. The Security issuances are subject to~regulatory approval Company plans to adopt SFAS No. 157 on January 1, by the Florida PSC pursuant to its rules and regulations. 2008 and is currently assessing its impact. Additionally, with respect to the public offering of securities, the Company files registration statements with Fair Value Option the SEC under the Securities Act of 1933, as amended (1933 Act). The amounts of securities authorized by the In February 2007, the FASB issued FASB Statement, Florida PSC, as well as the amounts, if any, registered No. 159, "Fair Value Option for Financial Assets and under the 1933 Act, are continuously monitored and Financial Liabilities - Including an Amendment of FASB appropriate filings are made to ensure flexibility in the Statement No. 115" (SFAS No. 159). This standard capital markets. permits an entity to choose to measure many financial instruments and certain other items at fair value. The The Company obtains financing separately without Company plans to adopt SFAS No. 159 on January 1, credit support from any affiliate. See Note 6 to the 2008 and is currently assessing its impact. financial statements under "Bank Credit Arrangements" for additional information. The Southern Company system FINANCIAL CONDITION AND LIQUIDITY does not maintain a centralized cash or money pool. ` ... Therefore, funds of the Company are not commingled Overview with funds of any other company. The Company's financial condition remained stable at To meet short-term cash needs and contingencies, the December 31, 2006. Net cash flow from operations Company has various internal and external sources of totaled $143.4 million, $152.7 million, and $144.5 million liquidity. At the beginning of 2007, the Company had for 2006, 2005, and 2004, respectively. The $9.3 million approximately $7.5 million of cash and cash equivalents, decrease in net cash flows in 2006 is due primarily to along with $120 million of unused committed lines of increased payments related to income taxes and fuel. The credit with banks to meet its short-term cash needs. These $8.2 million increase in net cash flows in 2005 was due bank credit arrangements will expire during 2007. The primarily to the recovery of Hurricane Ivan restoration Company plans to renew these lines of credit during costs. The $46.8 million decrease in net cash flows in 2007. In addition, the Company has substantial cash flow 2004 was primarily due to payments related to storm from operating activities and access to, the capital markets damage from Hurricane7 Ivan. Gross property additions including commercial paper programs to meet liquidity were $147.1 million in 2006. Funds for the Company's needs. See Note 6 to the financial statements under 'Bank property additions were provided by operating activities; Credit Arrangements" for additional information. capital contributions, and other financing activities. See the statements of cash flows for additional information. The Company may also meet short-term cash needs through a Southern Company subsidiary organized to The Company's ratio of common equity to total issue and sell commercial paper and extendible capitalization, including short-term debt, was 42.1 percent commercial notes at the request and for the benefit of the in 2006, 43.0 percent in 2005, and 43.2 percent in 2004. Company and' the other traditional operating companies. See Note 6 to the financial statements for additional Proceeds from such issuances for the benefit of the information. Company are loaned directly to the Company and are not commingled with proceeds from such issuances for the The Company has received investment grade ratings benefit of any other traditional operating company. There' from the major rating agencies with respect to its debt, is no cross' affiliate credit support. At December 31, 2006, preferred securities, and preference stock. the Company had $80.4 million in commercial paper notes and $40.0 million in bank notes outstanding. Sources of Capital The Company plans to obtain the funds required for Financing Activities construction and other purposes from sources similar to those used in the past, which were primarily from In December 2006, the Company issued $110 million of operating cash flows, securities issuances, term loans, and senior notes., A portion of the proceeds of this' issuance short-term indebtedness. However, the type and timing of was used to redeem $30.9 million of long-term debt any future fimancings, if needed, will depend on market payable to affiliated trusts. The remainder of the funds conditions, regulatory approval, and other factors. from the sale of senior notes was used for general . 11-210

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report corporate purposes, including the Company's continuous valuation, value at risk, stress testing, and sensitivity construction program. analysis., On January 19, 2007, the Company issued to To Mitigate residual risks relative to movements in Southern Company 800,000 shares of the, Company's electricity prices, the Company enters into fixed-price common stock, without par value, and realized proceeds contracts for the purchase and'sale of electricity through of $80 million. The proceeds were used to repay a portion the wholesale electricity market and, to a lesser extent, of the Company's short-term indebtedness and for other into similar contracts for natural gas purchases. The general corporate purposes. - Company_ has implemented a fuel-hedging program with the approval of the Florida PSC. I

The weighted average interest rate on $144.6 million Credit Rating Risk variable long-term debt that has not been hedged at' The Company does not have any credit arrangements that January 1, 2007 was 3.73 percent. If the Company would require material changes in payment schedules or sustained a 100 basis point change in interest rates for all terminations as a result of a credit rating downgrade. variable rate long-term debt, the change would affect There are certain contracts that could require collateral, annualized interest expense by approximately $1.4 million but not accelerated payment, in the event of. a credit at January, 1, 2007. The Company is not aware of any rating change to BBB- or Baa3, or below; Generally, facts or circumstances that'would significantly affect such collateral may be provided for by, a Southern Company exposures in. the near term. See Notes 1 and 6 to the guaranty, letter of credit, or cash. These contracts. are financial statements under "Financial Instruments" for primarily for physical electricity purchases and sales. At additionafinformation.

December 31, 2006, the maximum potential collateral:' requirements at a BBB- or Baa3 rating were .The changes in fair value of energy-related derivative contracts and year-end valuations were:as follows at approximately $23.1 million. The maximum potential December 31: collateral requirements at a rating below B)BB or Baa3 were approximately $46.3 million. Cnanges in Fair value 2006 2005 The Company, along with all members of the (in thousands) Southern.Company power pool, is party to'tertain derivative agreements that could require collateral and/or Contractsbeginning of year $11,526 $* 317 accelerated payment in the event of a credit rating change Contracts realized or settled 8,363 (15,023) to below investment grade for Alabama Pow4er and/or New, contracts at inception Georgia Power. These agreements are primarily for Changes in valuation techniques . natural gas and power price risk management activities. Current period changes(a) (27,075) 26,232 At December 31, 2006, the Company's total exposure to Contracts end of year , $ (7,186) $ 11,526 these types of agreements was approximately, - $27.4 million. (a) Current period changes also include the changes in fair value ofnew contracts entered into during the period. Market Price Risk Source of 2006 Year-End Valuation Prices Due to cost-based rate regulation, the Company has Maturity Total limited exposure to market volatility in interest rates, Fair Value 2007 2008-2009 commodity fuel prices, and prices of electricity. To (in thousands) manage the volatility attributable to these exposures, the Actively quoted $(7,324) $(6,641) $(683) Company nets the exposures to take advantage of natural External sources 138 138 - offsets and enters into various derivative transactions for Models and other methods - - the remaining exposures pursuant to the Company's policies in areas such as counterparty exposure and risk Contracts end of year $(7,186) $(6,503) $(683) management practices. Company policy is that derivatives are to be used primarily for hedging purposes and Unrealized gains and losses from mark-to-market mandates strict adherence to all applicable risk adjustments on derivative contracts related to the management policies. Derivative positions are monitored Company's fuel hedging programs are recorded as using techniques including but not limited to market regulatory assets and liabilities. Realized gains and losses 11-211

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND. RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report from these programs are included in fuel expense and are business conditions; environmental regulations; FERC recovered through the Company's fuel cost recovery rules and regulations; load projections; the cost and, clause. Gains and losses on derivative contracts that are efficiency of construction labor, equipment, and materials; not designated as hedges are recognized in the statements and the cost of capital. In addition, there can be no of income as incurred. At December 31, 2006, the fair assurance that' costs related to capijal expenditures will be value iainsl(losses) of'energy-related derivative contracts fully recovered. were reflected in the financial statements as follows: The Company does not have any new generating Amounts capacity under construction. Construction of new (in thousands) transmission and distribution facilities and capital Regulatory assets, net $(7,186) improvements, including those needed to meet Net income environmental standards for the Company's existing generation, transmission, and distribution facilities, is Total fair value . $(7,186) ongoing.. Unrealized (losses) recognized in income were not The Company has entered into two PPAs, one of material in any year presented. which is with Southern Power, for a total of approximately 487 megawatts annually from June 2009 The Company is exposed to market price risk in the through May 2014. The PPAs are the result"of a event of nonperformance by counterparties to the competitive request for proposals process initiated by the derivative energy contracts. The Company's policy is to Company in January 2006 to address the' anticipated need enter into agreements with counterparties that have for additional capacity beginning in 2009. These PPAs are investment grade credit ratings by Moody's and both subject to approval by the Florida PSC for purposes Standard & Poor's or with counterparties who have posted of cost recovery through the Company's purchased power' collateral to cover potential credit exposure. Therefore, capacity 'clause, and the PPA with Southern Power is also the Company does not anticipate market risk exposure subject to FERC approval. from nonperformance by the counterparties. See Notes I and 6 to the financial statements under "Financial As discussed in Note 2 to the financial statements, Instruments" for additional information. the Company provides postretirement benefits to substantially all employees and funds trusts to the extent Capital Requirements and Contractual Obligations required by-the FERC and the Florida PSC. The construction program of the Company is currently Other' unding requirements related to obligAtions estimated to be $278 million in 2007, $458 million in associated with scheduled maturities of long-term debt 2008, and $395 million in 2009. The construction and preferred securities, as well as the related interest, program also includes $171 million in 2007, $378 million derivative obligations, preference stock dividends, leases, in 2008, and $300 million in 2009 for environmental and other purchase commitments are as follows. See expenditures. Actual construction costs may vary from Notes 1, 6, and 7 to the financial statements for additional these estimates because of changes in such factors as: information. 11-212

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL .CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report Contractual Obligations 2008- 2010- After 2007 .2009, . 2011 2011 Total (iathousands) Long-term debt(a,) .. - I;*:f $ $ *703,793 Principal, ;l $ 703,793 34,924 "169,848 69,848 563,334 .737,954 Interest Other derivative obligations°"" 7,193 '838 - 8,031 Preference stock dividends(c). 3,300 6,600 6,600 16,500 Operating leases 4,380 5,635 2,661 3,574,1 16,250 Purchase commitments(d) Capital(e) 277,958 852,811, - 1,130,769 Coal :1 281,401 310,220 70,764 662,385 0 -526,453 Natural gas< 117,726 4156,346 6'3,275 189,106

    -Purchased powe             .                                                              '23,832             '53,672            57,915           135,419 Long-term service agreements                                             5,940             12,821              16,735             39,419-          74,915 Postretirement benefitsta).                                                  60,000             120,000                      -                          180,000 Total                                                                    $792,822         .$1558,951            $283,555          $1,557.141        $4.192,469 (a)" All amounts are reflected based on final Mfturity dates.'he Company plans to continue to retire higher-cost securities and replace these obligations with Iower-vost 'capitad if market Conditions permit. Variable rate interest obligations *re estimated based on rates as of January 1, 2007, as reflected in the statements of capitalization.      r                                                                            . ...           .

(b) For additional information, see Notes I and 6 to the financial statements. , (c) Preference stock does not mature; therefore, amounts are provided for the next five years only. (d) The Company generally. does not enter intq non-cancelable commitments for other operations and maintenance expenditures. Total other operations Coman I I or th last Tomyoheropraton and maintenance expense for the last three years were $260 million, $250 million, and $230 nillion, respectively. (e) The Company forecasts capital expeniditires'over a.three-year period. Amounts represent current estimates of total expenditures.. At December 31, 2006, significant purchase commitments~were outstanding in connection with the construction program. . - (f) Natural gas purchase commitments are based on various indices at the time of delivery. Ar"6unts reflected have been estimated based on the New York Mercantile Ex~change future pnces at December 31, 2006. (g) The'Company forecasts postretirement trust contributions over a three-year period. No contributions related to the' Company's pension trust are currently expected during this period. St W6te'2 to the financial statements. for additional information related to the pension and postretirement plans, including estimated benefit payments. Certain benefit payments will be made through the related trusts. Other benefit payments will be made from the Company's corporate assets.

            ,.-      ~~~..~~'.*ii "r*..,

I, Ii II I 11-213

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Gulf Power Company 2006 Annual Report Cautionary Statement Regarding Forward-Looking " investment performance of the Company's employee Statements benefit plans; The Company's 2006 Annual Report contains forward-

advances in technology; looking statements. Forward-looking statements include,
state and federal rate regulations and the impact of among other things, statements concerning the strategic pending and future rate cases and negotiations, goals for the Company's storm damage cost recovery and including rate actions relating to fuel and stornm-repairs, retail rates, environmental regulations and restoration cost recovery; expenditures, access to sources of capital, the Company's projections for postretirement benefit trust contributions,
internal restructuring or other restructuring options that financing activities, impacts of the adoption of new may be pursued; accounting rules, completion of construction projects, and
potential business strategies, including acquisitions or estimated construction and other expenditures. In some dispositions of assets or businesses, which cannot be cases, forward-looking statements can be identified by assured to be completed or beneficial to the Company; terminology such as "may," "will," "could;" "should" I "expects," "plans," "anticipates," "believes," "estimates,"
the ability of counterparties of the Company to make "projects," "predicts," "potential" or "continue" or the payments as and when due; negative of these tenns or other similar terminology.
the ability to obtain new short- and long-term-There are various factors that could cause actual results to contracts with neighboring utilities; differ materially from those suggested by the forward-looking statements; accordingly, there can be no
the direct or indirect effect on the Company's business assurance that such indicated results will be realized. resulting from terrorist incidents and the threat of, These factors include: terrorist incidents;
the impact of recent and future federal and state " interest rate fluctuations and financial market regulatory change, including legislative and regulatory conditions and the results of financing efforts, initiatives regarding deregulation and restructuring of including the Company's credit ratings;'

the electric utility industry, implementation of the

the ability of the Company to obtain additional Energy Policy Act of 2005, and also changes in generating capacity at competitive prices; environmental, tax and other laws and regulations to which the Company is subject, as well as changes in
catastrophic events such as fires, earthquakes,'

application of existing laws and regulations; explosions, floods, hurricanes, pandemic health events

current and future litigation, regulatory investigations, such as an avian influenza, or other similar occurrences; proceedings, or inquiries, including the pending EPA civil actions against the Company and FERC matters;
the direct or indirect effects on the Company's

" the effects, extent, and timing of the entry of business resulting from incidents similar to the August 2003 power outage in the Northeast; additional competition in the markets in which the Company operates; " the effect of accounting pronouncements issued " variations in demand for electricity, including those periodically by standard setting bodies; and relating to weather, the general economy and " other factors discussed elsewhere herein and in other population and business growth (and declines); reports (including the Form 10-K) filed by the " available sources and costs of fuels; Company from time to time with the SEC. " ability to control costs; The Company expressly disclaims any obligation to update any forward-looking statements. 11-214

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STATEMENTS OF INCOME For the Years Ended December 31, 2006, 2005, and 2004 Gulf Power Company 2006 Annual Report 2006 2005 2004 (in thousands) Operating Revenues: Retail revenues $ 952,038 $ 864,859 $736,870 Sales for resale - Non-affiliates 87,142 84,346 73,537 Affiliates 118,097 91,352 110,264 Other revenues 46,637 43,065 39,460 Total operating revenues 1,203,914 1,083,622 960,131 Operating Expenses: Fuel 534,921 415,789 367,155 Purchased power -- Non-affiliates 16,288 29,995 30,720 Affiliates 57,536 68,402 35,177 Other operations 192,375 176,620 160,635 Maintenance 67,144, 73,150 69,077 Depreciation and amortization 89,170 85,002 82,799 Taxes other than income taxes 79,808 76,387 69,856 Total operating expenses 1,037,242 925,345 815,419 Operating Income 166,672 158,277 144,712 Other Income and (Expense): Interest income 5,228 3,804 1,224 Interest expense, net of amounts capitalized (39,619) (35,727) (31,482) Interest expense to affiliate trusts (4,514) (4,590) (3,443) Distributions on mandatorily redeemable preferred securities - (1,113) Other income (expense), net (3,185) (813) (1,763) Total other income and (expense) (42,090) (37,326) (36,577) Earnings Before Income Taxes 124,582 120,951 108,135 Income taxes 45,293 44,981 39,695 Net Income 79,289 75,970 68,440 Dividends on Preferred and Preference Stock 3,300 761 217 Net Income After Dividends on Preferred and Preference Stock $ 75,989 $ 75,209 $ 68,223 The accompanying notes are an integral part of these financial statements. 11-215

STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2006, 2005, and 2004 Gulf Power Company 2006 Annual Report

                                                                                             -2006             2005 .        ..       2004 (in thousands)

Operating Activities: Net income $ 79,289 $ 75,970 $ 68,440 Adjustments to reconcile net income to net cash provided from operating activities - Depreciation and amortization 94,466 90,890 88,772 Deferred income taxes 1,170 33,161 . 46,255 Pension, postretirement, and other employee benefits 3,319 375 (895) Stock option expense 1,005 - ý' ! Tax benefit of.stock options 211 3,502 3,063 Hedge settlements . (5,399) .. Other, net 6,931 3,958 11,402 Changes in certain current assets and liabilities -- Receivables, ' (36,795) (46,248) 543 Fossil fuel stock (31,297) (11,740) 2,355 Materials andsupplies (2,330) 3,785 (831) Prepaid income, taxes (7,060) 31,898 (32,343) Property damage cost recovery ...... .24,544 20,045. - Other current assets (955) 3,453 2,721

          -Accounts payable ..                          ...                                 13,876         (72,532)               (51,876)

Accrued taxes (455)" 6,847 629 Accrued compensation (3,251) 311 1,946 Other current -liabilities .-6,165 9,011 . . 4,325 Net cash provided from operating activities 143,434 152,686 144,506 Investing Activities: Property additions . (154,377) (143,171) (148,765) Cost of removal net of salvage J.(4,564) (8,504) (10,259) Construction payables. 3,309 (8,806) . 13,682 Other (8,779) J.. (440) -8,952 Net cash used for investing activities (164,411) (160,921) (136,390) Financing Activities:.. Increase in notes payable, net 30,981 39,465 12,334 Proceeds -- Senior notes 110,000 60,000 110,000

     'Other long-term debt                                                                        -                  -            100,000 Preferred and preference stock                                            .....-                       55,000 Gross excess tax benefit of stock options                                                 423                  -

Capital contributions from parent company 26,140 (94) 29,481 Redemptions .. Pollution control bonds (12,075) - First mortgage bonds (25,000) (30,000) Senior notes (125,000) Other long-term debt (100,000) Preferred and preference stock ( (4,236) Long-term debt to affiliate trust (30,928) Payment of preferred and preference stock dividends (3,300) (761) (217) Payment of common stock dividends (70,300) (68,400) (70,000) Other (1,285) (3,721) (2,433) Net cash provided from (used for) financing activities 24,656 (52,747) 54,165 Net Change In Cash and Cash Equivalents 3,679 (60,982) 62,281 Cash and Cash Equivalents at Beginning of Year 3,847 64,829 2,548 Cash and Cash Equivalents at End of Year $ 7,526 $ 3,847 $ 64,829 Supplemental Cash Flow Information: Cash paid during the period for-- Interest (net of $160, $515, and $819 capitalized, respectively) $ 37,297 $ 35,786 $ 28,796 Income taxes (net of refunds) 54,533 (27,912) 24,130 The accompanying notes are an integral part of these financial statements. 11-216

BALANCE SHEETS At December 31, 2006 and 2005 Gulf Power Company 2006 Annual Report Assets .. 2006 2005 (in thousands) Current Assets: Cash and cash equivalents $ 7,526 $ 3,847 Receivables .. Customer accounts receivable 56,489 51,567 Unbilled revenues ; 38,287 39,951 Under recovered regulatory clauseý'renues 79,235 33,205 Other accounts and notes receivable, 9,015 '10,533 Affiliated companies I1 15,302 24,001 Accumulated provision for uncollectible accounts (1,279) (1,134) Fossil fuel stock, at average cost 76,036 44,740 Materials and supplies, at average cost 35,306, 32,976 Property damage cost recovery 28,771 28,744 Other regulatory assets 15,977 9,895 Other 14,259 19,636 Total current assets ". 374,924 297,961 Property, Plant, and E4uipment: In service 2,574,517 2,502,057 Less accumulated provision for depreciation 901,564 - 865,989 1,672,953 1,636,068 Construction work in progress 62,815 28,177 Total property, plant, and equipment 1,735,763 f,6641245 Other Property and Investments' 14,846,' '6736 Deferred Charges and Other Assets: Deferred charges related to income taxes 17,148 17,379 Prepaid pension costs, - 69,895 46,374 Other regulatory assets 110,077 123,258 Other 17,831 19,844 Total deferred charges and other assets 214,9i ' 206,855 Total Assets $2,340,489 $2,175,797 The accompanying notes are an integral part of these financial statements. 11-217

BALANCE SHEETS At December 31, 2006 and 2005 Gulf Power Company 2006 Annual Report Liabilities and Stockholder's Equity 2006 2005 (in thousands) Current Liabilities: Securities due within one year $ $ 37,075 Notes payable 120,446 89,465 Accounts payable - Affiliated 44,375 36,717 Other 49,979 44',139 Customer deposits 21,363 18,834 Accrued taxes - Income taxes 29,771 12,823 Other 15,033- 11,689 Accrued interest 7,645 7,713 Accrued compensation 16,932 20,336 Other regulatory liabilities 9,029 15,671 Other 30,975 21,844 Total current liabilities 345,548 -316,306 Long-term Debt (See accompanying statements) 654,860 544,388 Long-term Debt Payable to Affiliated ThIVSt (See accompanying statements) 41,238 72,166 Deferred Credits and Other Liabilities: Accumulated deferred income-taxes 237,862 256,490 Accumulated deferred investment tax credits 14,721, 16,569 Employee benefit obligations 7.3,922: 56,235 Other cost of removal obligations 165,410 153,665 Other regulatory liabilities 46,485 26,795 Other 72,533 76,948 Total deferred credits and other liabilities 610,933 586,702 Total Liabilities 1,652,579, 1,519,562 Preferred and Preference Stock (See accompanying statements) 53,887 53,891. Common Stockholder's Equity (See accompanying statements) 634,023, 602,344 Total Liabilities and Stockholder's Equity $2,340,489 $2,175,797 Commitments and Contingent Matters (See' notes) The accompanying notes are an integral part of these financial statements. 11-218

STATEMENTS OF CAPITALIZATION At December 31, 2006 and 2005 Gulf Power Company 2006 Annual Report 2006 --' 2005 2006 "2005 (in thousands) (percent of total) Long Term Debt: First mortgage bonds ..

 '6.50% due November. 1, 2006                                                  $            -         $   25,000 Total first mortgage bonds                                                                   -             25,000                       -'

Long-term notes payable -- 4.35% to 5.88% due 2013-2044 505,000 395,000 Total long-term notes payable 505,000 395,000 Other long-term debt -- Pollution control revenue bonds -- 5.25% due April 1, 2006 - 12,075 4.80% due September 1, 2028 13,000 13,000 Variable rates (3.53% to 4.04% at 1/1/07) due 2022-2037 144,555 144,555 Total other long-term debt - 157,555 ...... 169,630 Unamnortized debt premium- (discount), -net (7,695) . (8,167): Total long-term debt (annual interest-requirement -- $32.6 million) 654,860 . 581,463 Less amount due within one year . : 37,075. Long-term debt excluding amount due within one year 654,860 544,388 47.3% 42.8% Long-term Debt Payable to Affiliated Trusts: 5.6% to 7.38% due 2041 through 2042 (annual interest requirement -- $2.3 million) 41,238 72,166 3.0 5.7 Preferred and Preference Stock: Authorized - 2006: 20,000,000 shares--preferred stock

               - 2006: -0,000,000 shares--preference stock
                - 200(5: 20,000,000 shares--preferred stock
               - 2005: 10,000,000 shares--preference stock Outstanding - $100 par or stated value -- 6% preference stock                    53,887                 53,891
               - 2006: 550,000 shares (-nhn-cumulative)
               - 2005: 550,000 shares (non-cumulative)

Total preferred and preference stock - (annual dividend requirement -- $3.3 million) . 53,887 53,891- 3.9 (4.2 Common Stockholder's Equity: Common stock, without par value -- Authorized - 2006: 20,000,000 shares

               - 2005: 10,000,000 shares Outstanding - 2006: 992,717 shares
               - 2005: 992,717 shares                                              38,060                 38,060 Paid-in capital                                                                    428,592                400,815 Retained earnings                                                                  171,968                166,279 Accumulated other comprehensive income (loss)                                        (4,597)                (2,810)

Total common stockholder's equity 634.023 602,344 45.8 47.3 Total Capitalization $1,384,008 $1,272,789 100.0% 100.0% The accompanying notes are an integral part or these financial statements. 11-219

STATEMENTS OF COMMON STOCKHOLDER'S EQUITY For the Years Ended December 31, 2006, 2005, and 2004 Gulf Power Company 2006 Annual Report Other Common Paid-In Retained Comprehensive Stock Capital Earnings Income (loss) Total

                                                                                                  .-*                (in thousands)

Balance at December 31, 2003 $38,060 $364,864 $161,208 $(2,774) $561,358 Net income after dividends on preferred stodk - - 68,223 - . 68,223 Capital contributions from parent company :32,544 - - 32,544 Other comprehensive income (loss) - - - (91) (91) Cash dividends on common stock (70,000) (70,000) Other . .(..),150 - 138 Balance at December 31, 2004 38,060 397,396 159,581 , (2,865) 592,172 Net income after dividends on preferred stock - - 75'209 - 75,209 Capital contributions from parent company . 3,408 . - 3,408 Other comprehensive income (loss) - 55 M-55 Cash dividends on common stock. - (68,400) - (68,400) Other , 11 (111) - (100) Balance at December 31, 2005 38,060 - 460$815' 166,279 (2,810) 602,344 Net income after dividends on preferred and preference stock .,_.. , :" - 75,989 " 75,989 Capital contributions from parent company . " 27,777" - - 27,777 Other comprehensive income (loss) - . - (3,112) (3,112) Adjustment to initially apply . .... 1,325 13 FASB Statement No. 158, net of tax! 1,325 1,325 Cash dividends on common stock .-.. . -. - (70,300) - (70,300) Balance at December 31, 2006 . ,. $38,060 $428,592 $171,968 ,$(4,597) $634,023 The accompanying notes Are an ihtegral part of these financial staiements.. . ......... . - STATEMENTS OF COMPREHENSIVE INCOME For the Years Ended December 31, 2006,'2005, and 2004 . . Gulf Power Company 2006 Annual Report. 2006 2005 2004 (in thousands)

                                                                                                                        $75,989            $75,209            $68,223 Net income after dividends on preferred and preference stock "

Other comprehensive income (loss): - . Changes in additional minimum pension liability, net of tax of $(13), $(91) and $(184), respectively, (19) (146) (292) Change in fair value of marketable securities, net of tax of $-, $- and $35, respecti'Vely . .... . I - - 56 Changes in fair value of qualifying hedges, net of tax of $(2,082), $- and $-, respectively " (3,317) -- - Less: Reclassification adjusthtent for am 5unts included in net income, net of" . , .. tax of $140, $126 and $91,respekctively. 224 . 201 . 145 Total other compiehensive inc6me N16ss)' . (3,112) 55 (91) Comprehensive Income .. "$72,877 $75,264 $68,132 The accompanying notes are an integral part of these financial statements. 11-220

NOTES TO FINANCIAL STATEMENTS Gulf Power Company 2006 Annual Report

1.

SUMMARY

OF SIGNIFICANT ACCOUNTING States requires the use of estimates, and the actual results POLICIES may differ from those estimates. General Affiliate Transactions Gulf Power Company (the Company) is a wholly owned The Company has an agreement with SCS under which subsidiary of Southern Company, which is the parent the following services are rendered to the Company at company of four traditional operating companies, direct or allocated cost: general and design engineering, Southern Power Company (Southern Power), Southern purchasing, accounting and statistical analysis, finance, Company Services (SCS), Southern Communications and treasury, tax, information resources, marketing, Services (SouthernLINC Wireless), Southern Company auditing, insurance and pension administration, human Holdings (Southern Holdings), Southern Nuclear resources, systems and procedures, and other services Operating Company (Southern Nuclear), Southern with respect to business and operations and power pool Telecom, and other direct and indirect subsidiaries. The operations. Costs for these services amounted to traditional operating companies, Alabama Power, Georgia

                                                                  $59 million, $54 million, and $56 million during 2006, Power, the Company, and Mississippi Power are vertically 2005, and 2004, respectively. Cost allocation integrated utilities providing electric service in four methodologies used by SCS were approved by the Southeastern states. The Company provides retail service Securities and Exchange Commission prior to the repeal to customers in northwest Florida and to wholesale of the Public Utility Holding Company Act of 1935, as customers in the Southeast. Southern Power constructs, amended, and management believes they are reasonable.

acquires, and manages generation assets and sells The FERC permits services to be rendered ýat cost by electricity at market-based rates in the wholesale market. system service companies. SCS, the system service company, provides, at cost, specialized services to Southern Company and the The Company has agreements with Georgia Power subsidiary companies. SouthernLINC Wireless provides and Mississippi Power under which the Company owns a digital wireless communications services to the traditional portion.of Plant Scherer and Plant Daniel. Georgia Power operating companies and also markets these services to operates Plant Scherer and Mississippi Power operates the public within the Southeast. Southern Telecom Plant Daniel. The Company reimbursed Georgia Power provides fiber cable services within the Southeast. $8.0 million, $4.3 million, and $6.8 million and Southern Holdings is an intermediate holding company Mississippi Power $19.7 million, $19.5 million, and subsidiary for Southern Company's investments in $17.4 million in 2006, 2005, and 2004, respectively, for synthetic fuels and leveraged leases and various other its proportionate share of related expenses. See Note 4 energy-related businesses. Southern Nuclear operates and and Note 7 under "Operating Leases" for additional provides services to Southern Company's nuclear power information. plants. On January 4, 2006, Southern Company completed the sale of substantially all of the assets of Southern - " The Company provides incidental services to and Company Gas, its competitive retail natural gas marketing receives such services from other Southern Company subsidiary. subsidiaries which are generally minor in duration and amount. However, with the hurricane damage experienced The equity method is used for subsidiaries in which in 2004 and 2005, assistance provided to aid in storm the Company has significant influence but does not restoration, including Company labor, contract labor, and control and for variable interest entities where the materials, has caused an increase in these activities. The Company is not the primary beneficiary. Certain prior total amount of storm restoration provided to Mississippi years' data presented in the financial statements have Power was $0.2 million and $11.1 million in 2006 and been reclassified to conform with current year 2005, respectively, The Company received storm presentation. restoration assistance from other Southern Company subsidiaries totaling $5.8 million and $12.7 million in The Company is subject to regulation by the Federal 2005 and 2004, respectively. These activities were billed Energy Regulatory Commission (FERC) and the Florida at cost. Public Service Commission (PSC). The Company follows accounting principles generally accepted in the United The traditional operating companies, including the States and complies with the accounting policies and Company, and Southern Power jointly enter into various practices prescribed by its regulatory commissions. The types of wholesale energy, natural gas, and certain other preparation of financial statements in conformity with contracts, either directly or through SCS, as agent. Each accounting principles generally accepted in the United participating company may be jointly and severally liable 11-221

NOTES (continued) Gulf Power Company 2006 Annual Report for the obligations incurred under these agreements. See i ,lives, which may range up to 50 years. Asset retirement. Note 7 under "Fuel Commitments" for additional and removal liabilities will be settled and trued up information.. following completion of the related activities. (e) Fuel-hedging assets and liabilities are recorded over the life of the underlying hedged purchase contracts, which Regulatory Assets and Liabilities* generally do not exceed three years. Upon final settlement, costs are recovered through the fuel cost The Company is subject to the provisions of Financial recovery clause. Accounting Standards Board (FASB) Statement No. 71, (f) Recorded and recovered or amortized as approved by-the "Accounting for the Effects of Certain Types of Florida PSC..'. Regulation" (SFAS, No. 71). Regulatory assets represent (g) Recorded and recovered or amortized as approved by the probable future revenues associated with certain costs that Florida PSC. Storm cost recovery surcharge ends in June are expected to be recovered from customers through the 2009. ratemaking process. Regulatory liabilities represent. (h) Recovered and amortized over the average remaining probable future, reductions in revenues associated. with, service period which may range up to 15 years. See amounts that are expected to be credited to customers Note 2' under "Retirement Benefits." through the ratemaking process. Regulatory assets and In the event that a portion of the Company's (liabilities) reflected in the balance sheets at December 31 operations is no longer subject to the provisions of relate to: SFAS No. 71, the Company would be required'to "write S2006 : 200O Note off related regulatory assets and liabilities that are not J '(in thousands) specifically recoverable through regulated rates. In Environmental remediation $ . 57,230" '58,235 (a), addition, :the Company would be required to determine if 18,584I,' 19,433 any "mpairmentlto other assets, including plant, exists and Loss on reacquired debt (b) Vacation pay 5,795 51,662 (c) write down the assets, if impaired, to their fair values. All Deferred income tax charges 17,148 17,379 (d) regulatory assets and liabilities are reflected in rates. Fuel-hedging assets 8,031 2,411 (e) Underfunded retiree kevenues -- " "-. benefit plans 17,968, Energy-and other revenues are recognized as services are Other assets 3k309 ,, 3,3774 provided. Wnbilled revenues related to retail sales are Under recovered regulatory accrued at the end of each fiscal period. Wholesale clause revenues 77,480 31,634 capacity reyenues are generally recognized on a levelized Property damage reserve 45,654 74,352 basis overthe appropriate contract period. The Company's Asset retirement obligations (3,313) (640), retail electric rates include provisions to adjust billings' for Other cost of removal fluctuations in fuel costs, the energy component of obliga ions (165,410) ('153,665) purchased power costs, and certain other costs. The Deferred income tax credits (17,935) .(20,627) Company is required to notify the Florida PSC if tlhe Fuel-hedging liabilities (845) (13,950) projected ifuel .revenue over or under recovery exceeds Over recovered regulatory 10 percent of the projected fuel costs for the period and clause revenues (8,139),: indicate if an adjustment to the fuel cost recovery factor Other liabilities (1,804), (1,916) iS being requested. The Company has similar retail cost Overfunded retiree recovery clauses for energy conservation costs, purchased benefit plans (23,478) power capacity costs, and environmental compliance Total' $ 30,285 $ 16,M49 costs. Revenues are adjusted for differences between these actual costs and amounts billed in current regulated rates. Note: The recovery and amortization periods for these Under or over recovered regulatory clause revenues are regulatory assets and (liabilities) #re as follows: (a) Recovered through the environmental cost recovery, recorded in the balance sheets and are recovered or clause when the expense is incurred. returned to customers through adjustments to the billing (b) Recovered over the remaining life of the original issue, factors. Annually, the Company petitions 'for recovery of which may range up to 40 years.. projected costs including any- rue-up amount from prior (c) Recorded as earned by employees and recovered as paid, periods,anid approved rates are implemented each generally within one year.. January.' (d) "Asset retirement and removal liabilities'are recorded,' deferred income tax assets are recovered, and deferred The COmpany has a diversified base of customers. tax liabilities are amortized over the related property No single customer or industry comprises 10 percent or 11-222

NOTES (continued) Gulf Power Company 2006 Annual Report more of revenues. For all periods presented, uncollectible disposed of in the normal course of business, its original accounts averaged less than 1 percent of revenues. cost, together with the cost of removal, less salvage, is charged to accumulated depreciation. For other property Fuel Costs dispositions, the applicable cost and accumulated depreciation is removed from the balance sheet accounts Fuel costs are expensed as the fuel is used. and a gain or loss is recognized. Minor items of property included in the original cost of the plant are retired when Property, Plant, and Equipment the related property unit is retired. Property, plant, and equipment is stated at original'cost less regulatory disallowances and impairments. Original Asset Retirement Obligations and Other Costs of cost includes: materials; labor; minor items of property; Removal appropriate administrative and general costs; payroli-related costs such as taxes, pensions, and other benefits; Effective January 1, 2003, the Company adopted FASB and the' interest capitalized and/or cost of funds used Statement No. 143, "Accounting for Asset Retirement during construction. Obligations" (SFAS No. 143), which established new accounting and reporting standards for legal obligations The Company's property, plant, and equipment associated with the ultimate costs of retiring long-lived consisted of the following at December 31: assets. The present value of the ultimate costs of an 2006 . 2005 asset's future retirement is recorded in the period in (in thousands) which the liability is incu'rred. The costs are capitalized as Generation $1,347,881 $1,326,766 part of the related long-lived asset and depreciated over the asset's useful life. In addition, effective December 31, Transmission 270,658 262,168 2005, the Company adopted the provisions of FASB Distribution 831,494 788,711 Interpretation No. 47, "Conditional Asset Retirement General 120,666 120,339 Obligations" (FIN 47), which requires that an asset Plant acquisition adjustment 3,818 4,073 retirement obligation be recorded even though the timing and/or method of settlement are conditional on future Total plant in service $2,574,517 $2,502,057 events. Prior to December 2005, the Company did not The cost of replacements of property, exclusive of recognize asset retirement obligations for asbestos minor items of property, is capitalized. The cost of removal and disposal of polychlorinated biphenyls in maintenance, repairs, and replacement of minor items of certain transformers because the timing of their retirements was dependent on future events. The property is charged to maintenance expense as incurred or Company has received accounting guidance from the* performed. Florida PSC allowing the continued accrual of other future retirement costs for long-lived assets that the Income and Other Taxes" Compahy does not have a legal' obli.gation to retire.". The Company uses the liability method of accounting for Accordingly, the accumulated removal costs for these deferred income taxes and provides deferred income taxes obligations will continue to be reflected in the balance for all significant income tax temporary differences. sheets as a regulatory liability. Therefore, the Company Investment tax credits utilized are deferred and amortized had no cumulative effect to net income resulting from the to income over the average life of the related property. adoption of SFAS No. 143 or FIN 47. Taxes that are collected from customers on behalf of governmental agencies to be remitted to these agencies The liability recognized to retire long-lived assets are presented net on the statements of income. primarily relates to the Company's combustion turbines at its Pea Ridge facility, various landfill sites, and a barge Depreciation and Amortization unloading dock. In connection with the adoption of FIN 47, the Company also recorded additional asset Depreciation of the original cost of utility plant in service retirement obligations (and assets) of $9.1 million, is provided primarily by using composite straight-line primarily related to asbestos remocal, ash ponds, and rates, which approximated 3.7 percent in 2006 and disposal of polychlorinated biphenyls in certain 3.8 percent in 2005 and 2004. Depreciation studies are transformers. The Company'also has identified retirement conducted periodically to update the composite rates. obligations related to certain transmission and distribution These studies are approved by the Florida PSC. When facilities, certain wireless communication towers, and property subject to depreciation is retired or otherwise certain structures authorized by the United States Army 11-223

NOTES (continued) Gulf Power Company 2006 Annual Report Corps of Engineers. However, liabilities for the removal fair value of the assets and recording a loss if the carrying of these assets have not been recorded because the range value is greater than the fair value. For assets identified as of time over which the Company may settle these held for sale, the carrying value is compared to the obligations is unknown and cannot be reasonably estimated fair value less the cost to sell in order to estimated. The Company will continue to recognize in the determine if an impairment loss is required. Until the statements of income allowed removal costs in accordance assets are disposed of, their estimated fair value is re-with its regulatory treatment. Any differences between evaluated when circumstances or events change. costs recognized under SFAS No. 143 and FIN 47 and those reflected in rates are recognized as either a Property Damage Reserve regulatory asset or liability, as ordered by the Florida The Companya'ccrues for the cost of repairing damages PSC, and are reflected in the balance sheets. from major )stormis and 6ther uninsured property damages, Details of the asset retirement obligations included in including uninsured damages tO transmission and the balance sheets are as follows: distribution facilities, generation faciiities, and other property. The cost of such damages is charged to the 2006 2005 reserve. The Florida PSC approved annual .accrual to the (in thousands) property damage reserve' is $3.5 million, With a targei Balance beginning of year $15,298 $ 5,789 level for the reserve between $25.! million and Liabilities incurred 9,122 $36.06million. TheFlorida PSC also authorized the Liabilities settled Company to make additional accruals above the 785; 387 $3.5 miilli6n at the Company's discretion. The Company Accretion accrued to6al expenrses.of $6.5 million in 2006, Cash flow revisions (3,365)

                                                                      $9.5 million in'2005, and $18'.5;million in 2004. At Balance end of year                      $12,718       $15,298        December 31, 2006, the unrecovered balance in the property damage reserve totaled approximately
                                                                      $45.7 million, of which 'approximately $28.8 million and Allowance for Funds Used During Construction                          $16.9 million is included in Current Assets and Deferred (AFUDC)                                                               Chargesand Other Assets, respectively, in the balance In accordance with regulatory treatment, the Company                  sheets .'See Note 3 under "Retail Regulatory Matter s-records AFUDC, which represents the estimated debt and                Storm Damage Cost Recovery" for additional information equity costs of capital finds that are necessary to finance           regarding the surcharge mechanism approved by the the construction of new regulated facilities: While cash is           Florida PSC to replenish these reserves.

not realized currently from such allowance, it increases the revenue requirement over the seirvice life of the plant Environmenital Remediation Cost Recovery through a higher rate base and higher depreciation The Company must comply with other environmental expense. For the years 2006, 2005, and 2004,'the average" laws and regulations that cover the handling and disposal annual AFUDC rate was 7.48 percent. AFUDC, net of of waste and releases of hazardous substances. Under taxes, as a percentage of net income after dividends on these various laws and regulations, the Company may also preferred and preference stock was 0.61 percent, incur substantial costs to clean up properties. The 1.97 percent, and 3.46 percent, respectively, for 2006, Company received authority from the Florida PSC to 2005, and 2004. recover approved environmental compliance costs through the environmental cost recovery clause., The Florida PSC Impairment of Long-Lived Assets and Intangibles reviews costs and adjusts rates up or down annually. The Company evaluates long-lived assets for impairment The Company's environmental remediation liability when events or changes in circumstances indicate that the balances as of December 31, 2006 and 2005 totaled carrying value of such assets may not be recoverable. The $57.2 million and $58.2 million, respectively. These determination of whether an impairment has occurred is estimated costs relate to new regulations and more based on either a specific regulatory disallowance or an stringent site closure criteria by the Florida Department of estimate of undiscounted future cash flows attributable to Environmental'Protection (FDEP) for impacts to the assets, as compared with the carrying value of the groundwater from herbicide applications at the assets. If an impairment has occurred, the amount of the Company's substations. The schedule for completion of impairment recognized is determined by either the the remediation projects will be subject to FDEP amount of regulatory disallowance or by estimating the approval. The projects have been approved by the Florida 11-224

NOTES (continued) Gulf Power Company 2006 Annual Report PSC for recovery, as expended, through the Company's Stock Options environmental cost recovery clause; therefore, there was Southern Company provides non-qualified stock options no impact on the Company's net income, as a result of to a large segment of the Company's employees ranging these estimates. from line management to executives. Prior to January 1, 2006, the Company accounted for options gr-anted in Injuries and Damages Reserve accordance with Accounting Principles Board Opinion No. 25; thus, no compensation ex ense was recognized The Company is subject to claims and suits arising in the because the exercise price of all options granted equaled ordinary course of business. As permitted by the Florida the fair market value on the date of the grant. PSC, the Company accrues for the uninsured costs of injuries and damages by charges to'income amo'unting to Effective January 1, 2006, the Company adopted the $1.6 million annually. The Florida PSC has also given the fair value recognition provisions of FASB Statement Company the flexibilitypto increase its anniual accrual No. 123(k), "Share-Based Payment" (SFAS No. 123(R)), above $1.6 million to the extent tlei balance in the reserve using the modified prospective method. Under that does, not exceed $2 million and to defer, expense method, compensation cost for the year ended recognition of liabilities greater than ihe balance in the December 31, 2006 is recognized as the requisite service reserve. The cost of settling claimsr is-chargedto the. is rendered and includes: (a) compensation cost for the reserve. The injuries and damages reserve was $2.0 million portion of share-based awards granted prior to and that and $1.7 million at December 31, 2006 and 2005, were outstanding as of January 1, 2006, for which the respectively, and are included in Curr-et Liabilities in the requisite service has not been rendered, based on the balance'sheets. Liabilities in excess of the reserve balance grant-date fair value of those awards as calculated in of $1.7 million and $3.0 million at December 31, 2006 accordance with the original provisions of FASB and 2005, respectively, are included in Deferred Credits Statement No. 123, "Accounting for Stock-based and Other Liabilities in the balance sheets. Corresponding Compensation" (SFAS No. -123), and (b) compensation regulatory assets of $1.6 million at both December 31, cost for all share-based awards granted subsequent to 2006 and 2005 are included in Current Assets in the January 1, 2006, based on the grant-date fair value balance sheets. At December 31, 2006 and 2005, estimated in accordance with the provisions of respectively, $0.1 million and $1.4 million are included in SFAS No. 123(R). Results for prior periods have not been Deferred Charges and Other Assets in the balance sheets. restated. The compensation cost and tax benefit related to the Cash and Cash Equivalents grant and exercise of, Southern Company stock options to the Company's employees are recognized in the . . For purposes of the financial .statements, temporary cash Company's financial statements with a corresponding investments are considered cash equivalents. Temporary credit to equity, representing a capital contribution from cash investments are securities with original maturities of Southern Company. 90 days or less. For the Company, the adoption of SFAS No. 123(R) has resulted in a reduction in earnings before income Materials and Supplies taxes and net income of $1.0 million and $0.6 million, respectively, for the year ended December 31, 2006. Generally, rmaterials and supplies include the average cost Additionally, SFAS No. 123(R) requires the gross 'excess of transmission, distribution, and generating plant materials. Materials are charged to inventory when tax benefit from stock option exercises to be reclassified purchased and then expensed or capitalized to plant, as as a financing cash flow as opposed to an' operating cash appropriate, when installed. flow; the reduction in operating cash flows and increase in financing cash flows for the year ended December 31, 2006 was $0.4 million. Fuel Inventory Fuel inventory includes the average costs of oil, coal, natural gas, and emission allowances. Fuel is charged to inventory when purchased and then expensed as used. Emission allowances granted by the Environmental Protection Agency (EPA) are included in inventory at zero cost. , 11-225

NOTES (continued) Gulf Power Company 2006 Annual Report For the years prior to the adoption of SFAS No. 123(R), comprehensive income or regulatory assets and liabilities, the pro forma impact on net income of fair-value accounting respectively, until the hedged transactions occur. Any for options granted is as follows: ineffectiveness arising from cash flow hedges is recognized currently in net income. Other derivative Options contract.s are marked tomarket through current period As Impact After Pro income and are recorded on a net basis in the statements Net Income Reported Tax Forma of income., (in thousands) 2005 $75,209 $(586) $74,623 The Company is exposed to losses related to 2004 68,223 (522) 67,701 financial instruments in the event of counterparties' nonperformance. The Company has established controls to Because historical forfeitures have been insignificant deternmine and monitor the creditworthiness of and are expected to remain insignificant, no forfeitures counterparties in order to mitigate the Company's are assumed in the calculation of compens'ation expense; exposure to'counterparty credit risk. rather they are recognized when they occur. Other financial instruments for which the carrying The estimated fair values of stock options granted in amounts did not equal fair values at December 31 were as 2006, 2005, and 2004 were derived using the Black- follows: r Scholes stock option pricing model. Expected volatility is based on historical volatility of Southern Company's Carrying Fair stock over a period equal to the expected term. The Amount Value (in thousands) Company uses historical exercise data to estimate the expected term that represents the period of time that Long-term. debt: options granted to employees are expected to be .2006 $696,098, $682,641 outstanding. The risk-free rate is based on the 2005 653,629 644,677 U.S. Treasury yield curve in effect at the-time of grant that covers the expected term of the stock options. The The fair values were based on either closing market following table shows the assumptions used in the pricing prices or closing prices of comparable instruments. model and the weighted average grant-date fair value of stock options granted: Comprehensive Income Period ended December 31 2006 2005 2004

                                      *t16.9% *;17.9%                   The objective of comprehensive income is to report a Expected volatility                                          19.6%      measure of all changes in common stock equity of an Expected term (in years)                  5.0'       5.0      5.0       enterprise that result from transactions and other Interest rate                             4.6%       3,9%     3.1%      economic events of theperiod other than transactions with Dividend yield                            4.4%       4.4%     4.8%      owners.' Comprehensive income consists of net income, changes in the fair value of qualifying cash flow hedges Weighted average grant-date fair value                          $4.15      $3.90     $3.29       and marketal e !securities, and changes in additional minimum pensioh liability, less income taxes and' reclassifications for amounts included in net income.

Financial Instruments The Company uses derivative financi alinsiruments to Variable Interest Entities limit exposure to fluctuations in interest rates, the prices of certain fuel purchases, and electricity purchases and The primary beneficiary of a variable interest entity must sales. All derivative financial instruments are recognized consolidate'the related assets and liabilities. The as either assets or liabilities and are measured at fair Company has established certain wholly-owned trusts to value. Substantially all of the Company's bulk energy issue preferred securities. See Note 6 under "Long-Term purchases and sales contracts that meet the definition of a Debt Payable to Affiliated Trusts" for additional derivative are exempt from fair value accounting information. However, the Company is not considered the requirements and are accounted for under the accrual primary beneficiary of the trusts. Therefore, the method. Other derivative contracts qualify as cash flow investments in these trusts are reflected as Other hedges of anticipated transactions or are recoverable Investments for the Company, and the related loans from through the Florida PSC-approved hedging program. This the trusts are reflected as Long-term Debt Payable to results in the deferral of related gains and losses in other Affiliated Trusts in the balance sheets. 11-226

NOTES (continued) Gulf Power Company 2006 Annual Report

2. RETIREMENT BENEFITS SFAS No. 158 on individual line items in the balance sheets at December 31, 2006 follows:

The Company has a defined benefit, trusteed, pension Before Adjustments After plan covering substantially all employees. Theplan is (in millions) funded in accordance with requirements of the Employee Retirement Income Security Act of 1974, as amended Prepaid pensioft cost $ 47 $23 $ 70 (ERISA). No contributions to the plan are expected for Other regulatory the year ending December 31, 2007. The Company also assets 92 18 110 provides a defined benefit pension plan for a selected Othei property and group of management and highly compensated investments 16 (1) '15 employees. Benefits under this non-qualified p!an are Total assets 2,300 40 2,340 funded on a cash basis. In addition, the Company Accumulated provides certain medical care and life insurance benefits deferred income for retired employees through other postretirement benefit taxes (237) (1) (238) plans. The Company funds related trusts to the extent Other regulatory required by the Florida PSC. For the'year ending, liabilities (23) (23) '(46) December 31, 2007, postretirement trust contributions are Employee benefit obligation (59) (15) (74) expected to total approximately $60,000. Total liabilities (1,614) (39) (1,653) On December 31, 2006, the Company adopted FASB Accumulated other Statement No. 158, "Employers' Accounting for Defined comprehensive Benefit Pension and Other Postretirement Plans" income 6 (1) 5 (SFAS No. 158), which requires recognition of the funded Total stockholder's status of its defined benefit postretirement plans in its equity (687) (1) (688) balance sheet. Prior to the adoption of SFAS No. 158, the Company generally recognized only the difference Because the recovery of postretirement benefit expense through rates is considered probable, the between the benefit expense recognized and employer Company recorded offsetting regulatory assets or contributions to the plan as either a prepaid asset or as a regulatory liabilities under the provisions of SFAS No. 71 liability. With respect to its underfunded non-qualified with respect to the prepaid assets and the liabilities. pension plan, the Company recognized an additional minimum liability representing the difference between the The measurement date for plan assets and obligations plan's accumulated benefit obligation and its assets. is September 30 for each year presented. Pursuant to SFAS No. 158, the Company will be required to change With the adoption of SFAS No. 158, the Company the measurement date for its defined benefit was required to recognize-on its balance sheet previously postretirement plans from September 30 to December 31 unrecognized assets and liabilities related to unrecognized beginning with the year ending December 31, 2008. prior service cost, unrecognized gains or losses (from changes in actuarial assumptions and the difference. Pension Plans between actual and expected returns on plan assets), and The accumulated benefit obligation for the pension plans any unrecognized transition amounts (resulting from the was $242 million in 2006 and $226 million in 2005. change from cash-basis accounting to accrual accounting). These amounts will continue to be amortized as a component of expense over the employees' remaining average service life as SFAS No. 158 did not change the recognition of pension and other postretirement benefit expense in the statements of income. With the adoption of SFAS No. 158, the Company recorded an additional prepaid pension asset of $23.5 million with respect to its overfunded defined benefit plan and additional liabilities of $2.5 million and $12.9 million, respectively, related to its underfunded non-qualified pension plan and retiree benefit plans. The incremental effect of applying. 11-227

NOTES (continued) Gulf Power Company 2006 Annual Report Changes during the year in the projected benefit Company's pension plan assets as ofthe end of the year, obligations and fair value of plan assets were as follows: along with the targeted mix of assets, is presented below:

                                     ;'2006                  2005                                                Target       2006          2005 (in thousands)                                                     36%           38%           40%

Domestic equity'i", Change in benefit obligation Internationalequity - 24 23 - 24 Benefit obligation at beginning of Fixed income 15 16 17 year $248,026 $228,414 Real estate 15 16 :13 Service cost 6,980 6,318 Private equity' 10 7' 6 Interest cost 13,359' 12,866 (10,081) Q, -Total 100% 100% 100% Benefits paid (11,034) Plan amendments 385 1,568 Amoun'ts recognized in the balance sheets related to Actuarial (gain) loss (11,147) 8,941 the Company's pension plans consist of the following:'" Balance at end of year 246,569. 248,026 .. ... . 2006 2005 Change in plan assets (in thousands) Fair value of'plan assets at Prepaid pension costs $ 69,895 $46,374 beginning of year 280,366 250,238 Other iegulatory-assets ' 5,091 ' - Actual return on plan assets 34,440 38,478 Current liabilities, other (585) ' - Employer contributions f.)082 .732 Other regulatory liabilities (23,478) " Benefits paid.. (11,0$4) (10,081) Employee benefit obligations (10,207). (7,893) Employee transfers . 1,071 999 Other property and investments - 868 'Fair value of plan assets at end of Accumulated other comprehensive year 305,525 280,366 income 2,126 Funded status at end of year 58,956 32,340 Presented below are the amounts included in Unrecognized prior service cost , . 12,780 regulatory assets and regulatory liabilities at December 31, Unrecognized net (gain) loss. . . - (3,845) 2006, related to the defined -benefit pension plans that Fourth quarter contributions 147 200 have not yet been recognized in net periodic pension cost along' with-the estimated amortization of such amounts for Prepaid pension asset, net . $ 59,103 .'$ ,41,475 "' , the next:fiscal year: . At December 31, 2006, the projected benefit Prior Net' obligations for the qualified and iino-qualified pension 'Service (Gain)/ plans were $235.6 million and $10.9 nillion, respectively. Cost Loss All plan assets are related to the,qualified pension plan. (in thousands). Pension plan assets. are managed and invested in Balance at December 31, 2006:, accordance with all applicable, requirements,, including' Regulatory assets ' , $ 401,. $ 4,690 ERISA and the Internal Revenue Code of 4986, as' Regulatory liabilities 11,153 (34,631) amended (Internal Revenue Code).: The Company's $11,554 $(29,941) Total , investment policy covers a diversified mix of assets, including equity and fixed, income securities;,real estate, and private equity. 'Derivative instruments are used .... : primarily as hedging tools but may also -be used to gain,.. efficient exposure to the various asset classes. The . . Company primarily minimizes -the risk of large losses' through diversification but also monitors and manages other aspects of risk. The actual composition of the U-22g

NOTES (continued) Gulf Power Company 2006 Annual Report Estimated amortization in net periodic pension cost in Other Postretirement Benefits 2007: Changes during the year in the accumulated Prior Net postretirement benefit obligations (APBO) and in the fair Service (Gain)/ value of plan assets were as follows: Cost Loss 2006 2005 (in thousands) (in thousands) Regulatory assets $ 114 $360 Change in benefit obligation Regulatory liabilities 1,221 - Benefit obligation at beginning of Total $1,335 $360 year $ 73,280 $ 69,186 Service cost 1,424 1,357 Components of net periodic pension cost (income) Interest cost 3,940 3,892 were as follows: Benefits paid (3,728) (3,124) 2006 2005 2004 Actuarial (gain) loss (1,124) 1,969 (in thousands) Retiree drug subsidy 193 - Service cost $ 6,980 $ 6,317 $ 5,915 Balance at end of year 73,985 73,280 Interest cost 13,358 12,866 12,136 Change in plan assets Expected return on Fair value of plan assets at plan assets (20,727) (20,816) (20,689) beginning of year 16,434 14,296 Recognized net Actual return on plan assets 1,951 2,114 (gain)/loss 463 350 (317) Employer contributions 3,583 3,1148 Net amortization 1,313 502 486 Benefits paid (4,328) (3,124) Net periodic pension cost (income) $ 1,387 $ (781) $ (2,469) Fair value of plan assets at end of year - 17,640 16,434 Net periodic pension cost (income) is the sum of Funded status at end of year (56,345) (56,846) service cost, interest cost, and other costs netted against Unrecognized transition amount 2,589 the expected return on plan assets. The expected return on Unrecognized prior service cost 4,31-1 plan assets is determined by multiplying the expected rate Unrecognized net (gain)/loss 9,026 of return on plan assets and the market-related value of plan assets. In determining the market-related value of Fourth quarter contributions 932 973 plan assets, the Company has elected to amortize changes Accrued liability (recognized in in the market value of all plan assets over five years the balance sheet) $(55,413) $(39,947) rather than recognize the changes immediately. As a result, the accounting value of plan assets that is used to Other postretirement benefits plan assets are calculate the expected return on plan assets differs from managed and invested in accordance with all applicable the current fair value of the plan assets. requirements, including ERISA and the Internal Revenue Code. The Company's investment policy covers a Future benefit payments reflect expected future diversified mix of assets, including equity and fixed service and are estimated based on assumptions used to income securities,,'real estate, and private equity. measure the projected benefit obligation for the pension Derivative instruments are used primarily as hedging tools plans. At December 31, 2006, estimated benefit payments but may also be used to gain efficient exposure to the were as follows: various asset classes. The Company primarily minimizes (in thousands) the risk of large losses through diversification but, also 2007 $11,080 monitors and manages other aspects of risk. The actual 11,451 composition of the Company's other postretirement 2008 2009 11,852 2010 12,369 2011 13,055 2012 to 2016 77,555 11-229

NOTES (continued) Gulf Power Company 2006 Annual Report benefit plan assets as of the end of the year, along with Components of the other postretirement plans' net the targeted mix of assets, is presented below: periodic cost were as follows: Target 2006 2005 2006 2005 2004 (in thousands) Domestic equity 35% 37% 38% Service cbst $1,424 $ 1,357 $ 1,275 International equity 23 22 23 Interest cost 3,940 3,892 4,081 Fixed income 18 19 21 14 15 12 Expeted return on plan Real estate (1,264) (1,202) (1,220) assets Private equity 10 7 6 355 Transition obligation 356 356 Total 100% 100% 100% Prior service cost 346 346 344 Recognized net Amounts recognized in the balance sheets related to -(gain)/loss 155 33 241 the Company's other postretirement benefit plans consist of the following:. Net postretirement cost $ 4,957 $ 4,782 $ 5,078 2006 2005 In thethird quarter 2004, the Company prospectively (in thousands) adoptedFASB Staff Position 106-2, ++Accounting and Regulatory assets $12,877 $ Disclosure Requirernents'" (FSP 106-2) related to the! - Current liabilities, other (448) Medicare Prescription Drug, Improvement, and Employee benefit obligations (54,965) (39,947) Moderinizatin Act of 2003 (Medicare Act). The Medicare Act Pyrovides a ý8 percent prescription drug subsidy for, Presented below are the amounts included in Medicare eligible retirees. FSP 106-2 requires recognition regulatory assets at December 31, 2006,;related to the of thenimpacts of the Medicare Act in the APBO and future cost of service for postretiie'ient medical plan. The other postretirement benefit plans that have not yet been recognized in net periodic postretirement benefit cost effect of the subsidy reduced the Company's expenses for along with the estimated amortization of such amounts for the six months ended December 31, 2004 and for the the next fiscal year. years ended December 31, 2005 and 2006 by approximately $0.5 -million, $1.1 million, and $1.7 million, Prior Net respectively, and is expected to have a similar impact on Service '(Gain)/' Transition future expenses. Cost Loss Obligation (in thousands) Future benefit payments, including prescription drug Balance at December 31, 2006: benefits, reflect ýexpected future service and are estimated based on assumptions used to measure the APBO for the Regulatory assets. $3,965 $6,678 $2,234 postretirement plans. Estimated benefit payments are. Estimated amortization as net reduced by drug subsidy receipts expected as a result of periodic postretirement the'Medicar6 Act as follows:. " benefit cost in 2007: Benefit Subsidy Regulatory assets $ 346 $ 97 $ '356 Payments 'Receipts Total (in thousands)

" ' * . " + , J 'I , 2007 $,

                                                                                                            $3,373         .$     (285) $ 3,088 2008 :i ,         !              3,723             (333)     .3,390 2009                             4,075             (384)      3,691 2010       "4,358                                  (447)      3,911 2011                             4,711             (504)      4,207 2012 to 20i66                  26,937           (3,627): 23,310
                                                        *I 1-230

NOTES (continued) Gulf Power Company 2006 Annual Report Actuarial Assumptions extensive governmental regulation related to public health and the environment. Litigation over environmental issues The weighted average rates assumed in the actuarial and claims of various types, including property damage, calculations used to determine both the benefit obligations personal injury, and citizen enforcement of environmental as of the measurement date and the net periodic costs for requirements such as opacity and other air quality the pension and other postretirement benefit plans for the standards, has increased generally throughout the United following year are presented below. Net periodic benefit States. In particular, personal injury claims for damages costs for 2004 were calculated using a discount rate of caused by alleged exposure to hazardous materials have 6.00 percent. become more frequent. The ultimate outcome of such 2006 :2005 2004 pending or potential litigation against the Company cannot be predicted, at this time; however, for current. Discount 6.00% 5.50% 5.75% proceedings not specifically reported herein, management Annual salary increase 3.50 3.00 3.50 does not anticipate that the liabilities, if any, arising.from Long-term return on olan assets 8.50 8.50 8.50 such current proceedings would have a material adverse effect on the Company's financial statements. The Company determined the long-term rate of return based on historical asset class returns and current Environmental Matters market conditions, taking into account the diversification benefits of investing in multiple asset classes. New Source Review Actions An additional assumption used in measuring the In November 1999, the EPA brought a civil action in the APBO was a weighted average medical care cost trend U.S. District Court for the Northern District of Georgia rate of 9.56: percent for 2007, decreasing :gradually to against certain Southern Company subsidiaries, including 5.00 percent through the year 2015 and remaining at that Alabama Power and Georgia Power, alleging that these level thereafter. An annual increase or decrease in the subsidiaries had'violated the New Source Review (NSR) assumed medical care cost trend rate of 1 percent would provisions of the Clean Air Act and related state laws at affect the APBO and the service and interest cost certain coal-fired generating facilities. Through components at December 31, 2006 as follows: subsequent amendments and other legal procedures, the EPA filed a separate action in January 2001 against

-1 Percent .1 Percent Alabama Power in the U.S. District Court for the Increase Decrease Northern District of Alabama after it was dismissed from (in thousands) 1 the original action. In these lawsuits, the EPA alleged that Benefit obligation $4,586 $3,911 NSR violations occurred at eight coal-fired generating Service and interest costs 293 259 facilities operated by Alabama Power and Georgia Power (including a facility formerly owned by Savannah Electric). The civil actions request penalties and Employee Savings Plan injunctive relief, including an order requiring the The Company also sponsors a 401(k) defined contribution installation of the best available control technology at the plan covering substantially all employees. The Company affected units. The EPA concurrently issued notices of provides an 85 percent matching contribution up to violation relating to the Company's Plant Crist and a unit 6 percent of an employee's base salary. Prior to partially owned by the Company at Plant Scherer. See November 2006, the Company matched employee Note 4 for information on the Company's ownership contributions at a rate of 75 percent up to 6 percent of the interest in Plant Scherer Unit 3. In early 2000, the EPA employee's base salary. Total matching contributions filed a motion to amend its complaint to add the made to the plan for 2006, 2005, and 2004 were allegations in the notices of violation and to add the

$3.0 million, $2.9 million, and $2.7 million, respectively. Company as a defendant. However, in March 2001, the court denied the motion based on lack of jurisdiction, and

3. CONTINGENCIES AND REGULATORY the EPA has not refiled.

MATTERS On June 19, 2006, the U.S. District Court for the Northern District of Alabama entered a consent decree General Litigation Matters between Alabama Power and the EPA, resolving the The Company is subject to certain claims and legal alleged NSR violations at Plant Miller. The consent actions arising in the ordinary course of business. In decree required Alabama Power to pay $100,000 to addition, the Company's business activities are subject to resolve the government's claim for a civil penalty and to 11-231

NOTES (continued) Gulf Power Company 2006 Annual Report donate $4.9 million of sulfur dioxide emission allowances FERC Matters. to a nonprofit charitable organization and formalized Market-Based Rate Authority specific emissions reductions to be accomplished by Alabama Power, consistent with other Clean Air Act The Company has authorization from the FERC to sell programs that require emissions reductions. On August 14, power to non-affiliates, including short-term opportunity 2006, the district court in Alabama granted Alabama sales, at market-based prices. Specific FERC approval Power's motion for summary judgment'and entered final must be obtained with respect to a market-based contract judgment in favor of Alabama Power on the EPA's claims with an affiliate. ' related to Plants Barry, Gaston, Gorgas, and Greene In'December 2004, the FERC initiated a proceeding County. The plaintiffs have appealed this decision to the to assess Southern Company's generation dominance U.S. Court of Appeals for the Eleventh Circuit and, on within its retail service territory. The ability to charge November 14, 2006, the Eleventh Circuit granted the market-based rates in other markets is not an issue in that plaintiffs' request to stay the appeal, pehding the proceeding. Any new market-based rate sales by the U.S. Supreme Court's ruling in a similar NSR case filed Company inSouthern Company's retail service territory by the EPA against Duke Energy. The action against entered into :during a 15-month refund period beginning Georgia Power has been administratively cldsed since the February 27, 2005 could be subject to refund to the level spring of 2001, and none of the parties has sought to of the default cost-based rates, pending the outcome of reopen the case. the proceeding. Such sales through May' 27, 2006, the end The Company believes that it complied with of the refUnd period, were approximately $0.8 million for applicable laws and the EPA regulations and the Company, In the event that the FERC's default interpretations in effect at the time the work in question mitigation'measures for entities that are found to have took place. The Clean Air Act authorizes maximum civil maiket power are ultimately applied, the Company may penalties of $25,000 to $32,500 per day, per violation at be 'required to charge cost-based rates for certain each generating unit, depending on the date of the alleged wholesale sales in the Southern Company retail service violation. An adverse outcome in this matter could require territory, which may be lower than negotiated market-substantial capital expenditures*that cannot be determined based rates. The final outcome of this matter will depend at this time and could possibly require payment of on the form in which the final methodology for assessing substantial penalties. Such expenditures could affect generation market power and mitigation rules may be future results of operations, cash flows, and financial ultimateily adopted and cannot be determined at this time. condition if such costs are not recovered through Inaddition, in May 2005, the FERC started an regulated rates. investigation to determine whether Southern Company satisfies the other three parts of the FERC's market-based EnvironmentalRemediation raite analysis: transmission market power, barriers to entry, At December 31, 2006, the Company's liability for the and affiliate abuse or reciprocal dealing. The FERC estimated costs of enviroilmental remediation projects for established a new '15-month refund period related to this known sites was $57.2 millioi.' The schedule for expanded investigation. Any new market-based rate sales completion of the remediation projects will be subject to involving any Southern !Company subsidiary, ificluding the Florida Department of Environmental Protection (FDEP) Company, could be subject to refund to the extent the approval. These projects have been approved by the FERC orders lower rates as a result of this new Florida PSC for recovery through the environmental cost investigation. Such sales through October 19, 2006, the recovery clause. Therefore, the Company has recorded end of the refund period, were approximately' $3 million for the Comtpany, of which $0.6 million relates' to sales

 $1.7 million in Current 'Assets 'and Curreht Liabiiitids and insidethe ret-il service territory discussed above. The
 $55.5 million in Deferred Charges'.and' Other Assets and Deferred Credits and Other Liabilities'representing the'            FERC lso' directed thai'this expanded proceeding be held future recoverability of.these costs.,'                             in abeyance pending the outcome of the proceeding on the Intercompany Interchange Contract (IIC) discussed The final outcome of these matters cannot now be              below. On January 3, 2007, 'the FERC issued an order.

determined. However, based on the currently known noting settlement of the IIC proceeding and seeking conditions at these sites and themature and extent of the comment identifying any remaining issues and the proper Company's activities relating"to these sites, management procedure 'for addressing any such issues. does not believe that the Company's additional liability, if any, at these sites would be material to the financial ;'The Company believes that there is no meritorious statements. basis for these proceedings and is vigorously defending 11-232

NOTES (continued) Gulf Power Company 2006 Annual Report itself in this matter. However, the final outcome of this On November 22, 2004, generator company. matter, including any remedies to be applied in the event subsidiaries of Tenaska, Inc (Tenaska), as counterparties of an adverse ruling in these proceedings, cannot now be to three previously executed interconnection agreements determined. with subsidiaries of Southern Company filed complaints at the FERC requesting that the FERC modify the Intercompany Interchange Contract agreements and that those Southern Company subsidiaries refund a total of $19 million previously paid for The Company's generation fleet is operated under the IIC, interconnection facilities, with interest. Southern as approved by the FERC. In May 2005, the FERC Company has also received requests for similar initiated a new proceeding to examine (1) the provisions modifications from other entities, though no other of the IIC among, Alabama Power, Georgia Power, the complaints are pending with the FERC. On January 19, Company, Mississippi Power, Savannah Electric, Southern 2007, the FERC issued an order granting Tenaska's Power, and SCS, as agent, under the terms of which the requested relief. Although the FERC's order requires the power pool of Southern Company is operated, and, in modification of Tenaska's interconnection agreements, the particular, the propriety of the continued inclusion of order reduces the amount of the refund that had been Southern Power as a party to the IIC, (2) whether any requested by Tenaska. As a result, Southern Company parties to the IIC have violated theiFERC's standards of estimates indicate that no refund is due to. Tenaska. conduct applicable to utility companies that are Southern Company has requested rehearing of the FERC's transmission providers, and (3) whether Southern order. The final outcome of this matter cannot now be Company's code of conduct defining Southern Power as a "system company" rather than a "marketing affiliate" is determined. just and reasonable. In connection with the formation of Southern Power, the FERC authorized Southern Powet's Right of Way Litigation inclusion in the IIC in. 2000. The FERC also previously Southern Company and certain of its subsidiaries, approved Southern Company's code of conduct. - including the Company, Georgia Power, Mississippi On October 5, 2006, the' FERC issued an order Power, and Southern Telecom, hav e been named as accepting a settlement resolving the proceeding subject to defendants in numerous lawsuits brought by landowners Southern Company's agreement to accept certain since 2001. The plaintiffs' lawsuits claim that defendants modifications to the settlement's terms. On October 20, may not use,or Isublease to third parties, some or all of 2006, Southern Company notified the FERC thatit' the fiber 6ptic communications lines on the rights of way accepted the modifications. The modifications largely that cross the plaintiffs' properties, and that such actions involve functional separation and information restrictions exceed the easements or other property rights' held by" related to marketing activities conducted on behalf oft defendants. The plaintiffs assert claims for, among other Southern Power. Southern Company filed with theFERC, things, trespass and unjust enrichment, and seek, ' on November 6, 2006 an implementation plan to comply,- compensatory and punitive damages and injunctive relief. with the modifications set forth in the order. The impact The Company's management believes that it has complied of the modifications is not expected to have a material with applicable laws and that the plaintiffs' claims are impact on the Company's financial statements. without merit. Generation InterconnectionAgreements inNovember 2003, the Second Circuit Court' in Gadsden County, Florida, ruled in favor of the plaintiffs In July 2003, the FERC issued its final rule on the on their motion for partial summary judgment concerning' standardization of generation interconnection agreements liability in one such lawsuit brought by landowners' and procedures (Order 2003). Order 2003 slhifts muclh of regarding the installation and use of fiber optic cable over the financial burden of new transmission investment from the Company's rights of way located on the landowners' the generator to the transmission provider. The FERC has property. Subsequently, the plaintiffs sought to amend indicated that Order 2003,.which was effective January 20, their complaint and asked the court to enter a final 2004, is to be applied prospectively to new generatinrg declaratory judgment and to enter an order enjoining the facilities interconnecting to a transmission system. Order Company from allowing expanded general 2003 was affirmed by the U.S. Court of Appeals for the telecommunications use of the' fiber optic cables that are District of Columbia Circuit on January 12, 2007.'The the subject of this litigation. In-January 2005, the trial-cost impact resulting from Order 2003 .will vary on a court granted in, part the plaintiffs' motion to amend their case-by-case basis for each new generator interconnecting complaint and denied the requested declaratory and to the transmission system.. injunctive relief. In November 2005, the trial court ruled 11-233

NOTES (continued) Gulf Power Company 2006 Annual Report in favor of the plaintiffs and against the Company on their stayed, pending the outcome of the'litigation discussed respective motions for partial summary judgment. In that below. same order, the trial court also denied the Company's motion to dismiss certain claims. The court's ruling in Novemnber 2004, Georgia Power filed suit, on its own behalf, against the Monroe Board in the Superior allowed for an immediate appeal to the Florida First District Court of Appeal, which the Company filed in Court of Monroe- County. The suit could impact all co-December 2005. On October 26, '2006, ,the Florida First owners. Georgia Power contends that Monroe County District Court of Appeal issued an brder dismissing the acted without 'statutory authority in changing -the valuation Company's December 2005 appeal-on the basis that the of a centrally 'assessed utility as established by the * " trial court's order was a' non-final order and therefore not Revenuie:Commissioner of the State' of Georgia and subject to review on appeal at this time.- The case is once requests injunctive relief prohibiting Monroe County and again pending in the trial court for further proceedings. the Monroe Board from unlawfully changing the value of The final outcome of this matter cannot now be Plant Scherer and ultimately, collecting additional ad determined. In the event of an adverse verdict in this case, valorem taxes from Georgia Power. In December 2005, the Company could appeal the issues of both liability and the CoUrt granted Monroe County's motion -forsummary damages or other relief granted. judgment. Georgia Power has filed an' appeal of the Superior Court's'decision to the Gebrgia Suprenie Court. In addition, in late 2001, certain subsidiaries of Southern Company, including the, Company, Alabama If Georgia Power is not successful in its Power, Georgia Power, Mississip~pi Power, Savannith administrative appeals and if Monroe County is successful Electric, and Southern Telecom, were named as in defending the litigation, the Company could be subject defendants in a lawsuit brought by a telecommunications to total, addiional taxes through December 31, 2006 of up company that uses certain of the defendants' rights of to $4.4 million, plus penalties and interest. In accordance way. This lawsuit alleges, among other things, that the with the Company's unit power sales contract for Plant. defendants are contractually obligated to indemnify, Scherer, such property taxes would be recoverable from defend, and hold harmless the telecommunications the customer. The final outcome of this matter cannot company from any liability that maybe assessed -against now be determined. it in pending and future right of way litigation. The Company believes that the plaintiff's claims are without merit. In the fall of 2004, the trial court stayed the case Retail Regulatory Matters until resolution of the underlying landowner. litigation discussed above. In January 2005, the Georgia Court of Environmental Cost Recovery Appeals dismissed the telecommunications company's appeal of the trial court's order for lack of jurisdiction. The'Florida Legislature adopted legislation for an An adverse outcome in this matter, combined with an environmental cost recovery clause, which allows an adverse outcome against the telecommunications company electric utility to petition the Florida PSC for recovery' of in one or more of the right of way: lawsuits, could result. prudent environhiental compliance costs 'that are not being in substantial judgments; however, the final outcome of recoverýedthrough base rates or any other recovery these matters cannot now be determined. mechanism. Such environmental costs include operation and maintenance expense, emission allowancIe expensIe, Property Tax Dispute depreciation, 'and a return on invested capital. This legislation also allows recovery of costs incurred as a' Georgia Power and the Company are involved in a result of an agreement between the Company and the significant property tax dispute with Monroe County, FDEP for the purpose of ensuring compliance with ozone Georgia (Monroe County). The Monroe County Board of ambient air quality standards adopted by the EPA. During Tax Assessors (Monroe Board) has issued assessments 2006, 2005, and 2004, the Company recorded reflecting substantial increases in the ad valorem tax environmental cost recovery clause revenues of valuation of the Company's 6.25 percent ownership $40.9 imillion, $26.3 million, and $14.7 million, interest in Plant Scherer, which is located in-Monroe respectively. Annually, the Company seeks recovery of County, for tax years 2003 through 2006. Georgia Power' projected costs including any true-up amounts from prior and the Company are aggressively pursuing administrative periods. At December 31, 2006, the over recovered appeals in Monroe County and have filed notices of balance was $6.8 million primarily due to operations and arbitration for all four years. The appeals are currently maintenance 'expenses being less than anticipated. 11-234

NOTES (continued) Gulf Power Company 2006 Annual Report Storm Damage Cost Recovery of the 2006 Order do not alter or affect that portion of the prior agreement. Under authority granted by the Florida PSC, the Company maintains a reserve for property damage to cover the cost According to the 2006 Order, in the case of future, of uninsured damages from major storms to its storms, if the Company incurs cumulative costs for storm-transmin ssion and distribution facilities, generation recovery, activities in-excess of $10 million during any facilities, and other prop1erty." calendar year, the Company will be permitted to file a Hurricanes Dennis and Katrina hit the Gulf Coast of streamlined formal request for an interim surcharge. Any Florida in. July 2005 and August 2005,. respectively,-. interim surcharge, would provide for the recovery, subject damaging portions of the Company's service area. In to refund, of up to 80 percent of the claimed~costs for September 2004, Hurricane Ivan hit the Gulf Coast of storm-recovery activities. The Company would then Florida, causing substantial damage within the Company's petition the Florida PSC for full recovery through a final service area. In 2005, the Florida PSC issued, an order, " or non-interim surcharge or other cost recovery (2005 Order) that approved a stipulation, and settlement mechanism.

between the Company and several consumer groups and thereby, authorized the recovery, of the Company's storm See Note 1 under "Property Damage Reserve" for darmnge costs related to Hurricane Ivan through' the two- additional information.

year surcharge that began in April 2005. In July 2006, the Florida PSC issued-an order (2006 4. JOINT OWNERSHIP AGREEMENTS Order) approving anothersitipulation and settfement 66tWeen'the'Company and several consumer groups that The Company and Mississippi Power jointy own Plant resolved'all mnatters relating t tl06 Company's request for Daniel Units 1 and 2, which' together represent capacity recovery of incurred costs-for storm-recovery activities of 1,000 megawatts (MW).ý Pla~t Daniel is a generating related to the 2005 storms and the replenishment of'the plant located in Jackson County, Mississippi. In Company's property damage reserve. The 2006 Order h accordance with the operating agreement, Mississippi provides for an extension of the stormnrecovery surcharge Power acts as the Company's agent with respect to the currently being collected by the Company for an construction, operation, and maintenance of these units. additional 27 months, expiring in June 2009. The Company and Georgia Power jointly own the According to the 2006 Order, the funds resulting. 818 MW capacity Plant Scherer Unit 3'Plant Scherer is a from the extension of the current surcharge will first be generating plant located near Forsyth, Georgia. In credited to the unrecovered balance of storm-recovery accordance with the operating agreement, Georgia Power costs associated with Hurricane Ivan until these costs acts as the Company's agent with' respect to the have been fully recovered. The funds will then be credited construction, operation, and maintenance of the unit. to the property. reserve for recovery of the storm-recovery. costs of $52.6 million associated with Hurricanes Dennis The Company's pro rata share of expenses related to' and Katrina that were previously charged to the, reserve. both plants is included in the corresponding operating Should revenues collected by the Company through the expense accotints in the statements of income. extension of the storm-recovery surcharge exceed the storm-recovery costs associated with Hurricanes Dennis At December 31, 2006, the Company's percentage and Katrina, the excess, revenues will be credited to the ownership and its investment in these jointly owned reserve. facilities were as follows: The annual accrual to the reserve of $3.5 million and Plant' Plant the Company's limited discretionary authority to make. Scherer Daniel additional accruals to the reserve will continue as Unit 3 Units 1 & 2 previously approved by the Florida PSC. The Company (coal) (coal) made discretionary accruals to the reserve of $3 million, (in thousands) $6 million, and $15 million in 2006, 2005, and 2004, respectively. As part of the 2005 Order regarding Plant in service ' '$191',3 19(a) 1 $253,370 Hurricane Ivan costs that established the existing Accumulated depreciation 90,889 138,472 surcharge, the Company agreed that it would not seek, any Construction work in progress 2,430 699 additional increase in its base rates and charges to 0wnership 25% 50% become effective on or before March 1, 2007. The terms (a) Includes net plant acquisition adjustment of $3.8 million. 11-235

NOTES (continued) Gulf Power Company 2006 Annual Report

5. INCOME TAXES statements and their respective tax bases, which give rise to deferred tax assetsand liabilities, are as follows:, .,

Southern Company files a consolidated federal income tax return and combined State of Mississippi and State of 2006 2005 Georgia income tax returns. Under a joint consolidated (in thousands) income tax allocation agreement, each subsidiary's current Deferred tax liabilities: and deferred tax expense is computed on a stand-alone $245,906 Accelerated depreciation $245,147 basis and no subsidiary is allocated more expense than would be paid if they filed a separate income tax return. Fuel recovery clause 31,380 12,812 In accordance with Internal Revenue S~rvice regulations, Pension benefits and employee each company is jointly and severally liable for the tax benefit obligations 23,888 1.4,817 liability. J'roperty, reserve 17,612 29,393 At December 31, 2006, the tax-related regulatory Regulatory assets associated assets to be recovered from customers were , 17.1 million.

with employee benefit These assets are attributable to tax benefits flowed obligations 10,940 through to customers in prior years and to taxes Regulatory assets associated applicable to capitalized allowance for funds used during with asset retirement construction. At December 31, 2006, the tax-related obligations 5,151 6,195 regulatory liabilities to be credited to customers were 6,492 6,352 Other

$17.9miili~n. These liabilities arý attributable to deferred taxes previously recognized at rates higher than the Total 340,610 315,475 current enacted'iax law and to unamortized investment tax Deferred tax assets: credits. Federal effect df state deferred Details of income tax provisions are as follows: taxes !

                                                                                                               $   13,713       $ 13,591 2006          2005        2004            Post retirement benefits                 15,082          13,430 (in thousands)                                                             13,310             2,054 Pension lpiefits Federal-                                                                  Other comprehensive loss                  2,887             1;765 Current       -            $40,472      $11,330      $(4,255)

(470) 26,693 39,373 Regulato.ry liabilities associated Deferred with employee benefit 40,002 38,023 35,118 obligationrs 9,057 State - Asset retirement obligations 5,151 6,195 Current 3,651, 490 (2,305) 6,882 Other,. 13,777 13.082 Deferred 1,640 6,468 5,291 6,958 4,577 Total 72,977 50,117 Total $45,293 $44,981 $39,695 Net deferred tax liabilities 267,633 265,358 Less current portion, net (29,771) (8,868) The tax effects of temporary differences between the carrying amounts of assets and liabilities in the financial Accumulated deferred income taxes in the balance sheets $237,862 $256,490 In accordance with regulatory requirements, deferred investment tax'credits are amortized over the lives of the related properety w'ith such amortization normally applied as a credit to 'reduce depreciation in the statements of income. Credits amortized in this manner Iamounted to

                                                                       $1.8 million' in 2006, $1.9 million in 2005, andall 31, 2006,
                                                                       $2.0 million'i n 20041 At December investment tax credits available to reduce federal income taxes payable' had been utilized.

11-236

NOTES (continued) Gulf Power Company 2006 Annual Report A reconciliation of the federal statutory income tax On January 19, 2007, the Company issued to rate to the effective income tax rate is as follows: Southern Company 800,000 shares of the Company's common stock, without par value, and realized proceeds 2006 2005 2004 of $80 million. The proceeds were used to repay.a portion Federal statutory rate 35.0% 35.0% 35.0% of the Company's short-term indebtedness and for other general corporate purposes. State income tax, net of federal deduction 2.8 3.7 2.8 Pollution Control Bonds Non-deductible book depreciation 0.5 0.7 0.6 Pollution control obligations represent loans to the Difference in prior years' Company from public authorities of funds derived from deferred and current tax rate (0.8) (6.8) (1.1) sales by such authorities of revenue bonds issued to Other, net (1.1) (1.4) (0.6) finance pollution control facilities. The Company is required to make payments sufficient for the authorities to Effective income tax rate 36.4% 37.2% 36.7% meet principal and interest requirements of such bonds totaling $157.6 million.

6. FINANCING Assets Subject to Lien Long-Term Debt Payable to Affiliated Trusts In January 2007, the Company's first mortgage bond indenture was discharged. As a result, there are no longer The Company has formed certain wholly owned trust any first mortgage liens on the Company's property and subsidiaries for the purpose of issuing preferred securities. the Company n longer has to comply with the covenants The proceeds of the related equity investments and , and restrictions of the first mortgage bond indenture. The preferred security sales were loaned back to the Company Company has granted a lien on its property at Plant through the issuance of junior subordinated notes totaling Danielin connection with the issuance of two series of

$41.2 million, which constitute substantially all of the pollution control bonds with an outstanding principal assets of these trusts and are reflected in' the balance amount of $41 million. sheets as Long-term Debt Payable to Affiliated Trusts. The Company considers that the mechanisms and There are no agreements or other arrangements obligations relating to the preferred securities issued for among the affiliated companies under which the assets of its benefit, taken together, constitute a full and one company ha".e been pledged or otherwise made unconditional guarantee by it of the trusts' payment available to satisfy obligations of Southern Company or obligations with respect to these securities. At any of its subsidiaries. December 31, 2006, $41.2 million of thesei~securities were Bank Credit Arrangements outstanding. See Note 1 under "Variable Interest Entities" for additional information on the accounting treatment for At the beginning of 2007, the Company had $120 million these trusts and the related securities. of lines of credit with banks subject to renewal each-year, all of which remained unused. Of the $120 million, Outstanding Classes of Capital Stock $116 million provides liquidity support for the Company's commercial paper program and $4 million of daily The Company currently has preferred stock, Class A variable rate 'pollution control bonds. In connection with preferred stock, preference stock, and common stock these credit lines, the Company has agreed to pay authorized. The Company's preferred stock and Class A commitment fees. preferred stock, without, preference between classes, rank Certain credit arrangements contain covenants that senior to the Company's preference stock and common limit the level of indebtedness to capitalization to stock with respect to the payment of dividends,'and 65 percent, as defined in the arrangements. At voluntary or involuntary dissolution. No shares of December 31, 2006, the Company was in compliance preferred stock or Class A preferred stock were with these covenants. outstanding at December 31, 2006. The Company's, preference stock ranks senior to the common stock with In addition, certain credit arrangements contain cross respect to the payment of dividends and voluntary or default provisions to other indebtedness that would trigger involuntary dissolution. The outstanding preference stock an event of default if the Company defaulted on is subject to redemption at the option of the Company on indebtedness over a specified threshold. The cross default or after November 15, 2010. provisions are restricted only to indebtedness of the 11-237

NOTES (continued) Gulf Power Company 2006 Annual Report Company. The Company is currently in compliance with minimize ineffectiveness. As such, no material all such covenants. In the event of a material adverse ineffectiveness has been recorded in earnings. change, as defined in the Company's credit agreements,

                                                                          ! In 2006,1the Company terminated interest rate the Company would be prohibited from borrowing against derivatives, at the same time the related debt was issued, unused credit arrangements totaling $10 million.

with a notional value of $80 million at a cost of The Company borrows primarily through a $5.4 million., The hedge cost will be amortized over a commercial paper program that has the liquidity support 10-year peri.od. The Company had no interest rate of committed bank credit arrangements., The Company derivatives at December 31, 2006. For the years 2006, may also borrow through various other arrangements with 2005, and 2004, approximately $0.4 million, $0.3 million, banks and through an extendible commercial note and $0.3 million, respectively, of pre-tax losses were program. At December 31, 2006, the.Company had reclassified from other comprehensive income to interest $80.4 million in commercial paper and $40 million in expense. For 2007, pre-tax losses of approximately bank notes outstanding. At December 3J, 2005, the $0.9 millibt* hre expected to be reclassified from other Company had $14.5 million in commercial paper and comprehenisive income to interest expense. The Company $75 million in bank notes outstanding. During 2006, the has loss'&that are being amortized through 2016. peak amount outstanding for short term debt was $181.6 million and the average amount outstanding was 7. COMMITMENTS $113.8 million. The average annual interest rate on commercial paper was 5.36 percent. Construction Program The Company is engaged in a' continuous construction Financial Instruments program, the cost of which is currently estimated to total

                                                                       $278 mllion in-2007, $458 million in 2008, and The Company enters into energy'related derivatives'to
                                                                       $395 million in 2009. The construction program is subject hedge exposures to electricity, gas, andotlher fuel price to perigdi' review .and revision, and actual construction changes. However, due to cost-based r'te regulati6ns,'the costs may yary#frpm the above estimates because of Company has limited exposure to 'market volatility in**

numerous..factors. These factors include changes in commodity fuel prices and prices of'electricity.'The' business conditions; acquisition of additional generating Company has implemented fuel-hedging programs with assetý; rvised load growth estimates; changes in the approval of the Florida PSC. The Company enters into environmepta! regulations; changes in FERC rules and hedges of forward electricity sales. There was no material regulations; increasing costs of labor, equipment, and ineffectiveness recorded in earnings* in" 006, 2005, and materials;, and cost of capital. At December 31, 2006, 2004. significant purchase, commitments were outstanding in At December, 31, 2006, the fair value gains/(losses) connection with the pngoing construction program. of energy-related derivative contracts were reflected in the Included in the amounts -above are $171 million in financial statements as follows: 2007, $378 million in 2008, and $300 million in 2009 for Amounts environmental expenditures. The Company does not have

                                                 .(in thousands)       any neW generating capacity under construction.
                                                     $(7,186)          Construction of new transmission and distribution Regulatory assets, net facilities and other capital improvements, including those Net income                                                             needed to meet environmental standards for the Total fair value           '                         $(7,186)          Company's existing .generation, transmission, and distribution facilities, are ongoing.

The fair value gains or losses for cash flow hedges that are recoverable through the regulatory fuel clauses Long:Term Service Agreements are recorded as regulatory assets and liabilities and are The Company has a Long-Term Service Agreement recognized in earnings at-the same time the hedged items (LTSA) with General Electric (GE) for the purpose of affect earnings. The Company has energy-related hedges securing .maintenance support for combined cycle in place up to and including 2009. generating _facility. The LTSA provides that GE will The Company also may enter into derivatives to perform all planned inspections on the covered hedge exposure to interest rate changes. The derivatives equipment, whi ch includes the cost of all labor and employed as hedging instruments are structured to materials. GE is also obligated to cover the costs of 11-238

NOTES (continued) Gulf Power Company 2006 Annual Report unplanned maintenance on the covered equipment subject Additional commitments for fuel will be required to to a limit specified in the contract. supply the Company's future needs. In general, the LTSA is in effect through two major SCS may enter into various types of wholesale inspection cycles of the unit. Scheduled payments to GE energy and natural gas contracts acting as an agent for the are made at various intervals based on actual operating Company and all of the other Southern Company hours of the unit. Total remaining payments to GE under traditional operating companies and Southern Power. this agreement for facilities owned are currently estimated Under these agreements, each of the traditional operating at $74.9 million over the remaining life of the agreement, companies and Southern Power may be jointly and which is currently estimated to be up to.9 years. severally liable, The creditworthiness of Southern Power However, the LTSA contains various cancellation is currently inferior to the creditworthiness of the provisions at the option of the Company. traditional operating companies. Accordingly, Southern Company has entered into keep-well agreements with the Payments made to GE prior to the performance of Company and each of the other traditional operating any planned inspections are recorded as prepayments. companies to ensure the Company will not subsidize or These amounts are included in Current Assets and be responsible for any costs, losses, liabilities, or damages Deferred Charges and Other Assets in the balance sheets. resulting from the inclusion of Southern Power as a Inspection costs are capitalized or charged to expense contracting party untder these agreements. based on the nature of the work performed. Purchased Power and Fuel Commitments Operating Leases The Company has entered into long-term commitments The Company has operating lease agreements with for the purchase of electricity. various terms and expiration dates. Total operating lease expenses were $4.9 million, $3.0 million, and $2.0 million, To supply a portion of the fuel requirements of the for 2006, 2005, and 2004, respectively. Included in these generating plants, the Company has entered into various lease expenses are railcar lease costs which are charged to long-term commitments for the procurement of fossil fuel. fuel inventory and are allocated to fuel expense as the In most cases, these contracts contain provisions for price fuel is used. These expenses are then recovered through escalations, minimum purchase levels, and other financial the Company's fuel cost recovery clause. The Company's commitments. Coal commitments include forward share of the lease costs charged to fuel inventories was contract purchases for sulfur dioxide emission allowances. $4.6 million in 2006, $3.0 million in 2005, and Natural gas purchase commitments cofitain fixed volumes $1.9 million in 2004. The Company includes any step with prices based on various indices at' tie' time of rents, escalations, and lease concessions in its delivery. Amounts included in the chart below represent computation-of minimum lease payments, which are estimates based on New York Mercantile Exchange future recognized on a straight-line basis over the minimum prices at December 31, 2006. lease term. Total estimated minimum long-term obligations at At December 31, 2006, estimated minimum rental December 31, 2006 were as follows: commitments for noncancelable operating leases were as follows: Purchased Natural Year Power* Gas Coal Rail (in thousands) Year Cars Other Total 2007 $ - $117,726 $281,401 (in thousands) 2008 - 90,371 240,222 2007 $ 4,043 $337 $ 4,380 2009 23,832 65,975 69,998 2008 3,072 339 3,411 2010 26,811 43,194 70,764 2009 2,039 185 2,224 2011 26,861 20,081; 2010 2,006 59 2,065 2012 and thereafter 57,915 189,106 2011 596 - 596 2012 and thereafter 3,574 - 3,574 Total commitments $135,419 $526,453 $662,385

Included above is $76 million in obligations with affiliated companies. Total minimum payments $15,330 ý $920 $16,250 11-239

NOTES (continued) Gulf Power Company 2006 Annual Report The Company and Mississippi Power jointly entered The.Company's activity in the stock option plan for into operating lease agreements for aluminum railcars for 2006 is summarized below: . the transportation of coal to Plant Daniel. The Company Weighted-has the option to purchase the railcars at the greater of Shares Average lease termination value or fair market value or to renew Subject Exercise the leases at the end of each lease term. The Company to Option Price and Mississippi Power also have separate lease agreements for other railcars that do not include purchase Outstanding at Dec. 31, 2005 1,099,549 $27.07 options. Granted, 242,373 33.81, Exercised (142,941) 24.20 In addition to railcar leases, the Company has other (460) .32.66 Cancelled, operating leases for fuel handling equipment at Plant Outstanding at Dec. 31, 2006 .1;198,521 -$28.77 Daniel. The Company's share of these leases was charged to fuel handling expense in the amount of $0.3 million in Exercisable at Dec. 31, 2006 735,425 $26.27 2006. The Company's annual lease payments for 2007 to 2010 will average approximately $0.2 million. The number of stock options vested, and expected to vest in the future, as of December 31, 2006 is not

8. STOCK OPTION PLAN significantly different from the number of stock options outstanding, at December 31, 2006 as stated above.

Southern Company provides non-qualified stock options to a large segment of the Company's employees ranging As of December 31, 2006, the weighted average from line management to executives. As of December 31, remaining contractual term for options outstanding and 2006, there were 283 current and former employees of the options exercisable is 6.6 years and 5.5 years, Company participating in the stock option plan. The respectively, and the aggregate intrinsic value for the maximum number of shares of Southern Company options outstanding and options exercisable is $9.7 million common stock that may be issued under these programs and $7.8 million, respectively. may not exceed 57 million. The prices of options granted As of December 31, 2006, there was $0.5 million of to date have been at the fair market value of the shares on total unrecognized compensation cost related to stock the dates of grant. Options granted to date become option awards not yet vested. That cost is expected to be exercisable pro rata over a maximum period of three recognized over a weighted average period of years from the date of grant. The Company generally approximately 11 months. recognizes stock option expense on a straight-line basis over the vesting period which equates to the requisite The total intrinsic value of options exercised during service period; however, for employees who are eligible the years ended December 31, 2006, 2005, and 2004 was for retirement the total cost is expensed at the grant date. $1.6 million, $4.4 million, and $4.6 million, respectively. Options outstanding will expire no later than 10 years The actual tax benefit realized by the Company for after the date of grant, unless terminated earlier by the the tax deductions from stock option exercises totaled Southern Company Board of Directors in accordance with $0.6 million, $1.7 million, and $1.8 million, respectively, the stock option plan. For certain stock option awards a for the years ended December 31, 2006, 2005, and 2004. change in control will provide accelerated vesting. As part of the adoption of SFAS No. 123(R), as discussed in Note 1 under "Stock Options," Southern Company has not modified its stock option plan or outstanding stock options, nor has it changed the underlying valuation assumptions used in valuing the stock options, that were used under SFAS No. 123. 11-240

NOTES (continued) Gulf Power Company 2006 Annual Report

9. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Summarized quarterly financial data for 2006 and 2005 are as follows: Net Income After Dividends Operating Operating on Preferred and Quarter Ended Revenues Income Preference Stock (in thousands) March 2006 $263,042 $31,079 $12,402 June 2006 292,722 47,062 22,038 September 2006 373,030 66,511 34,577 December 2006 275,120 22,020 6,972 March 2005 $224,597 $31,229 $14,646 June 2005 251,297 44,153 21,458 September 2005 344,080 68,571 37,197 December 2005 263,648 14,324 1,908 The Company's business is influenced by seasonal weather conditions. 1 11-241

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SELECTED FINANCIAL AND OPERATING DATA 2002-2006 Gulf Power Company 2006 Annual Report 2006 2005 2004 2003 2002 Operating Revenues (in thousands) $1,203,914 $1,083,622 $ 960,131 $ 877,697 $ 820,467 Net Income after Dividends on Preferred and Preference Stock (in thousands) $ 75,989 $ 75,209 $ 68,223 $ 69,010 $ 67,036 Cash Dividends on Common Stock (in thousands) $ 70,300 $ 68,400 $ 70,000 $ 70,200 $ 65,500 Return on Average Common Equity (percent) 12.29 12.59 11.83 12.42 12.72 Total Assets (inthousands) $2,340,489 $2,175,797 $2,111,877 $1,839,053 $1,816,889 Gross Property Additions (in thousands) $ 147,086 $ 142,583 $ 161,205 $ 99,284 $ 106,624 Capitalization (in thousands): Common stock equity $ 634,023 $ 602,344 $ 592,172 $ 561,358 $ 549,505 Preferred and preference stock 53,887 53,891 4,098 4,236 4,236 Mandatorily redeemable preferred securities - - - 70,000 115,000 Long-term debt payable to affiliated trusts 41,238 72,166 72,166 - - Long-term debt 654,860 544,388 550,989 515,827 452,040 Total (excluding amounts due within one year) $1,384,008 $1,272,789 $1,219,425 $1,151,421 $1,120,781 Capitalization Ratios (percent): Common stock equity 45.8 47.3 48.6 48.8 49.0 Preferred and preference stock 3.9 4.2 0.3 0.4 0.4 Mandatorily redeemable preferred securities - - - 6.1 10.3 Long-term debt payable to affiliated trusts 3.0 5.7 5.9 - - Long-term debt 47.3 42.8 45.2 44.7 40.3 Total (excluding amounts due within one year) 100.0 100.0 100.0 100.0 100.0 Security Ratings: First Mortgage Bonds - Moody's - Al Al Al Al Standard and Poor's -A+ A+ A+ A+ Fitch A+ A+ A+ A+ Preferred Stock/ Preference Stock - Moody's Baal Baal Baal Baal Baal Standard and Poor's BBB+ BBB+ BBB+ BBB+ BBB+ Fitch A- A- A- A- A-Unsecured Long-Term Debt - Moody's . A2 A2 A2 A2 A2 Standard and Poor's A A A A A Fitch A A A A A Customers (year-end): Residential 364,647 354,466 343,151 341,935 333,757 Commercial 53,466 53,398 51,865 51,169 49,411 Industrial 295 298 285 285 281 Other 484 479 473 473 474 Total 418,892 408,641 395,774 393,862 383,923 Employees (year-end) 1,321 1,335 1,336 1,337 1,339 11-242

SELECTED FINANCIAL AND OPERATING DATA 2002-2006 (continued) Gulf Power Company 2006 Annual Report 2006 2005 2004 2003 2002 Operating Revenues (in thousands): Residential $ 510,995 $ 465,346 $ 401,382 $ 381,464 $ 365,693 Commercial 305,049 273,114 232,928 218,928 207,960 Industrial 132,339 123,044 99,420 95,702 89,385 Other 3,655 3,355 3,140 3,080 2,798 Total retail 952,038 864,859 736,870 699,174 665,836 Sales for resale - non-affiliates 87,142 84,346 73,537 76,767 77,171 Sales for resale - affiliates 118,097 91,352 110,264 63,268 40,391 Total revenues from sales of electricity 1,157,277 1,040,557 920,671 839,209 783,398 Other revenues 46,637 43,065 39,460 38,488 37,069 Total $ 1,203,914 $ 1,083,622 $ 960,131 $ 877,697 $ 820,467 Kilowatt-Hour Sales (in thousands): Residential 5,425,491 5,319,630 5,215,332 5,101,099 5,143,802 Commercial 3,843,064 3,735,776 3,695,471 3,614,255 3,552,931 Industrial 2,136,439 2,160,760 2,113,027 2,146,956 2,053,668 Other 23,886 22,730 22,579 22,479 21,496 Total retail 11,428,880 11,238,896 11,046,409 10,884,789 10,771,897 Sales for resale - non-affiliates 2,079,165 2,295,850 2,256,942 2,504,211 2,156,741 Sales for resale - affiliates 2,937,735 1,976,368 3,124,788 2,438,874 1,720,240 Total 16,445,780 15,511,114 16,428,139 15,827,874 14,648,878 Average Revenue Per Kilowatt-Hour (cents): Residential 9.42 8.75 7.70 7.48 7.11 Commercial 7.94 7.31 6.30 6.06 5.85 Industrial 6.19 5.69 4.71 4.46 4.35 Total retail 8.33 7.70 6.67 6.42 6.18 Sales for resale 4.09 4.411 3.42 2.83 3.03 Total sales 7.04 6.71 5.60 5.30 5.35 Residential Average Annual Kilowatt-Hour Use Per Customer 15,032 15,181 15,096 15,064 15,510 Residential Average Annual Revenue Per Customer $ 1,416 $ 1,328 $ 1,162 $1,126 $1,100 Plant Nameplate Capacity Ratings (year-end) (megawatts) 2,659 2,712 2,712 2,786 2,809 Maximum Peak-Hour Demand (megawatts): Winter 2,195 2,124 2,061 2,494 2,182 Summer 2,479 2,433 2,421 2,269 2,454 Annual Load Factor (percent) 57.9 57.7 57.1 54.6 55.3 Plant Availability Fossil-Steam (percent) 91.3 89.7 92.4 90.7 90.6 Source of Energy Supply (percent): Coal 82.5 79.7 77.9 78.7 69.8 Gas 12.4 13.1 14.4 11.9 15.5 Purchased power - From non-affiliates 1.9 2.8 4.5 3.2 4.6 From affiliates 3.2 4.4 3.2 6.2 10.1 Total 100.0 100.0 100.0 100.0 100.0 11-243

(This page intentionally left blank) MISSISSIPPI POWER COMPANY FINANCIAL SECTION II-244

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM: Mississippi Power Company We have audited the accompanying balance gheets and the amounts and disclosures in the financial statements, " statements of capitalization of Mississippi Power assessing the accounting principles used and significant, Company (the "Company") (a wholly owned subsidiary of estimates made by management, as well as evaluating the Southern Company) as of December 31,. 2006 and 2005, overall financial statement presentation. We believe that and the related statements of income, comprehensive our audits' provide a reasonable basis for our opinion. income, common stockholder's equity, and cash flows for each of the, three years in the period ended December 31, In our opinion; such financial statements (pages 2006. These financial; statements are the responsibility of 11-266 to 11-292) present fairly, in all material respects, the Company's management. Our responsibility is to the financial position of Mississippi Power Company at express an opinion on these financial statements based on December.3 1,, 2006 and 2005,, and the results of its our audits. operations and its cash flows for each of the three years We conducted our audits in accordance with the in the-period ended December 31, 2006, in conformity standards of-the Public .Company Accounting Oversight with accounting principles generally accepted in the Board (United States). Those standards require that we United States of America. plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material As discussed in Note 2 to the financial statements, in misstatement. The Company is not:r~quired to have, nor. 2006 Mississippi Power Company changed its method of-were we engaged to perform, an audit of its internal accounting for the funded status of the defined benefit control ,over financial reporting. Our audits included pension and other postretirement plans. consideration of internal control ,over financial reporting as a basis for designing audit .procedures that are appropriate in the, circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over fimancial reporting.. Accordingly, we express no such opinion. An audit also Atlanta, Georgia includes examining, on a test basis, evidence supporting Febýiaiy 26,"2007

1. ,It § ;

f" . I ý,

                                           . I 11-245

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Mississippi Power Company 2006 Annual Report OVERVIEW Performance Evaluation Plan" for more information on PEP. Business Activities Mississippi Power Company (Company) operates as a Key Performance Indicators vertically integrated utility providing electricity to retail customers within its traditional service area located within In striving to maximize shareholder value while providing the State of Mississippi and to wholesale customers in the cost effective energy to customers, the Company Southeast. continues-to focus on several key indicators. These . indicators are used to measure'the Company's Many factors affect the opportunities, challenges,' and performance for customers and employees. risks of the Company's business of selling electricity:. ' These factors include the ability to maintain a stable - Recognizing the critical role in the Company's regulatory environment, to achieve energy sales growth;, success played by the Company employees, employee-and to effectively manage anidsecure timely recovery of related measures are a'§ignificant management focus.- rising costs. These costs include thOse: related to growing These measures include diversity and safety. The 2006' demand, increasingly stringent environmental standards, safety'performance of thd Company was the best in the-ftiel prices, and storm restoration following Hurricane history of the Company with an Occupational Safety and' Katrina. Health Administration Incidence Rate of 0.39. This achievement resulted in the Company being recognized Appropriately balancing environmental expenditures with reasonable retail rates will continue to challenge the for the best' safety performance among all utilities in the Southeastern Electric Exchange.' Inclusion initiatives Company for the foreseeable future. Hurricane Katrina hit resulted in a performance above target for the year. In the Gulf Coast of Mississippi in August 2005, causing recognition that the Company's l6ng-term financial substantial damage to the Company's service territory as success is dependent upon how well it satisfies its the worst natural disaster in the Company's history. All of customers' needs' the Company'sretail base rate the Company's 195,000 customers were without service immediately after the storm. Through a coordinated effort mechanmsni, PEP, includes performance indicators that with Southern Company, as well as non-affiliates, the directly,'tie customer service indicators to the Company's allowed return. PEP measures the Company's Company restored power to all who could receive it within 12 days. However, over 12,000 customers performance on a 10-point scale as a weighted average of remained unable to receive service as of December 31, results in three areas: average customer price, as 2006. In October 2006, the Company received from the compared to prices of other regional utilities (weighted at 40 percent); service reliability, measured in outage Mississippi Development Authority (MDA) a Community Development Block Grant (CDBG) in the amount of minutes per customer (40 percent); and customer satisfaction, measured in surveys of residential customers $276.4 million for costs related to Hurricane Katrina, of (20 percent). See Note 3 to the financial statements under which $267.6 million was for the retail portion of the "Retail Regulatory Matters - Performance Evaluation Hurricane Katrina restoration costs. Plan" for more information on PEP. The Company's retail base rates are set under Performance Evaluation Plan (PEP), a rate plan approved In addition to the PEP performance indicators, the by the Mississippi Public Service Commission (PSC). Company focuses on other performance measures, PEP was designed with the objective to reduce the impact including broader measures of customer satisfaction, plant of rate changes on the customer and provide incentives availability, system reliability, and net income. The for the Company to keep customer prices low and Company's financial success is directly tied to the customer satisfaction and reliability high. In December satisfaction of its customers. Management uses customer 2005, the Company made its annual PEP filing for the satisfaction surveys to evaluate the Company's results. projected 2006 test period and requested an annual five Peak season equivalent forced outage rate (Peak Season percent, or $32 million, increase in retail base revenues. EFOR) is an indicator of plant availability and efficient The retail base rate case became effective April 2006. generation fleet operations during the months when generation needs are greatest. The rate is calculated by In December 2006, the Company made its annual dividing the number of hours of forced outages by total PEP filing for the projected 2007 test period in which no generation hours. Net income is the primary component rate change was requested. See Note 3 to the financial of the Company's contribution to Southern Company's statements under "Retail Regulatory Matters - earnings per share goal. 11-246

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report The Company's 2006 results compared with its compared to 2004 resulting from the loss on redemption targets for some of these key indicators are reflected in of preferred stock recognized in the third quarter 2004. the following chart. The net income after dividends on preferred stock of

                                                                 $76.8 million in 2004 increased when compared to Key                   2006                  2006 Performance              Target                 Actual       $73.5 million in 2003 due to retail sales growth and Indicator          Performance           Performance       higher non-territorial energy sales.

Customer Top quartile in RESULTS OF OPERATIONS Satisfaction customer surveys- Top quartile A condensed statement of income is as follows: Plant Availability- Increase (Decrease)' Peak Season Amount From Prior Year EFOR - 3.0% or less .,2.26% 2006 2006 2005 2004 Net Income $77.6 million $82.0 million (in thousands) Operati-*g revenues $1,009,237 $ 39,504 $ 59,407 $ 40,402 See RESULTS OF OPERATIONS herein for Fuel 438,622 80,050 33,690 95,189 additional information on the Company's financial Purchased power 73,247 (70,245) 36,729 " 13,566 perfoirmance. The financial performance achieved in 2006 . Other-operations reflects the continued emphasis that management places and maintenance 236,692 (2,930) 2,144 (62,198) on all'of these indicators, as well as the commitnment Depreciation and '* . shown by employees in achieving or exceeding amortization 46,853 13,304 (5,841) (16,310) management's expectations. Taxes other than income taxes 60,904- 846 14,486 1,581 Earnings Total operating ex inses - . .. 856,318 21,025 71,208. 731,828 The Company's net income after dividends on preferred Operating income 152,919 18,479 (11,801) f "8,574 stock was $82.0 million in 2006 compared to Total other income --

$73.8 -million in 2005. The increase in .2006 is primarily          and (expense)                 (21,079) (8,554) 2,417, t. 1,898 the result of a $25.9 million increase in retail base rates      Less-Income taxes.                   48,097     1,723     (4,292)      5,351 which became effective April :l, 2006, a $4.7 million increase in wholesale base revenues, and a $2.9 million           Net income                -,      83,743     8,202     (5,092)      5,121 decrease in non-fuel related expenses, partially offset by a      Dividends on:.-
$13.3 million increase in depreciatioh and amortization              preferred stock.                 1,733             J2,099)

(- 1,819 expenses due to the amortization of a regulatory liability- Net income'after , . - related to Plant Daniel capacity and a depreciation rate dividends on , increase effective January 1, 2006, an $8.6 million preferred stock $ 82,010 $ .8,202 $ (2,993) $ 3,302 decrease in total other income and expense as a result of - - -,* -'

charitable contributions, and higher interest rates on long-term debt.

Net income after dividends on preferred stock of

 $73.8 million in 2005 decreased when compared to
 $76.8 million in 2004 primarily due to a. $15.7 million decrease in retail base revenue due to the loss of customers as a result of Hurricane Katrina and a        '.'
 $2.5 million increase in non-fuel related :expenses primarily resulting from increased employee benefit expenses, partially. offset by a $5.8 million decrease in depreciation and amortization expenses due.to the i -

amortization of.a regulatory liability related to Plant Daniel capacity, a $3.3 million increase in wholesale base-revenues, a $1.2 million increase in other revenues, and a

 $2.0 million decrease in dividends on preferred stock as H-247

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report Revenues 2003 due to an increase in fuel expenses resulting from consistently higher fuel prices. Details of the Company's operating revenues in 2006 and the prior two years are as follows: Sales for resale to non-affiliates are influenced by the non-affiliate utilities' own customer demand, plant Amount availability, and fuel costs. Total revenues from sales for 2006 2005 2004 resale to non-affiliates decreased $14.6 million, or (in thousands) 5.1 percent, in 2006 as compared to 2005 as a result of a Retail - prior year $ 618,860 $584,313 $516,301 $14.7 million decrease in energy revenues, of which Change in - $10.1 million was associated with decreased sales and Base rates 25,872 - - $4.6 million was associated with lower fuel prices. In Sales growth and 2005, total revenues from sales for resale to non-affiliates weather (137) (15,734) 3,555 increased $17.5 million, or 6.6 percent, compared to Fuel cost recovery 2004. This increase primarily resulted from an increase in and other 2,591 50,281 64,457 price per KWH resulting from higher fuel costs. Total revenues from sales for resale to non-affiliates increased Retail -current year -647,186 618,860 584,313 in 2004 by $15.9 million, or 6.4 percent. This increase Sales for resale - primarily resulted from a $34.1 million increase in energy Non-affiliates 268,850 283,413 265,863 revenues, of 'which approximately $6 million was Affiliates 76,439 50,460 44,371 associated with increased KWH sales and $27.8 million Total sales for resale 345,289 333,873 310,234 was associated with higher fuel prices. The increase in Other'electric energy revenues was offset by an $18.3 million decrease operating, revenues 16,762 17,000 15,779 in capacity revenues due to the termination of a contract with Dynegy, Inc. in 2003. Total electric operating revenues $1,009,237 $969,733 $910,326 Included in sales for resale to non-affiliates are Percent change 4.1% 6.5% 4.6 % revenues from rural electric cooperative associations and municipalities located in southeastern Mississippi. Total retail revenues for 2006 increased 4.6 percent Compared to the prior year, KWH sales to these utilities when compared to 2005 primarily as a result of a retail increased 8.9 percent due to growth in the service base i'ate increase effective April 1, 2006. Higher fuel territory and recovery from Hirricane Katrina in.2006, costs also contributed to ihe increase. Total retail revenues decreased 5.0 percent due to Hurricane Katrina in 2005; for 2005 increased 5.9 percent when compared to 2004 as and:increased 3.3 percent in,2004, with the related a result of higher fuel revenue due to the increase in fuel revenues increasing 7.1 percent, 16.2 percent, and': cost. This increase in retail revenues was partially offset 12.4 percent, respectively. The customer demand by reductions for the loss of customers in all major experienced by these utilities is determined by factors classes as a result of Hui'rcane Kafrina. Total retail very similar to those experienced by the Company. Short-revenues for 2004 increased 13.2 percent when compared term opportunity energy sales are also included in sales to 2003. While higher fuel costs accounted for 92 percent for resale to. non-affiliates. These opportunity sales are of this increase, sales growth, particularly in the industrial made at market-based rates that generally provide'a class, also contributed to the increase. margin above the Company's variable cost to produce the energy. KWH sales to non-territorial customers decreased Electric rates for the Company include provisions to 33.0 percent compared to 2005 primarily due to less off-adjust billings for fluctuations in fuel costs, including the system- siles resulting from increased territorial load. " energy component of purchased powdr costs. Under these provisions, fuel revenues generally equal fuel expenses, Revenue from energy sales to affiliated companies including the fuel component of purchased power, and do within the Southern Company system will vary from year not affect net income. The fuel cost recovery and other to year depending on demand and the availability and cost revenues increased in 2006 when compared to 2005 as a of generating resourceslat each company. These sales are result of higher fuel costs and an increase in made in accordance with- the Intercompany Interchange kilowatt-hours (KWH) generated. In 2005, fuel cost Contract (TIC), as approved by the Federal Energy recovery and other revenues increased as compared to Regulatory Commission (FERC). These energy sales do 2004 due to higher fuel costs. During 2004, fuel cost not have a significant impact on earnings since the energy recovery and other revenues increased as compared to is generally sold at marginal cost. 11-248

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report Energy Sales Details of the Company's generation, fuel, and purchased power are as follows: KWH sales for 2006 and percent change by year were as 2006 2005 2004 follows: KWH Percent Change Total generation 2006 2006 2005 2004 (millions of KWH). 14,224 12,499 .14,058 (in millions) Total purchased power (millions of KWH) 1,718 2,637 3,254 Residential 2,118 (2.8)% (5.1)% 1.9% Commercial 2,676 (1.8) (8.2) 1.9 Sources.of generation 9.1 (10.3) 3.0 (percent) "7 Industrial 4,143 37 (2.5) (5.8) 1.0 Coal. 71 70 69 Other Gas 29 30 31. Total retail 8,974 2.7 (8.4) 2.4 Cost of fuel, generated Sales for resale (cents per net KWH) 7 Non-affiliated 4,624 (3.9) (20.2) 2.6 87.4 2.52 2.24 1.72 (14.9) 48.6 Coal . Affiliated 1,680 Gas . 6.04 5.94 4.59 Total 15,278 5.7 (13.1) 4.5, Average cost of fuel, generated (cents per net KWH) .. . 3.34 3.11 2.50 Total retail KWH sales increased in 2006 when Average cost of purchased compared to 2005 due to restoration' of cusiomers lost power :. I.. after Hurricane Katrina in 2005. Total retail KWH sales (cents per net KWH) 4.26. 5.44 3.28 decreased in 2005 when compared to 2004 as the result of the loss of customers following Hurricane Katrina. Total Fuel and purchased power expenses were retail KWH sales increased in 2004 when compared to $511.9 millibn in 2006, an increase of $9.8 million, or' 2003 as a result of economic recoveiy in the area which 2.0 percent, above the prior year costs. This increase was affected all customer classes, particularly the industrial primarily due to an increase of $9.7 million in thecost of class. fuel and purchased power. In 2005, fuel and purchased power expenses were $502.1 million, an increase of Expenses $70.4 million, or 16.3 percent, above the prior year costs. This increase was the result of a $127.6 million increase Total operating expenses increased $21.0 million, or in the cost of fuel and purchased power and a 2.5 percent, in 2006 when compared to 2005 as a result

                                                                      $57.2 million decrease related to total KWH generated of increases in fuel and purchased power and depreciation and purchased. Fuel and purchased power expenses in and amortization expenses. In 2005 and 2004, total 2004 were $431.6 million, an increase of $108.8 million, operating expenses increased $71.2 million, or 9.3 percent, and $31.8 million, or 4.3 percent, .respectively, primarily           or 33.7 percent, above the prior year costs. This increase was the result of a $95.4 million, increase in the cost of as the result of increases in fuel and purchased power, fuel and purchased power and a $13.3 million increase administrative and general expenses, and taxes other than income.                                                               related to total. KWH generated and purchased.

Fuel expense increased $80.1 million in 2006 as Fuel and PurchasedPower r . compared to. 2005 as a result of increases in fuel costs Fuel costs constitute the single largest expense for the and an increase in generation. This increase in fuel Company. The mix of fuel sources for generation of expense is due to a $30.0 million increase in the cost of electricity is determined primarily by demand, the unit fuel due to higher coal, gas, transportation, and emission cost of fuel consumed, and the availability of generation. allowance prices and a $50.0 million increase related to more KWH generated. Fuel expense increased

                                                                      $33.7 million in 2005 as compared to 2004. ,

Approximately $71 million in additional fuel expenses resulted from higher coal, gas, transportation prices, and emission allowances, which were partially offset by a

                                                                      $36 million decrease resulting from unit outages that reduced' generation. Fuel expense for 2004 increased
                                                                      $95.2 million as compared to 2003. Approximately
                                                                      $25 million of the increase was associated with increased 11-249

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report generation and approximately $70 million of the increase $5.2 million increase in employee benefit expenses, a was due to higher coal and gas prices. $1.7 million increase in rent expense on the Plant Daniel Purchased power expense decreased $70.2 million, or combined cycle lease, and higher bad debt expense of 49 percent, in 2006 when compared to 2005. The $1.0 million primarily resulting from Hurricane Katrina. In 2004, other operations expense decreased $69.2 million, decrease was primarily due to more generation being or 30 percent, due to approximately $11 million incurred available to meet customer demand and a decrease in the in 2003 to restructure the Plant Daniel combined cycle cost of purchased power. Purchased power expense lease agreement and $60 million in expense recorded in increased $36.7 million, or 34.4 percent, in 2005 when 2003 in connection with 'the recognition of a regulatory compared to 2004. The increase is primarily the result of liability following an accounting order from the the reduction in generation due to the damage caused by Mississippi PSC related to Plant Daniel capacity expense. Hurricane Katrina. In 2004, purchased power expense See FINANCIAL CONDITION AND LIQUIDITY- "Off-increased $13.6 million, or 14.6 percent, when compared Balance Sheet Financing Arrangements" and Notes 3 and to 2003. The increase was primarily due to an increase in 7 to the financial statements under "Retail Regulatory purchases from non-affiliates to meet increased customer Matters - Performance Evaluation Plan" and "Operating demand at lower prices than self-generation. Energy Leases - Plant Daniel Combined Cycle Generating Units," purchases vary from year to year depending on demand respectively, for additional information. and the availability and cost of the Company's generating resources. These expenses do not have a significant Maintenance expense decreased $4.9 million, or impact on earnings since the energy pirchases are 6.8 percent, in 2006, primarily due to the $3.4 million generally offset by energy revenues through the accrual of certain expenses arising from Hurricane Company's fuel cost recovery clause. - Katrina related to the wholesale portion of the business in While prices have moderated somewhat in 2006, a 2005 and the $2.8 million partial recovery of these significant upward trend in the cost of coal and natural expenses from the CDBG in 2006, partially offset by a, gas has emerged since 2003, and volatility in these $0.5 million increase in 2006 due to the increased. markets is expected to continue. Increased coal prices operation of combined cycle units .as gas c9sts decreased have been influenced by a worldwide increase in demand in 2006 when compared to 2005. Maintenance expense, as a result of rapid economic growth in China, as well as decreased $5.7 million, or 7.5 percent, in 2005 primarily by increases in mining and fuel transportation costs. as a result of a $1.1 million decrease in the operation of. Higher natural gas prices in the United States are the combined cycle units due to higher gas prices in 2005 result of increased demand and slightly lower gas supplies when compared to 2004 and a $4.5 million decrease in despite increased drilling activity. Natural gas production maintenance expense associated with changes in and supply interruptions, such as those caused by the scheduled maintenance as a result of restoritibn efforts.' 2004 and ,2005 hurricanes, result in an immediate market These restortion'exlienses have beiendeferred in' response; however, the long-term impact of this price accordance with a' Mississippi PSC' order. See FUTURE volatility may be reduced. by imports of liquefied natural EARNINGS POTENTIAL - "PSC Matters - Storm gas if new liquefied gas facilities are built., Fuel expenses'. Damage' Cost,Recoveiy" herein and Note 3: to the generally do not affect net income, since they: are offset financial statements under'"Retail Regulatory Matters-by fuel revenues under the Company's fuel cost recovery Storm Damage Cost Recovery" for additional information. clause. See FUTURE EARNINGS POTENTIAL - "PSC In 2004, maintenance expense increased $7.0 million, or Matters - Fuel Cost Recovery" and Note I to the financial 9.9 percent, over the prior year, primriiily resulting fromn statements under "Fuel Costs" for additional information. higher operation of combined cycle units and, increased distribution line maintenance during 2004 as compared to Othber Operationsand Maintenance 2003.:See Note 7 to the financial statements under "Long-Term Service Agreements" for further information. Total other operations and maintenance, expense decreased $2.9 million from 2005 to 2006. Other operations expense Depreciationand Amortization increased $1.9 million, or 1.1 percent :in 2006 compared to 2005 primarily as a result of a $1.8 million increase in Depreciation and amortization expenses increased distribution operations expense and a $1.5 million $13.3 million in 2006 compared to 2005 due to increase in employee benefit expenses, partially offset by amortization related to a regulatory liability recorded in a $1.0 million decrease in bad debt expense. In 2005, 2003 in connection with the Mississippi PSC's accounting other operations expense increased $7.9 million, or order on Plant Daniel capacity and the impact of a new 4.9 percent, compared to 2004 primarily as a result a depreciation study effective January 1, 2006. Depreciation 11-250

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report and amortization expenses decreased $5.8 million. in 2005 inflation rate has been relatively low in recent years and and $16.3 million in 2004 as compared to the prior years any; adverse effect of inflation on the Company has not primarily as a result of amortization related to a been significant. regulatory liability recorded in 2003 in connection with, the Mississippi PSC's accounting order on the Plant FUTURE EARNINGS POTENTIAL Daniel capacity. See Note 3 under "Retail Regulatory General , Matters - Performance Evaluation Plan" for additional information. The Company operates as a vertically integrated utility providing electricity to retail customers within its Taxes Other Than Income Taxes traditional service area located in southeast Mississippi. Taxes other than income taxes increased 1.4 percent in and wholesale customers in the southeastern United 2006 compared to 2005 primarily as a result of a States. Prices for electricity relating to purchased power $0.5 million increase in ad valorem taxes and a agreements,,interconnecting transmission lines and the $0.3 million increase in municipal franchise taxes. The exchange.of electric power are regulated by the FERC. retail portion, or approximately 83 percent, of the increase Prices forelectricity provided by the Company to retail in ad valorem taxes is recoverable under the Company's customers are.set by the Mississippi PSC under cost-, ad valorem tax cost recovery clause and, therefore, does based regulatory principles. Retail rates and earnings are not affect net income. The increase in municipal franchise reviewed and pay be adjusted periodically within cerTain limitations., See ACCOUNTING POLICIES - taxes is directly related to the increase in total retail revenues. In 2005, taxes other, than income taxes : "Application of Critical Accounting Policies and Estimates - Electric Utility Regulation", herein and Note 3 increased 8.1 percent over the prior year primarily due to "FERC Matters" and. to the financial statements under a $2.9 million increase in ad valorem taxes-and a

$1.1 million increase. in municipal franchise taxes. Taxes         "Retail Regulatory, Matters" for additional information other than income taxes increased 2.9 percent in 2004 as           about regulatory matters.

compared to 2003 primarily due to additional municipal The results of operations for the past three Iyears are franchise taxes. not necessarily indicative of future earnings potential. The level of the Company's future earnings depends on Total Other Income and (Expense) numerous factors that affect the opportunities, challenges The $8.6 million decrease in total other income and and risks of.the Company's business of selling electricity. expense in 2006 compared to 2005fis primarily'due to These factors include the ability of the Company to charitable contributions and higher interest rates on long- maintain a stable regulatory environment that continuesjto term debt. The increases in total other income and allow for the recovery of all prudently incurred costs . expense in 2005 compared to 204"are' due to a reversal, during a time of increasing costs. Future earnings in. the, as a result of changes in the legal and rigulatory near term will depend, in part, upon growth in energy, environment, of a $2.5 million liability originally sales, which is subject to a number of factors. These recorded for the potential assessment of interest" factors include weather, competition, new energy contracts.. associated with a customer advance. This amount was with neighboring utilities, energy conservation practiced by. partially offset by expenses related to recovery. from customers, the price of electricity, the price elasticity of Hurricane Katrina. In 2004, the increase in total other demand, and the rate of economic growth in the income and expense compared to 2003: was due to Interest Company's service area in the aftermath of Hurricane rates on long-term debt decreasing and lower principal Katrina. amount of debt outstanding. Environmental Matters Effects of Inflation' Complianee costs related to the'Clean Air Act and other The Company is subject to rate regulation that -is based on environmental regulations could affect earnings if such the recovery of costs. PEP is based on annual projected costs cannot be 'ully recovered in rates on a 'timely' basi s.' costs, including estimates for inflation. When historical Environmental comphliance spending' ov'er-thenext several costs are. included, or when inflation exceeds projected: years may exceed amounts estimated. Soome of ihe 'factors costs used in rate regulation, the effects of inflation can driving the 'potential for such an increase are higher create an economic loss since the recovery of costs could commodity costs, market demand for labor, and scope be in dollars that have less purchasing power. In addition, additions-and clarifications. The timing, .specific the income tax laws are based on historical costs. The requirements, and estimated costs could also change as 11-251

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report environmental regulations are modified. See Note 3 to the penalties of $25,000 to $32,500 per day; per violation at' financial statements under "Environmental Matters" for each generating unit, depending on the date of the alleged additional information. violation. An adverse outcome in this matter could require substantial capital expenditures that cannot be determined New Source Review Actions at this time and could possibly require payment of substantial penalties. Such expenditures could affect In November 1999, the Environmental Protection Agency future results of operations, cash flows, and financial (EPA) brought a civil action in the U.S. District Court for condition if such costs are not recovered through the Northern District of Georgia against certain Southern regulated rates. Company subsidiaries, including Alabama Power and Georgia Power, alleging violations of the New Source The EPA has issued a series of proposed and final Review (NSR) provisions of the Cledn' Air Act and revisions to its' NSR regulations under the Clean Air Act, related state laws at certain coal-fired generating facilities. many of which" have been subject to legal challenges by Through subsequent amendments and other legal I'L environmental groups and states. On June 24, 2005, the procedures, the EPA filed a separate action in January U.S. Court of Appeals for the District of Columbia 2001 against Alabama Power in the U.S. District Court Circuit upheld, in part, the EPA's revisions to NSR for the Northern District of Alabama after Alabama regulations that 'vere issued in December 2002 but Power was dismissed from the original action. In these vacated portions of those revisions addressing the-lawsuits, the EPA alleged that NSR violailons occurred at exclusion of certain pollution control projects. The*' eight coal-fired generating facilities operated by Alabama Mississippi Department of Environmental Quality Power and Georgia Power (including a facility formerly (MDEQ) formally adopted the 2002 NSR rules effective owned by' Savannah Electric),; including one co-owned by in July 2005, but did not adopt the provisions vacated by the Company. The civil actions requested penalties and the District of Columbia Circuit. On March 17, '2006, the injunctive relief, including an order requiring the U.S. Court of Appeals for the District of Columbia ' installation of the best available control technology at the Circuit also' vacated an EPA rule which sought to clarify affected units. the scope of the existing Routine Maintenance,- Repair On June 19, 2006, the U.S. District Court for the and Replacement exclusion. In October 2005 and ' Northern Distric( of Alabama entered a consentt decree' September 2006, the EPA also published proposed rules between Alabama Power and the EPA* resolving the clarifying the test for determining When an emissions alleged NSR violations at Plant Miller, The consent decree increase subject to the NSR permitting requirements has required Alabama Power to pay $100,000 to resolve'the occurred. The impact of these proposed rules will depend government's' claim for a civil penalty and to donate on adoption of the final rules by the EPA and the State of $4.9 million of sulfur dioxide emission allowances to a Mississippi's implementation of such rules, as well as the nonprofit charitable organization and formalized specific outcome of any additional legal challenges, and, emissions reductions to be accomplished by Alabama therefore, cannot be determined at this time. Power, consistent Witi; other Clean Air Act programs that" require emissions reductions. On August 14, 2006, the Carbon Dioxide Litigation district'court in Alabama granted Alabama Power's motion In July 2004, attorneys general from eight states, each for summary judgment and entered final'judgment in favor outside of Southern Company's service territory, *and the of Alabama Power on the EPA's claims related to Plants' Barry, Gaston, Gorgas, and Greene County. The plaintiffs corporation counsel' for-New York City filed a complaint in the U.S. District Court for the Southern District of have appealed this decision to the U.S. Court of Appeals New York against Southern Company and four other for the Eleventh Circuit and, on November 14, 2006, the electric power companies. A nearly identical complaint Eleventh Circuit granted plaintiffs' request to stay the was filed by three environmental groups in the same appeal, pending the U.S. Supreme Court's ruling in a court. The complaints allege that the companies' similar NSR case filed by the EPA against Duke Energy. emissions of carbon dioxide, a greenhouse gas, contribute The action against Georgia Power has been to global warming, which the plaintiffs assert is a public administratively closed since the spring of 2001, and none nuisance. Under common law public and private nuisance of the parties has 'sought to reopen the case. theories, the plaintiffs seek a judicial order (1) holding The Company believes that it complied with each defendant jointly and severally liable for creating, applicable laws and the EPA regulations and , contributing to, and/or maintaining global warming and interpretations in effect at the time the work in question (2) requiring each of the defendants to cap its emissions took place., The Clean Air Act authorizes maximum civil of carbon dioxide and then reduce those emissions by a 11-252

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report specified percentage each year for at least a decade." air quality, or other environmental and health concerns Plaintiffs have not, however, requested'that damages be could als6 significantly affect the Company; New awarded in connection with their claims., Southern environmental legislation or regulations; or changes to Company believes these claims are without merit and existing ,statutes or regulations, could affect 'many -areas of notes that the complaint cites no statutory or regulatory the Company's operations; however, the full impact of basis for the claims. In September 2005,"the U.S. District any 'such changes cannot be determined at this time. Court for the Southern District of New' York. granted, Southern Company's and the other defendants' motions to Air Qudlity' dismiss these cases. The plaintiffs filed an appeal to the Compliance with, the Clean Air Act and resulting U.S. Court of Appeals for the Second Circuit in October 2005. The ultimate 'outcome of these'matters cannot be' regulatiohsi ha's been and will contitnue to be a significant determined at this time. focus foir the'Company. Through 2006, the Company had spent'approximiately $77.5 million in reducing sulfur dioxide (SO 2) and nitrogen oxide (NOx) emissions and in' Environmental Statutes and Regulations monitoring emissions pursuant to the Clean Air Act. General In'2005, the EPA revoked the one-hour ozone air The Company's operations are subject to extensive quality standard and published the second 'of two sets of regulation by state and federal environmental agencies final rules for implementation of the new, more stririgent under a variety of statutes and regulations governing eight-houir ozone standard. During 2005, the EPA's fine environmental media, including 'air, water, and land particulate matter nonattainment designations also became resources. Applicable statutes include the Clean Air Act; effective for several areas across the United States. No the Clean Water Act; the Comprehensive Environmental areas .within the Company's service area, however, have Response, Compensation, and Liability Act;, the Resource been designated as nonattainment under either the , Conservation and Recovery Act; the Toxic Substances eight-hour ozone standard or the fine particulate matter Control Act; the Emergency Planning & Community standard. Right-to-'Know Act; and the Endangered Species Act. The EPA issued the final Clean Air Interstate Rule in Compliance with these environmental requirements Mardh 2005. This cap-and-trade rule addresses power involves significant capital and operating Costs, a major plant4SOj and NO,, emissions that were'found to ' ý portion of which is expected to be recovered: through the contribute to nonattainment of the eightihour ozone'and' Company's Environmental Compliance Overview Plan fine'particulate matter, standards' in downwind states. (ECO) Plan. See Note 3 to the financial statements under Twenty-eight 'eastern 'states, including the State of '

"Retail Regulatory Matters - Envirohnmental Compliance                Mississippi,    are subject to the requirements  of the rule.

Overview Plan" for' additional information.' Through 2006, The rule' calls for additional reductions of NO, and/or the Company had invested approximately $144.0 million SO 2 to be achieved in two phases, '2009/2010 and 2015. in capital projects to comply with these requirements, These reductions will be accomplished by the installation with annual totals of $4.8 million, $4.0 'million, and of additional emission controls at the Company's coal-

 $2.9 million for 2006, 2005, and 2004;- respectively. The            fired facilities' or by the purchase of emission allowances Company expects that capital expenditures' to assure                 from a cap-and-trade program.

compliance with existing and new regulations will be an The Clean Air Visibility Rule (formerly called the additional $21.0 million, $91.1 million' and $81.8 million Rego'*nadle Rule) was finalized in July 2005. The goal for 2007, 2008, and 2009, respectively. Because the of this rule is to restore natural visibility conditions in Company's compliance strategy is impacted by changes to certain areas (primarily national parks and wilderness existing environmental laws and regulations, the cost, areas) by 2064. The rule involves (1) the application of availability, and existing inventory of emi'ssion Best Available Retrofit Technology (BART) to certain allowances, and the Company's fuel mix, the ultimate sources built between 1962 and 1977 and (2) the outcome cannot be determined at this time. application of any additional emissions reductions which Environmental costs that are known and estimable at this may be deemed necessary for each'designated area to time are included in capital expenditures discussed under achieve ieasonable progress toward the natural conditions FINANCIAL CONDITION AND LIQUIDITY - "Capital goal by 2018. Thereafter, for each 10-year planning Requirements and Contractual Obligations" herein. period, additional emissions reductions will be required to Compliance with possible additional'federal or state continue to demonstrate reasonable progress in each area legislation' or regulations related to giobal climate change, during fhat period.: For power plants, the Clean Air 11-253

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued), Mississippi Power Company 2006 Annual Report Visibility Rule allows states to determine that the Clean of fish protection technology near some intake structures Air Interstate Rule satisfies BART requirements for S02 at existing power plants. On January 25, 2007, the, and NO,. However, additional BART requirements for U.S. Court of Appeals for the Second Circuit overturned particulate matter could be imposed, and the reasonable and remanded several provisions of the rule to the EPA progress provisions could result in requirements for for revisions. Among other things, the court rejected the additional S02 controls. By December 17, 2007, states EPA's use. of:"cost-benefit" analysis and suggested some must submit implementation plans that contain strategies ways to incorporate cost considerations. The full impact for BART and any other control measures required to of these regulations will depend on subsequent legal. achieve the first phase of reasonable progress. proceedings, further rulemaking by the EPA, theresults of studies and analyses performed as part of the rules' In March 2005, the EPA published the final. Clean implementation, and the actual requirements established Air Mercury Rule, a cap-and-trade program for the by state regulatory agencies and, therefore, cannot now be reduction of mercury emissions from coal-fired power determined. plants. The rule sets caps on mercury emissions to be implemented in two phases, 2010 and 2018, and provides One facility within the Southern Company system is for an emission allowance trading market. The Company retrofitting a closed-loop recirculating cooling tower anticipates that emission controls installed to achieve under the Clean Water Act to cool water prior to compliance with the Clean Air Interstate Rule and the, discharge and similar projects are being considered at eight-hour ozone and fine-particulate air quality standards other facilities. will also result in mercury emission reductions. However, the long-term capability of emission control equipment to Environmental Remediation reduce mercury emissions is still being evaluated, and the The Company must comply with other environmental installation of additional control technologies may be laws and'regulations that cover the handling and disposal, required. ofwaste and release of hazardous substances. Under these The impacts of the eight-hour ozone and the fine variou's'laws and regulations,, the Company could. incur, - particulate matter nonattainment designations, the Clean substantial costs to clean up properties. The Company Air Interstate Rule, the Clean Air Visibility, Rule, and the conducts stiidies to determine the extent of any reqiuired Clean Air Mercury Rule on the Company will depend on cleanup and has recognized in the financial statements the the development and implementation of rules at the state costs to clean. up known sites. Amounts for cleanup and level. States implementing the Clean Air Mercury: Rule ongoing monitoring costs were. not material for any year and the Clean Air Interstate Rule, in particular,. have the presented. The Company may be liable for some or all option not to participate in. the national cap-and-trade required cleanup costs, for additional sites that may programs and could require reductions greater than those require environmental remediation. The Company has mandated by the federal rules. Impacts will also depend received authority from the Mississippi PSC to recover on resolution of pending legal challenges to these rules. approved environmental compliance costs through specific Therefore, the full effects of these regulations on the retail rate clauses. Within limits approved by the:; t Company cannot be determined at this time. The Mississippi PSC, these rates are adjusted annually.; See Company has developed and continually updates a Note 3 to theý financial statements under "Environmental comprehensive environmental compliance strategy to Matters -Environmental Remediation" and "Retail comply with the continuing and new environmental Regulatory Matters - Environmental: Compliance requirements discussed above. As part of this strategy, the Overview Plan" for additional information:. Company plans to install additional'SO%, NO., and-mercury emission controls within'the next several years to Global Climate Issues assure continued compliance with applicable air quality Domestic efforts to limitigreenhouse gas emissions have requirements. been spurred by international negotiations under the Framework Convention on Climate Change and Water Quality specifically the Kyoto Protocol, which proposes a binding In July 2004, the EPA published its final technology- limitation on the emissions of greenhouse gases for based regulations under the CleanWater Act for the industrialized c6untries. The, Bush Administration has not purpose of reducing impingement and entrainment of fish, supported U.S. ratificatcion' of the Kyoto Protocol or other shellfish, and other forms of aquatic life at existing power mandatory carbon dioxide reduction legislation; however, plant cooling water intake structures. The rules require,.. in 2002, it did announce a goal to reduce the greenhouse baseline biological information and, perhaps, installation gas intensity of the U.S. economy, the ratio of greenhouse [1-254

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report gas emissions to the value of U.S..economic output, by on the form in which the final methodology for assessing 18 percent by 2012., Southern Company is participating in generation market power and mitigation rules may be the voluntary electric, utility sector climate change ultimately adopted and cannot be determined at this time. initiative, known as Power Partners, under the Bush Administration's Climate VISION program. The utility In addition, in May 2005, the FERC started an sector pledged to reduce its greenhouse gas emissions rate investigation to determine whether Southern Company by 3 percent to 5 percent by 2010-2012. Southern satisfies the other three parts of the FERC's market-based Company continues to evaluate future energy and rate analysis: transmission market power, barriers to entry, emission profiles relative to the Power Partners program and affiliate abuse or reciprocal dealing. The FERC and is participating in voluntary programs to support the established a new 15-month refund period related to this industry initiative. In addition, Southern Company is, expanded investigation. Any new market-based rate sales involving any Southern Company subsidiary, including the participating in the Bush Administration's Asia Pacific Partnership on Clean Development and Climate, a pubiic/ Company, could be subject to refund to the extent the private partnership to work together to meet goals for FERC orders lower rates as a result of this new energy security, national air. pollution reduction, and investigation. Such sales through October 19, 2006, the climate change in ways that promote sustainable end of the refund period, were approximately

                                                                       $14.5 million for'the Company, of which $7.3 million economic growth and poverty reduction. Legislative proposals that would impose mandatory restrictions on                   relates to sales inside the retail service territory as carbon dioxide emissions continue to be considered in                  discussed -above. The FERC also directed that this Congress. The ultimate outcome cannot be determined at                  expanded proceeding be held in abeyance pending the outcme 'of the ýroceeding on the IIC discussed below.

this time; however, mandatory restrictions on the Company's carbon dioxide emissions could result in On January 3, 2007, the FERC issued an order noting significant additional compliance costs that could affect settlement of the HC proceeding and seeking comment identifying any remaining issues and the proper procedure future results of operations, cash flows, and financial for addressing any such issues. condition if such costs are not recovered through regulated rates. The Company believes that there is no meritorious basis forthese proceedings and is vigorously defending FERC Matters itself in this matter. However, the final outcome of this Market-Based Rate Authority matter, including any remedies to be applied in the event of an adverse ruling in these proceedings, cannot now be The Company has authorization from the FERC to sell determined.: power to non-affiliates, including short-term opportunity sales, at market-based prices. Specific FERC approval must be obtained with respect to a market-based contract Intercompany Interchange Contract with an affiliate. The Company s generation fleet is operated under the IIC, In December 2004, the FERC initiated a proceeding as approved by the FERC. Ii May 2005, the FERC to assess Southern Company's generation dominance initiated a new prdceeding'to examine (1) the provisions within its retail' service territory. The ability to charge of the IIC amojiig Alabama Power, Georgia Power, Gulf market-based rates in other markets is not an issue in that Power, the Company, SavannahlElectric, Southern Power, proceeding. Any new market-based rate sales by the and Souihern Company Services, Inc. (SCS) as agent, Company in Southern Company's retail service territory under the teims of which the power pool of Southern entered into during a 15-month refund-period beginning Company is operated, and, in particular, the propriety of February 27, 2005'could be subject to, refund to the level, the continued inclusion of Southern Power as a party to of the default cost-based rates; pending'the:outcome of. the IIC, (2) whethei any parties to the IIC have violated the proceeding. Such sales.through May 27, 2006, the. end the FERC'ý-standards of conduct applicable to utility of the refund period, were approximately $8.4 millionfor companies that are transmission providers, and (3) whether the Company. In the event that the FERC's default Southern Company's code of conduct defining Southern mitigation -measures for entities that are found to have Power as a "system' company" rather Ithan a "'marketing market power are ultimately applied, the Company may affiliate" is just and reasonable. In connection with the be required to charge cost-based rates for certain formation of Southern Power, the FERC authorized wholesale sales in the Southern Company retail service Southern Power's inclusion in the IIC in 2000. The FERC territory, which may be lower than negotiated market- also previously approved Southern Company's code of conduct, ,, . I based rates. The final outcome of this matter will depend 11-255

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report On October 5, 2006, the FERC issued an order time, there have been a number of additional proceedings accepting a settlement resolving the proceeding subject to at the FERC designed to encourage further voluntary Southern Company's agreement to accept certain formation of RTOs or to mandate their formation. modifications to the settlement's terms. On October 20, However, at the current time, there are no active 2006, Southern Company notified the FERC that it proceedings that would require the Company to accepted the modifications. The modifications largely participate in an RTO. Current FERC efforts that may involve functional separation and information restrictions potentially change the regulatory and/or operational related to marketing activities conducted on behalf of structure of transmission include rules related to the Southern Power. Southern Company filed with the FERC standardization of generation interconnection, as well as on November 6, 2006 an implementation plan to comply an inquiry into, among other things, market power by with the modifications set forth in the order. The impact vertically integrated utilities. See "Market-Based Rate of the modifications is not expected to have a material Authority" and "Generation Interconnection Agreements" impact on the Company's financial statements. above for additional information. The final outcome of these proceedings cannot now be determined. However, Generation InterconnectionAgreements the Company's financial condition, results of operations, In July 2003, the FERC issued its final rule on the and cash flows could be adversely affected by future standardization of generation interconnection agreements changes in the federal regulatory or operational structure and procedures (Order 2003). Order 2003 shifts much of of transmission. the financial burden of new transmission investment from the generator to the transmission provider. The FERC has indicated that Order 2003, which was effective January 20, PSC Matters 2004, is to be applied prospectively to new generating facilities interconnecting to a transmission system. Order Performance Evaluation Plan 2003 was affirmed by the U.S. Court of Appeals for the District of Columbia Circuit on January 12, 2007. The See Note 3 to the financial statements under "Retail cost impact resulting from Order 2003 will vary on a Regulatory Matters - Performance Evaluation Plan" for case-by-case basis for each new generator interconnecting information on the Company's base rates. In May 2004, to the transmission system. the Mississippi PSC approved the Company's request to reclassify 266 megawatts of Plant Daniel Units 3 and 4 On November 22, 2004, generator company capacity to jurisdictional cost of service effective subsidiaries of Tenaska, Inc. (Tenaska), as counterparties January 1, 2004, and authorized the Company to include to three previously executed interconnection agreements the related costs and, revenue credits in jurisdictional rate with subsidiaries of Southern Company, filed complaints base, cost of service, and revenue requirement at the FERC requesting that the FERC modify the calculations for purposes of retail rate recovery. The agreements and that those Southern Company subsidiaries Company is amortizing the regulatory liability established refund a total of $19 million previously paid for pursuant to the Mississippi PSC's order to earnings as interconnection facilities, with interest. Southern follows: $16.5 million in 2004, $25.1 million in 2005, Company has also received requests for similar $13.0 million in 2006, and $5.7 million in 2007, resulting modifications from other entities, though no other in reductions of costs in each of those years. complaints are pending with the FERC. On January 19, 2007, the FERC issued an order granting Tenaska's In December 2006, the Company submitted its requested relief. Although the FERC's order requires the annual PEP filing for 2007, which resulted in no rate modification of Tenaska's interconnection agreements, the change. Pursuant to the PEP rate schedule, an order isnot order reduces the amount of the refund that had been required from the Mississippi PSC for the Company to requested by Tenaska. As a result, Southern Company continue to bill the filed rate in effect. In March 2006, the estimates indicate that no refund is due to Tenaska. Mississippi PSC approved the Company's 2006 PEP Southern Company has requested rehearing of the FERC's filing, which included an annual retail base rate increase order. The final outcome of this matter cannot now be of 5 percent, or $32 million, that was effective in April, determined. 2006. Ordinarily, PEP limits annual rate increases to - - 4 percent; however, the Company. had requested that the Transmission Mississippi PSC approve a temporary change to allow it In December 1999, the FERC issued its final rule on to exceed this cap as a result of the ongoing effects of Regional Transmission Organizations (RTOs). Since that Hurricane Katrina. 11-256

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report System Restoration Rider increase to the billing factor will have no significant effect on the Company's revenues or net income, but will In September 2006, the Company filed with the increase annual cash flow. Mississippi PSC a request to implement a System Restoration Rider (SRR) to increase the Company's cap Storm Damage Cost Recovery on the property damage reserve and to authorize the calculation of an annual property damage accrual based In August 2005, Hurricane Katrina hit the Gulf Coast of on a formula. The purpose of the SRR is to provide for Mississippi and caused significant damage within the recovery of costs associated with property damage Company's service area. The Company maintains a (property insurance and the costs of self insurance) and to reserve for property damage to cover the cost of damage facilitate the Mississippi PSC's review of these costs. The from major storms to its transmission and distribution Company would be required to make annual SRR filings lines and the cost of uninsured damage to its generation to determine the revenue requirement associated with any facilities and other property. A 1999 Mississippi PSC property damage. The Company recorded a regulatory order allowed the Company to accrue $1.5 million to liability in the amount of approximately $2.4 million in $4.6 million to the reserve annually, with a maximum 2006 for the estimated amount due to retail customers reserve totaling $23 million. In October 2006, in that would be passed through SRR, In February 2007, the conjunction with the -Hurricane Katrina-related financing Company received an order from the Mississippi PSC order, the Mississippi PSC ordered the Company to cease approving the SRR. all accruals to the retail property damage reserve until a new reserve cap is established.' However, in the same EnvironmentalCompliance Overview Plan financing order, the Mississippi PSC approved the replenishment of the property damage reserve with In February 2007, the Company filed with the Mississippi $60 million to be funded with a portion of the proceeds PSC its annual Environmental Compliance Overview of bonds to 'be issued by the Mississippi Development (ECO) Plan evaluation for 2007. The Company requested Bank on behalf of the State of Mississippi and reported as an 86 cent per 1,000 KWH increase for retail customers. liabilities by the State of Mississippi. This increase represents approximately $7.5 million in annual revenues for the Company. H1arings with the In June 2006, the Mississippi PSC issued an order Mississippi PSC are expected to be held in April 2007. In based upon a stipulation between the Company and the April 2006 the Mississippi PSC approved the Company's Mississippi Public Utilities Staff. The stipulation and the 2006 ECO Plan, which included a 12-cent per 1,000 associated order certified actual storm restoration costs KWH reduction 'for retail customers. This decrease relating to Hurricane Katrina through April 30, 2006, of represented a reduction of approximately $1.3 million in $267.9 million and affirmed estimated additional costs annual revenues for the Company. The' new rates were through December 31, 2007, of $34.5 million, for total effective in April 2006. See Note 3 to the financial storm restoration costs of $302.4 million, which was net statements under "Retail Regulatory Matters - of expected insurance proceeds of approximately Environmental Compliance Overview Plan" for additional $77 :million, without offset for the property damage information. The outcome of the 2007 filing cannot now reserve of $3;,. million. Of the total amount, be determined. $292.8 milJ'on applies to the Company's retail jurisdictiop. The order directed the Company to file an Fuel Cost Recovery application with the MDA for a CDBG. The Company establishes annually a fuel cost recovery The Company filed the CDBG application with the factor that is approved by the Mississippi PSC. Over the MDA in September 2006. On October 30, 2006, the past two years, the Company has continued to experience Company received from the MDA a CDBG in the amount higher than expected fuel costs for coal and natural gas. of $276.4 million. The Company has appropriately The Company is required to file for an adjustment to the allocated and applied these CDBG proceeds to both retail fuel cost recovery factor annually; such filing occurred in and wholesale storm restoration cost recovery. The retail November 2006. As a result, the Mississippi PSC portion of $267.6 million was applied to the retail approved an increase in the fuel cost recovery factor regulatory asset in the balance sheets. For the remaining effective January 2007 in an amount equal to 4.6 percent wholesale portion of $8.8 million, $3.3 million was of total retail revenues..The Company's operating credited to operations and maintenance expense in the revenues are adjusted for differences in actual recoverable statements of income and $5.5 million was applied to fuel cost and amounts billed in accordance with the accumulated provision for depreciation in the balance currently approved cost recovery rate. Accordingly, this sheets. The CDBG proceeds related to capital of 11-257

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report $152.7 million and $120.3 million related to retail Matters - Storm Damage Cost Recovery:' respectively, for operations and maintenance expense are included in the additional information. statements of cash flows as separate line items. The cash portions of storm costs are included in the statements of cash flows under Hurricane Katrina accounts payable, Other Matters property additions, and cost of removal, net of salvage and totaled approximately $50.5 million, $54.2 million, In June 2006, the Company filed an application with the and $4.6 million, respectively, for 2006 and totaled U.S. Department of Energy (DOE) for certain tax credits approximately $82.1 million, $81.7 million, and available to projects using clean coal technologies under $18.4 million, respectively, for 2005. the Energy Policy Act of 2005. The proposed project is an advanced coal gasification facility located in Kemper The balance in the retail regulatory asset account at County, Mississippi that would use locally mined lignite December 31, 2006, was $4.7 million, which is net of the coal. The proposed 693 megawatt plant, excluding the retail portion of insurance proceeds of $80.9 million, mine cost, is expected to require an approximate CDBG proceeds of $267.6 million, and tax credits of investment of $1.5 billion and is expected to be $0.3 million. Retail costs incurred through December 31, completed in 2013. The DOE subsequently certified the 2006 include approximately $148.1 million of capital and project and in November 2006, the Internal Revenue $124.5 million of operations and maintenance Service (IRS) allocated Internal Revenue Code of 1986, expenditures. Of the $302.4 million total storm costs as amended (Internal Revenue Code), Section 48A tax affirmed by the Mississippi PSC, the Company has credits to the Company of $133 million. The utilization of incurred total storm costs of $280.5 million as of these credits is dependent upon meeting the certification December 31, 2006. requirements for the project under the Internal Revenue Code. The plant would use an air-blown integrated The Company filed an application for a financing gasification combined cycle technology that generates order with the Mississippi PSC on July 3, 2006 for power from low-rank coals and coals with high moisture system restoration costs under the state bond program. On or high ash content. These coals, which include lignite, October 27, 2006, the Mississippi PSC issued a financing make up half the proven U.S. and worldwide coal order that authorizes the issuance of $121.2 million of reserves. The Company is still undergoing a feasibility system restoration bonds. This amount includes assessment of the project which could take up to two $25.2 million for the retail storm recovery costs not years. On December 21, 2006, the Mississippi PSC covered by the CDBG, $60 million for a property damage approved the Company's request for'accounting treatment reserve, and $36 million for the retail portion of the of the costs associated with the Company's generation construction of the storm operations facility. The bonds resource planning, evaluation, and screening activities. will be issued by the Mississippi Development Bank on The Mississippi PSC gave the Company the authority to behalf of the State of Mississippi and Will be reported as create and recognize a regulatory asset for such costs. The liabilities by thei State of Mississippi. Periodic true-up Company estimates that in order to reach the next major mechanisms will be structured to comply with terms and milestone in the evaluation process, it may spend up to requirements of the legislation. Details regarding the $12 million by the third quarter of 2007. These costs will issuance of the bonds have not been finalized. The final be charged to and remain as a regulatory asset until the outcome of this matter cannot now be determined. Mississippi PSC determines the prudence and ultimate The Mississippi PSC order also granted continuing recovery of such costs either in conjunction with a authority to record a regulatory asset in an amount equal certificate proceeding filed by the Company for approval to the retail portion of the recorded Hurricane Katrina of its next generating asset or by June 30, 2008, which restoration costs. For any future event causing damage to ever occurs first. The balance of,such regulatory asset will property beyond the balance in the reserve, the order also be included in the Company's rate base for ratemaking granted the Company the authority to record a regulatory purposes. Approval by various regulatory agencies, ' asset. The Company would then apply to the Mississippi including the Mississippi PSC, will also be required if the PSC for recovery of such amounts or for authority to project proceeds. The final outcome of this matter cannot otherwise' dispose of the regulatory asset. The Company now be determined. continues to report actual storm expenses to the The Company is involved in various other matters Mississippi PSC periodically. being litigated and regulatory, matters that could affect See Notes I and 3 to the financial statements under future earnings, See Note 3 to the financial statements for "Provision for Property Damage" and "Retail Regulatory information regarding material issues. 11-258

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)' Mississippi Power Company 2006 Annual Report ACCOUNTINGPOLICIES impact the amounts of such iegulatory assets and liabilities-.and could adversely impact. the Company's Application of Critical Accounting Policies and, financial statements. . Estimates , The Comj~any prepares its financial statements in Contingent Obligations accordance with accounting principles generally accepted The Company issubject to a number of iederal and state in the United States. Significant accounting'policies are laws and regulations, as well as other factorIs and described in Note 1 to the financial statemgnts'. In the conditiong that potentially subject it to environmental, application of these policies, certain estimates are'miade litigation, income tax, and other risks. See FUTURE that may have a material impact on the Company's results EARNINGS POTENTIAL herein and Note'3 to the of operations and related disclosures. Different estimates financial statements for more information regarding could produce assumptions and measurements certain of these contingencies.'The Company periodically that are significantly different from those recorded in'the evaluates :its exposure to 'such risks and records reserves financial statements. Senior management has reviewed, for those matters where aloss is considered probable and and discussed critical accounting policies and estimates reasonably, estimable in'accordance with generally ., described below with the Audit Committee of Southern accepted accounting principles. The adequacy of reserves Company's Board of Directors.. .' , .. . can be significantly affected by external events or conditions'ihat':can be unpredictable; thus, the ultimate Elektric Utility Regulation outcome of.such matters could materially affect the Company's financial statements. These events or The Company-is Aubject to retail regulation by, the conditions include the'following: Mississippi PSC and wholesale regulation bythe :FERC. These regulatory agencies set the.rates the Company is Changes in existing state or federal regulation by permitted to charge customers based on allowable costs. governmental authorities having jurisdiction over air As a result, the Company applies Financi, AccountinglA quality, water quality, control .of toxic substances,I-Standards Board (FASB) Statement No. 71, "Accounting hazardous and solid wastes, and other environmental for the Effects, of Certain Types, of Regulation" matters. (SFAS No. 71), which requires the financial statements to

Changes in existing income tax regulations 'or changes reflect the effects of rate regulation, Thrugh the in'IRS or state revenue department interpretations'of ratemaking process, the regulators may require the existing regulations.

inclusion of costs or revenues in periods different than when they would be recognized by a. n66regdlatedý

Idehitification of additional 'ites that require company. This treatment may result in the deferrdl of' environmental remediation or the filing of other expenses and the recording of related regulatory assets complaints in which the Company may.be asserted to based on anticipated futures recoyery through 'rates or the be a potentially responsible party.

deferral of gains or creation of liabilities anhd the' " Identification and evaluation of other potential lawsuits recording of related regulatory Hiab6lities. The applhcation obrrebrnplaints in which the Company may be named of SFAS No. 71 has a further effect on the.Company's " as a aefendant.- ' financial statements as a result of the estimates of allowable costs use'd in theyatemaking process. These

Resolution or progression of existing matters through estimates may differ from those6 actually incurred by the the legislative process, the court systems, the IRS, or Company; therefore,' the a'countmgn etimates inherent in the -P4. ,

specific costs such as depreciotinoi nid-pension-and postretirement'benefits have 'leýsof a Pirect inmp'acton'the UnbilledRevenues . Company's results of operations than they would on a Revenues related to the sale of electricity are recorded non-regulated company. when electricity is dehivered to customers. However," the As reflected in Note I to the financial istatements,' determination of KWH sales to individual customers is significant regulatory assets and' liabilitieg have been - !"; based on the reading of their meters,'which is! performed' recorded: Management reviews th6 ultimate 'recoverability on a systematic basis throughout the month. At the .end of of these regulatory assets and liabilities based on ,;I'.: each month, amounts of electricity delivered to customers, applicable regulatory guidelines and accouhting principles but not ytmetered and billed, are estimated. Components generally accepted in the United States, However, 'adverse' of the :unbilled-revenue estimates include total KWH'. legislative, judicial, or regulatory actions could materially territorial supply, total KWH billed, estimated total 11-259

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report electricity lost in delivery, and customer usage. These compensation cost relating to share-based payment - components can fluctuate as a result of a number of transactions be recognized in financial statements. That factors including weather, generation patterns, power cost is measured based on the grant date fair value of the delivery volume, and other operational constraints. These equity or liability instruments issued. Although the factors can be unpredictable and can vary from historical compensation expense required under the revised trends. As a result, the overall estimate of unbilled statement differs slightly, the-impacts on thp Company's revenues could be significantly iffected, which could have financial statements are similar to the pro forma a material impact on the Company's results of operations. disclosures included in Note 1 to the financial statements under "Stock Options." Plant Daniel OperatingLease As discussed in Note 7 to the financial statements under Pensions and Other PostretirenentPlans "Operating Leases - Plant Daniel Combined Cycle , Generating Units," the Company-leases a 1,064 megawatt On December 31, 2006, the Company adopted FASB natural gas combined cycle facility at Plant Daniel Statement No. 158, "Employers' Accounting for Defined (Facility) from Juniper Capital L.P. (Juniper). For both Benefit Pension and Other Postretirement Plans" accounting and rate recovery purposes, this transaction is (SFAS No. .158). which requires recognition of the funded treated as an operating lease, which means that the related status of its defined benefit postretirement plans in its obligations under this agreement are not reflected in the balance sheet. With the adoption of SFAS No. 158, the balance sheets. See FINANCIAL CONDITION AND Company recorded an additional prepaid pension asset of. LIQUIDITY - "Off-Balance Sheet Financing $21.3 million with respect to its overfunded defined Arrangements" herein for further information. The : benefit plan and additional liabilities, of$1.5 million and operating lease determination was based on assumptions $29.1 million, respectively, related to its underftinded and estimates related to the following: non-qualified pension plans and other postretirement benefit plans. Additionally; SEAS No. 158. will require the " Fair market value of the Facility at lease inception. Company to change the measurement date foir its defined " The Company's incremental borrowing rate. benefit postretirement plan assets and obligations from September 30'to December 31 beginning with the year " Timing of debt payments and the related amortization ending December 31, 2008. See Note 2 to the financial of the initial acquisition cost during the initial lease statements for additional information' . term.

Residual value of the Facility at the end of the lease Guidance on Consideringthe Materiality of, term. Misstatements

" Estimated economic life of the Facility. In September 2006, the Securities and Exchange " Juniper's status as a voting interest entity. Commission (SEC) issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year The determination of operating lease treatment was Misstatements when Quantifying Misstatements in. made at the inception of the lease agreement and is not Current Year Financial Statements" (SAB 108). SAB 108 subject to change unless subsequent changes are made to addresses how the effects of prior year uncorrected the agreement. However the Company also is required to misstatements should be considered ,when quantifying, monitor Juniper's ongoing status as a voting interest misstatements in current year financial statements. entity. Changes in that status could require the Company SAB 108'requires companies to 4tiantify misstatements to consolidate the Facility's assets and the related debt using both a balance sheet and an income statement and to record interest and depreciation expense 6f approach and to evaluate whether either approach results approximately $37 million annually, rather than annual in quantifying an error that is material in light of relevant, lease expense of approximately $27 million. quantitative and qualitative factors. When the effect of initial adoption is material, companies will record the New Accounting Standards effect as a cumulative effect adjustment to beginning of yearvretained earnings. The provisions of SAB 108 were Stock Options effective for the Company for the year ended . On January 1, 2006, the Company adopted FASB December 31, 2006. The. adoption of SAB 108 did, not Statement No. 123(R), "Share-Based Payment,' using the have a material impact on the Company's financial modified prospective method. This statement requires that statements., i 11-260

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) <:, ' Mississippi Power Company 2006 Annual Report Income Taxes and a reduction in notes payable in the amount of

                                                                      $151 million. Additional changes include a $54.7 million In July 2006, the FASB issued Interpretation No. 48,                   decrease in under recovered regulatory clause revenues "Accounting for Uncertainty in Income Taxes" '(FIN 48).                primarily due to fuel cost'recovery in 2006. For, additional This interpretation requires that tax benefits must be                 informAation regarding significant changes in the balance "more likely than not" of being sustained in .order to be sheets, see Nofe 2'to the financial statements under recognized. The Company adopted FIN 48 effective                       "Retirement Benefits." S6e FUTURE EARNINGS January 1, 2007. The adoption of FIN 48 did not have a                 POTENTIAL - "PSC Matters - Storm Damage Cost material impact: on the Company's financial statements.                Recovery'" herein and Note 3 to the financial statements under "Retail Regulatory Matters - Stormne Damage Fair Value Measurement                                                 Recovery'! for additional information related to the The FASB issued FASB Statement No. 157, "Fair Value                    deferral of ihe restoration costs, including both capital and Measurements" (SFAS No. 157),. in September 2006.                     operation andm   'maintenance 'expenditures.,

SFAS No. 157 provides guidance on how to measure fair The Company's ratio of common equity to total value where it is pernmitted or required under other capitalization, excluding long-term debt due within~one. accounting lýronouncements. SFAS No. 157 -also requires year, increased from 64.3 percent in 2005 to 65.4 percent additional disclosures' about fair value measurements. The at December 31, 2006. The Company-hag received, Company' plans to adopt SFAS No. 157 "onJanuary'1,' investment grade ratings from the major rating agencies wti respect-to debt, preferred se' a preferred 2008 and is currently assessing its impact. witl~ ' securiti~es, and prefre stock.': Fair Value Option Sources of Capital In February 2007, 'the FASB issued FASB Statement No. 159, "Fair Value Option for Financial Assets and ThetoomPpany plans to obtain the funds' required for Financial Liabilities ý- Including an Amendment of FASB construction, continued storm damage restoration, and Statement No. 115" (SFAS No. 159). This standard , other0purpses from sources similar to those used int the permits an entity to choose to measure many financial past,'whichw*ere primarily from operating cash flows, instruments and certain other items at fair value..The security issuances, term loans, and short-term borrowings. Company plans to adopt SFAS No. 159 on January 1, See Note 3 to the financial statements under."Storm 2008 and is currently assessing its impact... Damage Cost*Recovery" for additional information. The amount,, type, and timing-of any financings, if needed, FINANCIAL CONDITION AND LIQUIDITY will depend upon regulatory approval, prevailing market conditions; and other factors. Overview ThelsspaSice of securities by the Company is subject The Company's financial'condition'remained stable at to regulatorya'pproval by the FERC. 'Additionally, with December 31, 2006. Net cash flow'from operations, respecttt itlitiblic offering of securities, the .Company increased from 2005 by $153.0 million. The increase was files registration statements with the' SEC under the primarily due to the proceeds received from the CDBG' Securities"Act of 1933, as amended (1933 Act). The program. The $77.4 million ddcrease in 2005 lzompared to amount of 9ecuritie's authorized by the FERC, as well as 2004 resulted primarily from the storm damage costs the am6ounts registered under the 1933 Act, are related to Hurricane Katrina. See FUTURE EARNINGS contini*ously'ioinitored and appiopriate filings are made POTENTIAL - "PSC Matters - Storm Damage Cost to ensure'hlexibility in the capital markets. Recovery" for additional information.' TheCompany obtains financing separately without Significant changes in the balance sheet as of credit support from' any affiliate. The Southern Company December 31', 2006, compared to 2005, primarily relate to systeni' does not maintain a centralized cash 'or money Hurricane Katrina storm restoration activities. These

pool. Therefore, funds of the Company are not storm-related changes: include a reduction in the retail; con'm.ingled'with funds of' any other comPany.

regulatory asset primarily as aresult of'the CDBG proceeds of $267.6 million, the. decrease in insurance. To meet short-term cash needs and contingencies, the receivable primarily as a result of; the receipt of external- Company has 'various sources of liquidity. At insurance proceeds of $58 million, a reduction to December 31, 2006,-the Company had approximately affiliated payables in the amount of $98.3 million- $4.2 million of cash and cash equivalents and $181 million primarily due to the payment of storm-related charges,' of unused credit arrangements with banks. See Note 6 to 11-261

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report the financial statements under "Bank Credit the renewal period. Upon termination of the lease, at the Arrangements" for additional information; Company's option, it may either exercise its purchase option or the Facility can be sold to a third party. The Company may also meet short-term cash needs through a Southern Company subsidiary organized to The lease also provides for a residual value., issue and sell commercial paper and extendible guarantee. approximately 73 percent of the acquisition commercial notes at the request and for the benefit of the cost, by the Company that is due upon termination of the Company and the other traditional operating companies. lease in the event that the Company does not renew the Proceeds from such issuances for the benefit of the lease or purchase the Facility and that the fair market Company are loaned directly to the Company, and are not value is less than the unamortized cost of the Facility. commingled with proceeds from such issuances for the benefit of any other traditional operating company. The obligations of each company under these arrangements Credit. Rating Risk are several; there is no cross affiliate credit support. At The Company does not have any credit arrangements that December 31, 2006, the Company had $51.4 million would require material changes in payment schedules or outstanding in commercial paper. terminations as a result of a credit rating downgrade. However, the Company, along with all members of the Financing Activities Southern Company power pool, is party to certain During 2006, a portion of the CDBG funds was used to derivative agreements that could require collateral and/or repay short-term debt incurred to fund storm restoration' accelerated payment in the event of a credit rating change efforts. to below investment grade for Alabama Power and/or Georgia Power. These agreements are pnrmarily for In addition to any financings that may be. necessary natural gas and powerý price risk management activities. to meet capital requirements and contractual obligations, At December 31, 2006, the Company's total exposure to the Company plans to continue, when economically these types of agreements was approximately feasible, a program to retire higher-cost securities and' $27.4 million. replace these obligations with lower-cost capital if'market conditions permit: Market Price Risk Off-Balance Sheet Financing Arrangements Due to cost-based rate regulation, the Company has In 2001, the Company began an initial: 10-year term of a limited exposure to market volatility in interest rates, lease agreement for a combined cycle generating facility commodity fuel prices, and prices of electricity. To built at Plant Daniel. In June 2003, the Company entered manage the volatility attributable to these exposures, the into a restructured lease agreement for the Facility with Company nets the exposures to take advantage of natural Juniper, as discussed in Note 7 to the financial statements offsets and enters into various derivative transactions for under "Operating Leases- Plant Daniel Combined Cycle the remaining. exposures pursuant to the Company's. Generating Units." Juniper has also entered into leases policies in areas such as counterparty exposure and with other parties unrelated to the Company. The assets hedging practices. Company policy is that derivatives are leased by the Company comprise less than 50 percent of to be used primarily for hedging purposes and, mandates Juniper's assets. The Company does not consolidate the strict adherence to all applicable risk management leased assets and related liabilities, and the lease with policies. Derivative positions are monitored using Juniper is considered an operating lease. Accordingly, the techniques. that include, but are not limited to, market lease is not reflected in the balance sheets. valuation, value at risk, stress testing, and sensitivity analysis. The initial lease term ends in 2011, and the lease includes' a renewal and a purchase option based on the The Company does not' currently hedge interest rate cost of the Facility at the inception of the lease, which risk. The weighted average interest rate on variable long-was approximately $370 millioný,The Company is term debt at January 1, 2007 was 4.4l.percent If the required to amortize approximately fou'r percent of the Company sustained a 100 basis point change in interest initial acquisition cost over the initial lease term. Eighteen rates for all unhedged variable rate long-term debt, the months prior to the end of the initial lease, the Company change would affect annualized interest. expense by may elect to renew for 10 years. If the lease is renewed, approximately $1.2 million at December 31, 2006..The the agreement calls for the Company. to amortize an Company is not aware of any facts or circumstances that additional 17 percent of the initial completion cost over would significantly affect such exposures in the near term. 11-262

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report See Notes 1 and 6 to the financial statements under At December 31, 2006, the fair value gains/(losses) "Financial Instruments" for additional information. of energy-related derivative contracts were reflected in the financial statements as follows: To mitigate residual risks relative to movements in electricity prices, the Company enters into fixed-price Amounts contracts for the purchase and sale of electricity through (in thousands) the wholesale electricity market. At December 31, 2006, Regulatory assets, net $(7,321) exposure from these activities was not material to the Accumulated other comprehensive income 969 Company's financial statements. Net income (8) Total fair value $(6,360) In addition, at the instruction of the Mississippi PSC, the Company has implemented a fuel-hedging program. Unrealized pre-tax gains and losses from energy-At December 31, 2006, exposure from these' activities was related derivative contracts recognized in income were not not material to the Company's financial statements. material for any year presented. The Company is exposed The changes in fair value, of energy contracts and to market price risk in the event of nonperformance by year-end valuations were as follows: counterparties to the energy-related derivative contracts. The Company's policy is to enter into agreements with Changes in Fair Value counterparties that have investment grade credit ratings by 2006 2005 Moody's and Standard & Poor's or with counterparties who-have posted collateral to cover potential credit (in thousands) expo'ure.r Therefore, the Company.does not anticipate Contracts beginning of year $ 27,106 $ 889 market risk exposure from nonperformance by the Contracts realized or settled (494) (13,816) counterparties. See Notes 1 and 6 to the financial New contracts at inception . I statemenht under "Financial Instruments" for additional Changes in valuation techniques information. Current period changes(a) ,(32,972) 40,033 Contracts end of year $ (6,360) $ 27,106 Capital Requirements and Contractual Obligations (a) Current period changes also include the changes in fair value of new contracts entered' into during the period. The construction program of, the Company is currently estimated to be $146 million for 2007, of which $6 million Source of 2006 Year-End Valuation Prices' is related to Hurricane Katrina'restoration, $258 million for 2008, and $161 million for 2009. Environmental Total Maturity expenditures included in these amounts are $21 million, Fair Value Year 1 2-3 Years

                                                                              $917 million, and $82 million for 2007,'2008, and 2009, (in thousands)                      respectively. Actual, construction costs may vary from this Actively quoted              $(7,506)         $(6,065)        $( 1,441)        estimate because of changes in such factors as: business External sources                1,146            1,146                -        conditions; environmental regulations; FERC rules and Models and other                                                               regulations; load projections; storm impacts; the cost and methods                          -                  -                       efficiency of construction labor, equipment, and materials; Contracts end of year       $(6,360)         $(4,919)        $(1,441)          and the cost of capital. In addition, there can be no assurance that costs related to capital expenditures will be fully recovered.

These contracts are related primarily to fuel hedging programs under which unrealized gains and losses from In addition, as discussed in Note 2 to the financial mark to market adjustments are recorded as regulatory statements, the Company provides postretirement benefits assets and liabilities. Realized gains and losses from these to substantially all employees and funds trusts to the programs are included in fuel expense and are recovered extent required by the Mississippi PSC and the FERC. through the Company's energy cost management clause. Other funding requirements related to obligations Gains and losses on forward contracts for the sale of associated with scheduled maturities of long-term debt, as electricity that do not represent hedges are recognized in well as the related interest, derivative obligations, the statements of income as incurred. For the years ended preferred stock dividends, leases, and other purchase December 31, 2006, 2005, and 2004, these amounts were commitments, are as follows. See Notes 1, 6, and 7 to the not material. financial statements for additional information. 11-263

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report Contractual Obligations 2008- 2010- After 2007 2009 2011 2011 Total (in thousands) Long-term debt(a) Principal $ - $ 40,000 $ - $238,777 $ 278,777 Interest 14,694 29,388 24,956 278,796 347,834 Commodity derivative obligations(b) 8,572 2,681 - - 11,253 Preferred stock dividends(c) 1,733 3,466 3,466 - 8,665 Operating leases 40,095 71,592 59,721 3,574 174,982 Purchase commitments(d) Capital(e) 146,000 419,000 - - 565,000 Coal 280,602 271,185 35,100 31,200 618,087 Natural gast0 140,242 193,531 70,171 248,697 652,641 Long-term service agreements 10,547 20,768 21,765 101,856 154,936 Post retirement benefits trusteg) 190 380 - - 570 Total $642,675 $1,051,991 $215,179 $902,900 $2,812,745 (a) All amounts are reflected based on final maturity dates. The Company plans to continue to retire higher-cost securities and replace these obligations with lower-cost capital if market conditions permit. Variable rate interest obligations are estimated based on rates as of January 1, 2007, as reflected in the statements of capitalization. (b) For additional information, see Notes I and 6 to the financial statements. (c) Preferred stock does not mature; therefore, amounts are provided for the next five years only. (d) The Company generally does not enter into non-cancelable commitments for other operations and maintenance expenditures. Total other operations and maintenance expenses for 2006, 2005, and 2004 were $237 million, $240 million, and $237 million, respectively. (e) The Company forecasts capital expenditures over a three-year period. Amounts represent current estimates of total expenditures. At December 31, 2006, significant purchase commitments were outstanding in connection with the construction program. (f) Natural gas purchase commitments are based on various indices at the time of delivery. Amounts reflected have been estimated based on the New York Mercantile Exchange future prices at December 31, 2006. (g) The Company forecasts postretirement trust contributions over a three-year period. No contributions related to the Company's pension trust are currently expected during this period. See Note 2 to the financial statements for additional information related to the pension and postretirement plans, including estimated benefit payments. Certain benefit payments will be made through the related trusts. Other benefit payments will be made from the Company's corporate assets. 11-264

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 2006 Annual Report Cautionary Statement Regarding Forward-Looking " investment performance of the Company's employee Statements benefit plans; The Company's 2006 Annual Report contains forward-

advances in technology; looking statements. Forward-looking statements include,
state and federal rate regulations and the impact of among other things, statements concerning growth, retail pending and future rate cases and negotiations, rates, storm damage cost recovery and repairs, fuel cost including rate actions relating to fuel and storm recovery, environmental regulations and expenditures, restoration cost recovery; access to sources of capital, projections for postretirement benefit trust contributions, financing activities, impacts of
internal restructuring or other restructuring options that the adoption of new accounting rules, completion of may be pursued; construction projects, and estimated construction and " potential business strategies, including acquisitions or other expenditures. In some cases, forward-looking dispositions of assets or businesses, which cannot be statements can be identified by terminology such as assured to be completed or beneficial to the Company; "may," "will:' "could," "should:' "expects," "plans:'

"anticipates," "believes," "estimates," "projects,"

the ability of counterparties of the Company to make "predicts," "potential," or "continue" or the negative of payments as and when due; these terms or other similar terminology. There are
the ability to obtain new short- and long-term various factors that could cause actual results to differ contracts with neighboring utilities; materially from those suggested by the forward-looking

.statements; accordingly, there can be no assurance that

the direct or indirect effect on the Company's business such indicated results will be realized. These factors resulting from terrorist incidents and the threat of include: terrorist incidents;

" the impact of recent and future federal and state

interest rate fluctuations and financial market regulatory change, including legislative and regulatory conditions and the results of financing efforts, initiatives regarding deregulation and restructuring of including the Company's credit ratings; the electric utility industry, implementation of the " the ability of the Company to obtain additional Energy Policy Act of 2005, and also changes in generating capacity at competitive prices; environmental, tax, and other laws and regulations to which the Company is subject, as well as changes in
catastrophic events such as fires, earthquakes, application of existing laws and regulations; explosions, floods, hurricanes, pandemic health events such as an avian influenza, or other similar

" current and future litigation, regulatory investigations, occurrences; proceedings, or inquiries, including FERC matters and EPA civil actions;                                               " the direct or indirect effects on the Company's, business resulting from incidents similar to the August
" the effects, extent, and timing of the-entry of 2003.power outage in the Northeast; additional competition in the markets in which the Company operates;

the effect of accounting pronouncements issued periodically by standard setting bodies; and
variations in demand for electricity, including those relating to weather, the general economy and
other factors discussed elsewhere herein and in other population, and business growth (and declines); reports (including the Form 10-K) filed by the Company from time to time with the SEC.
available sources and costs of fuels;

" ability to control costs;                                          The Company expressly disclaims any obligation to update any forward-looking statements.

11-265

STATEMENTS OF INCOME For the Years Ended December 31, 2006, 2005, and 2004 Mississippi Power Company 2006 Annual Report 2006 2005 2004 (in thousands) Operating Revenues: Retail revenues $ 647,186 $618,860 $584,313 Sales for resale - Non-affiliates 268,850 283,413 265,863 Affiliates 76,439 50,460 44,371 Other revenues 16,762 17,000 15,779 Total operating revenues 1,009,237 969,733 910,326 Operating Expenses: Fuel 438,622 358,572 324,882 Purchased power - Non-affiliates 16,292 32,208 33,528 Affiliates 56,955 111,284 73,235 Other operations - Other 170,277 168,355 160,477 Maintenance 66,415 71,267 77,001 Depreciation and amortization 46,853 33,549 39,390 Taxes other than income taxes 60,904 60,058 55,572 Total operating expenses 856,318 835,293 764,085 Operating Income 152,919 134,440 146,241 Other Income and (Expense): Interest income 4,272 1,718 777 Interest expense (16,041) (11,230) (11,776) Interest expense to affiliate trust (2,598) (2,598) (1,948) Distributions on mandatorily redeemable preferred securities -- (630) Other income (expense), net (6,712) (415) (1,365) Total other income and (expense) (21,079) (12,525) (14,942) Earnings Before Income Taxes 131,840 121,915 131,299 Income taxes 48,097 46,374 50,666 Net Income 83,743 .75,541 80,633 Dividends on Preferred Stock 1,733 1,733 3,832 Net Income After Dividends on Preferred Stock $ 82,010 $ 73,808- $ 76,801 The accompanying notes are an integral part of these financial statements. 11-266

STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2006, 2005, and 2004 Mississippi Power Company 2006 Annual Report 2006 2005 2004 (in thousands) Operating Activities: Net income $ 83,743 $ 75,541 $ 80,633 Adjustments to reconcile net income to net cash provided from operating activities -- Depreciation and amortization 68,198 63,319 60,260 Deferred income taxes and investment tax credits, net (47,535) 118,316 44,424 Plant Daniel capacity (13,008) (25,125) (16,508) Pension, postretirement, and other employee benefits 5,650- 2,938 (1,084) Stock option expense 1,057 - - Tax benefit of stock options 258 3,723 1,532 Other, net (5,761) 1,493 (1,823) Changes in certain current assets and liabilities -- Receivables 64,976 (107,836) (26,250) Fossil fuel stock 7,765 (25,745) 5,528 Materials and supplies 750 (6,234) (3,768) Prepaid income taxes 20,247 (40,059) 3,419 Other current assets (6,560) (2,498) (2,018) Hurricane Katrina grant proceeds 120,328 Hurricane Katrina accounts payable .. (50,512) (82,102) Other accounts payable .... (30,419) 40,255 (5,555) Accrued taxes 1,972 i 4,001 151 Accrued compensation (629) 674 82 Over recovered regulatory clause revenues (26,188) 20,831 (25,761) Other current liabilities 634 441 6,052 Net cash provided from'operating activities 194,966 41,933 119,314 Investing Activities: - Property additions (127,290) (158,084) (72,066) Cost of removal net of salvage (9,420) (26,140) (3,189) Construction payables (7,596) 16,417 1,243 Hurricane Katrina capital grant proceeds 152,752 - Other (1,992) (2,655) (2,066) Net cash provided from (used for) investing activities 6,454 (170,462) (76,078) Financing Activities: Increase (decrease) ih notes payable, net (150,746) 202,124 Proceeds--

 *Senior notes                                                                                          30,000       ..40,000 Preferred stock                    -                                                         -              -        30,000 Gross excess tax benefii of stock options                                                 669                  -          -

Capital contributions from parent company 5,503 (25) 1,791 Redemptions-- First mortgage bonds - (30,000) - Senior notes - (80,000) Preferred stock - (28,388) Payment of preferred stock dividends (1,733) (1,733) (1,829) Payment of common stock dividends (65,200) (62,000) (66,200) Other - (2,481) (785) Net cash provided from (used for) financing activities (211,507) 135,885 (105,411) Net Change in Cash and Cash Equivalents (10,087) 7,356 (62,175) Cash and Cash Equivalents at Beginning of Year 14,301 6,945 69,120 Cash and Cash Equivalents at End of Year $ 4,214 $ 14,301 $ 6,945 Supplemental Cash Flow Information: Cash paid during the period for -- Interest (net of $-, $- and $- capitalized, respectively) $ 29,288 $ 13,499 $ 12,084 Income taxes (net of refunds) 75,209 (40,801) 6,654 The accompanying notes are an integral part of these financial statements. 11-267

BALANCE SHEETS At December 31, 2006 and 2005 Mississippi Power Company 2006 Annual Report Assets 2006 2005 (in thousands) Current Assets: Cash and cash equivalents $ ,4,214 $ 14,301 Receivables - Customer accounts receivable 42,099 36,747 Unbilled revenues 23,807 20,267 Under recovered regulatory clause revenues 50,778 105,505 Other accounts and notes receivable 5,870 21,507 Insurance receivable 20,551 60,163 Affiliated companies 23,696 19,595 Accumulated provision for uncollectible accounts (855) (2,321) Fossl fuel stock, at average cost 42,679 50,444 Materials and supplies, at average cost 27,927 28,678 Prepaid income taxes 22,031 42,278 Other regulatory assets 42,391 23,042 Other 15,091 25,160 Total current assets 320,279 445,366 Property, Plant, and Equipment: In service 2,054,151 1,987,294 Less accumulated provision for depreciation 836,922 803,754 1,217,229 1,183,540 Construction work in progress -40,608 52,225 Total property, plant, and equipment 1,257,837 1,235,765 Other Property and Investments 4,636 6,821 Deferred Charges and Other Assets: Deferred charges related to income taxes 9,280 9,863 Prepaid pension costs 36,424 17,264 Deferred property damage - 209,324 Other regulatory assets 61,086 22,241 Other 18,834 34,625 Total deferred charges and other assets 125,624 293,317 Total Assets $1,708,376 $1,981t,269 The accompanying notes are an integral part of these financial statements. 11-268

BALANCE SHEETS At December 31, 2006 and 2005 Mississippi Power Company 2006 Annual Report Liabilities and Stockholder's Equity 2006 2005 (in thousands) Current Liabilities: Notes payable $ 51,377 $ 202,124 Accounts payable - Affiliated 24,615 122,899 Other .73,236 89,598 Customer deposits 8,676 7,298 Accrued taxes - Income taxes 4,171 17,736 Other 50,346 -48,296 Accrued interest 2,332 3,408 Accrued compensation -23,958 24,587 Over recovered regulatory clause revenues - 26,188 Plant Daniel capacity 56913,008 Other 40,266 40,334 Total current liabilities 284,636 595,476 Long-term Debt (see accompanying statements) 242,553 242,548 Long-term Debt Payable to Affiliated Trust (See accompanying statements) 36,082 36,082 Deferred Credits and Other Liabilitiles: Accumulated deferred income taxes 236,202 266,629 Deferred credits related to income taxes 16,218 19,003 Accumulated deferred investment tax credits 16,402: 17,465 Employee benefit obligations 92,403 58,318 Other cost of removal obligations' 82,397 81,284 Other regulatory liabilities 22,559 13,411 Other -56,324 57,113 Total deferred credits and other liabilities 522,505 -513,223 Total Liabilities -1,085,776 1,387,329 Preferred Stock (See accompanying statements) 32,780 32,780 Common Stockholder's Equity (See accompanying statements) 589,820 561,160 Total Liabilities and Stockholder's Equity $1,708,376 $1,981,269 Commitments and Contingent Matters (See notes) The accompanying notes are an integral part of these financial statements. 11-269

STATEMENTS OF CAPITALIZATION At December 31, 2006 and 2005 Mississippi Power Company 2006 Annual Report 2006 2005 2006 -2005 (in thousands) (percent of total) Long-Term Debt: Lohg-term notes' payable - 5.4% to 5.625% due 2033-2035 $120,000 $120,000 Adjustable rates (5.54% at 1/1/07) due 2009 40,000 40,000 Total long-term notes payable 160,000 160,000 Other long-term debt -- Pollution control revenue bonds: Variable rates (3.75% to 4.04% at 1/1/07) due 2020-2028 82,695 82,695 Unamortized debt premium (discount), net (142) (147) Total long-term debt (annual interest requirement -- $12.1 million) 242,553 242,548 27.0% 27.8% Long-term Debt Payable to Affiliated Trust: 7.20% due 2041 (annual interest requirement -- $2.6 million) 36,082 36,082 4.0 4.1 Cumulative Preferred Stock: $100 par value Authorized: 1,244,139 shares Outstanding: 334,210 shares 4.40% to 5.25% (annual dividend requirement -- $1.7 million) 32,780 32,780 3.6 3.8 Common Stockholder's Equity: Common stock, without par value -- Authorized: 1,130,000 shares Outstanding: 1,121,000 shares 37,691 37,691. Paid-in capital C 307,019 -299,536 Retained earnings 244,511 227,701 Accumulated other comprehensive income (loss) 599 (3,768) Total common stockholder's equity 589,820, 561,1601 - 65.4. 64.3 Total Capitalization $901,235 $872,570 100,0% 100.0% The accompanying notes are an integral part of these financial statements. . Ii 11-270

STATEMENTS OF COMMON STOCKHOLDER'S EQUITY For the Years Ended December 31, 2006, 2005, and 2004 Mississippi Power Company 2006 Annual Report Other Common Paid-In Retained Comprehensive Stock Capital Earnings Income (loss) Total (in thousands) Balance at December 31, 2003 $37,691 $292,841 $203,419 $(1,462) $532,489 Net income after dividends on preferred stock . .- ,76,801 76,801 Capital contributions from parent company . 3,3233-. 3,323 Other comprehensive income (loss) -:-(2,122) (2,122) Cash dividends on common stock - - (66,200) - (66,200) Other (327) 1,873 - 1,546 Balance at December 31, 2004 37,691 295,837 215,893 (3,584) 545,837 Net income after dividends on preferred stock '- 73,808 - 73,808 Capital 'contributions from parent company . 3,699 -3,699 Other comprehensive income (loss) . (184) (184) Cash dividends on common stock - - (62,000) - (62,000) Balance at December 31, 2005 37,691 '-299,536 227,701 (3,768) 561,160 Net income after dividends on preferred stock " " 82,010 - 82,010 Capital contributions from parent company - 7,483 .. .. 7,483 Other comprehensive income (loss) " - - (180) (180) Adjustment to initially apply FASB Statement No. 158, net of tax .... 4,547 4,547 Cash dividends on common stock * - (65,200)' - (65,200) Balance at December 31, 2006 ' $37,691 $361,019 $244,511 $ 599 $589,820 The accompanying notes are an integral part of these financial statements. STATEMENTS'OF COMPREHENSIVE INCOME For the Years Ended December 31, 2006, 2005, and 2004 Mississippi Power Company 2006 Annual Report 2006 2005 2004 Net income after dividends on preferred stock $82,010 $73,808 $76,801 Other comprehensive income (loss): Change in additional minimum pension liability, net of tax of $(614), $(167) and $(1,131), respectively (990) (269) (1,825) Change in fair value of marketable securities, net of tax of $-, $- and $49, respectively - 80 Changes in fair value of qualifying hedges, net of tax of $502, $53 and $(184), respectively 810 85 (297) Less: Reclassification adjustmentfor amounts included in net income, net of tax of $-,i$- and $(49), respectively (80) Total other comprehensive income (loss) (180) (184) (2,122) Comprehensive Income" $81,830 $73,624 $74,679 The accompanying notes are an integral part of these financial statements. 11-271

NOTES TO FINANCIAL STATEMENTS Mississippi Power Company 2006 Annual Report

1.

SUMMARY

OF SIGNIFICANT ACCOUNTING estimates, and the actual results may differ from those POLICIES estimates. General

Affiliate Transactions Mississippi Power Company (Company) is a wholly The Company has an agreement with SCS under which owned subsidiary of Southern Company, which is the the following services are rendered to the Company at parent company of four traditional operating companies, direct or allocated cost: general and design engineering,..

Southern Power Company (Southern Power), Southern purchasing, accounting.and statistical analysis, finance Company Services (SCS), Southern Communications and treasury, tax, information resources, marketing, Services (SouthernLINC Wireless), Southern Company auditing, insurance and pension administration, human Holdings (Southern Holdings), Southern Nuclear: resources, systems and procedures, and other services Operating Company (Southern Nuclear), Southein with respect to business and operations, and power pool Telecom, and other direct and indirect subsidiaries. The transactions. Costs for these services amounted to traditional operating companies, Alabama Powei, Georgia $55.2 million, $51.6 million, and $45.3 million during Power, Gulf Power, and the Company, provide electric 2006, 2005, and 2004, respectively. Cost allocation service in four Southeastern states. The Company operates methodologies used by SCS were approved by the as a vertically integrated utility providing service, to retail Securities and-Exchange Commission prior to the repeal customers in southeast Mississippi and to wholesale of the Public Utility Holding Company Act of 1935, as customers in the Southeast. Southern Power constructs, amended, and managem'ent' believes they are reasonable. acquires, and manages generation assets, and sells The FERC permits services to be rendered at cost by electricity at market-based rates in the wholesale market. system service companies. SCS,, the system service company, provides, at cost, The Company provides incidental services to and specialized services to Southern.Company and its receives such services from other Southern Company ' subsidiary companies. SouthernLINC Wireless, provides subsidiaries which are generally minor in'duration and digital wireless communications services to the-traditional amount. However, with the hurricane damage experienced operating companies and also markets these services to in the last two years, assistance for storm restoration has the public within the Southeast. Southern Telecom caused an increase in these activities. The total amount of provides fiber cable services within the Southeast. storm restoration provided to Alabama Power, Georgia Southern Holdings is an intermediate holding company Power, and Gulf Power in 2004 and 2005 was $3.3 million subsidiary for Southern Company's investments in and $1.0 million, respectively. These activities were billed synthetic- fuels and leveraged leases and various other.. at cost. The'Compafy reCeived-storm restorationi... energy related businesses. Southern Nuclear operates and assistance from other Southern Company subsidiaries provides services to Southern Company's nuclear power totaling $1.5 million and $73.5 million in 2006 and 2005, plants. On January 4, 2006, Southern Company completed respectively. the sale of substantially all of the assets of Southern Company Gas, its competitive retail natural gas marketing The Company has an agreement with Alabama subsidiary. Power under which the Company owns- a portion of, Greene County Steam Plant!.Alabama Power operates The equity method is used for subsidiaries which are Greene County Steam Plant,; and the Company reimbkirses variable interest entities and for which the Company is Alabama Power for its -proportionate share of all.

not the primary beneficiary. Certain prior years' data associated expenditures ahid costs. The Company:

presented in the financial statements have been reimbursed Alabama Power for the Company's reclassified to conform with the current year presentation. proportionate share of related expenlse which totaled'

                                                                      $8.6 million, $8.2rmillion,,and $7.2 million in 2006, The Company is subject to regulation by the Federal              2005, and 2004, respectively. The Company also has an Energy Regulatory Commission (FERC) and the                            agreement with Gulf Power under which Gulf Power Mississippi Public Service Commission (PSC). The                       owns. a portion of Plant Daniel. The Company operates Company follows accounting principles generally                        Plant Daniel, and Gulf Power reimburses the Company accepted in the United States and complies with the                    for its proportionate share of all associated expenditures accounting policies and practices prescribed by its                    and costs. Gulf Power reimbursed the Company for Gulf regulatory commissions. The preparation of financial                   Power's proportionate share of related expenses which statements in conformity with accounting principles                    totaled $19.7 million, $19.5 million, and $17.4 million in generally accepted in the United States requires the use of            2006, 2005, and 2004, respectively. See Notes 4 and 5 for 11-272

NOTES (continued) Mississippi Power Company 2006 Annual Report additional information on certain deferred tax liabilities Regulatory assets and (liabilities), reflected in the payable to affiliates. ... I -. balance-sheets at December 31 relate to.: . . In 2006ý, for purposes of filing the consolidated- 2006 2005 Note Southern Company tax return, the Company treated, (in thousands) certain items as tax capital gains rather than deferring Hurricane Katrina' $ 4,683," $209,324 (i) those gains over the life of the related assets. This Underfunded retiree allowed two Southern Holdings entities to utilize certain benefit Plans. , -, .38,814 Property damage .. (4,356). (500). (g) tax capital losses in the current year rather than carry . Deferred income tax them forward to future years. The Company has recorded charges" ! I 9,860 10,443' (a) a deferred tax liability of approximately $22.8 million Property tax 18,2"4 15,148 (b) related to these Southern Holdings entities in Vacation-pay 7,078 6,954 Loss:pn reacquired debt ,9,626 ,10,381 "ACcumulated Deferred Income Taes" 'on' the'balance (d) Loss on redeemed sheets. " ,: ",' . " ,'

                                                                         , preferrid stock                            .743           "'914 " (t)ý Loss'-on rail'ais'                              1344              405 The traditional operating companies, including the Other regulatory assets                       4,798 Company, and Southern Power may joly enter into                        Fuel-hedging assets                       ,,.12,252/":.
                                                                                                                                        ,232    M.(1) various types of wholesale energy, natural gas, and certain            Asset retirement other contracts, either directly or through SCS, as agent.                  obligations                              6,954           10,668      (a)

Each participating company may be jointly and severIly Deferred income tax liable for the obligations incurred Under these agreements. credits (18,238) (220,559) (a)' Other cost of removal See Note 7 under "Fuel Commitments" for additional 'obligations , .(82,397) 81,284) . (a) information. Plant Daniel capacity' '(5,659) 18,667) `(h) Fuel-hedging'liabilities (3,644) 27,695) (g) Other liabilities - - : * (2,606) ,(660) (g) RegulatoryAssets and Liabilities . - Overfunde4o ptiree , The Company is subject to th. provisions of imainticia. benefit plans. (21,349) Accounting StandardsBoard(FA§B) StatementNo. 71, Total $(24,803) $1t15A,04 "Accounting for the Effects of Certainltyps of Note: The recovery'and amortization periods for these,' Regulation" (SFAS No. 71). Regulatory assets represent regulatory assets and (liabilities) are as follows: I." probable future revenues's cii ie'dýv[i cetain costs thht are expected to be recovered from customers through the (a) Asset'retirement and'removal liabilities are recorded,' deferred income' tkX assets are' retovered and deferred ratemaking process. Regulalory liabilities represent tax liabilities are amortized 0ver! the related property probable. future reductions in. revenues associated with lives, which may range up to 50 years. Asset retirement amounts that are, expected to be creqdited, to: customers and removal liabilities will be settled and trued up , . through the ratemaking process.._ -, following completion of the related activities. I . ; ; , : ' . * '" V ". ' , ', (b) Recovered through the ad valorem tax adjustment clause over a J2-month period beginning in April of the "moi1owing year.i. (c) Recorded as earned by employees and recovered as paid. generally within one year. I I (d) Recoyered over the remaining life-of the original issue. or, if refinanced, over the life of the.new issue, ,which may rangl up to 50 years., (e) 'Amortized over a period beginning in 2004 that is not to exceed seven years., (f) ':Fuelhedging assets and liabilities'are recorded over the A'life of the -underlying hedged purchase contracts, which generally do not excee tstto years.. Upon' final settlement, costs are recovered through the Energy Cost Management clause (ECM). (g) "':'Recorded and recovered as approved by'the Mississippi PSC., I, ' :.' ... . .I . 11-273

NOTES (continued) Mississippi Power Company 2006 Annual Report (h) Amortized over a four-year period ending in 2007. Mississippi PSC for an adjustment to the fuel cost (i) For additional information, see Note 3 under "Retail recovery factor annually. Regulatory Matters - Storm Damage Cost Recovery." The Company has a diversified base of customers. (j) Recovered and amortized over the average remaining For years ended December 31, 2006 and December 31, service period which.may range up to 15 years. See 2005, no single customer or industry comprises 10 percent Note 2 under "Retirement Benefits." or more of revenue. For all periods presented, In the event that a portion of the Company's uncollectible accounts averaged less than 1 percent of operations is no longer subject to the provisions of revenues. SFAS No. 71, the Company would be required to write off related regulatory assets and liabilities that are not Fuel Costs specifically recoverable through regulated rates. In addition, the Company would be required to determine if Fuel costs are expensed as the fuel is used. Fuel expense any impairment to other assets, including plant, exists and generally includes the cost of purchased emission write down the assets, if impaired, to their fair values. All allowances as they are used. Fuel costs also included regulatory assets and liabilities are to be reflected in rates. gains and/or losses from fuel hedging programs as See Note 3 under "Retail Regulatory Matters - Storm approved by the Mississippi PSC. Damage Cost Recovery." Income and Other Taxes Government Grants The Company uses the liability method of accounting for The Company received a grant in October 2006 from the deferred income taxes and provides deferred income taxes Mississippi Development Authority (MDA) for for all significant income tax temporary differences. $276.4 million, primarily for storm damage cost recovery. Investment tax credits utilized are deferred and amortized The grant proceeds do not represent a future obligation of to income over the average life of the related property. the Company. The portion of any grants received related Taxes that are collected from customers on behalf of tbo-retail storm recovery is applied to the retail regulatory governmental agencies to be remitted to these agencies asset that is :established as restoration costs are incurred. are presented net on the statements of income. The portion related, to wholesale storm recovery is recorded either as a reduction to operations and Property, Plant, and Equipment maintenance expense or as a reduction in accumulated depreciation depending on the restoration work performed Property, plant, and equipment is stated at original cost and the appropriate allocations of cost of service. less regulatory disallowances and impairments. Original cost includes: materials; labor, minor items of property; Revenues appropriate administrative and general costs; payroll-related costs such as taxes, pensions, and other benefits;6 Energy and other revenues are recognized as services are and the interest capitalized and/or cost of funds used rendered. Wholesale capacity revenues from long-term during construction for projects over $10 million. contracts are recognized at the lesser of the levelized amount or the amount billable under the contract over the The Company's property, plant, and equipment respective contract period. Unbilled revenues related to consisted of the following at December 31: retail sales are accrued at the end of each fiscal period. 2006 2005 The Company's retail and wholesale rates include (in thousands) provisions to adjust billings for fluctuations in fuel costs, Generation $ 847,904 $ 833,598 fuel hedging, the energy component of purchased power Transmission 414,490 390,961 costs, and certain other costs. Retail rates also include Distribution 648,304 624,769 provisions to adjust billings for fluctuations in costs for General 143,453 137,966 ad valorem taxes and certain qualifying environmental Total plant in service $2,054,151 $1,987,294 costs. Revenues are adjusted for differences between these actual costs and amounts billed in current regulated rates. The cost of replacements of property, exclusive of Under or over recovered regulatory clause revenues are minor items of property, is capitalized. The cost of recorded in the balance sheets and are recovered or maintenance, repairs, and replacement of minor items of returned to customers through adjustments to the billing property is charged to maintenance expense except for the factors. The Company is required to file with the cost of maintenance of coal cars and a portion of the 11-274

NOTES (continued) - i Mississippi Power Company 2006 Annual Report railway track maintenance costs,ýwhich are charged to the related long-lived asset and depreciated over the': fuel -stock and recovered through the Company's! fuel asset's useful life. In addition, effective December 31,' clause. . ,l ', I 2005, the Coimpany adopted the provisions of FASB Ii*'trpretattin No. 47, "Conditional Asset Retirement Depreciation and Amortization - ". . ,, Obligations" (FIN 47), which requires that an asset retirement obligation be recorded even though the timing Depreciatioq of the original cost 9f plant in fservice is and/or method of settlement are conditional on future provided primarily, by. using composite straight-line rates, events. Prior to December 2005, the Company did not which approximated 3.2 percent in 2006 And 3.4 percent iec'ognize asset retirement obligations for asbestos in each of 2005 and 2004. Depreciation studies are,- removal and 'disposal of polychlorinated biphenyls in conducted periodically .to update the ,compositerates. In, certain transformers because the timing of their March 2006, the Mississippi PSC approved the study, filed retirements was dependent on future events. The by the.Company in 2005,:with newirates effective ,. Company has received accounting guidance from the January 1, 2006. The new depreciation rates did not result Mississippi PSC allowing the continued accrual of other in a material chiage to annual depreciation expense.,,. future retirement costs for long-lived' assets that the: When property subject to depreciation is retired or . Compahytdoes'not have a legal obligation to retire. otherwise disposed of in the normal course of business, its Accordinigly, the-accumulated removal costs for these' cost, together with the cost of removal, We~s salyage,, is, obligations will continue- to be reflected 'in the balance,' charged to the accumulated depreciation provision. Minor sheets as a regulatory liability. Therefore, -the Company items 'of property included in the orikinal:cost of the plant had iio~cuniulative effect to net incotne resulting from the are retired when the related propeity' unit is retired. adoption'of SFAS No. 1430or FIN 47., Depreciation expense 'includes an amount -for the expected cost of removal of facilities.:' "The -Companyhas retirement o0ligations related to I.. ' - various landfill sites and underground storage tanks. In In January 2006, the Mississippi PSC issued an connectin with the adoption of FIN 47, the Company accounting order directing the ýCmppny- to exclude from also r rded additional asset retirement obligations (and its calculation of depreciation expense apprpximately assets) of $9.5 million, primarily related to asbestos. The $1.2 million related to capitalized Jiurricane Katrina costs Company, a]lso. has identified retiremenit bligatins' related since these costs Will be recovered separately... . to certain siransissiqfn and distrilution facilities, co-.. In December 2003, the MissisSippi PSC` issued an-!' generation 'acilities, cer'tain wjreless communication interim accounting order'directinig teW ohmpany to towers, and certain structures authorized by tie expense and record a regulatoiy' iability of $603 million United States "Armyr Corps of Engineers. However, while it considered the Company's iiequest to include liabilities for the removal of these assets have not been 266 megawatts of Plaiit Daniel tinits"3 nirid 4 enerating recorded because the range of time over which the Company may settle these obligations is unknown and capacity in-jurisdictioniai'cost f Service In M4y 2004,' the Mississippi PSC approved the 6fompany"g request cannot be; reasonably estimated. The.Company will,' effective lJanbaay l,"2004 and ordered thetCo mpany to toI continue to! recognize in the statements of income .allowed

                                                  'established           removal costs .in accordance with, its regulatory treatment.

am6rtize' the regulatbry'liability previously ý:." Any 'differiences between costs recognized under. . reduce depreciat*ion and rnortizatin exm200* I as follows: nses

$16.5 nuillion in r2 04, $25.1 inilllhoin                                SFAS;No, 143 and FIN.47 iand those reflected.             in   rates' are recognited'as either a regulatory asset or         Iiability,'iasA.'.i'
$13.0 million in 2006, and $5.7 million in 2007.J ordered bythe Mississippi PSC,,and are reflected in the r!

balance sheets.,.,. ! Asset Retirement Obligations and'Other Costs of Removal fi .,"., .' _ "., , EffectiveJanuary1, 2003, the Company, andopted FASB

                                                                                    . 4.-
                                                                                         ),', :,           ! '          *  . " .      *   .

Statement No. 143, "Accounting for Asset Retiuenment, Obligations" (SFAS No. 143), which established new accounting and reporting standards for legal obligations. associated with the ultimate cost 4f retirng long-lived assets. The presentt value of:the, ultimate 'cost of an asset's, future retirement is recorded in the period in which the liability is incurred.,The costs are capitalized as pait of II-275

NOTES (continued) Mississippi Power Company 2006 Annual Report Details of the asset retirement obligations included in Mississippi PSC approved the replenishment of the the balance sheets are as follows: property damage reserve with $60 million to be funded with a portion of the proceeds of bonds to be issued by 2006 2005 the Mississippi Development Bank on behalf of the State (in millions) of Mississippi and reported as liabilities by;the State of Balance, beginning of year $15.4 $ 5.5 Mississippi. The Company accrued $1.2 million in 2006, Liabilities incurred - 9.5 $1.5 million in 2005, and $4.6 million in 2004. The Liabilities settled (0.1) Company made no discretionary accruals in 2006 as a Accretion 0.8 0.4 result of the order. See Note 3 under "Storm Damage Cash flow revisions (0.3) Cost Recovery" and "System Restoration Rider" for Balance, end of year $15.8 $15.4 additional information regarding the depletion of these reserves following Hurricane Katrina and the deferral of Impairment of Long-Lived Assets and Intangibles additional costs, as well as additional rate riders or other cost recovery mechanisms which have and/or may be The Company evaluates long-lived assets for impairment approved by the Mississippi PSC to replenish these when events or changes in circumstances indicate that the reserves. carrying value of such assets may not be recoverable. The determination of whether an impairment has occurred is Environmental Cost Recovery based on either a specific regulatory disallowance or an estimate of undiscounted future cash flows attributable to The Company must comply with other environmental laws and regulations that cover the handling and disposal the assets, as compared with the carrying value of the assets. If an impairment has occurred, the amount of the of waste and releases of hazardous substances. Under impairment recognized is determined byeither the these various laws and regulations, the Company may also incur substantial costs to clean up properties. The amount of regulatory disallowance or by estimating the fair value of the asset and recording a loss for the amount Company has authority from the Mississippi PSC to recover approved environmental compliance costs through if the carrying value is greater than the fair value. For assets identified as held for sale, the carrying value is retail rates. In February 2007, the Company filed with the compared to the estimated fair value less the cost to sell Mississippi PSC its annual Environmental Compliance. in order to determine if an' impairment loss is required. Overview (ECO) Plan evaluation-for 2007. The Company Until the assets are disposed of, their estimated fair value requested an 86 cent per 1,000 kilowatt-hour (KWH) increase for retail customers. This increase represents is re-evaluated when circumstances or events change. approximately $7.5 million in annual revenues for the Company. Hearings with the Mississippi PSC are . Provision for Property Damage expected to be held in April 2007. In April 2006 the The Company carries insurance for the cost of certain Mississippi PSC approved the Company's 2006 ECO types of damage to generation plants andgeneral Plan, which included a 12 cent per 1,000 KWH reduction, property. However, the Company is self-insured for the for retail customers. This decrease represented a reduction cost of storm, fire, and other uninsured casualty damage of approximately $1.3 million per year in annual revenues to its property, including transmission and distribution for Mississippi Power. The new rates were effective in facilities. As permitted by the Mississippi PSC and the April 2006. The outcome of the 2007 filing cannot now FERC, the Company accrues for the cost of such damage be determined. through an annual expense accrual credited to a regulatory liability account. The cost of repairing actual Cash and Cash Equivalents damage resulting from such events that individually For purposes of the financial statements, temporary cash exceed $50,000 is charged to the reserve. A 1999 investments are, considered cash equivalents. Temporary Mississippi PSC order allowed the Company to accrue cash investments are securities With original maturities of $1.5 million to $4.6 million to the reserve annually, with 90 days or less. a maximum reserve totaling $23 million. In October 2006, in conjunction with the Mississippi PSC Hurricane Materials and Supplies Katrina-related financing order, the Mississippi PSC ordered the Company to cease all accruals to the retail Generally, materials and supplies include the average cost property damage reserve until a new reserve cap is of transmission, distribution, and generating plant established. However, in the same financing order, the materials.' Materials are charged to inventory when 11-276

NOTES (continued) Mississippi Power Company 2006 Annual Report purchased and-then expensed or capitalized to plant, as Additionally, SFAS No. 123(R) requires the gross excess appropriate, when installed or used. tax benefit from stock option exercises to be reclassified as a financing cash flow as opposed to an operating cash Fuel Inventory flow; the reduction in operating cash flows and increase in financing cash flows for the year ended December 31, Fuel inventory includes the average coits of oil, coal, 2006 was $0.7'million. natural gas, and emission allowances. Fuel is charged to inventory when purchased and then expensed asused and For the years prior to the adoption of SFAS recovered by the Company through fuel cost recovery No. 123(R), the pro forma impact on net income of fair-rates approved by.the.Mississippi PSC. Emission;. value accounting for options granted is as follows: allowances granted by the Environmental Protection

                                                                                                     !. I I Option Agency (EPA) are included in inventory. at zero cost.

As Impact Pro Net Income Reported After Tax Forma Stock Options (in thousands) Southern Company provides non-qualified stock options 2005 $73,808 $(648) . $73,160 to a large segment of the Company's employees ranging 2004 76,801 (682) 76,119 from line management to executives. Prior to January 1, 2006, the Company accounted for options granted in Because historical forfeitures have been insignificant accordance with Accounting Principles' bard opinion and are expected to remain insignificant, no forfeitures No. 25; thus, no compensation expense was recognized are assumed in the calculation of compensation expense; because the exercise price of all options granted equaled rather they are recognized when they .oKcur. the fair market value on the date of the'grant. The estimated fair values of stock optiofis granted in Effective'Januaiy 1, 2006, the Company adopted the 2006, 2005, and 2004 were derived using the Black-fair value recognition provisions of FASB Statement Scholes stock Option pricing model. Expected volatility is No. 123(R), "Share-Based Payment" (SFAS No. 123(R)), based on historical volatility of Southern Company's using the modified prospective method. Under that stock over a period equal to the expected tern. The method, compensation cost for the year ended Company uses historical exercise data to estimate the December 31, 2006 is recognized as' the requisite service expected ,term that represents the period of time that is rendered and includes: (a)'compensation cost for the options granted to employees are expected to be portion of share-based awards granted prior to and that outstanding. The. risk-free rate is based on the were outstanding as of January l,2;200,'jor which the U.S. Treasury yield curve in effect at the time of grant requisite service had not been rendered, based on the that covers.the expected term of the stock options. grant-date fair value of thpse awards as calculated in accordance with the original provisions of FASB The following table shows the assumptions used in Statement No. 123, "AccobInting for Stock-b'sed the pricing model and the weighted average grant-date Compensation" (SFAS No. 123),4and,(b) Compensation fair value of stock options granted: i cost for all share-based awards granted subsequent to Period ended December 31 2006 2005 2004 January 1, 2006, based oh 'the grant-date fair value estimated in accordance with the provisions of . Expected volatility 16.9% 17.9% 19.6% SFAS No. 123(R). Results for prior periods have not been Expected term:(in years) - 5.0 5.0 5.0 restated. . , Interest rate 4.6% 3.9% 3.1% 4.4% -4.4% 4.8% Dividend yield The compensation cost and tax. benefits related to the Weighted average grant-date grant and exercise of Southern Company stock options to fair value_ $4.15 $3.90 $3.29 the Company's employees are recognized in the Company's financial statements with a correspondmg credit to equity, representing a capital conribution from Financial InstrumentS Southern Company.: The Company uses derivative financial instruments to For the Company, the adoption of SFAS, No. 123(R) limit exposure to fluctuations in the prices of certain fuel has resulted in a reduction in earnings before income purchases and electricity purchases and sales. All taxes and net income .of $1.1 million and$0.7 million, derivative financial instruments are recognized as either respectively, for the year ended December 31, 2006. assets or liabilities and are measured at fair value. II-277

NOTES (continued) Mississippi Power Company 2006 Annual Report Substantially all of the Company's bulk energy purchases economic events of the period other than transactions with and sales contracts that meet the definition of a derivative owners. Comprehensive income consists of net income,: are exempt from fair value accounting requirements and changes in the fair value of qualifying cash flow hedges are accounted for under the accrual method. Other and marketable securities, and changes in the additionalr.- derivative contracts qualify as cash flow hedges of minimum pension liability, less income taxes and anticipated transactions or are recoverable, through the reclassifications for amounts included in net income. Mississippi PSC approved fuel. hedging program as discussed beloW. This results in the deferral of related Variable Interest Entitles gains and losses iti other comprehensive ihcome or" regulatory assets and liabilities, jespectively, as The primary beneficiary of a variable interest entity must. appropriate until'. the hedged transactions occur. Any consolidate the related assets and liabilities. The ineffectiveness arising from cash flow hedges is Company has established a wholly-owned trust to issue recognized currently in net income. Other derivative preferred securities. See Note 6 under "Mandatorily contracts are marked to market through current period Redeemable Preferred Securities/Long-Term Debt Payable income and are recorded on. a net basis in the statements to Affiliated Trust" for additional information. However, the Company is not c6niidered the primary beneficiary. of of income. the trust. Therefore,, tlhe investments in this trust are The Mississippi PSC has approved the Company's reflected as Other Investments and'the related loan from. request to implement an ECM which, among other things, the trust is reflected as Long-term Debt Payable to allows the Company to uiilize financial instruments to Affiliated Trust iiinthe balance sheets. hedge its fuel commitments. Changes in the' fair value of these financial instnriiments are recorded as'regulatory 2. RETIREMENT BEN'FITS,' assets or liabilities. Amounts paid or received as a result of financial settlement of these instruments are classified The Company has a defined benefit, trusteed pension plan as fuel expense and are included in the ECM factor covering*substantially all employees. The plan is funded applied to customer billings. The Company's in accordance-witli requirements of the Employee jurisdictional wholesale customers have a similar ECM Retirement Income Security Act of 1974, as amended (ERISA). No contributionsl to' the plan aie expected for mechanism, which has been approvei by the FERC. the year ending December 31i,2007.' The Company also The Company is exposed to losses related to provides certain defined benefit pension plans for a financial instruments in the event of ciounterpirties' selected group of '"nagementand highly compensated nonperformance. The Company 'has established controls to employees. Beneits. tnder these non-qualified plans are determine and monitor the creditworthiness of funded on a cash basis. In addition, the Company counterparties in order to mitigate the Company's provides certain. miedical care and life insurance benefits exposure to counterparty credit risk. for retired employees through other postretirement benefit plans. The Company funds related trusts. to the extent -. Other fihancial instruments fot which the carrying amounts did not equal the, fair values at December 31 required by the Mississippi PSC and the FERC. For the. year ending lDecember 31, 2007, postretirement trust were as follows: contributions are expected to totil approximately, Carrying Fair $0.2 million., Amount Value (in thousands) On December; 31, 2006, the Company' adopted FASB' Statement No. 158, "Employers' Accounting for Defined Long-term debt: Benefit Pensiorq and Other Postretirement Plans" 2006 $278,635 $275,745 (SFAS No. 658), which requires recogiititn of the. funded 2005 278,630 273,278 status of its defined benefit postretrement plans in its, The fair values were based on either closing market balance sheet. Prior o dthe adoption of SPAS No. 158, the' prices or closing prices of comparable instruments. Company generally recognized only the difference' between the benefit expense recognizedanid employer ' Comprehensive incomne, contributions to the plan as either a prepaid asset or as a liability. With respect to its underfunded non-qualified The objective of comprehensive income is to report a pension plan, the Company recognized an additional.- * . measure of all changes in common stock equity of an minimum liability representing the'difference between enterprise-that result from transactionsi and other ! each plan's accumulated benefit obligation and its assets.,- 11-278

NOTES (continued) Mississippi Power Company 2006 Annual Report

     'With the adoption of SFAS No. 158, the Company                       The measurement date for plan -assets and obligations was required to recognize on its balance sheet previously             is September 30 for each year presented. Pursuant to.

unrecognized assets and liabilities related to unrecognized SFAS No. 158, the Company will be required to change prior service cost, unrecognized gains or losses (from the measurement date for its defined benefit changes in actuarial assumptions and the difference postretirement plans from September 30 to December.31 between actual and expected returns on plan assets), and beginning with the year ending December 31, 2008.. any unrecognized transition amounts (resulting from the change from cash-basis accounting to accrual accounting). Pension Plans These amounts will continue to be amortized as a component of expense over the employees' remaining The total accumulated benefit obligation for the pension average service life as SFAS No. 158 did not change the plans was $233 million and $235 million for 2006 and recognition of pension and other postretirement benefit 2005, respectively. Changes during the year in the expense in the statements of income. With the adoption of projected benefit obligations and fair value of plan assets SFAS No. 158, the Company recorded an additional were as follows: prepaid pension asset of $21.3 million with respect to its 2006 '2005 overfunded defined benefit plan and additidnal liabilities (in thousands) of $1.5 million and $29.1 million, respectively, related to Change in benefit obligation its underfunded non-qualified pension plans and retiree benefit plans. Benefit obligation at beginning of year $255,037 $232,658 Service cost - 7,207 6,566 The incremental effect of applying SFAS No. 158 on Interest cost 13,727, 13,089 individual line items in the balance sheet at December 31, Benefits paid (11,288) (10,703) 2006 follows: . Actuarial loss and employee transfers (13,987) 12,080 Adjustments Before(in millions) After Amendments (153) 1,347 Balance at end of year 250,543 255,037 Prepaid pension costs' $ 115- i $21 $ 36 Change in plan assets Other regulatory Fair value of plan assets at assets 22 . .39 61 beginning of year 246,271 222,543 Other property and Actual return on' plan assets '30,304 33,654 5 investments S6'-* (1) Employer contributions ' 1,308 1,206 1,649 " 59 1,708 genefits paid (11,288). (10,703) Total assets Employee transfers 681 ' '(429) Acciumulated deferred income Fair value of plan assets at end - taxes (236) of year 267,276 246,271 Other regulatory Funded status at end of year . 16,733 (8,766) (2) (23) liabilities Unrecognized transition Employee benefit amount - (545) obligations

                            * (61).          ;(31!)         (92)                                                                    14,288 Unreco'gniited prior service cost -               -
                         *,(1,031)           (54).      (1,085)

Total liabilities Unrecogniied net loss ' 3,449 Accumulated other Fourth quarter contributions '- 433 '465 comprehensive Prepaid pension asset, net $ 17,166 $ 8,891 income 4 (1) Total stockholders' (5). 31, 2006, the projected benefit Sequity At December (618) (5) obligations for the qualified and non-qualified pension plans' were $230.9 million and $19.7 million, respectively. Because the recovery of postretirement benefit All plan assets are related to the qualified pension plane. expensd through rates is considered probable, the Company recorded offsetting regulatory assets or Pension plan assets are managed and invested in regulatory liabilities under the provisions of SFAS No. 71 accordance with all applicable requirements, including with.respect to.the-prepaid assets and the liabilities. ERISA'and the Internal Revenue Code of 1986, as 11-279

NOTES (continued) Mississippi Power Company 2006 Annual Report amended (Internal Revenue Code). The Company's Estimated amortization in net periodic pension cost in investment policy covers a diversified mix of assets, 2007: including equity and flied income securities, real estate, and private equity. Derivative instruments are used Prior ,Net., primarily as hedging tools but-may also be used to gain Service (Gain)I efficient exposure to the various asset classes. The (in thousands). Company primarily minimizes the risk of large losses through diversification but also monitors and manages Regulatory asset , $214' $658 other. aspects ,of risk. The actual composition of the Regulatory -liabilities , 1,277 . - Company's pension plan assets as of the end of the year, Total ' ""' ' $1,491 ' $658 along with the targeted mix of assets, is presented below: Comiponents9 of et'periodic pension cost (income) Target 2006 2005 were as follows: Domestic equity 36% 38% 40% .2006 .2005 2004 International equity 24 23 24 .I (in thousands) Fixed income 15 16 17 Service cost-' $ 7,207 $ 6,566 $. 6,153 Real estate 15 16 13 Interest cost ' 13,727- '13,089; ' 12,249 Private equity 10 7 ' 6 Expected return on plan Total 100% 100% 100% assets , (18,107) (18,437) (18,325) Recogfnized net (gain) Amounts recognized in the balance sheets related to loss 7b3 ' -26 '865 the Company's pension plan consist of the following: Net amortization 1,013 937 '(361) Net periodic, pension 2006 2005' cost (income) ' $ 4,613 $ 2,681 $ 581 (in thousands) Prepaid pension costs $ 36,424 $ 17,264 Net periodic pension cost (income) is the sum 9f. Other regulatory assets 9,707, service cost, interest cost, and other costs netted against , Current liabilities, other (1,209) the expected return on plan. assets. The expected return on Other, regulatory liabilities (21,319) - plan assets is determined by multiplying the exp"d rate, Employee benefit obligations (18,049) (16,357) of return on plan assets and the market-related value of ,Other property and investments 2,224 plan assets. In determining the market-related value of. Accumulated other plan assets, the Company has elected to amortize changes com-Aprehensive income 7 5,760 in the market value of all plan assets over five. years rather than recognize the changes immediately. As a

 ---Presented below are the amounts included                                  result, the accounting value'of plan assets that is use tp in*

accumulated other comprehensive income, regulatory" calculate the expected return on plan assets differs from ,assets, and regulatory liabilities at December 31, 2006, the current fair *vaiue of the"plan assets. related to the defined benefit pension plans that have not Future benefit payments reflect expected ftiture yet been recognized in net periodic pension, cost along service and are estimated batd on assumptions' used to with the estimated amortization of such, amounts for the measure the projected benefit obligation for the pensibo next fiscal year. plans. At December 31, 2006, estimated benefit payments were as follows: Prior Net Service - (Gain)/ (in thousands) Cost Loss 2007 $11,286 2008 11,532 Balance at December 31, 2006::-. ,' (in thousands) 2009 J p1,989, Regulatory asset $ 798 $ 8,909 , :.%', 12,374'" 2010 Regulatory liabilities ' 11,488 ' '(32,807) 2011 12,862. Total .... . $12,286 $(23,898) 2012 to 2016 7.7,477, I1-290

NOTES (continued) +* !< , Mississippi Power Company 2006 Annual Report Other Postretirement Benefits benefit plan assets ýas of the end bfithe year, along with Changes during the year. in the accumulated, the targeted mix of assets, is presented-below: postretirement benefit obligations (APBO) and in the fair Target 2006 2005 value of plan assets were as follows: 28% 30%, 31% Domestic equity, 2006 .'2005 International 'equity' * . 19 18, 18 (in thousands) Fixed incomei,. 34'. 36 Real esta(e".!" 7 "12 13 10 Change in benefit obligation -

                                                                                                                                                          .        -     5)                 5 Benefit obligation at beginning of                                                                 Prfiate egdity'                                   8 year            '                                       $ 86,482            $ 75,435            Tota":'"'               '                                          100%                100%

Service cost 1,520 1,427 Interest cost 4,654 4,242 Amounts recognized in the badance sheets related to' Benefits paid (3,836) n' (3,937) t ohCiipany s other postretirement' benefit plans cohsist Actuarial (gain) loss 596 r 9,315 of thd f6fliwingi" ' n f.. plans" o"'st Retiree drug subsidy . . ... 257 2006 2005 Balance at end of year 89,673 86,482 ..(iithousands) Change in plan assets + r - R t assets" $ 29,107 $ Fair value of plan assets at Employee benefit obligations +(4,563) (31,961) beginning of .year 22,759 20,193

                                        "                '  -2,290'                 2,462              ,P6sented below are the' amourits included in Actual   return    on   plan  assets Employer contributions-                                           3,652           -. 4,051         accumulated other comprehensive'income and regulatory+

Benefits paid .' -)(5,012) (3,937) assets at December 31, 2006, related to the other Fair value of pin assets at end of" pstretirement benefit.plans that have ,not yet been year ": ". . 2, "22759 recognized In net-periodic postretirement benefit -cost (65,984) (63,723) Ilong with the estimated amortization of such amounts .for Funded status at end of year -. 24.,3 the1 hqext fiscal yeqr. Unrecognized transition amount Unrecognized prior service cost 1,398 Prior Net Unrecognized net loss 26,919 Service . (Gain)/ Transition Fourth quarter contributions , 1,421 -902 CoStt Loss Obligation (in thousands) Accrued liability (recognized in the balance sheet) $(64,563) (31,961) Balance at December 31, 2006: Regulatory asset $1,293 $25,618 ,., $2,196 Other postretirement benefits plan assets are managed and invested in aecordance w.ith all applicable Estimat damiortization as net periodic postretirement requirements,! including ERI.A and the Interal Revenue. b6eiifiti&t In 2607: : Code. The Company's investment policy covers a diversified mix of assets ,including equity and fixed., 1.. Regulatory asset $106-- $1,190. -...$346-income securities; reid estate, and private equity.. n p+ p*+4 s Lof the 1lComponents I. ._ postretirement, other "plans'

                                                                                                                                                                                    ,net.,

Derivative instruments are Vsed. primarily as hedging tools , - l,ý I* , - ,'- II , ,

periodic cost were as follows:

but may also be. used to gaip efficient exposure to the various asset classes. The Company prInarily minimizes. , . 2006 2005 2004 the risk of large losses thrpugh: diversification .but also (in thousands) - monitors and manages other, aspects of risk4 ;The actual. "Serice cost - 1,520 $ 1,427 $1,330 composition ofthe Company's other postretirement I 4,654 44;242 " 1 Interest cost'

               , .q. ,;;

i:.,* ' ,:l,. .:*I ".I:. I i' ,l . J "II ' * " Expected return on

                                                                                                      -plan assets--                      (1,642)       ---   (1,563)                (1',716)

Transition obligation 346 346 346 Prior sevle cost - 640 106 '

106 Recognizel net loss 41,2'0 "'166 408 Net postretirement cost $ 6,234 - $ 5,264 $4,489 11-281

NOTES (continued) Mississippi Power Company 2006 Annual Report In the third quarter 2004, the Company prospectively An additional assumption used in measuring the adopted FASB Staff Position 106-2, "Accounting and APBO was a weighted average medical care cost trend Disclosure Requirements" (FSP 106-2), related to the rate of 9.56 percent for 2007, decreasing gradually to Medicare Prescription Drug, Improvement, and 5.00 percent through the year 2015, and remaining at that Modernization Act of 2003 (Medicare Act). The Medicare level thereafter. An annual increase or decrease in the Act provides a 28 percent prescription drug subsidy for assumed medical care cost trend rate of 1 percent would Medicare eligible retirees. FSP 106-2 requires recognition affect the APBO and the service and interest cost of the impacts of the Medicare Act in the APBO and components at December 31, 2006 as follows: future cost of service for postretirement medical plan. The effect of the subsidy reduced the Company's expenses for 1 Percent the six months ended December 31, 2004 and for the Increase Decrease years ended December 31, 2005 and 2006 by (in thousands) approximately $0.5 million, $1.2 million, and $2.0 million, Benefit obligation $6,552 $5,567 respectively, aiid is expected to have a similar impact on Service and interest costs 393 350 future expenses. Future benefit payments, including prescription drug benefits, reflect expected future service and are estimated Employee Savings Plan based on assumptions used to measure the APBO for the postretirement plans. Estimated benefit payments are The Company also sponsors a 401(k) defined contribution reduced by drug subsidy receipts expected as a result of plan covering substantially all employees. The Company the Medicare Act as follows: provides an 85 percent matching contribution up to 6 percent of an employee's base salary. Prior to Benefit Subsidy November 2006, the Company matched employee Payments Receipts Total contributions at a rate of 75 percent up to six percent of (in thousands) the employee's base salary. Total matching contributions 2007 $ 3,878 $ (366) $ 3,512 made to the plan for 2006, 2005, and 2004 were 2008 4,253 (431) 3,822 $3.0 million, $2.9 million, and $2.8 million, respectively. 2009 4,628 (499) 4,129 2010 5,036 (565) 4,471 2011 5,370 (644) 4,726 3. CONTINGENCIES AND REGULATORY 2012 to 2016 31,526 (4,510) 27,016 MATTERS Actuarial Assumptions General Litigation Matters The weighted average rates ass umned in the actuarial The Company is subject to certain claims and legal calculations used to determine both the benefit obligations actions arising in the ordinary course of business. In as of the measurement date andI the net periodic costs for addition, the Company's business activities are subject to the pension and other postretire ment benefit plans for the extensive governmental regulation related to public health following year are presented be*low. Net periodic benefit and the environment. Litigation over environmental issues costs for 2004 were calculated using a discount rate of and claims of various types, including property damage, 6.00 percent. personal injury, and citizen enforcement of environmental 2006 2005 2004 requirements such as opacity and other air quality standards, has increased generally throughout the United Discount 6.00% 5.50% 5.75% States. In particular, personal injury claims for damages Annual salary increase 3.50 3.00 3.50 caused by alleged exposure to hazardous materials have Long-term return on plan become more frequent. The ultimate outcome of such assets 8.50 8.50 8.50 pending or potential litigation against the Company cannot be predicted at this time; however, for current The Company determined the long-term rate of proceedings not specifically reported herein, management return based on historical asset class returns and current does not anticipate that the liabilities, if any, arising from market conditions, taking into account the diversification such current proceedings would have a material adverse benefits of investing in multiple6 asset classes. effect on the Company's financial statements. 11-282

NOTES (continued) Mississippi Power Company 2006 Annual Report Environmental Matters penalties of $25,000 to $32,500 per day, per violation at each generating unit, depending on the date of the alleged New Source Review Acions " violation. An adverse outcome inany one of these, matters In November 1999, the EPA brought a civil action inthe could: require substantial capital expenditures that cannot U.S. District Court for the Northern District of Georgia be determined at this time and could possibly require.* against certain Southern Comprany subsidiaries, including payment ofsubstantial penalties. Such expenditures could Alabama Power and Georgia Powerr kleginig that thesei affect future results of operations, cash flows, ands...-- I subsidiaries had vi'late6dthe' New Source Review (NSR)' financial condition if such costs are not recovered through regulated rates. provisions of the Clean Air Act and reliated stie laws at certain coal-fired generating faciliies. Thr'ouih subsequent amendments and other legal procedures, the EnvironmentalRermediation EPA filed a separate action infJanuary 2001 ,against In 2003, the Texas Commission on Environmental Quality Alabama' Power in the U.S. District Court for the (TCEQ) de'signated the Company as a potentially ' ' Northern DIstrict of Alabama after Alabamia" Power was responsible pirty at a site in Texas.. The site was owned, these lawsuuts, the dismissed from the original actiion. In by an-elktric lransftrmer compahiy that handled the EPA alleged that NSR 'violations occurred at eight coal-, Cornpanytsti-ansformers as well as those of many other Alabama Power and fired generating facilities operated by entities., The site owner is now in bankruptcy and the, Georgia Power (including a ficility-foriely owned by State of Texas has entered into an agreement with the Savannah Electric), including one co-owned by the Company 0afid.'Several othei utilities to investigate and' Company. The civil actions request penalties and: remediate thelsite. Amounts'expensed during 2004, 2005, injunctive relief, including an order requiring the and 2006 related to this work were not material. installation of the best Available control technology at the Hundreds of entities have received notices frohi the affected uniits. ' " TCEQ requesting their participation 'in the anticipited site OnJune 19, 2006, the U.S. District Court for the remediation. The final outcome of this matter to the Northern District of Alabama entered a consent decree Company will depend upon further environmental. between Alabama Power and the EPA, resolving the asseis'l*4int afid the ultimate number of potentially alleged NSR violations at Plant Miller. The Xconsent responsible partia'aid cahnot now be determined. The' decree required Alabama Power to pay $100,000 to remediation'expenges incurred by the Company are resolve, the government's claim for a civil penalty and to expected to'be recovered through 'theECO'Plan. donate $4.9 million of sulfur dioxide emission allowances to a nonprofit charitable organizationt and formalized FERC .Matters specific emissions reductions to be accomplished by Mar)Wt-kasid 'RateAuthority Alabama Power, consistent withother Clean Air Act programs that require emissions reductions. On August 14, The Company has authorization from the FERC to sell 2006, the district court in:Alabama granted 'Alabam-a power to non-affiliates, including short-term opportunity Power's mLtion for summary judgment and eiitered final sales, at market-based prices. Specific FERC approval judgment in favorl f Alabama Power on the EPA's 'caims must be obtained with respectito a market-based contract,'. related to Plants Ba-ry, Gaston, Gorgas,' and Greene with an affiliate. County. The plaintiffs 64*e appea'led this decision to the;, In December 2004, the FERC: initiated a' proceeding U.S. Court of Appeals for the'Eleventh Circuit and, 'on November 14,' 2006, the'Eleventh Circu'it' granted to assess (Southern Company's generation dominance within its retail service territory, The :ability to charge plaintiffs' riquest to stiy the ippeal, pending the marker-based rates in other markets is not an issue inthat U.S. Supreme 'Couit'g rtiling in a -simiflar' NSR case filed proceeding.7 Ary new market-based rate sales by the':- by the EPA' aAihst Duke Energy. The action against Company, in ,Southern Company's retail service territory Georgia? Power has bbeei Idministratively closed sinic the spring of 2.001, and onfie of the parlies'has'~ought to entered into during a 15-month refund period beginning February ;27;,2005 could be subject wtorefund to the level' i reopen the case.' of the default cost-based rates, pending theoutcome of, The Company believes-that it complied with, the proceedingSuch sales through May '27. 2006, the end applicable laws and the EPA regulations and of therefund*period, were approximately $8.4 million for, interpretations in effect at the time the work. in question the Company. In the event that:the FERC's default', took place. ,The Clean Air Act authorizes maximum civil mitigation. measures for entities that are found to have 11-283

NOTES (continued) Mississippi Power Company 2006 Annual Report market power are ultimately applied, the Company may In connection with the formation of Southern Power, the be required to charge cost-based rates for certain FERC authorized Southern Power's inclusion in the IIC in wholesale sales in the Southern Company retail service 2000. The FERC also previously approved Southern territory, which may beý lower than negotiated market- Company's code of conduct. based rates. The final outcome of this matter will depend on the form in which the final methodology for assessing On October 5, 2006, the FERC issued an order generation market power and mitigation rules may be accepting a settlement resolving the proceeding subject to ultimately adopted and cannot be determined at this time. Southern Company's agreement to accept certain modifications to the settlement's terms. On October 20, In addition, in May 2005, the FERC started an 2006, SouthernCompany notified the FERC that it investigation to determine whether Southern Company accepted the modifications. The modifications largely satisfies the other three parts of the FERC's market-based involve functional separation and information restrictions rate analysis: transmission market power, barriers to entry, related to marketing activities conducted on behalf of and affiliate abuse or reciprocal dealing. The FERC Southern Power. Southern Company filed with the FERC established a new 15-month refund period related to this on November 6, 2006 an implementation plan to comply expanded investigation. Any new market-based rate sales with the modifications set forth in the order. The impact, involving any Southern Company subsidiary, including the of the modifications is not expected to have a material Company, could be subject to refund to the extent the impact on the Company's financial statements. FERC orders lower rates as a result of this new investigation. Such sales through October 19; 2006, the end of the refund period, were approximately - .. GenerationInterconnection Agreements $14.5 million for the Company, of which $7.3 million In July 2003, the FERC issued its final rule on the relates to sales inside the retail service territory discussed standardization of generation interconnection agreements above. The FERC also directed that this expanded and procedures (Order 2003). Order 2003 shifts much of proceeding be held in abeyance pending the outcome of the financial: burden of new transmission investment from the proceeding on the Intercompany Interchange Contract the generator to the transmission provider. The FERC has (1IC) discussed below. On January 3, 2007, the FERC indicated that Order 2003, which was effective January 20, issued an order noting settlement of the IIC proceeding 2004, is to be applied prospectively to new generating and seeking comment identifying any remaining issues. facilities interconnecting to a transmission system. Order and the proper procedure for addressing any such issues. 2003 was affirmed by the U.S. Court of Appeals for the The Company believes that there is no meritorious District of Columbia Circuit on January 12, 2007. The basis for these proceedings and is vigorously defending cost impact resulting from Order 2003 will vary on a itself in this matter. However, the final outcome of this case-by-case basis for each new generator interconnecting matter, including any remedies to be applied in the event to the transmission system. of an adverse ruling in these proceedings, cannot now be On November 22, 2004, generator company determined. subsidiaries of Tenaska, Inc. (Tenaska), as counterparties to three previously executed interconnection agreements Intercompany Interchange Contract with subsidiaries of Southern Company, filed complaints The Company's generation fleet is operated under the IIC, at the FERC requesting that the FERC modify. the as approved by the FERC. In May 2005, the FERC agreements and that those Southern Company subsidiaries initiated a new proceeding to examine (1) the provisions refund a total of $19 million previously paid for of the IIC among 'Alabama Power, Georgia Power, Gulf interconnection facilities, with interest. Southern Power, the Company, Savannah Electric, Southern Power, Company has also received requests for similar and SCS, as agent, under the terms of which the power modifications from other entities, though no other, pool of Southern Company is operated and, in particular, complaints are pending with the FERC. On January 19, the propriety of the continued inclusion of Southern 2007, the FERC issued an order granting Tenaska's Power as a party to the IIC, (2) whether any parties to requested relief. Although the FERC's order requires the the IIC have violated the FERC's standards of conduct modification-of Tenaska's interconnection agreements, the applicable to utility companies that are transmission order reduces the amount of the refund that had been providers, and (3) whether Southern Company's code of requested by Tenaska. As a result, Southern Company conduct defining Southern Power as a "system company" estimates indicate that no refund is due to Tenaska. rather than a "marketing affiliate" is just and reasonable. Southern Company has requested rehearing of the FERC's 11-284

NOTES (continued) Mississippi Power Company 2006 Annual Report order. The final outcome of this matter cannot'how be Retail Regulatory Matters determined. Performanin'EvaluationPlan Right of Way Litigation The Company's retail base rates are'set under' Performance Evaluation Plan (PEP), a rate plan approved Southern Company and certain of its subsidiaries,:. by the Mississippi PSC. PEP was, designed with the including the Company, Georgia Power, Gulf Power,.and objective that PEP would reduce the impact of rate.. Southern Telecom, have been named as defendants in changes -on the customer and provide incentives for the numerous lawsuits brought by :landowners -since 2001. Company 4o keep customer prices low and customer The plaintiffs' lawsuits claim that defendants may not. satisfaction and' reliability high. PEP is a mechanism for use, or sublease to third parties, some or all. of the fiber . rate adjustments based on three indicators: price, optic communications lines on the rights of way that cross customer. satisfaction, and service reliability. the plaintiffs' properties and that-such actions exceed the In May 20041,the Mississippi PSC approved the easements or other property .rights held by defendants. The plaintiffs -assert claims for, among other things, Company's request to modify certain portions of its PEP and to reclassify, to jurisdictional cost of service the' 266 trespass and unjust enrichment and seek compensatory megawatts of Plant Daniel Units 3 and 4 capacity, and punitive damages and injunctive relief. Management effective January 1, 2004. The Mississippi PSC authorized of the Company believes that it has complied with -, the Company to include the related costs and revenue applicable laws and that the plaintiffs' claims are without credits in jurisdictional rate base, cost of service, and. merit. revenue requirement calculations for purposes of retail To date, the Company has 'entered into agreements rate recovery.;The Company is amortizing the regulatory with plaintiffs in approximately 90 percent of the actions liability established pursuant to the Mississippi PSC's pending against the Company to clarify; the Company's interim, December 2003 accounting order, as approved in easement rights in the State of Mississippi. These

the May 2004 order, to earnings as follows: $16.5 million agreements have been approved by the Circuit Courts of in 2004,1$25.1 million in 2005, $13.0 million in 2006, Harrison County and Jasper County, !Mississippi (First and $5.7 million in 2007, resulting in increases to.

Judicial Circuit) and dismissals of the related cases are in earnings-in each of those years.- progress. These agreements have not had any material In addition, the Mississippi PSC also approved the impact on the Company's financial statements. Company's requested changes to PEP, including the use In.addition, in late 2001, certain subsidiaries of of a foriardlodking test year, With appropriate oversight; Southern Company, including Alabama Power, Georgia annual, rather than semi-annual, filings; and certain' cha'ges io the performance indicator mechanisms. Rate Power, Gulf Power, the Company, Savannah Electric, and Southern Telecom, were named as defendants in a lawsuit changes'will be limited to four percent of retail revenues brought by a telecommunications company. that uses an*ally und.r the revised PEP. The Mississippi PSC will certain of the defendants' rights of way. This lawsuit review all aspects of PEP in 2007. PEP will remain in alleges, among other things, that the defendants are effect until 'the 'Mississippi PSC modifies,, suspends, or contractually obligated to indemnify,'defend, 'and hold terminates the plan. harmless the telecommunications companiy from any In 'Mirch 2006, the Mississippi PSC approved the liability that'may be assessed againstuit in pending and Company's 2006 PEP filing, which included an annual future right of way litigation. The Company believes that retail baserate increase of 5 percent, or $32 million, to be the plaintiff's claims are' without merit.- In the fall of effectivein April 2006. Ordinarily, PEP limits annual rate 2004, the trial court stayed the case until resolution of the increases to 4. percent; however, the.Company had underlying landowner litigation' discussed abov'e. In' requested that the Mississippi PSC approve a temporary January 2005, the Georgia Court of Ap~peals dismissed the change"to allow' it'to exceed this cap as a result, of thde, telecommunications company's appealof the trial court's ongoing effects of Hurricane Katrina.. order for lack of jurisdiction. An adverse outcome in this matter, combined with an adverse'outcome against, the "Iri'December 2006, the Compan submitted its telecommunications company in one or more of the right annual PEP filing for 2007, which resulted in no rate of way lawsuits, could result in substantial judgments; change.' Pursuant to the PEP rate schedule, an order is not however, the final outcome of these matters cannot now required froin'the Mississippi PSC for the Company to be determined. continue to bill the filed rate in effect. 1I-285

NOTES (continued) Mississippi Power Company 2006 Annual Report System Restoration Rider Storm Damage Cost Recovery In September 2006, the Company filed with the. In August 2005, Hurricane Katrina hit the Gulf Coast of Mississippi PSC a request to implement a System the United States and caused significant damage within Restoration Rider (SRR), to increase the Company's cap' the Company's service area. The Company maintains a on the property damage reserve -and to authorize the reserve to cover the cost of damage from major storms to calculation of an annual property damage accrual 'based its transmission and distribution' facilities and the cost of on a formula. The purpose of~the SRR is to provide for. uninsured damage to its generation facilities and other recovery of costs associated with property damage property. A 1999 Mississippi PSC order allowed the (property insurance and the costs of self insurance) and to' Company to accrue $1.5 million to $4.6 million to the facilitate the Mississippi PSC's review of these costs. The reserve annually,' with a maximum reserve totaling' Company would be required to make annual SRR filings $23 million. In October 2006, in conjunction with the to determine the revenue requirement associated with the Mississippi PSC Hurricane Katrina-related financing property, damage. The Company recorded a regulatory order, the Mississippi PSC ordered the Company to cease liability in the amount of approximately $2.4 million in all accruals to the retail property damage reserve, until a 2006 for the estimated amount due to retail customers new reserve cap is established. However, in the same that would be passed through SRR. Ini Februiary 2007, the financing order, the Mississippi PSC approved the Company received an order from the Mississippi PSC replenishment of the property damage'reserve with approving the SRR. $60 million to be funded Wvith' a portion of the proceeds of bonds to be issued by the Mississippi Development Environmental Complianc Overview Plan Bank on behalf of the State of Mississippi and reported as liabilities by the State of Mississippi. The ECO Plan establishes procedures to facilitate the Mississippi PSC's overview of the Company's In June 2006, the Mississippi PSC issued an order environmental strategy and provides for recovery of costs based upon a stipulation between the Company and the (including cost of capital) associated with environmental Mississippi Public Utilities Staff. The stipulation and the projects approved by the Mississippi PSC. Under the ECO associated order certified actual storm restoration costs Plan, any increase in the annual, revenue requirement is relating to Hurricane Katrina through April 30, 2006 of limited to two percent of retail revenues. However, the $267.9 million and affirmed estimated additional costs ECO Plan also provides for carryover of any amount over through December. 31,.2007 of $34.5 million, for total the two percent limit into the' next year's revenue storm restoration costs of $302.4 million, which was net requirement. The Company conducts studies, when of expected insurance proceeds of approximately possible, to determine the extent of any required $77 million, without offset for the property damage environmental remediation. Should such remediation be reserve of $3.0 million. Of the total amount, determined to be probable, reasonable estimates of costs $292.8 million applies 'to the Company's retail to clean up such sites are developed and recognizeo in the jurisdiction. The order diiected the Company to file an financial 'statements. In accordance with the Mississippi application with the MDA for a Community Development PSC order, the'.Compay re'coveIrs such costs under the, Block Grant (CDBG). ECO' Plan as they are incurred. The Company filed the CDBG application with the. In February 2007, the Company filed with the MDA in September. 2006. On October, 30, 2006, the Mississippi PSC its annual ECO Plan evaluation for 2007. Company received from the MDA a CDBG in the amount The Company requested an 86 cent per 1,000 KWH of $276.4 million. The Company has appropriately,. increase for retail customers. This increase represents allocated and applied these CDBG proceeds to both retail: approximately $7.5 million in annual revenues for the and wholesale storm restoration cost recovery. The retail Company. Hearings with'the Mississippi PSCare portion of $267.6 million was applied to, the retail ., expected to be held in April 2007. In April 2006 the regulatory asset in the balance sheets. For the remaining, Mississippi PSC approved the Company's 2006 ECO wholesale portion of, $8.8 million, $3.3 million was: Plan, which included a 12 cent per 1,000 KWH reduction credited to operations and maintenance, expense in the for retail customers. This decrease represented a reduction statements of income, and $5.5 million was applied to of approximately $1.3 million, in annual, revenues for the accumulated provision for depreciation in the balance Company. The new rates were effective in April 2006. sheets. The CDBG proceeds related to capital of The outcome of the 2007 filing cannot now be $152.7 million and $120.3 million related to retail . determined. operations and maintenance expense are included in the 11-286

NOTES (continued) Mississippi Power Company 2006 Annual Report statement of cash flows as separate line items. The cash 4. JOINT OWNERSHIP AGREEMENTS portions of storm costs are included in the statements of cash flows under Hurricane Katrina accounts payable, The Company and Alabama Power own, as tenants in property additions, and cost of removal, net of salvage common, Uniis I and 2 with a total capacity of and totaled approximately $50.5 ýmillion, $54.2 million, 500 megawatts atGreene County Steam Plant, which is and $4.6 million, respectively, for 2006 and totaled located in Alabama and operated by Alabama Power. approximately $82.1 million, $81.7 million, and Additionallyrthe Company and Gulf Power, own as $18.4 million, respectively, for 2005. tenants in common, Units 1 and 2 with a total capacity of 1,000 megawatts ht Plant Daniel, which is located in The balance in the retail regulatory asset account at Mississippi anid operated by the Company. December 31, 2006, was $4.7 million, which is net of the

                                                                        .At'December 31, 2006, the Company's percentage retail portion of insurance proceeds of $80.9 million, CDBG proceeds of $267.6 million, and tax credits of               ownership, and investment in these jointly owned facilities

$0.3 million. Retail costs incurred through December 31, were ads follows: 2006, include approximately $148.1 million of capital and $124.5 million of operations and maintenance:, , Generating Percent Gross Accumulated Plaint Ownership Investment Depreciation expenditures. Of the $302.4 million total'storm costs affirmed by the Mississippi PSC, the Company has (in thousands) incurred total storm costs of $280.5 million as of GreenetCo'nkty 40% $ 75,668 $ 42,813 December 31, 2006. Units l and 2 The Company filed an application for a financing Daniel 50% $263,566 $130,025 order with the Mississippi PSC on July 3, 2006 for, Units I and 2 system restoration costs under the state bond program. On October 27, 2006, the Mississippi PSC issued a financing The Company's proportionate share of plant order that authorizes the issuance of $121.2 million of operating expenses is included in the statements of" system restoration bonds. This amount includes -.. income.

$25.2 million for the retail storm recovery costs not -.

covered by the CDBG, $60 million for a property damage reserve, and $36 million for the retail portion of the 5. INCoME TAXES construction of the storm operations facility. The bonds will be issued by the Mississippi Development Banklon Southern Company files a consolidated federal income tax behalf of the State of Mississippi and will be reported as retumr and combined income tax returns for the State of liabilities by the State of Mississippi. Periodic true-up" Alabama and the. State of Mississippi. Under a joint mechanisms will be structured to comply with terms and consolidated income tax allocation agreement, each requirements of the legislation. Details regarding the subsidiary's current and deferred tax expense is computed issuance of the bonds have not been finalized. The final on a stand-alboie basis and no subsidiary is allocated more outcome of this matter cannot now be ,determined. expense than wohld be paid if th*y filed a separate income tax return. In accordance with Internal Revenue The Mississippi PSC order also granted continuing Service regulations, each company, is jointly and severally authority to record a regulatory asset-iii an amount equal liable for thetax .!iability. to the retail portion of the recorded Hiurricane Katrina restoration costs. For any future event causing damage to At December,31, 2006, the tax-related regulatory property beyondtdie balance in the reserve, the order also assets andliabilities were $9.9 million and $18.2 million, granted the Company the authority. to record a regulatory. respectively. These assets are attributable to tax benefits asset. The Company would then apply to the Mississippi.. flowed through to customers in prior years and to taxes PSC for recovery of such amounts or for authority to applic'able t60capitalized interest. These liabilities are otherwise dispose of the regulatory asset. The Company attributable to deferred taxes previously recognized at continues to report actual storm expenses to the rates higher than the current enacted tax law and to Mississippi PSC periodically. unamortized investment tax credits. 11-287

NOTES (continued) Mississippi Power Company 2006 Annual Report Details of the income tax provisions were as follows: .: In accordance with regulatory requirements, deferred 2006 2005 2004 investment taxcredits are amortized over the lives of the. (in thousands) related property with such amortization normally applied as a credit to reduce depreciation in the statements of , Federal - Current $ 79,332' $?6f,933) $ 3,700 income.' Credits amortized in this manner amounted to.. Deferred (36,889)'. 102,659 '40;350 $1.1 millionfor 2006 and $1.2 million for each of 2005. 42,443 - 40,726 44,050 and 2004. At. December 31, 2006, all investment tax State - credits available to reduce federal income taxes payable Current 16,300. (10,009). 2,542 had been utilized. Deferred (10,646), , 15,657 4,074 In'2006, for purposes of filing the consolidated 5,654 5,648 6,616 Sotithern Company tax return, the Company treated Total $ 48,097 $ 46,374 .$50,666 certain ,items as tax capital gains rather than deferring The tax effects of temporary differences between the those 'gaifig over the life of the related assets. This , I carrying amounts of assets and liabilities in the financial allowed two Southern Holdings entities to utilize: certain statements and their respective. tax. bases, which give rise tax capital losses, in.the current year rather than carry to deferred tax assets and liabilities, are as follows: them forward to~future years. The Company has recorded a deferred, tax, liability of approximately $22.8 million

                                           -           2006           2005         related to these. Southern Holdings; entities in (in thousands)              "Accumulated Deferred Income Taxes" in the balance Deferred tax liabilities:                                                           sheets.

Accelerated depreciation $259,729 $269,188 Basis differences 13,615 8,630 The provision for income taxes differs from the Fuel clause under recovered 9,660 41,627 - amount of income'taxes determined by applying the' Regulatory assets associated applicable U.S. fedei'alV statutory rate to earnings before' with asset retirement incbmeý taxes and preferred'dividends as a result of the, obligations . 6,324,, 6,162 following: L Regulatory assets associated with employee 2006 2005 2004 benefit obligations 19,695 Federal statutory rate' . 35.0% 35.0% 35.0% Other 42,142 59,883 State income tax, net of Total 351,165 385,490 federal deduction, 3.0 3.0 3.3 Deferred tax assets: Non-deductible book . Federal effect of state Depreciation ,. 0.3 0.5 ,0.4 deferred taxes 11,252 13,642 Other_... (2.0) (0.5) (0.1) Other property basis differences k'8,538 9,244 Effective income, tax rate, * - 36.3%,,38.0%'. 38.6% Pension and other benefits 35,210 13,473 Property insurance . . 1,646 3,618 Unbilled fuel : . , 8,812' , 7,660

6. FINANCING Other comprehensive loss .,(388), 2,4,41 Asset retirement obligations. , 6,24 6,162 MandatOrily Redeemable Preferred Securitle ..

Regulatory liabilities , Long-Term Debt Payable to Affiliated Trust associated with employee The Company has formed a wholly-owned trust benefit obligations , 8,154-subsidiary for the. purose of issuing preferred securities. Other 31,244 44,961 The proceeds of the related eq.uity investment and Total " 110,792- 101,201 preferred secunity sale were loaned back' to the Company Total deferred tax throughi' the issuance of junior subordinated noties totaling liabilities, net 240,373 284,289 $36 milliion, which constitute substanti ai. all of the Portion included in assets of the trustand 'are reflected in the' balance sheets' accrued income taxes, net ':i (4,171) (17,660) as Long-term Debt Payable to Affiliated Trust (including Accumulated deferred .. SecuI-ities:Die Within One Year). The Company considers income taxes in the -. , that the mechanisms 'and obligations relating to the- : " balance sheets - $236,202 $266,629 preferred securities issued for its benefit, taken together, 11-288

NOTES (continued) Mississippi Power Company 2006 Annual Report constitute a full and unconditional guarantee by it.of the December'31, 2006, the Company had $51.4 million , trust's payment obligations with respect to these : . outstanding. in commercial notes. The credit arrangements securities. ,At December 31, 2006, preferred securities of also provide support to the Company's variable daily rate- $35 million were outstanding, See Note 1 under "Variable tax-exempt pollution control bonds totaling $40.1 million. Interest EntitieS" for additional information on. the During 2006, the peak amount outstanding for shod-accounting treatment for the trust and the related amount term debt was 1$372.3 million and the averageannual securities.. outstanding was $256.8 million. The average

interest rate on short-term debt was 5.19 percent for 2006.

Pollution Control Bonds , - and"3.85.percýnt for *00. Pollution control obligations represent Ioans to the Company from public authortes of funds derived from Finaný,pjnstruents sales by such authorities of revenu6 bonds isusied to finance pollution control facilities. The Company is The Company'also enters into energy-related derivatives required to make payments sufficient for authoi-ties to to'hedgeexli6sures to electricity, gas, and other fuel price meet principal and interest requirements of such bonds. changes. However, due to cost-based rate regulations,'the The amount of tax-exempt pollution control ,revenue Company has limited exposure to market volatility in. bonds outstanding at December 31, 2006' was commodity fuel prices and prices of electricity. The

$82.7 million.                                                      Company has implemented fuel-hedgingprograms With the approval -of the Mississippi PSC. The Company enters into hedges ofoiward f               electricity sales, There was no Outstandinj Classes of Capital 'Stocki material m'ieffectiv'e'ness recorded in earnings in 2006, The Company currently' has preferred stock,;depositary,              2005, or201.

preferred stock (each share, of depositary preferred 'tock representing one-fourth of a share of preferred' stock), and At December, 31 2006, the fair value gains/(losses) - common stock ouistanding.: The Company's preferred of energy'related derivative contracts 'were reflected in the stock and depositary prefeiied 'st6ck, without preference financial' statements as follows:, . ' between classes, rank senior to'the Company's common Amounts stock with respect to payment of dividends and voluntary (in thousands) or involuntary dissolution. .Certain series of the preferred Regul atory assets, net, -$(7,321) stock and depositary preferred stoci are subject to' redemption at the option of the Company on or after a Accunitflaie 6tlier tompre ensi.e income 969 specified date, Net income'. ' '(8) Bank Credit Arrangements Total fair .value $(6,360)

                                                                                     !: ,1 .:
                                                                                   .:'.         ..                                    h d e At the beginning of 2007, the Company had total unused                      The .fa*,Vr.ue gains or losses for cash flow hed'ges committed credit agreements with banks of $181 million,              are recorded as regulatory assets and liabilities, if they Are, Of the total, $101 million expires in 2007 and $80 million          recoyerable through the regulatory clauses, otherwise they in 2008. The facilities contain $39 million 2-7year, term. [:_       are recorded in other comprehensive income, and are loan options and $15 million 1-year term loan options., ,!           recognized in earnings at the same time 'the hedged                 items '

The Company expects to renew its-credit facilities, as 'arnngs. F'orithe year 2007, approximýately affedct needed, prior to expiration.

                                                                     $1.0 million 6tf pre-tax. gains are expected to be ' ,

In connection with these 'credit artangementsA'the.' reclissified 'frQm other comprehensive income to fuel': Company agrees to pay commitment fees based on the expense!Tlie:Compahy has energy-related hedges in'place unused portions of the commriitments or to maintain up to and 'iffldding 2009. . '. .... . -' compensating balances with the binks. Commitment fees are of i' percent or,,Iess for the'Comnpany. " 7. 'COMMITMENTS' "- '.:'. Compensating balances are not leglly restrictedfirom withdrrawal.' Construction Program This $181 million in unused credit arrangements' The Company is eifigaged in continuous construction' provides required liquidity support to the Company's. programs;,'cuirently estimated to total $146 million in borrowings through a commercial'paper program. At 2007i'of which $6 million is related to Hurricane Katrina 11-289

NOTES (continued) Mississippi Power Company 2006 Annual Report restoration, $258 million in 2008, and $161 million in at various intervals based on actual operating hours of the 2009. The construction program is subject to periodic unit. Payments to ABB under this agreement are currently review and revision, and actual construction costs may estimated to total $0.6 million over the remaining term of vary from the above estimates because of numerous the agreement, which is approximately three months. factors. These factors include changes in business However, the LTSA contains various cancellation conditions; acquisition of additional generation assets; provisions at the option of the Company. Payments made revised load growth estimates; chahges in environmental to ABB prior to the performance of any planned regulations; changes in FERC rules and regulations; maintenance are recorded as a prepayment in the balance increasing costs of labor, equipment,. and materials; and sheets. Inspection costs are capitalized or charged to,-

cost of capital. At December 31, 2006, significant expense based on the nature of the work performed. After purchase commitments were outstanding in connection this contract expires, the Company expects to replace it with the construction program. The Company has &io with a newf contract with similar terms.

generating plants under construction. Capital improvements to generating, transmission, and distribution Fuel Commitments facilities, including those to meet environmental standards, will continue. To supply a portion of the fuel requirements of the generating plants, the Company has entered into various Long-Term Service Agreements. long-term commitments for the procurement of fuel. In most cases, these contracts contain provisions for price The Company has entered'into a Long-Term Service escalations, minimum purchase levels, and other financial Agreement (LTSA) with General Electric (GE) for the commitments. Coal commitments include forward purpose of securing maintenance support for the leased contract purchases for, sulfur dioxide emission allowances. combined cycle units at Plant Daniel. The LTSA provides Natural gas purchase commitments contain fixed volumes that GE Will perform all planned inspections on the with prices based on various indices at the time of covered equipment, which includes the cost of all labor delivery. Amounts included in the chart below represent and materials. GE is also obligated to: cover the costs of estimates based on New York Mercantile Exchange future unplanned maintenance on the covered equipment subject prices at December 31, 2006. to a limit specified in the contract. Total estimated minimum long-term obligations at In general, the LTSA is in effect through, two major December 31, 2006 were as follows: inspection cycles of the units. Scheduled payments to GE are made monthly based on estimated operating hours of Year Natural Gas Coal the units and are recognized as expense based on actual (in thousands) ý hours of operation. The Company has recognized 2007 $140,242 $280,602 $8.4 million, $7.9 million, and $9.0 million for 2006, 2008 112,049 '222,905 2005, and 2004, respectively, which is included in 2009 81,482 48,280 maintenance expense 'in the statements of income. 2010 50,612 19,500 Remaining payments to GE under this agreement are 201.1 19,559 15,600 currently estimated to total $154 million over the next 2012 and thereafter 248,697 '. 31,200 13 years. However, the LTSA contains various cancellation provisions at the option of the Company. Total commitments $652,641 $618,087 The Company also has entered into a LTSA with Additional commitments for fuel will be required to ABB Power Generation Inc. (ABB) for the purpose of supply the Company's future needs.: securing maintenance support for its Chevron Unit 5 combustion turbine plant. In summary, the LTSA SCS may enter into various types of wholesale stipulates that ABB will perform all planned maintenance energy and natural gas contracts acting as anagent for the on the covered equipment, which includes the cost of all Company and the other traditional operating companies labor and materials. ABB is also obligated to cover the and Southern Power. Under these agreemenis, each of the costs of unplanned maintenance on the covered equipment traditional operating companies and Southern Power may subject to a limit specified in the contract. be jointly and severally liable. The creditworthiness of Southern Power is currently inferior to the In general, this LTSA is in effect through two major creditworthiness of the traditional operating companies. inspection cycles. Scheduled payments to ABB are made Accordingly, Southern Company has entered into keep-11-290

NOTES (continued) Mississippi Power Company 2006 Annual Report well agreements with the-Company and each of the 6ther during a period when retail access was under review by traditional operating companies: to ensure the Company' the Mississippi PSC. The lease arrangement provided a will not subsidize or be responsible for any costs, losses, lower cost alternative to its cost based rate regulated liabilities, or damages resulting from the inclusion of customers ihana traditional -rate base-asset. See Note 3 Southern Power as a contracting party under these under "R'letail Regulatory Matters - Performance agreements. Evaluation Plan" for a description of the Company's forrinila rate plan. Operating Leases In 2003, the Facility was acquired by Juniper Capital Railcar Leases-, L.P.-: Junfiper), whose partners are unaffiliated with the Company. Simultaneously, Juniper entered into a "- The Company and Gulf Power have jointly entered into. operating lease agreements for the use-of 745 aluminum restruýitrd'lease agreement. with the Company. Juniper has also entered into leases with other parties unrelated to railcars. The Company has the option to purchase the railcars at the greater of lease terminatiow value or fair the Company. The assets leased by the Company, market value, or to renew the leases at the end of the comprise less than 50 percent of,Juniper's assets. The lease term. The Company also has miltiple operating Company is not required to consolidate the leased assets lease agreements for the use of an additional and' related 1fagilities, 'and the lease with Juniper is 120 aluminum railcars that do not contain a purchase I e:.d a-ý anopera-considered operatinging ...... The lease.. . ....

                                                                                                                   ý . agreement lease ... . .. ..is option. All of these leases are forthe transport of coal to            treated an operating lease, for, accounting purposes, as Plant Daniel.                                                          well as for .Ioth retail and 'wholesale rate recovery, purposes,'for income tax purposes, the Company retains The Company's share (50 percent) of the leases,                 tax ownership. The initial lease term ends imn2011 and the charged to fuel stock and recovered through the fuel 'cost lease includes a purchase and renewal option. based on the recovery clause, was $4.6 million -in 2006, $3.0 million in cost of the Facility at thp inception of the lease, which 2005, and $1.9 million in 2004. The Company's annual was $37,Q million.. The Company is requiredto amortize lease payments for 2007 through 2011 will average approýimately four percent.of the initial acquisition cost approximately $2.4 million and after 2012, lease -

over the initial lease term. Eighteen months prior to the payments total in aggregate approximately $3.6 million.- end of the -initial lease, the Company may elect to renew,

In addition to railcar leases, the Company has other for 10 years. -Ifthe lease is renewed, the agreement calls:

operating leases for fuel-handling equiprmient at Plants for the.Company to amortize an -additional 17 percent of* Daniel and Watson and operating leases for barges-and the initial crmpletion dost over the'renewal period. Upon> tow/shift boats for the transport of coal at Plant ,Watson. terminiati6n'of the Ilease,' at the. Company's option, 'it may The Company's share (50 percent at Plant Daniel and: - either exeicise'its purchase ciption or the Facility can be 100 percent at Plant Watson) of the leases for fuel sold t a third party.'......,. handling was charged to fuel hadhirig expense mi th amount of $0.9 fiffllio in 2066 n $0.6 rilionm i2005. Th~eleasepirovides for" a residual ,value guarantee, The Company's ann'uAl lease' paymients for 2007 thiough approximately' 73 percent of the acquisition cost,' by the", 2011 will average -apprqximately $0.5 million. The ; Company, that' is due uipon tei-minatibih of the lease 'ini th6 " Company. charged to fuel, stock and recovered through event tliart'he' Company does niot renew the lease or fuel.-cost recovery the barge transportationi leases in the.i?- purchagse'di 'FTcility and that the fair market value'is le'ss amount of $4.9. million in, 2006 related to barges and than the unamortized cost of the Facility. A liability' tow/shift boats. The Company's annual lease payments for approximately $9 million and $11 million for the fair 2007 through 2009, with regards to these barge market value of this residual value guarantee is included transportation leases, will average approximately in the balance sheets at December 31, 2006 and 2005,

$4.9 million.

respectively. Lease expenses were $27 million,

                                                                       $27 million, and $25 million in 2006, 2005, and 2004, PlantDaniel Combined Cycle Generating Units respectively.

In May 2001, the Company began the initial 10-year term of the lease agreement for a 1,064 megawatt natural gas The Company estimates that its annual amount of combined cycle generating facility built at Plant Daniel future minimum operating lease payments under this (Facility). The Company entered into this transaction arrangement, exclusive of any payment related to the 11-291

NOTES (continued) Mississippi Power Company 2006 Annual Report residual value guarantee, as of December 31, 2006, are as The Company's activity in the stock option plan for follows: 2006 is summarized below: Year Lease Payments Weighted (in thousands) Shares Average 2007 $ 28,718 Subject Exercise 2008 28,615 to O*ption Price 2009 28,504 Outstanding at 2010 28,398 December 31, 2005 1,444,438 $26.86 2011 28,291 Granted 254,135- 33.81 2012 and thereafter Exercised (214,761) 22.95 Total commitments $142,526 Cancelled (569) 32.71 Outstanding at

8. STOCK OPTION PLAN December 31, 2006 1,483,243 $28.62 Southern Company provides non-qualified stock options Exercisable at -

to a large segment of the Company's employees ranging December 31, 2006 1,007,549 $26.68 from line management to executives. As of December 31, 2006, there were 272 cuffeht 'and former employees of the The number of stock options vested and expected to Company participating in the stock option plan. The vest in the future as of December 31, 2006, is not maximum number of shares of Southern Company significantly different from the number of stock options common stock that may be issued under these programs outstanding at December 31, 2006 as stated above. may not exceed 57 million. The prices of options granted As of December 31, 2006, the weighted average to date have been at the fair market value of the shares on remaining contractual term for the options outstanding the dates of grant. Options granted to date become and options exercisable is 6.1 years and 5.0 years, exercisable pro rata over a maximum period of three respectively, and the aggregate intrinsic value for the years from the date of grant. The Company generally options outstanding and options exercisable is recognizes stock option expense on a straight-line basis $12.2 million and $10.3 million,ý respectively. over the vesting period which equates to the requisite service period; however, for employees who are eligible As of December 31, 2006, there was $0.4 million of for retirement the total cost is expensed at the grant date. total unrecognized: compensation cost related to stock Options outstanding will expire; no later than 10 years option awards not yet vested. That cost is expected to be after the date of grant, unless terminated earlier by the recognized over a weighted-average period of Southern Company Board of Directors in accordance with approximately 11 months. the stock option plan. For certain stock option awards a The total intrinsic value of options exercised during change in control will provide accelerated vesting. As part the years ended December 31, 2006, 2005, and 2004 was of the adoption of SFAS No. 123(R), as discussed in $2.4 million, $4.3 million, and $2.3, million, respectively. Note 1 under "Stock Options," Southern Company has not modified its stock option plan or outstanding stock The actual tax benefit realized by the Company for options, nor has it changed the underlying valuation the tax deductions from stock option exercises totaled assumptions used in valuing the stock options that were $0.9 million, $1.7 million, and $0.9 million, respectively, used under SFAS No. 123. for the years ended December 31, 2006, 2005, and 2004. 11-292

NOTES (continued) Mississippi Power Company 2006 Annual Report I,,

9. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Summarized quarterly financial data for 2006 and 2005 are as follows:

Net Income AfterDividends q Operating Operating On Preferred Quarter Ended Revenues Income Stock

                                 '(in thousands)

March 2006 $208,941 '$18,728 $15,282 June 2006 254,920 40,392 -22,766 September 2006 310,747 ý2;215 3*,638 December 2006 234,629 21,584 . - 7,314 - March 2005 $215,216 $31,904 $16,947 June 2005 248,576 .43,059 25,632 September 2005 277,907 51,975 28,244 December 2005 228,034 7,502 2,985 The Company's business is influenced by seasonal weather conditions. 11-293

SELECTED FINANCIAL AND OPERATING DATA 2002-2006 Mississippi Power Company 2006 Annual Report 2006 2005 2004 2003 2002 Operating Revenues (in thousands) $ 1,009,237 $ 969,733 $ 910,326 $ 869,94' $ 924,165 Net Income after Dividends on Preferred 'A Stock (in thousands) $ 82,010 $ 73,808 $ 76,801 $ 73,499 $ 73,013 Cash Dividends on Common Stock (in 6 6003 thousands) $ 65,200 $ 62,000 $ 66,200 $ 66,000 $ 63,500 Return on Average Common Equity (percent) 14.25 13.33 14.24 13.99 14.46 Total Assets (in thousands) $ 1,708,376 $ 1,981,269 $ 1,479,113 $ 1,511,174 $ 1,482,040 Gross Property Additions (in thousands) $ 127,290 $ 158,084 $ ,70,063 $ 69,345 $ 67,460 Capitalization (in thousands): _- Common stock equity $ 589,820 $ 561,160 $' 545,837 $ 532,489 $ 517,953 Preferred stock 32,780 32,780 32,780 31,809 31,809 Mandatorily redeemable preferred securities - . - - 35,000 . 35,000 Long-term debt payable to affiliated trust 36,082 36,082 :36,082 " Long-term debt 242,553 242,548 .242,498 202,488 243,715 Total (excluding amounts due within one year) $ 901,235 $ 872,570 $ 857,197 $ 801,786 $ 828,477 Capitalization Ratios (percent): Common stock equity 65.4 64.3 63.7 66.4 62.5 Preferred stock 3.6 3.8 3.8 4.0 3.8 Mandatorily redeemable preferred securities - - - 4.4 4.2 Long-term debt payable to affiliated trust 4.0 4.1 4.2 - - Long-term debt 27.0 27.8 28.3 25.2 29.5 Total (excluding amounts due within one year) 100.0 100.0 100.0 100.0' 100.0 Security Ratings: First Mortgage Bonds - Moody's - Aa3 Aa3 Aa3 Standard and Poor's - A+ A+ A+ Fitch - AA AA- AA-Preferred Stock - Moody's A3 A3 A3 A3 A3 Standard and Poor's BBB+ BBB+ BBB+ BBB+ BBB+ Fitch A+ A+ A+ A A Unsecured Long-Term Debt - Moody's Al Al Al Al Al Standard and Poor's A A A A A Fitch AA- AA- AA- A+ A+ Customers (year-end): Residential 147,643 142,077 160,189 159,582 158,873 Commercial 32,958 30,895 33,646 33,135 32,713 Industrial 507 512 522 520 489 Other 177 176 183 171 171 Total 181,285 173,660 194,540 193,408 192,246 Employees (year-end) 1,270 1,254 1,283 1,290 1,301 11-294

SELECTED FINANCIAL AND OPERATING DATA 2002-2006 Mississippi Power Company 2006 Annual Report (continued) 2006 2005 2004 2003 2002 Operating Revenues (inthousands): Residential $ 214,472 $ 209,546 $ 199,242 $ 180,978 $ 186,522 Commercial 215,451 213,093 199,127 175,416 181,224 Industrial 211,451. 190,720 180,516 154,825 164,042 Other 5,812 5,501 5,428 5,082 5,039 Total retail 647,186 618,860 584,313 516,301 536,827 Sales for resale - non-affiliates 268,850 283,413 265,863 249,986 224,275 Sales for resale - affiliates 76,439 50,460 44,371 26,723 46,314 Total revenues from sales of electricity 992,475 952,733 894,547 793,010 807,416 Other revenues 16,762 17,000 15,779 76,914 16,749 Total $ 1,009,237 $ 969,733 $ 910,326 $ 869,924 $ 824,165 Kilowatt-Hour Sales (inthousands): Residential 2,118,106 2,179,756 2,297,110 2,255,445 2,300,017 Commercial 2,675,945 2,725,274 2,969,829 2,914,133 2,902,291 Industrial 4,142,947 3,798,477 4,235,290 4,111,199 4,161,902 Other 36,959 37,905 40,229 39,890 39,635 Total retail 8,973,957 8,741,412 9,542,458 9,320,667 9,403,845 Sales for resale - non-affiliates 4,624,092 4,811,250 6,027,666 5,874,724 5,380,145 Sales for resale - affiliates 1,679,831 896,361 1,053,471 709,065 1,586,968 Total 15,277,880 14,449,023 16,623,595 15,904,456 16,370,958 Average Revenue Per Kilowatt-Hour (cents): Residential 10.13 9.61 8.67 8.02 8.11 Commercial 8.05 7.82 6.70 6.02 6.24 Industrial 5.15.02 4.26 3.77 3.94 Total retail 7.21 7.08, 6.12 5.54 5.71 Sales for resale 5.48 5.85 4.38 4.20 3.88 Total sales 6.50 6.59 5.38 4.99 4.93 Residential Average Annual Kilowatt-Hour Use Per Customer 14,480 14,111 14,357 14,161 14,453 Residential Average Annual Revenue Per Customer $ 1,466 $ 1,357 $ 1,245 $ 1,136 $ 1,172 Plant Nameplate Capacity Ratings (year-end) 3,5 (megawatts) 3163,156 3,156 3,156 3,156 Maximum Peak-Hour Demand (megawatts): Winter 2,204 2,178 2,173 2,458 2,311 Summer 2,390 2,493 2,427 2,330 2,492 Annual Load Factor (percent) 61.3 56.6 62.4 60.5 61.8 Plant Availability Fossil-Steam (percent) 81.1 82.8 91.4 92.6 91.7 Source of Energy Supply (percent): Coal 63.1 58.1 55.7 57.7 50.8 Oil and gas 26.1 24.4 25.5 19.9 37.7 Purchased power - From non-affiliates 3.5 5.1 6.4 3.5 3.1 From affiliates 7.3 12.4 12.4 18.9 8.4 Total 100.0 100.0 100.0 100.0 100.0 11-295

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SOUTHERN POWER COMPANY FINANCIAL SECTION 11-296

REPORT OF INDEPENDENT REGISTERbD PUBLIC ACCOUNTING FIRM Southern Power Company Acc6rdingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting We have audited the accompanying, consolidated balance the amounts and disclosures in the financial statements, sheets of Southern Power Company and Subsidiary assessing the accounting principles used and significant Companies (the "Company") (a wholly owned subsidiary estimates made by management, as well as evaluating the of Southern Company) as of December 31, 2006 and 2005, and the related consolidated statements of income,. overall f'mnncial statement presentation. We believe that comprehensive income, common stockholder's equity, and our audits provide a reasonable basis for our opinion. cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the Inbur opinion, such consolidated financial responsibility of the Company's management Our statements (pages 11-312 to 11-325) present fairly, in all responsibility is to express an opinion on these financial matefial respects, the financial position bf Southern Power statements based on our audits. Company-and Subsidiary Companies at December 31, 2006 and 20(,5 aind the results of their operations and We conducted our audits in accordance with the their cash flpwý for each of the thrge years in the period standards of the Public Company Accounting Oversight ended December 31, 2006, in conformity with accounting Board (United States). Those standards require that we principles generally accepted in the United States of. plan and perform the audit to obtan reasonable assurance America., about whether the financial siatements:are free of material misstatement. The Company is nottiequir&d to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of the" Atlanta, Peorgia Company's internal control over finahcial reporting. February 26,; 2007

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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL. CONDITION AND RESULTS OF OPERATIONS Southern Power Company and Subsidiary Companies 2006 Annual Report OVERVIEW wholesale contracts exceeds 10 years, which reduces re-marketing risk. The Company continues to face Business Activities challenges at the federal regulatory level relative to Southern Power Company and its wholly-owned market'power and affiliate transactions. See FUTURE subsidiaries (the Company) construct, acquire, own, and EARNINGS POTENTIAL - "FERC Matters" for manage generation assets and sell electricity at market- additional information. based prices in the Super-Southeast wholesale market. The Company focused on executing its regional strategy Key Performance Indicators in 2006 by signing purchased power agreements (PPAs) with investor owned utilities and electric cooperatives as To evaluate operating results and to ensure the Company's well as acquiring generation with existing PPAs. ability to meet its contractual commitments to customers, the Company focuses on several key performance In June 2006, the Company acquired all of the indicators. These indicators consist of plant availability, outstanding membership interests of DeSoto County peak season equivalent forced outage rate (EFOR), and Generating Company, LLC (DeSoto) from a subsidiary of net income. Plant availability shows the percentage of Progress Energy, Inc. DeSoto owns a 344 megawatt time during the year that the Company's generating units (MW) nameplate capacity dual-fueled simple cycle are available to be called upon to generate (the higher the combustion turbine plant in Arcadia, Florida. The better), whereas the EFOR more narrowly defines the Company has PPAs with Florida Power & Light Company hours during peak demand times when the Company's (FP&L) covering the entire output of the plant. generating units are not available due to forced outages In September 2006, the Company acquired all of the (the lower the better). Net income is the primary outstanding membership interests of Rowan County component of the Company's contribution to Southern Power, LLC (Rowan) from the same subsidiary of Company's earnings per share goal. The Company's Progress Energy, Inc. Rowan was merged into the actual performance in 2006 surpassed targets in these key Company and the Company now owns a 986 MW performance areas. See RESULTS OF OPERATIONS nameplate capacity dual-fired generating plant near herein for additional information on the Company's Salisbury, North Carolina. The Company currently has financial performance. PPAs with Duke Power, LLC (Duke), North Carolina Municipal Power Agency No. 1 (NCMPA 1), and Energy Earnings United Electric Membership Corporation (EnergyUnited) covering much of the output of the plant. The Company's 2006 earnings were $124.5 million, a

                                                                   $9.7 million increase over 2005. This increase was In 2006, the Company continued construction on               primarily the result of new PPAs starting or acquired in three ongoing projects. One project is Franklin Unit 3, a          the period, including contracts with Piedmont Municipal combined cycle unit with an expected capacity of                   Power Authority (PMPA) and EnergyUnited and the PPAs 621 MW near Smiths, Alabama. This plant is expected to             related to the acquisition of Plants DeSoto and Rowan in be completed in 2008. The second project is Oleander               June 2006 and September 2006, respectively. Short-term Unit 5, a combustion turbine with an expected capacity of          energy sales and increased sales from existing resources 160 MW, in Brevard County, Florida, which is expected               also contributed to this increase.

to be completed in late 2007. The third project is an Integrated Gasification Combined Cycle (IGCC) project The Company's 2005 earnings were $114.8 million, in Orlando, Florida, expected to be completed in 2010. a $3.3 million increase over 2004. The 2005 increase was This project is a partnership with the Orlando Utilities primarily attributed to the acquisition of Oleander in June Commission (OUC) and is located at OUC's Stanton 2005 and additional revenues associated with energy Energy Center site. A cooperative agreement with the margins from fully contracted units, which were partially U.S. Department of Energy (DOE) provides up to offset by the expiration of PPAs at Plant Dahlberg. In $235 million in funding to be applied by the joint owners addition, interest expense increased in connection with the for the construction and demonstration of the gasification Oleander acquisition as well as the reduction in interest portion of this project. capitalized related to the conclusion of the Company's initial construction program. As of December 31, 2006, the Company had 6,733 MW nameplate capacity in commercial operation. The Company's 2004 earnings were $111.5 million. The weighted average duration of the Company's This was a decrease of $43.6 million from 2003 primarily I-.298

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued). Southern Power Company and Subsidiary Companies 2006 Annual Report the result of a one time $50 million gain in May 2003 PPA for Plant Harris Unit 2 became effective in June from the termination of PPAs with Dynegy Inc. 2004. These increases were partially offset by the expiration of PPAs at Plant Dahlberg. RESULTS OF OPERATIONS Operating revenues in 2004 were $701.3 million, a A condensed income statement is as follows: $19.5 million (2.9 percent) increase from 2003. The Increase (Decrease) increase was primarily related to a full year of revenues Amount From Prior Year under PPAs from new units. Plant Harris Units 1 and 2 2006 2006 - ;(2005 2004 and Plant Franklin Unit 2 were placed in service in June (inthousands) 2003. Plant Stanton A was placed in service in October Operating revenues $777,048 $ (3,956) $ 79,693 $ 19,531 2003.' Fuel 145,236 (63,772) 81,905 11,847 Capacity revenues are an integral component of the Purchased power 170,697 10,641 (28,400) 3,155 Other operations Company's* PPAS with both affiliate and non-affiliate and maintenance 95,276 14,471 5,610 12,954 customers and represent the greatest contribution to net Depreciation and income. Energy under PPAs is generally sold at variable amortization 65,959 11,705 3,093 12,149 cost or is indexed to published gas indices. Energy Taxes other than revenues also include fees for support services, fuel income taxes 15,637 2,323 2,041 4,608 storage, -and unitstart*charges. Details of these PPA Total operating capacity and'energy revenues are as follows: expenses 492,805 (24,632) '64,249 44,713 Operating income 284,243 20,676 15,444 (25,182) 2006 2005 2004 Other income, net 2,191 (188) .(29) 4,002 Less - (in thousands) Interest expense Capacity revenues and other, net 80,154 832 .13,234 34,380 Affiliates $279,089 $278,22i $247,914 Income taxes 81,811 9,978 (1,102) (12,286) Cumulative effect Non-Affidiates .103,365 68,645 73,980 of accounting Total 382,454 346,866 321,894 change - . - (367) Energy revenues Net Income $124,469 $ 9,678 $ 3,283 $(43,641) Affiliates: , 190,046 254,844 124,837 Non-Affiliates .' 144,891 141,496 80,825 Revenues Total"' *, 334,937 ,396,340 205,662 Total PPA' Operating revenues in 2006 were $777 imillion,'a revenues $717,391 $743,206 $527,556 $4.0 million (0.5 percent) decrease from"2005. This decrease was primarily due to reduced eneigy revenues as a result of lower natural gas prices. Thisi reduction is . Revenues from sales to affiliated companies within accompanied by a reduction in related fuel costs and does the Southern Company system that are not covered by not have a significant net income impact. Offsetting this PPAs are. made in accordance with the Intercompany energy related reduction were increasedsales from a full Interchange Contract (IIC), as approved by the Federal year of operations at Plant Oleander and new sales under Energy Regulatory Commission (FERC), and will vary PPAs with PMPA, EnergyUnited and those PPAs acquired depending on demand and the ,availability and cost of in the DeSoto and Rowan acquisitions.: See FUTURE generating resources at each.company that participates in EARNINGS POTENTIAL - "Power Sales Agreements" the centralized operation and dispatch of the Southern and Note 2 to the financial statements under "DeSoto and Company fleet of generating plants (Southern Pool). Rowan Acquisitions." , These transactions do not have a significant impact on earnings since the energy is generally sold at variable Operating revenues in 2005 were*$781.0oillion, a cost. $79.7 million (11.4 percent) increase from 2004; This increase was primarily due to PPAs, related to the Other operating revenues increased by $4.6 million Oleander acquisition" a new PPA 'With Fliht Energies (360.4 percent) from 2005. This increase reflects new (Flint EMC), and a. full year of revenue from PPAs with PPAs, in 2006 with PMPA and EnergyUnited and is Georgia Power at Plant Franklin Unitr2 andPlant Harris primarily the result of additional transmission revenues. Unit 2. The Georgia Power PPA for Plant Franklin Unit 2 These transmission revenues are largely. offset by had a scheduled sales increase in June 2004, while the additional transmission expenses included in operations 11-299

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Power Company and Subsidiary Companies 2006 Annual Report and maintenance expenses and do not contribute Purchased power increased $3.2 million (1.7 percent) substantially to net income. in 2004 over 2003;'consisting of a $15.4 million increase for non-affiliates and a $12.3 million decrease for Expenses affiliates as a result of the availability of lower cost energy from contracts with Georgia electric membership Fuel and PurchasedPower corporations (EMO)'and North Carolina municipIalities, in addition to other market sources. Purchased power may In 2006, fuel expense decreased by $63.8 million change markedly year to year as weather, fuel prices, and (30.5 percent) compared to 2005. The decrease was availability of lower cost energy resources influence the driven by a 25.4 percent reduction in the average cost of demand and optimal economics to serve the Company's natural gas. Gas prices in 2006 were lower and had less contracts. weather-driven volatility than the previous two years. The fuel price decrease was partially offset by volume Purchased power expenses will vary depending on' increases primarily from increased generation at Plants demand and the availability and cost of generating, Wansley and Dahlberg. resources available throughout the Southern Company system and other contract resources. Load requirements In 2005, fuel expense increased by $81.9 million are submitted to the Southern Pool'on an hourly basis and (64.4 percent). The increase was driven by a 54.2 percent are fulfilled with the lowest cost alternative, whether that increase in the average cost of natural gas per decatherm. is generation owned by the Company, affiliate-owned In 2004, fuel expense increased by $11.8 million generation, or external purchases. (10.3 percent), primarily due to increased gas transportation expenses associated with Plant Harris Unit 2 prior to its commitment with Georgia Power. The Other Operations and Maintenance average cost of natural gas per decatherm also increased Other operations and maintenance expenses have 8.3 percent from 2003 to 2004. increased during the period from 2003 through 2006. In While prices for fuel hav& moderated somewhat in 2006, other operations and maintenance expenses 2006, a significant upward trend in the cost of natural gas increased $14.5 million (17.9 percent). In 2005 and 2004, has emerged since 2003, and volatility in this market is other operations and maintenance increased $5.6 million expected to continue. Higher natural gas prices in the and $13.0 million, respectively. The year-to-year increases United States are the result of increased demand and are primarily the result of the operation of new generating slightly lower gas supplies. despite increased drilling, units. In 2003, Plant Franklin Unit 2, Plant Harris Units 1 activity. Natural gas production and supply interruptions, and 2, and Plant Stanton A were placed in service at such as those caused by 2004 and 2005 hurricanes, result differing dates. Unit additions from acquisitions began in in an immediate market response; however, the long-term 2005 with Plant Oleander and have continued in 2006 impact of this price volatility may be reduced by imports with Plant DeSoto and Plant Rowan. See Note 2 to the of liquefied natural gas if new liquefied gas facilities are financial- statements under "DeSoto and Rowan, built. The Company's PPAs generally provide that the Acquisitions" and "Oleander Acquisition." counterparties are responsible for substantially all of the cost of fuel and fuel costs do not significantly affect net Depreciatin and Amortization income. Under most of the PPAs, either the Company incurs the fuel expense and concurrently recovers the cost Depreciation and amortization increased by $1137 million through energy revenues or the counterparty purchases the (21.6 percent) from 2005. This increase' was primarily the fuel directly. result of higher depreciation rates from a new ý - ".,ý depreciation study adopted in March 2006. The change in Purchased power increased $10.6 million rates contributed an additional $6.3 million of expense. (6.6 percent) in 2006, primarily due to increased Additional plant in service from acquisitions also purchases of lower cost energy resources from the contributed $5.4 million to the increase: Additions have Southern Pool and contracts with PMPA and Dalton included Plant Oleander in June 2005, Plant DeSoto in Utilities. Purchased power volume in 2006 increased June 2006, and Plant' Rowan in September 2006. 51 percent compared to 2005. This follows a $28.4 million (15.1 percent) decrease in 2005, due to limited short term Depreciation and amortization increased by market energy sales as the Company's generating $3.1 million in 2005 and by $12.1 million in 2004. Prior resources were employed for increased PPA increases have been primarily through additional plant in commitments. service. : 1 11-300

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Power Company and Subsidiary Companies 2006 Annual Report Taxes Other than Income Taxes Effects of Inflation Taxes other than income taxes increased $2.3 million When inflation exceeds projections used in market, term, (17.4 percent) in 2006. This was primarily due to and cost evaluations performed at contract initiation, the incremental ad valorem taxes on new assets. In 2005 and effects of inflation can create an economic loss. In 2004, taxes other than income taxes increased $2.0 million addition, the income tax laws are based on historical and $4.6 million, respectively. Increases in taxes other costs. Therefore inflation creates an economic loss as the than income taxes have followed additions to plant in Company is recovering its costs of investments in dollars service since 2002. Plant in service additions have come that could have less purchasing power. While the inflation through completed construction activities or acquisitions. rate has been relatively low in recent years, it continues to have an adverse effect on the Company due to large investment in utility plant with long economic lives. Interest Conventional accounting for historical costs does not recognize this economic loss or the partially offsetting Interest expense has increased by $0.8 million, gain that arises through financing facilities with fixed $13.2 million, and $34.4 million in 2006, 2005, and 2004, money obligations such as long-term debt. respectively. The 2006 increase Was primarily' the result of additional debt incurred for acquisitions. This increase FUTURE EARNINGS POTENTIAL was offset by higher levels of interest capitalized during construction reflecting the Company's construction General program. Prior year increases were due to incremental The results of operations for the past three years are not;. debt incurred for the Oleander acquisition and necessarily indicative of future earnings potential. Several construction. Additional factors for prior year increases factors affect the opportunities, challenges, and risks of included a lower percentage of interest costs being the Company's competitive wholesale energy business. capitalized as projects reached completion* were sold, or These factors include the ability to achieve sales growth were suspended during those periods. Plant McIntosh while containing costs: Another major factor is federal Units 10 and 11 were transferred to Georgia Power and regulatory, policy, which may impact the Company's level: Savannah Electric and construction was suspended on of participation in this market. The level of future Plant Franklin Unit 3 during 2004, effectively ceasing all earnings depends on' numerous factors including capitalized interest. For additional information, see regulatory matters such as those related to affiliate FUTURE EARNINGS POTENTIAL - "Construction contracts, sales, creditworthiness of customers, total Projects - Plant Franklin Unit 3, Plant Oleander Unit 5, generating capacity available'in the Southeast, and the' and IGCC" and Note 3 to the financial statements under successful remarketing of capacity as current contracts "Plant Franklin Unit 3 Construction Project" and'Note 4' expire.' , to the financial statements under "IGCC." Power Sales Agreements Other Income (Expense), net The d6ompany's sales are primarily through long-term PPAs. The Company is working to maintain and expand , Changes in other income, net in 2006, 2005, and 2004 its share of the wholesale market in the Southeastern ." were primarily the result of unrealized gains and losses on power maikets. Although there is currenily'an oversuly derivative energy contracts. See FINANCIAL . of generating ýcapacity in the Super-Southeast, CONDITION AND LIQUIDITY - "Market Price Risk" opportunities remain in certain areas. herein and Notes 1 and 6 to the financial statements under '.Financial Instruments." In. February-2007, the Company entered into a PPA with Progress Energy Carolinas, Inc for 150 MW annually from January 2010 through December 2019 from Plant Income Taxes Rowan.:.:, Income taxes increased by $10.0 million' (13.9 percent)'in In O0tobeir 2606, the'Company entered into a PPA' 2006. Income taxes decreased $1.1 million (1.5 percent) with Gulf Power for 292 MW annually from June 2009 in 2005 and $12.2 million (14.4 perceni) in 2004. through May 2014 from Plant Dahlberg. This contract Fluctuations in income taxes are primarily the result of was filed with -the Florida Public' Service Commission changes to pre-tax income. Other factors may 'include new (PSC) in December 2006 and is subject to Florida PSC tax provisions or additional tax jurisdictions. and FERC approval. 11-301

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Power Company and Subsidiary Companies 2006 Annual Report In September 2006, the Company acquifxd PPAs period from June 2010 through, December 2015. A similar with Duke for 456 MW annually and PPAs with PPA with Progress Energy Florida was signed in NCMPAI for an average of 130 MW annually as part of November"2004 for 350 MW of annual capacity from the Rowan acquisition. These PPAs expire at various Franklin Unit 1 fdr thepperiod June 2010 through times through 2030. December 2015: The Florida PSC has approved these contracts. ' - In May 2006, the Company entered into three PPAs with EnergyUnited. Under two full requirements PPAs, Also in 2004, the Company executed multiple the Company will sell an average, monthly capacity of agreements with existing, customers., For the years 2007 177 MW from September 2006 thiough December 2010 through 2009, the Company will sell an average of and 351 MW from January 2011 through December 2025. approximately 132 MW of additional wholesale capacity The Company will also sell 205 MWof annual capacity from existing resources to Flint EMC. The Company also through a block contract to be served from Plant Rowan agreed to a 10-year extension of the OUC PPA for from January 2011 through December 2025. See Note 2 Stanton Unit A through October 2023. to the financial statements- under "DeSoto and Rowan The Company has entered into long-term power sales Acquisitions" for additional information. agreements, for a portion of its generating capacity. as., In June 2006, the Company acquired. PPAs with follows: FP&L as part of the DeSoto acquisition. These PPAs

                                                                              *     :              C2apacity        Initial cover the plant's capacity and energy through May 2007.

Project (me:gawatts) i Term 2 See Note 2 to the financial statements under "DeSoto and Rowan Acquisitions" f6r additional information. Affiliated Franklin Unit 1 - 563 6/02-5/10' In April 2006, the Company entered into a PPA with Franklin Unit 2 625 6/03-5/11 Progress. Ventures, Inc. for 621 MW ofi annual capacity Wansley Unitsf6 & 7. 1,148 6/02-12/09 from 2009 through 2015 with an option to extend through HarrisUnit 1.I 627. 6/03-5/10 2020, This capacity is expected to be provided from the Harris Unit 2 628 6/04-5/19 expected 621 MW capacity of Plant Franklin' Unit 3; See Dahlberg 292 6/09-5/14 Note 3 to the financial, statements under "Plant Franklin Unit 3 Construction Project';foradditional information. Non-Affiliated Franklin Unit 1, In February 2006, the Company entred' nto PPA (FP&L/Progress with Florida Municipal Power Ageficy (FMPA) for the Florida) 540 6/10-12/15 expected'160 MW capacity fr6m Plant Olea'nder Unit 5. Harris Unit 1 (FP&L) .600 . 6110-1t2/15 The PPA will commence'upon the completion df the Franklin Unit 3 (Progress;; plant, which is scheduled for late 2007, and will extend' Ventures) 621 " -11/09-12/15 through 2022. Stanton A (OUC) 338 11/03-10/23 Stanton A (Kissimmee In June 2005 as part of the Oleander acquisition, the Utilities Authority, Company acquired 'existing PPAs with FP&L and FMPA) 85 11/03-10/13 Semintle Ele&ric Cooperativei Inc. (Seminole). Th6 Oleander (FP&1 )'" -155 6/05-5/12 FP&L PPA is for one unit and exterids through the eýd of ' 6/03-12109 Oleander (Seminole) '465 1/10-12/15 May 2007. The Seminole PPA is for'three units at Plant Oleander (Seminole)' Oleander and extends through the end of io009. Inn Oleander (FMPkA) 160 12/07-12/22 February 2006, the Company signed an extension of ihe DeSoio,(FP&L) 320 .6/06-5/01 FP&L PPA for approximately 160 MW of annual. capacity Rowan (Duke) :152 9/06-5/10 through May 2012. Also in February 2006, the Company, Rowan (Duke) 304 9/06-12/10 signed an additional PPA with Seminole for Rowan (NCMPA1) 50 9/06-12/15 approximately 465 MW of annual capacity through Rowan (NCMPA 1) 138 1/11-12/30 December 2015. See Note 2 to the financial statements Rowan (Progress Energy under "Oleander Acquisition", for addiiional information. Carolinas) , 150 -1/10-12/19 In. August 2004, the Company entered into two PPAs, Rowan (EnergyUnited) with FP&L. Under the PPAs, the Comphny will provide Block , 205 1/*11-12/25 FP&L with a total of 790 MW of annual capacity from Flint EMC Block'. 132 1/05-12/09, Plant Harris Unit 1 and Plant Franklin Unit 1 for the 11-302

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Power Company and Subsidiary Companies 2006 Annual Report Many of thd,Company's PPAs have provisions that

                ,.          z           Capac't"f: i . '-Initial (megawais5s,' term 2.                             require the posting of collateral or an acceptable Project substitute guarantee in the event that Standard & Poor's GA EMC Full                            .                                                or Moody's downgrades the credit ratings of such.

Requirements 3 7 6/02-12/09 counterparty to an unacceptable'credit rating or the" PMPA Full Requirements ,, 65 1/06-12/10 counterparty is inot rated or fails to imaintain a minimum

                                     .1                    65 EnergyUnited Futll                                                                      coverage ratio. The PPAs 'are expected, to provide the.:

Requirements i17 9/06-12/10 Company with a stable source of revenue during their EnergyUnited Full respective terms. Reqiiirements , - ' 1'1/11-12/25

1. Capacity Value for full -equirements 'PAAis'a'verage monthly MW. FERC Matters

2. Excluding automatic renewal provisionsi..

3. GA EMC full requirements consist .9 f 11 .EMCs, each with an Market-Based Rate Authority annual capacity of 62-434 MW. At the 2009 ending date,, there is an option to convert from full requirements to a fixed capacity iale for The Company has authorization from the FERC to sell the majority of the EMCs. The Sawnee EMC and Coweta-Fayette power to non-affiliates, including short-term opportunity, EMC conversion option is' 12/12. : " , , ' ,

sales, at market-based prices. Specific FERC approval must be obtained with respect to a market-based contract The Company has PPAs with -some of the traditional wilh gin affiliate. '" operating companies and with other. investor owned, - utilities and electric cooperatives. Although some of: the In December 2004. the FERC initiated a proceeding Company's PPAs are with Southern, Company's traditional to assess Southern Company's generation dominance operating companies, the Company's. generating facilities within, is retail service -territory. The ability, to charge are not-in the traditional 9 peratng epmpanies' regulated market-basgd rates in other markets is not an issue in that, rate bases, and the Company is not able to seek recovery proceeding. Any :new, market-based/rate sales by the from the traditional operating companies' ratepayers for Company in Southern Company's retail service territory: construction, repair, evirionmenta1, orplaintenance costs. entered io during a 15-month refund period beginning The Company expects that the capacity payrmeptsi the February 27, 2005 could be subject to refund to the level PPAs will 'pioducesufficient cash -flow to cover costs, pay of the -default cost-based rates, pending the outcome of. debt service, and provide an equity etorn. the stowever, the proceeding. Such sales through May 27, 2006, the end Company's overall pr'ofit wili depend ,n numerous of the refund period, were approximately $0.7 million for. factors, including efficient operation 0f its generating. the Company,liIn_,the event that the FERC's default facilities. I' ' mitigation ,measures for ,ntities that are found to have marlet power are ultimately applied, the Company may

      -Asa general matter, existihg-PPAs provide that the,                             be required to charge cost-based rates for certain wholesale sales in the Southern Company retail service purchasers are responsible for substantially'all of the cost territory, which may be lower than negotiated market-of fuel relating tothe energy delivered under such PPAs.

based rates.' The final' outcome of this matter Will 'depend To the extent a particular generating, facility; does not meet the operational ,equirpments, Fntemplated-in the. on the ýform in'which the' final methidology'for assessing PPAs, the Company may _e, rxsponsble for. excess. fuel,. generation arfiiket power and mitigation 'rules may be', ultithat6ly' adopted and cannot -bedetermined atthis time.: costs. With respect.to fuel trar pprtation risk, most of the Company's PPAs provide that the counterparties :are Inaddition, in..ay 2005, the ERC started an responsible for procuring and transporting the fuel to the investigation to determine whether Southern Company particular generating facility. satisfies the other three parts of the FERC's market-based rate anlysis: ,transmission market power, barriers tO entry, xe and variable opeitionand 'mi'aintenanceoncosts and affiliate abuse or reciprocal dealing. The FERC based will 'be recovered thr6ugh capacity charges establisheda new !5-month refund period related to this il - ; - ' , or',. ,o :ars-per-megawatt

                   " I year dollars-per-kilowatt                          . .. lJ~ t ý V , -          ,, In.

hour. expanded investigation. Any. new market-based rate sales-, general, the'Company hasglong:term nervce contracts involving any Southern Company subsidiary, incliding the with: Generial'Electric (GE)1 iW'*diice"Itsseposure"to Company, could be subject to refund to the extent the certain' operation and maainitenain6e,' &stS relating to GE', FERC orders lower rates as a result of this new equipment. See Note 7 to the finadciai s*tiements under investigation. Such sales through October 19, 2006, the "Long-Termi Service Agreements" for additional end of the :refund period, were approximately. $4,5 million information. for the Company, -of which $0.6 million relates to sales 11-303

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Power Company and Subsidiary Companies 2006 Annual Report inside the retail service territory discussed above. The under a variety of statutes and regulations governing FERC also directed that this expanded proceeding be held environmental media, including air, water, and land in abeyance pending- the outcome of the proceeding on resources. Applicable statutes include the Clean Air-Act; the IIC discussed below. On January 3, 2007, the FERC the Clean Water Act; the Comprehensive Environmental issued an order noting settlement of the HC proceeding Response, Compensation, and Liability Act; the Resource and seeking comment identifying any remaining issues Conservation and Recovery Act; the Toxic Substances and the proper procedure for addressing any such issues. Control Act; the Emergency Planning & Community The Company believes that there is no meritorious Right-to-Know Act; the Endangered Species Act; and basis for these proceedings and is vigorously defending related federal and state regulations. Compliance with itself in this matter. However, the final outcome of this possible additional federal or state legislation or matter, including any remedies to be applied in the event regulations related to global climate change, air quality, or of an adverse ruling in these proceedings, cannot now be other environmental and health concerns could also affect determined. the Company. Intercompany Interchange Contract New environmental legislation or regulations, or The majority of the Company's generation fleet is changes to existing statutes or regulations could affect operated under the IIC, as approved by the FERC. In May many areas of the Company's operations. While the 2005, the FERC initiated a new proceeding to examine Company's PPAs generally contain provisions that permit (1) the provisions of the IIC among Alabama Power, charging the counterparty with some of the new costs Georgia Power, Gulf Power, Mississippi Power, Savannah incurred as a result of changes in environmental laws and Electric, the Company, and Southern Company Services, regulations, the full impact of any such regulatory or Inc. (SCS), as agent, under the terms of which the legislative changes cannot be determined at this time. Southern Pool is operated, and, in particular, the propriety of the continued inclusion of the Company as a party to Because each of the Company's units are newer gas-the IIC, (2) whether any parties to the IIC have violated fired generating facilities, costs associated with the FERC's standards of conduct applicable to utility environmental compliance for these facilities have been companies that are transmission providers, and (3) whether less significant than for sirmilarly situated coal-fired Southern Company's code of conduct defining the Company as a "system company" rather than a: generating facilities or older gas-fired generating "marketing affiliate" is just and reasonable. In connection facilities. Environmental, natural resource, and land use with the formation of the Company, the FERC authorized concerns, including the applicability of air quality the Company's inclusion in the IIC in 2000. The FERC limitations, the availability of water withdrawal rights, also previously approved Southern Company's code of uncertainties regarding aesthetic impacts such as increased conduct. light or noise, and concerns about potential adverse health impacts, can, however, increase the cost of siting and On October 5,, 2006, the FERC issued an order accepting a settlement resolving the proceeding subject to operating any. type of future electric generating facility. Southern Company's agreement to accept certain The impact of such statutes and regulations'on the modifications to the settlement's terms. On October 20, Company as a result of generating facilities that may be' 2006, Southern Company notified the FERC that it acquired or constructed in the future cannot be predicted accepted the modifications. The modifications largely at this time. involve functional separation and information restrictions related to marketing activities conducted on behalf of the Litigation over environmental issues and claimsf of Company. Southern-Company filed with the FERC on various types, including property damage, personal injury November 6, 2006 an implementation plan to comply and citizen enforcement of environmental requirements with the modifications set forth in the order. The such as opacity and other air quality standards, has, Company's cost of the modifications is expected to be increased generally throughout the United States. In approximately $9 million per year. particular, personal, injury claims for damages caused, by; alleged exposure to hazardous materials, have become Environmental Matters more frequent. The ultimate outcome of such potential The Company's operations are subject to extensive litigation against the Company cannot be predicted at this regulation by state and federal environmental agencies time. 11-304

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Power Company and Subsidiary Companies 2006 Annual Report Construction Projects December 31, 2006. The Company has the Option under the agreements'to end its participation in the project at Plant Franklin Unit 3 " the end of the project definition phase which is expected The Company restarted construction activities on Plant to be during 12007.' The final outcome of ihis matter cannot now be determined. Franklin Unit. 3 in 2006, with ani expected completion date in late 2008, The total cost is expected to be approximately $338.8 million, of which $198.3 million Othei Matters had been spent as of December 31, 2006. The expected The Company completed a depreciation study in. 2006 capacity of this unit is 621 MW and will be used to and updated the composite depreciation rates for its provide annual capacity for a PPA with Progress Ventures, property, plant, and equipment. This change in estimate Inc. from 2009 through 2015. See Note 3 to the financial arises from changes iin useful life assumptions for certain statements under "Plant Franklin Unit 3 Construction components of plant in service determined by a detailed Project" for more information., engineering study. This change increased depreciation expense and reduced net income. The 2006 income Plant Oleander Unit 5 impact of this change was $3.8 million. See Note 1 to the The Company is constructing an idditiofnal'init at Plant financial statements 'under "Depreciation" for additional information.. ., Oleander. Oleander Unit 5 is a combustion turbine with an expected capacity of 160 MW and is expected to be From time, to time, the Company is inyolved in completed in December 2007. The unit's 'cap"acijy'will be various other matters being litigated and regulatory used to provide annual capacity for a PPA with FMPA. matters that could affect future earnings. See Note 3 to The total cost of this project is expected o b ' the financial statements for information regarding material approximatiy $59 Imillion, of which $18.9'nmillion had issues. , ' been spent as of December 31,' 2006. ACCOUNTING POLICIES IntegratedGasificaton Combined Cycle (IGqCC) In December 2005,-the Compaiiy and OUC executed Applca'tion of Critical Accounting Policies and definitive agreements for development of the IGCC, a Estimates project of approximately 285 MW in 'Orlando,, Florida, The Company prepares its consolidated financial adjacent to Plant Stanton*Unit A, which is co-owned by statements in accordance with accounting principles the Company, OUC,, and others. The definitive agreements generally accepted in the United States. Significant provide that the Company will own at least 65 percent of accounting policies are described in Note 1 to the the gasifier portion of the project. OUC will own the finan'ciai statements. In the application of these 'policies,' remainder of the gasifier portion and 100 percent of the certain estimite'S are'made that may have a material' combined cycle portion of the project. OUC will make impact on lihe Company's results 'of operations and related capacity payments for all of the Company's gasifier discloSu'res. Dffereint' asSumptions and measurements capacity once the plant is in commercial operation: The could produce estimates that are sigificaritlydifferent Company will construct the project and bill OUC a fixed from those 'riecorded in the hnancilal ýstatements. Senior price for its shaie in the project. The Company will " management has reviewed and di'sctusd's'the critical' manage operations -fter'contruction is'completed 'using a accounting'.policies and estimates described below with joint staff of OUC and SCS"employees. Thý Coinpany the Audit'Committee of Southerm Company's'Board of signed a cooperative agreenrent *with'the DOE in February Directors" ' " ' 2006,. which provides for up to $235 million in grant funding for the construction and demonstration of the Revenue #?ecognition ' ' gasification 'portion of the project.The IGCC project'is subject to'National Environniental Policy Act review as The Company's revenue recognition 'depends on well as state envirninental, review,ý re46ires certain approprizaite classification and 'documentation of' ' -' regulatory approvals, and is expected to begin commercial transactions 'iii accordance -with Financial Acco6niting operation in 2010. The total cost related to the gasifier Standards'Bard (FASB) Statement No. 133, "Accounting portion of the IGCC project is currently being reviewed, for Derivative Instruments and Hedging Activities," as due to increases and may be higher than earlier estimates amended and interpreted (SFAS No. 133). In general;' the in commodity costs and increased market demand for 'Company's power sale transactions can be classified in labor. The Company had spent $7.8 million as of one of four categories: non-derivatives, normal sales, cash 11-305

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Power Company and Subsidiary Companies 2006 Annual Report flow hedges, and mark to market. For more information Cash Flow Hedge Transactions on derivative transactions, see FINANCIAL CONDITION AND LIQUIDITY - "Market Price Risk" and Notes 1 and The Company designates other derivative contracts for the 6 to the financial statements under "Financial sale of electricity as cash flow hedges of anticipated sale Instruments." The Company's revenues are dependent transactions. These contracts are marked to market upon significant judgments used to determine the through other comprehensive income over the life, of the appropriate transaction classification, which must be contract. Realized gains and losses are then recognized in documented upon the inception of each contract. Factors revenues as incurred. that must be considered in making these determinations include: Mark to Market Transactions " Assessing whether a sales contract meets the definition of a lease Contracts for sales of electricity that are not normal sales

Assessing whether a sales contract meets the definition and are not designated as cash flow hedges are marked to market and recorded directly through net income. Net of a derivative unrealized gains on such contracts were not material for

" Assessing whether a sales contract meets the definition the year ended December 31, 2006. of a capacity contract " Assessing the probability at inception and throughout Percentageof Completion the term of the individual contract that the contract will result in physical delivery The Company is currently engaged in a long term contract for engineering, procurement, and construction " Ensuring that the contract quantities do not exceed services to build a combined cycle unit for OUC. available generating capacity Construction activities commenced in 2006 and are

" Identifying the hedging instrument, the hedged                   expected to be complete by the end of 2010. Revenue and transaction, and the nature of the risk being hedged           costs are recognized using the percentage-of-completion method. The Company utilizes the cost-to-cost approach

" Assessing hedge effectiveness at inception and as this method is less subjective than relying on throughout the contract term. assessments of physical progress. The, percentage of completion represents the percentage of the total costs Normal Sale and Non-Derivative Transactions incurred to the estimated total cost of the contract. Revenues and costs are recognized by applying this The Company has capacity contracts that provide for the percentage to the total revenues and estimated costs of the sale of electricity and that involve physical delivery in contract. quantities within the Company's available generating, capacity. These contracts either do not meet the definition of a derivative or are designated as normal sales thus Asset Impairments exempting them from fair value accounting under SFAS No. 133. As a result, such transactions are The Company's investments in long-lived assets are accounted for as executory contracts; 'additionally the primarily generation assets, whether in service or under related revenue is recognized in accordance with construction. The Company evaluates the carrying value Emerging Issues Task Force (EITF) No. 91-6, "Revenue of these assets under FASB Statement No. 144, Recognition of Long-Term Power Sales Contracts" on an "Accounting for the Impairment or Disposal of Long-lived accrual basis in amounts equal to the lesser of the Assets," whenever indicators of potential impairment levelized amount or the amount billable under the exist. Examples of impairment indicators could include contract, over the respective contract periods. Revenues significant changes in construction, schedules, current are recorded on a gross basis in accordance with EITF period losses combined with a history of losses, or a No. 99-19 "Reporting Revenue Gross as a Principal projection of continuing losses or a significant decrease in versus Net as an Agent." Revenues from transactions that market prices. If an indicator exists, the asset is tested for do not meet the definition of a derivative are also recoverability by comparing the asset carrying value to recorded in this manner. Contracts recorded on the accrual the sum of the undiscounted expected future cash flows basis represented the majority of the Company's operating directly attributable to the asset. A high degree of revenues for the year ended December 31, 2006. judgment is required in developing estimates related to 11-306

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Power Company and Subsidiary Companies 2006 Annual Report these evaluations, which are based on projections of Income Taxes various factors, including the following:

Future demand for electricity' based on projections of In July 2006, the FASB issued Interpretation No. 48 "Accounting 'for Uncertainty in Income Taxes" (FIN 48).

economic growth and estimates of available generating This interpretation requires that tax benefits must be '

                                                                   "more likely than not" of being sustained in order'to be capacity recognized. The Company adopted FIN 48 effective

Future power ind natural gas prices, -whichlhave been January 1, 2007. The adoption of FIN 48 did not have a quite volatile'in recent years material impact on the Company's financial statements.
Futute operating costs.

Fair Value Measurement To date,-the Company's evaluations of its assets have not required any, impairment to be recorded. See Note 2 The FASB issued FASB Statement No.,157 "Fair Value to the financial statements under 'ýplant Franklin Unit 3 Measurements": (SFAS No. 157) in September 2006. This Construction Project" for additional information. standard proyides guidance on how to measure fair value where itis permitted or required under other accounting. pronouncements. SFAS No. 157 also requires additional, Acquisition Accounting disclosures; about fair value imeasurements. The Company, plans to adopt SFAS No. 157 on January 1, 2008 and is The Company has been engaged in'a'strategy of acquiring currently assessing its impact. assets. The Company has accounted for these acquisitions under the purchase method in accordance with FASB . Statement No. 141,"Business Combinations." Accordingly, FairValue Option' the Company has included these operations in the consolidated financial statements from the respective date In February 2007, the FASB issued FASB Statement of acquisition. The purchase price of each acquisition was No. 159, 'Pair Value Option for Financial Assets and Financial Liabilities Including ain Amendment of FASB allocated to the identifiable assets and liabilities based on a valuation prepared by a third party. Statement No.- 115" (SFAS No. 159). This standard permits an entity to choose to measure many, financial instruments and certain other itemsnat fair value. The New Accounting Standards Company plans to adopt SFAS No. 159 on January 1, 2008 and is currently assessing its impact. Guidance on Considering the Materiality of Misstatements FINANCIAL CONDITION AND LIQUIDITY In September 2006, the Securities. and Exchange, Commission (SEC) issued Staff Accounting Overview Bulletin No. 108, "Considering.the Effects of Prior Year Misstatements when Quantifying Misstatements in The major changes in the Company's financial condition Current Year Financial Statements" (SAB 108). SAB 108 during 2006-have been the acquisitions of Plant DeSoto in addresses how the effects of prior yea, uncorrected June and Plant Rowan in September, the continued misstatements should be considered when quantifying construction of Plant Franklin Unit 3, Plant Oleander misstatements in current year financial statements. Unit 5, and the IGCC, and the completion of the sale of. SAB 108 requires companies to quantify_ misstatements Cherokee Falls Development of South Carolina LLC (a using both a balance sheet and an income 9tatement former subsidiary of the Company) and its assets to approach and to evaluate whether either approach results Southern Company's nuclear development affiliate. The in quantifying an error that is material in light of relevant acquisitionsg'of Plant DeSoto and Plant Rowan resulted in quantitative and qualitative factors. When the effect of, $409.2 million'of utility plant and working capital in initial adoption is material, companies will record 'ihe 2006. Total'expenditures on current construction'projects effect as a cumulative-effect adjustment to beginning of are $225.0 million. Other changes have included the year retained earnings. The provisions of SAB 108 were payment of'$77.7 million in dividends to Southern effective for the Company' for ,the year ended Company 'and the issuance of $200 million of senior December 31, 2006. The adoption of SAB 108 did not notes. The Company has received investment grade have a material impact on the Compaiy's financial ratings from the major rating agencies with respect to its statements. . debt. 11-307

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Power Company and Subsidiary Companies 2006 Annual Report Sources of Capital Credit Rating Risk A The Company may use operating cash flows, external The Company does not hav, any credit arrangements that' funds, or equity capital from Southern Company to would require material changes, in payment schedules or finance any new projects, acquisitions, and ongoing terminations as a result of a credit downgrade. There are capital, requirements. The Company expects to generate certain contracts' that could require collateral, but not external funds from the issuance of unsecured senior debt accelerated payment, in the event of a credit rating and commercial paper or utilization of credit change to BBB: and Baa2, or to BBB, or Baa3 ,or below. arrangements from banks. Generally, collateral may be provided with a Southern Company guaranty, letter of credit, or cash. These The Company's current liabilities frequently exceed contracts are primarily for physical electricity purchases current assets due to the use of short-term debt as a and sales. At December 31, 2006, the maximum potential funding source. At December 31, 2006, the Company had collateral requirements at BBB and Baa2 ratings were approximately $29.9 million of cash arid cash equivalents approximately ý8.6 milli6n, ai BBB- or Baa3 ratings were to meet short-term cash needs and contingencies. To meet approximately $264.7 million, and below BBB- or Baa3 liquidity and capital' resource requiremlents, the Company ratings were approximately $424.2 million. In addition,' had at'December,31, 2006, $400 millibn of unused through the acquisition of Plant Rowan, the Company committed credit arrangements with banks that expire in assumed a PPA with Duke that could require collateral,.... 2(111. Proceeds from these credit arrangements may be but not accelerated payment, in the event of a downgrade used for working capital and general corporate purposes to the Company's credit rating to below BBB- or Baa3.,. as well as liquidity support for the Company's The amount of collateral required would depend upon.. commercial paper program. See Note 6 to the financial actuallosses, if any, resulting from a credit downgrade,; statements under "Bank Credit Arrangements" for. limited to the Company's remaining, obligations under the' additional information. contract. The Company, along with the other members of the Southern Pool, is also party, to certain derivative ....... , The Company's commercial paper program is used agreements that could require- collateral and/or accelerated to finance acquisition and construction costs related to electric generating facilitiqs and for general corporate payment in the event of a credit rating change to below-' investment grade for Alabama Power'and/or Georgia., , : purposes. At December 3.1.,2006, there was $123.8 million Power. These agreements are primarily for natural gas and of commercial paper outstanding. See Note 6 to the financial statements, under "Commercial Paper" for power price risk management activities. At December 31, 2006, the Company's total exposure- to these types of additional information. , agreements was approximately $27.4 million Financing Activities Market Price Risk During 2006, the Company issued $200 million of The Company is ex'posed to market risks, including 30-year unsecured long-term senior notes. The proceeds changes in interest rates, certaini energy-related of the issuance were used to repay a portion of the commodity prices', and, occasionally, currency exchange,", Company's outstanding short-term indebtedness and for rates. To manage the'volatility attrib'uiable to these othergeneral corporate purposes, including the exposures, the Company net's thý exposures to take Company's continuous construction program- In - advantage of naturaloffsets and enters into various conjunction with issuing the securities, the Company derivative transactions for the rimaiiiinr'exposuies i terminated $200 million in interest"swaps at a cost of pursuant to the Company's policies'in' areas such'as ' $8.1 million. This cost will be amortized over a 10-year counterparty exposure and hedging practicei. Company period. policy is that derivatives are to be used primarily for hedging purposes. Derivattve positions are monitored The issuance of all securities by theCompany is using techniques that include market valuation and' generally subject to regulatory approval by the FERC. sensitivity analysis. Additionally, with respect to the publicoffering of securities, the Company files registration statements with Because energy from the Company's facilities is. the SEC under the Securities Act of 1933, as amended primarily sold under long-tern PPAs with tolling.., (1933 Act). The amounts of securities authorized by the agreements and provisions shifting substantially all of the FERC, as well as the amounts registered under the 1933 responsibility' for fuel cost to the counterparties, the -, .... Act, are continuously monitored and appropriate filings Company's. exposure to market volatility in commodity,. are made to ensure flexibility in the capital markets. fuel prices and prices of electricity is limited. To mitigate 11-308

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Southern Power Company and Subsidiary Companies 2006 Annual Report residual risks in those areas, the Company enters into At December 31, 2006, the fair value gains/(losses) fixed-price contracts for the'sale of electricity. of energy related derivative contracts were reflected in the financial statements as follows: The fair value of changes in derivative energy contracts and year-end valuations were as follows at Amounts December 31: (in thousands) Changes in Net Income ,$ 493 Fair Value Accumulated other comprehensive income 1,357 2006 2005 Total fair value $1,850 (in thousands) Contracts beginning of year $ 223 $ 9 Contracts realized or settled - - (5,233) (168) Unrealized pre-tax gains add losses from energy-related derivative contracts recognized in income were not New contracts at inception material for any year presented. The Company is exposed Changes in valuation techniques - to market-price risk in the event of nonperformance by Current period changes (a) 6,860 382 counterpaes to the derivative energy contracts. The

                                                                  $ 223        Company's policy is to enter into agreements 'with _.,

Contracts end of year $ i,850 counterparties that have investment grade credit ratings by (a) Current period changes also include the changes in fair value of.new Standard & Poor's and Moody's or with counterparties contracts entered into during the period. who have posted collateral to cover potential credit At December 31, 2006, the sources of the valuation exposure. Therefore, the Company does not anticipate prices were as follows: market risk exposure from nonperformance by the counterparties. For additional information, see Notes 1 Source of 2006 Year-End Valuation Prices and 6 to the financial statements under "Financial Total Maturity Instruments." Fair Value 2007 2008-2009 At December 31, 2006, the Company had no variable (in thousands) long-term debt outstanding. Therefore, there would be no Actively quoted $ 413 $ 413 effect on annualized interest expense related to long-term External sources 1,437 1,437 debt if the Company sustained a 100 basis point change Models and other in interest rates. The Company is not aware of any facts methods - or circumstances that would significantly affect such Contracts end of exposures in the near term. year $1,850 $1,850 $_ Unrealized pre-tax gains and losses on electric Capital Requirements and Contractual Obligations contracts used to hedge anticipated sales, and gas The capital program of the Company is currently contracts used to hedge anticipated purchases and sales, estimated to be $240.7 million for 2007, $481.9 million are deferred in other comprehensive income. Gains and for 2008, and $844.4 million for 2009. These amounts losses on contracts that do not represent hedges are include estimates for potential plant acquisitions and/or recognized in the income statement as incurred. new construction. Actual construction costs may vary from these estimates because of changes in factors such as: business conditions; environmental regulations; FERC rules and transmission regulations; load projections; the cost and efficiency of construction labor, equipment, and materials; and the cost of capital. Currently, there are three plants under construction. Other funding requirements related to obligations associated with scheduled maturities of long-term debt, as well as the related interest, leases, and other purchase commitments are as follows. See Notes 1, 6, and 7 to the financial statements for additional information. II-309

MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) *.1-.~*,. -' Southern Power Company and Subsidiary Companies 2006 Annual Report

Contractual Obligations 2008- 2010- After I il.

2007 2009 2011 2011 Total (in millions) Long-term debt(a) - Principal $ 1.2 $ - $ - $1,300.0 $1,301.2 Interest 74.4 148.6 148.6 457.1 828.7 Operating leases . 0.6 0.6 0.6 10.9 12.7 Purchase commitments(b). Capital(c) 240.7. 1,326.3 - - 1,567.0 Natural gas(d) 100.3 222.0 112.3 ,,_ 264.7 . . 699.3 Long-term service agreements 28.2 62.4 84.7 883,0 1,058.3 Total . .- $445.4 $1,759.9 $346.2, $2,915.7, $5,467.2 (a)' All amounts are reflected based on final maturity 'dates. The Cdinpany plans to retire higher-cost securities and replace these obligations with lower-cost capital if market conditions permit. (b) The Company generally does not enter into fton-canc~lable commitients for other operations and maintenance expenditures. Total other operations and maintenance expenses for the last three years were $95.3 million, $80.8 million, and $75.2 million, respectively. (c) The ComoIany forecasts capital expendituires over a three-year period. Amounts represent currentestirmates'of total expenditures. (d) Natural gas purchase commitments are based on various indices at the time of delivery. Amounts reflected have been estiniated based on New York Mercantile Exchange future prices at December 31, 2006. I l

11-310

II MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) i./l

                                                                                    -J Southern Power Company and Subsidiary Companies 2006 Annual Report ..     :

Cautionary Statement Regarding Forward-Looking

state and federal rate regulations; Staternejits
the ability to control costs and avoid cost overruns The Company's 2006 Annual Report contains forward- during the development and construction of facilities, looking statements. Forward-looking statements include, including the IGCC; among other things, statements concerning environmental internal restructuring or other restructuring .options that regulations and expenditures, financing .activities, access may be pursued; -

to sources of capital, impacts of the adoption of new accounting rules, completion of construction projects, and potential business strategies, including acquisitions or. estimated construction arnd otherexpejiditures. In some -.. which cannot-be dispobitidns of assets or businesses, cases, forward-looking! statements can identfied by assured- to be completed or beneficial to the Company; terminology such as "may:' "will:' "could," "should:'

the ability of counterparties of the Company to make, "expects," "plans," "anticipates," "bdlieves" "estimates:' payments as and when due; "projects," "predicts," "potential," or "continue" or the negative of these terms or other siniliar 'terminology.
the ability to obtain new short- and long-term There are various factors7 that could caluse actual results to contracts with neighboring utilities; . -

differ materially from those suggest eby the forward-

the direct or indirect effect on the Company's business looking statements; accordingly, there'ci be no resulting from terrorist incidents and the threat of assurance that such indicated resulti' will be realized. terrorist incidents; .

These factors include: -

interest rate fluctuations and financial market
'the impact of receht and future- federal and state - conditions and the results of financing efforts,

   'regulatory change, :including legislative and regulatory including the Company's credit ratings; ..

initiatives regarding deregulation and restructuring of

    ýthe electric utility industry, implementation of the

the ability of the Company to"obtain additional

 ".Energy-Policy'Act of 2005, and lso changes in                           generating capacity atccompetitlve prices;-`

environmental, tax and other laws*.kid regulations to catastrophic events such as -fires, eartquaks. which the Company is subject, as wp211 as changes in explosions, floods, hurricanes, Oandemic health events application of existing laws and regulations; - _

                                                                    - -such.as       an avian-influenza, or similar occurrences;     -,

Sctirrent and future litigation, regulatoryrihvestigations, proceedings- or inquiries, including FERC matters;

the Airect-or indirect -effects on the Company's

                                                                      " -businms resulting frombinidents similar to the August

the effects, extent, and timing of the entry of 2003 power outage in the Northeast; additional competition in the markets in which the the effect of accounting pronouncements issued Company operates; periodically by standard-setting bodies; and
variations in demand for electricity, including those other factors discussed elsewhere herein and in other relating to weather, the general economy and reports (including the Form 10-K) filed by the population, and business growth (and declines); Company from time to time with the SEC.
available sources and costs of fuels; The Company expressly disclaims any obligation to
advances in technology; update any forward-looking statements.

II-311

CONSOLIDATED STATEMENTS OF INCOME - For the Years Ended December 31, 2006, 2005, and 2004 Southern Power Company and Subsidiary Companies 2006 Annual Report 2006 2005 2004 (in thousands) Operating Revenues: Sales for resale .. Non-affiliates $279,384 $223,058 $266,463 Affiliates 491,762 556,664 425,065 Other revenues 5,902 1,282 9,783 Total operating revenues 777,048 781,004 701,311 Operating Expenses: Fuel']]

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