Southern Co (SOMN) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Southern Company second quarter 2003 earnings conference call. During the presentation all participants will be in a listen-only mode. Later we will conduct a question-and-answer session. At that time, if you have a question, please press the "1" followed by the "4" on your telephone. As a reminder, this conference is being recorded Tuesday, July 29th, 2003. I will now like to turn the conference over to Allen Franklin, Chairman and CEO. Please go ahead sir.

Thank you, operator. Good afternoon, and thank all of you for joining us again. Very pleased to be with you for a second quarter earnings call. As usual, joining me today is Tom Fanning, our Chief Financial Officer. Let me remind you that we will be making forward-looking statements today, in addition to providing historical information. There are various important factors that could cause actual results to differ materially from those indicated in the forward-looking statements, including those matters discussed in our form 10-K and other S.E.C. filings. As you can see from the earnings material that we released earlier this morning, we had a very solid quarter. Our businesses are performing well, and we're on track to meet our financial targets. I am pleased to note that we raised our annual dividend last week by 3 cents a share. Our annual dividend is now $1.40 a share. Based on yesterday's closing price, that puts our yield at 4.9%.

One of our objectives is to provide a total return to shareholders. That's stock appreciation and reinvested dividends that's in the top quartile of the electric power industry. I think we've clearly exceeded that goal over time. Our total shareholder return including price appreciation and reinvested dividends is 18.4% for the past five years, and about 15.3% for the past ten years.

Investment trends obviously will come and go, but we believe that investors will continue to value dividends as an essential component of their total return. And I'm pleased that we could again demonstrate our strong commitment to the dividend with a higher dividend rate that we announced just last week.

At this point I'll turn things over to Tom Fanning for discussion of our financial highlights for the second quarter, and our earnings guidance for the rest of this year. Tom.

Thank you, Allen. We're very pleased with our performance in the second quarter. Obviously, our results were ahead of guidance. I'll review the specific reasons why in a few minutes. But first, let's discuss our numbers compared to second quarter actuals a year ago.

Our earnings in the second quarter including the impact of the Dynegy settlement were 60 cents a share. The results included a one-time after tax gain of $88 million in May 2003, from the previously announced termination of all long term wholesale power contracts between Southern Company and Dynegy. After adjusting for revenues that would have been recognized for the remainder of the year had the contracts remained in place, the adjusted gain for 2003 is $83 million, or 11 cents, which we are now reporting as an adjustment to our earnings per share for the second quarter. Therefore, our earnings per share for the second quarter excluding the Dynegy effects were 49 cents per share. This compares to 47 cents per share in the second quarter of 2002. For the first half of this year, our earnings excluding Dynegy are 90 cents a share. That's up 11 cents a share over the earnings we reported for the first half of 2002.

Now, here is the breakdown of our earnings for the second quarter compared with the same period last year. First, the negative factors. Mild weather across the Southeast particularly in the month of June reduced earnings in our retail business by 3 cents a share. Increased O&M expenses related to fees in the current period associated with the restructuring of a lease agreement with Mississippi Power reduced earnings by a penny a share. Finally, the additional shares we have outstanding also reduced earnings by 2 cents per share in the second quarter.

Here is a breakdown of the positive factors. Customer growth and the impact of a retail price change added 2 cents a share to our earnings. Our competitive generation business added 3 cents a share to our earnings in the second quarter. This contribution was driven largely by a combination of higher gas prices and mild weather which allowed us to optimize our coal-fired units plus the margins we received from additional units we brought on line at Southern Power. The leasing business also added a penny a a share to our second quarter earnings. Finally, our synthetic fuels business added 2 cents a share to our earnings. This increase was due largely to three factors. A discontinuation of the reserves related to tax credits which we had been taking, timing associated with the tax credits related to production, and an increase in the fees we obtained due to the relocation of one of the units. So overall, excluding Dynegy, our quarter came in at 49 cents a share compared to 47 cents a share in the same period last year.

Our earnings guidance for the second quarter was 45 cents a share, so we exceeded our guidance by four cents a share. Here is the breakdown. First, the negative factors. Mild weather, particularly in June, had a negative impact of 3 cents per share on our regulated retail business. This reduction was partially offset by a 2 cent per share gain from a tax settlement. So overall, our retail businesses were down a penny a share. Turning to the positive factors, our competitive generation business added a total of 3 cents a share to our earnings above guidance. 2 cents came from our ability to optimize our coal fleet during this time of mild weather and high gas prices. As we discussed last quarter, we cannot count on this trend to continue because hopefully in the hot summer months we'll have less capacity to sell off-system. The other penny above guidance from competitive generation is largely a timing effect from the Dynegy settlement. We received revenues that were expected to be earned in the third and fourth quarters that were, instead, received early as a result of the settlement. The remaining 2 cents above guidance is primarily from our synthetic fuel investments. A portion of this amount over our guidance is related to increased operating and site fees we received from our partners. Accelerated production is also contributed to our earnings above guidance for the quarter. However, this is largely a timing issue; and as we do not intend to generate more tax credits this year than we originally planned, the remainder of the amount over guidance is due to the discontinuation of reserve of tax credits we had been recording for our synthetic fuel projects. So overall we were four cents a share over guidance for the quarter. Turning now to our earnings guidance for the remainder of the year. It's clear that we're performing better than planned. However, there are still several important factors that will impact our business over the next two quarters. First, uncertainty over weather, which has been mild in July, is a major variable to our earnings. As you may know, about half of our annual net income is earned during the third quarter. The month of July alone generally accounts for 18% of our net income for the year. And for Atlanta only four times in the past 30 years have been cooler than July 2003. Normally July would have been -- would have had about 13 days over 90 degrees. To date Atlanta has had only one day at 90 degrees. Cooling degree days are 15% below average for Atlanta, 10% below for Birmingham. So the weather continues to be mild. Second, we have yet to see a sustainable and robust recovery in the southeast, although the signs are becoming slightly more positive. Finally we are anticipating a lower performance from our retail gas marketing business. This lower than expected performance which could amount to a negative 2 cents per share by year end, is due to higher than expected bad debt issues, related to high gas prices this winter, and increased costs associated with bringing customer service systems up to our standards. As a result of these factors we are maintaining our guidance for the full year, at $1.86. For the third quarter we're expecting to earn 77 cents per share. Again, our guidance for the third quarter is 77 cents a share. As Allen mentioned earlier, our board authorized an increase in our annual dividend rate of 3 cents from $1.37 to $1.40 a share. Our new quarterly dividend which is 35 cents a share, is payable September 6th to shareholders of record on August 4. It's clear to us that dividends matter and are an essential component in providing return to our shareholders. The upcoming dividend will mark the 223rd consecutive quarter that we will have paid a dividend - a strong track record that shows the quality and consistency of our earnings. At this point I'd like to take a few minutes to discuss our syn fuels business. As you're aware, last month the Internal Revenue Service suspended issuing new private letter rulings for facilities that produce synthetic fuels. The issue in question appears to be whether or not the coal feed stock used in the production ever syn fuels has undergone a significant chemical change. As you know, we have chosen to take a conservative approach to our synthetic fuels partnerships. First of all, all of our synthetic fuel units have private letter rulings from the IRS. Included with each private letter ruling filing was an analysis of our chemical change. We audit these results quarterly, and we have been able to replicate these chemical change results every time. Second, we have taken syn fuel tax reserves totaling some $37 million. These reserves were taken because the IRS was, at one time, considering placing a cap on syn fuel production at each facility. However, it appears that the IRS is focusing more on the chemical change issue; therefore, we thought taking the reserve in the second quarter of this year. The decision to discontinue the syn fuel reserve plus the operating and site fees associated with the move of one of our units to plant branch will add approximately 2 cents per share to our earnings this year. Therefore, going forward, syn fuels will contribute approximately 7 cents per share from the previous level of 5 cents per share. I should note that the section 29 tax credits will continue to remain a very small part of our business, less than 4% of our earnings per share guidance for 2003.

Now, before I turn the call back over to Allen I'd like to take a few minutes to discuss potential disclosure of the Merritt bankruptcy filing which occurred on July 14. As you may know we've made extensive disclosures in our financial filings outlining our potential obligations related to Mirant. The four areas of potential exposure are trading guarantees, guarantees related to Mobil energy, Mirant related litigation and exposure related to our consolidated tax filing. I'll be glad to cover any of these items in more detail in the question-and-answer session. Mirant's bankruptcy filing does not automatically trigger any Southern Company obligations, but it could affect us in several ways. Certainly, bankruptcy does impact the indemnity from Mirant to Southern Company; but we have no reason to believe that Southern Company have any significant exposure from the Mirant related guarantees or tax issues. Obviously we can't predict the outcome of any litigation, but we believe the claims against Southern Company are without merit. As a final note, we've received some good news recently on two of these matters. First, with respect to the securities litigation, Southern was dismissed from all California related claims from this suit. And second, as of July 17, we've been notified by Mirant that our net exposure from trading related guarantees has been reduced from $16 million to approximately $12 million. At this point I'll turn things back over to Allen for his closing remarks.

Thank you, Tom. And before we take your questions, I want to spend a few minutes discussing this matter related to the federal energy regulatory commission that has occurred since our last call. As you're probably aware, the FERC is conducting a review of two wholesale contracts between Southern Power, which of course is our competitive generation subsidiary, and Georgia Power and Savannah Electric. The two contracts were filed with FERC in April of this year. Last month, FERC approved the contracts for filing, subject to refund pending a hearing. The competitive bidding for these power purchase agreements was conducted in a state-sanctioned process that selected the most cost-effective supply options from the proposals that were received. It's not our conclusion that these are the most cost-effective options, but it's the conclusion of the Georgia Public Service Commission which held the hearings and issued an order to that effect. FERC's guidelines indicate that affiliate contracts selected in such a manner should be approved, and we expect that to be the ultimate outcome of this case. From a financial standpoint, these contracts take effect in June of '05; so they have no immediate impact on our earnings. This concludes our formal remarks at this point. Tom and I will be happy to answer any questions you might have. Operator, we'll now take the first question.

Thank you. Ladies and gentlemen, if you would like to ask a question press the "1" followed by a "4" on your telephone. You'll hear a three-tone prompt to acknowledge your request. If your question has been answered and you wish to withdraw your polling request, you may [inaudible] by pressing the "1" followed by the "3". If you are using a speaker phone, please pick up the hand set before entering your request. One moment please for the first question. our first question comes from the line of Ashar Khan with Foresight. Please go ahead.

I just wanted to confirm whether the target for the year for Southern Power still remains for about $180 million or 2,000 on the competitive generation side for the year?

Might be a little higher than that at year end. You in fact, you know we have put in place a gulf or competitive generation business of hitting $200 million in 2005. It's likely we'll approach that number this year. So it might be a little higher than 180.

Okay. Second, any decision yet on Franklin No. 3, what you're going to do with it?

Let me address that.

Yeah, sure.

We're obviously looking seriously at what to do with that project. We said earlier in calls that we would certainly delay the project. We're out searching diligently trying to find customers and places to put that power before we make the ultimate decision as to whether to delay it or ultimately cancel the unit. Can't make a firm determination now. We're continuing to do some work on it. Some additional work, but at a reduced level. So more to come on that in the next few months depending on how the market develops down here.

Okay. And if I can just end up, Tom, you mentioned from the Mirant thing that the trading exposure is down to 12 million.

That's right.

Ashar Khan Any other quantification in terms of the other matters that you mentioned?

Well, I mean, let's kind of think through that. The Mobil energy guarantees -- I think we've disclosed a total of 19 million of exposure; but we believe the chances of us being exposed to that are really pretty remote. We have two safety nets that reduce what we think our real exposure is. Number one is we have the indemnification agreement from Mirant for any claims. Number two is we have security interest in the equipment there. So there's been no problems with that unit. We think it's running fine. So we feel pretty good about our exposure related to Mobile. The next area relates to litigation. You know, you never can tell about litigation; but I think on balance the news we received recently about being removed from California-related issues with respect to the security side of the litigation is very positive. Now, certainly, there are two other issues that remain that really deal with the accounting issues, one of which relates to Mirant not taking an impairment on our western power subsidiary. We went through a full disclosure in our financials at that time. We think, you know, we've got a good leg to stand on there. And the other has to do with the accounting adjustments, the accounting errors that Mirant disclosed fairly recently. We don't have any more information on that. It was a very small number, 29 million for 2000. So that's clearly not material for us. The number grew to over $150 million by 2001. You might remember we spun Mirant in the first quarter of 2001. So whether there's any adjustment that needs to be made from Southern's standpoint it would have to be any of those areas which would have occurred in the first quarter. Further I remind you that really since the end of 2000 we started accounting for Mirant as a discontinued operation.

Ashar Khan Okay.

So you know, we'll see. The other litigation issues really relate to ARISA lawsuits, two of them that were filed by Mirant employees that really relate to holding Mirant security in 401K plans post a spin. We feel our exposure there is unlikely. I guess the last exposure area is the fact that Southern continues to file consolidated joint and several tax returns. Now with respect to Mirant, this only applies to the tax years 2000 and the first quarter of 2001. We have received, really as I mentioned earlier about this tax settlement, we received a settlement of all audit issues through '99. This audit is currently being undertaking by IRS and to date, we have no knowledge of any issues.

Ashar Khan Okay. I really appreciate it. Great work.

Sure. Thanks for the question. Appreciate you asking.

Our next question comes from the line of Carrie Stevens with Morgan Stanley. Please proceed with your question.

Hi, good afternoon.

Hello.

Hello.

My first question is with respect to the Dynegy contracts. I know you gave an update on Franklin , but I was hoping you could update us on [inaudible] the recontracting of Daniel and the Thalberg units.

In both cases, the Dalberg units were allocated to that contract only into 2005.

Right.

So we never counted on those contracts to provide revenue requirements for the Dalberg capacity. The Daniel capacity - of course part of that is already in retail rates at Mississippi Power Company and part of it was allocated to these contracts. Going forward, we'll be exploring basically two options. The merits of -- along with the Mississippi Public Service Commission, the merits of over some time putting that capacity into retail rate base, if it makes sense for restale consumers or selling it off system. And I would say at this point we're still exploring which of those options makes the most sense.

And I would just add that Southern Power continues to be successful in finding new customers. We announced on July 2nd that the Piedmont municipal power association selected Southern Power to enter into a new supply agreement, about 200 megawatts, this year; and it grows a bit -- actually starts in 2005 and grows a bit beyond that.

I was wondering, with respect to the target for competitive generation, I didn't know if there was any way you may be able to quantify how much wholesale sales from your coal-fired units have contributed year to date versus kind of the gas-fired generation capacity.

Allen Franklin I think we might be able to break it down in very general terms between our contract sales, in other words, where we make long term contract sales, versus simply spot sales into the short-term market.

Okay. That's a help.

In general terms. And selling into the spot market, a very high percentage of that would be out of coal fired units.

Right.

And we have that --

For Southern Power -- yeah, it's -- generation earned $24 million in the first quarter of 2003 and $19 million in the second quarter of 2003. That's the optimization from the unit.

And when Tom says competitive generation, that's selling into the -- into the short term real time market, probably most often out of coal-fired plants.

Right. So that was 24 in the first quarter and 19 in the second quarter?

That's right.

Okay, great, thanks a lot.

Sure.

Our next question comes from the line of Jay Dobson with Deutsche Banc.

Hi, how are you?

Great.

On the Dynegy thing, can you just,Tom, maybe reconcile for me, it is an $88 million gain. Is there an accounting reason why you're taking the 1 cent and making it 83? I'm thinking in cents per share 11 versus 12, or is it just --

For reporting purposes, we always knew that when we settled the contract you saw a 12 cent effect immediately and then for the remainder of this year it was a negative 1 cent. What we wanted to do for reporting purposes was essentially capture all those effects in this quarter. So that's why you see us adjust from 88 to 83.

But you probably understand this Jay, but the part of that settlement included prepayment of revenues, capacity revenues we would have received throughout the rest of the year.

Right.

So we took that 1 cent this quarter, but the effect is we lose that 1 cent for the rest of the year.

And that 1 cent really goes to the heart of Daniel which is kind of November and December and for Dahlberg which is June through December.

Got you. Okay. On that syn fuel reserve what you're not booking is what helps you. There's not been reversal of the 37 million?

That's exactly right. Exactly right. And of the 2 cents that we're looking at picking up for the rest of the year, about a cent and a half of that is due to the cessation of accruing more to that reserve.

Okay.

As I think Tom said in his earlier statements, we began to accrue that reserve when the IRS started making statements about concern about production levels. And of the general consensus in the industry and here was that they were reviewing production levels. Clearly, at least it appears clear to us now that they're no longer pursuing the question about production levels, as opposed they're looking at chemical change. And it's no longer appropriate to continue to accrue for production levels when that doesn't appear to be an issue.

What would be the decision process around reversing that?

Upon completion of successful audits.

Okay, fair enough. And then a small item, last one. Just the leasing business, what was driving the improvement there?

We added a new lease at the end of 2002, in December. Wait a minute, let me just get that information for you. It was a tractor bell (ph) lease is what we call it in Chacktaw county Mississippi. We think that we'll get for the year about a 5.2 million dollar addition to net income for that. Would you like more information? I can give it to you. 440 megawatt Lignite power plant.

Nope, that's perfect.

Okay.

Appreciate it.

Our next question comes from the line of Paul Freeman with Jefferies and Company. Please proceed with your question.

Thank you. Based on, I guess your comment with respect to not incorporating some of this benefit into annual guidance is related to weather in the third quarter and obviously July already being mild. But would you not have the same opportunities during a mild weather quarter to continue selling off-system power from your coal units?

That's certainly a possibility. It's not -- it's not just concern about the weather. I'd say we still see a lot of softness in the economy. Our industrial sales are -- the second quarter were well below industrial sales a year ago. I think about 4% below. Whereas, they had caught up the first quarter. So it looks like the industrial situation has flattened and maybe even deteriorated a little bit. We have a good bit of concern about the economy, and we have a good bit of concern about weather. The weather is just incredibly mild here in the summer. And if you look proportionately at the offset, we have really mild weather, what we lose there versus gaining through off-system sales, I think we lose more than we gain.

I think that's exactly right. You'd rather have the hot weather. And the other thing is, you know, when you think about how you calculate a margin in a wholesale market, with coal displacing gas, it's pretty clear with the injection levels that we've seen recently the gas prices have responded by going down. And so that has the effect of shrinking some of the margin. Allen, let me point out one thing real quick. Three months into June '03 to '02 industrial sales are down a percent , 1.1%.

Allen Franklin I'm not sure -- I'm not sure I even understand that.

Three months into June, 2003, versus --

You mean three months into June -

Three months ended June '03 to '02 is down 1.1%. The [inaudible] hours is residential

The [inaudible] hours is residential which is weather related.

Right.

On the guidance issue of course any time you make a projection for a year or six months is just -- is your best projection. And I think to change our guidance again, remember we changed it from $1.84 to $1.86 after the first quarter. And until -- until we see the results, at least of August, we're just not comfortable making a change. There's just too much softness in the economy and concern about the weather. But as you all know it's a projection. We make projections just like you do.

One last question would be, on the whole syn fuel issue, is there any action, let's say short of an audit, which would sort of bring back a review of your chemical change process?

We audit those things quarterly. We use a variety of testing methods. A variety of experts. In fact, we have had our own people in research and development near Birmingham review that whole thing. We feel pretty comfortable that in fact we are achieving the chemical change results that were attached in our private letter rulings. I can't foresee a reason why we would change from our current practice.

I think and I'm looking and Jim Flemming our lawyer who is very familiar with the syn fuel, we're comfortable with the chemical change. We're comfortable that we have been able to replicate that quarter after quarter. We're comfortable it's been audited. Now, nothing keeps the IRS from changing their view about what represents an appropriate chemical change. So there's always the issue and always the risk that the IRS will change its view or will set different standards. Of course, we don't have any control of that or any information that they would. But from our end, based on our representations and our process, we're comfortable.

So if the IRS were to make any type of a change in terms of its approach or attitude, would that manifest itself through an audit of the various companies that are currently collecting that tax benefit, or would they -- could that potentially happen without sort of an audit process?

I think -- I think we're going to let Jim speak directly to that. Jim Fleming is counsel here at Southern Company is very involved in this and opposed to us giving you the information secondhand. Jim, Why don't you answer that.

You would think any change would come through an actual audit of our process and of our units. We'll say one encouraging thing. We've all been struggling to try to figure out what exactly the IRS and the Treasury are concerned with here. Because not just us, but all -- many of the taxpayers that have these syn fuel projects did get private letter ruling from the IRS. Attached to those ruling requests were description of the chemical change. And we've had a concern, well now is the IRS going to go back and say well that's all well and good but we the IRS were just too generous and we're now going to - we're now going to say which of those chemical changes aren't adequate. There was a meeting last week, a public meeting with a number of representatives from the syn fuel industry and both Treasury and IRS officials. And our understanding from that meeting is that fairly high level folks in both treasury and IRS made it pretty clear that they are now looking to change the rules on chemical change. They are more concerned with whether the taxpayers were in fact getting the change that they said they were getting. Could they replicate, could they repeat the actual chemical change through current tests? And as Tom said, we do that on a quarterly basis; and we feel confidentthat we can replicate what we told the IRS we were doing. So that's kind of a long way to say, I think this is not going to be resolved until there are individual audits of probably every other syn fuel operator in the company.

This is an issue obviously we follow very closely. But keep in mind, it is a very small part of our net income.

Thank you.

Our next question comes from the line of Paul Patterson with Glen Rock Associates. Please proceed with your question.

Good afternoon.

Good afternoon.

Sorry to pound the small part of your business with more questions. But I just was a little unclear exactly how the reserves worked. I understand why you took them, you felt that there might be some limitation on how much you could produce. Does that mean that you were producing more than you were sure that you'd be able to recover?

What we did -- the IRS at one time talked about limiting production at one point to name plate of the facilities. And we were producing over name plate. Then the discussion went to limiting production based on an analysis of whether you were limited based on your ability to produce a brickette or pelletizing process. We have limited our ability based on that. We have taken reserves 20% at one of our projects, Alabama Syn Fuels, and 10% Carbon Tronics,based on the difference between name plate and this pelletizing or bricketting limitation.

Okay. But you still produced it; and it's still being produced another loss, right? If you don't have the tax credits so it seems a little peculiar that you'd still be producing if you're reserving against it. If you follow me?

I'm not sure do I. The economics are, you run it at an operating loss; andthe tax credits and the tax benefit of the operating loss helps produce the economics.

Right. If you were taking a reserve because you felt that the amount that you are producing might not be allowed by the IRS, that would indicate that you probably wouldn't be producing it since it has an operating loss.

I think we were just being conservative in our view here.

Okay, I think I just am. The other thing I wanted to ask was with respect to the 2 cents a share, and I guess 1.5 cents comes from not recognizing, you're just not going to take that reserve anymore, is that correct?

We're not adding to the reserve anymore.

You're not adding to the reserve, but you're not reversing it either. And we see that two cents again showing up in 2004?

Yes.

So that would be in addition -- if we're going to get 7 cents this year, it should probably be about 7 cents again next year?

You would think so.

I'm sorry, I just wanted to make sure.

No, that's all right.

I think that's about it. There are no claims with respect to the Mirant bankruptcy yet, are there? I mean people haven't - there hasn't been any litigation with respect to the Mirant bankruptcy as of yet?

No.

No.

Thank you very much.

Our next question comes from the line of San Nangia with Zimmer Lucas Partners. Please proceed with your question.

San Nangia Yes, hi. A couple of quick questions, the first one being on Mississippi power. I notice there was a big change year over year, and I was hoping you could help me understand that net income went from 21 million to 53 million.

Let me see. Yeah, it's the Dynegy settlement. It's their portion of that associated with plant annual.

Oh, okay. It's just that --

And 37.3 million was associated with Mississippi Power.

Okay. And you know what, that probably answers my next question, which is going to be that Southern Power only showed 79 million and I was taking the entire $88 million over there.

That is it.

That explains that.

Super.

Not to pound on the syn fuel issue but I can't resist. Just in terms of the -- what was said at that meeting. It was, you know, also our understanding that the IRS has not stated that, you know, the -- that whatever was sent along with the PLR is actually acceptable. Is that consistent with your understanding or --

Turn to Jim Flemming again.

I think there was a lot of confusion over whether taxpayers were making representation as to those chemical changes or whether the IRS was in effect ruling that the chemical change was adequate. At least our view and our belief that the IRS is -- what they're saying now is, okay, taxpayer didn't represent that the chemical change was in fact an adequate or subsubstantial chemical change. We the IRS accepted it as that. What we're now saying is we want you to prove that you can go do that chemical change.

Okay. So whatever the standard was that the taxpayer used originally, the IRS is willing to at least go with that standard for now?

That's my understanding and there is a letter that Pam Olson from the Treasury has sent out. And I think that letter basically says the same thing. They're not trying to -- at least this is what came out of that meeting.

That's great, thank you.

We have to be careful because obviously the IRS hasn't totally made up its mind what it's going to do here. At least from that meeting. It seemed pretty clear they're saying we're not trying to say that your chemical change is not substantial or adequate, whatever. We want to know whether you are in fact accomplishing that chemical change.

Whether they are accepting just -- since we have that chemical change in our filing for a private letter ruling, whether they are accepting that as adequate or not, Jim, I guess, we know. We really know. We hope that is the case, but we don't know that for a fact.

I think that meeting gives encouragement to the belief that they will accept chemical change. They're not trying to change their view of chemical change.

That's great. Thank you.

To be totally candid, you know you may have IRS agents out in the field that may have a different view. So it may be some time before this is all resolved.

Okay?

That's great. Thank you.

Super.

Our next question comes from the line of Michael Worms of Harris Nesbitt. Please proceed with your question.

Good afternoon and thank you. Just a quick question for you. In the Southern Company business outlook, you're now talking about annual demand growth in the service territory of about 2% and customer growth of 1.5%. I believe those numbers are lower than the numbers you provided after the first quarter. Can you just extrapolate on that a little bit? Maybe some of it has to do with the economy, but can you just talk about that?

I think that's exactly what it is. I think you're right on the money there. You know, we were just trying to kind of update that based on how we see the current economy unfolding. You know, looks like from all the economic data we see, it looks like we may have hit a trough sometime in very early 2002; and we've been on kind of a very slight recovery since then. We continued to see good growth in customers; but that growth in customers for example, in June, or period ended June, was 1.6%. So that's more consistent. And we think energy sales follows that.

So do you think the slow down in the economy is going to have a permanent impact on the growth numbers in your service territory?

Hard to say. You know it all depends on when we're going to come out of it. I guess you saw the consumer confidence numbers and all that, and I guess opinions are varied all over the place. The common wisdom has held that we'll start seeing a more robust recovery at the very end of this year and into 2004.

I think -- I don't believe that slow down in the economy is likely to have a long term impact on migration of people into this area. We're still seeing the same kind of population growth and the same kind of customer growth we saw back during the boom times. I think a greater concern is the fact that some large industrial plants that have shut down may not come back. So you know, I think of the industrial side, we have the same issue here as we have in the rest of the country, that most of the textile which it was fairly prevalent here, has gone offshore. We're now seeing some other manufacturing, in part because of high gas prices either closing or going off shore. So on the commercial side and on the population residential side, I think we're fine. It's just a question of how much of this industrial comes back.

So with that in mind you're still comfortable with 5% annual growth going forward?

Yeah, on an earnings-per-share basis. We're talking about a sales basis or kilowatt-hour basis more like 2%; and for years we've talked somewhere between two, 2.5 and 3%. I think we're still, our projections on kilowatt hour sales or energy demand growth is still pretty close to what it's been. And of course the 5% doesn't relate to sales, it relates to net income or earnings per share which includes the competitive generation business as well as the other businesses.

Thank you very much.

You bet.

Great.

Our next question comes from the line of Adula Murdy with FAC Capital.

Good afternoon.

How are you?

I'm well thanks. this kind of relates a little bit to what Mike was talking about. I was taking a look back, you know, when post Mirant spin when you kind of reset the base and everything like that. And at the time I think the regulated infrastructure of the utility earned in the year 2000 $1.54. And if you take a look right now in 2003 your last guidance you're looking at about $1.57 for the regulated infrastructure. So clearly the growth has come from competitive generation which is running well ahead of the plan in terms of when to get the 200 million. Looks like you should be there maybe beat it this year. And while products and services might be running a little behind, you've had syn fuels which I don't think existed back then as part of the outlook. What I'm getting at basically is with the larger base now of the competitive generation business and potential recontracting, you know when we start getting into '06, '07, I'm wondering talking about a longer term growth rate of at least 5%. Should we be expecting a more aggressivecompetitive generation buildout to maintain the momentum there? Will products and services become a more faster growing part? I'm wondering how we sustain that, given that the utility has been a while steady, a fairly flat business for the last few years?

Let me first take a shot at that by saying remember that a hallmark of our competitive generation business is that we do that business with long-term contracts. When you think about it, our long-term contracts I guess the majority of them go through about 2010 would be our first kind of significant recontracting risk. So in terms of an earnings stream through that time period, we see our way clear to getting pretty good results. We're also, I think, buoyed by the fact that we're able to continue to increase our sales. Most recently in this Piedmont Municipal Power Association last year there was an EMC 11 contract that we signed. We've been able to pick up a bit here and in a fairly tough market continue to make some sales. So certainly Southern Power is in the whole competitive generation business is a very important part of our earnings forecast going forward, but we feel pretty good about it.

Let me add to that. When you're talking about the growth rate in earnings from the regulated business over a very short period of time from one year to the next or over a couple of years, that's not a very reliable indicator of long term growth because you can have rate cases or not have rate cases. You have to look over a longer period of time. And if you just look at the math associated with the regulated business, the kinds of returns we have, the equity ratio, the payout ratio, you put all that together and we should be able to grow that business on an EPS basis maybe three, three and a half percent. So the question is how do you get from 3 or 3.5% to 5%? And Southern Power, the bigger it gets the harder it is to grow at a high rate, but the more effect it has. In other words, if it's only making a dollar a year and you're growing it at 400%, then it doesn't have much effect on Southern's growth rate. When it gets to $200 million a year and you can grow it 10% it has a huge impact when you rate that against the 3% out of the retail. So to try to clarify, I think we can grow the regulated business maybe 3% or 3.5% on an EPS basis. The rest of that, most of that is going to come from the wholesale business; but we're not going to get more aggressive as far as risks are concerned. I don't think we have to. If that's the way we have to increase their growth we will simply accept lower growth because our commitment is to be a low risk, disciplined, income oriented company. And that's -- we're going to stay that. As far as products and services, I think all of -- we're probably going to make our targets come close to our targets. This for a long time is going to be a very tiny part of our business. The major growth will come out of regulated retail and sticking with a conservative competitive generation basis. And I can say for the next few years, the 5% looks very, very makable. You know we started talking about 5% back in 2001 when we did the spin. We've actually had some good fortune and I guess some good decisions too; and we've grown more like 7% over the last two or three years. Just to put it in context, I'm very comfortable with the 5%.

Maybe I ought to follow up on that since you've had in your business plans, you know, achieving $200 million from competitive generation by 2005, and it looks like you'll get there this year. Given the pipeline that you have, both in terms of what's come on line this year and what you'll have coming on in 2005, can you rebase what is a more realistic number for the end of 2005, what we should be expecting from competitive generation because $2 million looks way too conservative?

Let me defer that until we give guidance for next year. We're in a lot of work looking at what market is out there. How to place and where to place this generation that came out of the Dynegy agreements. And would I prefer to get through that process before we-- we've had this goal of $200 million for a number of years; and before we give guidance beyond that, I'd like for us to get through that process. And we'll get that to you as soon as we're comfortable.

All right, thank you very much.

Our next question comes from the line of Suzannah Roman with Barkley. Please proceed with your question.

Most of my question was already answered, but maybe you can reaffirm my numbers. With Mississippi Power how much extra did Dynegy's contract termination add to its net income?

37.3 million.

And why are the operating revenues so much higher for this quarter in Mississippi?

$60 million is associated with the Dynegy settlement.

It's completely and the same with Southern Power right?

That's right, and that's $80 million.

80, thanks.

Sure.

Our next question comes from the line of Andy Smith with Lazard Freres. Please proceed with your question.

Good afternoon, guys.

Good afternoon.

Good afternoon.

A quick question. On page 9 in the press release the other electric revenues and other operating revenues are up pretty sharply. Is that Southern Company Gas or is there something else rolling through there as well?

Okay, Southern Company Gas -- Let's see other operating - other electric revenues --

Right. Other operating revenues, which electric I wouldn't think would be Southern Company Gas.

Yeah. Other operating revenues. That is a whole host of things. Southern Company Gas would be a lion's share of that. You know this is really the first full year of operation there, year to year.

Do you have a feel for how much Southern Company Gas contributed to that, just a rough breakdown?

Just a second.

On an annualized basis.

On an annual basis it would be 100 million. We don't have the six-month kind of result for you. We can get that for you when you like.

Just a rough ballpark is fine, and on the other revenues what drove the performance there?

That's the Dynegy settlement.

That's Dynegy flowing through there on the consolidated basis.

Sure.

Okay, great. One other thing I'm going to beat on the syn fuels a little bit more. What was the kickoff point or what got that whole issue started up, in-house, IRS things, did someone start to complain, that would be really helpful.

Let's let the lawyer that has dealth with that for the last five years.

Honestly we don't know what start they had last round. If you look back historically, there has been four times where the IRS has ceased issuing private letter rulings on syn fuels for various reasons. Obviously there are a lot of folks who do not think real highly of syn fuels and we don't know, honestly we don't think of anything specifically with any taxpayer that has caused this. Don't know honestly whether it was a field IRS agent who decided to challenge chemical change or whether it was the national office.

Great, thanks guys.

Super.

As a reminder, ladies and gentlemen, to ask a question please press the 1 followed by the 4. Paul Patterson with Glen Rock Associates. Please proceed with your question.

Just a quick follow-up. What's the method that you guys use in your syn fuel, is it Star Tech or Cobalt --do you know the process that you guys use?

We have that and hold on just a second.

We use, just let me turn to it so I'm precise here. Okay.

You can tell we're not chemical engineers. We're engineers, but not chemical.

It's not clear exactly what the IRS considers to be chemical engineer.

We're coming to it.

Just hang on.

That was a question we anticipated but not -- didn't have it up at the front.

Just a sec Okay. We use -- wait a minute, just a second, just a sec.

Let's go to another question and come back to that as soon as we find the answer. Do you have another question?

No, that's it, thank you very much.

We'll come back to that go ahead and take the next question.

Next question comes from the line of Peter Hark (ph) with Tolone Capital. (ph) Please proceed with your question.

Could you please reconcile your earnings of 77 cents with last year's reported third quarter of 84 cents?

Yeah, we can do that. Tom, why don't you do that. What we're trying to do is reconcile the guidance. Let somebody else look through the printout. The guidance of 77 cents versus the actual last year of 84 cents.

Okay. You know what I'd like to do, to do that is really kind of go through it for the last half of the year, even. If you -- if you think about include the whole next half of the year here, we had, in 2002, $1.07, okay? Now, of our total earnings last year, about 11 cents were nonoperating, nonrecurring. And 2 cents of that was in the second quarter of 2002. So of the six months remaining this year, 2002, you should deduct about 9 cents. Those things related to weather, 401 K dividend reduction, writeoff in energy solution, tax settlement and some other items. So for the remaining six months, 2002, you really about 98 cents. Okay? Now, what we're currently guiding you to, if you take 77 cents which is our guidance, and then the remainder to 1.86, you with us? The total amount of guidance then for the remainder of the year is 96 cents. Okay? Our adjustments that we think going forward to get there are something like this. Probably a cent for energy solutions, 2 cents for additional shares, Dynegy settlement of a cent, O&M timing, we talked in the first quarter about 3 cents there, Southern Gas we talked about 2 cents. That brings you all the way down from 98 down to 91. Now, we think that we'll be able to get back to our 96 by essentially managing our O&M and also our performance with growth and some other things, getting us back up to 96.

That's perfect. Actually, to further that, I was trying to get an idea by business segment, whether the anticipated shortfall would be more than explained by weather related decline at the utility. In other words, you know, in follow-up to some of the earlier questions, sounds like you're on track for $200 million of net income at a competitive generation which is about 28 cents a share. And you've done about 16 cents through the first half of '03 suggesting you have 12 cents of competitive generation to go here in the second half of '03. What was -- first question here, what was second half's '02's competitive generation contribution?

Let me have that. Let's look at that just a sec. Second half was ten cents.

Ten cents so you expect a two cent improvement in competitive generation in the second half of '03, suggesting that the utility would explain more than the shortfall in say third quarter earnings? Is that a way to look at it or --

Yeah, in fact I think that's a general trend what you've seen so far certainly in the second quarter is, you know, weather has hurt us a little bit but we have been able to offset with wholesale performance selling our excess coal, once we satisfy our needs of the retail customers and displace that higher price gas.

Is there a way to assign what the weather impact will be?

No, not yet.

All right, great, thanks very much.

Hey, I've got the question on the chemical change processes and all of that. Sorry for the delay there, I had all this paper in front of me. The Alabama syn fuels project uses a Star tech process which uses asphalt emulsion. The carbontronics project is the other one, uses a carbon-type process, which is asphalt emulsion mixed with Clinilan which is an accelerant.

The carbontronics machines are made by Gencore. The machines at Alabama are Star Tech machines. Some folks may say Star Tech really isn't a process, the process used by Star Tech machines is what Tom said, it uses asphalt emulsion process.

And it's -- I think you're rapidly getting beyond the technical capability of a lawyer and two nonchemical engineers. Let me suggest, if you have additional questions and really want to understand the chemical process, give us a call back. Call Len Cundert and he will put you in touch with people who really understand the process. Okay, do we have another question operator?

Next question comes from Jay Yanello of UBS.

Did I hear correctly that the current quarter includes a 2 cent tax gain somewhere in the regulated utilities?

That's right.

What was that for exactly?

Settlement of tax years and actually goes back, I get you all the details there, just a sec. Let's see, there were the settlement of a tax years 1988 to 1992. As well as a tax period '96 to '99. Most all of the income that we're showing is due to interest accrued on those settlement amounts. Both settlements, one occurred at Georgia Power was probably the most of it about 11.2 million and the balance at Alabama Power.

Okay. Just curious were there any other kind of lumpy like items throughout the numbers without getting too nitpicky that weren't in the release?

Not that we haven't talked to you about. I think those would be the most significant.

Okay, thank you.

Sure.

Our next question comes from the line of Vic Cayton (ph) with Deutsche Asset Management. Please proceed with your question.

Two questions. First, maybe I got confused here about this competitive generation. What percentage of that income is coming from long-term contract? Was it spot sales?

Most of it in the Southern Power most of it is.

So there was answer given earlier about maybe about 24 million and 19 million in the first quarter and second quarter.

That was for competitive generation for the system.

For the system, I see. And now what happens to the Dynegy feed up power, has that been recontracted or that's still yet to go through?

We don't have a firm bilateral contract for the Daniel capacity. Where we think we might use some of the Dahlberg capacity for the Piedmont sale perhaps some for the MC 11 stuff.

So does that mean that we will not have any kind of a short-term sales from those or --

Oh, yeah.

Sure.

We're selling short-term oust those plants now. But consistent with our basic philosophy on that business, we want those plants covered by contracts. So all of these plants that were originally in the Dynegy agreement will be working to either put them in existing contracts, and we have some space for additional capacity in existing contracts, are finding other customers to sell the power, or in the case, as I mentioned earlier, at Plant Daniel if it makes sense from a retail consumer standpoint, we would look at putting that in retail plant base in Mississippi if it works economically.

Dividend policy, your dividend growth is a little less than earnings growth. At what point do you see the dividend growth could start matching the earnings growth?

We've said that we thought to pay out a ratio of somewhere between 70 and 75% was a good spot for us to be. With a buck 86, you're just getting to a power ratio of about 75%. Both Allen and I feel comfortable moving in the lower end of that range.

So within a year or so you might start reaching that dividend?

If you just do the math within a couple of years you probably get pretty close. To provide some continuity, when we did the spin of Mirant our payout ratio was like 83% after the Mirant spin. And we said about -- we said we were going to get that down to 75 as fast as possible. And two years later, we are pretty much there. The truth is, we felt all along we'd rather be below 75. And now we're 275. I would rather be around 70. And I think Tom had, too. But we're not setting a hard target of saying 70 or 71 or 72. We'll sort of play it by ear. But I'd be more comfortable getting down close to 70 before we increase the dividend growth rate to approach that of the EPS growth rate.

I see. Yeah, because your other comment were that you are income oriented company with a low risk so maybe the dividend growth might be more aggressive then.

Okay. Hey, we've had Glen cut a note that we're over an hour on the call. If we could one more question.

All right, sir. Our last question comes from the line of Norman Greenberg with Norman Greenberg associates. Please proceed with your question.

Congratulations great job to start with.

Appreciate it.

Leaving everything else out, I've heard nothing about the gas business. Is that sort of a dead issue or you think you might expand that somewhere along the line?

Let me talk about the gas issue or the gas company. It's not a big company, but it's significant in our thinking. We -- as most of you know, we purchase the customers and some of the computer systems from New Power which was involved in the retail competitive gas business here in Georgia. And we bought about 200,000 customers maybe a little bit more. And I said last year, when we first bought it, we have a question about would we expand that. And my answer was no, we would not expand it until we fully understood the business, we're able to make it successful here, understood how profitable it could be, and whether it's something we really wanted to get into. So we were going to work hard on this company, this gas company, before we were worried about going broader. We're well into that. We've learned of a lot. One thing we learned is that if you have very high gas prices, a lot of people don't pay their bills. And that's different than electric, in the case of electric, in a vertically integrated company. If someone doesn't pay the bill, that same company, the electric utility, can disconnect those customers. The way the market is et up in the gas business here in Georgia, where it's now vertically disintegrated, the marketer is the one that doesn't get paid. But you have to go through the distribution company and a fairly lengthy process to get customers cut off. So the high gas price this winter resulted in very high levels of people that simply didn't pay their bill. And it took a long time to get them off. So the earnings for -- from the gas company are going to be negative this year, not -- not big numbers, but certainly negative. And I would say, in answer to your question, we're going to keep working on this company getting our -- the customer care up to where it needs to be, getting the earnings where they need to be, and over time, you know, over the next year or two years or three years, if this -- if we can make this business a really attractive business with this small company, then we would consider going more broadly. But not until we learn a lot more about it.

Thank you.

You bet. With that, first of all I appreciate all of you folks calling in and secondly, appreciate the great questions. They're all good questions. I hope we've adequately answered all of your questions. Appreciate your interest in the company and until the next earnings call or until we see you again, we'll sign off. Thanks a lot.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your lines.