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3/18/2003

For the transition period from                                  to                                 

Commission file number 1-1055

Florida Public Utilities Company

(Exact name of registrant as specified in its charter)

PART I

Item 1.  

Business

General

Florida Public Utilities Company (The Company or FPU) was incorporated on March 6, 1924 and reincorporated on April 29, 1925 under the 1925 Florida Corporation Law, continuing its corporate existence pursuant to such law and its Certificate of Reincorporation, as amended.  In 2001 the Company started a proactive process to look for opportunities to purchase small gas companies to assist in its growth.  In 2001 two acquisitions added approximately 7,300 customers and in 2002 one acquisition added approximately 1,200 customers.  The cost of each of these acquisitions was less than 10% of assets and they provide less than 10% of revenues and operating income excluding income taxes.

Description of Business

Florida Public Utilities Company is regulated by the Florida Public Service Commission, except for propane gas service supplied by its wholly owned subsidiary Flo-Gas Corporation, and provides natural and propane gas service, electric service and water service to consumers in Florida.  The Company is comprised of the following five divisions and number of customers as of December 31, 2002: (1) South Florida division serves natural gas to 29,697 customers and propane gas to 6,288 customers; (2) Central Florida division serves natural gas to 16,670 customers and propane gas to 3,789 customers; (3) Northwest Florida division provides electricity to 12,335 customers; (4) Northeast Florida division serves electric to 14,020 customers, water to 7,089 customers and propane gas to 1,456 customers; and (5) Nat ure Coast division which serves propane gas to 1,207 customers.

On December 3, 2002 the Company entered into an agreement to sell the assets of its water utility system to the City of Fernandina Beach. A tentative closing date of March 27, 2003 is scheduled (for additional information see "Discontinued Operations" in the Notes to Consolidated Financial Statements). The sale will provide working capital for future capital expenditures and acquisitions and aligns the Company with its strategic goal of providing for customers’ energy needs and expanding core energy related businesses.

The economy of the South Florida division relies somewhat on the migration of seasonal residents and tourists during the winter season; however, small commercial and residential customers, who are not seasonal, provide stability.

Seasonal residents and tourists continue to play a role in the Central Florida division; however the I-4 corridor, particularly in Seminole County’s Lake Mary/Heathrow area, is producing a greater amount of large business parks, individual corporate buildings and call centers.  Volusia County’s economy still seems to be dominated by small and privately owned businesses with the major employers being Florida Power and Florida Power & Light which own and operate three power plants in the area.

The Northwest division growth relies on the economies in Jackson, Calhoun and Liberty Counties.  All three are dependent upon a variety of agricultural industries mainly involved with timber, peanuts, cotton and beef production.  However, the largest employers within the three counties are the Federal, State and County governments involved in correction and rehabilitation centers.  There are also a number of smaller industries.

Northeast Florida’s economy is centered around two large paper mills, ITT Rayonier, Inc. and Jefferson Smurfit Corp.  The two large paper mills accounted for 8.6% of total 2002 electric division’s operating revenues and 4.0% of the Company's total operating revenues.  The mills accounted for 4.0% of total 2002 electric division gross profit and 1.3% of the Company's total gross profit. The beach area, Amelia Island, is noted for its fine beaches and resort amenities.

Natural Gas

The Company receives its total supply of natural gas at twelve City Gate Stations connected to Florida Gas Transmission Company's  (FGT) pipeline system. FGT is owned by Citrus Corporation, which is jointly owned by Enron Corporation and El Paso Corporation.  Due to the joint ownership of FGT, there has been no direct effect on FPU's operations from Enron’s bankruptcy.  Natural gas is primarily composed of methane, which is a colorless, odorless fuel that burns cleaner than many other traditional fossil fuels.  Odorant, which enables one to readily detect a gas leak, is added by the interstate transmission company and FPU.  Natural gas is one of the most popular forms of energy today.  It is used for heating, cooling, production of electricity and it finds many uses in the industry.  Increasingly, natural gas is being used in combination with other fuels to improve their environmental performance and decrease pollution. 

The Company has adequate gate stations in each distribution system to assure high levels of continuous service to our customers.  The vast majority of the natural gas the Company distributes is purchased in the gulf coast region both on-shore and offshore.  The Company has not experienced any supply availability issues or shortage of natural gas in recent history, nor does it expect any shortages in years to come.  In fact the U.S. Department of Energy estimates that there is more than a 60-year supply of natural gas reserves (see web site: http://www.fe.doe.gov/education/index.html).  

FGT is the sole natural gas pipeline serving FPU in peninsular Florida and is under the jurisdiction of the Federal Energy Regulatory Commission (FERC).  The Company uses FGT solely as a carrier of natural gas.  All gas supplies for the Company 's traditional sales markets are independently procured by the Company using gas marketers and producers.  The Company’s transportation customers are responsible for obtaining their own gas supplies and arranging for pipeline transportation. 

The Company has continued to be in full compliance with the Gas Industry Standards Board’s (GISB) standards.  The GISB was formed to develop a uniform nationwide network of natural gas producers, marketers, gathering systems, pipelines, distribution companies and customers.  The GISB’s standards place all participants on the same time schedules for procurement, capacity transactions, invoicing, etc.  It causes the network to be fully available twenty-four hours per day, 365 days per year.  

The Company has gained vast experience directly contracting for gas supplies with marketers and producers while contracting for transportation services from FGT.  This experience appropriately postured the Company to be most effective in operating within an unbundled industry environment. All fuel costs and associated savings are passed along to our traditional sales customers.  Additionally, the Company has actively reduced demand charges it pays for the pipeline capacity by "subletting" unused capacity, for short terms, to other shippers on FGT’s system.  The Company continues to be one of Florida’s lowest cost suppliers of natural gas.

The Company continued its activity in Off-System Sales since receiving approval for the appropriate tariff from the Florida Public Service Commission (FPSC).  Off-System Sales allow the Company to broaden its market to include any customer within the state of Florida who currently uses natural gas.  Since inception, Off-System Sales have been transacted between the Company and national marketers, electric generators, other gas distributors and agricultural firms, to name a few.  The tariff permits for profit sharing between the Company and its customers.  

The Company, through its Purchased Gas Adjustment (PGA) mechanism, collected the cost from its customers in 2002 for any 2001 under collections.  The Company's natural gas sales are affected by weather, which results in higher gas sales per day during the winter period as opposed to the summer season.  The Company's portfolio of customers is quite diverse with the largest customers using natural gas for the generation of electricity.  The Company is not dependent on a single natural gas customer for a large percentage of its total revenue. 

The Company provides unbundled gas service to its commercial natural gas customers whereby such customers have the option of purchasing their gas supplies from third parties or directly from FPU. The Company’s operating results are not adversely affected whether the customer purchases the gas from the Company or purchases the gas from third parties. This is because actual fuel costs are passed directly to customers and the Company does not profit on fuel sales. The Company officially offered unbundled services to commercial customers on August 1, 2001.  The FPSC approved various mechanisms, which will allow the Company to be reimbursed for the incremental cost of providing unbundled services.

Electricity  

The Company provides electrical service in the Northwest and Northeast divisions to customers in Jackson, Calhoun, Liberty and Nassau counties in Florida.  Wholesale electricity is purchased from two suppliers, Southern Company and Jacksonville Electric Authority.  In 1996, long term purchased power contracts were executed with both suppliers that will continue through 2007.  Southern Company provides electrical power to the Northwest division and the Jacksonville Electric Authority provides electrical power to the Northeast division.  Less than 1% of the Company's power supply is purchased on an as available basis from a self-generating paper mill located in Fernandina Beach.  These long-term contracts allow the Company to offer customers th e lowest electric rates in the State of Florida.

The Company is not a generating utility, which results in environmental regulations having minimal effect on operations.

Both the Northwest and Northeast divisions are located in northern Florida and experience a variety of weather patterns.  Hot summers and cold winters ensure that electrical sales are not extremely seasonal in nature.

The Company has no dependence upon any major customers.  No single customer accounts for more that 10% of sales or profit.

The electric utility industry has not been deregulated in the State of Florida.  All customers within a given service or franchise area purchase from the single electricity provider in that area.

Propane

Florida Public Utilities purchases its supply of propane gas from several different wholesale companies such as: Dynegy- Gas Liquids Division, Propane Resources, Sea3 of Tampa and Harper Industries.  Propane makes its way to Florida via ocean going barge to seaport terminals in Tampa and Ft. Lauderdale, by railcar and through the Dixie Pipeline terminus at Alma, Ga.  The propane supply infrastructure is more than adequate to meet the needs of the industry in Florida for the foreseeable future.

Propane is a non-pollutant, therefore not affected by environmental regulations as other petroleum products are.  Propane is a hazardous material and as such is subject to strict code enforcement and safety requirements as outlined in the National Fire Protection Association (NFPA) Code 58, Florida Model Building Code, NFPA 54 and various other state and local codes.

The sales volume of propane is affected by the season and the weather.  Florida typically has a tourist season that coincides with the winter season; propane sold during that period is affected by tourism and the weather. The propane division's sales volumes and revenues are closely balanced between residential and commercial customers.  Some of the strategies the Company is employing to become less weather dependant are concentrating on the burgeoning forklift propane cylinder exchange market and the marketing of appliances that are not used for heating air.  Water heaters and forklift cylinder exchange accounts are excellent ways to strive toward becoming less weather reliant.  The propane division does not have any one customer that represents more than ten percent of the overall sal es volume or revenues.

Competition in the propane business is significant.  Propane competes directly with other propane suppliers, natural gas and electric companies.  A major consolidation in the propane industry has and will continue to provide Florida Public Utilities with opportunities to expand its market share.  FPU competes on the basis of fair priced energy and excellent customer service.

Regulation

The Florida Public Service Commission (FPSC), pursuant to State Statutes, has authority encompassing natural gas, electric, and water rates, conditions of service, the issuance of securities and certain other matters affecting the operations of the Company.  The water segment of the business was not subject to FPSC regulation in 2002 until July 29 because the Board of Nassau County had, on September 17, 2001, rescinded the FPSC jurisdiction but returned it to the FPSC on July 29, 2002. The water segment is classified as discontinued operations due to its pending sale (for additional information see "Discontinued Operations" in the Notes to Consolidated Financial Statements).

Franchises

The Company holds franchises in each of the incorporated municipalities where natural gas, electric and water operations take place.  These franchises generally have terms from 15 to 30 years and terminate at various dates.  We are in negotiations with some of our municipalities in which the Company’s franchises have lapsed.  We continue to provide services to these municipalities and do not anticipate any interruption in our service.

Employees

On December 31, 2002 the Company had 353 employees, of whom 104 were covered under union contracts with two labor unions, the International Brotherhood of Electrical Workers and the International Chemical Workers Union.

Research Expenditures and Environmental Regulations

Environmental regulations do not have a material impact on the Company.  The Company does not engage in research activities.

Competition

Generally, in municipalities and other areas where the Company provides natural gas, electric and water services, no other utility directly renders such service.  Propane gas has several propane competitors competing on price and service.

Item 2.   Properties

The Company's properties consist primarily of distribution systems and related facilities.  At December 31, 2002 the Company owned 22 miles of electric transmission lines and 1,047 miles of electric distribution lines. The gas properties distribute gas through 1,405 miles of gas main.  The water property consists of deep wells, pumping equipment, water treatment facilities and a distribution system.  The propane gas systems operated by the Company's subsidiary have bulk storage facilities and tank installations on the customers' premises.

Certain properties of the Company and the shares of Flo-Gas Corporation, a wholly-owned subsidiary, are subject to a lien collateralizing the funded indebtedness of the Company under its Mortgage Indenture.

Item 3.   Legal Proceedings

Environmental. The Company has several contamination sites involving pending or threatened litigation and is in various stages of assessment in­vestiga­tion; see "Contingen­cies" in the Notes to Consolidated Financial Statements.  The Company believes that all future contamination assessment and remedial costs, legal fees and other related costs will not be in excess of the rate relief granted the Company and insurance settlement proceeds received.

Violet Skipper, PC Buyers, Inc. and Thomas Wade Skipper v. Florida Public Utilities Company, Case No. CL 00-10131-AF, Circuit Court of the Fifteenth Judicial Circuit, Palm Beach County, Florida. On or about October 18, 2000, FPU was sued by the Plaintiffs in this case for damages allegedly arising out of FPU's alleged negligence in failing to properly install and/or maintain electrical power lines, utility poles and related equipment which allegedly caused a fire that spread to and eventually destroyed a warehouse/office facility that was owned by Violet Skipper, that housed the place of business of the corporate plaintiff and that contained property therein owned by all the plaintiffs.  The warehouse/office facility was located in Jackson County, Florida.  Plaintiffs alleged damages i n excess of $1,000,000.  FPU has denied the claims in the complaint and is defending it on the theory that the alleged fire started within the warehouse/office facility and not at or in its electrical equipment.  FPU has liability insurance that will limit our exposure on this claim to a maximum of $250,000.

This case, though filed originally in Palm Beach County, Florida, was transferred to Jackson County, Florida.  Discovery is still in process.  No Motions are currently pending.  No trial date has been scheduled. At this time we are unable to provide an evaluation of the likelihood of an unfavorable outcome or provide an estimate of the amount or range of potential loss. In the event that the Company does not prevail in this suit, there may be a material adverse effect on the financial statements.  However, FPU believes there are meritorious defenses to this pending litigation.

Darrell Glenn v. Florida Public Utilities Company v. Utility Service and Maintenance of Missouri, Inc., Case No. CA 01-07810 AI, Circuit Court of the Fifteenth Judicial Circuit, Palm Beach County, Florida; Case No. 02-37-CA, Division A, Circuit Court for the Fourth Judicial Circuit, Nassau County, Florida. This is an action that was pending in state court in Palm Beach County, Florida until FPU successfully moved to have the case transferred to Nassau County, Florida.  Darrell Glenn ("Glenn"), an employee of a painting subcontractor, claimed to have been shocked and injured on May 16, 2001, while painting electrical equipment at FPU's Step down site in Fernandina Beach, Florida.  His employer, Utility Service & Maintenance, Inc. ("USM"), was operating under an ag reement that required it to supervise its own workers.   This matter has been settled by an agreement reached at mediation on January 15, 2003 pursuant to which FPU agreed to pay $300,000 to the plaintiff in return for a release. FPU will recover $50,000 of the settlement through liability insurance.

The Company is also involved with other various claims and litigation incidental to its business.  In the opinion of management, none of these incidental claims and litigation will have a material adverse effect on the Company's results of operations or its financial condition.

Item 4.   Submission of Matters to a Vote of Security Holders

None.

PART II

Item 5.

Market for the Registrant’s Common Equity and Related Stockholder Matters

QUARTERLY STOCK PRICES AND DIVIDENDS PAID

The Company's common shares are traded on the American Stock Exchange under the symbol FPU.  The quarterly cash dividends declared and the reported price range per share of FPU common stock for the most recent two years were as follows:

On February 8, 2003, there were approximately 2,736 holders of the Registrant’s Common Stock including individual participants in security position listing.

It is the Company's intent to continue to pay quarterly dividends in the foreseeable future.  Dividend policy is reviewed on an ongoing basis and is dependent upon the Company's expectation of future earnings, cash flow, financial condition, capital requirements and other factors.

The Company’s Fifteenth Supplemental Indenture of Mortgage and Deed of Trust restricts the amount that is available for cash dividends.  At December 31, 2002 approximately $4,000,000 of retained earnings were free of such restriction.

Recent Sales of unregistered securities

On November 14, 2001 the Company sold Palm Beach County Florida Industrial Development Revenue Bonds in the amount of $14,000,000. The aggregate offering price was $14,000,000, with payments relating to $420,000 in underwriting fees and $349,426 for insurance premiums.  The bond proceeds were restricted and held in trust until construction expenditures were actually incurred by the Company.  (See "Liquidity and Capital Resources" under Item 7 for additional information).  The Company issued its First Mortgage Bond, 4.9% Series due 2031 on November 14, 2001 in the aggregate principal amount of $14,000,000 as security for the $14,000,000 Palm Beach Industrial Development Revenue Development Bonds.  The pledged bond constitutes the Fifteenth Series of the Company's First Mortgage Bonds.

The exemption from registration is under the authority of Section 382 of the Securities Act of 1933, based on the bond being issued by a state and local government.

Item 6.

Selected Financial Data

(dollars in thousands, except per share data)

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations    

This discussion should be read in conjunction with the Notes to Consolidated Financial Statements contained herein.  In the following discussion, all comparisons are with the corresponding items in the prior year.

RESULTS OF OPERATIONS

Overview  ­The Com­pany is orga­nized into three regulated busi­ness seg­ments, natural gas, electric and water and one non-regulated business segment, propane gas.     

From the Florida Public Service Commission’s (FPSC) perspective the Company operates four distinct regulated "entities" consisting of Northwest Florida (Marianna) electric, Northeast Florida (Fernandina Beach) electric, Northeast Florida (Fernandina Beach) water and natural gas.  The Company considers the Northwest and Northeast electric divisions to be one electric segment.  The Company last received rate increases in the regulated entities as follows: natural gas operations, May 1995; Northwest Florida electric division, February 1994; Northeast Florida electric division, February 1989; and Northeast Florida water in May 2001. In 2002 the water segment of the business was not subject to FPSC until July 29, 2002, because the Board of Nassau County had, on September 17, 2001, resci nded the FPSC jurisdiction but returned jurisdiction to the FPSC on July 29, 2002.

On December 3, 2002 the Company entered into an agreement to sell certain assets comprising its water utility system to the City of Fernandina Beach.  Pursuant to the Agreement, the closing of this transaction is required to take place on or before March 31, 2003, and is currently scheduled for March 27, 2003.  The City has agreed to pay the Company $18,950,000 in cash at closing, with additional future consideration of $7,500,000, at an anticipated rate of $375,000 per year, commencing on or before February 15, 2004, and a like amount each year thereafter until February 15, 2010, when it is estimated that the Company will receive a final payment from the City in an amount of approximately $5,250,000. The fair value of the consideration is approximately $25,100,000. The assets of the water segmen t amount to approximately $10,200,000 or less than 10% of the Company’s assets including water. For the year ended December 31, 2002, the water segment’s operating income before income taxes was approximately 12% of total operating income excluding income taxes. Assuming the sale is consummated, the Company will thereupon file an application with the FPSC for approval of the sale to a governmental authority, which, pursuant to Florida Statutes, must be approved by the Commission as a matter of right. For additional information see "Discontinued Operations" in the Notes to Consolidated Financial Statements.

The Company’s strategic initiative is to concentrate on developing deeper relationships with our customers, including builders and developers.  We are approaching them as a total energy company, not just a supplier of gas or electricity. Included in the strategy is a plan to increase the rate of future growth by concentrating on increasing customers and territory using improved marketing programs, along with a goal of acquiring small energy related companies, particularly propane companies.  During 2001 the Company made two gas acquisitions, totaling less than 10% of assets, which added approximately 7,300 customers.  During 2002 the Company made another acquisition, of less than 10% of assets, which added approximately 1,200 customers.    

Definitions:

Gross Profit.  Gross Profit is defined as gross operating revenues less fuel costs, conservation and unbundling costs, and taxes based on revenues that are passed through to customers and provides a more meaningful basis for evaluating utility operations.  Fuel, conservation and unbundling costs along with taxes passed through to customers have no effect on results of operations and fluctuations in such costs distort the relationship of gross operating revenues between periods.  Gross profit is the net revenue retained by the Company for operating purposes.

Contributing to variations in gross profit are the effects of seasonal weather conditions, the timing of rate increases, acquisitions and the migration of winter residents and tourists to Florida during the winter season.

Operating Expenses.  Operating expenses, which include ‘Operations’ and ‘Taxes other than income taxes’, exclude fuel costs, conservation and unbundling costs, and taxes based on revenues that are passed through to customers.  These operating expenses have no effect on results of operations as they are passed on through revenue and fluctuations in such costs distort the relationship of operating expenses between periods.  These costs are grouped on a separate line of the income statement as ‘Cost of fuel and taxes based on revenues’.

Discussion of Operating Results:

Water has been excluded from operating results and is classified as discontinued operations.  See “Discontinued Operations” in the Notes to Consolidated Financial Statements for additional information.

Gross Profit

Electric Service

Electric service gross profit increased $299,000 in 2002.  This was attributed to average customer growth of 2% along with a 5% increase in units sold (excluding General Service Large Demand (GSLD) customers).  Higher units sold per customer along with the growth in customers contributed to the 5% increase in sales. The Company reduced gross profit by $30,000 to record potential 2002 over earnings in the Northeast Florida electric division.  The 2002 earnings are subject to review by the FPSC, and will not be finalized with respect to over earnings until 2003.

Electric service gross profit increased $659,000 in 2001.  Average customers grew by 2% for the year with the consumption per customer remaining relatively flat.  The customer growth accounted for approximately $200,000 of the increase, with new late fees that started during the year adding $134,000.  A decrease in gross profit of $305,000 for pending refunds to customers for over earnings in 2000 accounted for part of this increase. The Company did not have any over earnings adjustment in 2001.

Natural Gas Service

Natural gas service gross profit increased $3,204,000 or 20% in 2002 primarily due to recent acquisitions and a pipeline project contract with a Lake Worth generation facility that added over $1,100,000 of gross profit (see ‘Forward Looking Data’ for additional information about the future of the contract).  Transportation sales increased $800,000 in 2002, primarily due to a new ‘unbundling’ program that allows commercial customers to purchase their own natural gas.  As a result, transportation customers increased by 184, an increase of over 200%. However, since these were commercial customers transferring to transportation service, these increases were offset by fewer commercial customers and lower sales. Revenue also increased by over $500,000 due to late payment fees and charges for reconnecting services.

Overall average customers increased 12% and units sold increased 3%, both due to the acquisitions and normal growth. The effects of the asset purchase in December 2001 of Atlantic Utilities contributed significantly to the increases in customers and units sold. The increases in units sold from normal growth and acquisitions were offset by decreases in units sold per customer.

Natural gas service gross profit increased $424,000 in 2001 principally due to a 4% increase in average customers, an increase in transportation revenues of $216,000, a $91,000 increase relating to the December 2001 asset purchase of Atlantic Utilities, and new late payment fees. The Company began charging late fees in 2001 adding over $161,000 in additional gross profit. Consumption was down for the year by 3%, excluding transportation and off-system sales, primarily due to weak demand in the last quarter of the year caused by mild weather conditions and decreased tourism.

Propane Gas Service

Propane gas gross profit increased in 2002 by $1,486,000 or 48% primarily due to the recent acquisitions of Atlantic Utilities and Nature Coast. Average customers were up by 36% and units sold increased 57% primarily as a result of the recent acquisitions. Revenues also were up due to colder weather in December.

Propane gas gross profit increased $394,000 in 2001 due to a 4% increase in average customers, a 22% increase in consumption, and the addition of late payment fees.  The start up of the Northeast division's (Fernandina Beach) propane operations amounted to $136,000 of the increase, including the effect of acquiring Z-Gas, a propane company, on October 29, 2001. Impacting the increase in 2001 were increased bulk commercial customers in the South Florida division, resulting in a 68% increase in consumption and $131,000 of gross profit.  New late fees that began in 2001 amounted to $25,000.   

Operating Expenses (excluding income taxes)

Electric Service

Electric operating expenses, excluding income taxes, increased $212,000 in 2002.  General and administrative costs increased $393,000, which is discussed below in the administrative section.  Maintenance expenses decreased $272,000, primarily due to the prior year having additional expense for substation work, transmission line access work and overhead line balancing.  

Electric operating expenses, excluding income taxes, increased $783,000 in 2001.  General and administrative costs increased $447,000, which is discussed below in the administrative section.  Maintenance expenses increased by $126,000 due to substation maintenance work of $150,000 (including labor) and $55,000 for overhead conductors including overhead line balancing relating to cold weather early in the year in the Northeast division.  Lower maintenance expenses in the Northwest division offset these increases.  Customer accounts expenses increased over $58,000 due to additional payroll related to the new customer information and billing system and growth, along with an additional $25,000 in bad debts.  Additional efforts and procedures are being implemented to reduce future bad d ebt expense.

Natural Gas Service

Natural gas operating expenses, excluding income taxes, increased $2,207,000 in 2002.  General and administrative expenses increased $713,000 and are discussed separately in the administrative expenses section.

Customer administration expenses increased mainly due to higher bad debt expense and payroll.  The Company has provided for potential uncollectible amounts due from Lake Worth Generation for November and December 2002 due to the uncertainty in collecting these amounts (see ‘Forward Looking Data’ for additional information).  The Company also increased collection efforts to reduce bad debt expense by focusing on collections and the adequacy of deposits.  

Distribution expenses increased primarily due to more line locations and an increase in the cost per location by the contractor.  

Other factors are increased depreciation expense of $333,000 and taxes other than income taxes of $151,000, both primarily attributable to the assets acquired in the recent Atlantic Utilities acquisition.  The taxes other than income tax increase consisted primarily of payroll taxes associated with the increased payroll expenses and property taxes associated with the property acquired.   

Natural gas operating expenses, excluding income taxes, increased $918,000 in 2001.  General and administrative expenses increased $284,000 and are discussed separately in the administrative expenses section. Increased distribution expenses of $124,000 resulted from increased payroll and higher costs of performing line locations and supporting growth.  Customer accounts expense increased $33,000 due to added payroll and other expenses associated with the new customer information and billing system and growth, along with an additional $147,000 in bad debts.  Additional efforts and procedures are being implemented to reduce future bad debt expense.  Sales expenses were up $158,000 due to staffing of marketing positions for expanding marketing efforts.  Increased property taxes reflec ting increased plant and increased valuations, along with additional payroll taxes associated with increased payroll expense added $175,000 to operating expenses.  

Propane Gas Service

Propane gas operating expenses, excluding income taxes, increased $1,410,000 in 2002.  Administrative expenses increased $213,000 and are discussed in the administrative expenses section.  Payroll for operating and maintenance expenses increased $805,000 and depreciation expense increased $114,000, both primarily attributable to the recent acquisitions of Atlantic Utilities, Z-Gas and Nature Coast.  

Propane gas operating expenses, excluding income taxes, increased $226,000 in 2001.  Changes to administrative expenses were nominal.  The start up of the new Northeast (Fernandina Beach) propane operation added $158,000 of the increased expense.  In addition, $23,000 was for increased labor expenses associated with delivery of gas relating to growth, $12,000 was for increased payroll associated with the new billing system and increased bad debts, and $20,000 of the increase related to new marketing efforts to obtain additional customers.  

Administrative Expenses

Administrative expenses for 2002 increased $1,319,000.  This was primarily due to increased claims for general liability and medical self-insurance resulting in increased expenses of $248,000, and $273,000, respectively.  Workers’ compensation expense also increased $207,000 as a result of increased payroll and slightly higher rates.

Pension expense increased $83,000 as a primary result of declining economic conditions and the overall decline in the stock market.  Insurance premiums also increased $105,000, primarily in the later part of 2002, contributing to the overall administrative expense increase.  

Outside services increased as a result of a new internal audit program to help meet the requirements of the Sarbanes Oxley Act.  This new program increased expenses for the year by $46,000.  Other increases in outside services relating to accounting fees accounted for an additional increase of $39,000. Also, miscellaneous administrative expenses increased by $118,000 as a direct result of expensing costs associated with a previously planned stock issuance, which was not consummated.   

Administrative expenses for 2001 increased $731,000.  Growth and the cost of a more sophisticated billing system caused most of the increase.  Also, payroll expenses increased $195,000 due to replacing two management positions and hiring two safety directors.  The safety directors should assist in lowering workers’ compensation insurance costs and lost time.  Other expenses that increased were medical insurance costs of $56,000, pension cost of $165,000 and employee benefit costs of $46,000.

Interest Charges and Other

Interest Charges

Interest charges consist of interest on bonds, short-term borrowings and customer deposits.  Interest on long-term debt in 2002 increased $1,331,000 due to two additional bonds issued in September and November of 2001 totaling $29,000,000.  The bonds were primarily used to finance acquisitions, fund a major Lake Worth Generation pipeline project and to reduce our short-term debt.  The offsetting decrease to short-term debt interest charges was $502,000.

Interest charges on long-term debt increased $371,000 in 2001 over 2000 due to two additional bond issues totaling $29,000,000.  On September 27, 2001 there was a $15,000,000 bond issued and on November 14, 2001 there was a $14,000,000 bond issued.  Short-term interest expense decreased $136,000 primarily due to decreased interest rates and fluctuations in the amounts borrowed under the line of credit.  

For detailed information relating to interest charges see "Notes Payable" and "Capitalization" in the Notes to Consolidated Financial Statements.

Other

Merchandise and Service revenue and expenses both increased in 2002, primarily due to the gas division’s conservation program that offers rebates to customers for gas merchandise purchases.  Profitability has decreased due to increased costs of installing piping and servicing of appliances.  The South Florida merchandise revenue remained relatively flat due to the effects of road construction outside of the sales facility.

Other income increased $163,000, primarily due to the period of September 2001 to July 2002, in which the City regulated the water segment but no regulatory fee was due.  

Gains on the sale of property were $112,000 in 2002.  This was the non-regulated portion of the gains on the sale of property in our Central and South Florida divisions (See the Notes to Consolidated Financial Statements “Gains on Sale of Property” for additional information).

There were no material differences in ‘Other’ in the 2001 year.

Discontinued Operations

Water Service

On December 3, 2002 the Company entered into an agreement to sell certain assets comprising its water utility system to the City of Fernandina Beach and as a result of this action, the operating results of the water division were reclassified to discontinued operations for all reportable periods.  Pursuant to the Agreement, the closing of this transaction is required to take place on or before March 31, 2003, and is currently scheduled for March 27, 2003.  The City has agreed to pay the Company $18.95 million in cash at closing, with additional future consideration of $7.5 million, at an anticipated rate of $375,000 per year, commencing on or before February 15, 2004, and a like amount each year thereafter until February 15, 2010, when it is estimated that the Company will receive a final payment from the City in an amount of approximately $5.25 million. The fair value of the consideration is approximately $25.1 million.  The assets of the water segment amount to approximately $10,200,000 or less than 10% of the Company’s assets including water.  For the year ended December 31,2002, the water segment’s operating income before income taxes was approximately 12% of total operating income excluding income taxes. Assuming the sale is consummated, the Company will thereupon file an application with the FPSC for approval of the sale to a governmental authority, which, pursuant to Florida Statutes, must be approved by the Commission as a matter of right.

Acquisitions

In October 2001, the Company acquired Z-Gas Company, Inc., a propane gas service distribution company, in a stock for stock transaction valued at approximately $600,000. The acquisition added about 1,000 customers to the propane operation in the Northeast Florida division.

In December 2001, the Company acquired certain net assets of Atlantic Utilities, the Florida operation of Southern Union Company in a cash transaction valued at approximately $10,000,000. Atlantic Utilities served about 4,400 natural gas customers in New Smyrna Beach and about 1,900 propane customers in Central and South Florida.

The excess of the consideration paid over the estimated fair value, or the depreciated original cost for regulated entities, of net assets including intangibles acquired in both the Atlantic Utilities and Z-Gas acquisitions was approximately $3,100,000.  This was recorded as goodwill and in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, is not being amortized.  The natural gas portion of this amount is approximately $1,500,000.

In November 2002, the Company acquired Nature Coast Utilities, a propane gas service distribution company, in a cash for stock transaction valued at approximately $740,000.  The acquisition added about 1,200 customers to the Company’s new Nature Coast division located in West Central Florida.

The excess of the consideration paid over the fair value of assets acquired and liabilities assumed associated with this acquisition resulted in goodwill of approximately $223,000 and in accordance with SFAS No. 142, it is not being amortized. There are no other intangible assets identified with this acquisition.

For additional information concerning the acquisitions, see "Acquisitions" in Notes to Consolidated Financial Statements.

Goodwill and Intangible Assets

Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under this statement, the amortization of goodwill is no longer permitted and intangible assets with an indefinite life will not be amortized. The standard requires goodwill to be periodically tested for impairment and written down to fair value if considered impaired.  The reporting units have been determined to be propane gas and natural gas for the purposes of impairment testing.

Intangible assets associated with the Company’s recent acquisitions have been identified and are shown as separate line items on the balance sheet.  Amounts as of December 31, 2001 have been reclassified to conform to this presentation.  The intangibles subject to amortization over a five-year period are non-compete agreements totaling $35,000.  The remaining intangibles identified are customer distribution rights of $1,900,000 and customer relationships of $900,000, both of which have indefinite lives and are not subject to amortization.

All goodwill relates to the recent gas acquisitions and accordingly, there is no amortization of goodwill reported in the accompanying condensed consolidated financial statements. Goodwill is $1,513,000 in the natural gas segment and $1,835,000 in the propane segment. The test for goodwill impairment was performed for the reporting units during the second quarter of 2002, as of January 1, 2002. The test results showed that there was no impairment in either reporting unit.   

LIQUIDITY AND CAPITAL RESOURCES   

Portions of the Company's business are seasonal throughout the year, and accordingly, short-term debt is used to meet working capital requirements.  The Company also borrows under lines of credit to finance portions of its capital expenditures and acquisitions, pending refinancing at a later date through the issuance of equity or long-term debt, depending upon prevailing market conditions.

Capital expenditures for 2003 are budgeted to be $9,300,000 and relate mostly to system expansions and replacements.  In 2002, $14,100,000 was spent, which included unusual items such as completing the construction of a generation facility gas line, replacing an electric transformer, and construction of a new office building in Debary for the Central Florida division.  In 2001, $13,400,000 of capital expenditures included $3,100,000 to begin construction of a gas line to a generation facility.  The remaining net cash used by investing activities in 2001 was due to the purchase of Atlantic Utilities and purchase of the restricted funds from the proceeds of the Palm Beach County bonds issuance (see Bond Related Issues).  The Company usually has no material commitments for construction exp enditures.  The commitment of $5,895,000 for the gas line to the generation facility was funded from the restricted funds investment and completed in 2002.  

The Company has a $20,000,000 line of credit with its primary bank, of which $19,183,000 was borrowed at the end of 2002.  The line of credit provides for interest at LIBOR plus fifty basis points and expires in April 2003.  During 2002 the Company closed a $2,500,000 line of credit that it held with a secondary bank.  The Company is in the process of negotiating a new line of credit effective in April 2003.  The interest rate and terms will not be as favorable as the current line of credit. The Company reserves $1,000,000 in cash or the line of credit as a contingency for major storm repairs in the Northwest Florida electric division.  The interest rates for the line of credit at December 31, 2002, 2001 and 2000 were approximately 1.9%, 2.4% and 7.1% respectively.

Notes payable, long-term debt and preferred stock at December 31, 2002 comprised 70% of total capitalization, with equity of 30%.  This leverage, along with covenants of our line of credit, will likely prohibit additional long-term debt from being issued without additional equity financing.  An equity offering was in process last fall to meet future cash requirements until an agreement to sell the water segment was signed in December 2002 (for additional information see "Discontinued Operations" in the Notes to Consolidated Financial Statements).  The closing for the water asset sale is scheduled for March 27, 2003 with the proceeds planned to pay off the current line of credit.  After the sale, the Company expects that internally generated cash, coupled with short-term borrow ings, will be sufficient to satisfy its operating, normal capital expenditure and dividend requirements for several years.   In the long-term, additional equity financing is probable to pay off notes payable or pay for any major acquisitions.

On July 1, 2002, a four-for-three stock split was issued to the record holders of June 14, 2002.  All common share information has been restated to reflect the stock split.

Long-term debt has sinking fund payments that begin in 2008.  Lines of credit are generally for three years and are renewed at that time.

Off-Balance Sheet Arrangements

The Company does not use off-balance sheet financing, have minority interests in businesses, engage in energy trading activities, nor does it make loans or guarantee loans to executives or directors.  All debt of the business is reflected on the balance sheet.

Bond Related Issues

The Company's 1942 Indenture of Mortgage and Deed of Trust, which is a mortgage on all real and personal property, permits the issuance of additional bonds based upon a calculation of unencumbered net real and personal property.  At December 31, 2002, such calculation would permit the issuance of approximately $35.43 million of additional bonds.

The Company issued its First Mortgage Bond, 6.85% Series due 2031 on September 27, 2001 in the aggregate principal amount of $15,000,000 as security for the 6.85% Secured Insured Quarterly Notes, due October 1, 2031 (IQ Notes). Interest on the pledged bond accrues at the rate of 6.85% per annum payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, payable initially on January 1, 2002.  The pledge bond constitutes the Fourteenth Series of the Company's First Mortgage Bonds.

The Company issued $14,000,000 of Palm Beach County municipal bonds (Industrial Development Revenue Bonds) on November 14, 2001 to finance development in the area.  The bond proceeds were restricted and held in trust until the Company incurred construction expenditures in the county.  Funds were drawn after each month’s construction expenditures. On December 31, 2002 the restricted funds were fully utilized for construction financing and no balance remained.

Florida Public Utilities Company (FPU) has current approval from the Florida Public Service Commission to issue and sell and/or exchange any combination of long-term debt, short-term notes and equity securities and/or to assume liabilities or obligations as guarantor, endorser or surety during calendar year 2002 in the amount of $75 million. The Company received this approval on December 21, 2001. On November 25, 2002, the Company received approval to increase this amount to $130 million.

Impact of Recent Accounting Standards

Financial Accounting Standard No. 143

In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, "Accounting for Asset Retirement Obligations." The statement requires that the fair value of an asset retirement obligation be recognized in the period in which it is incurred and the associated asset retirement costs be capitalized as part of the carrying amount of the long-lived asset. The asset retirement cost is subsequently allocated to expense using a systematic and rational method over its useful life. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. Management believes the ultimate effect on the financial statements will be immaterial and that the impact on the regulated portion of the business, if any, would be an allowable item for recovery in the Company's rates.  

The Florida Public Service Commission (FPSC) is currently in the process of developing a rule on this treatment for regulated purposes and is currently proposing that the effects, if any, of the application of SFAS No. 143 shall be revenue neutral in the rate making process.  The FPSC is also proposing that all differences between the application of SFAS No. 143 and the method approved for regulated utilities will be recorded as Regulatory Assets or Liabilities. FPSC- Proposed Rule Development, "Accounting for Asset Retirement Obligations Under SFAS No. 143", Rule No. 25-14.014, F.A.C.

The estimated cost of removal expenses for normal retirements related to regulated fixed assets is being reserved under current commission guidelines through the depreciation expense and accumulated reserves.  The estimated value of the reserve that has been accumulated for future cost of removal as of December 31, 2002 is approximately $5,800,000 and is included in accumulated depreciation in the accompanying consolidated financial statements.  The Company does not believe it owns assets with retirement obligations as defined by SFAS No. 143, but will continue monitoring the handling of utility long-lived assets for interpretations of assets that are considered to have retirement obligations.

Financial Accounting Standard No. 144

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”  The statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets.  The statement supercedes, with exceptions, SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.”  SFAS No. 144 is effective for fiscal years beginning after December 15, 2001.  Management has evaluated the impact of implementing SFAS No. 144 and has shown the effects on the Company’s financial statements with respect to the upcoming sale of its water division, see “Discontinued Operations” section for additional details. Management feels that any future effect would be an a llowable item for recovery in the Company’s rates for regulated operations and it does not have any material effect on non-regulated operations.

Financial Accounting Standard No. 146

In June 2002, FASB issued SFAS No. 146, "Accounting for Cost Associated with Exit or Disposal Activities." The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. The Company will apply this guidance prospectively to any exit or disposal activities initiated after December 31, 2002.

Financial Accounting Standards No. 148

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock Based Compensation-Transition and Disclosure” This statement amends SFAS No. 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  Since the Company does not have any stock-based compensation for employees at this time the statement will not presently have any effect on our financial statements.

OTHER

Critical Accounting Policies and Estimates

Rate Regulated Basis of Accounting - The Company prepares its financial statements in accordance with the provisions of SFAS No. 71 – “Accounting for the Effects of Certain Types of Regulation” (SFAS No. 71) and it is our most critical accounting policy. In general, SFAS No. 71 recognizes that accounting for rate-regulated enterprises should reflect the relationship of costs and revenues introduced by rate regulation.  As a result, a regulated utility may defer recognition of a cost (a regulatory asset) or recognize an obligation (a regulatory liability) if it is probable that, through the rate making process, there will be a corresponding increase or decrease in revenues. SFAS No. 71 does not apply to the unregulated propane gas operations.

Use of Estimates - Management is often required to use its judgment and make assumptions in the calculation of estimates that affect the recorded amounts of assets, liabilities, revenues and expenses in the financial statements of Florida Public Utilities Company. Actual results could differ from these estimates.

Revenue Recognition – The Company bills utility customers on a monthly cycle basis; however, the billing cycle periods for most customers do not coincide with the accounting periods used for financial reporting. The Company accrues estimated revenue for gas and electric customers not yet billed during the accounting period. Determination of unbilled revenue relies on the use of estimates, fuel purchases, and historical data.

Effects of Inflation

The Company's tariffs associated with its utility operating divisions provide for fuel clauses through which rates charged to customers are adjusted for changes in the cost of fuel on a reasonably current basis. Increases in other utility costs and expenses not otherwise offset by increases in revenues or reductions in other expenses could have an adverse effect on earnings due to the time lag associated with obtaining regulatory approval to recover such increased costs and expenses, and the uncertainty of whether regulatory commissions will allow full recovery of such increased costs and expenses.

Forward Looking Information

This report contains forward looking information that is intended to qualify for the safe harbor provided by the Private Securities Litigation Reform Act of 1995.  Although the Company believes that its expectations are based on reasonable assumptions, actual results could differ materially from those currently anticipated.  Factors that could cause actual results to differ from those anticipated include, but are not limited to, the effects of regulatory actions, competition, future economic conditions and weather. In October 2002 the Company lost a large volume interruptible transportation customer in its natural gas segment.  This will cause annual gross profit to decrease by approximately $240,000.  This will be offset by the addition of a large volume transportation customer that co nnected in the third quarter of 2002 that should be approaching full capacity during the first quarter of 2003.  The estimated annual gross profit from this customer should be approximately $250,000 per year.

The Company reduced 2002 revenue by $30,000 to allow for estimated over earnings in the electric segment. This amount is subject to an FPSC audit, which will determine the actual amount of over earnings, and could result in a further reduction or increase to revenue in 2003 if the actual amount is determined to be different from the estimate. The Company determined that the natural gas segment did not have over earnings and a reduction was not made to revenue. However, an FPSC audit could determine that over earnings does exist and may potentially result in an insignificant reduction to revenue in 2003 related to 2002.  The Company is also requesting approval for the goodwill and intangible assets, associated with our recent Atlantic Utilities regulated asset acquisition, to be allowed in rate base, w hich will reduce any potential natural gas over earnings amount discussed above.

Recent events will have a significant unfavorable impact to earnings in upcoming financial periods.  The decline of the stock market has greatly decreased the value of the pension plan assets and will significantly increase pension expense in 2003.  Current actuarial estimates show pension expense increasing by approximately $689,000 in 2003 over 2002.

Industry events, the events of September 11, 2001, and the stock market decline, have resulted in greatly increased insurance costs.  Effective September 2002, insurance costs, excluding workers’ compensation and medical insurance, increased approximately $250,000 annually.  Workers’ compensation insurance increased about $125,000 per year effective October 1, 2002.  Both increases will carry over into 2003. Management also believes that medical costs will increase in 2003 and the Company made revisions to the medical plan to help minimize the effect on operating income.

Accounting, auditing, and tax service expenses could be increasing by an estimated $173,000 annually.  This is due to additional work requirements of recent regulations on the external auditors and an expanded internal audit program.

The Company is exploring opportunities to reduce operating expenses to offset some of these unfavorable increases. Also, the Company may seek rate relief for either the natural gas or electric segment in 2003 that will include recovering the additional expenses.

On July 21, 2000, the Company entered into a Gas Transportation Agreement ("GTA") with Lake Worth Generation, LLC ("LWG"), that provided for: (i) the construction of a natural gas pipeline ("LWG Lateral") by the Company to a power generation project being developed by LWG on behalf of the City of Lake Worth, Florida ("LWG Project"); (ii) the Company's agreement to transport natural gas to the LWG Project via the LWG Lateral; and (iii) LWG's commitment to pay certain charges for the gas transportation services provided by the Company over a 30 year period.  The charges for gas transportation services were set at an amount that would permit the Company to recover a return of 11.17% on its undepreciated investment in the construction of the LWG Lateral, plus recove r its operation and maintenance ("O&M") expenses.  LWG's obligation to pay for the gas transportation services was secured by an irrevocable letter of credit ("LC") issued on July 6, 2001, and provided to the Company in the amount of the initial estimated cost of construction of $5,490,449. The GTA required monthly payments by LWG in the amount of $109,423 for the first year of the contract, adjusted annually thereafter to account for depreciation of the LWG Lateral.  The GTA also required LWG to increase the amount of the LC to cover the actual cost of construction of the LWG Lateral, plus $37,900.  In the fourth quarter of 2002, LWG notified the Company that, due to financial difficulties encountered by LWG and its contractors in connection with the LWG Project, LWG would not be able to increase the LC, as required by the GTA, or make monthly payments prospectively beginning in December for services performed in November 2002.  The Company, LWG and the City of La ke Worth subsequently entered into a Forbearance Agreement, dated December 31, 2002, and an Amended Forbearance Agreement, dated February 19, 2003. Pursuant to the terms and conditions of these agreements, the City and the Company are negotiating a new gas transportation agreement to replace the GTA, that would provide for the Company's agreement to provide gas transportation services to the City on the LWG Lateral, subject to payment by the City of transportation charges that would be set initially to permit the Company to recover a return of 8.77% on its undepreciated investment in the construction of the LWG Lateral, plus O&M expenses.  The Company's rates would be subject to adjustment in subsequent rate proceedings before the Florida Public Service Commission.  In the event that the Company and the City execute a new gas transportation agreement by March 31, 2003, the Company will receive payment for the shortfalls in monthly payments under the GTA through March 31, 2003, plus interest, pl us a termination fee of $1.5 million dollars, plus other expenses.  In the event that a new gas transportation agreement is not executed by March 31, 2003, the forbearance agreements permit the Company to draw upon the LC and the GTA is deemed terminated.  At this time, the Company is unable to predict with any degree of certainty the likelihood that a new gas transportation agreement will be executed by March 31, 2003 and has reserved an amount for the current shortfalls in the monthly payments.

On December 3, 2002 the Company entered into an agreement to sell certain assets comprising its water utility system to the City of Fernandina Beach.  Pursuant to the Agreement, the closing of this transaction is required to take place on or before March 31, 2003, and is currently scheduled for March 27, 2003.  The City has agreed to pay the Company $18,950,000 in cash at closing, with additional future consideration of $7,500,000, at an anticipated rate of $375,000 per year, commencing on or before February 15, 2004, and a like amount each year thereafter until February 15, 2010, when it is estimated that the Company will receive a final payment from the City in an amount of approximately $5,250,000. The fair value of the consideration is approximately $25,100,000. The assets amount to approxima tely $10,200,000 or less than 10% of the Company’s assets including water.  The water segment’s operating income before income taxes was approximately 12% of total operating income excluding income taxes before the reclassification to discontinued operations. In the event the sale is consummated, the Company would thereupon file an application with the FPSC for approval of the sale to a governmental authority, which, pursuant to Florida Statutes, must be approved by the Commission as a matter of right. For additional information see the section titled “Discontinued Operations” in the Notes to Consolidated Financial Statements.

Environmental Matters

The Company has several contamination sites in various stages of assessment in­vestiga­tion; see "Contingen­cies" in the Notes to Consolidated Financial Statements.  The Company believes that all future contamination assessment and remedial costs, legal fees and other related costs will not be in excess of the rate relief granted the Company and insurance settlement proceeds received.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

All financial instruments held by the Company were entered into for purposes other than for trading.  The Company has market risk exposure only from the potential loss in fair value resulting from reasonably possible changes in interest rates.  The Company has no exposure relating to commodity prices because the Company, under its regulatory jurisdictions, is fully compensated for the actual costs of commodities (primarily natural gas and electricity) used in its operations. Any commodity price increases for propane are passed through monthly to propane customers as the fuel charge portion of their rate. This can be performed due to the competition having similar increases that are customarily passed through to their customers.

None of the Company’s gas or electric contracts are accounted for using the fair value method of accounting. While some of the Company’s contracts meet the definition of a derivative, the Company has designated these contracts as “normal purchases and sales” under SFAS No. 133, “Accounting for Derivatives”.

The Company has no exposure to equity risk, as it does not hold any equity instruments.  The Company’s exposure to interest rate risk is limited to investments held for environmental costs. These investments are fixed income debt securities whose carrying amounts are not materially different than fair value. Such investments mature from 2003 to 2004 and are expected to be held to maturity. Therefore, the Company does not believe it has material market risk exposure related to these instruments.  The indentures governing the Company’s two first mortgage bond series outstanding contain “make-whole” provisions, which are pre-payment penalties that charge for lost interest, which render refinancing impracticable.  In 2002, a hypothetical 1/2% (50 basis points) decrease in the long-term interest rate on $52,500 million debt would change the fair value from $60,215 million to $63,949 million.

Changes in short-term interest rates could have an effect on income depending on the balance borrowed on the variable rate line of credit. On December 31, 2002 and 2001, the Company had $19,183,000 and $20,430,000 in short-term debt, respectively.  A hypothetical 1% increase in interest rates would have resulted in a decrease in annual earnings by $120,000 and $127,000 respectively, based on the year-end borrowings.

Item 8.

Financial Statements and Supplementary Data

CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share data)

                                                                                                                 _Years Ended December 31_

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)                                                                         

December 31,

CONSOLIDATED STATEMENTS OF CAPITALIZATION

(dollars in thousands)                                                                            December 31,

CONSOLIDATED STATEMENTS OF CASH FLOWS

      (dollars in thousands)                                                                                    Years Ended December 31,

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Summary of Significant Accounting and Reporting Policies

Business and Regulation  Florida Public Utilities Company (the Company or FPU) is an operating public utility engaged principally in the purchase, transmission, distribution and sale of electricity and in the purchase, transmission, distribution, sale and transportation of natural gas.  The Company is subject to the jurisdiction of the Florida Public Service Commission (FPSC) with respect to its electric, natural gas and water operations.  The FPSC stopped regulating the water segment of the Company’s business on September 17, 2001 due to a resolution passed by Nassau County but regained regulation in July 2002. The suppliers of electrical power to the Northwest Florida division and of natural gas to the natural gas divisions are subject to the jurisdiction of the Federal Energy Regulatory Commission (FERC).  The Northeast Florida division is supplied most of its electrical power by a municipality which is exempt from FERC and FPSC regulation.  The Company also distributes propane gas through a non-regulated subsidiary.  The Company's accounting policies and practices conform to accounting principles generally accepted in the United States of America as applied to regulated public utilities and are in accordance with the accounting requirements and rate making practices of the FPSC.

The Company prepares its financial statements in accordance with the provisions of SFAS No. 71 – “Accounting for the Effects of Certain Types of Regulation”.  In general, SFAS No. 71 recognizes that accounting for rate-regulated enterprises should reflect the relationship of costs and revenues introduced by rate regulation.  As a result, a regulated utility may defer recognition of a cost (a regulatory asset) or recognize an obligation (a regulatory liability) if it is probable that, through the rate making process, there will be a corresponding increase or decrease in revenues.  Accordingly, the Company has recognized certain regulatory assets and regulatory liabilities in the consolidated balance sheets.  The Company believes that the FPSC will continue to allow the Compa ny to recover such items through its rates. In the event that a portion of FPU’s operations are no longer subject to the provisions of SFAS No. 71, the Company would be required to write off related regulatory assets and liabilities that are not specifically recoverable through regulated rates. In addition, the Company would be required to determine if an impairment related to other assets exists, including plant, and write down the assets, if impaired, to their fair value. A summary of such items is as follows (dollars in thousands):

Deferred development costs, unamortized piping and conversion costs, and unamortized loss on reacquired debt are included in deferred charges in the consolidated balance sheets.

⁽¹⁾ 2001 has been adjusted to include unamortized piping and conversion costs related to the acquisition of Atlantic Utilities Company.

The Company has agreed with the FPSC staff to limit its earned return on equity for its regulated electric and natural gas operations.  The disposition of any excess earnings is left to the discretion of the FPSC, with alternatives including a refund to customers, additional contributions to storm damage reserves, or the reduction of any depreciation reserve deficiency, if any.  The excess earnings for 1997, 1998 and 1999 at one of the Company’s electric divisions were ordered by the FPSC to be added to that division’s storm damage reserve.  Since that last order on the 1999 disposition of excess earnings, the FPSC has allowed the Company the automatic flexibility of funding the storm damage reserves each year thereafter through use of the excess earnings and allowing additional storm damage accruals up to a cap in those reserves of $1,500,000 and $1,400,000 in the Fernandina Beach and Marianna electric divisions, respectively.  The Company funded its Fernandina Beach electric storm reserve with an additional $237,000 relating to 2000 excess earnings.  In 2001, the Company did not have any excess earnings and accordingly has not funded any additional amounts to its storm damage reserves. In 2002, the Company has reserved for $30,000 in its electric segment for possible overearnings, and may also have additional over earnings in its natural gas segment.  As of the end of 2002, the Fernandina Beach and Marianna electric storm reserves were at approximately $1,257,000 and $847,000, respectively.

The Company filed the appropriate unbundled tariffs to give its commercial natural gas customers the option of purchasing their gas supplies from third parties.  The Company officially offered unbundled services to commercial customers on August 1, 2001.  Even though FPU has had the overall lowest gas costs in the Florida market, third party suppliers may be able to offer our customers additional programs, which a regulated gas company cannot offer.  Furthermore, by purchasing their gas supplies from third parties, our commercial customers may avoid certain taxes and fees, which FPU is required to collect and impose on the sale of natural gas.  The Company’s operating results will not be affected as the Company realizes the same gross profit regardless of w hether the customer purchases the gas from us or uses our system to transport the gas since it does not profit on the fuel sales.  The FPSC approved various mechanisms, which will allow the Company to be reimbursed for the incremental cost of providing unbundled services.

Revenue  The Company bills utility customers on a monthly cycle basis; however, the billing cycle periods for most customers do not coincide with the accounting periods used for financial reporting. The Company accrues estimated revenue for gas and electric customers not yet billed during the accounting period. Determination of unbilled revenue relies on the use of estimates, fuel purchases, and historical data.

The rates of the Company include base revenues, fuel adjustment charges and the pass-through of certain governmental imposed taxes based on revenues.  The base revenues are determined by the FPSC and remain constant until a request for an increase in such rates is filed and approved by the FPSC.  From the FPSC perspective, the Company operates four distinct "entities", i.e., Northwest Florida electric, Northeast Florida electric, Northeast Florida water, and natural gas, consisting of Palm Beach County, and the Sanford and DeLand area in Central Florida.  Thus, for the Company to recover through rate relief the effects of inflation and construction expenditures for all such "entities", a request for an increase in base revenues would require the filing of four separate ra te cases.  The FPSC allows for an annual automatic rate increase for water operations through the use of a price index.  Fuel adjustment charges are estimated for customer billing purposes and any under/over-recovery difference between the incurred cost of fuel and estimated amounts billed to customers is deferred for future recovery or refund and either charged or credited to customers.  Interest accrues on such under/over-recoveries and is included in the subsequent adjustment.

Consolidation  The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Flo-Gas Corporation.  All significant intercompany balances and transactions have been eliminated.

Certain reclassifications have been made to the prior years' financial statements and other financial information contained herein to conform to the 2002 presentation.

Utility Plant and Depreciation Utility plant is stated at original cost. Propane utility plant that has been acquired in recent acquisitions is stated at fair market value at the time of each acquisition. The costs of additions to utility plant include contracted services, direct labor, transportation and materials.  The costs of units of property retired are removed from utility plant, and such costs plus removal costs, less salvage, are charged to accumulated depreciation.  Maintenance and repairs of property and replacement and renewal of items determined not to be units of property are charged to operating expenses.  Substantially all of the utility plant and the shares of Flo-Gas Corporation collateralize the Company's First Mortgage Bonds.

Depreciation is computed using the composite straight-line method at rates prescribed by the FPSC for financial accounting purposes.  Propane depreciation is computed using a composite straight-line method at an average rate based on estimate life of approximately 20 years. Such rates are based on estimated service lives of the various classes of property.  Depreciation provisions on average depreciable property approximate 3.3% in 2002, 3.4% in 2001 and 3.6% in 2000.

Income Taxes  Deferred income taxes are provided on all significant temporary differences between the financial statements and tax basis of assets and liabilities at currently enacted tax rates.  Investment tax credits have been deferred and are amortized based upon the average useful life of the related property in accordance with the rate treatment.

Use of Estimates Inherent in the accounting process is the use of estimates when preparing financial statements in accordance with generally accepted accounting principles.  Actual results could differ from these estimates.  The Company has used estimates in the preparation of its financial statements including the accrual for uninsured liability claims.  The Company is self-insured for the first $250,000 of each general and auto liability claim and therefore accrues for estimated losses occurring from both asserted and unasserted claims.  The estimate for unasserted claims arising from unreported incidents is based on an analysis of historical claims data and judgment.  Management believes that its accrual for potential liability claims is adequate.

Notes Payable The Company has a $20,000,000 line of credit with its primary bank, of which $19,183,000 was borrowed at the end of 2002.  The line of credit provides for interest at LIBOR plus fifty basis points and expires in April 2003.  During 2002 the Company closed a $2,500,000 line of credit that it held with a secondary bank.  The Company is in the process of negotiating a new line of credit effective in April 2003.  The interest rate and terms will not be as favorable as the current line of credit. The Company reserves $1,000,000 in cash or the line of credit as a contingency for major storm repairs in the Northwest Florida electric division.  The interest rates for the line of credit at December 31, 2002, 2001, and 2000 were approximately 1.9%, 2.4% and 7.1% respectively.

Acquisitions  

In October 2001, the Company acquired Z-Gas Company, Inc., a propane gas service distribution company, in a stock for stock transaction valued at approximately $600,000. The transaction involved the issuance of 42,613 shares of the Company’s common stock and approximately $20,000 in cash. The acquisition added about 1,000 customers to the propane operation in the Northeast Florida Division.

In December 2001, the Company acquired certain net assets of Atlantic Utilities, the Florida operation of Southern Union Company in a cash transaction valued at approximately $10,000,000. Atlantic Utilities served about 4,400 natural gas customers in New Smyrna Beach and about 1,900 propane customers in central and south Florida.

The excess of the consideration paid over the estimated fair value, or the depreciated original cost for regulated entities, of net assets including intangibles acquired in both the Atlantic Utilities and Z-Gas acquisitions was approximately $3,100,000.  This was recorded as goodwill and according to SFAS No. 142 is not being amortized. This amount was subject to reclassifications to intangible assets and immaterial adjustments to the purchase price in 2002. The natural gas portion of this amount is approximately $1,500,000.

The following unaudited pro forma information combines the consolidated results of operations of Florida Public Utilities Company with those of Z-Gas and Atlantic Utilities as if these acquisitions had occurred at the beginning of 2000. The pro forma results are not necessarily an indication of the results that would have been achieved had the transactions been consummated as of the date indicated, or that may be achieved in the future. The 2001 information includes actual amounts for November and December information for Z-Gas and December 15-31 information for Atlantic Utilities.  The income statement for 2002 includes all the effects from these two acquisitions and no pro forma adjustments are necessary.

In November 2002, the Company acquired Nature Coast Utilities, a propane gas service distribution company, in a cash for stock transaction valued at approximately $740,000.  The acquisition added about 1,200 customers to the Company’s new Nature Coast division located in West Central Florida.

The excess of the consideration paid over the fair value of assets acquired and liabilities assumed associated with this acquisition, resulted in goodwill of approximately $223,000 and in accordance with SFAS No. 142, it is not being amortized.  There are no other intangible assets identified with this acquisition.

Goodwill and Intangible Assets

Effective January 1, 2002, the Company adopted (SFAS) No. 142, "Goodwill and Other Intangible Assets." Under this statement, the amortization of goodwill is no longer permitted and intangible assets with an indefinite life will not be amortized. The standard requires goodwill to be periodically tested for impairment and written down to fair value if considered impaired.  The reporting units have been determined to be propane gas and natural gas for the purposes of impairment testing.

Intangible assets associated with the Company’s recent acquisitions have been identified and are shown as separate line items on the balance sheet.  Amounts as of December 31, 2001 have been reclassified to conform to this presentation.  The intangibles subject to amortization over a five-year period are non-compete agreements totaling $35,000.  The remaining intangibles identified are customer distribution rights of $1,900,000 and customer relationships of $900,000, both of which have indefinite lives and are not subject to amortization.

All goodwill relates to the recent gas acquisitions and accordingly, there is no amortization of goodwill reported in the accompanying 2000, 2001, and 2002 consolidated financial statements. Goodwill is $1,513,000 in the natural gas segment and $1,835,000 in the propane segment. The test for goodwill impairment was performed for the reporting units during the second quarter of 2002, as of January 1, 2002. The test results showed that there was no impairment in either reporting unit.   

Discontinued Operations

On December 3, 2002 the Company entered into an agreement to sell certain assets comprising its water utility system to the City of Fernandina Beach.  Pursuant to the Agreement, the closing of this transaction is required to take place on or before March 31, 2003, and is currently scheduled for March 27, 2003.  The City has agreed to pay the Company $18,950,000 in cash at closing, as well as contingent “futures” consideration until February 15, 2010, when it is estimated that the Company will receive a final payment from the City. The fair value of the consideration is approximately $25,100,000. The assets amount to approximately $10,200,000 or less than 10% of the Company’s assets including water.  The water segment’s operating income before income taxes was approximately 12% of total operating income excluding income taxes before th e reclassification to discontinued operations.  In the event the sale is consummated, the Company would thereupon file an application with the FPSC for approval of the sale to a governmental authority, which, pursuant to Florida Statutes, must be approved by the Commission as a matter of right.

The accompanying consolidated financial statements have been restated for all periods presented for the discontinued operations of the water division. The net income of this water operation is reported as discontinued operations in the Consolidated Statements of Income.  The Company has not ceased recording depreciation expense due to the regulatory requirements and will continue to expense depreciation through the anticipated sales date of March 27, 2003. The assets and liabilities of the water division have been included in current assets and current liabilities, as assets and liabilities held for sale until the sale is consummated.  Results of discontinued operations for the years ended December 31, were as follows:

The major balance sheet classes included in assets and liabilities of discontinued operations in the Consolidated Balance Sheets, as of December 31, are as follows:

Gain on Sale of Property

The Company sold property held in Delray Beach, in its South Florida division, for a gain of approximately $529,000 in the first quarter of 2002.  This property was primarily regulated property and accordingly the majority of the gain was deferred awaiting Florida Public Service Commission (FPSC) approval on the disposition of that gain. The Company has been granted approval by the FPSC to allow amortization of the gain with an offset to depreciation expense over five years beginning April 2002. The non-regulated portion of the gain has been recognized in the first quarter of 2002 and amounts to $53,000, net of income taxes.  

The Company sold property held in DeLand, in its Central Florida division, for a gain of approximately $186,000 during the third quarter of 2002.  This property was primarily regulated property and accordingly the majority of the gain was deferred awaiting Florida Public Service Commission (FPSC) approval on the disposition of that gain.  The Company has been granted approval by the FPSC to allow amortization of the gain with an offset to depreciation expense over five years beginning August 2002.  The non-regulated portion of the gain has been recognized in the third quarter of 2002 and amounts to $17,000, net of income taxes.

The total earnings per share effect of both gains included in the Consolidated Statements of Income for the twelve months ended December 31, 2002 is $0.02. Excluding the property gains in the twelve months ended December 31, 2002 total earnings per share would be $0.84.  

Capitalization

Common Stock Split

In July 2002, the Company affected a four-for-three stock split in the form of a stock dividend and, accordingly, transferred from paid-in capital to common stock, an amount equal to the aggregate par value of the additional shares.  All per share data included herein have been retroactively restated to reflect the stock split.

Common Shares Reserved  

The Company has reserved 104,887 common shares for issuance under the Dividend Reinvestment Plan and 27,724 common shares for issuance under the Employee Stock Purchase Plan.  

Dividend Restriction

The Indenture of Mortgage and Deed of Trust and supplements thereto provide for restriction of the payment of cash dividends.  At December 31, 2002 approximately $4,000,000 of retained earnings were free of such restriction.

Long-Term Debt

The Company issued its First Mortgage Bond, 6.85% Series due 2031 on September 27, 2001 in the aggregate principal amount of $15,000,000 as security for the 6.85% Secured Insured Quarterly Notes, due October 1, 2031 (IQ Notes). Interest on the pledged bond accrues at the rate of 6.85% per annum payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, payable initially on January 1, 2002.  The pledge bond constitutes the Fourteenth Series of the Company's First Mortgage Bonds.

Sinking fund payments are scheduled to begin in 2008.

Restricted Bond Proceeds

The Company issued $14,000,000 of Palm Beach County municipal bonds (Industrial Development Revenue Bonds) on November 14, 2001 to finance development in the area.  The interest rate on the thirty-year callable bonds is 4.90%.  The bond proceeds were restricted and held in trust until construction expenditures were actually incurred by the Company.  In 2002 $8,008,000 was drawn from the restricted funds held by the trustee and no restricted funds were remaining at December 31, 2002.

Bond Proceeds

The Company issued its First Mortgage Bond, 6.85% Series due 2031 on September 27, 2001 in the aggregate principal amount of $15,000,000 as security for the 6.85% Secured Insured Quarterly Notes, due October 1, 2031 (IQ Notes). Interest on the pledged bond accrues at the rate of 6.85% per annum payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, payable initially on January 1, 2002.  The pledged bond constitutes the Fourteenth Series of the Company's First Mortgage Bonds.

Segment Information

The Company is organized into two continuing regulated business segments: natural gas and electric and one non-regulated business segment, propane gas.  Water, a regulated segment, has been classified as discontinued operations and has been eliminated from segment information with the exception of Identifiable assets. There are no material inter-segment sales or transfers.

Identifiable assets are those assets used in the Company's operations in each business segment.  Common assets are principally cash and overnight investments, deferred tax assets and common plant.

Business segment information for 2002, 2001 and 2000 is summarized as follows:

(dollars in thousands)

Employee Benefit Plans

Florida Public Utilities Company sponsors a qualified pension plan and postretirement medical and life benefit plans for its employees. The life plan obligations are de-minimis and not reflected in the Company’s disclosures.  The following tables provide a reconciliation of the changes in the plans’ benefit obligations and fair value of assets over the 2-year period ending December 31, 2002, and a statement of the funded status as of December 31 of both years:

The following table provides the amounts recognized in the statement of financial position as of December 31 of

both years:

The following table provides the components of net periodic benefit cost for the plans for fiscal years 2002, 2001, and 2000:

The amount included within other comprehensive income arising from a change in the additional minimum pension liability was $0 at December 31, 2002, $0 at December 31, 2001, and $0 at December 31, 2000.

The prior service costs are amortized on a straight-line basis over the average remaining service period of active participants.  Gains and losses in excess of 10% of the greater of the benefit obligation and the market-related value of assets are amortized over the average remaining service period of active participants.

The pension plan is noncontributory; the postretirement medical plan is contributory with participants’ contributions subject to adjustment annually.  The accounting for the health care plan anticipates future cost-sharing changes to the written plan such that retiree contributions will increase over time at the same rate as the total plan cost.

The assumptions used in the measurement of the Company’s benefit obligation are shown in the following table:

For measurement purposes, the annual rate of increase in the per capita cost of covered health care benefits during 2002 was 6.25%.  These rates were assumed to decrease gradually each year to a rate of 4.50% for 2007 and remain at that level thereafter.

Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans.  

A 1% change in assumed health care cost trend rates would have the following effects:

Health Plan

The Company is principally self-insured for its employee and retiree medical insurance plan.  The Company's health care liability under the plan is limited to $125,000 per individual per year, with a maximum annual total liability of $1,505,136.

A reserve for future benefit payments for active employees is maintained at a level sufficient to provide for estimated outstanding claims under the plan net of amounts contributed by employees.  Net health care benefits paid by the Company for active employees were approximately $732,000, $629,000 and $509,000 for 2002, 2001 and 2000, respectively.

Employee Stock Purchase Plan

The Company's Employee Stock Purchase Plan offers common stock at a discount to qualified employees.  During 2002, 2001 and 2000, 17,589, 15,699 and 14,465 shares, respectively, were issued under the Plan for aggregate consideration of $195,000, $162,000 and $165,000, respectively.

Dividend Reinvestment Plan

During 2002, 2001 and 2000, 13,413, 16,404 and 16,628 shares, respectively, were issued under the Company's Dividend Reinvestment Plan for aggregate consideration of $185,000, $196,000 and $193,000, respectively.

Fair Value of Financial Instruments

The carrying amounts reported in the balance sheet for investments held in escrow for environmental costs, notes payable, taxes accrued and other accrued liabilities approximate fair value.  As the older bonds contain ‘make whole’ provisions it would negate any fluctuation in interest rates.  The fair value of long-term debt is estimated by discounting the future cash flows of each issuance at rates currently offered to the Company for similar debt instruments of comparable maturities.

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Contingencies

Environmental

The Company is subject to federal and state legislation with respect to soil, groundwater and employee health and safety matters and to environmental regulations issued by the Florida Department of Environmental Protection (FDEP), the United States Environmental Protection Agency (EPA) and other federal and state agencies.  Except as discussed below, the Company does not expect to incur material future expenditures for compliance with existing environmental laws and regulations.

West Palm Beach Site.

FPU is currently conducting a contamination assessment investigation of a parcel of property owned by it in West Palm Beach, Florida upon which FPU previously operated a gasification plant.  After a preliminary contamination assessment investigation indicated soil and groundwater impacts, FPU entered into a consent order with the Florida Department of Environmental Protection ("FDEP").  The consent order required FPU to delineate the extent of soil and groundwater impacts associated with the prior operation of the gasification plant and to remediate such soil and groundwater impacts, if necessary. A Supplemental Contamination Assessment Report Addendum (“SCARA”) was submitted to FDEP in December 2001 for review and comment.  On September 26, 2002, FPU submitted a work plan for additional fieldwork to respond to FDEP's comments to the SCARA.  This work will be undertaken in conjunction with additional soil investigation planned for January/February 2003 to assist in the preparation of a feasibility study to evaluate remedial alternatives for the site.  The cost to complete the additional fieldwork, including the feasibility study, is approximately $355,000.  

Prior to completion of the contamination assessment/feasibility study phases, FPU is unable to determine the complete extent or cost of remedial action, which may be required.  A revised preliminary estimate from FPU's environmental consultant projected that remediation costs for this site may reach approximately $4,354,000.  A portion of the on-site impacts have been determined to be eligible for reimbursement from a state fund and the FDEP has determined that a portion of the work conducted off-site may be eligible for reimbursement under state law.

Sanford Site.

FPU owns a parcel of property located in Sanford, Florida, upon which a gasification plant was operated prior to FPU's acquisition of the property.  Upon the discovery of soil and groundwater impacts on the property, FPU has participated with four former owners and operators of the gasification plant in the funding of numerous investigations of the extent of the impacts and the identification of an appropriate remedy.  On or about March 25, 1998, FPU executed an Administrative Order of Consent (“AOC”) with the four former owners and operators (collectively, the “Group”) and the United States Environmental Protection Agency ("EPA") that obligated the Group to implement a Remedial Investigation/Feasibility Study (“RI/FS”) task and to pay EPA’s past and fut ure oversight costs for the RI/FS.  The Group also entered into a Participation Agreement and an Escrow Agreement on or about April 13, 1998. These agreements governed the manner and means by which all parties were to satisfy their respective obligations under the AOC for the RI/FS task.  FPU agreed to pay approximately 13.7% of the cost for the RI/FS.  Fieldwork for the RI/FS was initiated in 1998.  A final RI report was submitted to EPA in July 1999. The Group also submitted a Baseline Risk Assessment to EPA in January 2000, including an Ecological Risk Assessment (“ERA”).  Additional fieldwork will be required to complete the ERA at a total estimated cost of less than $50,000.  FPU's share of the additional ERA work is 13.7%.  

On July 5, 2000, EPA issued a Record of Decision ("ROD") approving the final remedial action for contaminated soils at the site ("OU1 Remedy"). The initial estimated cost for the OU1 Remedy described in the ROD ranges from $5,593,000 to $5,760,000.  On June 12, 2001, EPA issued a ROD approving the final remedial action for contaminated groundwater at the site  ("OU2 Remedy").  The present worth cost estimate for the OU2 Remedy is $320,252.  

The Group completed negotiations on a remedial design/remedial action ("RD/RA") Consent Decree with EPA to provide for the implementation of the OU1 Remedy and OU2 Remedy.  The Group anticipates that the Consent Decree will be signed by EPA and lodged with the United States District Court for public comment in early Spring 2003.  After lodging, there is a thirty (30) day minimum public comment period.  At the conclusion of the comment period, the Court will enter the Consent Decree, unless there has been opposition filed.  

Pursuant to the Consent Decree, pre-remedial design fieldwork was performed to assist in the design of the final remedy for OU1 and OU2.  The cost of the additional field and design work was approximately $850,000.  Upon EPA's approval of the final design, the Group will be obligated to implement the remedy for OU1 and OU2.  Based on fieldwork completed recently, it is now anticipated that the final cost of the remedy for OU1 and OU2 will exceed the $6,000,000 combined estimate provided in the RODs for OU1 and OU2.  Pursuant to the terms and conditions of the Second Participation Agreement entered into by members of the Group on August 1, 2000, FPU's share of costs for implementation of the OU1 Remedy and OU2 Remedy, including the pre-remedial design fieldwork, is 10.5%, up to a maximum cost of $6,000,000.  FPU will oppose any effort by the Group to increase FPU's share of total remedial costs above 10.5% of the current $6,000,000 cap, since the increased remedial cost is due to the discovery of additional impacted soils on property not owned by FPU.  The Consent Decree also obligates the Group to reimburse EPA's past costs of approximately $142,500 and EPA's future oversight costs.  FPU's share of EPA's past costs and future oversight costs is 10.5%.

Pensacola Site.

FPU is the prior owner/operator of the former Pensacola gasification plant, located at the intersection of Cervantes Street and the Louisville and Nashville (CSX) Railroad line, Pensacola, Florida.  Following notification on October 5, 1990 that FDEP had determined that FPU was one of several responsible parties for any environmental impacts associated with the former gasification plant site, FPU entered into cost sharing agreements with three other responsible parties providing for the funding of certain contamination assessment activities at the site.  

A final report describing the results of contamination assessment activities at the site was submitted to FDEP in November 1995.  The report concluded that soil or groundwater remediation was not warranted at the site. The report further recommended that existing environmental impacts be monitored through periodic sampling of groundwater at the site.  By letter dated July 16, 1997, FDEP approved a groundwater-monitoring plan that provides for annual sampling of selected monitoring wells at the site.  To date, FPU's share of these costs has not exceeded $3,000 annually.  

In March 1999, the EPA requested site access in order to undertake an Expanded Site Inspection ("ESI").  The ESI was completed by the EPA's contractor in 1999 and an ESI report was transmitted to FPU in January 2000 (the "ESI Report").  The ESI Report recommends additional work at the site.  The responsible parties met with FDEP on February 7, 2000 to discuss EPA's plans for the site.  In February 2000, the EPA preliminarily indicated that it would defer management of the site to FDEP; however, as of this date, FPU has not received any written confirmation from the EPA or FDEP regarding this matter.   Prior to receipt of EPA's written determination regarding site management, FPU is unable to determine whether additional field work or site remediation will be required by EPA, and if so, the scope or costs of such work.  

Based on existing information, FPU believes that all future contamination assessment and remedial costs, legal fees and other related costs will not be in excess of the rate relief granted in favor of and insurance settlement proceeds received by FPU.

Insurance Claims and Rate Relief

FPU notified its insurance carriers of environmental impacts detected at the former gasification plant sites discussed above. As a result of negotiations with FPU's major insurance carriers that concluded in 1997, such carriers agreed to pay settlement proceeds totaling approximately $4,300,000 for certain environmental costs. In addition, the Florida Public Service Commission has allowed FPU to recover through rate relief environmental expenses of approximately $2,400,000 over a ten-year period at the rate of approximately $240,000 per year. The Company currently has $5,204,000 reserved, which is net of costs paid to date, for environmental contingencies as of December 31, 2002.   

Other

Violet Skipper, PC Buyers, Inc. and Thomas Wade Skipper v. Florida Public Utilities Company, Case No. CL 00-10131-AF, Circuit Court of the Fifteenth Judicial Circuit, Palm Beach County, Florida. On or about October 18, 2000, FPU was sued by the Plaintiffs in this case for damages allegedly arising out of FPU's alleged negligence in failing to properly install and/or maintain electrical power lines, utility poles and related equipment which allegedly caused a fire that spread to and eventually destroyed a warehouse/office facility that was owned by Violet Skipper, that housed the place of business of the corporate plaintiff and that contained property therein owned by all the plaintiffs.  The warehouse/office facility was located in Jackson County, Florida.  Plaintiffs alleged damages in excess of $1,000,00 0.  FPU has denied the claims in the complaint and is defending same on the theory that the alleged fire started within the warehouse/office facility and not at or in its electrical equipment.

This case, though filed originally in Palm Beach County, Florida, was transferred to Jackson County, Florida.  Discovery is still in process.  No Motions are currently pending.  No trial date has been scheduled. All the principal witnesses have been deposed including the Skippers and Mark Cutshaw of FPU.  We anticipate the parties will depose expert witnesses shortly. Plaintiffs have identified Mr. Harold Deese and Mr. Frank Walker of Panama City as their expert witnesses. At this time, we are unable to provide an evaluation of the likelihood of an unfavorable outcome or provide an estimate of the amount or range of potential loss. In the event that the Company does not prevail in this suit, there may be a material adverse effect on the financial statements.  However, FPU believes there are meritorious defenses to this pending litigation. FPU has liability insurance that will limit our exposure on this claim to a maximum of $250,000.

Darrell Glenn v. Florida Public Utilities Company v. Utility Service and Maintenance of Missouri, Inc., Case No. CA 01-07810 AI, Circuit Court of the Fifteenth Judicial Circuit, Palm Beach County, Florida; Case No. 02-37-CA, Division A, Circuit Court for the Fourth Judicial Circuit, Nassau County, Florida. This is an action that was pending in state court in Palm Beach County, Florida until FPU successfully moved to have the case transferred to Nassau County, Florida.  Darrell Glenn ("Glenn"), an employee of a painting subcontractor, claimed to have been shocked and injured on May 16, 2001, while painting electrical equipment at FPU's Step down site in Fernandina Beach, Florida.  His employer, Utility Service & Maintenance, Inc. ("USM"), was operating under an agre ement that required it to supervise its own workers.   This matter has been settled by an agreement reached at mediation on January 15, 2003 pursuant to which FPU agreed to pay $300,000 to the plaintiff in return for a release. FPU will recover $50,000 of the settlement through liability insurance.

Pipeline Contract On July 21, 2000, the Company entered into a Gas Transportation Agreement ("GTA") with Lake Worth Generation, LLC ("LWG"), that provided for: (i) the construction of a natural gas pipeline ("LWG Lateral") by the Company to a power generation project being developed by LWG on behalf of the City of Lake Worth, Florida ("LWG Project"); (ii) the Company's agreement to transport natural gas to the LWG Project via the LWG Lateral; and (iii) LWG's commitment to pay certain charges for the gas transportation services provided by the Company over a 30 year period.  The charges for gas transportation services were set at an amount that would permit the Company to recover a return of 11.17% on its undepreciated investment in the construction of th e LWG Lateral, plus recover its operation and maintenance ("O&M") expenses.  LWG's obligation to pay for the gas transportation services was secured by an irrevocable letter of credit ("LC") issued on July 6, 2001, and provided to the Company in the amount of the initial estimated cost of construction of $5,490,449. The GTA required monthly payments by LWG in the amount of $109,423 for the first year of the contract, adjusted annually thereafter to account for depreciation of the LWG Lateral.  The GTA also required LWG to increase the amount of the LC to cover the actual cost of construction of the LWG Lateral, plus $37,900.  In the fourth quarter of 2002, LWG notified the Company that, due to financial difficulties encountered by LWG and its contractors in connection with the LWG Project, LWG would not be able to increase the LC, as required by the GTA, or make monthly payments prospectively beginning in December for services performed in November 2002.  The Compa ny, LWG and the City of Lake Worth subsequently entered into a Forbearance Agreement, dated December 31, 2002, and an Amended Forbearance Agreement, dated February 19, 2003. Pursuant to the terms and conditions of these agreements, the City and the Company are negotiating a new gas transportation agreement to replace the GTA, that would provide for the Company's agreement to provide gas transportation services to the City on the LWG Lateral, subject to payment by the City of transportation charges that would be set initially to permit the Company to recover a return of 8.77% on its undepreciated investment in the construction of the LWG Lateral, plus O&M expenses.  The Company's rates would be subject to adjustment in subsequent rate proceedings before the Florida Public Service Commission.  In the event that the Company and the City execute a new gas transportation agreement by March 31, 2003, the Company will receive payment for the shortfalls in monthly payments under the GTA through March 3 1, 2003, plus interest, plus a termination fee of $1.5 million dollars, plus other expenses.  In the event that a new gas transportation agreement is not executed by March 31, 2003, the forbearance agreements permit the Company to draw upon the LC and the GTA is deemed terminated.  At this time, the Company is unable to predict with any degree of certainty the likelihood that a new gas transportation agreement will be executed by March 31, 2003 and has reserved an uncollectible amount for the current shortfalls in the monthly payments.

Commitments

To ensure a reliable supply of power and natural gas at competitive prices, the Company has entered into long-term purchase and transportation contracts with various suppliers and producers, which expire at various dates through 2015.  Purchase prices under these contracts are determined by formulas either based on market prices or at fixed prices. At December 31, 2002, the Company has firm purchase and transportation commitments adequate to supply its expected future sales requirements. The Company is committed to pay demand or similar fixed charges of approximately $12,292,000 during 2003 related to gas purchase agreements.  Substantially all costs incurred under the electric and gas purchase agreements are recoverable from customers through fuel adjustment clause mechanisms.

Impact of Recent Accounting Standards

Financial Accounting Standard No. 143

In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, "Accounting for Asset Retirement Obligations." The statement requires that the fair value of an asset retirement obligation be recognized in the period in which it is incurred and the associated asset retirement costs be capitalized as part of the carrying amount of the long-lived asset. The asset retirement cost is subsequently allocated to expense using a systematic and rational method over its useful life. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. Management believes the ultimate effect on the financial statements will be immaterial and that the impact on the regulated portion of the business, if any, would be an allowable item for recovery in the Company's rates.  

The Florida Public Service Commission (FPSC) is currently in the process of developing a rule on this treatment for regulated purposes and is currently proposing that the effects, if any, of the application of SFAS No. 143 shall be revenue neutral in the rate making process.  The FPSC is also proposing that all differences between the application of SFAS No. 143 and the method approved for regulated utilities will be recorded as Regulatory Assets or Liabilities. FPSC- Proposed Rule Development, "Accounting for Asset Retirement Obligations Under SFAS No. 143", Rule No. 25-14.014, F.A.C.

The estimated cost of removal expenses for normal retirements related to regulated fixed assets is being reserved under current commission guidelines through the depreciation expense and accumulated reserves.  The estimated value of the reserve that has been accumulated for future cost of removal as of December 31, 2002 is approximately $5,800,000 and is included in accumulated depreciation in the accompanying consolidated financial statements.  The Company does not believe it owns assets with retirement obligations as defined by SFAS No. 143, but will continue monitoring the handling of utility long-lived assets for interpretations of assets that are considered to have retirement obligations.

Financial Accounting Standard No. 144

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”  The statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets.  The statement supercedes, with exceptions, SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.”  SFAS No. 144 is effective for fiscal years beginning after December 15, 2001.  Management has evaluated the impact of implementing SFAS No. 144 and has shown the effects on the Company’s financial statements with respect to the upcoming sale of its water division, see “Discontinued Operations” section for additional details. Management feels that any future effect would be an allowable item for recovery in the Company’s rates for regul ated operations and it does not have any material effect on non-regulated operations.

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Financial Accounting Standard No. 146

In June 2002, FASB issued SFAS No. 146, "Accounting for Cost Associated with Exit or Disposal Activities." The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. The Company will apply this guidance prospectively to any exit or disposal activities initiated after December 31, 2002.

Financial Accounting Standards No. 148

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock Based Compensation-Transition and Disclosure” This statement amends SFAS No. 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  Since the Company does not have any stock-based compensation for employees at this time the statement will not presently have any effect on our financial statements.

Quarterly Financial Data (Unaudited)

The quarterly financial data presented below reflects the influence of, among other things, seasonal weather conditions, the timing of rate increases and the migration of winter residents and tourists to Central and South Florida during the winter season. The water division has been classified as discontinued operations and is excluded from revenues, gross profit, and operating income excluding income tax. (dollars in thousands, except per share amounts):

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INDEPENDENT AUDITORS' REPORT

To the Directors and Shareholders of Florida Public Utilities Company:

We have audited the accompanying consolidated balance sheets and statements of capitalization of Florida Public Utilities Company and its wholly owned subsidiary, Flo-Gas Corporation as of December 31, 2002 and 2001, and the related consolidated statements of income, common shareholders' equity and cash flows for each of the three years in the period ended December 31, 2002.  These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America.  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test 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.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Florida Public Utilities Company and its wholly owned subsidiary, Flo-Gas Corporation at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.

DELOITTE & TOUCHE

Certified Public Accountants

West Palm Beach, Florida

February 19, 2003

Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

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PART III

Item 10.   Directors and Executive Officers of the Registrant

Information concerning directors and nominees of the Registrant is included under the caption "Nominees and Continuing Directors" in the Registrant's Proxy Statement for the 2003 Annual Meeting of Shareholders and is incorporated by reference herein.

The following table sets forth certain information about the executive officers of the Registrant as of March 12, 2003.  

     Name

Age

Position

Date

John T. English

59

Chief Executive Officer

1998 - Present

President

1997 - Present

Chief Operating Officer

1997 - 2000

Charles L. Stein

53

Senior Vice President

1997 - Present

Chief Operating Officer

2001 - Present

Jack R. Brown

68

Corporate Secretary

1988 - Present

Vice President

2001 - Present

Treasurer

1988 - 2000

George M. Bachman

43

Chief Financial Officer

And Treasurer

2001 - Present

Controller

1996- 2000

Mr. English was Senior Vice President from 1993 preceding his appointment as President and Chief Operating Officer.

Mr. Stein was Vice President from 1993 preceding his appointment as Senior Vice President.

There are no family relationships between the executive officers.

All executive officers are elected for a one-year term.

Item 11.

Executive Compensation

Information concerning executive compensation is included under the caption "Executive Compensation" in the Registrant's Proxy Statement and is incorporated by reference herein.

Item 12.

Security Ownership of Certain Beneficial Owners and Management

Information concerning the security ownership of certain of the Registrant's beneficial owners and management is included under the captions "Security Ownership of Certain Beneficial Owners" and "Nominees and Continuing Directors" in the Registrant's Proxy Statement and is incorporated by reference herein.

Item 13.

Certain Relationships and Related Transactions

There were no transactions with management in 2002.

PART IV

Item 14. Controls and Procedures

Disclosure Controls and Procedures

Within the 90 days prior to the filing of this Annual Report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in ensuring that information required to be disclosed in the reports the Company files and submits under the Exchange Act are recorded, processed, summarized and reported as and when required.

Changes in Internal Control

There were no significant changes in the Company's internal controls or in other factors that could significantly affect such internal controls subsequent to the date of the evaluation described in the paragraph above, including any corrective actions with regard to significant deficiencies and material weaknesses.

3/18/2003

Item 15.

Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a)

1.

Financial Statements

The following consolidated financial statements of Florida Public Utilities Company are included herein and in the Registrant's 2002 Annual Report to Shareholders.

Consolidated Statements of Income

Consolidated Balance Sheets

Consolidated Statements of Capitalization

Consolidated Statements of Common Shareholders' Equity

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Independent Auditors' Report

2.

Financial Statement Schedules

Valuation and Qualifying Accounts

Allowance for Uncollectible Accounts

3.

Exhibits

See exhibit index following signatures.

(b)

Reports on Form 8-K.

•

A form 8-K was filed November 6, 2002 announcing a press release relating to 3^rd quarter earnings and the acquisition of Nature Coast Gas, Inc.

•

A form 8-K was filed December 4, 2002, announcing a press release concerning an agreement with the City of Fernandina Beach to sell the water assets of the Company to the City.

3/18/2003

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

FLORIDA PUBLIC UTILITIES COMPANY

By       /s/ George M Bachman                  Date:  March 18, 2003

         George M Bachman, Chief Financial Officer

         (Duly Authorized Officer)

     Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.

         /s/ John T. English                           Date:  March 18, 2003

         John T. English

President, Chief Executive Officer, and

Director

      Certifications pursuant to 18 U.S.C. section 1350, as adopted pursuant to SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, are attached in exhibits 99(1) and 99(2).

         /s/  Ellen Terry Benoit                       Date:  March 18, 2003

         Ellen Terry Benoit

         Director

         /s/ Richard C. Hitchins                     Date:  March 18, 2003

         Richard C. Hitchins

         Director

         /s/ Paul L. Maddock, Jr.                    Date:  March 18, 2003

         Paul L. Maddock, Jr.

         Director

         /s/ Rudy E. Schupp                           Date:  March 18, 2003

         Rudy E. Schupp

         Director

3/18/2003

FLORIDA PUBLIC UTILITIES COMPANY

EXHIBIT INDEX

Regulation S-K

Item Number

3(i)+

Articles of Incorporation (as amended) (Filed as Exhibit 3(i) in June 2002 on Form 10-Q for the quarter ended June 30, 2002, SEC File No. 1-10608)

3(ii)+

By-Laws (as amended) (Filed as Exhibit 3(ii) in June 2002 on Form 10-Q for the quarter ended June 30, 2002, SEC File No. 1-10608)

4(a)**

Indenture of Mortgage and Deed of Trust of the Company dated as of September 1, 1942 (Exhibit 7-A to Registration No. 2-6087 is hereby incorporated by reference).

 4(b)#

Fourteenth Supplemental Indenture dated September 1, 2001.

 4(c) #

Fifteenth Supplemental Indenture dated November 1, 2001.

10(a) #

Contract for the transportation of natural gas between Florida Public Utilities Company and Lake Worth Generation, LLC dated July 21, 2000.

10(b)*

Second amendment to Second Amended and Restated Credit Agreement between Florida Public Utilities Company and Sun Bank/South Florida, National Association dated April 30, 2000.

10(c)***

Contract for the transportation of natural gas between Florida Public Utilities Company and Florida Gas Transmission Company under Service Agreement for Firm Transportation Service dated June 1, 1992 (Exhibit 10-b to Form S-2 for July 1992, File No. 0-1055, is hereby incorporated by reference).

10(d)***

Contract for the transportation of natural gas between Florida Public Utilities Company and Florida Gas Transmission Company under interruptible Transportation Service Agreement dated February 23, 1990 (Exhibit 10-c to Form S-2, for July 1992, File No. 0-1055, is hereby incorporated by reference).

10(e)***

Contract for the transportation of natural gas between Florida Public Utilities Company and the City of Lake Worth dated March 25, 1992 (Exhibit 10-f to Form S-2 for July 1992, File No. 0-1055, is hereby incorporated by reference).

10(f)*

Contract for the purchase of electric power between Florida Public Utilities Company and Jacksonville Electric Authority dated January 29, 1996.

10(g)*

Contract for the purchase of electric power between Florida Public Utilities Company and Gulf Power Company effective November 21, 1996.

10(h)***

Contract for the purchase of as-available capacity and energy between Florida Public Utilities Company and Container Corporation of America dated September 19, 1985 (Exhibit 10-i to Form S-2 for July 1992, File No. 0-1055, is hereby incorporated by reference).

10(i)***

Contract for the sale of electric service between Florida Public Utilities Company and Container Corporation of America dated August 26, 1982 (Exhibit 10-j to Form S-2 for July 1992, File No. 0-1055, is hereby incorporated by reference).

10(j)***

Contract for the sale of electric service between Florida Public Utilities Company and ITT Rayonier Inc. Dated April 1, 1982 (Exhibit 10-(k) to Form S-2 for July 1992, File No. 0-1055, is hereby incorporated by reference).

10(k)*

Employment agreement between Florida Public Utilities Company and John T. English, effective through May 31, 2003.

10(l)*

Employment agreements between Florida Public Utilities Company and Charles L. Stein, Jack R. Brown and George M. Bachman, effective through May 31, 2003. Essentially identical to the agreement in Item 10(k) above.

10(m)***

Form of Stock Purchase and Sale Agreement between Florida Public Utilities Company and three persons who, upon termination of two trusts, will become the record and beneficial owners of an aggregate of 313,554 common shares of the Registrant (Exhibit 10-p to Form S-2 for July 1992, File No. 0-1055, is hereby incorporated by reference).

10(n)1

Contract for the negotiation of a gas transportation agreement between the Company, Lake Worth Generation LLC and the City of Lake Worth dated December 31, 2002.

10(n)2

Amended contract for the negotiation of a new gas transportation agreement between the Company, Lake Worth Generation LLC and the City of Lake Worth dated February 19, 2003.

10(o)

Contract for the sale of certain assets comprising the Company’s water utility business to the City of Fernandina Beach dated December 3, 2002.

21.*    

Subsidiary of the registrant

23.    

Independent Auditors' Consent

99(1)

Certification of Chief Financial Officer (CFO) regarding truthfulness of SEC filing

99(2)

Certification of Chief Executive Officer (CEO) regarding truthfulness of SEC filing

*

Incorporated by reference to corresponding exhibits on the Company’s annual report on form 10-K for the year ended December 31, 2000

**

Incorporated by reference to Registration No. 2-6087

***

Incorporated by reference to Form S-2 for July 1992, File No. 0-1055

#

Incorporated by reference to corresponding exhibits on the Company’s annual report on form 10-K for the year ended December 31, 2001

+

Incorporated by reference to corresponding exhibits on the Company’s quarterly report on form 10-Q for the quarter ended June 30, 2002

3/18/2003

Exhibit 10(n) 1

FORBEARANCE AGREEMENT

THIS FORBEARANCE AGREEMENT (the "Agreement") is dated as of the 31st day of December, 2002 (the "Effective Date") by and among FLORIDA PUBLIC UTILITIES COMPANY, a Florida corporation ("FPUC"), LAKE WORTH GENERATION LLC, a limited liability company organized under the laws of the State of Delaware ("LWG") and the CITY OF LAKE WORTH, FLORIDA, a municipality (the "CITY").  FPUC, LWG and the CITY may be referred to individually as a "Party" and collectively as the "Parties" in this Agreement.

RECITALS

WHEREAS, FPUC and LWG entered into that certain Gas Transportation Agreement dated as of July 21, 2000 (the "Transportation Agreement") and capitalized terms not otherwise defined in this Agreement shall be defined as set forth in the Transportation Agreement;

WHEREAS, FPUC now has completed the construction of certain pipeline facilities defined as the "LWG Lateral" in the Transportation Agreement and LWG has caused to be issued to FPUC an irrevocable Letter of Credit (the "LC") in the initial principal amount of Five Million Four Hundred Ninety Thousand Four Hundred forty-Nine Dollars ($5,490,449.00) as provided for in Section 4.8 of the Transportation Agreement with an expiration date now amended to December 31, 2003;

WHEREAS, upon demand by FPUC, LWG has failed to:  (a) cause the LC to be amended to increase the principal amount by Four Hundred Forty Three Thousand Forty Five and 23/100 Dollars ($443,045.23) consisting of the Final Adjusted Construction Cost plus $37,900 as provided for in Section 4.8 of the Transportation Agreement (such total amount being the "Construction Adjustment Amount"), and (b) pay the monthly payment due to FPUC under Section 7.6 of the Transportation Agreement of One Hundred Nine Thousand Four Hundred Twenty Three and 48/100 Dollars ($109,423.48) due December 26, 2002 (collectively, the "Monthly Payments");

WHEREAS, LWG has advised FPUC that LWG is unable to continue the development of the Project, and that LWG is negotiating with the CITY and other third parties to arrange for the continuation of the Project, including the assignment of the Transportation Agreement;

WHEREAS, the CITY is a Project Party and requires continuation of the Project for the benefit of the residents of the CITY who will receive electrical service from the Project upon completion; and

WHEREAS, FPUC has agreed to forbear from terminating the Transportation Agreement and seeking a draw on the LC and from pursuing its claims against LWG for the balance owed to FPUC pursuant to the Transportation Agreement for the period of time set forth in this Agreement, subject to the terms and conditions set forth in this Agreement.

NOW, THEREFORE, in consideration of these premises and the mutual covenants and agreements set forth herein, the Parties agree as follows:

1.

Recitals.  The "Recitals" set forth hereinabove are incorporated herein by this reference.  

2.

Forbearance by FPUC.  FPUC agrees not to make a draw on the LC or terminate the Transportation Agreement until 1:00 p.m., February 21, 2003 (the "Forbearance Date").  It is the intent of the Parties that, during the period from the Effective Date to the Forbearance Date, they shall negotiate in good faith in order to establish the terms and conditions for the assignment of the Transportation Agreement to the CITY.  In the event that agreement for the assignment of the Transportation Agreement to the CITY is not executed by the Parties by the Forbearance Date, then FPUC may terminate the Transportation Agreement and thereupon draw upon the LC, subject to the provisions of paragraph 4 below.

3.

Additional Consideration for Forbearance by FPUC.  CITY agrees to consider: (a) execution of a new franchise agreement with FPUC substantially on the terms and conditions as are set forth in Exhibit "A" attached hereto; and (b) renewal of  FPUC's lease of  its gate station on property owned by the CITY on Davis Road for a period of 30 years at a rate of $1000.00 per year.  In the event CITY fails to execute the new franchise agreement and the lease renewal on such terms and conditions by February 18, 2003, FPUC may terminate this Agreement and, notwithstanding any provisions herein to the contrary, FPUC shall be entitled to draw upon the LC on February 19, 2003, subject to the provisions of paragraph 4 below.

4.

Letter of Credit.  LWG and FPUC agree that, during the term hereof, the amount of the LC shall not be reduced and shall remain at the current principal amount, that no recalculation adjustment to the LC on the next anniversary of the Commencement Date set forth in Section 4.8 of the Transportation Agreement shall be made.  LWG and FPUC reserve their respective rights under the Transportation Agreement and their respective rights to assert claims or defenses in any subsequent action that may be pursued by either party as provided in the Transportation Agreement.

5.

Agreement by CITY.  In consideration of FPUC's consent to forbearance as set forth in this Agreement, by no later than January 10, 2003, the CITY agrees to pay FPUC the sum of thirty thousand dollars ($30,000.00), representing a partial payment of the Monthly Payment due December 26, 2002.  In addition, by no later than January 27, 2003, the CITY agrees to pay FPUC the sum of thirty thousand dollars ($30,000.00), representing a partial payment of the Monthly Payment due January 27, 2003.  Further, in the event the CITY agrees in writing to an assignment of LWG's rights and obligations under the Transportation Agreement prior to the Forbearance Date, CITY shall pay to FPUC, by no later than February 25, 2003, the balance due on the Monthly Payments for December 2002, plus interest at 6. 3%, annually, calculated from December 26, 2002 to the date of payment,  and January 2003, plus interest at 6.3%, annually, calculated from January 27, 2003 to the date of payment; and FPUC's attorneys' fees and costs incurred in connection with the negotiation and implementation of this Agreement, up to a maximum of $20,000  ("Transactional Costs").  In the event that agreement for the assignment of the Transportation Agreement to the CITY is not executed by the Parties by the Forbearance Date, or the earlier termination of this Agreement as provided in paragraph 3 above, CITY shall have no further obligations under this Agreement.  FPUC shall provide the CITY with notice of its Transactional Costs, with time and expenses itemized, by no later than February 24, 2003.  The partial payment by the CITY of the December 2002 and January 2003 Monthly Payments is not dependent upon the existence of any relationship between FPUC and the CITY other than FPUC's agreement to provide for the transportation of natural gas on the LWG Lateral,  and is not subject to any claim or offset of any kind by the CITY.  The CITY hereby represents and warrants that this Agreement (a) has been duly authorized and is valid and enforceable against and is binding upon the CITY and (b) does not conflict with its organizational documents or any law binding upon the CITY and agrees to promptly deliver to FPUC an opinion of counsel confirming (a) and (b).  ANYTHING IN THIS AGREEMENT TO THE CONTRARY NOTWITHSTANDING, THE OBLIGATION OF THE CITY TO PAY ANY AMOUNTS REQUIRED PURSUANT TO THIS PARAGRAPH 5 OR OTHERWISE UNDER THE AGREEMENT SHALL CONSTITUTE A REVENUE OBLIGATION OF THE CITY PAYABLE SOLELY FROM REVENUES OF THE CITY’S WATER AND ELECTRIC UTILITY SYSTEM AND SHALL NOT IN ANY WAY BE CONSTRUED TO BE A DEBT OF THE CITY IN CONTRAVENTION OF APPLICABLE CONSTITUTIONAL, STATUTORY OR CHARTER LIMITATIONS OR REQUIREMENTS CONCERNING THE CREATION OF INDEBTEDNESS OF THE CITY.

6.

LWG's Representations and Warranties.  LWG represents and warrants that: (a) any collateral pledged by LWG to secure the LC was pledged more than ninety (90) days from the date of this Agreement, (b) if LWG files a petition for relief under any of the provisions of the United States Bankruptcy Code, LWG will not assert in any such proceeding that the LC, including any proceeds paid to FPUC by the issuing bank as a result of FPUC's draw upon the LC as otherwise provided herein, is property of the bankruptcy estate of LWG, (c) this Agreement has been duly authorized and is valid and enforceable against and is binding upon LWG and does not conflict with its organizational documents or any law binding upon LWG and LWG agrees to promptly deliver to FPUC an opinion of counsel confirming same.

7.

Tolling.  All applicable limitations periods, including state and federal statutes of limitation and other time-related defenses (including, but not limited to, waiver, laches or estoppel) with respect to any claims the Parties may have against each other (collectively, the "Claims") are tolled from the Effective Date until the Forbearance Date, or the earlier termination of this Agreement as provided in Paragraph 3 above ("Tolling Period").  All statute of limitations or other time-related defenses available to the Parties as of  the date of this Agreement shall remain available to them upon the termination of the Tolling Period.

8.

No Action.  None of the Parties (nor any of their respective representatives or agents), shall commence, or cause to be commenced, either directly or indirectly, any legal action or proceeding whatsoever, against each other, or against any of their respective representatives, agents, officers, directors or employees, based upon the Claims until the Forbearance Date or the earlier termination of this Agreement as provided in Paragraph 3 above.

9.

Non-Admission of Liability.  Except as set forth in this Agreement, this Agreement does not and shall not constitute an admission or implication that any of the Claims are valid, or that any conduct of any of the Parties was wrongful, unlawful, negligent or violative of any federal or state statute or regulation, or of any contract, agreement or common law.  By entering into this Agreement, none of the Parties shall be deemed to have:  (a) made any admissions against his or its respective interest; (b) admitted any alleged liability, wrongdoing or violation of any rule, regulation, agreement or statute; or (c) waived any claims or defenses, however denominated (other than the claims and defenses waived by this Agreement), and all such claims and defenses are expressly reserved.

10.

Miscellaneous.

a.

Headings.  The headings in this Agreement are for convenience of reference only and shall not control or affect the meaning or construction of any provisions hereof.

b.

Entire Agreement.  This Agreement constitutes the entire agreement and understanding of the parties hereto in respect of the subject matter contained herein, and there are no restrictions, promises, representations, warranties, covenants, or undertakings with respect to the subject matter hereof, other than those expressly set forth or referred to herein.  This Agreement supersedes all prior agreements and understandings between the parties hereto with respect to the subject matter hereof.  In the event of any conflict between the provisions of this Agreement and the Transportation Agreement, the terms of this Agreement shall prevail as between the parties hereto.

c.

Notices.  All notices, requests, demands and other communications required or permitted to be given hereunder shall be in writing (including facsimile transmission) and shall be sent by facsimile, overnight courier or hand delivery as follows:

if to FPUC, to the address and facsimile numbers set forth in Section 13.1 of the Agreement;

with a copy to:

William L. Pence, Esquire

Akerman Senterfitt

255 South Orange Avenue

Post Office Box 231

Orlando, Florida 32802-0231

Telecopier: (407) 843-6610

if to LWG, to:

Brian Chatlosh

AES Coral Corporation

70 Walnut Street

Wellesley Hills, MA  02481

Telecopier:  (781) 239-8223

with a copy to:

Joseph A. McGlothlin, Esquire

McWhirter, Reeves, McGlothlin, Davidson,

Decker, Kaufman & Arnold P.A.

117 South Gadsden Street

Tallahassee, FL 32301

Telecopier:  850-222-5606

if to the CITY, to:

Mr. Patrick Miller

Asst City Mgr/Utilities Dir.

City of Lake Worth

1900 Second Avenue North

Lake Worth, FL 33461

Telecopier:  561-586-1702

with a copy to:

Richard Miller, Esquire

Edwards & Angell, LLP

One N. Clematis St, Suite 400

West Palm Beach, FL 33401

Telecopier:  888-325-9184

or such other address or facsimile number as such party may hereinafter specify for such purpose to the party giving such notice.

d.

Notices.  All such notices, requests and other communications shall be deemed received on the date of receipt by the recipient thereof if received prior to 5 p.m. in the place of receipt and such day is a business day in the place of receipt.  Otherwise, any such notice, request or communication shall be deemed not to have been received until the next succeeding business day in the place of receipt.

e.

Governing Law/Attorneys' Fees.  This Agreement shall be construed in accordance with and governed by the laws of the State of Florida, without regard to the conflicts of law rules of such state.  In the event any litigation arises with respect to this Agreement or any matters covered by this Agreement, the prevailing party shall be entitled to its attorneys' fees and any costs and expenses associated with such litigation.

f.

Venue and Jurisdiction.  Any suit, action or proceeding arising out of, or with respect to, this Agreement may only be brought in any Florida state or federal court sitting in Palm Beach County, Florida. The parties hereto hereby accept the exclusive jurisdiction of such courts for the purpose of any such suit, action or proceeding.

g.

Inadmissibility.  This Agreement shall be admissible in any proceeding involving the Parties hereto only to prove the terms hereof, and shall be inadmissible for any other purpose.

h.

Authority of Persons Signing.  Each person signing this Agreement represents and warrants that he or she is authorized to bind to this Agreement the Party or Parties for whom he or she has signed.

i.

Amendments; Waivers.   

(a)

No failure or delay on the part of any party in exercising any right, power or privilege hereunder shall operate as a waiver thereof except as explicitly provided herein, nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right, power or privilege.  The rights and remedies herein provided shall be cumulative and not exclusive of any rights or remedies provided by law.

(b)

Any provision of this Agreement may be amended or waived if, but only if, such amendment or waiver is in writing and is signed, in the case of an amendment, by each party to this Agreement, or in the case of a waiver, by the party or permitted transferee against whom the waiver is to be effective.

a.

Counterparts; Facsimile Signatures.  This Agreement may be executed in any number of counterparts, each of which shall be deemed an original and all of which together shall be one and the same instrument.  This Agreement may be delivered by facsimile and signatures on any facsimile of this Agreement shall be valid and binding as an original signature.  Each party agrees that if its signature is delivered by facsimile, an original signature page of such party shall subsequently be delivered to the Company and the other parties hereto.

b.

Remedies.  The parties hereto acknowledge and agree that in the event of any breach of this Agreement, the parties would be irreparably harmed and could not be made whole by monetary damages.  Each party hereto accordingly agrees (i) not to assert by way of defense or otherwise that a remedy at law would be adequate, and (ii) that the parties agree, in addition to any other remedy to which they may be entitled, that the remedy of specific performance of this Agreement is appropriate in any action in court.

c.

Successors and Assigns.  This Agreement shall be binding upon and inure to the benefit of FPUC, LWG and the CITY and their respective successors, assigns and permitted transferees.  The rights of a party under this Agreement may not be assigned or otherwise conveyed by any party except as provided in this Agreement.

d.

Benefits Only to Parties.  Nothing expressed by or mentioned in this Agreement is intended or shall be construed to give any Person, other than the parties hereto any legal or equitable right, remedy or claim under or in respect of this Agreement or any provision herein contained.

e.

Publicity.  Except as otherwise required by law, none of the parties hereto shall issue or cause to be issued any press release or make or cause to be made any other public statement in each case relating to or connected with or arising out of this Agreement or the matters contained herein, without obtaining the prior written consent of the other parties to the contents and the manner of presentation and publication thereof.

[Signatures on Next Page]

IN WITNESS WHEREOF, the Parties hereto have executed, or caused this Agreement to be duly executed by their respective authorized officers or representative officials, as of the day and year first above written.

Signed, sealed and delivered

in our presence:

LAKE WORTH GENERATION, LLC