Management's Discussion and Analysis of Financial Condition and Results of Operation

RESULTS OF OPERATIONS

Revenues and Gross Profit Summary

The Florida Public Service Commission (FPSC) allows us to bill and include in our revenue the costs of fuel, conservation, and revenue-based taxes, incurred in our natural gas and electric segments. Revenues collected for these expenses have no effect on results of operations and fluctuations could distort the relationship of revenues between periods. We define gross profit as operating revenues less fuel, conservation and revenue-based taxes that are passed directly through to customers. Because gross profit excludes these cost recovery revenues, we believe it provides a more meaningful basis for evaluating utility revenue. The following summary compares gross profit, units sold, and average customers for the past three years. Units sold are shown in one thousand Dekatherm (MDth) for gas and Megawatt Hour (MWH) for electric.

                             Revenues and Gross Profit
                              (Dollars in thousands)
                                                  Years Ended December 31,
                                                     2008      2007      2006
      Natural Gas
      Revenues                                   $72,624   $64,850   $71,139
      Cost of fuel and other pass through costs   46,039    38,251    43,909
      Gross Profit                               $26,585   $26,599   $27,230
        Units sold: (MDth)                         5,966     6,042     6,230
        Customers (average for the period)        51,957    51,589    51,211
      Electric
      Revenues                                   $78,655   $55,521   $48,527
      Cost of fuel and other pass through costs   61,565    41,142    34,259
      Gross Profit                               $17,090   $14,379   $14,268
        Units sold: (MWH)                         739,532  810,604   849,124
        Customers (average for the period)        31,295    31,074    30,635
      Propane Gas
      Revenues                                   $17,269   $16,171   $15,115
      Cost of fuel                                 9,717     8,428     7,803
      Gross Profit                               $ 7,552    $7,743    $7,312
      Units sold:  (MDth)                            552       597       621
        Customers (average for the period)        12,463    13,140    13,048
      Consolidated
      Revenues                                  $168,548  $136,542  $134,781
      Cost of fuel and other pass through costs  117,321    87,821    85,971
      Gross Profit                              $ 51,227  $ 48,721  $ 48,810
      Customers (average for the period)          95,715    95,803    94,894

Natural Gas

Natural gas revenues increased $7.8 million, or 12% in 2008 over 2007 due to increases to recover fuel costs, which are passed through to customers. Our gross profit, which excludes expenses directly passed through to customers, remained flat as compared to the prior year. The percentage of gross profit to total revenues decreased by 4% compared to the prior year due to increases in our cost of fuel and the resulting increased pass-through revenue. The average customer growth increased marginally in 2008 compared to 2007 primarily due to the conversion of a large community from propane to natural gas in September 2007. In spite of colder weather, units sold decreased by 1% most likely as the result of conservation measures taken by our customers due to higher fuel costs, the downturn in the housing market, and the economy as a whole.

We recorded additional 2006 over-earnings of $135,000 which reduced revenues and gross profit in the third quarter of 2008. The FPSC approved finalization of the 2006 over-earnings on September 29, 2008 and ordered the Company to fund its natural gas storm reserve to offset any future storm costs.

Natural gas revenues decreased $6.3 million, or 9% in 2007 over 2006. As the cost of natural gas declined, the revenues to recover the fuel costs, which are passed through to customers, decreased by $5.7 million. Our gross profit, which excludes expenses directly passed through to customers, decreased by $631,000 or 2%. The percentage of gross profit to total revenues increased by 3% compared to the prior year due to increases in our cost of fuel and the resulting increased pass-through revenue. Although customer growth was up in 2007 compared to 2006, we experienced a 3% decrease in units sold primarily due to milder weather.

Electric

Electric revenues increased $23.1 million or 42% in 2008 over 2007. The cost of fuel and other costs passed through to customers contributed to $20.4 million of the increase, as a result of higher fuel costs reflected in new fuel contracts effective January 1, 2008 in our Northwest division. Gross profit increased $2.7 million, or 19% compared to 2007 primarily due to the recent base rate increase. The percentage of gross profit to total revenues decreased by 4% compared to the prior year due to increases in our cost of fuel and the resulting increased pass-through revenue. This was despite a 5% decrease in units sold to our non-industrial customers. The decrease in consumption may be the result of conservation measures taken by our customers and the overall downturn in the economy.

Gross profit was not materially impacted from reduced consumption as this was forecasted in our recent electric rate increase approved in April 2008. Rates were set to compensate for the anticipated reduction in units sold due to significant increases in fuel costs. The FPSC approved the final annual electric rate increase of approximately $3.9 million effective May 22, 2008. An interim rate increase of approximately $800,000 annually was in effect from November 22, 2007 until the final rates went into effect.

Electric revenues increased $7.0 million or 14% in 2007 over 2006. Cost of fuel and other costs that were passed through to customers contributed to $6.9 million of the increase as a result of higher fuel costs reflected in the new fuel contracts effective January 1, 2007 in our Northeast division. Gross profit, which excludes the fuel and other costs passed through in revenue, was flat compared to 2006. The percentage of gross profit to total revenues decreased by 4% compared to the prior year due to increases in our cost of fuel and the resulting increased pass-through revenue. Although the number of customers increased by 1%, there was a marginal decrease in units sold, excluding units sold to industrial customers, as a result of possible conservation measures taken by our customers due to the fuel cost increases.

Propane Gas

Propane revenues increased $1.1 million, or 7%, primarily as a result of increased rates to our customers to recover $1.3 million in increased fuel costs. Gross profit declined by $191,000 or 2% in 2008 compared to 2007 as a result of a 7.5% decrease in units sold. In spite of colder temperatures, units sold declined as a result of the conversion of a large development from propane to natural gas in September 2007. In addition, the downturn in the housing market and the economy had a negative impact on customer growth and usage per customer. Additionally, we recorded an inventory loss adjustment of approximately $110,000 in 2008. This loss may have been caused primarily by faulty metering equipment and measurement errors.

Propane revenues increased $1.1 million, or 7%, in 2007 compared to 2006. Higher fuel costs caused $625,000 of this increase. Gross profit increased $431,000 or 6% in 2007 compared to 2006. Although we experienced a 4% decrease in units sold to customers due to warmer weather, this was offset by increased rates and service fees.

Operating Expenses

Operating expenses include operation, maintenance, depreciation, amortization
and taxes other than income taxes, and exclude fuel costs, conservation and
taxes based on revenues that are directly passed through to customers and
recovered in revenues.


                                Operating Expenses
                              (Dollars in thousands)
                                          Year Ended December 31,
                                          2008         2007        2006
            Natural gas              $  23,022   $  21,951   $  21,112
            Electric                    12,885      11,726      11,215
            Propane gas                  6,211       6,223       6,306
            Total Operating Expenses $  42,118   $  39,900   $  38,633

Natural Gas

Natural gas operating expenses increased $1.1 million, or 5%, in 2008 as compared with 2007. Administrative expenses account for $401,000 of this increase and are discussed in a separate section below. We experienced a $449,000 increase in expenses relating to uncollectible accounts which may be another consequence of the declining economy. To address this issue, we have increased our collection efforts and are enforcing deposit requirements. The increase includes a large write off of $164,000 for a commercial customer bankruptcy. Depreciation expense increased $194,000 due to normal plant growth and the conversion of the Summer Glen development from propane to natural gas in September of 2007.

To help offset increased expenditures, we reduced selling expenses by eliminating sales positions. Additionally, other operating expenses decreased as a result of the slowdown in the economy and housing market. We experienced fewer installations of gas lines to residential customers as new construction activities continued to decline. The combined impact was a decrease in our other operating and sales expenses of $269,000.

Natural gas operating expenses increased $839,000, or 4%, in 2007 as compared with 2006. Administrative expenses accounted for $503,000 of the increase and are discussed in a separate section below. Depreciation expense increased $291,000 due in part to construction of mains and additional meters to distribute gas to new developments in South Florida along with increasing capacity requirements for existing customers. As a result of a new management focus to offset the effects of the construction industry and housing market slowdown, we increased our efforts to provide improved customer service and upgraded our existing meter equipment resulting in an increase of related expenses of $287,000. This increase was offset by a $245,000 reduction in sales expense resulting from the elimination of three sales positions due to cut backs related to the slowdown in the housing market.

Electric

Electric operating expenses increased $1.2 million, or 10%, in 2008 as compared with 2007. Administrative expenses account for $106,000 of the increase and are discussed in a separate section below. Operating expenses increased by $192,000 due to the addition of an engineering position and due to the additional substation, line and lighting inspections necessary to comply with new operating requirements. As a result of storm hardening initiatives recently mandated by the FPSC, tree trimming and other maintenance expenses increased by $231,000. New electric depreciation rates, that were effective January 1, 2008, and normal plant growth increased depreciation expense by $495,000. A portion of the 2008 depreciation expense was not recovered in 2008 in electric rates due to the timing of final rate increase.

Electric operating expenses increased $511,000, or 5%, in 2007 as compared with 2006. Administrative expenses accounted for $437,000 of the increase and are discussed in a separate section below. Due to a quiet hurricane season this year, we were able to re-direct work efforts and make some operating and safety improvements of our overall electric system, which increased operating expenses by $136,000. As a result of a milder storm season, we experienced a decrease in weather-related maintenance of conduct, lines and poles expenses of $184,000.

Propane Gas

Propane gas operating expenses remained flat in 2008 as compared with 2007. We experienced decreased selling expenses of $146,000 as a result of a continued drop in demand from the slowdown of new construction in South Florida and the overall economy.

Additionally, other operating expenses and depreciation expense decreased $133,000 and $75,000, respectively, due in a large part to a conversion of customers in our central Florida division from propane to natural gas in the fourth quarter of 2007. These expenses were offset by increased general administrative expenses of $236,000, discussed in a separate section below, and increased customer accounts expense of $67,000 relating to increased bad debts, due to the downturn in the economy.

Propane gas operating expenses decreased $83,000, or 1%, in 2007 as compared with 2006. The major reason for the decrease was lower selling expenses as a result of a drop in demand from the slowdown of new construction in South Florida. Additionally, the SummerGlen project was converted from a propane system to natural gas in the fourth quarter of 2007 causing all related expenses to shift to our natural gas segment.

Administrative Expenses

Administrative expenses which includes allocations for merchandising and jobbing, increased $743,000, or 7%, in 2008 over 2007. Approximately $500,000 of this increase was due to professional fees and expenses incurred in the second quarter of 2008 related to strategic development activity no longer ongoing.
The impact to net income for these expenses is approximately $312,000, or $.05 per share, for the year ending December 31, 2008. Pension and medical costs continued to outpace inflation, increasing $125,000 and $165,000, respectively. We experienced an increase to payroll and temporary staffing costs of $334,000 as a result of normal pay raises and additional temporary assistance related to tax work. These increases were partially offset by a drop in general liability expenses of $581,000, as discussed below, since claims in 2007 were above normal levels.

Administrative expenses increased $1 million, or 11%, in 2007 over 2006. Several unusual claims resulting in settlements were the primary reasons for the $796,000 increase to our liability expenses. These claims were for several general liability suits related to auto, employment and liability issues. In addition, our payroll expenses increased $163,000 as a result of annual pay raises.

Total Other Income and Deductions

Other income and deductions include merchandise and service revenues and expenses; gains and losses on disposal of property; interest expense; and miscellaneous income and expenses. Merchandise sales and installation and interest expenses are the largest components of this section and are discussed below.

Merchandise and Services Revenue and Expenses

Merchandise and services revenue and expenses decreased by $582,000 and $472,000, respectively, resulting in decreased profit of $110,000 in 2008 as compared to 2007. We continue to face a slowdown in the construction industry and housing market, in addition to current economic conditions. This has reduced the demand for new merchandise and installations. Management does not anticipate the housing market or economy will rebound in 2009, and expects sales to stay suppressed.

In 2007, merchandise and services revenue and expenses decreased by $1.1 million and $1.3 million, respectively, although our overall profit increased $125,000, as compared to 2006. A lower number of product installations actually improved our profit margin on the installation side of our business. We had fewer customer owned tank installations and we discontinued generator sales, both of which are historically less profitable. The slowdown in the construction industry and housing market, along with a quiet hurricane season, dramatically reduced the demand for new merchandise.

Interest Expense

Interest expense consists of interest on bonds, short-term borrowings, over earnings and customer deposits. In 2008, interest expense decreased $54,000. This is mainly due to a drop in tax related interest expense relating to prior year IRS audit findings and the related interest expense. Interest expense in long-term borrowing decreased due to the partial repayment of principal from a sinking fund payment. This was offset by increased short-term interest expense due to a higher balance on the line of credit.

Other

Income was generated in 2008 from a special project to build a propane facility for a fire rescue department. This is the primary reason for the $59,000 increase to other net non-operating income.

Income Taxes

Higher taxable income increased income tax expense by $106,000 in 2008 over 2007.

Liquidity and Capital Resources

Summary of Primary Sources and Uses of Cash

   (Dollars in thousands)                             Year Ended December 31,
                                                       2008       2007     2006
   Sources of Cash:
   Operating activities, including working capital  $12,620   $14,526  $20,090
   changes
   Net proceeds on short-term debt                    1,625     7,656        -
   Other sources of cash                                814       923    1,179
   Uses of Cash:
   Construction expenditures                         11,227    16,740   13,116
   Dividends paid                                     2,788     2,681    2,551
   Net payment on long-term & short-term debt         1,442         -    6,092
   Other uses of cash                                    83       290      121
      Net (use) source of cash                       $ (481) $  3,394  $  (611)

Cash Flows

Operating Activities

Net cash flow provided by operating activities decreased by approximately $1.9 million in 2008 as compared to 2007. This was caused by several factors:

·

Fuel costs increased over the prior year and we also refunded prior year over-recoveries. Both of these items caused a decrease in cash of $2.1 million compared to the prior year.

·

We experienced a $2.2 million decrease in cash as a result of higher receivables due to increased revenues.

·

We had a $2.2 million decrease in cash resulting from prepaid taxes primarily as a result of expected pension contributions to be made in 2009 for the 2008 plan year. We expect to receive this tax refund in the first half of 2009.

·

We experienced a $3.7 million increase in cash from reductions in current taxes paid compared to the prior year. The primary reason for this increase was depreciation true-ups for prior tax years. This partially offset the decrease to cash listed above.

Net cash flow provided by operating activities decreased in 2007 by approximately $5.6 million compared to 2006. We had a $6.4 million decrease related to refunding the prior over-recovery of fuel and other pass through costs.

Investing Activities

Capital expenditures decreased in 2008 compared to 2007 by approximately $5.5 million. The majority of the decrease was a result of purchase of land for the future site of our South Florida operations facility for approximately $3.5 million in the prior year. During 2007, our Northwest Florida electric division incurred above normal expenditures of $265,000 for storm hardening projects, meter, and regulator purchases. In our Northeast Florida electric division, $600,000 of 2008 scheduled electric transmission expenditures were delayed until 2009 due to contractor scheduling conflicts and specification changes. In addition there was a significant reduction in expenditures for distribution facilities and installations this year because of the slowdown in the construction industry and economy.

Capital expenditures increased in 2007 compared to 2006 by approximately $3.6 million. The major component of the increase was the purchase of land for approximately $3.5 million for the future site of our South Florida operations facility.

Financing Activities

Cash from short-term borrowings decreased by approximately $6.0 million in 2008, primarily due to increased borrowings in 2007 to fund the purchase of land for our South Florida division. Cash of $1.4 million was used in 2008 for sinking fund payments due in the second quarter of this year.

Short-term borrowings increased by approximately $7.7 million in 2007. The main reasons for the increase were the purchase of land for our South Florida operations center and the repayment of over-recoveries of fuel costs from prior periods.

Capital Resources

We have a revolving line of credit with Bank of America which expires July 1, 2010. Prior to March 2008, the available line of credit was $15 million with the ability to increase the limit to a maximum of $20 million upon 30 days notice. In March 2008, we amended our line of credit to allow us, upon 30 days notice, to increase our maximum credit line from $20 million to $26 million and to reduce the interest rate paid on borrowings by 0.10% or 10 basis points. In April 2008, we increased the currently available line of credit from $12 million to $15 million and at December 31, 2008, the balance outstanding was $12.7 million. We reserve $1 million of the line of credit to cover potential expenses for any major storm repairs in our electric segment and an additional $250,000 for a letter of credit insuring propane gas facilities.

The line of credit contains affirmative and negative covenants that, if violated, would give the bank the right to accelerate the due date of the loan to be immediately payable. The line of credit covenants with Bank of America include certain financial ratios, all of which are currently met. However, see 'Covenants' below under "Outlook and Subsequent Events".

The line of credit, long-term debt and preferred stock as of December 31, 2008 comprised 56% of total debt and equity capitalization.

Historically we have periodically paid off short-term borrowings under lines of credit using the net proceeds from the sale of long-term debt or equity securities. We continue to review our financing options including increasing our short-term line of credit, issuing equity, or issuing debt. The choice of financing will be dependent on prevailing market conditions, the impact to our financial covenants and the effect on income. The timing of additional funding will be dependent on projected environmental expenditures, building of the South Florida operations facility, pension contributions, and other capital expenditures.

Our 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, 2008, such calculation would permit the issuance of approximately $49.7 million of additional bonds.

On October 14, 2008 we received approval from the FPSC to issue and sell or exchange an additional amount of $45 million in 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 2009.

We have $3.5 million in invested funds for payment of future environmental costs. We expect to use some or all of these funds in 2010 and 2011.

We expect to receive tax refunds of approximately $2.2 million in early 2009. The primary reason for this refund is our planned pension contribution of $4.6 million for plan year 2008 expected to be made in 2009 as shown in Note 13A in the Notes to Consolidated Financial Statements. This pension contribution is a deduction for tax purposes in 2008 calendar year; but was not known at the time of estimated tax payments made in calendar year 2008.

As of December 31, 2008 there was approximately $5.9 million in receivables from the 2003 sale of our water assets. We received an installment of $252,000 in February of 2009. Final payment of principal and interest totaling $5.8 million is expected in February 2010.

Capital Requirements

Portions of our business are seasonal and dependent upon weather conditions in Florida. This affects the sale of electricity and gas and impacts the cash provided by operations. Construction costs also impact cash requirements throughout the year. Cash needs for operations and construction are met partially through short-term borrowings from our line of credit.

Capital expenditures were originally expected to be higher in 2009 compared to 2008 by approximately $3.1 million. However, management has decided to reduce capital expenditures significantly when possible for 2009, which should lower capital expenditures to the 2008 level of $11.2 million or below. Overall, 2008 experienced decreased capital investments due to the downturn in the economic climate and reduced construction levels. The 2009 projected capital expenditures reflect normal spending levels required for replacement natural gas construction related to expected road construction and include $800,000 for system improvements and expansion within our natural gas segments.

Cash requirements will increase significantly in the future due to environmental cleanup costs, sinking fund payments on long-term debt and pension contributions. Environmental cleanup is forecast to require payments of $774,000 in 2009, with remaining payments, which could total approximately $9.1 million, net of investment proceeds, beginning in 2010. Annual long-term debt sinking fund payments of approximately $1.4 million will continue in 2009 for ten years.

The Company made a voluntary contribution in our defined benefit pension plan of $400,000 in 2008 for the 2007 plan and expects to make 2009 contributions of $4.6 million for the 2008 plan and $1.2 million for the 2009 plan. Refer to Note 13A in the Notes to Consolidated Financial Statements. We will continue to make contributions as required by the Pension Protection Act funding rules. As a result of the current economic climate and the impact to the stock market investments held within our pension plan, future contributions to our defined benefit pension plan are expected to increase. Annual contributions are expected to range between approximately $1.8 million and $5.9 million in each of the next five calendar years. Our total pension contributions over the next five years are anticipated to be approximately $15 million. Annual pension expenses are projected to be between $1 million and $2 million per year over the next five years. The total expenses for this five year period are projected to be approximately $8 million.

In an effort to reduce anticipated pension costs and the pension liability, the Company is proposing to freeze this plan effective December 31, 2009. With the freeze, total pension expense and total pension contributions for the next five years are expected to be approximately $1 million and $12 million, respectively. As a result of the freeze, annual contribution payments are expected to be $3.7 million in 2010, $600,000 in 2011, $1.2 million in 2012 and $1.0 million in 2013.

We believe that cash from operations, coupled with short-term borrowings on our line of credit, will be sufficient to satisfy our operating expenses, normal construction expenditure and dividend payments through 2009; however we are considering equity or debt financing in 2009 or 2010. The need and timing will depend upon operational requirements, the timing of environmental expenditures, pension contributions and construction expenditures. In addition, if we experience significant environmental expenditures in the next two or three years it is possible we may need to raise additional funds. There can be no assurance, however, that equity or debt transaction financing will be available on favorable terms or at all when we make the decision to proceed with a financing transaction.

Outlook and Subsequent Events

Electric Franchise Marianna

The City of Marianna is currently reviewing the franchise agreement with the Company that is up for renewal in 2010. The City has hired a Consultant to review the feasibility of purchasing the portion of our electric system that is within the city limits. If the City elects to purchase the Marianna portion of the distribution system, it would be required to pay the fair market value, and would need to invest in the infrastructure to operate this limited facility. If . . .