EMERALD COAST UTILITIES AUTHORITY PENSACOLA, FLORIDA COMPREHENSIVE ANNUAL FINANCIAL REPORT FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2006

EMERALD COAST UTILITIES AUTHORITY PENSACOLA, FLORIDA COMPREHENSIVE ANNUAL FINANCIAL REPORT FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2006 Prepared by: Department of Finance Debra P. Buckley Director of Finance

INTRODUCTORY SECTION

EMERALD COAST UTILITIES AUTHORITY PENSACOLA, FLORIDA COMPREHENSIVE ANNUAL FINANCIAL REPORT FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2006 TABLE OF CONTENTS I INTRODUCTORY SECTION PAGE Letter of Transmittal... 1-7 7 Organizational Chart... 8 List of Principal Officials... 9 Certificate of Achievement for Excellence in Financial Reporting...10 II. FINANCIAL SECTION Independent Auditor's Report... 11-12 Management ' s Discussion and Analysis... 13-19 Basic Financial Statements: Comparative Balance Sheets... 22-23 Comparative Statements of Revenue, Expenses and Changes in Net Assets...24 Comparative Statements of Cash Flows... 26-27 Notes to Financial Statements... 29-45 Supplementary Information: Schedule of Expenditures of Federal Awards and State Financial Assistance...47 t Schedule of Revenue and Expenses Compared to Budget... 48-49

EMERALD COAST UTILITIES AUTHORITY PENSACOLA, FLORIDA COMPREHENSIVE ANNUAL FINANCIAL REPORT FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2006 TABLE OF CONTENTS (Continued) PAGE II. FINANCIAL SECTION (Continued) Water and Wastewater System - Comparative Schedules of Assets, Liabilities and Net Assets... 50-51 Comparative Schedules of Revenue, Expenses and Changes in Net Assets...53 Comparative Schedules of Cash Flows... 54-55 Schedule of Revenue and Expenses Compared to Budget... 56-57 Sanitation System - Comparative Schedules of Assets, Liabilities and Net Assets... 58-59 Comparative Schedules of Revenue, Expenses and Changes in Net Assets... 60 Comparative Schedules of Cash Flows... 62-63 Schedule of Revenue and Expenses Compared to Budget... 64-65 III. STATISTICAL SECTION- UNAUDITED Schedules of Revenue and Expenses - Last Ten Fiscal Years... 68-69 Debt Service Coverage - Last Ten Fiscal Years...70

EMERALD COAST UTILITIES AUTHORITY PENSACOLA, FLORIDA COMPREHENSIVE ANNUAL FINANCIAL REPORT FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2006 TABLE OF CONTENTS (Continued) III. STATISTICAL SECTION- UNAUDITED (Continued) PAGE Number of Active Customers at Fiscal Year End - Last Ten Fiscal Years...71 Principal Customers...72 Recorded Rainfall - Last Ten Fiscal Years...73 Water Consumption - Last Ten Fiscal Years...74 Sewage Plant Flows - Last Ten Fiscal Years...75 Miscellaneous Statistics - Last Ten Fiscal Years... 76-77 Schedule of Insurance... 78-82 IV. OTHER REPORTS Independent Auditor's Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed with Government Auditing Standards...83 Independent Auditor's Report on Compliance with Requirements Applicable to Each Major Federal Program and State Project and Internal Control Over Compliance in Accordance with OMB Circular A-133... 84-85 Schedule of Findings and Questioned Costs... 86-87 ManagementLetter 88-91

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EMERALD COAST UTILITIES AUTHORITY P. O. Box 15311 9255 Sturdevant Street Pensacola, Florida 32514-0311 ph: 850 476-5110 fax: 850 494-7346 March 20, 2007 Citizens of Escambia County and Members of the Board Emerald Coast Utilities Authority Pensacola, Florida The management and staff of the Emerald Coast Utilities Authority (the "Authority") are pleased to present the Comprehensive Annual Financial Report for the year ended September 30, 2006. The financial statements are audited in conformity with Chapter 166.241(1), Florida Statutes, and Chapter 10.550 of the Rules of the Auditor General of the State of Florida. Responsibility for both the completeness and fairness of the presentation, including all disclosures, rests with management. To the best of our knowledge and belief, the enclosed data are accurate in all material respects and are reported in a manner designed to present fairly the financial position and results of operation of the Authority. All disclosures necessary to enable the reader to gain an understanding of the Authority's financial activities have been included. Generally accepted accounting principles (GAAP) require that management provide a narrative introduction, overview, and analysis to accompany the basic financial statements in the form of Management's Discussion and Analysis (MD&A). This letter of transmittal is designed to complement the MD&A and should be read in conjunction with it. The Authority's MD&A can be found in the Financial Section immediately following the report of the independent auditors. The Authority's management staff is responsible for establishing and maintaining an internal control structure designed to ensure that the assets of the Authority are protected from loss, theft or misuse, and to ensure that adequate accounting data are compiled to allow for the preparation of financial statements in conformity with generally accepted accounting principles. The internal control structure is designed to provide reasonable, but not absolute, assurance that these objectives are met. The concept of reasonable assurance recognizes that: (1) the cost of a control should not exceed the benefits likely to be derived; and (2) the valuation of costs and benefits requires estimates and judgments by management. The Reporting Entity The Authority was created by State legislation in 1981 to acquire, consolidate, manage and operate the water and wastewater systems in Escambia County, Florida. The Authority is an independent special district and is governed by a board of five members who are elected from districts located in Escambia County. The Authority employs an executive director, who is the chief executive officer of the Authority. Logan Fink Lois Benson Elvin McCorvey Dale Perkins Larry Walker District One District Two District Three District Four District Five 1

The 2004 State legislature approved changing our name from Escambia County Utilities Authority to Emerald Coast Utilities Authority, effective June 29, 2004. This change will help to identify the Authority as a separate entity that is not connected with the Escambia County government. The Authority believes this will eliminate much of the confusion associated with the former name. The Authority's service area covers most of southern Escambia County, which is located in the far northwestern part of the State of Florida. In addition to the water and wastewater utility, the Authority operates a sanitation collection utility for residential and commercial garbage. The Authority Board annually approves an operating budget and a five-year capital improvement budget. Budgetary controls are maintained by the Authority. The objective of these budgetary controls is to ensure compliance with legal provisions embodied in the annual appropriated budget approved by the Board. The level of budgetary control (that is, the level at which expenditures cannot legally exceed the appropriated amount) is by total appropriations. The Executive Director may approve transfers of appropriations within the budget. However, changes in total appropriations require Board approval. Budget-to-actual comparisons are provided in the Comprehensive Annual Financial Report (CAFR) separately for the water and wastewater system and for the sanitation system, as well as for the entity as a whole. Although the water and wastewater system and the sanitation system do not meet the definition of separate "funds", the Authority has established a policy that both systems be self-supporting in accordance with sound accounting policy. Factors Affecting Financial Position Local economy. The county has a diverse economic base that includes military, industry, shipping, tourism and recreation, agriculture, services, and retail sales trade. Because of this diversified base, the local economy has been stable. Statistical information gathered by the Haas Center for Business Research and Economic Development-University of West Florida reported that the Northwest Florida region's unemployment rate for the second quarter of 2006 was 3.1%, just above the state average of 3.0% and well below the nation's 4.6% average. The military represents a significant portion of the economic activity in the Pensacola Metropolitan Statistical Area (MSA). The economic impact of the military in the MSA is $2.1 billion, with over 21,000 active military and civilian personnel, and well over 30,000 military retirees. Tourism plays a vital role as a source for economic activity in the local economy, contributing $1.1 billion annually. Pensacola Beach tourism generates approximately $277 million in local sales per year. Over 18,000 jobs are directly or indirectly related to tourism, with Pensacola Beach supporting approximately 4,000 of those jobs. The major tourist attractions are the local beaches, the Pensacola Historical District, the Gulf Island National Seashore, and the Naval Aviation Museum featuring an IMAX theater. The services sector employment increased in the Pensacola MSA between 1990 and 2006, accounting for 87% of total nonagricultural employment in 2006 compared to 85% in 1990. Leading employment within the services sector are education and health services, professional and business services, and retail trade. Retail sales increased 37.5% from the first quarter of 2003 to the first quarter of 2006. 2

Highlights and Initiatives Replacement of the Main Street Wastewater Treatment Plant. The replacement of the Main Street Wastewater Treatment Plant (WWTP), located near the shore of Pensacola Bay in downtown Pensacola, was a major component of the Authority's long-range planning even before it was inundated by storm waters driven by Hurricane Ivan on September 16, 2004. But after the storm, which knocked out the Authority's main wastewater treatment facility for three days, the desire to replace the plant became a necessity. The plant was subjected to a second hurricane when Hurricane Dennis made landfall July 10, 2005 as a category 3 storm. The Federal Emergency Management Agency (FEMA) awarded the Authority $134 million that can be used to either replace the plant, a project expected to cost $302 million, or to "armor" the existing plant in-place to protect it against future hurricane damage. Though the Authority applied to FEMA for an additional $115 million needed to complete the project, that request was rejected. FEMA requires that it be more expensive to repair the plant than to replace it, and that a documented history of repeated plant failures be provided. It will cost more to replace than repair the Main Street plant, and much of the required documentation needed to substantiate previous plant failures was destroyed in Ivan. Counting FEMA's $134 million grant, a $24 million grant from the State of Florida, and $24 million already committed to the project by the Authority, it is still expected that another $120 million is needed to accomplish the replacement. The accounting firm of O'Sullivan Creel was retained as a financial consultant to develop funding scenarios. Several funding options were evaluated, and it was determined that the most viable included rate increases. This scenario was presented to both the Pensacola City Council and the Escambia County Board of County Commissioners in January 2007 with the understanding that the rate increases would depend on how much the City of Pensacola and Escambia County, who will reap substantial economic benefits from the removal of the Main Street plant, might be willing to contribute to the plant's replacement costs. As of this writing, the Authority, the City of Pensacola, and Escambia County are involved in negotiations to reach a solution. In the meantime, the project is moving forward. We have completed approximately 60 percent of the detailed engineering work, and much of the geotechnical surveying required for permitting has been done. The Authority purchased about 2,000 acres of land in December 2006 for wetlands effluent disposal. A firm has been hired to acquire easements for the 24-mile pipeline that will carry the wastewater flow from the Main Street plant to the new site. We expect construction on the replacement site to begin by August 2007. t Hurricane Recovery. The loss of power to our Main Street wastewater treatment plant during and after a storm, is one of the greatest issues that the Authority faces in terms of being able to serve the community and protect public health. To that end, we have installed three 400kW stationary generator sets, (this includes the generator and diesel-powered motor) for the Main Street WWTP that will help us continue to provide basic treatment on a temporary basis until normal treatment can resume. This is meant to help keep overflows from occurring on and around the Main Street plant site. We purchased ten additional 60kW portable generator sets for lift stations, to be cycled through a lift station route, pumping down the stations on a rotating basis. This strategy proved very effective in the aftermath of the last two year's storms and we have added these generators to be able to include every lift station in the system on the pump down rotation. We now have nine routes, each covering an average of 36 stations. To ensure that our community's three major hospitals continue to have water available following a storm, we have purchased three 350kW portable generator sets for the three wells which serve the hospitals. We have also modified our design specifications for all future well sites and major lift stations to incorporate an automatic transfer switch and portable generator sets. 3

One of the latent impacts of Hurricane Ivan was the excessive accumulation of sand and grit within our damaged collection system. The sand and grit causes excessive wear on several major components within the sludge dryers. The fourth centrifuge installation was completed and this has allowed additional work to be completed on rehabilitation of the other three centrifuges. This has greatly improved the reliability of the solids handling system. Additionally, substantial rehabilitation was completed on the boilers for the dryers and the dryers themselves. Pensacola Beach Wastewater Treatment Plant No. 2 Replacement. The contract for the rehabilitation work on Plant No. 2 was awarded in the fall of 2005. The rehabilitation involves the complete replacement of all pumping, mechanical, electrical and standby electrical power systems. Funds for this work were secured through a Florida Department of Environmental Protection (FDEP) State Revolving Loan. The project is expected to be completed prior to the peak tourist season. Water Production Facilities. This past year the Authority produced 13.8 billion gallons of water, up from 12.5 billion gallons in 2005, for an average of 37.8 million gallons per day. A new well was put into service with a pumping rate of over 3,000 gallons per minute delivering a much needed boost to capacity in the southwest service area. Site preparation and construction are now underway for a new well to serve the northwest service area. Automated Meter Reading Device Installation. In October 2005, the Authority embarked on a ten-year program designed to convert the water meters in the distribution system from manually read devices to those which are read with radio signals. The Authority's Regional Services Department is responsible for the implementation of this program. Crews in this department are assigned to one of four regional service areas. The installation of the automated meter reading (AMR) devices primarily occurred in Region 2. Automated meter reading devices were installed in all new subdivisions in that region. Moreover, each time a crew performed meter work on a property, in any region, an AMR meter was installed. The new meters are equipped with a Radio Frequency transmitter. This enables the meter to be read either by using a handheld reading device equipped with an antenna that receives the radio frequency and electronically stores readings and other data collected by the meter reader or by a laptop computer equipped to receive the frequencies. In the routes that have been converted to AMR, we have seen a dramatic increase in the time efficiency of reading as well as the accuracy of readings obtained. There is no room for human error in taking a reading or keying in a read incorrectly. The office staff has also seen improvements in processing information for the handheld units. The readers can now set up their own units to unload when they come in each afternoon. Antennas were purchased for each handheld meter reading device so that the reading devices can record the reading as the meter reader walks by the meter. ECUA/IP Pipeline and Wetlands Project. This unique public/private partnership has been under development for approximately six years. Construction plans were prepared and submitted for permit review. In the spring of 2005, FDEP authorized publication of a "Notice of Intent" to issue the permit for the project. The proposed permit was challenged and an Administrative Hearing was held in the summer of 2006. A ruling is expected in the spring of 2007. If the findings of the administrative law judge support the issuance of the permit, the project will be advertised for bids and construction work will begin on the pipeline and wetlands improvements some time in the second half of 2007. J 4

Utility relocation coordination. Major roadway construction continued throughout the Authority service area in 2006. Most of these projects required extensive utility coordination. Utility relocation was completed on several projects including: the FDOT six-laning of Davis Highway from 1-10 south to Schubert Street, the Olive Road shoulder paving project from Old Palafox Highway to Ninth Avenue, the Pine Forest Road drainage project from Nine Mile Road to 1-10, various projects on Scenic Highway from Nine Mile Road to Cervantes Street, and several other minor projects. Utility relocations related to I-110 Widening (Fairfield to Maxwell) are continuing, and engineering work has begun on utility relocations from Airport Boulevard to Brent Lane for a new interchange on I-110. Utility relocation also involves coordination with the City of Pensacola, the Escambia County Board of County Commissioners, and the Santa Rosa Island Authority. Escambia County continued its large number of road and drainage projects in 2006, including: a major drainage project in the Ferry Pass area, the Whitmire/Sabra Drive drainage project, the Pine Forest Road drainage project, and numerous smaller projects. A major project on Pensacola Beach to widen Via De Luna and portions of Fort Pickens Road required extensive utility relocations in 2006. The State of Florida requires that water utilities have an effective cross-connection control program. These requirements necessitate that we establish specifications for backflow prevention assemblies, and inspection and testing of backflow meters. The Authority created its Environmental Control Programs Division in February 2004 to implement strict enforcement of our Cross-Connection Control Program. The number of installed backflow prevention devices increased by 29%, from 4,044 devices in 2005 to 5,215 devices in 2006. Seventy-five devices were installed on Authority lift stations. Sanitation. Authority residential customers generated an average of 1.57 tons of waste during fiscal year 2006 that resulted in our collection crews transporting 82,216 tons of residential solid waste to either the Perdido Landfill or Allied Waste Transfer Station. The total tonnage collected decreased by 8,006 tons. This decrease is due to less hurricane debris being placed in collection containers and the dry weather. The total number of residential customers at the end of fiscal year 2006 was 62,404. During fiscal year 2006, Authority yard trash crews collected 11,481 tons of yard trash. Bulk waste crews collected 4,698 tons of waste materials in FY 2006. Sanitation's bulk waste collection crews completed over 22,000 requests for bulk waste collection in fiscal year 2006. The bulk waste program allows residential customers to call in and request pick up of large household items that will not fit in the automated collection container. At the end of fiscal year 2006, commercial dumpster service was being provided to 2,249 customers. Commercial collections accounted for the disposal of 15,131 tons of waste at Perdido Landfill compared with 14,407 the previous year. The commercial roll-off operation continues to experience very heavy demand for service. Roll-off services provided 2,297 service pulls and 847 container deliveries throughout the year. The total number of requests for roll-off service was 3,144, which is a 22% increase over fiscal year 2005. These service requests produced 8,543 tons of debris in fiscal year 2006. 11 Sanitation received 14 additional Condor/Heil vehicles to replace Lodal vehicles in September 2006. The Lodal vehicles proved expensive to maintain and operate, and were prone to fires. After two years of operation, experience has shown the Condor/Heil vehicle has performed very well, experiencing only minor mechanical problems and very little down time. These vehicles also increased fuel mileage by 30%, when compared to the Lodal vehicles. The annual replacement program for the Lodal vehicles is ongoing with an additional seven new vehicles scheduled for delivery in 2007. 5

After a year of delays due to hurricanes and design issues, construction began on the new garage building at the sanitation complex in December 2005. The old facility does not have vehicle lift capacity and does not have room for all mechanics to work indoors. This decreased our ability to make repairs that required the vehicle to be elevated, and the lack of service bays required mechanics to make repairs outside. The new facility added six bays of space and has lift equipment capable of supporting the weight of a fully loaded collection vehicle. This equipment includes a 75,000 pound truck lift and a ten ton bridge crane. The new facility also has the equipment to lift vehicles and large components that garage staff has not had in the past. The availability of this type of equipment and space will allow many repairs that previously had to be sent to a dealer in Mobile, Alabama, to be done in house by Authority staff. The new garage was completed in October 2006. Long-term financial planning. The Authority maintains a five-year capital improvements plan. Capital construction planning entails an evaluation and ranking process that begins in advance of the operating budget process. It is the Authority's philosophy that new projects are only undertaken if current and future operating revenues are sufficient to fund the associated operating costs. The current capital improvements plan totals $483 million over the next five years. Cash management policies and practices. The Authority invested idle cash during the fiscal year according to investment policies adopted by the Board. Pursuant to Florida law, the policy follows the specific objectives of protection of principal, maximization of return, provision of sufficient liquidity, and diversification of investments to control risk. Funds were invested in the State of Florida, Board of Administration investment pool, U.S. treasury securities, mutual funds, and state and local government securities. Investment income includes appreciation in the fair value of investments. Increases in fair value during the current year, however, do not necessarily represent trends that will continue; nor is it always possible to realize such amounts, especially in the case of temporary changes in the fair value of investments that the Authority intends to hold to maturity. Additional information on the Authority's investments can be found in Note 2 in the notes to the financial statements. J Risk Management. The Authority is self-insured for general liabilities and worker' s compensation claims. The Authority carries additional property and business interruption insurance for catastrophic losses. Note 12 in the notes to the financial statements, and the Schedule of Insurance in the Statistical Section provide additional information regarding the Authority 's risk management program. Independent Audit. State statues require that the Authority's financial statements be audited by an independent certified public accounting firm. This requirement has been satisfied by the certified public accounting firm of Saltmarsh, Cleaveland & Gund. Their report on the Authority's financial statements is included in the financial section of this report. J 6

Awards and Acknowledgements The Authority received a Certificate of Achievement for Excellence in Financial Reporting from the Government Finance Officers Association (GFOA) for its CAFR for the fiscal year ended September 30, 2005. The Authority is proud to have received this award for eighteen consecutive years. The Certificate of Achievement is a prestigious national award recognizing conformance with the highest standards for preparation of state and local government financial reports. In order to be awarded a Certificate of Achievement, a government must publish an easily readable and efficiently organized CAFR. This report must satisfy both generally accepted accounting principles and applicable legal requirements. A Certificate of Achievement is valid for a period of one year only. We believe that our current CAFR continues to meet the Certificate of Achievement Program's requirements, and we are submitting it to the GFOA to determine its eligibility for another certificate. Preparation of this CAFR would not have been possible without the dedicated effort of the entire Finance Department staff. Credit must also be given to the Executive Director and to the Board for their commitment to maintaining the highest standards of professionalism in the management of the Authority. Respectfully submitted, Executive Director n I n t 7

EMERALD COAST UTILITIES AUTHORITY Board Executive Director I Utility Operations Utility Services & Information Customer Service Planning Technology Water Rec lamation Finance Engineering Sanitation Regional Water Serv ices Production/Lift Human Resources Stations & Ad m i n istrative Services Customer Services QA/QC Utility Operations Maintenance Environmental Programs 8

r^ EMERALD COAST UTILITIES AUTHORITY P. O. Box 15311 9255 Sturdevant Street Pensacola, Florida 32514-0311 ph: 850 476-5110 fax: 850 494-7346 9 PRINCIPAL OFFICIALS Board Members Logan Fink Lois Benson Elvin McCorvey Dale Perkins Larry Walker Authority Officials Stephen E. Sorrell Executive Director { Logan Fink Lois Benson Elvin McCorvey Dale Perkins Larry Walker District One District Two District Three District Four District Five 9

Certificate of Achievement for Excellence in Financial Reporting Presented to Emerald Coast Utilities Authority, Florida For its Comprehensive Annual Financial Report for the Fiscal Year Ended September 30, 2005 A Certificate of Achievement for Excellence in Financial Reporting is presented by the Government Finance Officers Association of the United States and Canada to government units and public employee retirement systems whose comprehensive annual financial reports (CAFRs) achieve the highest standards in government accounting and financial reporting. President Executive Director 10

FINANCIAL SECTION

Saltmarsh Saltmarsh, Cleaveland & Gund CERTIFIED PUBLIC ACCOUNTANTS AND CONSULTANTS INDEPENDENT AUDITOR'S REPORT Members of the Board Emerald Coast Utilities Authority Pensacola, Florida We have audited the accompanying basic financial statements of the Emerald Coast Utilities Authority as of and for the years ended September 30, 2006 and 2005, as listed in the table of contents. These basic financial statements are the responsibility of the Authority's management. Our responsibility is to express an opinion on these basic financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the basic financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the basic 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 our audits provide a reasonable basis for our opinion. In our opinion, the basic financial statements referred to in the first paragraph, present fairly, in all material respects, the financial position of the Emerald Coast Utilities Authority, as of September 30, 2006 and 2005, and the results of its operations and cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. In accordance with Government Auditing Standards, we have also issued a report dated December 21, 2006 on our consideration of the Emerald Coast Utilities Authority's internal control over financial reporting and our tests of its compliance with certain provisions of laws, regulations, contracts and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing and not to provide an opinion on the internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards and should be read in conjunction with this report in considering the results of our audits. Since 1944 www.scg-cpa.com 11 900 North 12th Avenue P. 0- Drawer 13207 Pensacola, FL 32591-3207 (850) 435-8300 Fax (850) 435-8352 Pensacola Fort Walton Beach Destin Tampa

Members of the Board Emerald Coast Utilities Authority The management's discussion and analysis on pages 13 through 19, is not a required part of the basic financial statements but is supplementary information required by accounting principles generally accepted in the United States of America. We have applied certain limited procedures, which consisted principally of inquiries of management regarding the methods of measurement and presentation of the required supplementary information. However, we did not audit the information and express no opinion on it. 11 Our audits were made for the purpose of forming opinion on the basic financial statements taken as a whole. The supplementary information and statistical data listed in the table of contents are presented for purposes of additional analysis and are not a required part of the basic financial statements of the Emerald Coast Utilities Authority. The accompanying Schedule of Expenditures of Federal Awards and State Financial Assistance is presented for purposes of additional analysis as required by U.S. Office of Management and Budget Circular A-133, Audits of States, Local Governments, and Non-Profit Organizations and by Section 215.97, Florida Statutes, and is also not a required part of the basic financial statements. Such information, except for that portion marked "unaudited," on which we express no opinion, has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly presented in all material respects in relation to the basic financial statements taken as a whole. Pensacola, Florida December 21, 2006 12

MANAGEMENT ' S DISCUSSION AND ANALYSIS fl Management's Discussion and Analysis offers readers of the Authority's financial statements an overview of the financial activities for the fiscal year ended on September 30, 2006. Please read it in conjunction with the letter of transmittal, and the financial statements with its accompanying notes. Financial Highlights The Authority's assets exceeded its liabilities on September 30, 2006 by $253 million (net assets), a $22.4 million increase over the previous fiscal year. Of this amount, $62.5 million (unrestricted net assets) may be used to meet the Authority's ongoing obligations to customers and creditors. Of the remaining $190 million, approximately $156.5 was invested in utility plant assets, while the remainder was restricted for utility plant expansion ($3.5) and debt service ($30 million). The Authority 's net utility plant increased by $23.3 million, or 7.7% over the previous year. Long-term debt increased by $12 million over fiscal year 2005. The Authority issued $17. 3 million in utility system revenue bonds to fund $17 million in capital improvement projects for the water and wastewater system. Total capital contributions received by the Authority decreased slightly from the previous fiscal year. The decrease in cash contributions of $2.4 million was offset by an increase in non-cash contributions of $1.7 million. Water and wastewater impact fees account for the bulk of the cash contributions. The decrease in impact fees is due to a lull in residential home building in Escambia County. Developers contributed $5 million in utility systems during 2006, up from $3.3 million contributed in 2005. Operating revenue for 2006 was $79.5 million compared with $71 million in 2005, a 12% increase. The increase is attributed to a 4.5% rate increase for water and wastewater service coupled with customer growth and increased water usage. Water and wastewater revenue increased 13.6%, or $7.5 million, while sanitation revenue remained at the same level as the previous fiscal year. Excluding depreciation, operating expenses increased 2.8%, or $1.4 million over fiscal year 2005. Overview of the Annual Financial Report The Comprehensive Annual Financial Report (CAFR) is presented in four sections: Introductory, Financial, Statistical, and Other Reports. The Introductory section includes a letter of transmittal, the Authority's Organization Chart, and a list of Principal Officials. The Financial section includes Management's Discussion and Analysis, Financial Statements with accompanying notes, and the Supplementary Information schedules. The Statistical section includes selected financial, operational, and demographic information generally presented on a multi-year basis. Other reports by the auditor regarding internal accounting controls and compliance with laws and regulations are included in the final section of this report, along with the auditor's management letter. 13

The Authority is a single enterprise fund even though it provides various utility services. The financial statements present the financial position of the Authority using full accrual accounting methods similar to those used by private sector companies. The financial statements include a balance sheet; a statement of revenues, expenses, and changes in net assets; a statement of cash flows; and notes to the financial statements. The balance sheet presents information on all of the Authority's assets and liabilities, with the difference reported as net assets. Over time, increases and decreases in net assets are one indicator of whether the financial position of the Authority is improving or deteriorating. The statement of revenues, expenses and changes in net assets presents the results of the business activities during the reporting period and information as to how the net assets changed during the year. All changes in net assets are reported as soon as the underlying event giving rise to the change occurs, regardless of the timing of the related cash flows. This statement can be used to determine whether the Authority has successfully recovered all its costs through its user fees and other charges. The statement of cash flows presents changes in cash and cash equivalents, resulting from operating, capital and related financing, and investing activities. This statement presents cash receipts and cash disbursement information, without consideration of the earnings event, when an obligation arises, or depreciation of capital assets. The notes to the financial statements provide required disclosures and other information essential to fully understand the data provided in the financial statements. The notes present information about the Authority's significant accounting policies, account balances and activities, material risks, obligations, commitments, and contingencies. The supplementary information section presents the schedule of expenditures of federal awards and state financial assistance, the schedule of revenue and expenses compared to budget, and schedules that focus on the Water and Wastewater System and the Sanitation System. The schedule of revenue and expenses compared to budget can be used to determine the Authority's compliance with the budget. The separate schedules reflecting financial information for the Water and Wastewater System and the Sanitation System can be used to determine if the separate systems have recovered all associated costs for that system. It is the Board's philosophy that each system should be self-supporting. 14

Financial Analysis The following comparative condensed balance sheets provide an analysis of the change in financial position from the previous fiscal years. Condensed Balance Sheets 2006 September 30, 2005 2004 2006 to 2005 Dollars % Capital assets: Producing assets $ 291,741,824 $ 274,565,223 $ 263,914,001 $ 17,176,601 6.3% Construction in progress 33,479,191 27,371,919 25,346,958 6,107,272 22.3% Current assets 41,727,841 34,903,916 28,954,529 6,823,925 19.6% Other assets 96,951,235 90,025,444 93,906,681 6,925,791 7.7% Total assets 463,900,091 426,866,502 412,122,169 37,033,589 8.7% Long-term liabilities $ 184,939,077 $ 172,963,680 $ 173,862,906 $ 11,975,397 6.9% Current liabilities 26,250,556 23,544,910 21,827,553 2,705,646 11.5% Total liabilities 211,189,633 196,508,590 195,690,459 14,681,043 7.5% Net assets: Invested in utility plant, net of related debt 156,525,222 141,404,313 127,736,904 15,120,909 10.7% Restricted 33,629,208 35,311,926 32,537,573 (1,682,718) -4.8% Unrestricted 62,556,028 53,641,673 56,157,233 8,914,355 16.6% Total net assets 252,710,458 230,357,912 216,431,710 22,352,546 9.7% Total liabilities and net assets $ 463,900,091 $ 426,866,502 $ 412,122,169 $ 37,033,589 96.5% As noted earlier, net assets may serve over time as a useful indicator of a government's financial position. However, other non-financial factors such as changes in economic conditions, customer growth and legislative mandates should also be taken into consideration. In the case of the Authority, assets exceeded liabilities by $253 million at the close of the most recent fiscal year. The increase in the Authority's net assets of $22 million represents the extent to which revenues exceeded expenses during the year. 16 The largest portion of the Authority' s net assets (62%) reflects its investment in capital assets (e.g., land, buildings, improvements and equipment ), less any related debt used to acquire those assets that is still outstanding. The Authority uses these assets to provide service to its customers and, consequently, these assets L are not available for future spending. Although the Authority' s investment in its capital assets is reported net of related debt, it should be noted that the resources needed to repay this debt must be provided from other sources, since the capital assets themselves cannot be used to liquidate these liabilities. 15

The following Condensed Statement of Revenues, Expenses, and Changes in Net Assets, show the results of operations for the current and the prior two fiscal years: Condensed Statement of Revenues, Expenses, and Changes in Net Assets Three-Year Comparison Year Ended September 30, 2006 2005 2004 Revenues: Customer charges: Wastewater $33,147,731 $30,224,943 $29,192,320 Water 29,046,764 24,521,255 24,511,246 Sanitation 14,518,622 14,275,674 14,063,381 Total customer charges 76,713,117 69,021,872 67,766,947 Connection charges 754,746 814,255 565,384 Other 1,992,047 1,129,080 917,739 Total operating revenues 79,459,910 70,965,207 69,250,070 Expenses: Operating expenses: Water & Wastewater 51,703,859 50,395,623 46,641,068 Sanitation 14,683,886 13,366,301 12,197,579 Total operating expenses 66,387,745 63,761,924 58,838,647 Operating income 13,072,165 7,203,283 10,411,423 Non-operating revenue: Investment income 4,215,056 2,698,941 1,753,107 Interest expense (9,009,524) (9,245,195) (9,796,096) Main Street Wastewater Treatment Plant relocation 5,990,251 1,768,936 - Hurricane disaster assistance (expense), net (124,236) 1,303,088 (36,045) Estimated insurance recoveries, net of estimated property losses - 911,228 43,714 Main Street WWTP repairs, net of reimbursements - - (626,490) Loss on disposal of assets (497,672) (59,113) (791,866) Increase in net assets, before contributions 13,646,040 4,581,168 957,747 Capital contributions: Cash 3,680,130 6,048,679 5,383,838 Non-cash 5,026,376 3,296,355 1,624,639 Total capital contributions 8,706,506 9,345,034 7,008,477 Change in net assets 22,352,546 13,926,202 7,966,224 Net assets at beginning of year 230,357,912 216,431,710 208,465,486 Total net assets $252,710,458 $230,357,912 $216,431,710 Operating revenues increased from fiscal year 2005 to 2006 by 12% while operating revenues remained steady from fiscal year 2004 to 2005. Water consumption billed increased by 1.7 billion gallons from fiscal year 2005 to 2006. Water consumption billed decreased from 2004 to 2005. Rainfall levels are considered to be the reason for the differences in water revenue for the three years shown above. Water revenues in 2005 were impacted by an extremely wet spring and summer. Escambia County received 68 inches of rainfall from March through September of 2005 versus 26.5 inches during the same months in 2006. 16

Average residential water and wastewater usage rose in fiscal year 2006 as shown in the chart below. Over the years, the average residential water consumption had declined from 9,059 gallons in 2000 to 7,442 gallons in 2005. Average residential wastewater flows declined from 5,892 gallons in 2000 to 5,404 gallons in 2005. The increase in water usage has a positive effect on the wastewater revenue, since residential wastewater bills are based on the resident's average water consumption during the winter. Water and wastewater revenues for fiscal year 2005 were also affected by the damage to housing during Hurricane Ivan in September 2004. Average Residential Usage 10,000.00 8,000.00 6,000.00 4,000.00 2,000.00-0.00 1 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 n Water n Wastewater In December 2005 the State of Florida awarded an additional $7.9 million grant to the Authority to be utilized for the replacement of the Main Street WWTP. The Authority received $4.9 million from the State the previous fiscal year. These funds will be funneled through the Florida Department of Environmental Protection on a reimbursement basis. As of the September 2006, $7,759,187 of the funds had been spent. Sanitation vehicles transported over 122,000 tons of commercial and residential waste to the landfill and transfer station during fiscal year 2006, compared with 110,479 tons in fiscal year 2005. The commercial rolloff operation continues to experience very heavy demand for service. 11 Roll-off services provided 2,297 service pulls and 847 container deliveries throughout the year. The total number of requests for roll-off service was 3,144, which is a 22% increase over fiscal year 2005. These service requests produced 8,543 tons of debris in fiscal year 2006. During fiscal year 2005, roll-off services provided 1,844 service pulls and 736 container deliveries throughout the year. The total number of requests for roll- off service in 2005 was 2,580, which is a 28% increase over fiscal year 2004. These service requests produced 3,331 tons of debris, which is a 52% increase over fiscal year 2004. The increase from 2004 to 2005 was a result of the heavy demand for service due to hurricane clean up and restoration efforts. Developers contributed $5 million in utility systems during 2006, up from $3.3 million in 2005 and $1.6 million in 2004. These utility systems are primarily residential and have been completed in accordance with plans and specifications approved by the Authority. These contributions are not budgeted, as they are generally non-cash, of limited relevance to rate setting, and the timing is not subject to the Authority control. 17

Capital Assets At the end of Fiscal Year 2006, the Authority had invested approximately $325 million in land, buildings and building improvements, improvements other than buildings, and equipment. A summary of the Authority's capital assets, net of accumulated depreciation, and changes therein, is presented in the following table. See Note 4 in the notes to the financial statements for additional information on the Authority's capital assets. Capital Assets, Net of Accumulated Depreciation September 30, (Dollars in Thousands) 2006 2005 2004 Land $ 6,463 $ 6,463 $ 6,037 Buildings & Building Improvements 5,941 6,178 6,212 Improvements Other than Buildings 264,557 248,285 240,024 Equipment 14,781 13,639 11,641 Construction in Progress 33,479 27,372 25,347 Total $ 325,221 $ 301,937 $ 289,261 During the fiscal year, approximately $30 million was expended on construction in progress. Significant capital investments in construction projects included $6 million for the Main Street WWTP replacement project, $4 million for sewer system expansion and line replacement, $3.4 million to replace fleet vehicles, $3.2 million on repairs and improvements to the Pensacola Beach WWTP, $2.8 million to construct or upgrade wells, and water lines, $2 million to upgrade lift stations, and $2 million for construction projects at the Main Street WWTP. Debt Administration In July 2006, the Authority issued $17.3 million in Utility System Revenue Bonds to fund $17 million in capital improvement projects for the water and wastewater system. As of September 30, 2006, the Authority had outstanding revenue bonds in the amount of $188.8 million. Debt incurred under the State of Florida revolving loan program outstanding at the end of the fiscal year amounted to $6.7 million. In addition, the Authority also has an outstanding lease purchase obligation for new computer equipment of $46,701. Additional information on the Authority's long-term debt can be found in Note 6 in the notes to the financial statements. In the bond resolution, the authority covenants that it will fix, establish, and revise from time to time whenever necessary, maintain and collect always such fees, rates, rentals, and other charges for the use of the product, services and facilities of the System which will always provide gross revenues in each year sufficient to pay 100% of all costs of operation and maintenance of the system and 125% of the bond service requirement due in each year on all outstanding bonds. The rate covenant in the bond resolution obligates the Authority to review rates annually and to revise such rates and charges as necessary to meet the coverage test and to pay 100% of all costs of operations and maintenance of the System during that fiscal year. 18

L ] Debt service coverage for 2006 and 2005 was 225% and 150% respectively. The following table presents the required net earnings as defined by the bond covenants, actual net earnings available for debt service, and total annual debt service. The Authority's debt service coverage remains strong. Additional debt service coverage is shown in the statistical section of this report. Net Earnings Available for Debt Service $40,000,000 $30,000,000 $20,000,000 $10,000,000 n Required Net Earnings n Net Earnings q Debt Service $0 2006 2005 2004 Economic Factors and Next Year's Budget and Rates The philosophy set forth by the Authority to fund increases in the basic budget through small annual rate adjustments has kept the Authority in a sound financial position for many years, and has had a minimal impact annually on customers. These small adjustments covered the effects of inflation, but did not provide funds to cover major cost increases in operational changes. The decline in average earnings from interest income, the overall reduction in the average water usage of residential customers, and the increase in rainfall have caused the Authority to implement a water and wastewater rate adjustment of 4.5% for fiscal years 2006 and 2007. A new sewage treatment plant is planned in central Escambia County to replace the Main Street wastewater treatment facility. The Main Street WWTP is located in downtown Pensacola near Pensacola Bay. The plant L received extensive damage from flooding during Hurricane Ivan in September 2004. This action would move the new plant out of the coastal flood plain, essentially eliminating the chance of storm surge flooding plus provide enough capacity to handle the growth in the central county area. Construction is expected to begin in July 2007. The Authority has obtained $ 182 million in funding for this project. An additional $ 120 million is needed. Negotiations are underway with the City of Pensacola and Escambia County for funding participation. Any additional funding will come in the form of rate increases for Authority wastewater customers. Requests for Information This financial report is designed to provide the Authority' s ratepayers and creditors with a general overview of the Authority' s finances and to demonstrate the Authority' s accountability for the money it receives. Questions concerning any of the information provided in this report or requests for additional information should be addressed to the Emerald Coast Utilities Authority, Director of Finance, PO Box 15311, Pensacola, Florida 32514-0311, or e-mail dbuckley( ecua.org. 19