**FORM 10-Q**

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

 

**Washington,D.C. 20549**

 

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended December 31, 2005**

 

**Commissionfile number: 1-7196**

 

**CASCADENATURAL GAS CORPORATION**

(Exact name ofRegistrant as specified in its charter)

 

| **Washington**                                                   | ** ** | **91-0599090**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                             |       |                                  |
| **222  Fairview Avenue North, Seattle, WA**                      | ** ** | **98109**                             |
| (Address of  principal executive offices)                        |       | (Zip code)                            |

 

(Registrant’stelephone number including area code)      **(206) 624-3900**

 

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes  ý    No  o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large acceleratedfiler   o               Acceleratedfiler   ý                  Non-acceleratedfiler   o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).Yes  o      No  ý

 

Indicate the number ofshares outstanding of each of the registrant’s classes of common stock, as ofthe latest practicable date.

 

| **Title**                             | ** ** | **Outstanding**                    |
|---------------------------------------|------------|------------------------------------|
|                                  |       |                               |
| Common Stock,  Par Value $1 per Share |       | 11,442,516 as of  January 31, 2006 |

 

 

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**CASCADENATURAL GAS CORPORATION**

 

Index

 
| Part I.   | Financial Information |                                                                                                |
|-----------|-----------------------|-----------------------------------------------------------------------------------------------------|
|      |                  |                                                                                                |   |
|      |                  | Item 1. Financial Statements                                                                        |   |
|      |                  |                                                                                                |   |
|      |                  | Consolidated Condensed  Statements of Income                                                        |   |
|      |                  |                                                                                                |   |
|      |                  | Consolidated Condensed  Balance Sheets                                                              |   |
|      |                  |                                                                                                |   |
|      |                  | Consolidated Condensed  Statements of Cash Flows                                                    |   |
|      |                  |                                                                                                |   |
|      |                  | Notes to Consolidated  Condensed Financial Statements                                               |   |
|      |                  |                                                                                                |   |
|      |                  | Item 2. Management’s Discussion  and Analysis of Financial Condition and Results of Operations |   |
|      |                  |                                                                                                |   |
|      |                  | Item 3. Quantitative and  Qualitative Disclosures about Market Risk                                 |   |
|      |                  |                                                                                                |   |
|      |                  | Item 4. Controls and Procedures                                                                     |   |
|      |                  |                                                                                                |   |
| Part II.  | Other Information     |                                                                                                |
|      |                  |                                                                                                |   |
|      |                  | Item 6. Exhibits                                                                                    |   |
|      |                  |                                                                                                |   |
| Signature |                  |

 

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# **PARTI.   Financial Information**

 

**Item 1. Financial Statements**

 

CASCADE NATURALGAS CORPORATION

CONSOLIDATEDCONDENSED STATEMENTS OF INCOME

(unaudited)

 
| ** **                                             | ** **     | **THREE  MONTHS ENDED**                | ** ** |
|--------------------------------------------------------|----------------|----------------------------------------|------------|
| ** **                                             | ** **     | ** **                             | ** ** | ** ** | ** ** |
| ** **                                             | ** **     | **Dec 31,  2005**                      | ** ** | **Dec 31,  2004** | ** ** |
| ** **                                             | ** **     | **(thousands  except per-share data)** | ** ** |
|                                                   |           |                                   |       |   |   |
| Operating  revenues                                    |           | $                                      | 158,632    |   | $ | 104,613 |   |
|                                                   |           |                                   |       |   |   |
| Less:  Gas purchases                                   |           | 118,065                                |       | 69,122 |   |
|                                                   | Revenue  taxes |                                   | 9,776      |   | 6,569 |   |
| Operating  margin                                      |           | 30,791                                 |       | 28,922 |   |
|                                                   |           |                                   |       |   |   |
| Cost  of operations:                                   |           |                                   |       |   |   |
| Operating  expenses                                    |           | 9,642                                  |       | 10,420 |   |
| Depreciation  and amortization                         |           | 4,414                                  |       | 4,205 |   |
| Property  and miscellaneous taxes                      |           | 986                                    |       | 959 |   |
|                                                   |           | 15,042                                 |       | 15,584 |   |
|                                                   |           |                                   |       |   |   |
| Income  from operations                                |           | 15,749                                 |       | 13,338 |   |
| Less  interest and other deductions - net              |           | 2,972                                  |       | 2,894 |   |
| Income  before income taxes                            |           | 12,777                                 |       | 10,444 |   |
|                                                   |           |                                   |       |   |   |
| Income  taxes                                          |           | 4,737                                  |       | 3,812 |   |
| Net  Income                                            |           | 8,040                                  |       | 6,632 |   |
| Other  Comprehensive Income (Loss)                     |           |                                   |       |   |   |
| Unrealized  losses on derivative commodity instruments |           | (95                                    | )          | — |   |
| Income  tax benefit                                    |           | 34                                     |       | — |   |
| Other  Comprehensive Income (Loss)                     |           | (61                                    | )          | — |   |
|                                                   |           |                                   |       |   |   |
| Comprehensive  Income                                  |           | $                                      | 7,979      |   | $ | 6,632 |   |
| Weighted  average common shares outstanding            |           | 11,428                                 |       | 11,279 |   |
| Earnings  per common share, basic and diluted          |           | $                                      | 0.70       |   | $ | 0.59 |   |
|                                                   |           |                                   |       |   |   |
| Cash  dividends per share                              |           | $                                      | 0.24       |   | $ | 0.24 |   |
|                                                        |                |                                        |            |  |  |  |  |  |

 

The accompanying notesare an integral part of these financial statements.

 

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**CASCADENATURAL GAS CORPORATION**

**CONSOLIDATEDCONDENSED BALANCE SHEETS**

(Dollars inThousands)

 
| ** **                                                                                                                  | ** ** | **Dec 31, 2005** | ** ** | **Sep 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                                  | ** ** | **(Unaudited)**  | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                                  | ** ** | ** **       | ** ** | ** **       | ** ** |
| Utility  Plant, net of accumulated depreciation of $261,237 and $257,008                                                    |       | $                | 340,651    |             | $          | 340,461 |   |
| Construction  work in progress                                                                                              |       | 1,282            |       | 2,021            |       |
|                                                                                                                        |       | 341,933          |       | 342,482          |       |
| Other  Assets:                                                                                                              |       |             |       |             |       |
| Investments  in non-utility property                                                                                        |       | 202              |       | 202              |       |
| Notes  receivable, less current maturities                                                                                  |       | 46               |       | 46               |       |
|                                                                                                                        |       | 248              |       | 248              |       |
| Current  Assets:                                                                                                            |       |             |       |             |       |
| Cash  and cash equivalents                                                                                                  |       | 2,320            |       | 1,128            |       |
| Accounts  receivable and current maturities of notes receivable, less allowance of  $1,427 and $1,319 for doubtful accounts |       | 96,658           |       | 23,163           |       |
| Prepaid  expenses and other assets                                                                                          |       | 6,059            |       | 9,463            |       |
| Derivative  instrument assets - energy commodity                                                                            |       | 48,426           |       | 91,957           |       |
| Materials,  supplies and inventories                                                                                        |       | 10,139           |       | 14,142           |       |
| Deferred  income taxes                                                                                                      |       | 2,286            |       | 2,292            |       |
|                                                                                                                        |       | 165,888          |       | 142,145          |       |
| Deferred  Charges and Other                                                                                                 |       |             |       |             |       |
| Gas  cost changes                                                                                                           |       | 15,223           |       | 16,630           |       |
| Derivative  instrument assets - energy commodity                                                                            |       | 35,810           |       | 43,440           |       |
| Other                                                                                                                       |       | 7,247            |       | 7,960            |       |
|                                                                                                                        |       | 58,280           |       | 68,030           |       |
|                                                                                                                        |       |             |       |             |       |
|                                                                                                                        |       | $                | 566,349    |             | $          | 552,905 |   |

 

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| ** **                                                                                                                    | ** ** | **Dec 31, 2005** | ** ** | **Sep 30, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                                    | ** ** | **(Unaudited)**  | ** ** | ** **       | ** ** |
| **COMMON SHAREHOLDERS’ EQUITY AND LIABILITIES**                                                                          | ** ** | ** **       | ** ** | ** **       | ** ** |
| Common  Shareholders’ Equity:                                                                                            |       |             |       |             |       |
| Common  stock, par value $1 per share, authorized 15,000,000 shares, issued and  outstanding 11,439,290 and 11,413,019 shares |       | $                | 11,439     |             | $          | 11,413 |   |
| Additional  paid-in capital                                                                                                   |       | 104,338          |       | 103,781          |       |
| Accumulated  other comprehensive income (loss)                                                                                |       | (12,549          | )          | (12,487          | )          |
| Retained  earnings                                                                                                            |       | 21,202           |       | 15,908           |       |
|                                                                                                                          |       | 124,430          |       | 118,615          |       |
|                                                                                                                          |       |             |       |             |       |
| Long-term  Debt                                                                                                               |       | 165,726          |       | 173,840          |       |
|                                                                                                                          |       |             |       |             |       |
| Current  Liabilities:                                                                                                         |       |             |       |             |       |
| Short-term  debt                                                                                                              |       | 18,900           |       | 12,500           |       |
| Current  maturities of long-term debt                                                                                         |       | 8,000            |       | —           |       |
| Accounts  payable                                                                                                             |       | 63,105           |       | 17,841           |       |
| Property,  payroll and excise taxes                                                                                           |       | 10,449           |       | 5,520            |       |
| Dividends  and interest payable                                                                                               |       | 5,398            |       | 6,920            |       |
| Regulatory  liabilities                                                                                                       |       | 48,372           |       | 91,217           |       |
| Other  current liabilities                                                                                                    |       | 12,826           |       | 8,209            |       |
|                                                                                                                          |       | 167,050          |       | 142,207          |       |
|                                                                                                                          |       |             |       |             |       |
| Deferred  Credits and Other Non-current Liabilities:                                                                          |       |             |       |             |       |
| Deferred  income taxes and investment tax credits                                                                             |       | 42,950           |       | 43,429           |       |
| Retirement  plan obligations                                                                                                  |       | 18,429           |       | 19,042           |       |
| Regulatory  liabilities                                                                                                       |       | 42,856           |       | 50,584           |       |
| Other                                                                                                                         |       | 4,908            |       | 5,188            |       |
|                                                                                                                          |       | 109,143          |       | 118,243          |       |
|                                                                                                                          |       |             |       |             |       |
| Commitments  and Contingencies                                                                                                |       | —           |       | —           |       |
|                                                                                                                          |       | $                | 566,349    |             | $          | 552,905 |   |

 

The accompanying notesare an integral part of these financial statements.

 

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CASCADE NATURALGAS CORPORATION

CONSOLIDATEDCONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 
| ** **                                                                         | ** ** | **THREE  MONTHS ENDED**     | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                         | ** ** | **(dollars  in thousands)** | ** ** |
| ** **                                                                         | ** ** | **Dec 31,  2005**           | ** ** | **Dec 31,  2004** | ** ** |
| Operating  Activities:                                                             |       |                        |       |   |   |
| Net  income                                                                        |       | $                           | 8,040      |   | $ | 6,632 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                        |       |   |   |
| Depreciation  and amortization                                                     |       | 4,414                       |       | 4,205 |   |
| Deferrals  of gas cost changes                                                     |       | (2,472                      | )          | 100 |   |
| Amortization  of gas cost changes                                                  |       | 3,880                       |       | 1,794 |   |
| Other  deferrals and amortizations                                                 |       | (679                        | )          | (154 | ) |
| Deferred  income taxes and tax credits - net                                       |       | (473                        | )          | 418 |   |
| Change  in current assets and liabilities                                          |       | (11,873                     | )          | (8,571 | ) |
| Net  cash provided by operating activities                                         |       | 837                         |       | 4,424 |   |
|                                                                               |       |                        |       |   |   |
| Investing  Activities:                                                             |       |                        |       |   |   |
| Capital  expenditures                                                              |       | (4,428                      | )          | (8,180 | ) |
| Customer  contributions in aid of construction                                     |       | 672                         |       | 410 |   |
| Net  cash used by investing activities                                             |       | (3,756                      | )          | (7,770 | ) |
|                                                                               |       |                        |       |   |   |
| Financing  Activities:                                                             |       |                        |       |   |   |
| Proceeds  from issuance of common stock                                            |       | 584                         |       | 504 |   |
| Repayment  of long-term debt                                                       |       | (114                        | )          | (4,000 | ) |
| Changes  in short-term debt, net                                                   |       | 6,400                       |       | 11,500 |   |
| Dividends  paid                                                                    |       | (2,747                      | )          | (2,710 | ) |
| Other                                                                              |       | (12                         | )          | — |   |
| Net  cash provided by financing activities                                         |       | 4,111                       |       | 5,294 |   |
|                                                                               |       |                        |       |   |   |
| Net  Increase in Cash and Cash Equivalents                                         |       | 1,192                       |       | 1,948 |   |
|                                                                               |       |                        |       |   |   |
| Cash  and Cash Equivalent:                                                         |       |                        |       |   |   |
| Beginning  of year                                                                 |       | 1,128                       |       | 499 |   |
| End  of period                                                                     |       | $                           | 2,320      |   | $ | 2,447 |   |

 

The accompanying notesare an integral part of these financial statements.

 

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**NOTES TOCONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

## **THREE-MONTHPERIOD ENDED DECEMBER 31**

 

The preceding statementswere taken from the books and records of the Company and reflect alladjustments which are, in the opinion of management, necessary for a fairstatement of the results for the interim periods.  Because of the highly seasonal nature of thenatural gas distribution business, earnings or loss for any portion of the yearare disproportionate in relation to the full year.

 

Referenceis directed to the Notes to Consolidated Financial Statements contained in the2005 Annual Report on Form 10-K for the fiscal year ended September 30, 2005.

 

**Note 1.  New Accounting Standards**

 

**FAS No.151:**  As of October 1,2005, the Company adopted Statement of Financial Accounting Standards (FAS) No.151, *“Inventory Costs”*.  This standard is an amendment of AccountingResearch Bulletin (ARB) No. 43, clarifying the requirement that abnormalamounts of idle facility expense, freight, handling costs, and spoilage berecognized as current period costs. Adoption of this standard did not have a significant impact on theCompany’s financial statements.

 

**FAS No. 123 (revised 2004): **As of October 1, 2005, theCompany adopted FAS No. 123 (revised 2004), *“Share-BasedPayment*” {FAS No. 123(R)}. This statement is a revision of FAS No.123, *“Accounting for Stock-BasedCompensation”*, and supersedes Accounting Principles Board (APB)Opinion No. 25, *“Accounting for Stock Issuedto Employees”*.  Under FAS No.123(R) the Company is required to recognize as expense the fair value of equityinstruments, including stock options, to be issued in exchange for goods orservices.  Adoption of this standard didnot have a significant impact on the Company’s financial statements, butadditional footnote disclosure is required and is included in Note 4 below.

 

**Note 2.  Earnings Per Share**

 

The following table setsforth the calculation of earnings per share:

 
| ** **                                             | ** ** | **Three  Months Ended December 31**       | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | **(in  thousands except per-share data)** | ** ** |
| Net  income                                            |       | $                                         | 8,040      |   | $ | 6,632 |   |
|                                                   |       |                                      |       |   |   |
| Weighted  average shares outstanding                   |       | 11,428                                    |       | 11,279 |   |
| Basic  earnings per share                              |       | $                                         | 0.70       |   | $ | 0.59 |   |
|                                                   |       |                                      |       |   |   |
| Weighted  average shares outstanding                   |       | 11,428                                    |       | 11,279 |   |
| Plus:  Issued on assumed exercise of stock options     |       | 2                                         |       | 13 |   |
| Weighted  average shares outstanding assuming dilution |       | 11,430                                    |       | 11,292 |   |
|                                                   |       |                                      |       |   |   |
| Diluted  earnings per share                            |       | $                                         | 0.70       |   | $ | 0.59 |   |

 

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**Note3.  Retirement Plan Information**

 

The following table setsforth the components of net periodic benefit costs recognized in the three-monthperiods ended December 31, 2005 and 2004:

 

**Net Periodic Benefits Cost**

 
| ** **                                      | ** ** | **Three  Months Ended**     | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | **Dec 31,  2005**           | ** ** | **Dec 31,  2004** | ** ** |
| ** **                                      | ** ** | **(Dollars  in Thousands)** | ** ** |
| **DEFINED BENEFIT PENSION PLANS**               |       |                        |       |   |   |
| Service  cost                                   |       | $                           | 216        |   | $ | 197 |   |
| Interest  cost                                  |       | 965                         |       | 961 |   |
| Expected  return on plan assets                 |       | (1,101                      | )          | (1,041 | ) |
| Recognized  gains or losses                     |       | 421                         |       | 386 |   |
| Prior  service cost                             |       | 38                          |       | 46 |   |
| Net  Periodic Benefit Cost Recognized           |       | $                           | 539        |   | $ | 549 |   |
|                                            |       |                        |       |   |   |
| **POSTRETIREMENT BENEFITS OTHER THAN PENSIONS** |       |                        |       |   |   |
| Service  cost                                   |       | $                           | 28         |   | $ | 35 |   |
| Interest  cost                                  |       | 164                         |       | 275 |   |
| Expected  return on plan assets                 |       | (219                        | )          | (211 | ) |
| Recognized  gains or losses                     |       | 181                         |       | 187 |   |
| Prior  service cost                             |       | (615                        | )          | (330 | ) |
| Net  Periodic Benefit Cost Recognized           |       | $                           | (461       | ) | $ | (44 | ) |
|                                            |       |                        |       |   |   |
| **DEFINED CONTRIBUTION PENSION PLAN**           |       |                        |       |   |   |
| Net  Periodic Benefit Cost Recognized           |       | $                           | 205        |   | $ | 243 |   |

 

**RetirementPlan Funding**

 

For the threemonths ended December 31, 2005, $630,000 of contributions have been made to theCompany’s defined benefit pension plans. The Company presently anticipates contributing an additional $2,690,000to fund its pension plans for a total of $3,320,000 in fiscal 2006.

### ** **

**Note4.  Share-Based Payment**

 

In the first quarter offiscal 2006, the Company adopted Statement of Financial Accounting StandardsNo. 123 (revised 2004), (FAS 123(R)), *Share-Based Payment*.  See Note 1 above.  During the quarter, the Company did not haveany share-based payment transactions. Following are disclosures under FAS 123(R) for share-based paymentarrangements that were in effect during the quarters ended December 31, 2005and 2004.

 

Under the Company’s 2000Director Stock Award Plan, each non-employee director is awarded 500 shares ofthe Company’s common stock annually. During the quarters ended December 31, 2005 and December 31, 2004, theCompany recognized $23,000 and $22,000 as expense under this plan.  The value of the stock granted under thisplan is based on the market value on the date of the award.

 

Under the Company’s 1998Stock Incentive Plan, there are 28,233 stock options granted in 2001,exercisable at $18.565, and 44,000 stock options granted in 2002, exercisableat $20.84.  The 2001 options expire in2006, and the 2002 options expire in 2012. All options are fully vested. When the options were

 

8

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granted and during thevesting periods, the Company applied the intrinsic value method underAccounting Principles Board (APB) Opinion 25, and no expense has beenrecognized.

 

The Company’s employmentcontracts with its Chief Executive Officer (CEO) and its Chief FinancialOfficer (CFO) contain grants of restricted stock.  Under the CEO grant, 5,000 shares arerestricted until the CEO completes one year of employment, and another 5,000shares are restricted until he completes two years of employment.  Under the CFO grant, 5,000 shares arerestricted until he completes one year of employment.  During this period, each executive isrestricted from selling his shares. The value of the shares granted was basedon the market value as of the grant date. During the quarter ended December 31, 2005, $62,000 was recognized ascompensation expense.  None wasrecognized in the quarter ended December 31, 2004.

 

**Note 5.  Commitments and Contingencies**

 

**UnregisteredShares of Common Stock Under DRIP**

 

The Company determined in April 2005 that the number ofshares of its common stock issued pursuant to the Company’s Automatic DividendReinvestment Plan (the DRIP) had exceeded the number of shares previouslyregistered for such purpose under the Securities Act of 1933, as amended (theSecurities Act).  As a result, theCompany may have failed to comply with the registration or qualificationrequirements of federal and applicable state securities laws with respect toshares issued under the DRIP from August 2003 to April 2005.

 

The Company has evaluated the impact of the issuance ofunregistered shares on the DRIP participants affected and has consideredwhether any actions, including a formal rescission offer to the purchasers ofthe unregistered shares, should be taken to rectify this oversight.  The estimated costs of conducting arescission offer as compared to the potential for financial benefit toparticipants in the DRIP indicate that a rescission offer may not be in thebest interests of the Company or its shareholders, including the participantsin the DRIP.  None of the DRIPparticipants involved has asked the Company to repurchase any of theunregistered shares, and the Company considers it unlikely that it will berequired to do so. However, if the Company were required to repurchase all ofthe unregistered shares sold since December 31, 2004 (approximately the periodremaining within the one-year statute of limitations applicable to sales ofunregistered shares under the Securities Act), cash of approximately $393,000would be used to retire approximately 19,131 shares.

 

# **Environmental Matters**

 

Thereare two claims against the Company for cleanup of alleged environmentalcontamination related to manufactured gas plant sites previously operated bycompanies that were subsequently merged into the Company.

 

Thefirst claim was received in 1995 and relates to a site in Oregon.  An investigation has shown that soil andgroundwater contamination exists at the site. There are parties in addition to the Company that are potentially liablefor cleanup of the contamination.  Someof these other parties have shared in the costs expended to date to investigatethe site, and it is expected that these and other parties will share in thecleanup costs.  Several alternatives forremediation of the site have been identified, with preliminary estimates forcleanup ranging from approximately $500,000 to $11,000,000.  It is not known at this time what share ofthe cleanup costs will actually be borne by Cascade.

 

The secondclaim was received in 1997 and relates to a site in Washington.  An investigation has determined that there isevidence of contamination at the site, but there is also evidence that otherproperty owners may have contributed to the contamination.  There is currently not enough informationavailable to estimate the potential liability associated with this claim, butthe Company and other parties may become more involved in investigations of thenature and extent of contamination and possible remediation of the site asincreased interest has been expressed concerning its potential forredevelopment.

 

9

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Management has recentlycompleted a review of the Company’s insurance coverage and believes it hasadequate insurance to cover costs of the above two claims.  In the event the insurance proceeds do notcompletely cover the costs, management intends to seek recovery from itscustomers through increased rates.  Thereis precedent for such recovery through increased rates, as both the WashingtonUtilities and Transportation Commission (WUTC) and the Oregon Public UtilitiesCommission (OPUC) have previously allowed regulated utilities to increasecustomer rates to cover similar costs.

 

# **Litigation and Other Contingencies**

 

# **Various lawsuits, claims, andcontingent liabilities may arise from time to time from the conduct of theCompany’s business.  No other claims nowpending, in the opinion of management, are expected to have a material effecton the Company’s financial position, results of operations, cash flows, orliquidity.**

 

# **Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

The following ismanagement’s assessment of the Company’s financial condition and a discussion ofthe principal factors that affected consolidated results of operations and cashflows for the three-month periods ended December 31, 2005 and 2004.

 

**OVERVIEW**

 

The Company is a localdistribution company (LDC) serving approximately 235,000 customers in theStates of Washington and Oregon.  Its service area consists primarily ofrelatively small cities and rural communities rather than larger urbanareas.  The Company’s primary source of revenue and operating margin isthe distribution of natural gas to end-use residential, commercial, industrial,and institutional customers.  Revenues are also derived from providing gasmanagement and other services to some of its large industrial and commercialcustomers.  The Company’s rates and practices are regulated by theWashington Utilities and Transportation Commission (WUTC) and the Oregon PublicUtility Commission (OPUC).

 

Key elements of theCompany’s strategy:

 

•                  Remain focused on the natural gasdistribution business.

•                  Pursueappropriate regulatory treatment, including initiatives to decouple the Company’searnings from weather fluctuations and changing customer consumption patterns,and remove other regulatory impediments to effective management of thebusiness.

•                  Economicexpansion of its customer base by prudently managing capital expenditures andensuring new customers provide sufficient margins for an appropriate return onthe new investment required to acquire the customers.

•     Continue to focus onoperational efficiencies.

•                  Generateearnings and manage cash flow to maintain and strengthen the Company’s abilityto attract the funding needed to reliably serve new and existing customers.

 

**Opportunitiesand Challenges**

 

The Company operates in adiverse service territory over a wide geographic area relative to the Company’soverall size and number of customers.  The economies of various parts ofthe service area are supported by a variety of industries and are affected bythe conditions that impact those industries.  Management believes thereare growth opportunities in the Company’s service area, especially in theresidential and commercial segments.  Factors contributing to theseopportunities include low market penetration in many of the towns served, andgeneral population growth in the service area, including some areas of rapidgrowth.

 

Overall revenues andmargins are negatively impacted by higher efficiency in new home and commercialbuilding construction, higher efficiency in gas-burning equipment, andcustomers taking additional measures to reduce energy usage.  Theincreasing cost of energy in recent years, including the wholesale

 

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cost of natural gas,continues to encourage such measures.  However, the Company continues tobelieve that energy efficiency and conservation are the most viable near-termtactics for reducing customer bills and influencing wholesale natural gasprices.  They also form a vital strategy for stabilizing the cost of gasover the long term.  The traditional regulatory establishment of ratesties the recovery of cost to volumetric sales. This traditional rate designcreates a financial disincentive for utilities to promote conservation. The Company is working with regulators and other stakeholders in each state todevelop an acceptable decoupling mechanism that will enable the Company topromote conservation while still recovering its operating costs and earning afair return on its invested capital.  Similar approaches have beenimplemented in many states and are endorsed by a variety of organizations,including the recent endorsement by the National Association of RegulatedUtility Commissions.  The results of such rate requests and otherinitiatives for regulatory relief are subject to significant uncertainties.

 

The Company earnsapproximately one third of its operating margin from industrial and electricgeneration customers.  Loss of major industrial customers, or unfavorableconditions affecting an industry segment, would have a detrimental impact onthe Company’s earnings.  Many external factors over which the Company hasno control can significantly impact the amount of gas consumed by industrialand electric generation customers and, consequently, the margins earned by theCompany.

 

Revenues and margins fromthe Company’s residential and small commercial customers are highlyweather-sensitive.  In a cold year, the Company’s earnings are boosted bythe effects of the weather, and conversely in a warm year, the Company’searnings suffer. Peak requirements also drive the need to reinforce our systems(i.e., increase capacity).  Our operations group considers innovativeapproaches such as temporarily utilizing mobile gas supply rather than makinglarge investments in long-term capacity increases which may not be fully utilized.

 

Prospects for continuingstrong residential and commercial customer growth are excellent.  The paceof new home and commercial construction remains steady in communities served bythe Company.  Good potential also exists for converting homes and businesseslocated on or near the Company’s current lines to gas from other fuels, as wellas for expanding the system into adjacent areas.  Customer count growth inthis sector has been about double the average of U.S. gas utilities.

 

Our customer service callcenter organization recently voted to accept union representation.  TheCompany plans to attempt to negotiate an agreement that will support our effortto cost-effectively provide superior customer service.  The timing andresults of negotiations are uncertain.

 

The contract with theunion representing our service mechanics and construction staff expires onApril 1, 2006.  Again, we plan to attempt to negotiate an agreementthat supports superior and cost-effective customer service.  We anticipate that negotiations will beconcluded by the contract expiration date of April 1, 2006.

 

We continue to pursueoperating efficiencies and cost reductions.  During fiscal 2004, wecompleted the implementation of automated meter reading capability covering ourentire service area.  This reduced our staffing needs by 27 full-timeequivalent positions.  During fiscal 2005, the centralization of ourcustomer service activities and other organizational changes, enabled by avariety of other improvements, reduced our staffing from 428 to 375, more thana 12% reduction.  Our current organization is able to service morecustomers at a lower cost than in prior years.  Changes completed duringfiscal 2005 alone resulted in improving our customer-per-employee ratio from500 to 600.  We continue to look for additional operating improvements.

 

We carefully analyze theeconomics of our spending to support growth.  When justified under ourtariffs, we work with developers, business owners and residents to sharecertain construction costs to assure a fair return to the Company. Non-revenue-generating spending is also managed to assure that we use the mosteconomically attractive solutions while providing for a safe and reliablesystem.  Improvements implemented duringthe current quarter have contributed to an average cost per service linereduction of 12%, while the number of new meters installed rose slightly.  These changes, combined with a reduction innon-revenue- generating initiatives as compared to a year ago, are expected toresult in a significant reduction in capital spending over the current fiscalyear.

 

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Management continuouslyseeks improvement opportunities in all areas.  Our discussion abovecovering regulatory change, labor relations, operating practices, ourorganization and our investment to maintain and expand our gas delivery systemare examples. To assist the Company in evaluating all available options tomaximize shareholder value, the Company has retained J.P. Morgan SecuritiesInc. to provide strategic and financial advice as well as regulatory support.The Company is currently finalizing its rate case filing, including itsConservation Alliance Plan (decoupling), for its Washington State operationsand expects to file before the end of the second fiscal quarter.

 

# **RESULTSOF OPERATIONS**

 

The Company’s net incomewas $8,040,000, or $0.70 per share, basic and diluted, for the fiscal 2006first quarter (quarter ended December 31, 2005), compared to $6,632,000, or$0.59 per share, basic and diluted, for the quarter ended December 31,2004.  The largest factors influencingthe quarterly comparisons were:

 

•                  Increase in residential andcommercial per-customer gas consumption: $0.08 per share

•                  Increase in margin from new residentialand commercial customers:  $0.06 pershare

•                  Reduction in labor expense:  $0.04 per share

•                  Reduction in employee benefitsexpense:  $0.03 per share

 

Factors mitigating thequarterly earnings improvement include:

 

•                  Accrual of incentive compensation:  ($0.04) per share

•                  Change in regulatory methodologyaffecting allocation of gas cost between quarters:  ($0.03) per share

# ** **

# **Operating Margin**

 

Operating margins bycustomer category for the first quarter of fiscal years 2006 and 2005 are setforth in the following tables:

 

**Residentialand Commercial Margin**

 
| ** **                             | ** ** | **First  Quarter of Fiscal** | ** ** | **Percent  Change** | ** ** |
|----------------------------------------|------------|------------------------------|------------|---------------------|------------|
| ** **                             | ** ** | **2006**                     | ** ** | **2005**            | ** ** | ** ** |
|                                   |       | **(dollars  in thousands)**  |       |                |       |
| **Degree Days**                        |       |                         |       |                |       |   |   |
| Actual                                 |       | 2,250                        |       | 1,945               |       | 15.7 | % |
| 5-Year  Average                        |       | 2,106                        |       | 2,091               |       |   |   |
| **Average Number of Customers Billed** |       |                         |       |                |       |   |   |
| Residential                            |       | 201,204                      |       | 191,100             |       | 5.3 | % |
| Commercial                             |       | 30,586                       |       | 29,840              |       | 2.5 | % |
| **Average Therm Usage per Customer**   |       |                         |       |                |       |   |   |
| Residential                            |       | 274                          |       | 251                 |       | 9.2 | % |
| Commercial                             |       | 1,325                        |       | 1,161               |       | 14.1 | % |
| **Operating Margin**                   |       |                         |       |                |       |   |   |
| Residential                            |       | $                            | 15,469     |                | $          | 14,224 |   | 8.8 | % |
| Commercial                             |       | $                            | 7,888      |                | $          | 7,461 |   | 5.7 | % |

 

Margin from sales toresidential and commercial customers increased by $1,672,000 on an aggregatebasis, and the net increase was influenced by three primary factors.  An overall increase of 10,850 in the averagenumber of residential and commercial customers billed, assuming the sameaverage consumption per customer as last year, contributed $1,069,000 inadditional margin.  The combined growthrate for

 

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residential andcommercial customers was 4.9%, more than two times the national average fornatural gas distribution companies. Additionally, the increase in average gas usage per customer added$1,420,000 in margin.  The primary use ofgas by residential customers is for space and water heating; therefore, averageconsumption per customer is very sensitive to weather, particularly during theCompany’s first and second fiscal quarters. Consumption by commercial customers is also sensitive to weather.  The sensitivity is more difficult to isolateand measure than for residential customers because of a variety of uses inaddition to space and water heating.

 

Partially offsetting theabove increases was a $535,000 reduction in the comparison of first quartermargins, which resulted from a change in how we recognize pipeline demandcharges.  This change was driven by theCompany’s October 1, 2005 Purchase Gas Adjustment (PGA) filing in Oregon.  The constant is that the cost of pipelinedemand charges, which are relatively flat, is recovered in monthly billingsbased on volume.  Thus, we collectsubstantially more during our two winter quarters, which is offset during oursummer quarters.  Until the first quarterof fiscal 2006, the Company recorded the collections as revenues when billable,and the costs as incurred, which resulted in a lift in the prior first quarter’sreported margins of the above amount. With the recent change, we recognize pipeline demand cost at a level tomatch its recovery each period, and any over or under collection flows to orfrom the deferred gas cost balance.  Theimpact has been to reduce the stated increase in quarterly margin due to themargin lift of a year ago.  This changeis not expected to have an impact on full-year earnings.

 

**Industrialand Other Margin**

 
| ** **                              | ** ** | **First  Quarter of Fiscal** | ** ** | **Percent  Change** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|---------------------|------------|
| ** **                              | ** ** | **2006**                     | ** ** | **2005**            | ** ** | ** ** |
|                                    |       | **(dollars  in thousands)**  |       |                |       |
| **Average Number of Customers**         |       |                         |       |                |       |   |   |
| Electric  Generation                    |       | 12                           |       | 14                  |       | -14.3 | % |
| Industrial                              |       | 702                          |       | 736                 |       | -4.6 | % |
|                                    |       | 714                          |       | 750                 |       | -4.8 | % |
| **Therms Delivered (thousands)**        |       |                         |       |                |       |   |   |
| Electric  Generation                    |       | 121,189                      |       | 117,365             |       | 3.3 | % |
| Industrial                              |       | 109,207                      |       | 110,414             |       | -1.1 | % |
|                                    |       | 230,396                      |       | 227,779             |       | 1.1 | % |
| **Operating Margin ($ thousands)** |       |                         |       |                |       |   |   |
| Electric  Generation                    |       | $                            | 2,267      |                | $          | 2,007 |   | 13.0 | % |
| Industrial                              |       | 5,135                        |       | 5,307               |       | -3.2 | % |
| Gas  Management Services                |       | 337                          |       | 391                 |       | -13.8 | % |
| Mark-to-Market  Valuations              |       | (579                         | )          | (668                | )          | -13.3 | % |
| Other                                   |       | 274                          |       | 200                 |       | 37.0 | % |
|                                    |       | $                            | 7,434      |                | $          | 7,237 |   | 2.7 | % |

 

The increase in marginfrom electric generation customers was equally split between the recognition ofa settlement involving an inactive power plant and greater gas consumption byother electric generation customers in response to cooler Decemberweather.  Looking ahead, gas usage bygeneration customers will continue to depend on regional demand for power,availability of hydro resources, and the relationship between the market priceof electricity and the cost of gas.

 

**Cost ofOperations**

 

Cost of Operations****(operating expense, depreciation andamortization, and property and miscellaneous taxes) was down by $542,000,compared to the first quarter of fiscal year 2005.   Management initiatives resulted in $1.6million in reduced quarterly operating expenses.  Last fall’s reduction in force, combined withother reduction opportunities and a focus on managing overtime, reduced directlabor costs by $638,000.  Outsourcing ourretiree medical obligations to an insurance company contributed toward the$617,000 in reduced benefit costs. Another $356,000 in year-to-year cost reductions was achieved in variouscorporate and administrative areas. These operating cost savings were partially offset by incentive

 

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compensationaccruals totaling $680,000.  Depreciationand amortization increased $209,000, consistent with capital spending over themost recent four quarters.  We alsoincreased bad-debt expense by $180,000 in anticipation of potential collectionissues due to recent gas cost increases.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

The seasonal nature ofthe Company’s business creates short-term cash requirements to finance customerreceivables, deferred gas costs and other business needs.  To provide working capital for theserequirements, the Company has a $60,000,000 bank revolving creditcommitment.  This agreement has avariable commitment fee and a term that expires in October 2007.  The Company also has a $10,000,000uncommitted line of credit.  As ofDecember 31, 2005, there was $18,900,000 outstanding under these credit lines.

 

Due to the nature of theCompany’s business, which is characterized by predictable payments from astable customer base, and our expectations that capital spending will bereduced from the last few years, we expect to have limited need for additionalcapital during fiscal year 2006.  Forthis reason, management believes it has adequate liquidity and borrowing linesto meet our anticipated needs and estimates that cash flow will be sufficientto support operations, fund capital spending, and pay dividends at theircurrent level.

 

### **OperatingActivities**

 

In spite of improved netincome, cash flow generated from operating activities declined $3,587,000compared to the first quarter of fiscal 2005. The largest single contributing factor was receivables growth reflectinghigher gas costs.  This was partiallyoffset with a decline in prepaid expenses, primarily due to a reduction inprepaid income taxes.

#####  

##### **Investing Activities**

 

Capital spending during the quarter was $3.8 million comparedto $7.8 million in the first quarter of fiscal year 2005.  Part of the difference was due to $1.0million relating to the completed AMR and call center centralization projects,and $1.4 million of one-time specific system reinforcement expenditures, in thefirst quarter of fiscal year 2005.  Theremaining $1.6 million reduction is attributable to the implementation of a newinvestment evaluation process to assure that all capital spending provides anadequate return or is required for safety or regulatory compliance.  Our current expectation is that we will endthe year at or below our fiscal 2006 capital budget of $22.0 million.

 

#### **Financing Activities**

 

Other than the payment ofdividends, the Company’s primary financing activity during the first quarter offiscal 2006 was the $6,400,000 net increase in short-term debt to provideseasonal working capital required by the growth in customer receivables.

 

## **CRITICAL ACCOUNTING POLICIES**

 

The Company’s financialstatements are prepared in accordance with accounting principles generally acceptedin the United States of America (GAAP). In following GAAP, management exercises judgment in selection andapplication of accounting principles. Management considers critical accounting policies to be those wheredifferent assumptions regarding application could result in materialdifferences in financial statements.  TheCompany’s critical accounting policies were described in its Annual Report onForm 10-K for the year ended September 30, 2005, under Part II, Item 7, andhave not changed significantly since that report.

** **

**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

 

The Company has evaluatedits risk related to financial instruments whose values are subject to marketsensitivity.  The Company has fixed-ratedebt obligations but does not currently have derivative financial instrumentssubject to interest rate risk.  TheCompany makes interest and principal payments on these

 

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obligations in the normalcourse of its business and may redeem its debt obligations prior to normalmaturities if warranted by market conditions.

 

The Company’s natural gaspurchase commodity prices are subject to fluctuations resulting from weather,congestion on interstate pipelines, and other unpredictable factors.  The Company’s Purchased Gas Cost Adjustment(PGA) mechanisms assure the recovery in customer rates of prudently incurredwholesale cost of natural gas purchased for the core market.  The Company primarily utilizes financial derivatives,and to a lesser extent, fixed price physical supply contracts to manage riskassociated with wholesale costs of natural gas purchased for customers.

 

With respect toderivative arrangements covering natural gas supplies for core customers,periodic changes in fair market value are recorded in regulatory asset orregulatory liability accounts, pursuant to authority granted by the WUTC andOPUC, recognizing that settlements of these arrangements will be recoveredthrough the PGA mechanism.

 

For derivative arrangementsrelated to supplies for non-core customers, which are not covered by a PGAmechanism, periodic changes in fair market value are recognized in earnings orin Other Comprehensive Income.

 

**Item4.  Controls and Procedures**

 

The Company maintainscontrols and procedures designed to provide reasonable assurance that requireddisclosure information in the reports the Company files or submits under theSecurities Exchange Act of 1934, as amended, is recorded, processed, summarizedand reported within the time period specified in the rules and forms of theSecurities and Exchange Commission. Based upon their evaluation of those controls and procedures as of theend of the quarter covered by this report, the Chief Executive Officer andChief Financial Officer of the Company concluded that the Company’s disclosurecontrols and procedures were effective. There were no changes in internal control over financial reporting thatoccurred during the quarter covered by this report that have materiallyaffected, or are reasonably likely to affect, the Company’s internal controlsover financial reporting.

# ** **

# **FORWARD-LOOKINGSTATEMENTS**

 

The Company’s discussionin this report, or in any information incorporated herein by reference, maycontain forward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995.  All statements, other than statements ofhistorical facts, are forward-looking statements, including statementsconcerning plans, objectives, goals, strategies, and future events or performance. When used in Company documents or oral presentations, the words “anticipate”, “believe”,“estimate”, “expect”, “objective”, “projection”, “forecast”, “goal”, or similarwords are intended to identify forward-looking statements.

 

These forward-lookingstatements reflect the Company’s current expectations, beliefs and projectionsabout future events that we believe may affect the Company’s business,financial condition and results of operations, and are expressed in good faithand are believed to have a reasonable basis.  However, each suchforward-looking statement involves risks, uncertainties and assumptions, and isqualified in its entirety by reference to the following important factors,among others, that could cause the Company’s actual results to differmaterially from those projected in such forward-looking statements:

 

•                  prevailingstate and federal governmental policies and regulatory actions, including thoseof the Washington Utilities and Transportation Commission, the Oregon Public UtilityCommission, and the U.S. Department of Transportation’s Office of PipelineSafety, with respect to allowed rates of return, industry and rate structure,purchased gas cost and investment recovery, acquisitions and dispositions ofassets and facilities, operation and construction of plant facilities, themaintenance of pipeline integrity, and present or prospective wholesale andretail competition;

 

•     weather conditions and othernatural phenomena;

 

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•                  unanticipatedpopulation growth or decline, and changes in market demand caused by changes indemographic or customer consumption patterns;

 

•                  changesin and compliance with environmental and safety laws, regulations and policies,including environmental cleanup requirements;

 

•                  competitionfrom alternative forms of energy and other sellers of energy;

 

•                  increasingcompetition brought on by deregulation initiatives at the federal and stateregulatory levels, as well as consolidation in the energy industry;

 

•                  thepotential loss of large volume industrial customers due to “bypass” or theshift by such customers to special competitive contracts at lower per-unitmargins;

 

•                  risks,including creditworthiness, relating to performance issues with customers and suppliers;

 

•                  risksresulting from uninsured damage to the Company’s property, intentional orotherwise, or from acts of terrorism;

 

•                  unanticipatedchanges that may affect the Company’s liquidity or access to capital markets;

 

•                  unanticipatedchanges in interest rates or in rates of inflation;

 

•                  economicfactors that could cause a severe downturn in certain key industries, thusaffecting demand for natural gas;

 

•                  unanticipatedchanges in operating expenses and capital expenditures;

 

•                  unanticipatedchanges in capital market conditions, including their impact on future expensesand liabilities relating to employee benefit plans;

 

•                  potentialinability to obtain permits, rights of way, easements, leases, or otherinterests or necessary authority to construct pipelines, or complete othersystem expansions;

 

•                  changesin the availability and price of natural gas; and

 

•                  legaland administrative proceedings and settlements.

 

In light of these risks,uncertainties and assumptions, the forward-looking events and circumstancesdiscussed in this report, or in any information incorporated herein byreference, may not occur and actual results could differ materially from thoseanticipated or implied in the forward-looking statements.  All subsequentforward-looking statements, whether written or oral and whether made by or onbehalf of the Company, also are expressly qualified by these cautionarystatements.

 

Any forward-lookingstatement by the Company is made only as of the date on which such statement ismade.  The Company undertakes no obligation to update any forward-lookingstatement to reflect events or circumstances after the date on which thestatement is made or to reflect the occurrence of any unanticipatedevents.  New factors emerge from time to time, and the Company is not ableto predict all such factors, nor can it assess the impact of each such factoror the extent to which such factors may cause results to differ materially fromthose contained in any forward-looking statement.

 

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**PART II. Other Information**

 

# **Item 6.  Exhibits**

 
| **No** | ** ** | **Description**                                                                                                          |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                     |
| 12     |       | Computation  of Ratio of Earnings to Fixed Charges                                                                       |
|   |       |                                                                                                                     |
| 31     |       | Certifications  Accompanying Periodic Report Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                  |
|   |       |                                                                                                                     |
| 32     |       | Certification  Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

 
| **CASCADE  NATURAL GAS CORPORATION** |
|--------------------------------------|
| ** **                           | ** ** | ** ** |
| ** **                           | ** ** | ** ** |
| By:                                  | /s/ Rick A.  Davis | . |
|                                 |   |   |
|                                 |   |   |
|                                 | Rick A. Davis |   |
|                                 | Chief Financial  Officer |   |
|                                 | (Principal  Financial Officer) |   |
|                                 |   |   |
|                                 |   |   |
| Date:                                | February 7, 2006 | . |
|                                 |   |   |

 

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