**FORM10-Q**

** **

**SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended December 31, 2003**

 

**Commissionfile number: 1-7196**

 

| **CASCADE  NATURAL GAS CORPORATION**                             |
|------------------------------------------------------------------|
| (Exact name of  Registrant 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’s telephone  number including area code)        |   | **(206)  624-3900** |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.Yes      ý      No      o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 23b-2of the Exchange Act)   Yes      ý      No      o

 

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

 
| **Title**                             |   | **Outstanding**                         |
|---------------------------------------|--------|-----------------------------------------|
|                                  |   |                                    |
| Common Stock, Par Value  $1 per Share |   | 11,189,307 as of  January 30, 2004 |

 

 

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**CASCADE NATURAL 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  2. Changes in Securities                                                                             |   |
|      |                                                                                                       |
|      | Item  4. Submission of Matters to a Vote of Security Holders                                               |   |
|      |                                                                                                       |
|      | Item 5. Other Information                                                                                  |   |
|      |                                                                                                       |
|      | Item 6.  Exhibits and Reports on Form 8-K                                                                  |   |
|      |                                                                                                       |
| Signature |                                                                                                       |
|           |                                                                                                            |        |  |  |

 

2

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# **PART I.   Financial Information**

# ** **

**Item 1. Financial Statements**

** **

**CASCADENATURAL GAS CORPORATION**

**CONSOLIDATED CONDENSED STATEMENTS OFINCOME**

**(unaudited)**

 
|                                        |   | **THREE  MONTHS ENDED**                |    |
|---------------------------------------------|--------|----------------------------------------|---------|
|                                        |   | **Dec 31,  2003**                      |    | **Dec 31,  2002** |   |
|                                        |   | **(thousands  except per share data)** |    |
|                                        |   |                                   |    |   |   |
| Operating  revenues                         |   | $                                      | 104,884 |   | $ | 100,496 |   |
|                                        |   |                                   |    |   |   |
| Less: Gas  purchases                        |   | 67,525                                 |    | 64,703 |   |
|  Revenue  taxes                        |   | 6,666                                  |    | 6,284 |   |
| Operating margin                            |   | 30,693                                 |    | 29,509 |   |
|                                        |   |                                   |    |   |   |
| Cost of  operations:                        |   |                                   |    |   |   |
| Operating  expenses                         |   | 10,278                                 |    | 11,153 |   |
| Depreciation and  amortization              |   | 3,921                                  |    | 3,778 |   |
| Property and  miscellaneous taxes           |   | 930                                    |    | 858 |   |
|                                        |   | 15,129                                 |    | 15,789 |   |
|                                        |   |                                   |    |   |   |
| Income from  operations                     |   | 15,564                                 |    | 13,720 |   |
| Less interest  and other deductions - net   |   | 3,116                                  |    | 3,199 |   |
| Income before  income taxes                 |   | 12,448                                 |    | 10,521 |   |
|                                        |   |                                   |    |   |   |
| Income taxes                                |   | 4,543                                  |    | 3,840 |   |
| Net Income                                  |   | $                                      | 7,905   |   | $ | 6,681 |   |
|                                        |   |                                   |    |   |   |
| Weighted average  common shares outstanding |   | 11,158                                 |    | 11,045 |   |
|                                        |   |                                   |    |   |   |
| Net earnings per  common share              |   |                                   |    |   |   |
| Basic                                       |   | $                                      | 0.71    |   | $ | 0.61 |   |
| Diluted                                     |   | $                                      | 0.71    |   | $ | 0.60 |   |
|                                        |   |                                   |    |   |   |
| Cash dividends  per share                   |   | $                                      | 0.24    |   | $ | 0.24 |   |

 

The accompanying notes are an integral part of thesefinancial statements

 

3

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**CASCADE NATURAL GAS CORPORATION**

**CONSOLIDATEDCONDENSED BALANCE SHEETS**

(Dollarsin Thousands)

 
|                                                                                                                      |   | **Dec 31,  2003** |    | **Sep 30,  2003** |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|-------------------|--------|
|                                                                                                                      |   | **(Unaudited)**   |    |              |   |
| **ASSETS**                                                                                                                |   |              |    |              |   |
| Utility Plant,  net of accumulated depreciation of $231,472 and $227,582                                                  |   | $                 | 307,681 |              | $      | 302,225 |   |
| Construction  work in progress                                                                                            |   | 11,119            |    | 10,078            |   |
|                                                                                                                      |   | 318,800           |    | 312,303           |   |
| Other Assets:                                                                                                             |   |              |    |              |   |
| Investments in  non-utility property                                                                                      |   | 202               |    | 202               |   |
| Notes  receivable, less current maturities                                                                                |   | 49                |    | 52                |   |
|                                                                                                                      |   | 251               |    | 254               |   |
| Current Assets:                                                                                                           |   |              |    |              |   |
| Cash and cash  equivalents                                                                                                |   | 1,139             |    | 7,452             |   |
| Accounts  receivable and current maturities of notes receivable, less allowance of  $1,053 and $877 for doubtful accounts |   | 48,654            |    | 12,296            |   |
| Materials,  supplies and inventories                                                                                      |   | 12,099            |    | 14,737            |   |
| Prepaid expenses  and other assets                                                                                        |   | 4,473             |    | 6,144             |   |
| Deferred income  taxes                                                                                                    |   | 808               |    | 755               |   |
|                                                                                                                      |   | 67,173            |    | 41,384            |   |
| Deferred Charges                                                                                                          |   |              |    |              |   |
| Gas cost changes                                                                                                          |   | 10,561            |    | 11,584            |   |
| Other                                                                                                                     |   | 5,745             |    | 5,931             |   |
|                                                                                                                      |   | 16,306            |    | 17,515            |   |
|                                                                                                                      |   |              |    |              |   |
|                                                                                                                      |   | $                 | 402,530 |              | $      | 371,456 |   |

 

4

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**CASCADE NATURAL GAS CORPORATION**

**CONSOLIDATED CONDENSED BALANCE SHEETS**

(Dollarsin Thousands)

 
|                                                                                                                          |   | **Dec 31,  2003** |    | **Sep 30,  2003** |   |
|-------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|-------------------|--------|
|                                                                                                                          |   | **(Unaudited)**   |    |              |   |
| **COMMON  SHAREHOLDERS’ EQUITY AND LIABILITIES**                                                                         |   |              |    |              |   |
| Common  Shareholders’ Equity:                                                                                            |   |              |    |              |   |
| Common stock,  par value $1 per share, authorized 15,000,000 shares, issued and outstanding  11,181,119 and 11,131,860 shares |   | $                 | 11,181  |              | $      | 11,132 |   |
| Additional  paid-in capital                                                                                                   |   | 99,670            |    | 98,877            |   |
| Accumulated  other comprehensive income (loss)                                                                                |   | (13,430           | )       | (13,430           | )      |
| Retained  earnings                                                                                                            |   | 21,199            |    | 15,981            |   |
|                                                                                                                          |   | 118,620           |    | 112,560           |   |
|                                                                                                                          |   |              |    |              |   |
| Long-term Debt                                                                                                                |   | 138,930           |    | 142,930           |   |
|                                                                                                                          |   |              |    |              |   |
| Current  Liabilities:                                                                                                         |   |              |    |              |   |
| Notes payable  and commercial paper                                                                                           |   | 2,500             |    | 3,800             |   |
| Current  maturities of long-term debt                                                                                         |   | 26,000            |    | 22,000            |   |
| Accounts payable                                                                                                              |   | 30,255            |    | 10,501            |   |
| Property,  payroll and excise taxes                                                                                           |   | 8,408             |    | 5,387             |   |
| Dividends and  interest payable                                                                                               |   | 5,484             |    | 7,884             |   |
| Other current  liabilities                                                                                                    |   | 10,668            |    | 6,431             |   |
|                                                                                                                          |   | 83,315            |    | 56,003            |   |
|                                                                                                                          |   |              |    |              |   |
| Deferred Credits  and Other Liabilities                                                                                       |   | 61,665            |    | 59,963            |   |
|                                                                                                                          |   |              |    |              |   |
| Commitments and  Contingencies                                                                                                |   | —            |    | —            |   |
|                                                                                                                          |   | $                 | 402,530 |              | $      | 371,456 |   |

 

The accompanying notesare an integral part of these financial statements

 

5

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**CASCADENATURAL GAS CORPORATION**

**CONSOLIDATEDCONDENSED STATEMENTS OF CASH FLOWS**

(Unaudited)

 
|                                                                               |   | **THREE  MONTHS ENDED**     |   |
|------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                               |   | **(dollars  in thousands)** |   |
|                                                                               |   | **Dec 31,  2003**           |   | **Dec 31,  2002** |   |
| Operating  Activities                                                              |   |                        |   |   |   |
| Net income                                                                         |   | $                           | 7,905  |   | $ | 6,681 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |                        |   |   |   |
| Depreciation and  amortization                                                     |   | 3,921                       |   | 3,778 |   |
| Deferrals of gas  cost changes                                                     |   | (752                        | )      | 1,164 |   |
| Amortization of  gas cost changes                                                  |   | 1,774                       |   | 1,481 |   |
| Other deferrals  and amortizations                                                 |   | 321                         |   | 1,025 |   |
| Deferred income  taxes and tax credits — net                                  |   | 1,367                       |   | 951 |   |
| Change in  current assets and liabilities                                          |   | (7,488                      | )      | (8,222 | ) |
| Net cash  provided by operating activities                                         |   | 7,048                       |   | 6,858 |   |
|                                                                               |   |                        |   |   |   |
| Investing  Activities                                                              |   |                        |   |   |   |
| Capital  expenditures                                                              |   | (10,456                     | )      | (5,585 | ) |
| Customer  contributions in aid of construction                                     |   | 240                         |   | 61 |   |
| Other                                                                              |   | —                      |   | 8 |   |
| Net cash used by  investing activities                                             |   | (10,216                     | )      | (5,516 | ) |
|                                                                               |   |                        |   |   |   |
| Financing  Activities                                                              |   |                        |   |   |   |
| Proceeds from  issuance of common stock                                            |   | 842                         |   | — |   |
| Changes in notes  payable and commercial paper, net                                |   | (1,300                      | )      | — |   |
| Dividends paid                                                                     |   | (2,687                      | )      | (2,651 | ) |
| Net cash  provided (used) by financing activities                                  |   | (3,145                      | )      | (2,651 | ) |
|                                                                               |   |                        |   |   |   |
| Net Increase  (Decrease) in Cash and Cash Equivalents                              |   | (6,313                      | )      | (1,309 | ) |
|                                                                               |   |                        |   |   |   |
| Cash and Cash  Equivalents                                                         |   |                        |   |   |   |
| Beginning of  year                                                                 |   | 7,452                       |   | 3,688 |   |
| End of period                                                                      |   | $                           | 1,139  |   | $ | 2,379 |   |

 

The accompanying  notes are an integral part of thesefinancial statements

 

6

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**CASCADE NATURAL GASCORPORATION**

**NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

## **THREE MONTHS ENDED DECEMBER 31, 2003**

## ** **

The preceding statements were taken from the books andrecords of the Company and reflect all adjustments which are, in the opinion ofmanagement, necessary for a fair statement of the results for the interimperiods. All adjustments were of a normal and recurring nature. Because of thehighly seasonal nature of the natural gas distribution business, earnings orloss for any portion of the year are disproportionate in relation to the fullyear.

 

Reference is directed to the Notes to ConsolidatedFinancial Statements contained in the 2003 Annual Report on Form 10-K for thefiscal year ended September 30, 2003, and comments included therein under“Management’s Discussion and Analysis of Financial Condition and Results ofOperations”.

 

**Reclassifications**

 

Certain reclassifications have been made in the financialstatements for the quarter ended December 31, 2003 to conform to theclassifications used in fiscal 2004.

 

# **New Accounting Standards**

# ** **

**FAS No.132 (revised 2003)**

 

In December 2003, the Financial AccountingStandards Board (FASB) issued *Statement of Financial Accounting Standards (FAS) No.132 (revised 2003), Employers’ Disclosures about Pensions and OtherPostretirement Benefits,* to revise employers’ annual and quarterlydisclosures about pension plans and other postretirement benefit plans. It doesnot change the measurement or recognition of those plans required by FAS No.87, *Employers’Accounting for Pensions,* FAS No. 88, *Employers’ Accounting for Settlementsand Curtailments of Defined Benefit Pension Plans and for Termination Benefits,*and FAS No. 106, *Employers’ Accounting for Postretirement Benefits Other Than Pensions.*This Statement retains the disclosure requirements contained in FAS No. 132, *Employers’Disclosures about Pensions and Other Postretirement Benefits,*whichit replaces. It requires additional disclosures to those in the originalStatement 132 about the assets, obligations, cash flows, and net periodicbenefit cost of defined benefit pension plans and other defined benefitpostretirement plans. The annual disclosure requirements under this Statementare effective for fiscal years ending after December 15, 2003, and thequarterly disclosure requirements are effective for interim periods beginningafter December 15, 2003. The Company will provide disclosures requiredunder this Statement in its Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2004, and subsequent reports.

 

**FSPFAS No. 106-1**

** **

In January 2004, the FASB issued *FASB StaffPosition (FSP) No. FAS 106-1, Accounting and Disclosure Requirements Related tothe Medicare Prescription Drug, Improvement and Modernization Act of 2003.*FSP No. FAS 106-1 provides guidance which permits a sponsor of a postretirementhealth care plan that provides a prescription drug benefit to make a one-timeelection to defer accounting for the effects of the Medicare Prescription Drug,Improvement and Modernization Act of 2003 (the Act). Regardless of whether thesponsor elects the deferral, the FSP requires certain disclosures pendingfurther consideration of the underlying accounting issues. The guidance in thisFSP is effective for quarterly and annual financial statements for fiscal yearsending after December 7, 2003.

 

The Act, signed into law by President Bush onDecember 8, 2003, introduces a prescription drug benefit under Medicare (MedicarePart D) as well as a federal subsidy to sponsors of retiree health care benefitplans that provide a benefit that is at least actuarially equivalent toMedicare Part D. The Company has not developed estimates of the impact of theAct on its cash flows, accumulated postretirement benefit obligation (APBO), ornet periodic postretirement benefit cost. And it has not determined whether tochange its postretirement medical plan in response to the Act. FAS No. 106 doesnot provide guidance on how and when the federal subsidy should be accountedfor. As provided under the FSP, the Company has

 

7

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elected to defer accounting for the impact of the Act until suchguidance is provided by the FASB. This election will expire if, subsequent toJanuary 31, 2004, but prior to the issuance of authoritative guidance, asignificant event occurs, such as a plan amendment, settlement, or curtailmentthat would ordinarily call for remeasurement of the postretirement medicalplan’s assets and obligations.

 

**EarningsPer Share**

 

The following table sets forth the calculation ofearnings per share as prescribed in Statement of Financial Accounting Standards(FAS) No. 128.

 
|                                                     |   | **Quarter  Ended December 31**       |   |
|----------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                     |   | **2003**                                  |   | **2002** |   |
|                                                     |   | **(in thousands  except per-share data)** |   |
|                                                     |   |                                      |   |   |   |
| Net income (loss)                                        |   | $                                         | 7,905  |   | $ | 6,681 |   |
|                                                     |   |                                      |   |   |   |
| Weighted average shares outstanding                      |   | 11,158                                    |   | 11,045 |   |
| Basic earnings per share                                 |   | $                                         | 0.71   |   | $ | 0.61 |   |
|                                                     |   |                                      |   |   |   |
| Weighted average shares outstanding                      |   | 11,158                                    |   | 11,045 |   |
| Plus:  Issued on assumed  exercise of stock options |   | 14                                        |   | 19 |   |
| Weighted average shares outstanding assuming dilution    |   | 11,172                                    |   | 11,064 |   |
|                                                     |   |                                      |   |   |   |
| Diluted earnings per share                               |   | $                                         | 0.71   |   | $ | 0.60 |   |

 

### **Stock-BasedCompensation**

### ** **

Compensation cost for stock options is measured as theexcess of the market price of the Company’s stock at the date of the grant overthe price the employee must pay to acquire the stock. The Company accounts forits stock-based compensation using the intrinsic value method prescribed in AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees”rather than using the fair-value-based method prescribed under FAS No. 123,“Accounting for Stock-Based Compensation”. The Company has adopted thedisclosure requirements of FAS No. 123. Had compensation expense beendetermined in accordance with FAS 123, the Company’s net income would have beenas follows:

 

8

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|                                                                                                                          |   | **Quarter  Ended December 31**       |       |
|-------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|------------|
|                                                                                                                          |   | **2003**                                  |       | **2002** |   |
|                                                                                                                          |   | **(in  thousands except per-share data)** |       |
|                                                                                                                          |   |                                      |       |   |   |
| **Amounts  as reported, reflecting stock-based employee compensation cost determined  under APB No. 25:**                     |   |                                      | ** ** |   | ** ** |
| Stock-based  employee compensation cost, net of tax effect                                                                    |   | $                                         | —     |   | $ | — |   |
| Net income  (loss)                                                                                                            |   | $                                         | 7,905      |   | $ | 6,681 |   |
| Basic earnings  (loss) per share                                                                                              |   | $                                         | 0.71       |   | $ | 0.61 |   |
| Diluted earnings  (loss) per share                                                                                            |   | $                                         | 0.71       |   | $ | 0.60 |   |
|                                                                                                                          |   |                                      |       |   |   |
| **Proforma  amounts, reflecting stock-based employee compensation cost as if determined  under fair value (FAS 123) method:** |   |                                      | ** ** |   | ** ** |
| Stock-based  employee compensation cost, net of tax effect                                                                    |   | $                                         | 13         |   | $ | 27 |   |
| Net income  (loss)                                                                                                            |   | $                                         | 7,892      |   | $ | 6,654 |   |
| Basic earnings  (loss) per share                                                                                              |   | $                                         | 0.71       |   | $ | 0.60 |   |
| Diluted earnings  (loss) per share                                                                                            |   | $                                         | 0.71       |   | $ | 0.60 |   |

 

**Commitmentsand Contingencies**

 

# **Environmental Matters**

# ** **

There are two claims against the Company for as yetunknown costs for cleanup of alleged environmental contamination related tomanufactured gas plant sites that were previously operated by companies whichwere subsequently merged into Cascade.

 

The first claim was received in 1995 and relates to asite in Oregon. An investigation has shown that contamination does exist, butthere is currently not enough information available to estimate the potentialliability associated with this claim. It is expected that other parties willparticipate in the cleanup costs. Through the end of the fiscal year theamounts spent, primarily on investigation and containment, have beenimmaterial.

 

The second claim was received in 1997 and relates to asite in Washington. An investigation has determined there is evidence ofcontamination at the site, but there is also evidence of an oil line crossingthe property, operated by an unrelated party, which may have also contributedto the contamination. There is currently not enough information available toestimate the potential liability associated with this claim. The party whooriginally made this claim has not been actively pursuing it.

 

Management intends to pursue reimbursement from itsinsurance carriers, and recovery from its customers through increased rates,for any remediation costs for which the Company is determined to be liable.There is precedent for such recovery through increased rates, as both the WUTCand OPUC have previously allowed regulated utilities to increase customer ratesto recover similar costs. No claims now pending, in the opinion of management,are expected to have a material effect on the Company’s financial position,results of operations, or liquidity.

 

# **Litigation and Other Contingencies**

# ** **

Various lawsuits, claims, and contingent liabilitiesmay arise from time to time from the conduct of the Company’s business.

 

9

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In the fourth quarter of fiscal 2002 a fatal accidentoccurred involving facilities owned by the Company, located on the property ofone of the Company’s commercial customers. In fiscal 2003 a settlement of allplaintiffs’ claims was agreed to in consideration of a $750,000 payment. TheCompany and  the property owner haveeach paid $375,000 and have agreed to resolve the allocation of the totalsettlement payment between them in future negotiations or proceedings.

 

No other claims now pending, in the opinion ofmanagement, are expected to have a material effect on the Company’s financialposition, results of operations, or liquidity.

 

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

# ** **

Thefollowing is management’s assessment of the Company’s financial condition and adiscussion of the principal factors that affected consolidated results ofoperations and cash flows for the three-month periods ended December 31,2003 and December 31, 2002.

 

## **CRITICALACCOUNTING POLICIES**

## ** **

The Company’s financialstatements are prepared in accordance with accounting principles generallyaccepted in the United States of America (GAAP). In following GAAP, managementexercises judgment in selection and application of accounting principles.Management considers Critical Accounting Policies to be those where differentassumptions regarding application could result in material differences infinancial statements.

 

## **Use of Estimates**

## ** **

The preparation of financialstatements in conformity with GAAP requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities, anddisclosure of contingent assets and liabilities, at the date of the financialstatements, and the reported amounts of revenues and expenses during thereporting period. The Company has used estimates in measuring certain deferredcharges and deferred credits related to items subject to approval of the WUTCand the OPUC. Estimates are also used in the development of discount rates andtrend rates related to the measurement of retirement benefit obligations andaccrual amounts, allowances for doubtful accounts, unbilled revenue, valuationof derivative instruments, and in the determination of depreciable lives ofutility plant. On an ongoing basis, management evaluates the estimates used,based on historical experience, current conditions and on various otherassumptions believed to be reasonable under the circumstances. Actual resultsmay differ from these estimates under different assumptions or conditions.

 

## **RevenueRecognition**

## ** **

## **The Company recognizes operatingrevenues based on deliveries of gas and other services to customers. Thisincludes estimated revenues for gas delivered but not billed to residential andcommercial customers from the latest meter reading date to the end of theaccounting period.**

## ** **

## **RegulatoryAccounting**

## ** **

The Company’s accountingpolicies and practices are generally the same as used by unregulated companiesfor financial reporting under GAAP. However, Statement of Financial AccountingStandards (FAS) No. 71, “Accounting for the Effects of Certain Types of Regulation”,requires regulated companies to apply special accounting treatment to reflectthe financial impact of regulation. For example, in establishing the rates tobe charged to the Company’s retail customers, the Washington Utilities andTransportation Commission (WUTC) and the Oregon Public Utility Commission(OPUC) may not allow the Company to charge its customers for recovery ofcertain expenses in the same period they are incurred. Instead, rates areestablished in the future to recover costs that were incurred in a priorperiod. In this situation, FAS No. 71 requires the Company to defer these costsand include them as regulatory assets on the balance sheet. In the subsequentperiod when these costs are recovered from customers, the Company then amortizesthese costs as expense in the income statement, in an amount equivalent to theamounts

 

10

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recovered. Similarly, certain revenue items, orcost reductions may be deferred as regulatory liabilities, which are lateramortized to the income statement as customer rates are reduced. In order toapply the provisions of FAS No. 71, the following conditions must apply:

 

•                  Anindependent regulator approves the company’s customer rates.

•                  Therates are designed to recover the company’s costs of providing the regulatedservices or products.

•                  Thereis sufficient demand for the regulated service to reasonably assure that ratescan be set at a level to recover the costs.

 

The Company periodicallyassesses whether conditions merit the continued applicability of FAS No. 71. Inthe event the Company should determine in the future that all or a portion ofits regulatory assets and liabilities no longer meet the above criteria, itwould be required to write off the related balances of its regulatory assetsand liabilities, and reflect the write off in its income statement. AtDecember 31, 2003 there were $13,220,000 of regulatory assets included inDeferred Gas Cost Changes and Other Deferred Charges, and $4,637,000 of regulatoryliabilities included in Deferred Credits and Other Liabilities.

 

## **Pension Plans**

## ** **

The Company has a defined benefitpension plan covering substantially all employees over 21 years of age with oneyear of service. The Company also provides executive officers with supplementalretirement, death and disability benefits. These plans were amended in fiscal2003, so that subsequent to September 30, 2003, benefits under these plansno longer accrue to non-bargaining-unit employees. The pension plan remainssubstantially unchanged for bargaining-unit employees.

 

The Company’s pension costs for these plans areaffected by the amount of cash contributions to the plans, the return on planassets, and by employee demographics, including age, compensation, and length ofservice. Actuarial formulas are used in the determination of pension costs andare affected by actual plan experience and assumptions of future experience.Key actuarial assumptions include the expected return on plan assets, thediscount rate used in determining the projected benefit obligation and pensioncosts, and the assumed rate of increase in employee compensation. Changes inthese assumptions may significantly affect pension costs. Changes to theprovisions of the plans may also impact current and future pension costs.Changes in pension plan obligations resulting from these factors may not beimmediately recognized as pension costs, but generally are recognized in futureyears over the remaining average service period of pension plan participants.

 

The Company’s funding policy is to contribute amountsequal to or greater than the minimum amounts required to be funded under theEmployee Retirement Income Security Act, and not more than the maximum amountscurrently deductible for income tax purposes. The Company contributed$4,412,000 in 2002 and $4,269,000 in 2003 to the pension and supplementalexecutive retirement plans, and expects to contribute $3,500,000 in 2004.

 

In selecting a discount rate, the Company uses theaverage of the 20 year and above Aaa, Aa, A, and Baa debt rates published byMoody’s. These are rates considered to be consistent with the expected term ofpension benefits. In 2003 the Company reduced the discount rate from 6.75% to6.25% in connection with remeasurement of the pension obligation at May 1,2003, with a further reduction to 6.00% at September 30, 2003. A reductionin the discount rate results in increases in projected benefit obligation,pension liability, and pension costs.

 

In selecting an assumed long-term rate of return onplan assets, the Company considers past performance and economic forecasts forthe types of investments held by the plan. In 2002 and 2003 the Company’sassumed rate of return on plan assets was 8.25%. A reduction in the assumedrate of return would result in increases in pension liability and pensioncosts.

 

## **Derivatives**

## ** **

The Company accounts for derivative transactionsaccording to the provisions of FAS No. 133, as amended by FAS No. 138 and by**FASNo. 149. These standards require that the fair value of all derivative

 

11

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financial instruments be recognized as either assets or liabilities onthe Company’s balance sheet and the recognition of unrealized gains and losses.

 

The Company’s contracts for purchase and sale ofnatural gas qualify for the normal purchase and normal sales exception underFAS No. 133 and are not required to be recorded as derivative assets andliabilities.  Accordingly, the Companyrecognizes revenues and expenses on an accrual basis, based on physicaldelivery of natural gas. The company applies mark-to-market accounting tofinancial derivative contracts. Periodic changes in fair market value arerecognized in earnings. The differences in accounting for purchases and salescontracts versus financial contracts do not change the underlying economics ofthe transactions, but could result in increased quarterly earnings volatility.

 

**MedicarePrescription Drug, Improvement and Modernization Act of 2003**

** **

On December 8, 2003,President Bush signed into law the *Medicare Prescription Drug, Improvement andModernization Act of 2003* (the Act). The Act introduces aprescription drug benefit under Medicare (Medicare Part D) as well as a federalsubsidy to sponsors of retiree health care benefit plans that provide a benefitthat is at least actuarially equivalent to Medicare Part D. The Company has notdetermined what, if any, impact the Act will have on its cash flows, netperiodic postretirement benefit cost, or accumulated postretirement benefitobligation, and the financial statements in this report do not reflect anyimpact of the Act. Please refer to the information contained under the caption“FSP FAS No. 106-1”, under New Accounting Standards in the Notes to theConsolidated Condensed  FinancialStatements, contained in Item 1 of this report.

 

**NewAccounting Standards:**

 

Information on newaccounting standards is included in the Notes to the ConsolidatedCondensed  Financial Statements,contained in Item 1 of this report.

 

# **RESULTS OF OPERATIONS**

# ** **

Net income for the first quarter of fiscal 2004(quarter ended December 31, 2003) was $7,905,000, or $0.71 per share,basic and diluted, compared to $6,681,000, or $0.61 per share, basic and $0.60per share diluted, for the quarter ended December 31, 2002. Primaryfactors influencing the quarterly comparisons were improved operating marginsand reductions in operating expenses.

 

# **Operating Margin**

# ** **

Operating margins by customer category for the firstfiscal quarter of fiscal years 2004 and 2003 are set forth in the followingtables:

 

**Residential and Commercial Margin**

 
|                                  |   | **First  Quarter of Fiscal** |   | **Percent  Change** |   |
|---------------------------------------|--------|------------------------------|--------|---------------------|--------|
|                                  |   | **2004**                     |   | **2003**            |   |   |
|                                  |   | **(dollars  in thousands)**  |   |                |   |
| **Degree  Days**                      |   | 2,106                        |   | 2,027               |   | 3.9 | % |
| **Average  Number of Customers**      |   |                         |   |                |   |   |   |
| Residential                           |   | 182,397                      |   | 175,176             |   | 4.1 | % |
| Commercial                            |   | 29,131                       |   | 28,619              |   | 1.8 | % |
| **Average  Therm Usage per Customer** |   |                         |   |                |   |   |   |
| Residential                           |   | 272                          |   | 257                 |   | 5.8 | % |
| Commercial                            |   | 1,252                        |   | 1,208               |   | 3.6 | % |
| **Operating  Margin**                 |   |                         |   |                |   |   |   |
| Residential                           |   | $                            | 14,056 |                | $      | 12,992 |   | 8.2 | % |
| Commercial                            |   | $                            | 7,538  |                | $      | 7,275 |   | 3.6 | % |

 

Margins from sales to residential and commercialcustomers increased $1,327,000 compared to first quarter of fiscal 2003. Growthin the number of billed customers by 7,733 contributed approximately

 

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$744,000 of the increase. The remainder of the improvement stemsprimarily from the increase in average gas consumption per customer. Theincrease in therms per customer is primarily attributed to colder weather. Theprimary use of gas by residential customers is for space heating and waterheating, therefore average consumption per customer is very sensitive toweather, particularly during the Company’s first and second fiscal quarters.Consumption by commercial customers is also sensitive to weather, but to alesser extent than residential customers because of a variety of uses inaddition to space and water heating.

 

**Oregon Earnings Sharing.** In the firstquarter of fiscal 2004, the Company recorded, as a reduction of operatingmargin, a $250,000 accrual as an estimated liability to Oregon customers underits Oregon earnings-sharing arrangement with the Oregon Public UtilityCommission. Under that arrangement, the Company is authorized to retain all ofits earnings up to a threshold level equal to the average of the annual yields,reported monthly, for five-, seven-, and ten-year US Treasury debtsecurities for the test period plus 710 basis points.  If the adjusted Oregon earnings are below the threshold, there isno rate adjustment. If the adjusted earnings are above the threshold, one-thirdof the earnings exceeding the threshold will be refunded to customers throughfuture rate reductions.

There was not a corresponding amount recorded in the first quarter offiscal 2003.

 

**Industrialand Other Margin**

 
|                                |   | **First  Quarter of Fiscal** |   | **Percent  Change** |   |
|-------------------------------------|--------|------------------------------|--------|---------------------|--------|
|                                |   | **2004**                     |   | **2003**            |   |   |
|                                |   | **(dollars  in thousands)**  |   |                |   |
| **Average  Number of Customers**    |   |                         |   |                |   |   |   |
| Electric  Generation                |   | 14                           |   | 16                  |   | -12.5 | % |
| Industrial                          |   | 745                          |   | 740                 |   | 0.7 | % |
|                                |   |                         |   |                |   |   |   |
| **Therms  Delivered (thousands)**   |   |                         |   |                |   |   |   |
| Electric  Generation                |   | 145,145                      |   | 152,213             |   | -4.6 | % |
| Industrial                          |   | 115,742                      |   | 108,156             |   | 7.0 | % |
|                                |   |                         |   |                |   |   |   |
| **Operating  Margin ($ thousands)** |   |                         |   |                |   |   |   |
| Electric  Generation                |   | $                            | 2,241  |                | $      | 2,521 |   | -11.1 | % |
| Industrial                          |   | $                            | 5,432  |                | $      | 5,294 |   | 2.6 | % |
| Gas Management  Services            |   | $                            | 1,538  |                | $      | 1,285 |   | 19.7 | % |
| Other                               |   | $                            | 139    |                | $      | 142 |   | -2.1 | % |

 

Margin derived from electric generation customersdeclined $280,000 for the quarter. The decline can be attributed to the effectsof the slow economy and weather conditions on the demand for electricity, aswell as on increased availability of hydroelectric resources in 2003. Marginfrom delivering gas to other industrial customers increased $138,000, stemmingprimarily from increased volumes of gas delivered.

 

Margin from providing gas management services to agroup of industrial customers increased $253,000 over the first quarter offiscal 2003. A significant portion of gas management service margins is derivedfrom arranging gas supplies for these customers. As these arrangements expire andnew ones are entered into, margins will fluctuate. Included in gas managementmargins for the first quarter of fiscal 2004 were $406,000 in favorablemark-to-market adjustments related to changes in the values of financialderivative contracts entered into in 2003 in the form of a cap and a swap.

 

The derivative arrangements were entered into for thepurpose of effectively fixing the price of supplies to be purchased fordelivery to gas management customers for a one-year period beginning in fiscal2004, effectively mitigating the risk associated with fluctuating market pricesof natural gas. As prescribed in FAS No. 133, the Company appliesmark-to-market accounting to these derivatives. Increases in market prices ofnatural gas cause the value of the derivative instrument to increase.Correspondingly, decreases in market prices of natural gas will cause the valueof the derivative to decrease. These increases or decreases in market value maycontinue to result in increased volatility in future earnings on aquarter-to-quarter basis, but do not change the underlying economics of thetransactions, and are not expected to result in earnings volatility over thelives of the respective contracts and the related supply agreements.

 

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**Cost ofOperations**

 

Cost of operations for the first quarter of fiscal2004, which consists of operating expenses, depreciation and amortization, andproperty and miscellaneous taxes, decreased $660,000, or 4.2% for the quarter,compared to the prior year.

 

Operating Expenses,which are primarily labor and benefits expenses, decreased $875,000 for thequarter. The primary factor contributing to this decrease was an $816,000reduction in employee benefits expenses stemming from changes to the Company’sretirement and medical plans announced in 2003. (Additional information onthese changes is contained below under “Employee Benefits Plan Changes”.) Thecomparison is also impacted by the inclusion in last year’s first quarter of a$375,000 charge for the settlement of a personal injury claim. All otherexpense categories, in the aggregate, increased $316,000, or 4.3%.

 

Employee Benefits Plan Changes. Infiscal 2003, the Company conducted a comprehensive review of its employeebenefits plans, and in the third quarter of fiscal 2003 began to implementsignificant changes to its employee retirement plan, executive retirement planand healthcare plans for both retirees and non-bargaining unit activeemployees. The changes are designed to reduce annual benefits costs by anestimated $3.0 to $3.5 million, beginning in fiscal 2004. Changes to theCompany’s medical benefits plan were made effective January 1, 2004. Thetotal changes are also designed to reduce future volatility in benefits expensesand facilitate management control over future cost increases, while retaining abenefits package management believes is competitive.

 

Some ofthe changes involve the Company’s employee retirement plan and executivesupplemental retirement plan.  As of September 30,2003 these defined benefit plans stopped accruing additional benefits.  Instead, defined contribution plans are usedfor benefits earned beginning October 1, 2003.

 

Depreciation andAmortization increased $143,000 for the quarter over lastyear, primarily as a result of increases in depreciable gas distribution systemassets.

 

Property andMiscellaneous Taxes increased $72,000 for the quarter dueprimarily to higher property taxes reflecting higher assessments associatedwith increases in gas distribution system assets.

 

# **Interest and Other Deductions – Net**

# ** **

Interest and other deductions – net, was $83,000 lowerfor the quarter, primarily stemming from higher amount of interest charged toconstruction.

 

# **LIQUIDITY AND CAPITAL RESOURCES**

# ** **

The seasonal nature of the Company’s business createsshort-term cash requirements to finance customer accounts receivable andconstruction expenditures. To provide working capital for these requirements,the Company has a $50,000,000 bank revolving credit commitment. This agreementhas an annual 0.16% commitment fee, and a term that expires inNovember 2004. The Company also has a $10,000,000 uncommitted bank creditline. As of December 31, 2003, there was $2,500,000 outstanding debt underthese credit lines.

 

To provide longer-termfinancing the Company filed an omnibus registration statement in 2001, underthe Securities Act of 1933, which provided the ability to issue up to$150,000,000 of new debt and equity securities.  Of that amount, thecompany has $110,000,000 remaining available for issuance subject to marketconditions and other factors.

 

Because of the availability of short-term credit andthe ability to issue long-term debt and additional equity, management believesit has adequate financial flexibility to meet its anticipated cash needs.

 

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# **Operating Activities**

# ** **

Net cash provided by operating activities for thequarter ended December 31, 2003 was $7,048,000, a slight increase over the$6,858,000 for the comparable period last year. The higher net income waspartially offset by negative cash flow from deferral of gas cost changes.

 

**InvestingActivities**

 

Cash used by investing activities for the quarterended December 31, 2003 was $10,216,000, compared to $5,516,000 for theprior year’s period. The increase is primarily related to $2,874,000  expenditures on a project to automate meterreading. The project began in fiscal 2003, and is expected to be completed inthe first quarter of fiscal 2005, at a total cost of approximately $16 million.Additionally, capital expenditures for expansion of the gas distribution systemare approximately $1,500,000 greater than last year.  Full fiscal 2004 capital expenditures are expected to beapproximately $35,000,000, including $10 million for the automated meterreading project.

 

**FinancingActivities**

 

Net financing activities for the quarter endedDecember 31, 2003 used $3,145,000, compared to $2,651,000 for the prioryear. The primary financing activity during both quarters was the payment ofdividends on common stock. During the first quarter of fiscal 2004, the Companypaid down outstanding debt under its bank credit line from $3,800,000 to$2,500,000. It also received $842,000 in proceeds from issuance of commonstock. In the second quarter of fiscal 2003, the Company began issuing newstock to its dividend reinvestment plan and 401(k) plans, and on exercise ofstock options. The prior practice was to use funds received to purchase sharesof stock on the open market, thus there was no cash from issuance of commonstock in the first quarter of fiscal 2003.

 

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

 

Cascade has evaluated its risk related to financialinstruments whose values are subject to market sensitivity. The Company hasfixed-rate debt obligations, but does not have derivative financial instrumentssubject to interest rate risk. Cascade makes interest and principal payments onthese obligations in the normal course of its business.

 

The Company’s purchased natural gas  has commodity prices subject to fluctuationsresulting from weather, congestion on interstate pipelines, and otherunpredictable factors. The Company’s PGA mechanisms assure the recovery of prudentlyincurred wholesale cost of gas purchased for the core market. The Companyutilizes fixed price contracts and financial derivatives to manage riskassociated with wholesale costs of gas purchased for non-core customers.

 

**Item 4: Controls and Procedures**

** **

The Company maintains controls and procedures designedto ensure that required disclosure information in reports the Company files orsubmits under the Securities Exchange Act of 1934, as amended, is recorded,processed, summarized and reported within the time period specified in the rulesand forms of the Securities and Exchange Commission.  Based upon their evaluation of these controls and procedures, asof the end of the quarter covered by this report, the Chief Executive Officerand Chief Financial Officer of the Company concluded that the Company’sdisclosure controls and procedures were effective.

 

The Company made no significant changes in itsinternal controls or in other factors that could significantly affect thosecontrols during the quarter covered by this report or subsequent to the date ofthe evaluation of those controls by the Chief Executive Officer and ChiefFinancial Officer.

 

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**FORWARD-LOOKINGSTATEMENTS**

 

Statements contained inthis report that are not historical in nature are forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995.Forward-looking statements are subject to risks and uncertainties that maycause actual future results to differ materially. Such risks and uncertaintieswith respect to the Company include, among others, its ability to successfullyimplement internal performance goals, competition from alternative forms ofenergy, consolidation in the energy industry, performance issues with keynatural gas suppliers, the capital-intensive nature of the Company’s business,regulatory issues, including the need for adequate and timely rate relief torecover increased capital and operating costs resulting from customer growthand to sustain dividend levels, the weather, increasing competition brought onby deregulation initiatives at the federal and state regulatory levels, thepotential loss of large volume industrial customers due to “bypass” or theshift by such customers to special competitive contracts at lower per-unitmargins, exposure to environmental cleanup requirements, and economicconditions, particularly in the Company’s service area.

 

 

**PART II.  Other Information**

 

**Item2.  Changes in Securities and Use ofProceeds**

 

Under the terms of its bank credit agreement, theCompany is required to maintain a minimum tangible net worth of $107,406,000 asof December 31, 2003. Under this agreement, approximately $19,168,000 wasavailable for payment of dividends at December 31, 2003.

 

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

** **

At the annual meeting of shareholders on January 28, 2004, thefollowing directors were elected by the vote indicated for terms of officeexpiring in 2005:

 
|                |   | **For**   |   | **Withheld** |   |
|---------------------|--------|-----------|--------|--------------|--------|
|                |   |      |   |         |   |
| Pirkko H.  Borland  |   | 8,897,752 |   | 264,569      |   |
| Carl Burnham,  Jr.  |   | 8,923,647 |   | 238,674      |   |
| Thomas E. Cronin    |   | 8,905,169 |   | 257,152      |   |
| David A. Ederer     |   | 8,925,118 |   | 237,203      |   |
| W. Brian  Matsuyama |   | 8,912,386 |   | 249,935      |   |
| Larry L. Pinnt      |   | 8,976,176 |   | 298,087      |   |
| Mary Pugh           |   | 8,914,045 |   | 248,276      |   |
| Brooks G. Ragen     |   | 8,891,591 |   | 270,730      |   |
| Douglas G.  Thomas  |   | 8,913,988 |   | 248,333      |   |

 

In addition, a proposal to approve an increase in thenumber of shares of Common Stock available for issuance under the Company’s2000 Director Stock Award Plan by 35,000 shares was approved by a vote of5,323,991 for, and 963,864 against.

 

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**Item 5.  Other Information**

 

Ratio of Earnings to Fixed Charges:

 
| **Twelve  Months Ended** |   |
|--------------------------|--------|
| **12/31/2003**           |   | **9/30/2003** |   | **9/30/2002** |   | **9/30/2001** |   | **9/30/2000** |   | **9/30/1999** |   |
|                     |   |   |   |   |   |   |   |   |   |   |   |
| 2.20                     |   | 2.06 |   | 2.27 |   | 3.39 |   | 3.12 |   | 3.00 |   |
|                          |        |  |  |  |  |  |  |  |  |  |  |  |

 

For purposes of this calculation, earnings includeincome before income taxes, plus fixed charges. Fixed charges include interestexpense and the amortization of debt issuance expenses. Refer to Exhibit 12 forthe calculation of these ratios, as well as the ratio of earnings to fixedcharges including preferred dividends.

 

# **Item6.  Exhibits and Reports on Form 8-K**

# ** **

a. Exhibits:

 
| **No.** |   | **Description**                                                                                                                    |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                               |
| 12      |   | Computation of Ratio of Earnings to Fixed Charges                                                                                  |
|    |   |                                                                                                                               |
| 31      |   | Certification 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 |

 

b. Reports on Form 8-K:

 

On November 17, 2003, theCompany furnished a Report on Form 8-K dated November 10, 2003, to providethe information contained in its November 10 release of fourth quarter andfull fiscal year 2003 earnings.

 

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**SIGNATURE**

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
| **CASCADE NATURAL GAS CORPORATION** |
|-------------------------------------|
|                                |
|                                |
| By:                                 | /s/  J. D.   Wessling |   |
|                                |   |   |
|                                | J. D. Wessling |   |
|                                | Chief Financial Officer |   |
|                                | (Principal Financial  Officer) |   |
|                                |   |   |
|                                |   |   |
| Date:                               | February 9, 2004 |   |

 

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