**FORM10-Q**

** **

**SECURITIESAND 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 June 30, 2004**

** **

**Commissionfile number: 1-7196**

 

**CASCADENATURAL GAS CORPORATION**

(Exact name of Registrantas 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 the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes  ý      No o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 23b-2 of the ExchangeAct).   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 |       | 11,245,757 as of  July 30, 2004 |

 

 

----

 

**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 5. Other Information                                                                                  |                                                  |
|      |                                                                                                       |                                                  |
|      | Item  6. Exhibits and Reports on Form 8-K                                                                  |                                                  |
|      |                                                                                                       |                                                  |   |
| Signature |                                                                                                       |                                                  |   |
|           |                                                                                                            |                                                       |  |  |  |

 

2

----

 

# **PART I.   Financial Information**

# ** **

**Item 1.**  FinancialStatements

** **

**CASCADENATURAL GAS CORPORATION**

**CONSOLIDATEDCONDENSED STATEMENTS OF INCOME**

**(unaudited)**

 
| ** **                                  | ** ** | **THREE MONTHS ENDED**                | ** ** | **NINE MONTHS ENDED** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **Jun 30, 2004**                      | ** ** | **Jun 30, 2003**      | ** ** | **Jun 30, 2004** | ** ** | **Jun 30, 2003** | ** ** |
| ** **                                  | ** ** | ** **                            | ** ** | ** **            | ** ** | **(Restated  See Note 1)** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **(thousands except per share data)** | ** ** |
|                                        |       |                                  |       |                  |       |   |   |   |   |
| Operating  revenues                         |       | $                                     | 52,077     |                  | $          | 53,793 |   | $ | 276,416 |   | $ | 263,575 |   |
|                                        |       |                                  |       |                  |       |   |   |   |   |
| Less: Gas  purchases                        |       | 31,896                                |       | 32,652                |       | 178,019 |   | 169,481 |   |
| Revenue taxes                               |       | 3,544                                 |       | 3,813                 |       | 18,924 |   | 17,610 |   |
| Operating margin                            |       | 16,637                                |       | 17,328                |       | 79,473 |   | 76,484 |   |
|                                        |       |                                  |       |                  |       |   |   |   |   |
| Cost of  operations:                        |       |                                  |       |                  |       |   |   |   |   |
| Operating  expenses                         |       | 9,729                                 |       | 12,465                |       | 30,656 |   | 34,601 |   |
| Depreciation and  amortization              |       | 4,026                                 |       | 3,846                 |       | 11,882 |   | 11,466 |   |
| Property and  miscellaneous taxes           |       | 941                                   |       | 938                   |       | 2,748 |   | 2,720 |   |
|                                        |       | 14,696                                |       | 17,249                |       | 45,286 |   | 48,787 |   |
|                                        |       |                                  |       |                  |       |   |   |   |   |
| Income from  operations                     |       | 1,941                                 |       | 79                    |       | 34,187 |   | 27,697 |   |
| Less interest  and other deductions - net   |       | 3,099                                 |       | 3,197                 |       | 9,337 |   | 9,508 |   |
| Income (loss)  before income taxes          |       | (1,158                                | )          | (3,118                | )          | 24,850 |   | 18,189 |   |
|                                        |       |                                  |       |                  |       |   |   |   |   |
| Income taxes                                |       | (492                                  | )          | (1,138                | )          | 8,943 |   | 6,639 |   |
| Net Income  (Loss)                          |       | $                                     | (666       | )                     | $          | (1,980 | ) | $ | 15,907 |   | $ | 11,550 |   |
|                                        |       |                                  |       |                  |       |   |   |   |   |
| Weighted average  common shares outstanding |       | 11,227                                |       | 11,086                |       | 11,193 |   | 11,063 |   |
|                                        |       |                                  |       |                  |       |   |   |   |   |
| Net earnings  (loss) per common share       |       |                                  |       |                  |       |   |   |   |   |
| Basic                                       |       | $                                     | (0.06      | )                     | $          | (0.18 | ) | $ | 1.42 |   | $ | 1.04 |   |
| Diluted                                     |       | $                                     | (0.06      | )                     | $          | (0.18 | ) | $ | 1.42 |   | $ | 1.04 |   |
|                                        |       |                                  |       |                  |       |   |   |   |   |
| Cash dividends  per share                   |       | $                                     | 0.24       |                  | $          | 0.24 |   | $ | 0.72 |   | $ | 0.72 |   |

 

The accompanyingnotes are an integral part of these financial statements

 

3

----

 

**CASCADENATURAL GAS CORPORATION**

**CONSOLIDATEDCONDENSED BALANCE SHEETS**

(Dollars in Thousands)

** **
| ** **                                                                                                              | ** ** | **Jun 30, 2004** | ** ** | **Sep 30, 2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                              | ** ** | **(Unaudited)**  | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                              |       |             |       |             |       |
| Utility Plant,  net of accumulated depreciation of $239,530 and $227,582                                                |       | $                | 316,619    |             | $          | 302,225 |   |
| Construction  work in progress                                                                                          |       | 12,938           |       | 10,078           |       |
|                                                                                                                    |       | 329,557          |       | 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                                                                                              |       | 562              |       | 7,452            |       |
| Accounts  receivable and current maturities of notes receivable, less allowance of $946  and $877 for doubtful accounts |       | 19,213           |       | 12,296           |       |
| Materials,  supplies and inventories                                                                                    |       | 11,866           |       | 14,737           |       |
| Prepaid expenses  and other assets                                                                                      |       | 7,946            |       | 6,144            |       |
| Deferred income  taxes                                                                                                  |       | 911              |       | 755              |       |
|                                                                                                                    |       | 40,498           |       | 41,384           |       |
| Deferred Charges                                                                                                        |       |             |       |             |       |
| Gas cost changes                                                                                                        |       | 9,288            |       | 11,584           |       |
| Other                                                                                                                   |       | 7,668            |       | 5,931            |       |
|                                                                                                                    |       | 16,956           |       | 17,515           |       |
|                                                                                                                    |       |             |       |             |       |
|                                                                                                                    |       | $                | 387,262    |             | $          | 371,456 |   |

 

4

----

 

**CASCADE NATURAL GAS CORPORATION**

**CONSOLIDATED CONDENSED BALANCE SHEETS (Continued)**

(Dollarsin Thousands)

 
| ** **                                                                                                                    | ** ** | **Jun 30, 2004** | ** ** | **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  11,240,716 and 11,131,860 shares |       | $                | 11,241     |             | $          | 11,132 |   |
| Additional  paid-in capital                                                                                                   |       | 100,837          |       | 98,877           |       |
| Accumulated  other comprehensive income (loss)                                                                                |       | (13,430          | )          | (13,430          | )          |
| Retained  earnings                                                                                                            |       | 23,811           |       | 15,981           |       |
|                                                                                                                          |       | 122,459          |       | 112,560          |       |
|                                                                                                                          |       |             |       |             |       |
| Long-term Debt                                                                                                                |       | 133,930          |       | 142,930          |       |
|                                                                                                                          |       |             |       |             |       |
| Current  Liabilities:                                                                                                         |       |             |       |             |       |
| Notes payable  and commercial paper                                                                                           |       | 1,000            |       | 3,800            |       |
| Current  maturities of long-term debt                                                                                         |       | 31,000           |       | 22,000           |       |
| Accounts payable                                                                                                              |       | 14,644           |       | 10,501           |       |
| Property,  payroll and excise taxes                                                                                           |       | 4,996            |       | 5,387            |       |
| Dividends and  interest payable                                                                                               |       | 5,504            |       | 7,884            |       |
| Other current  liabilities                                                                                                    |       | 8,654            |       | 6,431            |       |
|                                                                                                                          |       | 65,798           |       | 56,003           |       |
|                                                                                                                          |       |             |       |             |       |
| Deferred Credits  and Other Liabilities                                                                                       |       | 65,075           |       | 59,963           |       |
|                                                                                                                          |       |             |       |             |       |
| Commitments and  Contingencies                                                                                                |       | —           |       | —           |       |
|                                                                                                                          |       | $                | 387,262    |             | $          | 371,456 |   |

 

The accompanyingnotes are an integral part of these financial statements

 

5

----

 

**CASCADENATURAL GAS CORPORATION**

**CONSOLIDATEDCONDENSED STATEMENTS OF CASH FLOWS**

(Unaudited)

 
| ** **                                                                         | ** ** | **NINE MONTHS ENDED**      | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                         | ** ** | **(dollars in thousands)** | ** ** |
| ** **                                                                         | ** ** | **Jun 30, 2004**           | ** ** | **Jun 30, 2003** | ** ** |
| ** **                                                                         | ** ** | **(Restated  See Note 1)** | ** ** | ** ** | ** ** |
| Operating  Activities                                                              |       |                       |       |   |   |
| Net income                                                                         |       | $                          | 15,907     |   | $ | 11,550 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                       |       |   |   |
| Depreciation and  amortization                                                     |       | 11,882                     |       | 11,466 |   |
| Deferrals of gas  cost changes                                                     |       | (3,378                     | )          | 3,391 |   |
| Amortization of  gas cost changes                                                  |       | 5,674                      |       | 5,268 |   |
| Other deferrals  and amortizations                                                 |       | (453                       | )          | 2,692 |   |
| Deferred income  taxes and tax credits - net                                       |       | 3,982                      |       | 1,992 |   |
| Change in  current assets and liabilities                                          |       | (2,252                     | )          | 2,595 |   |
| Net cash  provided by operating activities                                         |       | 31,362                     |       | 38,954 |   |
|                                                                               |       |                       |       |   |   |
| Investing  Activities                                                              |       |                       |       |   |   |
| Capital  expenditures                                                              |       | (29,762                    | )          | (17,553 | ) |
| Customer  contributions in aid of construction                                     |       | 318                        |       | 713 |   |
| Other                                                                              |       | —                     |       | 10 |   |
| Net cash used by  investing activities                                             |       | (29,444                    | )          | (16,830 | ) |
|                                                                               |       |                       |       |   |   |
| Financing  Activities                                                              |       |                       |       |   |   |
| Proceeds from  issuance of common stock                                            |       | 2,070                      |       | 1,041 |   |
| Changes in notes  payable and commercial paper, net                                |       | (2,800                     | )          | — |   |
| Dividends paid                                                                     |       | (8,078                     | )          | (7,974 | ) |
| Net cash used by  financing activities                                             |       | (8,808                     | )          | (6,933 | ) |
|                                                                               |       |                       |       |   |   |
| Net Increase  (Decrease) in Cash and Cash Equivalents                              |       | (6,890                     | )          | 15,191 |   |
|                                                                               |       |                       |       |   |   |
| Cash and Cash  Equivalents                                                         |       |                       |       |   |   |
| Beginning of  year                                                                 |       | 7,452                      |       | 3,688 |   |
| End of period                                                                      |       | $                          | 562        |   | $ | 18,879 |   |

 

The accompanying notes are an integral part of these financial statements

 

6

----

 

**CASCADE NATURAL GASCORPORATION**

**NOTES TO CONSOLIDATED CONDENSEDFINANCIAL STATEMEN****TS**

## **THREE- AND NINE-MONTH PERIODS ENDED JUNE 30, 2004**

## ** **

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”.

 

**Note 1.****Restatement and Reclassifications**

 

The Company has restated its earnings for the quarterended March 31, 2004 as a result of the remeasurement of retiree medicalexpense, with a remeasurement date of December 31, 2003. This remeasurement,reducing operating expenses by $158,000, is described in Note 2 under thecaption “FSP FAS Nos. 106-1 and 106-2”. The following table sets forth thereported and restated amounts for the quarter ended March 31, 2004.

 
| ** **           | ** ** | **Quarter Ended  March 31, 2004**      | ** ** | **Six Months Ended  March 31, 2004** | ** ** |
|----------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **           | ** ** | **(thousands except per-share data )** | ** ** |
| ** **           | ** ** | **As Reported**                        | ** ** | **As Restated**                      | ** ** | **As Reported** | ** ** | **As Restated** | ** ** |
| Operating  Expenses  |       | $                                      | 10,807     |                                 | $          | 10,649 |   | $ | 21,085 |   | $ | 20,927 |   |
| Net Income           |       | $                                      | 8,511      |                                 | $          | 8,669 |   | $ | 16,415 |   | $ | 16,573 |   |
| Earnings Per  Share, |       |                                   |       |                                 |       |   |   |   |   |
| Basic and  Diluted   |       | $                                      | 0.76       |                                 | $          | 0.77 |   | $ | 1.47 |   | $ | 1.48 |   |

 

The restatement reduces Other Liabilities by $158,000as of March 31, 2004.

 

Certain reclassifications have been made in thefinancial statements for the quarter and year-to-date periods ended June 30,2003 to conform to the classifications used in fiscal 2004.

 

# **Note 2.**New Accounting Standards

# ** **

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

 

In December 2003,the Financial Accounting Standards Board (FASB) issued FAS No. 132 (revised2003), “Employers’ Disclosures about Pensions and Other PostretirementBenefits.”  This statement requires expanded disclosures with respect topension plan assets, benefit obligations, cash flows, benefit costs and otherrelevant information.  However, this statement does not change themeasurement and recognition provisions of previous FASB statements related topensions and other postretirement benefits.  The Company was required toadopt this statement during the quarter ended March 31, 2004.  Theadoption of this statement did not have any effect on the Company’s financialstatements.  The expanded disclosures required by this statement areincluded in Note 4.

 

7

----

 

**FSP FASNos. 106-1 and 106-2**

** **

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 provided guidance permitting asponsor of a postretirement health care plan that provides a prescription drugbenefit to make a one-time election to defer accounting for the effects of theMedicare Prescription Drug, Improvement and Modernization Act of 2003 (theAct). At that time the Company made such an election. The Act, signed into lawby President Bush on December 8, 2003, introduces a prescription drug benefitunder Medicare (Medicare Part D) as well as a federal subsidy to sponsors ofretiree health care benefit plans that provide a benefit that is at leastactuarially equivalent to Medicare Part D.

 

In May 2004, the FASB issued *FSP FAS No. 106-2*, superseding *FSP No. FAS 106-1.* This standard applies tosponsors of single-employer defined benefit postretirement health care plansfor which (a) the employer has concluded that prescription drug benefitsavailable under the plan to some or all participants for some or all futureyears are “actuarially equivalent” to Medicare Part D and thus qualify for thesubsidy under the Act, and (b) the expected subsidy will offset or reduce theemployer’s share of the cost of the underlying postretirement prescription drugcoverage on which the subsidy is based.

 

This FSP is effective for the first interim or annualperiod beginning after June 15, 2004, with earlier adoption permitted. TheCompany has concluded that prescription drug benefits available under the planto some or all participants for some or all future years are “actuariallyequivalent” to Medicare Part D and thus qualify for the subsidy under the Act,and elected to remeasure its postretirement medical expense for fiscal year2004, with a remeasurement date of December 31, 2003. The result of theremeasurement is a reduction of retiree medical expense applicable to thesecond, third, and fourth fiscal quarters of $475,000, with $158,000 of the reductionapplicable to each quarter. Because of the remeasurement, and as prescribed inthe FSP, the Company has restated its earnings for the quarter ended March 31,2004. Additional information on the restatement is included in Note 1. Furtherinformation regarding postretirement medical benefits is included in Note 4.

 

**FIN 46**

 

In January 2003, the FASB issuedInterpretation No. 46, “Consolidation of Variable Interest Entities,” which wasrevised in December 2003 (collectively referred to as FIN 46). Variableinterest entities are commonly referred to as special purpose entities oroff-balance sheet structures. FIN 46 requires a variable interest entity to beconsolidated by the primary beneficiary of that entity. The primary beneficiaryis subject to a majority of the risk of loss from the variable interestentity’s activities or it is entitled to receive a majority of the entity’sresidual returns. The Company does not have any variable interest entitiesand adoption of FIN 46 did not have any effect on the Company’s financialstatements.

 

8

----

 

**Note 3.****Earnings Per Share**

 

The following table sets forth the calculation ofearnings per share.

 
| ** **                                               | ** ** | **Three Months Ended June 30**           | ** ** | **Nine Months Ended June 30** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------|------------|-------------------------------|------------|
| ** **                                               | ** ** | **2004**                                 | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                               | ** ** | ** **                               | ** ** | ** **                    | ** ** | **(Restated  See Note 1)** | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **(in thousands except per-share data)** | ** ** |
|                                                     |       |                                     |       |                          |       |   |   |   |   |
| Net income (loss)                                        |       | $                                        | (666       | )                             | $          | (1,980 | ) | $ | 15,907 |   | $ | 11,550 |   |
|                                                     |       |                                     |       |                          |       |   |   |   |   |
| Weighted average shares outstanding                      |       | 11,227                                   |       | 11,086                        |       | 11,193 |   | 11,063 |   |
| Basic earnings (loss) per share                          |       | $                                        | (0.06      | )                             | $          | (0.18 | ) | $ | 1.42 |   | $ | 1.04 |   |
|                                                     |       |                                     |       |                          |       |   |   |   |   |
| Weighted average shares outstanding                      |       | 11,227                                   |       | 11,086                        |       | 11,193 |   | 11,063 |   |
| Plus:  Issued on assumed  exercise of stock options |       | 13                                       |       | 16                            |       | 14 |   | 17 |   |
| Weighted average shares outstanding assuming dilution    |       | 11,240                                   |       | 11,102                        |       | 11,207 |   | 11,080 |   |
|                                                     |       |                                     |       |                          |       |   |   |   |   |
| Diluted earnings (loss) per share                        |       | $                                        | (0.06      | )                             | $          | (0.18 | ) | $ | 1.42 |   | $ | 1.04 |   |

 

9

----

 

**Note 4.****Retirement Plan Information**

 

The following table setsforth the components of net periodic benefit costs recognized in the three-andnine-month periods ended June 30, 2004 and 2003.

 

**NetPeriodic Benefits Cost**

 
| ** **                                       | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **Jun 30, 2004**           | ** ** | **Jun 30, 2003**      | ** ** | **Jun 30, 2004** | ** ** | **Jun 30, 2003** | ** ** |
| ** **                                       | ** ** | **(Thousands of Dollars)** | ** ** |
| **DEFINED  BENEFIT PENSION PLANS**               |       |                       |       |                  |       |   |   |   |   |
| Service cost                                     |       | $                          | 192        |                  | $          | 346 |   | $ | 576 |   | $ | 1,223 |   |
| Interest cost                                    |       | 932                        |       | 932                   |       | 2,796 |   | 2,819 |   |
| Expected return  on plan assets                  |       | (978                       | )          | (942                  | )          | (2,935 | ) | (2,785 | ) |
| Amortization of  unrecognized                    |       |                       |       |                  |       |   |   |   |   |
| transition  obligation                           |       | —                     |       | 8                     |       | — |   | 58 |   |
| Recognized gains  or losses                      |       | 349                        |       | 295                   |       | 1,048 |   | 856 |   |
| Prior service  cost                              |       | 57                         |       | 78                    |       | 172 |   | 305 |   |
| Curtailment loss                                 |       | —                     |       | 1,451                 |       | — |   | 1,451 |   |
| Net Periodic  Benefit Cost Recognized            |       | $                          | 552        |                  | $          | 2,168 |   | $ | 1,657 |   | $ | 3,927 |   |
|                                             |       |                       |       |                  |       |   |   |   |   |
| **POSTRETIREMENT  BENEFITS OTHER THAN PENSIONS** |       |                       |       |                  |       |   |   |   |   |
| Service cost                                     |       | $                          | 39         |                  | $          | 125 |   | $ | 121 |   | $ | 421 |   |
| Interest cost                                    |       | 308                        |       | 517                   |       | 963 |   | 1,702 |   |
| Expected return  on plan assets                  |       | (217                       | )          | (184                  | )          | (636 | ) | (546 | ) |
| Amortization of  unrecognized                    |       |                       |       |                  |       |   |   |   |   |
| transition  obligation                           |       | 164                        |       | 164                   |       | 493 |   | 493 |   |
| Recognized gains  or losses                      |       | 234                        |       | 311                   |       | 799 |   | 881 |   |
| Prior service  cost                              |       | (366                       | )          | (139                  | )          | (1,097 | ) | (175 | ) |
| Net Periodic  Benefit Cost Recognized            |       | $                          | 162        |                  | $          | 794 |   | $ | 643 |   | $ | 2,776 |   |
|                                             |       |                       |       |                  |       |   |   |   |   |
| **DEFINED  CONTRIBUTION PENSION PLAN**           |       |                       |       |                  |       |   |   |   |   |
| Net Periodic  Benefit Cost Recognized            |       | $                          | 242        |                  | $          | — |   | $ | 729 |   |   |   |

 

**RetirementPlan Changes**

** **

The comparability of the amounts in the above table isaffected by changes in the Company’s retirement plans for non-bargaining unitemployees announced in the third quarter of fiscal 2003 as part of acomprehensive review of its employee benefit plans.

 

Effective October 1, 2003, no additional benefitsaccrue under the defined benefit pension plans for the affected employees.Subsequent benefits are in the form of contributions to the existing 401(k)Plan. In addition to the existing match for employee contributions the Companycontributes 4% of eligible salaries, and a 1% to 4% transition contribution, toemployee retirement accounts. Additionally there will be annually determined“profit-sharing” contributions dependent on the Company achieving establishedtargets.

 

The Company’s health care plan provides PostretirementBenefits Other than Pensions (PBOP), consisting of medical and prescriptiondrug benefits, to its retired employees hired prior to June 1, 1992, and theireligible dependents. Changes to this plan, announced in 2003, provide for theaddition of participant contributions which began January 1, 2004.

 

10

----

 

**RetirementPlan Funding**

** **

For the nine months ended June 30, 2004, $3,168,000 ofcontributions have been made to the Company’s definedbenefit pension plans. The Company presently anticipates contributing anadditional $675,000 to fund its pension plans for a total of $3,843,000 infiscal 2004.

 

### **Note5.**Stock-Based Compensation

### ** **

**The Company follows the disclosure-only provisionsof FAS No. 123, “Accounting for Stock-Based Compensation.”  Accordingly, employee stock options areaccounted for under Accounting Principle Board Opinion (APB) No. 25,“Accounting for Stock Issued to Employees.” Stock options are granted at exercise prices not less than the fairvalue of common stock on the date of grant. Under APB No. 25, no compensation expense is recognized related to theCompany’s stock option plans.  Ifcompensation expense for the Company’s stock option plans were determinedconsistent with SFAS No. 123, net income and earnings per common share wouldhave been the following pro forma amounts for the three- and nine-month periodsended June 30:**

** **
| ** **                                                                                                | ** ** | **Three Months Ended**                   | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                | ** ** | **Jun 30, 2004**                         | ** ** | **Jun 30, 2003**      | ** ** | **Jun 30, 2004** | ** ** | **Jun 30, 2003** | ** ** |
| ** **                                                                                                | ** ** | **(in thousands except per-share data)** | ** ** |
| Net income  (loss)                                                                                        |       |                                     |       |                  |       |   |   |   |   |
| As reported                                                                                               |       | $                                        | (666       | )                     | $          | (1,980 | ) | $ | 15,907 |   | $ | 11,550 |   |
| Less total  stock-based employee compensation expense determined under the fair value  method, net of tax |       | $                                        | 13         |                  | 27         |   | 40 |   | 82 |   |
| Pro forma net  income (loss)                                                                              |       | $                                        | (679       | )                     | $          | (2,007 | ) | $ | 15,867 |   | $ | 11,468 |   |
|                                                                                                      |       |                                     |       |                  |       |   |   |   |   |
| Earnings (loss)  per share                                                                                |       |                                     |       |                  |       |   |   |   |   |
| As reported,  basic and diluted                                                                           |       | $                                        | (0.06      | )                     | $          | (0.18 | ) | $ | 1.42 |   | $ | 1.04 |   |
| Pro forma, basic                                                                                          |       | $                                        | (0.06      | )                     | $          | (0.18 | ) | $ | 1.42 |   | $ | 1.04 |   |
| Pro forma,  diluted                                                                                       |       | $                                        | (0.06      | )                     | $          | (0.18 | ) | $ | 1.42 |   | $ | 1.03 |   |

 

**Note 6.****Commitments and Contingencies**

 

# **EnvironmentalMatters**

# ** **

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 been immaterial.

 

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 to

 

11

----

 

estimatethe potential liability associated with this claim. The party who originallymade 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 theWashington Utilities and Transportation Commission (WUTC) and the Oregon PublicUtilities Commission (OPUC) have previously allowed regulated utilities toincrease customer rates to recover similar costs.

 

# **Litigation andOther Contingencies**

# ** **

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

 

In the fourth quarter of fiscal 2002 a fatal accident occurred involving facilities owned by the Company, locatedon the property of one of the Company’s commercial customers. In fiscal 2003 asettlement of all plaintiffs’ claims was agreed to in consideration of a$750,000 payment. The Company and the property owner have each paid $375,000and have agreed to resolve the allocation of the total settlement paymentbetween 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 Analysis ofFinancial 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- and nine-month periods ended June 30,2004 and June 30, 2003.

 

# **OVERVIEW**

# ** **

The Company is a localdistribution company (LDC) serving approximately 215,000 customers in theStates of Washington and Oregon. Its service area consists primarily ofrelatively small cities and rural communities rather than larger urban areas.The Company’s primary source of revenue and operating margin is thedistribution of natural gas to end-use residential, commercial, industrial, andinstitutional 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 the WUTC and theOPUC.

 

Key elements of the Company’s strategy include:

•                  Remain focusedon the natural gas distribution business.

•                  Achieve earningsgrowth through expansion of its customer base and operating efficiencies ratherthan seek rate increases to recover increased costs.

 

## **Opportunities and Challenges**

## ** **

The Company operates in a diverse service territoryover a wide geographic area relative to the Company’s overall size and numberof customers. The economies of various parts of the

 

12

----

 

servicearea are supported by a variety of industries, and are affected by theconditions that impact those industries.

 

Management believes there are growth opportunities inthe Company’s service area.   Factorscontributing to these opportunities include low market penetration in many ofthe towns served, and general population growth in the service area, includingsome areas of rapid growth.

 

Rates charged by theCompany for its utility services are regulated by the WUTC and the OPUC.  The Company’s basic business strategy is tominimize reliance on rate increases for earnings growth.  However, realization of risks affectingearnings could require the Company to seek approval of higher rates.  The results of such rate requests are subjectto uncertainties associated with the regulatory process.

 

The Company earns morethan one third of its operating margin from industrial and electric generationcustomers. Loss of a major industrial customer, or unfavorable conditions affectingan industry segment, could have a significant detrimental impact on theCompany’s earnings. Many external factors over which the Company has no controlcan significantly impact the amount of gas consumed by industrial and electricgeneration customers, and consequently the margins earned by the Company.

 

Revenues and margins from the Company’s residentialand small commercial customers are highly weather sensitive. In a cold year,the Company’s earnings are boosted by the effects of the weather, andconversely in a warm year, the Company’s earnings suffer. The Company continuesto explore alternatives such as weather normalization mechanisms that utilityregulators in many jurisdictions have approved, to reduce weather relatedvolatility in earnings and in customers’ bills.

 

Overall revenues and margins are also negativelyimpacted by customers taking measures to reduce energy usage.  The increasing cost of energy in recentyears, including the wholesale cost of natural gas, continues to encourage suchmeasures.

 

The Company enters into various seasonal and annualgas supply contracts designed to match the load requirements of its customers.Interstate pipelines provide natural gas to the Company from production areasin the Rocky Mountain states and from western Canada.Management believes gas supply resources in those areas are adequate to servethe Company’s current needs and to support future growth.  The wholesale price of gas in the region hasincreased in recent years, paralleling national trends.  Additionally, a favorable differential thathas historically existed between Pacific Northwest gas prices and nationalprices has narrowed as new pipelines have increased access to Rocky Mountainand Canadian supplies by California and mid-west markets.

 

To mitigate price volatility the Company has in thepast relied primarily on three year fixed-price physical gas supply contractswith its suppliers. Due to the continued volatility of the price of natural gasand the increased business risk associated with the potential for supplierfailure, the company is currently implementing a new gas procurement strategyfor core customers for supplies to be delivered in fiscal year 2005 andbeyond.  The company has entered intophysical gas supply contracts with suppliers at published first-of-the-monthindex prices for up to five-year terms. To mitigate the price volatility, these index related supplies will be converted tofixed-price physical contracts with suppliers or hedged through the use ofderivatives, primarily swaps, with financial institutions.  The company plans to have 90% of the coremarket’s requirement for fiscal 2005, 60% of fiscal 2006, and 30% of fiscal2007 secured with fixed prices by the end of fiscal 2004. To minimize earningsvolatility, the company received accounting orders from the WUTC and the OPUCto apply FAS No. 71 to periodic

 

13

----

 

changesin fair market value of derivatives associated with supplies for core customersand records such changes in regulatory asset and regulatory liability accounts.The accounting orders permit the recognition of settlement of these contractsand financial instruments in the Company’s normal purchased gas adjustmentprocess.

 

# **RESULTS OF OPERATIONS**

# ** **

The Company reported a $666,000 net loss, or $0.06 pershare, basic and diluted for the fiscal 2004 third quarter  (quarter ended June 30, 2004),compared to a $1,980,000 net loss, or $0.18 per share, basic and diluted, forthe quarter ended June 30, 2003. Primary factors influencing the quarterlycomparisons were:

 

•                  Recognition in2003 of retirement plans curtailment losses.

•                  2004 reductionsin employee benefit expenses from plan changes and the favorable impact of theMedicare prescription drug subsidy.

•                  Addition of new customers.

 

Partially offsetting these factorswere lower margins from customers related to lower per-customer gas use.

 

On ayear-to-date basis, as restated, basic and diluted earnings per share improved37%, to $1.42 from $1.04, on net income of $15,907,000, compared to$11,550,000. The year-to-date comparisons were influenced by similar factors tothe third quarter comparisons as well as improved margins in 2004 fromresidential, commercial, and industrial customers, and charges in fiscal 2003of $375,000 for a claim settlement, and $865,000 for a gas supply contracttermination.

 

# **Operating Margin**

# ** **

Operating margins by customer category for the thirdquarter and year-to-date periods of fiscal years 2004 and 2003 are set forth inthe following tables:

 

**Residentialand Commercial Margin**

 
| ** **                             | ** ** | **Three Months Ended June 30** | ** ** | **Percent** | ** ** | **Nine Months Ended June 30** | ** ** | **Percent** | ** ** |
|----------------------------------------|------------|--------------------------------|------------|-------------|------------|-------------------------------|------------|-------------|------------|
| ** **                             | ** ** | **2004**                       | ** ** | **2003**    | ** ** | **Change**                    | ** ** | **2004**    | ** ** | **2003** | ** ** | **Change** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)**     | ** ** | ** **  | ** ** | **(dollars in thousands)**    | ** ** | ** **  | ** ** |
| **Degree Days**                        |       |                           |       |        |       |                          |       |        |       |   |   |   |   |
| Actual                                 |       | 661                            |       | 826         |       | -20.0                         | %          | 5,015       |       | 4,902 |   | 2.3 | % |
| 5-Year Average                         |       | 874                            |       | 871         |       |                          |       | 5,193       |       | 5,185 |   |   |   |
| **Average Number of Customers Billed** |       |                           |       |        |       |                          |       |        |       |   |   |   |   |
| Residential                            |       | 185,584                        |       | 177,978     |       | 4.3                           | %          | 185,114     |       | 177,246 |   | 4.4 | % |
| Commercial                             |       | 29,471                         |       | 28,984      |       | 1.7                           | %          | 29,422      |       | 28,903 |   | 1.8 | % |
| **Average Therm Usage per Customer**   |       |                           |       |        |       |                          |       |        |       |   |   |   |   |
| Residential                            |       | 97                             |       | 114         |       | -14.9                         | %          | 654         |       | 638 |   | 2.5 | % |
| Commercial                             |       | 536                            |       | 591         |       | -9.3                          | %          | 3,223       |       | 3,078 |   | 4.7 | % |
| **Operating Margin**                   |       |                           |       |        |       |                          |       |        |       |   |   |   |   |
| Residential                            |       | $                              | 6,299      |        | $          | 6,945                         |       | -9.3        | %          | $ | 35,533 |   | $ | 33,485 |   | 6.1 | % |
| Commercial                             |       | $                              | 3,414      |        | $          | 3,786                         |       | -9.8        | %          | $ | 19,602 |   | $ | 18,661 |   | 5.0 | % |

 

Residential and commercial operating margin for thethird quarter decreased $1,018,000. Lower gas use bycustomers, related to 20% warmer weather, depressed margins by approximately$1,439,000. This reduction was partially offset by $406,000 highermargin resulting from the addition of 8,093 more residential and commercialcustomers. The primary use of gas by residential customers is for space heatingand water heating, therefore average consumption percustomer is very sensitive to weather, particularly during the Company’s firstand second fiscal quarters, but also during the third quarter. Consumption bycommercial customers is also sensitive to weather. The sensitivity is moredifficult to isolate and measure

 

14

----

 

thanfor residential customers because of a variety of uses in addition to space andwater heating. The combined growth rate for residential and commercialcustomers was 3.9%, more than two times the national average for natural gasdistribution companies.

 

Of the $2,989,000 increase in year-to-date residentialand commercial margins, approximately $2,073,000 resulted from the addition ofnew customers and the remainder is primarily from higher per-customerconsumption earlier in the fiscal year.

 

**Industrial and Other Margin**

 
| ** **                        | ** ** | **Three Months Ended June 30** | ** ** | **Percent** | ** ** | **Nine Months Ended June 30** | ** ** | **Percent** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|-------------|------------|-------------------------------|------------|-------------|------------|
| ** **                        | ** ** | **2004**                       | ** ** | **2003**    | ** ** | **Change**                    | ** ** | **2004**    | ** ** | **2003** | ** ** | **Change** | ** ** |
| ** **                        | ** ** | **(dollars in thousands)**     | ** ** | ** **  | ** ** | **(dollars in thousands)**    | ** ** | ** **  | ** ** |
| **Average  Number of Customers**  |       |                           |       |        |       |                          |       |        |       |   |   |   |   |
| Electric  Generation              |       | 14                             |       | 14          |       | 0.0                           | %          | 14          |       | 14 |   | 0.0 | % |
| Industrial                        |       | 736                            |       | 737         |       | -0.1                          | %          | 740         |       | 739 |   | 0.1 | % |
|                              |       |                           |       |        |       |                          |       |        |       |   |   |   |   |
| **Therms  Delivered (thousands)** |       |                           |       |        |       |                          |       |        |       |   |   |   |   |
| Electric  Generation              |       | 88,586                         |       | 86,769      |       | 2.1                           | %          | 342,404     |       | 383,877 |   | -10.8 | % |
| Industrial                        |       | 93,801                         |       | 89,898      |       | 4.3                           | %          | 324,764     |       | 305,184 |   | 6.4 | % |
|                              |       |                           |       |        |       |                          |       |        |       |   |   |   |   |
| **Operating  Margin**             |       |                           |       |        |       |                          |       |        |       |   |   |   |   |
| Electric  Generation              |       | $                              | 1,667      |        | $          | 1,457                         |       | 14.4        | %          | $ | 5,803 |   | $ | 6,470 |   | -10.3 | % |
| Industrial                        |       | $                              | 4,245      |        | $          | 4,200                         |       | 1.1         | %          | $ | 15,364 |   | $ | 14,993 |   | 2.5 | % |
| Gas Management  Services          |       | $                              | 612        |        | $          | 947                           |       | -35.4       | %          | $ | 3,028 |   | $ | 2,827 |   | 7.1 | % |
| Other                             |       | $                              | 396        |        | $          | 149                           |       | 165.8       | %          | $ | 668 |   | $ | 399 |   | 67.4 | % |

 

Distribution service margins from electric generationcustomers were up $210,000, or 14% for the quarter,but below our original expectations for this group. High wholesale natural gasprices throughout the spring, combined with availability of cheaperhydroelectric power, reduced demand from gas-fired generators.  Consumption levels by generators willcontinue to be governed by whether alternative generating resources cheaperthan gas are available to meet regional demands for electricity.  The Company expects some increase in gas usagefrom third quarter levels for the remainder of the year, but probably not asmuch as was experienced during the fourth quarter last year.

 

Operating margin from distribution services for otherindustrial customers improved by $45,000 for the quarter.  Although current high gas costs alsonegatively affect industrial usage, the Company expects continued moderateimprovement in industrial distribution revenue as Washington and Oregonindustry recovers from the effects of the economic slowdown.

 

The reduction in margin from gas management was due inpart to a $117,000 negative mark-to-market valuationfor instruments to hedge prices on gas supply contracts to serve thisgroup.  On a year-to-date basis thecomparison is affected by a favorable mark-to-market valuation of $358,000 anda 2003 contract termination charge that reduced gas management margin by$865,000. Competition continues to increase for the sale of gas supplies tolarge volume customers, resulting in lower commodity margins than were availablein the past.  Since such sales accountfor most of the revenues from these services, in the near term the Companyexpects less contribution to margins from this sector.

 

15

----

 

**Oregon Earnings Sharing.**

 

The following table sets forth theamounts accrued as a charge to operating margin under the Company’searnings-sharing arrangement with the Oregon Public Utility Commission (OPUC).

 
| ** **               | ** ** | **Three Months Ended Jun 30** | ** ** | **Nine Months Ended Jun 30** | ** ** |
|--------------------------|------------|-------------------------------|------------|------------------------------|------------|
| ** **               | ** ** | **2004**                      | ** ** | **2003**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **               | ** ** | **(dollars in thousands)**    | ** ** | **(dollars in thousands)**   | ** ** |
|                     |       |                          |       |                         |       |   |   |   |   |
| Oregon Earnings  Sharing |       | $                             | 3          |                         | $          | (156 | ) | $ | (525 | ) | $ | (351 | ) |
|                          |            |                               |            |                              |            |  |  |  |  |  |  |  |  |

 

Under this arrangement, the Company is authorized toretain all of its earnings up to a threshold rate of return, based on Oregonjurisdictional earnings. If the adjusted Oregon earnings are below thethreshold, there is no rate adjustment. If the adjusted earnings are above thethreshold, one-third of the earnings exceeding the threshold will be refundedto customers through future rate reductions. In the third quarter of fiscal2004, the OPUC issued an order that raises the earnings-sharing threshold to areturn on equity of 13.25% for the current year, replacing a calculation thatwould have required sharing at approximately 10.5%.

 

## **Cost of Operations**

## ** **

Compared to the prior year, overallCost of Operations was $2,553,000 lower for the quarter and $3,501,000 lower for theyear-to-date period. Within Cost of Operations, notable changes in OperatingExpenses included a reduction in employee benefits expenses of $2,044,000 forthe quarter and $3,607,000 year-to-date. The quarterly comparison is affectedby retirement plan curtailment charges of $1,451,000 in the third quarter last year, and by the $158,000 favorable impact of the Medicareprescription drug subsidy in third quarter 2004. Additional information on theMedicare prescription drug subsidy is included in Item 1 of this report underNote 2 in the Notes to Consolidated Condensed Financial Statements under thecaption *“FSP-FAS Nos. 106-1 and 106-2”*.

 

The same factors affect theyear-to-date comparisons, as well as an additional $158,000 impact of theMedicare prescription drug subsidy applicable to second quarter 2004. TheMedicare prescription drug subsidy was passed into law in December 2003. TheCompany elected to restate its second quarter earnings in order to adopt therecognition of the effect of the subsidy retroactive to the beginning of thesecond quarter.

 

Other than the aforementioned items,the benefit expense reductions result primarily from plan changes implementedbeginning in July 2003, designed to reduce overall benefits expenses.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

The seasonal nature ofthe Company’s business creates short-term cash requirements to finance customeraccounts receivable and construction expenditures. To provide working capitalfor these requirements, the Company has a $50,000,000 bank revolving creditcommitment. This agreement has an annual 0.16% commitment fee, and a term thatexpires in November 2004. Several banks have made proposals to the Company forrenewing and increasing its credit line. Management considers its relationshipwith its bankers to be excellent, and does not anticipate problems in renewingor increasing the credit line. The Company also has a $10,000,000 uncommittedbank credit line. As of June 30, 2004, there was $1,000,000 outstanding debtunder these credit lines.  In August 2004a $22 million long-term Medium-Term Note matures and will be repaid using fundsavailable from the short-term credit line.

 

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

 

16

----

 

equitysecurities.  Of that amount, the Company has $110,000,000 remainingavailable for issuance subject to market conditions and other factors.

 

Because of theavailability of short-term credit and the ability to issue long-term debt andadditional equity, management believes it has adequate financial flexibility tomeet its anticipated cash needs, including cash requirements for investing andfinancing activities described in the following paragraphs.

 

# **OperatingActivities**

# ** **

In spite of $4.4 million higher net income compared to2003, cash provided by operating activities is $7.6 million less in the ninemonths ended June 30, 2004 compared to 2003. A significant factor is reflectedin Deferrals of gas cost changes, resulting from higher wholesale gas costspaid this year relative to the amount built in to customer rates. Alsoaffecting the year-to-year comparison of cash provided by operating activitiesis the net change in inventories of materials and supplies and natural gasstorage for the two periods. A primary contributing factor is the annualrefilling of gas storage earlier in 2004 compared to 2003, with approximately48% more gas in storage at June 30, 2004 compared to June 30, 2003. Thisdifference is reflected in Change in current assets and liabilities.

 

Cash provided by operating activitiesin fiscal 2004 continues to benefit from Amortization of gas cost changes,contributing $5,674,000 year-to-date through June 30, 2004. Thisresults from a temporary component of customer rates designed to collectun-recovered gas costs incurred primarily during the winter of 2000 – 2001 whenwholesale gas prices reached unprecedented high levels, and the Company did notimmediately increase customer rates to recover the full amount of higher costs.This temporary rate component is set to expire in November 2004. As a result ofhigher gas costs experienced in fiscal 2004, the Company expects a newtemporary rate component, effective December 2004, at approximately the samelevel as the one expiring. There is no impact on operating margin or net incomefrom Amortization of gas cost changes.

 

**Investing Activities**

 

Net capital expendituresfor the nine months of $29,444,000 are approximately 75% greater than lastyear. The increase is primarily attributable to $9,192,000 expended on aproject to install electronic devices on all the Company’s customer meters toallow for automated reading of the meters (AMR Project.) The project was begunin 2003, and total expenditures to date are $12,875,000 out of a totalestimated project cost of $16,000,000. Because the Company expects the AMRproject to progress ahead of schedule for the remainder of the year,expenditures planned for fiscal 2005 will likely be incurred in 2004. Inaddition, the January cold snap produced record peak demands in some areas ofthe Company’s distribution system, identifying the need for additionaldistribution capacity in a few localized parts of the system.  These factors will likely push full fiscal2004 expenditures closer to $38 million, from the previously budgeted amount of$35 million.

 

**Financing Activities**

 

Other than the payment of dividends, the primaryfinancing activity during fiscal 2004 was paying down the debt under theCompany’s bank credit line by $2,800,000. The Company also received $2,070,000in proceeds from issuance of common stock. In the second quarter of fiscal2003, the Company began issuing new stock through its dividend reinvestmentplan, 401(k) plan, and on exercise of stock options. The prior practice was topurchase shares of stock on the open market.

 

Over the next seven months, concluding in January2005, the Company will repay $31,000,000 in current maturities of long-termdebt, beginning with $22,000,000 in August 2004. The Company expects to fundthese repayments primarily through use of its bank credit lines and with cashfrom operating activities.

 

17

----

 

## **EFFICIENCYINITIATIVES**

## ** **

## **Automated Meter Reading**

## ** **

The Automated Meter Reading (AMR) project is discussedabove under “Investing Activities”. Objectives of the project include thereduction of labor cost associated with reading of customer meters and improvedaccuracy of meter reading. The AMR project, started in the third quarter oflast year, is proceeding ahead of schedule. The Company is already using thenew system to read over three fourths of its customers’ meters.  When completed, the project is expected toenable the Company to reduce the number of meter readers from thirty-two fulltime employees to three.  Many of theseexperienced employees are being redeployed to expand service and constructioncapabilities, displacing the use of outside contractors. The AMR project willalso allow for more efficient use of service and construction personnel who actas back-up meter-readers, and will eliminate the need to add new meter readersto keep up with customer growth.

 

## **Call Center**

## ** **

The Company is in the process of implementing acustomer-service call center at its present Bellingham, Washington districtoffice location. This will consolidate under one roof the customer servicefunction, which is now spread through fifteen local offices.  The new call center is expected to reduceexpenses through the elimination of sixteen full time equivalent positions, andto allow for more specialization, increased efficiency, and improved servicequality.  The Company expects the centerto be fully operational in the spring of 2005.

 

## **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.

 

## **Revenue Recognition**

## ** **

## **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.**

## ** **

## **Regulatory Accounting**

## ** **

The Company’s accounting policies and practices aregenerally the same as used by unregulated companies for financial reportingunder GAAP. However, Statement of Financial Accounting Standards

 

18

----

 

(FAS) No. 71, “Accounting for the Effects of CertainTypes of Regulation”, requires regulated companies to apply accountingtreatment intended to reflect the financial impact of regulation. For example,in establishing the rates to be charged to the Company’s retail customers, theWUTC and the OPUC may not allow the Company to charge its customers forrecovery of certain expenses in the same period they are incurred. Instead,rates are established in the future to recover costs that were incurred in aprior period. In this situation, FAS No. 71 requires the Company to defer thesecosts and include them as regulatory assets on the balance sheet. In thesubsequent period when these costs are recovered from customers, the Companythen amortizes these costs as expense in the income statement, in an amountequivalent to the amounts recovered. Similarly, certain revenue items, or costreductions may be deferred as regulatory liabilities, which are later amortizedto the income statement as customer rates are reduced. In order to apply theprovisions 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.

 

## **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 plans nolonger accrue to non-bargaining-unit employees and officers. The pension planremains substantially unchanged for bargaining-unit employees at this time.

 

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 lengthof service. Actuarial formulas are used in the determination of pension costsand are affected by actual plan experience and assumptions of futureexperience. Key actuarial assumptions include the expected return on planassets, the discount rate used in determining the projected benefit obligationand pension costs, and the assumed rate of increase in employee compensation.Changes in these assumptions may significantly affect pension costs. Changes tothe provisions 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 befunded under the Employee Retirement Income Security Act, and not more than themaximum amounts currently deductible for income tax purposes. The Companycontributed $4,412,000 in 2002 and $4,269,000 in 2003 to the pension andsupplemental executive retirement plans, and expects to contribute $3,843,000in 2004.

 

In selecting a discount rate, the Company uses theaverage of the 20 year and above Aaa, Aa, A, and Baadebt rates published by Moody’s. These are rates considered to be consistentwith the expected term of pension benefits. In 2003 the Company reduced thediscount rate from 6.75% to 6.25% in connection with remeasurement of the pensionobligation at May 1, 2003, with a further reduction to 6.00% at September 30,2003. A reduction in the discount rate results in increases in projectedbenefit 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

 

19

----

 

Company’s assumed rate ofreturn on plan assets was 8.25%. A reduction in the assumed rate of returnwould result in increases in pension liability and pension costs.

 

## **Derivatives**

## ** **

The Company accounts for derivative transactionsaccording to the provisions of FAS No. 133, as amended by FAS No. 138 and by**FAS No. 149. These standards require that the fair value ofall derivative financial instruments be recognized as either assets orliabilities on the Company’s balance sheet and the recognition of unrealizedgains and losses.

 

Most of the Company’s contracts for purchase and saleof natural 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 ofderivatives associated with supplies for non-core customers are recognized inearnings. The differences in accounting for purchases and sales contractsversus financial contracts do not change the underlying economics of thetransactions, but could result in increased quarterly earnings volatility. Thecompany applies FAS No. 71 to periodic changes in fair market value ofderivatives associated with supplies for core customers and records them inregulatory asset and regulatory liability accounts.

 

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

** **

On December 8, 2003,President Bush signed into law the *Medicare PrescriptionDrug, Improvement and Modernization Act of 2003* (the Act). The Actintroduces a prescription drug benefit under Medicare (Medicare Part D) as wellas a federal subsidy to sponsors of retiree health care benefit plans thatprovide a benefit that is at least actuarially equivalent to Medicare Part D.The Company has elected to recognize the impact of this subsidy retroactive tothe beginning of the second quarter of fiscal 2004. Please refer to theinformation contained under the caption “FSP FAS No. 106-1 and 106-2”, under NewAccounting Standards in the Notes to the Consolidated Condensed FinancialStatements, contained in Item 1 of this report.

 

**New Accounting Standards:**

 

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

 

**Item 3.****  Quantitative and Qualitative Disclosures 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 gashas commodity prices subject to fluctuations resulting from weather, congestionon interstate pipelines, and other unpredictable factors. The Company’sPurchased Gas Adjustment mechanisms provide for 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 core and non-corecustomers.

 

**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

 

20

----

 

amended,is recorded, processed, summarized and reported within the time periodspecified in the rules and forms of the Securities and ExchangeCommission.  Based upon their evaluationof these controls and procedures, as of the end of the quarter covered by thisreport, the Chief Executive Officer and Chief Financial Officer of the Companyconcluded that the Company’s disclosure controls and procedures were effective.

 

The Company made no material changes in its internalcontrol over financial reporting during the quarter covered by this report.

 

**FORWARD-LOOKING STATEMENTS**

 

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, natural disasters, acts ofterrorism, accidents resulting in personal injury, labor issues, the Company’sability to successfully implement internal performance goals, competition fromalternative forms of energy, consolidation in the energy industry, natural gasprices, performance issues with key natural gas suppliers and upstreampipelines, the capital-intensive nature of the Company’s business, regulatoryissues, including the need for adequate and timely rate relief to recovercapital and operating costs and to sustain dividend levels, the weather,increasing competition brought on by deregulation initiatives at the federaland state regulatory levels, the potential loss of large volume industrialcustomers due to “bypass” or the shift by such customers to special competitivecontracts at lower per-unit margins, exposure to environmental cleanuprequirements, and economic conditions, particularly in the Company’s servicearea.

 

**PART II.****  Other Information**

 

**Item 2.****  Changes in Securities and Use of Proceeds**

 

Under the terms of its bank creditagreement, the Company is required to maintain a minimum tangible net worth of$108,441,000 as of June 30, 2004. Under this agreement, approximately$22,295,000 was available for payment of dividends at June 30, 2004.

 

**Item 5.****  Other Information**

 

a)

 

Ratio of Earnings toFixed Charges:

 
| **Twelve Months Ended** | ** ** |
|-------------------------|------------|
| **6/30/2004**           | ** ** | **9/30/2003** | ** ** | **9/30/2002** | ** ** | **9/30/2001** | ** ** | **9/30/2000** | ** ** | **9/30/1999** | ** ** |
|                    |       |   |   |   |   |   |   |   |   |   |   |
| 2.56                    |       | 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.

 

b) There have been nochanges in the Company’s procedures by which security holders may recommendnominees to the Company’s Board of Directors.

 

21

----

 

# **Item 6.** Exhibits and Reports on Form 8-K

# ** **

a. Exhibits:

 
| **No.** | ** ** | **Description**                                                                                                         |
|---------|------------|-------------------------------------------------------------------------------------------------------------------------|
|    |       |                                                                                                                    |
| 3.2     |       | Amended and Restated Bylaws of the Registrant                                                                           |
|    |       |                                                                                                                    |
| 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 April 21, 2004, the Company fileda Report on Form 8-K to furnish its April 19, 2004 release of second quarterfiscal 2004 earnings.

 

22

----

 

**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:  | August 9, 2004                 | .      |

 

23

----