**FORM 10-Q**

** **

**SECURITIESAND EXCHANGE COMMISSION**

 

**Washington,D.C. 20549**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended December 31, 2004**

 

**Commissionfile number: 1-7196**

 

**CASCADENATURAL GAS CORPORATION**

(Exact name ofRegistrant as specified in its charter)

 
| **Washington**                                            | ** ** | **91-0599090**       |
|-----------------------------------------------------------|------------|----------------------|
| (State or other  jurisdiction of                          |       | (I.R.S. Employer     |
| incorporation or  organization)                           |       | 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 markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes  ý  No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 23b-2 of theExchange Act). Yes  ý  No  o

 

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

 
| **Title**                             | ** ** | **Outstanding**                    |
|---------------------------------------|------------|------------------------------------|
|                                  |       |                               |
| Common Stock, Par Value  $1 per Share |       | 11,293,156 as of  January 24, 2005 |

 

 

----

 

**CASCADENATURAL GAS CORPORATION**

 

Index

 
| Part I.   | Financial Information |                                                                                                 |
|-----------|-----------------------|------------------------------------------------------------------------------------------------------|
|      |                  |                                                                                                 |   |
|      |                  | Item 1. Financial Statements                                                                         |   |
|      |                  |                                                                                                 |   |
|      |                  | Consolidated  Condensed Statements of Income                                                         |   |
|      |                  |                                                                                                 |   |
|      |                  | Consolidated  Condensed Balance Sheets                                                               |   |
|      |                  |                                                                                                 |   |
|      |                  | Consolidated  Condensed Statements of Cash Flows                                                     |   |
|      |                  |                                                                                                 |   |
|      |                  | Notes to Consolidated  Condensed Financial Statements                                                |   |
|      |                  |                                                                                                 |   |
|      |                  | Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations |   |
|      |                  |                                                                                                 |   |
|      |                  | Item 3. Quantitative and Qualitative Disclosures  about Market Risk                                  |   |
|      |                  |                                                                                                 |   |
|      |                  | Item 4. Controls and Procedures                                                                      |   |
|      |                  |                                                                                                 |   |
| Part II.  | Other Information     |                                                                                                 |
|      |                  |                                                                                                 |   |
|      |                  | Item 5. Other Information                                                                            |   |
|      |                  |                                                                                                 |   |
|      |                  | Item 6. Exhibits                                                                                     |   |
|      |                  |                                                                                                 |   |
| Signature |                  |                                                                                                 |   |

 

2

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# **PART I**.   Financial Information

 

**Item 1**. Financial Statements

 

CASCADE NATURAL GAS CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

(unaudited)

 
| ** **                                  | ** ** | **THREE  MONTHS ENDED**                | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|
| ** **                                  | ** ** | **Dec 31,  2004**                      | ** ** | **Dec 31,  2003** | ** ** |
| ** **                                  | ** ** | **(thousands  except per share data)** | ** ** |
|                                        |       |                                   |       |   |   |
| Operating  revenues                         |       | $                                      | 104,613    |   | $ | 104,884 |   |
|                                        |       |                                   |       |   |   |
| Less: Gas  purchases                        |       | 69,122                                 |       | 67,525 |   |
|   Revenue  taxes                  |       | 6,569                                  |       | 6,666 |   |
| Operating margin                            |       | 28,922                                 |       | 30,693 |   |
|                                        |       |                                   |       |   |   |
| Cost of  operations:                        |       |                                   |       |   |   |
| Operating  expenses                         |       | 10,420                                 |       | 10,278 |   |
| Depreciation and  amortization              |       | 4,205                                  |       | 3,921 |   |
| Property and  miscellaneous taxes           |       | 959                                    |       | 930 |   |
|                                        |       | 15,584                                 |       | 15,129 |   |
|                                        |       |                                   |       |   |   |
| Income from  operations                     |       | 13,338                                 |       | 15,564 |   |
| Less interest  and other deductions - net   |       | 2,894                                  |       | 3,116 |   |
| Income before  income taxes                 |       | 10,444                                 |       | 12,448 |   |
|                                        |       |                                   |       |   |   |
| Income taxes                                |       | 3,812                                  |       | 4,543 |   |
| Net Income                                  |       | $                                      | 6,632      |   | $ | 7,905 |   |
|                                        |       |                                   |       |   |   |
| Weighted average  common shares outstanding |       | 11,279                                 |       | 11,158 |   |
|                                        |       |                                   |       |   |   |
| Net earnings per  common share              |       |                                   |       |   |   |
| Basic                                       |       | $                                      | 0.59       |   | $ | 0.71 |   |
| Diluted                                     |       | $                                      | 0.59       |   | $ | 0.71 |   |
|                                        |       |                                   |       |   |   |
| Cash dividends  per share                   |       | $                                      | 0.24       |   | $ | 0.24 |   |

 

The accompanying notesare an integral part of these financial statements

 

3

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**CASCADENATURAL GAS CORPORATION**

**CONSOLIDATED CONDENSED BALANCESHEETS**

(Dollars inThousands)

 
| ** **                                                                                                                | ** ** | **Dec 31,  2004** | ** ** | **Sep 30,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                                                                | ** ** | **(Unaudited)**   | ** ** | ** **        | ** ** |
| **ASSETS**                                                                                                                |       |              |       |              |       |
| Utility Plant,  net of accumulated depreciation of $246,843 and $242,691                                                  |       | $                 | 330,552    |              | $          | 327,345 |   |
| Construction  work in progress                                                                                            |       | 7,196             |       | 7,229             |       |
|                                                                                                                      |       | 337,748           |       | 334,574           |       |
| Other Assets:                                                                                                             |       |              |       |              |       |
| Investments in  non-utility property                                                                                      |       | 202               |       | 202               |       |
| Notes  receivable, less current maturities                                                                                |       | 46                |       | 43                |       |
|                                                                                                                      |       | 248               |       | 245               |       |
| Current Assets:                                                                                                           |       |              |       |              |       |
| Cash and cash  equivalents                                                                                                |       | 2,447             |       | 499               |       |
| Accounts  receivable and current maturities of notes receivable, less allowance of $943  and $1,028 for doubtful accounts |       | 50,764            |       | 15,001            |       |
| Prepaid expenses  and other assets                                                                                        |       | 17,728            |       | 18,674            |       |
| Derivative  instrument assets - energy commodity                                                                          |       | 1,330             |       | 17,983            |       |
| Materials,  supplies and inventories                                                                                      |       | 12,773            |       | 13,268            |       |
| Deferred income  taxes                                                                                                    |       | 982               |       | 955               |       |
|                                                                                                                      |       | 86,024            |       | 66,380            |       |
| Deferred Charges  and Other                                                                                               |       |              |       |              |       |
| Gas cost changes                                                                                                          |       | 10,395            |       | 12,288            |       |
| Derivative  instrument assets - energy commodity                                                                          |       | 2,292             |       | 3,952             |       |
| Other                                                                                                                     |       | 5,316             |       | 5,183             |       |
|                                                                                                                      |       | 18,003            |       | 21,423            |       |
|                                                                                                                      |       |              |       |              |       |
|                                                                                                                      |       | $                 | 442,023    |              | $          | 422,622 |   |

 

4

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**CASCADENATURAL GAS CORPORATION**

**CONSOLIDATEDCONDENSED BALANCE SHEETS (Continued)**

(Dollars in Thousands)

 
| ** **                                                                                                                    | ** ** | **Dec 31,  2004** | ** ** | **Sep 30,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                                                                    | ** ** | **(Unaudited)**   | ** ** | ** **        | ** ** |
| **COMMON SHAREHOLDERS’ EQUITY AND LIABILITIES**                                                                          |       |              |       |              |       |
| Common Shareholders’  Equity:                                                                                            |       |              |       |              |       |
| Common stock,  par value $1 per share, authorized 15,000,000 shares, issued and outstanding  11,292,120 and 11,268,069 shares |       | $                 | 11,292     |              | $          | 11,268 |   |
| Additional  paid-in capital                                                                                                   |       | 101,834           |       | 101,354           |       |
| Accumulated  other comprehensive income (loss)                                                                                |       | (12,608           | )          | (12,608           | )          |
| Retained  earnings                                                                                                            |       | 22,422            |       | 18,500            |       |
|                                                                                                                          |       | 122,940           |       | 118,514           |       |
|                                                                                                                          |       |              |       |              |       |
| Long-term Debt                                                                                                                |       | 128,900           |       | 128,900           |       |
|                                                                                                                          |       |              |       |              |       |
| Current  Liabilities:                                                                                                         |       |              |       |              |       |
| Notes payable  and commercial paper                                                                                           |       | 45,000            |       | 33,500            |       |
| Current  maturities of long-term debt                                                                                         |       | 10,000            |       | 14,000            |       |
| Accounts payable                                                                                                              |       | 34,214            |       | 12,923            |       |
| Property,  payroll and excise taxes                                                                                           |       | 8,167             |       | 5,287             |       |
| Dividends and  interest payable                                                                                               |       | 5,049             |       | 7,125             |       |
| Regulatory  liabilities                                                                                                       |       | 1,330             |       | 17,209            |       |
| Other current  liabilities                                                                                                    |       | 11,858            |       | 8,972             |       |
|                                                                                                                          |       | 115,618           |       | 99,016            |       |
|                                                                                                                          |       |              |       |              |       |
| Deferred Credits  and Other Non-current Liabilities                                                                           |       |              |       |              |       |
| Deferred income  taxes and investment tax credits                                                                             |       | 38,836            |       | 38,392            |       |
| Retirement plan  obligations                                                                                                  |       | 20,658            |       | 20,780            |       |
| Regulatory  liabilities                                                                                                       |       | 8,845             |       | 10,515            |       |
| Other                                                                                                                         |       | 6,226             |       | 6,505             |       |
|                                                                                                                          |       | 74,565            |       | 76,192            |       |
|                                                                                                                          |       |              |       |              |       |
| Commitments and  Contingencies                                                                                                |       | —            |       | —            |       |
|                                                                                                                          |       | $                 | 442,023    |              | $          | 422,622 |   |

 

The accompanyingnotes are an integral part of these financial statements

 

5

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CASCADE NATURAL GAS CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 
| ** **                                                                         | ** ** | **THREE  MONTHS ENDED**     | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                         | ** ** | **(dollars  in thousands)** | ** ** |
| ** **                                                                         | ** ** | **Dec 31,  2004**           | ** ** | **Dec 31,  2003** | ** ** |
| Operating  Activities                                                              |       |                        |       |   |   |
| Net income                                                                         |       | $                           | 6,632      |   | $ | 7,905 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                        |       |   |   |
| Depreciation and  amortization                                                     |       | 4,205                       |       | 3,921 |   |
| Deferrals of gas  cost changes                                                     |       | 100                         |       | (752 | ) |
| Amortization of  gas cost changes                                                  |       | 1,794                       |       | 1,774 |   |
| Other deferrals  and amortizations                                                 |       | (154                        | )          | 321 |   |
| Deferred income  taxes and tax credits - net                                       |       | 418                         |       | 1,367 |   |
| Change in  current assets and liabilities                                          |       | (8,571                      | )          | (7,488 | ) |
| Net cash  provided by operating activities                                         |       | 4,424                       |       | 7,048 |   |
|                                                                               |       |                        |       |   |   |
| Investing  Activities                                                              |       |                        |       |   |   |
| Capital  expenditures                                                              |       | (8,180                      | )          | (10,456 | ) |
| Customer  contributions in aid of construction                                     |       | 410                         |       | 240 |   |
| Net cash used by  investing activities                                             |       | (7,770                      | )          | (10,216 | ) |
|                                                                               |       |                        |       |   |   |
| Financing  Activities                                                              |       |                        |       |   |   |
| Proceeds from  issuance of common stock                                            |       | 504                         |       | 842 |   |
| Repayment of  long-term debt                                                       |       | (4,000                      | )          | — |   |
| Changes in notes  payable and commercial paper, net                                |       | 11,500                      |       | (1,300 | ) |
| Dividends paid                                                                     |       | (2,710                      | )          | (2,687 | ) |
| Net cash  provided (used) by financing activities                                  |       | 5,294                       |       | (3,145 | ) |
|                                                                               |       |                        |       |   |   |
| Net Increase  (Decrease) in Cash and Cash Equivalents                              |       | 1,948                       |       | (6,313 | ) |
|                                                                               |       |                        |       |   |   |
| Cash and Cash  Equivalents                                                         |       |                        |       |   |   |
| Beginning of  year                                                                 |       | 499                         |       | 7,452 |   |
| End of period                                                                      |       | $                           | 2,447      |   | $ | 1,139 |   |

 

The accompanying notesare an integral part of these financial statements

 

6

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**CASCADENATURAL GAS CORPORATION**

**NOTES****TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

## **THREE-MONTHPERIOD ENDED DECEMBER 31, 2004**

## ** **

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

 

Reference is directed to the Notes to Consolidated FinancialStatements contained in the 2004 Annual Report on Form 10-K for the fiscal yearended September 30, 2004, and comments included therein under “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”.

 

**Note 1.****Earnings Per Share**

 

The following table setsforth the calculation of earnings per share.

 
| ** **                                             | ** ** | **Three  Months Ended December 31**       | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                             | ** ** | **2004**                                  | ** ** | **2003** | ** ** |
| ** **                                             | ** ** | **(in  thousands except per-share data)** | ** ** |
| Net income  (loss)                                     |       | $                                         | 6,632      |   | $ | 7,905 |   |
|                                                   |       |                                      |       |   |   |
| Weighted average  shares outstanding                   |       | 11,279                                    |       | 11,158 |   |
| Basic earnings  (loss) per share                       |       | $                                         | 0.59       |   | $ | 0.71 |   |
|                                                   |       |                                      |       |   |   |
| Weighted average  shares outstanding                   |       | 11,279                                    |       | 11,158 |   |
| Plus: Issued on  assumed exercise of stock options     |       | 13                                        |       | 14 |   |
| Weighted average  shares outstanding assuming dilution |       | 11,292                                    |       | 11,172 |   |
|                                                   |       |                                      |       |   |   |
| Diluted earnings  (loss) per share                     |       | $                                         | 0.59       |   | $ | 0.71 |   |

 

7

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**Note2.****RetirementPlan Information**

 

Thefollowing table sets forth the components of net periodic benefit costsrecognized in the three-month periods ended December 31, 2004 and 2003.

 

**Net Periodic Benefits Cost**

 
| ** **                                       | ** ** | **Three  Months Ended**     | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **Dec 31,  2004**           | ** ** | **Dec 31,  2003** | ** ** |
| ** **                                       | ** ** | **(Thousands  of Dollars)** | ** ** |
| **DEFINED  BENEFIT PENSION PLANS**               |       |                        |       |   |   |
| Service cost                                     |       | $                           | 197        |   | $ | 192 |   |
| Interest cost                                    |       | 961                         |       | 932 |   |
| Expected return  on plan assets                  |       | (1,041                      | )          | (978 | ) |
| Recognized gains  or losses                      |       | 386                         |       | 349 |   |
| Prior service  cost                              |       | 46                          |       | 57 |   |
| Net Periodic  Benefit Cost Recognized            |       | $                           | 549        |   | $ | 552 |   |
|                                             |       |                        |       |   |   |
| **POSTRETIREMENT  BENEFITS OTHER THAN PENSIONS** |       |                        |       |   |   |
| Service cost                                     |       | $                           | 35         |   | $ | 44 |   |
| Interest cost                                    |       | 275                         |       | 348 |   |
| Expected return  on plan assets                  |       | (211                        | )          | (213 | ) |
| Recognized gains  or losses                      |       | 187                         |       | 308 |   |
| Prior service cost                               |       | (330                        | )          | (330 | ) |
| Net Periodic  Benefit Cost Recognized            |       | $                           | (44        | ) | $ | 157 |   |
|                                             |       |                        |       |   |   |
| **DEFINED  CONTRIBUTION PENSION PLAN**           |       |                        |       |   |   |
| Net Periodic  Benefit Cost Recognized            |       | $                           | 243        |   | $ | 242 |   |

 

**RetirementPlan Funding**

** **

For the three monthsended December 31, 2004, $625,000 of contributions havebeen made to the Company’s defined benefit pension plans. The Company presentlyanticipates contributing an additional $2,900,000 to fund its pension plans fora total of $3,525,000 in fiscal 2005.

 

### **Note 3.** 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, “Accountingfor Stock Issued to Employees.”  Stockoptions are granted at exercise prices not less than the fair value of commonstock on the date of grant. Under APB No. 25, no compensation expense isrecognized related to the Company’s stock option plans. If compensation expensefor the Company’s stock option plans were determined consistent with SFAS No.123, net income and earnings per common share would have been the following proforma amounts for the three-month periods ended December 31:**

 

8

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| ** **                                                                                                | ** ** | **Three  Months Ended**                   | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                | ** ** | **Dec 31,  2004**                         | ** ** | **Dec 31,  2003** | ** ** |
| ** **                                                                                                | ** ** | **(in  thousands except per-share data)** | ** ** |
| Net income                                                                                                |       |                                      |       |   |   |
| As reported                                                                                               |       | $                                         | 6,632      |   | $ | 7,905 |   |
| Less total  stock-based employee compensation expense determined under the fair value  method, net of tax |       | $                                         | 13         |   | 13 |   |
| Pro forma net  income                                                                                     |       | $                                         | 6,619      |   | $ | 7,892 |   |
|                                                                                                      |       |                                      |       |   |   |
| Earnings per  share, basic and diluted                                                                    |       |                                      |       |   |   |
| As reported                                                                                               |       | $                                         | 0.59       |   | $ | 0.71 |   |
| Pro forma                                                                                                 |       | $                                         | 0.59       |   | $ | 0.71 |   |

 

**Note 4.****Commitments and Contingencies**

 

# **Environmental Matters**

# ** **

There are two claimsagainst the Company for as yet unknown costs for cleanup of allegedenvironmental contamination related to manufactured gas plant sites that werepreviously operated by companies which were subsequently merged into Cascade.

 

The first claim was receivedin 1995 and relates to a site in Oregon. An investigation has shown thatcontamination does exist, but there is currently not enough informationavailable to estimate the potential liability associated with this claim. It isexpected that other parties will participate in the cleanup costs. Through theend of the quarter the amounts spent, primarily on investigation and containment, have been immaterial.

 

The second claim wasreceived in 1997 and relates to a site in Washington. An investigation has determinedthere is evidence of contamination at the site, but there is also evidence ofan oil line crossing the property, operated by an unrelated party, which mayhave also contributed to the contamination. There is currently not enoughinformation available to estimate the potential liability associated with thisclaim. The party who originally made this claim has not been actively pursuingit.

 

Management intends topursue reimbursement from its insurance carriers, and recovery from itscustomers through increased rates, for any remediation costs for which theCompany is determined to be liable. There is precedent for such recoverythrough increased rates, as both the Washington Utilities and TransportationCommission (WUTC) and the Oregon Public Utilities Commission (OPUC) havepreviously allowed regulated utilities to increase customer rates to recoversimilar costs.

 

# **Litigation and Other Contingencies**

# ** **

Various lawsuits, claims,and contingent liabilities may arise from time to time from the conduct of theCompany’s business. No other 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.

 

9

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# **Item2**. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations

# ** **

The following ismanagement’s assessment of the Company’s financial condition and a discussionof the principal factors that affected consolidated results of operations andcash flows for the three-month periods ended December 31, 2004 and December 31,2003.

 

**OVERVIEW**

 

The Company is a localdistribution company (LDC) serving approximately 225,000 customers in theStates of Washington and Oregon. Our 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 theCompany’s strategy include:

 

•                  Remain focusedon the natural gas distribution business.

 

•                  Achieve earningsgrowth through and minimize the need to seek rate increases by:

 

•                  Expanding ourcustomer base

•                  Increasingoperating efficiencies

•                  Exploitopportunities to expand our service offerings inside and outside our serviceterritory

 

**Opportunitiesand Challenges**

 

The Company operates in adiverse service territory over a wide geographic area relative to its overallsize and number of customers. The economies of various parts of the servicearea are supported by a variety of industries, and are affected by theconditions that impact those industries.

 

Management believes thereare growth opportunities in the Company’s service area. Factors contributing tothese opportunities include low market penetration in many of the towns served,and general population growth in the service area, including some areas ofrapid growth.

 

Rates charged by theCompany for its utility services are regulated by the WUTC and the OPUC. TheCompany’s basic business strategy is to minimize reliance on rate increases forearnings growth. However, realization of risks affecting earnings could requirethe Company to seek approval of higher rates. The results of such rate requestsare subject to uncertainties associated with the regulatory process.

 

The Company earns morethan one third of its operating margin from industrial and electric generationcustomers. Loss of major industrial customers, or unfavorable conditionsaffecting an industry segment, could have a detrimental impact on the Company’searnings. Many external factors over which the Company has no control cansignificantly impact the amount of gas consumed by industrial and electricgeneration customers, and consequently the margins earned by the Company.

 

Revenues and margins fromthe Company’s residential and small commercial customers are highly weathersensitive. In a cold year, the Company’s earnings are boosted by the effects ofthe weather, and conversely in a warm year, the Company’s earnings suffer. TheCompany continues to explore alternatives such as weather normalizationmechanisms that utility regulators in many jurisdictions have approved, toreduce weather related volatility in earnings and in customers’ bills.

 

10

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Overall revenues andmargins are also negatively impacted by customers taking measures to reduceenergy usage. The increasing cost of energy in recent years, including thewholesale cost of natural gas, continues to encourage such measures.

 

Prospects for continuingstrong residential and commercial customer growth are excellent. The pace ofnew home and commercial construction remains steady in our communities. Goodpotential also exists for converting homes and businesses located on or nearour current lines to gas from other fuels, as well as for expanding our systeminto adjacent areas.

 

# **RESULTSOF OPERATIONS**

# ** **

The Company’s net incomewas $6,632,000, or $0.59 per share, basic and diluted, for the fiscal 2005first quarter (quarter ended December 31, 2004), compared to $7,905,000, or $0.71 per share, basic and diluted, for thequarter ended December 31, 2003. Primary factors influencing the quarterlycomparisons were:

 

•                  Unfavorablenon-core mark-to-market valuations in fiscal 2005 compared to favorablevaluations in fiscal 2004 – ($0.06) per share

•                  Decline inmargin from gas management services – ($0.04) per share

•                  Decline inresidential and commercial per-customer gas consumption – ($0.05) per share

•                  Increase inmargin from new residential and commercial customers - $0.06 per share

 

# **Operating Margin**

# ** **

Operating margins bycustomer category for the first quarter of fiscal years 2005 and 2004 are setforth in the following tables:

 

**Residentialand Commercial Margin**

 
| ** **                              | ** ** | **First  Quarter of Fiscal** | ** ** | **Percent** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|-------------|------------|
| ** **                              | ** ** | **2005**                     | ** ** | **2004**    | ** ** | **Change** | ** ** |
| ** **                              | ** ** | **(dollars  in thousands)**  | ** ** | ** **  | ** ** |
| **Degree  Days**                        |       |                         |       |        |       |   |   |
| Actual                                  |       | 1,945                        |       | 2,106       |       | -7.6 | % |
| 5-Year Average                          |       | 2,091                        |       | 2,044       |       |   |   |
| **Average  Number of Customers Billed** |       |                         |       |        |       |   |   |
| Residential                             |       | 191,100                      |       | 182,397     |       | 4.8 | % |
| Commercial                              |       | 29,840                       |       | 29,131      |       | 2.4 | % |
| **Average  Therm Usage per Customer**   |       |                         |       |        |       |   |   |
| Residential                             |       | 251                          |       | 272         |       | -7.7 | % |
| Commercial                              |       | 1,161                        |       | 1,252       |       | -7.3 | % |
| **Operating  Margin**                   |       |                         |       |        |       |   |   |
| Residential                             |       | $                            | 14,225     |        | $          | 14,056 |   | 1.2 | % |
| Commercial                              |       | $                            | 7,461      |        | $          | 7,538 |   | -1.0 | % |

 

Margin from sales toresidential and commercial customers increased by $92,000 on an aggregatebasis, and the net increase was influenced by two primary factors. An overallincrease of 9,412 in the number of residential and commercial customers, assumingthe same average consumption per customer as last year, contributed $990,000 inadditional margin. The combined growth rate for residential and commercialcustomers was 4.4%, more than two times the national average for natural gasdistribution companies. However, the decrease in average gas usage per customerlargely offset the contribution from 

 

11

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new customers, resulting in thenet increase of $92,000. The primary use of gas by residential customers is forspace and water heating, therefore average consumptionper customer is very sensitive to weather, particularly during the Company’sfirst and second fiscal quarters. Consumption by commercial customers is alsosensitive to weather. The sensitivity is more difficult to isolate and measurethan for residential customers because of a variety of uses in addition tospace and water heating.

 

**Industrialand Other Margin**

 
| ** **                               | ** ** | **First  Quarter of Fiscal** | ** ** | **Percent** | ** ** |
|------------------------------------------|------------|------------------------------|------------|-------------|------------|
| ** **                               | ** ** | **2005**                     | ** ** | **2004**    | ** ** | **Change** | ** ** |
| ** **                               | ** ** | **(dollars  in thousands)**  | ** ** | ** **  | ** ** |
| **Average  Number of Customers**         |       |                         |       |        |       |   |   |
| Electric  Generation                     |       | 14                           |       | 14          |       | 0.0 | % |
| Industrial                               |       | 736                          |       | 744         |       | -1.1 | % |
|                                     |       | 750                          |       | 758         |       | -1.1 | % |
| **Therms  Delivered (thousands)**        |       |                         |       |        |       |   |   |
| Electric  Generation                     |       | 117,365                      |       | 145,145     |       | -19.1 | % |
| Industrial                               |       | 110,414                      |       | 115,742     |       | -4.6 | % |
|                                     |       | 227,779                      |       | 260,887     |       | -12.7 | % |
| **Operating  Margin ($ thousands)** |       |                         |       |        |       |   |   |
| Electric  Generation                     |       | $                            | 2,007      |        | $          | 2,241 |   | -10.4 | % |
| Industrial                               |       | 5,306                        |       | 5,432       |       | -2.3 | % |
| Gas Management  Services                 |       | 391                          |       | 1,132       |       | -65.5 | % |
| Mark-to-Market  Valuations               |       | (668                         | )          | 406         |       | -264.5 | % |
| Other                                    |       | 200                          |       | 139         |       | 43.9 | % |
|                                     |       | $                            | 7,236      |        | $          | 9,350 |   | -22.6 | % |

 

**ElectricGeneration:**The decline in margin from electric generationcustomers is attributed to adequate supplies of lower cost hydroelectric powerand weaker demand resulting, in part, from the high wholesale price of naturalgas. Looking ahead, gas usage by generation customers will continue to dependon regional demand for power, availability of hydro resources, and therelationship between the market price of electricity and the cost of gas.

 

**GasManagement Services:** The $741,000 decline in margin from gasmanagement services is attributed to fewer gas management customers and lowerper-therm margin on gas supply sales compared to last year. The re-emergence ofenergy marketers, an industry segment that all but disappeared in the wake ofthe Enron failure, has resulted in stiff competition for gas supply sales tolarger gas customers. Cascade has lost some customers to such marketers, andmargins that are available for any sales are smaller than in the past. We willcontinue to provide gas supply services to customers to facilitate their use ofgas, but expect revenues from the activity to be limited.

 

**Mark-to-MarketValuations:** These valuations result from periodic changes inthe fair value of the derivative instruments used to hedge the cost of suppliesfor gas management customers. The hedging instruments are in place toeffectively fix the price of those supplies. As market prices of natural gasforward contracts increase, the value of the instruments increases. Conversely,when market prices decrease, the value of the instruments also decreases.During the fiscal 2005 first quarter, forward natural gas prices decreased fromthe beginning of the quarter to the end of the quarter, hence the $668,000charge for the quarter. During the first quarter last year, these pricesincreased, resulting in the $406,000 credit. These hedging instruments are forfixed periods that correspond to the periods of the physical supply contractsto serve these customers. The hedged volumes also correspond to the volumesexpected to be purchased under these contracts. At the end of the life of thehedging instruments the cumulative income statement effects of themark-to-market valuations will net to zero. But market fluctuations in interimperiods do result in mark-to-market valuation effects in those periods’ incomestatements.

 

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**OregonEarnings Sharing:** In addition to the above described margindifferences, the comparison of first quarter 2005 versus 2004 is affected byaccruals of estimated liability for Oregon Earnings Sharing. In the firstquarter of 2004 we accrued $250,000 as an estimate of a liability to be paidback to Oregon customers. No additional amount was accrued in the first quarterof fiscal 2005.

 

**Cost ofOperations**

 

Compared to last year,overall Cost of Operations was $455,000 higher for the quarter. Within Cost ofOperations, notable changes in Operating Expenses included a $347,000 increasein labor expense, including normal annual wage and salary increases and$151,000 in severance pay, stemming primarily from planned staffing reductionsin connection with implementation of a new customer service call center in thesecond quarter of fiscal 2005. Included in operating expense is a $120,000accrual for a penalty proposed by the staff of the Washington Utilities andTransportation Commission for pipeline safety audit weaknesses. Also reflectedin operating expense changes for the quarter was a $480,000 reduction inemployee benefits expense, reflecting the full impact of benefit plan changesinitiated in 2003. Various smaller increases and decreases in other categoriesof expense, in the aggregate, accounted for the remainder of the change in OperatingExpenses for the quarter.

 

The $284,000 increase inDepreciation and Amortization is related to the approximately $38 millionincrease in Utility Plant compared to a year ago. Included in the increasedplant balance is approximately $15 million in equipment installed for ourautomated meter reading system.

 

## **Interestand Other Deductions – Net**

## ** **

The $222,000 reduction inInterest and Other Deductions-Net is a result of repayment of long-term debtand temporarily replacing that debt with lower cost short-term borrowing underour bank line of credit.

 

**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 $60,000,000 bank revolving creditcommitment. This agreement has a variable commitment fee, and a term thatexpires in October 2007. As of December 31, 2004, there was $45,000,000outstanding debt under this 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 equity securities.  Of that amount, the Companyhad $110,000,000 remaining available for issuance, as of December 31, 2004,subject to market conditions and other factors. On January 25, 2005, the Company issued $30,000,000 of 30-year 5.25%Insured Quarterly Notes under this registration statement, leaving $80,000,000available for future issuance of securities. The proceeds were used to pay downthe debt under the revolving credit line. In the remainder of fiscal 2005, theCompany will repay $10,000,000 in current maturities of long-term debt, beginningwith $5,000,000 in January. The Company expects to fund these repaymentsprimarily through use of its bank credit lines, cash from operating activities,and long-term capital sources.

 

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**

### ** **

Cash provided byoperating activities for the first quarter of fiscal 2005 declined $2,624,000compared to last year. Other than net lower income, a significant contributingfactor was higher current income tax. As a component of net income, this highercurrent income tax expense is offset by lower deferred income tax expense.Deferred income taxes represent a non-cash charge to expense, and effectively 

 

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offset lower cash payments forincome taxes in the current period. Current Income Taxes were lower last yearprimarily from the effect of a temporary provision in the federal tax code thatallowed a first-year bonus depreciation deduction in the amount of 50% of thecost of new assets placed in service. This provision expires in fiscal 2005.For the full year of fiscal 2004, current income taxes were lower byapproximately $7 million resulting from first-year bonus depreciation..

 

**Investing Activities**

 

Net capital expendituresof $7,770,000 for the first quarter of fiscal 2005 were approximately 24% lessthan first quarter last year. The decrease is primarily attributable toapproximately $2.9 million expended last year on the installation of electronicdevices on all the Company’s customer meters to allow for automated meterreading (AMR). The AMR project was completed in 2004.

 

#### **Financing Activities**

####  

Other than the payment ofdividends, the Company’s primary financing activities during the first quarterof fiscal 2005 were the repayment of $4,000,000 in long-term debt andincreasing its borrowing under its bank credit line by $11,500,000.

 

## **EFFICIENCY INITIATIVE – CUSTOMER SERVICE CALL CENTER**

## ** **

In January 2005 theCompany began operation of a customer-service call center at our existingdistrict office in Bellingham, Washington. This call center will consolidate inone location the customer service function, which has been spread throughfifteen local offices.  The new callcenter is expected to reduce expenses through the elimination of sixteen fulltime equivalent positions, and to allow for more specialization, increasedefficiency, and improved service quality. Activation of the call center is being phased in, and we plan for thecenter to be fully operational in March 2005.

 

## **CRITICAL ACCOUNTING POLICIES**

## ** **

TheCompany’s financial statements are prepared in accordance with accountingprinciples generally accepted in the United States of America (GAAP). Infollowing GAAP, management exercises judgment in selection and application ofaccounting principles. Management considers Critical Accounting Policies to bethose where different assumptions regarding application could result inmaterial differences in financial statements.

 

## **Useof Estimates**

## ** **

Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities, and disclosure of contingent assets and liabilities, at thedate of the financial statements, and the reported amounts of revenues andexpenses during the reporting period. The Company has used estimates inmeasuring certain deferred charges and deferred credits related to itemssubject to approval of the WUTC and the OPUC. Estimates are also used in thedevelopment of discount rates and trend rates related to the measurement ofretirement benefit obligations and accrual amounts, allowances for doubtfulaccounts, unbilled revenue, valuation of derivative instruments, and in thedetermination of depreciable lives of utility plant. On an ongoing basis,management evaluates the estimates used, based on historical experience,current conditions and on various other assumptions believed to be reasonableunder the circumstances. Actual results may differ from these estimates underdifferent assumptions or conditions.

 

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## **RevenueRecognition**

## ** **

## **The Company recognizes operating revenues based ondeliveries of gas and other services to customers. This includes estimatedrevenues for gas delivered but not billed to residential and commercialcustomers from the latest meter reading date to the end of the accountingperiod.**

## ** **

## **RegulatoryAccounting**

## ** **

The Company’s accounting policies andpractices are generally the same as used by unregulated companies for financialreporting under GAAP. However, Statement of Financial Accounting Standards(FAS) No. 71, “Accounting for the Effects of Certain Types of Regulation”,requires regulated companies to apply accounting treatment intended to reflectthe financial impact of regulation. For example, in establishing the rates tobe charged to the Company’s retail customers, the WUTC and the OPUC may notallow the Company to charge its customers for recovery of certain expenses inthe same period they are incurred. Instead, rates are expected to beestablished to recover costs that were incurred in a prior period. In thissituation, following FAS No. 71 requires the Company to defer these costs andinclude them as regulatory assets on the balance sheet. In the subsequent periodwhen these costs are recovered from customers, the Company then amortizes thesecosts as expense in the income statement, in an amount equivalent to theamounts recovered. Similarly, certain revenue items, or cost reductions may bedeferred as regulatory liabilities, which are later amortized to the incomestatement as customer rates are reduced. In order to apply the provisions ofFAS 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.

 

TheCompany periodically assesses whether conditions merit the continuedapplicability of FAS No. 71. In the event the Company should determine in thefuture that all or a portion of its regulatory assets and liabilities no longermeet the above criteria, it would be required to write off the related balancesof its regulatory assets and liabilities, and reflect the write off in itsincome statement.

 

## **PensionPlans**

## ** **

TheCompany has a defined benefit pension plan covering substantially all employeesover 21 years of age with one year of service. The Company also providesexecutive officers with supplemental retirement, death and disability benefits.These plans were amended in fiscal 2003, so that subsequent to September 30,2003, benefits under these plans no longer accrue to non-bargaining-unitemployees and officers. The pension plan remains substantially unchanged forbargaining-unit employees at this time.

 

The Company’s pensioncosts for these plans are affected by the amount of cash contributions to theplans, the return on plan assets, and by employee demographics, including age,compensation, and length of service. Actuarial formulas are used in thedetermination of pension costs and are affected by actual plan experience andassumptions of future experience. Key actuarial assumptions include theexpected return on plan assets, the discount rate used in determining theprojected benefit obligation and pension costs, and the assumed rate ofincrease in employee compensation. Changes in these assumptions maysignificantly affect pension costs. Changes to the provisions of the plans mayalso impact current and future pension costs. Changes in pension planobligations resulting from these factors may not be immediately recognized aspension costs, but generally are recognized in future years over the remainingaverage service period of pension plan participants.

 

The Company’s fundingpolicy is to contribute amounts equal to or greater than the minimum amountsrequired to be funded under the Employee RetirementIncome Security Act, and not more than the maximum amounts currently deductiblefor income tax purposes. The Company contributed $3,843,000 in 2004 to thepension and supplemental executive retirement plans, and expects to contribute$3,525,000 in 2005.

 

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The discount rate theCompany selects is based on the average of the 20 year and above Aa debt rates published by Moody’s. These are ratesconsidered to be consistent with the expected term of pension benefits. AtSeptember 30, 2004, the Company used a discount rate of 6.00%. This same rateis used in the development of pension expense for fiscal 2005. A reduction inthe discount rate results in increases in projected benefit obligation, pensionliability, and pension costs.

 

In selecting an assumedlong-term rate of return on plan assets, the Company considers past performanceand economic forecasts for the types of investments held by the plan. In 2004and 2005 the Company’s assumed rate of return on plan assets is 8.25%. A reductionin the assumed rate of return would result in increases in pension liabilityand pension costs.

 

## **Derivatives**

## ** **

The Company accounts forderivative transactions according to the provisions of FAS No. 133, as amendedby FAS No. 138 and by**FAS No. 149. Thesestandards require that the fair value of all derivative financial instrumentsbe recognized as either assets or liabilities on the Company’s balance sheetand the recognition of unrealized gains and losses.

 

Most of the Company’scontracts for purchase and sale of natural gas qualify for the normal purchaseand normal sales exception under FAS No. 133 and are not required to berecorded as derivative assets and liabilities. Accordingly, the Company recognizes revenues and expenses on an accrualbasis, based on physical delivery of natural gas. The Company appliesmark-to-market accounting to financial derivative contracts. Periodic changesin fair market value of derivatives associated with supplies for non-corecustomers are recognized in earnings. The differences in accounting forpurchases and sales contracts versus financial contracts do not change theunderlying economics of the transactions, but could result in increasedquarterly earnings volatility. The Company applies FAS No. 71 to periodic changesin fair market value of derivatives associated with supplies for core customersand records an offset in regulatory asset and regulatory liability accounts.

 

**Item 3**. Quantitative and Qualitative Disclosures AboutMarket Risk

** **

Cascade has evaluated itsrisk related to financial instruments whose values are subject to marketsensitivity. The Company has fixed-rate debt obligations, but does not havederivative financial instruments subject to interest rate risk. Cascade makesinterest and principal payments on these obligations in the normal course ofits business, and does not plan to redeem these obligations prior to normalmaturities.

 

The Company’s natural gaspurchase commodity prices are subject to fluctuations resulting from weather,congestion on interstate pipelines, and other unpredictable factors. TheCompany’s Purchased Gas Cost Adjustment (PGA) mechanisms assure the recovery incustomer rates of prudently incurred wholesale cost of gas purchased for thecore market. The Company utilizes fixed price contracts and financialderivatives to manage risk associated with wholesale costs of gas purchased forcustomers.

 

With respect toderivative arrangements covering gas supplies for core customers, periodicchanges in fair market value are recorded in regulatory asset or regulatoryliability accounts, pursuant to authority granted by the WUTC and OPUCrecognizing that settlements of these arrangements will be recovered throughthe PGA mechanism.

 

For derivativearrangements related to supplies for non-core customers, whichare not covered by a PGA mechanism, periodic changes in fair market value arerecognized in earnings.

 

**Item 4**. Controls and Procedures

** **

The Company maintainscontrols and procedures designed to provide reasonable assurance that requireddisclosure information in the reports the Company files or submits under theSecurities Exchange Act of 1934, as amended, is recorded, processed, summarizedand reported within the time period specified 

 

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in the rules and forms of theSecurities and Exchange Commission. Based upon their evaluation of those controls and procedures as of theend of the quarter covered by this report, the Chief Executive Officer andChief Financial Officer of the Company concluded that the Company’s disclosurecontrols and procedures were effective.

 

In response to thechanges in the filing requirements for Current Reports on Form 8-K effectiveAugust 23, 2004, the Company implemented additional controls and procedures designedto provide reasonable assurance that required disclosures under such newrequirements will be made in a timely manner. During the period covered by this report, we identified two materialcontracts for which we determined reports on Form 8-K had not been filed withinthe required four business days.  TheCompany has since filed the required reports, and has adopted additionalprocedures to correct these deficiencies. We did not make any other****changes in our internal control overfinancial reporting during the quarter ended December 31, 2004 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

# **FORWARD-LOOKINGSTATEMENTS**

# ** **

Statementscontained in this report that are not historical in nature are forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995. Forward-looking statements are subject to risks and uncertainties thatmay cause actual future results to differ materially. Such risks anduncertainties with respect to the Company include, among others, its ability tosuccessfully implement internal performance goals, competition from alternativeforms of energy and other sellers of energy, consolidation in the energyindustry, performance issues with key natural gas suppliers, thecapital-intensive nature of the Company’s business, regulatory issues,including the need for adequate and timely rate relief to recover capital andoperating costs and to sustain dividend levels, the weather, increasingcompetition brought on by deregulation initiatives at the federal and stateregulatory levels, the potential loss of large volume industrial customers dueto “bypass” or the shift by such customers to special competitive contracts atlower per unit margins, exposure to environmental cleanup requirements, andeconomic conditions, particularly in the Company’s service area.

 

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

 

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

 

a)

 

b)There have been no changes in the Company’s procedures by which securityholders may recommend nominees to the Company’s Board of Directors.

 

# **Item6**. Exhibits

# ** **

| **No.** | ** ** | **Description**                                                                                                          |
|---------|------------|--------------------------------------------------------------------------------------------------------------------------|
|    |       |                                                                                                                     |
| 10.1    |       | Agreement and General  Release between the Registrant and J.D. Wessling, Chief Financial Officer                         |
|    |       |                                                                                                                     |
| 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 |

 

17

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**SIGNATURE**

** **

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

 

 
| **CASCADE  NATURAL GAS CORPORATION** | ** **                     | ** ** |
|--------------------------------------|--------------------------------|------------|
| ** **                           | ** **                     | ** ** | ** ** | ** ** |
| ** **                           | ** **                     | ** ** | ** ** | ** ** |
| By:                                  | /s/ J. D.  Wessling            | .          |   |   |   |
|                                 |                           |       |   |   |
|                                 |                           |       |   |   |
|                                 | J. D. Wessling                 |       |   |   |
|                                 | Chief Financial  Officer       |       |   |   |
|                                 | (Principal  Financial Officer) |       |   |   |
|                                 |                           |       |   |   |
|                                 |                           |       |   |   |
| Date:                                | February 7, 2005               | .          |   |   |   |

 

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