**FORM10-Q**

 

**SECURITIES AND EXCHANGECOMMISSION**

 

**Washington, D.C. 20549**

 

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

**OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the quarterly period ended March 31, 2005**

 

**Commission file number: 1-7196**

 

**CASCADE NATURAL GAS CORPORATION**

(Exact name of Registrant as specified in its charter)

 
| **Washington**                                                  | ** ** | **91-0599090**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **222 Fairview Avenue North, Seattle, WA**                      | ** ** | **98109**                             |
| (Address of principal executive offices)                        |       | (Zip code)                            |
|                                                            |       |                                  |
| (Registrant’s telephone number including area code)        |       | **(206) 624-3900**                    |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý                               No o

 

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

 

Indicatethe number of shares outstanding of each of the registrant’s classes of commonstock, as of the latest practicable date.

 
| **Title**                            | ** ** | **Outstanding**                       |
|--------------------------------------|------------|---------------------------------------|
|                                 |       |                                  |
| Common Stock, Par Value $1 per Share |       | 11,359,612 as of April 29,  2005 |

 

 

----

 

**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  4. Submission of Matters to a Vote of Security Holders                                        |   |
|      |                  |                                                                                                |   |
|      |                  | Item 5. Other Information                                                                           |   |
|      |                  |                                                                                                |   |
|      |                  | Item 6. Exhibits                                                                                    |   |
|      |                  |                                                                                                |   |
| Signature |                  |

 

2

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# **PART I**.   Financial Information

 

**Item 1**.  FinancialStatements

 

CASCADE NATURAL GASCORPORATION

CONSOLIDATED CONDENSEDSTATEMENTS OF INCOME

(unaudited)

 
| ** **                                 | ** ** | **THREE MONTHS ENDED**                 | ** ** | **SIX MONTHS ENDED** | ** ** |
|--------------------------------------------|------------|----------------------------------------|------------|----------------------|------------|
| ** **                                 | ** ** | **Mar 31, 2005**                       | ** ** | **Mar 31, 2004**     | ** ** | **Mar 31, 2005** | ** ** | **Mar 31, 2004** | ** ** |
| ** **                                 | ** ** | **(thousands except per share  data)** | ** ** |
|                                       |       |                                   |       |                 |       |   |   |   |   |
| Operating revenues                         |       | $                                      | 117,711    |                 | $          | 119,454 |   | $ | 222,324 |   | $ | 224,339 |   |
|                                       |       |                                   |       |                 |       |   |   |   |   |
| Less: Gas purchases                        |       | 78,331                                 |       | 78,598               |       | 147,452 |   | 146,123 |   |
| Revenue taxes                              |       | 8,538                                  |       | 8,714                |       | 15,108 |   | 15,381 |   |
| Operating margin                           |       | 30,842                                 |       | 32,142               |       | 59,764 |   | 62,835 |   |
|                                       |       |                                   |       |                 |       |   |   |   |   |
| Cost of operations:                        |       |                                   |       |                 |       |   |   |   |   |
| Operating expenses                         |       | 11,021                                 |       | 10,649               |       | 21,441 |   | 20,927 |   |
| Depreciation and amortization              |       | 4,280                                  |       | 3,935                |       | 8,485 |   | 7,855 |   |
| Property and miscellaneous taxes           |       | 944                                    |       | 876                  |       | 1,903 |   | 1,807 |   |
|                                       |       | 16,245                                 |       | 15,460               |       | 31,829 |   | 30,589 |   |
|                                       |       |                                   |       |                 |       |   |   |   |   |
| Income from operations                     |       | 14,597                                 |       | 16,682               |       | 27,935 |   | 32,246 |   |
| Less interest and other deductions - net   |       | 2,976                                  |       | 3,121                |       | 5,870 |   | 6,237 |   |
| Income before income taxes                 |       | 11,621                                 |       | 13,561               |       | 22,065 |   | 26,009 |   |
|                                       |       |                                   |       |                 |       |   |   |   |   |
| Income taxes                               |       | 4,269                                  |       | 4,892                |       | 8,081 |   | 9,436 |   |
| Net Income                                 |       | 7,352                                  |       | 8,669                |       | 13,984 |   | 16,573 |   |
|                                       |       |                                   |       |                 |       |   |   |   |   |
| Weighted average common shares outstanding |       | 11,312                                 |       | 11,196               |       | 11,296 |   | 11,177 |   |
|                                       |       |                                   |       |                 |       |   |   |   |   |
| Net earnings per common share              |       |                                   |       |                 |       |   |   |   |   |
| Basic                                      |       | $                                      | 0.65       |                 | $          | 0.77 |   | $ | 1.24 |   | $ | 1.48 |   |
| Diluted                                    |       | $                                      | 0.65       |                 | $          | 0.77 |   | $ | 1.24 |   | $ | 1.48 |   |
|                                       |       |                                   |       |                 |       |   |   |   |   |
| Cash dividends per share                   |       | $                                      | 0.24       |                 | $          | 0.24 |   | $ | 0.48 |   | $ | 0.48 |   |

 

The accompanying notesare an integral part of these financial statements

 

3

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**CASCADE NATURAL GAS CORPORATION**

**CONSOLIDATED CONDENSED BALANCE SHEETS**

(unaudited)

 
| ** **                                                                                                                 | ** ** | **Mar 31, 2005**           | ** ** | **Sep 30, 2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------|------------|
| ** **                                                                                                                 | ** ** | **(dollars in thousands)** | ** ** |
| **ASSETS**                                                                                                                 | ** ** | ** **                 | ** ** | ** **       | ** ** |
| Utility Plant, net of accumulated depreciation of  $251,061 and $242,691                                                   |       | $                          | 334,767    |             | $          | 327,345 |   |
| Construction work in progress                                                                                              |       | 6,433                      |       | 7,229            |       |
|                                                                                                                       |       | 341,200                    |       | 334,574          |       |
| Other Assets:                                                                                                              |       |                       |       |             |       |
| Investments in non-utility property                                                                                        |       | 202                        |       | 202              |       |
| Notes receivable, less current maturities                                                                                  |       | 50                         |       | 43               |       |
|                                                                                                                       |       | 252                        |       | 245              |       |
| Current Assets:                                                                                                            |       |                       |       |             |       |
| Cash and cash equivalents                                                                                                  |       | 6,105                      |       | 499              |       |
| Accounts receivable and current maturities of notes  receivable, less allowance of $1,139 and $1,028 for doubtful accounts |       | 48,780                     |       | 15,001           |       |
| Prepaid expenses and other assets                                                                                          |       | 4,977                      |       | 18,674           |       |
| Derivative instrument assets - energy commodity                                                                            |       | 26,551                     |       | 17,983           |       |
| Materials, supplies and inventories                                                                                        |       | 5,772                      |       | 13,268           |       |
| Deferred income taxes                                                                                                      |       | 1,009                      |       | 955              |       |
|                                                                                                                       |       | 93,194                     |       | 66,380           |       |
| Deferred Charges and Other                                                                                                 |       |                       |       |             |       |
| Gas cost changes                                                                                                           |       | 10,804                     |       | 12,288           |       |
| Derivative instrument assets - energy commodity                                                                            |       | 9,942                      |       | 3,952            |       |
| Other                                                                                                                      |       | 6,869                      |       | 5,183            |       |
|                                                                                                                       |       | 27,615                     |       | 21,423           |       |
|                                                                                                                       |       |                       |       |             |       |
|                                                                                                                       |       | $                          | 462,261    |             | $          | 422,622 |   |

 

4

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**CASCADE NATURAL GAS CORPORATION**

**CONSOLIDATED CONDENSED BALANCESHEETS (Continued)**

(unaudited)

 
| ** **                                                                                                                   | ** ** | **Mar 31, 2005**           | ** ** | **Sep 30, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------|------------|
| ** **                                                                                                                   | ** ** | **(dollars in thousands)** | ** ** |
| **COMMON SHAREHOLDERS’ EQUITY AND LIABILITIES**                                                                         |       |                       |       |             |       |
| Common Shareholders’ Equity:                                                                                            |       |                       |       |             |       |
| Common stock, par value $1 per share, authorized  15,000,000 shares, issued and outstanding 11,337,642 and 11,268,069 shares |       | $                          | 11,337     |             | $          | 11,268 |   |
| Additional paid-in capital                                                                                                   |       | 102,575                    |       | 101,354          |       |
| Accumulated other comprehensive income (loss)                                                                                |       | (12,608                    | )          | (12,608          | )          |
| Retained earnings                                                                                                            |       | 27,052                     |       | 18,500           |       |
|                                                                                                                         |       | 128,356                    |       | 118,514          |       |
|                                                                                                                         |       |                       |       |             |       |
| Long-term Debt                                                                                                               |       | 158,900                    |       | 128,900          |       |
|                                                                                                                         |       |                       |       |             |       |
| Current Liabilities:                                                                                                         |       |                       |       |             |       |
| Notes payable and commercial paper                                                                                           |       | 13,500                     |       | 33,500           |       |
| Current maturities of long-term debt                                                                                         |       | 5,000                      |       | 14,000           |       |
| Accounts payable                                                                                                             |       | 22,887                     |       | 12,923           |       |
| Property, payroll and excise taxes                                                                                           |       | 8,645                      |       | 5,287            |       |
| Dividends and interest payable                                                                                               |       | 7,081                      |       | 7,125            |       |
| Regulatory liabilities                                                                                                       |       | 26,023                     |       | 17,209           |       |
| Other current liabilities                                                                                                    |       | 9,901                      |       | 8,972            |       |
|                                                                                                                         |       | 93,037                     |       | 99,016           |       |
|                                                                                                                         |       |                       |       |             |       |
| Deferred Credits and Other Non-current Liabilities                                                                           |       |                       |       |             |       |
| Deferred income taxes and investment tax credits                                                                             |       | 39,281                     |       | 38,392           |       |
| Retirement plan obligations                                                                                                  |       | 20,731                     |       | 20,780           |       |
| Regulatory liabilities                                                                                                       |       | 15,930                     |       | 10,515           |       |
| Other                                                                                                                        |       | 6,026                      |       | 6,505            |       |
|                                                                                                                         |       | 81,968                     |       | 76,192           |       |
|                                                                                                                         |       |                       |       |             |       |
| Commitments and Contingencies                                                                                                |       | —                     |       | —           |       |
|                                                                                                                         |       | $                          | 462,261    |             | $          | 422,622 |   |

 

Theaccompanying notes are an integral part of these financial statements

 

5

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CASCADE NATURAL GAS CORPORATION

CONSOLIDATED CONDENSEDSTATEMENTS OF CASH FLOWS

(Unaudited)

 
| ** **                                                                         | ** ** | **SIX MONTHS ENDED**       | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                         | ** ** | **(dollars in thousands)** | ** ** |
| ** **                                                                         | ** ** | **Mar 31, 2005**           | ** ** | **Mar 31, 2004** | ** ** |
| Operating Activities                                                               |       |                       |       |   |   |
| Net income                                                                         |       | $                          | 13,984     |   | $ | 16,573 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                       |       |   |   |
| Depreciation and amortization                                                      |       | 8,485                      |       | 7,855 |   |
| Deferrals of gas cost changes                                                      |       | (2,266                     | )          | (1,730 | ) |
| Amortization of gas cost changes                                                   |       | 3,750                      |       | 4,825 |   |
| Other deferrals and amortizations                                                  |       | (491                       | )          | 641 |   |
| Deferred income taxes and tax credits - net                                        |       | 835                        |       | 2,629 |   |
| Change in current assets and liabilities                                           |       | 1,860                      |       | 805 |   |
| Net cash provided by operating activities                                          |       | 26,157                     |       | 31,598 |   |
|                                                                               |       |                       |       |   |   |
| Investing Activities                                                               |       |                       |       |   |   |
| Capital expenditures                                                               |       | (16,130                    | )          | (20,206 | ) |
| Customer contributions in aid of construction                                      |       | 601                        |       | 318 |   |
| Net cash used by investing activities                                              |       | (15,529                    | )          | (19,888 | ) |
|                                                                               |       |                       |       |   |   |
| Financing Activities                                                               |       |                       |       |   |   |
| Proceeds from issuance of long-term debt, net                                      |       | 28,119                     |       | — |   |
| Proceeds from issuance of common stock                                             |       | 1,290                      |       | 1,440 |   |
| Repayment of long-term debt                                                        |       | (9,000                     | )          | — |   |
| Changes in notes payable and commercial paper, net                                 |       | (20,000                    | )          | (3,800 | ) |
| Dividends paid                                                                     |       | (5,431                     | )          | (5,378 | ) |
| Net cash used by financing activities                                              |       | (5,022                     | )          | (7,738 | ) |
|                                                                               |       |                       |       |   |   |
| Net Increase in Cash and Cash Equivalents                                          |       | 5,606                      |       | 3,972 |   |
|                                                                               |       |                       |       |   |   |
| Cash and Cash Equivalents                                                          |       |                       |       |   |   |
| Beginning of year                                                                  |       | 499                        |       | 7,452 |   |
| End of period                                                                      |       | $                          | 6,105      |   | $ | 11,424 |   |

 

The accompanying notesare an integral part of these financial statements

 

6

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**CASCADE NATURAL GAS CORPORATION**

**NOTES TO CONSOLIDATED CONDENSEDFINANCIAL STATEMENTS**

## **THREE-AND SIX-MONTH PERIODS ENDED MARCH 31**

 

Thepreceding statements were taken from the books and records of the Company andreflect all adjustments which are, in the opinion of management, necessary fora fair statement of the results for the interim periods. Because of the highlyseasonal nature of the natural gas distribution business, earnings or loss forany portion of the year are disproportionate in relation to the full year.

 

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

 

#### **Note 1.****Restatement**

####  

As disclosed in theQuarterly Report on Form 10-Q for the quarter ended June 30, 2004, theCompany restated its earnings for the quarter ended March 31, 2004. Thisrestatement was a result of the remeasurement of retiree medical expense, witha remeasurement date of December 31, 2003. This remeasurement reducedoperating expenses by $158,000 for the three- and six-month periods ended March 31,2004.

 

Fiscal year 2004 amountsreported in this quarterly report, including amounts in the followingfootnotes, reflect the restated amounts.

 

**Note 2.****Earnings Per Share**

 

Thefollowing table sets forth the calculation of earnings per share.

 
| ** **                                             | ** ** | **Three Months Ended**                    | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|----------------------|------------|
| ** **                                             | ** ** | **Mar 31, 2005**                          | ** ** | **Mar 31, 2004**     | ** ** | **Mar 31, 2005** | ** ** | **Mar 31, 2004** | ** ** |
| ** **                                             | ** ** | **(in thousands except per-share  data)** | ** ** |
| Net income                                             |       | $                                         | 7,352      |                 | $          | 8,669 |   | $ | 13,984 |   | $ | 16,573 |   |
|                                                   |       |                                      |       |                 |       |   |   |   |   |
| Weighted average shares outstanding                    |       | 11,312                                    |       | 11,196               |       | 11,296 |   | 11,177 |   |
| Basic earnings per share                               |       | $                                         | 0.65       |                 | $          | 0.77 |   | $ | 1.24 |   | $ | 1.48 |   |
|                                                   |       |                                      |       |                 |       |   |   |   |   |
| Weighted average shares outstanding                    |       | 11,312                                    |       | 11,196               |       | 11,296 |   | 11,177 |   |
| Plus: Issued on assumed exercise of stock options      |       | 3                                         |       | 18                   |       | 4 |   | 14 |   |
| Weighted average shares outstanding assuming  dilution |       | 11,315                                    |       | 11,214               |       | 11,300 |   | 11,191 |   |
|                                                   |       |                                      |       |                 |       |   |   |   |   |
| Diluted earnings per share                             |       | $                                         | 0.65       |                 | $          | 0.77 |   | $ | 1.24 |   | $ | 1.48 |   |

 

7

----

 

**Note 3.****Retirement Plan Information**

 

The following table sets forth the components of netperiodic benefit costs recognized.

 

**Net Periodic Benefits Cost**

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                      | ** ** | **Mar 31, 2005**       | ** ** | **Mar 31, 2004**     | ** ** | **Mar 31, 2005** | ** ** | **Mar 31, 2004** | ** ** |
| ** **                                      | ** ** | **(in thousands)**     | ** ** |
| **DEFINED BENEFIT PENSION PLANS**               |       |                   |       |                 |       |   |   |   |   |
| Service cost                                    |       | $                      | 197        |                 | $          | 192 |   | $ | 394 |   | $ | 384 |   |
| Interest cost                                   |       | 961                    |       | 932                  |       | 1,922 |   | 1,864 |   |
| Expected return on plan assets                  |       | (1,041                 | )          | (978                 | )          | (2,081 | ) | (1,956 | ) |
| Recognized gains or losses                      |       | 386                    |       | 349                  |       | 772 |   | 699 |   |
| Prior service cost                              |       | 46                     |       | 57                   |       | 91 |   | 114 |   |
| Net Periodic Benefit Cost Recognized            |       | $                      | 549        |                 | $          | 552 |   | $ | 1,098 |   | $ | 1,105 |   |
|                                            |       |                   |       |                 |       |   |   |   |   |
| **POSTRETIREMENT BENEFITS OTHER THAN PENSIONS** |       |                   |       |                 |       |   |   |   |   |
| Service cost                                    |       | $                      | 35         |                 | $          | 38 |   | $ | 70 |   | $ | 83 |   |
| Interest cost                                   |       | 275                    |       | 308                  |       | 550 |   | 655 |   |
| Expected return on plan assets                  |       | (211                   | )          | (213                 | )          | (423 | ) | (426 | ) |
| Recognized gains or losses                      |       | 187                    |       | 218                  |       | 374 |   | 526 |   |
| Prior service cost                              |       | (330                   | )          | (330                 | )          | (660 | ) | (660 | ) |
| Net Periodic Benefit Cost Recognized            |       | $                      | (44        | )                    | $          | 21 |   | $ | (89 | ) | $ | 178 |   |
|                                            |       |                   |       |                 |       |   |   |   |   |
| **DEFINED CONTRIBUTION PENSION PLAN**           |       |                   |       |                 |       |   |   |   |   |
| Net Periodic Benefit Cost Recognized            |       | $                      | 250        |                 | $          | 245 |   | $ | 492 |   | $ | 487 |   |

 

**RetirementPlan Funding**

 

For the six monthsended March 31, 2005, $1,025,000 of contributions havebeen made to the Company’s defined benefit pension plans. The Company presentlyanticipates contributing an additional $2,295,000 to fund its pension plans fora total of $3,320,000 in fiscal 2005.

 

### **Note 4.** Stock-Based Compensation

 

**The Company follows thedisclosure-only provisions of Statement of Financial Accounting Standards (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 FAS No.123, net income and earnings per common share would have been the following proforma amounts for the three- and six-month periods ended March 31:**

 

8

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| ** **                                                                                               | ** ** | **Three Months Ended**                    | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|----------------------|------------|
| ** **                                                                                               | ** ** | **Mar 31, 2005**                          | ** ** | **Mar 31, 2004**     | ** ** | **Mar 31, 2005** | ** ** | **Mar 31, 2004** | ** ** |
| ** **                                                                                               | ** ** | **(in thousands except per-share  data)** | ** ** |
| Net income                                                                                               |       |                                      |       |                 |       |   |   |   |   |
| As reported                                                                                              |       | $                                         | 7,352      |                 | $          | 8,669 |   | $ | 13,984 |   | $ | 16,573 |   |
| Less total stock-based employee compensation expense  determined under the fair value method, net of tax |       | $                                         | 13         |                 | 13         |   | $ | 26 |   | 26 |   |
| Pro forma net income                                                                                     |       | $                                         | 7,339      |                 | $          | 8,656 |   | $ | 13,958 |   | $ | 16,547 |   |
|                                                                                                     |       |                                      |       |                 |       |   |   |   |   |
| Earnings per share, basic and diluted                                                                    |       |                                      |       |                 |       |   |   |   |   |
| As reported                                                                                              |       | $                                         | 0.65       |                 | $          | 0.77 |   | $ | 1.24 |   | $ | 1.48 |   |
| Pro forma                                                                                                |       | $                                         | 0.65       |                 | $          | 0.77 |   | $ | 1.24 |   | $ | 1.48 |   |

 

**Note 5.****Commitments and Contingencies**

 

**Unregistered Shares of Common Stock Under DRIP**

 

Inconnection with modifying administrative procedures and updating the prospectusfor the Company’s Automatic Dividend Reinvestment Plan (the DRIP), the Companyhas learned that the number of shares of its common stock issued pursuant tothe DRIP exceeded the number of shares previously registered for such purposeunder the Securities Act of 1933, as amended (the Securities Act). As a result,the Company may have failed to comply with the registration or qualificationrequirements of federal and applicable state securities laws with respect tosuch shares.

 

Based upon the Company’sinvestigation, it appears that approximately 122,800 shares of its common stockwere issued to approximately 3,500 DRIP participants between August 2003and April 2005 in excess of the number of shares registered specificallyfor such purpose.  Such shares wereissued at prices ranging from $18.18 to $22.95 per share.

 

The Company iscontinuing to investigate details concerning the DRIP participants affected andis evaluating appropriate actions to be taken, including a possible rescissionoffer, to rectify this oversight.  Shouldthe Company repurchase all of the unregistered shares at the purchase pricesfor which they were issued, cash of approximately $2,508,000 would be used toretire approximately 122,800 outstanding shares.  Should the Company repurchase only theunregistered shares sold since May 1, 2004 (approximately the periodcovered by the one-year statute of limitations applicable to sales ofunregistered shares under the Securities Act), cash of approximately $1,493,000would be used to retire approximately 73,000 outstanding shares.

 

The Company has not yetobtained all of the necessary information concerning individual DRIPparticipants to determine whether a rescission offer is the appropriate actionto take and, if so, how it should be structured.  If the Company should proceed with arescission offer, additional costs, including interest, legal, accounting, dataprocessing, printing, mailing and related administrative expenses, will beincurred.  Depending on the specificterms of a rescission offer, the Company’s current estimates of such costs,after offsetting dividends paid on shares repurchased, range from $200,000 to$300,000.

 

# **Environmental Matters**

 

Thereare two claims against the Company for as yet unknown costs for cleanup ofalleged environmental contamination related to manufactured gas plant sitesthat were previously operated by companies which were subsequently merged intothe Company.

 

Thefirst claim was received in 1995 and relates to a site in Oregon. Aninvestigation has shown that contamination does exist, but there is currentlynot enough information available to estimate the potential liability associatedwith this claim. It is expected that other parties will participate in thecleanup costs. Through the end of the quarter the amounts spent, primarily oninvestigation and containment, have been immaterial.

 

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

 

9

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Managementintends to pursue reimbursement from its insurance carriers, and recovery fromits customers 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 OtherContingencies**

 

Various lawsuits,claims, and contingent liabilities may arise from time to time from the conductof the Company’s business. No other claims now pending, in the opinion ofmanagement, are expected to have a material effect on the Company’s financialposition, results of operations, cash flows, or liquidity.

 

# **Item 2**. Management’s Discussion and Analysis of Financial Condition and Resultsof 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 six-month periods ended March 31,2005 and March 31, 2004.

 

**OVERVIEW**

 

TheCompany is a local distribution company (LDC) serving approximately 228,000customers in the States of Washington and Oregon. The Company’s service areaconsists primarily of relatively small cities and rural communities rather thanlarger urban areas. The Company’s primary source of revenue and operatingmargin is the distribution of natural gas to end-use residential, commercial,industrial, and institutional customers. Revenues are also derived fromproviding gas management and other services to some of its large industrial andcommercial customers. The Company’s rates and practices are regulated by theWashington Utilities and Transportation Commission (WUTC) and the Oregon PublicUtility Commission (OPUC).

 

Keyelements of the Company’s strategy include:

 

•                  Remain focused on delivering naturalgas to a growing residential, commercial, and industrial customer base inWashington and Oregon.

•                  Provide gas management, engineering, construction and maintenance services for customer-ownednatural gas facilities when the risk / reward ratio is appropriate.

•                  Pursue additional opportunitiesclosely aligned with the Company’s core business by building on its existingresources and customers.

•                  Continuously evaluate the mosteffective utilization of corporate resources.

 

**Opportunitiesand Challenges**

 

TheCompany operates in a diverse service territory over a wide geographic arearelative to its overall size and number of customers. The economies of variousparts of the service area are supported by a variety of industries, and areaffected by the conditions that impact those industries.

 

Managementbelieves there are growth opportunities in the 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.

 

Ratescharged by the Company for its utility services are regulated by the WUTC andthe OPUC. The Company’s basic business strategy is to minimize reliance on rateincreases for earnings growth. However, realization of risks affecting earningscould require the Company to seek approval of higher rates. The results of suchrate requests are subject to uncertainties associated with the regulatoryprocess.

 

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TheCompany earns more than one third of its operating margin from industrial andelectric generation customers. Loss of major industrial customers, orunfavorable conditions affecting an industry segment, could have a detrimentalimpact on the Company’s earnings. Many external factors over which the Companyhas no control can significantly impact the amount of natural gas consumed byindustrial and electric generation customers, and consequently the marginsearned by the Company.

 

Revenues and margins from the Company’s residential and smallcommercial customers are highly weather sensitive. In a cold year, the Company’searnings are boosted by the effects of the weather, and conversely in a warmyear, the Company’s earnings suffer. Overall revenues and margins are alsonegatively impacted by customers taking measures to reduce energy usage. Theincreasing cost of energy in recent years, including the wholesale cost ofnatural gas, continues to encourage such measures. The Company continues toexplore alternatives such as weather normalization or decoupling mechanismsthat utility regulators in many jurisdictions have approved. The WUTC hasopened a Rulemaking Docket to investigate decoupling.  A workshop under this docket is set for May12, 2005.  The Company will be presentingits proposed mechanism at this workshop.

 

Prospectsfor continuing strong residential and commercial customer growth are excellent.The pace of new home and commercial construction remains steady in the Company’scommunities. Good potential also exists for converting to natural gas fromelectricity or other fuels, homes and businesses located on or near the Company’scurrent lines, as well as for expanding the system into adjacent areas.

 

# **RESULTS OF OPERATIONS**

 

Netincome for the second quarter of fiscal 2005 (quarter ended March 31,2005) was $7,352,000, or $0.65 per share, basic and diluted, compared to$8,669,000, or $0.77 per share, basic and diluted, for the quarter ended March 31,2004. Primary factors negatively impacting the quarterly comparisons were:

 

•                  Lower 2005 operating margins fromresidential and commercial customers.

•                  Lower 2005 distribution and gasmanagement margins from industrial customers.

•                  Executive transition costs in 2005.

•                  Increased uncollectible accountsexpense in 2005.

•                  Severance and related expenses in2005 of consolidating customer service operations.

 

Partiallyoffsetting the above factors were the following items favorably impacting theearnings comparisons:

 

•                  Reduced labor and benefits expensesin 2005.

•                  2005 adjustment of 2004 accrual ofestimate of Oregon earnings sharing.

•                  Mark-to-market valuations ofderivative instruments.

 

The year-to-date comparisons were affected by the same factors,except that on a year-to-date basis the mark-to-market valuations had anegative impact.

 

# **Operating Margin**

 

Operatingmargins by customer category are set forth in the following tables:

 

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**Residential and Commercial Margin**

 
| ** **                             | ** ** | **Second Quarter of Fiscal** | ** ** | **Percent** | ** ** | **Fiscal Year to Date** | ** ** | **Percent** | ** ** |
|----------------------------------------|------------|------------------------------|------------|-------------|------------|-------------------------|------------|-------------|------------|
| ** **                             | ** ** | **2005**                     | ** ** | **2004**    | ** ** | **Change**              | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)**   | ** ** |
| **Degree Days**                        |       |                         |       |        |       |                    |       |        |       |   |   |   |   |
| Actual                                 |       | 2,230                        |       | 2,249       |       | -0.8                    | %          | 4,175       |       | 4,355 |   | -4.1 | % |
| 5-Year Average                         |       | 2,271                        |       | 2,275       |       |                    |       | 4,362       |       | 4,319 |   |   |   |
| **Average Number of Customers Billed** |       |                         |       |        |       |                    |       |        |       |   |   |   |   |
| Residential                            |       | 196,094                      |       | 187,042     |       | 4.8                     | %          | 193,597     |       | 184,730 |   | 4.8 | % |
| Commercial                             |       | 30,475                       |       | 29,665      |       | 2.7                     | %          | 30,157      |       | 29,398 |   | 2.6 | % |
| **Average Therm Usage per Customer**   |       |                         |       |        |       |                    |       |        |       |   |   |   |   |
| Residential                            |       | 266                          |       | 286         |       | -7.0                    | %          | 517         |       | 558 |   | -7.3 | % |
| Commercial                             |       | 1,328                        |       | 1,434       |       | -7.4                    | %          | 2,491       |       | 2,688 |   | -7.3 | % |
| **Operating Margin**                   |       |                         |       |        |       |                    |       |        |       |   |   |   |   |
| Residential                            |       | $                            | 14,231     |        | $          | 15,178                  |       | -6.2        | %          | $ | 28,455 |   | $ | 29,234 |   | -2.7 | % |
| Commercial                             |       | $                            | 7,724      |        | $          | 8,650                   |       | -10.7       | %          | $ | 15,185 |   | $ | 16,187 |   | -6.2 | % |

 

The decline inmargin from sales to residential and commercial customers results from lowerusage of natural gas on a per-customer basis for both the quarterly andyear-to-date periods. The margin decline attributed to lower usage was$2,990,000 for the quarter and $3,884,000 year to date. Partially offsettingthis decline was the favorable impact of the increase in the number ofcustomers billed in 2005. Assuming the same average consumption per customer aslast year, this growth in customers contributed $1,117,000 in additional marginfor the quarter and $2,103,000 year to date. The primary use of natural gas byresidential customers is for space and water heating; therefore, averageconsumption per customer is very sensitive to weather, particularly during theCompany’s first and second fiscal quarters. Consumption by commercial customersis also sensitive to weather. The sensitivity is more difficult to isolate andmeasure than for residential customers because of a variety of uses in additionto space and water heating. Other factors also have a negative impact on gasusage, including conservation efforts spurred by higher natural gas prices andhigher energy efficiency in buildings and appliances.

 

**Industrial and Other Margin**

 
| ** **                        | ** ** | **Second Quarter of Fiscal** | ** ** | **Percent** | ** ** | **Fiscal Year to Date** | ** ** | **Percent** | ** ** |
|-----------------------------------|------------|------------------------------|------------|-------------|------------|-------------------------|------------|-------------|------------|
| ** **                        | ** ** | **2005**                     | ** ** | **2004**    | ** ** | **Change**              | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
|                              |       |                         |       |        |       |                    |       |        |       |   |   |   |   |
| **Average Number of Customers**   |       |                         |       |        |       |                    |       |        |       |   |   |   |   |
| Electric Generation               |       | 13                           |       | 14          |       | -7.1                    | %          | 13          |       | 14 |   | -7.1 | % |
| Industrial                        |       | 724                          |       | 740         |       | -2.2                    | %          | 730         |       | 743 |   | -1.7 | % |
|                              |       | 737                          |       | 754         |       | -2.3                    | %          | 743         |       | 757 |   | -1.8 | % |
| **Therms Delivered (thousands)**  |       |                         |       |        |       |                    |       |        |       |   |   |   |   |
| Electric Generation               |       | 113,977                      |       | 108,672     |       | 4.9                     | %          | 231,342     |       | 253,817 |   | -8.9 | % |
| Industrial                        |       | 114,913                      |       | 115,221     |       | -0.3                    | %          | 225,327     |       | 230,963 |   | -2.4 | % |
|                              |       | 228,890                      |       | 223,893     |       | 2.2                     | %          | 456,669     |       | 484,780 |   | -5.8 | % |
| **Operating Margin ($thousands)** |       |                         |       |        |       |                    |       |        |       |   |   |   |   |
| Electric Generation               |       | $                            | 2,026      |        | $          | 1,895                   |       | 6.9         | %          | $ | 4,034 |   | $ | 4,136 |   | -2.5 | % |
| Industrial                        |       | 5,333                        |       | 5,695       |       | -6.4                    | %          | 10,544      |       | 11,100 |   | -5.0 | % |
| Gas Management Services           |       | 324                          |       | 818         |       | -60.4                   | %          | 715         |       | 1,942 |   | -63.2 | % |
| Mark-to-Market Valuations         |       | 549                          |       | 69          |       | 695.7                   | %          | (119        | )          | 475 |   | -125.1 | % |
| Other                             |       | 129                          |       | 116         |       | 11.2                    | %          | 425         |       | 290 |   | 46.6 | % |
|                              |       | $                            | 8,361      |        | $          | 8,593                   |       | -2.7        | %          | $ | 15,599 |   | $ | 17,943 |   | -13.1 | % |

 

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**IndustrialMargin:**The declinein margin from distribution services to industrial customers is primarilyattributable to reduced usage.

 

**GasManagement Services:** The decline in margin from gasmanagement services is attributed to fewer gas management customers and lowerper-therm margin on natural gas supply sales compared to last year. There-emergence of energy marketers, an industry segment that all but disappearedin the wake of the Enron failure, has resulted in stiff competition for naturalgas supply sales to larger natural gas customers. The Company has lost somecustomers to such marketers, and margins that are available for any sales aresmaller than in the past. The Company will continue to provide natural gassupply services to customers to facilitate their use of gas, but expectsrevenues 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 second quarter, forward natural gas prices increasedfrom the beginning of the quarter to the end of the quarter, hence the $549,000credit to operating margin for the quarter. During the quarter last year, theseprices increased much less dramatically, resulting in the smaller $69,000credit. These hedging instruments are for fixed periods that correspond to theperiods of the physical supply contracts to serve these customers. The hedgedvolumes also correspond to the volumes expected to be purchased under thesecontracts. At the end of the life of the hedging instruments the cumulativeincome statement effects of the mark-to-market valuations will net to zero. Butmarket fluctuations in interim periods do result in mark-to-market valuationeffects in those periods’ income statements.

 

**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. Over the first twoquarters of 2004 the Company accrued a total liability of $525,000 as anestimate of earnings that would be required to be shared with Oregon customers.However, based on an analysis of the results for the entire year, managementhas concluded that 2004 earnings in Oregon were not sufficient as to trigger asharing with customers. As a result, in the second quarter of 2005 the Companyrecorded a reversal of the estimate accrued in 2004. The analysis is subject tofinal review and approval by the OPUC, which we expect prior to the end offiscal 2005.

 

**Cost of Operations**

 

Comparedto last year, overall Cost of Operations was $785,000 (5.1%) higher for thequarter. Year-to-date, the increase was $1,240,000 (4.1%). Within Cost ofOperations, notable changes in Operating Expenses included charges forexecutive transition, as well as transition to the Company’s new customerservice call center, as shown in the following table.

 
| ** **                | ** ** | **Second  Quarter** | ** ** | **Year-to-date** | ** ** |
|---------------------------|------------|---------------------|------------|------------------|------------|
| ** **                | ** ** | **($000)**          | ** ** |
| Call center consolidation |       | $                   | 146        |             | $          | 313 |   |
| Executive transition      |       | $                   | 590        |             | $          | 615 |   |

 

Callcenter consolidation costs are primarily severance and employee relocationcompensation related to consolidating the customer service function in a singlecall center. Executive transition costs are primarily severance compensationaccruals related to early retirements of the Chief Executive Officer and ChiefFinancial Officer. Also reflected in operating expense changes for thequarterly and year-to-date periods were $275,000 and $755,000 reductions inemployee benefits expense, reflecting the full impact of benefit plan changesinitiated in 2003. Bad debts expense increased $404,000 for the quarter and $125,000year-to-date. Contributing to the higher bad debts expense is increasedwrite-off experience. Actual bad

 

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debtwrite-offs in the second quarter were $182,000 higher than second quarter 2004,with half of the increase attributable to a single commercial customer. Alsoaffecting the comparison was a fiscal year 2004 second quarter favorable$135,000 impact due to a reduction in the reserve related to receivables from agroup of customers where write-off experience was less than expected. Varioussmaller increases and decreases in other categories of expense, in theaggregate, accounted for the remainder of the change in Operating Expenses forthe quarter and year-to-date periods.

 

Theincreases in Depreciation & Amortization and in Property &Miscellaneous Taxes are related to ongoing investments in new utility plant,related primarily to expanding the Company’s distribution system to serve newcustomers, as well as investments related to automated meter reading.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Theseasonal nature of the Company’s business creates short-term cash requirementsto finance customer accounts receivable and construction expenditures. Toprovide working capital for these requirements, the Company has a $60,000,000bank revolving credit commitment. This agreement has a variable commitment fee,and a term that expires in October 2007. As of March 31, 2005, therewas $13,500,000 outstanding under this credit line.  The Company also has a $10,000,000uncommitted line of credit.

 

Toprovide longer-term financing the Company filed an omnibus registrationstatement in 2001, under the Securities Act of 1933, which provided the abilityto issue up to $150,000,000 of new debt and equity securities. In the secondquarter of fiscal 2005, the Company issued $30,000,000 of 30-year 5.25% InsuredQuarterly Notes under this registration statement, leaving $80,000,000available for future issuance of securities, subject to market conditions andother factors. The proceeds were used to pay down debt under the revolvingcredit line. In the remainder of fiscal 2005, the Company will repay $5,000,000in current maturities of long-term debt. The Company expects to fund theserepayments primarily through use of its bank credit lines, cash from operatingactivities, and long-term capital sources.

 

Becauseof the availability of short-term credit and the ability to issue long-termdebt and additional equity, management believes it has adequate financialflexibility to meet its anticipated cash needs, including cash requirements forinvesting and financing activities described in the following paragraphs andfor possible repurchase of unregistered shares issued under the Company’s DRIP(see Note 5 of Notes to Consolidated Condensed Financial Statements).

 

### **OperatingActivities**

 

Cashprovided by operating activities for the first six months of fiscal 2005declined $5,441,000 compared to last year. Other than net lower income, asignificant contributing factor was higher current income tax. As a componentof net income, this higher current income tax expense is offset by lowerdeferred income tax expense. 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 capitalexpenditures of $15,529,000 for the first six months of fiscal 2005 wereapproximately 22% less than the first six months of last year. Capitalexpenditures are lower due to the completion in 2004 of the Automated MeterReading Project described in prior reports.

 

#### **Financing Activities**

 

Otherthan the payment of dividends, the Company’s primary financing activitiesduring the first six months of fiscal 2005 were the issuance of $30,000,000 innew long-term debt as described in the preceding paragraphs under “Liquidityand Capital Resources”, repayment of $9,000,000 in current maturities oflong-term debt and paying down borrowing under the bank credit line by$20,000,000.

 

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

 

In January 2005the Company began operation of a customer-service call center at its existingdistrict office in Bellingham, Washington. This call center consolidated in onelocation the Company’s customer service function, which had been spread throughfifteen local offices.  The new callcenter is expected to reduce future expenses through the elimination of sixteenfull time equivalent positions, and to allow for more specialization, increasedefficiency, and improved service quality. Activation of the call center was phased in, and it became fullyoperational in March 2005.

 

## **CRITICAL ACCOUNTINGPOLICIES**

 

The Company’s financial statements are prepared inaccordance with accounting principles generally accepted in the United Statesof America (GAAP). In following GAAP, management exercises judgment inselection and application of accounting principles. Management considersCritical Accounting Policies to be those where different assumptions regardingapplication could result in material differences in financial statements.

 

## **Use of Estimates**

 

The preparation of financial statements in conformity with GAAP requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities, and disclosure of contingent assets and liabilities,at the date of the financial statements, and the reported amounts of revenuesand expenses 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.

 

## **Revenue Recognition**

 

## **The Company recognizes operatingrevenues based on deliveries of natural gas and other services to customers.This includes estimated revenues for natural gas delivered but not billed toresidential and commercial customers from the latest meter reading date to theend of the accounting period.**

 

## **Regulatory Accounting**

 

The Company’s accountingpolicies and practices are generally the same as used by unregulated companiesfor financial reporting under GAAP. However, Statement of Financial AccountingStandards (FAS) No. 71, “Accounting for the Effects of Certain Types ofRegulation”, requires regulated companies to apply accounting treatmentintended to reflect the financial impact of regulation. For example, inestablishing 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 expected to be established to recover costs that were incurred in aprior period. In this situation, following FAS No. 71 requires the Company todefer these costs and include them as regulatory assets on the balance sheet.In the subsequent period when these costs are recovered from customers, theCompany then amortizes these costs as expense in the income statement, in anamount equivalent to the amounts recovered. Similarly, certain revenue items,or cost reductions may be deferred as regulatory liabilities, which are lateramortized to the income statement as customer rates are reduced. In order toapply the provisions of FAS No. 71, the following conditions must apply:

 

•                  An independent regulator approves the Company’scustomer rates.

 

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•                  The rates are designed to recover the Company’scosts of providing the regulated services or products.

•                  There is sufficient demand for the regulatedservice to reasonably assure that rates can be set at a level to recover thecosts.

 

The Company 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.

 

## **Pension Plans**

 

The Company has a defined benefit pension plan coveringsubstantially all employees over 21 years of age with one year of service. TheCompany also provides executive officers with supplemental retirement, deathand disability benefits. The Company follows FAS No. 87, *“***Employers’ Accounting forPensions***,”*inaccounting for these plans. These plans were amended in fiscal 2003, so thatsubsequent to September 30, 2003, benefits under these plans no longeraccrue to non-bargaining-unit employees and officers. The pension plan remainssubstantially unchanged for bargaining-unit employees at this time.

 

TheCompany’s pension costs for these plans are affected by the amount of cashcontributions to the plans, the return on plan assets, and by employeedemographics, including age, compensation, and length of service. Actuarialformulas are used in the determination of pension costs and are affected byactual plan experience and assumptions of future experience. Key actuarialassumptions include the expected return on plan assets, the discount rate usedin determining the projected benefit obligation and pension costs, and theassumed rate of increase in employee compensation. Changes in these assumptionsmay significantly affect pension costs. Changes to the provisions of the plansmay also 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.

 

TheCompany’s funding policy is to contribute amounts equal to or greater than theminimum amounts required to be funded under theEmployee Retirement Income Security Act, and not more than the maximum amountscurrently deductible for income tax purposes. The Company contributed$3,843,000 in 2004 to the pension and supplemental executive retirement plans,and expects to contribute $3,320,000 in 2005.

 

The discount ratethe Company 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. At September 30,2004, the Company used a discount rate of 6.00%. This same rate is used in thedevelopment of pension expense for fiscal 2005. A reduction in the discountrate results in increases in projected benefit obligation, pension liability,and pension costs.

 

Inselecting an assumed long-term rate of return on plan assets, the Companyconsiders past performance and economic forecasts for the types of investmentsheld by the plan. In 2004 and 2005 the Company’s assumed rate of return on planassets is 8.25%. A reduction in the assumed rate of return would result inincreases in pension liability and pension costs.

 

## **Derivatives**

## ** **

TheCompany accounts for derivative transactions according to the provisions of FASNo. 133, “Accounting for Derivatives and Hedging Activities”, as amended. 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 theCompany’s contracts for purchase and sale of natural gas qualify for the normalpurchase and normal sales exception under FAS No. 133 and are not required tobe recorded as derivative assets and liabilities.  Accordingly, the Company recognizes revenuesand expenses on an accrual basis, based on physical delivery of natural gas.

 

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The Companyapplies mark-to-market accounting to financial derivative contracts. Periodicchanges in fair market value of derivatives associated with supplies fornon-core customers are recognized in earnings. The differences in accountingfor purchases 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 periodicchanges in fair market value of derivatives associated with supplies for corecustomers and records an offset in regulatory asset and regulatory liabilityaccounts.

 

 

**Forward-Looking Statements**

 

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

 

These forward-lookingstatements reflect the Company’s current expectations,beliefs and projections about future events that we believe may affect theCompany’s business, financial condition and results of operations, and areexpressed in good faith and are believed to have a reasonable basis.  However, each such forward-looking statementinvolves risks, uncertainties and assumptions, and is qualified in its entiretyby reference to the following important factors, among others, that could causethe Company’s actual results to differ materially from those projected in suchforward-looking statements:

 

•      prevailingstate and federal governmental policies and regulatory actions, including thoseof the Washington Utilities and Transportation Commission, the Oregon PublicUtility Commission, and the U.S. Department of Transportation’s Office ofPipeline Safety, with respect to allowed rates of return, industry and ratestructure, purchased gas cost and investment recovery, acquisitions anddispositions of assets and facilities, operation and construction of plantfacilities, the maintenance of pipeline integrity, and present or prospectivewholesale and retail competition;

 

•      weather conditions and other natural phenomena;

 

•      unanticipated population growth or decline, and changes inmarket demand caused by changes in demographic or customer consumptionpatterns;

 

•      changes in and compliance with environmental and safetylaws, regulations and policies, including environmental cleanup requirements;

 

•      competition from alternative forms of energy and othersellers of energy;

 

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

 

•      the potential loss of large volume industrial customers dueto “bypass” or the shift by such customers to special competitive contracts atlower per-unit margins;

 

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

 

•      risks resultingfrom uninsured damage to the Company’s property, intentional or otherwise, orfrom acts of terrorism;

 

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

 

•      the Company’s ability to complete itsassessment and, if necessary, remediation of internal controls over financialreporting in compliance with Section 404 of the Sarbanes-Oxley Act of2002;

 

•      unanticipatedchanges in interest rates or in rates of inflation;

 

•      economic factorsthat could cause a severe downturn in certain key industries, thus affectingdemand for natural gas;

 

•      unanticipatedchanges in operating expenses and capital expenditures;

 

•      unanticipatedchanges in capital market conditions, including their impact on  future expenses and liabilities relating toemployee benefit plans;

 

•      potential inability to obtain permits,rights of way, easements, leases, or other interests or necessary authority toconstruct pipelines, or complete other system expansions;

 

•      changes in theavailability and price of natural gas; and

 

•      legal andadministrative proceedings and settlements.

 

Inlight of these risks, uncertainties and assumptions, the forward-looking eventsand circumstances discussed in this report, or in any informationincorporated herein by reference,may not occur and actual results could differ materially from those anticipatedor implied in the forward-looking statements. All subsequent forward-looking statements, whether written or oral andwhether made by or on behalf of the Company, also are expressly qualified bythese cautionary statements.

 

Anyforward-looking statement by the Company is made only as of the date on whichsuch statement is made.  The Companyundertakes no obligation to update any forward-looking statement to reflectevents or circumstances after the date on which the statement is made or toreflect the occurrence of any unanticipated events.  New factors emerge from time-to–time, and theCompany is not able to predict all such factors, nor can it assess the impactof each such factor or the extent to which such factors may cause results todiffer materially from those contained in any forward-looking statement.

 

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**Item 3**.  Quantitativeand Qualitative Disclosures About Market Risk

 

Cascadehas evaluated its risk related to financial instruments whose values aresubject to market sensitivity. The Company has fixed-rate debt obligations, butdoes not have derivative financial instruments subject to interest rate risk.Cascade makes interest and principal payments on these obligations in thenormal course of its business, and does not plan to redeem these obligationsprior to normal maturities.

 

TheCompany’s natural gas purchase commodity prices are subject to fluctuationsresulting from weather, congestion on interstate pipelines, and otherunpredictable factors. The Company’s Purchased Gas Cost Adjustment (PGA)mechanisms assure the recovery in customer rates of prudently incurredwholesale cost of natural gas purchased for the core market. The Companyprimarily utilizes financial derivatives, and to a lesser extent, fixed pricephysical supply contracts to manage risk associated with wholesale costs ofnatural gas purchased for customers.

 

Withrespect to derivative arrangements covering natural gas supplies for corecustomers, periodic changes in fair market value are recorded in regulatoryasset or regulatory liability accounts, pursuant to authority granted by theWUTC and OPUC recognizing that settlements of these arrangements will berecovered through the PGA mechanism.

 

Forderivative arrangements related to supplies for non-core customers, which are not covered by a PGA mechanism, periodic changesin fair market value are recognized in earnings.

 

**Item 4**. Controls and Procedures

 

The Companymaintains controls and procedures designed to provide reasonable assurance thatrequired disclosure information in the reports the Company files or submitsunder the Securities Exchange Act of 1934, as amended, is recorded, processed,summarized and reported within the time period specified in the rules and formsof the Securities 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.

 

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

 

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

 

At the annual meeting ofshareholders on February 11, 2005, the following directors were elected bythe vote indicated for terms of office expiring in 2006:

 

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| ** **                | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|---------------------------|------------|------------|------------|--------------|------------|
| ** **                | ** ** | ** ** | ** ** | ** **   | ** ** |
| Scott M. Boggs            |       | 9,329,313  |       | 195,829      |       |
| Pirkko H. Borland         |       | 9,210,345  |       | 314,797      |       |
| Carl Burnham, Jr.         |       | 9,325,916  |       | 199,226      |       |
| Thomas E. Cronin          |       | 9,417,303  |       | 107,839      |       |
| David E. Ederer           |       | 9,318,468  |       | 206,674      |       |
| W. Brian Matsuyama (note) |       | 9,327,727  |       | 197,415      |       |
| Larry L. Pinnt            |       | 9,308,303  |       | 216,839      |       |
| Brooks G. Ragen           |       | 9,317,229  |       | 207,913      |       |
| Douglas G. Thomas         |       | 9,413,739  |       | 111,403      |       |

 

Note:                   W. BrianMatsuyama resigned as a director effective March 31, 2005, and David W.Stevens was elected by the Board of Directors to serve the remainder of histerm.

 

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

 

a)None

 

b) There have been no changes in the Company’sprocedures by which security holders may recommend nominees to the Company’sBoard of Directors.

 

# **Item 6**.  Exhibits

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

 

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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:                               | May 10, 2005 |   |   |   |   |
|                                     |  |  |  |  |  |  |

 

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