**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

**ý****   QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended June 30, 2005**

 

**or**

 

**o****   TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from           to          **

 
| **Commission  File Number** | ** ** | **Registrant, State of Incorporation, Address and Telephone Number**                                                                       | ** ** | **I.R.S. Employer  Identification No.** |
|-----------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|
|                        |       |                                                                                                                                       |       |                                    |
| **1-11377**                 | ** ** | **CINERGY CORP.**

**(A  Delaware Corporation)  139 East Fourth Street  Cincinnati, Ohio 45202  (513) 421-9500**                           | ** ** | **31-1385023**                          |
|                        |       |                                                                                                                                       |       |                                    |
| **1-1232**                  | ** ** | **THE CINCINNATI GAS & ELECTRIC COMPANY**

**(An  Ohio Corporation)  139 East Fourth Street  Cincinnati, Ohio 45202  (513) 421-9500**  | ** ** | **31-0240030**                          |
|                        |       |                                                                                                                                       |       |                                    |
| **1-3543**                  | ** ** | **PSI ENERGY, INC.**

**(An  Indiana Corporation)  1000 East Main Street  Plainfield, Indiana 46168  (513) 421-9500**                      | ** ** | **35-0594457**                          |
|                        |       |                                                                                                                                       |       |                                    |
| **2-7793**                  | ** ** | **THE UNION LIGHT, HEAT AND POWER COMPANY**

**(A  Kentucky Corporation)  139 East Fourth Street  Cincinnati, Ohio 45202  (513) 421-9500** | ** ** | **31-0473080**                          |

 

Indicate by check markwhether the registrants (1) have 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 registrants were required tofile such reports), and (2) have been subject to such filing requirements forthe past 90 days.

Yes ýNo o

 

 

----

 

Indicate by check markwhether each registrant is an accelerated filer (as defined in Rule 12b-2 ofthe Act).

 
|   |   |                                       |   |   |   |   |   |   |
|--------|--------|--------------------------------------------|--------|--------|--------|--------|--------|--------|
|   |   | Cinergy Corp.                              | Yes    |   | ý |   | No     | o      |
|   |   | The Cincinnati Gas  & Electric Company | Yes    |   | o      |   | No     | ý |
|   |   | PSI Energy, Inc.                           | Yes    |   | o      |   | No     | ý |
|   |   | The Union Light, Heat  and Power Company   | Yes    |   | o      |   | No     | ý |

 

This combined Form 10-Qis separately filed by **Cinergy Corp.**,**The Cincinnati Gas & Electric Company**,**PSI Energy, Inc.**, and **The Union Light, Heat and Power Company**.  Information contained herein relating to anyindividual registrant is filed by such registrant on its own behalf.  Each registrant makes no representation as toinformation relating to the other registrants.

 

**TheUnion Light, Heat and Power Company** meets the conditions setforth in General Instruction H(1)(a) and (b) of Form 10-Q and is thereforefiling its company specific information with the reduced disclosure formatspecified in General Instruction H(2) of Form 10-Q.

 

As of July 31, 2005,shares of common stock outstanding for each registrant were as listed:

 
| **Registrant**                                 | ** ** | **Description**                                | ** ** | **Shares**  | ** ** |
|------------------------------------------------|------------|------------------------------------------------|------------|-------------|------------|
|                                           |       |                                           |       |        |       |
| **Cinergy  Corp.**                             |       | Par value $.01 per share                       |       | 198,881,451 |       |
| ** **                                     |       |                                           |       |        |       |
| **The  Cincinnati Gas & Electric Company** |       | Par value $8.50 per share                      |       | 89,663,086  |       |
| ** **                                     |       |                                           |       |        |       |
| **PSI  Energy, Inc.**                          |       | Without par value, stated value $.01 per share |       | 53,913,701  |       |
| ** **                                     |       |                                           |       |        |       |
| **The  Union Light, Heat and Power Company**   |       | Par value $15.00 per share                     |       | 585,333     |       |

 

2

----

 

**TABLE OF CONTENTS**

 
| **Item  Number** | ** **                                                                                      | ** ** |
|------------------|-------------------------------------------------------------------------------------------------|------------|
|             | **PART I. FINANCIAL  INFORMATION**                                                              | ** ** |
|             |                                                                                            |       |
| 1                | **Financial Statements**                                                                        | ** ** |
|             | **Cinergy Corp. and Subsidiary  Companies**                                                     | ** ** |
|             | Condensed  Consolidated Statements of Income                                                    |       |
|             | Condensed  Consolidated Balance Sheets                                                          |       |
|             | Condensed  Consolidated Statements of Changes in Common Stock Equity                            |       |
|             | Condensed  Consolidated Statements of Cash Flows                                                |       |
|             |                                                                                            |       |
|             | **The  Cincinnati Gas & Electric Company and  Subsidiary Companies**                        | ** ** |
|             | Condensed  Consolidated Statements of Income and Comprehensive Income                           |       |
|             | Condensed  Consolidated Balance Sheets                                                          |       |
|             | Condensed  Consolidated Statements of Cash Flows                                                |       |
|             |                                                                                            |       |
|             | **PSI Energy, Inc. and  Subsidiary Company**                                                    | ** ** |
|             | Condensed  Consolidated Statements of Income and Comprehensive Income                           |       |
|             | Condensed  Consolidated Balance Sheets                                                          |       |
|             | Condensed  Consolidated Statements of Cash Flows                                                |       |
|             |                                                                                            |       |
|             | **The Union Light, Heat and Power Company**                                                     | ** ** |
|             | Condensed Statements of Income                                                                  |       |
|             | Condensed  Balance Sheets                                                                       |       |
|             | Condensed Statements of Cash Flows                                                              |       |
|             |                                                                                            |       |
|             | **Notes to Condensed Financial Statements**                                                     | ** ** |
|             |                                                                                            |       |
|             | **Cautionary Statements Regarding  Forward-Looking Information**                                | ** ** |
|             |                                                                                            |       |
| 2                | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | ** ** |
|             | Pending Merger                                                                                  |       |
|             | Executive Summary                                                                               |       |
|             | 2005  Quarterly Results of Operations - Cinergy                                                 |       |
|             | 2005  Quarterly Results of Operations - CG&E                                                |       |
|             | 2005  Quarterly Results of Operations - PSI                                                     |       |
|             | 2005  Year-to-date Results of Operations - Cinergy                                              |       |
|             | 2005  Year-to-date Results of Operations - CG&E                                             |       |
|             | 2005  Year-to-date Results of Operations - PSI                                                  |       |
|             | 2005  Year-to-date Results of Operations - ULH&P                                            |       |
|             | Liquidity and Capital Resources                                                                 |       |
|             | Future Expectations/Trends                                                                      |       |
|             | Market Risk Sensitive Instruments                                                               |       |
|             | Accounting  Matters                                                                             |       |
|             |                                                                                            |       |
| 3                | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | ** ** |
|             |                                                                                            |       |
| 4                | **Controls and  Procedures**                                                                    | ** ** |
|             |                                                                                            |       |
|             | **PART  II. OTHER INFORMATION**                                                                 | ** ** |
|             |                                                                                            |       |
| 1                | **Legal Proceedings**                                                                           | ** ** |
|             |                                                                                            |       |
| 2                | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                | ** ** |
|             |                                                                                            |       |
| 6                | **Exhibits**                                                                                    | ** ** |
|             |                                                                                            |       |
|             | **Signatures**                                                                                  | ** ** |

 

3

----

 

**CINERGY CORP.**

**AND SUBSIDIARY COMPANIES**

 

4

----

 

**CINERGY CORP.**

**CONDENSED CONSOLIDATED STATEMENTSOF INCOME**

 
| ** **                                                 | ** **   | **Quarter Ended  June 30**                   | ** **   | **Year to Date  June 30** | ** ** |
|------------------------------------------------------------|--------------|----------------------------------------------|--------------|---------------------------|------------|
| ** **                                                 | ** **   | **2005**                                     | ** **   | **2004**                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                 | *** *** | **(in thousands, except per share amounts)** | *** *** |
| *** ***                                               | *** *** | **(unaudited)**                              | *** *** |
| **Operating  Revenues**                                    |         |                                         |         |                      |       |   |   |   |   |
| Electric                                                   |         | **$**                                        | **914,338**  | ** **                | $          | 870,236 |   | **$** | **1,840,635** | ** ** | $ | 1,728,672 |   |
| Gas                                                        |         | **79,598**                                   | ** **   | 108,082                   |       | **392,694** | ** ** | 458,928 |   |
| Other                                                      |         | **120,327**                                  | ** **   | 75,419                    |       | **225,183** | ** ** | 154,795 |   |
| **Total  Operating Revenues**                              |         | **1,114,263**                                | ** **   | 1,053,737                 |       | **2,458,512** | ** ** | 2,342,395 |   |
|                                                       |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| **Operating  Expenses**                                    |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| Fuel, emission  allowances, and purchased power            |         | **312,714**                                  | ** **   | 298,756                   |       | **617,677** | ** ** | 592,646 |   |
| Gas purchased                                              |         | **56,089**                                   | ** **   | 47,420                    |       | **264,689** | ** ** | 270,936 |   |
| Costs of fuel  resold                                      |         | **93,087**                                   | ** **   | 59,062                    |       | **178,849** | ** ** | 116,524 |   |
| Operation and  maintenance                                 |         | **351,121**                                  | ** **   | 332,358                   |       | **682,910** | ** ** | 643,194 |   |
| Depreciation                                               |         | **130,455**                                  | ** **   | 114,331                   |       | **256,941** | ** ** | 219,188 |   |
| Taxes other than  income taxes                             |         | **65,083**                                   | ** **   | 65,072                    |       | **144,015** | ** ** | 147,319 |   |
| **Total  Operating Expenses**                              |         | **1,008,549**                                | ** **   | 916,999                   |       | **2,145,081** | ** ** | 1,989,807 |   |
|                                                       |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| **Operating  Income**                                      |         | **105,714**                                  | ** **   | 136,738                   |       | **313,431** | ** ** | 352,588 |   |
|                                                       |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| **Equity  in Earnings of Unconsolidated Subsidiaries**     |         | **13,576**                                   | ** **   | 7,331                     |       | **18,411** | ** ** | 10,079 |   |
| **Miscellaneous  Income (Expense) – Net**             |         | **14,535**                                   | ** **   | 5,033                     |       | **16,875** | ** ** | (10,475 | ) |
| **Interest  Expense**                                      |         | **68,649**                                   | ** **   | 70,276                    |       | **132,712** | ** ** | 137,671 |   |
| **Preferred  Dividend Requirements of Subsidiaries**       |         | **858**                                      | ** **   | 858                       |       | **1,716** | ** ** | 1,716 |   |
|                                                       |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| **Income  Before Taxes**                                   |         | **64,318**                                   | ** **   | 77,968                    |       | **214,289** | ** ** | 212,805 |   |
| ** **                                                 |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| **Income  Taxes**                                          |         | **13,610**                                   | ** **   | 19,464                    |       | **46,225** | ** ** | 51,286 |   |
| ** **                                                 |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| **Net  Income**                                            |         | **$**                                        | **50,708**   | ** **                | $          | 58,504 |   | **$** | **168,064** | ** ** | $ | 161,519 |   |
| ** **                                                 |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| **Average  Common Shares Outstanding – Basic**        |         | **198,492**                                  | ** **   | 180,236                   |       | **197,066** | ** ** | 179,749 |   |
|                                                       |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| **Earnings  Per Common Share – Basic****(Note 11)**   |         | **$**                                        | **0.25**     | ** **                | $          | 0.33 |   | **$** | **0.85** | ** ** | $ | 0.90 |   |
|                                                       |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| **Average  Common Shares Outstanding – Diluted**      |         | **199,441**                                  | ** **   | 182,277                   |       | **198,075** | ** ** | 182,106 |   |
|                                                       |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| **Earnings  Per Common Share – Diluted****(Note 11)** |         | **$**                                        | **0.25**     | ** **                | $          | 0.32 |   | **$** | **0.85** | ** ** | $ | 0.89 |   |
|                                                       |         | ** **                                   | ** **   |                      |       | ** ** | ** ** |   |   |
| **Cash  Dividends Declared Per Common Share**              |         | **$**                                        | **0.48**     | ** **                | $          | 0.47 |   | **$** | **0.96** | ** ** | $ | 0.94 |   |

 

**The accompanying notes as they relate to CinergyCorp. are an integral part of these condensed consolidated financialstatements.**

 

5

----

 

**CINERGY CORP.**

**CONDENSED CONSOLIDATED BALANCESHEETS**

 
| ** **                                                                                                                         | ** ** | **June 30  2005**          | ** **     | **December 31  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|----------------|-----------------------|------------|
| ** **                                                                                                                         | ** ** | **(dollars in thousands)** | ** **     |
| ** **                                                                                                                         | ** ** | **(unaudited)**            | ** **     |
| **ASSETS**                                                                                                                         |       |                       |           |                  |       |
| ** **                                                                                                                         |       |                       |           |                  |       |
| **Current  Assets**                                                                                                                |       |                       |           |                  |       |
| Cash and cash  equivalents                                                                                                         |       | **$**                      | **148,178**    | ** **            | $          | 164,541 |   |
| Notes  receivable, current                                                                                                         |       | **122,976**                | ** **     | 214,513               |       |
| Accounts  receivable less accumulated provision for doubtful accounts of $5,455 at June  30, 2005, and $5,514 at December 31, 2004 |       | **939,715**                | ** **     | 1,061,140             |       |
| Fuel, emission  allowances, and supplies                                                                                           |       | **502,482**                | ** **     | 444,750               |       |
| Energy risk  management current assets                                                                                             |       | **352,397**                | ** **     | 381,146               |       |
| Prepayments and  other                                                                                                             |       | **279,138**                | ** **     | 174,624               |       |
| **Total  Current Assets**                                                                                                          |       | **2,344,886**              | ** **     | 2,440,714             |       |
|                                                                                                                               |       | ** **                 | ** **     |                  |       |
| **Property,  Plant, and Equipment – at Cost**                                                                                 |       | ** **                 | ** **     |                  |       |
| Utility plant in  service                                                                                                          |       | **10,386,087**             | ** **     | 10,076,468            |       |
| Construction  work in progress                                                                                                     |       | **377,517**                | ** **     | 333,687               |       |
| **Total  Utility Plant**                                                                                                           |       | **10,763,604**             | ** **     | 10,410,155            |       |
| Non-regulated  property, plant, and equipment                                                                                      |       | **4,798,284**              | ** **     | 4,700,009             |       |
| Accumulated  depreciation                                                                                                          |       | **5,355,813**              | ** **     | 5,180,699             |       |
| **Net  Property, Plant, and Equipment**                                                                                            |       | **10,206,075**             | ** **     | 9,929,465             |       |
|                                                                                                                               |       | ** **                 | ** **     |                  |       |
| **Other  Assets**                                                                                                                  |       | ** **                 | ** **     |                  |       |
| Regulatory  assets                                                                                                                 |       | **988,308**                | ** **     | 1,030,333             |       |
| Investments in  unconsolidated subsidiaries                                                                                        |       | **488,411**                | ** **     | 513,675               |       |
| Energy risk  management non-current assets                                                                                         |       | **306,495**                | ** **     | 138,787               |       |
| Notes  receivable, non-current                                                                                                     |       | **182,815**                | ** **     | 193,857               |       |
| Other  investments                                                                                                                 |       | **125,192**                | ** **     | 125,367               |       |
| Restricted funds  held in trust                                                                                                    |       | **313,692**                | ** **     | 358,006               |       |
| Goodwill and  other intangible assets                                                                                              |       | **154,047**                | ** **     | 132,752               |       |
| Other                                                                                                                              |       | **147,685**                | ** **     | 119,361               |       |
| **Total  Other Assets**                                                                                                            |       | **2,706,645**              | ** **     | 2,612,138             |       |
|                                                                                                                               |       | ** **                 | ** **     |                  |       |
| **Total  Assets**                                                                                                                  |       | **$**                      | **15,257,606** | ** **            | $          | 14,982,317 |   |

 

**The accompanying notes as they relate to CinergyCorp. are an integral part of these condensed consolidated financialstatements.**

 

6

----

 

**CINERGY CORP.**

**CONDENSED CONSOLIDATED BALANCESHEETS**

 
| ** **                                                                                                                                                                                                                                                    | ** ** | **June 30  2005**          | ** **     | **December 31  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|----------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                    | ** ** | **(dollars in thousands)** | ** **     |
| ** **                                                                                                                                                                                                                                                    | ** ** | **(unaudited)**            | ** **     |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                                |       |                       |           |                  |       |
|                                                                                                                                                                                                                                                          |       |                       |           |                  |       |
| **Current  Liabilities**                                                                                                                                                                                                                                      |       |                       |           |                  |       |
| Accounts payable                                                                                                                                                                                                                                              |       | **$**                      | **1,255,484**  | ** **            | $          | 1,348,576 |   |
| Accrued taxes                                                                                                                                                                                                                                                 |       | **128,713**                | ** **     | 216,804               |       |
| Accrued interest                                                                                                                                                                                                                                              |       | **59,016**                 | ** **     | 54,473                |       |
| Notes payable  and other short-term obligations (Note 5)                                                                                                                                                                                                      |       | **865,257**                | ** **     | 958,910               |       |
| Long-term debt  due within one year                                                                                                                                                                                                                           |       | **478,046**                | ** **     | 219,967               |       |
| Energy risk  management current liabilities                                                                                                                                                                                                                   |       | **370,960**                | ** **     | 310,741               |       |
| Other                                                                                                                                                                                                                                                         |       | **134,525**                | ** **     | 171,188               |       |
| **Total  Current Liabilities**                                                                                                                                                                                                                                |       | **3,292,001**              | ** **     | 3,280,659             |       |
|                                                                                                                                                                                                                                                          |       | ** **                 | ** **     |                  |       |
| **Non-Current  Liabilities**                                                                                                                                                                                                                                  |       | ** **                 | ** **     |                  |       |
| Long-term debt                                                                                                                                                                                                                                                |       | **3,975,072**              | ** **     | 4,227,741             |       |
| Deferred income  taxes                                                                                                                                                                                                                                        |       | **1,554,037**              | ** **     | 1,597,120             |       |
| Unamortized  investment tax credits                                                                                                                                                                                                                           |       | **95,413**                 | ** **     | 99,723                |       |
| Accrued pension  and other postretirement benefit costs                                                                                                                                                                                                       |       | **732,361**                | ** **     | 688,277               |       |
| Regulatory  liabilities                                                                                                                                                                                                                                       |       | **575,729**                | ** **     | 557,419               |       |
| Energy risk  management non-current liabilities                                                                                                                                                                                                               |       | **299,541**                | ** **     | 127,340               |       |
| Other                                                                                                                                                                                                                                                         |       | **205,247**                | ** **     | 225,298               |       |
| **Total  Non-Current Liabilities**                                                                                                                                                                                                                            |       | **7,437,400**              | ** **     | 7,522,918             |       |
|                                                                                                                                                                                                                                                          |       | ** **                 | ** **     |                  |       |
| **Commitments  and Contingencies**                                                                                                                                                                                                                            |       | ** **                 | ** **     |                  |       |
|                                                                                                                                                                                                                                                          |       | ** **                 | ** **     |                  |       |
| **Total  Liabilities**                                                                                                                                                                                                                                        |       | **10,729,401**             | ** **     | 10,803,577            |       |
|                                                                                                                                                                                                                                                          |       | ** **                 | ** **     |                  |       |
| **Cumulative  Preferred Stock of Subsidiaries**                                                                                                                                                                                                               |       | ** **                 | ** **     |                  |       |
| Not subject to  mandatory redemption                                                                                                                                                                                                                          |       | **62,818**                 | ** **     | 62,818                |       |
|                                                                                                                                                                                                                                                          |       | ** **                 | ** **     |                  |       |
| **Common  Stock Equity**                                                                                                                                                                                                                                      |       | ** **                 | ** **     |                  |       |
| Common stock -  $.01 par value; authorized shares – 600,000,000; issued shares – 198,668,812  at June 30, 2005, and 187,653,506 at December 31, 2004; outstanding shares –  198,528,683 at June 30, 2005, and 187,524,229 at December 31, 2004 |       | **1,987**                  | ** **     | 1,877                 |       |
| Paid-in capital                                                                                                                                                                                                                                               |       | **2,941,747**              | ** **     | 2,559,715             |       |
| Retained  earnings                                                                                                                                                                                                                                            |       | **1,594,053**              | ** **     | 1,613,340             |       |
| Treasury shares  at cost – 140,129 shares at June 30, 2005, and 129,277 shares at December 31,  2004                                                                                                                                                     |       | **(4,766**                 | **)**          | (4,336                | )          |
| Accumulated  other comprehensive loss                                                                                                                                                                                                                         |       | **(67,634**                | **)**          | (54,674               | )          |
| **Total  Common Stock Equity**                                                                                                                                                                                                                                |       | **4,465,387**              | ** **     | 4,115,922             |       |
|                                                                                                                                                                                                                                                          |       | ** **                 | ** **     |                  |       |
| **Total  Liabilities and Shareholders’ Equity**                                                                                                                                                                                                          |       | **$**                      | **15,257,606** | ** **            | $          | 14,982,317 |   |

 

**The accompanying notes as they relate to CinergyCorp. are an integral part of these condensed consolidated financialstatements.**

 

7

----

 

**CINERGY CORP.**

**CONDENSED CONSOLIDATED STATEMENTSOF CHANGES IN COMMON STOCK EQUITY**

 
| ** **                                                          | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | **Accumulated**   | ** ** | **Total**   | ** ** |
|---------------------------------------------------------------------|------------|------------------------------------------------------|------------|-------------|------------|---------------|------------|--------------|---------------|-------------------|------------|-------------|------------|
| ** **                                                          | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | **Other**         | ** ** | **Common**  | ** ** |
| ** **                                                          | ** ** | **Common**                                           | ** ** | **Paid-in** | ** ** | **Retained**  | ** ** | **Treasury** | ** **    | **Comprehensive** | ** ** | **Stock**   | ** ** |
| ** **                                                          | ** ** | **Stock**                                            | ** ** | **Capital** | ** ** | **Earnings**  | ** ** | **Stock**    | ** **    | **Income (Loss)** | ** ** | **Equity**  | ** ** |
| ** **                                                          | ** ** | **(dollars in thousands, except per share amounts)** | ** ** |
| ** **                                                          | ** ** | **(unaudited)**                                      | ** ** |
| * *                                                            | * *   | * *                                             | * *   | * *    | * *   | * *      | * *   | * *     | * *      | * *          | * *   | * *    | * *   |
| **Quarter  Ended June 30, 2005**                                    | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **  | ** ** |
| ** **                                                          | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **  | ** ** |
| **Balance  at April 1, 2005 (197,989,654 shares)**                  | ** ** | **$**                                                | **1,981**  | ** **  | **$**      | **2,919,758** | ** ** | **$**        | **1,638,704** | ** **        | **$**      | **(4,635**  | **)**      | **$** | **(59,831** | **)** | **$** | **4,495,977** | ** ** |
| **Comprehensive  income:**                                          | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **  | ** ** |
| **Net  income**                                                     | ** ** | ** **                                           | ** ** | ** **  | ** ** | **50,708**    | ** ** | ** **   | ** **    | ** **        | ** ** | **50,708**  | ** ** |
| **Other  comprehensive income (loss), net of tax effect of $4,204** | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **  | ** ** |
| **Foreign  currency translation adjustment**                        | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | **(7,269**        | **)**      | **(7,269**  | **)**      |
| **Unrealized  gain on investment trusts**                           | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | **221**           | ** ** | **221**     | ** ** |
| **Cash  flow hedges**                                               | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | **(755**          | **)**      | **(755**    | **)**      |
| **Total  comprehensive income**                                     | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | **42,905**  | ** ** |
| ** **                                                          | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **  | ** ** |
| **Issuance  of common stock – net (540,296 shares)**           | ** ** | **6**                                                | ** ** | **23,760**  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | **23,766**  | ** ** |
| **Treasury  shares purchased (1,267 shares)**                       | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | **(131**     | **)**         | ** **        | ** ** | **(131**    | **)**      |
| **Dividends  on common stock ($0.48 per share)**                    | ** ** | ** **                                           | ** ** | ** **  | ** ** | **(95,197**   | **)**      | ** **   | ** **    | ** **        | ** ** | **(95,197** | **)**      |
| **Other**                                                           | ** ** | ** **                                           | ** ** | **(1,771**  | **)**      | **(162**      | **)**      | ** **   | ** **    | ** **        | ** ** | **(1,933**  | **)**      |
| ** **                                                          | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **  | ** ** |
| **Ending  balance at June 30, 2005 (198,528,683 shares)**           | ** ** | **$**                                                | **1,987**  | ** **  | **$**      | **2,941,747** | ** ** | **$**        | **1,594,053** | ** **        | **$**      | **(4,766**  | **)**      | **$** | **(67,634** | **)** | **$** | **4,465,387** | ** ** |
| ** **                                                          | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **  | ** ** |
| Quarter Ended  June 30, 2004                                        |       |                                                 |       |        |       |          |       |         |          |              |       |        |       |
|                                                                |       |                                                 |       |        |       |          |       |         |          |              |       |        |       |
| Balance at April  1, 2004 (179,544,917 shares)                      |       | $                                                    | 1,797      |        | $          | 2,220,748     |       | $            | 1,569,995     |              | $          | (3,862      | )          | $ | (43,369 | ) | $ | 3,745,309 |   |
| Comprehensive  income:                                              |       |                                                 |       |        |       |          |       |         |          |              |       |        |       |
| Net income                                                          |       |                                                 |       |        |       | 58,504        |       |         |          |              |       | 58,504      |       |
| Other comprehensive  income (loss), net of tax effect of $(2,176)   |       |                                                 |       |        |       |          |       |         |          |              |       |        |       |
| Foreign currency  translation adjustment                            |       |                                                 |       |        |       |          |       |         |          | 446               |       | 446         |       |
| Unrealized gain  (loss) on investment trusts                        |       |                                                 |       |        |       |          |       |         |          | (259              | )          | (259        | )          |
| Cash flow hedges                                                    |       |                                                 |       |        |       |          |       |         |          | 3,378             |       | 3,378       |       |
| Total comprehensive  income                                         |       |                                                 |       |        |       |          |       |         |          |              |       | 62,069      |       |
|                                                                |       |                                                 |       |        |       |          |       |         |          |              |       |        |       |
| Issuance of  common stock – net (781,507 shares)               |       | 7                                                    |       | 25,129      |       |          |       |         |          |              |       | 25,136      |       |
| Treasury shares  purchased (3,178 shares)                           |       |                                                 |       |        |       |          |       | (104         | )             |              |       | (104        | )          |
| Dividends on  common stock ($0.47 per share)                        |       |                                                 |       |        |       | (84,558       | )          |         |          |              |       | (84,558     | )          |
| Other                                                               |       |                                                 |       | 2,207       |       | (58           | )          |         |          |              |       | 2,149       |       |
|                                                                |       |                                                 |       |        |       |          |       |         |          |              |       |        |       |
| Ending balance  at June 30, 2004 (180,323,246 shares)               |       | $                                                    | 1,804      |        | $          | 2,248,084     |       | $            | 1,543,883     |              | $          | (3,966      | )          | $ | (39,804 | ) | $ | 3,750,001 |   |

 

**The accompanying notes as they relate to CinergyCorp. are an integral part of these condensed consolidated financialstatements.**

 

8

----

 
| ** **                                                          | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | **Accumulated**   | ** ** | **Total**    | ** ** |
|---------------------------------------------------------------------|------------|------------------------------------------------------|-----------------|-------------|------------|---------------|------------|--------------|---------------|-------------------|------------|--------------|------------|
| ** **                                                          | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | **Other**         | ** ** | **Common**   | ** ** |
| ** **                                                          | ** ** | **Common**                                           | ** **      | **Paid-in** | ** ** | **Retained**  | ** ** | **Treasury** | ** **    | **Comprehensive** | ** ** | **Stock**    | ** ** |
| ** **                                                          | ** ** | **Stock**                                            | ** **      | **Capital** | ** ** | **Earnings**  | ** ** | **Stock**    | ** **    | **Income (Loss)** | ** ** | **Equity**   | ** ** |
| ** **                                                          | ** ** | **(dollars in thousands, except per share amounts)** | ** **      |
| ** **                                                          | ** ** | **(unaudited)**                                      | ** **      |
| ** **                                                          | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **   | ** ** |
| **Year to  Date June 30, 2005**                                     | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **   | ** ** |
| ** **                                                          | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **   | ** ** |
| **Balance  at January 1, 2005 (187,524,229 shares)**                | ** ** | **$**                                                | ** 1,877** | ** **  | **$**      | **2,559,715** | ** ** | **$**        | **1,613,340** | ** **        | **$**      | **(4,336**   | **)**      | **$** | **(54,674** | **)** | **$** | **4,115,922** | ** ** |
| **Comprehensive  income:**                                          | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **   | ** ** |
| **Net  income**                                                     | ** ** | ** **                                           | ** **      | ** **  | ** ** | **168,064**   | ** ** | ** **   | ** **    | ** **        | ** ** | **168,064**  | ** ** |
| **Other  comprehensive income (loss), net of tax effect of $6,635** | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **   | ** ** |
| **Foreign  currency translation adjustment**                        | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | **(13,107**       | **)**      | **(13,107**  | **)**      |
| **Unrealized  loss on investment trusts**                           | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | **(954**          | **)**      | **(954**     | **)**      |
| **Cash  flow hedges**                                               | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | **1,101**         | ** ** | **1,101**    | ** ** |
| **Total  comprehensive income**                                     | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | **155,104**  | ** ** |
| ** **                                                          | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **   | ** ** |
| **Issuance  of common stock – net (11,015,306 shares)**        | ** ** | **110**                                              | ** **      | **377,513** | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | **377,623**  | ** ** |
| **Treasury  shares purchased (10,852 shares)**                      | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | **(430**     | **)**         | ** **        | ** ** | **(430**     | **)**      |
| **Dividends  on common stock ($0.96 per share)**                    | ** ** | ** **                                           | ** **      | ** **  | ** ** | **(187,076**  | **)**      | ** **   | ** **    | ** **        | ** ** | **(187,076** | **)**      |
| **Other**                                                           | ** ** | ** **                                           | ** **      | **4,519**   | ** ** | **(275**      | **)**      | ** **   | ** **    | ** **        | ** ** | **4,244**    | ** ** |
| ** **                                                          | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **   | ** ** |
| **Ending  balance at June 30, 2005 (198,528,683 shares)**           | ** ** | **$**                                                | **1,987**       | ** **  | **$**      | **2,941,747** | ** ** | **$**        | **1,594,053** | ** **        | **$**      | **(4,766**   | **)**      | **$** | **(67,634** | **)** | **$** | **4,465,387** | ** ** |
| ** **                                                          | ** ** | ** **                                           | ** **      | ** **  | ** ** | ** **    | ** ** | ** **   | ** **    | ** **        | ** ** | ** **   | ** ** |
|                                                                |       |                                                 |            |        |       |          |       |         |          |              |       |         |       |
| Year to Date  June 30, 2004                                         |       |                                                 |            |        |       |          |       |         |          |              |       |         |       |
| ** **                                                          |       |                                                 |            |        |       |          |       |         |          |              |       |         |       |
| Balance at  January 1, 2004 (178,336,854 shares)                    |       | $                                                    | 1,784           |        | $          | 2,195,985     |       | $            | 1,551,003     |              | $          | (3,255       | )          | $ | (44,835 | ) | $ | 3,700,682 |   |
| Comprehensive  income:                                              |       |                                                 |            |        |       |          |       |         |          |              |       |         |       |
| Net income                                                          |       |                                                 |            |        |       | 161,519       |       |         |          |              |       | 161,519      |       |
| Other comprehensive  income, net of tax effect of $(3,090)          |       |                                                 |            |        |       |          |       |         |          |              |       |         |       |
| Foreign currency  translation adjustment                            |       |                                                 |            |        |       |          |       |         |          | 1,432             |       | 1,432        |       |
| Unrealized gain  on investment trusts                               |       |                                                 |            |        |       |          |       |         |          | 496               |       | 496          |       |
| Cash flow hedges                                                    |       |                                                 |            |        |       |          |       |         |          | 3,103             |       | 3,103        |       |
| Total comprehensive  income                                         |       |                                                 |            |        |       |          |       |         |          |              |       | 166,550      |       |
| ** **                                                          |       |                                                 |            |        |       |          |       |         |          |              |       |         |       |
| Issuance of  common stock – net (2,008,423 shares)             |       | 20                                                   |            | 46,211      |       |          |       |         |          |              |       | 46,231       |       |
| Treasury shares  purchased (22,031 shares)                          |       |                                                 |            |        |       |          |       | (711         | )             |              |       | (711         | )          |
| Dividends on  common stock ($0.94 per share)                        |       |                                                 |            |        |       | (168,545      | )          |         |          |              |       | (168,545     | )          |
| Other                                                               |       |                                                 |            | 5,888       |       | (94           | )          |         |          |              |       | 5,794        |       |
| ** **                                                          |       |                                                 |            |        |       |          |       |         |          |              |       |         |       |
| Ending balance  at June 30, 2004 (180,323,246 shares)               |       | $                                                    | 1,804           |        | $          | 2,248,084     |       | $            | 1,543,883     |              | $          | (3,966       | )          | $ | (39,804 | ) | $ | 3,750,001 |   |

 

**The accompanying notes as they relate to CinergyCorp. are an integral part of these condensed consolidated financialstatements.**

 

9

----

 

**CINERGY CORP.**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

 
| ** **                                                                            | ** ** | **Year to Date  June 30**  | ** **  |
|---------------------------------------------------------------------------------------|------------|----------------------------|-------------|
| ** **                                                                            | ** ** | **2005**                   | ** **  | **2004** | ** ** |
| ** **                                                                            | ** ** | **(dollars in thousands)** | ** **  |
| ** **                                                                            | ** ** | **(unaudited)**            | ** **  |
| **Cash  Flows from Operations**                                                       |       |                       |        |   |   |
| Operating  Activities                                                                 |       |                       |        |   |   |
| Net income                                                                            |       | **$**                      | **168,064** | ** ** | $ | 161,519 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:    |       | ** **                 | ** **  |   |   |
| Depreciation                                                                          |       | **256,941**                | ** **  | 219,188 |   |
| Loss on  impairment or disposal of subsidiaries and investments, net                  |       | **7,542**                  | ** **  | 29,362 |   |
| Change in net  position of energy risk management activities                          |       | **93,461**                 | ** **  | (23,669 | ) |
| Deferred income  taxes and investment tax credits – net                          |       | **11,094**                 | ** **  | 41,938 |   |
| Equity in  earnings of unconsolidated subsidiaries                                    |       | **(18,411**                | **)**       | (10,079 | ) |
| Allowance for  equity funds used during construction                                  |       | **(4,402**                 | **)**       | (976 | ) |
| Regulatory  asset/liability deferrals                                                 |       | **(62,480**                | **)**       | (14,894 | ) |
| Regulatory  assets amortization                                                       |       | **61,435**                 | ** **  | 48,302 |   |
| Accrued pension  and other postretirement benefit costs                               |       | **44,084**                 | ** **  | 35,426 |   |
| Cost of removal                                                                       |       | **(13,722**                | **)**       | (9,118 | ) |
| Changes in  current assets and current liabilities:                                   |       | ** **                 | ** **  |   |   |
| Accounts and  notes receivable                                                        |       | **209,790**                | ** **  | 420,693 |   |
| Fuel, emission  allowances, and supplies                                              |       | **(91,642**                | **)**       | (44,545 | ) |
| Prepayments                                                                           |       | **(107,064**               | **)**       | (31,762 | ) |
| Accounts payable                                                                      |       | **(92,575**                | **)**       | (213,787 | ) |
| Accrued taxes  and interest                                                           |       | **(83,548**                | **)**       | (44,933 | ) |
| Other assets                                                                          |       | **(13,255**                | **)**       | 4,910 |   |
| Other  liabilities                                                                    |       | **(66,459**                | **)**       | 28,788 |   |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Net  cash provided by operating activities**                                        |       | **298,853**                | ** **  | 596,363 |   |
|                                                                                  |       | ** **                 | ** **  |   |   |
| Financing  Activities                                                                 |       | ** **                 | ** **  |   |   |
| Change in  short-term debt                                                            |       | **(93,653**                | **)**       | 137,832 |   |
| Issuance of  long-term debt                                                           |       | **4,612**                  | ** **  | - |   |
| Redemption of  long-term debt                                                         |       | **(9,487**                 | **)**       | (319,511 | ) |
| Issuance of  common stock                                                             |       | **377,623**                | ** **  | 46,231 |   |
| Dividends on  common stock                                                            |       | **(187,076**               | **)**       | (168,545 | ) |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Net  cash provided by (used in) financing activities**                              |       | **92,019**                 | ** **  | (303,993 | ) |
|                                                                                  |       | ** **                 | ** **  |   |   |
| Investing  Activities                                                                 |       | ** **                 | ** **  |   |   |
| Construction  expenditures (less allowance for equity funds used during construction) |       | **(523,979**               | **)**       | (309,699 | ) |
| Proceeds from  notes receivable                                                       |       | **9,800**                  | ** **  | 8,559 |   |
| Withdrawal of  restricted cash held in trust                                          |       | **65,380**                 | ** **  | 10,413 |   |
| Acquisitions and  other investments                                                   |       | **(6,415**                 | **)**       | (11,350 | ) |
| Proceeds from  distributions by investments and sale of investments and subsidiaries  |       | **47,979**                 | ** **  | 14,405 |   |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Net  cash used in investing activities**                                            |       | **(407,235**               | **)**       | (287,672 | ) |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Net  increase (decrease) in cash and cash equivalents**                             |       | **(16,363**                | **)**       | 4,698 |   |
| **Cash  and cash equivalents at beginning of period**                                 |       | **164,541**                | ** **  | 169,120 |   |
| **Cash  and cash equivalents at end of period**                                       |       | **$**                      | **148,178** | ** ** | $ | 173,818 |   |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Supplemental  Disclosure of Cash Flow Information**                                 | ** ** | ** **                 | ** **  | ** ** | ** ** |
| Cash paid during  the period for:                                                     |       | ** **                 | ** **  |   |   |
| Interest (net of  amount capitalized)                                                 |       | **$**                      | **134,900** | ** ** | $ | 139,868 |   |
| Income taxes                                                                          |       | **$**                      | **66,089**  | ** ** | $ | 32,123 |   |

 

**The accompanying notes as they relate to CinergyCorp. are an integral part of these condensed consolidated financialstatements.**

 

10

----

 

**THE CINCINNATI GAS & ELECTRICCOMPANY**

**AND SUBSIDIARY COMPANIES**

 

11

----

 

**THE CINCINNATI GAS & ELECTRICCOMPANY**

**CONDENSED CONSOLIDATED STATEMENTSOF INCOME AND COMPREHENSIVE INCOME**

 
| ** **                                      | ** ** | **Quarter Ended  June 30** | ** **  | **Year to Date  June 30** | ** ** |
|-------------------------------------------------|------------|----------------------------|-------------|---------------------------|------------|
| ** **                                      | ** ** | **2005**                   | ** **  | **2004**                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(dollars in thousands)** | ** **  |
| ** **                                      | ** ** | **(unaudited)**            | ** **  |
| * *                                        | * *   | * *                   | * *    | * *                  | * *   | * * | * * | * * | * * |
| **Operating  Revenues**                         |       |                       |        |                      |       |   |   |   |   |
| Electric                                        |       | **$**                      | **459,890** | ** **                | $          | 433,246 |   | **$** | **924,221** | ** ** | $ | 851,161 |   |
| Gas                                             |       | **100,468**                | ** **  | 90,651                    |       | **406,822** | ** ** | 418,303 |   |
| Other                                           |       | **60,105**                 | ** **  | 22,030                    |       | **112,776** | ** ** | 41,722 |   |
| **Total  Operating Revenues**                   |       | **620,463**                | ** **  | 545,927                   |       | **1,443,819** | ** ** | 1,311,186 |   |
|                                            |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| **Operating  Expenses**                         |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| Fuel, emission  allowances, and purchased power |       | **154,456**                | ** **  | 127,497                   |       | **300,158** | ** ** | 249,155 |   |
| Gas purchased                                   |       | **56,089**                 | ** **  | 47,418                    |       | **263,871** | ** ** | 270,935 |   |
| Costs of fuel  resold                           |       | **49,232**                 | ** **  | 19,628                    |       | **90,218** | ** ** | 37,374 |   |
| Operation and  maintenance                      |       | **171,476**                | ** **  | 150,158                   |       | **333,624** | ** ** | 299,921 |   |
| Depreciation                                    |       | **45,206**                 | ** **  | 45,477                    |       | **90,370** | ** ** | 89,863 |   |
| Taxes other than  income taxes                  |       | **52,441**                 | ** **  | 49,305                    |       | **111,875** | ** ** | 113,500 |   |
| **Total  Operating Expenses**                   |       | **528,900**                | ** **  | 439,483                   |       | **1,190,116** | ** ** | 1,060,748 |   |
|                                            |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| **Operating  Income**                           |       | **91,563**                 | ** **  | 106,444                   |       | **253,703** | ** ** | 250,438 |   |
|                                            |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| **Miscellaneous  Income – Net**            |       | **3,633**                  | ** **  | 3,189                     |       | **7,156** | ** ** | 6,043 |   |
| **Interest  Expense**                           |       | **23,853**                 | ** **  | 22,415                    |       | **46,803** | ** ** | 44,851 |   |
|                                            |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| **Income  Before Taxes**                        |       | **71,343**                 | ** **  | 87,218                    |       | **214,056** | ** ** | 211,630 |   |
| ** **                                      |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| **Income  Taxes**                               |       | **17,720**                 | ** **  | 31,909                    |       | **75,767** | ** ** | 78,866 |   |
| ** **                                      |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| **Net  Income**                                 |       | **$**                      | **53,623**  | ** **                | $          | 55,309 |   | **$** | **138,289** | ** ** | $ | 132,764 |   |
| ** **                                      |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| **Preferred  Dividend Requirement**             |       | **211**                    | ** **  | 212                       |       | **423** | ** ** | 423 |   |
| ** **                                      |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| **Net  Income Applicable to Common Stock**      |       | **$**                      | **53,412**  | ** **                | $          | 55,097 |   | **$** | **137,866** | ** ** | $ | 132,341 |   |
| ** **                                      |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| **Net  Income**                                 |       | **$**                      | **53,623**  | ** **                | $          | 55,309 |   | **$** | **138,289** | ** ** | $ | 132,764 |   |
| ** **                                      |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| **Other  Comprehensive Income, Net of Tax**     |       | **11**                     | ** **  | 3,207                     |       | **1,729** | ** ** | 2,883 |   |
| ** **                                      |       | ** **                 | ** **  |                      |       | ** ** | ** ** |   |   |
| **Comprehensive  Income**                       |       | **$**                      | **53,634**  | ** **                | $          | 58,516 |   | **$** | **140,018** | ** ** | $ | 135,647 |   |

 

**The accompanying notes as they relate to TheCincinnati Gas & Electric Company are an integral part of these condensedconsolidated financial statements.**

 

12

----

 

**THE CINCINNATI GAS & ELECTRICCOMPANY**

**CONDENSED CONSOLIDATED BALANCESHEETS**

 
| ** **                                                            | ** ** | **June 30  2005**          | ** **    | **December 31  2004** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------|---------------|-----------------------|------------|
| ** **                                                            | ** ** | **(dollars in thousands)** | ** **    |
| ** **                                                            | ** ** | **(unaudited)**            | ** **    |
| **ASSETS**                                                            |       |                       |          |                  |       |
|                                                                  |       |                       |          |                  |       |
| **Current  Assets**                                                   |       |                       |          |                  |       |
| Cash and cash  equivalents                                            |       | **$**                      | **6,262**     | ** **            | $          | 4,154 |   |
| Notes receivable  from affiliated companies                           |       | **55,859**                 | ** **    | 121,559               |       |
| Accounts  receivable less accumulated provision for doubtful accounts |       | **196,872**                | ** **    | 145,105               |       |
| Accounts  receivable from affiliated companies                        |       | **37,142**                 | ** **    | 30,916                |       |
| Fuel, emission  allowances, and supplies                              |       | **215,564**                | ** **    | 199,769               |       |
| Energy risk  management current assets                                |       | **227,848**                | ** **    | 148,866               |       |
| Prepayments and  other                                                |       | **133,334**                | ** **    | 54,650                |       |
| **Total  Current Assets**                                             |       | **872,881**                | ** **    | 705,019               |       |
|                                                                  |       | ** **                 | ** **    |                  |       |
| **Property,  Plant, and Equipment – at Cost**                    |       | ** **                 | ** **    |                  |       |
| Utility plant in  service                                             |       | ** **                 | ** **    |                  |       |
| Electric                                                              |       | **2,283,947**              | ** **    | 2,249,352             |       |
| Gas                                                                   |       | **1,206,528**              | ** **    | 1,179,764             |       |
| Common                                                                |       | **250,962**                | ** **    | 249,576               |       |
| **Total  Utility Plant In Service**                                   |       | **3,741,437**              | ** **    | 3,678,692             |       |
| Construction  work in progress                                        |       | **73,838**                 | ** **    | 45,762                |       |
| **Total  Utility Plant**                                              |       | **3,815,275**              | ** **    | 3,724,454             |       |
| Non-regulated  property, plant, and equipment                         |       | **3,755,293**              | ** **    | 3,660,226             |       |
| Accumulated  depreciation                                             |       | **2,763,863**              | ** **    | 2,694,708             |       |
| **Net  Property, Plant, and Equipment**                               |       | **4,806,705**              | ** **    | 4,689,972             |       |
|                                                                  |       | ** **                 | ** **    |                  |       |
| **Other  Assets**                                                     |       | ** **                 | ** **    |                  |       |
| Regulatory  assets                                                    |       | **542,121**                | ** **    | 609,550               |       |
| Energy risk  management non-current assets                            |       | **134,868**                | ** **    | 47,276                |       |
| Restricted funds  held in trust                                       |       | **79,035**                 | ** **    | 93,671                |       |
| Other                                                                 |       | **113,651**                | ** **    | 86,871                |       |
| **Total  Other Assets**                                               |       | **869,675**                | ** **    | 837,368               |       |
|                                                                  |       | ** **                 | ** **    |                  |       |
| **Total  Assets**                                                     |       | **$**                      | **6,549,261** | ** **            | $          | 6,232,359 |   |

 

**The accompanying notes as they relate to TheCincinnati Gas & Electric Company are an integral part of these condensedconsolidated financial statements.**

 

13

----

 

**THE CINCINNATI GAS & ELECTRICCOMPANY**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                | ** ** | **June 30  2005**          | ** **    | **December 31  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|---------------|-----------------------|------------|
| ** **                                                                                                                                                | ** ** | **(dollars in thousands)** | ** **    |
| ** **                                                                                                                                                | ** ** | **(unaudited)**            | ** **    |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                            |       |                       |          |                  |       |
|                                                                                                                                                      |       |                       |          |                  |       |
| **Current  Liabilities**                                                                                                                                  |       |                       |          |                  |       |
| Accounts payable                                                                                                                                          |       | **$**                      | **392,103**   | ** **            | $          | 332,316 |   |
| Accounts payable  to affiliated companies                                                                                                                 |       | **40,696**                 | ** **    | 85,127                |       |
| Accrued taxes                                                                                                                                             |       | **172,016**                | ** **    | 149,010               |       |
| Accrued interest                                                                                                                                          |       | **20,263**                 | ** **    | 19,408                |       |
| Notes payable  and other short-term obligations (Note 5)                                                                                                  |       | **112,100**                | ** **    | 112,100               |       |
| Notes payable to  affiliated companies (Note 5)                                                                                                           |       | **231,940**                | ** **    | 180,116               |       |
| Long-term debt  due within one year                                                                                                                       |       | **—**                 | ** **    | 150,000               |       |
| Energy risk  management current liabilities                                                                                                               |       | **219,430**                | ** **    | 120,204               |       |
| Other                                                                                                                                                     |       | **32,772**                 | ** **    | 33,712                |       |
| **Total  Current Liabilities**                                                                                                                            |       | **1,221,320**              | ** **    | 1,181,993             |       |
|                                                                                                                                                      |       | ** **                 | ** **    |                  |       |
| **Non-Current  Liabilities**                                                                                                                              |       | ** **                 | ** **    |                  |       |
| Long-term debt                                                                                                                                            |       | **1,594,300**              | ** **    | 1,443,668             |       |
| Deferred income  taxes                                                                                                                                    |       | **1,066,857**              | ** **    | 1,090,897             |       |
| Unamortized  investment tax credits                                                                                                                       |       | **70,299**                 | ** **    | 73,120                |       |
| Accrued pension  and other postretirement benefit costs                                                                                                   |       | **238,967**                | ** **    | 228,058               |       |
| Regulatory  liabilities                                                                                                                                   |       | **184,203**                | ** **    | 164,846               |       |
| Energy risk  management non-current liabilities                                                                                                           |       | **133,273**                | ** **    | 40,184                |       |
| Other                                                                                                                                                     |       | **65,309**                 | ** **    | 70,395                |       |
| **Total  Non-Current Liabilities**                                                                                                                        |       | **3,353,208**              | ** **    | 3,111,168             |       |
|                                                                                                                                                      |       | ** **                 | ** **    |                  |       |
| **Commitments  and Contingencies**                                                                                                                        |       | ** **                 | ** **    |                  |       |
|                                                                                                                                                      |       | ** **                 | ** **    |                  |       |
| **Total  Liabilities**                                                                                                                                    |       | **4,574,528**              | ** **    | 4,293,161             |       |
|                                                                                                                                                      |       | ** **                 | ** **    |                  |       |
| **Cumulative  Preferred Stock**                                                                                                                           |       | ** **                 | ** **    |                  |       |
| Not subject to  mandatory redemption                                                                                                                      |       | **20,485**                 | ** **    | 20,485                |       |
|                                                                                                                                                      |       | ** **                 | ** **    |                  |       |
| **Common  Stock Equity**                                                                                                                                  |       | ** **                 | ** **    |                  |       |
| Common stock –  $8.50 par value; authorized shares – 120,000,000; outstanding shares – 89,663,086  at June 30, 2005, and December 31, 2004 |       | **762,136**                | ** **    | 762,136               |       |
| Paid-in capital                                                                                                                                           |       | **584,176**                | ** **    | 584,176               |       |
| Retained  earnings                                                                                                                                        |       | **644,038**                | ** **    | 610,232               |       |
| Accumulated  other comprehensive loss                                                                                                                     |       | **(36,102**                | **)**         | (37,831               | )          |
| **Total  Common Stock Equity**                                                                                                                            |       | **1,954,248**              | ** **    | 1,918,713             |       |
|                                                                                                                                                      |       | ** **                 | ** **    |                  |       |
| **Total  Liabilities and Shareholders’ Equity**                                                                                                      |       | **$**                      | **6,549,261** | ** **            | $          | 6,232,359 |   |

 

**The accompanying notes as they relate to TheCincinnati Gas & Electric Company are an integral part of these condensedconsolidated financial statements.**

 

14

----

** **

**THECINCINNATI GAS & ELECTRIC COMPANY**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                            | ** ** | **Year to Date  June 30**  | ** **  |
|---------------------------------------------------------------------------------------|------------|----------------------------|-------------|
| ** **                                                                            | ** ** | **2005**                   | ** **  | **2004** | ** ** |
| ** **                                                                            | ** ** | **(dollars in thousands)** | ** **  |
| ** **                                                                            | ** ** | **(unaudited)**            | ** **  |
| * *                                                                              | * *   | * *                   | * *    | * * | * * |
| **Operating  Activities**                                                             |       |                       |        |   |   |
| Net income                                                                            |       | **$**                      | **138,289** | ** ** | $ | 132,764 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:    |       | ** **                 | ** **  |   |   |
| Depreciation                                                                          |       | **90,370**                 | ** **  | 89,863 |   |
| Deferred income  taxes and investment tax credits – net                          |       | **8,666**                  | ** **  | 16,294 |   |
| Change in net  position of energy risk management activities                          |       | **25,741**                 | ** **  | (23,280 | ) |
| Allowance for  equity funds used during construction                                  |       | **(684**                   | **)**       | (719 | ) |
| Regulatory  asset/liability deferrals                                                 |       | **1,682**                  | ** **  | 7,558 |   |
| Regulatory  assets amortization                                                       |       | **39,646**                 | ** **  | 27,022 |   |
| Accrued pension  and other postretirement benefit costs                               |       | **10,909**                 | ** **  | 6,638 |   |
| Cost of removal                                                                       |       | **(3,301**                 | **)**       | (3,774 | ) |
| Changes in  current assets and current liabilities:                                   |       | ** **                 | ** **  |   |   |
| Accounts and  notes receivable                                                        |       | **7,707**                  | ** **  | 88,007 |   |
| Fuel, emission  allowances, and supplies                                              |       | **(44,829**                | **)**       | (30,965 | ) |
| Prepayments                                                                           |       | **(78,503**                | **)**       | (7,544 | ) |
| Accounts payable                                                                      |       | **15,356**                 | ** **  | (55,176 | ) |
| Accrued taxes  and interest                                                           |       | **23,861**                 | ** **  | 22,994 |   |
| Other assets                                                                          |       | **(2,766**                 | **)**       | 1,858 |   |
| Other  liabilities                                                                    |       | **8,676**                  | ** **  | 10,081 |   |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Net  cash provided by operating activities**                                        |       | **240,820**                | ** **  | 281,621 |   |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Financing  Activities**                                                             |       | ** **                 | ** **  |   |   |
| Change in  short-term debt, including net affiliate notes                             |       | **51,824**                 | ** **  | 81,112 |   |
| Redemption of  long-term debt                                                         |       | **—**                 | ** **  | (110,000 | ) |
| Dividends on  preferred stock                                                         |       | **(423**                   | **)**       | (423 | ) |
| Dividends on  common stock                                                            |       | **(104,061**               | **)**       | (110,538 | ) |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Net  cash used in financing activities**                                            |       | **(52,660**                | **)**       | (139,849 | ) |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Investing  Activities**                                                             |       | ** **                 | ** **  |   |   |
| Construction  expenditures (less allowance for equity funds used during construction) |       | **(201,733**               | **)**       | (148,762 | ) |
| Withdrawal of  restricted funds held in trust                                         |       | **15,635**                 | ** **  | — |   |
| Other  investments                                                                    |       | **46**                     | ** **  | (2 | ) |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Net  cash used in investing activities**                                            |       | **(186,052**               | **)**       | (148,764 | ) |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Net  increase (decrease) in cash and cash equivalents**                             |       | **2,108**                  | ** **  | (6,992 | ) |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Cash  and cash equivalents at beginning of period**                                 |       | **4,154**                  | ** **  | 15,842 |   |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Cash  and cash equivalents at end of period**                                       |       | **$**                      | **6,262**   | ** ** | $ | 8,850 |   |
|                                                                                  |       | ** **                 | ** **  |   |   |
| **Supplemental  Disclosure of Cash Flow Information**                                 |       | ** **                 | ** **  |   |   |
| Cash paid during  the period for:                                                     |       | ** **                 | ** **  |   |   |
| Interest (net of  amount capitalized)                                                 |       | **$**                      | **47,835**  | ** ** | $ | 45,345 |   |
| Income taxes                                                                          |       | **$**                      | **11,201**  | ** ** | $ | 11,264 |   |

 

**The accompanying notes as they relate to TheCincinnati Gas & Electric Company are an integral part of these condensedconsolidated financial statements.**

 

15

----

 

**PSI ENERGY, INC.**

**AND SUBSIDIARY COMPANY**

 

16

----

 

**PSIENERGY, INC.**

**CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME AND COMPREHENSIVE INCOME**

 
| ** **                                         | ** ** | **Quarter Ended**          | ** **  | **Year to Date** | ** ** |
|----------------------------------------------------|------------|----------------------------|-------------|------------------|------------|
| ** **                                         | ** ** | **June 30**                | ** **  | **June 30**      | ** ** |
| ** **                                         | ** ** | **2005**                   | ** **  | **2004**         | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | **(dollars in thousands)** | ** **  |
| ** **                                         | ** ** | **(unaudited)**            | ** **  |
| * *                                           | * *   | * *                   | * *    | * *         | * *   | * * | * * | * * | * * |
| **Operating  Revenues**                            |       |                       |        |             |       |   |   |   |   |
| Electric                                           |       | **$**                      | **428,457** | ** **       | $          | 414,444 |   | **$** | **853,864** | ** ** | $ | 830,723 |   |
|                                               |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| **Operating  Expenses**                            |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| Fuel, emission  allowances, and purchased power    |       | **134,080**                | ** **  | 155,139          |       | **266,117** | ** ** | 310,045 |   |
| Operation and  maintenance                         |       | **122,468**                | ** **  | 122,752          |       | **243,039** | ** ** | 231,553 |   |
| Depreciation                                       |       | **66,448**                 | ** **  | 55,059           |       | **133,295** | ** ** | 103,890 |   |
| Taxes other than  income taxes                     |       | **10,272**                 | ** **  | 14,121           |       | **25,933** | ** ** | 30,533 |   |
| **Total  Operating Expenses**                      |       | **333,268**                | ** **  | 347,071          |       | **668,384** | ** ** | 676,021 |   |
|                                               |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| **Operating  Income**                              |       | **95,189**                 | ** **  | 67,373           |       | **185,480** | ** ** | 154,702 |   |
|                                               |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| **Miscellaneous  Income – Net**               |       | **7,114**                  | ** **  | 3,017            |       | **10,493** | ** ** | 3,564 |   |
| **Interest  Expense**                              |       | **26,912**                 | ** **  | 21,701           |       | **51,677** | ** ** | 41,625 |   |
|                                               |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| **Income Before  Taxes**                           |       | **75,391**                 | ** **  | 48,689           |       | **144,296** | ** ** | 116,641 |   |
| ** **                                         |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| **Income  Taxes**                                  |       | **32,661**                 | ** **  | 23,243           |       | **59,222** | ** ** | 50,389 |   |
| ** **                                         |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| **Net  Income**                                    |       | **$**                      | **42,730**  | ** **       | $          | 25,446 |   | **$** | **85,074** | ** ** | $ | 66,252 |   |
| ** **                                         |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| **Preferred  Dividend Requirement**                |       | **647**                    | ** **  | 646              |       | **1,293** | ** ** | 1,293 |   |
| ** **                                         |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| **Net  Income Applicable to Common Stock**         |       | **$**                      | **42,083**  | ** **       | $          | 24,800 |   | **$** | **83,781** | ** ** | $ | 64,959 |   |
| ** **                                         |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| **Net  Income**                                    |       | **$**                      | **42,730**  | ** **       | $          | 25,446 |   | **$** | **85,074** | ** ** | $ | 66,252 |   |
| ** **                                         |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| **Other  Comprehensive Income (Loss), Net of Tax** |       | **(535**                   | **)**       | (118             | )          | **(1,730** | **)** | 366 |   |
| ** **                                         |       | ** **                 | ** **  |             |       | ** ** | ** ** |   |   |
| **Comprehensive  Income**                          |       | **$**                      | **42,195**  | ** **       | $          | 25,328 |   | **$** | **83,344** | ** ** | $ | 66,618 |   |

 

**The accompanying notes as they relate to PSIEnergy, Inc. are an integral part of these condensed consolidated financialstatements.**

 

17

----

 

**PSIENERGY, INC.**

**CONDENSED CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                            | ** ** | **June 30**                | ** **    | **December 31** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------|---------------|-----------------|------------|
| ** **                                                            | ** ** | **2005**                   | ** **    | **2004**        | ** ** |
| ** **                                                            | ** ** | **(dollars in thousands)** | ** **    |
| ** **                                                            | ** ** | **(unaudited)**            | ** **    |
| **ASSETS**                                                            | * *   | * *                   | * *      | * *        | * *   |
| ** **                                                            | * *   | * *                   | * *      | * *        | * *   |
| **Current  Assets**                                                   |       |                       |          |            |       |
| Cash and cash  equivalents                                            |       | **$**                      | **15,715**    | ** **      | $          | 10,794 |   |
| Restricted  deposits                                                  |       | **25,890**                 | ** **    | 22,063          |       |
| Notes receivable  from affiliated companies                           |       | **45,880**                 | ** **    | 72,958          |       |
| Accounts  receivable less accumulated provision for doubtful accounts |       | **38,010**                 | ** **    | 31,177          |       |
| Accounts  receivable from affiliated companies                        |       | **437**                    | ** **    | 437             |       |
| Fuel, emission  allowances, and supplies                              |       | **147,888**                | ** **    | 108,793         |       |
| Prepayments and  other                                                |       | **12,856**                 | ** **    | 11,804          |       |
| **Total  Current Assets**                                             |       | **286,676**                | ** **    | 258,026         |       |
|                                                                  |       | ** **                 | ** **    |            |       |
| **Property,  Plant, and Equipment – at Cost**                    |       | ** **                 | ** **    |            |       |
| Utility plant in  service                                             |       | **6,644,650**              | ** **    | 6,397,776       |       |
| Construction  work in progress                                        |       | **303,243**                | ** **    | 287,925         |       |
| **Total  Utility Plant**                                              |       | **6,947,893**              | ** **    | 6,685,701       |       |
| Accumulated  depreciation                                             |       | **2,375,789**              | ** **    | 2,284,932       |       |
| **Net  Property, Plant, and Equipment**                               |       | **4,572,104**              | ** **    | 4,400,769       |       |
|                                                                  |       | ** **                 | ** **    |            |       |
| **Other  Assets**                                                     |       | ** **                 | ** **    |            |       |
| Regulatory  assets                                                    |       | **446,187**                | ** **    | 420,783         |       |
| Other  investments                                                    |       | **72,503**                 | ** **    | 73,396          |       |
| Restricted funds  held in trust                                       |       | **221,676**                | ** **    | 264,335         |       |
| Other                                                                 |       | **45,264**                 | ** **    | 32,587          |       |
| **Total  Other Assets**                                               |       | **785,630**                | ** **    | 791,101         |       |
|                                                                  |       | ** **                 | ** **    |            |       |
| **Total  Assets**                                                     |       | **$**                      | **5,644,410** | ** **      | $          | 5,449,896 |   |
|                                                                       |            |                            |               |                 |            |  |  |  |

 

**The accompanying notes as they relate to PSIEnergy, Inc. are an integral part of these condensed consolidated financialstatements.**

 

18

----

 

**PSIENERGY, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                    | ** ** | **June 30**                | ** **    | **December 31** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|---------------|-----------------|------------|
| ** **                                                                                                                                                                    | ** ** | **2005**                   | ** **    | **2004**        | ** ** |
| ** **                                                                                                                                                                    | ** ** | **(dollars in thousands)** | ** **    |
| ** **                                                                                                                                                                    | ** ** | **(unaudited)**            | ** **    |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                                                                | * *   | * *                   | * *      | * *        | * *   |
|                                                                                                                                                                          | * *   | * *                   | * *      | * *        | * *   |
| **Current  Liabilities**                                                                                                                                                      |       |                       |          |            |       |
| Accounts payable                                                                                                                                                              |       | **$**                      | **90,555**    | ** **      | $          | 65,151 |   |
| Accounts payable  to affiliated companies                                                                                                                                     |       | **32,100**                 | ** **    | 38,292          |       |
| Accrued taxes                                                                                                                                                                 |       | **56,485**                 | ** **    | 65,871          |       |
| Accrued interest                                                                                                                                                              |       | **31,365**                 | ** **    | 27,532          |       |
| Notes payable  and other short-term obligations (Note 5)                                                                                                                      |       | **135,500**                | ** **    | 135,500         |       |
| Notes payable to  affiliated companies (Note 5)                                                                                                                               |       | **78,425**                 | ** **    | 130,580         |       |
| Long-term debt  due within one year                                                                                                                                           |       | **456,166**                | ** **    | 50,000          |       |
| Other                                                                                                                                                                         |       | **50,366**                 | ** **    | 33,326          |       |
| **Total  Current Liabilities**                                                                                                                                                |       | **930,962**                | ** **    | 546,252         |       |
|                                                                                                                                                                          |       | ** **                 | ** **    |            |       |
| **Non-Current  Liabilities**                                                                                                                                                  |       | ** **                 | ** **    |            |       |
| Long-term debt                                                                                                                                                                |       | **1,418,354**              | ** **    | 1,824,219       |       |
| Deferred income  taxes                                                                                                                                                        |       | **660,883**                | ** **    | 638,061         |       |
| Unamortized  investment tax credits                                                                                                                                           |       | **25,113**                 | ** **    | 26,603          |       |
| Accrued pension  and other postretirement benefit costs                                                                                                                       |       | **221,674**                | ** **    | 209,992         |       |
| Regulatory  liabilities                                                                                                                                                       |       | **391,525**                | ** **    | 392,573         |       |
| Other                                                                                                                                                                         |       | **71,585**                 | ** **    | 88,665          |       |
| **Total  Non-Current Liabilities**                                                                                                                                            |       | **2,789,134**              | ** **    | 3,180,113       |       |
|                                                                                                                                                                          |       | ** **                 | ** **    |            |       |
| **Commitments  and Contingencies**                                                                                                                                            |       | ** **                 | ** **    |            |       |
| ** **                                                                                                                                                                    |       | ** **                 | ** **    |            |       |
| **Total  Liabilities**                                                                                                                                                        |       | **3,720,096**              | ** **    | 3,726,365       |       |
|                                                                                                                                                                          |       | ** **                 | ** **    |            |       |
| **Cumulative  Preferred Stock**                                                                                                                                               |       | ** **                 | ** **    |            |       |
| Not subject to  mandatory redemption                                                                                                                                          |       | **42,333**                 | ** **    | 42,333          |       |
|                                                                                                                                                                          |       | ** **                 | ** **    |            |       |
| **Common  Stock Equity**                                                                                                                                                      |       | ** **                 | ** **    |            |       |
| Common stock –  without par value; $.01 stated value; authorized shares – 60,000,000;  outstanding shares – 53,913,701 at June 30, 2005, and December 31, 2004 |       | **539**                    | ** **    | 539             |       |
| Paid-in capital                                                                                                                                                               |       | **826,019**                | ** **    | 626,019         |       |
| Retained  earnings                                                                                                                                                            |       | **1,081,131**              | ** **    | 1,078,617       |       |
| Accumulated  other comprehensive loss                                                                                                                                         |       | **(25,708**                | **)**         | (23,977         | )          |
| **Total  Common Stock Equity**                                                                                                                                                |       | **1,881,981**              | ** **    | 1,681,198       |       |
|                                                                                                                                                                          |       | ** **                 | ** **    |            |       |
| **Total  Liabilities and Shareholders’ Equity**                                                                                                                          |       | **$**                      | **5,644,410** | ** **      | $          | 5,449,896 |   |

 

**The accompanying notes as they relate to PSIEnergy, Inc. are an integral part of these condensed consolidated financialstatements.**

 

19

----

 

**PSIENERGY, INC.**

**CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                                            | ** ** | **Year to Date**            | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                            | ** ** | **June 30**                 | ** ** |
| ** **                                                                            | ** ** | **2005**                    | ** ** | **2004** | ** ** |
| ** **                                                                            | ** ** | **(dollars  in thousands)** | ** ** |
| ** **                                                                            | ** ** | **(unaudited)**             | ** ** |
| * *                                                                              | * *   | * *                    | * *   | * * | * * |
| **Operating  Activities**                                                             |       |                        |       |   |   |
| Net income                                                                            |       | **$**                       | **85,074** | ** ** | $ | 66,252 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:    |       | ** **                  | ** ** |   |   |
| Depreciation                                                                          |       | **133,295**                 | ** ** | 103,890 |   |
| Deferred income  taxes and investment tax credits – net                          |       | **17,776**                  | ** ** | 35,052 |   |
| Allowance for  equity funds used during construction                                  |       | **(3,719**                  | **)**      | (257 | ) |
| Regulatory  asset/liability deferrals                                                 |       | **(64,162**                 | **)**      | (22,452 | ) |
| Regulatory  assets amortization                                                       |       | **21,789**                  | ** ** | 21,280 |   |
| Accrued pension  and other postretirement benefit costs                               |       | **11,682**                  | ** ** | 10,260 |   |
| Cost of removal                                                                       |       | **(10,421**                 | **)**      | (5,344 | ) |
| Changes in  current assets and current liabilities:                                   |       | ** **                  | ** ** |   |   |
| Accounts and  notes receivable                                                        |       | **20,245**                  | ** ** | 7,118 |   |
| Fuel, emission  allowances, and supplies                                              |       | **(43,693**                 | **)**      | 3,863 |   |
| Prepayments                                                                           |       | **(778**                    | **)**      | (32 | ) |
| Accounts payable                                                                      |       | **19,212**                  | ** ** | (41,508 | ) |
| Accrued taxes  and interest                                                           |       | **(5,553**                  | **)**      | (2,679 | ) |
| Other assets                                                                          |       | **(18,239**                 | **)**      | (783 | ) |
| Other  liabilities                                                                    |       | **1,942**                   | ** ** | 3,835 |   |
|                                                                                  |       | ** **                  | ** ** |   |   |
| **Net  cash provided by operating activities**                                        |       | **164,450**                 | ** ** | 178,495 |   |
|                                                                                  |       | ** **                  | ** ** |   |   |
| **Financing  Activities**                                                             |       | ** **                  | ** ** |   |   |
| Change in  short-term debt, including net affiliate notes                             |       | **(52,155**                 | **)**      | 30,337 |   |
| Contribution  from parent                                                             |       | **200,000**                 | ** ** | — |   |
| Dividends on  preferred stock                                                         |       | **(1,293**                  | **)**      | (1,293 | ) |
| Dividends on  common stock                                                            |       | **(81,268**                 | **)**      | (57,870 | ) |
|                                                                                  |       | ** **                  | ** ** |   |   |
| **Net  cash provided by (used in) financing activities**                              |       | **65,284**                  | ** ** | (28,826 | ) |
|                                                                                  |       | ** **                  | ** ** |   |   |
| **Investing  Activities**                                                             |       | ** **                  | ** ** |   |   |
| Construction  expenditures (less allowance for equity funds used during construction) |       | **(269,341**                | **)**      | (140,606 | ) |
| Withdrawal of  restricted funds held in trust                                         |       | **45,227**                  | ** ** | 10,413 |   |
| Other  investments                                                                    |       | **(699**                    | **)**      | (1,346 | ) |
|                                                                                  |       | ** **                  | ** ** |   |   |
| **Net  cash used in investing activities**                                            |       | **(224,813**                | **)**      | (131,539 | ) |
|                                                                                  |       | ** **                  | ** ** |   |   |
| **Net  increase in cash and cash equivalents**                                        |       | **4,921**                   | ** ** | 18,130 |   |
| ** **                                                                            |       | ** **                  | ** ** |   |   |
| **Cash  and cash equivalents at beginning of period**                                 |       | **10,794**                  | ** ** | 6,565 |   |
| ** **                                                                            |       | ** **                  | ** ** |   |   |
| **Cash  and cash equivalents at end of period**                                       |       | **$**                       | **15,715** | ** ** | $ | 24,695 |   |
|                                                                                  |       | ** **                  | ** ** |   |   |
| **Supplemental  Disclosure of Cash Flow Information**                                 |       | ** **                  | ** ** |   |   |
| Cash paid during  the period for:                                                     |       | ** **                  | ** ** |   |   |
| Interest (net of  amount capitalized)                                                 |       | **$**                       | **53,100** | ** ** | $ | 43,894 |   |
| Income taxes                                                                          |       | **$**                       | **34,650** | ** ** | $ | 19,502 |   |

 

**The accompanying notes as they relate to PSIEnergy, Inc. are an integral part of these condensed consolidated financialstatements.**

 

20

----

 

**THE UNION LIGHT, HEAT AND POWER COMPANY**

 

21

----

 

**THEUNION LIGHT, HEAT AND POWER COMPANY**

**CONDENSEDSTATEMENTS OF INCOME**

 
| ** **                                           | ** ** | **Quarter Ended**          | ** ** | **Year to Date** | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|------------------|------------|
| ** **                                           | ** ** | **June 30**           | ** ** | **June 30** | ** ** |
| ** **                                           | ** ** | **2005**                   | ** ** | **2004**         | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)** | ** ** |
| ** **                                           | ** ** | **(unaudited)**            | ** ** |
| * *                                             | * *   | * *                   | * *   | * *         | * *   | * * | * * | * * | * * |
| **Operating Revenues**                               |       |                       |       |             |       |   |   |   |   |
| Electric                                             |       | **$**                      | **56,424** | ** **       | $          | 56,732 |   | **$** | **111,008** | ** ** | $ | 112,947 |   |
| Gas                                                  |       | **18,672**                 | ** ** | 15,985           |       | **76,447** | ** ** | 74,124 |   |
| **Total Operating Revenues**                         |       | **75,096**                 | ** ** | 72,717           |       | **187,455** | ** ** | 187,071 |   |
|                                                 |       | ** **                 | ** ** |             |       | ** ** | ** ** |   |   |
| **Operating Expenses**                               |       | ** **                 | ** ** |             |       | ** ** | ** ** |   |   |
| Electricity purchased from parent company for resale |       | **39,936**                 | ** ** | 39,854           |       | **79,436** | ** ** | 79,307 |   |
| Gas purchased                                        |       | **10,625**                 | ** ** | 7,481            |       | **50,824** | ** ** | 48,314 |   |
| Operation and maintenance                            |       | **17,489**                 | ** ** | 13,795           |       | **33,204** | ** ** | 27,555 |   |
| Depreciation                                         |       | **5,177**                  | ** ** | 5,027            |       | **10,287** | ** ** | 9,952 |   |
| Taxes other than income taxes                        |       | **1,600**                  | ** ** | 1,239            |       | **3,084** | ** ** | 2,677 |   |
| **Total Operating Expenses**                         |       | **74,827**                 | ** ** | 67,396           |       | **176,835** | ** ** | 167,805 |   |
|                                                 |       | ** **                 | ** ** |             |       | ** ** | ** ** |   |   |
| **Operating Income**                                 |       | **269**                    | ** ** | 5,321            |       | **10,620** | ** ** | 19,266 |   |
| ** **                                           |       | ** **                 | ** ** |             |       | ** ** | ** ** |   |   |
| **Miscellaneous Income – Net**                  |       | **715**                    | ** ** | 242              |       | **1,565** | ** ** | 741 |   |
| **Interest Expense**                                 |       | **1,703**                  | ** ** | 1,270            |       | **3,448** | ** ** | 2,497 |   |
| ** **                                           |       | ** **                 | ** ** |             |       | ** ** | ** ** |   |   |
| **Income (Loss) Before Taxes**                       |       | **(719**                   | **)**      | 4,293            |       | **8,737** | ** ** | 17,510 |   |
| ** **                                           |       | ** **                 | ** ** |             |       | ** ** | ** ** |   |   |
| **Income Taxes**                                     |       | **(232**                   | **)**      | 1,202            |       | **3,030** | ** ** | 6,531 |   |
| ** **                                           |       | ** **                 | ** ** |             |       | ** ** | ** ** |   |   |
| **Net Income (Loss)**                                |       | **$**                      | **(487**   | **)**            | $          | 3,091 |   | **$** | **5,707** | ** ** | $ | 10,979 |   |

 

**Theaccompanying notes as they relate to The Union Light, Heat and Power Companyare an integral part of these condensed financial statements.**

 

22

----

 

**THEUNION LIGHT, HEAT AND POWER COMPANY**

**CONDENSEDBALANCE SHEETS**

 
| ** **                                                            | ** ** | **June 30**           | ** **   | **December 31** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------|--------------|----------------------|------------|
| ** **                                                            | ** ** | **2005**                   | ** **   | **2004**             | ** ** |
| ** **                                                            | ** ** | **(dollars in thousands)** | ** **   |
| ** **                                                            | ** ** | **(unaudited)**            | ** **   |
| * *                                                              | * *   | *** ***               | *** *** | * *             | * *   |
| **ASSETS**                                                            |       | ** **                 | ** **   |                 |       |
|                                                                  |       | ** **                 | ** **   |                 |       |
| **Current Assets**                                                    |       | ** **                 | ** **   |                 |       |
| Cash and cash equivalents                                             |       | **$**                      | **6,486**    | ** **           | $          | 4,197 |   |
| Notes receivable from affiliated companies                            |       | **8,099**                  | ** **   | 20,675               |       |
| Accounts receivable less accumulated provision for  doubtful accounts |       | **927**                    | ** **   | 1,451                |       |
| Accounts receivable from affiliated companies                         |       | **1,016**                  | ** **   | 5,671                |       |
| Inventory and supplies                                                |       | **7,311**                  | ** **   | 8,500                |       |
| Prepayments and other                                                 |       | **1,176**                  | ** **   | 285                  |       |
| **Total Current Assets**                                              |       | **25,015**                 | ** **   | 40,779               |       |
|                                                                  |       | ** **                 | ** **   |                 |       |
| **Property, Plant, and Equipment – at Cost**                     |       | ** **                 | ** **   |                 |       |
| Utility plant in service                                              |       | ** **                 | ** **   |                 |       |
| Electric                                                              |       | **291,473**                | ** **   | 285,828              |       |
| Gas                                                                   |       | **263,260**                | ** **   | 256,667              |       |
| Common                                                                |       | **42,018**                 | ** **   | 42,176               |       |
| **Total Utility Plant In Service**                                    |       | **596,751**                | ** **   | 584,671              |       |
| Construction work in progress                                         |       | **13,257**                 | ** **   | 6,070                |       |
| **Total Utility Plant**                                               |       | **610,008**                | ** **   | 590,741              |       |
| Accumulated depreciation                                              |       | **183,139**                | ** **   | 176,726              |       |
| **Net Property, Plant, and Equipment**                                |       | **426,869**                | ** **   | 414,015              |       |
|                                                                  |       | ** **                 | ** **   |                 |       |
| **Other Assets**                                                      |       | ** **                 | ** **   |                 |       |
| Regulatory assets                                                     |       | **7,111**                  | ** **   | 10,070               |       |
| Other                                                                 |       | **2,492**                  | ** **   | 2,801                |       |
| **Total Other Assets**                                                |       | **9,603**                  | ** **   | 12,871               |       |
|                                                                  |       | ** **                 | ** **   |                 |       |
| **Total Assets**                                                      |       | **$**                      | **461,487**  | ** **           | $          | 467,665 |   |

 

**The accompanying notes as they relate to The UnionLight, Heat and Power Company are an integral part of these condensed financialstatements.**

 

23

----

 

**THEUNION LIGHT, HEAT AND POWER COMPANY**

**CONDENSEDBALANCE SHEETS**

 
| ** **                                                                                                                                                      | ** ** | **June 30**           | ** **   | **December 31** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|--------------|----------------------|------------|
| ** **                                                                                                                                                      | ** ** | **2005**                   | ** **   | **2004**             | ** ** |
| ** **                                                                                                                                                      | ** ** | **(dollars in thousands)** | ** **   |
| ** **                                                                                                                                                      | ** ** | **(unaudited)**            | ** **   |
| * *                                                                                                                                                        | * *   | *** ***               | *** *** | * *             | * *   |
| **LIABILITIES AND SHAREHOLDER’S EQUITY**                                                                                                                   |       | ** **                 | ** **   |                 |       |
|                                                                                                                                                            |       | ** **                 | ** **   |                 |       |
| **Current Liabilities**                                                                                                                                         |       | ** **                 | ** **   |                 |       |
| Accounts payable                                                                                                                                                |       | **$**                      | **5,056**    | ** **           | $          | 16,028 |   |
| Accounts payable to affiliated companies                                                                                                                        |       | **7,319**                  | ** **   | 22,236               |       |
| Accrued interest                                                                                                                                                |       | **1,460**                  | ** **   | 1,370                |       |
| Notes payable to affiliated companies (Note 5)                                                                                                                  |       | **18,867**                 | ** **   | 11,246               |       |
| Other                                                                                                                                                           |       | **8,863**                  | ** **   | 7,009                |       |
| **Total Current Liabilities**                                                                                                                                   |       | **41,565**                 | ** **   | 57,889               |       |
|                                                                                                                                                            |       | ** **                 | ** **   |                 |       |
| **Non-Current Liabilities**                                                                                                                                     |       | ** **                 | ** **   |                 |       |
| Long-term debt                                                                                                                                                  |       | **94,375**                 | ** **   | 94,340               |       |
| Deferred income taxes                                                                                                                                           |       | **59,417**                 | ** **   | 58,422               |       |
| Unamortized investment tax credits                                                                                                                              |       | **2,499**                  | ** **   | 2,626                |       |
| Accrued pension and other postretirement benefit  costs                                                                                                         |       | **18,876**                 | ** **   | 17,762               |       |
| Regulatory liabilities                                                                                                                                          |       | **33,453**                 | ** **   | 29,979               |       |
| Other                                                                                                                                                           |       | **13,083**                 | ** **   | 14,136               |       |
| **Total Non-Current Liabilities**                                                                                                                               |       | **221,703**                | ** **   | 217,265              |       |
|                                                                                                                                                            |       | ** **                 | ** **   |                 |       |
| **Commitments and Contingencies**                                                                                                                               |       | ** **                 | ** **   |                 |       |
| ** **                                                                                                                                                      |       | ** **                 | ** **   |                 |       |
| **Total Liabilities**                                                                                                                                           |       | **263,268**                | ** **   | 275,154              |       |
|                                                                                                                                                            |       | ** **                 | ** **   |                 |       |
| **Common Stock Equity**                                                                                                                                         |       | ** **                 | ** **   |                 |       |
| Common stock – $15.00 par value; authorized shares –  1,000,000; outstanding shares – 585,333 at June 30, 2005, and December 31,  2004 |       | **8,780**                  | ** **   | 8,780                |       |
| Paid-in capital                                                                                                                                                 |       | **23,455**                 | ** **   | 23,455               |       |
| Retained earnings                                                                                                                                               |       | **167,270**                | ** **   | 161,562              |       |
| Accumulated other comprehensive loss                                                                                                                            |       | **(1,286**                 | **)**        | (1,286               | )          |
| **Total Common Stock Equity**                                                                                                                                   |       | **198,219**                | ** **   | 192,511              |       |
|                                                                                                                                                            |       | ** **                 | ** **   |                 |       |
| **Total Liabilities and Shareholder’s Equity**                                                                                                             |       | **$**                      | **461,487**  | ** **           | $          | 467,665 |   |

 

**The accompanying notes as they relate to The UnionLight, Heat and Power Company are an integral part of these condensed financialstatements.**

 

24

----

 

**THEUNION LIGHT, HEAT AND POWER COMPANY**

**CONDENSEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                                            | ** ** | **Year to Date**           | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                            | ** ** | **June 30**           | ** ** |
| ** **                                                                            | ** ** | **2005**                   | ** ** | **2004** | ** ** |
| ** **                                                                            | ** ** | **(dollars in thousands)** | ** ** |
| ** **                                                                            | ** ** | **(unaudited)**            | ** ** |
| * *                                                                              | * *   | * *                   | * *   | * * | * * |
| **Operating Activities**                                                              |       | ** **                 | ** ** |   |   |
| Net income                                                                            |       | **$**                      | **5,707**  | ** ** | $ | 10,979 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:    |       | ** **                 | ** ** |   |   |
| Depreciation                                                                          |       | **10,287**                 | ** ** | 9,952 |   |
| Deferred income taxes and investment tax credits –  net                          |       | **2,561**                  | ** ** | 393 |   |
| Allowance for equity funds used during construction                                   |       | **(308**                   | **)**      | 9 |   |
| Regulatory asset/liability deferrals                                                  |       | **1,446**                  | ** ** | 2,370 |   |
| Regulatory assets amortization                                                        |       | **1,968**                  | ** ** | 617 |   |
| Accrued pension and other postretirement benefit  costs                               |       | **1,114**                  | ** ** | 756 |   |
| Cost of removal                                                                       |       | **(523**                   | **)**      | (852 | ) |
| Changes in current assets and current liabilities:                                    |       | ** **                 | ** ** |   |   |
| Accounts and notes receivable                                                         |       | **17,755**                 | ** ** | 14,134 |   |
| Inventory and supplies                                                                |       | **1,189**                  | ** ** | 142 |   |
| Prepayments                                                                           |       | **(891**                   | **)**      | 279 |   |
| Accounts payable                                                                      |       | **(25,889**                | **)**      | (9,207 | ) |
| Accrued taxes and interest                                                            |       | **2,088**                  | ** ** | 8,273 |   |
| Other assets                                                                          |       | **680**                    | ** ** | 301 |   |
| Other liabilities                                                                     |       | **(1,640**                 | **)**      | (769 | ) |
|                                                                                  |       | ** **                 | ** ** |   |   |
| **Net cash provided by operating activities**                                         |       | **15,544**                 | ** ** | 37,377 |   |
|                                                                                  |       | ** **                 | ** ** |   |   |
| **Financing Activities**                                                              |       | ** **                 | ** ** |   |   |
| Change in short-term debt, including net affiliate  notes                             |       | **7,621**                  | ** ** | (16,135 | ) |
|                                                                                  |       | ** **                 | ** ** |   |   |
| **Net cash provided by (used in) financing  activities**                              |       | **7,621**                  | ** ** | (16,135 | ) |
|                                                                                  |       | ** **                 | ** ** |   |   |
| **Investing Activities**                                                              |       | ** **                 | ** ** |   |   |
| Construction expenditures (less allowance for equity  funds used during construction) |       | **(20,876**                | **)**      | (16,147 | ) |
|                                                                                  |       | ** **                 | ** ** |   |   |
| **Net cash used in investing activities**                                             |       | **(20,876**                | **)**      | (16,147 | ) |
|                                                                                  |       | ** **                 | ** ** |   |   |
| **Net increase in cash and cash equivalents**                                         |       | **2,289**                  | ** ** | 5,095 |   |
| ** **                                                                            |       | ** **                 | ** ** |   |   |
| **Cash and cash equivalents at beginning of period**                                  |       | **4,197**                  | ** ** | 1,899 |   |
| ** **                                                                            |       | ** **                 | ** ** |   |   |
| **Cash and cash equivalents at end of period**                                        |       | **$**                      | **6,486**  | ** ** | $ | 6,994 |   |
|                                                                                  |       | ** **                 | ** ** |   |   |
| **Supplemental Disclosure of Cash Flow Information**                                  |       | ** **                 | ** ** |   |   |
| Cash paid during the period for:                                                      |       | ** **                 | ** ** |   |   |
| Interest (net of amount capitalized)                                                  |       | **$**                      | **3,198**  | ** ** | $ | 2,295 |   |
| Income taxes                                                                          |       | **$**                      | **—** | ** ** | $ | 4 |   |

 

**The accompanying notes as they relate to The UnionLight, Heat and Power Company are an integral part of these condensed financialstatements.**

 

25

----

 

**INDEX**

 

**NOTESTO CONDENSED FINANCIAL STATEMENTS**

 
| **Note**   | ** ** | ** **                                                   | ** ** |
|------------|------------|--------------------------------------------------------------|------------|
| **Number** | ** ** | ** **                                                   | ** ** |
| ** ** | ** ** | ** **                                                   | ** ** |
| 1          |       | Organization and Summary of  Significant Accounting Policies |       |
|       |       |                                                         |       |
| 2          |       | Common Stock                                                 |       |
|       |       |                                                         |       |
| 3          |       | Cumulative Preferred Stock                                   |       |
|       |       |                                                         |       |
| 4          |       | Long-Term Debt                                               |       |
|       |       |                                                         |       |
| 5          |       | Notes Payable and Other  Short-term Obligations              |       |
|       |       |                                                         |       |
| 6          |       | Energy Trading Credit Risk                                   |       |
|       |       |                                                         |       |
| 7          |       | Financial Instruments                                        |       |
|       |       |                                                         |       |
| 8          |       | Pension and Other  Postretirement Benefits                   |       |
|       |       |                                                         |       |
| 9          |       | Commitments and Contingencies                                |       |
|       |       |                                                         |       |
| 10         |       | Financial  Information by Business Segment                   |       |
|       |       |                                                         |       |
| 11         |       | Earnings Per Common  Share                                   |       |
|       |       |                                                         |       |
| 12         |       | Transfer  and Acquisition of Generating Assets               |       |
|       |       |                                                         |       |
| 13         |       | Pending Merger                                               |       |

 

26

----

 

 

### **NOTES TO CONDENSED FINANCIAL STATEMENTS**

 

In this report **Cinergy** (which includes **Cinergy Corp.** and all of our regulated andnon-regulated subsidiaries) is, at times, referred to in the first person as “we,”“our,” or “us.”  In addition, whendiscussing **Cinergy’s** financialinformation, it necessarily includes the results of The Cincinnati Gas &Electric Company (**CG&E**), PSIEnergy, Inc. (**PSI**), The UnionLight, Heat and Power Company (**ULH&P**)and all of **Cinergy’s** otherconsolidated subsidiaries.  Whendiscussing **CG&E’s** financialinformation, it necessarily includes the results of **ULH&P** and all of **CG&E’s**other consolidated subsidiaries.

 

**1.**              Organization and Summary ofSignificant Accounting Policies

** **

***(a)***                                  PendingMerger

*** ***

On May 8, 2005, **Cinergy Corp.** entered into an agreement and plan of mergerwith Duke Energy Corporation (Duke), a North Carolina corporation, whereby **Cinergy Corp.** will be merged with Duke.  Under the merger agreement, each share of **Cinergy Corp.** Common Stock will be converted into 1.56shares of the newly formed company, Duke Energy Holding Corp.

 

The merger agreement hasbeen approved by both companies’ Boards of Directors.  Consummation of the merger is subject to customaryconditions, including, among others, the approval of the shareholders of bothcompanies and the approvals of various regulatory authorities.  See Note 13 for further information regardingthe merger.

 

***(b)***                                  Presentation

*** ***

Our Condensed FinancialStatements reflect all adjustments (which include normal, recurringadjustments) necessary in the opinion of the registrants for a fairpresentation of the interim results. These results are not necessarily indicative of results for a fullyear.  These statements should be read inconjunction with the Financial Statements and the notes thereto included in theregistrants’ combined Form 10-K for the year ended December 31, 2004(2004 10-K).  Certain amounts in the 2004Condensed Financial Statements have been reclassified to conform to the 2005presentation.

 

Management makesestimates and assumptions when preparing financial statements under generallyaccepted accounting principles.  Keyestimates and judgments include:

 

•                  Valuing derivative contracts used inour energy marketing and trading activities;

•                  Evaluating the regulatoryrecoverability of various costs;

•                  Providing reserves for contingencies,including legal, environmental, and income taxes; and

•                  Evaluating various non-regulatedfixed assets and investments for impairment.

 

These estimates andjudgments are discussed more fully in “Critical Accounting Estimates” in our2004 10-K.  Actual results could differ,as these estimates and assumptions involve judgment about future events orperformance.

 

***(c)***                                  RevenueRecognition

*** ***

*(i)*                                  UtilityRevenues

* *

**CG&E**,**PSI**, and **ULH&P** (collectively, our utilityoperating companies) record *OperatingRevenues* for electric and gas service when delivered tocustomers.  Customers are billedthroughout the month as both gas and electric meters are read.  We recognize revenues for retail energy salesthat have not yet been billed, but where gas or electricity has been consumed.  This is termed “unbilled revenues” and is awidely recognized and accepted practice for utilities.  In making our estimates of unbilled revenues,we use systems that consider various factors, including weather, in ourcalculation of retail customer consumption at the end of each month.  Given the use of these systems and the factthat customers are billed monthly, we believe it is unlikely that materiallydifferent results will occur in future periods when these amounts aresubsequently billed.

 

27

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Unbilled revenues for **Cinergy**, **CG&E**,**PSI**, and **ULH&P** as of June 30, 2005 and2004, were as follows:

 
| ** **                    | ** ** | **2005**          | ** ** | **2004**   | ** ** |
|-------------------------------|------------|-------------------|------------|------------|------------|
| ** **                    | ** ** | **(in millions)** | ** ** |
| * *                      | * *   | * *          | * *   | * *   | * *   |
| **Cinergy**                   |       | **$**             | **148**    | ** ** | $          | 135 | ** ** |
| **CG&E** and subsidiaries |       | **77**            |       | 70         |       |
| **PSI**                       |       | **71**            |       | 65         |       |
| **ULH&P**                 |       | **12**            |       | 12         |       |
|                               |            |                   |            |            |            |  |  |

 

*(ii)*                              EnergyMarketing and Trading Revenues

* *

We market and tradeelectricity, natural gas, and other energy-related products.  Many of the contracts associated with theseproducts qualify as derivatives in accordance with Statement of FinancialAccounting Standards No. 133, *Accountingfor Derivative Instruments and Hedging Activities*.  We designate derivative transactions aseither trading or non-trading at the time they are originated in accordancewith Emerging Issues Task Force Issue 02-3, *IssuesInvolved in Accounting for Derivative Contracts Held for Trading Purposes andContracts Involved in Energy Trading and Risk Management Activities*.  Trading contracts are reported on a net basisand non-trading contracts are reported on a gross basis.  Net reporting requires presentation of realizedand unrealized gains and losses on trading derivatives on a net basis in *Operating Revenues*.  Gross reporting requires presentation ofsales contracts in *Operating Revenues*and purchase contracts in *Fuel, emissionallowances, and purchased power* expense or *Gas purchased* expense.

 

*(iii)*                          OtherOperating Revenues

* *

**Cinergy**and **CG&E** recognize revenue from coalorigination, which represents contract structuring and marketing of physicalcoal.  These revenues are included in *Other Operating Revenues* on the Condensed ConsolidatedStatements of Income.  *Other Operating Revenues* for **Cinergy**also includes sales of synthetic fuel.

 

***(d)***                                  AccountingChanges

*** ***

*(i)*                                  AssetRetirement Obligations

* *

In March 2005, theFinancial Accounting Standards Board (FASB) issued Interpretation No. 47, *Accounting for Conditional Asset RetirementObligations* (Interpretation 47), an interpretation of Statement ofFinancial Accounting Standards No. 143, *Accountingfor Asset Retirement Obligations*(Statement 143).  Statement 143 requires recognition of legalobligations associated with the retirement or removal of long-lived assets atthe time the obligations are incurred.  Interpretation 47 clarifies that a conditionalasset retirement obligation (which occurs when the timing and/or method of settlementare conditional on a future event that may or may not be within the control ofthe entity) is a legal obligation within the scope of Statement 143.  As such, the fair value of a conditionalasset retirement obligation must be recognized as a liability when incurred ifthe liability’s fair value can be reasonably estimated.  Interpretation 47 also clarifies whensufficient information exists to reasonably estimate the fair value of an assetretirement obligation.

 

**Cinergy**will adopt Interpretation 47 on December 31, 2005.  Upon adoption of Interpretation 47 **Cinergy** will recognize the impact, if any, of additionalliabilities for conditional asset retirement obligations as a cumulative effectof a change in accounting principle.  We havebegun evaluating the impact of adopting this new interpretation and arecurrently unable to predict whether the implementation of this accountingstandard will be material to our financial position or results of operations.

 

28

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* *

*(ii)*                              Share-BasedPayment

* *

In December 2004,the FASB issued a replacement of Statement of Financial Accounting Standards No. 123,*Accounting for Stock-Based Compensation* (Statement123), *Statement of Financial Accounting Standards No. 123(revised 2004), Share-Based Payment* (Statement 123R).  This standard will require, among otherthings, accounting for all stock-based compensation arrangements under the fairvalue method.

 

In 2003, we prospectivelyadopted accounting for our stock-based compensation plans using the fair valuerecognition provisions of Statement 123, as amended by Statement of FinancialAccounting Standards No. 148, *Accounting for Stock-BasedCompensation-Transition and Disclosure*, for all employee awardsgranted or with terms modified on or after January 1, 2003.  Therefore, the impact of implementation ofStatement 123R on stock options within our stock-based compensation plans isnot expected to be material.  Statement123R contains certain provisions that will modify the accounting for variousstock-based compensation plans other than stock options.  We are in the process of evaluating theimpact of this new standard on these plans. **Cinergy** will adopt Statement 123R on January 1,2006.

 

*(iii)*                          IncomeTaxes

* *

In October 2004, theAmerican Jobs Creation Act (AJCA) was signed into law.  The AJCA includes a one-time deduction of 85percent of certain foreign earnings that are repatriated, as defined in theAJCA.  Based on our analysis, we do not believe that repatriation pursuant to thisprovision will have a material impact on our financial position or results ofoperations.

 

**2.**              Common Stock

** **

As discussed in the 200410-K, in January and February 2005, **Cinergy****Corp.** issued a total of 9.2 millionshares of common stock pursuant to certain stock purchase contracts that wereissued as a component of combined securities in December 2001.  Net proceeds from the transaction of $316million were used to reduce short-term debt.

 

**Cinergy**issues new **Cinergy Corp.** commonstock shares to satisfy obligations under certain of its employee stock plansand the Cinergy Corp. Direct Stock Purchase and Dividend ReinvestmentPlan.  During the six months ended June 30,2005, **Cinergy** issued 1.9 millionshares under these plans.

 

In June 2005, **Cinergy Corp.** contributed $200 million in capital to **PSI**.  The capitalcontribution was used to repay short-term indebtedness and is consistent withsupporting **PSI’s** current credit ratings.

 

**3.**              Cumulative Preferred Stock

** **

**In July 2005,**PSI notified holders of its $31.075 million notionalamount 6.875% Cumulative Preferred Stock that it intends to redeem alloutstanding shares on August 17, 2005 at a price of $103.09 per share plusaccrued and unpaid dividends.

** **

**4.**              Long-Term Debt

** **

In July 2005, **PSI** notified holders of its $50 million principal amount Series ZZFirst Mortgage secured 5 3⁄4% Series 1993B Environmental Revenue RefundingBonds, due February 15, 2028, of its intention to redeem all outstandingbonds in August 2005.  **PSI** will redeemthese bonds with the proceeds from the issuance by the Indiana FinanceAuthority of $50 million principal amount of its Environmental RevenueRefunding Bonds, Series 2005A, due July 1, 2035.  The bonds beara fixed rate of interest through 2035 of 4.50 percent.

 

****In August 2005,********PSI********notified holders ofits $30 million principal amount 7.125% Series AAA First Mortgage Bonds,due 2024, of its intention to redeem all outstanding bonds on September 2,2005.  In anticipation of these bonds being redeemed, they have beenclassified as *Long-term debt due within oneyear*on the Condensed Consolidated Balance Sheets.****

 

29

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Also in August 2005,**PSI** redeemed the $50 million 6.50%Synthetic Putable Yield Securities due August 1, 2026 through the exerciseof call provisions of the securities.  Because these securities would havebeen subject to mandatory redemption if the call provision had not beenexercised, they have been classified as *Long-termdebt due within one year* on the Condensed Consolidated BalanceSheets.

 

**5.**              Notes Payable andOther Short-term Obligations

** **

**CinergyCorp.’s**short-term borrowings consist primarily of unsecuredrevolving lines of credit and the sale of commercial paper.  **CinergyCorp.’s** $2 billion revolving credit facilities and $1.5 billioncommercial paper program also support the short-term borrowing needs of **CG&E**, **PSI**,and **ULH&P**.  In addition, **Cinergy Corp.**, **CG&E**,and **PSI** maintain uncommitted linesof credit.  These facilities are not firmsources of capital but rather informal agreements to lend money, subject toavailability, with pricing determined at the time of advance.  The following table summarizes our *Notes payable and other short-term obligations* and *Notes payable to affiliated companies*:

 
| ** **                   | ** ** | **June 30, 2005**    | ** ** | **December 31, 2004** | ** ** |
|------------------------------|------------|---------------------------|------------|----------------------------|------------|
| ** **                   | ** ** | ** **                | ** ** | ** **                 | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                   | ** ** | **Established**           | ** ** | ** **                 | ** ** | **Average** | ** ** | **Established** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                   | ** ** | **Lines**                 | ** ** | **Outstanding**            | ** ** | **Rate** | ** ** | **Lines** | ** ** | **Outstanding** | ** ** | **Rate** | ** ** |
| ** **                   | ** ** | **(dollars in millions)** | ** ** |
|                         |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **Cinergy**                  |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **Cinergy Corp.**            |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Revolving lines(1)           |       | **$**                     | **2,000**  | ** **                 | **$**      | **—** | ** ** | **—** | **%** | $ | 2,000 |   | $ | — |   | — | % |
| Uncommitted lines            |       | **40**                    | ** ** | **—**                 | ** ** | **—** | ** ** | 40 |   | — |   | — |   |
| Commercial paper(2)          |       | ** **                | ** ** | **547**                    | ** ** | **3.35** | ** ** |   |   | 676 |   | 2.45 |   |
|                         |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Utility operating companies  |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Uncommitted lines            |       | **75**                    | ** ** | **—**                 | ** ** | **—** | ** ** | 75 |   | — |   | — |   |
| Pollution control notes      |       | ** **                | ** ** | **248**                    | ** ** | **2.81** | ** ** |   |   | 248 |   | 2.43 |   |
|                         |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Non-regulated subsidiaries   |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Revolving lines(3)           |       | **162**                   | ** ** | **40**                     | ** ** | **3.85** | ** ** | 158 |   | 8 |   | 5.67 |   |
| Short-term debt              |       | ** **                | ** ** | **5**                      | ** ** | **8.61** | ** ** |   |   | 2 |   | 4.50 |   |
| Pollution control notes      |       | ** **                | ** ** | **25**                     | ** ** | **2.62** | ** ** |   |   | 25 |   | 2.30 |   |
|                         |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **Cinergy Total**            |       | ** **                | ** ** | **$**                      | **865**    | ** ** | **3.23** | **%** |   |   | $ | 959 |   | 2.47 | % |
|                         |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **CG&E**and subsidiaries |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Uncommitted lines            |       | **$**                     | **15**     | ** **                 | **$**      | **—** | ** ** | **—** | **%** | $ | 15 |   | — |   | — | % |
| Pollution control notes      |       | ** **                | ** ** | **112**                    | ** ** | **2.73** | ** ** |   |   | 112 |   | 2.34 |   |
| Money pool                   |       | ** **                | ** ** | **232**                    | ** ** | **3.31** | ** ** |   |   | 180 |   | 2.38 |   |
|                         |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **CG&E Total**           |       | ** **                | ** ** | **$**                      | **344**    | ** ** | **3.12** | **%** |   |   | $ | 292 |   | 2.36 | % |
|                         |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **PSI**                      |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Uncommitted lines            |       | **$**                     | **60**     | ** **                 | **$**      | **—** | ** ** | **—** | **%** | $ | 60 |   | $ | — |   | — | % |
| Pollution control notes      |       | ** **                | ** ** | **136**                    | ** ** | **2.87** | ** ** |   |   | 136 |   | 2.49 |   |
| Money pool                   |       | ** **                | ** ** | **78**                     | ** ** | **3.31** | ** ** |   |   | 130 |   | 2.38 |   |
|                         |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **PSI Total**                |       | ** **                | ** ** | **$**                      | **214**    | ** ** | **3.03** | **%** |   |   | $ | 266 |   | 2.44 | % |
|                         |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **ULH&P**                |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Money pool                   |       | ** **                | ** ** | **$**                      | **19**     | ** ** | **3.31** | **%** |   |   | $ | 11 |   | 2.38 | % |
|                         |       | ** **                | ** ** | ** **                 | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| **ULH&P Total**          |       | ** **                | ** ** | **$**                      | **19**     | ** ** | **3.31** | **%** |   |   | $ | 11 |   | 2.38 | % |

 

----

(1)          Consists of a three-year $1 billionfacility and a five-year $1 billion facility. The three-year facility was entered into in April 2004 and maturesin April 2007.  The five-year facilitywas entered into in December 2004, matures in December 2009, andcontains $500 million sublimits each for **CG&E**and **PSI**.

(2)          **Cinergy Corp.’s** commercial paper program limit is $1.5billion.  The commercial paper program issupported by **Cinergy Corp.’s**revolving lines of credit.

(3)          Of the $162 million and $158 million, in2005 and 2004, respectively, $150 million relates to a three-year seniorrevolving credit facility that Cinergy Canada, Inc. entered into in December 2004and matures in December 2007.

 

30

----

 

At June 30, 2005, **Cinergy Corp.** had $1.4 billion remaining unused andavailable capacity relating to its $2 billion revolving credit facilities.  These revolving credit facilities include thefollowing:

 
| **Credit Facility**         | ** ** | **Expiration**     | ** ** | **Established  Lines** | ** ** | **Outstanding  and  Committed** | ** ** | **Unused and  Available** | ** ** |
|-----------------------------|------------|--------------------|------------|------------------------|------------|---------------------------------|------------|---------------------------|------------|
| ** **                  | ** ** | ** **         | ** ** | ** **             | ** ** | **(in millions)**               | ** ** | ** **                | ** ** |
|                        |       |               |       |                   |       |                            |       |                      |       |
| Five-year senior revolving  |       | December 2009 |       |                   |       |                            |       |                      |       |
| Direct borrowing            |       |               |       |                   |       | $                               | —     |                      |       |   |
| Commercial paper support    |       |               |       |                   |       | —                          |       |                      |       |
|                        |       |               |       |                   |       |                            |       |                      |       |
| Total five-year facility(1) |       |               |       | $                      | 1,000      |                            | —     |                      | $          | 1,000 |   |
|                        |       |               |       |                   |       |                            |       |                      |       |
| Three-year senior revolving |       | April 2007    |       |                   |       |                            |       |                      |       |
| Direct borrowing            |       |               |       |                   |       | —                          |       |                      |       |
| Commercial paper support    |       |               |       |                   |       | 547                             |       |                      |       |
| Letter of credit support    |       |               |       |                   |       | 11                              |       |                      |       |
|                        |       |               |       |                   |       |                            |       |                      |       |
| Total three-year facility   |       |               |       | 1,000                  |       | 558                             |       | 442                       |       |
|                        |       |               |       |                   |       |                            |       |                      |       |
| Total Credit Facilities     |       |               |       | $                      | 2,000      |                            | $          | 558                       |       | $ | 1,442 |   |

 

----

(1)          **CG&E** and **PSI** each have$500 million borrowing sublimits on this facility.

 

In our credit facilities,**Cinergy Corp.** has covenanted tomaintain:

 

•                  a consolidated net worth of $2billion; and

•                  a ratio of consolidated indebtednessto consolidated total capitalization not in excess of 65 percent.

 

As part of **CG&E’s** $500 million sublimit under the $1 billionfive-year credit facility, **CG&E** hascovenanted to maintain:

 

•                  a consolidated net worth of $1billion; and

•                  a ratio of consolidated indebtednessto consolidated total capitalization not in excess of 65 percent.

 

As part of **PSI’s** $500 million sublimit under the $1 billion five-yearcredit facility, **PSI** has covenanted to maintain:

 

•                  a consolidated net worth of $900million; and

•                  a ratio of consolidated indebtednessto consolidated total capitalization not in excess of 65 percent.

 

A breach of these covenantscould result in the termination of the credit facilities and the accelerationof the related indebtedness.  In additionto breaches of covenants, certain other events that could result in thetermination of available credit and acceleration of the related indebtednessinclude:

 

•                  bankruptcy;

•                  defaults in the payment of otherindebtedness; and

•                  judgments against the company thatare not paid or insured.

 

The latter two events,however, are subject to dollar-based materiality thresholds.  As of June 30, 2005, **Cinergy**, **CG&E**, and **PSI** are in compliance with all of their debt covenants.

 

**6.**              Energy TradingCredit Risk

** **

**Cinergy’s**extension of credit for energy marketing and trading is governed by a CorporateCredit Policy.  Written guidelinesapproved by **Cinergy’s** Risk PolicyCommittee document the management approval levels for credit limits, evaluationof creditworthiness, and credit risk mitigation procedures.  Exposures to credit risks are monitored dailyby the Corporate Credit Risk function, which is independent of all tradingoperations.  As of June 30, 2005, 95

 

31

----

 

percent of the creditexposure, net of credit collateral, related to energy trading and marketingactivity was with counterparties rated investment grade or the counterparties’obligations were guaranteed or secured by an investment grade entity.  The majority of these investment gradecounterparties are externally rated.  Ifa counterparty has an external rating, the lower of Standard & Poor’s RatingsServices or Moody’s Investors Service is used; otherwise, **Cinergy’s** internal rating of thecounterparty is used.  The remaining fivepercent represents credit exposure of $33 million with counterparties ratednon-investment grade.

 

As of June 30, 2005,**CG&E** had a concentration oftrading credit exposure of $48 million with two counterparties accounting forgreater than ten percent of **CG&E’s**total trading credit exposure.  Thesecounterparties are rated investment grade.

 

Energy commodity pricescan be extremely volatile and the market can, at times, lack liquidity.  Because of these issues, credit risk forenergy commodities is generally greater than with other commodity trading.

 

We continually review andmonitor our credit exposure to all counterparties and secondarycounterparties.  If appropriate, we mayadjust our credit reserves to attempt to compensate for increased credit riskwithin the industry.  Counterparty creditlimits may be adjusted on a daily basis in response to changes in a counterparty’sfinancial status or public debt ratings.

 

**7.**              FinancialInstruments

** **

We enter into financialderivative contracts for the purpose of managing financial instrumentrisk.  Forward starting swaps are a typeof financial derivative that mitigates volatility associated with fluctuationsin interest rates between the time of execution of the swap and the date of anexpected debt issuance.

 

In June 2005, **PSI** executed two forward starting swaps with a combinednotional amount of $325 million.  Theforward starting swaps effectively fix the benchmark interest rate of ananticipated issuance of fixed-rate debt from June 2005 through June 2006,the expected date of issuance of the debt securities.  Both forward starting swaps have beendesignated as cash flow hedges under the provisions of Statement 133.  As the terms of these swap agreements mirrorthe terms of the forecasted debt issuance, we anticipate they will be highlyeffective hedges.  Changes in the fairvalue of these swaps are recorded in *Accumulated othercomprehensive income (loss)*.

 

**8.**              Pension and OtherPostretirement Benefits

** **

As discussed in the 200410-K, **Cinergy Corp.** sponsors bothpension and other postretirement benefits plans.  Our qualified defined benefit pension planscover substantially all United States employees meeting certain minimum age andservice requirements.  Funding for thequalified defined benefit pension plans is based on actuarially determinedcontributions, the maximum of which is generally the amount deductible forincome tax purposes and the minimum being that required by the EmployeeRetirement Income Security Act of 1974, as amended.  The pension plans’ assets consist ofinvestments in equity and debt securities. In addition, we sponsor non-qualified pension plans that cover officers,certain other key employees, and non-employee directors.  We provide certain health care and lifeinsurance benefits to retired United States employees and their eligibledependents.  These benefits are subjectto minimum age and service requirements. The health care benefits include medical coverage, dental coverage, andprescription drug coverage and are subject to certain limitations, such asdeductibles and co-payments.

 

Based on preliminaryestimates, we expect 2005 contributions of $102 million for qualified pensionbenefits, which is an increase from the $72 million disclosed in the 200410-K.  This $30 million increase isprimarily the result of a change in the retirement age assumption which increasedthe near-term funding estimates.  Actualcontributions for the first six months of 2005 were zero.

 

32

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Our benefit plans’ costsfor the quarter and year to date ended June 30, 2005 and 2004, includedthe following components:

 
| ** **                                    | ** ** | **Qualified  Pension Benefits** | ** ** | **Non-Qualified  Pension Benefits** | ** ** | **Other Postretirement  Benefits** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                    | ** ** | **2005**                        | ** ** | **2004**                            | ** ** | **2005**                           | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                    | ** ** | **(in millions)**               | ** ** |
| * *                                      | * *   | * *                        | * *   | * *                            | * *   | * *                           | * *   | * * | * * | * * | * * | * * | * * |
| **Quarter Ended June 30**                | * *   | * *                        | * *   | * *                            | * *   | * *                           | * *   | * * | * * | * * | * * | * * | * * |
| * *                                      | * *   | * *                        | * *   | * *                            | * *   | * *                           | * *   | * * | * * | * * | * * | * * | * * |
| Service cost                                  |       | **$**                           | **9.6**    |                                | $          | 8.8                                |       | **$** | **1.4** |   | $ | 1.2 |   | **$** | **1.6** |   | $ | 1.2 |   |
| Interest cost                                 |       | **24.0**                        |       | 22.1                                |       | **1.8**                            |       | 1.7 |   | **5.7** |   | 5.4 |   |
| Expected return on plans’ assets         |       | **(22.1**                       | )          | (20.1                               | )          | **—**                         |       | — |   | **—** |   | — |   |
| Amortization of transition (asset) obligation |       | **(0.1**                        | )          | (0.1                                | )          | **—**                         |       | — |   | **0.1** |   | 0.1 |   |
| Amortization of prior service cost            |       | **1.2**                         |       | 1.1                                 |       | **0.5**                            |       | 0.5 |   | **(0.3** | ) | — |   |
| Recognized actuarial (gain) loss              |       | **2.0**                         |       | 0.5                                 |       | **0.6**                            |       | 0.7 |   | **2.8** |   | 1.9 |   |
| Net periodic benefit cost                     |       | **$**                           | **14.6**   |                                | $          | 12.3                               |       | **$** | **4.3** |   | $ | 4.1 |   | **$** | **9.9** |   | $ | 8.6 |   |
|                                          |       | ** **                      |       |                                |       | ** **                         |       |   |   | ** ** |   |   |   |
| **Year to Date June 30**                 |       | ** **                      |       |                                |       | ** **                         |       |   |   | ** ** |   |   |   |
|                                          |       | ** **                      |       |                                |       | ** **                         |       |   |   | ** ** |   |   |   |
| Service cost                                  |       | **$**                           | **19.2**   |                                | $          | 17.6                               |       | **$** | **2.8** |   | $ | 2.4 |   | **$** | **3.2** |   | $ | 2.6 |   |
| Interest cost                                 |       | **48.1**                        |       | 44.2                                |       | **3.6**                            |       | 3.4 |   | **11.4** |   | 11.4 |   |
| Expected return on plans’ assets         |       | **(44.1**                       | )          | (40.2                               | )          | **—**                         |       | — |   | **—** |   | — |   |
| Amortization of transition (asset) obligation |       | **(0.1**                        | )          | (0.2                                | )          | **—**                         |       | — |   | **0.2** |   | 0.9 |   |
| Amortization of prior service cost            |       | **2.3**                         |       | 2.2                                 |       | **1.0**                            |       | 1.0 |   | **(0.4** | ) | — |   |
| Recognized actuarial (gain) loss              |       | **3.9**                         |       | 1.0                                 |       | **1.2**                            |       | 1.4 |   | **5.5** |   | 4.0 |   |
| Net periodic benefit cost                     |       | **$**                           | **29.3**   |                                | $          | 24.6                               |       | **$** | **8.6** |   | $ | 8.2 |   | **$** | **19.9** |   | $ | 18.9 |   |

 

The net periodic benefitcosts by registrant for the quarter and year to date ended June 30, 2005and 2004, were as follows:

 
| ** **                     | ** ** | **Qualified  Pension Benefits** | ** ** | **Non-Qualified  Pension Benefits** | ** ** | **Other Postretirement  Benefits** | ** ** |
|--------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **2005**                        | ** ** | **2004**                            | ** ** | **2005**                           | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                     | ** ** | **(in millions)**               | ** ** |
| * *                       | * *   | * *                        | * *   | * *                            | * *   | * *                           | * *   | * * | * * | * * | * * | * * | * * |
| **Quarter Ended June 30** | * *   | * *                        | * *   | * *                            | * *   | * *                           | * *   | * * | * * | * * | * * | * * | * * |
| *** ***                   | * *   | * *                        | * *   | * *                            | * *   | * *                           | * *   | * * | * * | * * | * * | * * | * * |
| **Cinergy(1)**                 |       | **$**                           | **14.6**   |                                | $          | 12.3                               |       | **$** | **4.3** |   | $ | 4.1 |   | **$** | **9.9** |   | $ | 8.6 |   |
| **CG&E**and subsidiaries   |       | **4.3**                         |       | 3.7                                 |       | **0.2**                            |       | 0.2 |   | **2.6** |   | 2.0 |   |
| **PSI**                        |       | **3.7**                         |       | 3.2                                 |       | **0.1**                            |       | 0.2 |   | **5.0** |   | 4.7 |   |
| **ULH&P**                  |       | **0.4**                         |       | 0.4                                 |       | **—**                         |       | — |   | **0.2** |   | 0.2 |   |
| ** **                     |       | ** **                      |       |                                |       | ** **                         |       |   |   | ** ** |   |   |   |
| **Year to Date June 30**  |       | ** **                      |       |                                |       | ** **                         |       |   |   | ** ** |   |   |   |
| ** **                     |       | ** **                      |       |                                |       | ** **                         |       |   |   | ** ** |   |   |   |
| **Cinergy(1)**                 |       | **$**                           | **29.3**   |                                | $          | 24.6                               |       | **$** | **8.6** |   | $ | 8.2 |   | **$** | **19.9** |   | $ | 18.9 |   |
| **CG&E**and subsidiaries   |       | **8.7**                         |       | 7.4                                 |       | **0.4**                            |       | 0.4 |   | **5.2** |   | 4.6 |   |
| **PSI**                        |       | **7.5**                         |       | 6.4                                 |       | **0.3**                            |       | 0.4 |   | **9.9** |   | 10.0 |   |
| **ULH&P**                  |       | **0.8**                         |       | 0.8                                 |       | **—**                         |       | — |   | **0.5** |   | 0.4 |   |

 

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(1)          The results of **Cinergy** also include amounts related to non-registrants.

 

33

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** **

**9.**              Commitments andContingencies

** **

***(a)***                                  Environmental

*** ***

*(i)*                                  EmissionReduction Rulemakings

* *

In October 1998, theEnvironmental Protection Agency (EPA) finalized its ozone transport rule, alsoknown as the nitrogen oxides (NOX) State Implementation Plan (SIP)Call, which addresses wind-blown ozone and ozone precursors that impact airquality in downwind states.  The EPA’sfinal rule, which applies to 22 states in the eastern United States includingthe three states in which our electric utilities operate, required states todevelop rules to reduce NOX emissions from utility andindustrial sources.  In a related matter,in response to petitions filed by several states alleging air quality impactsfrom upwind sources located in other states, the EPA issued a rule pursuantto Section 126 of the Clean Air Act (CAA) that required reductions similarto those required under the NOX SIP Call.  Various states and industry groups challengedthe final rules in the Court of Appeals for the District of ColumbiaCircuit, but the court upheld the key provisions of the rules.

 

The EPA has proposedwithdrawal of the Section 126 rule in states with approved rules underthe final NOX SIP Call, which includes Indiana, Kentucky, and Ohio.** **All three stateshave adopted a cap and trade program as the mechanism to achieve the requiredreductions.  **Cinergy**, **CG&E**, and **PSI** have installed selective catalyticreduction units (SCR) and other pollution controls and implemented certaincombustion turbine improvements at various generating stations to comply withthe NOX SIP Call.  **Cinergy** also utilizes the NOXemission allowance market to buy or sell NOX emission allowances asappropriate.  We currently estimate thatwe will incur capital costs of approximately $8 million in addition to $816 millionalready incurred to comply with this program.

 

InMarch 2005, the EPA issued the Clean Air Interstate Rule (CAIR) whichwould require states to revise their SIP by September 2006 to addressalleged contributions to downwind non-attainment with the revised NationalAmbient Air Quality Standards for ozone and fine particulate matter.  The rule established a two-phase,regional cap and trade program for sulfur dioxide (SO2) and NOX, affecting 28 states, including Ohio,Indiana, and Kentucky, and requires SO2 and NOX emissionsto be cut 70 percent and 65 percent, respectively, by 2015.  At the same time, the EPA issued the CleanAir Mercury Rule (CAMR) which requires reductions in mercury emissionsfrom coal-fired power plants.  The finalregulation also adopts a two-phase cap and trade approach that requires mercuryemissions to be cut by 70 percent by 2018. State SIPs must comply with the prescribed reduction levels under CAIRand CAMR; however, the states have the ability to introduce more stringentrequirements if desired.  Under both CAIRand CAMR, companies have flexible compliance options including installation ofpollution controls on large plants where such controls are particularlyefficient and utilization of emission allowances for smaller plants wherecontrols are not cost effective.  In August 2005,the EPA proposed a Federal Implementation Plan (FIP) to act as a backstop toensure that states implement the CAIR in a timely manner.  If a state fails to develop a CAIR SIP, the EPAintends to finalize the FIP in time to implement CAIR for the state by the CAIRdeadline.  Numerous states, environmentalorganizations, industry groups, including some of which **Cinergy**is a member, and individual companies have challenged various portions of bothrules.  Those challenges are currentlypending in the Federal Circuit Court for the District of Columbia.  At this time we cannot predict the outcome ofthese matters.

 

Overthe 2005-2009 time period, we expect to spend approximately $1.8 billion toreduce mercury, SO2, and NOX emissions.  These estimates include estimated costs tocomply at plants that we own but do not operate and could change when takinginto consideration compliance plans of co-owners or operators involved.  Moreover, as market conditions change,additional compliance options may become available and our plans will beadjusted accordingly.  Approximately 60percent of these estimated environmental costs would be incurred at **PSI’s** coal-fired plants, for which recoverywould be pursued in accordance with regulatory statutes governing environmentalcost recovery.  See (b)(*i*) for more details.  **CG&E** wouldreceive partial recovery of depreciation and financing costs related toenvironmental compliance projects for 2005-2008 through its recently approvedrate stabilization plan (RSP).  See (b)(*ii*) for more details.

 

TheEPA made final state non-attainment area designations to implement the revisedozone standard and to implement the new fine particulate standard in June 2004and April 2005, respectively. Several counties in which we operate have been designated as being innon-attainment with the new ozone standard and/or fine

 

34

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particulatestandard.  States with counties that aredesignated as being in non-attainment with the new ozone and/or fine particulatestandards are required to develop a plan of compliance by June 2007 and April 2008,respectively.  Industrial sources in ornear those counties are potentially subject to requirements for installation ofadditional pollution controls.  In March 2005,various states, local governments, environmental groups, and industry groups,including some of which **Cinergy** is amember, filed petitions for review in the United States Court of Appeals forthe D.C. Circuit to challenge the EPA’s particulate matter non-attainmentdesignations.  Although the EPA hasattempted to structure CAIR to resolve purported utility contributions to ozoneand fine particulate non-attainment, at this time, **Cinergy** cannot predict the effect of current or futurenon-attainment designations on its financial position or results of operations.

 

InJuly 2005, the EPA issued its final regional haze rules andimplementing guidelines in response to a 2002 judicial ruling overturning keyprovisions of the original program.  Theregional haze program is aimed at reducing certain emissions impactingvisibility in national parks and wilderness areas.  The EPA has announced that it can foresee nocircumstances where the requirements of the regional haze rule wouldrequire utility controls beyond those required under CAIR.  The EPA also found that states participatingin the CAIR cap and trade program need not require electric generating units toadhere to best available retrofit requirements. The states have until December 2007 to finalize their SIPsaddressing compliance with EPA regulations. The states may choose to implement more stringent guidelines thanpromulgated by the EPA, and therefore it is not possible to predict whether theregional haze rule will have a material effect on our financial positionor results of operations.

 

*(ii)*                              Section 126Petitions

* *

In March 2004, thestate of North Carolina filed a petition under Section 126 of the CAA inwhich it alleges that sources in 13 upwind states including Ohio, Indiana, andKentucky, significantly contribute to North Carolina’s non-attainment withcertain ambient air quality standards. In August 2005, the EPA issued a proposed response to thepetition.  The EPA proposed to deny theozone portion of the petition based upon a lack of contribution to air qualityby the named states.  The EPA alsoproposed to deny the particulate matter portion of the petition based upon theCAIR FIP, described earlier, that would address the air quality concerns fromneighboring states.  We expect a finalFIP and ruling from the EPA on this matter by March 2006.  It is unclear at this time whether anyadditional reductions would be necessary beyond those required under the CAIR.

 

*(iii)*                          CleanAir Act Lawsuit

* *

In November 1999, and through subsequent amendments,the United States brought a lawsuit in the United States Federal District Courtfor the Southern District of Indiana against **Cinergy**,**CG&E**, and **PSI** alleging various violations of theCAA.  Specifically, the lawsuit allegesthat we violated the CAA by not obtaining Prevention of SignificantDeterioration (PSD), Non-Attainment New Source Review (NSR), and Ohio andIndiana SIP permits for various projects at our owned and co-owned generatingstations.  Additionally, the suit claimsthat we violated an Administrative Consent Order entered into in 1998 betweenthe EPA and **Cinergy** relating toalleged violations of Ohio’s SIP provisions governing particulate matter atUnit 1 at **CG&E’s** W.C. BeckjordStation.  The suit seeks (1) injunctiverelief to require installation of pollution control technology on variousgenerating units at **CG&E’s** W.C.Beckjord and Miami Fort Stations, and **PSI’s**Cayuga, Gallagher, Wabash River, and Gibson Stations, and (2) civilpenalties in amounts of up to $27,500 per day for each violation.  In addition, three northeast states and twoenvironmental groups have intervened in the case.  The case is currently in discovery and is setfor trial by jury commencing in February 2006.

 

In March 2000, the United States also filed in theUnited States District Court for the Southern District of Ohio an amendedcomplaint in a separate lawsuit alleging violations of the CAA relating to PSD,NSR, and Ohio SIP requirements regarding various generating stations, includinga generating station operated by Columbus Southern Power Company (CSP) andjointly-owned by CSP, The Dayton Power and Light Company (DP&L), and **CG&E**. The EPA is seeking injunctive relief and civil penalties of up to$27,500 per day for each violation.  Thissuit is being defended by CSP.  In April 2001,the United States District Court for the Southern District of Ohio in that caseruled that the Government and the intervening plaintiff environmental groupscannot seek monetary damages for alleged violations that occurred prior to November 3,1994; however, they are entitled to seek injunctive relief for such allegedviolations.  Neither party appealed thatdecision.  This matter was heard in trialin July 2005.  A decision isexpected by the end of 2005.

 

35

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In addition, **Cinergy**and **CG&E** have been informed byDP&L that in June 2000, the EPA issued a Notice of Violation (NOV) toDP&L for alleged violations of PSD, NSR, and Ohio SIP requirements at astation operated by DP&L and jointly-owned by DP&L, CSP, and **CG&E**. The NOV indicated the EPA may (1) issue an order requiringcompliance with the requirements of the Ohio SIP, or (2) bring a civilaction seeking injunctive relief and civil penalties of up to $27,500 per dayfor each violation.  In September 2004,Marilyn Wall and the Sierra Club brought a lawsuit against **CG&E**,DP&L and CSP for alleged violations of the CAA at this same generatingstation.

 

We are unable to predict whether resolution of thesematters would have a material effect on our financial position or results ofoperations.  We intend tovigorously defend against these allegations.

 

*(iv)*                            CarbonDioxide (CO2) Lawsuit

* *

In July 2004, thestates of Connecticut, New York, California, Iowa, New Jersey, Rhode Island,Vermont, Wisconsin, and the City of New York brought a lawsuit in the UnitedStates District Court for the Southern District of New York against **Cinergy**, American Electric Power Company, Inc., American ElectricPower Service Corporation, The Southern Company, Tennessee Valley Authority,and Xcel Energy Inc.  That same day, asimilar lawsuit was filed in the United States District Court for the SouthernDistrict of New York against the same companies by Open Space Institute, Inc.,Open Space Conservancy, Inc., and The Audubon Society of NewHampshire.  These lawsuits allege thatthe defendants’ emissions of CO2 from the combustion of fossil fuelsat electric generating facilities contribute to global warming and amount to apublic nuisance.  The complaints alsoallege that the defendants could generate the same amount of electricity whileemitting significantly less CO2. The plaintiffs are seeking an injunction requiring each defendant to capits CO2 emissions and then reduce them by a specified percentageeach year for at least a decade.  **Cinergy** intends to defend these lawsuitsvigorously in court and filed motions to dismiss with the other defendants in September 2004.  We are not able to predict whether resolutionof these matters would have a material effect on our financial position orresults of operations.

 

*(v)*        Selective Catalytic Reduction Units at GibsonStation

* *

In May 2004, SCRsand other pollution control equipment became operational at Units 4 and 5 of **PSI’s** Gibson Station in accordance withcompliance deadlines under the NOX SIP Call.  In June and July 2004, GibsonStation temporarily shut down the equipment on these units due to a concernthat portions of the plume from those units’ stacks appeared to break apart anddescend to ground level, at certain times, under certain weatherconditions.  As a result, and, workingwith the City of Mt. Carmel, Illinois, Illinois EPA, Indiana Department ofEnvironmental Management (IDEM), EPA, and the State of Illinois, we developed aprotocol regarding the use of the SCRs while we explored alternatives toaddress this issue.  After the protocolwas finalized, the Illinois Attorney General brought an action in Wabash CountyCircuit Court against **PSI** seeking apreliminary injunction to enforce the protocol. In August 2004, the court granted that preliminary injunction.  **PSI** isappealing that decision to the Fifth District Appellate Court, but we cannotpredict the ultimate outcome of that appeal or of the underlying action by theIllinois Attorney General.

 

In April 2005, wecompleted the installation of a permanent control system to address thisissue.  The new control system willsupport all five Gibson generating units. We will seek recovery of any related capital as well as increasedemission allowance expenditures through the regulatory process.  Wedo not believe costs related to resolving this matter will have a materialimpact on our financial position or results of operations.

 

*(vi)*                            ZimmerStation Lawsuit

* *

In November 2004, acitizen of the Village of Moscow, Ohio, the town adjacent to **CG&E’s** Zimmer Station, brought a purported class actionin the United States District Court for the Southern District of Ohio seekingmonetary damages and injunctive relief against **CG&E**for alleged violations of the CAA, the Ohio SIP, and Ohio laws against nuisanceand common law nuisance.  **CG&E** fileda motion to dismiss the lawsuit on primarily procedural grounds and we intendto defend against these claims vigorously.  The plaintiffs have filed anumber of additional notices of intent to sue and two lawsuits raising claimssimilar to those in the original claim. At this time, we cannot predict whether the outcome of this matter willhave a material impact on our financial position or results of operations.

 

36

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*(vii)*                        ManufacturedGas Plant (MGP) Sites

* *

Coal tar residues,related hydrocarbons, and various metals have been found in at least 22 sitesthat **PSI** or its predecessorspreviously owned and sold in a series of transactions with Northern Indiana PublicService Company (NIPSCO) and Indiana Gas Company, Inc. (IGC).  The 22 sites are in the process of beingstudied and will be remediated, if necessary. In 1998 NIPSCO, IGC, and **PSI**entered into Site Participation and Cost Sharing Agreements to allocateliability and responsibilities between them. The IDEM oversees investigation and cleanup of all of these sites.  Thus far, **PSI**has primary responsibility for investigating, monitoring and, if necessary,remediating nine of these sites.  In December 2003,**PSI** entered into a voluntaryremediation plan with the state of Indiana, providing a formal framework forthe investigation and cleanup of the sites.

 

In April 1998, **PSI** filed suit in Hendricks County in thestate of Indiana against its general liability insurance carriers.  **PSI**sought a declaratory judgment to obligate its insurance carriers to (1) defendMGP claims against **PSI** andcompensate **PSI** for its costs ofinvestigating, preventing, mitigating, and remediating damage to property andpaying claims related to MGP sites; or (2) pay **PSI’s** cost of defense.  **PSI** settled, in principle, its claims with all but one ofthe insurance carriers in January 2005 prior to commencement of thetrial.  With respect to the loneinsurance carrier, a jury returned a verdict against **PSI**in February 2005.  **PSI** has appealed this decision.  At the present time, **PSI**cannot predict the outcome of this litigation, including the outcome of theappeal.

 

**PSI**has accrued costs related to investigation, remediation, and groundwatermonitoring for those sites where such costs are probable and can be reasonablyestimated.  We will continue toinvestigate and remediate the sites as outlined in the voluntary remediationplan.  As additional facts become knownand investigation is completed, we will assess whether the likelihood ofincurring additional costs becomes probable. Until all investigation and remediation is complete, we are unable todetermine the overall impact on our financial position or results ofoperations.

 

**CG&E**and **ULH&P** have performed siteassessments on certain of their sites where we believe MGP activities haveoccurred at some point in the past and have found no imminent risk to theenvironment.  At the present time, **CG&E** and **ULH&P** cannot predict whether investigation and/orremediation will be required in the future at any of these sites.

 

*(viii)*                    AsbestosClaims Litigation

* *

**CG&E**and **PSI** have been named asdefendants or co-defendants in lawsuits related to asbestos at their electricgenerating stations.  Currently, thereare approximately 120 pending lawsuits. In these lawsuits, plaintiffs claim to have been exposed toasbestos-containing products in the course of their work at the **CG&E** and **PSI** generating stations. The plaintiffs further claim that as the property owner of thegenerating stations,**CG&E** and **PSI** should be held liable for theirinjuries and illnesses based on an alleged duty to warn and protect them fromany asbestos exposure.  A majority of thelawsuits to date have been brought against **PSI**.  The impact on **CG&E’s** and **PSI’s**financial position or results of operations of these cases to date has not beenmaterial.

 

Of these lawsuits, onecase filed against **PSI** has beentried to verdict.  The jury returned averdict against **PSI** in the amountof approximately $500,000 on a negligence claim and a verdict for **PSI** on punitive damages.  **PSI**appealed this decision up to the Indiana Supreme Court.  In July 2005, the Indiana Supreme Court upheldthe jury’s verdict.  In addition, **PSI** has settled a number of other lawsuitsfor amounts, which neither individually nor in the aggregate, are material to **PSI’s** financial position or results ofoperations.  We are currently evaluatingthe effect of the Indiana Supreme Court’s ruling on our existing docket ofcases.

 

At this time, **CG&E** and **PSI**are not able to predict the ultimate outcome of theselawsuits or the impact on **CG&E’s**and **PSI’s** financial position orresults of operations.

 

*(ix)*                            DunavanWaste Superfund Site

* *

In July 2005, **PSI** received notice from the EPA that it has been identifiedas a de minimus potentially responsible party under the ComprehensiveEnvironmental Response, Compensation, and Liability Act at the Dunavan WasteOil

 

37

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Site in Oakwood,Vermilion County, Illinois.  At thistime, **PSI** does not have any furtherinformation regarding the scope of potential liability associated with thismatter.

 

***(b)***                                  Regulatory

*** ***

*(i)*                                  PSIEnvironmental Compliance Case

* *

In November 2004,******PSI**filed a compliance plan case with the IndianaUtility Regulatory Commission (IURC) seeking approval of**PSI’s**plan for complying with SO2, NOX, and mercury emissionreduction requirements discussed previously in (a)(*i*),including approval of cost recovery and an overall rate of return of eight percentrelated to certain projects.  **PSI** requested approval to recover the financing,depreciation, and operation and maintenance costs, among others, related to$1.08 billion in capital projects designed to reduce emissions of SO2,NOX, and mercury at **PSI’s** coal-burninggenerating stations.  An evidentiaryhearing was held in May 2005 and a final IURC Order is expected in thethird quarter of 2005.

 

*(ii)*                              CG&EElectric Rate Filings

* *

In response to the PublicUtilities Commission of Ohio (PUCO’s) request that **CG&E** propose a RSP to mitigate the potential forsignificant rate increases when the market development period comes to an end, **CG&E** filed a proposed RSP which was approved by the PUCOin November 2004.  The majorfeatures of the RSP are as follows:

 

•                  **Provider of Last Resort(POLR) Charge:**  **CG&E** began collecting a POLR charge from non-residentialcustomers effective January 1, 2005, and will begin to collect a POLRcharge from residential customers effective January 1, 2006.  The POLR charge includes several discretecharges, the most significant being an annually adjusted component (AAC)intended to provide cost recovery primarily for environmental complianceexpenditures; an infrastructure maintenance fund charge (IMF) intended to provide compensation to **CG&E** for committing its physical capacity to meet itsPOLR obligation; and********a system reliabilitytracker (SRT) intended to provide cost recovery for capacity purchases,purchased power, reserve capacity, and related market costs for purchases tomeet capacity needs.  We anticipate thecollection of the AAC and IMF will result in an approximate $36 millionincrease in revenues in 2005 and an additional $50 million in 2006.  The SRT will be billed based ondollar-for-dollar costs incurred.  Aportion of these charges are avoidable by certain customers who switch to analternative generation supplier. Therefore, these estimates are subject to change, depending on the levelof switching that occurs in future periods. In 2007 and 2008, **CG&E** couldseek additional increases in the AAC component of the POLR based on **CG&E’s** actual net costs for the specified expenditures.

 

•                  **Generation Rates and FuelRecovery: **A new rate has beenestablished for generation service after the market development periodends.  In addition, a fuel cost recoverymechanism that is adjusted quarterly has been established to recover costs forfuel, emission allowances, and certain purchased power costs, that exceed theamount originally included in the rates frozen in the **CG&E** transition plan.  These new rates were applied tonon-residential customers beginning January 1, 2005 and will be applied toresidential customers beginning January 1, 2006.

 

•                  **Generation RateReduction: **The existing fivepercent generation rate reduction required by statute for residential customersimplemented under **CG&E’s** 2000plan will end on December 31, 2005.

 

•                  **Transmission CostRecovery: **Transmission costrecovery mechanisms were established beginning January 1, 2005 fornon-residential customers and will be established beginning January 1,2006 for residential customers.  Thetransmission cost recovery mechanisms are designed to permit **CG&E** to recover Midwest Independent Transmission SystemOperator, Inc. charges, all Federal Energy Regulatory Commission (FERC) approvedtransmission costs, and all congestion costs allocable to retail ratepayersthat are provided service by **CG&E**.

 

•                  **Distribution CostRecovery:  CG&E** will havethe ability to defer certain capital-related distribution costs from July 1,2004 through December 31, 2005 with recovery from non-residentialcustomers to be provided through a rider beginning January 1, 2006 throughDecember 31, 2010.

 

**CG&E**had also filed an electric distribution base rate case for residential andnon-residential customers to be effective January 1, 2005.  Under the terms of the RSP describedpreviously, **CG&E** withdrew thisbase rate case

 

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and, in February 2005,**CG&E** filed a new distribution baserate case with rates to become effective January 1, 2006.  The requested amount of the increase is $78million.

 

In March 2005, the OhioConsumers’ Counsel asked the Ohio Supreme Court to overturn the RSP.  We expect the court to decide the case beforeJanuary 1, 2006; however, at this time we cannot predict the outcome ofthis matter.

 

*(iii)*                          ULH&PGas Rate Case

* *

In 2002, the Kentucky Public Service Commission (KPSC)approved **ULH&P’s** gas base ratecase requesting, among other things, recovery of costs associated with anaccelerated gas main replacement program of up to $112 million over tenyears.  The costs would be recoveredthrough a tracking mechanism for an initial three year period, with thepossibility of renewal up to ten years.  To date, we have capitalized $56 million incosts associated with the accelerated gas main replacement program through thistracking mechanism.** **The tracking mechanismallows **ULH&P** to recoverdepreciation costs and rate of return annually over the life of the deferredassets.  Through June 30, 2005, **ULH&P** has recovered $7.5 million underthis tracking mechanism.  The KentuckyAttorney General has appealed to the Franklin Circuit Court the KPSC’s approvalof the tracking mechanism and the new tracking mechanism rates.  At the present time, **ULH&P** cannot predict the timing oroutcome of this litigation.

 

In February 2005, **ULH&P** filed a gas base rate case with the KPSC.**  ULH&P**is requesting approval to continue the tracking mechanism in addition to itsrequest for a $14 million increase in base rates, which is a seven percentincrease in current retail gas rates.  **ULH&P** expects that the KPSC will issueits decision by the fourth quarter of 2005.

 

*(iv)*                            GasDistribution Plant

* *

In June 2003, thePUCO approved an amended settlement agreement between **CG&E** and the PUCO Staff in a gasdistribution safety case arising out of a gas leak at a service head-adapter(SHA) style riser on **CG&E’s**distribution system.  The amendedsettlement agreement required **CG&E**to expend a minimum of $700,000 to replace SHA risers by December 31,2003, and to file a comprehensive plan addressing all SHA risers on itsdistribution system.  **CG&E** filed a comprehensive plan with the PUCO in December 2004providing for replacement of approximately 5,000 risers in 2005 with continuedmonitoring thereafter.  **CG&E** estimates the replacement cost of these risers willnot be material.  In April 2005, thePUCO issued an order closing this case. The PUCO issued a separate order opening a statewide investigation intoriser leaks in gas pipeline systems throughout Ohio.  At this time, **Cinergy**and**CG&E**cannot predict the outcome orthe impact of the statewide investigation.

 

***(c)***                                  Other

*** ***

*(i)*                                  EnergyMarket Investigations

* *

In August 2003, **Cinergy**, along with Cinergy Marketing &Trading, LP (Marketing & Trading) and 37 other companies, were namedas defendants in civil litigation filed as a purported class action on behalfof all persons who purchased and/or sold New York Mercantile Exchange naturalgas futures and options contracts between January 1, 2000, and December 31,2002.  The complaint alleges thatimproper price reporting caused damages to the class.  Two similar lawsuits have subsequently beenfiled, and these three lawsuits have been consolidated for pretrialpurposes.  The plaintiffs filed aconsolidated class action complaint in January 2004.  **Cinergy’s**motion to dismiss was granted in September 2004 leaving only Marketing &Trading in the lawsuit.  We believe thisaction against Marketing & Trading is without merit and intend todefend this lawsuit vigorously.

 

**Cinergy**continuesto provide various Assistant United States Attorneys with information withrespect to their investigations into energy market practices.  We understand that we are neither a targetnor are we under investigation by the Department of Justice in relation to anyof these communications.

 

At this time, we do notbelieve the outcome of these investigations and litigation will have a materialimpact on **Cinergy’s** financialposition or results of operations.

 

39

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*(ii)*                              SyntheticFuel Production

* *

**Cinergy**produces from two facilities synthetic fuel that qualifies for tax credits(through 2007) in accordance with Section 29 of the Internal Revenue Code (IRC)if certain requirements are satisfied.

 

**Cinergy’s** sale of synthetic fuelhas generated $271 million in tax credits through June 30, 2005.  The Internal Revenue Service (IRS) iscurrently auditing **Cinergy** for the2002 and 2003 tax years and has recently challenged certain other taxpayers’ Section 29tax credits.  While we cannot predictwhether the IRS will challenge our Section 29 tax credits, we expect theIRS will evaluate the various key requirements for claiming our Section 29credits related to synthetic fuel.  Ifthe IRS challenges our Section 29 tax credits related to synthetic fuel,and such challenges were successful, this could result in the disallowance ofup to all $271 million in previously claimed Section 29 tax credits forsynthetic fuel produced by the applicable **Cinergy** facilitiesand a loss of our ability to claim future Section 29 tax credits forsynthetic fuel produced by such facilities. We believe that we operate in conformity with all the necessaryrequirements to be allowed such tax credits under Section 29.  Upon consummation of the pending merger ofDuke and **Cinergy**, the synthetic fuel produced byone of **Cinergy’s** facilities pursuant to theexisting commercial arrangement would cease to qualify for the Section 29credit.  **Cinergy**is evaluating a transaction for the disposition of a portion of the affectedfacility that **Cinergy** believes would enable thefuel produced by the facility to continue to qualify for credit under IRC Section 29.In the event a suitable transaction is not achieved, **Cinergy**anticipates that its production of synthetic fuel at the affected facilitywould be suspended upon consummation of the pending merger with Duke.

 

Section 29 alsoprovides for a phase-out of the credit based on the average price of crude oilduring a calendar year.  The phase-out isbased on a prescribed calculation and definition of crude oil prices.  Basedon current crude oil prices, we do not currently expect a**material negative impact on our ability to recognize the projected benefit of Section 29tax credits in 2005.

 

*(iii)*                          FirstEnergyLawsuit

* *

FirstEnergy has filed alawsuit in the Court of Common Pleas in Summit County, Ohio against **Cinergy** with respect to a transaction between **Cinergy** and a subsidiary of FirstEnergy, relating to a jointventure company, Avon Energy Partners Holdings (Avon).  In 1999, the FirstEnergy subsidiary acquired **Cinergy’s** share of Avon which it subsequently sold to athird party.  The original transactiondocuments included an indemnity by **Cinergy** withrespect to a certain investment owned by Avon. FirstEnergy claims that this indemnity was triggered by its sale of Avonto a third party, and is seeking to recover $15 million from **Cinergy**.  The case iscurrently in discovery.  **Cinergy** intends to defend this lawsuit vigorously.  At this time, we cannot predict the outcomeof this matter.

 

*(iv)*                            Guarantees

* *

In the ordinary course ofbusiness, **Cinergy**enters intovarious agreements providing financial or performance assurances to thirdparties on behalf of certain unconsolidated subsidiaries and joint ventures.  These agreements are entered into primarilyto support or enhance the creditworthiness otherwise attributed to theseentities****on a stand-alone basis,thereby facilitating the extension of sufficient credit to accomplish theirintended commercial purposes.  Theguarantees have various termination dates, from short-term (less than one year)to open-ended.

 

In many cases, themaximum potential amount of an outstanding guarantee is an express term, setforth in the guarantee agreement, representing the maximum potential obligationof **Cinergy**under that guarantee(excluding, at times, certain legal fees to which a guaranty beneficiary may beentitled).  In those cases where there isno maximum potential amount expressly set forth in the guarantee agreement, wecalculate the maximum potential amount by considering the terms of theguaranteed transactions, to the extent such amount is estimable.

 

**Cinergy**had guaranteed borrowings by individuals under the Director,Officer, and Key Employee Stock Purchase Program.  Under these guarantees, **Cinergy**would have been obligated to paythe debt’s principal and any related interest in the event of an unexcusedbreach of a guaranteed payment obligation by certain directors, officers, andkey employees.  This program terminatedpursuant to its terms during the first quarter of 2005 and as of March 31,2005, all borrowings had been repaid by the participants.

 

40

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**CinergyCorp.** has also provided performance guarantees on behalf ofcertain unconsolidated subsidiaries and joint ventures.  These guarantees support performance undervarious agreements and instruments (such as construction contracts, operationand maintenance agreements, and energy service agreements).  **CinergyCorp.**may be liable in the event of an unexcused breach of aguaranteed performance obligation by an unconsolidated subsidiary.  **CinergyCorp.** has estimated its maximum potential liability to be $52 millionunder these guarantees as of June 30, 2005. **Cinergy Corp.** may also haverecourse to third parties for claims required to be paid under certain of theseguarantees.  The majority of theseguarantees expire at the completion of the underlying performance agreement,the majority of which expire from 2016 to 2019.

 

**Cinergy**hasentered into contracts that include indemnification provisions as a routinepart of its business activities. Examples of these****contractsinclude purchase and sale agreements and operating agreements.  In general, these provisions indemnify thecounterparty for matters such as breaches of representations and warranties andcovenants contained in the contract.  Insome cases, particularly with respect to purchase and sale agreements, thepotential liability for certain indemnification obligations is capped, in wholeor in part (generally at an aggregate amount not exceeding the sale price), andsubject to a deductible amount before****anypayments would become due.** **In other cases (such asindemnifications for willful misconduct of employees in a joint venture), themaximum potential liability is not estimable given that the magnitude of anyclaims under those indemnifications would be a function of the extent ofdamages actually incurred.  **Cinergy** has estimated the maximum potentialliability, where estimable, to be $103 million under these indemnificationprovisions.  The termination period forthe majority of matters provided by indemnification provisions in these typesof agreements generally ranges from 2005 to 2009.

 

We believe the likelihoodthat **Cinergy**would be required toperform or otherwise incur any significant losses associated with any or all ofthe guarantees described in the preceding paragraphs is remote.

 

**10.**       Financial Information byBusiness Segment

 

As discussed in the 200410-K, we conduct operations through our subsidiaries, and manage through thefollowing three reportable segments:

 

•                  RegulatedBusiness Unit (Regulated);

•                  CommercialBusiness Unit (Commercial); and

•                  PowerTechnology and Infrastructure Services Business Unit (Power Technology andInfrastructure).

 

Regulated consists of **PSI’s** regulated generation and transmissionand distribution operations, and **CG&E**andits subsidiaries’ regulated electric and gas transmission and distributionsystems.  Regulated plans, constructs,operates, and maintains **Cinergy’s**transmission and distribution systems and delivers gas and electric energy toconsumers.  Regulated also earns revenuesfrom wholesale customers primarily by these customers transmitting electricpower through **Cinergy’s**transmission system.  These businessesare subject to cost of service rate making where rates to be charged tocustomers are based on prudently incurred costs over a test period plus a reasonablerate of return.

 

Commercial manages ourwholesale generation and energy marketing and trading activities.  Commercial also performs energy riskmanagement activities, provides customized energy solutions and is responsiblefor all of our international operations.

 

Power Technology andInfrastructure primarily manages Cinergy Ventures, LLC (Ventures), **Cinergy’s** venture capital subsidiary.  Ventures identifies, invests in, andintegrates new energy technologies into **Cinergy’s**existing businesses, focused primarily on operational efficiencies and cleanenergy technologies.  In addition, PowerTechnology and Infrastructure manages our investments in other energyinfrastructure and telecommunication service providers.

 

Following are thefinancial results by business unit. Certain prior year amounts have been reclassified to conform to thecurrent presentation.

 

41

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Financial results bybusiness unit for the quarters ended June 30, 2005, and June 30, 2004, are asindicated below.

 
| ** **                       | ** ** | **Cinergy Business Units** | ** ** | ** **     | ** ** | ** **                              | ** ** |
|----------------------------------|------------|----------------------------|------------|----------------|------------|-----------------------------------------|------------|
| ** **                       | ** ** | **Regulated**              | ** ** | **Commercial** | ** ** | **Power Technology and Infrastructure** | ** ** | **Total** | ** ** | **Reconciling Eliminations(1)** | ** ** | **Consolidated** | ** ** |
| ** **                       | ** ** | **(in millions)**          | ** ** |
| * *                         | * *   | * *                   | * *   | * *       | * *   | * *                                | * *   | * * | * * | * * | * * | * * | * * |
| **Quarter  ended June 30, 2005** |       |                       |       |           |       |                                    |       |   |   |   |   |   |   |
|                             |       |                       |       |           |       |                                    |       |   |   |   |   |   |   |
| **Operating  revenues**          |       |                       |       |           |       |                                    |       |   |   |   |   |   |   |
| **External  customers**          | ** ** | **$**                      | **706**    | ** **     | **$**      | **408**                                 | ** ** | **$** | **—** | ** ** | **$** | **1,114** | ** ** | **$** | **—** | ** ** | **$** | **1,114** | ** ** |
| **Intersegment  revenues**       | ** ** | **2**                      | ** ** | **38**         | ** ** | **—**                              | ** ** | **40** | ** ** | **(40** | **)** | **—** | ** ** |
| ** **                       | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Gross  margins**               | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Electric**                     | ** ** | **434**                    | ** ** | **168**        | ** ** | **—**                              | ** ** | **602** | ** ** | **—** |   | 602 | (3)  |
| **Gas**                          | ** ** | **44**                     | ** ** | **(20**        | **)**      | **—**                              | ** ** | **24** | ** ** | **—** |   | 24 | (4)  |
| ** **                       | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Segment  profit (loss)(2)**    | ** ** | **50**                     | ** ** | **3**          | ** ** | **(2**                                  | **)**      | **51** | ** ** | **—** | ** ** | **51** | ** ** |
| ** **                       | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quarter ended  June 30, 2004     | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating  revenues              |       |                       |       |           |       |                                    |       |   |   |   |   |   |   |
| External  customers              |       | $                          | 688        |           | $          | 366                                     |       | $ | — |   | $ | 1,054 |   | $ | — |   | $ | 1,054 |   |
| Intersegment  revenues           |       | 7                          |       | 52             |       | —                                  |       | 59 |   | (59 | ) | — |   |
|                             |       |                       |       |           |       |                                    |       |   |   |   |   |   |   |
| Gross margins                    |       |                       |       |           |       |                                    |       |   |   |   |   |   |   |
| Electric                         |       | 396                        |       | 175            |       | —                                  |       | 571 |   | — |   | 571 | (3)  |
| Gas                              |       | 44                         |       | 17             |       | —                                  |       | 61 |   | — |   | 61 | (4)  |
|                             |       |                       |       |           |       |                                    |       |   |   |   |   |   |   |
| Segment profit  (loss)(2)        |       | 35                         |       | 31             |       | (7                                      | )          | 59 |   | — |   | 59 |   |

 

----

(1)          The ReconcilingEliminations category eliminates the intersegment revenues of Commercial andRegulated.

(2)          Management utilizessegment profit (loss), after taxes, to evaluate segment performance.

(3)          Electric grossmargin is calculated as *Electric operatingrevenues* less *Fuel, emissionallowances, and purchased power* expense from the CondensedConsolidated Statements of Income.

(4)          Gas gross marginis calculated as *Gas operating revenues*less *Gas purchased* expense fromthe Condensed Consolidated Statements of Income.

 

42

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Financial results bybusiness unit for year to date June 30, 2005, and June 30, 2004, are asindicated below.

 
| ** **                      | ** ** | **Cinergy Business Units** | ** ** | ** **     | ** ** | ** **                               | ** ** |
|---------------------------------|------------|----------------------------|------------|----------------|------------|------------------------------------------|------------|
| ** **                      | ** ** | **Regulated**              | ** ** | **Commercial** | ** ** | **Power Technology  and Infrastructure** | ** ** | **Total** | ** ** | **Reconciling  Eliminations(1)** | ** ** | **Consolidated** | ** ** |
| ** **                      | ** ** | **(in millions)**          | ** ** |
| * *                        | * *   | * *                   | * *   | * *       | * *   | * *                                 | * *   | * * | * * | * * | * * | * * | * * |
| **Year to  Date June 30, 2005** |       |                       |       |           |       |                                     |       |   |   |   |   |   |   |
|                            |       |                       |       |           |       |                                     |       |   |   |   |   |   |   |
| **Operating  revenues**         |       |                       |       |           |       |                                     |       |   |   |   |   |   |   |
| **External  customers**         | ** ** | **$**                      | **1,618**  | ** **     | **$**      | **841**                                  | ** ** | **$** | **—** | ** ** | **$** | **2,459** | ** ** | **$** | **—** | ** ** | **$** | **2,459** | ** ** |
| **Intersegment  revenues**      | ** ** | **14**                     | ** ** | **83**         | ** ** | **—**                               | ** ** | **97** | ** ** | **(97** | **)** | **—** | ** ** |
| ** **                      | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Gross  margins**              | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Electric**                    | ** ** | **876**                    | ** ** | **347**        | ** ** | **—**                               | ** ** | **1,223** | ** ** | **—** |   | **1,223** | (3)  |
| **Gas**                         | ** ** | **142**                    | ** ** | **(14**        | **)**      | **—**                               | ** ** | **128** | ** ** | **—** |   | **128** | (4)  |
| ** **                      | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Segment  profit (loss)(2)**   | ** ** | **125**                    | ** ** | **49**         | ** ** | **(6**                                   | **)**      | **168** | ** ** | **—** | ** ** | **168** | ** ** |
| ** **                      | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Year to Date  June 30, 2004     | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** **                 | ** ** | ** **     | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating revenues              |       |                       |       |           |       |                                     |       |   |   |   |   |   |   |
| External  customers             |       | $                          | 1,600      |           | $          | 742                                      |       | $ | — |   | $ | 2,342 |   | $ | — |   | $ | 2,342 |   |
| Intersegment  revenues          |       | 31                         |       | 102            |       | —                                   |       | 133 |   | (133 | ) | — |   |
|                            |       |                       |       |           |       |                                     |       |   |   |   |   |   |   |
| Gross margins                   |       |                       |       |           |       |                                     |       |   |   |   |   |   |   |
| Electric                        |       | 802                        |       | 334            |       | —                                   |       | 1,136 |   | — |   | 1,136 | (3)  |
| Gas                             |       | 148                        |       | 40             |       | —                                   |       | 188 |   | — |   | 188 | (4)  |
|                            |       |                       |       |           |       |                                     |       |   |   |   |   |   |   |
| Segment profit  (loss)(2)       |       | 115                        |       | 76             |       | (29                                      | )          | 162 |   | — |   | 162 |   |

 

----

(1)          The ReconcilingEliminations category eliminates the intersegment revenues of Commercial andRegulated.

(2)        Management utilizes segmentprofit (loss), after taxes, to evaluate segment performance.

(3)          Electric grossmargin is calculated as *Electric operatingrevenues* less *Fuel, emissionallowances, and purchased power* expense from the CondensedConsolidated Statements of Income.

(4)          Gas gross marginis calculated as *Gas operating revenues*less *Gas purchased* expense fromthe Condensed Consolidated Statements of Income.

 

43

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Total segment assets at June30, 2005, and December 31, 2004, are as indicated below:

 
| ** **                                 | ** ** | **Cinergy Business Units** | ** ** | ** **     | ** ** |
|--------------------------------------------|------------|----------------------------|------------|----------------|------------|
| ** **                                 | ** ** | **Regulated**              | ** ** | **Commercial** | ** ** | **Power Technology  and Infrastructure** | ** ** | **Total** | ** ** | **Consolidated** | ** ** |
| ** **                                 | ** ** | **(in millions)**          | ** ** | ** **     | ** ** |
| * *                                   | * *   | * *                   | * *   | * *       | * *   | * * | * * | * * | * * | * * | * * |
| **Total  segment assets at June 30, 2005** | ** ** | **$**                      | **9,137**  | ** **     | **$**      | **5,990** | ** ** | **$** | **131** | ** ** | **$** | **15,258** | ** ** | **$** | **15,258** | ** ** |
|                                       |       |                       |       |           |       |   |   |   |   |   |   |
| Total segment  assets at December 31, 2004 |       | $                          | 9,097      |           | $          | 5,746 |   | $ | 139 |   | $ | 14,982 |   | $ | 14,982 |   |

 

44

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**11.**       Earnings Per Common Share (EPS)

 

A reconciliation of EPS –basic to EPS – diluted is presented below for the quarters ended June 30, 2005and 2004:

 
| ** **                              | ** ** | **Income**                                   | ** ** | **Shares** | ** **  | **EPS**    | ** ** |
|-----------------------------------------|------------|----------------------------------------------|------------|------------|-------------|------------|------------|
| ** **                              | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Quarter  Ended June 30, 2005**        |       |                                         |       |       |        |       |       |
| **EPS –  basic:**                  | ** ** | **$**                                        | **50,708** | ** ** | **198,492** | ** ** | **$**      | **0.25** | ** ** |
| ** **                              | ** ** | ** **                                   | ** ** | ** ** | ** **  | ** ** | ** ** |
| **Effect  of dilutive securities:**     | ** ** | ** **                                   | ** ** | ** ** | ** **  | ** ** | ** ** |
| **Common  stock options**               | ** ** | ** **                                   | ** ** | **671**    | ** **  | ** ** | ** ** |
| **Directors’  compensation plans** | ** ** | ** **                                   | ** ** | **146**    | ** **  | ** ** | ** ** |
| **Contingently  issuable common stock** | ** ** | ** **                                   | ** ** | **132**    | ** **  | ** ** | ** ** |
| ** **                              | ** ** | ** **                                   | ** ** | ** ** | ** **  | ** ** | ** ** |
| **EPS –  diluted:**                | ** ** | **$**                                        | **50,708** | ** ** | **199,441** | ** ** | **$**      | **0.25** | ** ** |
| ** **                              | ** ** | ** **                                   | ** ** | ** ** | ** **  | ** ** | ** ** |
| Quarter Ended  June 30, 2004            |       |                                         |       |       |        |       |       |
| EPS – basic:                       |       | $                                            | 58,504     |       | 180,236     |       | $          | 0.33 |   |
|                                    |       |                                         |       |       |        |       |       |
| Effect of  dilutive securities:         |       |                                         |       |       |        |       |       |
| Common stock  options                   |       |                                         |       | 574        |        |       |       |
| Directors’  compensation plans     |       |                                         |       | 155        |        |       |       |
| Contingently  issuable common stock     |       |                                         |       | 471        |        |       |       |
| Stock purchase  contracts               |       |                                         |       | 841        |        |       |       |
|                                    |       |                                         |       |       |        |       |       |
| EPS – diluted:                     |       | $                                            | 58,504     |       | 182,277     |       | $          | 0.32 |   |

 

Options to purchaseshares of common stock are excluded from the calculation of EPS – diluted, ifthey are considered to be anti-dilutive. Share amounts of 1.4 million and 1.2 million were excluded from the EPS –diluted calculation for the quarters ended June 30, 2005 and 2004,respectively.

 

Also excluded from theEPS – diluted calculation for the quarter ended June 30, 2004 are 10.0 millionshares, issuable pursuant to the stock purchase contracts issued by **Cinergy Corp.** in December 2001 associatedwith the preferred trust securities transaction.  As discussed in the 2004 10-K, in January andFebruary 2005, **Cinergy Corp.** issued a total of 9.2million shares of common stock associated with these preferred stocksecurities.

 

A reconciliation of EPS –basic to EPS – diluted is presented below for the year to date June 30, 2005and 2004:

 
| ** **                              | ** ** | **Income**                                   | ** **  | **Shares** | ** **  | **EPS**    | ** ** |
|-----------------------------------------|------------|----------------------------------------------|-------------|------------|-------------|------------|------------|
| ** **                              | ** ** | **(in thousands, except per share amounts)** | ** **  |
| **Year to  Date June 30, 2005**         |       |                                         |        |       |        |       |       |
| **EPS –  basic:**                  | ** ** | **$**                                        | **168,064** | ** ** | **197,066** | ** ** | **$**      | **0.85** | ** ** |
| ** **                              | ** ** | ** **                                   | ** **  | ** ** | ** **  | ** ** | ** ** |
| **Effect  of dilutive securities:**     | ** ** | ** **                                   | ** **  | ** ** | ** **  | ** ** | ** ** |
| **Common  stock options**               | ** ** | ** **                                   | ** **  | **652**    | ** **  | ** ** | ** ** |
| **Directors’  compensation plans** | ** ** | ** **                                   | ** **  | **146**    | ** **  | ** ** | ** ** |
| **Contingently  issuable common stock** | ** ** | ** **                                   | ** **  | **66**     | ** **  | ** ** | ** ** |
| **Stock  purchase contracts**           | ** ** | ** **                                   | ** **  | **145**    | ** **  | ** ** | ** ** |
| ** **                              | ** ** | ** **                                   | ** **  | ** ** | ** **  | ** ** | ** ** |
| **EPS –  diluted:**                | ** ** | **$**                                        | **168,064** | ** ** | **198,075** | ** ** | **$**      | **0.85** | ** ** |
| ** **                              | ** ** | ** **                                   | ** **  | ** ** | ** **  | ** ** | ** ** |
| Year to Date  June 30, 2004             |       |                                         |        |       |        |       |       |
| EPS – basic:                       |       | $                                            | 161,519     |       | 179,749     |       | $          | 0.90 |   |
|                                    |       |                                         |        |       |        |       |       |
| Effect of  dilutive securities:         |       |                                         |        |       |        |       |       |
| Common stock  options                   |       |                                         |        | 702        |        |       |       |
| Directors’  compensation plans     |       |                                         |        | 155        |        |       |       |
| Contingently  issuable common stock     |       |                                         |        | 523        |        |       |       |
| Stock purchase  contracts               |       |                                         |        | 977        |        |       |       |
|                                    |       |                                         |        |       |        |       |       |
| EPS – diluted:                     |       | $                                            | 161,519     |       | 182,106     |       | $          | 0.89 |   |

 

45

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Options to purchaseshares of common stock are excluded from the calculation of EPS – diluted, ifthey are considered to be anti-dilutive. Share amounts of 1.4 million and 1.2 million were excluded from the EPS –diluted calculation for the year to date June 30, 2005 and 2004, respectively.

 

Also excluded from theEPS – diluted calculation for the year to date June 30, 2004 are 9.9 millionshares issuable pursuant to the stock purchase contracts issued by **Cinergy Corp.** in December 2001 associatedwith the preferred trust securities transaction.  As discussed in the 2004 10-K, in January andFebruary 2005, **Cinergy Corp.** issued a total of9.2 million shares of common stock associated with these preferred stocksecurities.

 

**12.**       Transfer and Acquisition ofGenerating Assets

** **

***(a)***                                  Transfer of Generating Assets to ULH&P

*** ***

TheKPSC and the FERC have approved **ULH&P’s**plannedacquisition of **CG&E’s** approximately69 percent ownership interest in the East Bend Station, located in BooneCounty, Kentucky, the Woodsdale Station, located in Butler County, Ohio, andone generating unit at the four-unit Miami Fort Station located in HamiltonCounty, Ohio, and associated transactions. **ULH&P** is currently seeking approvalof the transaction in a proceeding before the Securities and Exchange Commission(SEC), wherein the Ohio Consumers’ Counsel has intervened in opposition.  The transfer, which will be at net bookvalue, will not affect current electric rates for **ULH&P’s** customers, as power will be provided under thesame terms as under the current wholesale power contract with **CG&E** through December 31, 2006.  Assuming receipt of SEC approval, we wouldanticipate the transfer to take place in the third quarter of 2005.

 

***(b)***                                  Wheatland Generating Facility Acquisition

*** ***

On May 6, 2005, wesigned a definitive agreement with subsidiaries of Allegheny Energy, Inc.whereby, subject to the terms and upon satisfaction of the conditions toclosing provided in the purchase agreement, **PSI**and/or **CG&E** had the right to acquire the512-megawatt Wheatland generating facility for approximately $100million.  The Wheatland facility, locatedin Knox County, Indiana, has four natural gas-fired simple cycle combustionturbines and is directly connected to the **Cinergy**transmission system.  In June and August 2005,respectively, the FERC and IURC approved the acquisition and the Department ofJustice and Federal Trade Commission completed their review of the transactionpursuant to the notification requirements of the Hart-Scott-Rodino AntitrustImprovements Act.  We have determinedthat **PSI** will acquire 100% of the Wheatlandfacility.  Its output will be used tobolster the reserve margins on the **PSI**system.  **Cinergy**expects to close the acquisition in August 2005.

 

**13.**       Pending Merger

** **

On May 8, 2005, **Cinergy Corp.** entered into an agreement and plan of mergerwith Duke, a North Carolina corporation, whereby **CinergyCorp.** will be merged with Duke. Under the merger agreement, each share of **CinergyCorp.** Common Stock will be converted into 1.56 shares of the newlyformed company, Duke Energy Holding Corp.

 

The merger agreement hasbeen approved by both companies’ Boards of Directors.  Consummation of the merger is subject to customaryconditions, including, among others, the approval of the shareholders of bothcompanies and the approvals of various regulatory authorities.

 

Immediately following consummationof the merger, former **Cinergy**shareholders will own approximately 24 percent of Duke Energy Holding’s commonstock.  Paul Anderson, Duke’s CEO andChairman of the Board will remain Chairman of the combined company and JimRogers, **Cinergy’s** President, CEO and Chairmanof the Board, will become the President and Chief Executive Officer of thecombined company.  The new Duke EnergyHolding board will be comprised of 10 members appointed by Duke and fivemembers appointed by **Cinergy**.

 

The merger will berecorded using the purchase method of accounting whereby the total purchaseprice of approximately $9 billion will be allocated to **Cinergy’s**identifiable tangible and intangible assets acquired and liabilities assumedbased on their fair values as of the closing of the merger.

 

46

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The merger isexpected to close in 2006, however the actual timing is contingent on severalapprovals including:  FERC, stateregulatory commissions of Ohio, Indiana, Kentucky, North Carolina, and SouthCarolina, and shareholders of each company. The following regulatory filings have been made in June and July of2005:

 

•                  InJune 2005, Duke and **Cinergy** filedan application with the PUCO for approval of a change in control with respectto **CG&E** and to modify certainaccounting procedures to defer certain merger-related costs.  We expect that the PUCO will set a proceduralschedule in the third quarter of 2005.

 

•                  InJune 2005, **PSI** filed a petition with the IURCconcerning, among other things, certain merger-related affiliate agreements,the sharing of merger-related benefits with customers, and deferred accountingof certain merger-related costs.  Apre-hearing conference has been scheduled for August 2005 and a proceduralschedule will be set at that time.

 

•                  InAugust 2005, Duke and **Cinergy** filedan application with the KPSC seeking approval of a transfer and acquisition ofcontrol of **ULH&P**.  A procedural schedule has not yet been set.

 

•                  InJuly 2005, Duke and **Cinergy** filedan application with the FERC requesting approval of the merger and thesubsequent internal restructuring and consolidation of the merged company toestablish a more efficient corporate structure.

 

•                  InJuly 2005, Duke filed applications with the respective state utility regulatoryagencies in both North and South Carolina. The application filed with the North Carolina Utility Commissionrequests both the authorization to enter into a business combinationtransaction and the approval of various affiliate agreements.  The application filed with the Public ServiceCommission of South Carolina requests authorization to enter into a businesscombination.

 

The pending mergeragreement also provides that Duke and **Cinergy** willuse their reasonable best efforts to transfer five generating stations locatedin the Midwest from Duke to **CG&E**.  This transfer will require regulatoryapproval by the FERC and there can be no guarantee that such approval will be obtainedor will be obtained on terms or with conditions acceptable to Duke, **Cinergy**, and Duke Energy Holding.  Duke intends to effectuate the transfer as anequity infusion into **CG&E** atbook value.  In conjunction with thetransfer, Duke and **CG&E** intendto enter into a financial arrangement to eliminate any potential cashshortfalls that may result from owning and operating the assets.  At this time, we cannot predict the outcomeof this matter.

 

Themerger agreement contains certain termination rights for both Duke and **Cinergy**, and further provides that, upontermination of the merger agreement under specified circumstances, a partywould be required to pay the other party’s fees and expenses in an amount notto exceed $35 million and/or a termination fee of $300 million in the case of afee payable by **Cinergy** to Duke ora termination fee of $500 million in the case of a fee payable by Duke to **Cinergy**; provided that any termination feepayable will be reduced by any amount of any fees and expenses previouslyreimbursed by such party.

 

In May, a purportedshareholder class action was filed in the Court of Common Pleas in HamiltonCounty, Ohio against **Cinergy** andeach of the members of the Board of Directors. The lawsuit alleges that thedefendants breached their duties of due care and loyalty to shareholders byagreeing to the merger agreement between Duke and **Cinergy**andis seeking to either enjoin or amend the terms of the merger.  **Cinergy** and theindividual defendants filed a motion to dismiss this lawsuit in July.  We believe this lawsuit is without merit and **Cinergy** intends to defend this lawsuit vigorously incourt.  We are unable to predict whetherresolution of this matter will impact our pending merger.

 

Although Managementbelieves that this merger should close in 2006, the actual timing of thistransaction could be delayed or the merger could be terminated by the inabilityto obtain one or more of the required approvals.

 

In light of the impendingrepeal of the Public Utility Holding Company Act, as amended (PUHCA), effectiveFebruary 2006, the merger will no longer require SEC authorization under PUHCA.For further details, see “Energy Bill” in “Item 2. Management’s Discussion andAnalysis of Financial Condition and Results of Operations - Liquidity andCapital Resources.”

 

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**CAUTIONARY STATEMENTS**

** **

In this report **Cinergy** (which includes **Cinergy Corp.** and all of our regulated andnon-regulated subsidiaries) is, at times, referred to in the first person as “we,”“our,” or “us.”

 

## **CAUTIONARY STATEMENTS** REGARDING FORWARD-LOOKING INFORMATION

 

This document includesforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking statements are based onmanagement’s beliefs and assumptions. These forward-looking statements are identified by terms and phrasessuch as “anticipate”, “believe”, “intend”, “estimate”, “expect”, “continue”, “should”,“could”, “may”, “plan”, “project”, “predict”, “will”, and similar expressions.

 

Forward-lookingstatements involve risks and uncertainties that may cause actual results to bematerially different from the results predicted.  Factors that could cause actual results todiffer materially from those indicated in any forward-looking statementinclude, but are not limited to:

 

•                  Factors affecting operations, suchas:

 

(1)          unanticipated weatherconditions;

(2)          unscheduled generationoutages;

(3)          unusual maintenance orrepairs;

(4)          unanticipated changes incosts, including costs of coal and emission allowances;

(5)          environmental incidents;and

(6)          electric transmission orgas pipeline system constraints.

 

•                  Legislative and regulatoryinitiatives and legal developments.

 

•                  Additional competition in electric orgas markets and continued industry consolidation.

 

•                  Financial or regulatory accountingprinciples including costs of compliance with existing and future environmentalrequirements.

 

•                  Changing market conditions and otherfactors related to physical energy and financial trading activities.

 

•                  The performance of projectsundertaken by our non-regulated businesses and the success of efforts to investin and develop new opportunities.

 

•                  Availability of, or cost of, capital.

 

•                  Employee workforce factors.

 

•                  Delays and other obstacles associatedwith mergers, acquisitions, and investments in joint ventures.

 

•                  Costs and effects of legal andadministrative proceedings, settlements, investigations, and claims.

 

•                  The Regulatory approval process for theDuke Energy Corporation and **Cinergy** pendingmerger could delay the consummation of the pending merger or impose conditionsthat could materially impact the combined company.

 

•                  Business uncertainties, contractualrestrictions, and the potential inability to attract and retain key personneldue to the pending merger.

 

We undertake no obligation to update the information contained herein

 

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**MD&A - PENDING MERGER**

 

## **ITEM 2.  MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

In this report, **Cinergy** (which includes **Cinergy Corp.** and all of its regulated andnon-regulated subsidiaries) is, at times, referred to in the first person as “we,”“our,” or “us.”

 

The following discussionshould be read in conjunction with the accompanying financial statements andrelated notes included elsewhere in this report and the combined Form 10-K forthe year ended December 31, 2004 (2004 10-K). We have reclassified certain prior-year amounts in the financialstatements of **Cinergy**, The Cincinnati Gas &Electric Company (**CG&E**), PSIEnergy, Inc. (**PSI**), and The Union Light, Heatand Power Company (**ULH&P**) toconform to current presentation.  Thefollowing discussions of results are not necessarily indicative of the resultsto be expected in any future period.

 

### **PENDING MERGER**

 

On May 8, 2005, **Cinergy Corp.** entered into an agreement and plan of mergerwith Duke Energy Corporation (Duke), a North Carolina corporation, whereby **Cinergy Corp.** will be merged with Duke.  Under the merger agreement, each share of **Cinergy Corp.** Common Stock will be converted into 1.56shares of the newly formed company, Duke Energy Holding Corp.

 

The merger agreement hasbeen approved by both companies’ Boards of Directors.  Consummation of the merger is subject to customaryconditions, including, among others, the approval of the shareholders of bothcompanies and the approvals of various regulatory authorities.

 

Immediately followingconsummation of the merger, former **Cinergy**shareholders will own approximately 24 percent of Duke Energy Holding’s commonstock.  Paul Anderson, Duke’s CEO andChairman of the Board will remain Chairman of the combined company and JimRogers, **Cinergy’s** President, CEO and Chairmanof the Board, will become the President and Chief Executive Officer of thecombined company.  The new Duke EnergyHolding board will be comprised of 10 members appointed by Duke and fivemembers appointed by **Cinergy**.

 

The merger isexpected to close in 2006, however the actual timing is contingent on severalapprovals including:  Federal EnergyRegulatory Commission (FERC), state regulatory commissions of Ohio, Indiana,Kentucky, North Carolina, and South Carolina, and shareholders of eachcompany.  The following regulatoryfilings have been made in June and July of 2005:

 

•                  InJune 2005, Duke and **Cinergy** filedan application with the Public Utilities Commission of Ohio (PUCO) for approvalof a change in control with respect to **CG&E** and tomodify certain accounting procedures to defer certain merger-relatedcosts.  We expect that the PUCO will seta procedural schedule in the third quarter of 2005.

 

•                  InJune 2005, **PSI** filed a petition with theIndiana Utility Regulatory Commission (IURC) concerning, among other things,certain merger-related affiliate agreements, the sharing of merger-relatedbenefits with customers, and deferred accounting of certain merger-relatedcosts.  A pre-hearing conference has beenscheduled for August 2005 and a procedural schedule will be set at that time.

 

•                  InAugust 2005, Duke and **Cinergy** filedan application with the Kentucky Public Service Commission (KPSC) seekingapproval of a transfer and acquisition of control of **ULH&P**.  A procedural schedule has not yet been set.

 

•                  InJuly 2005, Duke and **Cinergy** filedan application with the FERC requesting approval of the merger and thesubsequent internal restructuring and consolidation of the merged company toestablish a more efficient corporate structure.

 

•                  InJuly 2005, Duke filed applications with the respective state utility regulatoryagencies in both North and South Carolina. The application filed with the North Carolina Utility Commissionrequests both the

 

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authorization to enterinto a business combination transaction and the approval of various affiliateagreements.  The application filed withthe Public Service Commission of South Carolina requests authorization to enterinto a business combination.

 

The pending mergeragreement also provides that Duke and **Cinergy** willuse their reasonable best efforts to transfer five generating stations locatedin the Midwest from Duke to **CG&E**.  This transfer will require regulatoryapproval by the FERC and there can be no guarantee that such approval will beobtained or will be obtained on terms or with conditions acceptable to Duke, **Cinergy**, and Duke Energy Holding.  Duke intends to effectuate the transfer as anequity infusion into **CG&E** atbook value.  In conjunction with thetransfer, Duke and **CG&E** intendto enter into a financial arrangement to eliminate any potential cashshortfalls that may result from owning and operating the assets.  At this time, we cannot predict the outcomeof this matter.

 

Themerger agreement contains certain termination rights for both Duke and **Cinergy**, and further provides that, upontermination of the merger agreement under specified circumstances, a partywould be required to pay the other party’s fees and expenses in an amount notto exceed $35 million and/or a termination fee of $300 million in the case of afee payable by **Cinergy** to Duke ora termination fee of $500 million in the case of a fee payable by Duke to **Cinergy**; provided that any termination feepayable will be reduced by any amount of any fees and expenses previouslyreimbursed by such party.

 

Although Managementbelieves that this merger should close in 2006, the actual timing of thistransaction could be delayed or the merger could be terminated by the inabilityto obtain one or more of the required approvals.

 

In light of the impendingrepeal of the Public Utility Holding Company Act, as amended (PUHCA), effectiveFebruary 2006, the merger will no longer require The Securities and ExchangeCommission (SEC) authorization under PUHCA. For further details, see “EnergyBill” in “Liquidity and Capital Resources.”

 

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**MD&A - EXECUTIVE SUMMARY**

 

### **EXECUTIVE SUMMARY**

 

In Management’sDiscussion and Analysis of Financial Condition and Results of Operations(MD&A), we explain our general operating environment, as well as ourresults of operations, liquidity, capital resources, futureexpectations/trends, market risk sensitive instruments, and accountingmatters.  Specifically, we discuss thefollowing:

 

•                  factorsaffecting current and future operations;

•                  whyresults changed from period to period;

•                  potentialsources of cash for future capital expenditures; and

•                  howthese items affect our overall financial condition.

 

#### **Organization**

 

**CinergyCorp.**, a Delaware corporation organized in 1993, owns alloutstanding common stock of **CG&E**and **PSI**, both of which are publicutilities.  As a result of thisownership, we are considered a utility holding company.  Because we are a holding company withmaterial utility subsidiaries operating in multiple states, we are registeredwith and are subject to regulation by the SEC under the PUHCA.  For a discussion of the pending PUHCA Repeal,see “Energy Bill” in “Liquidity and Capital Resources.”  Our other principal subsidiaries are Cinergy Services,Inc. (Services) and Cinergy Investments, Inc. (Investments).

 

**CG&E**,an Ohio corporation organized in 1837, is a combination electric and gas publicutility company that provides service in the southwestern portion of Ohio and,through **ULH&P**, in nearby areas ofKentucky.  **CG&E** is responsible for the majority of our powermarketing and trading activity.  **CG&E’s** principal subsidiary, **ULH&P**, a Kentucky corporation organizedin 1901, provides electric and gas service in northern Kentucky.

 

**PSI**,an Indiana corporation organized in 1942, is a vertically integrated andregulated electric utility that provides service in north central, central, andsouthern Indiana.

 

The following tablepresents further information related to the operations of our domestic utilitycompanies **CG&E**, **PSI**,and **ULH&P** (our utility operatingcompanies):

 

 
| **Principal Line(s) of Business** |
|-----------------------------------|
| ** **                        | ** ** | ** ** |
| **CG&E**  and  subsidiaries   | • | Generation, transmission, distribution, and sale of electricity |
| •                            | Sale and/or transportation of natural gas |
| •                            | Electric commodity marketing and trading operations |
|                              |   |   |
| **PSI**                           | • | Generation,  transmission, distribution, and sale of electricity |
|                              |   |   |
| **ULH&P**(1)                  | • | Transmission,  distribution, and sale of electricity |
| •                            | Sale and transportation  of natural gas |

 

----

(1)          See Note 12 of the“Notes to Condensed Financial Statements” in “Item 1. Financial Statements” forfurther discussion of the possible transfer of generation assets.

 

Services is a servicecompany that provides our subsidiaries with a variety of centralizedadministrative, management, and support services.  Investments holds most of our non-regulated,energy-related businesses and investments, including natural gas marketing andtrading operations (which are primarily conducted through Cinergy Marketing& Trading, LP, one of its subsidiaries).

 

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#### **Financial Highlights**

 

Net income for **Cinergy** for the quarter and six monthsended June 30, 2005, and 2004 was as follows:

 
| ** **                    | ** ** | **Cinergy**       | ** ** |
|-------------------------------|------------|-------------------|------------|
| ** **                    | ** ** | **2005**          | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                    | ** ** | **(in millions)** | ** ** |
| * *                      | * *   | * *          | * *   | * * | * * | * * | * * | * * | * * |
| **Quarter  ended June 30**    |       | **$**             | **51**     |   | $ | 59 |   | $ | (8 | ) | (14 | )% |
|                          |       | ** **        |       |   |   |   |   |   |   |
| **Six  months ended June 30** |       | **$**             | **168**    |   | $ | 162 |   | $ | 6 |   | 4 | % |

 

##### ***Quarterly Highlights***

 

Thedecrease in net income was primarily due to the following factors:

 

•                  Adecrease in the Commercial Business Unit’s (Commercial) gas gross margins whichreflects trading strategies employed in the second quarter of 2005 that resultedin negative margins;

•                  Increasesin *Operation and maintenance*expensesincluding costs related to the pending Duke-**Cinergy**merger and labor expenses; and

•                  Adecrease in gross margins on power marketing, trading, and originationcontracts.

 

These decreases werepartially offset by increases in rate tariff adjustments resulting from **PSI’s** 2004 base retail electric rate increase and theimplementation of **CG&E’s** rate stabilization plan (RSP) inJanuary 2005.

 

For further information,see “2005 Quarterly Results of Operations – **Cinergy**”.

 

##### ***Year to Date Highlights***

 

Theincrease in net income was primarily due to the following factors:

 

•                  Increasesin rate tariff adjustments resulting from **PSI’s** 2004 baseretail electric rate increase and the implementation of **CG&E’s**RSP in January 2005; and

•                  Anincrease in electric gross margins relating to certain activities in our assetoptimization business.  This increase wascomprised of increases in margins from the sale of emission allowancespartially offset by unrealized losses on forward coal and power contracts.

 

These increases werepartially offset by:

 

•                  Adecrease in Commercial’s gas gross margins which primarily reflects tradingstrategies employed in the second quarter of 2005 that resulted in negativemargins; and

•                  Increasesin *Operation and maintenance*expense primarily due to regulatory asset amortization, expenses associatedwith the pending Duke-**Cinergy** merger,and increased operating expenses for non-regulated subsidiaries.

 

For further information,see “2005 Year to Date Results of Operations – **Cinergy**”.

 

#### **Forward-looking Challengesand Risks**

#### ** **

##### ***Merger Challenges and Risks***

##### *** ***

The pending mergerbetween Duke and **Cinergy** presents significantchallenges.  The integration of the twocompanies will be complex and time-consuming, due to the size and complexity ofeach organization.  The principal challengeswill be integrating the combined regulated electric utility operations,combining each of the unregulated wholesale power generation businesses andcombining the energy marketing and trading businesses.  All of these businesses are complex, and someof the business units are dispersed. Such efforts could also divert management’s

 

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focus and resources fromother strategic opportunities during the integration process.   The pending merger is subject to approvalsof numerous governmental agencies and approval of the shareholders of bothcompanies, all of which are discussed in more detail in “Pending Merger.”  The approval process could delay consummationof the pending merger, impose conditions that could materially impact the combinedcompany, or cause the merger to be abandoned. Both companies will incur significant transaction and merger-relatedintegration costs in connection with the merger.  Additionally, we will be subject to businessuncertainties and contractual restrictions while the merger is pending whichcould adversely affect our businesses. Although both companies intend to take steps to reduce any adverseaffects, these uncertainties may impair our ability to attract and retain keypersonnel until the merger is consummated and for a period of time thereafter,and could cause customers, suppliers and others that deal with us to seek tochange existing business relationships.

 

##### ***Environmental Challenges***

 

**Cinergy** facesmany uncertainties with regard to future environmental legislation and theimpact of this legislation on our generating assets and our decisions toconstruct new assets.  In March 2005, theEnvironmental Protection Agency (EPA) finalized two rulemakings that willrequire significant reductions in sulfur dioxide (SO2), nitrogenoxides (NOX), and mercury emissions from power plants.  Numerousstates, environmental organizations, industry groups, including some of which **Cinergy** is a member, and individual companies havechallenged various portions of both rules.  Additionally, multi-emissionsreductions legislation is still being discussed in the Senate, although theoutcome of these discussions is still highly uncertain at this time.  Presently, greenhouse gas (GHG) emissions,which principally consist of carbon dioxide (CO2), are notregulated, and while several legislative proposals have been introduced inCongress to reduce utility GHG emissions, none have been passed.  Nevertheless, we anticipate a mandatoryprogram to reduce GHG emissions will exist in the future.  In 2004, **Cinergy’s**utility operating companies began an environmental construction program toreduce overall plant emissions that is estimated to cost approximately $1.8billion over the next five years.  Webelieve that our construction program optimally balances these uncertaintiesand provides a level of emission reduction that will be required and/oreconomical to **Cinergy** under a variety ofpossible regulatory outcomes.  See “EnvironmentalIssues” in “Liquidity and Capital Resources” for further information.

 

##### ***Midwest IndependentTransmission System Operator, Inc. (Midwest ISO) Energy Markets***

 

Effective April 1, 2005the Midwest ISO began operating under the Energy Markets Tariff (sometimesreferred to as a Locational Marginal Pricing (LMP) market or MISO Day 2market).  The implementation of an LMPmarket introduced new scheduling requirements, new products for mitigatingtransmission congestion risks, and new pricing points for the purchase and saleof power.  We have been operating underthe Energy Markets Tariff since April 2005 and continue to work with theMidwest ISO to monitor the implementation of the new market.  See “Midwest ISO Energy Markets” in “FutureExpectations/Trends” for further details regarding these new markets.

 

##### ***Rising Coal and EmissionAllowance Prices***

##### *** ***

The prices of coal and SO2emission allowances increased dramatically in 2004, as compared to 2003, andhave continued to increase in 2005. Contributing to the increases in coal and SO2 prices havebeen (1) increases in demand for electricity, (2) environmental regulation, and(3) decreases in the number of suppliers of coal from prior years.  **CG&E’s** RSPallows for recovery of fuel and emission allowance expenses effective January1, 2005 for retail non-residential customers in Ohio.  As part of the RSP, we will begin recoveringthese costs from residential customers in Ohio effective January 1, 2006.  We continue to recover these costs from **PSI** retail customers through previously established raterecovery mechanisms.  To the extent thatthese increased fuel and SO2 prices are not offset by regulatoryrecovery or increases in the market price of power for wholesale transactions,they will negatively impact ongoing earnings. The impact of these price increases on earnings in 2005 is discussed inmore detail in “2005 Quarterly Results of Operations” and “2005 Year to DateResults of Operations”.

 

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**MD&A – 2005 QUARTERLY RESULTSOF OPERATIONS - CINERGY**

 

### **2005 QUARTERLYRESULTS OF OPERATIONS – CINERGY**

 

Given the dynamics of ourbusiness, which include regulatory revenues with directly offsetting expensesand commodity trading operations for which results are primarily reported on anet basis, we have concluded that a discussion of our results on a gross marginbasis is most appropriate.  Electricgross margins represent electric operating revenues less the related directcosts of fuel, emission allowances, and purchased power.  Gas gross margins represent gas operatingrevenues less the related direct cost of gas purchased.  Within each of these areas, we will discussthe key drivers of our results.  Grossmargins for **Cinergy**for the Regulated BusinessUnit (Regulated) and Commercial for the quarters ended June 30, 2005, and 2004were as follows:

 
| ** **                | ** ** | **Cinergy**       | ** ** |
|---------------------------|------------|-------------------|------------|
| ** **                | ** ** | **Regulated**     | ** ** | **Commercial** | ** ** |
| ** **                | ** ** | **2005**          | ** ** | **2004** | ** ** | **Change** | ** ** | **%****Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **Change** | ** ** | **%****Change** | ** ** |
| ** **                | ** ** | **(in millions)** | ** ** |
| * *                  | * *   | * *          | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| Electric gross  margin(1) |       | **$**             | **434**    |   | $ | 396 |   | $ | 38 |   | 10 | % | **$** | **168** |   | $ | 175 |   | $ | (7 | ) | (4 | )% |
| Gas gross margin(2)       |       | **44**            |       | 44 |   | — |   | — |   | **(20** | ) | 17 |   | (37 | ) | N/M |   |
|                           |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)                    Electricgross margin is calculated as *Electric operatingrevenues*less *Fuel, emission allowances,and purchased power* expense from the Condensed ConsolidatedStatements of Income.

(2)                    Gas grossmargin is calculated as *Gas operating revenues*less*Gas purchased expense*from the CondensedConsolidated Statements of Income.

N/M         Not meaningful to anunderstanding of the change.

 

Cooling degree days andheating degree days are metrics commonly used in the utility industry as ameasure of the impact weather has on results of operations.  Cooling degree days and heating degree daysin **Cinergy’s** service territory forthe quarters ended June 30, 2005, and 2004 were as follows:

 
| ** **                 | ** ** | **Cinergy** | ** ** |
|----------------------------|------------|-------------|------------|
| ** **                 | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
|                       |       |        |       |   |   |   |   |   |   |
| Cooling degree  days(1)    |       | **337**     |       | 335 |   | 2 |   | 1 | % |
| Heating degree  days(2)(3) |       | **239**     |       | 236 |   | 3 |   | 1 |   |

 

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(1)        Cooling degree days are the differencesbetween the average temperature for each day and 65 degrees, assuming theaverage temperature is greater than 65 degrees.

(2)        Heating degree days are the differencesbetween the average temperature for each day and 59 degrees, assuming theaverage temperature is less than 59 degrees.

(3)          Beginningin January 2005, we modified our heating degree days base temperature from 65degrees to 59 degrees to more accurately reflect current consumerbehavior.  Prior year amounts have beenupdated to reflect this change.

 

The change in coolingdegree days and heating degree days did not have a material effect on **Cinergy’s** gross margins for the period.

 

#### **Regulated**

#### ** **

##### ***Gross Margins***

##### *** ***

The 10 percent increasein Regulated’s electric gross margins was primarily due to the followingfactors:

 

•                  A$30 million increase resulting primarily from a higher price received permegawatt hour (MWh) due to **PSI’s**2004 baseretail electric rate increase; and

•                  A$17 million increase in **PSI’s**non-retail margins, primarily resulting from reduced fuel expense reflectingadjustments to **PSI’s** cost of synthetic fuel.

 

Partially offsettingthese increases was a decline of $11 million reflecting rate reductionsassociated with a property tax adjustment for **PSI**.

 

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#### **Commercial**

 

##### ***Gross Margins***

 

The four percent decreasein Commercial’s electric gross margins was due, in part, to a $6 milliondecrease in gross margins on power marketing, trading, and originationcontracts.

 

Commercial’s retailmargins were relatively flat for the quarter ended June 30, 2005, as comparedto 2004.  Rate increases from the RSPprovided a $13 million increase in margins. However, this was offset by fuel, emission allowance and purchased powercost increases related to fixed price residential customers of approximately$11 million.

 

Commercial’s other non-retailmargins were relatively flat for the quarter. We actively manage our non-regulated generation portfolio through a mixof real-time and forward sales of power and the corresponding purchase of fuel(primarily coal) and emission allowances.  When power is sold forward,we typically purchase the fuel and emission allowances required to produce thepower, thereby locking in our eventual margin at the time of delivery. The market values of these commodities change independently over time. Attimes, the value of the fuel and emission allowances becomes greater than thatof the output of electricity.  In these instances, we will purchaseforward power to be used to deliver against forward power sales, and in turnsell the fuel and/or emission allowances.

 

During the secondquarter of 2005, we recognized margins of $35 million more than the comparableperiod in 2004 as a result of selling emission allowances which were no longerneeded to meet our non-retail forward power sales commitments.  This gain reflects significant increases inprices of SO2 emission allowances throughout much of 2004 and intoearly 2005.  Based on projectedgeneration, we have sufficient fuel and emission allowances to meet ournon-retail forward power sales commitments over the next several years, and wewill continue to evaluate and optimize our generation resources to produce thebest economic returns for these assets.

 

Gains from thesale of emission allowances were largely offset by the following:

 

•                  A$4 million decline due to timing differences in revenue recognition betweencertain components of our generation portfolio. Emission allowances and the majority of fuel contracts typically followthe accrual method of accounting. However, generally accepted accountingprinciples (GAAP) requires that certain forward purchases of coal and forwardsales of power (those classified as derivatives) use the mark-to-market (MTM)method of accounting.  This differing accounting treatment for thevarious components of the generation portfolio can lead to volatilityin reported results.  Our gross margins reflect $8 million ofunrealized losses in the second quarter of 2005 and $4 million of unrealizedlosses in the comparable period in 2004 (representing a $4 million changequarter on quarter) as a result of forward purchases of coal and forward salesof power and the use of MTM accounting.

 

•                  Lowermargins from non-retail power sales caused by a decline in volumes and lowermargins per MWh, which reflects higher fuel costs.

 

Commercial’s gas grossmargins decreased, as compared to the same period last year due to thefollowing factors:

 

•                  A$35 million decrease which reflects trading strategies employed in the secondquarter of 2005 that resulted in negative margins; and

 

•                  A$5 million decrease due to timing differences in revenue recognition betweenphysical storage activities and the associated derivative contracts that hedgethe physical storage. These agreements with pipelines to store natural gas anddeliver in a future period with higher prices (typically winter) follow theaccrual method of accounting.  However,the derivative contracts hedging the gas are required under GAAP to beaccounted for under the MTM method of accounting.  The differing accounting treatments can leadto volatility in reported results.  Ourquarter-to-date gross margins reflect $6 million of unrealized losses in 2005and $1 million of unrealized losses in 2004 (representing a $5 million changequarter on quarter) as a result of derivative contracts and the use of MTMaccounting.

 

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##### ***Other Operating Revenues andCosts of Fuel Resold***

##### *** ***

The 60 percent increasein *Other Operating Revenues* was primarilydue to the following factors:

 

•                  A$32 million increase in Commercial’s revenues from coal origination resultingfrom increases in coal prices and the number of coal originationcontracts.  Coal origination includescontract structuring and marketing of physical coal; and

•                  A$15 million increase in Commercial’s revenues from the sale of synthetic fuel.

 

*Costs of fuel resold*includes Commercial’s costs of coal origination activities and the productionof synthetic fuel.  These costs haveincreased in 2005, which is consistent with the increases in the associatedrevenues as previously discussed.

 

The followingexplanations correspond with the line items on the Condensed ConsolidatedStatements of Income for **Cinergy**.  However, only the line items that variedsignificantly from prior periods are discussed.

 

#### **Other Operating Expenses**

 
| ** **                     | ** ** | **Cinergy**       | ** ** |
|--------------------------------|------------|-------------------|------------|
| ** **                     | ** ** | **2005**          | ** ** | **2004** | ** ** | **Change** | ** ** | **%****Change** | ** ** |
| ** **                     | ** ** | **(in millions)** | ** ** |
| * *                       | * *   | * *          | * *   | * * | * * | * * | * * | * * | * * |
| Operation and  maintenance     | ** ** | **$**             | **351**    |   | $ | 332 |   | $ | 19 |   | 6 | % |
| Depreciation                   |       | **131**           |       | 114 |   | 17 |   | 15 |   |
| Taxes other than  income taxes |       | **65**            |       | 65 |   | — |   | — |   |
|                                |            |                   |            |  |  |  |  |  |  |  |  |  |

 

##### ***Operation and Maintenance***

 

The six percent increasein *Operation and maintenance* expense wasprimarily due to the following factors:

 

•                  Increasedlabor expenses of $13 million primarily resulting from severance paymentspartially offset by a decrease of $5 million in employee incentive costs;

•                  Expensesof $11 million related to the pending Duke-**Cinergy** merger;

•                  Anincrease of $6 million in costs associated with environmental litigation; and

•                  Increasedregulatory asset amortization of $4 million related to **CG&E’s**Regulatory Transition Charge (RTC).

 

These increases werepartially offset by $12 million of costs incurred in 2004 associated with thecontinuous improvement initiative and a $5 million decrease in maintenanceexpenses, primarily generation and distribution related.

 

##### ***Depreciation***

##### *** ***

The 15 percent increasein *Depreciation*expense wasprimarily due to (a) higher depreciation rates, as a result of changes inuseful lives of production assets and an increased rate for cost of removal,(b) recovery of deferred depreciation costs, and (c) the addition ofdepreciable plant for pollution control equipment, all of which are recoveredfrom ratepayers.

 

#### **Miscellaneous Income(Expense) *–* Net**

#### ** **

The increase in *Miscellaneous Income (Expense) – Net* was primarily due to $7million in impairment charges recognized in the second quarter of 2004 relatedto investments in Power Technology and Infrastructure.

 

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#### **Income Taxes**

#### ** **

The effective income taxrate decreased for the quarter ended June 30, 2005, as compared to 2004.  The decrease was primarily a result of anincrease in the amount of estimated annual tax credits associated with theproduction and sale of synthetic fuel.  **Cinergy’s** 2005 effective tax rate is expected to beapproximately 23 percent.

 

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### **2005 QUARTERLYRESULTS OF OPERATIONS - CG&E**

 

#### **Summary of Results**

 

Net income for **CG&E** for the quarters ended June 30,2005, and 2004 was as follows:

 
| ** ** | ** ** | **CG&E**and subsidiaries | ** ** |
|------------|------------|------------------------------|------------|
| ** ** | ** ** | **2005**                     | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** ** | ** ** | **(in millions)**            | ** ** |
| * *   | * *   | * *                     | * *   | * * | * * | * * | * * | * * | * * |
| Net income |       | **$**                        | **53**     |   | $ | 56 |   | $ | (3 | ) | (5 | )% |
|            |            |                              |            |  |  |  |  |  |  |  |  |  |

 

The decrease in netincome was primarily due to the following factors:

 

•                  Increasesin *Operation and maintenance*expenses including costs related to the pending Duke-**Cinergy**merger; and

•                  Adecrease in margins on power marketing, trading, and origination contracts.

 

These decreases werepartially offset by an increase in rate tariff adjustments resulting from theimplementation of **CG&E’s** RSPin January 2005.

 

#### **Gross Margins**

 

Gross margins for **CG&E** for the quarters ended June 30, 2005, and 2004 wereas follows:

 
| ** **                | ** ** | **CG&E**and subsidiaries | ** ** |
|---------------------------|------------|------------------------------|------------|
| ** **                | ** ** | **2005**                     | ** ** | **2004** | ** ** | **Change** | ** ** | **%****Change** | ** ** |
| ** **                | ** ** | **(in millions)**            | ** ** |
| * *                  | * *   | * *                     | * *   | * * | * * | * * | * * | * * | * * |
| Electric gross  margin(1) |       | **$**                        | **305**    |   | $ | 306 |   | $ | (1 | ) | — | % |
| Gas gross  margin(2)      |       | **44**                       |       | 43 |   | 1 |   | 2 |   |
|                           |            |                              |            |  |  |  |  |  |  |  |  |  |

 

----

(1)        Electric gross margin is calculated as *Electric operating revenues*less *Fuel,emission allowances, and purchased power* expense from the CondensedConsolidated Statements of Income.

(2)      Gas gross margin is calculated as *Gas operating revenues* less *Gaspurchased* expense from the Condensed Consolidated Statements ofIncome.

 

Cooling degree days andheating degree days in **CG&E’s**service territory for the quarters ended June 30, 2005, and 2004 were asfollows:

 
| ** **                 | ** ** | **CG&E**and  subsidiaries | ** ** |
|----------------------------|------------|-------------------------------|------------|
| ** **                 | ** ** | **2005**                      | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
|                       |       |                          |       |   |   |   |   |   |   |
| Cooling degree  days(1)    |       | **340**                       |       | 327 |   | 13 |   | 4 | % |
| Heating degree  days(2)(3) |       | **224**                       |       | 243 |   | (19 | ) | (8 | ) |

 

----

(1)        Cooling degree days are the differences between theaverage temperature for each day and 65 degrees, assuming the averagetemperature is greater than 65 degrees.

(2)        Heating degree days are the differences between theaverage temperature for each day and 59 degrees, assuming the averagetemperature is less than 59 degrees.

(3)          Beginning in January 2005, we modified our heating degree days basetemperature from 65 degrees to 59 degrees to more accurately reflect currentconsumer behavior.  Prior year amountshave been updated to reflect this change.

 

The change in coolingdegree days and heating degree days did not have a material effect on **CG&E’s** gross margins for the period.

 

58

----

 

##### ***Electric Gross Margins***

##### *** ***

**CG&E’s**electric gross margins were relatively flat for the quarter ended June 30, 2005,as compared to 2004.

 

**CG&E’s**grossmargins on power marketing, trading, and origination contracts decreased $6million in the quarter.

 

**CG&E’s**retail margins were relatively flat for the quarter ended June 30, 2005, ascompared to 2004.  Rate increases fromthe RSP provided a $13 million increase in margins.  However, this was offset by fuel, emissionallowance and purchased power cost increases related to fixed price residentialcustomers of approximately $11 million.

 

**CG&E’s**other non-retail margins were up slightly during the quarter.  We actively manage our non-regulatedgeneration portfolio through a mix of real-time and forward sales of power andthe corresponding purchase of fuel (primarily coal) and emissionallowances.  When power is sold forward, we typically purchase the fuel andemission allowances required to produce the power, thereby locking in oureventual margin at the time of delivery.  The market values of thesecommodities change independently over time. At times, the value of the fuel andemission allowances becomes greater than that of the output ofelectricity.  In these instances, we will purchase forward power to beused to deliver against forward power sales, and in turn sell the fuel and/oremission allowances.

 

During the secondquarter of 2005, we recognized margins of $35 million more than the comparableperiod in 2004 as a result of selling emission allowances which were no longerneeded to meet our non-retail forward power sales commitments.  This gain reflects significant increases inprices of SO2 emission allowances throughout much of 2004 and intoearly 2005.  Based on projectedgeneration, we have sufficient fuel and emission allowances to meet ournon-retail forward power sales commitments over the next several years, and wewill continue to evaluate and optimize our generation resources to produce thebest economic returns for these assets.

 

Gains from thesale of emission allowances were largely offset by the following:

 

•                  A$4 million decline due to timing differences in revenue recognition betweencertain components of our generation portfolio. Emission allowances and the majority of fuel contracts typically followthe accrual method of accounting. However, GAAP requires that certain forwardpurchases of coal and forward sales of power (those classified as derivatives)use the MTM method of accounting.  This differing accountingtreatment for the various components of the generation portfolio can lead tovolatility in reported results.  Our gross margins reflect $8 millionof unrealized losses in the second quarter of 2005 and $4 million of unrealizedlosses in the comparable period in 2004 (representing a $4 million changequarter on quarter) as a result of forward purchases of coal and forward salesof power and the use of MTM accounting.

 

•                  Lowermargins from non-retail power sales caused by a decline in volumes and lowermargins per MWh, which reflects higher fuel costs.

 

#### **Other Operating Revenues andCosts of Fuel Resold**

#### ** **

The increase in *Other Operating Revenues* was due to a $38 million increasein revenues from coal origination resulting from increases in coal prices andthe number of coal origination contracts. This increase includes $12 million of sales to non-regulated affiliates.

 

*Costs of fuel resold*represents the costs of coal origination activities.  These costs have increased in 2005, which isconsistent with the increase in the associated revenues as previouslydiscussed.

 

59

----

 

The followingexplanations correspond with the line items on the Condensed ConsolidatedStatements of Income for **CG&E**.  However, only the line items that variedsignificantly from prior periods are discussed.

 

#### **Other Operating Expenses**

 
| ** **                     | ** ** | **CG&E** and subsidiaries | ** ** |
|--------------------------------|------------|-------------------------------|------------|
| ** **                     | ** ** | **2005**                      | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | **(in millions)**             | ** ** |
| * *                       | * *   | * *                      | * *   | * * | * * | * * | * * | * * | * * |
| Operation and  maintenance     |       | **$**                         | **172**    |   | $ | 150 |   | $ | 22 |   | 15 | % |
| Depreciation                   |       | **45**                        |       | 46 |   | (1 | ) | (2 | ) |
| Taxes other than  income taxes |       | **53**                        |       | 50 |   | 3 |   | 6 |   |
|                                |            |                               |            |  |  |  |  |  |  |  |  |  |

 

##### ***Operation and Maintenance***

 

The 15 percent increasein *Operation and maintenance* expense wasprimarily due to the following factors:

 

•                  Increasedexpenses of $8 million related to the pending Duke-**Cinergy**merger;

•                  Increasedregulatory asset amortization of $4 million related to **CG&E’s**RTC; and

•                  Increasedlabor expenses of $3 million primarily resulting from severance payments partiallyoffset by a decrease in employee incentive costs.

 

#### **Income Taxes**

#### ** **

The effective income taxrate decreased for the quarter ended June 30, 2005, as compared to 2004.  The decrease was primarily a result of achange in Ohio law to phase-out the Ohio franchise tax.  The phase-out of the Ohio franchise taxresulted in the elimination of state income tax deferrals under GAAP thusreducing the effective income tax rate during the period.  See “Ohio Taxes” in “FutureExpectation/Trends” for additional information.

 

60

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**MD&A– 2005 QUARTERLY RESULTS OF OPERATIONS - PSI**

 

**2005QUARTERLY RESULTS OF OPERATIONS - PSI**

 

**Summary of Results**

 

Net income for **PSI** for thequarters ended June 30, 2005, and 2004 was as follows:

 
| ** ** | ** ** | **PSI**           | ** ** |
|------------|------------|-------------------|------------|
| ** ** | ** ** | **2005**          | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** ** | ** ** | **(in millions)** | ** ** |
| * *   | * *   | *** ***      | * *   | * * | * * | * * | * * | * * | * * |
| Net income |       | **$**             | **43**     |   | $ | 25 |   | $ | 18 |   | 72 | % |
|            |            |                   |            |  |  |  |  |  |  |  |  |  |

 

The increase in net income was primarily due to the impact of **PSI’s** 2004 base retail electric rate increase.

 

**Electric Gross Margins**

 

Gross margins for **PSI**for thequarters ended June 30, 2005, and 2004 were as follows:

 
| ** **               | ** **   | **PSI**           | ** **   |
|--------------------------|--------------|-------------------|--------------|
| ** **               | ** **   | **2005**          | ** **   | **2004** | ** ** | **Change** | ** ** | **%****Change** | ** ** |
| *** ***             | *** *** | **(in millions)** | *** *** |
| * *                 | * *     | *** ***      | * *     | * * | * * | * * | * * | * * | * * |
| Electric gross margin(1) |         | **$**             | **295**      |   | $ | 260 |   | $ | 35 |   | 13 | % |
|                          |              |                   |              |  |  |  |  |  |  |  |  |  |

 

----

(1)          Electric grossmargin is calculated as *Electric operatingrevenues*less *Fuel, emission allowances,and purchased power* expense from the Condensed ConsolidatedStatements of Income.

 

Cooling degree days and heating degree days in **PSI’s** service territory for the quartersended June 30, 2005, and 2004 were as follows:

 
| ** **                 | ** ** | **PSI**  | ** ** |
|----------------------------|------------|----------|------------|
| ** **                 | ** ** | **2005** | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
|                       |       |     |       |   |   |   |   |   |   |
| Cooling degree days(1)     |       | **333**  |       | 342 |   | (9 | ) | (3 | )% |
| Heating  degree days(2)(3) |       | **254**  |       | 228 |   | 26 |   | 11 |   |

 

----

(1)          Cooling degreedays are the differences between the average temperature for each day and 65degrees, assuming the average temperature is greater than 65 degrees.

(2)          Heating degreedays are the differences between the average temperature for each day and 59degrees, assuming the average temperature is less than 59 degrees.

(3)          Beginning inJanuary 2005, we modified our heating degree days base temperature from 65degrees to 59 degrees to more accurately reflect current consumerbehavior.  Prior year amounts have beenupdated to reflect this change.

 

The change in cooling degree days and heating degree days did not havea material effect on **PSI’s** grossmargins for the period.

 

The 13 percent increase in **PSI’s** electricgross margins was primarily due to the following factors:

 

•                  A $30 millionincrease resulting primarily from a higher price received per MWh due to **PSI’s**2004 base retail electric rate increase; and

•                  A $17 millionincrease in non-retail margins, primarily resulting from reduced fuel expensereflecting adjustments to **PSI’s** cost ofsynthetic fuel.

 

Partially offsetting these increases was a decline of $11 millionreflecting rate reductions associated with a property tax adjustment.  This decline is partially offset by areduction in property tax expense, as discussed further below.

 

61

----

 

The following explanations correspond with the line items on theCondensed Consolidated Statements of Income for **PSI**.  However, only theline items that varied significantly from prior periods are discussed.

 

**Other Operating Expenses**

 
| ** **                    | ** ** | **PSI**           | ** ** |
|-------------------------------|------------|-------------------|------------|
| ** **                    | ** ** | **2005**          | ** ** | **2004** | ** ** | **Change** | ** ** | **%****Change** | ** ** |
| ** **                    | ** ** | **(in millions)** | ** ** |
|                          |       |              |       |   |   |   |   |   |   |
| Operation and maintenance     |       | **$**             | **122**    |   | $ | 123 |   | $ | (1 | ) | (1 | )% |
| Depreciation                  |       | **66**            |       | 55 |   | 11 |   | 20 |   |
| Taxes other than income taxes |       | **10**            |       | 15 |   | (5 | ) | (33 | ) |
|                               |            |                   |            |  |  |  |  |  |  |  |  |  |

 

***Depreciation***

* *

The 20 percent increase in *Depreciation*expense was primarily due to (a) higher depreciation rates, as aresult of changes in useful lives of production assets and an increased ratefor cost of removal, (b) recovery of deferred depreciation costs, and (c) theaddition of depreciable plant for pollution control equipment, all of which arerecovered from ratepayers.

 

***Taxes other than Income Taxes***

 

The 33 percent decrease in *Taxes other than income taxes*expense was primarily due to the settlement of various property tax matters.

 

**Miscellaneous Income - Net**

 

The increase in *Miscellaneous Income – Net*was primarily due to an increase in the rate for allowance for equity fundsused during construction and reimbursements from **PSI’s**insurance carriers for costs of investigating, preventing, mitigating, andremediating damage to property and paying claims related to MGP sites.

 

**Interest Expense**

 

The 24 percent increase in *Interest Expense*was primarily due to an increase in average long-term debt outstanding andincreases in variable interest rates. This expense was partially offset by interest income received onrestricted deposits obtained through these incremental borrowings, which isrecorded in *Miscellaneous Income – Net*, associatedwith the additional long-term debt outstanding.

 

**Income Taxes**

 

The effective income tax rate decreased for the quarter ended June 30,2005, as compared to June 30, 2004, primarily as a result of an adjustment inthe second quarter of 2004 to reflect an increase in the Indiana state incometax provision.

 

62

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**MD&A– 2005 YEAR TO DATE RESULTS OF OPERATIONS - CINERGY**

 

**2005 YEARTO DATE RESULTS OF OPERATIONS – CINERGY**

** **

Given the dynamics of our business, which include regulatory revenueswith directly offsetting expenses and commodity trading operations for whichresults are primarily reported on a net basis, we have concluded that adiscussion of our results on a gross margin basis is most appropriate.  Electric gross margins represent electricoperating revenues less the related direct costs of fuel, emission allowances,and purchased power.  Gas gross marginsrepresent gas operating revenues less the related direct cost of gaspurchased.  Within each of these areas,we will discuss the key drivers of our results. Gross margins for **Cinergy**forRegulated and Commercial for the six months ended June 30, 2005, and 2004 wereas follows:

 
| ** **               | ** ** | **Cinergy**       | ** ** |
|--------------------------|------------|-------------------|------------|
| ** **               | ** ** | **Regulated**     | ** ** | **Commercial** | ** ** |
| ** **               | ** ** | **2005**          | ** ** | **2004** | ** ** | **Change** | ** ** | **%****Change** | ** ** | **2005** | ** ** | **2004** | ** ** | ** Change** | ** ** | **%****Change** | ** ** |
| ** **               | ** ** | **(in millions)** | ** ** |
|                     |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Electric gross margin(1) |       | **$**             | **876**    |   | $ | 802 |   | $ | 74 |   | 9 | % | **$** | **347** |   | $ | 334 |   | $ | 13 |   | 4 | % |
| Gas gross  margin(2)     |       | **142**           |       | 148 |   | (6 | ) | (4 | ) | **(14** | **)** | 40 |   | (54 | ) | N/M |   |
|                          |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)                    Electric gross margin is calculated as *Electric operating revenues*less *Fuel,emission allowances, and purchased power* expense from theCondensed Consolidated Statements of Income.

(2)                    Gas gross margin is calculated as *Gas operating revenues* less *Gaspurchased* expense from the Condensed Consolidated Statements ofIncome.

N/M         Not meaningfulto an understanding of the change.

 

Cooling degree days and heating degree days are metrics commonly usedin the utility industry as a measure of the impact weather has on results ofoperations.  Cooling degree days andheating degree days in **Cinergy’s**service territory for the six months ended June 30, 2005, and 2004 were asfollows:

 
| ** **                | ** ** | **Cinergy** | ** ** |
|---------------------------|------------|-------------|------------|
| ** **                | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
|                      |       |        |       |   |   |   |   |   |   |
| Cooling degree days(1)    |       | **337**     |       | 336 |   | 1 |   | — | % |
| Heating degree days(2)(3) |       | **2,320**   |       | 2,446 |   | (126 | ) | (5 | ) |

 

----

(1)          Cooling degree daysare the differences between the average temperature for each day and 65degrees, assuming the average temperature is greater than 65 degrees.

(2)          Heating degree days are the differencesbetween the average temperature for each day and 59 degrees, assuming theaverage temperature is less than 59 degrees.

(3)          Beginning in January 2005,we modified our heating degree days base temperature from 65 degrees to 59degrees to more accurately reflect current consumer behavior.  Prior year amounts have been updated toreflect this change.

 

The change in cooling degree days and heating degree days did not havea material effect on **Cinergy’s** grossmargins for the period.

 

**Regulated**

 

***Gross Margins***

 

The nine percent increase in Regulated’s electric gross margins wasprimarily due to the following factors:

 

•                  A $68 millionincrease resulting primarily from a higher price received per MWh due to **PSI’s**2004 base retail electric rate increase; and

•                  A $14 millionincrease in **PSI’s** non-retail margins,primarily resulting from reduced fuel expense reflecting adjustments to **PSI’s** cost of synthetic fuel.

 

These increases were partially offset by a decline of $11 millionreflecting rate reductions associated with a property tax adjustment for **PSI**.

 

63

----

 

The four percent decrease in Regulated’s gas gross margins wasprimarily due to a decline in non-weather related demand.

 

**Commercial**

 

***Gross Margins***

 

The four percent increase in Commercial’s electric gross margins wasdriven primarily by the following factors:

 

•                  Retail rateincreases from the RSP provided a $25 million increase in margins.  This increase was partially offset by fuel,emission allowance and purchased power cost increases of approximately $17million attributable to our fixed price residential customers.  Margins attributable to retail volumes wereup slightly during the period, due in part to the return of certain **CG&E**retail customers to full electric service.

 

•                  Margins fromCommercial’s power marketing, trading, and origination contracts increased $6million during the period.

 

•                  Commercial’sother non-retail margins were up slightly during 2005, as compared to2004.  We actively manage ournon-regulated generation portfolio through a mix of real-time and forward salesof power and the corresponding purchase of fuel (primarily coal) andemission allowances.  When power is sold forward, we typically purchasethe fuel and emission allowances required to produce the power, thereby lockingin our eventual margin at the time of delivery.  The market values ofthese commodities change independently over time. At times, the value of thefuel and emission allowances becomes greater than that of the output ofelectricity.  In these instances, we will purchase forward power to beused to deliver against forward power sales, and in turn sell the fuel and/oremission allowances.

 

During 2005, werecognized margins of $66 million more than the comparable period in 2004 as aresult of selling emission allowances which were no longer needed to meet ournon-retail forward power sales commitments. This gain reflects significant increases in prices of SO2emission allowances throughout much of 2004 and into early 2005.  Based on projected generation, we havesufficient fuel and emission allowances to meet our non-retail forward powersales commitments over the next several years, and we will continue to evaluateand optimize our generation resources to produce the best economic returns forthese assets.

 

This gain wasoffset by the following factors:

 

•                  A$38 million decline due to timing differences in revenue recognition betweencertain components of our generation portfolio. Emission allowances and the majority of fuel contracts typically followthe accrual method of accounting. However, GAAP requires that certain forwardpurchases of coal and forward sales of power (those classified as derivatives)use the MTM method of accounting.  This differing accountingtreatment for the various components of the generation portfolio can lead tovolatility in reported results.  Our gross margins reflect $32million of unrealized losses in 2005 and $6 million of unrealized gains in 2004(representing a $38 million change period to period) as a result of forwardpurchases of coal and forward sales of power and the use of MTMaccounting.

 

•                  Lowermargins from non-retail power sales caused by a decline in volumes and lowermargins per MWh, which reflects higher fuel costs.

 

Commercial’s gas gross margins decreased, as compared to the sameperiod last year due to the following factors:

 

•                  A $34 million decreasewhich primarily reflects trading strategies employed in the second quarter of2005 that resulted in negative margins; and

•                  An $18 milliondecrease due to timing differences in revenue recognition between physicalstorage activities and the associated derivative contracts that hedge thephysical storage. These agreements with pipelines to store natural gas anddeliver in a future period with higher prices (typically winter) follow theaccrual method of accounting.  However,the derivative contracts hedging the gas are required under

 

64

----

 

GAAP to be accounted for under the MTM method of accounting.  The differing accounting treatments can leadto volatility in reported results.  Ouryear-to-date gross margins reflect $17 million of unrealized losses in 2005 and$1 million of unrealized gains in 2004 (representing an $18 million changeperiod to period) as a result of derivative contracts and the use of MTMaccounting.

 

##### ***OtherOperating Revenues and Costs of Fuel Resold***

 

The 45 percent increase in *Other Operating Revenues*was primarily due to the following factors:

 

•                  A $58 millionincrease in Commercial’s revenues from coal origination resulting fromincreases in coal prices and the number of coal origination contracts; and

•                  A $26 millionincrease in Commercial’s revenues from the sale of synthetic fuel.

 

Partially offsetting these increases was a $13 million decrease inrevenues from non-regulated energy service subsidiaries.

 

*Costs of fuel resold* includes Commercial’scosts of coal origination activities and the production of synthetic fuel.  These costs have increased in 2005, which isconsistent with the increases in the associated revenues as previouslydiscussed.

 

The following explanations correspond with the line items on theCondensed Consolidated Statements of Income for **Cinergy**.  However, onlythe line items that varied significantly from prior periods are discussed.

 

#### **Other Operating Expenses**

 
| ** **                    | ** ** | **Cinergy**       | ** ** |
|-------------------------------|------------|-------------------|------------|
| ** **                    | ** ** | **2005**          | ** ** | **2004** | ** ** | **Change** | ** ** | **%****Change** | ** ** |
| ** **                    | ** ** | **(in millions)** | ** ** |
| * *                      | * *   | * *          | * *   | * * | * * | * * | * * | * * | * * |
| Operation and maintenance     | ** ** | **$**             | **683**    |   | $ | 643 |   | $ | 40 |   | 6 | % |
| Depreciation                  |       | **257**           |       | 219 |   | 38 |   | 17 |   |
| Taxes other than income taxes |       | **144**           |       | 147 |   | (3 | ) | (2 | ) |
|                               |            |                   |            |  |  |  |  |  |  |  |  |  |

 

***Operation and Maintenance***

 

The six percent increase in *Operation and maintenance*expense was primarily due to the following factors:

 

•                  Increased laborexpenses of $16 million primarily resulting from severance payments partiallyoffset by a decrease of $10 million in employee incentive costs;

•                  Increasedregulatory asset amortization of $12 million related to **CG&E’s**RTC;

•                  Expenses of $11million related to the pending Duke-**Cinergy** merger;

•                  A $6 millionincrease in operation expenses for non-regulated service subsidiaries,including those that started operations, or became fully consolidated, duringor after the second quarter of 2004; and

•                  Increasedexpenses of $6 million related to environmental litigation.

 

These increases were partially offset by expenses of $12 millionincurred in 2004 associated with the continuous improvement initiative.

 

##### ***Depreciation***

 

The 17 percent increase in *Depreciation*expense was primarily due to (a) higher depreciation rates, as aresult of changes in useful lives of production assets and an increased ratefor cost of removal, (b) recovery of deferred depreciation costs, and (c) theaddition of depreciable plant for pollution control equipment, all of which arerecovered from ratepayers.

 

65

----

 

#### **Equity in Earnings of Unconsolidated Subsidiaries**

 

The 83 percent increase in *Equity in Earnings ofUnconsolidated Subsidiaries* is primarily due to $5 million in equityin earnings of a cogeneration project that became fully operational in April of2004.

 

#### **Miscellaneous Income (Expense) *–* Net**

 

The increase in *Miscellaneous Income(Expense) – Net* was due to $34 million in impairment chargesrecognized in the first half of 2004 primarily related to technologyinvestments in Power Technology and Infrastructure.

 

**Income Taxes**

 

The effective income tax rate decreased for the six months ended June30, 2005, as compared to 2004.  Thedecrease was primarily a result of an increase in the amount of estimatedannual tax credits associated with the production and sale of synthetic fueland the resolution of certain tax matters. **Cinergy’s** 2005 effective tax rate isexpected to be approximately 23 percent.

 

66

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**MD&A– 2005 YEAR TO DATE RESULTS OF OPERATIONS – CG&E**

 

**2005 YEARTO DATE RESULTS OF OPERATIONS - CG&E**

 

**Summary of Results**

 

Net income for **CG&E**for the six months ended June 30, 2005, and 2004 was as follows:

 
| ** ** | ** ** | **CG&E**and subsidiaries | ** ** |
|------------|------------|------------------------------|------------|
| ** ** | ** ** | **2005**                     | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** ** | ** ** | **(in millions)**            | ** ** |
| * *   | * *   | * *                     | * *   | * * | * * | * * | * * | * * | * * |
| Net income |       | **$**                        | **138**    |   | $ | 133 |   | $ | 5 |   | 4 | % |
|            |            |                              |            |  |  |  |  |  |  |  |  |  |

 

The increase in net income was primarily due to the following factors:

 

•                  An increase inelectric gross margins relating to certain activities in our asset optimizationbusiness.  This increase was comprised ofincreases in margins from the sale of emission allowances partially offset by unrealizedlosses on forward coal and power contracts; and

•                  An increase inrate tariff adjustments resulting from the implementation of **CG&E’s** RSP in January 2005.

 

These increases were partially offset by the increases in *Operation and maintenance* primarily due to increasedregulatory asset amortization and expenses associated with the pending Duke-**Cinergy** merger.

 

**Gross Margins**

 

Gross margins for **CG&E** forthe six months ended June 30, 2005, and 2004 were as follows:

 
| ** **               | ** ** | **CG&E**and subsidiaries | ** ** |
|--------------------------|------------|------------------------------|------------|
| ** **               | ** ** | **2005**                     | ** ** | **2004** | ** ** | **Change** | ** ** | **%****Change** | ** ** |
| ** **               | ** ** | **(in millions)**            | ** ** |
| * *                 | * *   | * *                     | * *   | * * | * * | * * | * * | * * | * * |
| Electric gross margin(1) |       | **$**                        | **624**    |   | $ | 602 |   | $ | 22 |   | 4 | % |
| Gas gross margin(2)      |       | **143**                      |       | 147 |   | (4 | ) | (3 | ) |
|                          |            |                              |            |  |  |  |  |  |  |  |  |  |

----

(1)          Electric gross margin iscalculated as *Electric operating revenues*less *Fuel, emission allowances, and purchased power* expense fromthe Condensed Consolidated Statements of Income.

(2)          Gas gross margin iscalculated as *Gas operating revenues* less *Gas purchased* expense from the Condensed ConsolidatedStatements of Income.

 

Cooling degree days and heating degree days in **CG&E’s** service territory for the sixmonths ended June 30, 2005, and 2004 were as follows:

 
| ** **                | ** ** | **CG&E**and  subsidiaries | ** ** |
|---------------------------|------------|-------------------------------|------------|
| ** **                | ** ** | **2005**                      | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
|                      |       |                          |       |   |   |   |   |   |   |
| Cooling degree days(1)    |       | **340**                       | ** ** | 327 |   | 13 |   | 4 | % |
| Heating degree days(2)(3) |       | **2,213**                     | ** ** | 2,386 |   | (173 | ) | (7 | ) |

----

(1)          Cooling degree days are the differencesbetween the average temperature for each day and 65 degrees, assuming theaverage temperature is greater than 65 degrees.

(2)          Heating degree days are the differencesbetween the average temperature for each day and 59 degrees, assuming theaverage temperature is less than 59 degrees.

(3)          Beginning in January 2005, we modifiedour heating degree days base temperature from 65 degrees to 59 degrees to moreaccurately reflect current consumer behavior.  Prior year amounts have been updated toreflect this change.

 

The change in cooling degree days and heating degree days did not havea material effect on **CG&E’s**gross margins for the period.

 

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***Electric Gross Margins***

 

The four percent increase in **CG&E’s**electric gross margins was driven primarily by the following factors:

 

•                  Retail rateincreases from the RSP provided a $25 million increase in margins.  This increase was partially offset by fuel,emission allowance and purchased power cost increases of approximately $17million attributable to our fixed price residential customers.  Margins attributable to retail volumes wereup slightly during the period, due in part to the return of certain retailcustomers to full electric service.

 

•                  Margins from **CG&E’s** power marketing, trading, and originationcontracts increased $4 million during the period.

 

•                  **CG&E’s** other non-retail margins were up slightly during2005, as compared to 2004.  We activelymanage our non-regulated generation portfolio through a mix of real-time andforward sales of power and the corresponding purchase of fuel (primarilycoal) and emission allowances.  When power is sold forward, wetypically purchase the fuel and emission allowances required to produce thepower, thereby locking in our eventual margin at the time of delivery. The market values of these commodities change independently over time. Attimes, the value of the fuel and emission allowances becomes greater than thatof the output of electricity.  In these instances, we will purchaseforward power to be used to deliver against forward power sales, and in turnsell the fuel and/or emission allowances.

 

During 2005, werecognized margins of $66 million more than the comparable period in 2004 as aresult of selling emission allowances which were no longer needed to meet ournon-retail forward power sales commitments. This gain reflects significant increases in prices of SO2emission allowances throughout much of 2004 and into early 2005.  Based on projected generation, we havesufficient fuel and emission allowances to meet our non-retail forward powersales commitments over the next several years, and we will continue to evaluateand optimize our generation resources to produce the best economic returns forthese assets.

 

This gain wasoffset by the following factors:

 

•                  A$38 million decline due to timing differences in revenue recognition betweencertain components of our generation portfolio. Emission allowances and the majority of fuel contracts typically followthe accrual method of accounting. However, GAAP requires that certain forwardpurchases of coal and forward sales of power (those classified as derivatives)use the MTM method of accounting.  This differing accounting treatmentfor the various components of the generation portfolio can lead to volatilityin reported results.  Our gross margins reflect $32 million ofunrealized losses in 2005 and $6 million of unrealized gains in 2004(representing a $38 million change period to period) as a result of forwardpurchases of coal and forward sales of power and the use of MTMaccounting.

 

•                  Lowermargins from non-retail power sales caused by a decline in volumes and lowermargins per MWh, which reflects higher fuel costs.

 

***Gas Gross Margins***

 

The three percent decrease in **CG&E’s** gasgross margins was primarily due to a decline in non-weather related demand.

 

**Other Operating Revenues and Costs of Fuel Resold**

 

The increase in *Other Operating Revenues*was due to a $71 million increase in revenues from coal origination resultingfrom increases in coal prices and the number of coal originationcontracts.  This increase includes $23million of sales to non-regulated affiliates.

 

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*Costs of fuel resold* represents the costs ofcoal origination activities.  These costshave increased in 2005, which is consistent with the increase in the associatedrevenues as previously discussed.

 

The following explanations correspond with the line items on theCondensed Consolidated Statements of Income for **CG&E**.  However, onlythe line items that varied significantly from prior periods are discussed.

 

**Other Operating Expenses**

 
| ** **                    | ** ** | **CG&E**and subsidiaries | ** ** |
|-------------------------------|------------|------------------------------|------------|
| ** **                    | ** ** | **2005**                     | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                    | ** ** | **(in millions)**            | ** ** | ** ** |
| * *                      | * *   | * *                     | * *   | * * | * * | * * | * * | * * | * * |
| Operation and maintenance     |       | **$**                        | **334**    |   | $ | 300 |   | $ | 34 |   | 11 | % |
| Depreciation                  |       | **90**                       |       | 90 |   | — |   | — |   |
| Taxes other than income taxes |       | **112**                      |       | 114 |   | (2 | ) | (2 | ) |
|                               |            |                              |            |  |  |  |  |  |  |  |  |  |

 

***Operation and Maintenance***

 

The 11 percent increase in *Operation and maintenance*expense was primarily due to increased regulatory asset amortization of $12million related to **CG&E’s** RTCand increased expenses of $8 million related to the pending Duke-**Cinergy** merger.

 

**Income Taxes**

 

The effective income tax rate decreased for the six months ended June30, 2005, as compared to 2004.  Thedecrease was primarily a result of a change in Ohio law to phase-out the Ohiofranchise tax.  The phase-out of the Ohiofranchise tax resulted in the elimination of state income tax deferrals underGAAP thus reducing the effective income tax rate during the period.  See “Ohio Taxes” in “FutureExpectation/Trends” for additional information.

 

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**MD&A– 2005 YEAR TO DATE RESULTS OF OPERATIONS – PSI**

 

**2005 YEARTO DATE RESULTS OF OPERATIONS - PSI**

 

**Summary of Results**

 

Net income for **PSI** for thesix months ended June 30, 2005, and 2004 was as follows:

 
|       |   | **PSI**           |       |
|------------|--------|-------------------|------------|
|       |   | **2005**          | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** |   |
|       |   | **(in millions)** |       |
| Net income |   | **$**             | **85**     |   | $ | 66 |   | $ | 19 |   | 29 | % |
|            |        |                   |            |  |  |  |  |  |  |  |  |  |

 

The increase in net income was primarily due to the impact of **PSI’s** 2004 base retail electric rate increase.

 

**Electric Gross Margins**

 

Gross margins for **PSI**for the sixmonths ended June 30, 2005, and 2004 were as follows:

 
| ** **               | ** ** | **PSI**           | ** ** |
|--------------------------|------------|-------------------|------------|
| ** **               | ** ** | **2005**          | ** ** | **2004** | ** ** | **Change** | ** ** | **%****Change** | ** ** |
| ** **               | ** ** | **(in millions)** | ** ** |
| * *                 | * *   | * *          | * *   | * * | * * | * * | * * | * * | * * |
| Electric gross margin(1) |       | **$**             | **588**    |   | $ | 521 |   | $ | 67 |   | 13 | % |
|                          |            |                   |            |  |  |  |  |  |  |  |  |  |

----

(1)          Electric gross margin is calculated as *Electric operating revenues*less *Fuel,emission allowances, and purchased power* expense from the CondensedConsolidated Statements of Income.

 

Cooling degree days and heating degree days in **PSI’s** service territory for the six monthsended June 30, 2005, and 2004 were as follows:

 
| ** **                 | ** ** | **PSI**   | ** ** |
|----------------------------|------------|-----------|------------|
| ** **                 | ** ** | **2005**  | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
|                       |       |      |       |   |   |   |   |   |   |
| Cooling degree days(1)     |       | **333**   |       | 344 |   | (11 | ) | (3 | )% |
| Heating  degree days(2)(3) |       | **2,426** |       | 2,505 |   | (79 | ) | (3 | ) |

----

(1)          Cooling degree days are thedifferences between the average temperature for each day and 65 degrees,assuming the average temperature is greater than 65 degrees.

(2)          Heating degree days are thedifferences between the average temperature for each day and 59 degrees,assuming the average temperature is less than 59 degrees.

(3)          Beginning in January 2005, wemodified our heating degree days base temperature from 65 degrees to 59 degreesto more accurately reflect current consumer behavior.  Prior year amounts have been updated toreflect this change.

 

The change in cooling degree days and heating degree days did not havea material effect on **PSI’s** grossmargins for the period.

 

The 13 percent increase in **PSI’s** electric grossmargins was primarily due to the following factors:

 

•                  A $68 millionincrease resulting primarily from a higher price received per MWh due to **PSI’s**2004****base retailelectric rate increase; and

•                  A $14 millionincrease in non-retail margins, primarily resulting from reduced fuel expensereflecting adjustments to **PSI’s** cost ofsynthetic fuel.

 

These increases were partially offset by a decline of $11 millionreflecting rate reductions associated with a property tax adjustment.  This decline is partially offset by areduction in property tax expense, as discussed further below.

 

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The following explanations correspond with the line items on theCondensed Consolidated Statements of Income for **PSI**.  However, only theline items that varied significantly from prior periods are discussed.

 

**Other Operating Expenses**

 
| ** **                    | ** ** | **PSI**           | ** ** |
|-------------------------------|------------|-------------------|------------|
| ** **                    | ** ** | **2005**          | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                    | ** ** | **(in millions)** |
| * *                      | * *   | * *          | * *   | * * | * * | * * | * * | * * | * * |
| Operation and maintenance     |       | **$**             | **243**    |   | $ | 232 |   | $ | 11 |   | 5 | % |
| Depreciation                  |       | **133**           |       | 104 |   | 29 |   | 28 |   |
| Taxes other than income taxes |       | **26**            |       | 31 |   | (5 | ) | (16 | ) |
|                               |            |                   |            |  |  |  |  |  |  |  |  |  |

 

***Operation and Maintenance***

 

The five percent increase in *Operation and maintenance*expense was primarily due to increased expenses of $4 million related toadditional amortization of regulatory assets, which were approved for recoverythrough **PSI’s** base retail electric rate caseand increased expense of $2 million related to environmental litigation.

 

***Depreciation***

 

The 28 percent increase in *Depreciation*expense was primarily due to (a) higher depreciation rates, as aresult of changes in useful lives of production assets and an increased ratefor cost of removal, (b) recovery of deferred depreciation costs, and (c) theaddition of depreciable plant for pollution control equipment, all of which arerecovered from ratepayers.

 

***Taxes other than Income Taxes***

 

The 16 percent decrease in *Taxes other than income taxes*expense was primarily due to the settlement of various property tax matters.

 

**Miscellaneous Income – Ne*t***

 

The increase in *Miscellaneous Income – Net*was primarily due to an increase in the rate for allowance for equity fundsused during construction and reimbursements from **PSI’s**insurance carriers for costs of investigating, preventing, mitigating, andremediating damage to property and paying claims related to MGP sites.

 

**Interest Expense**

 

The 24 percent increase in *Interest Expense*was primarily due to an increase in average long-term debt outstanding andincreases in variable interest rates. This expense was partially offset by interest income received onrestricted deposits obtained through these incremental borrowings, which isrecorded in *Miscellaneous Income – Net*, associatedwith the additional long-term debt outstanding.   Also contributing to this increase was adecrease in post-in-service carrying costs deferred for recovery due to **PSI’s** 2004 base retail electric rate increase.

 

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**MD&A– 2005 YEAR TO DATE RESULTS OF OPERATIONS – ULH&P**

 

**2005 YEARTO DATE RESULTS OF OPERATIONS - ULH&P**

 

**Summary of Results**

 

The Results of Operations discussion for **ULH&P**is presented only for the six months ended June 30, 2005, in accordance withGeneral Instruction H(2)(a) of Form 10-Q.

 

Electric and gas gross margins and net income for **ULH&P** for the six months ended June 30,2005, and 2004 were as follows:

 
| ** **                | ** ** | **ULH&P**     | ** ** |
|---------------------------|------------|-------------------|------------|
| ** **                | ** ** | **2005**          | ** ** | **2004** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                | ** ** | **(in millions)** |
| * *                  | * *   | * *          | * *   | * * | * * | * * | * * | * * | * * |
| Electric  gross margin(1) |       | **$**             | **32**     |   | $ | 34 |   | $ | (2 | ) | (6 | )% |
| Gas gross margin(2)       |       | **26**            |       | 26 |   | — |   | — |   |
| Net income                |       | **6**             |       | 11 |   | (5 | ) | (45 | ) |
|                           |            |                   |            |  |  |  |  |  |  |  |  |  |

 

----

(1)          Electric gross margin iscalculated as *Electric operating revenues*less *Electricity purchased from parent company for resale* expensefrom the Condensed Statements of Income.

(2)          Gas gross margin iscalculated as *Gas operating revenues* less *Gas purchased* expense from the Condensed Statements ofIncome.

 

The six percent decrease in electric gross margins was due, in part, tomilder weather during 2005.  Gas grossmargins remained flat as an increase in rate tariff adjustments associated withthe gas main replacement program and the demand-side management program, whichencourages efficient customer gas usage, was partially offset by a decline innon-weather related demand.

 

The 45 percent decrease in net income for the quarter was partially dueto the decreased electric gross margins as previously discussed.  Also contributing to the decrease were higheroperation and maintenance costs associated with transmission of electricity andthe demand-side management program. Partially offsetting this decrease was a decline in income taxesprimarily as a result of a reduction of the Kentucky corporate tax rate from8.25 percent to seven percent and the resolution of certain tax matters.  The Kentucky corporate tax rate is expectedto decrease to six percent effective January 1, 2007.

 

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**MD&A –****LIQUIDITY AND CAPITALRESOURCES**

 

### **LIQUIDITY AND CAPITAL RESOURCES**

 

#### **Capital Requirements**

 

##### ***EnvironmentalIssues***

 

*EnvironmentalProtection Agency Regulations*

 

In March 2005, the EPA issued the Clean AirInterstate Rule (CAIR) which would require states to revise their StateImplementation Plan (SIP) by September 2006 to address alleged contributions todownwind non-attainment with the revised National Ambient Air Quality Standardsfor ozone and fine particulate matter. The rule established a two-phase, regional cap and trade program for SO2and NOX, affecting 28 states, including Ohio,Indiana, and Kentucky, and requires SO2 and NOX emissionsto be cut 70 percent and 65 percent, respectively, by 2015.  At the same time, the EPA issued the CleanAir Mercury Rule (CAMR) which requires reductions in mercury emissions fromcoal-fired power plants.  The finalregulation also adopts a two-phase cap and trade approach that requires mercuryemissions to be cut by 70 percent by 2018. State SIPs must comply with the prescribed reduction levels under CAIRand CAMR; however, the states have the ability to introduce more stringentrequirements if desired.  Under both CAIRand CAMR, companies have flexible compliance options including installation ofpollution controls on large plants where such controls are particularlyefficient and utilization of emission allowances for smaller plants wherecontrols are not cost effective.  InAugust 2005, the EPA proposed a Federal Implementation Plan (FIP) to act as abackstop to ensure that states implement the CAIR in a timely manner.  If a state fails to develop a CAIR SIP, theEPA intends to finalize the FIP in time to implement CAIR for the state by theCAIR deadlines.  Numerous states,environmental organizations, industry groups, including some of which **Cinergy** is a member, and individual companies havechallenged various portions of both rules. Those challenges are currently pending in the Federal Circuit Court forthe District of Columbia.  At this timewe cannot predict the outcome of these matters.

 

Over the 2005-2009 time period, we expect tospend approximately $1.8 billion to reduce mercury, SO2, and NOXemissions.  These estimates includeestimated costs to comply at plants that we own but do not operate and couldchange when taking into consideration compliance plans of co-owners oroperators involved.  Moreover, as marketconditions change, additional compliance options may become available and ourplans will be adjusted accordingly. Approximately 60 percent of these estimated environmental costs would beincurred at **PSI’s** coal-firedplants, for which recovery would be pursued in accordance with regulatorystatutes governing environmental cost recovery. See (b)(*i*) for moredetails.  **CG&E**would receive partial recovery of depreciation and financing costs related toenvironmental compliance projects for 2005-2008 through its recently approvedrate stabilization plan (RSP).  See (b)(*ii*) for more details.

 

The EPA made final state non-attainment areadesignations to implement the revised ozone standard and to implement the newfine particulate standard in June 2004 and April 2005, respectively.  Several counties in which we operate have beendesignated as being in non-attainment with the new ozone standard and/or fineparticulate standard.  States withcounties that are designated as being in non-attainment with the new ozoneand/or fine particulate standards are required to develop a plan of complianceby June 2007 and April 2008, respectively. Industrial sources in or near those counties are potentially subject torequirements for installation of additional pollution controls.  In March 2005, various states, localgovernments, environmental groups, and industry groups, including some of which**Cinergy** is a member, filed petitionsfor review in the United States Court of Appeals for the D.C. Circuit tochallenge the EPA’s particulate matter non-attainment designations.  Although the EPA has attempted to structureCAIR to resolve purported utility contributions to ozone and fine particulatenon-attainment, at this time, **Cinergy**cannot predict the effect of current or future non-attainment designations onits financial position or results of operations.

 

In July 2005, the EPA issued its finalregional haze rules and implementing guidelines in response to a 2002 judicialruling overturning key provisions of the original program.  The regional haze program isaimed at reducing certain emissions impacting visibility in national parks andwilderness areas.  The EPA has announcedthat it can foresee no circumstances where the requirements of the regionalhaze rule would require utility controls beyond those required under CAIR.  The EPA also found that states participatingin the CAIR cap and trade program need not require

 

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electric generating units to adhere to best available retrofitrequirements.  The states have untilDecember 2007 to finalize their SIPs addressing compliance with EPAregulations.  The states may choose toimplement more stringent guidelines than promulgated by the EPA, and thereforeit is not possible to predict whether the regional haze rule will have amaterial effect on our financial position or results of operations.

 

*Clear SkiesLegislation*

 

President Bushhas proposed environmental legislation that would combine a series of Clean AirAct (CAA) requirements, including the recent mercury, SO2, and NOXreduction regulations for coal-fired power plants with a legislative solutionthat includes trading and specific emissions reductions and timelines to meetthose reductions.  The President’s “ClearSkies Initiative” would seek an overall 70 percent reduction in emissions frompower plants over a phased-in reduction schedule beginning in 2010 andcontinuing through 2018.  When the ClearSkies Initiative was stalled in Congress, the EPA finalized the CAIR and CAMRregulations to accomplish Clear Skies’ goals within the existing framework ofthe CAA.  Clear Skies has beenreintroduced in the Senate in 2005, but its prospects for passage are uncertainin the current session.  At this time wecannot predict whether this or any multi-emissions bill will be passed.

 

*Energy Bill*

 

A comprehensive energy bill(the Energy Policy Act of 2005) passed Congress July 22, 2005 and has beensent to President Bush for signature, which is expected on August 8,2005.  The bill, among other things,  repeals PUHCA effective six months after thebill’s enactment (i.e., February 2006), amends certain provisions of theFederal Power Act and the Public Utility Regulatory Policies Act of 1978, andexpands FERC’s authority to review mergers and acquisitions.  Pursuant to the terms of the bill, **Cinergy’s** pending merger with Duke would be grandfatheredunder FERC’s existing authority. At this time, we are still analyzing the billto determine its impact on our financial position or results of operations.

 

*EnvironmentalLawsuits*

 

We are currently involved in the following lawsuits which are discussedin more detail in Note 9(a) of the “Notes to Condensed Financial Statements” in“Item 1. Financial Statements.”  Anunfavorable outcome of any of these lawsuits could have a material impact onour liquidity and capital resources.

 

•                  CAA Lawsuit

•                  CO2Lawsuit

•                  SelectiveCatalytic Reduction Units at Gibson Station

•                  Zimmer StationLawsuit

•                  Manufactured GasPlant Sites

•                  Asbestos ClaimsLitigation

 

##### ***Pension andOther Postretirement Benefits***

 

**Cinergy** maintainsqualified defined benefit pension plans covering substantially all UnitedStates employees meeting certain minimum age and service requirements.  Plan assets consist of investments in equityand debt securities.  Funding for thequalified defined benefit pension plans is based on actuarially determinedcontributions, the maximum of which is generally the amount deductible for taxpurposes and the minimum being that required by the Employee Retirement IncomeSecurity Act of 1974, as amended (ERISA). Although mitigated by strong performance in 2003 and 2004, ongoingretiree payments and the decline in market value of the investment portfolio in2002 reduced the assets held in trust to satisfy plan obligations.  Additionally, continuing low long-terminterest rates have increased the liability for funding purposes.  As a result of these events, our near termfunding targets have increased substantially. **Cinergy** has adopted afive-year plan to reduce, or eliminate, the unfunded pension obligationinitially measured as of January 1, 2003. This unfunded obligation will be recalculated as of January 1 of eachyear in the five-year plan.  Because thisunfunded obligation is the difference between the liability determined

 

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actuarially on an ERISA basis and the fair value of plan assets as ofJanuary 1, 2003, the liability determined by this calculation is different thanthe pension liability calculated for accounting purposes reported on **Cinergy’s** Condensed Consolidated BalanceSheets.

 

**Cinergy’s** minimumrequired contributions in calendar year 2004 totaled $16 million.  Actual contributions in 2004 were $117million, reflecting additional discretionary contributions of $101 millionunder the aforementioned five-year plan. Due to the significant 2004 and previous calendar year contributions, **Cinergy’s** minimum required contributions incalendar year 2005 are expected to be zero. Should **Cinergy** continuefunding under the five-year plan, discretionary contributions are expected to be$102 million in 2005, which is an increase from the $72 million disclosed inthe 2004 10-K.  This $30 million increaseis primarily the result of a change in the retirement age assumption whichincreased the near-term funding estimates. Actual contributions for the six months ended June 30, 2005 werezero.  **Cinergy**may consider making discretionary contributions in 2006 and future periods;however, at this time, we are unable to determine the amount of thosecontributions.  Estimated contributionsfluctuate based on changes in market performance of plan assets and actuarialassumptions.  Absent the occurrence ofinterim events that could materially impact these targets, we will update ourexpected target contributions annually as the actuarial funding valuations arecompleted and make decisions about future contributions at that time.

 

##### ***OtherInvesting Activities***

 

Our ability to invest in growth initiatives is limited by certain legaland regulatory requirements, including the PUHCA.  For a discussion of the pending PUHCA Repeal,see “Energy Bill” in “Liquidity and Capital Resources.”    The PUHCA limits the types of non-utilitybusinesses in which **Cinergy** andother registered holding companies under the PUHCA can invest as well as theamount of capital that can be invested in permissible non-utilitybusinesses.  Also, the timing and amountof investments in the non-utility businesses is dependent on the developmentand favorable evaluations of opportunities. Under the PUHCA restrictions, we are allowed to invest, or commit toinvest, in certain non-utility businesses, including:

 

•                  Exempt WholesaleGenerators (EWG) and Foreign Utility Companies (FUCO)

 

An EWG is anentity, certified by the Federal Energy Regulatory Commission (FERC), devotedexclusively to owning and/or operating, and selling power from one or moreelectric generating facilities.  An EWGwhose generating facilities are located in the United States is limited tomaking only wholesale sales of electricity. An entity claiming status as an EWG must provide notification thereof tothe SEC under the PUHCA.

 

A FUCO is acompany all of whose utility assets and operations are located outside theUnited States and which are used for the generation, transmission, ordistribution of electric energy for sale at retail or wholesale, or thedistribution of gas at retail.  A FUCOmay not derive any income, directly or indirectly, from the generation,transmission, or distribution of electric energy for sale or the distributionof gas at retail within the United States. An entity claiming status as a FUCO must provide notification thereof tothe SEC under the PUHCA.

 

In June 2005, the SEC issued an order under PUHCA authorizing **Cinergy** to invest (including by wayof guarantees) an aggregate amount in EWGs and FUCOs equal to the sum of (1)our average consolidated retained earnings from time to time plus (2) $2billion through the earlier of (a) the closing of the pending Duke-**Cinergy** merger or (b) June 23, 2006.  As of June 30, 2005, we had invested orcommitted to invest $0.7 billion in EWGs and FUCOs, leaving availableinvestment capacity under the order of $2.9 billion.

 

•                  QualifyingFacilities and Energy-Related Non-utility Entities

 

SEC regulationsunder the PUHCA permit **Cinergy** andother registered holding companies to invest and/or guarantee an amount equalto 15 percent of consolidated capitalization (consolidated capitalization isthe sum of *Notes payable and othershort-term obligations*, *Long-termdebt* (including amounts due within one year), Cumulative**Preferred Stock of Subsidiaries, and Total Common Stock Equity) in domesticqualifying cogeneration and small power production plants (qualifyingfacilities) and certain other domestic energy-related non-utilityentities.  At June 30,

 

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2005, we hadinvested and/or guaranteed $1.0****billionof the $1.5 billion available.  In August2004, **Cinergy** filed an application with theSEC requesting authority under the PUHCA to increase its investment and/orguarantee authority by $2 billion above the current authorized amount.  In light of our existing unused capacity,together with the pending repeal of PUHCA and the pending merger with Duke, **Cinergy** withdrew this application in the third quarter of2005.

 

•                  Energy-RelatedAssets

 

**Cinergy**has been granted SEC authority under the PUHCA to invest up to $1 billion innon-utility Energy-Related Assets within the United States, Canada, andMexico.  Energy-Related Assets includenatural gas exploration, development, production, gathering, processing,storage and transportation facilities and equipment, liquid oil reserves andstorage facilities, and associated assets, facilities and equipment, but wouldexclude any assets, facilities, or equipment that would cause the owner oroperator thereof to be deemed a public utility company.  As of June 30, 2005, we did not have anyinvestments in these Energy-Related Assets.

 

•                  InfrastructureServices Companies

 

In July 2005, theSEC issued an order under the PUHCA authorizing **Cinergy**to invest up to $100 million (including existing investments and guarantees)through June 30, 2008 in companies that derive or will derive substantially allof their operating revenues from the sale of Infrastructure Services including:

 

•                  Design,construction, retrofit, and maintenance of utility transmission anddistribution systems;

•                  Installationand maintenance of natural gas pipelines, water and sewer pipelines, andunderground and overhead telecommunications networks; and

•                  Installationand servicing of meter reading devices and related communications networks,including fiber optic cable.

 

At June 30, 2005,we had invested $30 million in Infrastructure Services companies.

 

##### ***Guarantees***

 

On June 23, 2005, the SEC issued an order under the PUHCA authorizing **Cinergy Corp.** to provide guarantees in an aggregate amountnot to exceed $3.0 billion.  For adiscussion of the pending PUHCA Repeal, see “Energy Bill” in “Liquidity andCapital Resources.”  As of June 30, 2005,we had $756 million outstanding under the guarantees issued, of which 97percent represents guarantees of obligations reflected on **Cinergy’s** Condensed Consolidated BalanceSheets.  The amount outstandingrepresents **Cinergy Corp.’s**guarantees of liabilities and commitments of its consolidated subsidiaries,unconsolidated subsidiaries, and joint ventures.

 

SeeNote 9(c)(*iv*) of the “Notes toCondensed Financial Statements” in “Item 1. Financial Statements” for a discussion ofguarantees in accordance with Financial Accounting Standards Board InterpretationNo. 45, *Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others* (Interpretation 45).  Interpretation 45 requires disclosure ofmaximum potential liabilities for guarantees issued on behalf of unconsolidatedsubsidiaries and joint ventures and under indemnification clauses in variouscontracts.  The Interpretation 45disclosure differs from the PUHCA restrictions in that it requires a calculationof maximum potential liability, rather than actual amounts outstanding; itexcludes guarantees issued on behalf of consolidated subsidiaries; and itincludes potential liabilities under indemnification clauses.

 

##### ***Marketing& Trading Liquidity Risks***

 

**Cinergy**has certaincontracts in place, primarily with trading counterparties, that require theissuance of collateral in the event our debt ratings are downgraded belowinvestment grade.  Based upon our June30, 2005 trading portfolio,

 

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if such an event were to occur, **Cinergy**would be required to issue up to $403 million in collateral related to its gasand power trading operations, of which $157 million is related to **CG&E**.

 

#### **Capital Resources**

 

**Cinergy**, **CG&E**, **PSI**, and **ULH&P** meettheir current and future capital requirements through a combination of fundingsources including, but not limited to, internally generated cash flows,tax-exempt bond issuances, capital lease and operating lease structures, thesecuritization of certain asset classes, short-term bank borrowings, issuanceof commercial paper, and issuances of long-term debt and equity.  Funding decisions are based on marketconditions, market access, relative pricing information, borrowing duration andcurrent versus forecasted cash needs.  **Cinergy**, **CG&E**, **PSI**, and **ULH&P** arecommitted to maintaining balance sheet health, responsibly managingcapitalization, and maintaining adequate credit ratings.  **Cinergy**, **CG&E**, **PSI**, and **ULH&P** believe that they have adequate financialresources to meet their future needs.

 

##### ***Sale ofAccounts Receivable***

 

**CG&E**, **PSI**, and **ULH&P**have an agreement with Cinergy Receivables Company, LLC (Cinergy Receivables),an affiliate, to sell, on a revolving basis, nearly all of the retail accountsreceivable and related collections of **CG&E**,**PSI**, and **ULH&P**. Cinergy Receivables funds its purchases with borrowings from commercialpaper conduits that obtain a security interest in the receivables.  This program accelerates the collection ofcash for **CG&E**, **PSI**, and **ULH&P**related to these retail receivables.  **Cinergy Corp.** does not consolidate CinergyReceivables because it meets the requirements to be accounted for as aqualifying special purpose entity (SPE).

 

##### ***Notes Payableand Other Short-term Obligations***

 

We are required to secure authority to issue short-term debt from theSEC under the PUHCA and from the Public Utilities Commission of Ohio(PUCO).  The SEC under the PUHCAregulates the issuance of short-term debt by **CinergyCorp.**, **PSI**, and **ULH&P**. The PUCO has regulatory jurisdiction over the issuance of short-termdebt by **CG&E**. For a discussionof the pending PUHCA Repeal, see “Energy Bill” in “Liquidity and CapitalResources.”

 
| ** **                     | ** ** | **Short-term Regulatory Authority  June 30, 2005** | ** ** |
|--------------------------------|------------|----------------------------------------------------|------------|
| ** **                     | ** ** | **Authority**                                      | ** ** | **Outstanding** | ** ** |
|                           |       | **(in millions)**                                  |       |
| **Cinergy Corp.**              |       | $                                                  | 4,000      | (1) | $ | 547 |   |
| **CG&E** and  subsidiaries |       | 665                                                | (2)        | 232 |   |
| **PSI**                        |       | 600                                                |       | 78 |   |
| **ULH&P**                  |       | 65                                                 | (2)        | 19 |   |
|                                |            |                                                    |            |  |  |  |  |

 

----

(1)                                  **In June 2005, the SEC issued anorder under PUHCA authorizing****Cinergy****to increase its**total capitalization (excluding *retained earnings*and *accumulated other comprehensive income (loss)*),which may be any combination of debt and equity securities, by $4 billion overthe September 30, 2004 levels.  Outsidethis requirement, **CinergyCorp.** is not subject to specific regulatory debtauthorizations.

 

(2)                                  InDecember 2004, **Cinergy**and **ULH&P**requested approval from the SEC for an increase in **ULH&P****’****s**authority from $65 million to $150 million to coincide with the completion ofits pending transaction with **CG&E**in which **ULH&P**will acquire interests in three of **CG&E****’****s**electric generating stations.  At thistime, we are unable to predict whether the SEC will approve this request.

 

For the purposes of quantifying regulatory authority, short-term debtincludes revolving credit line borrowings, uncommitted credit line borrowings,intercompany money pool obligations, and commercial paper.

 

77

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**Cinergy Corp.’s**short-termborrowings consist primarily of unsecured revolving lines of credit and thesale of commercial paper.  **Cinergy Corp.’s** $2 billion revolving creditfacilities and $1.5 billion commercial paper program also support theshort-term borrowing needs of **CG&E**,**PSI**, and **ULH&P**. In addition, **Cinergy Corp.**,**CG&E**, and **PSI** maintain uncommitted lines ofcredit.  These facilities are not firmsources of capital but rather informal agreements to lend money, subject toavailability, with pricing determined at the time of advance.  The following table summarizes our *Notes payable and other short-term obligations* and *Notes payable to affiliated companies*:

 
| ** **                     | ** ** | **Short-term Borrowings** | ** ** |
|--------------------------------|------------|---------------------------|------------|
| ** **                     | ** ** | **June 30, 2005**         | ** ** |
| ** **                     | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Available** | ** ** |
| ** **                     | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Revolving** | ** ** |
| ** **                     | ** ** | **Established**           | ** ** | ** ** | ** ** | ** ** | ** ** | **Standby** | ** ** | **Lines of** | ** ** |
| ** **                     | ** ** | **Lines**                 | ** ** | **Outstanding** | ** ** | **Unused** | ** ** | **Liquidity(1)** | ** ** | **Credit** | ** ** |
| ** **                     | ** ** | **(in millions)**         | ** ** |
| * *                       | * *   | * *                  | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| **Cinergy**                    |       |                      |       |   |   |   |   |   |   |   |   |
| **Cinergy Corp.**              |       |                      |       |   |   |   |   |   |   |   |   |
| Revolving lines(2)             |       | $                         | 2,000      |   | $ | — |   | $ | 2,000 |   | $ | 558 |   | $ | 1,442 |   |
| Uncommitted lines              |       | 40                        | ** ** | — |   | 40 |   |   |   |   |   |
| Commercial paper(3)            |       |                      |       | 547 |   |   |   |   |   |   |   |
|                           |       |                      |       |   |   |   |   |   |   |   |   |
| Utility operating companies    |       |                      |       |   |   |   |   |   |   |   |   |
| Uncommitted lines              |       | 75                        |       | — |   | 75 |   |   |   |   |   |
| Pollution control notes        |       |                      |       | 248 |   |   |   |   |   |   |   |
|                           |       |                      |       |   |   |   |   |   |   |   |   |
| Non-regulated subsidiaries     |       |                      |       |   |   |   |   |   |   |   |   |
| Revolving lines(4)             |       | 162                       |       | 40 |   | 122 |   | — |   | 122 |   |
| Short-term debt                |       |                      |       | 5 |   |   |   |   |   |   |   |
| Pollution control notes        |       |                      |       | 25 |   |   |   |   |   |   |   |
|                           |       |                      |       |   |   |   |   |   |   |   |   |
| **Cinergy Total**              |       |                      |       | $ | 865 |   |   |   |   |   | $ | 1,564 |   |
|                           |       |                      |       |   |   |   |   |   |   |   |   |
| **CG&E** and  subsidiaries |       |                      |       |   |   |   |   |   |   |   |   |
| Uncommitted lines              |       | $                         | 15         |   | $ | — |   | $ | 15 |   |   |   |   |   |
| Pollution control notes        |       |                      |       | 112 |   |   |   |   |   |   |   |
| Money pool                     |       |                      |       | 232 |   |   |   |   |   |   |   |
|                           |       |                      |       |   |   |   |   |   |   |   |   |
| **CG&E Total**             |       |                      |       | $ | 344 |   |   |   |   |   |   |   |
| ** **                     |       |                      |       |   |   |   |   |   |   |   |   |
| **PSI**                        |       |                      |       |   |   |   |   |   |   |   |   |
| Uncommitted lines              |       | $                         | 60         |   | $ | — |   | $ | 60 |   |   |   |   |   |
| Pollution control notes        |       |                      |       | 136 |   |   |   |   |   |   |   |
| Money pool                     |       |                      |       | 78 |   |   |   |   |   |   |   |
|                           |       |                      |       |   |   |   |   |   |   |   |   |
| **PSI Total**                  |       |                      |       | $ | 214 |   |   |   |   |   |   |   |
| ** **                     |       |                      |       |   |   |   |   |   |   |   |   |
| **ULH&P**                  |       |                      |       |   |   |   |   |   |   |   |   |
| Money pool                     |       |                      |       | $ | 19 |   |   |   |   |   |   |   |
| ** **                     |       |                      |       |   |   |   |   |   |   |   |   |
| **ULH&P Total**            |       |                      |       | $ | 19 |   |   |   |   |   |   |   |
|                                |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)                                  Standbyliquidity is reserved against the revolving lines of credit to support thecommercial paper program and outstanding letters of credit (currently $547million and $11 million, respectively).

(2)                                  Consists of athree-year $1 billion facility and a five-year $1 billion facility.  The three-year facility was entered into inApril 2004 and matures in April 2007. The five-year facility was entered into in December 2004, matures inDecember 2009, and contains $500 million sublimits each for **CG&E**and **PSI**.

(3)                                  **CinergyCorp.’s** commercial paper program limit is $1.5 billion.  The commercial paper program is supported by **Cinergy Corp.’s**revolving lines of credit.

(4)                                  Of the $162million, $150 million relates to a three-year senior revolving credit facilitythat Cinergy Canada, Inc. entered into in December 2004 and matures in December2007.

 

78

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At June 30, 2005, **Cinergy Corp.**had $1.4 billion remaining unused and available capacity relating to its $2billion revolving credit facilities. These revolving credit facilities include the following:

 

| **Credit  Facility**        | ** ** | **Expiration** | ** ** | **Established  Lines** | ** ** | **Outstanding  and  Committed** | ** ** | **Unused and  Available** | ** ** |
|-----------------------------|------------|----------------|------------|------------------------|------------|---------------------------------|------------|---------------------------|------------|
| ** **                  | ** ** | ** **     | ** ** | ** **             | ** ** | **(in millions)**               | ** ** | ** **                | ** ** |
| Five-year senior revolving  |       | December 2009  |       |                   |       |                            |       |                      |       |
| Direct borrowing            |       |           |       |                   |       | $                               | —     |                      |       |   |
| Commercial paper support    |       |           |       |                   |       | —                          |       |                      |       |
|                        |       |           |       |                   |       |                            |       |                      |       |
| Total five-year facility(1) |       |           |       | $                      | 1,000      |                            | —     |                      | $          | 1,000 |   |
|                        |       |           |       |                   |       |                            |       |                      |       |
| Three-year senior revolving |       | April 2007     |       |                   |       |                            |       |                      |       |
| Direct borrowing            |       |           |       |                   |       | —                          |       |                      |       |
| Commercial paper support    |       |           |       |                   |       | 547                             |       |                      |       |
| Letter of credit support    |       |           |       |                   |       | 11                              |       |                      |       |
|                        |       |           |       |                   |       |                            |       |                      |       |
| Total three-year facility   |       |           |       | 1,000                  |       | 558                             |       | 442                       |       |
|                        |       |           |       |                   |       |                            |       |                      |       |
| Total Credit Facilities     |       |           |       | $                      | 2,000      |                            | $          | 558                       |       | $ | 1,442 |   |

 

----

(1)        **CG&E**and **PSI**each have$500 million borrowing sublimits on this facility.

 

In our credit facilities, **CinergyCorp.** has covenanted to maintain:

 

•                  a consolidatednet worth of $2 billion; and

•                  a ratio ofconsolidated indebtedness to consolidated total capitalization not in excess of65 percent.

 

As part of **CG&E’s** $500million sublimit under the $1 billion five-year credit facility, **CG&E** has covenanted to maintain:

 

•                  a consolidatednet worth of $1 billion; and

•                  a ratio ofconsolidated indebtedness to consolidated total capitalization not in excess of65 percent.

 

As part of **PSI’s** $500million sublimit under the $1 billion five-year credit facility, **PSI** has covenanted to maintain:

 

•                  a consolidatednet worth of $900 million; and

•                  a ratio ofconsolidated indebtedness to consolidated total capitalization not in excess of65 percent.

 

A breach of these covenants could result in the termination of thecredit facilities and the acceleration of the related indebtedness.  In addition to breaches of covenants, certainother events that could result in the termination of available credit andacceleration of the related indebtedness include:

 

•                  bankruptcy;

•                  defaults in thepayment of other indebtedness; and

•                  judgmentsagainst the company that are not paid or insured.

 

The latter two events, however, are subject to dollar-based materialitythresholds.  As of June 30, 2005, **Cinergy**, **CG&E**, and **PSI** are in compliance with all of their debt covenants.

 

##### ***Long-term Debt***

We are required to secure authority to issue long-term debt from theSEC under the PUHCA and the state utility commissions of Ohio, Kentucky, andIndiana.  For a discussion of the pendingPUHCA Repeal, see “Energy Bill” in “Liquidity and Capital Resources.”  The SEC under the PUHCA regulates theissuance of long-term debt by **Cinergy Corp.**  The respective state utility commissionsregulate the issuance of long-term debt by our utility operating companies.

 

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A current summary of our long-term debt authorizations at June 30,2005, was as follows:

 
| ** **                                       | ** ** | **Authorized**    | ** ** | **Used** | ** ** | **Available** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|----------|------------|---------------|------------|
| ** **                                       | ** ** | **(in millions)** | ** ** |
| * *                                         | * *   | * *          | * *   | * * | * *   | * *      | * *   |
| **Cinergy Corp.**                                |       |              |       |     |       |          |       |
| PUHCA total capitalization(1)                    |       | $                 | 4,000      |     | $          | 305           |       | $ | 3,695 |   |
|                                             |       |              |       |     |       |          |       |
| **CG&E**and  subsidiaries(2)                 |       |              |       |     |       |          |       |
| State Public Utility Commissions                 |       | $                 | 575        |     | $          | —        |       | $ | 575 |   |
| State Public Utility Commission -  Tax-Exempt    |       | 250               |       | 94       |       | 156           |       |
|                                             |       |              |       |     |       |          |       |
| **PSI**                                          |       |              |       |     |       |          |       |
| State Public Utility Commission                  |       | $                 | 500        |     | $          | —        |       | $ | 500 |   |
| State Public Utility Commission -  Tax-Exempt(3) |       | 250               |       | —   |       | 250           |       |
|                                             |       |              |       |     |       |          |       |
| **ULH&P**                                    |       |              |       |     |       |          |       |
| State Public Utility Commission(4)               |       | $                 | 75         |     | $          | —        |       | $ | 75 |   |

 

----

(1)**                                 ****In June 2005, the SEC issued an order under****PUHCA****authorizing****Cinergy****to increase its total capitalization(excluding *retained earnings*and*accumulated other comprehensive income (loss)*), which maybe any combination of debt and equity securities, by $4 billion over theSeptember 30, 2004 levels. Outside this requirement, Cinergy Corp. is notsubject to specific regulatory debt authorizations.**

(2)                                  Includes amounts for **ULH&P**.

(3)                                  In June 2005, the Indiana Utility RegulatoryCommission (IURC) granted **PSI** financingauthority to borrow the proceeds from the issuance and sale of up to $250million principal amount of tax exempt securities through December 31, 2005.

(4)                                  In April 2005, the Kentucky Public ServiceCommission (KPSC) granted **ULH&P**financing authority to issue and sell up to $500 million principal amountof secured and unsecured debt; enter into inter-company promissory notesup to an aggregate principal amount of $200 million; and borrow up to a maximumof $200 million aggregate principal amount of tax-exempt debt through December31, 2006. This authority is contingent upon the pending transaction with **CG&E** in which **ULH&P** willacquire interests in three of **CG&E’s**electric generating stations.

 

**Cinergy Corp.** has aneffective shelf registration statement with the SEC relating to the issuance ofup to $750 million in any combination of common stock, preferred stock, stockpurchase contracts or unsecured debt securities, of which $323 million remainsavailable for issuance.  **CG&E** has an effective shelfregistration statement with the SEC relating to the issuance of up to $800million in any combination of unsecured debt securities, first mortgage bonds,or preferred stock, all of which remains available for issuance.  **PSI**has an effective shelf registration statement with the SEC relating to theissuance of up to $800 million in any combination of unsecured debt securities,first mortgage bonds, or preferred stock, all of which remains available forissuance.  **ULH&P**has an effective shelf registration statement with the SEC for the issuance ofup to $75 million in unsecured debt securities, $35 million of which remainsavailable for issuance.  **ULH&P** also has an effective shelf registration statementwith the SEC relating to the issuance of up to $40 million in first mortgagebonds, of which $20 million remains available for issuance.

 

##### ***Off-BalanceSheet Arrangements***

 

As discussed in the 2004 10-K, **Cinergy** usesoff-balance sheet arrangements from time to time to facilitate financing ofvarious projects.  **Cinergy’s**primary off-balance sheet arrangement involves the sale of accounts receivableto a qualifying SPE.

 

In 2001, **Cinergy Corp.**issued $316 million notional amount of combined securities, a component ofwhich was stock purchase contracts. These contracts obligated the holder to purchase common shares of **Cinergy Corp.** stock by February 2005.  In January and February 2005, the stockpurchase contracts were settled, resulting in the issuance of common stock thatis recorded on **Cinergy’s** Condensed ConsolidatedBalance Sheets as Common Stock Equity.

 

80

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##### ***SecuritiesRatings***

 

As of June 30, 2005, the major credit rating agencies rated oursecurities as follows:

 
| ** **                 | ** ** | **Fitch(1)** | ** ** | **Moody’s(2)** | ** ** | **S&P(3)** | ** ** |
|----------------------------|------------|--------------|------------|---------------------|------------|----------------|------------|
|                       |       |         |       |                |       |           |       |
| **Cinergy Corp.**          |       |         |       |                |       |           |       |
| Corporate Credit           |       | BBB+         |       | Baa2                |       | BBB+           |       |
| Senior Unsecured Debt      |       | BBB+         |       | Baa2                |       | BBB            |       |
| Commercial Paper           |       | F-2          |       | P-2                 |       | A-2            |       |
| Preferred Trust Securities |       | BBB+         |       | Baa2                |       | BBB            |       |
|                       |       |         |       |                |       |           |       |
| **CG&E**               |       |         |       |                |       |           |       |
| Senior Secured Debt        |       | A-           |       | A3                  |       | A-             |       |
| Senior Unsecured Debt      |       | BBB+         |       | Baa1                |       | BBB            |       |
| Junior Unsecured Debt      |       | BBB          |       | Baa2                |       | BBB-           |       |
| Preferred Stock            |       | BBB          |       | Baa3                |       | BBB-           |       |
| Commercial Paper           |       | F-2          |       | P-2                 |       | Not Rated      |       |
|                       |       |         |       |                |       |           |       |
| **PSI**                    |       |         |       |                |       |           |       |
| Senior Secured Debt        |       | A-           |       | A3                  |       | A-             |       |
| Senior Unsecured Debt      |       | BBB+         |       | Baa1                |       | BBB            |       |
| Junior Unsecured Debt      |       | BBB          |       | Baa2                |       | BBB-           |       |
| Preferred Stock            |       | BBB          |       | Baa3                |       | BBB-           |       |
| Commercial Paper           |       | F-2          |       | P-2                 |       | Not Rated      |       |
|                       |       |         |       |                |       |           |       |
| **ULH&P**              |       |         |       |                |       |           |       |
| Senior Unsecured Debt      |       | BBB+         |       | Baa1                |       | BBB            |       |

 

----

(1)   Fitch Ratings (Fitch)

(2)   Moody’s Investors Service(Moody’s)

(3)   Standard & Poor’s Ratings Services (S&P)

 

The highest investment grade credit rating for Fitch is AAA, Moody’s isAaa1, and S&P is AAA.

The lowest investment grade credit rating for Fitch is BBB-, Moody’s isBaa3, and S&P is BBB-.

 

On May 10, 2005, S&P placed its ratings of **Cinergy Corp.** and its subsidiaries, on CreditWatchwith negative implications.  This actionwas in response to the announcement of the pending merger of Duke and **Cinergy** and the uncertainty around the final details of thetransaction.  Fitch has affirmed itsexisting ratings, noting that it anticipates the combined entity to achieve acredit profile similar to that of **Cinergy**.  Moody’s has also affirmed its ratings,anticipating that no incremental debt will be issued as a result of themerger.  See “Pending Merger” for afurther discussion of the transaction.

 

A security rating is not a recommendation to buy, sell, or holdsecurities.  These securities ratings maybe revised or withdrawn at any time, and each rating should be evaluatedindependently of any other rating.

 

##### ***Equity***

 

As discussed in the 2004 10-K, in January and February 2005, **Cinergy****Corp.** issued atotal of 9.2 million shares of common stock pursuant to certain stock purchasecontracts that were issued as a component of combined securities in December2001.  Net proceeds from the transactionof $316 million were used to reduce short-term debt.

 

**Cinergy** issues new **Cinergy Corp.** common stock shares tosatisfy obligations under certain of its employee stock plans and the CinergyCorp. Direct Stock Purchase and Dividend Reinvestment Plan.  During the six months ended June 30, 2005, **Cinergy** issued 1.9 million shares underthese plans.

 

In June 2005, **Cinergy Corp.**contributed $200 million in capital to **PSI**.  The capital contribution was used to repayshort-term indebtedness and is consistent with supporting **PSI’s**current credit ratings.

 

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**MD&A - FUTUREEXPECTATIONS/TRENDS**

 

### **FUTUREEXPECTATIONS/TRENDS**

 

In the “Future Expectations/Trends” section, we discuss developments inthe electric and gas industry and other matters.  Each of these discussions will address thecurrent status and potential future impact on our financial position or resultsof operations.

 

#### **Electric Industry**

 

##### ***RegulatoryOutlook***

 

*Ohio*

 

The pending merger agreement between Duke and **Cinergy**provides that both Duke and **Cinergy** willuse their reasonable best efforts to transfer five generating stations locatedin the Midwest from Duke to **CG&E**.  This transfer will require regulatoryapproval by the FERC and there can be no guarantee that such approval will beobtained or will be obtained on terms or with conditions acceptable to Duke, **Cinergy**, and Duke Energy Holding.  Duke intends to effectuate the transfer as anequity infusion into **CG&E** atbook value.  In conjunction with thetransfer, Duke and **CG&E** intendto enter into a financial arrangement to eliminate any potential cashshortfalls that may result from owning and operating the assets.  At this time, we cannot predict the outcomeof this matter.

 

*Kentucky*

 

The KPSC and the FERC have approved **ULH&P’s**plannedacquisition of **CG&E’s**approximately 69 percent ownership interest in the East Bend Station, locatedin Boone County, Kentucky, the Woodsdale Station, located in Butler County,Ohio, and one generating unit at the four-unit Miami Fort Station located inHamilton County, Ohio, and associated transactions.  **ULH&P** iscurrently seeking approval of the transaction in a proceeding before theSecurities and Exchange Commission (SEC), wherein the Ohio Consumers’ Counselhas intervened in opposition.  Thetransfer, which will be at net book value, will not affect current electricrates for **ULH&P’s** customers,as power will be provided under the same terms as under the current wholesalepower contract with **CG&E**through December 31, 2006.  Assumingreceipt of SEC approval, we would anticipate the transfer to take place in thethird quarter of 2005.

 

*Indiana*

 

On May 6, 2005, we signed a definitive agreement with subsidiariesof Allegheny Energy, Inc. whereby, subject to the terms and upon satisfactionof the conditions to closing provided in the purchase agreement, **PSI** and/or **CG&E** hadthe right to acquire the 512-megawatt Wheatland generating facility forapproximately $100 million.  TheWheatland facility, located in Knox County, Indiana, has four natural gas-firedsimple cycle combustion turbines and is directly connected to the **Cinergy** transmission system. In June and August 2005, respectively, the FERC and IURCapproved the acquisition and the Department of Justice and Federal TradeCommission completed their review of the transaction pursuant to thenotification requirements of the Hart-Scott-Rodino Antitrust ImprovementsAct.  We have determined that **PSI** will acquire 100% of the Wheatland facility.  Its output will be used to bolster the reservemargins on the **PSI** system.  **Cinergy** expectsto close the acquisition in August 2005.

 

##### ***FERC andMidwest ISO***

 

##### ***Midwest ISO Energy Markets***

 

The MidwestISO is a regional transmission organization established in 1998 as a non-profitorganization which maintains functional control over the combined transmissionsystems of its members, including **Cinergy**.  In March 2004, the Midwest ISO filed with theFERC proposed changes to its existing transmission tariff to add terms andconditions to implement a centralized economic dispatch platform supported by aDay-Ahead and Real-Time Energy Market design, including Locational MarginalPricing (LMP) and Financial Transmission Rights (FTRs)

 

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(EnergyMarkets Tariff).  The FERC has issuedorders that, among other things, conditionally approve the start-up of theEnergy Markets Tariff which occurred April 1, 2005.  The FERC issued orders in response torequests for rehearing on certain matters in the FERC’s original orders.  **Cinergy**has appealed****the FERC orders to a federal appeals court.

 

Specifically, the Energy Markets Tariff manages system reliabilitythrough the use of a market-based congestion management system and includes acentralized dispatch platform, the intent of which is to dispatch the mosteconomic resources to meet load requirements reliably and efficiently in theMidwest ISO region, which covers a large portion of 15 Midwestern states andone Canadian province.  The EnergyMarkets Tariff uses LMP (i.e., the energy price for the next MW may varythroughout the Midwest ISO market based on transmission congestion and energylosses), and the allocation or auction of FTRs, which are instruments thathedge against congestion costs occurring in the Day-Ahead market.  The Energy Markets Tariff also includesmarket monitoring and mitigation measures as well as a resource adequacyproposal, that proposes both an interim solution for participants providing andhaving access to adequate generation resources and a proposal to develop along-term solution to resource adequacy concerns.  The Midwest ISO performs a day-ahead unitcommitment and dispatch forecast for all resources in its market and alsoperforms the real-time resource dispatch for resources under its control on afive minute basis.  The **Cinergy** utility operating companies willseek to recover costs that they incur related to the Energy MarketsTariff.  We have been operating under theEnergy Markets Tariff since****April 2005.  We continue to work with the Midwest ISO tomonitor the implementation of the new market and at this time we do not believeit will have a material impact on our results of operations or financialposition.

 

##### ***Global ClimateChange***

 

Presently, GHGemissions, which principally consist of CO2, are not regulated, andwhile several legislative proposals have been introduced in Congress to reduceutility GHG emissions, none have been passed. Nevertheless, we anticipate a mandatory program to reduce GHG emissionswill exist in the future.  We expect thatany regulation of GHGs will impose costs on **Cinergy. **Depending on the details, any GHGregulation could mean:

 

•                  Increasedcapital expenditures associated with investments to improve plant efficiency orinstall CO2 emission reduction technology (to the extent that suchtechnology exists) or construction of alternatives to coal generation;

 

•                  Increasedoperation and maintenance expense;

 

•                  Ourolder, more expensive generating stations may operate fewer hours each yearbecause the addition of CO2 costs could cause their generation to beless economic; and

 

•                  Increasedexpenses associated with the purchase of CO2 emission allowances,should such an emission allowances market be created.

 

We would planto seek recovery of the costs associated with a GHG program in rate regulatedstates where cost recovery is permitted.

 

In September2003, **Cinergy** announced avoluntary GHG management commitment to reduce its GHG emissions during theperiod from 2010 through 2012 by five percent below our 2000 level, maintainingthose levels through 2012.  **Cinergy** expects to spend $21 millionbetween 2004 and 2010 on projects to reduce or offset its GHG emissions.  **Cinergy**is committed to supporting the President’s voluntary initiative, addressingshareholder interest in the issue, and building internal expertise in GHGmanagement and GHG markets.  Ourvoluntary commitment includes the following:

 

•                  Measuringand inventorying company-related sources of GHG emissions;

 

•                  Identifyingand pursuing cost-effective GHG emission reduction and offsetting activities;

 

•                  Fundingresearch of more efficient and alternative electric generating technologies;

 

•                  Fundingresearch to better understand the causes and consequences of climate change;

 

•                  Encouraginga global discussion of the issues and how best to manage them; and

 

•                  Participatingin discussions to help shape the policy debate.

 

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**Cinergy** is also studying the feasibility ofconstructing a commercial integrated coal gasification combined cycle (IGCC)generating station.  The IGCC plant wouldbe expected to run more efficiently than traditionally constructed coal-firedgeneration and would thus contribute fewer CO2 tons per megawatt ofelectricity produced.

 

#### **Other Matters**

 

##### ***Synthetic FuelProduction***

 

**Cinergy** produces from two facilities syntheticfuel that qualifies for tax credits (through 2007) in accordance with Section29 of the Internal Revenue Code (IRC) if certain requirements are satisfied.

 

**Cinergy’s**sale of synthetic fuel has generated $271 million in tax credits through June30, 2005.  The Internal Revenue Service(IRS) is currently auditing **Cinergy** for the2002 and 2003 tax years and has recently challenged certain other taxpayers’Section 29 tax credits.  While we cannotpredict whether the IRS will challenge our Section 29 tax credits, we expectthe IRS will evaluate the various key requirements for claiming our Section 29credits related to synthetic fuel.  Ifthe IRS challenges our Section 29 tax credits related to synthetic fuel, andsuch challenges were successful, this could result in the disallowance of up toall $271 million in previously claimed Section 29 tax credits for syntheticfuel produced by the applicable **Cinergy**facilities and a loss of our ability to claim future Section 29 tax credits forsynthetic fuel produced by such facilities. We believe that we operate in conformity with all the necessaryrequirements to be allowed such tax credits under Section 29.   Upon consummation of the pending merger ofDuke and **Cinergy**, the synthetic fuel produced byone of **Cinergy’s** facilities pursuant to theexisting commercial arrangement would cease to qualify for the Section 29credit.  **Cinergy**is evaluating a transaction for the disposition of a portion of the affectedfacility that **Cinergy** believes would enable thefuel produced by the facility to continue to qualify for credit under IRCSection 29. In the event a suitable transaction is not achieved, **Cinergy** anticipates that its production of synthetic fuel atthe affected facility would be suspended upon consummation of the pendingmerger with Duke.

 

Section 29 also provides for a phase-out of the credit based on theaverage price of crude oil during a calendar year.  The phase-out is based on a prescribedcalculation and definition of crude oil prices. Based on current crude oilprices, we do not currently expect a**materialnegative impact on our ability torecognize the projected benefit of Section 29 tax credits in 2005.

 

##### ***Ohio Taxes***

 

The Ohio legislature has approved sweeping changes to Ohio’stax law which will phase out theOhio corporate franchise tax over five years. The franchise tax will be replaced by a  “Commercial Activity Tax”, a tax imposed ongross receipts.  We do not expect the tax law changes to have a material impact on ourcash flows.  The phase-out of theOhio franchise tax resulted in the elimination of state income tax deferralsunder GAAP thus reducing the effective income tax rate for the currentquarter.  However, we do not expect thesechanges to have a material impact on our results of operations or financialposition going forward over the remainder of the phase-out period.

 

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**MD&A - MARKET RISKSENSITIVE INSTRUMENTS**

 

### **MARKETRISK SENSITIVE INSTRUMENTS**

 

#### **Energy Commodities Sensitivity**

 

The transactions associated with Commercial’s energy marketing andtrading activities and substantial investment in generation assets give rise tovarious risks, including price risk. Price risk represents the potential risk of loss from adverse changes inthe market price of electricity or other energy commodities.  As Commercial continues to develop its energymarketing and trading business, its exposure to movements in the price ofelectricity and other energy commodities may become greater.  As a result, we may be subject to increasedfuture earnings volatility.

 

As discussed in the 2004 10-K, Commercial’s energy marketing andtrading activities principally consist of Marketing & Trading’s natural gasmarketing and trading operations and **CG&E’s**power marketing and trading operations.

 

##### ***Changes inFair Value***

 

The changes in fair value of the energy risk management assets andliabilities for **Cinergy** and **CG&E** for the six months ended June 30,2005 and 2004 are presented in the table below.

 
| ** **                                                                                | ** ** | **Change in Fair Value** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                | ** ** | **June 30, 2005**        | ** ** | **June 30, 2004** | ** ** |
| ** **                                                                                | ** ** | **Cinergy(1)**           | ** ** | **CG&E** | ** ** | **Cinergy(1)** | ** ** | **CG&E** | ** ** |
| ** **                                                                                | ** ** | **(in millions)**        | ** ** |
| * *                                                                                  | * *   | * *                 | * *   | * * | * * | * * | * * | * * | * * |
| Fair value of contracts outstanding at the  beginning of the year                         |       | **$**                    | **82**     | ** ** | **$** | **36** |   | $ | 41 |   | $ | 20 |   |
|                                                                                      |       | ** **               | ** ** | ** ** |   |   |   |   |   |
| Changes in fair value attributable to  changes in valuation techniques and assumptions(2) |       | **(3**                   | **)**      | **(3** | ) | — |   | — |   |
|                                                                                      |       | ** **               | ** ** | ** ** |   |   |   |   |   |
| Other changes in fair value(3)                                                            |       | **(31**                  | **)**      | **5** |   | 103 |   | 49 |   |
|                                                                                      |       | ** **               | ** ** | ** ** |   |   |   |   |   |
| Option premiums paid/(received)                                                           |       | **14**                   | ** ** | **11** |   | (3 | ) | 2 |   |
|                                                                                      |       | ** **               | ** ** | ** ** |   |   |   |   |   |
| Contracts settled                                                                         |       | **(74**                  | **)**      | **(39** | ) | (76 | ) | (28 | ) |
|                                                                                      |       | ** **               | ** ** | ** ** |   |   |   |   |   |
| Fair value of contracts outstanding at end  of period                                     |       | **$**                    | **(12**    | **)** | **$** | **10** |   | $ | 65 |   | $ | 43 |   |

 

----

(1)          Theresults of **Cinergy** also include amountsrelated to non-registrants.

(2)          Representschanges in fair value recognized in income, caused by changes in assumptionsused in calculating fair value or changes in modeling techniques.

(3)          Representschanges in fair value recognized in income, primarily attributable tofluctuations in price. This amount includes both realized and unrealized gainson energy trading contracts.

 

The following are the balances at June 30, 2005 and 2004 of our energyrisk management assets and liabilities:

 
| ** **                                        | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|---------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                        | ** ** | **Cinergy(1)**    | ** ** | **CG&E**      | ** ** | **Cinergy(1)** | ** ** | **CG&E** | ** ** |
| ** **                                        | ** ** | **(in millions)** | ** ** |
| * *                                          | * *   | * *          | * *   | * *          | * *   | * * | * * | * * | * * |
| Energy risk management assets - current           |       | **$**             | **352**    | ** **        | **$**      | **228** |   | $ | 425 |   | $ | 156 |   |
| Energy risk management assets - non-current       |       | **307**           | ** ** | **135**           |       | 138 |   | 58 |   |
|                                              |       | ** **        | ** ** | ** **        |       |   |   |   |   |
| Energy risk management liabilities -  current     |       | **371**           | ** ** | **219**           |       | 384 |   | 134 |   |
| Energy risk management liabilities -  non-current |       | **300**           | ** ** | **134**           |       | 114 |   | 37 |   |
|                                              |       | ** **        | ** ** | ** **        |       |   |   |   |   |
|                                              |       | **$**             | **(12**    | **)**             | **$**      | **10** |   | $ | 65 |   | $ | 43 |   |

 

----

(1)           The results of **Cinergy**also include amounts related to non-registrants.

 

85

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The following table presents the expected maturity of the energy riskmanagement assets and liabilities as of June 30, 2005 for **Cinergy** and **CG&E**:

 
| ** **                                             | ** ** | **Fair Value of Contracts at June 30, 2005** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                             | ** ** | **Maturing**                                 | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Within 12**                                | ** ** | **12-36** | ** ** | **36-60** | ** ** | ** ** | ** ** | **Total** | ** ** |
| **Source of Fair Value(1)**                            | ** ** | **months**                                   | ** ** | **months** | ** ** | **months** | ** ** | **Thereafter** | ** ** | **Fair Value** | ** ** |
| ** **                                             | ** ** | **(in millions)**                            | ** ** |
| **Cinergy(2)**                                         |       |                                         |       |   |   |   |   |   |   |   |   |
| Prices actively quoted                                 |       | $                                            | (27        | ) | $ | 4 |   | $ | — |   | $ | — |   | $ | (23 | ) |
|                                                   |       |                                         |       |   |   |   |   |   |   |   |   |
| Prices based on models and other valuation  methods(3) |       | 9                                            |       | (2 | ) | 5 |   | (1 | ) | 11 |   |
|                                                   |       |                                         |       |   |   |   |   |   |   |   |   |
| Total                                                  |       | $                                            | (18        | ) | $ | 2 |   | $ | 5 |   | $ | (1 | ) | $ | (12 | ) |
|                                                   |       |                                         |       |   |   |   |   |   |   |   |   |
| **CG&E**                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Prices actively quoted                                 |       | $                                            | 6          |   | $ | (1 | ) | $ | — |   | $ | — |   | $ | 5 |   |
|                                                   |       |                                         |       |   |   |   |   |   |   |   |   |
| Prices based on models and other valuation  methods(3) |       | 2                                            |       | (3 | ) | 4 |   | 2 |   | 5 |   |
|                                                   |       |                                         |       |   |   |   |   |   |   |   |   |
| Total                                                  |       | $                                            | 8          |   | $ | (4 | ) | $ | 4 |   | $ | 2 |   | $ | 10 |   |

 

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(1)   Whileliquidity varies by trading regions, active quotes are generally available fortwo years for standard electricity transactions and three years for standardgas transactions.  Non-standardtransactions are classified based on the extent, if any, of modeling used indetermining fair value.  Long-termtransactions can have portions in both categories depending on the length.

(2)   The resultsof Cinergy also include amounts related to non-registrants.

(3)   Asubstantial portion of these amounts include option values.

 

##### ***GenerationPortfolio Risks***

 

**Cinergy** optimizes the value of itsnon-regulated portfolio.  The portfolioincludes generation assets (power and capacity), fuel, and emission allowancesand we manage all of these components as a portfolio.  We use models that forecast future generationoutput, fuel requirements, and emission allowance requirements based on forwardpower, fuel and emission allowance markets. The component pieces of the portfolio are bought and sold based on thismodel in order to manage the economic value of the portfolio.  With the issuance of Statement of FinancialAccounting Standards No. 149, *Amendment of Statement 133on Derivative Instruments and Hedging Activities* (Statement 149),most forward power transactions from management of the portfolio are accountedfor at fair value. The other component pieces of the portfolio are typicallynot subject to Statement 149 and are accounted for using the accrual method,where changes in fair value are not recognized. As a result, we are subject to earnings volatility via MTM gains orlosses from changes in the value of the contracts accounted for using fairvalue.  A hypothetical $1.00 per MWhincrease or decrease consistently applied to all forward power prices wouldhave resulted in an increase or decrease in fair value of these contracts ofapproximately $5.2 million as of June 30, 2005. See “2005 Quarterly Results of Operations” and “2005 Year to DateResults of Operations” for further discussion of the impact on current quarterand year to date results.

 

#### **Energy Trading Credit Risk**

 

**Cinergy’s** extension of credit for energymarketing and trading is governed by a Corporate Credit Policy.  Written guidelines approved by **Cinergy’s** Risk Policy Committee document the managementapproval levels for credit limits, evaluation of creditworthiness, and creditrisk mitigation procedures.  **Cinergy** analyzes net credit exposure and establishes creditreserves based on the counterparties’ credit rating, payment history, andlength of the outstanding obligation. Exposures to credit risks are monitored daily by the Corporate CreditRisk function, which is independent of all trading operations.  Energy commodity prices can be extremelyvolatile and the market can, at times, lack liquidity.  Because of these issues, credit risk forenergy commodities is generally greater than with other commodity trading.

 

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The following tables provide information regarding **Cinergy’s** and **CG&E’s** exposure on energy trading contracts as of June 30,2005.  The tables include accountsreceivable and energy risk management assets, which are net of accounts payableand energy risk management liabilities with the same counterparties when wehave the right of offset.  The creditcollateral shown in the following tables includes cash and letters of credit.

 

**Cinergy(1)**

 
| ** **                            | ** ** | ** **                    | ** ** | ** **             | ** ** | ** **       | ** ** | ** **              | ** ** | **Number of**            | ** ** | ** **                        | ** ** |
|---------------------------------------|------------|-------------------------------|------------|------------------------|------------|------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------------|------------|
| ** **                            | ** ** | ** **                    | ** ** | ** **             | ** ** | ** **       | ** ** | ** **              | ** ** | **Counterparties**       | ** ** | **Net Exposure of**               | ** ** |
| ** **                            | ** ** | **Total Exposure**            | ** ** | ** **             | ** ** | ** **       | ** ** | **Percentage  of**      | ** ** | **Greater than  10% of** | ** ** | **Counterparties  Greater than**  | ** ** |
| **Rating**                            | ** ** | **Before Credit  Collateral** | ** ** | **Credit  Collateral** | ** ** | **Net Exposure** | ** ** | **Total  Net Exposure** | ** ** | **Total Net  Exposure**  | ** ** | **10% of Total Net  Exposure(4)** | ** ** |
| ** **                            | ** ** | **(in millions)**             | ** ** |
| * *                              | * *   | * *                      | * *   | * *               | * *   | * *         | * *   | * *                | * *   | * *                 | * *   | * *                          | * *   |
| Investment Grade(2)                   |       | $                             | 713        |                   | $          | 126              |       | $                       | 587        |                     | 83         | %                                 | —     |   | $ | — |   |
| Internally Rated-Investment Grade(3)  |       | 127                           |       | 42                     |       | 85               |       | 12                      |       | —                   |       | —                            |       |
| Non-Investment Grade                  |       | 44                            |       | 30                     |       | 14               |       | 2                       |       | —                   |       | —                            |       |
| Internally Rated-Non-Investment Grade |       | 49                            |       | 30                     |       | 19               |       | 3                       |       | —                   |       | —                            |       |
|                                  |       |                          |       |                   |       |             |       |                    |       |                     |       |                              |       |
| Total                                 |       | $                             | 933        |                   | $          | 228              |       | $                       | 705        |                     | 100        | %                                 | —     |   | $ | — |   |

 

----

(1)          Includes amounts related tonon-registrants.

(2)          Includes counterparties ratedInvestment Grade or the counterparties’ obligations are guaranteed or securedby an Investment Grade entity.

(3)          Counterparties include avariety of entities, including investor-owned utilities, privately heldcompanies, cities and municipalities.  **Cinergy**assigns internal credit ratings to all counterparties within our credit riskportfolio, applying fundamental analytical tools.  Included in this analysis is a review of (butnot limited to) counterparty financial statements with consideration given tooff-balance sheet obligations and assets, specific business environment, accessto capital, and indicators from debt and equity capital markets.

(4)          Exposures, positive ornegative, with counterparties that are related to one another are notaggregated when no right of offset exists and as a result, credit is extendedand evaluated on a separate basis.

 

**CG&E**

 
| ** **                            | ** ** | ** **                    | ** ** | ** **             | ** ** | ** **       | ** ** | ** **              | ** ** | **Number of**            | ** ** | ** **                        | ** ** |
|---------------------------------------|------------|-------------------------------|------------|------------------------|------------|------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------------|------------|
| ** **                            | ** ** | ** **                    | ** ** | ** **             | ** ** | ** **       | ** ** | ** **              | ** ** | **Counterparties**       | ** ** | **Net Exposure of**               | ** ** |
| ** **                            | ** ** | **Total Exposure**            | ** ** | ** **             | ** ** | ** **       | ** ** | **Percentage  of**      | ** ** | **Greater than  10% of** | ** ** | **Counterparties  Greater than**  | ** ** |
| **Rating**                            | ** ** | **Before Credit  Collateral** | ** ** | **Credit  Collateral** | ** ** | **Net Exposure** | ** ** | **Total  Net Exposure** | ** ** | **Total Net  Exposure**  | ** ** | **10% of Total Net  Exposure(3)** | ** ** |
| ** **                            | ** ** | **(in millions)**             | ** ** |
|                                  |       |                          |       |
| Investment Grade(1)                   |       | $                             | 223        |                   | $          | 73               |       | $                       | 150        |                     | 79         | %                                 | 2          |   | $ | 48 |   |
| Internally Rated-Investment Grade(2)  |       | 30                            |       | —                 |       | 30               |       | 16                      |       | —                   |       | —                            |       |
| Non-Investment Grade                  |       | 12                            |       | 9                      |       | 3                |       | 2                       |       | —                   |       | —                            |       |
| Internally Rated-Non-Investment Grade |       | 18                            |       | 12                     |       | 6                |       | 3                       |       | —                   |       | —                            |       |
|                                  |       |                          |       |                   |       |             |       |                    |       |                     |       |                              |       |
| Total                                 |       | $                             | 283        |                   | $          | 94               |       | $                       | 189        |                     | 100        | %                                 | 2          |   | $ | 48 |   |
|                                       |            |                               |            |                        |            |                  |            |                         |            |                          |            |                                   |            |  |  |  |  |  |  |  |  |  |

 

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(1)          Includes counterparties ratedInvestment Grade or the counterparties’ obligations are guaranteed or securedby an Investment Grade entity.

(2)          Counterparties includevarious cities and municipalities.

(3)          Exposures, positive ornegative, with counterparties that are related to one another are notaggregated when no right of offset exists and as a result, credit is extendedand evaluated on a separate basis.

 

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**MD&A - ACCOUNTING MATTERS**

 

### **ACCOUNTING MATTERS**

 

#### **Critical Accounting Estimates**

 

Preparation of financial statements and related disclosures incompliance with GAAP requires the use of assumptions and estimates regardingfuture events, including the likelihood of success of particular investments orinitiatives, estimates of future prices or rates, legal and regulatorychallenges, and anticipated recovery of costs. Therefore, the possibility exists for materially different reportedamounts under different conditions or assumptions.  We consider an accounting estimate to becritical if:  1) the accounting estimaterequires us to make assumptions about matters that were reasonably uncertain atthe time the accounting estimate was made, and 2) changes in the estimate arereasonably likely to occur from period to period.

 

**Cinergy’s** 2004 10-Kincludes a discussion of accounting policies that are critical to thepresentation of **Cinergy’s**financial position and results of operations. These include:

 

•                  FairValue Accounting for Energy Marketing and Trading;

•                  RegulatoryAccounting;

•                  IncomeTaxes;

•                  Contingencies;

•                  Impairmentof Long-Lived Assets; and

•                  Impairmentof Unconsolidated Investments.

 

#### **Accounting Changes**

 

##### ***AssetRetirement Obligations***

 

In March 2005, the Financial Accounting Standards Board (FASB) issuedInterpretation No. 47, *Accounting forConditional Asset Retirement Obligations* (Interpretation 47), aninterpretation of Statement of Financial Accounting Standards No. 143, *Accounting for Asset Retirement Obligations*(Statement143).  Statement 143 requires recognitionof legal obligations associated with the retirement or removal of long-livedassets at the time the obligations are incurred.  Interpretation 47 clarifies that aconditional asset retirement obligation (which occurs when the timing and/ormethod of settlement are conditional on a future event that may or may not bewithin the control of the entity) is a legal obligation within the scope ofStatement 143.  As such, the fair valueof a conditional asset retirement obligation must be recognized as a liabilitywhen incurred if the liability’s fair value can be reasonably estimated.  Interpretation 47 also clarifies whensufficient information exists to reasonably estimate the fair value of an assetretirement obligation.

 

**Cinergy** will adopt Interpretation 47 onDecember 31, 2005.  Upon adoption ofInterpretation 47 **Cinergy** willrecognize the impact, if any, of additional liabilities for conditional asset retirementobligations as a cumulative effect of a change in accounting principle.  We have begun evaluating the impact ofadopting this new interpretation and are currently unable to predict whetherthe implementation of this accounting standard will be material to ourfinancial position or results of operations.

 

##### ***Share-BasedPayment***

 

In December 2004, the FASB issued a replacement of Statement ofFinancial Accounting Standards No. 123, *Accounting for Stock-BasedCompensation* (Statement 123), *Statement of FinancialAccounting Standards No. 123 (revised 2004), Share-Based Payment*(Statement 123R).  This standard willrequire, among other things, accounting for all stock-based compensationarrangements under the fair value method.

 

In 2003, we prospectively adopted accounting for our stock-basedcompensation plans using the fair value recognition provisions of Statement123, as amended by Statement of Financial Accounting Standards No. 148, *Accounting for Stock-Based Compensation-Transition and Disclosure*,for all employee awards granted or with terms modified on or after January 1,2003.  Therefore, the impact ofimplementation of Statement 123R on stock options within our stock-basedcompensation plans is not expected to be material.  Statement 123R contains certain

 

88

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provisions that will modify the accounting for various stock-basedcompensation plans other than stock options. We are in the process of evaluating the impact of this new standard onthese plans.  **Cinergy**will adopt Statement 123R on January 1, 2006.

 

##### ***Income Taxes***

 

In October 2004, the American Jobs Creation Act (AJCA) was signed intolaw.  The AJCA includes a one-timededuction of 85 percent of certain foreign earnings that are repatriated, as definedin the AJCA.  Based on our analysis, we do not believe that repatriation pursuant tothis provision will have a material impact on our financial position or resultsof operations.

 

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**QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

##  

## **ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

This information is provided in, and incorporated by reference from,the “Market Risk Sensitive Instruments” section in “Item 2. Management’s Discussionand Analysis of Financial Condition and Results of Operations”.

 

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**CONTROLS AND PROCEDURES**

 

## **ITEM4.  CONTROLS AND PROCEDURES**

 

#### **Evaluation of Disclosure Controls and Procedures**

 

Disclosurecontrols and procedures are our controls and other procedures that are designedto provide reasonable assurance that information required to be disclosed by usin the reports that we file or submit under the Securities Exchange Act of 1934(Exchange Act) is recorded, processed, summarized, and reported, within thetime periods specified by the Securities and Exchange Commission’s (SEC) rulesand forms.  Disclosure controls andprocedures include, without limitation, controls and procedures designed toprovide reasonable assurance that information required to be disclosed by us inthe reports that we file under the Exchange Act is accumulated and communicatedto our management, including our chief executive officer and chief financialofficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

Under thesupervision and with the participation of our management, including our chiefexecutive officer and chief financial officer, we have evaluated theeffectiveness of our disclosure controls and procedures as of June 30, 2005,and, based upon this evaluation, our chief executive officer and chieffinancial officer have concluded that these controls and procedures areeffective in providing reasonable assurance that information requiringdisclosure is recorded, processed, summarized, and reported within thetimeframe specified by the SEC’s rules and forms.

 

#### **Changes in Internal Control Over Financial Reporting**

 

Under the supervision and with the participation of our management,including our chief executive officer and chief financial officer, we haveevaluated changes in our internal control over financial reporting (as suchterm is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) duringthe fiscal quarter ended June 30, 2005.

 

On April 1, 2005, the Midwest Independent Transmission SystemOperation, Inc. (Midwest ISO), as ordered by the Federal Energy RegulatoryCommission, implemented the Day-Ahead and Real-time Energy Markets designincluding Locational Marginal Pricing and Financial Transmission Rights (EnergyMarkets Tariff).  As a result, **Cinergy** acquired and implemented changes to software systemsand processes to facilitate implementation of the Midwest ISO Energy MarketsTariff, which included software designed to communicate commercial bids andoffers with the Midwest ISO on an hourly basis and which is connected to **Cinergy’s** market transaction system.  Theinformation communicated between the Midwest ISO and **Cinergy**is utilized by the Midwest ISO to produce and reconcile daily settlementstatements submitted to **Cinergy**.  **Cinergy** also modified other systems and processes toaccommodate changes emanating from the Energy Markets Tariff implementation.

 

Effective April 1, 2005, **Cinergy**transitioned to a new finance and accounting system which contains newprocesses and tools that are designed to create more efficiency ingathering and reporting **Cinergy**financial data, provide greater transparency of financial data for reportingand compliance, and improve the consistency of how data is reported, thusaiding financial analysis and decision-making.

 

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**PART II. OTHER INFORMATION**

 

## **PARTII.  OTHER INFORMATION**

 

## **ITEM1.  LEGAL PROCEEDINGS**

 

### **CLEAN AIR ACT (CAA) LAWSUIT**

 

In November 1999,and through subsequent amendments, the United States brought a lawsuit in theUnited States Federal District Court for the Southern District of Indianaagainst **Cinergy**, The CincinnatiGas & Electric Company (**CG&E**), and PSI Energy, Inc. (**PSI**)alleging various violations of the CAA. Specifically, the lawsuit alleges that we violated the CAA by notobtaining Prevention of Significant Deterioration (PSD), Non-Attainment NewSource Review (NSR), and Ohio and Indiana State Implementation Plan (SIP)permits for various projects at our owned and co-owned generatingstations.  Additionally, the suit claimsthat we violated an Administrative Consent Order entered into in 1998 betweenthe Environmental Protection Agency (EPA) and **Cinergy**relating to alleged violations of Ohio’s SIP provisions governing particulatematter at Unit 1 at **CG&E’s**W.C. Beckjord Station.  The suit seeks(1) injunctive relief to require installation of pollution control technologyon various generating units at **CG&E’s**W.C. Beckjord and Miami Fort Stations, and **PSI’s**Cayuga, Gallagher, Wabash River, and Gibson Stations, and (2) civil penaltiesin amounts of up to $27,500 per day for each violation.  In addition, three northeast states and twoenvironmental groups have intervened in the case.  The case is currently in discovery and is setfor trial by jury commencing in February 2006.

 

In March 2000, theUnited States also filed in the United States District Court for the SouthernDistrict of Ohio an amended complaint in a separate lawsuit alleging violationsof the CAA relating to PSD, NSR, and Ohio SIP requirements regarding variousgenerating stations, including a generating station operated by ColumbusSouthern Power Company (CSP) and jointly-owned by CSP, The Dayton Power andLight Company (DP&L), and **CG&E**.  The EPA is seeking injunctive relief andcivil penalties of up to $27,500 per day for each violation.  This suit is being defended by CSP.  In April 2001, the United States DistrictCourt for the Southern District of Ohio in that case ruled that the Governmentand the intervening plaintiff environmental groups cannot seek monetary damagesfor alleged violations that occurred prior to November 3, 1994; however, theyare entitled to seek injunctive relief for such alleged violations.  Neither party appealed that decision.  This matter was heard in trial in July2005.  A decision is expected by the endof 2005.

 

In addition, **Cinergy** and **CG&E** have been informed by DP&L that in June 2000, theEPA issued a Notice of Violation (NOV) to DP&L for alleged violations ofPSD, NSR, and Ohio SIP requirements at a station operated by DP&L andjointly-owned by DP&L, CSP, and **CG&E**.  The NOV indicated the EPA may (1) issue anorder requiring compliance with the requirements of the Ohio SIP, or (2) bringa civil action seeking injunctive relief and civil penalties of up to $27,500per day for each violation.  In September2004, Marilyn Wall and the Sierra Club brought a lawsuit against **CG&E**, DP&L and CSP for alleged violations of the CAAat this same generating station.

 

We are unable topredict whether resolution of these matters would have a material effect on ourfinancial position or results of operations.  We intend to vigorously defend against theseallegations.

 

### **CARBON DIOXIDE (CO2)LAWSUIT**

 

In July 2004, the states of Connecticut, New York, California, Iowa,New Jersey, Rhode Island, Vermont, Wisconsin, and the City of New York broughta lawsuit in the United States District Court for the Southern District of NewYork against **Cinergy**, American Electric Power Company, Inc.,American Electric Power Service Corporation, The Southern Company, TennesseeValley Authority, and Xcel Energy Inc. That same day, a similar lawsuit was filed in the United States DistrictCourt for the Southern District of New York against the same companies by OpenSpace Institute, Inc., Open Space Conservancy, Inc., and The Audubon Society ofNew Hampshire.  These lawsuits allegethat the defendants’ emissions of CO2 from the combustion of fossilfuels at electric generating facilities contribute to global warming and amountto a public nuisance.  The complaintsalso allege that the defendants could generate the same amount of electricitywhile emitting significantly less CO2.  The plaintiffs are seeking an injunctionrequiring each defendant to cap its CO2 emissions and then reducethem by a specified percentage each year for at least a decade.  **Cinergy**intends to defend these lawsuits vigorously in court

 

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and filed motions to dismiss with the other defendants in September2004.  We are not able to predict whetherresolution of these matters would have a material effect on our financialposition or results of operations.

 

### **SELECTIVECATALYTIC REDUCTION UNITS (SCR) AT GIBSON STATION**

 

In May 2004, SCRs and other pollution control equipment becameoperational at Units 4 and 5 of **PSI’s**Gibson Station in accordance with compliance deadlines under the nitrogen oxideSIP Call.  In June and July 2004, GibsonStation temporarily shut down the equipment on these units due to a concernthat portions of the plume from those units’ stacks appeared to break apart anddescend to ground level, at certain times, under certain weatherconditions.  As a result, and, workingwith the City of Mt. Carmel, Illinois, Illinois EPA, Indiana Department ofEnvironmental Management (IDEM), EPA, and the State of Illinois, we developed aprotocol regarding the use of the SCRs while we explored alternatives toaddress this issue.  After the protocolwas finalized, the Illinois Attorney General brought an action in Wabash CountyCircuit Court against **PSI** seeking apreliminary injunction to enforce the protocol. In August 2004, the court granted that preliminary injunction.  **PSI** isappealing that decision to the Fifth District Appellate Court, but we cannotpredict the ultimate outcome of that appeal or of the underlying action by theIllinois Attorney General.

 

In April 2005, we completed the installation of a permanent controlsystem to address this issue.  The newcontrol system will support all five Gibson generating units.  We will seek recovery of any related capitalas well as increased emission allowance expenditures through the regulatoryprocess.  We do not believe costs related to resolving this matterwill have a material impact on our financial position or results of operations.

 

### **ZIMMER STATION LAWSUIT**

 

In November 2004, a citizen of the Village of Moscow, Ohio, the townadjacent to **CG&E’s** Zimmer Station, broughta purported class action in the United States District Court for the SouthernDistrict of Ohio seeking monetary damages and injunctive relief against **CG&E** for alleged violations of the CAA, the Ohio SIP, andOhio laws against nuisance and common law nuisance.  **CG&E**filed a motion to dismiss the lawsuit on primarily procedural grounds and weintend to defend against these claims vigorously.  The plaintiffs havefiled a number of additional notices of intent to sue and two lawsuits raisingclaims similar to those in the original claim. At this time, we cannot predict whether the outcome of this matter willhave a material impact on our financial position or results of operations.

 

### **MANUFACTURED GAS PLANT (MGP)SITES**

 

Coal tar residues, related hydrocarbons, andvarious metals have been found in at least 22 sites that **PSI** or its predecessors previously ownedand sold in a series of transactions with Northern Indiana Public ServiceCompany (NIPSCO) and Indiana Gas Company, Inc. (IGC).  The 22 sites are in the process of beingstudied and will be remediated, if necessary. In 1998 NIPSCO, IGC, and **PSI**entered into Site Participation and Cost Sharing Agreements to allocateliability and responsibilities between them. The IDEM oversees investigation and cleanup of all of these sites.  Thus far, **PSI**has primary responsibility for investigating, monitoring and, if necessary,remediating nine of these sites.  InDecember 2003, **PSI** entered into avoluntary remediation plan with the state of Indiana, providing a formalframework for the investigation and cleanup of the sites.

 

In April 1998, **PSI** filed suit in Hendricks County in the state of Indianaagainst its general liability insurance carriers.  **PSI**sought a declaratory judgment to obligate its insurance carriers to (1) defendMGP claims against **PSI** andcompensate **PSI** for its costs ofinvestigating, preventing, mitigating, and remediating damage to property andpaying claims related to MGP sites; or (2) pay **PSI’s** cost of defense.  **PSI** settled, in principle, its claims with all but one ofthe insurance carriers in January 2005 prior to commencement of the trial.  With respect to the lone insurance carrier, ajury returned a verdict against **PSI** in February2005.  **PSI**has appealed this decision.  At thepresent time, **PSI** cannot predict the outcome ofthis litigation, including the outcome of the appeal.

 

**PSI** has accruedcosts related to investigation, remediation, and groundwater monitoring forthose sites where such costs are probable and can be reasonably estimated.  We will continue to investigate and remediatethe sites as outlined in the voluntary remediation plan.  As additional facts become known andinvestigation is completed, we

 

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will assess whether the likelihood of incurring additional costsbecomes probable.  Until all investigationand remediation is complete, we are unable to determine the overall impact onour financial position or results of operations.

 

**CG&E** and **ULH&P**have performed site assessments on certain of their sites where we believe MGPactivities have occurred at some point in the past and have found no imminentrisk to the environment.  At the presenttime, **CG&E** and **ULH&P** cannot predict whetherinvestigation and/or remediation will be required in the future at any of thesesites.

 

### **ASBESTOS CLAIMS LITIGATION**

 

**CG&E** and **PSI** have been named as defendants orco-defendants in lawsuits related to asbestos at their electric generatingstations.  Currently, there areapproximately 120 pending lawsuits.  Inthese lawsuits, plaintiffs claim to have been exposed to asbestos-containingproducts in the course of their work at the **CG&E**and **PSI** generating stations.  The plaintiffs further claim that as theproperty owner of the generating stations,**CG&E** and **PSI** shouldbe held liable for their injuries and illnesses based on an alleged duty towarn and protect them from any asbestos exposure.  A majority of the lawsuits to date have beenbrought against **PSI**.  The impact on **CG&E’s** and **PSI’s**financial position or results of operations of these cases to date has not beenmaterial.

 

Of these lawsuits, one case filed against **PSI** has been tried to verdict. The jury returned a verdict against **PSI**in the amount of approximately $500,000 on a negligence claim and a verdict for**PSI** on punitive damages.  **PSI**appealed this decision up to the Indiana Supreme Court.  In July 2005, the Indiana Supreme Courtupheld the jury’s verdict.  In addition, **PSI** has settled a number of other lawsuitsfor amounts, which neither individually nor in the aggregate, are material to **PSI’s** financial position or results ofoperations.  We are currently evaluatingthe effect of the Indiana Supreme Court’s ruling on our existing docket ofcases.

 

At this time, **CG&E** and**PSI**are not able to predict theultimate outcome of these lawsuits or the impact on **CG&E’s** and **PSI’s**financial position or results of operations.

 

### **MERGER LAWSUIT**

 

In May, a purported shareholder class action was filed in the Court ofCommon Pleas in Hamilton County, Ohio against **Cinergy**and each of the members of the Board of Directors. The lawsuit alleges that thedefendants breached their duties of due care and loyalty to shareholders byagreeing to the merger agreement between Duke and **Cinergy**and is seeking to either enjoin or amend the terms of the merger.  **Cinergy** and theindividual defendants filed a motion to dismiss this lawsuit in July.  We believe this lawsuit is without merit and **Cinergy** intends to defend this lawsuit vigorously incourt.  We are unable to predict whetherresolution of this matter will impact our pending merger.

 

**DUNAVAN WASTE SUPERFUND SITE**

 

In July 2005, **PSI** received notice from the EPA that it has been identifiedas a de minimus potentially responsible party under the ComprehensiveEnvironmental Response, Compensation, and Liability Act at the Dunavan Waste OilSite in Oakwood, Vermilion County, Illinois.  At this time, **PSI**doesnot have any further information regarding the scope of potential liabilityassociated with this matter.

 

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## **ITEM2.  UNREGISTERED SALES OF EQUITY SECURITIESAND USE OF PROCEEDS**

 

The number of shares (or units) provided in the table below representshares exchanged in connection with employee option exercises and sharespurchased by the plan trustee on behalf of the 401(k) Excess Plan.

 
| **Period**              | ** ** | **(a) Total Number of  Shares (or Units)  Purchased** | ** ** | **(b) Average Price  Paid per Share (or  Unit)** | ** ** | **(c) Total Number of  Shares (or Units)  Purchased as Part of  Publicly Announced  Plans or Programs** | ** ** | **(d) Maximum Number  (or Approximate  Dollar Value) of  Shares (or Units) that  May Yet Be  Purchased Under the  Plans or Programs** | ** ** |
|-------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|
|                    |       |                                                  |       |                                             |       |                                                                                                    |       |                                                                                                                                  |       |
| April 1 – April 30 |       | —                                                |       | $                                                | —     |                                                                                                    | —     |                                                                                                                                  | —     |   |
| May 1 – May 31     |       | 49,118                                                |       | $                                                | 41.59      |                                                                                                    | —     |                                                                                                                                  | —     |   |
| June 1 – June 30   |       | 5,721                                                 |       | $                                                | 44.16      |                                                                                                    | —     |                                                                                                                                  | —     |   |

 

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## **ITEM 6.  EXHIBITS**

 

The documents listed below are being furnished or filed on behalf of **Cinergy Corp.**, The Cincinnati Gas &Electric Company (**CG&E**), PSIEnergy, Inc. (**PSI**), and The UnionLight, Heat and Power Company (**ULH&P**).  Exhibits not identified as previously furnishedor filed are furnished or filed herewith:

 
| **Exhibit  Designation** | ** ** | **Registrant**                                   | ** ** | **Nature of Exhibit**                                                                                                                                                                                                                                                       | ** ** | **Previously Filed  as Exhibit to:**             | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
|                     |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
| **Additional Exhibits**  |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
|                     |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
| 2-a                      |       | **Cinergy  Corp.**                               | ** ** | Agreement  and Plan of Merger by and among Duke Energy Corporation, **Cinergy  Corp.**, Deer Holding Corp., Deer Acquisition Corp. and Cougar  Acquisition Corp., dated May 8, 2005                                                                                         | ** ** | **Cinergy  Corp.**  Form 8-K, filed May 10, 2005 |       |
|                     |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
| 2-b                      |       | **Cinergy  Corp.**                               |       | Amendment  No. 1 to the Agreement and Plan of Merger                                                                                                                                                                                                                        |       |                                             |       |
|                     |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
| 10-ffff                  |       | **Cinergy  Corp.**                               | ** ** | Retirement  and Consulting Agreement and Waiver and Release Agreement, dated May 5, 2005,  between **Cinergy Corp.** and William J. Grealis                                                                                                                                 |       | **Cinergy  Corp.**  March 31, 2005  Form 10-Q    |       |
|                     |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
| 10-gggg                  |       | **Cinergy  Corp.**                               | ** ** | Employment  Agreement Term Sheet, James E. Rogers, dated May 8, 2005, by Duke Energy  Corporation, **Cinergy Corp.**, Deer Holding  Corp., and James E. Rogers                                                                                                              |       | **Cinergy  Corp.**  Form 8-K, filed May 10, 2005 |       |
|                     |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
| 10-hhhh                  |       | **Cinergy  Corp.**                               | ** ** | Form  of Amendment to Employment Agreement                                                                                                                                                                                                                                  |       | **Cinergy  Corp.**  Form 8-K, filed May 10, 2005 |       |
|                     |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
| 10-iiiii                 |       | **Cinergy  Corp.**                               | ** ** | Separation  Agreement and Waiver and Release Agreement, dated July 8, 2005, between  Cinergy Services, Inc. and R. Foster Duncan                                                                                                                                            |       | **Cinergy  Corp.**  Form 8-K, filed July 8, 2005 |       |
|                     |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
| 10-jjjj                  |       | **Cinergy  Corp.**                               | ** ** | Amendment  to Employment Agreement, effective May 24, 2005, between Cinergy Services,  Inc. and Michael J. Cyrus                                                                                                                                                            |       | **Cinergy  Corp.**  Form 8-K, filed July 8, 2005 |       |
|                     |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
| 10-kkkk                  |       | **CG&E****PSI**                              |       | Asset  Purchase Agreement by and among PSI Energy, Inc. and The Cincinnati Gas &  Electric Company and Allegheny Energy Supply Company, LLC, Allegheny Energy  Supply Wheatland Generating Facility, LLC and Lake Acquisition Company,  L.L.C., dated as of May 6, 2005 |       |                                             |       |
|                     |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
| **Certificates**         |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
|                     |       |                                             |       |                                                                                                                                                                                                                                                                        |       |                                             |       |
| **31-a**                 | ** ** | **Cinergy Corp.  CG&E  PSI  ULH&P** | ** ** | **Certification  by James E. Rogers pursuant to Rule 13a-14(a)/15d-14(a) of the Securities  Exchange Act of 1934, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.**                                                                                  | ** ** | ** **                                       | ** ** |
| ** **               | ** ** | ** **                                       | ** ** | ** **                                                                                                                                                                                                                                                                  | ** ** | ** **                                       | ** ** |
| **31-b**                 | ** ** | **Cinergy Corp.  CG&E  PSI  ULH&P** | ** ** | **Certification  by James L. Turner pursuant to Rule 13a-14(a)/15d-14(a) of the Securities  Exchange Act of 1934, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.**                                                                                  | ** ** | ** **                                       | ** ** |
| ** **               | ** ** | ** **                                       | ** ** | ** **                                                                                                                                                                                                                                                                  | ** ** | ** **                                       | ** ** |
| **32-a**                 | ** ** | **Cinergy Corp.  CG&E  PSI  ULH&P** | ** ** | **Certification  by James E. Rogers pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.**                                                                                                                            | ** ** | ** **                                       | ** ** |
| ** **               | ** ** | ** **                                       | ** ** | ** **                                                                                                                                                                                                                                                                  | ** ** | ** **                                       | ** ** |
| 32-b                     |       | **Cinergy Corp.  CG&E  PSI  ULH&P** |       | Certification  by James L. Turner 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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## **SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,each of the Registrants has duly caused this report to be signed on its behalfby the undersigned thereunto duly authorized.

 

CINERGY CORP.

THE CINCINNATI GAS & ELECTRIC COMPANY

PSI ENERGY, INC.

THE UNION LIGHT, HEAT AND POWER COMPANY

Registrants

 

 
| Date: August 4, 2005 | /s/    | Lynn J. Good                  |   |
|----------------------|--------|-------------------------------|--------|
|                 |   | Lynn J. Good                  |   |
|                 |   | (duly authorized officer      |   |
|                 |   | and                           |   |
|                 |   | principal accounting officer) |   |

 

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