**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-Q**

**(MarkOne)**

**ý**  QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe quarterly period ended June 30, 2003**

**or**

**o**  TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**Forthe transition 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  ý  No  o

 

----

 

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

Yes  ý  No  o

 

----

 

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 asto information 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, 2003,shares of common stock outstanding for each registrant were as listed:

 

| **Registrant**                                 |   | **Description**                                 |   | **Shares**  |
|------------------------------------------------|--------|-------------------------------------------------|--------|-------------|
|                                           |   |                                            |   |        |
| **Cinergy  Corp.**                             |   | Par value $.01 per  share                       |   | 177,496,253 |
|                                           |   |                                            |   |        |
| **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.***                                                                             |
|             | Consolidated  Statements of Income                                                              |
|             | Consolidated Balance Sheets                                                                     |
|             | Consolidated  Statements of Changes in Common Stock Equity                                      |
|             | Consolidated  Statements of Cash Flows                                                          |
|             |                                                                                            |
|             | ***The  Cincinnati Gas & Electric Company***                                                |
|             | Consolidated  Statements of Income and Comprehensive Income                                     |
|             | Consolidated Balance Sheets                                                                     |
|             | Consolidated  Statements of Cash Flows                                                          |
|             |                                                                                            |
|             | ***PSI Energy, Inc.***                                                                          |
|             | Consolidated  Statements of Income and Comprehensive Income                                     |
|             | Consolidated Balance Sheets                                                                     |
|             | Consolidated  Statements of Cash Flows                                                          |
|             |                                                                                            |
|             | ***The Union  Light, Heat and Power Company***                                                  |
|             | Statements of Income                                                                            |
|             | Balance Sheets                                                                                  |
|             | Statements of Cash Flows                                                                        |
|             |                                                                                            |
|             | **Notes to Financial  Statements**                                                              |
|             |                                                                                            |
|             | **Cautionary  Statements Regarding Forward-Looking Information**                                |
|             |                                                                                            |
| 2                | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** |
|             | Introduction                                                                                    |
|             | Organization                                                                                    |
|             | Liquidity and Capital  Resources                                                                |
|             | 2003 Quarterly Results of Operations  - Historical                                              |
|             | 2003  Year to Date Results of Operations - Historical                                           |
|             | Results of Operations -  Future                                                                 |
|             |                                                                                            |
| 3                | **Quantitative  and Qualitative Disclosures About Market Risk**                                 |
|             |                                                                                            |
| 4                | **Controls and  Procedures**                                                                    |
|             |                                                                                            |
|             | **PART II  OTHER INFORMATION**                                                             |
|             |                                                                                            |
| 1                | **Legal Proceedings**                                                                           |
|             |                                                                                            |
| 6                | **Exhibits and  Reports on Form 8-K**                                                           |
|             |                                                                                            |
|             | **Signatures**                                                                                  |

 

3

----

 

 

 

**CINERGYCORP.**

**AND SUBSIDIARY COMPANIES**

 

4

----

 

**CINERGYCORP.**

**CONSOLIDATED STATEMENTS OF INCOME**

** **
|                                                                                                 |   | **Quarter Ended  June 30**                    |         | **Year to Date  June 30** |   |
|------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------------|---------------------------|--------|
|                                                                                                 |   | **2003**                                      |         | **2002**                  |   | **2003** |   | **2002** |   |
|                                                                                                 |   | **(in  thousands, except per share amounts)** |         |
|                                                                                                 |   | **(unaudited)**                               | *** *** |
| **Operating Revenues** (Note 1(g)(*i*))                                                              |   |                                          |         |                      |   |   |   |   |   |
| Electric                                                                                             |   | **$**                                         | **769,258**  | ** **                | $      | 804,463 |   | **$** | **1,592,316** | ** ** | $ | 1,565,848 |   |
| Gas                                                                                                  |   | **114,932**                                   | ** **   | 80,208                    |   | **513,845** | ** ** | 270,272 |   |
| Other                                                                                                |   | **49,733**                                    | ** **   | 22,624                    |   | **95,719** | ** ** | 39,561 |   |
| **Total Operating Revenues**                                                                         |   | **933,923**                                   | ** **   | 907,295                   |   | **2,201,880** | ** ** | 1,875,681 |   |
|                                                                                                 |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| **Operating Expenses**                                                                               |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| Fuel and purchased and exchanged power (Note 1(g)(*i*))                                         |   | **240,470**                                   | ** **   | 241,686                   |   | **510,335** | ** ** | 459,492 |   |
| Gas purchased (Note 1(g)(*i*))                                                                       |   | **53,319**                                    | ** **   | 29,562                    |   | **289,314** | ** ** | 139,442 |   |
| Operation and maintenance                                                                            |   | **330,006**                                   | ** **   | 338,306                   |   | **655,168** | ** ** | 598,918 |   |
| Depreciation                                                                                         |   | **105,228**                                   | ** **   | 97,979                    |   | **208,863** | ** ** | 194,295 |   |
| Taxes other than income taxes                                                                        |   | **66,958**                                    | ** **   | 64,247                    |   | **144,707** | ** ** | 136,669 |   |
| **Total Operating Expenses**                                                                         |   | **795,981**                                   | ** **   | 771,780                   |   | **1,808,387** | ** ** | 1,528,816 |   |
|                                                                                                 |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| **Operating Income**                                                                                 |   | **137,942**                                   | ** **   | 135,515                   |   | **393,493** | ** ** | 346,865 |   |
|                                                                                                 |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| **Equity in Earnings (Losses) of  Unconsolidated Subsidiaries**                                      |   | **6,104**                                     | ** **   | (581                      | )      | **6,696** | ** ** | 4,108 |   |
| **Miscellaneous – Net**                                                                         |   | **7,767**                                     | ** **   | (3,063                    | )      | **15,382** | ** ** | (4,448 | ) |
| **Interest Expense**                                                                                 |   | **60,394**                                    | ** **   | 58,431                    |   | **119,548** | ** ** | 117,604 |   |
| **Preferred Dividend Requirement of  Subsidiary Trust**                                              |   | **5,970**                                     | ** **   | 5,968                     |   | **11,940** | ** ** | 11,881 |   |
|                                                                                                 |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| **Income Before Taxes**                                                                              |   | **85,449**                                    | ** **   | 67,472                    |   | **284,083** | ** ** | 217,040 |   |
|                                                                                                 |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| **Income Taxes**                                                                                     |   | **8,983**                                     | ** **   | 21,298                    |   | **66,966** | ** ** | 75,842 |   |
| **Preferred Dividend Requirements of  Subsidiaries**                                                 |   | **858**                                       | ** **   | 858                       |   | **1,716** | ** ** | 1,716 |   |
|                                                                                                 |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| **Income Before Discontinued  Operations and Cumulative Effect of Changes in Accounting Principles** |   | **75,608**                                    | ** **   | 45,316                    |   | **215,401** | ** ** | 139,482 |   |
|                                                                                                 |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| Discontinued operations, net of tax (Note 7)                                                         |   | **9,045**                                     | ** **   | (333                      | )      | **8,875** | ** ** | 1,229 |   |
| Cumulative effect of changes in accounting  principles, net of tax (Note 1(g)(*vii*))                |   | **—**                                    | ** **   | —                    |   | **26,462** | ** ** | (10,899 | ) |
| **Net Income**                                                                                       |   | **$**                                         | **84,653**   | ** **                | $      | 44,983 |   | **$** | **250,738** | ** ** | $ | 129,812 |   |
|                                                                                                 |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| **Average Common Shares Outstanding**                                                                |   | **176,645**                                   | ** **   | 167,330                   |   | **175,025** | ** ** | 165,821 |   |
|                                                                                                 |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| **Earnings Per Common Share** (Note 9)                                                               |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| Income  Before Discontinued Operations and Cumulative Effect of Changes in Accounting  Principles    |   | **$**                                         | **0.42**     | ** **                | $      | 0.27 |   | **$** | **1.23** | ** ** | $ | 0.84 |   |
| Discontinued  operations, net of tax                                                                 |   | **0.05**                                      | ** **   | —                    |   | **0.05** | ** ** | 0.01 |   |
| Cumulative  effect of changes in accounting principles, net of tax                                   |   | **—**                                    | ** **   | —                    |   | **0.15** | ** ** | (0.06 | ) |
| Net  Income                                                                                          |   | **$**                                         | **0.47**     | ** **                | $      | 0.27 |   | **$** | **1.43** | ** ** | $ | 0.79 |   |
|                                                                                                 |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| **Earnings Per Common Share - Assuming Dilution** (Note  9)                                     |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| Income  Before Discontinued Operations and Cumulative Effect of Changes in Accounting  Principles    |   | **$**                                         | **0.42**     | ** **                | $      | 0.26 |   | **$** | **1.22** | ** ** | $ | 0.83 |   |
| Discontinued  operations, net of tax                                                                 |   | **0.05**                                      | ** **   | —                    |   | **0.05** | ** ** | 0.01 |   |
| Cumulative  effect of changes in accounting principles, net of tax                                   |   | **—**                                    | ** **   | —                    |   | **0.15** | ** ** | (0.06 | ) |
| Net  Income                                                                                          |   | **$**                                         | **0.47**     | ** **                | $      | 0.26 |   | **$** | **1.42** | ** ** | $ | 0.78 |   |
|                                                                                                 |   |                                          | ** **   |                      |   |   | ** ** |   |   |
| **Dividends Declared Per Common Share**                                                              |   | **$**                                         | **0.46**     | ** **                | $      | 0.45 |   | **$** | **0.92** | ** ** | $ | 0.90 |   |

 

**The accompanying notes as they relateto Cinergy Corp. are an integral part of these consolidated financialstatements.**

 

5

----

 

**CINERGYCORP.**

**CONSOLIDATED BALANCE SHEETS**

 

**ASSETS**

 
|                                                                                                                                           |   | **June 302003**     |           | **December 31  2002** |     |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|----------------|-----------------------|----------|
|                                                                                                                                           |   | **(in  thousands)** |           |
|                                                                                                                                           |   | **(unaudited)**     |           |
|                                                                                                                                           |   |                | * *       |                  | * * |
| **Current Assets**                                                                                                                             |   |                |           |                  |     |
| Cash and cash equivalents                                                                                                                      |   | **$**               | **249,016**    | ** **            | $        | 200,112 |   |
| Restricted deposits                                                                                                                            |   | **3,609**           | ** **     | 3,092                 |     |
| Notes receivable                                                                                                                               |   | **78,112**          | ** **     | 135,873               |     |
| Accounts receivable less accumulated provision for  doubtful accounts of $11,447 at June 30, 2003, and $16,368 at  December 31, 2002 |   | **1,163,652**       | ** **     | 1,280,810             |     |
| Materials, supplies, and fuel (Note 1(c))                                                                                                      |   | **321,247**         | ** **     | 319,454               |     |
| Energy risk management current assets (Note 1(b)(*i*))                                                                                         |   | **401,054**         | ** **     | 464,028               |     |
| Prepayments and other                                                                                                                          |   | **121,168**         | ** **     | 107,086               |     |
| **Total Current Assets**                                                                                                                       |   | **2,337,858**       | ** **     | 2,510,455             |     |
|                                                                                                                                           |   |                | ** **     |                  |     |
| **Property, Plant, and Equipment - at  Cost**                                                                                                  |   |                | ** **     |                  |     |
| Utility plant in service (Note 11)                                                                                                             |   | **9,374,785**       | ** **     | 8,641,351             |     |
| Construction work in progress                                                                                                                  |   | **349,212**         | ** **     | 469,300               |     |
| **Total Utility Plant**                                                                                                                        |   | **9,723,997**       | ** **     | 9,110,651             |     |
| Non-regulated property, plant, and equipment (Note  11)                                                                                        |   | **4,310,498**       | ** **     | 4,616,754             |     |
| Accumulated depreciation (Note 1(g)(*iii*))                                                                                                    |   | **5,246,376**       | ** **     | 5,157,040             |     |
| **Net Property, Plant, and Equipment**                                                                                                         |   | **8,788,119**       | ** **     | 8,570,365             |     |
|                                                                                                                                           |   |                | ** **     |                  |     |
| **Other Assets**                                                                                                                               |   |                | ** **     |                  |     |
| Regulatory assets                                                                                                                              |   | **1,015,024**       | ** **     | 1,022,696             |     |
| Investments in unconsolidated subsidiaries                                                                                                     |   | **453,906**         | ** **     | 417,188               |     |
| Energy risk management non-current assets (Note 1(b)(*i*))                                                                                     |   | **151,159**         | ** **     | 162,773               |     |
| Other investments                                                                                                                              |   | **173,203**         | ** **     | 163,851               |     |
| Goodwill                                                                                                                                       |   | **43,717**          | ** **     | 43,717                |     |
| Other intangible assets                                                                                                                        |   | **1,777**           | ** **     | 2,059                 |     |
| Other                                                                                                                                          |   | **316,408**         | ** **     | 266,659               |     |
| **Total Other Assets**                                                                                                                         |   | **2,155,194**       | ** **     | 2,078,943             |     |
|                                                                                                                                           |   |                | ** **     |                  |     |
| **Assets of Discontinued Operations** (Note 7)                                                                                                 |   | **7,187**           | ** **     | 147,265               |     |
|                                                                                                                                           |   |                | ** **     |                  |     |
| **Total Assets**                                                                                                                               |   | **$**               | **13,288,358** | ** **            | $        | 13,307,028 |   |

 

**The accompanying notes as they relateto Cinergy Corp. are an integral part of these consolidated financialstatements.**

 

6

----

 

**CINERGYCORP.**

**CONSOLIDATED BALANCE SHEETS**

** **

**LIABILITIES AND SHAREHOLDERS’ EQUITY**

 
|                                                                                                                                                   |   | **June 30  2003**   |           | **December 31  2002** |     |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|----------------|-----------------------|----------|
|                                                                                                                                                   |   | **(in  thousands)** |           |
|                                                                                                                                                   |   | **(unaudited)**     |           |
|                                                                                                                                                   |   |                | * *       |                  | * * |
| **Current Liabilities**                                                                                                                                |   |                |           |                  |     |
| Accounts payable                                                                                                                                       |   | **$**               | **1,102,251**  | ** **            | $        | 1,318,379 |   |
| Accrued taxes                                                                                                                                          |   | **191,864**         | ** **     | 258,613               |     |
| Accrued interest                                                                                                                                       |   | **69,767**          | ** **     | 62,244                |     |
| Notes payable and other short-term obligations (Note  4)                                                                                               |   | **409,269**         | ** **     | 667,973               |     |
| Long-term debt due within one year (Note 3)                                                                                                            |   | **387,038**         | ** **     | 176,000               |     |
| Energy risk management current liabilities (Note 1(b)(*i*))                                                                                            |   | **384,885**         | ** **     | 407,710               |     |
| Other                                                                                                                                                  |   | **130,165**         | ** **     | 105,026               |     |
| **Total Current Liabilities**                                                                                                                          |   | **2,675,239**       | ** **     | 2,995,945             |     |
|                                                                                                                                                   |   |                | ** **     |                  |     |
| **Non-Current Liabilities**                                                                                                                            |   |                | ** **     |                  |     |
| Long-term debt (Note 3)                                                                                                                                |   | **3,977,446**       | ** **     | 4,011,568             |     |
| Deferred income taxes                                                                                                                                  |   | **1,508,123**       | ** **     | 1,458,171             |     |
| Unamortized investment tax credits                                                                                                                     |   | **113,489**         | ** **     | 118,095               |     |
| Accrued pension and other postretirement benefit  costs                                                                                                |   | **660,922**         | ** **     | 626,167               |     |
| Energy risk management non-current liabilities (Note  1(b)(*i*))                                                                                       |   | **156,946**         | ** **     | 143,991               |     |
| Other                                                                                                                                                  |   | **206,466**         | ** **     | 179,767               |     |
| **Total Non-Current Liabilities**                                                                                                                      |   | **6,623,392**       | ** **     | 6,537,759             |     |
|                                                                                                                                                   |   |                | ** **     |                  |     |
| **Liabilities of Discontinued  Operations** (Note 7)                                                                                                   |   | **8,877**           | ** **     | 108,833               |     |
|                                                                                                                                                   |   |                | ** **     |                  |     |
| **Total Liabilities**                                                                                                                                  |   | **9,307,508**       | ** **     | 9,642,537             |     |
|                                                                                                                                                   |   |                | ** **     |                  |     |
| **Preferred Trust Securities** (Note 1(g)(*vi*))                                                                                                       |   |                | ** **     |                  |     |
| Company obligated, mandatorily redeemable, preferred  trust securities of subsidiary, holding solely debt securities of the company                    |   | **309,216**         | ** **     | 308,187               |     |
|                                                                                                                                                   |   |                | ** **     |                  |     |
| **Cumulative Preferred Stock of  Subsidiaries**                                                                                                        |   |                | ** **     |                  |     |
| Not subject to mandatory redemption                                                                                                                    |   | **62,818**          | ** **     | 62,828                |     |
|                                                                                                                                                   |   |                | ** **     |                  |     |
| **Common Stock Equity** (Note 2)                                                                                                                       |   |                | ** **     |                  |     |
| Common stock -$.01 par value; authorized shares  -600,000,000; outstanding shares -176,947,118 at June 30, 2003, and  168,663,115 at December 31, 2002 |   | **1,769**           | ** **     | 1,687                 |     |
| Paid-in capital                                                                                                                                        |   | **2,135,968**       | ** **     | 1,918,136             |     |
| Retained earnings                                                                                                                                      |   | **1,495,502**       | ** **     | 1,403,453             |     |
| Accumulated other comprehensive income (loss)                                                                                                          |   | **(24,423**         | **)**          | (29,800               | )        |
| **Total Common Stock Equity**                                                                                                                          |   | **3,608,816**       | ** **     | 3,293,476             |     |
|                                                                                                                                                   |   |                | ** **     |                  |     |
| **Commitments and Contingencies** (Note 6)                                                                                                             |   |                | ** **     |                  |     |
|                                                                                                                                                   |   |                | ** **     |                  |     |
| **Total Liabilities and Shareholders’  Equity**                                                                                                   |   | **$**               | **13,288,358** | ** **            | $        | 13,307,028 |   |

 

**The accompanying notes as they relateto Cinergy Corp. are an integral part of these consolidated financialstatements.**

 

7

----

 

**CINERGYCORP.**

**CONSOLIDATED STATEMENTS OFCHANGES IN COMMON STOCK EQUITY**

 
|                                                                                                              |   | **Common  Stock**   |         | **Paid-in  Capital** |         | **Retained  Earnings** |         | **Accumulated  Other  Comprehensive  Income/(Loss)** |          | **Total  Common  Stock  Equity** |         |
|-------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------------|----------------------|--------------|------------------------|--------------|------------------------------------------------------|---------------|----------------------------------|--------------|
|                                                                                                              |   | **(in  thousands)** |         |
|                                                                                                              |   | **(unaudited)**     |         |
|                                                                                                              |   |                | *** *** |                 | *** *** |                   | *** *** |                                                 | *** ***  |                             | *** *** |
| **Quarter Ended June 30,  2003**                                                                                  |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
|                                                                                                              |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
| **Balance at April 1,  2003 (175,876,919 shares)**                                                                |   | **$**               | **1,759**    | ** **           | **$**        | **2,116,222**          | ** **   | **$**                                                | **1,491,861** | ** **                       | **$**        | **(29,013** | **)** | **$** | **3,580,829** | ** ** |
| **Comprehensive income:**                                                                                         |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
| **Net income**                                                                                                    |   |                | ** **   |                 | ** **   | **84,653**             | ** **   |                                                 | ** **    | **84,653**                       | ** **   |
| **Other comprehensive  income (loss), net of tax effect of ($2,284)**                                             |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
| **Foreign currency  translation adjustment, net of reclassification adjustments of $6,134 (net of  tax)**(Note 7) |   |                |         |                 | ** **   |                   | ** **   | **3,963**                                            | ** **    | **3,963**                        | ** **   |
| **Unrealized gain (loss)  on investment trusts**                                                                  |   |                |         |                 |         |                   | ** **   | **3,370**                                            | ** **    | **3,370**                        | ** **   |
| **Cash flow hedges**(Note 1(b))                                                                                   |   |                |         |                 |         |                   | ** **   | **(2,743**                                           | **)**         | **(2,743**                       | **)**        |
| **Total comprehensive  income**                                                                                   |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    | **89,243**                       | ** **   |
|                                                                                                              |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
| **Issuance of common  stock - net**(1,070,199 shares)                                                             |   | **10**              | ** **   | **25,459**           | ** **   |                   | ** **   |                                                 | ** **    | **25,469**                       | ** **   |
| **Dividends on common  stock ($.46 per share)**                                                                   |   |                |         |                 |         | **(80,992**            | **)**        |                                                 | ** **    | **(80,992**                      | **)**        |
| **Other**(Note 2(b))                                                                                              |   |                |         | **(5,713**           | **)**        | **(20**                | **)**        |                                                 | ** **    | **(5,733**                       | **)**        |
|                                                                                                              |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
| **Ending balance at June 30, 2003**(176,947,118 shares)                                                           |   | **$**               | **1,769**    | ** **           | **$**        | **2,135,968**          | ** **   | **$**                                                | **1,495,502** | ** **                       | **$**        | **(24,423** | **)** | **$** | **3,608,816** | ** ** |
|                                                                                                              |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
| Quarter  Ended June 30, 2002                                                                                      |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
|                                                                                                              |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
| Balance at April 1, 2002 (166,826,096 shares)                                                                     |   | $                   | 1,669        |                 | $            | 1,839,338              |         | $                                                    | 1,350,090     |                             | $            | (19,188 | ) | $ | 3,171,909 |   |
| Comprehensive income:                                                                                             |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
| Net income                                                                                                        |   |                |         |                 |         | 44,983                 |         |                                                 |          | 44,983                           |         |
| Other comprehensive income (loss), net of tax effect  of ($7,772)                                                 |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
| Foreign currency translation adjustment                                                                           |   |                |         |                 |         |                   |         | 16,897                                               |          | 16,897                           |         |
| Unrealized gain (loss) on investment trusts                                                                       |   |                |         |                 |         |                   |         | (583                                                 | )             | (583                             | )            |
| Cash flow hedges (Note 1(b))                                                                                      |   |                |         |                 |         |                   |         | (1,913                                               | )             | (1,913                           | )            |
| Total comprehensive income                                                                                        |   |                |         |                 |         |                   |         |                                                 |          | 59,384                           |         |
|                                                                                                              |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
| Issuance of common stock - net (660,033 shares)                                                                   |   | 6                   |         | 19,518               |         |                   |         |                                                 |          | 19,524                           |         |
| Dividends on common stock ($.45 per share)                                                                        |   |                |         |                 |         | (75,200                | )            |                                                 |          | (75,200                          | )            |
| Other                                                                                                             |   |                |         | 2,833                |         | 8                      |         |                                                 |          | 2,841                            |         |
|                                                                                                              |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
| Ending balance at June 30, 2002 (167,486,129 shares)                                                              |   | $                   | 1,675        |                 | $            | 1,861,689              |         | $                                                    | 1,319,881     |                             | $            | (4,787 | ) | $ | 3,178,458 |   |

 

**The accompanying notes as they relate to Cinergy Corp. are anintegral part of these consolidated financial statements.**

 

8

----

 

**CINERGYCORP.**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN COMMON STOCK EQUITY**

** **
|                                                                                                              |   | **Common  Stock**   |         | **Paid-in  Capital** |         | **Retained  Earnings** |         | **Accumulated  Other  Comprehensive  Income/(Loss)** |          | **Total  Common  Stock  Equity** |         |
|-------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------------|----------------------|--------------|------------------------|--------------|------------------------------------------------------|---------------|----------------------------------|--------------|
|                                                                                                              |   | **(in  thousands)** |         |
|                                                                                                              |   | **(unaudited)**     |         |
|                                                                                                              |   |                | *** *** |                 | *** *** |                   | *** *** |                                                 | *** ***  |                             | *** *** |
| **Year to Date June 30,  2003**                                                                                   |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
|                                                                                                              |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
| **Balance at January 1,  2003 (168,663,115 shares)**                                                              |   | **$**               | **1,687**    | ** **           | **$**        | **1,918,136**          | ** **   | **$**                                                | **1,403,453** | ** **                       | **$**        | **(29,800** | **)** | **$** | **3,293,476** | ** ** |
| **Comprehensive income:**                                                                                         |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
| **Net income**                                                                                                    |   |                | ** **   |                 | ** **   | **250,738**            | ** **   |                                                 | ** **    | **250,738**                      | ** **   |
| **Other comprehensive  income (loss), net of tax effect of ($2,558)**                                             |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
| **Foreign currency  translation adjustment, net of reclassification adjustments of $6,134 (net of  tax)**(Note 7) |   |                |         |                 |         |                   | ** **   | **6,054**                                            | ** **    | **6,054**                        | ** **   |
| **Unrealized gain (loss)  on investment trusts**                                                                  |   |                |         |                 |         |                   | ** **   | **2,518**                                            | ** **    | **2,518**                        | ** **   |
| **Cash flow hedges**(Note 1(b))                                                                                   |   |                |         |                 |         |                   | ** **   | **(3,195**                                           | **)**         | **(3,195**                       | **)**        |
| **Total comprehensive  income**                                                                                   |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    | **256,115**                      | ** **   |
|                                                                                                              |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
| **Issuance of common  stock - net**(8,284,003 shares)                                                             |   | **82**              | ** **   | **219,355**          | ** **   |                   |         |                                                 | ** **    | **219,437**                      | ** **   |
| **Dividends on common  stock ($.92 per share)**                                                                   |   |                |         |                 |         | **(158,677**           | **)**        |                                                 | ** **    | **(158,677**                     | **)**        |
| **Other**(Note 2(b))                                                                                              |   |                |         | **(1,523**           | **)**        | **(12**                | **)**        |                                                 | ** **    | **(1,535**                       | **)**        |
|                                                                                                              |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
| **Ending balance at June 30, 2003**(176,947,118 shares)                                                           |   | **$**               | **1,769**    | ** **           | **$**        | **2,135,968**          | ** **   | **$**                                                | **1,495,502** | ** **                       | **$**        | **(24,423** | **)** | **$** | **3,608,816** | ** ** |
|                                                                                                              |   |                | ** **   |                 | ** **   |                   | ** **   |                                                 | ** **    |                             | ** **   |
| Year  to Date June 30, 2002                                                                                       |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
|                                                                                                              |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
| Balance at January 1, 2002 (159,402,839 shares)                                                                   |   | $                   | 1,594        |                 | $            | 1,619,659              |         | $                                                    | 1,337,135     |                             | $            | (16,929 | ) | $ | 2,941,459 |   |
| Comprehensive income:                                                                                             |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
| Net income                                                                                                        |   |                |         |                 |         | 129,812                |         |                                                 |          | 129,812                          |         |
| Other comprehensive income (loss), net of tax effect  of ($6,688)                                                 |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
| Foreign currency translation adjustment                                                                           |   |                |         |                 |         |                   |         | 15,313                                               |          | 15,313                           |         |
| Unrealized gain (loss) on investment trusts                                                                       |   |                |         |                 |         |                   |         | (1,634                                               | )             | (1,634                           | )            |
| Minimum pension liability adjustment                                                                              |   |                |         |                 |         |                   |         | 136                                                  |          | 136                              |         |
| Cash flow hedges (Note 1(b))                                                                                      |   |                |         |                 |         |                   |         | (1,673                                               | )             | (1,673                           | )            |
| Total comprehensive income                                                                                        |   |                |         |                 |         |                   |         |                                                 |          | 141,954                          |         |
|                                                                                                              |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
| Issuance of common stock - net (8,083,290 shares)                                                                 |   | 81                  |         | 235,412              |         |                   |         |                                                 |          | 235,493                          |         |
| Dividends on common stock ($.90 per share)                                                                        |   |                |         |                 |         | (147,082               | )            |                                                 |          | (147,082                         | )            |
| Other                                                                                                             |   |                |         | 6,618                |         | 16                     |         |                                                 |          | 6,634                            |         |
|                                                                                                              |   |                |         |                 |         |                   |         |                                                 |          |                             |         |
| Ending balance at June 30, 2002 (167,486,129 shares)                                                              |   | $                   | 1,675        |                 | $            | 1,861,689              |         | $                                                    | 1,319,881     |                             | $            | (4,787 | ) | $ | 3,178,458 |   |

 

**Theaccompanying notes as they relate to Cinergy Corp. are an integral part ofthese consolidated financial statements.**

 

9

----

 

**CINERGYCORP.**

**CONSOLIDATED STATEMENTS OFCASH FLOWS**

** **
|                                                                                  |   | **Year to Date  June 30** |        |
|---------------------------------------------------------------------------------------|--------|---------------------------|-------------|
|                                                                                  |   | **2003**                  |        | **2002** |   |
|                                                                                  |   | **(in  thousands)**       |        |
|                                                                                  |   | **(unaudited)**           |        |
|                                                                                  |   |                      | * *    |   | * * |
| **Operating Activities**                                                              |   |                      |        |   |   |
| Net income                                                                            |   | **$**                     | **250,738** | ** ** | $ | 129,812 |   |
| Items providing or (using) cash currently:                                            |   |                      | ** **  |   |   |
| Depreciation                                                                          |   | **208,863**               | ** **  | 194,295 |   |
| Loss (Gain) on disposal of discontinued operations,  net of tax                       |   | **(8,878**                | **)**       | — |   |
| Cumulative effect of changes in accounting  principles, net of tax                    |   | **(26,462**               | **)**       | 10,899 |   |
| Change in net position of energy risk management  activities                          |   | **12,421**                | ** **  | (54,030 | ) |
| Deferred income taxes and investment tax credits -  net                               |   | **24,315**                | ** **  | 20,779 |   |
| Equity in (earnings) losses of unconsolidated  subsidiaries                           |   | **(6,696**                | **)**       | (4,108 | ) |
| Allowance for equity funds used during construction                                   |   | **(6,191**                | **)**       | (7,167 | ) |
| Regulatory assets deferrals                                                           |   | **(40,084**               | **)**       | (43,403 | ) |
| Regulatory assets amortization                                                        |   | **52,273**                | ** **  | 53,288 |   |
| Accrued pension and other postretirement benefit  costs                               |   | **34,755**                | ** **  | 41,223 |   |
| Deferred costs under gas recovery mechanism                                           |   | **(36,422**               | **)**       | (1,073 | ) |
| Changes in current assets and current liabilities:                                    |   |                      | ** **  |   |   |
| Restricted deposits                                                                   |   | **(517**                  | **)**       | (765 | ) |
| Accounts and notes receivable                                                         |   | **178,214**               | ** **  | (296,104 | ) |
| Materials, supplies, and fuel                                                         |   | **(1,793**                | **)**       | (45,907 | ) |
| Prepayments                                                                           |   | **(7,074**                | **)**       | (9,174 | ) |
| Accounts payable                                                                      |   | **(216,128**              | **)**       | 317,942 |   |
| Accrued taxes and interest                                                            |   | **(59,226**               | **)**       | 19,380 |   |
| Other assets                                                                          |   | **(2,388**                | **)**       | 26,868 |   |
| Other liabilities                                                                     |   | **54,061**                | ** **  | 17,105 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Net cash provided by (used in)  operating activities**                              |   | **403,781**               | ** **  | 369,860 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Financing Activities**                                                              |   |                      | ** **  |   |   |
| Change in short-term debt                                                             |   | **(258,704**              | **)**       | (35,337 | ) |
| Issuance of long-term debt                                                            |   | **291,198**               | ** **  | — |   |
| Redemption of long-term debt                                                          |   | **(141,759**              | **)**       | (20,292 | ) |
| Retirement of preferred stock of subsidiaries                                         |   | **(10**                   | **)**       | (2 | ) |
| Issuance of common stock                                                              |   | **219,437**               | ** **  | 235,493 |   |
| Dividends on common stock                                                             |   | **(158,677**              | **)**       | (147,082 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Net cash provided by (used in)  financing activities**                              |   | **(48,515**               | **)**       | 32,780 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Investing Activities**                                                              |   |                      | ** **  |   |   |
| Construction expenditures (less allowance for equity  funds used during construction) |   | **(334,522**              | **)**       | (395,407 | ) |
| Acquisitions and other investments                                                    |   | **(23,092**               | **)**       | (17,186 | ) |
| Proceeds from disposal of subsidiaries                                                |   | **51,252**                | ** **  | — |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Net cash provided by (used in)  investing activities**                              |   | **(306,362**              | **)**       | (412,593 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Net increase (decrease) in cash and  cash equivalents**                             |   | **48,904**                | ** **  | (9,953 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Cash and cash equivalents at  beginning of period**                                 |   | **200,112**               | ** **  | 87,257 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Cash and cash equivalents at end of  period**                                       |   | **$**                     | **249,016** | ** ** | $ | 77,304 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Supplemental Disclosure of Cash  Flow Information**                                 |   |                      | ** **  |   |   |
| Cash paid during the period for:                                                      |   |                      | ** **  |   |   |
| Interest (net of amount capitalized)                                                  |   | **$**                     | **117,496** | ** ** | $ | 119,766 |   |
| Income taxes                                                                          |   | **$**                     | **96,696**  | ** ** | $ | 32,083 |   |

 

**The accompanying notes as they relateto Cinergy Corp. are an integral part of these consolidated financialstatements.**

 

10

----

 

**THECINCINNATI GAS & ELECTRIC COMPANY**

**AND SUBSIDIARY COMPANIES**

 

11

----

 

**THECINCINNATI GAS & ELECTRIC COMPANY**

**CONSOLIDATED STATEMENTS OFINCOME AND COMPREHENSIVE INCOME**

 
|                                                                                  |   | **Quarter Ended  June 30** |        | **Year to Date  June 30** |     |
|---------------------------------------------------------------------------------------|--------|----------------------------|-------------|---------------------------|----------|
|                                                                                  |   | **2003**                   |        | **2002**                  |     | **2003** |   | **2002** |   |
|                                                                                  |   | **(in  thousands)**        |        |
|                                                                                  |   | **(unaudited)**            |        |
|                                                                                  |   |                       | * *    |                      | * * |   | * * |   | * * |
| **Operating Revenues** (Note 1(g)(*i*))                                               |   |                       |        |                      |     |   |   |   |   |
| Electric                                                                              |   | **$**                      | **397,455** | ** **                | $        | 409,709 |   | **$** | **826,019** | ** ** | $ | 806,807 |   |
| Gas                                                                                   |   | **85,311**                 | ** **  | 56,008                    |     | **360,587** | ** ** | 235,617 |   |
| **Total Operating Revenues**                                                          |   | **482,766**                | ** **  | 465,717                   |     | **1,186,606** | ** ** | 1,042,424 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Operating Expenses**                                                                |   |                       | ** **  |                      |     |   | ** ** |   |   |
| Fuel and purchased and exchanged power (Note 1(g)(*i*))                               |   | **106,267**                | ** **  | 108,585                   |     | **236,821** | ** ** | 215,833 |   |
| Gas purchased                                                                         |   | **48,086**                 | ** **  | 24,471                    |     | **219,851** | ** ** | 132,439 |   |
| Operation and maintenance                                                             |   | **125,937**                | ** **  | 138,341                   |     | **260,697** | ** ** | 244,196 |   |
| Depreciation                                                                          |   | **50,313**                 | ** **  | 48,892                    |     | **99,577** | ** ** | 97,052 |   |
| Taxes other than income taxes                                                         |   | **49,739**                 | ** **  | 45,719                    |     | **110,257** | ** ** | 99,205 |   |
| **Total Operating Expenses**                                                          |   | **380,342**                | ** **  | 366,008                   |     | **927,203** | ** ** | 788,725 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Operating Income**                                                                  |   | **102,424**                | ** **  | 99,709                    |     | **259,403** | ** ** | 253,699 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Miscellaneous - Net**                                                               |   | **6,899**                  | ** **  | 4,563                     |     | **13,483** | ** ** | 1,880 |   |
| **Interest Expense**                                                                  |   | **29,419**                 | ** **  | 21,774                    |     | **55,260** | ** ** | 44,629 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Income Before Taxes**                                                               |   | **79,904**                 | ** **  | 82,498                    |     | **217,626** | ** ** | 210,950 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Income Taxes**                                                                      |   | **28,985**                 | ** **  | 29,828                    |     | **80,409** | ** ** | 80,695 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Income Before Cumulative Effect of  Changes in Accounting Principles**              |   | **50,919**                 | ** **  | 52,670                    |     | **137,217** | ** ** | 130,255 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| Cumulative effect of changes in accounting  principles, net of tax (Note 1(g)(*vii*)) |   | **—**                 | ** **  | —                    |     | **30,938** | ** ** | — |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Net Income**                                                                        |   | **$**                      | **50,919**  | ** **                | $        | 52,670 |   | **$** | **168,155** | ** ** | $ | 130,255 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Preferred Dividend Requirement**                                                    |   | **212**                    | ** **  | 212                       |     | **423** | ** ** | 423 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Net Income Applicable to Common  Stock**                                            |   | **$**                      | **50,707**  | ** **                | $        | 52,458 |   | **$** | **167,732** | ** ** | $ | 129,832 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Net Income**                                                                        |   | **$**                      | **50,919**  | ** **                | $        | 52,670 |   | **$** | **168,155** | ** ** | $ | 130,255 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Other Comprehensive Income (Loss),  Net of Tax Effect**                             |   | **(2,721**                 | **)**       | (1,913                    | )        | **(3,027** | **)** | (2,085 | ) |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Comprehensive Income**                                                              |   | **$**                      | **48,198**  | ** **                | $        | 50,757 |   | **$** | **165,128** | ** ** | $ | 128,170 |   |

 

**The accompanying notes as they relateto The Cincinnati Gas & Electric Company are an integral part of theseconsolidated financial statements.**

 

12

----

 

**THECINCINNATI GAS & ELECTRIC COMPANY**

**CONSOLIDATED BALANCE SHEETS**

 

**ASSETS**

 
|                                                                                                                              |   | **June 30  2003**   |          | **December 31  2002** |     |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------------|-----------------------|----------|
|                                                                                                                              |   | **(in  thousands)** |          |
|                                                                                                                              |   | **(unaudited)**     |          |
|                                                                                                                              |   |                | * *      |                  | * * |
| **Current Assets**                                                                                                                |   |                |          |                  |     |
| Cash and cash equivalents                                                                                                         |   | **$**               | **63,192**    | ** **            | $        | 45,336 |   |
| Restricted deposits                                                                                                               |   | **3,037**           | ** **    | 3,071                 |     |
| Notes receivable from affiliated companies                                                                                        |   | **201,634**         | ** **    | 148,823               |     |
| Accounts receivable less accumulated provision for  doubtful accounts of $3,714 at June 30, 2003, and $5,942 at December 31, 2002 |   | **97,460**          | ** **    | 117,269               |     |
| Accounts receivable from affiliated companies                                                                                     |   | **23,692**          | ** **    | 97,584                |     |
| Materials, supplies, and fuel                                                                                                     |   | **118,277**         | ** **    | 121,881               |     |
| Energy risk management current assets (Note 1(b)(*i*))                                                                            |   | **67,755**          | ** **    | 57,912                |     |
| Prepayments and other                                                                                                             |   | **27,840**          | ** **    | 8,560                 |     |
| **Total Current Assets**                                                                                                          |   | **602,887**         | ** **    | 600,436               |     |
|                                                                                                                              |   |                | ** **    |                  |     |
| **Property, Plant, and Equipment - at  Cost**                                                                                     |   |                | ** **    |                  |     |
| Utility plant in service (Note 11)                                                                                                |   |                | ** **    |                  |     |
| Electric                                                                                                                          |   | **2,120,288**       | ** **    | 2,073,133             |     |
| Gas                                                                                                                               |   | **1,028,589**       | ** **    | 1,003,870             |     |
| Common                                                                                                                            |   | **248,956**         | ** **    | 248,938               |     |
| **Total Utility Plant In Service**                                                                                                |   | **3,397,833**       | ** **    | 3,325,941             |     |
| Construction work in progress                                                                                                     |   | **98,322**          | ** **    | 84,249                |     |
| **Total Utility Plant**                                                                                                           |   | **3,496,155**       | ** **    | 3,410,190             |     |
| Non-regulated property, plant, and equipment (Note  11)                                                                           |   | **3,488,169**       | ** **    | 3,445,056             |     |
| Accumulated depreciation (Note 1(g)(*iii*))                                                                                       |   | **2,722,956**       | ** **    | 2,712,105             |     |
| **Net Property, Plant, and Equipment**                                                                                            |   | **4,261,368**       | ** **    | 4,143,141             |     |
|                                                                                                                              |   |                | ** **    |                  |     |
| **Other Assets**                                                                                                                  |   |                | ** **    |                  |     |
| Regulatory assets                                                                                                                 |   | **602,092**         | ** **    | 604,776               |     |
| Energy risk management non-current assets (Note  1(b)(*i*))                                                                       |   | **63,452**          | ** **    | 64,762                |     |
| Other investments                                                                                                                 |   | **1,079**           | ** **    | 1,082                 |     |
| Other                                                                                                                             |   | **186,848**         | ** **    | 127,550               |     |
| **Total Other Assets**                                                                                                            |   | **853,471**         | ** **    | 798,170               |     |
|                                                                                                                              |   |                | ** **    |                  |     |
| **Total Assets**                                                                                                                  |   | **$**               | **5,717,726** | ** **            | $        | 5,541,747 |   |

 

**The accompanying notes as they relateto The Cincinnati Gas & Electric Company are an integral part of theseconsolidated financial statements.**

 

13

----

 

**THECINCINNATI GAS & ELECTRIC COMPANY**

**CONSOLIDATEDBALANCE SHEETS**

 

**LIABILITIES AND SHAREHOLDER’S EQUITY**

 
|                                                                                                                                       |   | **June 30  2003**   |          | **December 31  2002** |     |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------------|-----------------------|----------|
|                                                                                                                                       |   | **(in  thousands)** |          |
|                                                                                                                                       |   | **(unaudited)**     |          |
|                                                                                                                                       |   |                | * *      |                  | * * |
| **Current Liabilities**                                                                                                                    |   |                |          |                  |     |
| Accounts payable                                                                                                                           |   | **$**               | **165,721**   | ** **            | $        | 195,812 |   |
| Accounts payable to affiliated companies                                                                                                   |   | **37,738**          | ** **    | 146,558               |     |
| Accrued taxes                                                                                                                              |   | **162,940**         | ** **    | 159,199               |     |
| Accrued interest                                                                                                                           |   | **29,057**          | ** **    | 22,872                |     |
| Notes payable and other short-term obligations (Note  4)                                                                                   |   | **112,100**         | ** **    | 112,100               |     |
| Notes payable to affiliated companies (Note 4)                                                                                             |   | **8,258**           | ** **    | 8,947                 |     |
| Long-term debt due within one year (Note 3)                                                                                                |   | **130,000**         | ** **    | 120,000               |     |
| Energy risk management current liabilities (Note  1(b)(*i*))                                                                               |   | **78,963**          | ** **    | 49,288                |     |
| Other                                                                                                                                      |   | **37,451**          | ** **    | 37,160                |     |
| **Total Current Liabilities**                                                                                                              |   | **762,228**         | ** **    | 851,936               |     |
|                                                                                                                                       |   |                | ** **    |                  |     |
| **Non-Current Liabilities**                                                                                                                |   |                | ** **    |                  |     |
| Long-term debt (Note 3)                                                                                                                    |   | **1,721,865**       | ** **    | 1,569,713             |     |
| Deferred income taxes                                                                                                                      |   | **919,289**         | ** **    | 882,628               |     |
| Unamortized investment tax credits                                                                                                         |   | **82,192**          | ** **    | 85,198                |     |
| Accrued pension and other postretirement benefit  costs                                                                                    |   | **208,160**         | ** **    | 201,284               |     |
| Energy risk management non-current liabilities (Note  1(b)(*i*))                                                                           |   | **54,041**          | ** **    | 31,326                |     |
| Other                                                                                                                                      |   | **84,609**          | ** **    | 88,843                |     |
| **Total Non-Current Liabilities**                                                                                                          |   | **3,070,156**       | ** **    | 2,858,992             |     |
|                                                                                                                                       |   |                | ** **    |                  |     |
| **Total Liabilities**                                                                                                                      |   | **3,832,384**       | ** **    | 3,710,928             |     |
|                                                                                                                                       |   |                | ** **    |                  |     |
| **Cumulative Preferred Stock**                                                                                                             |   |                | ** **    |                  |     |
| Not subject to mandatory redemption                                                                                                        |   | **20,485**          | ** **    | 20,485                |     |
|                                                                                                                                       |   |                | ** **    |                  |     |
| **Common Stock Equity**                                                                                                                    |   |                | ** **    |                  |     |
| Common stock - $8.50 par value; authorized shares -  120,000,000; outstanding shares - 89,663,086 at June 30, 2003, and December  31, 2002 |   | **762,136**         | ** **    | 762,136               |     |
| Paid-in capital                                                                                                                            |   | **586,292**         | ** **    | 586,292               |     |
| Retained earnings                                                                                                                          |   | **545,202**         | ** **    | 487,652               |     |
| Accumulated other comprehensive income (loss)                                                                                              |   | **(28,773**         | **)**         | (25,746               | )        |
| **Total Common Stock Equity**                                                                                                              |   | **1,864,857**       | ** **    | 1,810,334             |     |
|                                                                                                                                       |   |                | ** **    |                  |     |
| **Commitments and Contingencies** (Note 6)                                                                                                 |   |                | ** **    |                  |     |
|                                                                                                                                       |   |                | ** **    |                  |     |
| **Total Liabilities and Shareholder’s  Equity**                                                                                       |   | **$**               | **5,717,726** | ** **            | $        | 5,541,747 |   |

 

**The accompanying notes as they relateto The Cincinnati Gas & Electric Company are an integral part of theseconsolidated financial statements.**

 

14

----

 

**THECINCINNATI GAS & ELECTRIC COMPANY**

**CONSOLIDATED STATEMENTS OFCASH FLOWS**

 
|                                                                                  |   | **Year to Date  June 30** |        |
|---------------------------------------------------------------------------------------|--------|---------------------------|-------------|
|                                                                                  |   | **2003**                  |        | **2002** |   |
|                                                                                  |   | **(in  thousands)**       |        |
|                                                                                  |   | **(unaudited)**           |        |
|                                                                                  |   |                      | * *    |   | * * |
| **Operating Activities**                                                              |   |                      |        |   |   |
| Net income                                                                            |   | **$**                     | **168,155** | ** ** | $ | 130,255 |   |
| Items providing or (using) cash currently:                                            |   |                      | ** **  |   |   |
| Depreciation                                                                          |   | **99,577**                | ** **  | 97,052 |   |
| Deferred income taxes and investment tax credits -  net                               |   | **12,144**                | ** **  | 21,393 |   |
| Cumulative effect of changes in accounting  principles, net of tax                    |   | **(30,938**               | **)**       | — |   |
| Change in net position of energy risk management  activities                          |   | **1,161**                 | ** **  | (5,840 | ) |
| Allowance for equity funds used during construction                                   |   | **(1,841**                | **)**       | 480 |   |
| Regulatory assets deferrals                                                           |   | **(12,725**               | **)**       | (28,195 | ) |
| Regulatory assets amortization                                                        |   | **19,654**                | ** **  | 17,951 |   |
| Accrued pension and other postretirement benefit  costs                               |   | **6,876**                 | ** **  | 5,323 |   |
| Deferred costs under gas cost recovery mechanism                                      |   | **(36,422**               | **)**       | (1,073 | ) |
| Changes in current assets and current liabilities:                                    |   |                      | ** **  |   |   |
| Restricted deposits                                                                   |   | **34**                    | ** **  | (764 | ) |
| Accounts and notes receivable                                                         |   | **131,511**               | ** **  | (219,100 | ) |
| Materials, supplies, and fuel                                                         |   | **3,604**                 | ** **  | 24,512 |   |
| Prepayments                                                                           |   | **(7,962**                | **)**       | (4,318 | ) |
| Accounts payable                                                                      |   | **(138,911**              | **)**       | 244,575 |   |
| Accrued taxes and interest                                                            |   | **9,926**                 | ** **  | 23,804 |   |
| Other assets                                                                          |   | **(4,388**                | **)**       | 9,326 |   |
| Other liabilities                                                                     |   | **(5,635**                | **)**       | 4,032 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Net cash provided by (used in)  operating activities**                              |   | **213,820**               | ** **  | 319,413 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Financing Activities**                                                              |   |                      | ** **  |   |   |
| Change in short-term debt, including net affiliate  notes                             |   | **(91,310**               | **)**       | (65,629 | ) |
| Issuance of long-term debt                                                            |   | **256,198**               | ** **  | — |   |
| Redemption of long-term debt                                                          |   | **(100,000**              | **)**       | — |   |
| Dividends on preferred stock                                                          |   | **—**                | ** **  | (349 | ) |
| Dividends on common stock                                                             |   | **(110,182**              | **)**       | (91,653 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Net cash provided by (used in)  financing activities**                              |   | **(45,294**               | **)**       | (157,631 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Investing Activities**                                                              |   |                      | ** **  |   |   |
| Construction expenditures (less allowance for equity  funds used during construction) |   | **(150,672**              | **)**       | (161,394 | ) |
| Other investments                                                                     |   | **2**                     | ** **  | (1 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Net cash provided by (used in)  investing activities**                              |   | **(150,670**              | **)**       | (161,395 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Net increase (decrease) in cash and  cash equivalents**                             |   | **17,856**                | ** **  | 387 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Cash and cash equivalents at  beginning of period**                                 |   | **45,336**                | ** **  | 9,074 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Cash and cash equivalents at end of  period**                                       |   | **$**                     | **63,192**  | ** ** | $ | 9,461 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Supplemental Disclosure of Cash  Flow Information**                                 |   |                      | ** **  |   |   |
| Cash paid during the period for:                                                      |   |                      | ** **  |   |   |
| Interest (net of amount capitalized)                                                  |   | **$**                     | **30,010**  | ** ** | $ | 40,504 |   |
| Income taxes                                                                          |   | **$**                     | **37,155**  | ** ** | $ | 15,495 |   |

 

**The accompanying notes as they relateto The Cincinnati Gas & Electric Company are an integral part of theseconsolidated financial statements.**

 

15

----

 

**PSI ENERGY, INC.**

**AND SUBSIDIARY COMPANY**

 

16

----

 

**PSIENERGY, INC.**

**CONSOLIDATED STATEMENTS OFINCOME AND COMPREHENSIVE INCOME**

 
|                                                                                  |   | **Quarter Ended  June 30** |        | **Year to Date  June 30** |     |
|---------------------------------------------------------------------------------------|--------|----------------------------|-------------|---------------------------|----------|
|                                                                                  |   | **2003**                   |        | **2002**                  |     | **2003** |   | **2002** |   |
|                                                                                  |   | **(in  thousands)**        |        |
|                                                                                  |   | **(unaudited)**            |        |
|                                                                                  |   |                       | * *    |                      | * * |   | * * |   | * * |
| **Operating Revenues** (Note 1(g)(*i*))                                               |   |                       |        |                      |     |   |   |   |   |
| Electric                                                                              |   | **$**                      | **361,385** | ** **                | $        | 378,618 |   | **$** | **773,073** | ** ** | $ | 745,019 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Operating Expenses**                                                                |   |                       | ** **  |                      |     |   | ** ** |   |   |
| Fuel and purchased and exchanged power  (Note 1(g)(*i*))                         |   | **121,998**                | ** **  | 128,546                   |     | **288,870** | ** ** | 251,595 |   |
| Operation and maintenance                                                             |   | **122,947**                | ** **  | 142,549                   |     | **235,332** | ** ** | 257,628 |   |
| Depreciation                                                                          |   | **44,944**                 | ** **  | 38,380                    |     | **87,656** | ** ** | 76,128 |   |
| Taxes other than income taxes                                                         |   | **16,150**                 | ** **  | 17,149                    |     | **32,032** | ** ** | 33,546 |   |
| **Total Operating Expenses**                                                          |   | **306,039**                | ** **  | 326,624                   |     | **643,890** | ** ** | 618,897 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Operating Income**                                                                  |   | **55,346**                 | ** **  | 51,994                    |     | **129,183** | ** ** | 126,122 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Miscellaneous - Net**                                                               |   | **5,411**                  | ** **  | 4,370                     |     | **7,569** | ** ** | 9,721 |   |
| **Interest Expense**                                                                  |   | **22,038**                 | ** **  | 17,789                    |     | **42,153** | ** ** | 37,080 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Income Before Taxes**                                                               |   | **38,719**                 | ** **  | 38,575                    |     | **94,599** | ** ** | 98,763 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Income Taxes**                                                                      |   | **15,640**                 | ** **  | 8,861                     |     | **37,299** | ** ** | 30,966 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Income Before Cumulative Effect of  a Change in Accounting Principle**              |   | **23,079**                 | ** **  | 29,714                    |     | **57,300** | ** ** | 67,797 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| Cumulative effect of a change in accounting  principle, net of tax (Note 1(g)(*vii*)) |   | **—**                 | ** **  | —                    |     | **(494** | **)** | — |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Net Income**                                                                        |   | **$**                      | **23,079**  | ** **                | $        | 29,714 |   | **$** | **56,806** | ** ** | $ | 67,797 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Preferred Dividend Requirement**                                                    |   | **646**                    | ** **  | 646                       |     | **1,293** | ** ** | 1,293 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Net Income Applicable to Common  Stock**                                            |   | **$**                      | **22,433**  | ** **                | $        | 29,068 |   | **$** | **55,513** | ** ** | $ | 66,504 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Net Income**                                                                        |   | **$**                      | **23,079**  | ** **                | $        | 29,714 |   | **$** | **56,806** | ** ** | $ | 67,797 |   |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Other Comprehensive Income (Loss),  Net of Tax Effect**                             |   | **2,954**                  | ** **  | (471                      | )        | **2,324** | ** ** | (968 | ) |
|                                                                                  |   |                       | ** **  |                      |     |   | ** ** |   |   |
| **Comprehensive Income**                                                              |   | **$**                      | **26,033**  | ** **                | $        | 29,243 |   | **$** | **59,130** | ** ** | $ | 66,829 |   |

 

**The accompanying notes as they relateto PSI Energy, Inc. are an integral part of these consolidated financialstatements.**

 

17

----

 

**PSIENERGY, INC.**

**CONSOLIDATED BALANCE SHEETS**

 

**ASSETS**

 
|                                                                                                                                         |   | **June 30  2003**   |          | **December 31  2002** |     |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------------|-----------------------|----------|
|                                                                                                                                         |   | **(in  thousands)** |          |
|                                                                                                                                         |   | **(unaudited)**     |          |
|                                                                                                                                         |   |                | * *      |                  | * * |
| **Current Assets**                                                                                                                           |   |                |          |                  |     |
| Cash and cash equivalents                                                                                                                    |   | **$**               | **906**       | ** **            | $        | 2,007 |   |
| Restricted deposits                                                                                                                          |   | **571**             | ** **    | 20                    |     |
| Notes receivable from affiliated companies                                                                                                   |   | **34,365**          | ** **    | 53,755                |     |
| Accounts receivable less accumulated provision for doubtful  accounts of $1,935 at June 30, 2003, and $5,656 at December 31,  2002 |   | **74,828**          | ** **    | 84,819                |     |
| Accounts receivable from affiliated companies                                                                                                |   | **1,617**           | ** **    | 437                   |     |
| Materials, supplies, and fuel                                                                                                                |   | **143,287**         | ** **    | 137,292               |     |
| Energy risk management current assets (Note 1(b)(*i*))                                                                                       |   | **7,325**           | ** **    | 8,701                 |     |
| Prepayments and other                                                                                                                        |   | **36,433**          | ** **    | 44,725                |     |
| **Total Current Assets**                                                                                                                     |   | **299,332**         | ** **    | 331,756               |     |
|                                                                                                                                         |   |                | ** **    |                  |     |
| **Property, Plant, and Equipment - at  Cost**                                                                                                |   |                | ** **    |                  |     |
| Utility plant in service                                                                                                                     |   | **5,976,952**       | ** **    | 5,315,410             |     |
| Construction work in progress                                                                                                                |   | **250,890**         | ** **    | 385,051               |     |
| **Total Utility Plant**                                                                                                                      |   | **6,227,842**       | ** **    | 5,700,461             |     |
| Accumulated depreciation                                                                                                                     |   | **2,402,932**       | ** **    | 2,334,157             |     |
| **Net Property, Plant, and Equipment** (Note 11)                                                                                             |   | **3,824,910**       | ** **    | 3,366,304             |     |
|                                                                                                                                         |   |                | ** **    |                  |     |
| **Other Assets**                                                                                                                             |   |                | ** **    |                  |     |
| Regulatory assets                                                                                                                            |   | **412,932**         | ** **    | 417,920               |     |
| Energy risk management non-current assets (Note  1(b)(*i*))                                                                                  |   | **10,789**          | ** **    | 16,590                |     |
| Other investments                                                                                                                            |   | **59,559**          | ** **    | 54,683                |     |
| Other                                                                                                                                        |   | **43,144**          | ** **    | 35,703                |     |
| **Total Other Assets**                                                                                                                       |   | **526,424**         | ** **    | 524,896               |     |
|                                                                                                                                         |   |                | ** **    |                  |     |
| **Total Assets**                                                                                                                             |   | **$**               | **4,650,666** | ** **            | $        | 4,222,956 |   |

 

**The accompanying notes as they relateto PSI Energy, Inc. are an integral part of these consolidated financialstatements.**

 

18

----

 

**PSIENERGY, INC.**

**CONSOLIDATED BALANCE SHEETS**

 

**LIABILITIES AND SHAREHOLDER’S EQUITY**

 
|                                                                                                                                                           |   | **June 30  2003**   |          | **December 31  2002** |     |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------------|-----------------------|----------|
|                                                                                                                                                           |   | **(in  thousands)** |          |
|                                                                                                                                                           |   | **(unaudited)**     |          |
|                                                                                                                                                           |   |                | * *      |                  | * * |
| **Current Liabilities**                                                                                                                                        |   |                |          |                  |     |
| Accounts payable                                                                                                                                               |   | **$**               | **50,590**    | ** **            | $        | 113,563 |   |
| Accounts payable to affiliated companies                                                                                                                       |   | **34,017**          | ** **    | 107,364               |     |
| Accrued taxes                                                                                                                                                  |   | **98,565**          | ** **    | 105,960               |     |
| Accrued interest                                                                                                                                               |   | **30,964**          | ** **    | 23,078                |     |
| Notes payable and other short-term obligations (Note  4)                                                                                                       |   | **—**          | ** **    | 35,000                |     |
| Notes payable to affiliated companies (Note 4)                                                                                                                 |   | **236,588**         | ** **    | 138,055               |     |
| Long-term debt due within one year (Note 3)                                                                                                                    |   | **257,038**         | ** **    | 56,000                |     |
| Energy risk management current liabilities (Note  1(b)(*i*))                                                                                                   |   | **7,048**           | ** **    | 8,000                 |     |
| Other                                                                                                                                                          |   | **22,654**          | ** **    | 22,335                |     |
| **Total Current Liabilities**                                                                                                                                  |   | **737,464**         | ** **    | 609,355               |     |
|                                                                                                                                                           |   |                | ** **    |                  |     |
| **Non-Current Liabilities**                                                                                                                                    |   |                | ** **    |                  |     |
| Long-term debt (Note 3)                                                                                                                                        |   | **1,499,254**       | ** **    | 1,315,984             |     |
| Deferred income taxes                                                                                                                                          |   | **540,580**         | ** **    | 538,745               |     |
| Unamortized investment tax credits                                                                                                                             |   | **31,297**          | ** **    | 32,897                |     |
| Accrued pension and other postretirement benefit  costs                                                                                                        |   | **191,779**         | ** **    | 184,299               |     |
| Energy risk management non-current liabilities (Note  1(b)(*i*))                                                                                               |   | **15,354**          | ** **    | 17,157                |     |
| Other                                                                                                                                                          |   | **81,811**          | ** **    | 80,879                |     |
| **Total Non-Current Liabilities**                                                                                                                              |   | **2,360,075**       | ** **    | 2,169,961             |     |
|                                                                                                                                                           |   |                | ** **    |                  |     |
| **Total Liabilities**                                                                                                                                          |   | **3,097,539**       | ** **    | 2,779,316             |     |
|                                                                                                                                                           |   |                | ** **    |                  |     |
| **Cumulative Preferred Stock**                                                                                                                                 |   |                | ** **    |                  |     |
| Not subject to mandatory redemption                                                                                                                            |   | **42,333**          | ** **    | 42,343                |     |
|                                                                                                                                                           |   |                | ** **    |                  |     |
| **Common Stock Equity**                                                                                                                                        |   |                | ** **    |                  |     |
| Common stock - without par value; $.01 stated value;  authorized shares - 60,000,000; outstanding shares - 53,913,701 at June 30,  2003, and December 31, 2002 |   | **539**             | ** **    | 539                   |     |
| Paid-in capital (Note 2(c))                                                                                                                                    |   | **526,931**         | ** **    | 426,931               |     |
| Retained earnings                                                                                                                                              |   | **989,119**         | ** **    | 981,946               |     |
| Accumulated other comprehensive income (loss)                                                                                                                  |   | **(5,795**          | **)**         | (8,119                | )        |
| **Total Common Stock Equity**                                                                                                                                  |   | **1,510,794**       | ** **    | 1,401,297             |     |
|                                                                                                                                                           |   |                | ** **    |                  |     |
| **Commitments and Contingencies** (Note 6)                                                                                                                     |   |                | ** **    |                  |     |
|                                                                                                                                                           |   |                | ** **    |                  |     |
| **Total Liabilities and Shareholder’s  Equity**                                                                                                           |   | **$**               | **4,650,666** | ** **            | $        | 4,222,956 |   |

 

**The accompanying notes as they relateto PSI Energy, Inc. are an integral part of these consolidated financialstatements.**

 

19

----

 

**PSIENERGY, INC.**

**CONSOLIDATED STATEMENTS OFCASH FLOWS**

 
|                                                                                  |   | **Year to Date  June 30** |        |
|---------------------------------------------------------------------------------------|--------|---------------------------|-------------|
|                                                                                  |   | **2003**                  |        | **2002** |   |
|                                                                                  |   | **(in  thousands)**       |        |
|                                                                                  |   | **(unaudited)**           |        |
|                                                                                  |   |                      | * *    |   | * * |
| **Operating Activities**                                                              |   |                      |        |   |   |
| Net income                                                                            |   | **$**                     | **56,806**  | ** ** | $ | 67,797 |   |
| Items providing or (using) cash currently:                                            |   |                      | ** **  |   |   |
| Depreciation                                                                          |   | **87,656**                | ** **  | 76,128 |   |
| Cumulative effect of a change in accounting  principle, net of tax                    |   | **494**                   | ** **  | — |   |
| Deferred income taxes and investment tax credits -  net                               |   | **(937**                  | **)**       | (8,881 | ) |
| Change in net position of energy risk management  activities                          |   | **635**                   | ** **  | 603 |   |
| Allowance for equity funds used during construction                                   |   | **(4,350**                | **)**       | (7,647 | ) |
| Regulatory assets deferrals                                                           |   | **(27,359**               | **)**       | (15,208 | ) |
| Regulatory assets amortization                                                        |   | **32,619**                | ** **  | 35,337 |   |
| Accrued pension and other postretirement benefit  costs                               |   | **7,480**                 | ** **  | 9,923 |   |
| Changes in current assets and current liabilities:                                    |   |                      | ** **  |   |   |
| Restricted deposits                                                                   |   | **(551**                  | **)**       | (2 | ) |
| Accounts and notes receivable                                                         |   | **28,201**                | ** **  | 120,198 |   |
| Materials, supplies, and fuel                                                         |   | **(5,995**                | **)**       | (36,653 | ) |
| Prepayments                                                                           |   | **(406**                  | **)**       | (4,589 | ) |
| Accounts payable                                                                      |   | **(136,320**              | **)**       | (66,185 | ) |
| Accrued taxes and interest                                                            |   | **491**                   | ** **  | 36,566 |   |
| Other assets                                                                          |   | **6,344**                 | ** **  | (7,655 | ) |
| Other liabilities                                                                     |   | **(1,755**                | **)**       | 5,862 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Net cash provided by (used in)  operating activities**                              |   | **43,053**                | ** **  | 205,594 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Financing Activities**                                                              |   |                      | ** **  |   |   |
| Change in short-term debt, including net affiliate  notes                             |   | **63,533**                | ** **  | 77,806 |   |
| Issuance of long-term debt                                                            |   | **35,000**                | ** **  | — |   |
| Redemption of long-term debt                                                          |   | **(27,896**               | **)**       | (23,000 | ) |
| Contribution from parent                                                              |   | **100,000**               | ** **  | — |   |
| Retirement of preferred stock                                                         |   | **(10**                   | **)**       | (2 | ) |
| Dividends on preferred stock                                                          |   | **(1,293**                | **)**       | (1,293 | ) |
| Dividends on common stock                                                             |   | **(48,340**               | **)**       | (55,138 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Net cash provided by (used in) financing  activities**                              |   | **120,994**               | ** **  | (1,627 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Investing Activities**                                                              |   |                      | ** **  |   |   |
| Construction expenditures (less allowance for equity  funds used during construction) |   | **(164,082**              | **)**       | (201,852 | ) |
| Other investments                                                                     |   | **(1,066**                | **)**       | (2,337 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Net cash provided by (used in)  investing activities**                              |   | **(165,148**              | **)**       | (204,189 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Net increase (decrease) in cash and  cash equivalents**                             |   | **(1,101**                | **)**       | (222 | ) |
|                                                                                  |   |                      | ** **  |   |   |
| **Cash and cash equivalents at  beginning of period**                                 |   | **2,007**                 | ** **  | 1,587 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Cash and cash equivalents at end of  period**                                       |   | **$**                     | **906**     | ** ** | $ | 1,365 |   |
|                                                                                  |   |                      | ** **  |   |   |
| **Supplemental Disclosure of Cash  Flow Information**                                 |   |                      | ** **  |   |   |
| Cash paid during the period for:                                                      |   |                      | ** **  |   |   |
| Interest (net of amount capitalized)                                                  |   | **$**                     | **20,465**  | ** ** | $ | 43,131 |   |
| Income taxes                                                                          |   | **$**                     | **55,919**  | ** ** | $ | 13,590 |   |
|                                                                                  |   |                      | ** **  |   |   |
| Non-cash financing and investing activities:                                          |   |                      | ** **  |   |   |
| Issuance of promissory notes to affiliated company  for acquisition of assets         |   | **$**                     | **375,969** | ** ** | $ | — |   |

 

**The accompanying notes as they relateto PSI Energy, Inc. are an integral part of these consolidated financialstatements.**

 

20

----

 

**THEUNION LIGHT, HEAT AND POWER COMPANY**

 

21

----

 

**THEUNION LIGHT, HEAT AND POWER COMPANY**

**STATEMENTS OF INCOME**

 
|                                                 |   | **Quarter Ended  June 30** |       | **Year to Date  June 30** |     |
|------------------------------------------------------|--------|----------------------------|------------|---------------------------|----------|
|                                                 |   | **2003**                   |       | **2002**                  |     | **2003** |   | **2002** |   |
|                                                 |   | **(in  thousands)**        |       |
|                                                 |   | **(unaudited)**            |       |
|                                                 |   |                       | * *   |                      | * * |   | * * |   | * * |
| **Operating Revenues**                               |   |                       |       |                      |     |   |   |   |   |
| Electric                                             |   | **$**                      | **51,096** | ** **                | $        | 54,139 |   | **$** | **106,025** | ** ** | $ | 104,975 |   |
| Gas                                                  |   | **14,383**                 | ** ** | 11,016                    |     | **63,767** | ** ** | 46,220 |   |
| **Total Operating Revenues**                         |   | **65,479**                 | ** ** | 65,155                    |     | **169,792** | ** ** | 151,195 |   |
|                                                 |   |                       | ** ** |                      |     |   | ** ** |   |   |
| **Operating Expenses**                               |   |                       | ** ** |                      |     |   | ** ** |   |   |
| Electricity purchased from parent company for resale |   | **37,136**                 | ** ** | 37,808                    |     | **76,259** | ** ** | 74,646 |   |
| Gas purchased                                        |   | **9,450**                  | ** ** | 5,311                     |     | **40,950** | ** ** | 28,200 |   |
| Operation and maintenance                            |   | **13,794**                 | ** ** | 13,928                    |     | **26,379** | ** ** | 23,380 |   |
| Depreciation                                         |   | **4,583**                  | ** ** | 4,512                     |     | **9,028** | ** ** | 8,732 |   |
| Taxes other than income taxes                        |   | **1,121**                  | ** ** | 1,167                     |     | **2,282** | ** ** | 2,368 |   |
| **Total Operating Expenses**                         |   | **66,084**                 | ** ** | 62,726                    |     | **154,898** | ** ** | 137,326 |   |
|                                                 |   |                       | ** ** |                      |     |   | ** ** |   |   |
| **Operating Income (Loss)**                          |   | **(605**                   | **)**      | 2,429                     |     | **14,894** | ** ** | 13,869 |   |
|                                                 |   |                       | ** ** |                      |     |   | ** ** |   |   |
| **Miscellaneous - Net**                              |   | **901**                    | ** ** | 1,959                     |     | **2,380** | ** ** | (2,188 | ) |
| **Interest Expense**                                 |   | **1,470**                  | ** ** | 1,452                     |     | **2,972** | ** ** | 2,957 |   |
|                                                 |   |                       | ** ** |                      |     |   | ** ** |   |   |
| **Income (Loss) Before Taxes**                       |   | **(1,174**                 | **)**      | 2,936                     |     | **14,302** | ** ** | 8,724 |   |
|                                                 |   |                       | ** ** |                      |     |   | ** ** |   |   |
| **Income Taxes**                                     |   | **(679**                   | **)**      | 944                       |     | **5,391** | ** ** | 2,848 |   |
|                                                 |   |                       | ** ** |                      |     |   | ** ** |   |   |
| **Net Income (Loss)**                                |   | **$**                      | **(495**   | **)**                     | $        | 1,992 |   | **$** | **8,911** | ** ** | $ | 5,876 |   |

 

**The accompanying notes as they relateto The Union Light, Heat and Power Company are an integral part of thesefinancial statements.**

 

22

----

 

**THEUNION LIGHT, HEAT AND POWER COMPANY**

**BALANCE SHEETS**

 

**ASSETS**

 
|                                                                                                                         |   | **June 30  2003**   |        | **December 31  2002** |     |
|------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-------------|-----------------------|----------|
|                                                                                                                         |   | **(in  thousands)** |        |
|                                                                                                                         |   | **(unaudited)**     |        |
|                                                                                                                         |   |                | * *    |                  | * * |
| **Current Assets**                                                                                                           |   |                |        |                  |     |
| Cash and cash equivalents                                                                                                    |   | **$**               | **3,935**   | ** **            | $        | 3,926 |   |
| Notes receivable from affiliated companies                                                                                   |   | **6,438**           | ** **  | 13,337                |     |
| Accounts receivable less accumulated provision for  doubtful accounts of $111 at June 30, 2003, and $84 at December 31, 2002 |   | **729**             | ** **  | 703                   |     |
| Accounts receivable from affiliated companies                                                                                |   | **170**             | ** **  | 1,671                 |     |
| Materials, supplies, and fuel                                                                                                |   | **6,633**           | ** **  | 8,182                 |     |
| Prepayments and other                                                                                                        |   | **558**             | ** **  | 316                   |     |
| **Total Current Assets**                                                                                                     |   | **18,463**          | ** **  | 28,135                |     |
|                                                                                                                         |   |                | ** **  |                  |     |
| **Property, Plant, and Equipment - at  Cost**                                                                                |   |                | ** **  |                  |     |
| Utility plant in service (Note 11)                                                                                           |   |                | ** **  |                  |     |
| Electric                                                                                                                     |   | **267,672**         | ** **  | 258,094               |     |
| Gas                                                                                                                          |   | **224,400**         | ** **  | 215,505               |     |
| Common                                                                                                                       |   | **31,898**          | ** **  | 31,679                |     |
| **Total Utility Plant In Service**                                                                                           |   | **523,970**         | ** **  | 505,278               |     |
| Construction work in progress                                                                                                |   | **11,615**          | ** **  | 14,745                |     |
| **Total Utility Plant**                                                                                                      |   | **535,585**         | ** **  | 520,023               |     |
| Accumulated depreciation                                                                                                     |   | **195,590**         | ** **  | 187,876               |     |
| **Net Property, Plant, and Equipment**                                                                                       |   | **339,995**         | ** **  | 332,147               |     |
|                                                                                                                         |   |                | ** **  |                  |     |
| **Other Assets**                                                                                                             |   |                | ** **  |                  |     |
| Regulatory assets                                                                                                            |   | **9,561**           | ** **  | 5,134                 |     |
| Other                                                                                                                        |   | **20,774**          | ** **  | 16,811                |     |
| **Total Other Assets**                                                                                                       |   | **30,335**          | ** **  | 21,945                |     |
|                                                                                                                         |   |                | ** **  |                  |     |
| **Total Assets**                                                                                                             |   | **$**               | **388,793** | ** **            | $        | 382,227 |   |

 

**The accompanying notes as they relateto The Union Light, Heat and Power Company are an integral part of thesefinancial statements.**

 

23

----

 

**THEUNION LIGHT, HEAT AND POWER COMPANY**

**BALANCE SHEETS**

** **

**LIABILITIES AND SHAREHOLDER’S EQUITY**

 
|                                                                                                                                   |   | **June 30  2003**   |        | **December 31  2002** |     |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-------------|-----------------------|----------|
|                                                                                                                                   |   | **(in  thousands)** |        |
|                                                                                                                                   |   | **(unaudited)**     |        |
|                                                                                                                                   |   |                | * *    |                  | * * |
| **Current Liabilities**                                                                                                                |   |                |        |                  |     |
| Accounts payable                                                                                                                       |   | **$**               | **4,048**   | ** **            | $        | 8,816 |   |
| Accounts payable to affiliated companies                                                                                               |   | **19,420**          | ** **  | 22,297                |     |
| Accrued taxes                                                                                                                          |   | **810**             | ** **  | 1,487                 |     |
| Accrued interest                                                                                                                       |   | **1,305**           | ** **  | 1,226                 |     |
| Long-term debt due within one year                                                                                                     |   | **20,000**          | ** **  | 20,000                |     |
| Notes payable to affiliated companies (Note 4)                                                                                         |   | **20,952**          | ** **  | 14,076                |     |
| Other                                                                                                                                  |   | **5,810**           | ** **  | 6,368                 |     |
| **Total Current Liabilities**                                                                                                          |   | **72,345**          | ** **  | 74,270                |     |
|                                                                                                                                   |   |                | ** **  |                  |     |
| **Non-Current Liabilities**                                                                                                            |   |                | ** **  |                  |     |
| Long-term debt                                                                                                                         |   | **54,669**          | ** **  | 54,653                |     |
| Deferred income taxes                                                                                                                  |   | **48,230**          | ** **  | 43,360                |     |
| Unamortized investment tax credits                                                                                                     |   | **3,011**           | ** **  | 3,143                 |     |
| Accrued pension and other postretirement benefit  costs                                                                                |   | **16,213**          | ** **  | 15,620                |     |
| Other                                                                                                                                  |   | **14,556**          | ** **  | 14,017                |     |
| **Total Non-Current Liabilities**                                                                                                      |   | **136,679**         | ** **  | 130,793               |     |
|                                                                                                                                   |   |                | ** **  |                  |     |
| **Total Liabilities**                                                                                                                  |   | **209,024**         | ** **  | 205,063               |     |
|                                                                                                                                   |   |                | ** **  |                  |     |
| **Common Stock Equity**                                                                                                                |   |                | ** **  |                  |     |
| Common stock - $15.00 par value; authorized shares -  1,000,000; outstanding shares - 585,333 at June 30, 2003, and December 31,  2002 |   | **8,780**           | ** **  | 8,780                 |     |
| Paid-in capital                                                                                                                        |   | **23,644**          | ** **  | 23,644                |     |
| Retained earnings                                                                                                                      |   | **147,405**         | ** **  | 144,800               |     |
| Accumulated other comprehensive income (loss)                                                                                          |   | **(60**             | **)**       | (60                   | )        |
| **Total Common Stock Equity**                                                                                                          |   | **179,769**         | ** **  | 177,164               |     |
|                                                                                                                                   |   |                | ** **  |                  |     |
| **Commitments and Contingencies** (Note 6)                                                                                             |   |                | ** **  |                  |     |
|                                                                                                                                   |   |                | ** **  |                  |     |
| **Total Liabilities and Shareholder’s  Equity**                                                                                   |   | **$**               | **388,793** | ** **            | $        | 382,227 |   |

 

**The accompanying notes as they relateto The Union Light, Heat and Power Company are an integral part of thesefinancial statements.**

 

24

----

 

**THEUNION LIGHT, HEAT AND POWER COMPANY**

**STATEMENTS OF CASH FLOWS**

 
|                                                                                  |   | **Year to Date  June 30** |       |
|---------------------------------------------------------------------------------------|--------|---------------------------|------------|
|                                                                                  |   | **2003**                  |       | **2002** |   |
|                                                                                  |   | **(in  thousands)**       |       |
|                                                                                  |   | **(unaudited)**           |       |
|                                                                                  |   |                      | * *   |   | * * |
| **Operating Activities**                                                              |   |                      |       |   |   |
| Net income                                                                            |   | **$**                     | **8,911**  | ** ** | $ | 5,876 |   |
| Items providing or (using) cash currently:                                            |   |                      | ** ** |   |   |
| Depreciation                                                                          |   | **9,028**                 | ** ** | 8,732 |   |
| Deferred income taxes and investment tax credits -  net                               |   | **4,737**                 | ** ** | (132 | ) |
| Allowance for equity funds used during construction                                   |   | **(287**                  | **)**      | (259 | ) |
| Regulatory assets deferrals                                                           |   | **(197**                  | **)**      | 4,435 |   |
| Regulatory assets amortization                                                        |   | **209**                   | ** ** | (1,077 | ) |
| Accrued pension and other postretirement benefit  costs                               |   | **593**                   | ** ** | 1,048 |   |
| Deferred costs under gas cost recovery mechanism                                      |   | **(8,375**                | **)**      | 4,109 |   |
| Changes in current assets and current liabilities:                                    |   |                      | ** ** |   |   |
| Accounts and notes receivable                                                         |   | **8,374**                 | ** ** | 14,063 |   |
| Materials, supplies, and fuel                                                         |   | **1,549**                 | ** ** | 3,760 |   |
| Prepayments                                                                           |   | **(242**                  | **)**      | (332 | ) |
| Accounts payable                                                                      |   | **(7,645**                | **)**      | 3,799 |   |
| Accrued taxes and interest                                                            |   | **(598**                  | **)**      | 2,784 |   |
| Other assets                                                                          |   | **598**                   | ** ** | 714 |   |
| Other liabilities                                                                     |   | **(630**                  | **)**      | 621 |   |
|                                                                                  |   |                      | ** ** |   |   |
| **Net cash provided by (used in)  operating activities**                              |   | **16,025**                | ** ** | 48,141 |   |
|                                                                                  |   |                      | ** ** |   |   |
| **Financing Activities**                                                              |   |                      | ** ** |   |   |
| Change in short-term debt, including net affiliate  notes                             |   | **6,876**                 | ** ** | (32,024 | ) |
| Dividends on common stock                                                             |   | **(6,305**                | **)**      | (2,675 | ) |
|                                                                                  |   |                      | ** ** |   |   |
| **Net cash provided by (used in)  financing activities**                              |   | **571**                   | ** ** | (34,699 | ) |
|                                                                                  |   |                      | ** ** |   |   |
| **Investing Activities**                                                              |   |                      | ** ** |   |   |
| Construction expenditures (less allowance for equity  funds used during construction) |   | **(16,587**               | **)**      | (15,260 | ) |
| Other investments                                                                     |   | **—**                | ** ** | (20 | ) |
|                                                                                  |   |                      | ** ** |   |   |
| **Net cash provided by (used in)  investing activities**                              |   | **(16,587**               | **)**      | (15,280 | ) |
|                                                                                  |   |                      | ** ** |   |   |
| **Net increase (decrease) in cash and  cash equivalents**                             |   | **9**                     | ** ** | (1,838 | ) |
|                                                                                  |   |                      | ** ** |   |   |
| **Cash and cash equivalents at  beginning of period**                                 |   | **3,926**                 | ** ** | 4,099 |   |
|                                                                                  |   |                      | ** ** |   |   |
| **Cash and cash equivalents at end of  period**                                       |   | **$**                     | **3,935**  | ** ** | $ | 2,261 |   |
|                                                                                  |   |                      | ** ** |   |   |
| **Supplemental Disclosure of Cash  Flow Information**                                 |   |                      | ** ** |   |   |
| Cash paid during the period for:                                                      |   |                      | ** ** |   |   |
| Interest (net of amount capitalized)                                                  |   | **$**                     | **1,437**  | ** ** | $ | 2,170 |   |
| Income taxes                                                                          |   | **$**                     | **3,001**  | ** ** | $ | 2,386 |   |

 

**The accompanying notes as they relateto The Union Light, Heat and Power Company are an integral part of thesefinancial statements.**

 

25

----

 

### **NOTES TO 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”.

 

**1.  Summaryof Significant Accounting Policies**

*** ***

***(a)***                                  Presentation

 

Our Financial Statementsreflect all adjustments (which include normal, recurring adjustments) necessaryin the opinion of the registrants for a fair presentation of the interimresults.  These results are notnecessarily indicative of results for a full year.  These statements should be read in conjunction with the FinancialStatements and the notes thereto included in the registrants’ combined Form10-K for the year ended December 31, 2002 and Form 8-K filed on June 10, 2003(together, the 2002 10-K).  Certainamounts in the 2002 Financial Statements have been reclassified to conform tothe 2003 presentation.

 

Management makesestimates and assumptions when preparing financial statements under generallyaccepted accounting principles (GAAP). Actual results could differ, as these estimates and assumptions involvejudgment.

 

***(b)***                                  Derivatives

 

We use derivatives tomanage exposures to commodity price risk and fluctuations in interest rates.

 

We account forderivatives under Statement of Financial Accounting Standards No. 133, *Accounting for Derivative Instruments and HedgingActivities* (Statement 133), which requires all derivatives, subjectto certain exemptions, to be accounted for at fair value.  Changes in the derivative’s fair value mustbe recognized currently in earnings unless specific hedge accounting criteriaare met.  Gains and losses onderivatives that qualify as hedges can (a) offset related fair value changes onthe hedged item in the income statement for fair value hedges; or (b) berecorded in other comprehensive income for cash flow hedges.  To qualify for hedge accounting, derivativesmust be designated as a hedge (for example, an offset of interest rate risks)and must be effective at reducing the risk associated with the hedgeditem.  Accordingly, changes in the fairvalues or cash flows of instruments designated as hedges must be highlycorrelated with changes in the fair values or cash flows of the related hedgeditems.

 

*(i)*               Energy Marketing and Trading

 

We market and tradeelectricity, natural gas, coal, and other energy-related products.  We designate derivative transactions astrading or non-trading at the time they are originated in accordance withEmerging Issues Task Force (EITF) Issue 02-3, *IssuesInvolved in**Accounting forDerivative Contracts Held for Trading Purposes and Contracts Involved in EnergyTrading and Risk Management Activities* (EITF 02-3).  Derivatives are classified as non-tradingonly when we have the intent and projected ability to fulfill substantially allobligations from company-owned assets. Such classification is generally limited to the sale of generation tothird

 

26

----

 

parties when it is notrequired to meet native load requirements (end-use customers within our publicutility companies’ franchise service territory).  All other energy derivatives (excluding electric and gas purchasecontracts for use in serving our native load requirements) are classified astrading.  Gas trading is comprised oftransactions for which gas is physically delivered to a customer (physical gastrading), as well as transactions that are financial in nature for whichdelivery rarely occurs (financial gas trading).  Since our gas marketing and trading operations own no gasproduction and have limited transmission ownership, their gas transactions areconsidered trading whether physical or financial.  Certain gas and coal contracts do not meet the definition of aderivative and, therefore, are not required to be classified as trading ornon-trading.

 

In 2003, we beganreflecting realized and unrealized gains and losses on trading derivatives on anet basis in *Operating Revenues* pursuantto the requirements of EITF 02-3, regardless of whether the transactions weresettled physically.  Prior to 2003, therealized results for trading contracts that were physical in nature werepresented as either (a) *Operating Revenues*,**if sales contracts**or (b)*Fuel and purchased and exchanged power* expense or *Gas purchased* expense, if purchasecontracts.  The presentation for 2002has been reclassified to conform to the new presentation.  Non-trading derivatives, as well as energymarketing contracts that are not derivatives, are presented on a gross basis in*Operating Revenues* or *Fuel and purchased and exchanged power*expense.  (For more information see (g)(*i*)).

 

We account for nearly allnon-trading derivatives and non-derivative energy contracts on the accrualbasis of accounting (accrual contracts). Non-trading derivatives are accounted for as accrual only if thecontract qualifies for the normal purchases and sales scope exception in Statement133.  Trading derivatives are accountedfor at fair value with changes in fair value, which represent unrealized gainsand losses, included as revenues in our Statements of Income.  These derivatives are shown in our BalanceSheets as *Energyrisk management assets* and *Energy risk management liabilities*.  In October 2002, the EITF reached aconsensus in EITF 02-3 to rescind EITF Issue 98-10, *Accounting for Contracts Involved inEnergy Trading and Risk Management Activities* (EITF 98-10).  Thisdecision required that non-derivative contracts and natural gas inventorypreviously accounted for at fair value be accounted for on an accrual basis,beginning January 1, 2003.  In June2003, we began applying fair value hedge accounting to certain quantities ofnatural gas inventory.  See (c) for furtherdiscussion.

 

Although we intend tosettle accrual contracts with company-owned assets, occasionally we settlethese contracts with purchases on the open trading markets.  The cost of these purchases could be inexcess of the associated revenues.  Werecognize the gains or losses on these transactions as delivery occurs.  Open market purchases may occur for thefollowing reasons:

 

•                  generatingstation outages;

•                  least-costalternative;

•                  nativeload requirements; and

•                  extremeweather.

 

We anticipate that someof the electricity obligations, even though considered trading derivatives,will ultimately be settled using company-owned generation.  The variable cost

 

27

----

 

of this generation istypically below the market price at which the trading portfolio has beenvalued.  The potential for earningsvolatility from period to period is increased due to the risks associated withmarketing and trading electricity, natural gas, and other energy-relatedproducts.

 

We value tradingderivatives using end-of-the-period fair values, utilizing the followingfactors (as applicable):

 

•                  closingexchange prices (that is, closing prices for standardized electricity andnatural gas products traded on an organized exchange, such as the New YorkMercantile Exchange);

•                  broker-dealerand over-the-counter price quotations; and

•                  modelpricing (which considers time value and historical volatility factors ofelectricity and natural gas).

 

*(ii)*           Interest Rate Risk

 

We use interest rate swaps(an agreement by two parties to exchange fixed-interest rate cash flows forfloating-interest rate cash flows) and treasury locks (an agreement that fixesthe yield or price on a specific treasury security for a specific period, whichwe sometimes use in connection with the issuance of fixed rate debt).  We account for such derivatives at fairvalue, and we assess the effectiveness of any interest rate swaps and/ortreasury locks used in hedging activities.

 

At June 30, 2003, theineffectiveness of instruments that we have classified as fair value or cashflow hedges of debt instruments was not material.  Reclassification of unrealized gains or losses on cash flowhedges of debt instruments from *Accumulatedother comprehensive income (loss)* occurs as interest is accrued onthe debt instrument.  We currentlyestimate that on an after-tax basis, $5 million of unrealized losses will bereclassified as a charge to *Interest Expense*during the twelve-month period ending June 30, 2004.

 

***(c)***                                  Inventory

 

Prior to January 1, 2003,natural gas inventory for our North American gas trading operation, wasaccounted for at fair value.  All otherinventory was accounted for at the lower of cost or market, cost beingdetermined through the weighted average method.  Effective January 1, 2003, accounting for the North American gastrading operation’s inventory was adjusted to the lower of cost or marketmethod with a cumulative effect adjustment, as required by EITF 02-3.  See (g)(*i*)below for additional discussion of the impacts of adopting EITF 02-3.

 

In June 2003, inaccordance with the provisions of Statement 133, **Cinergy** designated specific derivatives as fair value hedgesfor certain volumes of our natural gas inventory.  Under this accounting election, changes in the fair value of boththe derivative as well as the hedged item (the specified inventory) areincluded in income.  We assess theeffectiveness of the derivatives in offsetting the change in fair value of theinventory on a quarterly basis.  For thethree months ended, June 30, 2003, the hedges’ ineffectiveness was notmaterial.

 

28

----

 

***(d)***                                  Stock-BasedCompensation

 

Effective January 1,2003, **Cinergy** adoptedprospectively the fair value recognition provisions of Statement of FinancialAccounting Standards No. 123, *Accounting forStock-Based Compensation*, as amended by Statement of FinancialAccounting Standards No. 148, *Accounting forStock-Based Compensation—Transition and Disclosure*, for all employeeawards granted or modified after January 1, 2003.  Prior to 2003, we accounted for our stock-based compensationplans using the intrinsic value method under Accounting Principles BoardOpinion No. 25, *Accounting for Stock Issuedto Employees*.  The followingtable illustrates the effect on our *NetIncome* and *Earnings Per CommonShare* (EPS) if the fair value based method had been applied to alloutstanding and unvested awards in each period.

 
|                                 |                                                                                                                            | **Quarter Ended June 30**                    |       | **Year to Date June 30** |   |
|--------------------------------------|---------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------|------------|--------------------------|--------|
|                                 |                                                                                                                            | **(in  millions, except per share amounts)** |       |
|                                 |                                                                                                                            |                                         |       |                     |   |   |   |   |   |
|                                 |                                                                                                                            | **2003**                                     |       | **2002**                 |   | **2003** |   | **2002** |   |
|                                 |                                                                                                                            |                                         |       |                     |   |   |   |   |   |
| Net income, as reported              |                                                                                                                            | **$**                                        | **85**     | ** **               | $      | 45 |   | **$** | **251** | ** ** | $ | 130 |   |
|                                 |                                                                                                                            |                                         | ** ** |                     |   |   | ** ** |   |   |
| Add:                                 | Stock-based employee compensation expense included  in reported net income, net of related tax effects.                         |                                         | **6**      | ** **               | 2      |   | **9** | ** ** | 5 |   |
|                                 |                                                                                                                            |                                         |       | ** **               |   |   |   | ** ** |   |   |
| Deduct:                              | Stock-based employee compensation expense determined  under fair value based method for all awards, net of related tax effects. |                                         | **6**      | ** **               | 3      |   | **10** | ** ** | 6 |   |
|                                 |                                                                                                                            |                                         | ** ** |                     |   |   | ** ** |   |   |
| Pro-forma net income                 |                                                                                                                            | **$**                                        | **85**     | ** **               | $      | 44 |   | **$** | **250** | ** ** | $ | 129 |   |
|                                 |                                                                                                                            |                                         | ** ** |                     |   |   | ** ** |   |   |
| EPS  - as reported                   |                                                                                                                            | **$**                                        | **0.47**   | ** **               | $      | 0.27 |   | **$** | **1.43** | ** ** | $ | 0.79 |   |
| EPS  - pro-forma                     |                                                                                                                            | **$**                                        | **0.47**   | ** **               | $      | 0.27 |   | **$** | **1.42** | ** ** | $ | 0.78 |   |
|                                 |                                                                                                                            |                                         | ** ** |                     |   |   | ** ** |   |   |
| EPS  assuming dilution - as reported |                                                                                                                            | **$**                                        | **0.47**   | ** **               | $      | 0.26 |   | **$** | **1.42** | ** ** | $ | 0.78 |   |
| EPS  assuming dilution - pro-forma   |                                                                                                                            | **$**                                        | **0.47**   | ** **               | $      | 0.26 |   | **$** | **1.41** | ** ** | $ | 0.77 |   |

 

The pro-forma amountsreflect certain assumptions used in estimating fair values.  As a result of this and other factors whichmay effect the timing and amounts of stock-based compensation, the pro-formaeffect on *Net Income* and EPS maynot be representative of future periods.

 

***(e)***                                  AssetRetirement Obligations

 

We recognize the fairvalue of legal obligations associated with the retirement or removal oflong-lived assets at the time the obligations are incurred.  The initial recognition of this liability isaccompanied by a corresponding increase in property, plant, and equipment.  Subsequent to the initial recognition, theliability is adjusted for any revisions to the expected cash flows of the retirementobligation (with corresponding adjustments to property, plant, and equipment),and for accretion of the liability due to the passage of time (recognized as *Operation and maintenance* expense).  Additional depreciation expense is recordedprospectively for any property, plant, and equipment increases.

 

29

----

 

We do not recognizeliabilities for asset retirement obligations for which the fair value cannot bereasonably estimated.  The CincinnatiGas & Electric Company (**CG&E**)and PSI Energy, Inc. (**PSI**) haveasset retirement obligations associated with river structures at certaingenerating stations.  However, theretirement date for these river structures cannot be reasonably estimated;therefore, the fair value of the associated liability currently cannot beestimated and no amounts are recognized in the financial statements herein.

 

Effective with ouradoption of Statement of Financial Accounting Standards No. 143, *Accounting for Asset Retirement Obligations*(Statement 143), on January 1, 2003, we do not accrue the estimated cost ofremoval when no obligation exists for any of our non-regulated assets, even ifremoval of the asset is likely.  For ourrate-regulated assets where our tariff rate includes a cost of removalcomponent, we recognize a charge for estimated cost of removal under Statementof Financial Accounting Standards No. 71, *Accountingfor the Effects of Certain Types of Regulation*(Statement 71), aspart of depreciation.  This includesmost assets for **PSI**, **CG&E**, except for its generating assets,and The Union Light, Heat and Power Company (**ULH&P**). See (g)(*iii*) foradditional information.

 

***(f)***                                    OperatingRevenues

 

Our operating companiesrecord *Operating Revenues* forelectric and gas service when delivered to customers.  Customers are billed throughout the month as both gas andelectric meters are read.  We recognizerevenues for retail energy sales that have not yet been billed, but where gasor electricity has been consumed.  Thisis termed “unbilled revenue” and is a widely recognized and accepted practicefor utilities.  In making our estimatesof unbilled revenue, we use complex systems that consider various factors,including weather, in our calculation of retail customer consumption at the endof each month.  Given the use of thesesystems and the fact that customers are billed monthly, we believe it isunlikely that materially different results will occur in future periods whenrevenue is subsequently billed.

 

The amount of unbilledrevenues for **Cinergy**, **CG&E**, **PSI**,and **ULH&P** as of June 30, 2003and 2002, were as follows:

 

|                          |   | **2003**           |     | **2002** |     |
|-------------------------------|--------|--------------------|----------|----------|----------|
|                          |   | **(in  millions)** |     |
|                          |   |               | * * |     | * * |
| **Cinergy**                   |   | $                  | **123**  |     | $        | 132 |   |
| **CG&E**and  subsidiaries |   | **64**             |     | 68       |     |
| **PSI**                       |   | **59**             |     | 64       |     |
| **ULH&P**                 |   | **10**             |     | 11       |     |
|                               |        |                    |          |          |          |  |  |

 

***(g)***                                 AccountingChanges

 

*(i)*               Energy Trading

 

In October 2002, the EITFreached consensus in EITF 02-3, to (a) rescind EITF 98-10, (b) generallypreclude the recognition of gains at the inception of derivatives, and (c)require all realized and unrealized gains and losses on energy tradingderivatives to be presented net in the Statements of

 

30

----

 

Income, whether or notsettled physically.  The consensus torescind EITF 98-10 required most energy trading contracts that do not qualifyas derivatives to be accounted for on an accrual basis, rather than at fairvalue.  The consensus was immediatelyeffective for all new contracts executed after October 25, 2002, and required acumulative effect adjustment to income, net of tax, on January 1, 2003, for allcontracts executed on or prior to October 25, 2002.  The cumulative effect adjustment, on a net of tax basis, was aloss of $13 million for **Cinergy**and $8 million for **CG&E**, whichincludes primarily the impact of certain coal contracts, gas inventory, andcertain gas contracts, which were all accounted for at fair value.  We expect this rescission to have thelargest ongoing impact on our gas trading business, which uses financialcontracts, physical contracts, and gas inventory to take advantage of variousarbitrage opportunities.  Prior to the rescissionof EITF 98-10, all of these activities were accounted for at fair value.  Under the revised guidance, only certainitems are accounted for at fair value, which could increase inter-periodvolatility in reported results of operations. As a result, we began applying fair value hedge accounting in June 2003to certain quantities of gas inventory (more fully discussed in (c) above) andare further reviewing additional applications for hedge accounting.

 

The consensus to requireall gains and losses on energy trading derivatives to be presented net in theStatements of Income was effective January 1, 2003, and requiredreclassification for all periods presented. This resulted in substantial reductions in reported *Operating Revenues, Fuel and purchased and exchangedpower*expense, and *Gas purchased*expense.  However, *Operating Income* and *Net Income* were not affected by thischange.

 

The following tablepresents the effect of the change in revenue presentation in *Operating Revenues, Fuel and purchased and exchangedpower*expense, and*Gas purchased*expensefor the quarter ended and year to date June 30, 2002.

 
|                                                  |   | **Cinergy(1)**      |      | **CG&E and  subsidiaries** |     | **PSI** |     |
|-------------------------------------------------------|--------|---------------------|-----------|--------------------------------|----------|---------|----------|
|                                                  |   | **(in  thousands)** |      |
|                                                  |   |                | * *  |                           | * * |    | * * |
| **Quarter Ended June 30, 2002**                       |   |                |      |                           |     |    |     |
|                                                  |   |                |      |                           |     |    |     |
| *Electric Operating Revenues* as  previously reported |   | $                   | 1,340,370 |                           | $        | 866,450 |     | $ | 467,428 |   |
|                                                  |   |                |      |                           |     |    |     |
| Adjustment  for effect of EITF 02-3 implementation    |   | (511,124            | )         | (456,741                       | )        | (88,810 | )        |
| Other(2)                                              |   | (24,783             | )         | —                         |     | —  |     |
|                                                  |   |                |      |                           |     |    |     |
| *Electric Operating Revenues* as adjusted             |   | 804,463             |      | 409,709                        |     | 378,618 |     |
|                                                  |   |                |      |                           |     |    |     |
| *Gas Operating Revenues* as previously  reported      |   | 1,116,953           |      | 56,008                         |     | —  |     |
|                                                  |   |                |      |                           |     |    |     |
| Adjustment  for effect of EITF 02-3 implementation    |   | (1,036,745          | )         | —                         |     | —  |     |
|                                                  |   |                |      |                           |     |    |     |
| *Gas Operating Revenues* as adjusted                  |   | 80,208              |      | 56,008                         |     | —  |     |
|                                                       |        |                     |           |                                |          |         |          |  |  |  |

 

31

----

 
|                                                                     |   | **Cinergy(1)**      |      | **CG&E and  subsidiaries** |     | **PSI**   |     |
|--------------------------------------------------------------------------|--------|---------------------|-----------|--------------------------------|----------|-----------|----------|
| **Quarter Ended June 30, 2002 (continued)**                              |   | **(in  thousands)** |      |
|                                                                     |   |                | * *  |                           | * * |      | * * |
| *Fuel and purchased and exchanged power*  expense as previously reported |   | 758,673             |      | 564,329                        |     | 217,356   |     |
|                                                                     |   |                |      |                           |     |      |     |
| Adjustment  for effect of EITF 02-3 implementation                       |   | (501,116            | )         | (455,744                       | )        | (88,810   | )        |
| Other(2)                                                                 |   | (15,871             | )         | —                         |     | —    |     |
|                                                                     |   |                |      |                           |     |      |     |
| *Fuel and purchased and exchanged power*  expense as adjusted            |   | 241,686             |      | 108,585                        |     | 128,546   |     |
|                                                                     |   |                |      |                           |     |      |     |
| *Gas purchased* expense as previously  reported                          |   | 1,076,315           |      | 24,471                         |     | —    |     |
|                                                                     |   |                |      |                           |     |      |     |
| Adjustment  for effect of EITF 02-3 implementation                       |   | (1,046,753          | )         | —                         |     | —    |     |
|                                                                     |   |                |      |                           |     |      |     |
| *Gas purchased* expense as adjusted                                      |   | 29,562              |      | 24,471                         |     | —    |     |
|                                                                     |   |                |      |                           |     |      |     |
| **Year to Date June 30, 2002**                                           |   |                |      |                           |     |      |     |
|                                                                     |   |                |      |                           |     |      |     |
| *Electric Operating Revenues* as  previously reported                    |   | $                   | 2,623,794 |                           | $        | 1,502,336 |     | $ | 1,097,272 |   |
|                                                                     |   |                |      |                           |     |      |     |
| Adjustment  for effect of EITF 02-3 implementation                       |   | (1,004,045          | )         | (695,529                       | )        | (352,253  | )        |
| Other(2)                                                                 |   | (53,901             | )         | —                         |     | —    |     |
|                                                                     |   |                |      |                           |     |      |     |
| *Electric Operating Revenues* as adjusted                                |   | 1,565,848           |      | 806,807                        |     | 745,019   |     |
|                                                                     |   |                |      |                           |     |      |     |
| *Gas Operating Revenues* as previously  reported                         |   | 2,020,214           |      | 235,617                        |     | —    |     |
|                                                                     |   |                |      |                           |     |      |     |
| Adjustment  for effect of EITF 02-3 implementation                       |   | (1,749,942          | )         | —                         |     | —    |     |
|                                                                     |   |                |      |                           |     |      |     |
| *Gas Operating Revenues* as adjusted                                     |   | 270,272             |      | 235,617                        |     | —    |     |
|                                                                     |   |                |      |                           |     |      |     |
| *Fuel and purchased and exchanged power*  expense as previously reported |   | 1,486,220           |      | 909,344                        |     | 603,848   |     |
|                                                                     |   |                |      |                           |     |      |     |
| Adjustment  for effect of EITF 02-3 implementation                       |   | (994,037            | )         | (693,511                       | )        | (352,253  | )        |
| Other(2)                                                                 |   | (32,691             | )         | —                         |     | —    |     |
|                                                                     |   |                |      |                           |     |      |     |
| *Fuel and purchased and exchanged power*  expense as adjusted            |   | 459,492             |      | 215,833                        |     | 251,595   |     |
|                                                                     |   |                |      |                           |     |      |     |
| *Gas purchased* expense as previously  reported                          |   | 1,899,392           |      | 132,439                        |     | —    |     |
|                                                                     |   |                |      |                           |     |      |     |
| Adjustment  for effect of EITF 02-3 implementation                       |   | (1,759,950          | )         | —                         |     | —    |     |
|                                                                     |   |                |      |                           |     |      |     |
| *Gas purchased* expense as adjusted                                      |   | 139,442             |      | 132,439                        |     | —    |     |
|                                                                          |        |                     |           |                                |          |           |          |  |  |  |

 

----

(1)               The results of **Cinergy** also include amounts related tonon-registrants and include the elimination of certain intercompany amounts.

(2)               Item representsamounts reclassified to *Discontinuedoperations, net of tax*.

 

*(ii)*           Intangible Assets

 

In June 2001, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 142, *Goodwill andOther Intangible Assets* (Statement 142).  With the adoption of Statement 142, goodwill and otherintangibles with indefinite lives are no longer subject to amortization.  Statement 142 requires that goodwill beassessed for impairment upon

 

32

----

 

adoption (transitionimpairment test) and at least annually thereafter by applying afair-value-based test, as opposed to the undiscounted cash flow test appliedunder prior accounting standards.

 

We began applyingStatement 142 in the first quarter of 2002. The discontinuance of amortization of goodwill, which began in the firstquarter of 2002, was not material to our financial position or results of operations.  We finalized our transition impairment testin the fourth quarter of 2002 and recognized a non-cash impairment charge ofapproximately $11 million (net of tax) for goodwill related to certain of ourinternational assets.  This amount isreflected in **Cinergy’s**Statementsof Income as a cumulative effect adjustment, net of tax.  While Statement 142 did not require theinitial transition impairment test to be completed until December 31, 2002, itrequired the cumulative effect adjustment to be reflected as of January 1,2002.

 

**CinergyCorp.’s** condensed financial results below revise previouslyreported results as filed in the Form 10-Q for the period ended June 30, 2002,to reflect the impairment charge as of January 1, 2002.

 
|                                                               |   | **Year to Date  June 30, 2002**    |     |
|--------------------------------------------------------------------|--------|------------------------------------|----------|
|                                                               |   | **Net Income**                     |     | **EPS** |   | **EPS-  Assuming  Dilution** |   |
|                                                               |   | **(in  millions, except for EPS)** |     |
|                                                               |   |                               | * * |   | * * |   | * * |
| Reported results                                                   |   | $                                  | 141      |   | $ | 0.85 |   | $ | 0.84 |   |
| Cumulative effect of a  change in accounting principle, net of tax |   | (11                                | )        | (0.06 | ) | (0.06 | ) |
| Revised results                                                    |   | $                                  | 130      |   | $ | 0.79 |   | $ | 0.78 |   |

 

*(iii)*       Asset Retirement Obligations

 

In July 2001, the FASBissued Statement 143, which requires fair value recognition beginning January1, 2003, of legal obligations associated with the retirement or removal oflong-lived assets, at the time the obligations are incurred.  Our accounting policy for such legalobligations is described in (e) above.

 

We adopted Statement 143on January 1, 2003, and **Cinergy**and**CG&E** both recognized a gain of$39 million (net of tax) for the cumulative effect of this change in accountingprinciple.  Substantially all of thisadjustment reflects the reversal of previously accrued cost of removal for **CG&E’s** generating assets, which do notapply Statement 71.  *Accumulated depreciation* at adoptionincludes $316 million, $25 million, and $146 million of accumulated cost ofremoval related to **PSI’s**, **ULH&P’s**, and **CG&E’s**utility plant in service assets, respectively,which represent regulatory liabilities and were not included as part of thecumulative effect adjustment.  Theincreases in assets and liabilities from adopting Statement 143 were notmaterial to our financial position.

 

33

----

 

Pro-forma results as ifStatement 143 was applied retroactively for the years ended December 31, 2002,2001, and 2000 and the quarter ended and year to date June 30, 2002 are notmaterially different from reported results.

 

*(iv)*         Derivatives

 

In May 2003, the FASBissued Statement of Financial Accounting Standards No. 149, *Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities* (Statement 149).  Statement 149 primarily amends Statement 133 to incorporateimplementation conclusions previously cleared by the FASB staff, to clarify thedefinition of a derivative and to require derivative instruments that includeup-front cash payments to be classified as a financing activity in thestatement of cash flows.  Implementationissues that have been previously cleared by the FASB staff will continue to beapplied in accordance with their respective effective dates at the time thatthey were cleared and new guidance has varying implementation provisions, noneof which will apply until the third quarter of 2003.  We are continuing to evaluate the impacts of adopting Statement149 but currently do not believe the impacts will be material to our results ofoperations or financial position.

 

In June 2003, the FASB issued final guidance on theuse of broad market indices (e.g., consumer price index) in power purchase andsales contracts.  This guidanceclarifies when the normal purchases and sales scope exception is precluded if acontract contains a broad market index. This guidance, which is effective in the fourth quarter of 2003, is notexpected to have a material impact on our financial position or results ofoperations upon adoption.

 

*(v)*             Consolidationof Special Purpose Entities (SPE)

 

The FASB issuedInterpretation No. 46, *Consolidation ofVariable Interest Entities* in January 2003.  This interpretation significantly changesthe consolidation requirements for SPEs and certain other entities subject toits scope.  We have determined thatcertain entities will be required to be consolidated effective July 1, 2003, inaccordance with this interpretation. These entities consist of (a) two SPEs that are engaged in selling powerand (b) certain joint ventures engaged in providing various energyservices.  The two SPEs have individualpower sale agreements to an unrelated third party for approximately 45megawatts (MW) of capacity, ending in 2009, and 35 MW of capacity, ending in 2016.  In addition, these SPEs have individualpower purchase agreements with Cinergy Capital & Trading, Inc. (Capital& Trading) to supply the power. Capital & Trading also provides various services, including certaincredit support facilities.  Upon theinitial consolidation of these two SPE’s, approximately $225 million ofnon-recourse debt and a comparable amount of assets will be included on **Cinergy’s** Balance Sheet.  However, the impact of consolidating thesetwo SPEs on **Cinergy’s** results ofoperations will be immaterial.  Theimpact of consolidating the joint ventures will be immaterial to our results ofoperations and financial position.

 

**Cinergy’s**quantifiable exposure to loss as a result of involvement with these two SPEs is$28 million, which includes investments in these entities of $3 million andexposure under the capped credit facilities of approximately $25 million.  There is also a non-capped facility, but it

 

34

----

 

can only be called uponin the event the SPE breaches representations, violates covenants, or otherunlikely events.

 

**Cinergy**has concluded that its accounts receivable sale facility, as discussed in the2002 10-K, will remain unconsolidated since it involves transfers of financialassets to a qualifying SPE, which is exempted from consolidation by Statementof Financial Accounting Standards No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities* and this interpretation.

 

*(vi)*         Financial Instruments with Characteristics ofboth Liabilities and Equity

 

In May 2003, the FASBissued Statement of Financial Accounting Standards No. 150, *Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity*(Statement 150).  Statement 150 establishes standards for howan issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity.  This statement was effective for financial instruments enteredinto or modified after May 31, 2003, and was effective on July 1, 2003, forfinancial instruments held prior to issuance of this statement.

 

In 2001, **Cinergy Corp**. issued approximately $316million notional amount of combined securities consisting of (a) 6.9 percentpreferred trust securities, due February 2007, and (b) stock purchase contractsobligating the holders to purchase between 9.2 and 10.8 million shares of **Cinergy Corp**. common stock in, and/orbefore, February 2005.  These securitiesare more fully described in the 2002 10-K. Statement 150 will require the preferred trust securities (currentlyrecorded as *Company obligated, mandatorilyredeemable, preferred trust securities of subsidiary, holding solely debtsecurities of the company* with a carrying value of $309 million) tobe classified as long-term debt, effective July 1, 2003.  Dividends paid on the preferred trustsecurities will be recorded as *InterestExpense* after July 1, 2003. Prior period financial statements are not permitted to be restated foreither of these changes.

 

*(vii)*     Cumulative effect of changes in accountingprinciples, net of tax

 

The following tablesummarizes the various cumulative effect adjustments (net of tax) discussedabove for the rescission of EITF 98-10 and the adoption of Statement 142 and Statement143:

 
|                                                  |   | **Year  to Date June 30** |       |
|-------------------------------------------------------|--------|---------------------------|------------|
|                                                  |   |                      |       |   |   |
|                                                  |   | **2003**                  |       | **2002** |   |
|                                                  |   | **(in  thousands)**       |       |
|                                                  |   |                      | * *   |   | * * |
| **Cinergy**(1)                                        |   |                      |       |   |   |
| Goodwill impairment  (Statement 142 adoption)         |   | **$**                     | **—** |   | $ | (10,899 | ) |
| Rescission of EITF 98-10  (EITF 02-3 adoption)        |   | **(12,512**               | **)**      | — |   |
| Asset retirement obligation  (Statement 143 adoption) |   | **38,974**                |       | — |   |
|                                                  |   | **$**                     | **26,462** |   | $ | (10,899 | ) |
| **CG&E**                                          |   |                      |       |   |   |
| Rescission of EITF 98-10  (EITF 02-3 adoption)        |   | **$**                     | **(8,239** | **)** | $ | — |   |
| Asset retirement  obligation (Statement 143 adoption) |   | **39,177**                |       | — |   |
|                                                  |   | **$**                     | **30,938** |   | $ | — |   |
| **PSI**                                               |   |                      |       |   |   |
| Rescission of EITF 98-10  (EITF 02-3 adoption)        |   | **$**                     | **(494**   | **)** | $ | — |   |
|                                                  |   | **$**                     | **(494**   | **)** | $ | — |   |

 

----

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

 

35

----

 

**2.  CommonStock Equity**

*** ***

***(a)***                                  Changes InCommon Stock Outstanding

 

As discussed in the 200210-K, **Cinergy** issues new **Cinergy Corp.** common stock shares tosatisfy obligations under its various employee stock plans and the CinergyCorp. Direct Stock Purchase and Dividend Reinvestment Plan.  During 2003, **Cinergy** has issued approximately 2.6 million shares underthese plans.

 

On January 15, 2003, **Cinergy Corp.** filed a registrationstatement with the Securities and Exchange Commission (SEC) with respect to theissuance of common stock, preferred stock, and other securities in an aggregateoffering amount of $750 million.  OnFebruary 5, 2003, **Cinergy** sold 5.7million shares of common stock of **CinergyCorp.** with net proceeds of approximately $175 million under thisregistration statement.  The netproceeds from the transaction were used to reduce short-term debt of **Cinergy Corp.** and for other generalcorporate purposes.

 

***(b)***                                  Stock-BasedCompensation Plan

 

The Compensation Committee of the Board of Directorsgrants certain performance share awards under the **Cinergy Corp.** 1996 Long-Term Incentive Compensation Plan(LTIP).  Historically, the performanceshares have been paid 100 percent in the form of common stock.  In order to maintain market-competitivenessin respect to the form of LTIP awards and to ensure continued compliance withinternal guidelines on common share dilution, the Compensation Committeeapproved the future payment of performance share awards 50 percent in commonstock and 50 percent in cash.  As aresult, in the second quarter of 2003 we have reclassified the expected cashpayout portion of the performance shares from *Paid-incapital* to other current liabilities and other non-currentliabilities.

** **

***(c)***                                  ContributedCapital

 

In May 2003, **Cinergy Corp.**made a $100 million capitalcontribution to **PSI** in order tosupport **PSI’s** current creditratings.

 

**3.  Long-termDebt**

 

In October 2002, **PSI** filed a petition with the IndianaUtility Regulatory Commission (IURC) for the purpose of securing authorizationand approval to issue two subordinated promissory notes to **Cinergy Corp.** for the acquisition of theButler County, Ohio and Henry County, Indiana peaking plants.  In January 2003, the IURC granted thisrequest, and in February 2003, **PSI**issued the notes.  One subordinated notewas for the principal amount of $200 million with an annual interest rate of6.30% and will mature on April 15, 2004. The second subordinated note was for $176 million with an annualinterest rate of 6.40% and will mature on September 1, 2004.

 

On March7, 2003, **PSI** borrowed theproceeds from the issuance by the Indiana Development Finance Authority of $35million of its Environmental Refunding Revenue Bonds Series 2003,due April 1, 2022.  Interest wasinitially set at 1.05% and resets every 35 days by auction. The

 

36

----

 

bonds are not putable bythe holders; therefore, **PSI’s** debtobligation is classified as *Long-term debt*.  On March 28, 2003, the proceeds from thisborrowing plus the interest income earned were used to cause therefunding of the $35 million principal amount outstanding of the Cityof Princeton, Indiana Pollution Control Revenue Refunding Bonds, 1997Series.

 

On April 25, 2003, **PSI**redeemed $26.8 million of the following Series A, Medium-term Notes:

 

| **Principal  Amount** |    | **Interest Rate** |         | **Maturity Date** |           |
|-----------------------|---------|-------------------|--------------|-------------------|----------------|
| ***(in millions)***   |    |              |         |              |           |
|                  |    |              | *** *** |              | *** ***   |
| **$**                 | **2.0** |              | **8.37**     | **%**             | **11/08/2006** | ** ** |
| **5.0**               |    | **8.81**          | ** **   | **05/16/2022**    | ** **     |
| **3.0**               |    | **8.80**          | ** **   | **05/18/2022**    | ** **     |
| **16.8**              |    | **8.67**          | ** **   | **06/01/2022**    | ** **     |
|                       |         |                   |              |                   |                |  |

 

On June 16, 2003, **CG&E**issued $200 million principal amount of its 5 3/8% 2003 Series B Debentures dueJune 15, 2033 (effective interest rate of 5.66%).   Proceeds from this issuance will be used for general corporatepurposes, including the funding of capital expenditures related to constructionprojects and environmental compliance initiatives, and the repayment ofoutstanding indebtedness.

 

Also, on June 16, 2003, **CG&E** modified existing debt resultingin a $200 million principal amount 5.40% 2003 Series A Debenture with a 30 yearmaturity. The effective interest rate is 6.90%.  The coupon rate differs from the effective rate due to theamortization of costs associated with modifying the existing debt.

 

On June 30, 2003, **CG&E** redeemed its $100 million 8.28%Junior Subordinated Debentures due July 1, 2025.  The redeemed amount was slightly above carrying value resultingin an insignificant loss.

 

37

----

 

**4.**                                      NotesPayable and Other Short-term Obligations

 

At June 30, 2003, **Cinergy Corp.**had $704 million remaining unused and available capacity relating to its $1billion revolving credit facilities. These revolving credit facilities included the following:

 

| **Credit Facility**          |   | **Expiration** |   | **Established  Lines** |   | **Outstanding  and  Committed** |   | **Unused and  Available** |   |
|------------------------------|--------|----------------|--------|------------------------|--------|---------------------------------|--------|---------------------------|--------|
|                         |   |           |   |                   |   | **(in  millions)**              |   |                      |   |
|                         |   |           |   |                   |   |                            |   |                      |   |
| 364-day senior  revolving    |   | April 2004     |   |                   |   |                            |   |                      |   |
| Direct borrowing             |   |           |   | $                      |   |                            | $      | —                    |   | $ |   |   |
| Commercial paper  support    |   |           |   |                   |   | 281                             |   |                      |   |
|                         |   |           |   |                   |   |                            |   |                      |   |
| Total 364-day  facility      |   |           |   | 600                    |   | 281                             |   | 319                       |   |
|                         |   |           |   |                   |   |                            |   |                      |   |
| Three-year  senior revolving |   | May 2004       |   |                   |   |                            |   |                      |   |
| Direct borrowing             |   |           |   |                   |   | —                          |   |                      |   |
| Commercial paper  support    |   |           |   |                   |   | —                          |   |                      |   |
| Letter of Credit  support    |   |           |   |                   |   | 15                              |   |                      |   |
|                         |   |           |   |                   |   |                            |   |                      |   |
| Total three-year  facility   |   |           |   | 400                    |   | 15                              |   | 385                       |   |
|                         |   |           |   |                   |   |                            |   |                      |   |
| Total credit  facilities     |   |           |   | $                      | 1,000  |                            | $      | 296                       |   | $ | 704 |   |

 

In April 2003, **Cinergy Corp.** successfully placed a $600million, 364-day senior unsecured revolving credit facility.  This facility replaced the $600 million,364-day facility that expired April 30, 2003.

 

On August 1, 2003, **CG&E** caused the remarketing by the OhioAir Quality Development Authority of $84 million of its State of Ohio AirQuality Development Revenue Refunding Bonds, due September 1, 2030.  The issuance consists of a $42 million 1995Series A and a $42 million 1995 Series B. The remarketing effected the conversion from a daily interest rate resetmode supported by a letter of credit to an unsecured weekly interest ratemode.  The interest rate for both Serieswas initially set at 1.30% and will reset every seven days going forward.  Because the holders of these notes have theright to have their notes redeemed on a weekly basis, they will be reflected in*Notes payable and other short-termobligations* on the Balance Sheets for **Cinergy** and **CG&E**.

 

Also on August 1,2003, **CG&E** caused theremarketing by the Ohio Air Quality Development Authority of $12.1 million ofits State of Ohio Air Quality Development Revenue Bonds 2001 Series A dueAugust 1, 2033.  The remarketingeffected the conversion from an unsecured one-year interest rate reset mode toa daily interest rate reset mode supported by a letter of credit.  The interest rate was initially set at 0.95%and will be reset daily going forward. Because the holders of these notes have the right to have their notesredeemed on a daily basis, they will be reflected in *Notes payable and other short-term obligations* on theBalance Sheets for **Cinergy** and **CG&E**.

 

38

----

 

The followingtable summarizes our *Notes payable and othershort-term obligations*, and *Notespayable to affiliated companies*.

 
|                              |   | **June 30,  2003**     |       | **December  31, 2002** |       |
|-----------------------------------|--------|------------------------|------------|------------------------|------------|
|                              |   | **Established  Lines** |       | **Outstanding**        |       | **Established  Lines** |   | **Outstanding** |   |
|                              |   | **(in  millions)**     |       |
| **Cinergy**                       |   |                   |       |                   |       |   |   |   |   |
| **Cinergy  Corp.**                |   |                   |       |                   |       |   |   |   |   |
| Revolving lines                   |   | **$**                  | **1,000**  | ** **             | **$**      | **—** | ** ** | $ | 1,000 |   | $ | 25 |   |
| Uncommitted  lines (1)            |   | **65**                 | ** ** | **—**             | ** ** | 65 |   | — |   |
| Commercial paper  (2)             |   |                   | ** ** | **281**                | ** ** |   |   | 473 |   |
|                              |   |                   | ** ** |                   | ** ** |   |   |   |   |
| Operating  companies              |   |                   | ** ** |                   | ** ** |   |   |   |   |
| Uncommitted  lines (1)            |   | **75**                 | ** ** | **—**             | ** ** | 75 |   | — |   |
| Pollution  control notes          |   |                   | ** ** | **112**                | ** ** |   |   | 147 |   |
|                              |   |                   | ** ** |                   | ** ** |   |   |   |   |
| Non-regulated  subsidiaries       |   |                   | ** ** |                   | ** ** |   |   |   |   |
| Revolving lines                   |   | **17**                 | ** ** | **9**                  | ** ** | 7 |   | 1 |   |
| Short-term debt                   |   |                   | ** ** | **7**                  | ** ** |   |   | 22 |   |
|                              |   |                   | ** ** |                   | ** ** |   |   |   |   |
| **Cinergy  Total**                |   |                   | ** ** | **$**                  | **409**    | ** ** |   |   | $ | 668 |   |
|                              |   |                   | ** ** |                   | ** ** |   |   |   |   |
| **CG&E****and  subsidiaries** |   |                   | ** ** |                   | ** ** |   |   |   |   |
| Uncommitted  lines (1)            |   | **$**                  | **15**     | ** **             | **$**      | **—** | ** ** | $ | 15 |   | $ | — |   |
| Pollution  control notes          |   |                   | ** ** | **112**                | ** ** |   |   | 112 |   |
| Money pool                        |   |                   | ** ** | **8**                  | ** ** |   |   | 9 |   |
|                              |   |                   | ** ** |                   | ** ** |   |   |   |   |
| **CG&E  Total**               |   |                   | ** ** | **$**                  | **120**    | ** ** |   |   | $ | 121 |   |
|                              |   |                   | ** ** |                   | ** ** |   |   |   |   |
| **PSI**                           |   |                   | ** ** |                   | ** ** |   |   |   |   |
| Uncommitted  lines (1)            |   | **$**                  | **60**     | ** **             | **$**      | **—** | ** ** | $ | 60 |   | $ | — |   |
| Pollution  control notes          |   |                   | ** ** | **—**             | ** ** |   |   | 35 |   |
| Money pool                        |   |                   | ** ** | **237**                | ** ** |   |   | 138 |   |
|                              |   |                   | ** ** |                   | ** ** |   |   |   |   |
| **PSI  Total**                    |   |                   | ** ** | **$**                  | **237**    | ** ** |   |   | $ | 173 |   |
|                              |   |                   | ** ** |                   | ** ** |   |   |   |   |
| **ULH&P**                     |   |                   | ** ** |                   | ** ** |   |   |   |   |
| Money pool                        |   |                   | ** ** | **$**                  | **21**     | ** ** |   |   | $ | 14 |   |
|                              |   |                   | ** ** |                   | ** ** |   |   |   |   |
| **ULH&P  Total**              |   |                   | ** ** | **$**                  | **21**     | ** ** |   |   | $ | 14 |   |

 

----

(1)               Outstanding amountsmay be greater than established lines as uncommitted lenders are, at times,willing to loan funds in excess of the established lines.

(2)               The commercialpaper program is limited to $800 million and is supported by **Cinergy Corp.’s** revolving lines.

 

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

 

•                  aconsolidated net worth of $2 billion; and

•                  aratio of consolidated indebtedness to consolidated total capitalization not inexcess of 65 percent.

 

39

----

 

A breach of thesecovenants could result in the termination of the credit facilities and theacceleration of the related indebtedness. In addition to breaches of covenants, certain other events that couldresult in the termination of available credit and acceleration of the relatedindebtedness include:

 

•                  bankruptcy;

•                  defaultsin the payment of other indebtedness; and

•                  judgmentsagainst the company that are not paid or insured.

 

The latter two events,however, are subject to dollar-based materiality thresholds.

 

**5.  EnergyTrading Credit Risk**

** **

**Cinergy’s**extension of credit for energy marketing and trading is governed by a CorporateCredit Policy.  Written guidelinesdocument the management approval levels for credit limits, evaluation ofcreditworthiness, and credit risk mitigation procedures.  Exposures to credit risks are measured andmonitored daily by our Corporate Credit Risk function, which is independent ofall trading operations.  As of June 30,2003, approximately 98 percent of the credit exposure related to energy tradingand marketing activity was with counterparties rated Investment Grade or thecounterparties’ obligations were guaranteed or secured by a parent company orother Investment Grade entity.  Nosingle non-investment grade counterparty accounts for more than one percent ofour total credit exposure.  Energy commodityprices can be extremely volatile and the market can, at times, lackliquidity.  Because of these issues,credit risk for energy commodities is generally greater than with othercommodity 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.  Counterpartycredit limits may be adjusted on a daily basis in response to changes in acounterparty’s creditworthiness, financial status, or public debt ratings.

 

**6.  Commitmentsand Contingencies**

 

***(a)***                                  Guarantees

 

In the ordinary course ofbusiness, **Cinergy**enters intovarious agreements providing financial or performance assurances to thirdparties on behalf of certain unconsolidated subsidiaries and jointventures.  These agreements are enteredinto primarily to support or enhance the creditworthiness otherwise attributedto these entities****on a stand-alonebasis, thereby facilitating the extension of sufficient credit to accomplishtheir intended 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 thereis no maximum potential amount expressly set forth in

 

40

----

 

the guarantee agreement,we calculate the maximum potential amount by considering the terms of theguaranteed transactions, to the extent such amount is estimable.

 

**Cinergy**hasguaranteed the payment of $33 million as of June 30, 2003, for unconsolidatedsubsidiaries’ debt and for borrowings by individuals under the Director,Officer, and Key Employee Stock Purchase Program.  **Cinergy**may be obligatedto pay the debt’s principal and any related interest in the event of anunexcused breach of a guaranteed payment obligation by the unconsolidatedsubsidiaries or an unexcused breach of guaranteed payment obligations bycertain directors, officers, and key employees.  Most of the guarantees do not have a set termination date;however, the borrowings associated with the majority of the guarantees are duein the first quarter of 2005.

 

**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 amount to be $133 millionunder these guarantees as of June 30, 2003. **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 agreements,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 the counterpartyfor matters such as breaches of representations and warranties and covenantscontained in the contract.  In somecases, particularly with respect to purchase and sale agreements, the potentialliability for certain indemnification obligations is capped, in whole or inpart (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 amount is not estimable given that the magnitude of anyclaims under those indemnifications would be a function of the extent ofdamages actually incurred, which is not practicable to estimate unless anduntil the event occurs.  **Cinergy** has estimated the maximum potentialamount, where estimable, to be $125 million under these indemnificationprovisions and considers the likelihood of making any material payments underthese provisions to be remote.  Thetermination period for the majority of matters provided by indemnificationprovisions in purchase and sale agreements generally ranges from 2003 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.

 

***(b)***                                  OzoneTransport Rulemakings

 

In June 1997, the OzoneTransport Assessment Group, which consisted of 37 states, made a wide range ofrecommendations to the Environmental Protection Agency (EPA) to address theimpact of ozone transport on serious non-attainment areas (geographic areasdefined by the EPA as non-

 

41

----

 

compliant with ozonestandards) in the Northeast, Midwest, and South.  Ozone transport refers to wind-blown movement of ozone andozone-causing materials across city and state boundaries.

 

*(i)*          Nitrogen Oxide (NOX) StateImplementation Plan (SIP) Call

 

In October 1998, the EPA finalized its ozone transport rule, also knownas the NOX SIP Call.  Itapplied to 22 states in the eastern half of the United States (U.S.), includingthe three states in which our electric utilities operate, and proposed a modelNOX emission allowance trading program.  This rule recommended that states reduce NOX emissionsprimarily from industrial and utility sources to a certain level by May 2003.

 

In August 2000, the U.S. Circuit Court of Appeals for the District ofColumbia (Court of Appeals) extended the deadline for NOX reductionsto May 31, 2004.  In June 2001, theCourt of Appeals remanded portions of the NOX SIP Call to the EPAfor reconsideration of how growth was factored into the state NOXbudgets.  On May 1, 2002, the EPApublished, in the Federal Register, a final rule reaffirming its growth factorsand state NOX budgets, with additional explanation.  The states of West Virginia and Illinois,along with various industry groups (some of which we are a member), havechallenged the growth factors and state NOX budgets in an action filedin the Court of Appeals.  Oral argumentis scheduled for September 15, 2003, and a decision is expected some time afterDecember 2003.  It is unclear whetherthe Court of Appeals’ decision in this matter will result in an increase ordecrease in the size of the NOX reduction requirement, or a deferralof the May 31, 2004 compliance deadline.

 

The states of Indiana andKentucky developed final NOX SIP rules in response to the NOXSIP Call, through cap and trade programs, in June and July of 2001, respectively.  On November 8, 2001, the EPA approvedIndiana’s SIP rules, which became effective on December 10, 2001.  OnApril 11, 2002, the EPA approved Kentucky’s SIP rules, which became effectiveon June 10, 2002.  The state ofOhio completed its NOX SIP rules in response to the NOXSIP Call on July 8, 2002, with an effective date of July 18, 2002.  On January 16, 2003, the EPA proposed adirect final rule to approve Ohio’s SIP. The EPA has since withdrawn that proposal, and on August 5, 2003 issueda conditional approval that takes effect on September 4, 2003.  The conditional approval is based upon awritten commitment from the Ohio EPA to make an additional change to its NOXSIP (relating to the date flow control takes effect).  **Cinergy’s** currentplans for compliance with the EPA’s NOX SIP Call would also satisfycompliance with Indiana’s, Kentucky’s, and Ohio’s SIP rules.

 

On September 25, 2000, **Cinergy** announced a plan for itssubsidiaries, **CG&E** and **PSI**, to invest in pollution controlequipment and other methods to reduce NOX emissions.  This plan includes the following:

 

•                  installselective catalytic reduction units at several different generating stations;

•                  installother pollution control technologies, including new computerized combustioncontrols, at all generating stations;

•                  makecombustion improvements; and

•                  utilizethe NOX allowance market to buy or sell NOX allowances asappropriate.

 

42

----

 

The current estimate foradditional expenditures for this plan is approximately $200 million and is inaddition to the $642 million already incurred to comply with this program.

 

*(ii)*      Section 126 Petitions

 

In February 1998, severalnortheast states filed petitions seeking the EPA’s assistance in reducing ozonein the Eastern U.S. under Section 126 of the Clean Air Act (CAA).  The EPA believes that Section 126 petitionsallow a state to claim that sources in another state are contributing to itsair quality problem and request that the EPA require the upwind sources toreduce their emissions.

 

In December 1999, the EPAgranted four Section 126 petitions relating to NOX emissions.  This ruling affected all of our Ohio andKentucky facilities, as well as some of our Indiana facilities, and required usto reduce our NOX emissions to a certain level by May 2003.  In May 2001, the Court of Appealssubstantially upheld a challenge to the Section 126 requirements, and remandedportions of the rule to the EPA for reconsideration of how growth was factoredinto the emission limitations.  On May1, 2002, the EPA issued a final rule extending the Section 126 rule compliancedeadline to May 31, 2004, thus harmonizing the deadline with that for the NOXSIP Call.

 

On April 4, 2003, the EPAissued a proposed rule withdrawing the Section 126 rule in states with approvedSIPs under the NOX SIP Call, which include the states of Indiana andKentucky.  The proposed rule states thatthe EPA will withdraw the Section 126 in Ohio once Ohio has a fully approvedSIP.  As a result of these actions, weanticipate that the Section 126 rule will not affect any of our facilities.

 

See (e) below for adiscussion of the tentative EPA Agreement, the implementation of which couldaffect our strategy for compliance with the final NOX SIP Call.

 

***(c)***                                  New SourceReview (NSR)

 

The CAA’s NSR provisionsrequire that a company obtain a pre-construction permit if it plans to build anew stationary source of pollution or make a major modification to an existingfacility, unless the changes are exempt.

 

On November 3, 1999, theUnited States sued a number of holding companies and electric utilities,including **Cinergy**, **CG&E**, and **PSI**, in various U.S. District Courts.  The **Cinergy**,**CG&E**, and **PSI** suit alleged violations of the CAA attwo of our generating stations relating to NSR and New Source PerformanceStandards requirements.  The suit sought(1) injunctive relief to require installation of pollution control technologyon each of the generating units at **CG&E’s**W.C. Beckjord Generating Station (Beckjord Station) and at **PSI’s** Cayuga Generating Station, and (2)civil penalties in amounts of up to $27,500 per day for each violation.  Since that time, two amendments to thecomplaint have been filed by the United States, alleging additional violationsof the CAA, including allegations involving different generating units.  In addition, three northeast states and twoenvironmental groups have intervened in the case.

 

43

----

 

On December 21, 2000, **Cinergy**, **CG&E**,and **PSI** reached an agreement inprinciple with the parties in the litigation for a negotiated resolution of theCAA claims in the litigation.  See (e)below for a discussion of the tentative EPA Agreement, which relates to mattersdiscussed within this note.

 

On October 9, 2002,consistent with a Revised Case Management Plan, the Indiana District Court setthe case for trial by jury commencing on October 4, 2004.  The parties have subsequently agreed tomodify the Revised Case Management Plan, including continuing the trial date,by recent motion filed with the court.

 

At this time, it is notpossible to predict whether a final agreement implementing the agreement inprinciple can be reached.  The partiescontinue to negotiate on a number of significant issues.  If the settlement is not completed, weintend to defend against the allegations vigorously in court.  In such an event, it is not possible todetermine the likelihood that the plaintiffs would prevail upon their claims orwhether resolution of these matters would have a material effect on ourfinancial position or results of operations.

 

On March 1, 2000, the EPA also filed an amendedcomplaint in a separate lawsuit alleging violations of the CAA relating to NSR,Prevention of Significant Deterioration (PSD), and Ohio SIP requirementsregarding various generating stations, including a generating station operatedby the Columbus Southern Power Company (CSP) and jointly-owned by CSP, theDayton Power and Light Company (DP&L), and **CG&E**.  The EPA isseeking injunctive relief and civil penalties of up to $27,500 per day for eachviolation.  This suit is being defendedby CSP.  On April 4, 2001, the DistrictCourt in that case ruled that neither the Government nor the interveningplaintiff environmental groups could obtain civil penalties for any allegedviolations that occurred more than five years prior to the filing of thecomplaint, but that both parties could seek injunctive relief for allegedviolations that occurred more than five years before the filing of thecomplaint.  Thus, if the plaintiffsprevail in their claims, any calculation for penalties will not start on thedate of the alleged violations, unless those alleged violations occurred afterNovember 3, 1994, but CSP would be forced to install the controls required underthe CAA.  Neither party appealed thatdecision.

 

In addition, **Cinergy** and **CG&E** have been informed by DP&L, the operator of J.M.Stuart Generating Station (Stuart Station), that on June 30, 2000, the EPAissued a Notice of Violation (NOV) to DP&L for alleged violations of NSR,PSD, and SIP requirements at this station. **CG&E** owns approximately40 percent of the Stuart Station.  TheNOVs indicated the EPA may (1) issue an order requiring compliance with therequirements of the SIP, or (2) bring a civil action seeking injunctive reliefand civil penalties of up to $27,500 per day for each violation.

 

***(d)***                                  BeckjordStation NOV

 

On November 30, 1999, theEPA filed an NOV against **Cinergy**and **CG&E**, alleging thatemissions of particulate matter at the Beckjord Station exceeded the allowablelimit.  On June 22, 2000, the EPA issuedan NOV and a finding of violation (FOV) alleging additional particulateemission violations at Beckjord Station. The NOV/FOV indicated the EPA may issue an administrative compliance order,issue an administrative penalty order, or bring a civil or criminalaction.  See (c) above for a discussionof the allegations.

 

44

----

 

See (e) below for adiscussion of the tentative EPA Agreement, which relates to matters discussedwithin this note.

 

***(e)***                                  EPAAgreement

 

On December 21, 2000, **Cinergy**, **CG&E**,and **PSI** reached an agreement inprinciple with the United States, three northeast states, and two environmentalgroups for a negotiated resolution of CAA claims and other related mattersbrought against coal-fired power plants owned and operated by **Cinergy’s** operating subsidiaries.  The complete resolution of these issues iscontingent upon establishing a final agreement with the EPA and otherparties.  If a final agreement isreached with these parties, it would resolve past claims of alleged NSRviolations as well as the Beckjord Station NOVs/FOV discussed previously under(c) and (d).

 

In return forresolution of claims regarding past maintenance activities, as well as futureoperational certainty, we have tentatively committed in the agreement inprinciple to:

 

•                  shutdown or repower with natural gas, nine small coal-fired boilers at three powerplants beginning in 2004;

•                  buildfour additional sulfur dioxide (SO2) scrubbers, the first of whichmust be operational by December 31, 2007;

•                  upgradeexisting particulate control systems;

•                  phasein the operation of NOX reduction technology year-round starting in2004;

•                  reduceour existing Title IV SO2 cap by 35 percent in 2013;

•                  paya civil penalty of $8.5 million to the U.S. government; and

•                  implement$21.5 million in environmental mitigation projects, including retiring 50,000tons of SO2 allowances by 2005.

 

The estimated cost forthese capital expenditures is expected to be approximately $700 million through2013.  These capital expenditures are inaddition to our previously announced commitment to install NOXcontrols as discussed in (b) above, but does include capital costs that **Cinergy** would expect to spend regardless ofthe settlement due to new environmental requirements expected in the secondhalf of this decade.

 

**Cinergy**,**CG&E**, and **PSI** have accrued costs related to certainaspects of the tentative agreement.  Inreaching the tentative agreement, we did not admit any wrongdoing and remainfree to continue our current maintenance practices, as well as implement futureprojects for improved reliability.

 

At this time, it is notpossible to predict whether a final agreement implementing the agreement inprinciple can be reached.  The partiescontinue to negotiate and a final agreement may require control equipment,capital expenditures and other costs greater than estimated for the agreementin principle.  If the settlement is notcompleted, we intend to defend against the allegations, discussed in (c) and(d) above, vigorously in court.  In suchan event, it is not possible to determine the likelihood that the plaintiffswould prevail upon their claims or whether resolution of these matters wouldhave a material effect on our financial position or results of operations.

 

45

----

 

***(f)***                                    ManufacturedGas Plant (MGP) Sites

 

Prior to the 1950s, gaswas produced at MGP sites through a process that involved the heating of coaland/or oil.  The gas produced from thisprocess was sold for residential, commercial, and industrial uses.

 

Coal tar residues,related hydrocarbons, and various metals associated with MGP sites have beenfound at former MGP sites in Indiana, including at least 21 sites which **PSI** or its predecessors previouslyowned.  **PSI** acquired four of the sites from Northern Indiana PublicService Company (NIPSCO) in 1931.  Atthe same time, **PSI** sold NIPSCO thesites located in Goshen and Warsaw, Indiana. In 1945, **PSI** sold 19 ofthese sites (including the four sites it acquired from NIPSCO) to thepredecessor of the Indiana Gas Company, Inc. (IGC).  IGC later sold the site located in Rochester, Indiana to NIPSCO.

 

IGC and NIPSCO madeclaims against **PSI** for the costsof investigating and remediating the sites. In 1998, NIPSCO, IGC, and **PSI**entered into Site Participation and Cost Sharing Agreements (Agreements).  These Agreements allocated the ComprehensiveEnvironmental Response, Compensation and Liability Act (CERCLA) liability forpast and future costs at the MGP sites in Indiana among the threecompanies.  These agreements concludedall CERCLA and similar claims between the three companies related to MGP sites.  The parties continue to investigate andremediate the sites, as appropriate, under the agreements and applicablelaws.  The Indiana Department ofEnvironmental Management (IDEM) oversees investigation and cleanup of some ofthe sites.

 

**PSI**notified its insurance carriers of the claims related to MGP sites raised byIGC, NIPSCO, and IDEM.  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**, or (2) pay**PSI’s** costs of defense andcompensate **PSI** for its costs ofinvestigating, preventing, mitigating, and remediating damage to property andpaying claims related to MGP sites.  Thetrial court issued a variety of rulings with respect to the claims and defensesin the litigation.  **PSI**has appealed certain adverse rulings tothe Indiana Court of Appeals.  At thepresent time, **PSI** cannot predictthe outcome of this litigation, including the outcome of the appeals.

 

**CG&E**is aware of potential sites where MGP activities have occurred at some time inthe past.  None of these sites is knownto present a risk to the environment.  **CG&E** has begun preliminary siteassessments to obtain information about some of these MGP sites.

 

**PSI**and **CG&E**, including itsutility subsidiaries, have accrued costs for the sites related toinvestigation, remediation, and groundwater monitoring to the extent such costsare probable and can be reasonably estimated. **PSI** and **CG&E**, including its utilitysubsidiaries, do not believe they can provide an estimate of the reasonablypossible total remediation costs for any site before a remedialinvestigation/feasibility study is performed. To the extent remediation is necessary, the timing of the remediationactivities impacts the cost of remediation. Therefore, **PSI** and **CG&E**, including its utilitysubsidiaries, currently cannot determine the total costs that may be incurredin connection with remediation of all sites, to the extent that remediation isrequired.  Until investigation andremediation activities have been completed on these sites, we are unable

 

46

----

 

to reasonably estimatethe total costs and impact on our financial position or results of operations.

 

***(g)***                                 Asbestos ClaimsLitigation

** **

**CG&E**and **PSI** have been named inlawsuits related to asbestos at their electric generating stations.  In these lawsuits, plaintiffs claim to havebeen exposed to asbestos-containing products 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 been brought against **PSI**. The impact on **CG&E’s**and **PSI’s** financial position orresults of operations of these cases to date has not been material.

 

One specific case filedagainst **PSI** has been tried toverdict.  The jury returned a verdictagainst **PSI** in the amount ofapproximately $500,000 on a negligence claim and for **PSI** on punitive damages. **PSI** is appealing thejudgment in this case.

 

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

 

***(h)***                                 Gas CustomerChoice

 

InJanuary 2000, Cinergy Investments (Investments) sold Cinergy Resources, Inc.(Resources), a former subsidiary, to Licking Rural Electrification, Inc., doingbusiness as The Energy Cooperative (Energy Cooperative).  In February 2001, **Cinergy**, **CG&E**, and Resources were named as defendants in three class action lawsuitsbrought by customers relating to Energy Cooperative’s removal from the Ohio GasCustomer Choice program and the failure to deliver gas to customers.  This customer litigation is pending in theHamilton County Common Pleas Court.  Atrial date has not been set.

 

Subsequently,these class action suits were amended and consolidated into one suit.  **CG&E** has been dismissed as a defendant in the consolidated suit.  In March 2001, **Cinergy**, **CG&E**, and Investments were named as defendants in a lawsuit filed by bothEnergy Cooperative and Resources.  Thislawsuit concerns any obligations or liabilities Investments may have to EnergyCooperative following its sale of Resources. This lawsuit is pending in the Licking County Common Pleas Court.  Trial is anticipated to occur in November2004.  In October 2001, **Cinergy**, **CG&E**,and Investments initiated litigation against the Energy Cooperative requestingindemnification by the Energy Cooperative for the claims asserted by formercustomers in the class action litigation. We intend to vigorously defendthese lawsuits.  At the present time, wecannot predict the outcome of these suits.

 

***(i)***                                    PSI FuelAdjustment Charge

 

In June 2001, **PSI** filed a petition with the IURCrequesting authority to recover $16 million in under billed deferred fuel costsincurred from March 2001 through May 2001. The IURC approved recovery of these costs subject to refund pending thefindings of an investigative sub-docket.

 

47

----

 

The sub-docket was openedto investigate the reasonableness of, and underlying reasons for, the under billeddeferred fuel costs.  A hearing was heldin July 2002, and in March 2003 the IURC issued an order giving final approvalto **PSI’s** recovery of the $16million.

 

***(j)***                                    PSI RetailRate Case

 

In December 2002, **PSI** filed a petition with the IURC seekingapproval of a base retail electric rate increase.  **PSI** filed initialtestimony in this case in March 2003 and initial hearings were held in June2003.  Based on updated testimony filedin July 2003, **PSI** proposes anincrease in revenues of approximately $190 million, or an average increase ofapproximately 14 percent over **PSI’s**retail electric rates in effect at the end of 2002.  An IURC decision is expected in the first quarter of 2004.

 

***(k)***                                PSIConstruction Work in Progress (CWIP) Ratemaking Treatment for NOX Equipment

 

In April 2003, **PSI** filed an application with the IURCrequesting that its CWIP rate adjustment mechanism be updated for expendituresthrough December 2002 related to NOX equipment currently beinginstalled at certain **PSI**generation facilities.  CWIP ratemakingtreatment allows for the recovery of carrying costs on certain pollutioncontrol equipment while and after the equipment is under construction.  Testimony and exhibits supporting **PSI’s** second CWIP rate adjustment mechanismupdate were filed in July 2003.  Amountsproposed for potential recovery are presented below:

 

**PSICWIP Ratemaking for NOX Equipment**

 

|                                                       |   | **PSI**              |   |
|------------------------------------------------------------|--------|----------------------|--------|
|                                                       |   | ***(in  millions)*** |   |
|                                                       |   |                 |   |
| Total retail CWIP  expenditures as of December 31, 2002    |   | $                    | 305    |   |
|                                                       |   |                 |   |
| Proposed total amount  requested through CWIP mechanism(1) |   | 35                   |   |
| Less: previously approved  CWIP mechanism amounts          |   | (28                  | )      |
| Proposed incremental CWIP  mechanism amounts               |   | $                    | 7      |   |

 

----

(1)               Amounts includeretail customers’ portion only and represent an annual return on qualified NOXequipment expenditures.

 

**PSI’s**initial CWIP rate mechanism adjustment (authorized in July 2002) resulted in anapproximately one percent increase in customer rates.  Under the IURC’s CWIP rules, **PSI**may update its CWIP tracker at six-month intervals.  The first such update to **PSI’s** CWIP rate mechanism occurred in thefirst quarter of 2003.  The IURC’s July2002 order also authorized **PSI** todefer, for subsequent recovery, post-in-service depreciation and to continuethe accrual for allowance for funds used during construction (AFUDC).  Pursuant to Statement of FinancialAccounting Standards No. 92, *RegulatedEnterprises-Accounting for Phase-in Plans*, the equity component ofAFUDC will not be deferred for financial reporting after the related assets areplaced in service.

 

48

----

 

***(l)***                                    EnvironmentalCompliance Cost Recovery

 

In 2002, the IndianaGeneral Assembly passed legislation that, among other things, encourages thedeployment of advanced technologies that reduce regulated air emissions, whileallowing the continued use of high sulfur Midwestern coal in existing electricgenerating plants.  The legislationauthorizes the IURC to provide financial incentives to utilities that deploysuch advanced technologies.  **PSI**is currently seeking IURC approvalunder this new law of a cost tracking mechanism for **PSI’s** NOX equipment-related depreciation andoperation and maintenance costs, authority to use accelerated (18-year)depreciation for its NOX compliance equipment, and approval of a NOXemission allowance purchase and sales tracker. A hearing before the IURC is scheduled for October 2003.

 

***(m)***                              PSIPurchased Power Tracker (Tracker)

 

The Tracker was designedto provide for the recovery of costs related to purchases of power necessary tomeet native load requirements to the extent such costs are not recoveredthrough the existing fuel adjustment clause.

 

**PSI**is authorized to seek recovery of 90 percent of its purchased power expensesthrough the Tracker (net of the displaced energy portion recovered through thefuel recovery process and net of the mitigation credit portion), with theremaining 10 percent deferred for subsequent recovery in **PSI’s**general rate case.  In March 2002, **PSI** filed a petition with the IURC seeking approval to extendthe Tracker process beyond the summer of 2002. A hearing was held in January 2003, and in June 2003 the IURC approvedthe extension for up to an additional two years with the ultimate determinationconcerning **PSI’s** continued use ofthe Tracker process to be made in **PSI’s**pending retail electric rate case.

 

In June 2002, **PSI** alsofiled a petition with the IURC seeking approval of the recovery through theTracker of its actual summer 2002 purchased power costs.  In May 2003, the IURC approved **PSI’s** recovery of $18 million related toits summer 2002 purchased power costs, and also authorized $2 million ofdeferred costs sought for recovery in **PSI’s**general rate case.

 

***(n)***                                 CG&E GasRate Case

 

In the third quarter of2001, **CG&E** filed a retail gasrate case with the Public Utilities Commission of Ohio (PUCO) seeking toincrease base rates for natural gas distribution service and requestingrecovery through a tracking mechanism of the costs of an accelerated gas mainreplacement program with an estimated capital cost of $716 million over 10years.  **CG&E** entered into a settlement agreement with most of theparties and a hearing on this matter was held in April 2002.  An order was issued in May 2002, in whichthe PUCO approved the settlement agreement and authorized a base rate increaseof approximately $15 million, or 3.3 percent overall, effective May 30,2002.  In addition, the PUCO authorized **CG&E** to implement the trackingmechanism to recover the costs of the accelerated gas main replacement program,subject to certain rate caps that increase in amount annually through May 2007,through the effective date of new rates in **CG&E’s**next retail gas rate case.  In thefourth quarter of 2002, **CG&E**filedan application to increase its rates under the tracking mechanism.  In April 2003,

 

49

----

 

**CG&E**entered into a settlement agreement with the parties, providing for an increaseof $6.5 million, which the PUCO subsequently approved.  This increase was effective in May 2003.

 

***(o)***                                  ULH&PGas Rate Case

 

Asdiscussed in the 2002 10-K, in the second quarter of 2001, **ULH&P** filed a retail gas rate case with theKentucky Public Service Commission (KPSC) seeking to increase base rates fornatural gas distribution services and requesting recovery through a trackingmechanism of the costs of an accelerated gas main replacement program with anestimated capital cost of $112 million over 10 years.  **ULH&P** made its second annual filing for an increase under the trackingmechanism in March 2003.  Theapplication seeks an increase of $2 million. A hearing was held in July 2003 and the KPSC is expected to ruleon the application during the third quarter of 2003.  At the present time, **ULH&P**cannot predict the outcome of this proceeding. The Kentucky Attorney Generalhas appealed the KPSC’s approval of the tracking mechanism to the FranklinCircuit Court and has also appealed the KPSC’s August 2002 order approving thenew tracking mechanism rates.  At thepresent time, **ULH&P** cannot predict the timing or outcome of this litigation.

 

***(p)***                                  GasDistribution Plant

 

In June 2003, the PUCOapproved an amended settlement agreement between **CG&E** and PUCO Staff in a gas distribution safety casearising out of a gas leak at a service head-adapter (SHA) style riser on **CG&E’s** distribution system.  The amended settlement agreement calls for **CG&E** to replace a specified minimumnumber of SHA risers by December 31, 2003, and to file a comprehensive planaddressing all SHA risers on its distribution system.  **Cinergy** has an estimated198,000 SHA risers on its distribution system, of which 155,000 are in **CG&E’s** service area.  Further investigation as to whether anyadditional SHA risers will need maintenance or replacement is ongoing.  If **Cinergy**determines that replacement of all SHA risers is appropriate, the replacementcost could be up to approximately $50 million and **Cinergy** would pursue recovery of this cost through rates.  At this time, **Cinergy** and **CG&E**cannot predict the outcome of this matter.

 

***(q)***                                  ContractDisputes

** **

**Cinergy**,through a subsidiary of Investments, is currently involved in negotiations toresolve a customer billing dispute.  Theprimary issue of contention between the parties relates to the determinantsused in calculating the monthly charge billed for electricity.  **Cinergy**has reserved for a portion of the amount billed based on our current estimateof net realizable value.  Although wecannot predict the outcome of this matter, we believe the ultimate impact on **Cinergy’s** financial position and results ofoperations, beyond amounts reserved, will not be material.

 

Cinergy Marketing &Trading, LP (Marketing & Trading) was in arbitration with ApacheCorporation (Apache) concerning disputes under an agreement whereby we marketednatural gas that Apache produced or acquired in North America.  We had reserved for a portion of the amountbilled based on estimates of the net realizable value.

 

50

----

 

Effective July 1, 2003,Marketing & Trading terminated its marketing relationship with Apache.  The termination of the marketingrelationship ended the arbitration and all outstanding monetary issues relatedto the arbitration were settled.  The impactof the settlement was not material to our financial position or results of operations.

 

***(r)***                                  Enron Corp.(Enron) Bankruptcy

 

In December 2001, Enron filed for protection under Chapter 11 of theU.S. Bankruptcy Code in the Southern District of New York.  We decreased our trading activities withEnron in the months prior to its bankruptcy filing and have filed a motion withthe bankruptcy court overseeing the Enron bankruptcy seeking appropriatenetting of the various payables and receivables between and among Enron and **Cinergy** entities.  We intend to resolve any contract differences pursuant to theterms of those contracts, business practices, and the applicable provisions ofthe U.S. Bankruptcy Code, as approved by the court.  While we cannot predict the court’s resolution of these matters,we do not believe that any exposure relating to those contracts would have amaterial impact on our financial position or results of operations.

 

***(s)***                                  SyntheticFuel Production

 

In July 2002, Capital& Trading acquired an “Earthco” coal-based synthetic fuel productionfacility.   The facility uses emulsifiedasphalt as a chemical change agent to convert coal feedstock into syntheticfuel for sale to a third party.  As ofJune 30, 2003, Capital & Trading’s net book value in this facility wasapproximately $60 million.  Thesynthetic fuel produced at this facility qualifies for tax credits inaccordance with Section 29 of the Internal Revenue Code.  Eligibility for these credits expires in2007.  **Cinergy**received a private letter ruling from the Internal Revenue Service (IRS) inconnection with the acquisition of the facility.  To date, **Cinergy** hasproduced and sold approximately three million tons of synthetic fuel at thisfacility, resulting in approximately $80 million in tax credits, includingapproximately $40 million in 2003.

 

The IRS recently announced,in connection with an audit of another taxpayer, that it has reason to questionand is reviewing the scientific validity of that taxpayer’s test procedures andresults that were presented as evidence that the fuel underwent a significantchemical change.  The IRS has indicatedthat if it were to determine that the test procedures and results do notdemonstrate the occurrence of significant chemical change, it would takeappropriate action, including revoking private letter rulings relying on suchresults.

 

**Cinergy**believes that it is justified in its reliance on the private letter ruling itobtained from the IRS, the chemical change testing by an independentlaboratory, and that its facility has been operated in a manner consistent withSection 29 of the Internal Revenue Code. It is not possible for **Cinergy**to predict the outcome of the IRS’s review of these matters or the implicationsthis might have for its synthetic fuel production facility.

 

51

----

 

***(t)***                                    EnergyMarket Investigations

 

In July 2003, **Cinergy** received a subpoena from theCommodity Futures Trading Commission (CFTC). As has been previously reported by the press, the CFTC has servedsubpoenas on numerous other energy companies. The CFTC request seeks certain information regarding our tradingactivities, including price reporting to energy industry publications.  The CFTC seeks particular informationconcerning these matters for the period May 2000 through January 2001 as to oneof **Cinergy’s** employees.  Based on a limited review of these matters,we have placed that employee on administrative leave.  **Cinergy** iscontinuing its review and intends to fully cooperate with the CFTC inconnection with its investigation.

 

In the second quarter of2003, **Cinergy** received initial andfollow-up subpoenas from the SEC requesting information related to particulartrading activity with one of its counterparties.  **Cinergy** has, andintends to, fully cooperate with the SEC in connection with this matter.

 

At this time it is notpossible to predict the outcome of these investigations or the impact on **Cinergy’s** financial position or results ofoperations.

 

**7.**                                      DiscontinuedOperations

 

During the second quarterof 2003, **Cinergy** completed thedisposal of its gas distribution operation in South Africa, sold its remainingwind assets in the United States, and substantially sold or liquidated theassets of its energy trading operation in the Czech Republic.

 

GAAP requiresconsolidated entities, which have been disposed of, to be presented as *Discontinued operations, net of tax* in theStatements of Income and as *Assets/Liabilitiesof Discontinued Operations* in the Balance Sheets.  The accompanying financial statements havebeen reclassified to account for the disposals occurring during the secondquarter of 2003, as well as disposals in prior periods, as discontinuedoperations.

 

As a result of the secondquarter 2003 transactions, assets of discontinued operations of approximately$140 million have been sold or converted into cash and liabilities ofdiscontinued operations of approximately $100 million have been assumed bybuyers or liquidated.  The net,after-tax, gain from these disposal and liquidation transactions wasapproximately $9 million (including a net after-tax cumulative currencytranslation gain of approximately $6 million).

 

52

----

 

The table below reflectsthe results of operations and the income (loss) on disposal related toinvestments accounted for as discontinued operations for the quarter ended andyear to date June 30, 2003 and 2002:

 

|                                                  |   | **Quarter ended  June 30** |       | **Year to Date  June 30** |     |
|-------------------------------------------------------|--------|----------------------------|------------|---------------------------|----------|
|                                                  |   | **2003**                   |       | **2002**                  |     | **2003** |   | **2002** |   |
|                                                  |   | ***(in  thousands)***      |       |
|                                                  |   |                       | * *   |                      | * * |   | * * |   | * * |
| **Revenues**(1)                                       |   | **$**                      | **8,433**  |                      | $        | 24,860 |   | **$** | **22,257** | ** ** | $ | 54,116 |   |
|                                                  |   |                       |       |                      |     |   | ** ** |   |   |
| **Income  (Loss) Before Taxes**                       |   | **$**                      | **—** |                      | $        | (444 | ) | **$** | **(593** | **)** | $ | 2,051 |   |
|                                                  |   |                       |       |                      |     |   | ** ** |   |   |
| **Income  (Loss) from Discontinued Operations**       |   |                       |       |                      |     |   | ** ** |   |   |
| Income (Loss) from  operations                        |   | **$**                      | **—** |                      | $        | (333 | ) | **$** | **(3** | **)** | $ | 1,229 |   |
| Gain on disposal, net of  tax                         |   | **9,045**                  |       | —                    |     | **8,878** | ** ** | — |   |
|                                                  |   |                       |       |                      |     |   | ** ** |   |   |
| **Total  Income (Loss) from Discontinued Operations** |   | **$**                      | **9,045**  |                      | $        | (333 | ) | **$** | **8,875** | ** ** | $ | 1,229 |   |

 

----

(1)               Presented forinformational purposes only.  Allresults of operations are reported net in our Statements of Income.

 

The table below reflectsthe assets and liabilities related to the investments accounted for asdiscontinued operations as of June 30, 2003 and December 31, 2002:

 

|                                |   | **June 30  2003**     |      | **December 31  2002** |     |
|-------------------------------------|--------|-----------------------|-----------|-----------------------|----------|
|                                |   | ***(in  thousands)*** |      |
|                                |   |                  | * *  |                  | * * |
| **Assets**                          |   |                  |      |                  |     |
| Current assets                      |   | $                     | **7,187** |                  | $        | 48,719 |   |
| Property, plant, and  equipment-net |   | —                |      | 78,309                |     |
| Other assets                        |   | —                |      | 20,237                |     |
|                                |   |                  |      |                  |     |
| **Total  Assets**                   |   | $                     | **7,187** |                  | $        | 147,265 |   |
|                                |   |                  |      |                  |     |
| **Liabilities**                     |   |                  |      |                  |     |
| Current liabilities                 |   | $                     | **8,877** |                  | $        | 6,632 |   |
| Long-term debt                      |   | —                |      | 84,654                |     |
| Other                               |   | —                |      | 17,547                |     |
|                                |   |                  |      |                  |     |
| **Total  Liabilities**              |   | $                     | **8,877** |                  | $        | 108,833 |   |

 

**8.  FinancialInformation by Business Segment**

 

As discussed in the 200210-K, we conduct operations through our subsidiaries, and manage through thefollowing three business units:

 

•                  EnergyMerchant Business Unit (Energy Merchant);

•                  RegulatedBusinesses Business Unit (Regulated Businesses); and

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

 

53

----

 

The following sectiondescribes the activities of our business units as of June 30, 2003.

 

Energy Merchant manageswholesale generation and energy marketing and trading of energycommodities.  Energy Merchant operatesand maintains our regulated and non-regulated electric generating plants includingsome of our jointly-owned plants. Energy Merchant is also responsible for all of our internationaloperations and performs the following activities:

 

•                  energyrisk management;

•                  proprietaryarbitrage activities; and

•                  customizedenergy solutions.

 

Regulated Businessesconsists of **PSI’s** regulated,integrated utility operations, and **Cinergy’s**other regulated electric and gas transmission and distribution systems.  Regulated Businesses plans, constructs,operates, and maintains **Cinergy’s**transmission and distribution systems and delivers gas and electric energy toconsumers.  Regulated Businesses alsoearns revenues from wholesale customers primarily by transmitting electricpower through **Cinergy’s**transmission system.

 

Power Technologyprimarily manages the development, marketing, and sales of our non-regulatedretail energy and energy-related businesses. This is accomplished through various subsidiaries and jointventures.  Power Technology also managesCinergy Ventures, LLC (Ventures), **Cinergy’s**venture capital subsidiary.  Venturesinvests in emerging energy technologies that can benefit future **Cinergy** business development activities.

 

Following are thefinancial results by business unit. Certain amounts for the prior year have been restated to reflectimplementation of EITF 02-3 and other prior year amounts have been reclassifiedto conform to the current presentation.

 

54

----

 

Financial results by business unit for the quartersended June 30, 2003, and June 30, 2002, are as indicated below.

 

**BusinessUnits**

 
|                                        |   | **Cinergy  Business Units** |        |                      |       |                  |       |
|---------------------------------------------|--------|-----------------------------|-------------|---------------------------|------------|-----------------------|------------|
|                                        |   | **Energy  Merchant**        |        | **Regulated  Businesses** |       | **Power  Technology** |       | **Total** |   | **Reconciling  Eliminations(1)** |   | **Consolidated** |   |
|                                        |   | ***(in  thousands)***       |        |
|                                        |   |                        | * *    |                      | * *   |                  | * *   |   | * * |   | * * |   | * * |
| **Quarter ended June 30, 2003**             |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
|                                        |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Operating revenues-**                     |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **External  customers**                     |   | **$**                       | **350,198** | ** **                | **$**      | **583,723**           | **(3)**    | **$** | **2** |   | **$** | **933,923** | ** ** | **$** | **—** | ** ** | **$** | **933,923** | ** ** |
| **Intersegment  revenues**                  |   | **37,156**                  | ** **  | **—**                | ** ** | **—**            | ** ** | **37,156** | ** ** | **(37,156** | **)** | **—** | ** ** |
|                                        |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Cost of sales -**                         |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Fuel  and purchased and exchanged power** |   | **132,986**                 | ** **  | **107,484**               | ** ** | **—**            | ** ** | **240,470** | ** ** | **—** | ** ** | **240,470** | ** ** |
| **Gas  purchased**                          |   | **5,233**                   | ** **  | **48,086**                | ** ** | **—**            | ** ** | **53,319** | ** ** | **—** | ** ** | **53,319** | ** ** |
|                                        |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Discontinued operations, net of tax**     |   | **9,045**                   | ** **  | **—**                | ** ** | **—**            | ** ** | **9,045** | ** ** | **—** | ** ** | **9,045** | ** ** |
|                                        |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Segment profit (loss)(2)**                |   | **64,332**                  | **(4)**     | **26,105**                | ** ** | **(5,784**            | **)**      | **84,653** | ** ** | **—** | ** ** | **84,653** | ** ** |
|                                        |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Quarter ended June 30, 2002                 |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
|                                        |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Operating revenues-                         |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| External  customers                         |   | $                           | 348,875     |                      | $          | 558,422               |       | $ | (2 | ) | $ | 907,295 |   | $ | — |   | $ | 907,295 |   |
| Intersegment  revenues                      |   | 38,897                      |        | —                    |       | —                |       | 38,897 |   | (38,897 | ) | — |   |
|                                        |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| Cost of sales -                             |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| Fuel and  purchased and exchanged power     |   | 146,312                     |        | 95,374                    |       | —                |       | 241,686 |   | — |   | 241,686 |   |
| Gas purchased                               |   | 5,091                       |        | 24,471                    |       | —                |       | 29,562 |   | — |   | 29,562 |   |
|                                        |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| Discontinued operations, net of tax         |   | (333                        | )           | —                    |       | —                |       | (333 | ) | — |   | (333 | ) |
|                                        |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| Segment profit (loss)(2)                    |   | 23,505                      |        | 29,141                    |       | (7,663                | )          | 44,983 |   | — |   | 44,983 |   |

 

----

(1)               The ReconcilingEliminations category eliminates the intersegment revenues of Energy Merchant.

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

(3)               The increase in2003 is primarily due to the increase in price reflecting a substantialincrease in the wholesale gas commodity costs which is passed directly to theretail customer dollar-for-dollar under the state mandated gas cost recoverymechanism. 

(4)               The increase in2003 is primarily due to the gain on disposal of discontinued operations andsynthetic fuel tax credits discussed in Note 7 and Note 6(s),respectively.  This increase alsoreflects changes associated with employee severance programs and the write-offsof certain equipment and technology investments that were taken in the secondquarter of 2002.

 

55

----

 

Financial results by business unit for year to dateJune 30, 2003 and June 30, 2002, are as indicated below.

 

**BusinessUnits**

 
|                                                                   |   | **Cinergy  Business Units** |        |                      |       |                  |       |
|------------------------------------------------------------------------|--------|-----------------------------|-------------|---------------------------|------------|-----------------------|------------|
|                                                                   |   | **Energy  Merchant**        |        | **Regulated  Businesses** |       | **Power  Technology** |       | **Total** |   | **Reconciling  Eliminations(1)** |   | **Consolidated** |   |
|                                                                   |   | ***(in  thousands)***       |        |
|                                                                   |   |                        | * *    |                      | * *   |                  | * *   |   | * * |   | * * |   | * * |
| **Year to Date June 30, 2003**                                         |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
|                                                                   |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| **Operating revenues-**                                                |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **External  customers**                                                |   | **$**                       | **783,839** | **(3)**                   | **$**      | **1,418,038**         | **(4)**    | **$** | **3** | ** ** | **$** | **2,201,880** |   | **$** | **—** | ** ** | **$** | **2,201,880** | ** ** |
| **Intersegment  revenues**                                             |   | **76,279**                  | ** **  | **—**                | ** ** | **—**            | ** ** | **76,279** | ** ** | **(76,279** | **)** | **—** | ** ** |
|                                                                   |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Cost of sales -**                                                    |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Fuel  and purchased and exchanged power**                            |   | **261,863**                 | ** **  | **248,472**               | ** ** | **—**            | ** ** | **510,335** | ** ** | **—** | ** ** | **510,335** | ** ** |
| **Gas  purchased**                                                     |   | **69,463**                  | ** **  | **219,851**               | ** ** | **—**            | ** ** | **289,314** | ** ** | **—** | ** ** | **289,314** | ** ** |
|                                                                   |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Discontinued  operations, net of tax**                               |   | **8,875**                   | ** **  | **—**                | ** ** | **—**            | ** ** | **8,875** | ** ** | **—** | ** ** | **8,875** | ** ** |
| **Cumulative  effect of changes in accounting principles, net of tax** |   | **26,462**                  | ** **  | **—**                | ** ** | **—**            | ** ** | **26,462** | ** ** | **—** | ** ** | **26,462** | ** ** |
|                                                                   |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Segment profit (loss)(2)**                                           |   | **161,437**                 | **(5)**     | **100,174**               |       | **(10,873**           | **)**      | **250,738** |   | **—** | ** ** | **250,738** | ** ** |
|                                                                   |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| Year to Date June 30, 2002                                             |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
|                                                                   |   |                        | ** **  |                      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Operating revenues-                                                    |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| External  customers                                                    |   | $                           | 602,497     |                      | $          | 1,273,184             |       | $ | — |   | $ | 1,875,681 |   | $ | — |   | $ | 1,875,681 |   |
| Intersegment  revenues                                                 |   | 76,198                      |        | —                    |       | —                |       | 76,198 |   | (76,198 | ) | — |   |
|                                                                   |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| Cost of sales -                                                        |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| Fuel and  purchased and exchanged power                                |   | 242,860                     |        | 216,632                   |       | —                |       | 459,492 |   | — |   | 459,492 |   |
| Gas purchased                                                          |   | 7,003                       |        | 132,439                   |       | —                |       | 139,442 |   | — |   | 139,442 |   |
|                                                                   |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| Discontinued operations, net of tax                                    |   | 1,229                       |        | —                    |       | —                |       | 1,229 |   | — |   | 1,229 |   |
| Cumulative effect  of changes in accounting principle, net of tax      |   | (10,899                     | )           | —                    |       | —                |       | (10,899 | ) | — |   | (10,899 | ) |
|                                                                   |   |                        |        |                      |       |                  |       |   |   |   |   |   |   |
| Segment profit (loss)(2)                                               |   | 40,143                      |        | 101,938                   |       | (12,269               | )          | 129,812 |   | — |   | 129,812 |   |

 

----

(1)               The ReconcilingEliminations category eliminates the intersegment revenues of Energy Merchant.

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

(3)               The increase in2003 is primarily due to the increase in volumes and gross margins realized onwholesale commodity transactions and the sale of synthetic fuel which began inJuly 2002. 

(4)               The increase in2003 is primarily due to the increase in the average price received perthousand cubic feet (mcf) delivered reflecting a substantial increase in thewholesale gas commodity costs, which is passed directly to the retail customerdollar-for-dollar under the state mandated gas cost recovery mechanism.  Also contributing to this increase washigher mcf volumes sold due to colder than normal weather.

(5)               The increase in2003 is primarily due to the gain on disposal of discontinued operations andsynthetic fuel credits discussed in Note 7 and Note 6(s), respectively.  This increase also reflects changesassociated with employee severance programs and the write-offs of certainequipment and technology investments that were taken in the second quarter of2002.

 

56

----

 

Total segment assets atJune 30, 2003, and December 31, 2002, were as follows:

 
|                                             |   | **Cinergy Business Units** |          |                      |         |                  |         |
|--------------------------------------------------|--------|----------------------------|---------------|---------------------------|--------------|-----------------------|--------------|
| **Business Units**                               |   | **Energy  Merchant**       |          | **Regulated  Businesses** |         | **Power  Technology** |         | **Total** |   | **All  Other(1)** |   | **Consolidated** |   |
|                                             |   | ***(in  thousands)***      |          |
|                                             |   |                       | *** ***  |                      | *** *** |                  | *** *** |   | *** *** |   | *** *** |   | *** *** |
| **Segment  assets from continuing operations**   |   | **$**                      | **5,297,042** | **(2)**                   | **$**        | **7,736,795**         | **(2)**      | **$** | **160,335** | ** ** | **$** | **13,194,172** | ** ** | **$** | **86,999** | ** ** | **$** | **13,281,171** | ** ** |
| **Segment assets from  discontinued operations** |   | **7,187**                  | ** **    | **—**                | ** **   | **—**            | ** **   | **7,187** | ** ** | **—** | ** ** | **7,187** | ** ** |
| **Total segment assets at  June 30, 2003**  |   | **$**                      | **5,304,229** | ** **                | **$**        | **7,736,795**         | ** **   | **$** | **160,335** | ** ** | **$** | **13,201,359** | ** ** | **$** | **86,999** | ** ** | **$** | **13,288,358** | ** ** |
|                                             |   |                       | ** **    |                      | ** **   |                  | ** **   |   | ** ** |   | ** ** |   | ** ** |
| Segment assets from continuing operations        |   | $                          | 5,627,485     |                      | $            | 7,283,812             |         | $ | 155,252 |   | $ | 13,066,549 |   | $ | 93,214 |   | $ | 13,159,763 |   |
| Segment assets from discontinued operations      |   | 147,265                    |          | —                    |         | —                |         | 147,265 |   | — |   | 147,265 |   |
| Total segment assets at December 31, 2002        |   | $                          | 5,774,750     |                      | $            | 7,283,812             |         | $ | 155,252 |   | $ | 13,213,814 |   | $ | 93,214 |   | $ | 13,307,028 |   |

 

----

(1)   The All Other categoryrepresents miscellaneous corporate items which are not allocated to businessunits for purposes of segment performance measurement.

(2)   June 30, 2003 balancesreflect the transfer of generating assets as discussed in Note 11.

 

57

----

 

**9.****                                      EPS**

 

A reconciliation of EPSto EPS – assuming dilution is presented below for the quarters ended June 30,2003 and June 30, 2002:

 
|                                          |   | **Income**                                      |       | **Shares** |        | **EPS**    |   |
|-----------------------------------------------|--------|-------------------------------------------------|------------|------------|-------------|------------|--------|
|                                          |   | ***(in  thousands, except per share amounts)*** |       |
| **Quarter  ended June 30, 2003**              |   |                                            | ** ** |       | ** **  |       |   |
| **EPS:**                                      |   |                                            | ** ** |       | ** **  |       |   |
| **Income  before discontinued operations**    |   | **$**                                           | **75,608** | ** ** |        | ** ** | **$**  | **0.42** |   |
| **Discontinued  operations, net of tax**      |   | **9,045**                                       | ** ** |       | ** **  | **0.05**   |   |
| **Net  Income**                               |   | **$**                                           | **84,653** | ** ** | **176,645** | ** ** | **$**  | **0.47** |   |
|                                          |   |                                            | ** ** |       | ** **  |       |   |
| **Effect  of dilutive securities:**           |   |                                            | ** ** |       | ** **  |       |   |
| **Common  stock options**                     |   |                                            | ** ** | **866**    | ** **  |       |   |
| **Employee  stock purchase and savings plan** |   |                                            | ** ** | **18**     | ** **  |       |   |
| **Directors’  compensation plans**       |   |                                            | ** ** | **145**    | ** **  |       |   |
| **Contingently  issuable common stock**       |   |                                            | ** ** | **824**    | ** **  |       |   |
| **Stock  purchase contracts**                 |   |                                            | ** ** | **415**    | ** **  |       |   |
|                                          |   |                                            | ** ** |       | ** **  |       |   |
| **EPS  - assuming dilution:**                 |   |                                            | ** ** |       | ** **  |       |   |
| **Net  income plus assumed conversions**      |   | **$**                                           | **84,653** | ** ** | **178,913** | ** ** | **$**  | **0.47** |   |
|                                          |   |                                            |       |       |        |       |   |
| Quarter ended  June 30, 2002                  |   |                                            |       |       |        |       |   |
| EPS:                                          |   |                                            |       |       |        |       |   |
| Income before  discontinued operations        |   | $                                               | 45,316     |       |        |       | $      | 0.27 |   |
| Discontinued  operations, net of tax          |   | (333                                            | )          |       |        | —     |   |
| Net Income                                    |   | $                                               | 44,983     |       | 167,330     |       | $      | 0.27 |   |
|                                          |   |                                            |       |       |        |       |   |
| Effect of  dilutive securities:               |   |                                            |       |       |        |       |   |
| Common stock  options                         |   |                                            |       | 1,116      |        |       |   |
| Employee stock  purchase and savings plan     |   |                                            |       | 11         |        |       |   |
| Directors’  compensation plans           |   |                                            |       | 155        |        |       |   |
| Contingently  issuable common stock           |   |                                            |       | 869        |        |       |   |
| Stock purchase  contracts                     |   |                                            |       | 323        |        |       |   |
|                                          |   |                                            |       |       |        |       |   |
| EPS - assuming  dilution:                     |   |                                            |       |       |        |       |   |
| Net income plus  assumed conversions          |   | $                                               | 44,983     |       | 169,804     |       | $      | 0.26 |   |

 

Options to purchase shares of common stock are excluded from thecalculation of EPS - assuming dilution when the exercise prices of theseoptions are greater than the average market price of the common shares duringthe period.  Approximately 1.5 millionshares were excluded from the EPS - assuming dilution calculation for thequarters ended June 30, 2003 and 2002.

 

Also excluded from theEPS - assuming dilution calculation for the quarters ended June 30, 2003 and2002, are up to 10.4 million and 10.5 million shares, respectively, issuablepursuant to the stock purchase contracts associated with the preferred trustsecurities issued by **Cinergy Corp.**in December 2001.  The number of sharesissuable pursuant to the stock purchase contracts is contingent upon the marketprice of **Cinergy Corp.** stock inFebruary 2005 and could range between 9.2 and 10.8 million shares.

 

58

----

 

A reconciliationof EPS to EPS - assuming dilution is presented below for the year to date June30, 2003 and June 30, 2002:

 
|                                                                                                  |   | **Income**                                      |        | **Shares** |        | **EPS**    |       |
|-------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------|-------------|------------|-------------|------------|------------|
|                                                                                                  |   | ***(in  thousands, except per share amounts)*** |        |
| **Year  to Date June 30, 2003**                                                                       |   |                                            | ** **  |       | ** **  |       | ** ** |
| **EPS:**                                                                                              |   |                                            | ** **  |       | ** **  |       | ** ** |
| **Income  before discontinued operations and cumulative effect of changes in accounting  principles** |   | **$**                                           | **215,401** | ** ** |        | ** ** | **$**      | **1.23** | ** ** |
| **Discontinued  operations, net of tax**                                                              |   | **8,875**                                       | ** **  |       | ** **  | **0.05**   | ** ** |
| **Cumulative  effect of changes in accounting principles, net of tax**                                |   | **26,462**                                      | ** **  |       | ** **  | **0.15**   | ** ** |
| **Net  Income**                                                                                       |   | **$**                                           | **250,738** | ** ** | **175,025** | ** ** | **$**      | **1.43** | ** ** |
|                                                                                                  |   |                                            | ** **  |       | ** **  |       | ** ** |
| **Effect  of dilutive securities:**                                                                   |   |                                            | ** **  |       | ** **  |       | ** ** |
| **Common  stock options**                                                                             |   |                                            | ** **  | **791**    | ** **  |       | ** ** |
| **Employee  stock purchase and savings plan**                                                         |   |                                            | ** **  | **9**      | ** **  |       | ** ** |
| **Directors’  compensation plans**                                                               |   |                                            | ** **  | **145**    | ** **  |       | ** ** |
| **Contingently  issuable common stock**                                                               |   |                                            | ** **  | **770**    | ** **  |       | ** ** |
|                                                                                                  |   |                                            | ** **  |       | ** **  |       | ** ** |
| **EPS  - assuming dilution:**                                                                         |   |                                            | ** **  |       | ** **  |       | ** ** |
| **Net  income plus assumed conversions**                                                              |   | **$**                                           | **250,738** | ** ** | **176,740** | ** ** | **$**      | **1.42** | ** ** |
|                                                                                                  |   |                                            |        |       |        |       |       |
| Year to Date  June 30, 2002                                                                           |   |                                            |        |       |        |       |       |
| EPS:                                                                                                  |   |                                            |        |       |        |       |       |
| Income before  discontinued operations and cumulative effect of changes in accounting  principles     |   | $                                               | 139,482     |       |        |       | $          | 0.84 |   |
| Discontinued operations,  net of tax                                                                  |   | 1,229                                           |        |       |        | 0.01       |       |
| Cumulative  effect of changes in accounting principles, net of tax                                    |   | (10,899                                         | )           |       |        | (0.06      | )          |
| Net Income                                                                                            |   | $                                               | 129,812     |       | 165,821     |       | $          | 0.79 |   |
|                                                                                                  |   |                                            |        |       |        |       |       |
| Effect of  dilutive securities:                                                                       |   |                                            |        |       |        |       |       |
| Common stock  options                                                                                 |   |                                            |        | 1,028      |        |       |       |
| Employee stock  purchase and savings plan                                                             |   |                                            |        | 6          |        |       |       |
| Directors’  compensation plans                                                                   |   |                                            |        | 155        |        |       |       |
| Contingently  issuable common stock                                                                   |   |                                            |        | 836        |        |       |       |
|                                                                                                  |   |                                            |        |       |        |       |       |
| EPS - assuming  dilution:                                                                             |   |                                            |        |       |        |       |       |
| Net income plus  assumed conversions                                                                  |   | $                                               | 129,812     |       | 167,846     |       | $          | 0.78 |   |

 

Options to purchase shares of common stock are excluded from thecalculation of EPS - assuming dilution when the exercise prices of theseoptions are greater than the average market price of the common shares duringthe period.  For year to date June 30,2003 and 2002, approximately 2.1 million and 1.9 million shares, respectively,were excluded from the EPS - assuming dilution calculation.

 

Also excluded from the EPS - assuming dilution calculation for year todate June 30, 2003 and 2002, are up to 10.8 million shares issuable pursuant tothe stock purchase contracts associated with the preferred trust securitiesissued by **Cinergy Corp.** inDecember 2001.  The number of sharesissuable pursuant to the stock purchase contracts is contingent upon the marketprice of **Cinergy Corp.** stock inFebruary 2005 and could range between 9.2 and 10.8 million shares.

 

59

----

 

**10.  OhioDeregulation**

 

As discussed in the 200210-K, **CG&E** is in a marketdevelopment period, beginning the transition to electric deregulation in thestate of Ohio.  The transition period isgoverned by Amended Substitute Senate Bill No. 3 (Electric Restructuring Bill)and a stipulated agreement adopted and approved by the PUCO.  Under **CG&E’s**transition plan, retail customers continue to receive electric distributionservices from **CG&E**, but maypurchase electricity from another supplier. Retail customers that purchase electricity from another supplier receiveshopping credits from **CG&E**.  The shopping credits generally reflect thecosts of electric generation included in **CG&E’s**frozen rates.  However, shopping creditsfor the first 20 percent of electricity usage in each customer class to switchsuppliers are higher than shopping credits for subsequent switchers in order tostimulate the development of the competitive retail electric service market,pursuant to **CG&E’s** stipulatedagreement.

 

**CG&E**recovers its regulatory assets and other transition coststhrough a Regulatory Transition Charge (RTC) paid by all retail customers.  As the RTC is collected from customers, **CG&E** amortizes the deferred balance ofregulatory assets and other transition costs. A portion of the RTC collected from customers is recognized in earningscurrently as a return on the deferred balance of regulatory assets and othertransition costs and as reimbursement for the difference in the shoppingcredits provided to customers and the wholesale revenues from switchedgeneration.  The ability of **CG&E** to recover its regulatory assetsand other transition costs is dependent on several factors, including, but notlimited to, the level of **CG&E’s**electric sales, prices in the wholesale power markets, and the amount ofcustomers switching to other electric suppliers.

 

On January 10, 2003, **CG&E** filed an application with the PUCOfor approval of a methodology to establish how market-based rates fornon-residential customers will be determined when the market development periodends.  In the filing, **CG&E** seeks to establish a market-basedstandard service offer rate for non-residential customers that do not switchsuppliers and a process for establishing the competitively bid generationservice option required by the Electric Restructuring Bill.  As of June 30, 2003, more than 20 percent ofthe load of **CG&E’s** commercialand industrial customer classes have switched to other electric suppliers.  Under its transition plan, **CG&E** may end the market developmentperiod for those classes of customers once 20 percent switching has beenachieved; however, PUCO approval of the standard service offer rate andcompetitive bidding process is required before the market development periodcan be ended.  **CG&E** is not requesting to end themarket development period for any customers at this time.  **CG&E**is unable to predict the outcome of this proceeding.

 

**11.  Transferof Generating Assets**

 

In December 2002, theIURC approved a settlement agreement among **PSI**,the Indiana Office of the Utility Consumer Counselor, and the IURC TestimonialStaff authorizing **PSI’s** purchasesof the Henry County, Indiana and Butler County, Ohio, gas-fired peaking plantsfrom two non-regulated affiliates.  InFebruary 2003, the Federal Energy Regulatory Commission (FERC) issued an orderunder Section 203 of the Federal Power Act authorizing **PSI’s** acquisitions of the plants, whichoccurred on February 5, 2003. Subsequently, in April 2003, the FERC issued a

 

60

----

 

tolling order allowingadditional time to consider a request for rehearing filed in response to theFebruary 2003 FERC order.  At this time,we cannot predict the outcome of this matter.

 

On July 21, 2003, **ULH&P** filed an application with theKPSC requesting approval of a long-term electric supply plan to acquire **CG&E’s** ownership interests in the EastBend Generation Station, located in Boone County, Kentucky, the WoodsdaleGenerating Station, located in Butler County, Ohio, and one generating unit atthe four-unit Miami Fort Generating Station located in Hamilton County, Ohio.  **ULH&P**also requested KPSC approval of a back-up power supply agreement under which **CG&E** would provide replacement power to**ULH&P**when the transferredgenerating facilities are out of service, and for approval of another agreementunder which the transferred units would be jointly dispatched with **CG&E’s** remaining fleet of generatingunits.  The transfer, which will be madeat net book value, will not affect current electric rates for **ULH&P’s** customers, as power will beprovided under the same terms as under the current wholesale power contractwith **CG&E** through at leastDecember 31, 2006.  A proceduralschedule has not yet been established by the KPSC.  This transfer is also contingent upon receipt of approval fromthe FERC and the SEC.  **ULH&P** is unable to predict the outcomeof this matter.

 

61

----

 

**CAUTIONARYSTATEMENTS**

 

## **CAUTIONARY STATEMENTS REGARDINGFORWARD-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 similarexpressions.

 

Forward-lookingstatements involve risks and uncertainties that may cause actual results to bematerially different from the results predicted.  Factors that could cause actual results to differ materially fromthose indicated in any forward-looking statement include, but are not limitedto:

 

•                  Factorsaffecting operations, such as:

 

(1)          unanticipated weatherconditions;

(2)          unscheduled generationoutages;

(3)          unusual maintenance orrepairs;

(4)          unanticipated changes incosts;

(5)          environmental incidents,including costs of compliance with existing

andfuture environmental requirements; and

(6)          electric transmission orgas pipeline system constraints.

 

•                  Legislativeand regulatory initiatives.

 

•                  Additionalcompetition in electric or gas markets and continued industry consolidation.

 

•                  Financialor regulatory accounting principles.

 

•                  Political,legal, and economic conditions and developments in the countries in which wehave a presence.

 

•                  Changingmarket conditions and other factors related to physical energy and financialtrading activities.

 

•                  Theperformance of projects undertaken by our non-regulated businesses and thesuccess of efforts to invest in and develop new opportunities.

 

•                  Availabilityof, or cost of, capital.

 

•                  Employeeworkforce factors.

 

•                  Delaysand other obstacles associated with mergers, acquisitions, and investments injoint ventures.

 

62

----

 

•                  Costsand effects of legal and administrative proceedings, settlements,investigations, and claims.  Examplescan be found in Note 6 of the “Notes to Financial Statements” in “Part I.Financial Information”.

 

We undertake noobligation to update the information contained herein.

 

63

----

 

**MD&A- INTRODUCTION**

 

## **ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

In this report **Cinergy**(which includes **Cinergy Corp.** and all of our regulated and non-regulatedsubsidiaries) 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, 2002 and Form 8-K filed on June 10, 2003 (together,the 2002 10-K).  The results discussedbelow are not necessarily indicative of the results that may occur in anyfuture periods.

 

### **INTRODUCTION**

 

In Management’sDiscussion and Analysis of Financial Condition and Results of Operations(MD&A), we explain our general operating environment, as well as ourliquidity and capital resources and results of operations.  Specifically, we discuss the following:

 

•                  factorsaffecting current and future operations;

•                  potentialsources of cash for future capital expenditures;

•                  whyrevenues and expenses changed from period to period; and

•                  howthe above items affect our overall financial condition.

 

### **ORGANIZATION**

** **

**CinergyCorp.**, a Delaware corporation created in October 1994, ownsall outstanding common stock of The Cincinnati Gas & Electric Company (**CG&E**) and PSI Energy, Inc. (**PSI**), both of which are public utilitysubsidiaries.  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 Securities and Exchange Commission(SEC) under the Public Utility Holding Company Act of 1935, as amended(PUHCA).  Our other principalsubsidiaries are:

 

•                  CinergyWholesale Energy, Inc. (Wholesale Energy);

•                  CinergyServices, Inc. (Services); and

•                  CinergyInvestments, Inc. (Investments).

 

**CG&E**,an Ohio corporation, is a combination electric and gas public utility companythat provides service in the southwestern portion of Ohio and, through itssubsidiaries, in nearby areas of Kentucky and Indiana.  **CG&E’s**principal subsidiary, The Union Light, Heat and Power Company (**ULH&P**), is a Kentucky corporation thatprovides electric and gas service in northern Kentucky.  **CG&E’s**other subsidiaries are insignificant to its results of operations.

 

In 2001, **CG&E** began a transition to electricderegulation and customer choice. Currently, the competitive retail electric market in Ohio is in thedevelopment stage.  **CG&E** is recovering its 

 

64

----

 

**MD&A- LIQUIDITY AND CAPITAL RESOURCES**

 

Public UtilitiesCommission of Ohio (PUCO) approved costs and retail electric rates are frozenduring this market development period.

 

**PSI**,an Indiana corporation, is a vertically integrated and regulated electricutility that provides service in north central, central, and southern Indiana.

 

Services is a servicecompany that provides our subsidiaries with a variety of centralizedadministrative, management, and support services.  Investments holds most of our domestic non-regulated, energy-relatedbusinesses and investments, including gas marketing and trading operations.

 

Wholesale Energy, througha wholly-owned subsidiary, Cinergy Power Generation Services, LLC, provideselectric production-related construction, operation, and maintenance servicesto certain affiliates and non-affiliated third parties.

 

The majority of ouroperating revenues are derived from the sale of electricity and the sale and/ortransportation of natural gas.

 

### **LIQUIDITYAND CAPITAL RESOURCES**

#### ** **

#### **EnvironmentalIssues**

##### *** ***

##### ***Ambient Air Standards***

 

In 1997, theEnvironmental Protection Agency (EPA) revised the National Ambient Air QualityStandards (NAAQS) for ozone and fine particulate matter.  State ozone non-attainment area designationswere due to the EPA on July 15, 2003, and the EPA is under a court-ordereddeadline to make final designations by April 15, 2004.  The EPA has stated that it will requirestate fine particulate non-attainment designations on February 15, 2004, andwill make final designations by December 15, 2004.  Fine particulate matter refers to very small solid or liquidparticles in the air.  Followingidentification of non-attainment areas, each individual state will identify thesources of emissions and develop emission reduction plans.  These plans may be state-specific orregional in scope.  Under the Clean AirAct (CAA), individual states have up to 12 years from the date of designationto secure emissions reductions from sources contributing to the problem.

 

The EPA has announcedthat it will propose, within the next year or so, a regional or nationalregulation requiring significant reductions in sulfur dioxide and nitrogenoxide (NOX) emissions from power plants to implement the fineparticulate matter NAAQS.  Thisregulation would be expected to impact all of **Cinergy’s**coal-fired power plants.  However, **Cinergy** cannot predict the exact amount andtiming of these reductions at this time. Nonetheless, **Cinergy**expects that compliance costs with these new standards will be significant.

 

65

----

 

As discussed in **Cinergy’s** 2002 10-K, additionalenvironmental issues that could affect our liquidity include:

 

•                  RegionalHaze;

•                  GlobalClimate Change; and

•                  AirToxics Regulation.

 

In addition, see Note 6of the “Notes to Financial Statements” in “Part I.  Financial Information” contained herein, for additionalinformation regarding other environmental items and other matters that couldeffect our liquidity.

 

##### ***Pensions***

** **

**Cinergy**maintains qualified defined benefit pension plans covering substantially allUnited States (U.S.) employees meeting certain minimum age and servicerequirements.  Plan assets consist ofinvestments in equity and fixed income securities.  Funding for the qualified defined benefit pension plans is based uponactuarially determined contributions that take into account the amountdeductible for income tax purposes and the minimum contribution required underthe Employee Retirement Income Security Act of 1974, as amended.  Due to the decline in market value of theinvestment portfolio over the last few years, assets held in trust to satisfyplan obligations have decreased. Additionally, recent decreases in long-term interest rates have theeffect of increasing the measured liability for funding purposes.  As a result of these events, future fundingobligations could increase substantially. **Cinergy’s** minimum requiredcontributions for calendar year 2003 are $11 million, as compared to $4 millionfor the calendar year 2002.  We willmake additional contributions of $60 to $70 million for the calendar year 2003.

 

##### ***Other Investing Activities***

 

Our ability to invest ingrowth initiatives is limited by certain legal and regulatory requirements,including PUHCA.  The PUHCA limits thetypes of non-utility businesses in which **Cinergy**and other registered holding companies under 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:

 

•                  ExemptWholesale Generators (EWG) and Foreign Utility Companies (FUCO)

 

An EWG is an entity,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 U.S. is limited to making onlywholesale sales of electricity.

 

A FUCO is a company allof whose utility assets and operations are located outside the U.S. and whichare used for the generation, transmission, or distribution of electric energyfor sale at retail or wholesale, or the distribution of gas at retail.  A

 

66

----

 

FUCO may not derive anyincome, directly or indirectly, from the generation, transmission ordistribution of electric energy for sale or the distribution of gas at retailwithin the U.S.  An entity claimingstatus as a FUCO must provide notification thereof to the SEC under PUHCA.

 

In May 2001, the SECissued an order under PUHCA authorizing **Cinergy**to invest (including by way of guarantees) an aggregate amount in EWGs andFUCOs equal to the sum of (1) our average consolidated retained earnings fromtime to time plus (2) $2 billion.  As ofJune 30, 2003, we had invested or committed to invest $0.9 billion in EWGs andFUCOs, leaving available investment capacity under the May 2001 order of $2.5billion.

 

•                  Qualifying Facilities andEnergy-Related Non-utility Entities

 

SEC regulations under the PUHCA permit **Cinergy** and other registered holdingcompanies to invest and/or guarantee an amount equal to 15 percent ofconsolidated capitalization (consolidated capitalization is the sum of *Notes payable and other short-term obligations*,*Long-term debt* (including amountsdue within one year), *Preferred TrustSecurities*, *Cumulative PreferredStock of Subsidiaries*, and total *CommonStock Equity*) in domestic qualifying cogeneration and small powerproduction plants (qualifying facilities) and certain other domesticenergy-related non-utility entities.  AtJune 30, 2003, we had invested and/or guaranteed approximately $0.6 billion ofthe $1.3 billion available.

 

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

 

We are subject to an SECorder under the PUHCA, which limits the amounts **Cinergy Corp.** can have outstanding under guarantees at any onetime to $2 billion.  As of June 30,2003, we had $662 million outstanding under the guarantees issued, of whichapproximately 86 percent represents guarantees of obligations reflected on **Cinergy’s** Balance Sheets.  The amount outstanding represents **Cinergy Corp.’s** guarantees of liabilitiesand commitments of its consolidated subsidiaries, unconsolidated subsidiaries,and joint ventures.  See Note 6(a) of the “Notes to FinancialStatements” in “Part I. Financial Information” for a discussion of guaranteesin accordance with Financial Accounting Standards Board (FASB) 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 acalculation of maximum potential liability, rather than actual amountsoutstanding; it excludes guarantees issued on behalf of consolidatedsubsidiaries; and it includes potential liabilities under indemnificationclauses.

 

##### ***Collateral Requirements***

** **

**Cinergy**hascertain contracts in place, primarily with trading counterparties, that requirethe issuance of collateral in the event our debt ratings are downgraded belowinvestment grade.  Based upon our June30, 2003 trading portfolio, if such an event were to occur, **Cinergy** would

 

67

----

 

be required to issue upto approximately $83 million in collateral related to its gas and power tradingoperations.

 

#### **CapitalResources**

 

We meet our current andfuture capital requirement needs through a combination of internally andexternally generated funds, including the issuance of debt and/or equitysecurities.  **Cinergy** believes that it has adequate financial resources tomeet its future needs.

 

##### ***Notes Payable and Other Short-termObligations***

 

We are required to secureauthority to issue short-term debt from the SEC under the PUHCA and from thePUCO.  The SEC under the PUHCA regulatesthe 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**.

 

|                          |   | **Short-term Regulatory Authority  June 30, 2003** |   |
|-------------------------------|--------|----------------------------------------------------|--------|
|                          |   | ***(millions)***                                   |   |
|                          |   | **Authority**                                      |   | **Outstanding** |   |
|                          |   |                                               |   |   |   |
| **Cinergy  Corp.**            |   | $                                                  | 5,000  | (1) | $ | 281 |   |
| **CG&E**and  subsidiaries |   | 671                                                |   | 8 |   |
| **PSI**                       |   | 600                                                |   | 237 |   |
| **ULH&P**                 |   | 65                                                 |   | 21 |   |
|                               |        |                                                    |        |  |  |  |  |

 

----

(1)               **Cinergy Corp.**, under the PUHCA, was grantedapproval to increase total capitalization (excluding retained earnings andaccumulated other comprehensive income (loss)), which may be any combination ofdebt and equity securities, by $5 billion. Outside this requirement, **Cinergy Corp.**is not subject to specific regulatory debt authorizations.

 

For the purposes ofquantifying regulatory authority, short-term debt includes revolving creditborrowings, uncommitted credit line borrowings, inter-company money poolobligations, and commercial paper.

 

68

----

 

**CinergyCorp.’s**short-term borrowing consists primarily of unsecuredrevolving lines of credit and the sale of commercial paper.  **CinergyCorp.’s** $1 billion revolving credit facilities and $800 millioncommercial paper program also support the short-term borrowing needs of **CG&E** and **PSI**.  In addition, **Cinergy**, **CG&E**,and **PSI** maintain uncommitted linesof credit.  These facilities are notfirm sources of capital but rather informal agreements to lend money, subjectto availability, with pricing determined at the time of advance.  The following is a summary of outstandingshort-term borrowings for **Cinergy**,**CG&E**, **PSI**, and **ULH&P**,including variable rate pollution control notes:

 
|                          |   | **Short-term  Borrowings  June 30, 2003** |     |
|-------------------------------|--------|-------------------------------------------|----------|
|                          |   | **Established  Lines**                    |     | **Outstanding** |   | **Unused** |   | **Standby  Liquidity(3)** |   | **Available  Revolving  Lines of  Credit** |   |
|                          |   | ***(in  millions)***                      |     |
|                          |   |                                      | * * |   | * * |   | * * |   | * * |   | * * |
| **Cinergy**                   |   |                                      |     |   |   |   |   |   |   |   |   |
| **Cinergy  Corp.**            |   |                                      |     |   |   |   |   |   |   |   |   |
| Revolving lines               |   | $                                         | 1,000    |   | $ | — |   | $ | 1,000 |   | $ | 296 |   | $ | 704 |   |
| Uncommitted lines(1)          |   | 65                                        |     | — |   | 65 |   |   |   |   |   |
| Commercial paper(2)           |   |                                      |     | 281 |   | 519 |   |   |   |   |   |
|                          |   |                                      |     |   |   |   |   |   |   |   |   |
| Operating companies           |   |                                      |     |   |   |   |   |   |   |   |   |
| Uncommitted lines(1)          |   | 75                                        |     | — |   | 75 |   |   |   |   |   |
| Pollution control notes       |   |                                      |     | 112 |   |   |   |   |   |   |   |
|                          |   |                                      |     |   |   |   |   |   |   |   |   |
| Non-regulated subsidiaries    |   |                                      |     |   |   |   |   |   |   |   |   |
| Revolving lines               |   | 17                                        |     | 9 |   | 8 |   |   |   | 8 |   |
| Short-term debt               |   |                                      |     | 7 |   |   |   |   |   |   |   |
|                          |   |                                      |     |   |   |   |   |   |   |   |   |
| **Cinergy  Total**            |   |                                      |     | $ | 409 |   |   |   |   |   | $ | 712 |   |
|                          |   |                                      |     |   |   |   |   |   |   |   |   |
| **CG&E**and  subsidiaries |   |                                      |     |   |   |   |   |   |   |   |   |
| Uncommitted lines(1)          |   | $                                         | 15       |   | $ | — |   | $ | 15 |   |   |   |   |   |
| Pollution control notes       |   |                                      |     | 112 |   |   |   |   |   |   |   |
| Money pool                    |   |                                      |     | 8 |   |   |   |   |   |   |   |
|                          |   |                                      |     |   |   |   |   |   |   |   |   |
| **CG&E  Total**           |   |                                      |     | $ | 120 |   |   |   |   |   |   |   |
|                          |   |                                      |     |   |   |   |   |   |   |   |   |
| **PSI**                       |   |                                      |     |   |   |   |   |   |   |   |   |
| Uncommitted lines(1)          |   | $                                         | 60       |   | $ | — |   | $ | 60 |   |   |   |   |   |
| Money pool                    |   |                                      |     | 237 |   |   |   |   |   |   |   |
|                          |   |                                      |     |   |   |   |   |   |   |   |   |
| **PSI Total**                 |   |                                      |     | $ | 237 |   |   |   |   |   |   |   |
|                          |   |                                      |     |   |   |   |   |   |   |   |   |
| **ULH&P**                 |   |                                      |     |   |   |   |   |   |   |   |   |
| Money pool                    |   |                                      |     | $ | 21 |   |   |   |   |   |   |   |
|                          |   |                                      |     |   |   |   |   |   |   |   |   |
| **ULH&P  Total**          |   |                                      |     | $ | 21 |   |   |   |   |   |   |   |
|                               |        |                                           |          |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          Outstanding amounts may begreater than established lines as uncommitted lenders are, at times, willing toloan funds in excess of the established lines.

(2)          The commercial paper programis limited to $800 million and is supported by **Cinergy Corp.’s** revolving lines.

(3)          Standby liquidity isreserved against the revolving lines to support the commercial paper programand outstanding letters of credit (currently $281 million and $15 million,respectively).

 

69

----

 

At June 30, 2003, **Cinergy Corp.** had $704 million remainingunused and available capacity relating to its $1 billion revolving creditfacilities.  These revolving creditfacilities included the following:

 

| **Credit Facility**         |   | **Expiration** |     | **Established  Lines** |     | **Outstanding  and  Committed** |     | **Unused and  Available** |     |
|-----------------------------|--------|----------------|----------|------------------------|----------|---------------------------------|----------|---------------------------|----------|
|                        |   |           |     |                   |     | ***(in  millions)***            |     |                      |     |
|                        |   |           | * * |                   | * * |                            | * * |                      | * * |
| 364-day senior revolving    |   | April 2004     |     |                   |     |                            |     |                      |     |
| Direct borrowing            |   |           |     | $                      |     |                            | $        | —                    |     | $ |   |   |
| Commercial paper support    |   |           |     |                   |     | 281                             |     |                      |     |
|                        |   |           |     |                   |     |                            |     |                      |     |
| Total 364-day facility      |   |           |     | 600                    |     | 281                             |     | 319                       |     |
|                        |   |           |     |                   |     |                            |     |                      |     |
| Three-year senior revolving |   | May 2004       |     |                   |     |                            |     |                      |     |
| Direct borrowing            |   |           |     |                   |     | —                          |     |                      |     |
| Commercial paper support    |   |           |     |                   |     | —                          |     |                      |     |
| Letter of Credit support    |   |           |     |                   |     | 15                              |     |                      |     |
|                        |   |           |     |                   |     |                            |     |                      |     |
| Total three-year facility   |   |           |     | 400                    |     | 15                              |     | 385                       |     |
|                        |   |           |     |                   |     |                            |     |                      |     |
| Total credit facilities     |   |           |     | $                      | 1,000    |                            | $        | 296                       |     | $ | 704 |   |

 

In April 2003, **Cinergy Corp.** successfully placed a $600million, 364-day senior unsecured revolving credit facility.  This facility replaced the $600 million,364-day facility that expired April 30, 2003.

 

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

 

•                  aconsolidated net worth of $2 billion; and

•                  aratio of consolidated indebtedness to consolidated total capitalization not inexcess of 65 percent.

 

A breach of thesecovenants could result in the termination of the credit facilities and theacceleration of the related indebtedness. In addition to breaches of covenants, certain other events that couldresult in the termination of available credit and acceleration of the relatedindebtedness include:

 

•                  bankruptcy;

•                  defaultsin the payment of other indebtedness; and

•                  judgmentsagainst the company that are not paid or insured.

 

The latter two events,however, are subject to dollar-based materiality thresholds.

 

As discussed in Note1(g)(*vi*) and 1(g)(*v*), respectively, of the “Notes toFinancial Statements” in “Part I. Financial Information”, long-term debt willincrease in the third quarter of 2003 resulting from the adoptions of Statementof Financial Accounting Standards No. 150, *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity* (Statement

 

70

----

 

150) and InterpretationNo. 46, *Consolidation of Variable InterestEntities* (Interpretation 46). This adjustment in our debt will not cause **Cinergy** to be in breach of any covenants.

 

*Variable Rate Pollution Control Notes*

** **

**CG&E**has issued certain variable rate pollution control notes (tax-exempt notesobtained to finance equipment or land development for pollution controlpurposes).  Because the holders of thesenotes have the right to have their notes redeemed on a daily, monthly, orannual basis, they are reflected in *Notespayable and other short-term obligations* on the Balance Sheets for **Cinergy** and **CG&E**.  At June 30,2003, **CG&E** had $112 millionoutstanding in variable rate pollution control notes, classified as short-termdebt.  **PSI**and**ULH&P** had nooutstanding short-term pollution control notes.  Any short-term pollution control note borrowings outstanding donot reduce the unused and available short-term debt regulatory authority of **CG&E**, **PSI**,and **ULH&P**.  See Note 4 of the “Notes to FinancialStatements” in “Part I. Financial Information” for additional informationregarding pollution control notes.

 

*Money Pool*

** **

**CinergyCorp.**, Services, and our operating companies participate in amoney pool arrangement to better manage cash and working capitalrequirements.  Under this arrangement,those companies with surplus short-term funds provide short-term loans toaffiliates (other than **Cinergy Corp.**)participating under this arrangement. This surplus cash may be from internal or external sources.  The amounts outstanding under this moneypool arrangement are shown as a component of *Notesreceivable from affiliated companies* and/or *Notes payable to affiliated companies* onthe Balance Sheets of **CG&E**, **PSI**, and **ULH&P**.  Any money pool borrowings outstanding reducethe unused and available short-term debt regulatory authority of **CG&E**, **PSI**,and **ULH&P**.

 

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

 

We are required to secureauthority to issue long-term debt from the SEC under the PUHCA and the stateutility commissions of Ohio, Kentucky, and Indiana.  The SEC under the PUHCA regulates the issuance of long-term debtby **Cinergy Corp.**  The respective state utility commissionsregulate the issuance of long-term debt by our operating companies.

 

71

----

 

A summary of ourlong-term debt authorizations at June 30, 2003, is as follows:

 

|                              |   | **Authorized**    |   | **Used** |   | **Available** |   |
|-----------------------------------|--------|-------------------|--------|----------|--------|---------------|--------|
|                              |   | **(in millions)** |   |
|                              |   |              |   |     |   |          |   |
| **Cinergy  Corp.**                |   |              |   |     |   |          |   |
| PUHCA total  capitalization(1)    |   | $                 | 5,000  |     | $      | 1,629         |   | $ | 3,371 |   |
|                              |   |              |   |     |   |          |   |
| **CG&E**and subsidiaries(2)   |   |              |   |     |   |          |   |
| State Public  Utility Commissions |   | 575               |   | 400      |   | 175           |   |
|                              |   |              |   |     |   |          |   |
| **PSI**                           |   |              |   |     |   |          |   |
| State Public  Utility Commission  |   | 500               |   | 83       |   | 417           |   |
|                              |   |              |   |     |   |          |   |
| **ULH&P**                     |   |              |   |     |   |          |   |
| State Public  Utility Commission  |   | 75                |   | —   |   | 75            |   |
|                                   |        |                   |        |          |        |               |        |  |  |  |

 

----

(1)       **CinergyCorp.**, under PUHCA, was granted approval to increase total capitalization(excluding retained earnings and accumulated other comprehensive income (loss)),which may be any combination of debt and equity securities, by $5 billion.  Outside this requirement, **Cinergy Corp.** is not subject to specificregulatory debt authorizations.

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

 

**CinergyCorp.** has an effective shelf registration statement with theSEC relating to the issuance of up to $750 million in any combination of commonstock, preferred stock, stock purchase contracts or unsecured debt securities,of which approximately $574 million remains available for issuance.  **CG&E**has an effective shelf registration statement with the SEC relating to theissuance of up to $500 million in any combination of unsecured debt securities,first mortgage bonds, or preferred stock, of which $100 million remainsavailable for issuance.  **PSI** has an effective shelf registrationstatement with the SEC relating to the issuance of up to $700 million in anycombination of unsecured debt securities, first mortgage bonds, or preferredstock, all of which remains available for issuance.  **ULH&P** haseffective shelf registration statements with the SEC relating to the issuanceof up to $50 million in unsecured debt securities and up to $40 million infirst mortgage bonds, of which $30 million in unsecured debt securities and $20million in first mortgage bonds remain available for issuance.

 

##### ***Off-Balance Sheet Financing***

 

As discussed in the 200210-K, **Cinergy** uses special-purposeentities (SPE) to finance various projects. The FASB issued Interpretation 46 in January 2003.  This interpretation significantly changesthe consolidation requirements for SPEs. For further discussions see “Consolidation of SPEs” under “AccountingChanges” in MD&A-Future.

 

**Cinergy**holds investments in various unconsolidated subsidiaries which are accountedfor under the equity method and has guaranteed approximately $8 million of thedebt of these entities.

 

72

----

 

***Securities Ratings***

** **

As of June 30, 2003, themajor credit ratings agencies rated our securities 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      |   | Not Rated    |   | Baa1                |   | BBB            |   |

 

----

(1)          Fitch IBCA (Fitch)

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

(3)          Standard & Poor’sRatings Services (S&P)

 

The lowest investment gradecredit rating for Fitch is BBB-, Moody’s is Baa3, and S&P is BBB-.

 

These securities ratingsmay be revised or withdrawn at any time, and each rating should be evaluatedindependently of any other rating.

 

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

 

As discussed in the 200210-K, under the SEC’s June 2000 Order, **CinergyCorp.** is permitted to increase its total capitalization by $5billion.  The proceeds from any newissuances will be used for general corporate purposes.

 

On January 15, 2003, **Cinergy Corp.** filed a registrationstatement with the SEC with respect to the issuance of common stock, preferredstock, and other securities in an aggregate offering amount of $750million.  On February 5, 2003, **Cinergy** sold 5.7 million shares of commonstock of **Cinergy Corp.** with netproceeds of approximately $175 million under this registration statement.

 

See Note 2(a) of the“Notes to Financial Statements” in “Part I. Financial Information” foradditional information regarding other common stock issuances.

 

In May 2003, **Cinergy Corp.**made a $100 million capital contribution to **PSI**in order to support **PSI’s** currentcredit ratings.

 

73

----

 

**MD&A- QUARTERLY RESULTS OF OPERATIONS - HISTORICAL**

 

### **2003 QUARTERLY RESULTS OFOPERATIONS - HISTORICAL**

 

#### **Summary ofResults**

 

Electric and gas grossmargins and net income for **Cinergy**,**CG&E**, and **PSI** for the quarters ended June 30, 2003and 2002 were as follows:

 

|                  |   | **Cinergy (1)**       |        | **CG&E and subsidiaries** |   | **PSI**    |   |
|-----------------------|--------|-----------------------|-------------|-------------------------------|--------|------------|--------|
|                  |   | **2003**              |        | **2002**                      |   | **2003**   |   | **2002** |   | **2003** |   | **2002** |   |
|                  |   | ***(in  thousands)*** |        |
|                  |   |                  |        |                          |   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Electric gross margin |   | **$**                 | **528,788** |                          | $      | 562,777    |   | **$** | **291,188** |   | $ | 301,124 |   | **$** | **239,387** |   | $ | 250,072 |   |
| Gas gross margin      |   | **61,613**            |        | 50,646                        |   | **37,225** |   | 31,537 |   | **—** |   | — |   |
| Net income            |   | **84,653**            |        | 44,983                        |   | **50,919** |   | 52,670 |   | **23,079** |   | 29,714 |   |

 

----

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

 

**Cinergy’s**net income for the second quarter of 2003 was $85 million($.47 per share on a diluted basis) as compared to $45 million ($.26 per shareon a diluted basis) for the same period last year.  Income before taxes for the period was $85 million compared to$67 million for the same period a year ago. The increase in 2003 net income was primarily the result of $66 millionin charges related to employee severance programs and the write-offs of certainequipment and technology investments in the second quarter of 2002.  **Cinergy’s**increasedincome also reflects increased gas gross margins from both gas trading andretail operations, gains realized in the second quarter of 2003 from thedisposal of discontinued operations, and lower income taxes resulting primarilyfrom tax credits associated with the production of synthetic fuel.  Offsetting these increases was a decrease inelectric gross margins attributable to milder than normal weather in thequarter and a sluggish economy.

 

#### **ElectricOperating Revenues**

 
|      |   | **Cinergy (1)**      |    | **CG&E and subsidiaries** |   | **PSI**      |   |
|-----------|--------|----------------------|---------|-------------------------------|--------|--------------|--------|
|      |   | **2003**             |    | **2002**                      |   | **% Change** |   | **2003** |   | **2002** |   | **% Change** |   | **2003** |   | **2002** |   | **% Change** |   |
|      |   | ***(in  millions)*** |    |
|      |   |                 |    |                          |   |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Retail    |   | **$**                | **636** |                          | $      | 670          |   | (5 | ) | **$** | **319** |   | $ | 345 |   | (8 | ) | **$** | **316** |   | $ | 325 |   | (3 | ) |
| Wholesale |   | **111**              |    | 98                            |   | 13           |   | **59** |   | 35 |   | 69 |   | **39** |   | 45 |   | (13 | ) |
| Other     |   | **22**               |    | 36                            |   | (39          | )      | **19** |   | 30 |   | (37 | ) | **6** |   | 9 |   | (33 | ) |
| Total     |   | $                    | **769** |                          | $      | 804          |   | (4 | ) | **$** | **397** |   | $ | 410 |   | (3 | ) | **$** | **361** |   | $ | 379 |   | (5 | ) |

 

----

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

 

*Electricoperating revenues*decreased for **Cinergy**,**CG&E**,****and **PSI**for the quarter ended June 30, 2003, as compared to 2002.  Retail revenues decreased for **Cinergy**, **CG&E**,and **PSI**primarily due to decreasedmegawatt hour (MWh) sales resulting from milder weather.  The number of cooling degree days wasapproximately 47 percent lower than the second quarter of 2002.  A sluggish regional economy also contributedto the decline in revenues.  Partially

 

74

----

 

offsetting this decreasefor **PSI**was a higher price received per MWh due to tariff adjustments associated withthe fuel cost recovery mechanism and certain construction programs.

 

Wholesale revenuesincreased for **Cinergy**and**CG&E**,and decreased for**PSI**for the quarter ended June 30, 2003, as compared to 2002.  The increase in wholesale revenues for **Cinergy** and **CG&E** primarily reflects higher wholesale volumes.  In addition, there was an increase in theaverage price received per wholesale MWh. Wholesale electric spot prices increased 21 percent in the secondquarter of 2003.  **PSI’s**decrease primarily reflects lowerwholesale sales volumes due to the implementation of the new joint operatingagreement as discussed in the 2002 10-K. With this agreement, the majority of new wholesale contracts enteredinto since April 2002 were originated on behalf of **CG&E**.

 

Other electric operatingrevenues decreased for **Cinergy**and **CG&E**for thequarter ended June 30, 2003, as compared to 2002.  **Cinergy’s**and **CG&E’s**decrease was primarily the result ofdecreased third party coal sales and decreased transmission revenues.

 

#### **Gas OperatingRevenues**

 

|                       |   | **Cinergy (1)**      |     | **CG&E and subsidiaries** |     |
|----------------------------|--------|----------------------|----------|-------------------------------|----------|
|                       |   | **2003**             |     | **2002**                      |     | **% Change** |   | **2003** |   | **2002** |   | **% Change** |   |
|                       |   | ***(in  millions)*** |     |
|                       |   |                 | * * |                          | * * |   | * * |   | * * |   | * * |   | * * |
| Retail                     |   | **$**                | **85**   |                          | $        | 55 |   | 55 |   | **$** | **85** |   | $ | 55 |   | 55 |   |
| Wholesale                  |   | **26**               |     | 17                            |     | 53 |   | **—** |   | — |   | — |   |
| Storage and transportation |   | **4**                |     | 8                             |     | (50 | ) | **—** |   | — |   | — |   |
| Other                      |   | **—**           |     | —                        |     | — |   | **—** |   | 1 |   | N/M |   |
| Total                      |   | **$**                | **115**  |                          | $        | 80 |   | 44 |   | **$** | **85** |   | $ | 56 |   | 52 |   |
|                            |        |                      |          |                               |          |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

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

N/M Not meaningful to an understanding of the change.

 

*Gasoperating revenues* increased for **Cinergy** and **CG&E**for the quarter ended June 30, 2003, as compared to 2002, primarily due to anincrease in price received per thousand cubic feet (mcf) delivered.  The higher prices per mcf delivered reflectsan increase in **CG&E’s** baserates, as approved by the PUCO in May 2002 and an increase in tariffadjustments associated with the gas main replacement program and gas costrecovery mechanism.****  **CG&E’s**wholesale gas commodity cost is passed directly to the retail customerdollar-for-dollar under the gas cost recovery mechanism mandated by statelaw.  For further information see Note6(n) in the “Notes to Financial Statements” in “Part I. Financial Information”.

 

#### **Other Revenues**

* *

*Otherrevenues*for **Cinergy**increased for the quarter ended June 30, 2003, as compared to 2002, primarilydue to the sale of synthetic fuel, which began in July 2002.

 

75

----

 

#### **OperatingExpenses**

 
|                            |   | **Cinergy (1)**     |     | **CG&E and  subsidiaries** |     | **PSI**      |     |
|---------------------------------|--------|---------------------|----------|--------------------------------|----------|--------------|----------|
|                            |   | **2003**            |     | **2002**                       |     | **% Change** |     | **2003** |   | **2002** |   | **% Change** |   | **2003** |   | **2002** |   | **% Change** |   |
|                            |   | ***(in millions)*** |     |
|                            |   |                | * * |                           | * * |         | * * |   | * * |   | * * |   | * * |   | * * |   | * * |   | * * |
| Fuel                            |   | **$**               | **219**  |                           | $        | 205          |     | 7 |   | $ | **88** |   | $ | 96 |   | (8 | ) | $ | **116** |   | $ | 99 |   | 17 |   |
| Purchased and exchanged  power  |   | **22**              |     | 37                             |     | (41          | )        | **18** |   | 13 |   | 38 |   | **6** |   | 30 |   | (80 | ) |
| Gas purchased                   |   | **47**              |     | 24                             |     | 96           |     | **48** |   | 24 |   | 100 |   | **—** |   | — |   | — |   |
| Gas storage and  transportation |   | **6**               |     | 6                              |     | —       |     | **—** |   | — |   | — |   | **—** |   | — |   | — |   |
| Operation and maintenance       |   | **330**             |     | 338                            |     | (2           | )        | **126** |   | 138 |   | (9 | ) | **123** |   | 143 |   | (14 | ) |
| Depreciation                    |   | **105**             |     | 98                             |     | 7            |     | **50** |   | 49 |   | 2 |   | **45** |   | 38 |   | 18 |   |
| Taxes other than income taxes   |   | **67**              |     | 64                             |     | 5            |     | **50** |   | 46 |   | 9 |   | **16** |   | 17 |   | (6 | ) |
| Total                           |   | **$**               | **796**  |                           | $        | 772          |     | 3 |   | $ | **380** |   | $ | 366 |   | 4 |   | $ | **306** |   | $ | 327 |   | (6 | ) |

 

----

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

 

##### ***Fuel***

* *

*Fuel*primarily represents the cost of coal, natural gas, and oil that is used togenerate electricity.  The followingtable details the changes to fuel expense from the quarter ended June 30, 2002,to the quarter ended June 30, 2003:

 

|                                      |   | **Cinergy (1)** |       | **CG&E**         |       | **PSI** |       |
|-------------------------------------------|--------|-----------------|------------|----------------------|------------|---------|------------|
|                                      |   |            |       | ***(in  millions)*** |       |    |       |
|                                      |   |            | * *   |                 | * *   |    | * *   |
| Fuel expense - June 30, 2002              |   | $               | 205        |                 | $          | 96      |       | $ | 99 |   |
|                                      |   |            |       |                 |       |    |       |
| *Increase (decrease) due to changes  in:* |   |            |       |                 |       |    |       |
| Price of fuel                             |   | 7               |       | (1                   | )          | 8       |       |
| Deferred fuel cost                        |   | 11              |       | —               |       | 11      |       |
| Fuel consumption                          |   | (8              | )          | (6                   | )          | (2      | )          |
| Other                                     |   | 4               |       | (1                   | )          | —  |       |
|                                      |   |            | ** ** |                 | ** ** |    | ** ** |
| **Fuel expense – June 30, 2003**     |   | **$**           | **219**    | ** **           | **$**      | **88**  | ** ** | **$** | **116** | ** ** |

 

----

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

 

##### ***Purchased and Exchanged Power***

* *

*Purchasedand exchanged power* expense increased for **CG&E**and****decreased for **Cinergy**and**PSI**for****the quarter ended June 30, 2003, ascompared to 2002.  **CG&E’s** increase was primarily theresult of an increase in price paid per MWh, an increase in purchases for **CG&E** retail customers, and a loweramount of deferred purchased power.  **PSI’s** decrease was primarily attributableto fewer intercompany purchases under the new joint operating agreement.

 

76

----

 

##### ***Gas Purchased***

* *

*Gaspurchased* expense increased for **Cinergy** and **CG&E**for the quarter ended June 30, 2003, as compared to 2002.  This increase was primarily due to anincrease in the average cost per mcf of gas purchased.  Average wholesale gas cost per mcf increased68 percent over the same period last year. **CG&E’s** wholesale commoditycost is passed directly to the retail customer dollar-for-dollar under the gascost recovery mechanism mandated by state law.

 

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

* *

*Operationand maintenance* expense decreased for **Cinergy**, **CG&E**,and**PSI** for the quarter ended June30, 2003, as compared to 2002.  Thisdecrease primarily reflects costs associated with employee severance programsin 2002 (See “Summary of Results”). Also contributing to this decrease were lower transmission costs.  These decreases were largely offset by anincrease in the cost of employee compensation and benefit programs, costsassociated with employee retirement and severance programs recorded in thesecond quarter of 2003, and higher maintenance costs.  Partially offsetting **Cinergy’s**decrease were the costs associated with the production of synthetic fuel, whichbegan in July 2002.

 

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

* *

*Depreciation*expense increased for **Cinergy**,**CG&E**, and **PSI** for the quarter ended June 30, 2003, ascompared to 2002.  This increase wasprimarily attributable to the addition of depreciable plant.  **Cinergy’s**increasealso included the addition of depreciable equipment associated with theproduction of synthetic fuel, which began in July 2002.

 

##### ***Taxes Other Than Income Taxes***

* *

*Taxesother than income taxes*expense increased for **Cinergy** and **CG&E** and decreased for **PSI**for the quarter ended June 30, 2003, as compared to 2002.  **Cinergy’s**and **CG&E’s** increase wasprimarily attributable to an increase in Ohio excise and property taxes.  **PSI’s**decrease was primarily the result of a decrease in property taxes.

 

#### **Miscellaneous- Net**

* *

*Miscellaneous- net* increased for **Cinergy**and **CG&E** for thequarter ended June 30, 2003, as compared to 2002.  **Cinergy’s** increaseprimarily reflects the 2002 write-offs of certain equipment and technologyinvestments.  (See “Summary ofResults”).  **CG&E’s** as well as**Cinergy’s** increase also reflects a gain on the sale of non-utilityproperty.

 

#### **InterestExpense**

* *

*Interest**Expense* increased for **Cinergy**, **CG&E**,and **PSI**for the quarter ended June30, 2003, as compared to 2002.  **Cinergy’s** and **CG&E’s** increase was mainly due to an increase in theamount of long-term debt outstanding.  **Cinergy’s** increase was partially offset bya reduction in the amount of short-term debt outstanding and lower costsassociated with this debt.  In general,long-term fixed interest rates are higher than variable short-term interestrates.  **PSI’s**increase

 

77

----

 

was primarily the resultof the issuance of two subordinated promissory notes to **Cinergy Corp.** to acquire two peaking plantsin the first quarter of 2003 as discussed in “Supply-Side Actions” inMD&A-Future.

 

#### **Income Taxes**

* *

*IncomeTaxes* expense decreased for **Cinergy**and increased for **PSI**for thequarter ended June 30, 2003, as compared to 2002.  **Cinergy’s**decreasewas primarily a result of the tax credits associated with the production andsale of synthetic fuel, which began in July 2002.  Based on its current estimates, **Cinergy**expects that its effective income tax rate for 2003 will approximate 25percent.  **PSI’s**increase was primarily due to the reversal in 2002 oftax reserves, which were determined to be no longer needed, and an increase inthe Indiana state income tax rate in 2003.

 

#### **Equity inEarnings (Losses) of Unconsolidated Subsidiaries**

* *

*Equityin Earnings (Losses) of Unconsolidated Subsidiaries* increasedfor the quarter ended June 30, 2003, as compared to 2002, primarily due tochanges in the market valuation of certain investments accounted for at fairvalue and an increase in net income of certain unconsolidated subsidiaries inthe second quarter of 2003.

 

#### **DiscontinuedOperations**

 

During the second quarterof 2003, **Cinergy**completed thedisposal of its gas distribution operation in South Africa, sold its remainingwind assets in the United States, and substantially sold or liquidated theassets of its energy trading operation in the Czech Republic.  Pursuant to Statement of FinancialAccounting Standards No. 144, *Accounting forthe Impairment of Long-lived Assets* (Statement 144), theseinvestments have been classified as discontinued operations in our financialstatements.  See Note 7 of the “Notes toFinancial Statements” in “Part I. Financial Information” for additionalinformation.

 

78

----

 

### **2003 YEAR TO DATE RESULTS OFOPERATIONS - HISTORICAL**

#### ** **

#### **Summary ofResults**

 

Electric and gas grossmargins and net income for **Cinergy**,**CG&E**, and **PSI** for the six months ended June 30, 2003and 2002 were as follows:

 
|                  |   | **Cinergy (1)**       |          | **CG&E and subsidiaries** |     | **PSI**     |     |
|-----------------------|--------|-----------------------|---------------|-------------------------------|----------|-------------|----------|
|                  |   | **2003**              |          | **2002**                      |     | **2003**    |     | **2002** |   | **2003** |   | **2002** |   |
|                  |   | ***(in  thousands)*** |          |
|                  |   |                  | * *      |                          | * * |        | * * |   | * * |   | * * |   | * * |
| Electric gross margin |   | **$**                 | **1,081,981** |                          | $        | 1,106,356   |     | **$** | **589,198** |   | $ | 590,974 |   | **$** | **484,203** |   | $ | 493,424 |   |
| Gas gross margin      |   | **224,531**           |          | 130,830                       |     | **140,736** |     | 103,178 |   | **—** |   | — |   |
| Net income            |   | **250,738**           |          | 129,812                       |     | **168,155** |     | 130,255 |   | **56,806** |   | 67,797 |   |
|                       |        |                       |               |                               |          |             |          |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

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

 

**Cinergy’s**net income for the six months ended June 30, 2003, was $251 million ($1.42 pershare on a diluted basis) as compared to $130 million ($.78 per share on adiluted basis) for the same period last year. Income before taxes for the period was $284 million compared to $217million for the same period a year ago. The increase in 2003 income primarily reflects higher gas margins fromwholesale and retail operations and $66 million in charges associated withemployee severance programs and the write-offs of certain equipment andtechnology investments that were taken in the second quarter of 2002.  The increased gas margins primarily reflectthe results of our domestic gas trading operation, Cinergy Marketing &Trading, LP (Marketing & Trading), as well as increased volume of retailgas sales due to colder than normal weather during the first quarter of2003.  Also contributing to the gasmargin increase over 2002 was the impact of accounting changes that requiredcertain gas contracts and inventory to be accounted for on the accrual basisbeginning in 2003.  Offsetting theincrease in gas margins was a decrease in electric margins due to milder thannormal weather in the second quarter of 2003. **Cinergy’s**increased netincome also reflects a net gain resulting from the implementation of certainaccounting changes, which have been reflected as a cumulative effect of changesin accounting principles (see Note 1(g)(*vii*)of the “Notes to Financial Statements” in “Part I. Financial Information”), andgains realized in the second quarter of 2003 from the disposal of discontinuedoperations and lower income taxes resulting primarily from tax creditsassociated with the production of synthetic fuel which began in July 2002.

 

79

----

 

#### **ElectricOperating Revenues**

 
|      |   | **Cinergy (1)**      |      | **CG&E and subsidiaries** |     | **PSI**      |     |
|-----------|--------|----------------------|-----------|-------------------------------|----------|--------------|----------|
|      |   | **2003**             |      | **2002**                      |     | **% Change** |     | **2003** |   | **2002** |   | **% Change** |   | **2003** |   | **2002** |   | **% Change** |   |
|      |   | ***(in  millions)*** |      |
|      |   |                 | * *  |                          | * * |         | * * |   | * * |   | * * |   | * * |   | * * |   | * * |   | * * |
| Retail    |   | **$**                | **1,319** |                          | $        | 1,324        |     | — |   | **$** | **653** |   | $ | 681 |   | (4 | ) | **$** | **666** |   | $ | 643 |   | 4 |   |
| Wholesale |   | **223**              |      | 174                           |     | 28           |     | **129** |   | 68 |   | 90 |   | **95** |   | 89 |   | 7 |   |
| Other     |   | **50**               |      | 68                            |     | (26          | )        | **44** |   | 58 |   | (24 | ) | **12** |   | 13 |   | (8 | ) |
| Total     |   | **$**                | **1,592** |                          | $        | 1,566        |     | 2 |   | **$** | **826** |   | $ | 807 |   | 2 |   | **$** | **773** |   | $ | 745 |   | 4 |   |

 

----

(1)  Theresults of **Cinergy** also includeamounts related to non-registrants.

 

*Electric operating revenues*for **Cinergy**, **CG&E**, and **PSI** increased for the six months ended June 30, 2003, ascompared to 2002.

 

Wholesale revenues increased for **Cinergy**and **CG&E** for thesix months ended June 30, 2003, as compared to 2002.  **Cinergy’s**and **CG&E’s**increase was primarily attributable to theincreased wholesale volumes due to the colder than normal weather in the firstquarter of 2003.  Also contributing tothe increase was an increase in the wholesale gross margin realized perMWh.  **CG&E’s** increase also reflects the implementation ofthe new joint operating agreement with **PSI** that became effective April 2002 as discussed in the 2002 10-K.  With this agreement, the majority of newwholesale contracts entered into since April 2002 were originated on behalf of **CG&E**.

 

Retail revenues decreased for **CG&E**as a result of decreased revenue from commercial and industrial customers.  This decrease reflects a sluggish economyand the migration of certain customers to a transportation-only tariff inconnection with the Ohio electric customer choice program.  **PSI’s**retail revenues increased due to an increase in average price realized perMWh.  The increase in average pricerealized was due to the increase in rate adjustment riders associated with thefuel cost recovery mechanism and certain construction programs.  The cost of fuel for **PSI’s** retail customers is passed ondollar-for-dollar under the state mandated fuel cost recovery mechanism.

 

Other electric operating revenues decreased for **Cinergy**and **CG&E** for the six months ended June 30, 2003, as comparedto 2002 primarily reflecting a reduction in third party coal sales and lower transmission revenues.

 

80

----

 

#### **Gas OperatingRevenues**

 
|                       |   | **Cinergy  (1)**     |     | **CG&E  and subsidiaries** |     |
|----------------------------|--------|----------------------|----------|--------------------------------|----------|
|                       |   | **2003**             |     | **2002**                       |     | **%****Change** |   | **2003** |   | **2002** |   | **%****Change** |   |
|                       |   | ***(in  millions)*** |     |
|                       |   |                 | * * |                           | * * |   | * * |   | * * |   | * * |   | * * |
| Retail                     |   | **$**                | **358**  |                           | $        | 233 |   | 54 |   | **$** | **358** |   | $ | 233 |   | 54 |   |
| Wholesale                  |   | **64**               |     | 24                             |     | N/M |   | **—** |   | — |   | — |   |
| Storage and transportation |   | **91**               |     | 12                             |     | N/M |   | **—** |   | — |   | — |   |
| Other                      |   | **1**                |     | 1                              |     | — |   | **3** |   | 3 |   | — |   |
| Total                      |   | **$**                | **514**  |                           | $        | 270 |   | 90 |   | **$** | **361** |   | $ | 236 |   | 53 |   |

 

----

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

N/M  Not meaningful to an understanding of thechange.

 

*Gasoperating revenues* increased for **Cinergy** and **CG&E**for the six months ended June 30, 2003, as compared to 2002.  **Cinergy’s**and**CG&E’s** retail gas revenuesincreased due to an increase in retail sales volumes and higher prices receivedper mcf delivered.  The increase inretail gas sales volumes was primarily the result of the colder than normal weatherin the first quarter of 2003.  Thehigher price per mcf delivered reflects an increase in **CG&E’s** base rates, as approved by thePUCO in May 2002, and tariff adjustments associated with the gas mainreplacement program and gas cost recovery mechanism.  For further information see Note 6(n) in the “Notes to FinancialStatements” in “Part I. Financial Information”.**  CG&E’s** wholesalegas commodity cost is passed directly to the retail customer dollar-for-dollarunder the gas cost recovery mechanism mandated by state law.

 

**Cinergy**began reporting revenues from energy trading derivative contracts on a netbasis in 2003, in accordance with the required adoption of Emerging Issues TaskForce (EITF) Issue 02-3, *Issues Involved inAccounting for Derivatives Contracts Held for Trading Purposes and ContractsInvolved in Energy Trading and Risk Management Activities* (EITF02-3).  See Note 1(g)(*i*) in the “Notes to Financial Statements”in “Part I. Financial Information” for additional information.

 

**Cinergy’s**wholesale gas revenues (which represent net gains and losses on energy tradingderivatives) increased for the six months ended June 30, 2003, as compared to2002, primarily due to an increase in the volatility of natural gas prices inthe first six months of 2003 as compared to the same period in 2002.

 

**Cinergy’s**gas storage and transportation revenues increased for the sixmonths ended June 30, 2003, as compared to 2002.  Marketing & Trading had no significant storage activities inthe first six months of 2002.  Sales ofstorage gas occurred primarily in the first quarter of 2003 resulting inincreased revenues, which must be presented on a gross revenue basis.   Storage activity involves acquiring andstoring gas primarily during off-peak periods, primarily summer, for withdrawaland sale during periods of higher demand, primarily winter.

 

81

----

 

#### **OperatingExpenses**

 
|                           |   | **Cinergy (1)**      |      | **CG&E and subsidiaries** |     | **PSI**      |     |
|--------------------------------|--------|----------------------|-----------|-------------------------------|----------|--------------|----------|
|                           |   | **2003**             |      | **2002**                      |     | **% Change** |     | **2003** |   | **2002** |   | **% Change** |   | **2003** |   | **2002** |   | **% Change** |   |
|                           |   | ***(in  millions)*** |      |
|                           |   |                 | * *  |                          | * * |         | * * |   | * * |   | * * |   | * * |   | * * |   | * * |   | * * |
| Fuel                           |   | **$**                | **459**   |                          | $        | 409          |     | 12 |   | **$** | **193** |   | $ | 189 |   | 2 |   | **$** | **251** |   | $ | 209 |   | 20 |   |
| Purchased and exchanged power  |   | **51**               |      | 51                            |     | —       |     | **44** |   | 27 |   | 63 |   | **38** |   | 43 |   | (12 | ) |
| Gas purchased                  |   | **222**              |      | 131                           |     | 69           |     | **220** |   | 133 |   | 65 |   | **—** |   | — |   | — |   |
| Gas storage and transportation |   | **67**               |      | 8                             |     | N/M          |     | **—** |   | — |   | — |   | **—** |   | — |   | — |   |
| Operation and maintenance      |   | **655**              |      | 599                           |     | 9            |     | **261** |   | 244 |   | 7 |   | **235** |   | 258 |   | (9 | ) |
| Depreciation                   |   | **209**              |      | 194                           |     | 8            |     | **99** |   | 97 |   | 2 |   | **88** |   | 76 |   | 16 |   |
| Taxes other than income taxes  |   | **145**              |      | 137                           |     | 6            |     | **110** |   | 99 |   | 11 |   | **32** |   | 33 |   | (3 | ) |
| Total                          |   | **$**                | **1,808** |                          | $        | 1,529        |     | 18 |   | **$** | **927** |   | $ | 789 |   | 17 |   | **$** | **644** |   | $ | 619 |   | 4 |   |

 

----

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

N/M Not meaningful to an understanding of the change.

 

##### ***Fuel***

* *

*Fuel*primarily represents the cost of coal, natural gas, and oil that is used togenerate electricity.   The followingtable details the changes to fuel expense from the six months ended June 30,2002, to the six months ended June 30, 2003:

 

|                                      |   | **Cinergy (1)**     |       | **CG&E** |       | **PSI** |       |
|-------------------------------------------|--------|---------------------|------------|--------------|------------|---------|------------|
|                                      |   | ***(in millions)*** |       |
|                                      |   |                | * *   |         | * *   |    | * *   |
| Fuel expense - June 30, 2002              |   | $                   | 409        |         | $          | 189     |       | $ | 209 |   |
|                                      |   |                |       |         |       |    |       |
| *Increase (decrease) due to changes  in:* |   |                |       |         |       |    |       |
| Price of fuel                             |   | 12                  |       | (1           | )          | 13      |       |
| Deferred fuel cost                        |   | 24                  |       | —       |       | 24      |       |
| Fuel consumption                          |   | 6                   |       | 1            |       | 5       |       |
| Other                                     |   | 8                   |       | 4            |       | —  |       |
|                                      |   |                | ** ** |         | ** ** |    | ** ** |
| **Fuel expense - June 30,  2003**         |   | **$**               | **459**    | ** **   | **$**      | **193** | ** ** | **$** | **251** | ** ** |

 

----

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

##### ***Purchased and Exchanged Power***

* *

*Purchasedand exchanged power*expense increased for **CG&E** and decreased for **PSI** for the six months ended June 30, 2003,as compared to 2002.   **CG&E’s** increase was due to an increasein the purchase price paid per MWh as a result of the colder than normalweather conditions in the first quarter of 2003, an increase in purchases for **CG&E’s** retail customers, and lessdeferred purchased power.  As previouslydiscussed, **CG&E’s** and **PSI’s***Purchasedand exchanged*

 

82

----

 

*power*expense also reflects the effects of the implementation of the new jointoperating agreement beginning in April 2002 as discussed in the 2002 10-K.

 

##### ***Gas Purchased***

* *

*Gaspurchased* expense increased for **Cinergy** and **CG&E**forthe six months ended June 30, 2003, as compared to 2002, primarily due to anincreased average cost per mcf of gas purchased.  Wholesale gas commodity spot purchases were 102 percent higher onaverage than the six months ended 2002. **CG&E’s** wholesalecommodity cost is passed directly to the retail customer dollar-for-dollarunder the gas cost recovery mechanism mandated by state law.

 

##### ***Gas Storage and Transportation***

 

Gas storage andtransportation expense increased for **Cinergy**for the six months ended June 30, 2003, as compared to 2002 primarily due to anincrease in storage activity in 2003. Marketing & Trading began engaging in significant storage activitiesat the end of the second quarter of 2002. Gas storage expense is recognized on our statements of income as naturalgas is sold from inventory.  Aspreviously discussed, storage activity involves acquiring and storing gasprimarily during off-peak periods for withdrawal and sale during periods ofhigher demand, as occurred in the first quarter of 2003.

 

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

* *

*Operationand maintenance* expense increased for **Cinergy** and **CG&E** and decreased for **PSI**for the six months ended June 30, 2003, as compared to 2002.  **Cinergy’s**increasewas primarily due to the costs associated with the production of syntheticfuel, which began in July 2002.  **Cinergy’s**and **CG&E’s**increase also reflects higher costs of employeecompensation and benefit programs. Partially offsetting this increase for **Cinergy**and **CG&E**and thereduction for **PSI** is therecognition of costs associated with employee severance programs in 2002 andlower transmission costs.

 

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

* *

*Depreciation*expense increased for **Cinergy**, **CG&E**, and **PSI** for the six months ended June 30, 2003, as compared to2002, primarily because of the addition of depreciable plant.  Also contributing to **Cinergy’s** increase was the addition of thedepreciable equipment associated with the production of synthetic fuel, whichbegan in July 2002.

 

##### ***Taxes Other Than Income Taxes***

* *

*Taxesother than income taxes* expense increased for **Cinergy**and **CG&E**and decreased for **PSI**for the six months ended June 30, 2003, as compared to 2002.  The increase for **Cinergy**and **CG&E**was primarily attributable to an increase in Ohio excise taxes.  Also contributing to **CG&E’s** increase was an increase in propertytaxes.  **PSI’s** decrease was primarily the result of lower property taxes.

 

83

----

 

#### **InterestExpense**

* *

*Interest**Expense* increased for **Cinergy**,**CG&E**, and **PSI**forthe six months ended June 30, 2003, as compared to 2002.  **Cinergy’s**and **CG&E’s** increase was mainlydue to an increase in the amount of long-term debt outstanding.  **Cinergy’s**increase was partially offset by a reduction in the amount of short-term debtoutstanding and lower costs associated with this debt.  In general, long-term fixed interest ratesare higher than variable short-term interest rates.  **PSI’s** increase wasprimarily the result of the issuance of two subordinated promissory notes to **Cinergy** to acquire two peaking plants inthe first quarter of 2003 as discussed in “Supply-Side Actions” inMD&A-Future.

 

#### **Income Taxes**

* *

*IncomeTaxes*expense decreased for **Cinergy**and increased for **PSI**for the six months ended June 30, 2003, as compared to 2002.  **Cinergy’s**decrease was primarily a result of the tax credits associated with theproduction and sale of synthetic fuel, which began in July 2002.  Based on its current estimates, **Cinergy** expects that its effective incometax rate for 2003 will approximate 25 percent. **PSI’s**increase wasprimarily due to the reversal in 2002 of tax reserves, which were determined tobe no longer needed, and an increase in the Indiana state income tax rate in2003.

 

#### **Miscellaneous- Net**

* *

*Miscellaneous- Net* increased for **Cinergy**and **CG&E** for the six monthsended June 30, 2003, as compared to 2002. **Cinergy’s** increaseprimarily reflects the 2002 write-offs of certain equipment and technologyinvestments (See “Summary of Results”). **Cinergy’s**and**CG&E’s** increase also reflects a gainon the sale of non-utility property and the recognition of expenses in 2002 forpreviously deferred costs that were denied recovery in the final order of **ULH&P’s** gas rate case.

 

**Cumulative Effect of Changes in Accounting Principles,Net of Tax**

 

In 2003, **Cinergy**,**CG&E**, and **PSI**recognizeda *Cumulative effect of changes in accountingprinciples, net of tax* gain/(loss) of approximately $26 million, $31million, and $(0.5) million, respectively. The cumulative effect of changes in accounting principles was a resultof the adoption of Statement of Financial Accounting Standards No. 143, *Accounting for Asset Retirement Obligations*(Statement 143) and the rescission of EITF Issue 98-10, *Accounting for Contracts Involved in Energy Tradingand Risk Management Activities* (EITF 98-10).  See Note 1(g)(*vii*) of the “Notes to Financial Statements” in “Part I.Financial Information” for further information.

 

In 2002, **Cinergy** recognized a *Cumulative effect of changes in accountingprinciples, net of tax*loss of approximately $11 million as a resultof implementation of Statement of Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets*(Statement 142).  See Note 1(g)(*vii*) of the “Notes to FinancialStatements” in “Part I. Financial Information” for further information.

 

84

----

 

#### **DiscontinuedOperations**

 

During the second quarterof 2003, **Cinergy** completed thedisposal of its gas distribution operation in South Africa, sold its remainingwind assets in the United States, and substantially sold or liquidated theassets of its energy trading operation in the Czech Republic.  Pursuant to Statement 144, these investmentshave been classified as discontinued operations in our financialstatements.  See Note 7 of the “Notes toFinancial Statements” in “Part I. Financial Information” for additional information.

 

85

----

 

**ULH&P**

 

The Results of Operationsdiscussion for **ULH&P** ispresented only for the six months ended June 30, 2003, in accordance withGeneral Instruction H(2)(a) of Form 10-Q.

 

Electric and gasgross margins and net income for **ULH&P**for the six months ended June 30, 2003 and 2002, were as follows:

 

|                  |   | **ULH&P**         |       |
|-----------------------|--------|-----------------------|------------|
|                  |   | **2003**              |       | **2002** |   |
|                  |   | ***(in  thousands)*** |       |
|                  |   |                  | * *   |   | * * |
| Electric gross margin |   | **$**                 | **29,766** |   | $ | 30,329 |   |
| Gas gross margin      |   | **22,817**            |       | 18,020 |   |
| Net income            |   | **8,911**             |       | 5,876 |   |
|                       |        |                       |            |  |  |  |  |

 

#### **ElectricOperating Revenues**

* *

*Electricoperating revenues* increased for the six months ended June30, 2003, as compared to 2002.  Thisincrease was primarily due to higher MWh sales resulting from colder thannormal weather in the first quarter of 2003.

 

#### **ElectricityPurchased from Parent Company for Resale**

* *

*Electricitypurchased from parent company for resale* increased for thesix months ended June 30, 2003, as compared to 2002 due to an increase inconsumption as a result of colder than normal weather in the first quarter of2003.

 

#### **Gas OperatingRevenues**

* *

*Gasoperating revenues* increased for the six months ended June30, 2003, as compared to 2002.  Thisincrease was primarily due to an increase in mcf sold and higher pricesreceived per mcf, as a result of colder than normal weather in the firstquarter of 2003.  New base rates for **ULH&P**, which were effective January 31,2002, and tariff adjustments associated with the gas main replacement programand gas cost recovery mechanism also contributed to this increase.  **ULH&P’s**wholesale gas commodity cost is passed directly to the retail customerdollar-for-dollar under the gas cost recovery mechanism mandated by statelaw.  For further information see Note6(o) in the “Notes to Financial Statements” in “Part I.  Financial Information”.

 

#### **Gas Purchased**

* *

*Gaspurchased* expense increased for the six months ended June 30,2003, as compared to 2002, due to increased purchases and higher prices paidper mcf, primarily the result of colder than normal weather experienced in theMidwest in the first three months of 2003, which drove up the demand and theprice for natural gas.  The wholesalegas commodity cost is passed directly to

 

86

----

 

the retail customerdollar-for-dollar under the gas cost recovery mechanism mandated under statelaw.

 

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

* *

*Operationand maintenance* expense increased for the six months endedJune 30, 2003, as compared to 2002, primarily due to increased amortization ofdemand side management program costs, higher employee benefit costs, andincreased maintenance of overhead lines costs. This increase also reflects costs associated with employee severanceprograms in 2003.

 

#### **Miscellaneous- Net**

* *

*Miscellaneous- Net* increased for the six months ended June 30, 2003, ascompared to 2002, primarily due to the recognition of expenses in 2002 forpreviously deferred costs, that were denied recovery in the final order on **ULH&P’s** gas rate case.

 

#### **Income Taxes**

* *

*IncomeTaxes* expense increased for the six months ended June 30, 2003,as compared to 2002, primarily due to an increase in taxable income and anincrease in the Kentucky state income tax rate.

 

87

----

 

### **FUTURE EXPECTATIONS/TRENDS**

 

In the “FutureExpectations/Trends” section, we discuss electric and gas industrydevelopments, market risk sensitive instruments and positions, and accountingmatters.  Each of these discussions willaddress the current status and potential future impact on our results ofoperations and financial condition.

 

### **ELECTRIC INDUSTRY**

#### ** **

#### **WholesaleMarket Developments**

##### *** ***

##### ***Supply-side Actions***

 

In December 2001, theIndiana Utility Regulatory Commission (IURC) approved **PSI’s** plan for converting its Noblesvillegenerating station from coal to natural gas. The conversion increases the electric generating capacity at the plantfrom approximately 100 megawatts (MW) to 300 MW.  The conversion was completed and the station became operationalin June 2003.  In addition to increasingcapacity, overall emissions to the environment will be reduced.

 

In December 2002, theIURC approved a settlement agreement among **PSI**,the Indiana Office of the Utility Consumer Counselor, and the IURC TestimonialStaff authorizing **PSI’s** purchaseof the Henry County, Indiana and Butler County, Ohio, gas-fired peaking plantsfrom two non-regulated affiliates.  InFebruary 2003, the FERC issued an order under Section 203 of the Federal PowerAct authorizing **PSI’s** acquisitionof the plants, which occurred on February 5, 2003.  Subsequently, in April 2003, the FERC issued a tolling orderallowing additional time to consider a request for rehearing filed in responseto the February 2003 FERC order.  Atthis time, we cannot predict the outcome of this matter.

 

On July 21, 2003, **ULH&P** filed an application with theKentucky Public Service Commission (KPSC) requesting approval of a long-termelectric supply plan to acquire **CG&E’s**ownership interests in the East Bend Generating Station, located in BooneCounty, Kentucky, the Woodsdale Generating Station, located in Butler County,Ohio, and one generating unit at the four-unit Miami Fort Generating Stationlocated in Hamilton County, Ohio.  **ULH&P** also requested KPSC approval of aback-up power supply agreement under which **CG&E**would provide replacement power to **ULH&P**when the transferred generating facilities are out of service, and for approvalof another agreement under which the transferred units would be jointlydispatched with **CG&E’s**remaining fleet of generating units. The transfer, which will be made at net book value, will not affectcurrent electric rates for **ULH&P’s**customers, as power will be provided under the same terms as under the currentwholesale power contract with **CG&E**through at least December 31, 2006.  Aprocedural schedule has not yet been established by the KPSC.  This transfer is also contingent uponreceipt of approval from the FERC and the SEC. **ULH&P** is unable topredict the outcome of this matter.

 

88

----

 

#### **Retail MarketDevelopments**

##### *** ***

##### ***Ohio***

 

As discussed in the 200210-K, **CG&E** is in a marketdevelopment period, beginning the transition to electric deregulation in thestate of Ohio.  The transition period isgoverned by Amended Substitute Senate Bill No. 3 (Electric Restructuring Bill)and a stipulated agreement adopted and approved by the PUCO.  Under **CG&E’s**transition plan, retail customers continue to receive electric distributionservices from **CG&E**, but maypurchase electricity from another supplier. Retail customers that purchase electricity from another supplier receiveshopping credits from **CG&E**.  The shopping credits generally reflect thecosts of electric generation included in **CG&E’s**frozen rates.  However, shopping creditsfor the first 20 percent of electricity usage in each customer class to switchsuppliers are higher than shopping credits for subsequent switchers in order tostimulate the development of the competitive retail electric service market,pursuant to **CG&E’s** stipulatedagreement.

 

**CG&E**recovers its regulatory assets and other transition coststhrough a Regulatory Transition Charge (RTC) paid by all retail customers.  As the RTC is collected from customers, **CG&E** amortizes the deferred balance ofregulatory assets and other transition costs. A portion of the RTC collected from customers is recognized in earningscurrently as a return on the deferred balance of regulatory assets and othertransition costs and as reimbursement for the difference in the shoppingcredits provided to customers and the wholesale revenues from switchedgeneration.  The ability of **CG&E** to recover its regulatory assetsand other transition costs is dependent on several factors, including, but notlimited to, the level of **CG&E’s**electric sales, prices in the wholesale power markets, and the amount of customersswitching to other electric suppliers.

 

On January 10, 2003, **CG&E** filed an application with the PUCOfor approval of a methodology to establish how market-based rates fornon-residential customers will be determined when the market development periodends.  In the filing, **CG&E** seeks to establish a market-basedstandard service offer rate for non-residential customers that do not switchsuppliers and a process for establishing the competitively bid generationservice option required by the Electric Restructuring Bill.  As of June 30, 2003, more than 20 percent ofthe load of **CG&E’s** commercialand industrial customer classes has switched to other electric suppliers.  Under its transition plan, **CG&E** may end the market developmentperiod for those classes of customers once 20 percent switching has beenachieved; however, PUCO approval of the standard service offer rate andcompetitive bidding process is required before the market development periodcan be ended.  **CG&E** is not requesting to end themarket development period for any customers at this time.  **CG&E**is unable to predict the outcome of this proceeding.

 

##### ***Federal Update***

* *

*Energy Bill*

 

The U.S. House ofRepresentatives (House) passed the Energy Policy Act in April of 2003.  The legislation, as it passed the House,includes repeal of the PUHCA, as well as tax incentives for gas and electricdistribution lines, and combined heat and power and renewable energy projects.

 

89

----

 

The U.S. Senate (Senate)Energy and Natural Resources Committee passed its version of comprehensiveenergy legislation in April of 2003.  ****On July 31, 2003 the Senate passedcomprehensive energy legislation by substituting last year’s energy bill as itpassed the Senate for the committee draft.  The legislation, as passed bythe Senate, amongst other things, includes PUHCA repeal and creates arenewable energy portfolio standard for utilities.  The House and Senateversions of the comprehensive energy legislation will be the subject of ConferenceCommittee deliberations during the third quarter of 2003.  At this time,Cinergy is unable to predict whether or not this legislation will pass.****

 

*Clear Skies Legislation*

 

President Bush hasproposed environmental legislation that would replace a series of CAArequirements for coal-fired power plants with a cap and trade program.  The President’s “Clear Skies Initiative”would seek an overall 70 percent reduction in emissions from power plants overa phased-in reduction schedule beginning in 2010 and continuing to 2018.  The Senate Environment and Public WorksCommittee has held several hearings on the “Clear Skies Initiative” proposaland is expected to vote on the legislation in the third quarter of 2003.  The House Subcommittee on Energy and Air Qualityof the House Energy and Commerce Committee has also held hearings on the “ClearSkies Initiative” but timing for consideration of the bill in subcommittee isless certain.  At this time,**Cinergy** cannot predict whether or not“Clear Skies Initiative” legislation will pass.

 

#### **MidwestIndependent Transmission System Operator, Inc. (Midwest ISO)**

##### *** ***

##### ***Historical***

 

As part of the effort tocreate a competitive wholesale power marketplace, the FERC approved theformation of the Midwest ISO during 1998. In that same year, **Cinergy**agreed to join the Midwest ISO in preparation for meeting anticipated changesin the FERC regulations and future deregulation requirements.  The Midwest ISO was established as anon-profit organization to maintain functional control over the combinedtransmission systems of its members.

 

##### ***FERC Orders***

 

In related activity, theFERC issued an order in December 2001, in response to protests of the MidwestISO’s proposed methodology related to the calculation of its administrativeadder fees for the services it provides. **Cinergy** and a number ofother parties filed protests to the proposed methodology, suggesting, amongother things, that the methodology was inconsistent with the transmissionowners’ prior agreement with the Midwest ISO and selectively allowed onlyindependent transmission companies to choose which unbundled administrativeadder services they wished to purchase from the Midwest ISO.  A partial settlement was reached in the FERCproceeding, resolving the issues addressed by **Cinergy’s**protest in a manner favorable to **Cinergy**.  The settlement agreement was approved by theFERC in a February 24, 2003 order with implementation initiated on March 1,2003.  The settlement results inapproximately $25 million of administrative adder credits to be shared amongthe Midwest ISO transmission owners and customers responsible for Schedule 10charges.  **Cinergy’s** share is approximately $3 million.

 

90

----

 

In late 2001 and early2002, the FERC issued its Opinion Nos. 453 and 453-A ordering, among otherthings, that transmission service for bundled retail customers (i.e., customerswho cannot select an alternative energy provider) be provided under the MidwestISO’s open access transmission tariff, and that the Midwest ISO’s charges forits administrative services apply to bundled retail customers.  **Cinergy**and other parties appealed these orders to the U.S. Court of Appeals for theDistrict of Columbia Circuit (the Court), challenging the application of theMidwest ISO’s tariff, and the Midwest ISO’s charges for its administrativeservices to bundled retail customers. At the request of the FERC, the Court remanded the matter back to theFERC for further proceedings.  In itsorder on remand, the FERC upheld its prior determinations in Opinion Nos. 453and 453-A.  **Cinergy** and other Midwest ISO transmission owners requestedrehearing of the FERC’s order on remand. In a July 2, 2003 order, the FERC denied **Cinergy’s** and other Midwest ISO transmission owners’ requestfor rehearing and/or clarification.  **Cinergy** and other Midwest ISO transmissionowners plan to appeal this order to the Court, challenging again theapplication of the Midwest ISO’s tariff, and the Midwest ISO’s charges for itsadministrative services to bundled retail customers.  **Cinergy** is not in aposition to predict the outcome of the appeal.

 

In response to prior FERCorders, on July 25, 2003, the Midwest ISO filed with the FERC proposed changesto its existing transmission tariff to add terms and conditions to implementDay-Ahead and Real-Time Energy Markets and Financial Transmission Rights.  The Midwest ISO’s filing indicated that theMidwest ISO intends to make supplemental filings concerning such proposedtariff revisions by October 15, 2003, and in early 2004.  The Midwest ISO has requested an effectivedate of March 31, 2004 for these proposed changes.  **Cinergy** cannotpredict the effect of the Midwest ISO’s proposals on its results of operations.

 

#### **SignificantRate Developments**

##### *** ***

##### ***PSI Retail Rate Case***

 

In December 2002, **PSI** filed a petition with the IURC seekingapproval of a base retail electric rate increase.  **PSI** filed initialtestimony in this case in March 2003 and initial hearings were held in June2003.  Based on updated testimony filed inJuly 2003, **PSI** proposes anincrease in revenues of approximately $190 million, or an average increase ofapproximately 14 percent over **PSI’s**retail electric rates in effect at the end of 2002.  An IURC decision is expected in the first quarter of 2004.

 

##### ***PSI Purchased Power Tracker (Tracker)***

 

The Tracker was designedto provide for the recovery of costs related to purchases of power necessary tomeet native load requirements to the extent such costs are not recoveredthrough the existing fuel adjustment clause.

 

**PSI**is authorized to seek recovery of 90 percent of its purchased power expensesthrough the Tracker (net of the displaced energy portion recovered through thefuel recovery process and net of the mitigation credit portion), with theremaining 10 percent deferred for subsequent recovery in **PSI’s**general rate case.  In March 2002, **PSI** filed a petition with the IURC seeking approval

 

91

----

 

to extend the Trackerprocess beyond the summer of 2002.  Ahearing was held in January 2003 and in June 2003 the IURC approved theextension for up to an additional two years with the ultimate determinationconcerning **PSI’s** continued use ofthe Tracker process to be made in **PSI’s**pending retail electric rate case.

 

In June 2002, **PSI** also filed a petition with the IURCseeking approval of the recovery through the Tracker of its actual summer 2002purchased power costs.  In May 2003, theIURC approved **PSI’s** recovery of$18 million related to its summer 2002 purchased power costs, and alsoauthorized $2 million of deferred costs sought for recovery in **PSI’s** general rate case.

 

##### ***PSI Fuel Adjustment Charge***

 

In June 2001, **PSI** filed a petition with the IURCrequesting authority to recover $16 million in under billed deferred fuel costsincurred from March 2001 through May 2001. The IURC approved recovery of these costs subject to refund pending thefindings of an investigative sub-docket. The sub-docket was opened to investigate the reasonableness of, andunderlying reasons for, the under billed deferred fuel costs.  A hearing was held in July 2002, and inMarch 2003 the IURC issued an order giving final approval to **PSI’s** recovery of the $16 million.

 

##### ***PSI Construction Work in Progress (CWIP)Ratemaking Treatment for NOX Equipment***

 

In April 2003, **PSI** filed an application with the IURCrequesting that its CWIP rate adjustment mechanism be updated for expendituresthrough December 2002 related to NOX equipment currently beinginstalled at certain **PSI**generation facilities.  CWIP ratemakingtreatment allows for the recovery of carrying costs on certain pollutioncontrol equipment while and after the equipment is under construction.  Testimony and exhibits supporting **PSI’s** second CWIP rate adjustment mechanismupdate were filed in July 2003.  Amountsproposed for potential recovery are presented below:

 

**PSICWIP Ratemaking for NOX Equipment**

 

|                                                       |   | **PSI**              |   |
|------------------------------------------------------------|--------|----------------------|--------|
|                                                       |   | ***(in  millions)*** |   |
|                                                       |   |                 |   |
| Total retail CWIP  expenditures as of December 31, 2002    |   | $                    | 305    |   |
|                                                       |   |                 |   |
| Proposed total amount  requested through CWIP mechanism(1) |   | 35                   |   |
| Less: previously approved  CWIP mechanism amounts          |   | (28                  | )      |
| Proposed incremental CWIP  mechanism amounts               |   | $                    | 7      |   |

 

----

(1)  Amountsinclude retail customers’ portion only and represent an annual return onqualified NOX equipment expenditures.

 

**PSI’s**initial CWIP rate mechanism adjustment (authorized in July 2002) resulted in anapproximately one percent increase in customer rates.  Under the IURC’s CWIP rules, **PSI**may update its CWIP tracker at six-month intervals.  The first such update to **PSI’s** CWIP rate mechanism occurred in thefirst quarter of 2003.  The IURC’s July2002 order also authorized **PSI** todefer, for subsequent recovery, post-in-service depreciation and to continuethe accrual

 

92

----

 

for allowance for fundsused during construction (AFUDC). Pursuant to Statement of Financial Accounting Standards No. 92, *Regulated Enterprises-Accounting for Phase-in Plans*,the equity component of AFUDC will not be deferred for financial reportingafter the related assets are placed in service.

 

##### ***Environmental Compliance Cost Recovery***

 

In 2002, the IndianaGeneral Assembly passed legislation that, among other things, encourages thedeployment of advanced technologies that reduce regulated air emissions, whileallowing the continued use of high sulfur Midwestern coal in existing electricgenerating plants.  The legislationauthorizes the IURC to provide financial incentives to utilities that deploysuch advanced technologies.  **PSI** is currently seeking IURC approvalunder this new law of a cost tracking mechanism for **PSI’s** NOX equipment-related depreciation andoperation and maintenance costs, authority to use accelerated (18-year)depreciation for its NOX compliance equipment, and approval of a NOXemission allowance purchase and sales tracker. A hearing before the IURC is scheduled for October 2003.

 

### **GAS INDUSTRY**

#### ** **

#### **ULH&P GasRate Case**

 

Asdiscussed in the 2002 10-K, in the second quarter of 2001, **ULH&P** filed a retail gas rate case with the KPSCseeking to increase base rates for natural gas distribution services andrequesting recovery through a tracking mechanism of the costs of an acceleratedgas main replacement program with an estimated capital cost of $112 millionover 10 years.  **ULH&P** made its second annual filing for anincrease under the tracking mechanism in March 2003.  The application seeks an increase of $2 million.  A hearing was held in July 2003 andthe KPSC is expected to rule on the application during the third quarter of2003. At the present time, **ULH&P** cannot predict the outcome of this proceeding.  The Kentucky Attorney General has appealed the KPSC’s approval ofthe tracking mechanism to the Franklin Circuit Court and has also appealed theKPSC’s August 2002 order approving the new tracking mechanism rates.  At the present time, **ULH&P** cannot predict the timing or outcome of thislitigation.

 

#### **CG&E Gas Rate Case**

 

In the third quarter of2001, **CG&E** filed a retail gasrate case with the PUCO seeking to increase base rates for natural gas distributionservice and requesting recovery through a tracking mechanism of the costs of anaccelerated gas main replacement program with an estimated capital cost of $716million over 10 years.  **CG&E** entered into a settlementagreement with most of the parties and a hearing on this matter was held inApril 2002.  An order was issued in May2002, in which the PUCO approved the settlement agreement and authorized a baserate increase of approximately $15 million, or 3.3 percent overall, effectiveMay 30, 2002.  In addition, the PUCOauthorized **CG&E** to implementthe tracking mechanism to recover the costs of the accelerated gas mainreplacement program, subject to certain rate caps that increase in amountannually through May 2007, through the effective date of new rates in **CG&E’s** next retail gas rate case.  In the fourth quarter of 2002, **CG&E**filed an application to increaseits rates under the tracking mechanism. In April 2003, **CG&E**entered into a settlement agreement with

 

93

----

 

the parties, providingfor an increase of $6.5 million, which the PUCO subsequently approved.  This increase was effective in May 2003.

 

#### **GasDistribution Plant**

 

In June 2003, the PUCOapproved an amended settlement agreement between **CG&E** and PUCO Staff in a gas distribution safety casearising out of a gas leak at a service head-adapter (SHA) style riser on **CG&E’s** distribution system.  The amended settlement agreement calls for **CG&E** to replace a specified minimumnumber of SHA risers by December 31, 2003, and to file a comprehensive planaddressing all SHA risers on its distribution system.  **Cinergy** has anestimated 198,000 SHA risers on its distribution system, of which 155,000 arein **CG&E’s** service area.  Further investigation as to whether anyadditional SHA risers will need maintenance or replacement is ongoing.  If **Cinergy**determines that replacement of all SHA risers is appropriate, the replacementcost could be up to approximately $50 million and **Cinergy** would pursue recovery of this cost through rates.  At this time, **Cinergy** and **CG&E**cannot predict the outcome of this matter.

 

#### **Gas Prices**

 

Natural gas prices began to escalate dramaticallyduring the fourth quarter of 2002 and peaked midway through the first quarterof 2003.  This significant increase ingas costs prompted **CG&E** and **ULH&P** to make additional interimfilings with the PUCO and KPSC, respectively, to increase their gas costadjustment rates for the remaining two months of the quarter which began inMarch 2003.  These interim filings weresubsequently approved by the PUCO and KPSC. In July 2003, **CG&E**filed an application with the PUCO for approval to begin adjusting its gas costadjustment rates on a monthly basis commencing in September 2003.  This application is currently pending.  **ULH&P**expects to file a similar application with the KPSC for monthly gas costadjustment rates beginning in December 2003. Gas prices are expected to remain above normal for the remainder of2003.** **Currently, neither **CG&E**nor **ULH&P** profit from changesin the cost of gas.  Natural gaspurchase costs are passed directly to the customer dollar-for-dollar under thegas cost recovery mechanism that is mandated under state law.

 

In May 2003, **ULH&P**filed an application with the KPSC requesting approval of a gasprocurement-hedging program designed to mitigate the effects of gas pricevolatility on customers.  In June 2003,the KPSC approved the hedging program through March 31, 2005.  The program will allow the pre-arranging ofbetween 20-65 percent of winter heating season base load gas requirements andbetween 0-50 percent of summer season base load gas requirements.

 

**ULH&P**uses primarily fixed price forward contracts and contractswith a ceiling and floor on the price. These contracts employ the normal purchases and sales exemption, and donot involve hedges under Statement of Financial Accounting Standards No. 133, *Accounting for Derivative Instruments and HedgingActivity* (Statement 133).

 

94

----

 

### **MARKET RISK SENSITIVE INSTRUMENTS AND POSITIONS**

 

The transactionsassociated with the Energy Merchant Business Unit (Energy Merchant) energymarketing and trading activities give rise to various risks, including pricerisk.  Price risk represents thepotential risk of loss from adverse changes in the market price of electricityor other energy commodities.  As EnergyMerchant continues to develop its energy marketing and trading business (anddue to its substantial investment in generation assets), its exposure to movementsin the price of electricity and other energy commodities may becomegreater.  As a result, we may be subjectto increased future earnings volatility.

 

*Changes in Fair Value*

 

The changes infair value of the energy risk management assets and liabilities, for theperiods ended June 30, 2003 and 2002, are presented in the table below:

 
|                                                                                       |   | **Change  in Fair Value  Year to Date** |       |
|--------------------------------------------------------------------------------------------|--------|-----------------------------------------|------------|
|                                                                                       |   | **June 30, 2003**                       |       | **June 30, 2002** |   |
|                                                                                       |   | **Cinergy(1)**                          |       | **CG&E** |   | **PSI** |   | **Cinergy(1)** |   | **CG&E** |   | **PSI** |   |
|                                                                                       |   | ***(in  millions)***                    |       |
|                                                                                       |   |                                    | * *   |   | * * |   | *** *** |   | * * |   | * * |   | * * |
| Fair value of contracts outstanding at beginning of  year                                  |   | **$**                                   | **75**     | ** ** | **$** | **42** | ** ** | **$** | **—** | ** ** | $ | 18 |   | $ | 28 |   | $ | (7 | ) |
|                                                                                       |   |                                    | ** ** |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Inception value of new contracts when entered (2)                                          |   | **—**                              | ** ** | **—** | ** ** | **—** | ** ** | 5 |   | 4 |   | 1 |   |
|                                                                                       |   |                                    | ** ** |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Changes in fair value attributable to changes in valuation  techniques and assumptions (3) |   | **1**                                   | ** ** | **1** | ** ** | **—** | ** ** | — |   | — |   | — |   |
|                                                                                       |   |                                    | ** ** |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Other changes in fair value (4)                                                            |   | **82**                                  | ** ** | **19** | ** ** | **2** | ** ** | 35 |   | 13 |   | 1 |   |
|                                                                                       |   |                                    | ** ** |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Option premiums paid/(received)                                                            |   | **(11**                                 | **)**      | **(2** | **)** | **—** | ** ** | 24 |   | — |   | — |   |
|                                                                                       |   |                                    | ** ** |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Cumulative effect of  changes in accounting principle (5)                             |   | **(20**                                 | **)**      | **(13** | **)** | **(1** | **)** | — |   | — |   | — |   |
|                                                                                       |   |                                    | ** ** |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Contract reclassification (6)                                                              |   | **—**                              | ** ** | **—** | ** ** | **—** | ** ** | 14 |   | 7 |   | 16 |   |
|                                                                                       |   |                                    | ** ** |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Contracts settled                                                                          |   | **(117**                                | **)**      | **(49** | **)** | **(5** | **)** | (10 | ) | (11 | ) | (2 | ) |
|                                                                                       |   |                                    | ** ** |   | ** ** |   | ** ** |   |   |   |   |   |   |
| Fair value of contracts outstanding at end of period                                       |   | **$**                                   | **10**     | ** ** | **$** | **(2** | **)** | **$** | **(4** | **)** | $ | 86 |   | $ | 41 |   | $ | 9 |   |

 

----

| (1) |   | The  results of **Cinergy** also include  amounts related to non-registrants.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Represents  fair value, recognized in income, attributable to long-term, structured  contracts, primarily in power, which is recorded on the date a deal is  signed.  These contracts are primarily  with end-use customers or municipalities that seek to limit their risk to  power price volatility.  While caps  and floors often exist in such contracts, the amount of power supplied can  vary from hour to hour to mirror the customers load volatility.  See Note 1(g)(*i*) in the “Notes to Financial Statements” in “Part I.  Financial Information” for additional information regarding inception gains. |
| (3) |   | Represents  changes in fair value recognized in income, caused by changes in assumptions  used in calculating fair value or changes in modeling techniques.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (4) |   | Represents  changes in fair value, recognized in income, primarily attributable to fluctuations  in price.  This amount includes both  realized and unrealized gains on energy trading contracts.                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (5) |   | See  Note 1(g)(*i*) of the “Notes to  Financial Statements” in “Part I. Financial Information” for further  information.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (6) |   | Represents  reclassifications of the settlement value of contracts that have been  terminated as a result of counterparty non-performance to non-current other  liabilities.  These contracts no  longer have price risk and are therefore not considered energy trading  contracts.                                                                                                                                                                                                                                                                                                                                                                |

 

95

----

 

The following table presents the expected maturity of the energy riskmanagement assets and liabilities, as of June 30, 2003:

 
|                                               |   | **Fair Value of  Contracts as of June 30, 2003** |     |
|----------------------------------------------------|--------|--------------------------------------------------|----------|
|                                               |   | **Maturing**                                     |     |   |   |
| **Source of Fair Value(1)**                        |   | **Within  12 months**                            |     | **12-36  months** |   | **36-60  months** |   | **Thereafter** |   | **Total  Fair Value** |   |
|                                               |   | **(in  millions)**                               |     |
|                                               |   |                                             | * * |   | * * |   | * * |   | * * |   | * * |
| **Cinergy(2)**                                     |   |                                             |     |   |   |   |   |   |   |   |   |
| Prices actively quoted                             |   | $                                                | 19       |   | $ | (14 | ) | $ | — |   | $ | — |   | $ | 5 |   |
|                                               |   |                                             |     |   |   |   |   |   |   |   |   |
| Prices based on models and other valuation methods |   | (3                                               | )        | 13 |   | 3 |   | (8 | ) | 5 |   |
|                                               |   |                                             |     |   |   |   |   |   |   |   |   |
| Total                                              |   | $                                                | 16       |   | $ | (1 | ) | $ | 3 |   | $ | (8 | ) | $ | 10 |   |
|                                               |   |                                             |     |   |   |   |   |   |   |   |   |
| **CG&E**                                       |   |                                             |     |   |   |   |   |   |   |   |   |
| Prices actively quoted                             |   | $                                                | (7       | ) | $ | (6 | ) | $ | — |   | $ | — |   | $ | (13 | ) |
|                                               |   |                                             |     |   |   |   |   |   |   |   |   |
| Prices based on models and other valuation methods |   | (4                                               | )        | 12 |   | 3 |   | — |   | 11 |   |
|                                               |   |                                             |     |   |   |   |   |   |   |   |   |
| Total                                              |   | $                                                | (11      | ) | $ | 6 |   | $ | 3 |   | $ | — |   | $ | (2 | ) |
|                                               |   |                                             |     |   |   |   |   |   |   |   |   |
| **PSI**                                            |   |                                             |     |   |   |   |   |   |   |   |   |
| Prices actively quoted                             |   | $                                                | (2       | ) | $ | (10 | ) | $ | — |   | $ | — |   | $ | (12 | ) |
|                                               |   |                                             |     |   |   |   |   |   |   |   |   |
| Prices based on models and other valuation methods |   | 3                                                |     | 3 |   | 2 |   | — |   | 8 |   |
|                                               |   |                                             |     |   |   |   |   |   |   |   |   |
| Total                                              |   | $                                                | 1        |   | $ | (7 | ) | $ | 2 |   | $ | — |   | $ | (4 | ) |

 

----

(1)               Active quotes areconsidered to be available for two years for standard electricity transactionsand three years for standard gas transactions. Non-standard transactions are classified based on the extent, if any, ofmodeling used in determining fair value. Long-term transactions can have portions in both categories depending onthe tenor.

(2)               The results of **Cinergy** also include amounts related tonon-registrants.

 

*Energy Trading Credit Risk*

** **

**Cinergy’s**extension of credit for energy marketing and trading is governed by a CorporateCredit Policy.  Written guidelinesdocument the management approval levels for credit limits, evaluation ofcreditworthiness, and credit risk mitigation procedures.  Exposures to credit risks are measured andmonitored daily by our Corporate Credit Risk function, which is independent ofall trading operations.  As of June 30,2003, approximately 98 percent of the credit exposure related to energy tradingand marketing activity was with counterparties rated Investment Grade or thecounterparties’ obligations were guaranteed or secured by a parent company orother Investment Grade entity.  No singlenon-investment grade counterparty accounts for more than one percent of ourtotal credit exposure.  Energy commodityprices can be extremely volatile and the market can, at times, lackliquidity.  Because of these issues,credit risk for energy commodities is generally greater than with othercommodity trading.

 

96

----

 

We continually review and monitor our credit exposureto all counterparties and secondary counterparties.  If appropriate, we may adjust our credit reserves to attempt tocompensate for increased credit risk within the industry.  Counterparty credit limits may be adjustedon a daily basis in response to changes in a counterparty’s creditworthiness,financial status, or public debt ratings.

 

### **ACCOUNTING MATTERS**

#### ** **

#### **CriticalAccounting Policies**

 

Preparation of financialstatements and related disclosures in compliance with generally acceptedaccounting principles (GAAP) requires the use of assumptions andestimates.  In certain instances, theapplication of GAAP requires judgments regarding future events, including thelikelihood of success of particular initiatives, legal and regulatorychallenges, and anticipated recovery of costs. Therefore, the possibility exists for materially different reportedamounts under different conditions or assumptions.

 

**Cinergy’s**2002 10-K includes a discussion of accounting policies that are significant tothe presentation of **Cinergy’s**financial position and results of operations. These include:

 

•                  FairValue Accounting for Energy Marketing and Trading;

•                  RetailCustomer Revenue Recognition;

•                  RegulatoryAccounting;

•                  Pensionand Other Postretirement Benefits; and

•                  Impairmentof Long-lived Assets.

 

#### **AccountingChanges**

 

##### ***Energy Trading***

 

In October 2002, the EITFreached consensus in EITF 02-3, to (a) rescind EITF 98-10, (b) generallypreclude the recognition of gains at the inception of derivatives, and (c)require all realized and unrealized gains and losses on energy tradingderivatives to be presented net in the Statements of Income, whether or notsettled physically.  The consensus torescind EITF 98-10 required most energy trading contracts that do not qualifyas derivatives to be accounted for on an accrual basis, rather than at fairvalue.  The consensus was immediatelyeffective for all new contracts executed after October 25, 2002, and required acumulative effect adjustment to income, net of tax, on January 1, 2003, for allcontracts executed on or prior to October 25, 2002.  The cumulative effect adjustment, on a net of tax basis, was aloss of $13 million for **Cinergy**and $8 million for **CG&E**, whichincludes primarily the impact of certain coal contracts, gas inventory, andcertain gas contracts, which were all accounted for at fair value.  We expect this rescission to have thelargest ongoing impact on our gas trading business, which uses financialcontracts, physical contracts, and gas inventory to take advantage of variousarbitrage opportunities.  Prior to therescission of EITF 98-10, all of these activities were accounted for at fairvalue.  Under the revised guidance, onlycertain items are accounted for at fair value, which could increaseinter-period volatility in reported results of operations.  As a result, we began applying fair valuehedge accounting in June 2003 to certain quantities of gas inventory (morefully discussed in Note 1(c) of the “Notes to Financial

 

97

----

 

Statements” in “PartI.  Financial Information”) and arefurther reviewing additional applications for hedge accounting.

 

##### ***Intangible Assets***

 

In June 2001, the FASBissued Statement 142.  With the adoptionof Statement 142, goodwill and other intangibles with indefinite lives are nolonger subject to amortization.  Statement142 requires that goodwill be assessed for impairment upon adoption (transitionimpairment test) and at least annually thereafter by applying afair-value-based test, as opposed to the undiscounted cash flow test appliedunder prior accounting standards.

 

We began applyingStatement 142 in the first quarter of 2002. The discontinuance of amortization of goodwill, which began in the firstquarter of 2002, was not material to our financial position or results ofoperations.  We finalized our transitionimpairment test in the fourth quarter of 2002 and recognized a non-cashimpairment charge of approximately $11 million (net of tax) for goodwillrelated to certain of our international assets.  This amount is reflected in **Cinergy’s**Statements of Income as a cumulative effect adjustment, net oftax.  While Statement 142 did notrequire the initial transition impairment test to be completed until December31, 2002, it required the cumulative effect adjustment to be reflected as ofJanuary 1, 2002.

 

##### ***Asset Retirement Obligations***

 

In July 2001, the FASBissued Statement 143, which requires fair value recognition beginning January1, 2003, of legal obligations associated with the retirement or removal oflong-lived assets, at the time the obligations are incurred.  Our accounting policy for such legalobligations is described in Note 1(e) of the “Notes to Financial Statements” in“Part I.  Financial Information”.

 

##### ***Derivatives***

 

In May 2003, the FASBissued Statement of Financial Accounting Standards No. 149, *Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities* (Statement 149).  Statement 149 primarily amends Statement 133 to incorporateimplementation conclusions previously cleared by the FASB staff, to clarify thedefinition of a derivative and to require derivative instruments that includeup-front cash payments to be classified as a financing activity in thestatement of cash flows.  Implementationissues that have been previously cleared by the FASB staff will continue to beapplied in accordance with their respective effective dates at the time thatthey were cleared and new guidance has varying implementation provisions, noneof which will apply until the third quarter of 2003.  We are continuing to evaluate the impacts of adopting Statement149 but currently do not believe the impacts will be material to our results ofoperations or financial position.

 

In June 2003, the FASB issued final guidance on theuse of broad market indices (e.g., consumer price index) in power purchase andsales contracts.  This guidanceclarifies when the normal purchases and sales scope exception is precluded if acontract contains a broad market index.

 

98

----

 

This guidance, which is effective in the fourthquarter of 2003, is not expected to have a material impact on our financialposition or results of operations upon adoption.

 

##### ***Consolidation of SPEs***

 

The FASB issuedInterpretation 46 in January 2003.  Thisinterpretation significantly changes the consolidation requirements for SPEsand certain other entities subject to its scope.  We have determined that certain entities will be required to beconsolidated effective July 1, 2003, in accordance with thisinterpretation.  These entities consistof (a) two SPEs that are engaged in selling power and (b) certain jointventures engaged in providing various energy services.  The two SPEs have individual power saleagreements to an unrelated third party for approximately 45 MW of capacity,ending in 2009, and 35 MW of capacity, ending in 2016.  In addition, these SPEs have individualpower purchase agreements with Cinergy Capital & Trading, Inc. (Capital& Trading) to supply the power. Capital & Trading also provides various services, including certaincredit support facilities.  Upon theinitial consolidation of these two SPE’s, approximately $225 million ofnon-recourse debt and a comparable amount of assets will be included on **Cinergy’s** Balance Sheet.  However, the impact of consolidating thesetwo SPEs on **Cinergy’s** results ofoperations will be immaterial.  Theimpact of consolidating the joint ventures will be immaterial to our results ofoperations and financial position.

 

**Cinergy’s**quantifiable exposure to loss as a result of involvement with these two SPEs is$28 million, which includes investments in these entities of $3 million andexposure under the capped credit facilities of approximately $25 million.  There is also a non-capped facility, but itcan only be called upon in the event the SPE breaches representations, violatescovenants, or other unlikely events.

 

**Cinergy**has concluded that its accounts receivable sale facility, as discussed in the2002 10-K, will remain unconsolidated since it involves transfers of financialassets to a qualifying SPE, which is exempted from consolidation by Statementof Financial Accounting Standards No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities* and this interpretation.

 

##### ***Financial Instruments with Characteristics ofboth Liabilities and Equity***

 

In May 2003, the FASBissued Statement 150.  Statement 150establishes standards for how an issuer classifies and measures certainfinancial instruments with characteristics of both liabilities and equity.  This statement was effective for financialinstruments entered into or modified after May 31, 2003, and was effective onJuly 1, 2003, for financial instruments held prior to issuance of thisstatement.

 

In 2001, **Cinergy Corp.** issued approximately $316million notional amount of combined securities consisting of (a) 6.9 percentpreferred trust securities, due February 2007, and (b) stock purchase contractsobligating the holders to purchase between 9.2 and 10.8 million shares of **Cinergy Corp.** common stock in, and/orbefore, February 2005.  These securitiesare more fully described in the 2002 10-K. Statement 150 will require the preferred trust securities discussed inthe 2002 10-K (currently recorded as *Companyobligated, mandatorily redeemable, preferred trust securities of subsidiary,holding solely debt securities of the company* with a carrying valueof $309 million) to be classified as long-term debt, effective July 1,2003.  Dividends paid on the preferredtrust securities will be recorded as *InterestExpense* after July 1, 2003. Prior period financial statements are not permitted to be restated foreither of these changes.

 

99

----

 

**Other Matters**

##### *** ***

##### ***Employee Severance Programs***

 

During the second quarterof 2003, **Cinergy** offered aVoluntary Early Retirement Program and other severance benefits (Severance Programs)to certain non-union employees.  As aresult of the non-union employees electing the Severance Programs, **Cinergy** recorded expenses of approximately$9 million during the quarter.

 

**Cinergy**estimates it will record $4 million in the third quarter of 2003 as a result ofunion employees electing Severance Programs that ended in July 2003 under aseparate program than mentioned above.

 

##### ***Synthetic Fuel Production***

 

In July 2002, Capital& Trading acquired an “Earthco” coal-based synthetic fuel production facility.   The facility uses emulsified asphalt as achemical change agent to convert coal feedstock into synthetic fuel for sale toa third party.  As of June 30, 2003,Capital & Trading’s net book value in this facility was approximately $60million.  The synthetic fuel produced atthis facility qualifies for tax credits in accordance with Section 29 of theInternal Revenue Code.  Eligibility forthese credits expires in 2007.  **Cinergy** received a private letter rulingfrom the Internal Revenue Service (IRS) in connection with the acquisition ofthe facility.  To date, **Cinergy** has produced and sold approximatelythree million tons of synthetic fuel at this facility, resulting inapproximately $80 million in tax credits, including approximately $40 millionin 2003.

 

The IRS recentlyannounced, in connection with an audit of another taxpayer, that it has reasonto question and is reviewing the scientific validity of that taxpayer’s testprocedures and results that were presented as evidence that the fuel underwenta significant chemical change.  The IRShas indicated that if it were to determine that the test procedures and resultsdo not demonstrate the occurrence of significant chemical change, it would takeappropriate action, including revoking private letter rulings relying on suchresults.

 

**Cinergy** believesthat it is justified in its reliance on the private letter ruling it obtainedfrom the IRS, the chemical change testing by an independent laboratory, andthat its facility has been operated in a manner consistent with Section 29 ofthe Internal Revenue Code.  It is notpossible for **Cinergy** to predictthe outcome of the IRS’s review of these matters or the implications this mighthave for its synthetic fuel production facility.

 

##### ***Energy Market Investigations***

 

In July 2003, **Cinergy** received a subpoena from theCommodity Futures Trading Commission (CFTC). As has been previously reported by the press, the CFTC has servedsubpoenas on numerous other energy companies. The CFTC request seeks certain information regarding our tradingactivities, including price reporting to energy industry publications.  The CFTC seeks particular informationconcerning these matters for the period May 2000 through January 2001 as to oneof **Cinergy’s** employees.  Based on a limited review of these matters,we have placed that employee on administrative leave.  **Cinergy** iscontinuing its review and intends to fully cooperate with the CFTC inconnection with its investigation.

 

In the second quarter of2003, **Cinergy** received initial andfollow-up subpoenas from the SEC requesting information related to particulartrading activity with one of its counterparties.  **Cinergy** has, andintends to, fully cooperate with the SEC in connection with this matter.

 

100

----

 

At this time it is notpossible to predict the outcome of these investigations or the impact on **Cinergy’s** financial position or results ofoperations.

 

101

----

 

## **ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

This information isprovided in, and incorporated by reference from, the “Market Risk SensitiveInstruments and Positions” section in “Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations” in “Part I. Financial Information”.

 

102

----

 

## **ITEM 4.  CONTROLS AND PROCEDURES**

 

Disclosure controls and procedures are our controlsand other procedures that are designed to provide reasonable assurance thatinformation required to be disclosed by us in the reports that we file orsubmit under the Securities Exchange Act of 1934 (Exchange Act) is recorded,processed, summarized, and reported, within the time periods specified in theSecurities and Exchange Commission’s (SEC) rules and forms.  Disclosure controls and procedures include,without limitation, controls and procedures designed to provide reasonableassurance that information required to be disclosed by us in the reports thatwe file under the Exchange Act is accumulated and communicated to ourmanagement, including our chief executive officer and chief financial officer,as appropriate to allow timely decisions regarding required disclosure.

 

Under the supervision and with the participation ofour management, including our chief executive officer and chief financialofficer, we have evaluated the effectiveness of our disclosure controls andprocedures as of June 30, 2003, and, based upon this evaluation, our chiefexecutive officer and chief financial officer have concluded that thesecontrols and procedures are effective in providing reasonable assurance thatinformation requiring disclosure is communicated to management in a timelymanner and reported within the timeframe specified by the SEC’s rules andforms.

 

Under the supervision andwith the participation of our management, including our chief executive officerand chief financial officer, we have evaluated any change in our internalcontrol over financial reporting (as such term is defined in Rules 13a-15(f)and 15d-15(f) under the Exchange Act) during the fiscal quarter ended June 30,2003 and found no change that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

103

----

 

## **PART II.  OTHER INFORMATION**

## ** **

## **ITEM 1.  LEGAL PROCEEDINGS**

 

We currently, and fromtime to time, are involved in lawsuits, claims, and complaints incidental tothe conduct of our business.  In theopinion of management, no such proceeding is likely to have a material adverseeffect on us.

 

See Note 6 of the “Notesto Financial Statements” in “Part I. Financial Information” for further information regarding our commitmentsand contingencies.

 

104

----

 

## **ITEM 6.  EXHIBITS AND REPORTS ONFORM 8-K**

 

(a)              The documents listedbelow are being filed on behalf of **CinergyCorp.**, The Cincinnati Gas & Electric Company (**CG&E**), PSI Energy, Inc. (**PSI**), and The Union Light, Heat and PowerCompany (**ULH&P**) and areincorporated herein by reference from the documents indicated and made a parthereof.  Exhibits not identified aspreviously filed are filed herewith:

 
| **Exhibit  Designation**   |   | **Registrant**                              |   | **Nature of Exhibit**                                                                                                                     |       | **Previously Filed  as Exhibit to:** |       |
|----------------------------|--------|---------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
|                       |   |                                        |   |                                                                                                                                      |       |                                 |       |
| **Additional****Exhibits** |   |                                        |   |                                                                                                                                      |       |                                 |       |
|                       |   |                                        |   |                                                                                                                                      |       |                                 |       |
| 3.1                        |   | **Cinergy Corp.**                           |   | By-laws of **Cinergy  Corp.**, as amended on July 23, 2003.                                                                     |       |                                 |       |
|                       |   |                                        |   |                                                                                                                                      |       |                                 |       |
| 3.2                        |   | **CG&E**                                |   | Regulations of **CG&E**  as amended, July 23, 2003.                                                                                   |       |                                 |       |
|                       |   |                                        |   |                                                                                                                                      |       |                                 |       |
| 3.3                        |   | **PSI**                                     |   | By-laws of **PSI**,  as amended on July 23, 2003.                                                                                         |       |                                 |       |
|                       |   |                                        |   |                                                                                                                                      |       |                                 |       |
| 3.4                        |   | **ULH&P**                               |   | By-laws of **ULH&P**,  as amended on July 23, 2003.                                                                                   |       |                                 |       |
|                       |   |                                        |   |                                                                                                                                      |       |                                 |       |
| 4.1                        |   | **CG&E**                                |   | Seventh Supplemental Indenture between **CG&E**and Fifth Third Bank dated as of  June 15, 2003 to Indenture dated as of May 15, 1995. |       |                                 |       |
|                       |   |                                        |   |                                                                                                                                      |       |                                 |       |
| 31.1                       |   | **Cinergy Corp.  CG&E  PSI  ULH&P** |   | Certification of James E. Rogers under Section 302  of Sarbanes-Oxley Act.                                                                |       |                                 |       |
|                       |   |                                        |   |                                                                                                                                      |       |                                 |       |
| 31.2                       |   | **Cinergy Corp.  CG&E  PSI  ULH&P** |   | Certification of R. Foster Duncan under Section  302 of Sarbanes-Oxley Act.                                                               |       |                                 |       |
|                       |   |                                        |   |                                                                                                                                      |       |                                 |       |
| 32.1                       |   | **Cinergy Corp.  CG&E  PSI  ULH&P** |   | Certification of James E. Rogers under Section 906  of Sarbanes-Oxley Act.                                                                |       |                                 |       |
|                       |   |                                        |   |                                                                                                                                      |       |                                 |       |
| 32.2                       |   | **Cinergy Corp.  CG&E  PSI  ULH&P** |   | Certification of R. Foster Duncan under Section  906 of Sarbanes-Oxley Act.                                                               | ** ** |                                 | ** ** |

 

(b)             The following reportson Form 8-K were filed during the quarter ended June 30, 2003.

 
| **Date of Report** |   | **Registrant**                   |   | **Item Filed**                                                 |   |
|--------------------|--------|----------------------------------|--------|----------------------------------------------------------------|--------|
|               |   |                             |   |                                                           |   |
| April 28, 2003     |   | **Cinergy Corp.**                |   | Item 12.   Results of Operations and  Financial Condition |   |
|               |   |                             |   |                                                           |   |
| June 10, 2003      |   | **Cinergy Corp.  CG&E  PSI** |   | Item 5.   Other Events and Regulation FD Disclosure       |   |
|               |   | **ULH&P**                    |   | Item 7.   Financial Statements and Exhibits               |   |

 

105

----

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theRegistrants have duly caused this report to be signed by an officer and thechief accounting officer on their behalf by the undersigned thereunto dulyauthorized.

 
| CINERGY CORP.                              |
|--------------------------------------------|
| THE CINCINNATI  GAS & ELECTRIC COMPANY |
| PSI ENERGY, INC.                           |
| THE UNION LIGHT,  HEAT AND POWER COMPANY   |
| Registrants                                |

 
|   | Date:  August 13, 2003 | /s/                            | David  L. Wozny           |   |
|--------|-----------------------------|--------------------------------|---------------------------|--------|
|   |                        |                           | David L. Wozny            |
|   |                        |                           | (duly authorized  officer |
|   |                        |                           | and                       |   |
|   |                        | principal  accounting officer) |
|        |                             |                                |                           |        |  |

 

106

----