UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR ~~15(~~d)15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~March 31,~~September 30, 2003

¨o TRANSITION REPORT PURSUANT TO SECTION 13 OR ~~15(~~d)15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the 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.	31-1385023
	(A Delaware Corporation) 139 East Fourth Street Cincinnati, Ohio 45202 (513) 421-9500

1-1232	THE CINCINNATI GAS & ELECTRIC COMPANY	31-0240030
	(An Ohio Corporation) 139 East Fourth Street Cincinnati, Ohio 45202 (513) 421-9500

1-3543	PSI ENERGY, INC.	35-0594457
	(An Indiana Corporation) 1000 East Main Street Plainfield, Indiana 46168 (513) 421-9500

2-7793	THE UNION LIGHT, HEAT AND POWER COMPANY	31-0473080
	(A Kentucky Corporation) 139 East Fourth Street Cincinnati, Ohio 45202 (513) 421-9500

Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days.

Yes ý No o

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

Yes ý No o

This combined Form 10-Q is 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 any individual registrant is filed by such registrant on its own behalf. Each registrant makes no representation as to information relating to the other registrants.

The Union Light, Heat and Power Company meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing its company specific information with the reduced disclosure format specified in General Instruction H(2) of Form 10-Q.

As of ~~April 30,~~October 31, 2003, shares of common stock outstanding for each registrant were as listed:

Registrant	Description	Shares

Cinergy Corp.	Par value $.01 per share	~~176,091,329~~178,070,206

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

TABLE OF CONTENTS

Item Number
PART I FINANCIAL INFORMATION

1		Financial Statements
		*Cinergy Corp.*
		Condensed Consolidated Statements of Income
			Condensed Consolidated ~~Statements of Income~~Balance Sheets
			~~Consolidated Balance Sheets~~
		Condensed Consolidated Statements of Changes in Common Stock Equity
			Condensed Consolidated Statements of Cash Flows

		*The Cincinnati Gas & Electric Company*
			Condensed Consolidated Statements of Income and Comprehensive Income
		Condensed Consolidated Balance Sheets
			~~Consolidated Balance Sheets~~
		Condensed Consolidated Statements of Cash Flows

		*PSI Energy, Inc.*
			Condensed Consolidated Statements of Income and Comprehensive Income
		Condensed Consolidated Balance Sheets
			~~Consolidated Balance Sheets~~
		Condensed Consolidated Statements of Cash Flows

		*The Union Light, Heat and Power Company*
		Condensed Statements of Income
			~~Statements of Income~~Condensed Balance Sheets
			~~Balance Sheets~~
		Condensed Statements of Cash Flows

		Notes to Condensed Financial Statements

		Cautionary Statements Regarding Forward-Looking Information

2		Management’s Discussion and Analysis of Financial Condition and Results of Operations
			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


4		Submission of Matters to a Vote of Security Holders


6		Exhibits and Reports on Form 8-K


		Signatures

	~~Certifications~~

CINERGY CORP.

AND SUBSIDIARY COMPANIES

CINERGY CORP.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

	Quarter Ended March 31					Quarter Ended September 30					Year to Date September 30
	2003		2002			2003		2002			2003		2002
	(in thousands, except per share amounts)					(dollars in thousands, except per share amounts) (unaudited)
	(unaudited)
Operating Revenues (Note 3)
Operating Revenues (Note 1(g)(i))
Electric	$	836,883	$	779,376		$	920,638	$	965,435		$	2,512,954	$	2,531,283
Gas	398,913		190,064			124,533		104,073			638,378		374,345
Other	45,986		16,937			46,806		49,730			142,525		89,291
Total Operating Revenues	1,281,782		986,377			1,091,977		1,119,238			3,293,857		2,994,919

Operating Expenses
Fuel and purchased and exchanged power (Note 3)	279,483		229,290
Gas purchased (Note 3)	235,995		109,880
Fuel and purchased and exchanged power (Note 1(g)(i))						329,997		302,366			840,332		761,858
Gas purchased (Note 1(g)(i))						79,582		49,283			368,896		188,725
Operation and maintenance	326,661		262,578			317,897		363,362			973,065		962,280
Depreciation	106,023		98,566			104,856		100,050			313,719		294,345
Taxes other than income taxes	77,749		72,422			55,828		64,890			200,535		201,559
Total Operating Expenses	1,025,911		772,736			888,160		879,951			2,696,547		2,408,767

Operating Income	255,871		213,641			203,817		239,287			597,310		586,152

Equity in Earnings (Losses) of Unconsolidated Subsidiaries	592		4,689
Miscellaneous - Net	8,375		(1,309		)
Interest	60,564		61,223
Preferred Dividend Requirement of Subsidiary Trust	5,970		5,913
Equity in Earnings of Unconsolidated Subsidiaries						4,956		3,248			11,652		7,356
Miscellaneous Income – Net						12,296		6,965			27,678		2,517
Interest Expense						73,075		62,518			192,623		180,122
Preferred Dividend Requirement of Subsidiary Trust (Note 1(g)(iii))						—		5,966			11,940		17,847

Income Before Taxes	198,304		149,885			147,994		181,016			432,077		398,056

Income Taxes	57,823		53,777			35,155		47,799			102,121		123,641
Preferred Dividend Requirements of Subsidiaries	858		858			858		859			2,574		2,575

Income Before Discontinued Operations and Cumulative Effect of a Change in Accounting Principles	139,623		95,250
Income Before Discontinued Operations and Cumulative Effect of Changes in Accounting Principles						111,981		132,358			327,382		271,840

Discontinued operations, net of tax	—		478
Cumulative effect of a change in accounting principles, net of tax (Note 1(j)(viii))	26,462		(10,899		)
Discontinued operations, net of tax (Note 8)						—		(1,790		)	8,875		(561		)
Cumulative effect of changes in accounting principles, net of tax (Note 1(g)(vii))						—		—			26,462		(10,899		)
Net Income	$	166,085	$	84,829		$	111,981	$	130,568		$	362,719	$	260,380

Average Common Shares Outstanding	173,387		164,295			177,751		167,967			175,944		166,544

Earnings Per Common Share (Note 9)
Income Before Discontinued Operations and Cumulative Effect of a Change in Accounting Principles	$	0.81	$	0.58
Earnings Per Common Share (Note 10)
Income Before Discontinued Operations and Cumulative Effect of Changes in Accounting Principles						$	0.63	$	0.79		$	1.86	$	1.63
Discontinued operations, net of tax	—		—			—		(0.01		)	0.05		—
Cumulative effect of a change in accounting principles, net of tax	0.15		(0.06		)
Cumulative effect of changes in accounting principles, net of tax						—		—			0.15		(0.06		)
Net Income	$	0.96	$	0.52		$	0.63	$	0.78		$	2.06	$	1.57

Earnings Per Common Share - Assuming Dilution (Note 9)
Income Before Discontinued Operations and Cumulative Effect of a Change in Accounting Principles	$	0.80	$	0.58
Earnings Per Common Share - Assuming Dilution (Note 10)
Income Before Discontinued Operations and Cumulative Effect of Changes in Accounting Principles						$	0.62	$	0.78		$	1.84	$	1.61
Discontinued operations, net of tax	—		—			—		(0.01		)	0.05		—
Cumulative effect of a change in accounting principles, net of tax	0.15		(0.06		)
Cumulative effect of changes in accounting principles, net of tax						—		—			0.15		(0.06		)
Net Income	$	0.95	$	0.52		$	0.62	$	0.77		$	2.04	$	1.55

Dividends Declared Per Common Share	$	0.46	$	0.45		$	0.46	$	0.45		$	1.38	$	1.35

The accompanying notes as they relate to Cinergy Corp. are an integral part of these condensed consolidated financial statements.

CINERGY CORP.

CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS

March 31
2003

December 31
2002

(in thousands)

September 30
2003

December 31
2002

(unaudited)

(dollars in thousands)
(unaudited)

Current Assets

Cash and cash equivalents

259,159

221,083

486,400

200,112

Restricted deposits

8,221

8,116

709

3,092

Notes receivable

96,884

135,873

Accounts receivable less accumulated provision for doubtful accounts of $12,881 at March 31, 2003, and $16,374 at December 31, 2002

1,383,244

1,292,410

Notes receivable, current

63,594

135,873

Accounts receivable less accumulated provision for doubtful accounts of $10,873 at September 30, 2003, and $16,368 at December 31, 2002

1,029,127

1,280,810

Materials, supplies, and fuel (Note 1(d))

245,061

319,456

319,632

319,454

Energy risk management current assets (Note 1(c))

439,358

464,028

Energy risk management current assets (Note 1(c)(i))

224,299

464,028

Prepayments and other

108,367

118,208

138,236

107,086

Total Current Assets

2,540,294

2,559,174

2,261,997

2,510,455

Property, Plant, and Equipment - at Cost

Utility plant in service

9,100,552

8,641,351

Utility plant in service (Note 12)

9,557,536

8,641,351

Construction work in progress

508,021

469,300

288,069

469,300

Total Utility Plant

9,608,573

9,110,651

9,845,605

9,110,651

Non-regulated property, plant, and equipment

4,355,409

4,704,904

Accumulated depreciation (Note 1(j)(iii))

5,184,319

5,166,881

Non-regulated property, plant, and equipment (Note 12)

4,326,626

4,616,754

Accumulated depreciation (Note 1(g)(vi))

5,319,500

5,157,040

Net Property, Plant, and Equipment

8,779,663

8,648,674

8,852,731

8,570,365

Other Assets

Regulatory assets

1,016,477

1,022,696

1,012,457

1,022,696

Investments in unconsolidated subsidiaries

427,378

417,188

482,978

417,188

Energy risk management non-current assets (Note 1(c))

92,631

162,773

Energy risk management non-current assets (Note 1(c)(i))

127,407

162,773

Notes receivable, non-current (Note 4)

218,347

—

Other investments

165,130

163,851

173,790

163,851

Goodwill

43,717

43,717

Goodwill (Note 1 (g)(v))

43,717

43,717

Other intangible assets

14,117

14,736

1,723

2,059

Other

336,811

273,099

300,825

266,659

Total Other Assets

2,096,261

2,098,060

2,361,244

2,078,943

Assets of Discontinued Operations

1,916

1,120

Assets of Discontinued Operations (Note 8)

7,187

147,265

Total Assets

13,418,134

13,307,028

13,483,159

13,307,028

The accompanying notes as they relate to Cinergy Corp. are an integral part of these condensed consolidated financial statements.

CINERGY CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS

~~CONSOLIDATED Balance Sheets~~

LIABILITIES AND SHAREHOLDERS’ EQUITY

	March 31 2003			December 31 2002
	(in thousands)						September 30 2003			December 31 2002
	(unaudited)						(dollars in thousands) (unaudited)

Current Liabilities
Accounts payable	$	1,455,370		$	1,321,968		$	947,882		$	1,318,379
Accrued taxes	235,646			254,823			228,225			258,613
Accrued interest	60,328			64,340			79,161			62,244
Notes payable and other short-term obligations (Note 5)	327,616			667,973			336,687			667,973
Long-term debt due within one year	318,949			191,454			1,113,319			176,000
Energy risk management current liabilities (Note 1(c))	434,111			407,710
Energy risk management current liabilities (Note 1(c)(i))							186,146			407,710
Other	91,450			108,056			133,677			105,026
Total Current Liabilities	2,923,470			3,016,324			3,025,097			2,995,945

Non-Current Liabilities
Long-term debt (Note 4)	3,977,024			4,080,768
Long-term debt (Note 3)							4,129,946			4,011,568
Deferred income taxes	1,507,089			1,471,872			1,519,097			1,458,171
Unamortized investment tax credits	115,792			118,095			111,186			118,095
Accrued pension and other postretirement benefit costs	642,121			626,167			606,375			626,167
Energy risk management non-current liabilities (Note 1(c))	84,805			143,991
Energy risk management non-current liabilities (Note 1(c)(i))							117,777			143,991
Other	213,643			183,613			233,768			179,767
Total Non-Current Liabilities	6,540,474			6,624,506			6,718,149			6,537,759

Liabilities of Discontinued Operations	1,831			1,707
Liabilities of Discontinued Operations (Note 8)							8,877			108,833

Commitments and Contingencies (Note 7)

Total Liabilities	9,465,775			9,642,537			9,752,123			9,642,537

Preferred Trust Securities
Preferred Trust Securities (Note 1(g)(iii))
Company obligated, mandatorily redeemable, preferred trust securities of subsidiary, holding solely debt securities of the company	308,702			308,187			—			308,187

Cumulative Preferred Stock of Subsidiaries
Not subject to mandatory redemption	62,828			62,828			62,818			62,828

Common Stock Equity (Note 2)
Common stock - $.01 par value; authorized shares - 600,000,000; outstanding shares - 175,876,919 at March 31, 2003, and 168,663,115 at December 31, 2002	1,759			1,687
Common stock - $.01 par value; authorized shares - 600,000,000; outstanding shares - 177,899,822 at September 30, 2003, and 168,663,115 at December 31, 2002							1,779			1,687
Paid-in capital	2,116,222			1,918,136			2,170,392			1,918,136
Retained earnings	1,491,861			1,403,453			1,525,727			1,403,453
Accumulated other comprehensive income (loss)	(29,013		)	(29,800		)	(29,680		)	(29,800		)
Total Common Stock Equity	3,580,829			3,293,476			3,668,218			3,293,476

Commitments and Contingencies (Note 7)

Total Liabilities and Shareholders’ Equity	$	13,418,134		$	13,307,028		$	13,483,159		$	13,307,028

The accompanying notes as they relate to Cinergy Corp. are an integral part of these condensed consolidated financial statements.

CINERGY CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCK EQUITY

	Common Stock		Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Common Stock Equity			Common Stock		Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income/(Loss)			Total Common Stock Equity
	(in thousands)													(dollars in thousands) (unaudited)
	(unaudited)
Quarter Ended September 30, 2003

Quarter Ended March 31, 2003

Balance at January 1, 2003 (168,663,115 shares)	$	1,687	$	1,918,136	$	1,403,453		$	(29,800	)	$	3,293,476
Balance at July 1, 2003 (176,947,118 shares)														$	1,769	$	2,135,968	$	1,495,502		$	(24,423	)	$	3,608,816
Comprehensive income:
Net income					166,085						166,085							111,981						111,981
Other comprehensive income (loss), net of tax effect of ($275)
Other comprehensive income (loss), net of tax effect of $2,532
Foreign currency translation adjustment																					(8,365		)	(8,365		)
Minimum pension liability adjustment																					26			26
Unrealized gain (loss) on investment trusts																					32			32
Cash flow hedges (Note 1(c))																					3,050			3,050
Total comprehensive income																								106,724

Issuance of common stock - net (952,704 shares)														10		31,824								31,834
Dividends on common stock ($.46 per share)																		(81,725		)				(81,725		)
Other (Note 2(b))																2,600		(31		)				2,569

Ending balance at September 30, 2003 (177,899,822 shares)														$	1,779	$	2,170,392	$	1,525,727		$	(29,680	)	$	3,668,218

Quarter Ended September 30, 2002

Balance at July 1, 2002 (167,486,129 shares)														$	1,675	$	1,861,689	$	1,319,881		$	(4,787	)	$	3,178,458
Comprehensive income:
Net income																		130,568						130,568
Other comprehensive income (loss), net of tax effect of $12,501
Foreign currency translation adjustment								2,090			2,090										4,810			4,810
Unrealized gain (loss) on investment trusts								(851		)	(851		)								(3,003		)	(3,003		)
Cash flow hedges (Note 1(j)(iv))								(452		)	(452		)
Cash flow hedges (Note 1(c))																					(18,744		)	(18,744		)
Total comprehensive income											166,872													113,631

Issuance of common stock - net (7,213,804 shares)	72		193,896								193,968
Dividends on common stock ($.46 per share)					(77,685		)				(77,685		)
Other			4,190		8						4,198

Ending balance at March 31, 2003 (175,876,919 shares)	$	1,759	$	2,116,222	$	1,491,861		$	(29,013	)	$	3,580,829

Quarter Ended March 31, 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					84,829						84,829
Other comprehensive income (loss), net of tax effect of $1,084
Foreign currency translation adjustment								(1,584		)	(1,584		)
Unrealized gain (loss) on investment trusts								(1,051		)	(1,051		)
Minimum pension liability adjustment								136			136
Cash flow hedges (Note 1(j)(iv))								240			240
Total comprehensive income											82,570

Issuance of common stock - net (7,423,257 shares)	75		215,894								215,969
Issuance of common stock - net (781,597 shares)														8		22,888								22,896
Dividends on common stock ($.45 per share)					(71,882		)				(71,882		)					(75,469		)				(75,469		)
Other			3,785		8						3,793					4,542		8						4,550

Ending balance at March 31, 2002 (166,826,096 shares)	$	1,669	$	1,839,338	$	1,350,090		$	(19,188	)	$	3,171,909
Ending balance at September 30, 2002 (168,267,726 shares)														$	1,683	$	1,889,119	$	1,374,988		$	(21,724	)	$	3,244,066

The accompanying notes as they relate to Cinergy Corp. are an integral part of these condensed consolidated financial statements.

CINERGY CORP.

CONDENSED CONSOLIDATED STATEMENTS OF ~~CASH FLOWS~~CHANGES IN COMMON STOCK EQUITY

Quarter Ended
March 31

2003

2002

(in thousands)

(unaudited)

Operating Activities

Net income

$
166,085

$
84,829

Items providing or (using) cash currently:

Depreciation

106,023

98,566

Loss (gain) on discontinued operations, net of tax

—

(478
)
Cumulative effect of a change in accounting principles, net of tax

(26,462
)
10,899

Change in net position of energy risk management activities

9,730

(50,005
)
Deferred income taxes and investment tax credits - net

18,013

2,594

Equity in (earnings) losses of unconsolidated subsidiaries

(592
)
(4,689
)
Allowance for equity funds used during construction

(3,579
)
(2,850
)
Regulatory assets deferrals

(20,588
)
(17,665
)
Regulatory assets amortization

27,966

29,976

Accrued pension and other postretirement benefit costs

15,954

(105
)
Deferred costs under gas recovery mechanism

(38,659
)
5,955

Changes in current assets and current liabilities:

Restricted deposits

(105
)
(728
)
Accounts and notes receivable

(51,845
)
76,442

Materials, supplies, and fuel

74,395

22,459

Prepayments

1,382

1,101

Accounts payable

133,402

(29,497
)
Accrued taxes and interest

(23,189
)
50,274

Other assets

3,489

13,449

Other liabilities

6,045

(6,918
)

Net cash provided by (used in) operating activities

397,465

283,609

Financing Activities

Change in short-term debt

(340,357
)
(205,918
)
Issuance of long-term debt

35,000

—

Redemption of long-term debt

(11,270
)
(30,722
)
Retirement of preferred stock of subsidiaries

—

(2
)
Issuance of common stock

193,968

215,969

Dividends on common stock

(77,685
)
(71,882
)

Net cash provided by (used in) financing activities

(200,344
)
(92,555
)

Investing Activities

Construction expenditures (less allowance for equity funds used during construction)

(151,187
)
(187,678
)
Acquisitions and other investments

(7,858
)
(18,125
)

Net cash provided by (used in) investing activities

(159,045
)
(205,803
)

Net increase (decrease) in cash and cash equivalents

38,076

(14,749
)

Cash and cash equivalents at beginning of period

221,083

111,067

Cash and cash equivalents at end of period

$
259,159

$
96,318

Supplemental Disclosure of Cash Flow Information

Cash paid during the period for:

Interest (net of amount capitalized)

$
67,259

$
48,373

Income taxes

$
66,477

$
19,242

	Common Stock		Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income/(Loss)			Total Common Stock Equity
	(dollars in thousands) (unaudited)

Year to Date September 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					362,719						362,719
Other comprehensive income (loss), net of tax effect of $(26)
Foreign currency translation adjustment, net of reclassification adjustments of $6,134 (net of tax) (Note 8)								(2,312		)	(2,312		)
Minimum pension liability adjustment								26			26
Unrealized gain (loss) on investment trusts								2,551			2,551
Cash flow hedges (Note 1(c))								(145		)	(145		)
Total comprehensive income											362,839

Issuance of common stock - net (9,236,707 shares)	92		251,179								251,271
Dividends on common stock ($1.38 per share)					(240,402		)				(240,402		)
Other (Note 2(b))			1,077		(43		)				1,034

Ending balance at September 30, 2003 (177,899,822 shares)	$	1,779	$	2,170,392	$	1,525,727		$	(29,680	)	$	3,668,218

Year to Date September 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					260,380						260,380
Other comprehensive income (loss), net of tax effect of $7,879
Foreign currency translation adjustment								20,123			20,123
Minimum pension liability adjustment								136			136
Unrealized gain (loss) on investment trusts								(4,637		)	(4,637		)
Cash flow hedges (Note 1(c))								(20,417		)	(20,417		)
Total comprehensive income											255,585

Issuance of common stock - net (8,864,887 shares)	89		258,300								258,389
Dividends on common stock ($1.35 per share)					(222,551		)				(222,551		)
Other			11,160		24						11,184

Ending balance at September 30, 2002 (168,267,726 shares)	$	1,683	$	1,889,119	$	1,374,988		$	(21,724	)	$	3,244,066

The accompanying notes as they relate to Cinergy Corp. are an integral part of these condensed consolidated financial statements.

CINERGY CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

	Year to Date September 30
	2003			2002
	(dollars in thousands) (unaudited)

Cash Flows from Continuing Operations
Operating Activities
Net income	$	362,719		$	260,380
Items providing or (using) cash currently:
Depreciation	313,719			294,345
(Income) Loss of discontinued operations, net of tax	(8,875		)	561
Cumulative effect of changes in accounting principles, net of tax	(26,462		)	10,899
Change in net position of energy risk management activities	(18,097		)	(61,838		)
Deferred income taxes and investment tax credits – net	35,828			169,377
Equity in (earnings) losses of unconsolidated subsidiaries	(11,652		)	(7,356		)
Allowance for equity funds used during construction	(7,111		)	(8,802		)
Regulatory assets deferrals	(61,846		)	(69,923		)
Regulatory assets amortization	74,686			93,163
Accrued pension and other postretirement benefit costs	(19,792		)	51,587
Deferred costs under gas recovery mechanism	(31,803		)	(2,592		)
Changes in current assets and current liabilities:
Restricted deposits	2,383			(798		)
Accounts and notes receivable	338,099			(357,370		)
Materials, supplies, and fuel	(178		)	(71,535		)
Prepayments	(29,923		)	(40,044		)
Accounts payable	(364,181		)	432,766
Accrued taxes and interest	(15,069		)	(97,625		)
Other assets	5,772			48,362
Other liabilities	58,130			11,322

Net cash provided by (used in) operating activities	596,347			654,879

Financing Activities
Change in short-term debt	(332,404		)	(417,228		)
Issuance of long-term debt	688,166			628,170
Redemption of long-term debt	(187,873		)	(115,672		)
Funds on deposit from issuance of debt securities	—			(131,600		)
Retirement of preferred stock of subsidiaries	(10		)	(3		)
Issuance of common stock	251,271			258,389
Dividends on common stock	(240,402		)	(222,551		)

Net cash provided by (used in) financing activities	178,748			(495		)

Investing Activities
Construction expenditures (less allowance for equity funds used during construction)	(508,671		)	(587,445		)
Proceeds from notes receivable	5,076			—
Acquisitions and other investments	(36,464		)	(56,439		)
Proceeds from sale of subsidiaries and equity investments	51,252			7,305

Net cash provided by (used in) investing activities	(488,807		)	(636,579		)

Net increase (decrease) in cash and cash equivalents from continuing operations	286,288			17,805

Cash and cash equivalents from continuing operations at beginning of period	200,112			87,257

Cash and cash equivalents from continuing operations at end of period	$	486,400		$	105,062

Cash Flows from Discontinued Operations
Operating activities	$	(7,285	)	$	17,992
Financing activities	(13,484		)	(22,551		)
Investing activities	(202		)	(5,046		)

Net increase (decrease) in cash and cash equivalents from discontinued operations	(20,971		)	(9,605		)

Cash and cash equivalents from discontinued operations at beginning of period	20,971			23,810

Cash and cash equivalents from discontinued operations at end of period	$	—		$	14,205

Supplemental Disclosure of Cash Flow Information
Cash paid during the period for:
Interest (net of amount capitalized)	$	182,108		$	207,659
Income taxes	$	90,281		$	30,900

The accompanying notes as they relate to Cinergy Corp. are an integral part of these condensed consolidated financial statements.

THE CINCINNATI GAS & ELECTRIC COMPANY

AND SUBSIDIARY COMPANIES

1011

THE CINCINNATI GAS & ELECTRIC COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

	Quarter Ended March 31						Quarter Ended September 30					Year to Date September 30
	2003			2002			2003		2002			2003			2002
	(in thousands)						(dollars in thousands) (unaudited)
	(unaudited)

Operating Revenues (Note 3)
Operating Revenues (Note 1(g)(i))
Electric	$	428,564		$	398,119		$	474,840	$	492,617		$	1,300,859		$	1,301,442
Gas	275,276			179,609			66,399		41,452			426,986			277,069
Total Operating Revenues	703,840			577,728			541,239		534,069			1,727,845			1,578,511

Operating Expenses
Fuel and purchased and exchanged power (Note 3)	130,554			107,248
Fuel and purchased and exchanged power (Note 1(g)(i))							144,794		136,459			381,615			352,292
Gas purchased	171,765			107,968			32,223		12,594			252,074			145,033
Operation and maintenance	134,760			105,855			133,474		150,247			394,171			394,443
Depreciation	49,264			48,160			42,542		49,005			142,119			146,057
Taxes other than income taxes	60,518			53,486			44,553		50,304			154,810			149,509
Total Operating Expenses	546,861			422,717			397,586		398,609			1,324,789			1,187,334

Operating Income	156,979			155,011			143,653		135,460			403,056			391,177

Miscellaneous - Net	6,584			(3,704		)
Interest	25,841			22,855
Miscellaneous Income - Net							9,654		4,140			23,137			4,002
Interest Expense							29,506		23,746			84,766			68,375

Income Before Taxes	137,722			128,452			123,801		115,854			341,427			326,804

Income Taxes	51,424			50,867			44,938		44,085			125,347			124,780

Income Before Cumulative Effect of a Change in Accounting Principles	86,298			77,585
Income Before Cumulative Effect of Changes in Accounting Principles							78,863		71,769			216,080			202,024

Cumulative effect of a change in accounting principles, net of tax (Note 1(j)(viii))	30,938			—
Cumulative effect of changes in accounting principles, net of tax (Note 1(g)(vii))							—		—			30,938			—

Net Income	$	117,236		$	77,585		$	78,863	$	71,769		$	247,018		$	202,024

Preferred Dividend Requirement	211			211			211		211			634			634

Net Income Applicable to Common Stock	$	117,025		$	77,374		$	78,652	$	71,558		$	246,384		$	201,390

Net Income	$	117,236		$	77,585		$	78,863	$	71,769		$	247,018		$	202,024

Other Comprehensive Income (Loss), Net of Tax Effect	(306		)	(172		)
Other Comprehensive Income (Loss), Net of Tax							2,720		(17,588		)	(307		)	(19,673		)

Comprehensive Income	$	116,930		$	77,413		$	81,583	$	54,181		$	246,711		$	182,351

The accompanying notes as they relate to The Cincinnati Gas & Electric Company are an integral part of these condensed consolidated financial statements.

1112

THE CINCINNATI GAS & ELECTRIC COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS

March 31
2003

December 31
2002

(in thousands)

September 30
2003

December 31
2002

(unaudited)

(dollars in thousands)
(unaudited)

Current Assets

Cash and cash equivalents

26,870

45,336

99,551

45,336

Restricted deposits

3,037

3,071

137

3,071

Notes receivable from affiliated companies

207,402

148,823

137,144

148,823

Accounts receivable less accumulated provision for doubtful accounts of $2,707 at March 31, 2003, and $5,942 at December 31, 2002

106,416

117,269

Accounts receivable less accumulated provision for doubtful accounts of $4,096 at September 30, 2003, and $5,942 at December 31, 2002

103,345

117,269

Accounts receivable from affiliated companies

27,650

97,584

9,730

97,584

Materials, supplies, and fuel

94,226

121,881

135,035

121,881

Energy risk management current assets (Note 1(c))

74,339

57,912

Energy risk management current assets (Note 1(c)(i))

78,689

57,912

Prepayments and other

14,409

8,560

35,565

8,560

Total Current Assets

554,349

600,436

599,196

600,436

Property, Plant, and Equipment - at Cost

Utility plant in service

Utility plant in service (Note 12)

Electric

2,097,439

2,073,133

2,146,147

2,073,133

Gas

1,019,175

1,003,870

1,043,356

1,003,870

Common

249,593

248,938

249,382

248,938

Total Utility Plant In Service

3,366,207

3,325,941

3,438,885

3,325,941

Construction work in progress

80,664

84,249

115,161

84,249

Total Utility Plant

3,446,871

3,410,190

3,554,046

3,410,190

Non-regulated property, plant, and equipment

3,469,525

3,445,056

Accumulated depreciation (Note 1(j)(iii))

2,692,027

2,712,105

Non-regulated property, plant, and equipment (Note 12)

3,510,124

3,445,056

Accumulated depreciation (Note 1(g)(vi))

2,754,575

2,712,105

Net Property, Plant, and Equipment

4,224,369

4,143,141

4,309,595

4,143,141

Other Assets

Regulatory assets

596,271

604,776

594,727

604,776

Energy risk management non-current assets (Note 1(c))

33,946

64,762

Energy risk management non-current assets (Note 1(c)(i))

61,789

64,762

Other investments

1,081

1,082

1,084

1,082

Other

193,325

127,550

178,884

127,550

Total Other Assets

824,623

798,170

836,484

798,170

Total Assets

5,603,341

5,541,747

5,745,275

5,541,747

The accompanying notes as they relate to The Cincinnati Gas & Electric Company are an integral part of these condensed consolidated financial statements.

1213

THE CINCINNATI GAS & ELECTRIC COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS

LIABILITIES AND SHAREHOLDER’S EQUITY

	March 31 2003			December 31 2002
	(in thousands)						September 30 2003			December 31 2002
	(unaudited)						(dollars in thousands) (unaudited)

Current Liabilities
Accounts payable	$	241,667		$	195,812		$	145,449		$	195,812
Accounts payable to affiliated companies	40,652			146,558			33,253			146,558
Accrued taxes	159,892			159,199			193,641			159,199
Accrued interest	18,042			22,872			32,478			22,872
Notes payable and other short-term obligations (Note 5)	112,100			112,100			112,100			112,100
Notes payable to affiliated companies (Note 5)	3,260			8,947			9,042			8,947
Long-term debt due within one year	230,000			120,000			395,500			120,000
Energy risk management current liabilities (Note 1(c))	89,627			49,288
Energy risk management current liabilities (Note 1(c)(i))							73,445			49,288
Other	37,255			37,160			28,834			37,160
Total Current Liabilities	932,495			851,936			1,023,742			851,936

Non-Current Liabilities
Long-term debt	1,459,760			1,569,713
Long-term debt (Note 3)							1,456,716			1,569,713
Deferred income taxes	916,930			882,628			942,250			882,628
Unamortized investment tax credits	83,695			85,198			80,689			85,198
Accrued pension and other postretirement benefit costs	205,087			201,284			206,003			201,284
Energy risk management non-current liabilities (Note 1(c))	20,335			31,326
Energy risk management non-current liabilities (Note 1(c)(i))							43,204			31,326
Other	84,583			88,843			82,430			88,843
Total Non-Current Liabilities	2,770,390			2,858,992			2,811,292			2,858,992

Commitments and Contingencies (Note 7)

Total Liabilities	3,702,885			3,710,928			3,835,034			3,710,928

Cumulative Preferred Stock
Not subject to mandatory redemption	20,485			20,485			20,485			20,485

Common Stock Equity
Common stock - $8.50 par value; authorized shares - 120,000,000; outstanding shares - 89,663,086 at March 31, 2003, and December 31, 2002	762,136			762,136
Common stock - $8.50 par value; authorized shares - 120,000,000; outstanding shares - 89,663,086 at September 30, 2003, and December 31, 2002							762,136			762,136
Paid-in capital	586,292			586,292			586,292			586,292
Retained earnings	557,595			487,652			567,381			487,652
Accumulated other comprehensive income (loss)	(26,052		)	(25,746		)	(26,053		)	(25,746		)
Total Common Stock Equity	1,879,971			1,810,334			1,889,756			1,810,334

Commitments and Contingencies (Note 7)

Total Liabilities and Shareholder’s Equity	$	5,603,341		$	5,541,747		$	5,745,275		$	5,541,747

The accompanying notes as they relate to The Cincinnati Gas & Electric Company are an integral part of these condensed consolidated financial statements.

1314

THE CINCINNATI GAS & ELECTRIC COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

	Quarter Ended March 31
	2003			2002			Year to Date September 30
	(in thousands)						2003			2002
	(unaudited)						(dollars in thousands) (unaudited)

Operating Activities
Net income	$	117,236		$	77,585		$	247,018		$	202,024
Items providing or (using) cash currently:
Depreciation	49,264			48,160			142,119			146,057
Deferred income taxes and investment tax credits - net	13,092			7,465			35,406			95,730
Cumulative effect of a change in accounting principles, net of tax	(30,938		)	—
Cumulative effect of changes in accounting principles, net of tax							(30,938		)	—
Change in net position of energy risk management activities	1,041			(2,069		)	(24,465		)	(19,560		)
Allowance for equity funds used during construction	(719		)	543			(2,566		)	261
Regulatory assets deferrals	(5,949		)	(11,131		)	(17,984		)	(45,007		)
Regulatory assets amortization	16,376			11,494			31,411			38,024
Accrued pension and other postretirement benefit costs	3,803			(307		)	4,719			5,549
Deferred costs under gas cost recovery mechanism	(38,659		)	5,955			(31,803		)	(2,592		)
Changes in current assets and current liabilities:
Restricted deposits	34			(764		)	2,934			(765		)
Accounts and notes receivable	103,008			121,927			157,926			(199,985		)
Materials, supplies, and fuel	27,655			33,593			(13,154		)	6,576
Prepayments	361			535			(8,040		)	(14,830		)
Accounts payable	(60,051		)	(59,074		)	(163,059		)	214,967
Accrued taxes and interest	(4,137		)	34,192			44,048			(7,301		)
Other assets	(4,677		)	4,331			(12,307		)	5,856
Other liabilities	(6,924		)	980			(15,350		)	(7,506		)

Net cash provided by (used in) operating activities	179,816			273,415			345,915			417,498

Financing Activities
Change in short-term debt, including net affiliate notes	(86,487		)	(141,171		)	(44,374		)	(451,627		)
Issuance of long-term debt							256,198			580,570
Redemption of long-term debt							(100,000		)	(100,000		)
Funds on deposit from issuance of debt securities							—			(84,000		)
Retirement of preferred stock							—			(1		)
Dividends on preferred stock	(211		)	(211		)	(634		)	(634		)
Dividends on common stock	(47,082		)	(44,787		)	(166,655		)	(138,712		)

Net cash provided by (used in) financing activities	(133,780		)	(186,169		)	(55,465		)	(194,404		)

Investing Activities
Construction expenditures (less allowance for equity funds used during construction)	(64,501		)	(80,191		)	(236,235		)	(223,740		)
Other investments	(1		)	(840		)	—			98

Net cash provided by (used in) investing activities	(64,502		)	(81,031		)	(236,235		)	(223,642		)

Net increase (decrease) in cash and cash equivalents	(18,466		)	6,215			54,215			(548		)

Cash and cash equivalents at beginning of period	45,336			9,074			45,336			9,074

Cash and cash equivalents at end of period	$	26,870		$	15,289		$	99,551		$	8,526

Supplemental Disclosure of Cash Flow Information
Cash paid during the period for:
Interest (net of amount capitalized)	$	30,010		$	9,551		$	69,321		$	68,749
Income taxes	$	29,451		$	12,620		$	38,146		$	16,121

The accompanying notes as they relate to The Cincinnati Gas & Electric Company are an integral part of these condensed consolidated financial statements.

1415

PSI ENERGY, INC.

AND SUBSIDIARY COMPANY

1516

PSI ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

	Quarter Ended March 31						Quarter Ended September 30						Year to Date September 30
	2003			2002			2003			2002			2003			2002
	(in thousands)						(dollars in thousands) (unaudited)
	(unaudited)

Operating Revenues (Note 3)
Operating Revenues(Note 1(g)(i))
Electric	$	411,688		$	366,401		$	437,084		$	470,772		$	1,210,157		$	1,215,791

Operating Expenses
Fuel and purchased and exchanged power (Note 3)	166,872			123,049
Fuel and purchased and exchanged power (Note 1(g)(i))							177,786			168,683			466,656			420,278
Operation and maintenance	112,385			115,079			113,336			128,931			348,668			386,559
Depreciation	42,712			37,748			47,695			39,826			135,351			115,954
Taxes other than income taxes	15,882			16,397			10,322			13,446			42,354			46,992
Total Operating Expenses	337,851			292,273			349,139			350,886			993,029			969,783

Operating Income	73,837			74,128			87,945			119,886			217,128			246,008

Miscellaneous - Net	2,158			5,351
Interest	20,115			19,291
Miscellaneous Income (Expense) - Net							(2,221		)	4,434			5,348			14,155
Interest Expense							21,324			18,782			63,477			55,862

Income Before Taxes	55,880			60,188			64,400			105,538			158,999			204,301

Income Taxes	21,659			22,105			26,808			37,895			64,107			68,861

Income Before Cumulative Effect of a Change in Accounting Principle	34,221			38,083			37,592			67,643			94,892			135,440

Cumulative effect of a change in accounting principle, net of tax (Note 1(j)(viii))	(494		)	—
Cumulative effect of a change in accounting principle, net of tax (Note 1(g)(vii))							—			—			(494		)	—

Net Income	$	33,727		$	38,083		$	37,592		$	67,643		$	94,398		$	135,440

Preferred Dividend Requirement	647			647			647			648			1,940			1,941

Net Income Applicable to Common Stock	$	33,080		$	37,436		$	36,945		$	66,995		$	92,458		$	133,499

Net Income	$	33,727		$	38,083		$	37,592		$	67,643		$	94,398		$	135,440

Other Comprehensive Income (Loss), Net of Tax Effect	(630		)	(497		)
Other Comprehensive Income (Loss), Net of Tax							(77		)	(2,716		)	2,247			(3,684		)

Comprehensive Income	$	33,097		$	37,586		$	37,515		$	64,927		$	96,645		$	131,756

The accompanying notes as they relate to PSI Energy, Inc. are an integral part of these condensed consolidated financial statements.

1617

PSI ENERGY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS

	March 31 2003		December 31 2002
	(in thousands)				September 30 2003		December 31 2002
	(unaudited)				(dollars in thousands) (unaudited)

Current Assets
Cash and cash equivalents	$	4,095	$	2,007	$	11,452	$	2,007
Restricted deposits	20		20		571		20
Notes receivable from affiliated companies	37,548		53,755		21,108		53,755
Accounts receivable less accumulated provision for doubtful accounts of $1,927 at March 31, 2003, and $5,656 at December 31, 2002	62,504		84,819
Accounts receivable less accumulated provision for doubtful accounts of $2,068 at September 30, 2003, and $5,656 at December 31, 2002					48,295		84,819
Accounts receivable from affiliated companies	439		437		4,328		437
Materials, supplies, and fuel	132,959		137,292		122,574		137,292
Energy risk management current assets (Note 1(c))	8,023		8,701
Energy risk management current assets (Note 1(c)(i))					7,090		8,701
Prepayments and other	34,806		44,725		33,751		44,725
Total Current Assets	280,394		331,756		249,169		331,756

Property, Plant, and Equipment - at Cost
Utility plant in service	5,734,345		5,315,410		6,118,651		5,315,410
Construction work in progress	427,357		385,051		172,908		385,051
Total Utility Plant	6,161,702		5,700,461		6,291,559		5,700,461
Accumulated depreciation	2,374,840		2,334,157		2,436,536		2,334,157
Net Property, Plant, and Equipment (Note 11)	3,786,862		3,366,304
Net Property, Plant, and Equipment (Note 12)					3,855,023		3,366,304

Other Assets
Regulatory assets	420,206		417,920		417,730		417,920
Energy risk management non-current assets (Note 1(c))	12,539		16,590
Energy risk management non-current assets (Note 1(c)(i))					8,988		16,590
Other investments	54,477		54,683		60,852		54,683
Other	42,044		35,703		46,278		35,703
Total Other Assets	529,266		524,896		533,848		524,896

Total Assets	$	4,596,522	$	4,222,956	$	4,638,040	$	4,222,956

The accompanying notes as they relate to PSI Energy, Inc. are an integral part of these condensed consolidated financial statements.

1718

PSI ENERGY, INC.
condensed consolidated balance sheets

~~CONSOLIDATED BALANCE SHEETS~~

LIABILITIES AND SHAREHOLDER’S EQUITY

	March 31 2003			December 31 2002
	(in thousands)						September 30 2003			December 31 2002
	(unaudited)						(dollars in thousands) (unaudited)

Current Liabilities
Accounts payable	$	73,155		$	113,563		$	42,452		$	113,563
Accounts payable to affiliated companies	39,150			107,364			13,486			107,364
Accrued taxes	107,385			105,960			117,415			105,960
Accrued interest	26,811			23,078			26,011			23,078
Notes payable and other short-term obligations (Note 5)	—			35,000			—			35,000
Notes payable to affiliated companies (Note 5)	229,865			138,055			164,974			138,055
Long-term debt due within one year	83,838			56,000			1,038			56,000
Energy risk management current liabilities (Note 1(c))	7,133			8,000
Energy risk management current liabilities (Note 1(c)(i))							14,648			8,000
Other	22,550			22,335			27,936			22,335
Total Current Liabilities	589,887			609,355			407,960			609,355

Non-Current Liabilities
Long-term debt (Note 4)	1,699,186			1,315,984
Long-term debt (Note 3)							1,720,330			1,315,984
Deferred income taxes	536,174			538,745			556,636			538,745
Unamortized investment tax credits	32,097			32,897			30,497			32,897
Accrued pension and other postretirement benefit costs	188,107			184,299			176,828			184,299
Energy risk management non-current liabilities (Note 1(c))	15,837			17,157
Energy risk management non-current liabilities (Note 1(c)(i))							3,352			17,157
Other	89,647			80,879			77,426			80,879
Total Non-Current Liabilities	2,561,048			2,169,961			2,565,069			2,169,961

Commitments and Contingencies (Note 7)

Total Liabilities	3,150,935			2,779,316			2,973,029			2,779,316

Cumulative Preferred Stock
Not subject to mandatory redemption	42,343			42,343			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 March 31, 2003, and December 31, 2002	539			539
Paid-in capital	426,931			426,931
Common stock - without par value; $.01 stated value; authorized shares - 60,000,000; outstanding shares - 53,913,701 at September 30, 2003, and December 31, 2002							539			539
Paid-in capital (Note 2(c))							626,931			426,931
Retained earnings	984,523			981,946			1,001,080			981,946
Accumulated other comprehensive income (loss)	(8,749		)	(8,119		)	(5,872		)	(8,119		)
Total Common Stock Equity	1,403,244			1,401,297			1,622,678			1,401,297

Commitments and Contingencies (Note 7)

Total Liabilities and Shareholder’s Equity	$	4,596,522		$	4,222,956		$	4,638,040		$	4,222,956

The accompanying notes as they relate to PSI Energy, Inc. are an integral part of these condensed consolidated financial statements.

PSI ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

	Quarter Ended March 31
	2003			2002			Year to Date September 30
	(in thousands)						2003			2002
	(unaudited)						(dollars in thousands) (unaudited)

Operating Activities
Net income	$	33,727		$	38,083		$	94,398		$	135,440
Items providing or (using) cash currently:
Depreciation	42,712			37,748			135,351			115,954
Cumulative effect of a change in accounting principle, net of tax	494			—			494			—
Deferred income taxes and investment tax credits - net	(2,654		)	(8,580		)	14,370			46,376
Change in net position of energy risk management activities	(1,245		)	133			(1,731		)	8,443
Allowance for equity funds used during construction	(2,860		)	(3,393		)	(4,545		)	(9,063		)
Regulatory assets deferrals	(14,639		)	(6,534		)	(43,862		)	(24,916		)
Regulatory assets amortization	11,590			18,482			43,275			55,139
Accrued pension and other postretirement benefit costs	3,808			2,864			(7,471		)	4,603
Changes in current assets and current liabilities:
Restricted deposits	—			(2		)	(551		)	(34		)
Accounts and notes receivable	38,520			99,305			65,280			222,369
Materials, supplies, and fuel	4,333			(16,776		)	14,718			(35,243		)
Prepayments	1,345			1,074			(154		)	(3,857		)
Accounts payable	(108,622		)	(60,867		)	(164,989		)	(147,681		)
Accrued taxes and interest	5,158			37,874			14,388			875
Other assets	7,355			534			6,980			4,881
Other liabilities	1,066			128			(909		)	(8,338		)

Net cash provided by (used in) operating activities	20,088			140,073			165,042			364,948

Financing Activities
Change in short-term debt, including net affiliate notes	56,810			24,057			(8,081		)	37,287
Issuance of long-term debt	35,000			—			431,968			47,600
Redemption of long-term debt	—			(23,000		)	(459,865		)	(23,000		)
Contribution from parent							200,000			—
Funds on deposit from issuance of debt securities							—			(47,600		)
Retirement of preferred stock	—			(2		)	(10		)	(2		)
Dividends on preferred stock	(647		)	(647		)	(1,940		)	(1,940		)
Dividends on common stock	(30,503		)	(26,944		)	(73,324		)	(83,448		)

Net cash provided by (used in) financing activities	60,660			(26,536		)	88,748			(71,103		)

Investing Activities
Construction expenditures (less allowance for equity funds used during construction)	(77,833		)	(104,977		)	(241,859		)	(286,610		)
Other investments	(827		)	(3,557		)	(2,486		)	(3,098		)

Net cash provided by (used in) investing activities	(78,660		)	(108,534		)	(244,345		)	(289,708		)

Net increase (decrease) in cash and cash equivalents	2,088			5,003			9,445			4,137

Cash and cash equivalents at beginning of period	2,007			1,587			2,007			1,587

Cash and cash equivalents at end of period	$	4,095		$	6,590		$	11,452		$	5,724

Supplemental Disclosure of Cash Flow Information
Cash paid during the period for:
Interest (net of amount capitalized)	$	20,465		$	22,819		$	72,455		$	75,807
Income taxes	$	36,000		$	6,590		$	50,419		$	13,590

Non-cash financing and investing activities:
Issuance of promissory notes to affiliated company for acquisition of assets	$	375,969		$	—		$	375,969		$	—

The accompanying notes as they relate to PSI Energy, Inc. are an integral part of these condensed consolidated financial statements.

1920

THE UNION LIGHT, HEAT

AND POWER COMPANY

2021

THE UNION LIGHT, HEAT AND POWER COMPANY
CONDENSED STATEMENTS OF INCOME

Quarter Ended
March 31

2003

2002

Quarter Ended
September 30

Year to Date
September 30

(in thousands)

2003

2002

2003

2002

(unaudited)

(dollars in thousands)
(unaudited)

Operating Revenues

Electric

$
54,929

$
51,857

$
64,199

$
68,353

$
170,224

$
175,346

Gas

49,384

35,204

11,240

7,364

75,007

53,584

Total Operating Revenues

104,313

87,061

75,439

75,717

245,231

228,930

Operating Expenses

Electricity purchased from parent company for resale

39,123

36,838

44,546

48,445

120,805

123,091

Gas purchased

31,500

22,889

5,620

2,732

46,570

30,932

Operation and maintenance

12,585

9,452

14,689

14,819

41,068

38,199

Depreciation

4,445

4,220

4,554

4,277

13,582

13,009

Taxes other than income taxes

1,161

1,201

1,135

1,167

3,417

3,535

Total Operating Expenses

88,814

74,600

70,544

71,440

225,442

208,766

Operating Income

15,499

12,461

4,895

4,277

19,789

20,164

Miscellaneous - Net

1,479

(5,168
)
Interest

1,502

1,505

Miscellaneous Income (Expense) - Net

886

1,690

3,266

(2,516
)
Interest Expense

1,548

1,431

4,520

4,388

Income Before Taxes

15,476

5,788

4,233

4,536

18,535

13,260

Income Taxes

6,070

1,904

1,667

1,302

7,058

4,150

Net Income

$
9,406

$
3,884

$
2,566

$
3,234

$
11,477

$
9,110

The accompanying notes as they relate to The Union Light, Heat and Power Company are an integral part of these condensed financial statements.

2122

THE UNION LIGHT, HEAT AND POWER COMPANY
CONDENSED BALANCE SHEETS
ASSETS

March 31
2003

December 31
2002

(in thousands)

September 30
2003

December 31
2002

(unaudited)

(dollars in thousands)
(unaudited)

Current Assets

Cash and cash equivalents

$
7,559

$
3,926

$
5,108

$
3,926

Notes receivable from affiliated companies

9,902

13,337

4,009

13,337

Accounts receivable less accumulated provision for doubtful accounts of $91 at March 31, 2003, and $84 at December 31, 2002

710

703

Accounts receivable less accumulated provision for doubtful accounts of $163 at September 30, 2003, and $84 at December 31, 2002

417

703

Accounts receivable from affiliated companies

682

1,671

509

1,671

Materials, supplies, and fuel

3,516

8,182

9,774

8,182

Prepayments and other

158

316

418

316

Total Current Assets

22,527

28,135

20,235

28,135

Property, Plant, and Equipment - at Cost

Utility plant in service

Electric

262,800

258,094

271,763

258,094

Gas

221,244

215,505

228,436

215,505

Common

31,629

31,679

32,324

31,679

Total Utility Plant In Service

515,673

505,278

532,523

505,278

Construction work in progress

11,482

14,745

11,717

14,745

Total Utility Plant

527,155

520,023

544,240

520,023

Accumulated depreciation

191,743

187,876

198,059

187,876

Net Property, Plant, and Equipment

335,412

332,147

Net Property, Plant, and Equipment (Note 12)

346,181

332,147

Other Assets

Regulatory assets

9,678

5,134

9,441

5,134

Other

22,309

16,811

19,095

16,811

Total Other Assets

31,987

21,945

28,536

21,945

Total Assets

$
389,926

$
382,227

$
394,952

$
382,227

The accompanying notes as they relate to The Union Light, Heat and Power Company are an integral part of these condensed financial statements.

2223

THE UNION LIGHT, HEAT AND POWER COMPANY
CONDENSED BALANCE SHEETS

LIABILITIES AND SHAREHOLDER’S EQUITY

March 31
2003

December 31
2002

(in thousands)

September 30
2003

December 31
2002

(unaudited)

(dollars in thousands)
(unaudited)

Current Liabilities

Accounts payable

$
13,565

$
8,816

$
3,775

$
8,816

Accounts payable to affiliated companies

20,331

22,297

17,291

22,297

Accrued taxes

1,016

1,487

3,877

1,487

Accrued interest

1,217

1,226

1,289

1,226

Long-term debt due within one year

20,000

20,000

20,000

20,000

Notes payable to affiliated companies (Note 5)

4,543

14,076

23,726

14,076

Other

6,658

6,368

6,146

6,368

Total Current Liabilities

67,330

74,270

76,104

74,270

Non-Current Liabilities

Long-term debt

54,661

54,653

54,676

54,653

Deferred income taxes

47,877

43,360

47,716

43,360

Unamortized investment tax credits

3,077

3,143

2,945

3,143

Accrued pension and other postretirement benefit costs

15,891

15,620

15,958

15,620

Other

14,520

14,017

15,217

14,017

Total Non-Current Liabilities

136,026

130,793

136,512

130,793

Commitments and Contingencies (Note 7)

Total Liabilities

203,356

205,063

212,616

205,063

Common Stock Equity

Common stock - $15.00 par value; authorized shares - 1,000,000; outstanding shares - 585,333 at March 31, 2003, and December 31, 2002

8,780

8,780

Common stock - $15.00 par value; authorized shares - 1,000,000; outstanding shares - 585,333 at September 30, 2003, and December 31, 2002

8,780

8,780

Paid-in capital

23,644

23,644

23,644

23,644

Retained earnings

154,206

144,800

149,972

144,800

Accumulated other comprehensive income (loss)

(60
)
(60
)

(60
)
(60
)
Total Common Stock Equity

186,570

177,164

182,336

177,164

Commitments and Contingencies (Note 7)

Total Liabilities and Shareholder’s Equity

$
389,926

$
382,227

$
394,952

$
382,227

The accompanying notes as they relate to The Union Light, Heat and Power Company are an integral part of these condensed financial statements.

2324

THE UNION LIGHT, HEAT AND POWER COMPANY
CONDENSED STATEMENTS OF CASH FLOWS

Quarter Ended
March 31

2003

2002

Year to Date
September 30

(in thousands)

2003

2002

(unaudited)

(dollars in thousands)
(unaudited)

Operating Activities

Net income

$
9,406

$
3,884

$
11,477

$
9,110

Items providing or (using) cash currently:

Depreciation

4,445

4,220

13,582

13,009

Deferred income taxes and investment tax credits - net

4,451

(727
)

4,157

1,395

Allowance for equity funds used during construction

(85
)
(47
)

(224
)
(523
)
Regulatory assets deferrals

(33
)
4,687

(424
)
4,168

Regulatory assets amortization

(22
)
(887
)

505

(1,064
)
Accrued pension and other postretirement benefit costs

271

(43
)

338

1,417

Deferred costs under gas cost recovery mechanism

(9,372
)
4,347

(7,279
)
7,246

Changes in current assets and current liabilities:

Accounts and notes receivable

4,417

14,388

10,776

17,142

Materials, supplies, and fuel

4,666

7,272

(1,592
)
(1,671
)
Prepayments

158

150

(102
)
(174
)
Accounts payable

2,783

3,648

(10,047
)
(1,619
)
Accrued taxes and interest

(480
)
1,990

2,453

2,194

Other assets

20

224

1,071

3,284

Other liabilities

174

397

375

(627
)

Net cash provided by (used in) operating activities

20,799

43,503

25,066

53,287

Financing Activities

Change in short-term debt, including net affiliate notes

(9,533
)
(35,978
)

9,650

(24,581
)
Dividends on common stock

(6,305
)
(2,675
)

Net cash provided by (used in) financing activities

(9,533
)
(35,978
)

3,345

(27,256
)

Investing Activities

Construction expenditures (less allowance for equity funds used during construction)

(7,633
)
(7,382
)

(27,229
)
(26,268
)
Other investments

—

(114
)

—

(70
)

Net cash provided by (used in) investing activities

(7,633
)
(7,496
)

(27,229
)
(26,338
)

Net increase (decrease) in cash and cash equivalents

3,633

29

1,182

(307
)

Cash and cash equivalents at beginning of period

3,926

4,099

3,926

4,099

Cash and cash equivalents at end of period

$
7,559

$
4,128

$
5,108

$
3,792

Supplemental Disclosure of Cash Flow Information

Cash paid during the period for:

Interest (net of amount capitalized)

$
1,437

$
875

$
4,240

$
4,194

Income taxes

$
3,000

$
1,901

$
3,001

$
2,398

The accompanying notes as they relate to The Union Light, Heat and Power Company are an integral part of these condensed financial statements.

2425

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

1.              Summary of Significant Accounting Policies
(a)                                  Presentation
~~(a)~~ ~~Presentation~~
Our Condensed Financial Statements reflect all adjustments (which include normal, recurring adjustments) necessary in the opinion of the registrants for a fair presentation of the interim results. These results are not necessarily indicative of results for a full year. These statements should be read in conjunction with the Financial Statements and the notes thereto included in the registrants’ combined Form 10-K for the year ended December 31, 2002 ~~(2002~~and Form 8-K filed on June 10, 2003 (together, the 2002 10-K). Certain amounts in the 2002 Condensed Financial Statements have been reclassified to conform to the 2003 presentation.

~~(b)~~                                  ~~Financial Derivatives~~Management makes estimates and assumptions when preparing financial statements under generally accepted accounting principles (GAAP). Actual results could differ, as these estimates and assumptions involve judgment.

(b)                                  Revenue Recognition
(i)          Operating Revenues
The Cincinnati Gas & Electric Company (CG&E), PSI Energy, Inc. (PSI), and The Union Light, Heat and Power Company (ULH&P) (collectively, our operating companies) record Operating Revenues for electric and gas service when delivered to customers. Customers are billed throughout the month as both gas and electric meters are read. We recognize revenues for retail energy sales that have not yet been billed, but where gas or electricity has been consumed. This is termed “unbilled revenue” and is a widely recognized and accepted practice for utilities. In making our estimates of unbilled revenue, we use ~~derivative financial instruments to manage funding costs~~complex systems that consider various factors, including weather, in our calculation of retail customer consumption at the end of each month. Given the use of these systems and ~~exposures to fluctuations~~the fact that customers are billed monthly, we believe it is unlikely that materially different results will occur in ~~interest rates.~~future periods when revenue is subsequently billed.

The amount of unbilled revenues for Cinergy, CG&E, PSI, and ULH&P as of September 30, 2003 and 2002, were as follows:

2003

2002

(in millions)

Cinergy

$
117

$
124

CG&E and subsidiaries

60

63

PSI

57

61

ULH&P

11

11

26

(ii)      Energy Marketing and Trading Revenues
We ~~account for~~market and trade electricity, natural gas, coal, and other energy-related products. Many of the contracts associated with these products qualify as derivatives ~~under~~in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (Statement 133). We designate derivative transactions as either trading or non-trading at the time they are originated in accordance with Emerging Issues Task Force (EITF) Issue 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities (EITF 02-3). Generally, trading contracts are reported on a net basis and non-trading contracts are reported on a gross basis.
1.               Gross Reporting
Gross reporting requires presentation of sales contracts in Operating Revenues and purchase contracts in Fuel and purchased and exchanged power expense or Gas purchased expense. Non-trading derivatives typically involve physical delivery of the underlying commodity and are therefore generally presented on a gross basis.
Derivatives are classified as non-trading only when (a) the contracts involve the purchase of gas or electricity to serve our native load requirements (end-use customers within our public utility companies’ franchise service territory), or (b) the contracts involve the sale of gas or electricity and we have the intent and projected ability to fulfill substantially all obligations from company-owned assets, which generally is limited to the sale of generation to third parties when it is not required to meet native load requirements.
Energy activities that do not principally involve derivatives (e.g., natural gas sales from storage) are presented on a gross basis.
2.               Net Reporting
Net reporting requires presentation of realized and unrealized gains and losses on trading derivatives on a net basis in Operating Revenues. In 2003, we began reflecting the results of trading derivatives on a net basis pursuant to the requirements of EITF 02-3, regardless of whether the transactions were settled physically. Prior to 2003, the realized results for trading contracts that were physical in nature were presented on a gross basis. The presentation for 2002 has been reclassified to conform to the new presentation. See (g)(i) below for further discussion.
Energy derivatives that are not classified as non-trading based on the above requirements are deemed to be trading. Trading typically involves frequent buying and selling with the objective of generating profits from differences in price.
(c)                                  Derivatives
We account for derivatives pursuant to Statement 133, which requires all derivatives, ~~that are not exempted~~subject to certain exemptions, to be accounted for at fair value. Changes in the derivative’s fair value must be recognized currently in earnings unless specific hedge accounting criteria are met. Gains and
27

losses on derivatives that qualify as hedges can (a) offset related fair value changes on the hedged item in the ~~income statement~~Statements of Income for fair value hedges; or (b) be recorded in other comprehensive income for cash flow hedges. To qualify for hedge accounting, ~~financial instruments~~derivatives must be designated as a hedge (for example, an offset of interest rate risks) ~~at the inception of the contract~~ and must be effective at reducing the risk associated with the hedged item. Accordingly, changes in the fair values or cash flows of instruments designated as hedges must be highly correlated with changes in the fair values or cash flows of the related hedged items.

We use interest rate swaps (an agreement by two parties to exchange fixed-interest rate cash flows for floating-interest rate cash flows) and treasury locks (an agreement that fixes the yield or price on a specific treasury security for a specific period, which we sometimes use in connection with the issuance of fixed rate debt). We account for such derivatives at fair value, and we assess the effectiveness of any interest rate swaps and/or treasury locks used in hedging activities.
At March 31, 2003, the ineffectiveness of instruments that we have classified as cash flow hedges of variable-rate debt instruments was not material. Reclassification of unrealized gains or losses on cash flow hedges of debt instruments from ~~Accumulated other comprehensive income (loss)~~(i) ~~occurs as interest is accrued on the debt instrument. We currently estimate that on an after-tax basis, $5 million of unrealized losses will be reclassified as a charge to~~ ~~Interest~~ ~~during~~
25

~~the twelve-month period ending March 31, 2004. See (j)(~~iv~~) below for further discussion of Statement 133.~~
~~(c)~~          Energy Marketing and Trading
We market and trade electricity, natural gas, coal, and other energy-related products. We designate derivative transactions as trading or non-trading at the time they are originated in accordance with Emerging Issues Task Force (EITF) Issue 02-3, ~~Issues Involved in~~~~Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities~~ (EITF 02-3). Derivatives are classified as non-trading only when we have the intent and projected ability to fulfill substantially all obligations from company-owned assets. Such classification is generally limited to the sale of generation to third parties when it is not required to meet native load requirements (end-use customers within our public utility companies’ franchise service territory). All other energy derivatives (excluding electric, coal, and gas purchase contracts for use in serving our native load requirements) are classified as trading. Gas trading is comprised of transactions for which gas is physically delivered to a customer (physical gas trading), as well as transactions that are financial in nature for which delivery rarely occurs (financial gas trading). Since ~~Cinergy~~ ~~owns no gas production and has limited transmission capabilities, all gas transactions (other than procurement and sale of gas to The Cincinnati Gas & Electric Company (~~~~CG&E~~~~) and to The Union Light, Heat and Power Company (~~~~ULH&P~~) retail customers) are considered trading whether physical or financial. Certain gas and coal contracts do not meet the definition of a derivative and, therefore, are not required to be classified as trading or non-trading.
We account for ~~non-trading~~all energy trading derivatives ~~and non-derivative energy contracts on the accrual basis of accounting (accrual contracts). Non-trading~~at fair value. These derivatives are accounted for as accrual only if the contract qualifies for the normal purchases and sales scope exception in Statement 133. We account for all trading derivatives using the fair value method of accounting. Under the fair value method of accounting, unrealized trading derivatives are shown ~~at fair value~~ in our Balance Sheets as Energy risk management assets and Energy risk management liabilities. ~~All changes~~Changes in the derivative’s fair value ~~of such contracts~~represent unrealized gains and losses and are ~~reflected~~recognized as ~~gains or losses~~revenues in our Statements of ~~Income.~~ Income unless specific hedge accounting criteria are met.
In October 2002, the EITF reached a consensus in EITF 02-3 to rescind EITF Issue 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities ~~(EITF~~(EITF 98-10). ~~This decision required that~~EITF 98-10 permitted non-derivative contracts to be accounted for at fair value if certain criteria were met. Effective with the adoption of EITF 02-3 on January 1, 2003, non-derivative contracts and natural gas inventory previously accounted for at fair value were required to be accounted for on an accrual ~~basis, beginning January 1, 2003.~~basis. See ~~(j)(~~i~~) below~~(d) for further discussion.

InAs a response to this discontinuance of fair value accounting, in June 2003, weCinergy began ~~reflecting realized and unrealized gains and losses on trading~~designating derivatives ~~on a net basis~~as fair value hedges for certain volumes of our natural gas inventory. Under this accounting election, changes in ~~Operating Revenues~~ ~~pursuant to~~ the ~~requirements~~fair value of ~~EITF 02-3, regardless of whether~~both the ~~transactions were settled physically. Prior to 2003, the realized results for trading contracts that were physical in nature were presented as either (a)~~ ~~Operating Revenues~~,~~if sales contractsor (b)~~ ~~Fuel and purchased and exchanged power~~ ~~expense or~~ ~~Gas purchased~~ ~~expense, if purchase contracts. The presentation for 2002 has been reclassified to conform to the new presentation. Non-trading derivatives,~~derivative as well as ~~substantially all energy marketing contracts that~~the hedged item (the specified inventory) are ~~not~~included in the Statements of Income. We assess the effectiveness of the derivatives ~~are presented~~in offsetting the change in fair value of the inventory on a ~~gross basis in~~ ~~Operating Revenues~~ or ~~Fuel and purchased and exchanged power~~ ~~expense. (For more information see Note 3).~~quarterly basis. For the three months ended, September 30, 2003, the hedges’ ineffectiveness was not material.

26Non-trading derivatives involve the physical delivery of energy and are therefore typically accounted for as accrual contracts, unless the contract does not qualify for the normal purchases and sales scope exception in Statement 133.

Although we intend to settle accrual contracts with company-owned assets, occasionally we settle these contracts with purchases on the open trading markets. The cost of these purchases could be in excess of the associated revenues. We recognize the gains or losses on these transactions as delivery occurs. Due to the infrequency of such settlements, both historical and projected, and the fact that physical settlement to the customer still occurs, we continue to apply the normal purchases and sales exemption to such physical contracts that constitute derivatives. Open market purchases may occur for the following reasons:

•                  generating station outages;
•                  least-cost alternative;
•                  native load requirements; and
•                  extreme weather.

We anticipate that some of the electricity obligations, even though considered trading derivatives, will ultimately be settled using company-owned generation. The variable cost of this generation is usually below the market price at which the trading portfolio has been valued. The potential for earnings volatility from period to period is increased due to the risks associated with marketing and trading electricity, natural gas, and other energy-related products.28

We value ~~trading~~ derivatives using end-of-the-period fair values, utilizing the following factors (as applicable):

•                  closing exchange prices (that is, closing prices for standardized electricity and natural gas products traded on an organized exchange, such as the New York Mercantile Exchange);
•                  broker-dealer and over-the-counter price quotations; and
•                  model pricing (which considers time value and historical volatility factors of electricity and natural gas).

(ii)      Financial
We use interest rate swaps (an agreement by two parties to exchange fixed-interest rate cash flows for floating-interest rate cash flows) and treasury locks (an agreement that fixes the yield or price on a specific treasury security for a specific period, which we sometimes use in connection with the issuance of fixed rate debt). We account for such derivatives at fair value and assess the effectiveness of any such derivative used in hedging activities.
At September 30, 2003, the ineffectiveness of instruments that we have classified as fair value or cash flow hedges of debt instruments was not material. Reclassification of unrealized gains or losses on cash flow hedges of debt instruments from Accumulated other comprehensive income (loss) occurs as interest is accrued on the debt instrument. The unrealized losses that will be reclassified as a charge to Interest Expense during the twelve-month period ending September 30, 2004 is not expected to be material.
(d)                                  Inventory
~~Inventory~~
Prior to January 1, 2003, natural gas inventory for our ~~domestic~~ gas trading operation ~~Cinergy Marketing & Trading, LP (Marketing & Trading)~~ was accounted for at fair value. All other inventory was accounted for at the lower of cost or market, cost being determined through the weighted average method. Effective January 1, 2003, accounting for ~~Marketing & Trading’s~~our gas trading operation’s inventory was adjusted to the lower of cost or market method with a cumulative effect adjustment, as required by EITF 02-3. ~~See (j)(~~i~~) below for additional discussion of the~~The impacts of adopting EITF ~~02-3.~~02-3 are discussed in (g)(i).

(e)                                  Stock-Based Compensation
~~Intangible Assets~~
Goodwill and other intangibles with indefinite lives are not amortized. Goodwill is assessed for impairment annually, or when circumstances indicate that the fair value of a reporting unit has declined significantly, by applying a fair-value-based test. This test is applied at the “reporting unit” level, which is not broader than the current business segments discussed in Note 8. Acquired intangible assets are separately recognized if the benefit of the intangible asset is
27

~~obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of intent to do so.~~
~~(f)~~                                    ~~Impairment of Long-lived Assets~~
We evaluate long-lived assets for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. So long as an asset or group of assets is not held for sale, the determination of whether an impairment has occurred is based on an estimate of undiscounted future cash flows attributable to the assets, as compared with the carrying value of the assets. If an impairment has occurred, the amount of the impairment recognized is determined by estimating the fair value of the assets and recording a provision for an impairment loss if the carrying value is greater than the fair value. Once assets are classified as held for sale, the comparison of undiscounted cash flows to carrying value is disregarded and an impairment loss is recognized for any amount by which the carrying value exceeds the fair value of the assets.
~~Cinergy~~ ~~has classified certain non-core investments as held for sale. The results of operations for these investments are presented as~~ ~~Discontinued operations, net of tax~~ ~~in our financial statements.~~
~~(g)~~                                 ~~Stock-Based Compensation~~
~~We have historically accounted for our stock-based compensation plans using the intrinsic value method under Accounting Principles Board (APB) Opinion No. 25,~~ ~~Accounting for Stock Issued to Employees~~ ~~(APB 25).~~ Effective January 1, 2003, Cinergy adopted prospectively the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation~~(Statement 123)~~, as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure ~~(Statement 148)~~, for all employee awards granted or modified after January 1, 2003. Prior to 2003, we accounted for all stock-based compensation plans using the intrinsic value method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. The following table illustrates the effect on our Net Income and Earnings Per Common Share (EPS) if the fair value based method had been applied to all outstanding and unvested awards in each period.

2829

Quarter Ended March 31

Quarter Ended September 30

Year to Date September 30

(in millions, except per share
amounts)

(in millions, except per share amounts)

2003

2002

2003

2002

2003

2002

Net income, as reported
Net income, as reported

$
166

$
85

$
112

$
131

$
363

$
260

Add:
Stock-based employee compensation expense included in reported net income, net of related tax effects.

4

3

Add: Stock-based employee compensation expense included in reported net income, net of related tax effects.

3

5

12

10

Deduct:
Stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects.

5

3

Deduct: Stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects.

4

5

14

11

Pro-forma net income
Pro-forma net income

$
165

$
85

$
111

$
131

$
361

$
259

EPS - as reported
EPS - as reported

$
0.96

$
0.52

$
0.63

$
0.78

$
2.06

$
1.57

EPS - pro-forma
EPS - pro-forma

$
0.95

$
0.52

$
0.63

$
0.78

$
2.05

$
1.56

EPS Assuming Dilution - as reported

$
0.95

$
0.52

EPS Assuming Dilution - pro-forma

$
0.94

$
0.52

EPS assuming dilution - as reported

$
0.62

$
0.77

$
2.04

$
1.55

EPS assuming dilution - pro-forma

$
0.62

$
0.77

$
2.03

$
1.54

The pro-forma amounts reflect certain assumptions used in estimating fair values. As a result of this and other factors which may ~~effect~~affect the timing and amounts of stock-based compensation, the pro-forma effect on Net Income and EPS may not be representative of future periods.

~~(h)~~(f)                                    Asset Retirement Obligations
We recognize the fair value of legal obligations associated with the retirement or removal of long-lived assets at the time the obligations are incurred. The initial recognition of this liability is accompanied by a corresponding increase in property, plant, and equipment. Subsequent to the initial recognition, the liability is adjusted for any revisions to the expected cash flows of the retirement obligation (with corresponding adjustments to property, plant, and equipment), and for accretion of the liability due to the passage of time (recognized as ~~an operation~~Operation and maintenance expense). Additional depreciation expense is recorded prospectively for any property, plant, and equipment increases.

We do not recognize liabilities for asset retirement obligations for which the fair value cannot be reasonably estimated. CG&E and ~~PSI Energy, Inc. (~~PSI) have asset retirement obligations associated with river structures at certain generating stations. However, the retirement date for these river structures cannot be ~~determined;~~reasonably estimated; therefore, the fair value of the associated liability currently cannot be estimated and no amounts are recognized in the financial statements herein.

Effective with our adoption 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 of removal when no obligation associated with retirement or removal exists for any of our non-regulated assets, even if removal of the asset is likely. For our rate-regulated assets where our tariff rate
29

includes a cost of removal component, we recognize a charge for estimated cost of removal under Statement of Financial Accounting Standards No. 71,
30

Accounting for the Effects of Certain Types of Regulation (Statement 71), as part of depreciation. This includes most assets for PSI, CG&E, except for its generating assets, and ULH&P. See ~~(j)~~(g)(~~iii~~vi) for additional information.

~~(i)~~(g)                                 Accounting Changes
~~Operating Revenues~~
~~Our operating companies record~~ ~~Operating revenues~~ for electric and gas service when delivered to customers. Customers are billed throughout the month as both gas and electric meters are read. We recognize revenues for retail energy sales that have not yet been billed, but where gas or electricity has been consumed. This is termed “unbilled revenue” and is a widely recognized and accepted practice for utilities. In making our estimates of unbilled revenue, we use complex systems that consider various factors, including weather, in our calculation of retail customer consumption at the end of each month. Given the use of these systems and the fact that customers are billed monthly, we believe it is unlikely that materially different results will occur in future periods when revenue is subsequently billed.
~~The amount of unbilled revenues for~~ ~~Cinergy~~, ~~CG&E~~, ~~PSI~~~~, and~~ ~~ULH&P~~ ~~as of March 31, 2003 and 2002, were as follows:~~

2003

2002

(in millions)

Cinergy

$
119

$
123

CG&E and subsidiaries

67

68

PSI

52

55

ULH&P

12

11

~~(j)~~                                    ~~Accounting Changes~~
(i)          Energy Trading
In October 2002, the EITF reached consensus in EITF 02-3, to (a) rescind EITF 98-10, (b) generally preclude the recognition of gains at the inception of ~~new~~ derivatives, and (c) require all realized and unrealized gains and losses on energy trading derivatives to be presented net in the Statements of Income, whether or not settled physically. The consensus to rescind EITF 98-10 required most energy trading contracts that do not qualify as derivatives to be accounted for on an accrual basis, rather than at fair value. The consensus was immediately effective for all new contracts executed after October 25, 2002, and required a cumulative effect adjustment to income, net of tax, on January 1, 2003, for all contracts executed on or prior to October 25, 2002. The cumulative effect adjustment, on a net of tax basis, was a loss of $13 million for Cinergy and $8 million for CG&E, which includes primarily the impact of certain coal contracts, gas inventory, and certain gas contracts, which were all accounted for at fair value. We expect ~~the ongoing impact of~~ this rescission to have the largest ongoing impact on our gas trading business, which uses financial contracts, physical contracts, and gas inventory to take advantage of various arbitrage opportunities. Prior to the rescission of EITF 98-10, all of these activities were
30

accounted for at fair value. Under the revised guidance, only certain items are accounted for at fair value, which could increase inter-period volatility in reported results of operations. As a result, we began applying fair value hedge accounting in June 2003 to certain quantities of gas inventory (more fully discussed in (c)(i) above) and are further reviewing additional applications for hedge accounting.

The consensus to require all gains and losses on energy trading derivatives to be presented net in the Statements of Income was effective January 1, 2003, and required reclassification for all periods presented. This resulted in substantial reductions in reported Operating Revenues, Fuel and purchased and exchanged power expense, and Gas purchased expense. However, Operating Income and Net Income were not affected by this change. ~~See Note 3~~
31

The following table presents the effect of the change in revenue presentation in Operating Revenues, Fuel and purchased and exchanged power expense, and Gas purchased expense for ~~additional information.~~the quarter ended and year to date September 30, 2002.

Cinergy(1)

CG&E and
subsidiaries

PSI

(in thousands)

Quarter Ended September 30, 2002

Electric Operating Revenues as previously reported

$
2,554,687

$
1,747,379

$
776,837

Adjustment for effect of EITF 02-3 implementation

(1,574,214
)
(1,254,762
)
(306,065
)
Other(2)

(15,038
)
—

—

Electric Operating Revenues as adjusted

$
965,435

$
492,617

$
470,772

Gas Operating Revenues as previously reported

$
1,281,411

$
41,452

$
—

Adjustment for effect of EITF 02-3 implementation

(1,171,709
)
—

—

Other(2)

(5,629
)
—

—

Gas Operating Revenues as adjusted

$
104,073

$
41,452

$
—

Fuel and purchased and exchanged power expense as previously reported

$
1,871,365

$
1,391,221

$
474,748

Adjustment for effect of EITF 02-3 implementation

(1,555,263
)
(1,254,762
)
(306,065
)
Other(2)

(13,736
)
—

—

Fuel and purchased and exchanged power expense as adjusted

$
302,366

$
136,459

$
168,683

Gas purchased expense as previously reported

$
1,243,507

$
12,594

$
—

Adjustment for effect of EITF 02-3 implementation

(1,190,659
)
—

—

Other(2)

(3,565
)
—

—

Gas purchased expense as adjusted

$
49,283

$
12,594

$
—

Year to Date September 30, 2002

Electric Operating Revenues as previously reported

$
5,178,481

$
3,249,715

$
1,874,109

Adjustment for effect of EITF 02-3 implementation

(2,578,261
)
(1,948,273
)
(658,318
)
Other(2)

(68,937
)
—

—

Electric Operating Revenues as adjusted

$
2,531,283

$
1,301,442

$
1,215,791

Gas Operating Revenues as previously reported

$
3,301,625

$
277,069

$
—

Adjustment for effect of EITF 02-3 implementation

(2,921,651
)
—

—

Other(2)

(5,629
)
—

—

Gas Operating Revenues as adjusted

$
374,345

$
277,069

$
—

Fuel and purchased and exchanged power expense as previously reported

$
3,357,585

$
2,300,565

$
1,078,596

Adjustment for effect of EITF 02-3 implementation

(2,549,301
)
(1,948,273
)
(658,318
)
Other(2)

(46,426
)
—

—

Fuel and purchased and exchanged power expense as adjusted

$
761,858

$
352,292

$
420,278

Gas purchased expense as previously reported

$
3,142,899

$
145,033

$
—

Adjustment for effect of EITF 02-3 implementation

(2,950,609
)
—

—

Other(2)

(3,565
)
—

—

Gas purchased expense as adjusted

$
188,725

$
145,033

$
—

(1)          The results of Cinergy also include amounts related to non-registrants and include the elimination of certain intercompany amounts.
(2)          Item represents amounts reclassified to Discontinued operations, net of tax.
32

(ii)                ~~Business Combinations and Intangible Assets~~      Derivatives

In ~~June 2001,~~May 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. ~~141,~~149, ~~Business Combinations~~Amendment of Statement 133 on Derivative Instruments and Hedging Activities (Statement ~~141)~~149). Statement 149 primarily amends Statement 133 to incorporate implementation conclusions previously cleared by the FASB staff, to clarify the definition of a derivative and to require derivative instruments that include up-front cash payments to be classified as a financing activity in the Statements of Cash Flows. Implementation issues that had been previously cleared by the FASB staff were effective at the time that they were cleared and new guidance was effective in the third quarter of 2003. In connection with our adoption, we reviewed certain power purchase or sale contracts to determine if they met the revised normal purchase and normal sale scope exception criteria in Statement 149. If these criteria were not met, the contract was accounted for at fair value. The impact of adopting Statement 149 was not material to our results of operations or financial position.
In June 2003, the FASB issued final guidance on the use of broad market indices (e.g., consumer price index) in power purchase and sales contracts. This guidance clarifies that the normal purchases and sales scope exception is precluded if a contract contains a broad market index that is not clearly and closely related to the asset being sold or purchased (or a direct factor in the production of the asset sold or purchased). The guidance provides criteria that must be met for the index to be considered clearly and closely related. This guidance, which is effective in the fourth quarter of 2003, is not expected to have a material impact on our results of operations or financial position upon adoption.
(iii) Consolidation of Variable Interest Entities (VIE)
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (Interpretation 46), which significantly changes the consolidation requirements for traditional special purpose entities (SPE) and certain other entities subject to its scope. This interpretation defines a VIE as (a) an entity that does not have sufficient equity to support its activities without additional financial support or (b) an entity that has equity investors that do not have voting rights or do not absorb losses or receive returns. These entities must be consolidated when certain criteria are met. The interpretation was originally to be effective as of July 1, 2003 for Cinergy; however, the FASB subsequently permitted deferral of the effective date to December 31, 2003 for either some or all potential VIEs. During this deferral period, the FASB plans to clarify and amend several provisions, much of which is intended to assist in the application of Interpretation 46 to operating entities. Clarifications were not needed for most traditional SPEs and we therefore elected to implement Interpretation 46 for such entities, as discussed below, in accordance with the original implementation date of July 1, 2003. Prior period financial statements were not restated for these changes.
Interpretation 46 requires us to consolidate two SPEs that have individual power sale agreements to Central Maine Power Company (CMP) for approximately 45 megawatts (MW) of capacity, ending in 2009, and 35 MW of capacity, ending in 2016. In addition, these SPEs have individual power purchase agreements with Cinergy Capital & Trading, Inc. (Capital & Trading) to supply the power. Capital & Trading also provides various services, including certain credit support
33

facilities. Upon the initial consolidation of these two SPEs, approximately $239 million of notes receivable, $225 million of non-recourse debt, and miscellaneous other assets and liabilities were included on Cinergy’s Balance Sheets. The debt was incurred by the SPEs to finance the buyout of existing power contracts that CMP held with former suppliers. The cash flows from the notes receivable are designed to repay the debt. Notes 3 and 4 provide additional information regarding the debt and the notes receivable, respectively.
In accordance with Interpretation 46, we are no longer permitted to consolidate a trust that was established by Cinergy Corp. in 2001 toissue approximately $316 million of combined preferred trust securities and stock purchase contracts. These securities are more fully described in the 2002 10-K. In 2001, the trust loaned the proceeds from the issuance of the securities to Cinergy Corp. in exchange for a note payable to the trust that was eliminated in consolidation. As a result of no longer consolidating the trust beginning July 1, 2003, the preferred trust securities (previously recorded as Company obligated, mandatorily redeemable, preferred trust securities of subsidiary, holding solely debt securities of the company) are no longer included in Cinergy’s Balance Sheets. In addition, the note payable owed to the trust, which has a current carrying value of approximately $319 million, was included in Long-term debt. The impact of not consolidating the trust was immaterial to Cinergy’s results of operations.
Cinergy has concluded that its accounts receivable sale facility, as discussed in the 2002 10-K, will remain unconsolidated since it involves transfers of financial assets to a qualifying SPE, which is exempted from consolidation by Interpretation 46 and Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.
Cinergy is continuing to evaluate the impact of Interpretation 46 on several operating joint ventures, primarily involved in cogeneration and energy efficiency operations, that we currently do not consolidate. If all these entities were consolidated, their total assets of approximately $675 million (the majority of which is non-current) and total liabilities of approximately $225 million (which includes long-term debt of approximately $100 million) would be recognized on our Balance Sheets. Cinergy’s current investment in these entities is approximately $250 million. We also guarantee certain performance obligations of these entities with an estimated maximum potential exposure of approximately $55 million, as disclosed in Note 7(a). As discussed above, we expect additional interpretative guidance to be issued by the FASB during the fourth quarter of 2003 and Cinergy will adopt those provisions effective December 31, 2003.
(iv)    Financial Instruments with Characteristics of Both Liabilities and Equity
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (Statement 150). Statement 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement was effective for financial instruments entered into or modified after May 31, 2003, and was effective on July 1, 2003, for financial instruments held prior to issuance of this statement. Statement 150 would have required Cinergy Corp.’s preferred trust securities to be reported as a liability; however, as described more fully above, the trust holding these securities is no longer permitted to be consolidated and the preferred trust securities are no longer reported on
34

Cinergy’s Balance Sheets. However, Cinergy’s note payable to the trust is recorded on the Balance Sheets as Long-term debt. As a result, the impact of adopting Statement 150 was not material to our results of operations or financial position.
As discussed in the 2002 10-K, Cinergy issued forward stock sale contracts that require purchase by the holder of a certain number of Cinergy shares in February 2005 (stock contracts). The number of shares to be issued is contingent on the market price of Cinergy Corp. stock, but subject to a predetermined ceiling and floor price. In October 2003, the FASB Staff released an interpretation of Statement 150 that requires an evaluation of these stock contracts to determine whether they constitute a liability, with any changes in accounting required in January 2004. We believe that this interpretation will have no impact on our current accounting.
(v)        Intangible Assets
In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (Statement 142). ~~Statement 141 requires all business combinations initiated after June 30, 2001, to be accounted for using the purchase method.~~ With the adoption of Statement 142, goodwill and other intangibles with indefinite lives ~~will~~are no longer be subject to amortization. Statement 142 requires that goodwill be assessed for impairment upon adoption (transition impairment test) and at least annually thereafter by applying a fair-value-based test, as opposed to the undiscounted cash flow test applied under prior accounting standards. This test must be applied at the “reporting unit” level, which is not permitted to be broader than the current business segments discussed in Note 8. Under Statement 142, an acquired intangible asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer’s intent to do so.

We began applying Statement ~~141 in the third quarter of 2001 and Statement~~ 142 in the first quarter of 2002. ~~The discontinuance of amortization of goodwill, which began in the first quarter of 2002, was not material to our financial position or results of operations.~~ We finalized our transition impairment test in the fourth quarter of 2002 and ~~have~~ recognized a non-cash impairment charge of approximately $11 million (net of tax) for goodwill related to certain of our international assets. This amount is reflected in Cinergy’s Statements of Income as a ~~Cumulative~~cumulative effect ~~of a change in accounting principles,~~adjustment, net of ~~tax~~.tax. While Statement 142 did not require the initial transition impairment test to be completed until December 31, 2002, it required ~~a transition impairment charge~~the cumulative effect adjustment to be reflected as of January 1, 2002. ~~We will continue to perform goodwill impairment tests annually, as required by Statement 142, or when circumstances indicate that the fair value of a reporting unit has declined significantly.~~

Cinergy Corp.’s condensed financial results below revise previously reported results as filed in the Form 10-Q for the year to date period ended September 30, 2002, to reflect the impairment charge as of January 1, 2002.

Year to Date
September 30, 2002

Net
Income

EPS

EPS-
Assuming
Dilution

(in millions, except for EPS)

Reported results

$
271

$
1.63

$
1.61

Cumulative effect of a change in accounting principle, net of tax

(11
)
(0.06
)
(0.06
)
Revised results

$
260

$
1.57

$
1.55

35

~~(iii)~~(vi)    Asset Retirement Obligations

In July 2001, the FASB issued Statement 143, which requires fair value recognition beginning January 1, 2003, of legal obligations associated with the retirement or removal of long-lived assets, at the time the obligations are incurred. ~~The initial recognition of this liability~~Our accounting policy for such legal obligations is ~~accompanied by a corresponding increase~~described in property, plant, and equipment. Subsequent to the initial recognition, the liability is adjusted for any revisions to the expected cash flows of the retirement obligation (with corresponding adjustments to property, plant, and equipment), and
31

for accretion of the liability due to the passage of time (recognized as an operation expense). Additional depreciation expense is recorded prospectively for any property, plant, and equipment increases.
We previously accrued costs of removal on many long-lived assets through depreciation expense if we believed removal of the assets at the end of their useful life was likely. The Securities and Exchange Commission (SEC) staff has interpreted Statement 143 to disallow the accrual of estimated cost of removal when no obligation exists under Statement 143, even if removal of the asset is likely. As a result, all accumulated cost of removal for our non-regulated assets, primarily ~~CG&E’s~~ generation assets, was reversed upon adoption. However, accrued cost of removal for rate-regulated assets is recoverable through our rates as a component of depreciation. Since Statement 71 applies, accruing estimated cost of removal continues to be acceptable. As a result, accumulated cost of removal was not reversed upon adoption of Statement 143 for the rate-regulated assets of ~~PSI~~, ~~CG&E~~~~, and~~ ~~ULH&P~~.(f) above.

We adopted Statement 143 on 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 accounting principle. Substantially all of this adjustment reflects the reversal of previously accrued cost of removal for CG&E’s generating assets, which do not apply Statement 71. Accumulated ~~Depreciation~~depreciation at adoption includes $316 million, $25 million, and $146 million of accumulated cost of removal 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 the cumulative effect adjustment. The increases in assets and liabilities from adopting Statement 143 were not material to our financial position.

Pro-forma results as if Statement 143 was applied retroactively for the years ended December 31, 2002, 2001, and 2000 and the quarter ended ~~March 31,~~and year to date September 30, 2002 are not materially different from reported results.

~~(iv)~~              ~~Derivatives~~
~~During 1998, the FASB issued Statement 133. This standard was effective for~~ ~~Cinergy~~ ~~beginning~~(vii) Cumulative Effect of Changes in ~~2001, and requires us to record derivative instruments, which are not exempt under certain provisions~~Accounting Principles, Net of Statement 133, as assets or liabilities, measured at fair value (i.e., mark-to-market). Our financial statements reflect the adoption of Statement 133 in the first quarter of 2001. Since many of our derivatives were previously required to use fair value accounting, the effects of implementation were not material.Tax
~~In May 2003, the FASB issued Statement of Financial Accounting Standards No. 149,~~ ~~Amendment of Statement 133 on Derivative Instruments and Hedging Activities~~ (Statement 149). Statement 149 primarily amends Statement 133 to incorporate implementation conclusions previously cleared by the FASB staff, to clarify the definition of a derivative and to require derivative instruments that include up-front cash payments to be classified as a financing activity in the statement of cash flows. Implementation issues that have been previously cleared by the FASB staff will continue to be applied in accordance with their respective effective dates at the time that they were cleared and new guidance has varying implementation provisions, none of
32

which will apply until the third quarter of 2003. We have begun to evaluate the impacts of adopting Statement 149 but are currently unable to determine whether the impacts will be material to our results of operations or financial position.
There has been recent discussion about the use of broad market indices (e.g., consumer price index) in power sales contracts and whether such indices disqualify capacity contracts that otherwise qualify for the use of the normal purchases and sales scope exception. In April 2003, the FASB staff provided some proposed clarifications on this issue. This guidance is currently open for public comment. We expect this guidance to be finalized sometime during the summer of 2003, with a proposed effective date for ~~Cinergy~~ of October 1, 2003. We are unable to determine whether the impact of this recent interpretation would be material to our results of operations or financial position until the FASB staff finalizes its guidance.
~~(v)~~                  ~~Exit Activities~~
~~In August 2002, the FASB issued Statement of Financial Accounting Standards No. 146,~~ ~~Accounting for Costs Associated with Exit or Disposal Activities~~ (Statement 146). Statement 146 addresses accounting and reporting for the recognition of exit costs, including, but not limited to, one-time employee benefit terminations, contract cancellations, and facility consolidations. This statement requires that such costs be recognized only when they meet the definition of a liability under generally accepted accounting principles. However, Statement 146 applies only to exit activities initiated in 2003 and after. All costs recorded through December 31, 2002, were unaffected by this pronouncement. The impact of adoption on our financial position and results of operations was not material.
~~(vi)~~              ~~Accounting for Stock-Based Compensation~~
~~We have historically accounted for our stock-based compensation plans under APB 25. In July 2002,~~ ~~Cinergy~~ announced that it would adopt Statement 123 for all employee awards granted or modified after January 1, 2003, and would begin measuring the compensation cost of stock-based awards under the fair value method. In December 2002, the FASB issued Statement 148, which amends Statement 123 and APB Opinion No. 28, ~~Interim Financial Reporting~~. Statement 148 provides alternative methods of transition to Statement 123 and more expanded disclosures about the method of accounting for stock-based employee compensation and the effect of the method used on reported results in both annual and interim financial statements. ~~Cinergy~~ adopted Statement 148 on January 1, 2003, and has adopted the transition provisions that require expensing options prospectively beginning in the year of adoption. Awards granted prior to January 1, 2003, will continue to follow the intrinsic value method prescribed by APB 25. The impact of adoption on our financial position and results of operations, assuming award levels and fair values similar to past years, is not material. This change will primarily impact the accounting for stock options and other performance based awards related to the Cinergy Corp. 1996 Long-Term Incentive Compensation Plan, the Cinergy Corp. Employee Stock Purchase and Savings Plan, and the Cinergy Corp. Stock Option Plan.
33

~~(vii)~~          ~~Consolidation of Special Purpose Entities (SPE)~~
~~The FASB issued Interpretation No. 46,~~ ~~Consolidation of Variable Interest Entities~~ in January 2003. This interpretation will significantly change the consolidation requirements for SPEs. We have begun reviewing the impact of this interpretation but have not yet concluded whether consolidation of certain SPEs will be required. There are two SPEs for which consolidation may be required. These SPEs have individual power sale agreements to an unrelated third party for approximately 45 megawatts (MW) of capacity, ending in 2009, and 35 MW of capacity, ending in 2016. In addition, the SPEs have individual power purchase agreements with Cinergy Capital & Trading, Inc. (Capital & Trading) to supply the power. Capital & Trading also provides various services, including certain credit support facilities.
~~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 and exposure under the capped credit facilities of approximately $25 million. There is also a non-capped facility, but it can only be called upon in the event the SPE breaches representations, violates covenants, or other unlikely events.
If appropriate, consolidation of all assets and liabilities of these two SPEs, at their carrying values, will be required in the third quarter of 2003. Approximately $225 million of non-recourse debt would be included in ~~Cinergy’s~~ ~~Balance Sheet upon initial consolidation. However, the impact on results of operations would be expected to be immaterial.~~
~~Cinergy~~ believes that its accounts receivable sale facility, as discussed in the 2002 10-K, would remain unconsolidated since it involves transfers of financial assets to a qualifying SPE, which is exempted from consolidation by Statement of Financial Accounting Standards No. 140, ~~Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities~~ ~~and this interpretation.~~
34

~~(viii)~~      ~~Cumulative effect of a change in accounting principles, net of tax~~

The following table summarizes the various cumulative effect adjustments (net of tax) discussed above for the rescission of EITF 98-10 and the adoption of Statement 142 and Statement 143:

Quarter Ended March 31

Year to Date September 30

2003

2002

2003

2002

(in thousands)

(in thousands)

Cinergy(1)

Cinergy(1)

Goodwill impairment (Statement 142 adoption)

$
—

$
(10,899
)

$
—

$
(10,899
)
Rescission of EITF 98-10 (EITF 02-3 adoption)

(12,512
)
—

(12,512
)
—

Asset retirement obligation (Statement 143 adoption)

38,974

—

38,974

—

26,462

(10,899
)

$
26,462

$
(10,899
)
CG&E

Rescission of EITF 98-10 (EITF 02-3 adoption)

(8,239
)
—

$
(8,239
)
$
—

Asset retirement obligation (Statement 143 adoption)

39,177

—

39,177

—

30,938

—

$
30,938

$
—

PSI

Rescission of EITF 98-10 (EITF 02-3 adoption)

(494
)
—

$
(494
)
$
—

(494
)
—

$
(494
)
$
—

(1)          The results of Cinergy also include amounts related to non-registrants.
36
~~(1)~~
~~The results of~~ ~~Cinergy~~

~~also include amounts related to non-registrants.~~

2.              Common Stock Equity
(a)                                  Changes In Common Stock Outstanding
As discussed in the 2002 10-K, Cinergy ~~currently~~ issues new Cinergy Corp. common stock shares to satisfy obligations under its various employee stock plans and the Cinergy Corp. Direct Stock Purchase and Dividend Reinvestment Plan. During ~~the first quarter of~~ 2003, Cinergy has issued approximately ~~1.5~~3.5 million shares under these plans.

On January 15, 2003, Cinergy Corp. filed a registration statement with the ~~SEC~~Securities and Exchange Commission (SEC) with respect to the issuance of common stock, preferred stock, and other securities in an aggregate offering amount of $750 million. On February 5, 2003, Cinergy sold 5.7 million shares of common stock of Cinergy Corp. with net proceeds of approximately $175 million under this registration statement. The net proceeds from the transaction were used to reduce short-term debt of Cinergy Corp. and for other general corporate purposes.

3.(b)                                  Stock-Based Compensation Plan
The Compensation Committee of the Board of Directors (Compensation Committee) grants certain performance share awards under the Cinergy Corp.                        ~~Change~~ 1996 Long-Term Incentive Compensation Plan (LTIP). Historically, the performance shares have been paid 100 percent in ~~Method~~the form of ~~Revenue Presentation for Energy Trading Derivatives~~common stock. In order to maintain market-competitiveness with respect to the form of LTIP awards and to ensure continued compliance with internal guidelines on common share dilution, the Compensation Committee approved the future payment of performance share awards 50 percent in common stock and 50 percent in cash. As a result, we have reclassified the expected cash payout portion of the performance shares from Paid-in capital to other current liabilities and other non-current liabilities.

~~In October 2002, the EITF reached consensus~~(c)                                  Contributed Capital
Cinergy Corp. contributed $200 million in ~~EITF 02-3~~capital to ~~require all realized and unrealized gains and losses on energy trading derivatives to be presented net~~PSI in two separate $100 million capital contributions in the ~~Statements~~second and third quarters of ~~Income, whether or not settled physically. This consensus was effective beginning January 1,~~ 2003, ~~and required reclassification for the quarter ended March 31, 2002.~~
35

~~We have reclassified amounts in our Statements of Income in accordance with EITF 02-3. The table below presents the effect of the change in revenue presentation on~~ ~~Operating Revenues, Fuel and purchased and exchanged power~~ ~~expense, and~~ ~~Gas purchased~~ ~~expense for the quarter ended March 31, 2002.~~ ~~Operating Income~~ ~~and~~ ~~Net Income~~respectively. These capital contributions were ~~not affected by this change.~~made to support PSI’s current credit ratings.

Cinergy(1)

CG&E and subsidiaries

PSI

(in thousands)

Electric Operating Revenues as previously reported

$
1,283,424

$
635,886

$
629,844

Adjustment for effect of EITF 02-3 implementation

(492,921
)
(237,767
)
(263,443
)
Other(2)

(11,127
)
—

—

Electric Operating Revenues as adjusted

779,376

398,119

366,401

Gas Operating Revenues as previously reported

903,261

179,609

—

Adjustment for effect of EITF 02-3 implementation

(713,197
)
—

—

Gas Operating Revenues as adjusted

190,064

179,609

—

Fuel and purchased and exchanged power expense as previously reported

727,547

345,015

386,492

Adjustment for effect of EITF 02-3 implementation

(492,921
)
(237,767
)
(263,443
)
Other(2)

(5,336
)
—

—

Fuel and purchased and exchanged power expense as adjusted

229,290

107,248

123,049

Gas purchased expense as previously reported

823,077

107,968

—

Adjustment for effect of EITF 02-3 implementation

(713,197
)
—

—

Gas purchased expense as adjusted

109,880

107,968

—

~~(1)~~
~~The results of~~ ~~Cinergy~~ ~~also include amounts related to non-registrants and include the elimination of certain intercompany amounts.~~
~~(2)~~
~~Item represents amounts reclassified to~~ ~~Discontinued operations, net of tax~~.

4.3.              Long-term Debt
In October 2002, PSI filed a petition with the Indiana Utility Regulatory Commission (IURC) for the purpose of securing authorization and approval to issue two subordinated promissory notes to Cinergy Corp. for the acquisition of the Butler County, Ohio and Henry County, Indiana peaking plants. In January 2003, the IURC granted this request, and in February 2003, PSI issued the notes. One subordinated note was for the principal amount of $200 million with an annual interest rate of ~~6.302% and will~~6.30% scheduled to mature on April 15, 2004. The second subordinated note was for $176 million with an annual interest rate of ~~6.403% and will~~6.40% scheduled to mature on September 1, 2004.

36

OnIn March 7, 2003, PSI borrowed the proceeds from the issuance by the Indiana Development Finance Authority of $35 million of its Environmental Refunding Revenue Bonds Series 2003,
37

due April 1, 2022. Interest was initially set at 1.05% and ~~will reset~~resets every 35 days by auction. The bonds are not putable by the holders; therefore, PSI’s debt obligation is classified as Long-term debt. OnLater in March ~~28,~~ 2003, the proceeds from this borrowing plus the interest income earned were used to cause the refunding of the $35 million principal amount outstanding of the City of Princeton, Indiana Pollution Control Revenue Refunding Bonds, 1997 Series.

OnIn 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

In June 2003, CG&E issued $200 million principal amount of its 5 3/8% 2003 Series B Debentures due June 15, 2033 (effective interest rate of 5.66%). Proceeds from this issuance were used for general corporate purposes, including the funding of capital expenditures related to construction projects and environmental compliance initiatives, and the repayment of outstanding indebtedness.
Also, in June 2003, CG&E modified existing debt resulting in a $200 million principal amount 5.40% 2003 Series A Debenture with a 30 year maturity. The effective interest rate is 6.90%. In June 2003, CG&E redeemed its $100 million 8.28% Junior Subordinated Debentures due July 1, 2025.
Cinergy adopted Interpretation 46 on July 1, 2003, as discussed in Note 1(g)(iii). The adoption of this new accounting principle had the following effects on long-term debt:
•Cinergy no longer consolidates the trust that held Company obligated, mandatorily redeemable, preferred trust securities of subsidiary, holding solely debt securities of the company. This resulted in the removal of these securities from our Balance Sheets and the addition to long-term debt of a $319 million note payable that Cinergy owes to the trust.
•Cinergy consolidated two SPEs effective July 1, 2003. As a result, Cinergy has approximately $221 million of additional non-recourse debt as of September 30, 2003, comprised of two separate notes.
The first note, with a September 30, 2003 balance of $114 million bears an interest rate of 7.81% and matures in June 2009. The second note, with a September 30, 2003 balance of $107 million, bears an interest rate of 9.23% and matures in November 2016.
38
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

The following table reflects the long-term maturities for this non-recourse debt.
Selected Long-term Debt Maturities

Cinergy

(in millions)

Next 12 months

$
17

13-24 months

19

25-36 months

22

37-48 months

24

49-60 months

27

Thereafter

112

$
221

In September 2003, PSI redeemed $56 million of its 5.93% Series B, Medium-term Notes at maturity.
In September 2003, PSI issued $400 million principal amount of its 5.00% Debentures due September 15, 2013 (effective interest rate of 5.20%). Proceeds from this issuance were used for the early redemption at par of two intercompany promissory notes, as discussed above, totaling $376 million. The remaining proceeds were used to reduce short-term indebtedness associated with general corporate purposes including funding capital expenditures related to construction projects and environmental compliance initiatives.
In October 2003, CG&E redeemed its $265.5 million First Mortgage Bonds, 7.20% due October 1, 2023.
4.              Notes Receivable
As discussed in Note 1(g)(iii), Cinergy consolidated two previously unconsolidated SPEs effective July 1, 2003. As a result, Cinergy has approximately $235 million of additional notes receivable as of September 30, 2003, comprised of two separate notes.
The first note, with a September 30, 2003 balance of $122 million bears an effective interest rate of 7.81% and matures in August 2009. The second note, with a September 30, 2003 balance of $113 million, bears an effective interest rate of 9.23% and matures in December 2016.
39

The following table reflects the maturities of these notes.
Notes Receivable Maturities

Cinergy

(in millions)

Next 12 months

$
17

13-24 months

19

25-36 months

22

37-48 months

24

49-60 months

28

Thereafter

125

$
235

5.              Notes Payable and Other Short-term Obligations
At ~~March 31,~~September 30, 2003, Cinergy Corp. had ~~$796~~$776 million remaining unused and available capacity relating to its $1 billion revolving credit facilities. These revolving credit facilities included the following:

Credit Facility

Expiration

Established
Lines

Outstanding
and
Committed

Unused and
Available

Expiration

Established
Lines

Outstanding
and
Committed

Unused and Available

(in millions)

(in millions)

364-day senior revolving

April 2003

April 2004

Direct borrowing

$

$
—

$

$

$
—

$

Commercial paper support

193

209

Total 364-day facility

600

193

407

600

209

391

Three-year senior revolving

May 2004

May 2004

Direct borrowing

—

—

Commercial paper support

—

—

Letter of Credit support

11

15

Total three-year facility

400

11

389

400

15

385

Total credit facilities

$
1,000

$
204

$
796

$
1,000

$
224

$
776

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

37In August 2003, CG&E caused the remarketing by the Ohio Air Quality Development Authority of $84 million of its State of Ohio Air Quality Development Revenue Refunding Bonds, due
40

September 1, 2030. The issuance consists of a $42 million 1995 Series A and a $42 million 1995 Series B. The remarketing effected the conversion from a daily interest rate reset mode supported by a letter of credit to an unsecured weekly interest rate mode. The interest rate for both series was initially set at 1.30% and will reset every seven days going forward. Because the holders of these notes have the right to have their notes redeemed on a weekly basis, they are reflected in Notes payable and other short-term obligations on the Balance Sheets of Cinergy and CG&E.
Also in August 2003, CG&E caused the remarketing by the Ohio Air Quality Development Authority of $12.1 million of its State of Ohio Air Quality Development Revenue Bonds 2001 Series A due August 1, 2033. The remarketing effected the conversion from an unsecured one-year interest rate reset mode to a 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 notes redeemed on a daily basis, they are reflected in Notes payable and other short-term obligations on the Balance Sheets of Cinergy and CG&E.
41

The following table summarizes our Notes payable and other short-term obligations, and Notes payable to affiliated companies.

March 31, 2003

December 31, 2002

September 30, 2003

December 31, 2002

Established
Lines

Outstanding

Established
Lines

Outstanding

Established
Lines

Outstanding

Established
Lines

Outstanding

(in millions)

(in millions)

Cinergy

Cinergy Corp.

Revolving lines

$
1,000

$
—

$
1,000

$
25

$
1,000

$
—

$
1,000

$
25

Uncommitted lines (1)

65

—

65

—

65

—

65

—

Commercial paper (2)

193

473

209

473

Operating companies

Uncommitted lines (1)

75

—

75

—

75

—

75

—

Pollution control notes

112

147

112

147

Non-regulated subsidiaries

Revolving lines

8

1

7

1

17

9

7

1

Short-term debt

22

22

22

22

7

22

Cinergy Total

$
328

$
668

$
337

$
668

CG&E and subsidiaries

Uncommitted lines (1)

$
15

$
—

$
15

$
—

$
15

$
—

$
15

$
—

Pollution control notes

112

112

112

112

Money pool

3

9

9

9

CG&E Total

$
115

$
121

$
121

$
121

PSI

Uncommitted lines (1)

$
60

$
—

$
60

$
—

$
60

$
—

$
60

$
—

Pollution control notes

—

35

—

35

Money pool

230

138

165

138

PSI Total

$
230

$
173

$
165

$
173

ULH&P

Money pool

$
5

$
14

$
24

$
14

ULH&P Total

$
5

$
14

$
24

$
14

~~(1)~~
(1)Outstanding amounts may be greater than established lines as uncommitted lenders are, at times, willing to loan funds in excess of the established lines.
(2)          The commercial paper program is limited to $800 million and is supported by Cinergy Corp.’s revolving lines.
~~(2)~~
~~The commercial paper program is limited to $800 million and is supported by~~ ~~Cinergy Corp.’s~~ ~~revolving lines.~~

In our credit facilities, Cinergy Corp. has covenanted to maintain:

•                  a consolidated net worth of $2 billion; and
•                  a ratio of consolidated indebtedness to consolidated total capitalization not in excess of 65 percent.

3842

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

•                  bankruptcy;
•                  defaults in the payment of other indebtedness; and
•                  judgments against the company that are not paid or insured.

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

As discussed in Note 1(g)(iii), long-term debt increased in the third quarter of 2003 resulting from the adoption of Interpretation 46. The debt which was recorded as a result of this new accounting pronouncement did not cause Cinergy to be in breach of any covenants.
6.                                      Energy Trading Credit Risk
Cinergy’s extension of credit for energy marketing and trading is governed by a Corporate Credit Policy. Written guidelines document the management approval levels for credit limits, evaluation of creditworthiness, and credit risk mitigation procedures. Exposures to credit risks are measured and monitored daily by ~~the~~our Corporate Credit Risk ~~function.~~function, which is independent of all trading operations. As of ~~March 31,~~September 30, 2003, approximately 9899 percent of the credit exposure related to energy trading and marketing activity was with counterparties rated Investment Grade or the counterparties’ obligations were guaranteed or secured by ~~a parent company or other entity rated~~an Investment ~~Grade.~~Grade entity. No single non-investment grade counterparty accounts for more than one percent of our total credit exposure. Energy commodity prices can be extremely volatile and the market can, at times, lack liquidity. Because of these issues, credit risk for energy commodities is generally greater than with other commodity trading.

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

7.                                      Commitments and Contingencies
(a)                                  Guarantees
~~(a)~~ ~~Guarantees~~
In the ordinary course of business, Cinergy enters into various agreements providing financial or performance assurances to third parties on behalf of certain unconsolidated subsidiaries and joint ventures. These agreements are entered into primarily to support or enhance the creditworthiness otherwise attributed to these entities on a stand-alone basis, thereby facilitating the extension of sufficient credit to accomplish their intended commercial purposes. The guarantees have various termination dates, from short-term (less than one year) to open-ended.

43

In many cases, the maximum potential amount of an outstanding guarantee is an express term, set forth in the guarantee agreement, representing the maximum potential obligation of Cinergy under that guarantee (excluding, at times, certain legal fees to which a guaranty beneficiary may be entitled). In those cases where there is no maximum potential amount expressly set forth in
39

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

Cinergy has guaranteed the payment of ~~$33~~$32 million as of ~~March 31,~~September 30, 2003, for unconsolidated subsidiaries’ debt and for borrowings by individuals under the Director, Officer, and Key Employee Stock Purchase Program. Cinergy may be obligated to pay the debt’s principal and any related interest in the event of an unexcused breach of a guaranteed payment obligation by the unconsolidated ~~subsidiary~~subsidiaries or ~~an unexcused breach of guaranteed payment obligations~~ by certain directors, officers, and key employees. ~~The~~Most of the guarantees do not have a set termination date; however, the borrowings associated with the majority of ~~these~~the guarantees ~~expire~~are due in ~~two years.~~the first quarter of 2005.

Cinergy Corp. has also provided performance guarantees on behalf of certain unconsolidated subsidiaries and joint ventures. These guarantees support performance under various agreements and instruments (such as construction contracts, operation and maintenance agreements, and energy service agreements). Cinergy Corp. may be liable in the event of an unexcused breach of a guaranteed performance obligation by an unconsolidated subsidiary. Cinergy Corp. has estimated its maximum potential amount to be $133 million under these guarantees as of ~~March 31,~~September 30, 2003. Cinergy Corp. may also have recourse to third parties for claims required to be paid under certain of these guarantees. The majority of these guarantees expire at the completion of the underlying performance agreements, ~~generally 15~~the majority of which expire from 2016 to ~~20 years.~~2019.

Cinergy has entered into contracts that include indemnification provisions as a routine part of its business activities. Examples of these contracts include purchase and sale agreements and operating agreements. In general, these provisions indemnify the counterparty for matters such as breaches of representations and warranties and covenants contained in the contract. In some cases, particularly with respect to purchase and sale agreements, the potential liability for certain indemnification obligations is capped, in whole or in part (generally at an aggregate amount not exceeding the sale price), and subject to a deductible amount before any payments would become due. In other cases (such as indemnifications for willful misconduct of employees in a joint venture), the maximum potential amount is not estimable given that the magnitude of any claims under those indemnifications would be a function of the extent of damages actually incurred, which is not practicable to estimate unless and until the event occurs. Cinergy has estimated the maximum potential amount, where estimable, to be ~~$129~~$124 million under these indemnification ~~provisions and considers the likelihood of making any material payments under these provisions to be remote.~~provisions. The termination period for the majority of matters provided by indemnification provisions in purchase and sale agreements generally ranges from ~~one~~2003 to ~~six years.~~2009.

We believe the likelihood that Cinergy would be required to perform or otherwise incur any significant losses associated with any or all of the guarantees described in the preceding paragraphs is remote.

44

(b)                                  Ozone Transport Rulemakings
In June 1997, the Ozone Transport Assessment Group, which consisted of 37 states, made a wide range of recommendations to the Environmental Protection Agency (EPA) to address the impact of ozone transport on serious non-attainment areas (geographic areas defined by the EPA as non-compliant
40

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

(i)          Nitrogen Oxide (NO_X) State Implementation Plan (SIP) Call
In October 1998, the EPA finalized its ozone transport rule, also known as the NO_X SIP Call. It applied to 22 states in the eastern half of the United States (U.S.), including the three states in which our electric utilities operate, and proposed a model NO_X emission allowance trading program. This rule recommended that states reduce NO_X emissions primarily 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 of Columbia (Court of Appeals) extended the deadline for NO_X reductions to May 31, 2004. ~~In June 2001, the Court of Appeals remanded portions of the NO~~_X ~~SIP Call to the EPA for reconsideration of how growth was factored into the state NO~~_X ~~budgets. On May 1, 2002, the EPA published, in the Federal Register, a final rule reaffirming its growth factors and state NO~~_X ~~budgets, with additional explanation.~~ The states of West Virginia and Illinois, along with various industry groups (some of which we are a member), have challenged portions of the ~~growth factors and state NO~~_X ~~budgets~~final rule that was published on May 1, 2002, in an action filed in the Court of Appeals. A decision is expected some time after December 2003. It is unclear ~~when~~whether the Court of ~~Appeals will reach a~~Appeals’ decision in this ~~case, or whether this decision~~matter will result in an increase or decrease in the size of the NO_X reduction requirement, or a deferral of the May 31, 2004 compliance deadline.

The states of Indiana and Kentucky developed final NO_X SIP rules in response to the NO_X SIP Call, through cap and trade programs, in June and July of 2001, respectively. ~~On November 8, 2001, the~~The EPA has approved Indiana’s and Kentucky’s SIP rules, which ~~became~~have both become effective, ~~December 10, 2001. On April 11, 2002,~~and has conditionally approved Ohio’s SIP rules. Ohio EPA is still promulgating the ~~EPA proposed direct final approval of Kentucky’s~~changes to its rules ~~and they became effective on June 10, 2002. The state of Ohio completed its NO~~_X ~~SIP rules in response~~ to satisfy the NO_X SIP Call on July 8, 2002, with an effective date of July 18, 2002. On January 16, 2003, the EPA proposed a direct final rule to approve Ohio’s SIP. The EPA has since withdrawn that proposal, and now intends to issue a conditional approval, which will not take effect until Ohio changes one specific aspect of its final rule (relating to the date flow control takes effect).EPA’s conditions for approval. Cinergy’s current plans for compliance with the EPA’s NO_X SIP Call would also satisfy compliance with Indiana’s, Kentucky’s, and Ohio’s SIP rules.

On September 25, 2000, Cinergy announced a plan for its subsidiaries, CG&E and PSI, to invest in pollution control equipment and other methods to reduce NO_X emissions. This plan includes the following:

•                  install ~~nine~~ selective catalytic reduction units at several different generating stations;
•                  install other pollution control technologies, including new computerized combustion controls, at all generating stations;
•                  make combustion improvements; and
•                  utilize the NO_X allowance market to buy or sell NO_X allowances as appropriate.

The current estimate for additional expenditures for this ~~investment~~plan is approximately ~~$238~~$167 million and is in addition to the ~~$604~~$682 million already incurred to comply with this program.

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(ii)      Section 126 Petitions
In February 1998, several northeast states filed petitions seeking the EPA’s assistance in reducing ozone in the Eastern U.S. under Section 126 of the Clean Air Act (CAA). The EPA believes that Section 126 petitions allow a state to claim that sources in another state are contributing to its air quality problem and request that the EPA require the upwind sources to reduce their emissions.

In December 1999, the EPA granted four Section 126 petitions relating to NO_Xemissions. This ruling affected all of our Ohio and Kentucky facilities, as well as some of our Indiana facilities, and required us to reduce our NO_X emissions to a certain level by May 2003. ~~In May 2001, the Court of Appeals substantially upheld a challenge to the Section 126 requirements, and remanded portions of the rule to the~~The EPA ~~for reconsideration of how growth was factored into the emission limitations. On May 1, 2002, the EPA issued a final rule extending~~subsequently extended the Section 126 rule compliance deadline to May 31, 2004, thus harmonizing the deadline with that for the NO_X SIP Call.

On April 4, 2003, the EPA issued a proposed rule withdrawing the Section 126 rule in states with approved SIPs under the NO_X SIP Call, which include the states of Indiana and Kentucky. The proposed rule states that the EPA will withdraw the Section 126 in Ohio once Ohio has a fully approved SIP. As a result of these actions, we anticipate that the Section 126 rule will not affect any of our facilities.

See (e) below for a discussion of the tentative EPA Agreement, ~~the implementation of~~ which could affect our strategy for compliance with the final NO_X SIP Call.

(c)                                  New Source Review (NSR)
The CAA’s NSR provisions require that a company obtain a pre-construction permit if it plans to build a new stationary source of pollution or make a major modification to an existing facility, unless the changes are exempt.

On November 3, 1999, the United 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 at two of our generating stations relating to NSR and New Source Performance Standards requirements. The suit sought (1) injunctive relief to require installation of pollution control technology on 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 the complaint have been filed by the United States, alleging additional violations of the CAA, including allegations involving different generating units. In addition, three northeast states and two environmental groups have intervened in the case.

Consistent with a Revised Case Management Plan, the Indiana District Court set the case for trial by jury commencing on June 6, 2005.
On December 21, 2000, Cinergy, CG&E, and PSI reached an agreement in principle with the parties in the litigation for a negotiated resolution of the CAA claims in the litigation. See (e) below for a discussion of the tentative EPA Agreement, which relates to matters discussed within this note. At this time, we believe it is unlikely that a final agreement will be reached on the

4246

~~On October 4, 2002,~~terms currently proposed by the ~~Indiana District Court issued a Revised Case Management Plan in~~ ~~Cinergy’s~~ case that sets forth the dates by which various events in the litigation, such as discovery and the filing of dispositive motions, must be completed. Consistent with the plan, on October 9, 2002, the Indiana District Court set the case for trial by jury commencing on October 4, 2004.
~~At this time, it is not possible to predict whether a final agreement implementing the agreement in principle can be reached. The parties continue to negotiate.~~plaintiffs. If the settlement is not completed, we intend to defend against the allegations vigorously in court. ~~In such an event,~~At this time, it is not possible to determine the likelihood that the plaintiffs would prevail upon their claims, whether resolution of these matters will be on terms similar to the terms of the tentative agreement, or whether resolution of these matters would have a material effect on our financial position or results of operations.

On March 1, 2000, the EPA also filed an amended complaint in a separate lawsuit alleging violations of the CAA relating to NSR, Prevention of Significant Deterioration (PSD), and Ohio SIP requirements regarding various generating stations, including a generating station operated by the Columbus Southern Power Company (CSP) and jointly-owned by CSP, the Dayton Power and Light Company (DP&L), and ~~(d)~~CG&E. The EPA is seeking injunctive relief and civil penalties of up to $27,500 per day for each violation. This suit is being defended by CSP. On April 4, 2001, the District Court in that case ruled that neither the Government nor the intervening plaintiff environmental groups could obtain civil penalties for any alleged violations that occurred more than five years prior to the filing of the complaint, but that both parties could seek injunctive relief for alleged violations that occurred more than five years before the filing of the complaint. Thus, if the plaintiffs prevail in their claims, any calculation for penalties will not start on the date of the alleged violations, unless those alleged violations occurred after November 3, 1994, but CSP would be forced to install the controls required under the CAA. Neither party appealed that decision.
In addition,                                   ~~Beckjord Station~~Cinergy and CG&E have been informed by DP&L, that on June 30, 2000, the EPA issued a Notice of Violation (NOV) to DP&L for alleged violations of NSR, PSD, and SIP requirements at a generating station operated by DP&L and jointly-owned by CG&E. The NOVs indicated the EPA may (1) issue an order requiring compliance with the requirements of the SIP, or (2) bring a civil action seeking injunctive relief and civil penalties of up to $27,500 per day for each violation.

At this time, it is not possible to predict whether resolution of these matters would have a material effect on our financial position or results of operations.
(d)                                  Beckjord Station NOV
On November 30, 1999, the EPA filed an NOV against Cinergy and CG&E, alleging that emissions of particulate matter at the Beckjord Station exceeded the allowable limit. ~~The allegations contained in this NOV were incorporated within the March 1, 2000 amended complaint, as discussed in (c) above.~~ On June 22, 2000, the EPA issued an NOV and a finding of violation (FOV) alleging additional particulate emission 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 criminal action.

See (e) below for a discussion of the tentative EPA Agreement, which relates to matters discussed within this note.

(e)                                  EPA Agreement
~~EPA Agreement~~
On December 21, 2000, Cinergy, CG&E, and PSI reached an agreement in principle with the United States, three northeast states, and two environmental groups for a negotiated resolution of
47

CAA claims and other related matters brought against coal-fired power plants owned and operated by Cinergy’s operating subsidiaries. The complete resolution of these issues is contingent upon establishing a final agreement with the EPA and other parties. If a final agreement is reached with these parties, it would resolve past claims of alleged NSR violations as well as the Beckjord Station NOVs/FOV discussed previously under (c) and (d).

In return for resolution of claims regarding past maintenance activities, as well as future operational certainty, we ~~have~~ tentatively ~~agreed~~committed in the agreement in principle to:

•                  shut down or repower with natural gas, nine small coal-fired boilers at three power plants beginning in 2004;
•                  build four additional sulfur dioxide (SO₂) scrubbers, the first of which must be operational by December 31, 2007;
•                  upgrade existing particulate control systems;
•                  phase in the operation of NO_X reduction technology year-round starting in 2004;
•                  reduce our existing Title IV SO₂ cap by 35 percent in 2013;
•                  pay a civil penalty of $8.5 million to the U.S. government; and
43

•                  implement $21.5 million in environmental mitigation projects, including retiring 50,000 tons of SO₂ allowances by 2005.
In reaching the tentative agreement, we did not admit to any wrongdoing.

The estimated cost for these capital expenditures is expected to be approximately $700 million through 2013. These capital expenditures are in addition to our previously announced commitment to install NO_X controls as discussed in (b) above, but does include capital costs that Cinergy would expect to spend regardless of the settlement due to new environmental requirements expected in the second half of this decade.

~~Cinergy~~, ~~CG&E~~~~, and~~ ~~PSI~~Although we have ~~accrued costs related~~continued to ~~certain aspects of~~negotiate with the ~~tentative agreement. In reaching~~plaintiffs to achieve a final agreement, the ~~tentative~~plaintiffs have insisted on commitments from us which go beyond those contained in the agreement ~~we did not admit any wrongdoing and remain free to continue our current maintenance practices, as well as implement future projects for improved reliability.~~
in principle. At this time we believe it is ~~not possible to predict whether~~unlikely that a final agreement ~~implementing~~will be reached on the ~~agreement in principle can be reached. The parties continue to negotiate.~~ terms currently proposed by the plaintiffs.
If the settlement is not completed, we intend to defend against the allegations, discussed in (c) and (d) above, vigorously in court. ~~In such an event,~~At this time, it is not possible to determine the likelihood that the plaintiffs would prevail upon their claims, whether resolution of these matters will be on terms similar to the terms of the tentative agreement, or whether resolution of these matters would have a material effect on our financial position or results of operations.

(f)                                    Manufactured Gas Plant (MGP) Sites
Prior to the 1950s, gas was produced at MGP sites through a process that involved the heating of coal and/or oil. The gas produced from this process was sold for residential, commercial, and industrial uses.

Coal tar residues, related hydrocarbons, and various metals ~~associated with MGP sites~~ have been found at former MGP sites in Indiana, including at least 2122 sites ~~which~~that PSI or its predecessors previously ~~owned.~~ owned and sold in a
48
~~PSI~~
~~acquired four~~
series of ~~the sites from~~transactions with Northern Indiana Public Service Company (NIPSCO) ~~in 1931. At the same time,~~ ~~PSI~~ ~~sold NIPSCO the sites located in Goshen~~ and ~~Warsaw, Indiana. In 1945,~~ ~~PSI~~ ~~sold 19 of these sites (including the four sites it acquired from NIPSCO) to the predecessor of the~~ Indiana Gas Company, Inc. (IGC). ~~IGC later sold the site located in Rochester, Indiana to NIPSCO.~~

~~IGC~~In a combination of lawsuits and ~~NIPSCO made claims against~~ ~~PSI~~ ~~for~~notices of violation, the ~~costs~~22 sites are in the process of ~~investigating~~being studied and ~~remediating the sites.~~will be remediated, if necessary. In 1998 NIPSCO, IGC, and PSI entered into Site Participation and Cost Sharing Agreements ~~(Agreements). These Agreements allocated the Comprehensive Environmental Response, Compensation~~to allocate liability and ~~Liability Act (CERCLA) liability for past and future costs at the MGP sites in Indiana among the three companies. These agreements concluded all CERCLA and similar claims~~responsibilities between ~~the three companies related to MGP sites. The parties continue to investigate and remediate the sites, as appropriate, under the agreements and applicable laws.~~them. The Indiana Department of Environmental Management (IDEM) oversees investigation and cleanup of ~~some~~all of ~~the~~these sites. Thus far, PSI has primary responsibility for investigating, monitoring and remediating, if necessary, nine of these sites.

PSI notified its insurance carriers of the claims related to MGP sites raised by IGC, NIPSCO, and IDEM. In April 1998, PSI filed suit in Hendricks County ~~Circuit Court~~ in the State of
44

Indiana against its general liability insurance carriers. PSI sought a declaratory judgment to obligate its insurance carriers to (1) defend MGP claims against PSI, or (2) pay PSI’s costs of defense and compensate PSI for its costs of investigating, preventing, mitigating, and remediating damage to property and paying claims related to MGP sites. The ~~lawsuit was moved to the Hendricks County Superior Court in July 1998. The~~ trial court issued a variety of rulings with respect to the claims and defenses in the litigation. PSI has appealed certain adverse rulings to the Indiana Court of Appeals. Oral argument on the appeal occurred on November 5, 2003. At the present time, PSI cannot predict the outcome of this litigation, including the outcome of the ~~appeals to the Indiana Court of Appeals.~~appeals.

CG&E ~~is aware of potential~~has performed site assessments on its sites where we believe MGP activities have occurred at some ~~time~~point in the ~~past. None of these sites is known to present a~~past and found no imminent risk to the environment.~~CG&E~~ ~~has begun preliminary site assessments to obtain information about some of these MGP sites.~~

PSI and CG&E, including its utility subsidiaries, have accrued costs ~~for the sites~~ related to investigation, remediation, and groundwater monitoring ~~to the extent~~for those sites where such costs are probable and can be reasonably estimated. ~~PSI~~As we continue to investigate and ~~CG&E~~~~, including its utility subsidiaries, do not believe they can provide an estimate of~~remediate the ~~reasonably possible total remediation~~sites and additional facts become known, additional costs for any site before a remedial investigation/feasibility study is performed. To the extent remediation is necessary, the timing of the remediation activities impacts the cost of remediation. Therefore, ~~PSI~~ ~~and~~ ~~CG&E~~~~, including its utility subsidiaries, currently cannot determine the total costs that~~ may be incurred ~~in connection with remediation of~~beyond those currently accrued. Until all ~~sites, to the extent that remediation is required. Until~~ investigation and remediation ~~activities have been completed on these sites, and the extent of insurance coverage for these costs, if any,~~ is ~~determined,~~complete, we are unable to ~~reasonably estimate~~determine the ~~total costs and~~overall impact on our financial position or results of operations.

(g)                                 Asbestos Claims Litigation
CG&E and PSI have been named as defendants or co-defendants in lawsuits related to ~~Asbestos~~asbestos at their electric generating stations. Currently, there are approximately 70 pending lawsuits. In these lawsuits, plaintiffs claim to have been exposed to ~~Asbestos containing~~asbestos-containing products in the course of their work at the CG&E and PSI generating stations. The plaintiffs further claim that as the property owner of the generating stations, CG&E and PSI should be held liable for their injuries and illnesses based on an alleged duty to warn and protect them from any ~~Asbestos~~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 or results of operations of these cases to date has not been material.

~~One specific~~Of these lawsuits, one case filed against PSI has been tried to verdict. The jury returned a verdict against PSI in the amount of approximately $500,000 on a negligence claim and for PSI on punitive damages. PSI is appealing the judgment in this case. ~~The total damages were immaterial to~~ ~~PSI’s~~ ~~financial position and results~~In addition, we have settled a number of ~~operations.~~ other lawsuits for substantially less than $500,000.
49

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

(h)                                 Gas Customer Choice
In January 2000, Cinergy Investments (Investments) sold Cinergy Resources, Inc. (Resources), a former subsidiary, to Licking Rural Electrification, Inc., doing business as The Energy
45

Cooperative (Energy Cooperative). In February 2001, Cinergy, CG&E, and Resources were named as defendants in three class action lawsuits brought by customers relating to Energy Cooperative’s removal from the Ohio Gas Customer Choice program and the failure to deliver gas to customers.
Subsequently, these class action suits were amended and consolidated into one suit. CG&E has been dismissed as a defendant in the consolidated suit. This customer litigation is pending in the Hamilton County Common Pleas Court. A trial date has not been set.
In March 2001, Cinergy, CG&E, and Investments were named as defendants in a lawsuit filed by ~~both~~ Energy Cooperative and Resources. This lawsuit concerns any obligations or liabilities Investments may have to Energy Cooperative following its sale of Resources. This lawsuit is pending in the Licking County Common Pleas Court. Trial is anticipated to occur in ~~late 2003 or early~~November 2004. In October 2001, Cinergy, CG&E, and Investments initiated litigation against the Energy Cooperative requesting indemnification by the Energy Cooperative for the claims asserted by former customers in the class action litigation. ~~This customer litigation is pending in the Hamilton County Common Pleas Court. A trial date has not been set.~~ We intend to vigorously defend these lawsuits. At the present time, we cannot predict the outcome of these suits.

(i)                                    PSI Fuel Adjustment Charge
In June 2001, PSI filed a petition with the IURC requesting authority to recover $16 million in under billed deferred fuel costs incurred from March 2001 through May 2001. The IURC approved recovery of these costs subject to refund pending the findings of an investigative sub-docket. The sub-docket was opened to investigate the reasonableness of, and underlying reasons for, the under billed deferred fuel costs. A hearing was held in July 2002, and in March 2003 the IURC issued an order giving final approval to PSI’s recovery of the $16 million.

(j)                                    PSI Retail Electric Rate Case
In December 2002, PSI filed a petition with the IURC seeking approval of a base retail electric rate increase. PSI has filed initial and rebuttal testimony in this case and the final set of hearings will take place in ~~March~~November 2003. Based on updated testimony filed in October 2003, PSI proposes an increase in annual revenues of approximately ~~$200~~$180 million, or an average increase of approximately 1514 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.

46

(k)                                PSI Construction Work in Progress (CWIP) Ratemaking Treatment for NO_X Equipment
In April 2003, PSI filed an application with the IURC requesting that its CWIP rate adjustment mechanism be updated for expenditures through December 2002 related to NO_XNOX equipment currently being installed at certain PSI generation facilities. CWIP ratemaking treatment allows
50

for the recovery of carrying costs on certain pollution control equipment while and after the equipment is under construction. ~~Testimony and exhibits supporting~~A final order was issued on September 24, 2003. The order granted substantially all of PSI’s ~~second~~requested relief, leaving only the issue of whether certain equipment qualified for CWIP ~~rate adjustment mechanism update have not yet been filed. However, amounts proposed~~ratemaking treatment to be decided in the first quarter of 2004. Amounts approved for ~~potential~~ recovery are presented below:

PSI CWIP Ratemaking for NO_X Equipment

PSI

PSI

(in millions)

(in millions)

Total retail CWIP expenditures as of December 31, 2002

$
305

$
305

Proposed total amount requested through CWIP mechanism(1)

35

Total amount requested through CWIP mechanism(1)

35

Less: previously approved CWIP mechanism amounts

(28
)

(28
)
Proposed incremental CWIP mechanism amounts

$
7

Incremental CWIP mechanism amounts

$
7

(1)Amounts include retail customers’ portion only and represent an annual return on qualified NO_X equipment expenditures.
~~Amounts include retail customers’ portion only and represent an annual return on qualified NO~~_X ~~equipment expenditures.~~

PSI’s initial CWIP rate mechanism adjustment (authorized in July 2002) resulted in an approximately 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 the first quarter of 2003. The IURC’s July 2002 order also authorized PSI to defer, for subsequent recovery, post-in-service depreciation and to continue the accrual for allowance for funds used 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 reporting after the related assets are placed in service.

(l)                                    Environmental Compliance Cost Recovery
In 2002, the Indiana General Assembly passed legislation that, among other things, encourages the deployment of advanced technologies that reduce regulated air emissions, while allowing the continued use of high sulfur Midwestern coal in existing electric generating plants. The legislation authorizes the IURC to provide financial incentives to utilities that deploy such advanced technologies. PSI is currently seeking IURC approval, under this new law, of a cost tracking mechanism for PSI’s NO_X equipment-related depreciation and operation and maintenance costs, authority to use accelerated (18-year) depreciation for its NO_X compliance equipment, and approval of a NO_X emission allowance purchase and sales tracker. In October, PSI reached a settlement with the other parties to this case that, if approved by the IURC, will provide for the relief described above for most of PSI’s environmental compliance equipment. PSI expects an IURC order addressing approval of the settlement agreement by the end of 2003. The issue of whether the remainder of PSI’s environmental compliance projects qualify for financial incentives is expected to be decided in the second quarter of 2004.
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(m)                              PSI Purchased Power Tracker (Tracker)
The Tracker was designed to provide for the recovery of costs related to purchases of power necessary to meet native load requirements to the extent such costs are not recovered through the existing fuel adjustment clause.

PSI is authorized to seek recovery of 90 percent of its purchased power expenses through the Tracker (net of the displaced energy portion recovered through the fuel recovery process and net of the mitigation credit portion), with the remaining 10 percent deferred for subsequent recovery in PSI’s general retail electric rate case. In March 2002, PSI filed a petition with the IURC seeking approval to extend the Tracker process beyond the summer of 2002. A hearing was held onin January ~~16,~~ 2003, and in June 2003 the ~~case is now awaiting~~IURC approved the extension for up to an ~~IURC order. We cannot predict~~additional two years with the ~~outcome~~ultimate determination concerning PSI’s continued use of ~~this proceeding at this time.~~the Tracker process to be made in PSI’s pending retail electric rate case.

47In June 2002, PSI also filed a petition with the IURC seeking approval of the recovery through the Tracker of its actual summer 2002 purchased power costs. In May 2003, the IURC approved PSI’s recovery of $18 million related to its summer 2002 purchased power costs, and also authorized $2 million of deferred costs sought for recovery in PSI’s general retail electric rate case.

In June 2003, PSI filed a petition with the IURC seeking approval of the recovery through the Tracker of its actual summer 2003 purchased power costs. Testimony was filed in support of PSI’s request in August 2003. An evidentiary hearing is scheduled for March 2004.

~~(m)~~(n)                                 CG&E Gas Rate Case
In the third quarter of 2001, CG&E filed a retail gas rate case with the Public Utilities Commission of Ohio (PUCO) seeking to increase base rates for natural gas distribution service and requesting recovery through a tracking mechanism of the costs of an accelerated gas main replacement program with an estimated capital cost of $716 million over 10 years. CG&E entered into a settlement agreement with most of the parties and a hearing on this matter was held in April 2002. An order was issued in May 2002, in which the PUCO approved the settlement agreement and authorized a base rate increase of approximately $15 million, or 3.3 percent overall, effective May 30, 2002. In addition, the PUCO authorized CG&E to implement the tracking mechanism 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 the fourth quarter of 2002, CG&E filed an application to increase its rates under the tracking mechanism. In April 2003, CG&E entered into a settlement agreement with the parties, providing for an increase of $6.5 million, which the PUCO subsequently approved. This increase was effective in May 2003. CG&E expects to file another application to increase its rates by approximately $6.4 million under the tracking mechanism in the fourth quarter of 2003. CG&E expects the PUCO will rule on this application by May 2004.

52
~~(n)~~
(o)                                  ULH&P Gas Rate Case
As discussed in the 2002 10-K, in the second quarter of 2001, ULH&P filed a retail gas rate case with the Kentucky Public Service Commission (KPSC) seeking to increase base rates for natural gas distribution services and requesting recovery through a tracking mechanism of the costs of an accelerated gas main replacement program with an estimated capital cost of $112 million over 10 years. ULH&P made its second annual filing for an increase under the tracking mechanism in March 2003. The application ~~seeks~~sought an increase of $2 million. ~~ULH&P~~ ~~expects~~A hearing was held in July 2003, and the KPSC ~~to rule on~~approved the application ~~during the second quarter of~~in August 2003. ~~At the present time,~~ ~~ULH&P~~ ~~cannot predict the outcome of this proceeding.~~ The Kentucky Attorney General has appealed to the Franklin Circuit Court the KPSC’s approval of the tracking mechanism ~~to the Franklin Circuit Court~~ and ~~has also appealed~~ the KPSC’s ~~August 2002 order~~orders approving the new tracking mechanism rates. At the present time, ULH&P cannot predict the timing or outcome of this litigation.

~~(o)~~(p)                                  Gas Distribution Plant
~~Contract Disputes~~
In June 2003, the PUCO approved an amended settlement agreement between CG&E and the PUCO Staff in a gas distribution safety case arising 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 expend a minimum of $700,000 to replace SHA risers by December 31, 2003, and to file a comprehensive plan addressing all SHA risers on its distribution system. Cinergy has an estimated 198,000 SHA risers on its distribution system, of which 155,000 are in CG&E’s service area. The remaining SHA risers are included in ULH&P’s service area. Further investigation as to whether any additional SHA risers will need maintenance or replacement is ongoing. If CG&E and ULH&P determine that replacement of all SHA risers is appropriate, the replacement cost could be up to approximately $50 million. CG&E and ULH&P would pursue recovery of this cost through rates. At this time, Cinergy, CG&E, and ULH&P cannot predict the outcome of this matter.
(q)                                  Contract Disputes
Cinergy, through a subsidiary of Investments, is currently involved in negotiations to resolve a customer billing dispute. The primary issue of contention between the parties relates to the determinants used in calculating the monthly charge billed for electricity. Receivables from the customer are recorded at what Cinergy ~~has reserved for a portion of the amount billed based on our current estimate of~~believes to be their net realizable value.
~~Cinergy~~, through a subsidiary of Capital & Trading, is in arbitration with a counterparty concerning various disputes under an agreement whereby we market natural gas that the counterparty produces or acquires in North America. We have reserved for a portion of the amount billed based on the current estimate of net realizable value. Absent a voluntary resolution to the disputes, we intend to pursue the arbitration vigorously.
48

Although we cannot predict the outcome of ~~these matters,~~this matter, we believe the ultimate impact on Cinergy’s financial position and results of operations ~~beyond amounts reserved,~~ will not be material.

Cinergy Marketing & Trading, LP (Marketing & Trading) was in arbitration with Apache Corporation (Apache) concerning disputes under an agreement whereby we marketed natural gas that Apache produced or acquired in North America. Effective July 1, 2003, Marketing & Trading terminated its marketing relationship with Apache. The termination of the marketing relationship ended the arbitration and all outstanding monetary issues related to the arbitration were settled. The impact of the settlement was not material to our financial position or results of operations.
53
~~(p)~~
(r)                                  Enron Corp. (Enron) Bankruptcy
In December 2001, Enron filed for protection under Chapter 11 of the U.S. Bankruptcy Code in the Southern District of New York. We decreased our trading activities with Enron in the months prior to its bankruptcy filing and have filed a motion with the bankruptcy court overseeing the Enron bankruptcy seeking appropriate netting of the various payables and receivables between and among Enron and Cinergy entities. We intend to resolve any contract differences pursuant to the terms of those contracts, business practices, and the applicable provisions of the U.S. Bankruptcy Code, as approved by the court. ~~While~~We have recently been involved in a court-sponsored mediation of our claims in the bankruptcy case and are attempting to resolve our disputes through that process. Based on judicial decisions regarding the permissibility of certain broad netting arrangements and the results of our mediation, we ~~cannot predict~~have entered into a tentative settlement agreement with Enron, which must go through creditors’ committee and bankruptcy court approval before becoming final. As a result of this tentative agreement, we believe the ~~court’s~~ resolution of our contract differences will result in a net payable to Enron of approximately $14 million. During the third quarter of 2003, an additional $12 million was charged to expense to reflect our current assessment of this matter. We believe this would resolve all of our claims with the Enron entities, except for one claim being handled outside the United States proceeding involving the recovery of an insignificant amount.
(s)                                  Synthetic Fuel Production
In July 2002, Capital & Trading acquired a coal-based synthetic fuel production facility. As of September 30, 2003, Capital & Trading’s net book value in this facility was approximately $60 million. The synthetic fuel produced at this facility qualifies for tax credits in accordance with Section 29 of the Internal Revenue Code. Eligibility for these credits expires after 2007. Cinergy received a private letter ruling from the Internal Revenue Service (IRS) in connection with the acquisition of the facility. To date, Cinergy has produced and sold approximately 3.6 million tons of synthetic fuel at this facility, resulting in approximately $100 million in tax credits, including approximately $60 million in 2003.
In the second quarter of 2003, the IRS announced, as a result of an audit of another taxpayer, that it had reason to question and was reviewing the scientific validity of test procedures and results that were presented as evidence the fuel underwent a significant chemical change. The IRS recently announced that it has finished its review and has determined that test procedures and results used by taxpayers are scientifically valid if the procedures are applied in a consistent and unbiased manner. The IRS also announced that it plans to impose new testing and record-keeping requirements on synthetic fuel producers and plans to issue guidance extending these requirements to taxpayers already holding private letter rulings on the issue of significant chemical change.
Cinergy believes that its testing procedures comply with the standards recently announced by the IRS. We do not anticipate that any new testing or record-keeping requirements imposed by the IRS will have a material effect on our financial position or results of operations.
54

(t)                                    Energy Market Investigations
In July 2003, Cinergy received a subpoena from the Commodity Futures Trading Commission (CFTC). As has been previously reported by the press, the CFTC has served subpoenas on numerous other energy companies. The CFTC request sought certain information regarding our trading activities, including price reporting to energy industry publications. The CFTC sought particular information concerning these matters for the period May 2000 through January 2001 as to one of Cinergy’s employees. Based on an initial review of these matters, we doplaced that employee on administrative leave and have subsequently terminated his employment. Cinergy is continuing an investigation of these matters and has been cooperating fully with the CFTC.
In September 2003, Cinergy, along with 38 other companies, was named as a defendant in civil litigation filed as a purported class action on behalf of all persons who purchased and/or sold New York Mercantile Exchange natural gas futures and options contracts between January 1, 2000 and December 31, 2002. The complaint alleges that improper price reporting caused damages to the class. Responsive pleadings in the case are due on November 17, 2003. We believe this action against us is without merit. At this time, it is not ~~believe that any exposure relating~~possible to ~~those contracts would~~predict the outcome of this matter.
In the second quarter of 2003, Cinergy received initial and follow-up third-party subpoenas from the SEC requesting information related to particular trading activity with one of its counterparties who was the target of an investigation by the SEC. Cinergy has and intends to fully cooperate with the SEC in connection with this matter.
At this time it is not possible to predict the outcome of these investigations and lawsuit or the impact on Cinergy’s financial position or results of operations; although, in the opinion of management, they are not likely to have a material ~~impact~~adverse effect on our financial position or results of operations.

(u)                                 CG&E Transmission and Distribution Rate Filings
In October 2003, CG&E filed an application with the PUCO seeking deferral of approximately $173 million, of which approximately $37 million has been incurred as of September 30, 2003, in depreciation, property taxes and carrying costs related to net additions to transmission and distribution utility plant in service from January 2001 through December 2005. Rates are frozen in Ohio under the state’s electric restructuring law from 2001 through the end of the market development period. CG&E intends to file a rate case to collect those costs after the market development period ends. CG&E has not deferred any of these costs as of September 30, 2003.
CG&E is also proposing a mechanism to recover costs related to net additions to transmission and distribution utility plant in service after the end of the market development period. The mechanism would work in a similar manner to the monthly customer charge the PUCO approved for CG&E’s accelerated natural gas main replacement program, discussed abovein (n), which is adjusted annually based on expenditures in the previous year.
55

8.              Discontinued Operations
During the second quarter of 2003, Cinergy completed the disposal of its gas distribution operation in South Africa, sold its remaining wind assets in the United States, and substantially sold or liquidated the assets of its energy trading operation in the Czech Republic.
GAAP requires consolidated entities, which have been disposed of, to be presented as Discontinued operations, net of tax in the Statements of Income and as Assets/Liabilities of Discontinued Operations in the Balance Sheets. The accompanying financial statements have been reclassified to account for the disposals occurring during the second quarter of 2003, as well as disposals in prior periods, as discontinued operations.
As a result of the second quarter 2003 transactions, assets of discontinued operations of approximately $140 million have been sold or converted into cash and liabilities of discontinued operations of approximately $100 million have been assumed by buyers or liquidated. The net, after-tax, gain from these disposal and liquidation transactions was approximately $9 million (including a net after-tax cumulative currency translation gain of approximately $6 million).
The table below reflects the results of operations and the income (loss) on disposal related to investments accounted for as discontinued operations for the quarter ended and year to date September 30, 2003 and 2002:

Quarter Ended
September 30

Year to Date
September 30

2003

2002

2003

2002

(in thousands)

Revenues (1)

$
—

$
20,827

$
22,257

$
74,945

Income (Loss) Before Taxes

$
—

$
(4,954
)
$
(593
)
$
(2,903
)

Income (Loss) from Discontinued Operations

Income (Loss) from operations

$
—

$
(1,790
)
$
(3
)
$
(561
)
Gain on disposal, net of tax

—

—

8,878

—

Total Income (Loss) from Discontinued Operations

$
—

$
(1,790
)
$
8,875

$
(561
)
(1)          Presented for informational purposes only. All results of operations are reported net in our Statements of Income.
56

The table below reflects the assets and liabilities related to the investments accounted for as discontinued operations as of September 30, 2003 and December 31, 2002:

September 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 (including Long-term debt due within one year)

—

84,654

Other

—

17,547

Total Liabilities

$
8,877

$
108,833

9.                                      Financial Information by Business Segment
As discussed in the 2002 10-K, we conduct operations through our subsidiaries, and manage through the following three business units:

•                  Commercial Business Unit (Commercial), formerly named the Energy Merchant Business ~~Unit (Energy Merchant);~~Unit;
•                  Regulated Businesses Business Unit (Regulated Businesses); and
•                  Power Technology and Infrastructure Services Business Unit (Power Technology).

The following section describes the activities of our business units as of ~~March 31,~~September 30, 2003.

~~Energy Merchant~~Commercial manages wholesale generation and energy marketing and trading of energy commodities. ~~Energy Merchant~~Additionally, Commercial operates and maintains our ~~regulated and non-regulated~~ electric generating plants including some of our jointly-owned plants. ~~Energy Merchant~~Commercial is also responsible for all of our international operations and performs the following activities:

•                  energy risk management;
•                  proprietary arbitrage activities; and
•                  customized energy solutions.

Regulated Businesses consists 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 to consumers. Regulated Businesses also earns revenues from wholesale customers primarily by transmitting electric power through Cinergy’s transmission system.

57

Power Technology primarily manages the development, marketing, and sales of our non-regulated retail energy and energy-related businesses. This is accomplished through various subsidiaries and joint ventures. Power Technology also manages Cinergy Ventures, LLC
49

(Ventures), Cinergy’s venture capital subsidiary. Ventures invests in emerging energy technologies that can benefit future Cinergy business development activities.

Following are the financial results by business unit. Certain amounts for the prior year have been restated to reflect implementation of EITF 02-3 and other prior year amounts have been reclassified to conform to the current presentation.

5058

Financial results by business unit for the quarters ended ~~March 31,~~September 30, 2003, and ~~March 31,~~September 30, 2002, are as indicated below.

Business Units

Cinergy Business Units

Cinergy Business Units

Energy
Merchant

Regulated
Businesses

Power
Technology

Total

Reconciling
Eliminations(1)

Consolidated

Commercial

Regulated
Businesses

Power
Technology

Total

Reconciling Eliminations   (1)

Consolidated

(in thousands)

(in thousands)

Quarter ended March 31, 2003

Operating revenues-

External customers

$
447,466
(3)
$
834,315
(4)
$
1

$
1,281,782

$
—

$
1,281,782

Intersegment revenues

39,123

—

—

39,123

(39,123
)
—

Cost of sales -

Fuel and purchased and exchanged power

138,495

140,988

—

279,483

—

279,483

Gas purchased

64,230

171,765

—

235,995

—

235,995

Discontinued operations, net of tax

—

—

—

—

—

—

Cumulative effect of a change in accounting principles, net of tax

26,462

—

—

26,462

—

26,462

Segment profit (loss)(2)

97,105

74,069

(5,089
)
166,085

—

166,085

Quarter ended March 31, 2002

Quarter Ended
September 30, 2003

Operating revenues -

External customers

$
271,613

$
714,762

$
2

$
986,377

$
—

$
986,377

$
439,059

$
652,946

$
(28
)
$
1,091,977

$
—

$
1,091,977

Intersegment revenues

36,838

—

—

36,838

(36,838
)
—

44,526

—

—

44,526

(44,526
)
—

Cost of sales -

Fuel and purchased and exchanged power

107,569

121,721

—

229,290

—

229,290

External customers

188,356

141,641

—

329,997

329,997

Intersegment costs

—

44,526

—

44,526

(44,526
)
—

Gas purchased

47,360

32,222

—

79,582

79,582

Segment profit (loss)(2)

52,204

62,814
(3)
(3,037
)
111,981

—

111,981

Quarter Ended
September 30, 2002

Operating revenues -

External customers

$
449,571

$
669,605

$
62

$
1,119,238

$
—

$
1,119,238

Intersegment revenues

51,590

—

—

51,590

(51,590
)
—

Cost of sales -

Fuel and purchased and exchanged power

External customers

174,224

128,142

—

302,366

302,366

Intersegment costs

—

51,590

—

51,590

(51,590
)
—

Gas purchased

1,912

107,968

—

109,880

—

109,880

36,689

12,594

—

49,283

49,283

Discontinued operations, net of tax

478

—

—

478

—

478

(1,790
)
—

—

(1,790
)
—

(1,790
)
Cumulative effect of a change in accounting principle, net of tax

(10,899
)
—

—

(10,899
)
—

(10,899
)

Segment profit (loss)(2)

16,638

72,797

(4,606
)
84,829

—

84,829

57,534

74,939

(1,905
)
130,568

—

130,568

(1)          The Reconciling Eliminations category eliminates the intersegment revenues of Commercial and the intersegment costs of Regulated Businesses.
(2)          Management utilizes segment profit (loss) to evaluate segment performance.
(3)          The decrease in 2003 is primarily due to lower megawatt hour (MWh) sales resulting from milder weather and the effects of a continuing sluggish economy.
~~(1)~~
~~The Reconciling Eliminations category eliminates the intersegment revenues of Energy Merchant.~~
~~(2)~~
~~Management utilizes segment profit (loss) to evaluate segment performance.~~
~~(3)~~
~~The increase in 2003 is primarily due to the increase in the average price realized on wholesale commodity non-firm transactions and the sale of synthetic fuel which began in July 2002.~~
~~(4)~~
The increase in 2003 is primarily due to the increase in the average price received per thousand cubic feet (mcf) delivered reflecting a substantial increase in the wholesale gas commodity costs, which is passed directly to the retail customer dollar-for-dollar under the state mandated gas cost recovery mechanism. Also contributing to this increase was higher mcf volumes sold due to colder than normal weather.

5159

Financial results by business unit for year to date September 30, 2003 and September 30, 2002, are as indicated below.
Business Units

Cinergy Business Units

Commercial

Regulated
Businesses

Power
Technology

Total

Reconciling
Eliminations (1)

Consolidated

(in thousands)

Year to Date
September 30, 2003

Operating revenues -

External customers

$
1,222,898
(3)
$
2,070,984
(4)
$
(25
)
$
3,293,857

$
—

$
3,293,857

Intersegment revenues

120,805

—

—

120,805

(120,805
)
—

Cost of sales -

Fuel and purchased and exchanged power

External customers

450,219

390,113

—

840,332

—

840,332

Intersegment costs

—

120,805

—

120,805

(120,805
)
—

Gas purchased

116,823

252,073

—

368,896

—

368,896

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)

213,641
(5)
162,988
(6)
(13,910
)
362,719

—

362,719

Year to Date
September 30, 2002

Operating revenues -

External customers

$
1,052,068

$
1,942,789

$
62

$
2,994,919

$
—

$
2,994,919

Intersegment revenues

127,788

—

—

127,788

(127,788
)
—

Cost of sales -

Fuel and purchased and exchanged power

External customers

417,084

344,774

—

761,858

—

761,858

Intersegment costs

—

127,788

—

127,788

(127,788
)
—

Gas purchased

43,692

145,033

—

188,725

—

188,725

Discontinued operations, net of tax

(561
)
—

—

(561
)
—

(561
)
Cumulative effect of changes in accounting principles, net of tax

(10,899
)
—

—

(10,899
)
—

(10,899
)
Segment profit (loss)(2)

97,677

176,877

(14,174
)
260,380

—

260,380

(1)          The Reconciling Eliminations category eliminates the intersegment revenues of Commercial and the intersegment costs of Regulated Businesses.
(2)          Management utilizes segment profit (loss) to evaluate segment performance.
(3)          The increase in 2003 is primarily due to the increase in average price realized on wholesale commodity transactions and the sale of synthetic fuel which began in July 2002.
(4)          The increase in 2003 is primarily due to the increase in the average price received per thousand cubic feet (mcf) of gas delivered reflecting a substantial increase in the wholesale gas commodity costs, which is passed directly to the retail customer dollar-for-dollar under the state mandated gas cost recovery mechanism. Also contributing to this increase was higher mcf volumes sold due to colder weather.
(5)          The increase in 2003 is primarily due to a change in accounting principle, the gain on disposal of discontinued operations and synthetic fuel credits discussed in Note 1(g)(iii), Note 8 and Note 7(s), respectively. This increase also reflects charges associated with employee severance programs and the write-offs of certain equipment and technology investments that were taken in the second quarter of 2002.
(6)          The decrease in 2003 is primarily due to lower MWh sales resulting from milder than normal weather during the summer and the effects of a continuing sluggish economy.
60

Total segment assets at ~~March 31,~~September 30, 2003, and December 31, 2002, were as follows:

Business Units

Cinergy Business Units

Cinergy Business Units

Energy
Merchant

Regulated
Businesses

Power
Technology

Total

All
Other(1)

Consolidated

Commercial

Regulated
Businesses

Power
Technology

Total

All
Other(1)

Consolidated

(in thousands)

(in thousands)

Segment assets from continuing operations

$
5,339,831
(2)
$
7,866,961
(2)
$
168,117

$
13,374,909

$
101,063

$
13,475,972

Segment assets from discontinued operations

7,187

—

—

7,187

—

7,187

Total segment assets at September 30, 2003

$
5,347,018

$
7,866,961

$
168,117

$
13,382,096

$
101,063

$
13,483,159

Total segment assets at March 31, 2003

$
5,305,552

$
7,902,311

$
159,185

$
13,367,048

$
51,086

$
13,418,134

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

$
5,774,750

$
7,283,812

$
155,252

$
13,213,814

$
93,214

$
13,307,028

(1)The All Other category represents miscellaneous corporate items which are not allocated to business units for purposes of segment performance measurement.
(2)September 30, 2003 balances reflect the transfer of generating assets as discussed in Note 12.
~~(1)~~
~~The All Other category represents miscellaneous corporate items which are not allocated to business units for purposes of segment performance measurement.~~

5261

9.10.       EPS
~~EPS~~
A reconciliation of EPS to EPS – ~~Assuming Dilution (EPS -~~ assuming ~~dilution)~~dilution is presented below for the quarters ended ~~March 31,~~September 30, 2003 and ~~March 31,~~ 2002:

Income

Shares

EPS

Income

Shares

EPS

(in thousands, except per share amounts)

(in thousands, except per share amounts)

Quarter ended March 31, 2003

Quarter Ended September 30, 2003

EPS:

Income before cumulative effect of a change in accounting principles

$
139,623

$
0.81

Cumulative effect of a change in accounting principles, net of tax

26,462

0.15

Net Income

$
111,981

177,751

$
0.63

Effect of dilutive securities:

Common stock options

629

Directors’ compensation plans

148

Contingently issuable common stock

891

Stock purchase contracts

118

EPS - assuming dilution:

Net income plus assumed conversions

$
111,981

179,537

$
0.62

Quarter Ended September 30, 2002

EPS:

Income before discontinued operations

$
132,358

$
0.79

Discontinued operations, net of tax

(1,790
)

(0.01
)
Net Income

$
166,085

173,387

$
0.96

$
130,568

167,967

$
0.78

Effect of dilutive securities:

Common stock options

724

843

Directors’ compensation plans

134

160

Contingently issuable common stock

717

1,118

EPS - assuming dilution:

Net income plus assumed conversions

$
166,085

174,962

$
0.95

$
130,568

170,088

$
0.77

Quarter ended March 31, 2002

EPS:

Income before discontinued operations and cumulative effect of a change in accounting principle

$
95,250

$
0.58

Discontinued operations, net of tax

478

—

Cumulative effect of a change in accounting principle, net of tax

(10,899
)

(0.06
)
Net Income

$
84,829

164,295

$
0.52

Effect of dilutive securities:

Common stock options

976

Employee stock purchase and savings plan

1

Directors’ compensation plans

151

Contingently issuable common stock

542

EPS - assuming dilution:

Net income plus assumed conversions

$
84,829

165,965

$
0.52

Options to purchase shares of common stock are excluded from the calculation of EPS - assuming dilution when the exercise ~~prices~~price of these options plus unrecognized compensation expense are greater than the average market price of ~~the~~a common ~~shares~~share during the ~~period. For~~period multiplied by the ~~quarters ended March 31, 2003 and 2002, approximately 3.5~~number of options outstanding at the end of the period because they are anti-dilutive. Approximately 2.1 million and ~~3.1~~3.3 million shares ~~respectively,~~ were excluded from the EPS - assuming dilution ~~calculation.~~calculation for the quarters ended September 30, 2003 and 2002, respectively.

Also excluded from the EPS - assuming dilution calculation for the quarters ended ~~March 31,~~September 30, 2003 and 2002, are up to 10.7 million and 10.8 million shares, respectively, issuable pursuant to the stock purchase contracts ~~associated with the preferred trust securities~~ issued by Cinergy Corp. in December ~~2001.~~2001 associated with the preferred trust securities transaction. The number of shares issuable pursuant to the stock purchase contracts is contingent upon the market price of Cinergy Corp. stock in February 2005 and could range between 9.2 and 10.8 million shares.

5362

A reconciliation of EPS to EPS - assuming dilution is presented below for the year to date September 30, 2003 and 2002:

Income

Shares

EPS

(in thousands, except per share amounts)

Year to Date September 30, 2003

EPS:

Income before discontinued operations and cumulative effect of changes in accounting principles

$
327,382

$
1.86

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

$
362,719

175,944

$
2.06

Effect of dilutive securities:

Common stock options

738

Directors’ compensation plans

147

Contingently issuable common stock

811

Stock purchase contracts

39

EPS - assuming dilution:

Net income plus assumed conversions

$
362,719

177,679

$
2.04

Year to Date September 30, 2002

EPS:

Income before discontinued operations and cumulative effect of changes in accounting principles

$
271,840

$
1.63

Discontinued operations, net of tax

(561
)

—

Cumulative effect of changes in accounting principles, net of tax

(10,899
)

(0.06
)
Net Income

$
260,380

166,544

$
1.57

Effect of dilutive securities:

Common stock options

981

Employee stock purchase and savings plan

5

Directors’ compensation plans

160

Contingently issuable common stock

1,138

EPS - assuming dilution:

Net income plus assumed conversions

$
260,380

168,828

$
1.55

Options to purchase shares of common stock are excluded from the calculation of EPS - assuming dilution when the exercise price of these options plus unrecognized compensation expense are greater than the average market price of a common share during the period multiplied by the number of options outstanding at the end of the period because they are anti-dilutive. For year to date September 30, 2003 and 2002, approximately 2.1 million and 2.7 million shares, respectively, were excluded from the EPS - assuming dilution calculation.
Also excluded from the EPS - assuming dilution calculation for year to date September 30, 2003 and 2002, are up to 10.8 million shares issuable pursuant to the stock purchase contracts issued by Cinergy Corp. in December 2001 associated with the preferred trust securities transaction. The number of shares issuable pursuant to the stock purchase contracts is contingent upon the market price of Cinergy Corp. stock in February 2005 and could range between 9.2 and 10.8 million shares.
63

~~10.~~11.       Ohio Deregulation
As discussed in the 2002 10-K, CG&E is in a market development period, ~~beginning the transition~~transitioning to electric deregulation in the state of Ohio. The transition period is governed by Amended Substitute Senate Bill No. 3 (Electric Restructuring Bill) and a stipulated ~~agreement~~transition plan adopted and approved by the PUCO. Under CG&E’s transition plan, retail customers continue to receive ~~transportation~~electric distribution services from CG&E, but may purchase electricity from another supplier. Retail customers that purchase electricity from another supplier receive shopping credits from CG&E. The shopping credits generally reflect the costs of electric generation included in CG&E’s frozen rates. However, shopping credits for the first 20 percent of electricity usage in each customer class to switch suppliers are higher than ~~CG&E’s~~ ~~electric generation costs~~shopping credits for subsequent switchers in order to stimulate the development of the competitive retail electric service ~~market.~~market, pursuant to CG&E’s stipulated agreement.

CG&E recovers its generation related regulatory assets and certain other transition costs deferred during the market development period through a Regulatory Transition Charge (RTC) paid by all retail customers. As the RTC is collected from customers, CG&E amortizes the deferred balance of regulatory assets and other transition costs. A portion of the RTC collected from customers is recognized in earnings currently as a return on the deferred balance of regulatory assets and other transition costs and as reimbursement for the difference inbetween the shopping credits provided to customers and the wholesale revenues from switched generation. The ability of CG&E to recover its regulatory assets and other transition costs is dependent on several factors, including, but not limited to, the level of CG&E’s electric sales, prices in the wholesale power markets, and the amount of customers switching to other electric suppliers.

On January 10, 2003, CG&E filed an application with the PUCO for approval of a methodology to establish how market-based rates for non-residential customers will be determined when the market development period ends. In the filing, CG&E seeks to establish a market-based standard service offer rate for non-residential customers that do not switch suppliers and a process for establishing the competitively bid generation service option required by the Electric Restructuring Bill. As of ~~March 31,~~September 30, 2003, more than 20 percent of the load ~~in each~~ of CG&E’s ~~non-residential~~commercial and industrial customer classes ~~has~~have switched to other electric suppliers. Under its transition plan, CG&E may end the market development period for those classes of customers once 20 percent switching has been achieved; however, PUCO approval of the standard service offer rate and competitive bidding process is required before the market development period can be ended. CG&E is not requesting to end the market development period for ~~non-residential~~any customers at this time. CG&E is unable to predict the outcome of this proceeding.

~~11.~~12.       Transfer of Generating Assets
In December 2002, the IURC approved a settlement agreement among PSI, the Indiana Office of the Utility Consumer Counselor, and the IURC Testimonial Staff authorizing PSI’s ~~purchase~~purchases of the Henry County, Indiana and Butler County, Ohio, gas-fired peaking plants from two non-regulated affiliates. In February 2003, the Federal Energy Regulatory Commission (FERC) issued an order under Section 203 of the Federal Power Act authorizing PSI’s ~~acquisition~~acquisitions of the plants, which occurred on February 5, 2003. Subsequently, in April 2003, the FERC issued a
64

tolling order allowing additional time to consider a request for rehearing filed in response to the February 2003 FERC order. At this time, we cannot predict the outcome of this matter.
On July 21, 2003, ULH&P filed an application with the KPSC requesting a certificate of public convenience and necessity to acquire CG&E’s ownership interests in the East Bend Generating Station, located in Boone County, Kentucky, the Woodsdale Generating Station, located in Butler County, Ohio, and one generating unit at the 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 transferred generating facilities are out of service, and for approval of another agreement under which the transferred units would be jointly dispatched with CG&E’s remaining fleet of generating units. An order from the KPSC is expected by the end of the year. The transfer, which will be made at net book value, will not affect current electric rates for ULH&P’s customers, as power will be provided under the same terms as under the current wholesale power contract with CG&E through at least December 31, 2006. This transfer is also contingent upon receipt of approval from the FERC and the SEC. ULH&P is unable to predict the outcome of this matter.

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CAUTIONARY STATEMENTS
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION
This document includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are based on management’s beliefs and assumptions. These forward-looking statements are identified by terms and phrases such as “anticipate”, “believe”, “intend”, “estimate”, “expect”, “continue”, “should”, “could”, “may”, “plan”, “project”, “predict”, “will”, and similar expressions.

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

•                  Factors affecting operations, such as:

(1)          unanticipated weather conditions;
(2)          unscheduled generation outages;
(3)          unusual maintenance or repairs;
(4)          unanticipated changes in costs;
(5)          environmental incidents, including costs of compliance with existing
and future environmental requirements; and
(6)          electric transmission or gas pipeline system constraints.

•                  Legislative and regulatory initiatives.

•                  Additional competition in electric or gas markets and continued industry consolidation.

•                  Financial or regulatory accounting principles.

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

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

•                  The performance of projects undertaken by our non-regulated businesses and the success of efforts to invest in and develop new opportunities.

•                  Availability of, or cost of, capital.

•                  Employee workforce factors.

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

5566

•                  Costs and effects of legal and administrative proceedings, settlements, investigations, and claims. Examples can be found in Note 7 of the “Notes to Condensed Financial Statements” in “Part 1.I. Financial Information”.

We undertake no obligation to update the information contained herein.

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MD&A - ~~- INTRODUCTION~~LIQUIDITY AND CAPITAL RESOURCES

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
In this report Cinergy (which includes Cinergy Corp. and all of our regulated and non-regulated subsidiaries) is, at times, referred to in the first person as “we”, “our”, or “us”.

The following discussion should be read in conjunction with the accompanying condensed financial statements and related notes included elsewhere in this report and the combined Form 10-K for the year ended December 31, 2002 ~~(2002~~and Form 8-K filed on June 10, 2003 (together, the 2002 10-K). The results discussed below are not necessarily indicative of the results that may occur in any future periods.

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

•                  factors affecting current and future operations;
•                  potential sources of cash for future capital expenditures;
•                  why revenues and expenses changed from period to period; and
•                  how the above items affect our overall financial condition.

ORGANIZATION
Cinergy Corp., a Delaware corporation created in October 1994, owns all outstanding common stock of The Cincinnati Gas & Electric Company (CG&E) and PSI Energy, Inc. (PSI), both of which are public utility subsidiaries. As a result of this ownership, we are considered a utility holding company. Because we are a holding company with material utility subsidiaries operating in multiple states, we are registered with 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 principal subsidiaries are:

•                  Cinergy Wholesale Energy, Inc. (Wholesale Energy);
•                  Cinergy Services, Inc. (Services); and
•                  Cinergy Investments, Inc.~~; and~~
•                  ~~Cinergy Global Resources, Inc.~~ (Investments).

CG&E, an Ohio corporation, is a combination electric and gas public utility company that provides service in the southwestern portion of Ohio and, through its subsidiaries, in nearby areas of Kentucky and Indiana.CG&E is responsible for the majority of our power marketing and trading activity. CG&E’s principal subsidiary, The Union Light, Heat and Power Company (ULH&P), is a Kentucky corporation that provides 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 electric deregulation and customer choice. Currently, the competitive retail electric market in Ohio is in the development stage. CG&E is recovering its

5768

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

Public Utilities Commission of Ohio (PUCO) approved costs and retail electric rates are frozen during this market development period.

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

Services is a service company that provides our subsidiaries with a variety of centralized administrative, management, and support services. Investments holds most of our domestic non-regulated, energy-related businesses and investments, including gas marketing and trading operations.
Wholesale Energy, through a wholly-owned subsidiary, Cinergy Power Generation Services, LLC, provides electric production-related construction, operation, and maintenance services to certain affiliates and non-affiliated third parties.
The majority of our operating revenues are derived from the sale of electricity and the sale and/or transportation of natural gas.

LIQUIDITY AND CAPITAL RESOURCES
Ambient Air Standards
In 1997, the Environmental Protection Agency (EPA) revised the National Ambient Air Quality Standards (NAAQS) for ozone and fine particulate matter. State ozone non-attainment area designations were due to the EPA on July 15, 2003, and the EPA is under a court-ordered deadline to make final designations by April 15, 2004. The following counties in which we operate have been tentatively designated (by their respective states) as being in non-attainment with the new ozone standard: Boone County, Kentucky; Hamilton County, Indiana; Floyd County, Indiana; Clermont County, Ohio; and Hamilton County, Ohio. The EPA has stated that it will require state fine particulate non-attainment designations on February 15, 2004, and will make final designations by December 15, 2004. Following identification of non-attainment areas, each individual state will identify the sources of emissions and develop emission reduction plans. Under the Clean Air Act (CAA), individual states have up to 12 years from the date of designation to secure emissions reductions from sources contributing to the problem. Cinergy cannot predict the timing or effect of either the ozone or fine particulate matter non-attainment designations at this time.

In the second quarter of 2003, the EPA announced that it would propose, within the next year or so, a regional or national regulation requiring significant reductions in sulfur dioxide and nitrogen oxide (NO_X) emissions from power plants to implement the fine particulate matter NAAQS. This regulation would be expected to impact all of ~~Environmental Issues~~Cinergy’s coal-fired power plants. However, Cinergy cannot predict the exact amount and timing of these reductions at this time. Nonetheless, Cinergy expects that compliance costs with these new standards will be significant.

69

Global Climate Change
On September 9, 2003, Cinergy announced an internal voluntary greenhouse gas (GHG) management goal to reduce its GHG emissions by 2010. Cinergy expects to spend $21 million between 2004 and 2010 on projects to reduce or offset its emissions. Cinergy’s goal is to support the President’s voluntary initiative, to address shareholder interest in the issue, and to build internal expertise in GHG management and GHG markets.
Our plan for managing the potential risk and uncertainty of regulations relating to climate change includes the following:
•                  implementing an internal voluntary goal to reduce Cinergy’s GHG emissions 5 percent below Cinergy’s 2000 baseline emission levels by 2010;
•                  measuring and inventorying company related sources of GHG emissions;
•                  identifying and pursuing cost-effective GHG emission reduction and offsetting activities;
•                  funding research of more efficient and alternative electric generating technologies;
•                  funding research to better understand the causes and consequences of climate change;
•                  encouraging a global discussion of the issues and how best to manage them; and
•                  advocating comprehensive legislation for fossil-fired power plants.
As discussed in Cinergy’s 2002 10-K, ~~includes a discussion of certain~~additional environmental issues that could affect our ~~liquidity. These~~liquidity include:

•                  ~~Ambient~~ Air ~~Standards;~~Toxics Regulation;
•                  Regional Haze; and
•                  Global Climate ~~Change; and~~
•                  ~~Air Toxics Regulation.~~Change

In addition, see Note 7 of the “Notes to Condensed Financial Statements” in ~~“Item 1.~~“Part I. Financial Information” contained herein, for additional information regarding other environmental items and other matters that could ~~effect~~affect our liquidity.

Pensions
Cinergy maintains qualified defined benefit pension plans covering substantially all United States (U.S.) employees meeting certain minimum age and service requirements. Plan assets consist of investments in equity and fixed income securities. Funding for the qualified defined benefit pension plans is based upon actuarially determined contributions that take into account the amount deductible for income tax purposes and the minimum contribution required under the Employee Retirement Income Security Act of 1974, as amended. Due to the decline in market value of the investment portfolio over the last few years, assets held in trust to satisfy plan obligations have decreased. Additionally, recent decreases in long-term interest rates have the effect of increasing the measured liability for funding purposes. As a result of these events, future funding obligations could increase substantially. Cinergy’s minimum required contributions for the calendar year 2003 are $11 million, as compared to $4 million for the calendar year 2002. We ~~are considering~~made an additional ~~discretionary contributions~~contribution of ~~up to $50~~$63 million ~~for~~in the calendar year 2003.
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Long-term debt due within one year
Long-term debt due within one year for Cinergy increased approximately $1 billion from December 31, 2002 to September 30, 2003. The ~~discretionary contributions would be intended to improve the overall funding~~primary cause of the ~~plan.~~increase was the reclassification of Cinergy Corp.’s $200 million 6.125% Debentures due April 15, 2004 and $500 million 6.25% Debentures due September 1, 2004 from Long-term debt to Long-term debt due within one year. An additional $265.5 million was reclassified from Long-term debt to Long-term debt due within one year for CG&E to reflect the early redemption on October 1, 2003 of its 7.20% first mortgage bonds due October 1, 2023.
As discussed in Note 3 of the “Notes to Condensed Financial Statements” in “Part I. Financial Information”, proceeds from the June 2003 issuance of debt by CG&E were used for the repayment of outstanding indebtedness includingthe early redemption of the 7.20% first mortgage bonds mentioned above. In September 2003, PSI issued $400 million principal amount of its 5.00% Debentures largely using the proceeds from this issuance for the early redemption of two intercompany promissory notes to Cinergy Corp. totaling $376 million. Cinergy Corp. plans to use the proceeds to partially fund the maturity of the 6.125% and 6.25% debentures discussed above. In the interim, Cinergy Corp. has used the proceeds to repay short-term indebtedness.

Cinergy plans to meet its remaining future debt obligations from the issuance of debt and/or equity securities and internally-generated funds.
Other Investing Activities
Our ability to invest in growth initiatives is limited by certain legal and regulatory requirements, including PUHCA. The PUHCA limits the types of non-utility businesses in which Cinergy and other registered holding companies under PUHCA can invest as well as the amount of capital
58

that can be invested in permissible non-utility businesses. Also, the timing and amount of investments in the non-utility businesses is dependent on the development and favorable evaluations of opportunities. Under the PUHCA restrictions, we are allowed to invest or commit to invest in certain non-utility businesses, including:

•                  Exempt Wholesale Generators (EWG) and Foreign Utility Companies (FUCO)

An EWG is an entity, certified by the Federal Energy Regulatory Commission (FERC), devoted exclusively to owning and/or operating, and selling power from one or more electric generating facilities. An EWG whose generating facilities are located in the U.S. is limited to making only wholesale sales of electricity.

A FUCO is a company all of whose utility assets and operations are located outside the U.S. and which are used for the generation, transmission, or distribution of electric energy for sale at retail or wholesale, or the distribution of gas at retail. A FUCO may not derive any income, directly or indirectly, from the generation, transmission or distribution of electric energy for sale or the distribution of gas at retail within the U.S. An entity claiming status as a FUCO must provide notification thereof to the SEC under PUHCA.

71
~~In May 2001, the SEC issued an order under PUHCA authorizing~~
Cinergy has been granted SEC authority under PUHCA to invest (including by way of guarantees) an aggregate amount in EWGs and FUCOs equal to the sum of (1) our average consolidated retained earnings from time to time plus (2) $2 billion. As of ~~March 31,~~September 30, 2003, we had invested or committed to invest ~~$1.0 billion~~approximately $775 million in EWGs and FUCOs, leaving available investment capacity under the ~~May 2001~~ order of ~~$2.4~~approximately $2.7 billion.

•                  Qualifying Facilities and Energy-Related Non-utility Entities

SEC regulations under the PUHCA permit Cinergy and other registered holding companies to invest and/or guarantee an amount equal to 15 percent of consolidated capitalization (consolidated capitalization is the sum of Notes payable and other short-term obligations, Long-term debt (including amounts due within one year), Preferred Trust Securities, Cumulative Preferred Stock of Subsidiaries, and total Common Stock Equity) in domestic qualifying cogeneration and small power production plants (qualifying facilities) and certain other domestic energy-related non-utility entities. At ~~March 31,~~September 30, 2003, we had invested and/or guaranteed approximately ~~$0.5billion~~$735million of the ~~$1.3~~$1.4 billion available.

•                  Energy-Related Assets
Cinergy has been granted SEC authority under PUHCA to invest up to $1 billion in non-utility Energy-Related Assets within the U.S., Canada, and Mexico. Energy-Related Assets include, natural gas exploration, development, production, gathering, processing, storage and transportation facilities and equipment, liquid oil reserves and storage facilities, and associated assets, facilities and equipment, but would exclude any assets, facilities or equipment that would cause the owner or operator thereof to be deemed a public utility company. As of September 30, 2003, we did not have any investments in these Energy-Related Assets.
•                  Infrastructure Services Companies
Cinergy has been granted SEC authority under PUHCA to invest up to $500 million in companies that derive or will derive substantially all of their operating revenues from the sale of Infrastructure Services including:
•                  Design, construction, retrofit and maintenance of utility transmission and distribution systems;
•                  Installation and maintenance of natural gas pipelines, water and sewer pipelines, and underground and overhead telecommunications networks; and
•                  Installation and servicing of meter reading devices and related communications networks, including fiber optic cable.
At September 30, 2003, we had invested approximately $25 million in these Infrastructure Services companies.
72

Guarantees
We are subject to an SEC order under the PUHCA, which limits the amounts Cinergy Corp. can have outstanding under guarantees at any one time to $2 billion. As of ~~March 31,~~September 30, 2003, we had ~~$608~~$538 million outstanding under the guarantees issued, of which approximately 8886 percent represents guarantees of obligations reflected on Cinergy’s ~~Consolidated~~ Balance Sheets. The amount outstanding represents Cinergy Corp.’s guarantees of liabilities and commitments of its
59

consolidated subsidiaries, unconsolidated subsidiaries, and joint ventures. See Note 7(a) of the “Notes to Condensed Financial Statements” in ~~“Item 1.~~“Part I. Financial Information” for a discussion of guarantees in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (Interpretation 45). Interpretation 45 requires disclosure of maximum potential liabilities for guarantees issued on behalf of unconsolidated subsidiaries and joint ventures and under indemnification clauses in various contracts. The Interpretation 45 disclosure differs from the PUHCA restrictions in that it requires a calculation of maximum potential liability, rather than actual amounts outstanding; it excludes guarantees issued on behalf of consolidated subsidiaries; and it includes potential liabilities under indemnification clauses.

Collateral Requirements
Cinergy has certain contracts in place, primarily with trading counterparties, that require the issuance of collateral in the event our debt ratings are downgraded below investment grade. Based upon our ~~March 31,~~September 30, 2003 trading portfolio, if such an event were to occur, Cinergy would be required to issue up to approximately ~~$75~~$64 million in collateral related to its gas and power trading ~~operations.~~operations, of which $34 million is related to CG&E.

Capital Resources
We meet our current and future capital requirement needs through a combination of internally and externally generated funds, including the issuance of debt and/or equity securities. Cinergy believes that it has adequate financial resources to meet its future needs.

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Notes Payable and Other Short-term Obligations
We are required to secure authority to issue short-term debt from the SEC under the PUHCA and from the PUCO. The SEC under the PUHCA regulates the issuance of short-term debt by Cinergy Corp., PSI, and ULH&P. The PUCO has regulatory jurisdiction over the issuance of short-term debt by CG&E.

Short-term Regulatory Authority
March 31, 2003

Short-term Regulatory Authority
September 30, 2003

(millions)

(millions)

Authority

Outstanding

Authority

Outstanding

Cinergy Corp.

$
5,000
(1)
$
193

$
5,000
(1)
$
209

CG&E and subsidiaries

671

3

671

9

PSI

600

230

600

165

ULH&P

65

5

65

24

~~(1)~~
(1)Cinergy Corp., under the 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 specific regulatory debt authorizations.

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

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Cinergy Corp.’s short-term borrowing consists primarily of unsecured revolving lines of credit and the sale of commercial paper. Cinergy Corp.’s $1 billion revolving credit facilities and $800 million commercial paper program also support the short-term borrowing needs of CG&E and PSI. In addition, Cinergy, CG&E, and PSI maintain uncommitted lines of credit. These facilities are not firm sources of capital but rather informal agreements to lend money, subject to availability, with pricing determined at the time of advance. The following is a summary of outstanding short-term borrowings for Cinergy, CG&E, PSI, and ULH&P, including variable rate pollution control notes:

Short-term Borrowings
March 31, 2003

Short-term Borrowings
September 30, 2003

Established
Lines

Outstanding

Unused

Standby
Liquidity(3)

Available
Revolving
Lines of
Credit

Established
Lines

Outstanding

Unused

Standby
Liquidity(3)

Available
Revolving
Lines of
Credit

(in millions)

(in millions)

Cinergy

Cinergy Corp.

Revolving lines

$
1,000

$
—

$
1,000

$
204

$
796

$
1,000

$
—

$
1,000

$
224

$
776

Uncommitted lines(1)

65

—

65

65

—

65

Commercial paper(2)

193

607

209

591

Operating companies

Uncommitted lines(1)

75

—

75

75

—

75

Pollution control notes

112

112

Non-regulated subsidiaries

Revolving lines

8

1

7

7

17

9

8

8

Short-term debt

22

22

—

7

Cinergy Total

$
328

$
803

$
337

$
784

CG&E and subsidiaries

Uncommitted lines(1)

$
15

$
—

$
15

$
15

$
—

$
15

Pollution control notes

112

112

Money pool

3

9

CG&E Total

$
115

$
121

PSI

Uncommitted lines(1)

$
60

$
—

$
60

$
60

$
—

$
60

Pollution control notes

—

Money pool

230

165

PSI Total

$
230

$
165

ULH&P

Money pool

$
5

$
24

ULH&P Total

$
5

$
24

~~(1)~~
~~Outstanding amounts may be greater than established lines as uncommitted lenders are, at times, willing to loan funds in excess of the established lines.~~
~~(2)~~
~~The commercial paper program is limited to $800 million and is supported by~~ ~~Cinergy Corp.’s~~ ~~revolving lines.~~
~~(3)~~
~~Standby liquidity is reserved against the revolving lines to support the commercial paper program and outstanding letters of credit (currently $193 million and $11~~
(1)Outstanding amounts may be greater than established lines as uncommitted lenders are, at times, willing to loan funds in excess of the established lines.
(2)The commercial paper program is limited to $800 million and is supported by Cinergy Corp.’s revolving lines.
(3)Standby liquidity is reserved against the revolving lines to support the commercial paper program and outstanding letters of credit (currently $209 million and $15 million, respectively).

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At ~~March 31,~~September 30, 2003, Cinergy Corp. had ~~$796~~$776 million remaining unused and available capacity relating to its $1 billion revolving credit facilities. These revolving credit facilities included the following:

Credit Facility

Expiration

Established
Lines

Outstanding
and
Committed

Unused and
Available

Expiration

Established
Lines

Outstanding
and
Committed

Unused and
Available

(in millions)

(in millions)

364-day senior revolving

April 2003

April 2004

Direct borrowing

$

$
—

$

$

$
—

$

Commercial paper support

193

209

Total 364-day facility

600

193

407

600

209

391

Three-year senior revolving

May 2004

May 2004

Direct borrowing

—

—

Commercial paper support

—

—

Letter of Credit support

11

15

Total three-year facility

400

11

389

400

15

385

Total credit facilities

$
1,000

$
204

$
796

$
1,000

$
224

$
776

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

In our credit facilities, Cinergy Corp. has covenanted to maintain:

•                  a consolidated net worth of $2 billion; and
•                  a ratio of consolidated indebtedness to consolidated total capitalization not in excess of 65 percent.

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

•                  bankruptcy;
•                  defaults in the payment of other indebtedness; and
•                  judgments against the company that are not paid or insured.

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

63As discussed in Note 1(g)(iii) of the “Notes to Condensed Financial Statements” in “Part I. Financial Information”, long-term debt increased in the third quarter of 2003 resulting from the adoption of Interpretation No. 46, Consolidation of Variable Interest Entities (Interpretation 46).
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The debt which was recorded as a result of this new accounting pronouncement did 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 notes obtained to finance equipment or land development for pollution control purposes). Because the holders of these notes have the right to have their notes redeemed on a daily, monthly, or annual basis, they are reflected in Notes payable and other short-term obligations on the Balance Sheets ~~for~~of Cinergy and CG&E. At ~~March 31,~~September 30, 2003, CG&E had $112 million outstanding in variable rate pollution control notes, classified as short-term debt. PSIand ULH&P had no outstanding short-term pollution control notes. Any short-term pollution control note borrowings outstanding do not reduce the unused and available short-term debt regulatory authority of CG&E, PSI, and ULH&P. See ~~Notes 4 and~~Note 5 of the “Notes to Condensed Financial Statements” in ~~“Item 1.~~“Part I. Financial Information” for additional information regarding pollution control notes.

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

Long-term Debt
We are required to secure authority to issue long-term debt from the SEC under the PUHCA and the state utility commissions of Ohio, Kentucky, and Indiana. The SEC under the PUHCA regulates the issuance of long-term debt by Cinergy Corp. The respective state utility commissions regulate the issuance of long-term debt by our operating companies.

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A summary of our long-term debt authorizations at ~~March 31,~~September 30, 2003, iswas as follows:

Authorized

Used

Available

Authorized

Used

Available

(in millions)

(in millions)

Cinergy Corp.

PUHCA total capitalization(1)

$
5,000

$
1,521

$
3,479

$
5,000

$
1,601

$
3,399

CG&E and subsidiaries(2)

State Public Utility Commissions

575

—

575

575

400

175

PSI

State Public Utility Commission

500

83

417

500

483

17

ULH&P

State Public Utility Commission

75

—

75

75

—

75

(1)Cinergy Corp., 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 specific regulatory debt authorizations.
(2)Includes amounts for ULH&P.
~~Cinergy Corp.,~~ 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 specific regulatory debt authorizations.~~
~~(2)~~
~~Includes amounts for~~ ~~ULH&P~~.

Cinergy Corp. has an effective shelf registration statement with the SEC relating to the issuance of up to $750 million in any combination of common stock, preferred stock, stock purchase contracts or unsecured debt securities, of which approximately ~~$573~~$574 million remains available for issuance. CG&E has an effective shelf registration statement with the SEC relating to the issuance of up to $500 million in any combination of unsecured debt securities, first mortgage bonds, or preferred stock, ~~all~~ of which $100 million remains available for issuance. PSI has an effective shelf registration statement with the SEC relating to the issuance of up to $700 million in any combination of unsecured debt securities, first mortgage bonds, or preferred stock, ~~all~~ of which $300 million remains available for issuance. ULH&P has effective shelf registration statements with the SEC relating to the issuance of up to $50 million in unsecured debt securities and up to $40 million in first mortgage bonds, of which $30 million in unsecured debt securities and $20 million in first mortgage bonds remain available for issuance.

Off-Balance Sheet Financing
As discussed in the 2002 10-K, Cinergy uses special-purpose entities (SPE) to finance various projects. The FASB issued Interpretation ~~No.~~ 46~~Consolidation of Variable Interest Entities~~ ~~(Interpretation 46)~~ in January 2003. This interpretation ~~will~~ significantly ~~change~~changes the consolidation requirements for ~~SPEs. We have begun reviewing the impact~~SPEs and certain other entities subject to its scope. For further discussions see “Consolidation of this interpretation but have not yet concluded whether consolidation of certain SPEs will be required. There are two SPEs for which consolidation may be required. These SPEs have individual power sale agreements to an unrelated third party for approximately 45 megawatts (MW) of capacity, endingVariable Interest Entities” under “Accounting Changes” in 2009, and 35 MW of capacity, ending in 2016. In addition, the SPEs have individual power purchase agreements with Cinergy Capital & Trading, Inc. (Capital & Trading) to supply the power. Capital & Trading also provides various services, including certain credit support facilities.MD&A-Future.

65

~~Cinergy’s~~ ~~quantifiable exposure to loss as a result~~As of involvement with these two SPEs is $28 million, which includes investments in these entities of $3 million and exposure under the capped credit facilities of approximately $25 million. There is also a non-capped facility, but it can only be called upon in the event the SPE breaches representations, violates covenants, or other unlikely events.
If appropriate, consolidation of all assets and liabilities of these two SPEs, at their carrying values, will be required in the third quarter of 2003. Approximately $225 million of non-recourse debt would be included in ~~Cinergy’s~~ ~~Consolidated Balance Sheets upon initial consolidation. However, the impact on results of operations would be expected to be immaterial.~~
September 30, 2003, Cinergy believes that its accounts receivable sale facility, as discussed in the 2002 10-K, would remain unconsolidated since it involves transfers of financial assets to a qualifying SPE, which is exempted from consolidation by Statement of Financial Accounting Standards No. 140, ~~Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities~~ ~~(Statement 140) and Interpretation 46.~~
~~Cinergy~~ ~~holds~~held investments in various unconsolidated subsidiaries which are accounted for under the equity method and ~~has~~had guaranteed approximately $8 million of the debt of these entities. In October 2003, Cinergy Corp. acquired controlling interest in these entities, and as a result, the entities will be consolidated by Cinergy Corp.

6678

Securities Ratings

As of ~~March 31,~~September 30, 2003, the major 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’s Ratings Services (S&P)
~~Fitch IBCA (Fitch )~~
~~(2)~~
~~Moody’s Investors Service (Moody’s )~~
~~(3)~~
~~Standard & Poor’s Ratings Services (S&P )~~

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

These securities ratings may be revised or withdrawn at any time, and each rating should be evaluated independently of any other rating.

Equity ~~Securities~~
As discussed in the 2002 10-K, ~~under~~ the ~~SEC’s June 2000 Order,~~SEC has granted Cinergy Corp. ~~is permitted~~authority to increase its total capitalization by $5 billion. The proceeds from any new issuances will be used for general corporate purposes.

OnIn January ~~15,~~ 2003, Cinergy Corp. filed a registration statement with the SEC with respect to the issuance of common stock, preferred stock, and other securities in an aggregate offering amount of $750 million. OnIn February 5, 2003, Cinergy sold 5.7 million shares of common stock of Cinergy Corp. with net proceeds of approximately $175 million under this registration statement.

See Note 22(a) of the “Notes to Condensed Financial Statements” in “Part 1.I. Financial Information” for additional information regarding other common stock issuances.
Cinergy Corp. contributed $200 million in capital to PSI in two separate $100 million capital contributions in the second and third quarters of 2003, respectively. These capital contributions were made to support PSI’s current credit ratings.

6779

MD&A ~~- -~~ – QUARTERLY RESULTS OF OPERATIONS - HISTORICAL

2003 QUARTERLY RESULTS OF OPERATIONS - HISTORICAL
Summary of Results
Electric and gas gross margins and net income for Cinergy, CG&E, and PSI for the quarters ended ~~March 31,~~September 30, 2003 and 2002 were as follows:

Cinergy(1)

CG&E and subsidiaries

PSI

Cinergy (1)

CG&E and subsidiaries

PSI

2003

2002

2003

2002

2003

2002

2003

2002

2003

2002

2003

2002

(in thousands)

(in thousands)

Electric gross margin

$
557,400

$
550,086

$
298,010

$
290,871

$
244,816

$
243,352

$
590,641

$
663,069

$
330,046

$
356,158

$
259,298

$
302,089

Gas gross margin

162,918

80,184

103,511

71,641

—

—

44,951

54,790

34,176

28,858

—

—

Net income

166,085

84,829

117,236

77,585

33,727

38,083

111,981

130,568

78,863

71,769

37,592

67,643

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

~~Net~~Cinergy’s net income for the ~~first~~third quarter of 2003 was ~~$166~~$112 million ($~~.95~~.62 per share on a diluted basis) as compared to ~~$85~~$131 million ($~~.52~~.77 per share on a diluted basis) for the same period last year. Income before taxes for the period was ~~$198~~$148 million compared to ~~$150~~$181 million for the same period a year ago. ~~Increased gross~~Electric margins at PSI and CG&E declined due to milder weather during the quarter. Gas margins decreased primarily ~~from wholesale and retail gas operations, were partially offset by higher operating costs. These gas margins primarily reflect~~due to the results of our ~~domestic~~ gas trading operation, Cinergy Marketing & Trading, LP (Marketing & Trading) ~~as well as an increased volume of~~, although this was partially offset by higher usage by CG&E’s retail ~~sales~~customers due to ~~colder than normal weather during~~cooler weather. During the ~~quarter.~~quarter, fewer trading opportunities were available as a result of market conditions. Also contributing to the ~~gas margin increase over 2002 was~~decrease in net income were costs associated with the ~~impact~~likely resolution of ~~accounting changes that required certain gas contracts~~claims with respect to the bankruptcy of Enron Corp. (Enron). Partially offsetting these decreases in net income were reductions in transmission costs and ~~inventory to be accounted for on the accrual basis beginning in 2003.~~ ~~Cinergy’s~~ increased income also reflects a net gain resulting from the implementation of certain accounting changes, which have been reflected as a cumulative effect of a change in accounting principles. See Note 1(j)(~~viii~~~~) of the “Notes to Financial Statements” in “Item 1. Financial Information” for further information regarding these accounting changes.~~property taxes.

Electric Operating Revenues

Cinergy(1)

CG&E and subsidiaries

PSI

Cinergy (1)

CG&E and subsidiaries

PSI

2003

2002

% Change

2003

2002

% Change

2003

2002

% Change

2003

2002

% Change

2003

2002

% Change

2003

2002

% Change

(in millions)

(in millions)

Retail

$
678

$
651

4

$
328

$
334

(2
)
$
350

$
318

10

$
744

$
805

(8
)
$
377

$
429

(12
)
$
367

$
377

(3
)
Wholesale

126

94

34

70

33

N/M

56

44

27

141

109

29

65

27

N/M

61

79

(23
)
Transportation

6

2

N/M

6

2

N/M

—

—

—

Other

27

32

(16
)
25

29

(14
)
6

4

50

36

51

(29
)
33

37

(11
)
9

15

(40
)
Total

$
837

$
779

7

$
429

$
398

8

$
412

$
366

13

$
921

$
965

(5
)
$
475

$
493

(4
)
$
437

$
471

(7
)

(1) The results of Cinergy also include amounts related to non-registrants.
N/M Not meaningful to an understanding of the change.
Electric operating revenues decreased for Cinergy, CG&E,and PSI for the quarter ended September 30, 2003, as compared to 2002. Retail revenues decreased for Cinergy, CG&E, and PSI primarily due to lower megawatt hour (MWh) sales resulting from milder weather. The number of cooling degree days for the third quarter was approximately 35 percent lower than the
80

comparable period of 2002, contributing to a reduction in residential MWh sales of approximately 15 percent and 10 percent for CG&E and PSI, respectively. Also contributing to the decrease were lower commercial and industrial MWh sales reflecting the effects of a continuing sluggish economy. Partially offsetting this decrease for PSI were increased tariff adjustments associated with the fuel cost recovery mechanism and certain construction programs.
Wholesale revenues increased for Cinergy and CG&E for the quarter ended September 30, 2003, as compared to the same period last year. Due to lower retail demand as a result of mild weather, more Cinergy generation capacity was available for wholesale transactions. In addition CG&E’s increase and PSI’s decrease in wholesale revenues reflects the implementation of the new joint operating agreement as discussed in the 2002 10-K. With this agreement, the majority of new wholesale contracts entered into are originated on behalf of CG&E.
Other electric operating revenues decreased for Cinergy, CG&E and PSI for the quarter ended September 30, 2003, as compared to 2002. Cinergy’s and CG&E’s decrease was primarily the result of decreased third party coal sales and lower transmission revenues. PSI’s decrease was primarily the result of decreased transmission revenues.
Gas Operating Revenues

Cinergy (1)

CG&E and subsidiaries

2003

2002

% Change

2003

2002

% Change

(in millions)

Retail

$
66

$
41

61

$
66

$
41

61

Wholesale

10

26

(62
)
—

—

—

Storage and transportation

49

36

36

—

—

—

Other

—

1

N/M

—

—

—

Total

$
125

$
104

20

$
66

$
41

61

(1) The results of Cinergy also include amounts related to non-registrants.
N/M Not meaningful to an understanding of the change.
~~Electric operating revenues~~ ~~increased for~~ ~~Cinergy~~, ~~CG&E~~,~~and~~ ~~PSI~~ ~~for the quarter ended March 31, 2003, as compared to 2002. Retail revenues increased for~~ ~~Cinergy~~ ~~and~~ ~~PSI~~ ~~primarily due to~~
68

~~increased megawatt hour (MWh) sales due to colder than normal weather.~~ ~~PSI’s~~ ~~retail revenues reflect increases in MWh sales in residential, commercial, and industrial customer classes.~~ ~~PSI’s~~ ~~increase also reflects a higher price received per MWh due to tariff adjustments associated with fuel cost recovery and certain construction programs.~~ ~~CG&E’s~~ retail revenues decreased slightly for the quarter ended March 31, 2003, as compared to 2002. Increased residential sales, attributable to colder than normal weather, were offset by decreases in revenue from commercial and industrial customers. This decrease reflects a sluggish economy and the migration of certain customers to a transportation-only tariff in connection with the Ohio electric customer choice program.
~~Wholesale revenues increased for~~ ~~Cinergy~~, ~~CG&E~~~~,and~~ ~~PSI~~ ~~for the quarter ended March 31, 2003, as compared to 2002. The increase in wholesale revenues for~~ ~~Cinergy~~ ~~and~~ ~~CG&E~~ ~~primarily reflects higher non-firm wholesale sales volumes due to the colder than normal weather. Also contributing to the increase was an increase in the wholesale gross margin realized per MWh.~~ ~~CG&E’s~~ increase also reflects the implementation of the new joint operating agreement effective April 2002. In connection with the implementation of the new operating agreement, the majority of new wholesale sales transactions entered into since April 2002 were originated on behalf of ~~CG&E~~. ~~PSI’s~~ ~~increase reflects higher wholesale gross margins realized per MWh. This increase was partially offset by lower wholesale sales volumes due to the new joint operating agreement.~~
~~Gas Operating Revenues~~

Cinergy(1)

CG&E and subsidiaries

2003

2002

% Change

2003

2002

% Change

(in millions)

Retail

$
253

$
161

57

$
253

$
161

57

Wholesale

125

11

N/M

—

—

—

Transportation

20

17

18

20

17

18

Other

1

1

—

2

2

—

Total

$
399

$
190

N/M

$
275

$
180

53

~~(1) The results of~~ ~~Cinergy~~ ~~also include amounts related to non-registrants.~~
~~N/M Not meaningful to an understanding of the change.~~

Gas operating revenues increased for Cinergy and CG&E for the quarter ended ~~March 31,~~September 30, 2003, as compared to 2002. ~~Cinergy’s~~ ~~and~~ ~~CG&E’s~~ ~~retail~~Retail gas revenues increased due to both an increase in ~~retail per~~ thousand cubic feet (mcf) ~~sales~~delivered and ~~higher prices~~an increase in price received per ~~mcf delivered. The increase in retail gas sales~~mcf. CG&E’s volumes isdelivered increased primarily ~~the result of the colder than normal~~due to cooler weather in the ~~first~~third quarter of ~~2003.~~2003, as compared to 2002. The higher ~~price~~prices per mcf ~~delivered reflects~~reflect an increase in~~CG&E’s~~ ~~base rates, as approved by the PUCO in May 2002, and~~ tariff adjustments associated with the gas main replacement program, the Ohio excise taxes, and the gas cost recovery mechanism. ~~For further information see Note 7(m) in the “Notes to Financial Statements” in “Item 1. Financial Information”.~~
CG&E’s wholesale gas commodity cost is passed directly to the retail customer dollar-for-dollar under the gas cost recovery mechanism mandated by state law. For further information see Note 7(n) in the “Notes to Condensed Financial Statements” in “Part I. Financial Information”.

69

~~Wholesale gas revenues consist almost exclusively of activity within Marketing & Trading.~~ Cinergy began reporting revenues from energy trading derivative contracts on a net basis in 2003, in accordance with the required adoption of Emerging Issues Task Force (EITF) Issue 02-3, Issues Involved in Accounting for Derivatives Contracts Held for Trading Purposes and
81

Contracts Involved in Energy Trading and Risk Management Activities (EITF 02-3). See Note 31(g)(iii) in the “Notes to Condensed Financial Statements” in ~~“Item 1.~~“Part I. Financial Information” for additional information. ~~Wholesale~~
Cinergy’s wholesale gas revenues (which represent net gains and losses on energy trading activity) decreased for the quarter ended September 30, 2003, as compared to 2002, primarily due to fewer trading opportunities in 2003 as a result of market conditions.
~~Cinergy~~Cinergy’s gas storage and transportation revenues increased for the quarter ended ~~March 31,~~September 30, 2003, as compared to ~~2002. Marketing & Trading began engaging in significant storage activities~~2002 due to an overall increase in the ~~second~~number of storage contracts that were entered into in the third quarter of 2002, resulting in increased revenues, which must be presented on a gross revenue basis.   (Storage activity involves acquiring and storing gas primarily during off-peak periods for withdrawal and sale during periods of higher demand.) Additionally, revenues (net margins) increased from basis trading due to extreme volatility of natural gas prices.2003.

Other Revenues
Other revenues for Cinergy ~~increased~~decreased for the quarter ended ~~March 31,~~September 30, 2003, as compared to 2002, primarily due to a decrease in the ~~sale~~production of synthetic fuel ~~which began~~as a result of a reduction in ~~July 2002.~~electric production by the third party purchaser of our synthetic fuel.

Operating Expenses

Cinergy(1)

CG&E and subsidiaries

PSI

Cinergy (1)

CG&E and subsidiaries

PSI

2003

2002

% Change

2003

2002

% Change

2003

2002

% Change

2003

2002

% Change

2003

2002

% Change

2003

2002

% Change

(in millions)

(in millions)

Fuel

$
240

$
204

18

$
105

$
93

13

$
135

$
110

23

$
287

$
270

6

$
111

$
114

(3
)
$
164

$
140

17

Purchased and exchanged power

39

25

56

26

14

86

32

13

N/M

43

32

34

34

23

48

14

29

(52
)
Gas purchased

236

110

N/M

172

108

59

—

—

—

30

13

N/M

32

13

N/M

—

—

—

Gas storage and transportation

50

36

39

—

—

—

—

—

—

Operation and maintenance

327

263

24

135

106

27

112

115

(3
)

317

364

(13
)
133

150

(11
)
113

129

(12
)
Depreciation

106

99

7

49

48

2

43

38

13

105

100

5

43

49

(12
)
48

40

20

Taxes other than income taxes

78

72

8

60

54

11

16

16

—

56

65

(14
)
45

50

(10
)
10

13

(23
)
Total

$
1,026

$
773

33

$
547

$
423

29

$
338

$
292

16

$
888

$
880

1

$
398

$
399

—

$
349

$
351

(1
)

(1) The results of Cinergy also include amounts related to non-registrants.
N/M Not meaningful to an understanding of the change.

7082

Fuel
Fuel primarily represents the cost of coal, natural gas, and oil that is used to generate electricity. The following table details the changes to fuel expense from the quarter ended ~~March 31,~~September 30, 2002, to the quarter ended ~~March 31,~~September 30, 2003:

Cinergy(1)

CG&E

PSI

Cinergy (1)

CG&E

PSI

(in millions)

(in millions)

Fuel expense - March 31, 2002

$
204

$
93

$
110

Fuel expense – September 30, 2002

$
270

$
114

$
140

Increase (decrease) due to changes in:

Price of fuel

6

—

6

3

2

1

Deferred fuel cost(2)

13

—

13

21

—

21

MWh generation

14

8

6

Fuel consumption

2

—

2

Other~~(2)~~(3)

3

4

—

(9
)
(5
)
—

Fuel expense - March 31, 2003

$
240

$
105

$
135

Fuel expense – September 30, 2003

$
287

$
111

$
164

(1) The results of Cinergy also include amounts related to non-registrants.
(2) Deferred fuel cost represents changes in fuel expense associated with PSI's fuel adjustment charge, which recovers retail fuel costs from customers on a dollar-for-dollar basis. Amounts that have been deferred are adjusted through fuel expense as fuel adjustment charge revenue is collected from customers.
(3) Includes costs of third party coal sales.
~~(2) Includes costs of third party coal sales.~~

Purchased and Exchanged Power
Purchased and exchanged power expense~~expense~~increased for Cinergy, ~~CG&E~~~~,and~~ ~~PSI~~ forthe quarter ended ~~March 31,~~September 30, 2003, as compared to ~~2002. This~~ the same period last year. The majority of Cinergy’s and CG&E’s increase is ~~primarily the~~a result of ~~increases in MWh volumes purchased caused by the colder than normal weather conditions. Also, contributing to this increase was~~ an increase in the price paid per ~~MWh. First quarter average wholesale electricity prices were 85 percent higher over~~MWh and a lower amount of deferred purchased power cost. Offsetting the ~~same period~~increase was a decrease in ~~2002. As discussed above,~~purchased and exchanged power expense at ~~CG&E’s~~PSI. More generation is available to serve PSI ~~and~~native load customers due to the repowering of PSI’s ~~Purchased~~Noblesville Station and ~~exchanged power~~ ~~expense also reflects~~ the ~~effects~~addition of peaking plants as discussed in Note 12 in the ~~implementation of the new joint operating agreement beginning~~“Notes to Condensed Financial Statements” in ~~April 2002.~~“Part I. Financial Information”.

Gas Purchased
Gas purchased expense increased for Cinergy and CG&E for the quarter ended ~~March 31,~~September 30, 2003, as compared to 2002. This increase was primarily due to an increase in the average cost per mcf of gas purchased. ~~Also, contributing~~In addition, CG&E’s gas customers usage increased approximately 17 percent in the quarter as compared to the ~~increase was increased volumes purchased. Theprimary cause of the price and consumption increases was the colder than normal weather experienced in the Midwest, which drove up the demand for natural gas.~~same period last year. CG&E’s wholesale commodity cost is passed directly to the retail customer dollar-for-dollar under the gas cost recovery mechanism mandated by state law. ~~As discussed under “Gas Operating Revenues”, storage activity is required to be presented on a gross basis, resulting in the utilization of storage gas being reflected as~~
Gas ~~purchased~~Storage and Transportation
Gas storage and transportation expense ~~rather than netted with gas revenue. With Marketing & Trading’s~~increased for Cinergy for the quarter ended September 30, 2003, as compared to 2002, primarily due to an increase in storage withdrawals which reflects increased storage ~~activity, a significantly greater quantity~~contract activity. Gas storage expense is recognized on our Statements of Income as natural gas ~~was~~is sold ~~during the quarter.~~from inventory.

7183

Operation and Maintenance
Operation and maintenance expense decreased for Cinergy, CG&E, and PSI for the quarter ended September 30, 2003, as compared to 2002. The decrease for Cinergy was a result of a decrease in the costs associated with the production of synthetic fuel in the third quarter of 2003 compared to 2002. Partially offsetting the decrease for Cinergy were the costs associated with our anticipated resolution of claims with respect to the bankruptcy of Enron. Cinergy’s, CG&E’s, and PSI’s decreases were also affected by a decrease in the amortization of certain regulatory assets due to lower electric revenues. Also contributing to the decrease for Cinergy, CG&E, and PSI were decreased transmission costs.
Depreciation
Depreciation expense increased for Cinergy and ~~CG&E~~PSI and decreased for ~~PSI~~CG&E for the quarter ended ~~March 31,~~September 30, 2003, as compared to 2002. Cinergy’s and PSI’s increase was primarily attributable to the addition of depreciable plant. CG&E’s decrease is primarily attributable to an increase in the estimated useful lives of our generating assets, resulting from a new depreciation study completed during the third quarter of 2003. Also contributing to CG&E’s decrease was the discontinuance of accruing costs of removal for our generating assets (which was previously included as part of Depreciation expense) as a result of the adoption of Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations (Statement 143). See Note 1(g)(vi) of the “Notes to Condensed Financial Statements” in “Part I. Financial Information” for further details. Prior periods were not restated for the adoption of Statement 143.
Taxes Other Than Income Taxes
Taxes other than income taxes expense decreased for Cinergy, CG&E, and PSI for the quarter ended September 30, 2003, as compared to 2002. This decrease was primarily due to lower property taxes.
Miscellaneous Income (Expense) - Net
Miscellaneous Income (Expense) - Net increased for Cinergy for the quarter ended September 30, 2003, as compared to 2002. Cinergy’s increase primarily reflects ~~costs associated with~~ the ~~production~~interest income on the notes receivable of ~~synthetic fuel, which began~~two newly consolidated subsidiaries. See Note 1(g)(iii) of the “Notes to Condensed Financial Statements” in ~~July 2002. Additionally,~~“Part I. Financial Information” for further details regarding the consolidation of these entities. In addition, ~~Cinergy’s~~,CG&E’s, increase and PSI’s decrease was a result of a final reconciliation between the two entities of a previous demutualization of a medical insurance carrier used by both companies.
Interest Expense
~~and~~ ~~PSI’s~~ ~~comparative~~
~~Operation and maintenance~~Interest ~~expenses reflect~~Expense increased for Cinergy, CG&E, and PSI for the quarter ended September 30, 2003, as compared to 2002. The impact of a decrease in short-term interest rates was more than offset by an increase in the ~~costs~~amount of ~~employee compensation and benefit programs.~~long-term debt outstanding for ~~Cinergy’s~~ Cinergy, CG&E, and ~~CG&E’s~~ PSI~~increase also reflects~~. Interest on long-term debt increased ~~amortization~~as a result of ~~regulatory transition assets.~~the additional debt recorded with the

84

consolidation of two new entities and the recognition of a note payable to a trust in accordance with the adoption of Interpretation 46, see Note 1(g)(~~Depreciation~~iii) of the “Notes to Condensed Financial Statements” in “Part I. Financial Information”.
Preferred Dividend Requirement of Subsidiary Trust
~~Depreciation~~ Preferred Dividend Requirement of Subsidiary Trust decreased for Cinergy for the quarter ended September 30, 2003, as a result of the implementation of Interpretation 46. Effective July 1, 2003, the preferred trust securities and the related dividends are no longer reported in Cinergy’s financial statements. See Note 1(g)(iii) of the “Notes to Condensed Financial Statements” in “Part I. Financial Information” for further details.
Income Taxes
Income Taxesexpense ~~increased~~decreased for Cinergy and PSI for the quarter ended September 30, 2003, as compared to 2002. Cinergy’s decrease was primarily a result of a decrease in taxable book income. Based on its current estimates, Cinergy expects that its effective income tax rate for 2003 will approximate 24 percent. PSI’s decrease was primarily due to a decrease in taxable book income. This decrease was partially offset by an increase in the Indiana state income tax rate in 2003.
85

MD&A - YEAR TO DATE RESULTS OF OPERATIONS - - HISTORICAL
2003 YEAR TO DATE RESULTS OF OPERATIONS - HISTORICAL
Summary of Results
Electric and gas gross margins and net income for Cinergy, CG&E, and PSI for the ~~quarter~~nine months ended ~~March 31,~~September 30, 2003 and 2002 were as follows:

Cinergy (1)

CG&E and subsidiaries

PSI

2003

2002

2003

2002

2003

2002

(in thousands)

Electric gross margin

$
1,672,622

$
1,769,425

$
919,244

$
949,150

$
743,501

$
795,513

Gas gross margin

269,482

185,620

174,912

132,036

—

—

Net income

362,719

260,380

247,018

202,024

94,398

135,440

(1) The results of Cinergy also include amounts related to non-registrants.
Cinergy’s net income for the nine months ended September 30, 2003, was $363 million ($2.04 per share on a diluted basis) as compared to $260 million ($1.55 per share on a diluted basis) for the same period last year. Income before taxes for the period was $432 million compared to $398 million for the same period a year ago. The increase in 2003 income primarily reflects higher gas margins from wholesale and retail operations in 2003 and $66 million in charges associated with employee severance programs and the write-offs of certain equipment and technology investments that were taken in the second quarter of 2002. ~~This increase was~~The increased gas margins primarily ~~attributable~~reflect the results of our domestic gas trading operation, Marketing & Trading, as well as increased volume of retail gas sales due to colder weather during the first and third quarters of 2003. Also contributing to the ~~addition~~gas margin increase over 2002 was the impact of ~~depreciable plant.~~accounting changes that required certain gas contracts and inventory to be accounted for on the accrual basis beginning in 2003. Offsetting the increase in gas margins was a decrease in electric margins due to milder than normal weather in the second and third quarter of 2003. Cinergy’s ~~increase~~increased net income also ~~includes~~reflects a net gain resulting from the ~~addition~~implementation of certain accounting changes, which have been reflected as a cumulative effect of changes in accounting principles (see Note 1(g)(v) of the ~~depreciable equipment~~“Notes to Condensed Financial Statements” in “Part I. Financial Information”), and gains realized in the second quarter of 2003 from the disposal of discontinued operations and lower income taxes resulting primarily from tax credits associated with the production of synthetic fuel which began in July 2002.

86

~~Taxes Other Than Income Taxes~~Electric Operating Revenues

Cinergy (1)

CG&E and subsidiaries

PSI

2003

2002

% Change

2003

2002

% Change

2003

2002

% Change

(in millions)

Retail

$
2,063

$
2,129

(3
)
$
1,030

$
1,110

(7
)
$
1,033

$
1,020

1

Wholesale

364

283

29

194

95

N/M

156

168

(7
)
Other

86

119

(28
)
77

96

(20
)
21

28

(25
)
Total

$
2,513

$
2,531

(1
)
$
1,301

$
1,301

—

$
1,210

$
1,216

—

(1) The results of Cinergy also include amounts related to non-registrants.
N/M Not meaningful to an understanding of the change.

~~Taxes other~~Electric operating revenues decreased for Cinergy and PSI for the nine months ended September 30, 2003, as compared to 2002.
Electric retail operating revenues decreased for Cinergy for the nine months ended September 30, 2003, compared to the same period last year. Contributing to Cinergy’s decrease was a decrease in MWh sales for PSI and CG&E due to milder than ~~income taxes~~ normal weather during the summer and a sluggish economy. For the nine months ended September 30, 2003, cooling degree-days were 39 percent lower for CG&E and 37 percent lower for PSI as compared to 2002. The mild summer weather was offset by a colder heating season during the first half of the year. For the nine months ended September 30, 2003, heating degree-days were approximately 17 percent and 19 percent higher for CG&E and PSI, respectively. The net effect contributed to a decrease in residential MWh of approximately four percent for CG&E and approximately two percent for PSI. The sluggish economy caused CG&E’s and PSI’s commercial and industrial MWh sales to decrease by approximately two percent for the nine months ended September 30, 2003, compared to the same period last year. Partially offsetting Cinergy’s decrease in electric retail revenue from lower MWh sales was an increase in the price paid per MWh at PSI during 2003. Increases in tariff adjustments associated with the fuel cost recovery mechanism and certain construction projects caused PSI’s retail operating revenue to increase for 2003.
Electric wholesale revenues increased for Cinergy and CG&E and decreased for PSI for the nine months ended September 30, 2003, as compared to the same period last year. Due to lower retail demand as a result of milder weather, more Cinergy generation capacity was available for wholesale transactions in the second and third quarters of 2003. In addition, CG&E’s increase and PSI’s decrease in wholesale revenues reflects the implementation of the new joint operating agreement as discussed in the 2002 10-K. With this agreement, the majority of new wholesale contracts entered into are originated on behalf of CG&E.
Other electric operating revenues decreased for Cinergy, CG&E, and PSI for the nine months ended September 30, 2003, as compared to 2002, primarily reflecting lower transmission revenues. The decrease for Cinergy and CG&E also reflects a reduction in third party coal sales.
87

Gas Operating Revenues

Cinergy (1)

CG&E and subsidiaries

2003

2002

% Change

2003

2002

% Change

(in millions)

Retail

$
424

$
274

55

$
424

$
274

55

Wholesale

73

50

46

—

—

—

Storage and transportation

140

48

N/M

—

—

—

Other

1

2

(50
)
3

3

—

Total

$
638

$
374

71

$
427

$
277

54

(1) The results of Cinergy also include amounts related to non-registrants.
N/M Not meaningful to an understanding of the change.
Gas operating revenues increased for Cinergy and CG&E for the nine months ended September 30, 2003, as compared to 2002. Cinergy’s and CG&E’s retail gas revenues increased due to an increase in retail sales volumes and higher prices received per mcf. The increase in retail gas sales volumes was primarily the result of the colder weather in the first and third quarters of 2003 as compared to the same period in 2002. The higher price per mcf reflects an increase in CG&E’s base rates, as approved by the PUCO in May 2002, and tariff adjustments associated with the gas main replacement program and gas cost recovery mechanism. For further information see Note 7(n) in the “Notes to Condensed Financial Statements” in “Part I. Financial Information”. CG&E’s wholesale gas commodity cost is passed directly to the retail customer dollar-for-dollar under the gas cost recovery mechanism mandated by state law.
Cinergy began reporting revenues from energy trading derivative contracts on a net basis in 2003, in accordance with the required adoption of EITF 02-3. See Note 1(g)(i) in the “Notes to Condensed Financial Statements” in “Part I. Financial Information” for additional information.
Cinergy’s wholesale gas revenues (which represent net gains and losses on energy trading derivatives) increased for the nine months ended September 30, 2003, as compared to 2002, primarily due to an increase in the volatility of natural gas prices in the first quarter of 2003, as compared to the same period in 2002.
Cinergy’s gas storage and transportation revenues increased for the nine months ended September 30, 2003, as compared to 2002. Marketing & Trading began engaging in significant storage activities at the end of the second quarter of 2002.
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Operating Expenses

Cinergy (1)

CG&E and subsidiaries

PSI

2003

2002

% Change

2003

2002

% Change

2003

2002

% Change

(in millions)

Fuel

$
746

$
680

10

$
304

$
304

—

$
415

$
349

19

Purchased and exchanged power

94

82

15

78

48

63

52

71

(27
)
Gas purchased

252

145

74

252

145

74

—

—

—

Gas storage and transportation

117

44

N/M

—

—

—

—

—

—

Operation and maintenance

973

962

1

394

394

—

349

387

(10
)
Depreciation

314

294

7

142

146

(3
)
135

116

16

Taxes other than income taxes

201

202

—

155

150

3

42

47

(11
)
Total

$
2,697

$
2,409

12

$
1,325

$
1,187

12

$
993

$
970

2

(1) The results of Cinergy also include amounts related to non-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 to generate electricity. The following table details the changes to fuel expense from the nine months ended September 30, 2002, to the nine months ended September 30, 2003:

Cinergy (1)

CG&E

PSI

(in millions)

Fuel expense - September 30, 2002

$
680

$
304

$
349

Increase (decrease) due to changes in:

Price of fuel

15

—

15

Deferred fuel cost(2)

44

—

44

Fuel consumption

9

2

7

Other (3)

(2
)
(2
)
—

Fuel expense - September 30, 2003

$
746

$
304

$
415

(1) The results of Cinergy also include amounts related to non-registrants.
(2) Deferred fuel cost represents changes in fuel expense associated with PSI's fuel adjustment charge, which recovers retail fuel costs from customers on a dollar-for-dollar basis. Amounts that have been deferred are adjusted through fuel expense as fuel adjustment charge revenue is collected from customers.
(3) Includes costs of third party coal sales.
Purchased and Exchanged Power
Purchased and exchanged power expense increased for Cinergy and CG&E for the ~~quarter~~nine months ended ~~March 31,~~September 30, 2003, as compared to ~~2002. This increase was primarily attributable to an increase in gas~~the same period last year. The majority of Cinergy’s and ~~electric sales volumes. Also contributing to~~ CG&E’s increase ~~was~~is a result of an increase in ~~property taxes.~~the price paid per MWh and a lower amount of deferred purchased power cost. PSI’s decrease in purchased and exchanged power is a result of more generation being available to serve PSI native load customers due to the repowering of
89

~~Miscellaneous - net~~PSI’s Noblesville station and the addition of peaking plants as discussed in Note 12 in the “Notes to Condensed Financial Statements” in “Part I. Financial Information”.

Gas Purchased
~~Miscellaneous - - net~~Gas purchased expense increased for Cinergy and CG&E for the ~~quarter~~nine months ended ~~March 31,~~September 30, 2003, as compared to 2002, primarily due to an increased average cost per mcf of gas purchased. In addition, CG&E’s gas customers usage increased approximately 21 percent for the nine months ended September 30, 2003, as compared to the same period last year. CG&E’s wholesale commodity cost is passed directly to the retail customer dollar-for-dollar under the gas cost recovery mechanism mandated by state law.
Gas Storage and Transportation
Gas storage and transportation expense increased for Cinergy for the nine months ended September 30, 2003, as compared to 2002, primarily due to an increase in storage activity in 2003. Also contributing to this increase was an increase in storage capacity in the third quarter of 2002 that was optimized during the first quarter of 2003. Marketing & Trading began engaging in significant storage activities at the end of the second quarter of 2002. Gas storage expense is recognized on our Statements of Income as natural gas is sold from inventory.
Operation and Maintenance
Operation and maintenance expense increased for Cinergy and decreased for PSI for the nine months ended September 30, 2003, as compared to 2002. Cinergy’s increase includes costs associated with the production of synthetic fuel, which began in July 2002, and the costs associated with Cinergy’s anticipated resolution of claims with respect to the bankruptcy of Enron. Partially offsetting Cinergy’s increase and primarily attributing to PSI’s decrease were lower transmission costs and costs associated with employee severance programs in 2002.
Depreciation
Depreciation expense increased for Cinergy and PSI and decreased for CG&E for the nine months ended September 30, 2003, as compared to 2002. Cinergy’s and PSI’s increase was primarily due to the addition of depreciable plant. Also contributing to Cinergy’s increase was the addition of the depreciable equipment associated with the production of synthetic fuel. CG&E’s decrease was primarily attributable to an increase in the estimated useful lives of certain assets resulting from a new depreciation study completed during the third quarter of 2003. Also contributing to CG&E’s decrease was the discontinuance of accruing costs of removal for our generating assets (which was previously included as part of Depreciation expense) as a result of the adoption of Statement 143. See Note 1(g)(vii) of the “Notes to Condensed Financial Statements” in “Part I. Financial Information” for further details. Prior periods were not restated for the adoption of Statement 143.
90

Taxes Other Than Income Taxes
Taxes other than income taxes expense increased for CG&E and decreased for PSI for the nine months ended September 30, 2003, as compared to 2002. The increase for CG&E was primarily attributable to an increase in Ohio excise taxes. PSI’s decrease was primarily the result of lower property taxes.
Equity in Earnings of Unconsolidated Subsidiaries
Equity in Earnings of Unconsolidated Subsidiaries increased for the year ended September 30, 2003, as compared to 2002, primarily due to a change in market valuation of certain investments accounted for at fair value.
Miscellaneous Income (Expense) - Net
Miscellaneous Income (Expense) - Net increased for Cinergy and CG&E for the nine months ended September 30, 2003, as compared to 2002. Cinergy’s increase primarily reflects the 2002 write-offs of certain equipment and technology investments and the interest income on the notes receivable of two newly consolidated subsidiaries. See Note 4 of the “Notes to Condensed Financial Statements” in “Part I. Financial Information” for further details. Cinergy’s and CG&E’s increase also reflects a gain on the sale of non-utility property and the recognition of ~~expense~~expenses in 2002 for previously deferred costs that were denied recovery in the final order onof ULH&P’s gas rate case. ~~Also contributing to this~~In addition, CG&E’s increase and PSI’s decrease was a ~~gain on~~result of a final reconciliation between the ~~sale~~two entities of ~~property held for potential future use in Ohio.~~a previous demutualization of a medical insurance carrier used by both companies.

Interest Expense
Interest Expense increased for Cinergy, CG&E, and PSI for the nine months ended September 30, 2003, as compared to 2002. The impact of a decrease in short-term interest rates was more than offset by an increase in the amount of long-term debt outstanding for Cinergy, CG&E, and PSI. Interest on long-term debt increased as a result of the additional debt recorded with the consolidation of two new entities and the recognition of a note payable to a trust in accordance with the adoption of Interpretation 46, see Note 1(g)(iii) of the “Notes to Condensed Financial Statements” in “Part I. Financial Information”.
Income Taxes
Income Taxes expense decreased for Cinergyand PSI ~~and increased for~~ ~~CG&E~~ for the ~~quarter~~nine months ended ~~March 31,~~September 30, 2003, as compared to 2002. Cinergy’s decrease was primarily ~~the~~a result of ~~lower interest rates.~~ ~~CG&E’s~~ increase was mainly due to an increase in the amount of long-term debt outstanding, partially offset by a reduction in the amount of short-term debt outstanding. In general, long-term fixed interest rates are higher than variable short-term interest rates.
~~Income Taxes~~
~~Income taxes~~ ~~expense increased for~~ ~~Cinergy~~ ~~for the quarter ended March 31, 2003, as compared to 2002, primarily due to increased taxable income. Partially offsetting this increase were~~ the tax credits associated with the production and sale 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 24 percent. PSI’s decrease was primarily due to a decrease in taxable book income. This decrease was partially offset by a reversal in 2002 of tax reserves, which were no longer needed, and an increase in the Indiana state income tax rate in 2003.

7291

Cumulative Effect of ~~a Change~~Changes in Accounting Principles, Net of Tax
In 2003, Cinergy, CG&E, and PSI recognized a Cumulative effect of ~~a change~~changes in accounting principles, net of tax gain/(loss) of approximately $26 million, $31 million, and $(0.5) million, respectively. The cumulative effect of ~~a change~~changes in accounting principles iswas a result of 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 Trading and Risk Management Activities (EITF 98-10). See Note ~~1(j)~~1(g)(~~viii~~vii) of the “Notes to Condensed Financial Statements” in ~~“Item 1.~~“Part I. Financial Information” for further information.

In 2002, Cinergy recognized a Cumulative effect of ~~a change~~changes in accounting ~~principle,~~principles, net of tax loss of approximately $11 million as a result of implementation of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (Statement 142). See Note ~~1(j)~~1(g)(~~viii~~vii) of the “Notes to Condensed Financial Statements” in ~~“Item 1.~~“Part I. Financial Information” for further information.

Discontinued Operations
73During the second quarter of 2003, Cinergy completed the disposal of its gas distribution operation in South Africa, sold its remaining wind assets in the U.S., and substantially sold or liquidated the assets of its energy marketing business in the Czech Republic. Pursuant to Statement of Financial Accounting Standards No. 144, Accounting for the Impairment of Long-lived Assets, these investments have been classified as discontinued operations in our financial statements. See Note 8 of the “Notes to Condensed Financial Statements” in “Part I. Financial Information” for additional information.
92

ULH&P

The Results of Operations discussion for ULH&P is presented only for the ~~three~~nine months ended ~~March 31,~~September 30, 2003, in accordance with General Instruction H(2)(a) of Form 10-Q.

Electric and gas gross margins and net income for ULH&P for the ~~three~~nine months ended ~~March 31,~~September 30, 2003 and 2002, were as follows:

ULH&P

ULH&P

2003

2002

2003

2002

(in thousands)

(in thousands)

Electric gross margin

$
15,806

$
15,019

$
49,419

$
52,255

Gas gross margin

17,884

12,315

28,437

22,652

Net income

9,406

3,884

11,477

9,110

Electric Operating Revenues
Electric operating revenues ~~increased~~decreased for the ~~three~~nine months ended ~~March 31,~~September 30, 2003, as compared to 2002. The majority of the decrease was a result of the milder weather in the second and third quarter of 2003, as compared to the same period in 2002, ~~mainly due to an increase~~that resulted in ~~MWh sales resulting from colder than normal weather.~~residential usage decreasing by approximately four percent. The residential usage decrease accounts for approximately 75 percent of the electric operating revenue decrease. The remaining electric operating revenue decrease is associated with decreased usage of commercial and industrial customers reflecting the effects of a continuing sluggish economy.

Electricity Purchased from Parent Company for Resale
Electricity purchased from parent company for resale ~~increased~~decreased for the ~~three~~nine months ended ~~March 31,~~September 30, 2003, as compared to 2002, primarily due to ~~an increase~~the mild weather in ~~consumption as a result~~the second and third quarters of ~~colder than normal weather.~~2003 and the sluggish economy.

Gas Operating Revenues
Gas operating revenues increased for the ~~three~~nine months ended ~~March 31,~~September 30, 2003, as compared to 2002. This increase iswas primarily due to an increase in mcf sold and higher prices received per mcf, as a result of colder ~~than normal weather.~~weather in the first and third quarters of 2003. New base rates for ULH&P, which were effective January 31, 2002, and tariff adjustments associated with the gas main replacement program and gas cost recovery mechanism also contributed to this increase. ~~For further information see Note 7(n) in the “Notes to Financial Statements” in “Item 1. Financial Information”.~~ ULH&P’s wholesale gas commodity cost is passed directly to the retail customer dollar-for-dollar under the gas cost recovery mechanism mandated by state law. For further information see Note 6(o) in the “Notes to Condensed Financial Statements” in “Part I. Financial Information”.

93

Gas Purchased
Gas purchased expense increased for the ~~three~~nine months ended ~~March 31,~~September 30, 2003, as compared to 2002, due to increased purchases and higher prices paid per mcf, primarily the result of colder ~~than normal~~ weather ~~experienced~~ in the ~~Midwest,~~first three months of 2003, which drove up the demand and the price for natural gas. In addition, the third quarter of 2003 was colder than 2002 necessitating a slight increase in gas purchases. The wholesale gas commodity cost is passed directly to the retail customer dollar-for-dollar under the gas cost recovery mechanism ~~that is~~ mandated under state law.

74

Operation and Maintenance
Operation and maintenance expense increased for the ~~three~~nine months ended ~~March 31,~~September 30, 2003, as compared to 2002, primarily due ~~primarily~~ to increased amortization of demand side management program costs and increased maintenance of overhead ~~lines costs.~~lines.

Miscellaneous Income (Expense) - ~~net~~Net
Miscellaneous Income (Expense) - ~~- net~~Net increased for the ~~three~~nine months ended ~~March 31,~~September 30, 2003, as compared to 2002, primarily due to the recognition of ~~expense~~expenses in 2002 for previously deferred costs, that were denied recovery in the final order on ULH&P’s gas rate case.

Income Taxes
Income ~~taxes~~Taxes expense increased for the ~~three~~nine months ended ~~March 31,~~September 30, 2003, as compared to ~~2002, primarily due~~2002. ULH&P’s increase is related to the increase in taxable book income and an increase in ~~taxable income.~~the Kentucky state income tax rate.

7594

MD&A - RESULTS OF OPERATIONS - FUTURE

FUTURE EXPECTATIONS/TRENDS
In the “Future Expectations/Trends” section, we discuss electric and gas industry developments, market risk sensitive instruments and positions, and accounting matters. Each of these discussions will address the current status and potential future impact on our results of operations and financial ~~condition.~~position.

ELECTRIC INDUSTRY
Wholesale Market Developments
Supply-side Actions
In December 2001, the Indiana Utility Regulatory Commission (IURC) approved PSI’s plan for converting its Noblesville generating station from coal to natural gas. The conversion increases the electric generating capacity at the plant from approximately 100 megawatts (MW) to 300 MW. The conversion was completed and the station became operational in June 2003. In addition to increasing capacity, overall emissions to the environment will be reduced.

In December 2002, the ~~Indiana Utility Regulatory Commission (IURC)~~IURC approved a settlement agreement among PSI, the Indiana Office of the Utility Consumer Counselor, and the IURC Testimonial Staff authorizing PSI’s ~~purchase~~purchases of the Henry County, Indiana and Butler County, Ohio, gas-fired peaking plants from two non-regulated affiliates. In February 2003, the FERC issued an order under Section 203 of the Federal Power Act authorizing PSI’s acquisition of the plants, which occurred on February 5, 2003. Subsequently, in April 2003, the FERC issued a tolling order allowing additional time to consider a request for rehearing filed in response to the February 2003 FERC order. At this time, we cannot predict the outcome of this matter.

On July 21, 2003, ULH&P filed an application with the Kentucky Public Service Commission (KPSC) requesting a certificate of public convenience and necessity to acquire CG&E’s ownership interests in the East Bend Generating Station, located in Boone County, Kentucky, the Woodsdale Generating Station, located in Butler County, Ohio, and one generating unit at the 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 transferred generating facilities are out of service, and for approval of another agreement under which the transferred units would be jointly dispatched with CG&E’s remaining fleet of generating units. An order from the KPSC is expected by the end of the year. The transfer, which will be made at net book value, will not affect current electric rates for ULH&P’s customers, as power will be provided under the same terms as under the current wholesale power contract with CG&E through at least December 31, 2006. This transfer is also contingent upon receipt of approval from the FERC and the SEC. ULH&P is unable to predict the outcome of this matter.
95

Retail Market Developments
Ohio
As discussed in the 2002 10-K, CG&E is in a market development period, ~~beginning the transition~~transitioning to electric deregulation in the state of Ohio. The transition period is governed by Amended Substitute Senate Bill No. 3 (Electric Restructuring Bill) and a stipulated ~~agreement~~transition plan adopted and approved by the PUCO. Under CG&E’s transition plan, retail customers continue to receive ~~transportation~~electric distribution services from CG&E, but may purchase electricity from another supplier. Retail customers that purchase electricity from another supplier receive shopping credits from CG&E. The shopping credits generally reflect the costs of electric generation included in CG&E’s frozen rates. However, shopping credits for the first 20 percent of electricity usage in each customer class to switch suppliers are higher than ~~CG&E’s~~ ~~electric generation costs~~shopping credits for subsequent switchers in order to stimulate the development of the competitive retail electric service ~~market.~~market, pursuant to CG&E’s stipulated agreement.

CG&E recovers its generation related regulatory assets and certain other transition costs deferred during the market development period through a Regulatory Transition Charge (RTC) paid by all retail customers. As the RTC is collected from customers, CG&E amortizes the deferred balance of regulatory assets and other transition costs. A portion of the RTC collected from customers is recognized in earnings currently as a return on the deferred balance of regulatory assets and other transition costs and as reimbursement for the difference inbetween the shopping credits provided to customers and the wholesale revenues from switched generation. The ability of CG&E to recover its regulatory assets and other transition costs is dependent on several factors, including, but not limited to, the level of CG&E’s electric sales, prices in the wholesale power markets, and the amount of ~~customer~~customers switching to other electric suppliers.
76

On January 10, 2003, CG&E filed an application with the PUCO for approval of a methodology to establish how market-based rates for non-residential customers will be determined when the market development period ends. In the filing, CG&E seeks to establish a market-based standard service offer rate for non-residential customers that do not switch suppliers and a process for establishing the competitively bid generation service option required by the Electric Restructuring Bill. As of ~~March 31,~~September 30, 2003, more than 20 percent of the load ~~in each~~ of CG&E’s ~~non-residential~~commercial and industrial customer classes ~~has~~have switched to other electric suppliers. Under its transition plan, CG&E may end the market development period for those classes of customers once 20 percent switching has been achieved; however, PUCO approval of the standard service offer rate and competitive bidding process is required before the market development period can be ended. CG&E is not requesting to end the market development period for ~~non-residential~~any customers at this time. CG&E is unable to predict the outcome of this proceeding.

Federal Update
Energy Bill
The U.S. House of Representatives (House) passed the Energy Policy Act in April 2003. ~~This followed extensive committee debate and attempts to pass similar~~The legislation, ~~in 2002. This year’s bill~~as it passed the House, includes repeal of the PUHCA, ~~repeal,~~as well as tax incentives for gas and electric distribution lines, and combined heat and power and renewable ~~energy.~~energy projects.

96

The U.S. Senate (Senate) Energy and Natural Resources Committee passed its version of ~~the Energy Bill~~comprehensive energy legislation in April 2003. ~~That~~On July 31, 2003 the Senate passed comprehensive energy legislation ~~is scheduled to be considered~~by substituting last year’s energy bill as it passed the Senate for the committee draft. The legislation, as passed by the ~~entire~~ Senate, ~~sometime during the second quarter of 2003. The Senate version~~among other things, includes PUHCA repeal and ~~encourages regional dialogues between states~~creates a renewable energy portfolio standard for utilities. The House and Senate versions of the ~~FERC on~~comprehensive energy legislation are currently the ~~continued formation~~subject of ~~regional transmission organizations.~~Conference Committee deliberations. At this time, Cinergy is unable to predict whether or not this legislation will pass.

Clear Skies Legislation
~~The importance of Clear Skies~~President Bush has proposed environmental legislation is that it would replace ~~unpredictable environmental regulations~~a series of CAA requirements for coal-fired power plants with ~~set targets~~a cap and ~~timetables, allowing the industry adequate time to access needed capital and build environmental improvement projects. Clear~~trade program. The President’s “Clear Skies ~~legislation~~Initiative” would seek an overall 70 percent ~~improvement~~reduction in emissions from power plants over a phased-in reduction schedule beginning in 2010 and ~~stretching~~continuing to 2018. The ~~first hearing was~~Senate Environment and Public Works Committee has held several hearings on the “Clear Skies Initiative” proposal and is expected to vote on the legislation in ~~early April 2003~~the third quarter of 2003. The House Subcommittee on Energy and ~~Cinergy~~ ~~testified in favor~~Air Quality of ~~swift passage. Additional~~the House Energy and Commerce Committee has also held hearings ~~are scheduled and~~on the ~~Senate Environment Committee hopes to review~~“Clear Skies Initiative” but timing for consideration of the bill in subcommittee ~~in the second quarter of 2003. Timing for consideration~~ is less ~~certain with the House. Therefore, the prospects for passage of the Clear~~certain. At this time, Cinergy cannot predict whether or not “Clear Skies Initiative” legislation ~~are unclear.~~will pass.

Midwest Independent Transmission System Operator, Inc. (Midwest ISO)
Historical
As part of the effort to create a competitive wholesale power marketplace, the FERC approved the formation of the Midwest ISO during 1998. In that same year, Cinergy agreed to join the Midwest ISO in preparation for meeting anticipated changes in the FERC regulations and future
77

deregulation requirements. The Midwest ISO was established as a non-profit organization to maintain functional control over the combined transmission systems of its members.

FERC Orders
~~In related activity, the~~The FERC issued an order in December 2001, in response to protests of the Midwest ISO’s proposed methodology related to the calculation of its administrative adder fees for the services it provides. Cinergy and a number of other parties filed protests to the proposed methodology, suggesting, among other things, that the methodology was inconsistent with the transmission owners’ prior agreement with the Midwest ISO and selectively allowed only independent transmission companies to choose which unbundled administrative adder services they wished to purchase from the Midwest ISO. A partial settlement was reached in the FERC proceeding, resolving the issues addressed by Cinergy’s protest in a manner favorable to Cinergy. The settlement agreement was approved by the FERC in a February 24, 2003 order ~~and will be implemented during 2003 - resulting~~with implementation initiated on March 1, 2003. The settlement results in ~~about~~approximately $25 million of administrative adder credits to be shared among the Midwest ISO transmission ~~owners.~~owners and customers responsible for Schedule 10 charges. Cinergy’s share was approximately $3 million.
97

As discussed in the 2002 10-K, the FERC issued a Notice of Proposed Rulemaking (NOPR) in 2002 on “Remedying Undue Discrimination through Open Access Transmission Service and Standard Electricity Market Design”. This NOPR would have required all public utilities with open access transmission tariffs to file modifications to their tariffs to implement FERC’s proposed standardization transmission services and standardized wholesale electric market design. The FERC has not taken action on this NOPR and has indicated that they will not require such tariff revisions if the utility has filed similar tariff revisions in their own region, in our case, the Midwest ISO.

In ~~late 2001 and early 2002,~~response to prior FERC orders, on July 25, 2003, the Midwest ISO filed with the FERC ~~issued~~proposed changes to its Opinion Nos. 453 and 453-A ordering, among other things, that transmission service for bundled retail customers (i.e., customers who cannot select an alternative energy provider) be provided under the Midwest ISO’s open accessexisting transmission tariff to add terms and conditions to implement Day-Ahead and Real-Time Energy Markets and Financial Transmission Rights (Energy Markets Tariff). In October 2003, the FERC approved a Midwest ISO filing to withdraw this Energy Markets Tariff. Cinergy anticipates that the Midwest ~~ISO’s charges for its administrative services apply to bundled retail customers.~~ ~~Cinergy~~ ~~and other parties have appealed these orders to~~ISO will file a new Energy Markets Tariff at sometime in the U.S. Court of Appeals for the District of Columbia Circuit (the Court), challenging the application of the Midwest ISO’s tariff, and the Midwest ISO’s charges for its administrative services to bundled retail customers. At the request of the FERC, the Court remanded the matter back to the FERC for further proceedings. In its order on remand, the FERC upheld its prior determinations in Opinion Nos. 453 and 453-A. ~~Cinergy~~ ~~and other Midwest ISO transmission owners have requested rehearing of the FERC’s order on remand.~~future; however, at this time, Cinergy cannot predict the ~~outcome of the rehearing request, whether the matter will again be appealed to the courts, or the outcome of~~effect any such ~~appeal.~~filing will have on its results of operations.

Significant Rate Developments
PSI Retail Electric Rate Case
In December 2002, PSI filed a petition with the IURC seeking approval of a base retail electric rate increase. PSI has filed initial and rebuttal testimony in this case and the final set of hearings will take place in ~~March~~November 2003. Based on updated testimony filed in October 2003, PSI proposes an increase in annual revenues of approximately ~~$200~~$180 million, or an average increase of approximately 1514 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 designed to provide for the recovery of costs related to purchases of power necessary to meet native load requirements to the extent such costs are not recovered through the existing fuel adjustment clause.
78

PSI is authorized to seek recovery of 90 percent of its purchased power expenses through the Tracker (net of the displaced energy portion recovered through the fuel recovery process and net of the mitigation credit portion), with the remaining 10 percent deferred for subsequent recovery in PSI’s general retail electric rate case. In March 2002, PSI filed a petition with the IURC seeking approval to extend the Tracker process beyond the summer of 2002. A hearing was held onin January ~~16,~~ 2003, and in June 2003 the ~~case is now awaiting~~IURC approved the extension for up to an ~~IURC order. We cannot predict~~additional two years with the ~~outcome~~ultimate determination concerning PSI’s continued use of ~~this proceeding at this time.~~the Tracker process to be made in PSI’s pending retail electric rate case.

In June 2002, PSI also filed a petition with the IURC seeking approval of the recovery through the Tracker of its actual summer 2002 purchased power costs. In May 2003, the IURC approved PSI’s recovery of $18 million related to its summer 2002 purchased power costs, and also
98

authorized $2 million of deferred costs sought for recovery in PSI’s general retail electric rate case.
In June 2003, PSI filed a petition with the IURC seeking approval of the recovery through the Tracker of its actual summer 2003 purchased power costs. Testimony was filed in support of PSI’s request in August 2003. An evidentiary hearing is scheduled for March 2004.
PSI Fuel Adjustment Charge
In June 2001, PSI filed a petition with the IURC requesting authority to recover $16 million in under billed deferred fuel costs incurred from March 2001 through May 2001. The IURC approved recovery of these costs subject to refund pending the findings of an investigative sub-docket. The sub-docket was opened to investigate the reasonableness of, and underlying reasons for, the under billed deferred fuel costs. A hearing was held in July 2002, and in March 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 ~~Nitrogen Oxide (NO~~NO_X Equipment
_X~~) Equipment~~
In April 2003, PSI filed an application with the IURC requesting that its CWIP rate adjustment mechanism be updated for expenditures through December 2002 related to NO_X equipment currently being installed at certain PSI generation facilities. CWIP ratemaking treatment allows for the recovery of carrying costs on certain pollution control equipment while and after the equipment is under construction. ~~Testimony and exhibits supporting~~A final order was issued on September 24, 2003. The order granted substantially all of PSI’s ~~second~~requested relief, leaving only the issue of whether certain equipment qualified for CWIP ~~rate adjustment mechanism update have not yet been filed. However, amounts proposed~~ratemaking treatment to be decided in the first quarter of 2004. Amounts approved for ~~potential~~ recovery are presented below:

PSI CWIP Ratemaking for NO_X Equipment_X ~~Equipment~~

PSI

PSI

(in millions)

(in millions)

Total retail CWIP expenditures as of December 31, 2002

$
305

$
305

Proposed total amount requested through CWIP mechanism(1)

35

Total amount requested through CWIP mechanism(1)

35

Less: previously approved CWIP mechanism amounts

(28
)

(28
)
Proposed incremental CWIP mechanism amounts

$
7

Incremental CWIP mechanism amounts

$
7

(1)          Amounts include retail customers’ portion only and represent an annual return on qualified NO_X equipment expenditures.
~~Amounts include retail customers’ portion only and represent an annual return on qualified NO~~_X ~~equipment expenditures.~~

PSI’s initial CWIP rate mechanism adjustment (authorized in July 2002) resulted in an approximately 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 the first quarter of 2003. The IURC’s July 2002 order also authorized PSI to defer, for subsequent recovery, post-in-service depreciation and to continue the accrual for allowance for funds used during construction (AFUDC). Pursuant to Statement of Financial
79

Accounting Standards No. 92, Regulated Enterprises-Accounting for Phase-in Plans, the equity
99

component of AFUDC will not be deferred for financial reporting after the related assets are placed in service.
Environmental Compliance Cost Recovery
In 2002, the Indiana General Assembly passed legislation that, among other things, encourages the deployment of advanced technologies that reduce regulated air emissions, while allowing the continued use of high sulfur Midwestern coal in existing electric generating plants. The legislation authorizes the IURC to provide financial incentives to utilities that deploy such advanced technologies. PSI is currently seeking IURC approval, under this new law, of a cost tracking mechanism for PSI’s NO_X equipment-related depreciation and operation and maintenance costs, authority to use accelerated (18-year) depreciation for its NO_X compliance equipment, and approval of a NO_X emission allowance purchase and sales tracker. In October, PSI reached a settlement with the other parties to this case that, if approved by the IURC, will provide for the relief described above for most of PSI’s environmental compliance equipment. PSI expects an IURC order addressing approval of the settlement agreement by the end of 2003. The issue of whether the remainder of PSI’s environmental compliance projects qualify for financial incentives is expected to be decided in the second quarter of 2004.
CG&E Transmission and Distribution Rate Filings
In October 2003, CG&E filed an application with the PUCO seeking deferral of approximately $173 million, of which approximately $37 million has been incurred as of September 30, 2003, in depreciation, property taxes and carrying costs related to net additions to transmission and distribution utility plant in service from January 2001 through December 2005. Rates are frozen in Ohio under the state’s electric restructuring law from 2001 through the end of the market development period. CG&E intends to file a rate case to collect those costs after the market development period ends. CG&E has not deferred any of these costs as of September 30, 2003.

CG&E is also proposing a mechanism to recover costs related to net additions to transmission and distribution utility plant in service after the end of the market development period. The mechanism would work in a similar manner to the monthly customer charge the PUCO approved for CG&E’s accelerated natural gas main replacement program, discussed belowin CG&E’s Gas Rate Case, which is adjusted annually based on expenditures in the previous year.
GAS INDUSTRY
ULH&P Gas Rate Case
As discussed in the 2002 10-K, in the second quarter of 2001, ULH&P filed a retail gas rate case with the ~~Kentucky Public Service Commission (KPSC)~~KPSC seeking to increase base rates for natural gas distribution services and requesting recovery through a tracking mechanism of the costs of an accelerated gas main replacement program with an estimated capital cost of $112 million over 10 years. ULH&P made its second annual filing for an increase under the tracking mechanism in March 2003. The application ~~seeks~~sought an increase of $2 million. ~~ULH&P~~ ~~expects~~A hearing was held in July 2003, and the KPSC ~~to rule on~~approved the application ~~during the second quarter of~~in August 2003. ~~At the present time,~~ ~~ULH&P~~ ~~cannot predict the outcome of this proceeding.~~ The Kentucky Attorney General has appealed to the Franklin Circuit Court the KPSC’s approval of the tracking mechanism ~~to the Franklin Circuit Court~~ and ~~has also appealed~~ the KPSC’s ~~August 2002 order~~orders approving
100

the new tracking mechanism rates. At the present time, ULH&P cannot predict the timing or outcome of this litigation.

CG&E Gas Rate Case
In the third quarter of 2001, CG&E filed a retail gas rate case with the PUCO seeking to increase base rates for natural gas distribution service and requesting recovery through a tracking mechanism of the costs of an accelerated gas main replacement program with an estimated capital cost of $716 million over 10 years. CG&E entered into a settlement agreement with most of the parties and a hearing on this matter was held in April 2002. An order was issued in May 2002, in which the PUCO approved the settlement agreement and authorized a base rate increase of approximately $15 million, or 3.3 percent overall, effective May 30, 2002. In addition, the PUCO authorized CG&E to implement the tracking mechanism 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 the fourth quarter of 2002, CG&E filed an application to increase its rates under the tracking mechanism. In April 2003, CG&E entered into a settlement agreement with the parties, providing for an increase of $6.5 million, which the PUCO subsequently approved. This increase was effective in May 2003. CG&E expects to file another application to increase its rates by approximately $6.4 million under the tracking mechanism in the fourth quarter of 2003. CG&E expects the PUCO will rule on this application by May 2004.

Gas Distribution Plant
In June 2003, the PUCO approved an amended settlement agreement between CG&E and the PUCO Staff in a gas distribution safety case arising 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 expend a minimum of $700,000 to replace SHA risers by December 31, 2003, and to file a comprehensive plan addressing all SHA risers on its distribution system. Cinergy has an estimated 198,000 SHA risers on its distribution system, of which 155,000 are in CG&E’s service area. The remaining SHA risers are included in ULH&P’s service area. Further investigation as to whether any additional SHA risers will need maintenance or replacement is ongoing. If CG&E and ULH&P determine that replacement of all SHA risers is appropriate, the replacement cost could be up to approximately $50 million. CG&E and ULH&P would pursue recovery of this cost through rates. At this time, Cinergy, CG&E, and ULH&P cannot predict the outcome of this matter.
Gas Prices
Natural gas prices ~~began to escalate~~escalated dramatically during the fourth quarter of 2002 and peaked midway through the first quarter of 2003. ~~This significant increase in~~These higher natural gas ~~costs prompted~~ ~~CG&E~~prices have moderated throughout the spring and ~~ULH&P~~summer but are still expected to ~~make additional interim filings with the PUCO and KPSC, respectively, to increase their gas cost adjustment rates~~remain higher than previous years for the ~~remaining two months~~remainder of ~~the quarter which began in March 2003. These interim filings were subsequently approved by the Commissions.~~2003 and into 2004. Currently, neither CG&E nor ULH&P profit from changes in the cost of ~~gas. Natural~~gas since natural gas purchase costs are passed directly to the customer dollar-for-dollar under the gas cost recovery mechanism that is mandated under state law. These higher natural gas prices could lead to increases in write-offs of our customer receivables, however we believe the overall impact will be immaterial.

80101

In July 2003, CG&E filed an application with the PUCO for approval to begin adjusting its gas cost adjustment rates on a monthly basis commencing in September 2003. In August 2003, the PUCO approved the change from quarterly to monthly. ULH&P filed a similar application with the KPSC for monthly gas cost adjustment rates in September 2003 for billing in December 2003.

In May 2003, ULH&P filed an application with the KPSC requesting approval of a gas procurement-hedging program designed to mitigate the effects of gas price volatility on customers. IfIn June 2003, the KPSC approved the hedging program through March 31, 2005. The program will allow the pre-arranging of between ~~20-65~~20-75 percent of winter heating season base load gas requirements and ~~between 0-50~~up to 50 percent of summer season base load gas requirements.CG&E similarly hedges its gas procurement costs, however CG&E’s gas procurement-hedging program has not been pre-approved by the PUCO but rather it is subject to PUCO review as part of the normal fuel adjustment process.

CG&E and ULH&P ~~uses~~use primarily fixed price forward contracts and contracts with a ceiling and floor on the price. These contracts employ the normal purchases and sales ~~exemption,~~scope exception, and do not involve hedges under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activity (Statement 133)~~, hedges.~~.

MARKET RISK SENSITIVE INSTRUMENTS AND POSITIONS
The transactions associated with the Commercial Business Unit’s (Commercial) (formerly named the Energy Merchant Business ~~Unit (Energy Merchant)~~Unit) energy marketing and trading activities give rise to various risks, including price risk. Price risk represents the potential risk of loss from adverse changes in the market price of electricity or other energy commodities. As ~~Energy Merchant~~Commercial continues to develop its energy marketing and trading business (and due to its substantial investment in generation assets), its exposure to movements in the price of electricity and other energy commodities may become greater. As a result, we may be subject to increased future earnings volatility.

81102

Changes in Fair Value
The changes in fair value of the energy risk management assets and liabilities, for the ~~quarters~~periods ended ~~March 31,~~September 30, 2003 and 2002, are presented in the table below:

Change in Fair Value

March 31, 2003

March 31, 2002

Cinergy(1)

CG&E

PSI

Cinergy(1)

CG&E

PSI

(in millions)

Fair value of contracts outstanding at beginning of period:

$
75

$
42

$
—

$
18

$
28

$
(7
)

Inception value of new contracts when entered(2)

—

—

—

3

1

1

Changes in fair value attributable to changes in valuation techniques and assumptions(3)

1

1

—

—

—

—

Other changes in fair value(4)

73

4

3

1

5

—

Option premiums paid/(received)

(2
)
1

—

28

—

—

Cumulative effect of a change in accounting principle(5)

(20
)
(13
)
(1
)
—

—

—

Contracts settled

(114
)
(37
)
(4
)
18

(4
)
(1
)

Fair value of contracts outstanding at end of period

$
13

$
(2
)
$
(2
)
$
68

$
30

$
(7
)

Change in Fair Value
Year to Date

September 30, 2003

September 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)

—

—

—

6

5

2

Changes in fair value attributable to changes in valuation techniques and assumptions (3)

1

1

—

14

6

9

Other changes in fair value (4)

120

40

1

72

26

3

Option premiums paid/(received)

(6
)
3

—

24

—

—

Accounting Changes (5)

Cumulative effect of changes in accounting principle

(20
)
(14
)
(1
)
—

—

—

Consolidation of previously unconsolidated entities

7

—

—

—

—

—

Contract reclassification (6)

—

—

—

14

18

5

Contract acquisitions (7)

—

—

—

(16
)
—

—

Contracts settled

(129
)
(48
)
(2
)
(38
)
(28
)
(11
)

Fair value of contracts outstanding at end of period

$
48

$
24

$
(2
)
$
94

$
55

$
1

(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(j)~~1(g)(i) in the “Notes to Condensed Financial Statements” in ~~“Item 1.~~“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(j)~~1(g)(i) and Note 1(g)(iii) of the “Notes to Condensed Financial Statements” in ~~“Item 1.~~“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.
82(7)Cinergy Capital & Trading, Inc. (Capital & Trading) acquired a portfolio of gas contracts and inventory in July 2002. This amount represents the fair value of net Energy risk management liabilities assumed. There was no inception gain or loss recognized at the date of acquisition.
103

The following table presents the expected maturity of the ~~Energy~~energy risk management assets and ~~Energy risk management~~ liabilities, as of ~~March 31,~~September 30, 2003:

Fair Value of Contracts as of March 31, 2003

Fair Value of Contracts as of September 30, 2003

Maturing

Maturing

Source of Fair Value(1)

Within
12 months

12-36
months

36-60
months

Thereafter

Total
Fair Value

Within
12 months

12-36
months

36-60
months

Thereafter

Total
Fair Value

(in millions)

(in millions)

Cinergy(2)

Cinergy(2)

Prices actively quoted

$
(4
)
$
(2
)
$
—

$
—

$
(6
)

$
32

$
(2
)
$
—

$
—

$
30

Prices based on models and other valuation methods

9

15

3

(8
)
19

6

12

5

(5
)
18

Total

$
5

$
13

$
3

$
(8
)
$
13

$
38

$
10

$
5

$
(5
)
$
48

CG&E

Prices actively quoted

$
(11
)
$
(5
)
$
—

$
—

$
(16
)

$
(2
)
$
5

$
—

$
—

$
3

Prices based on models and other valuation methods

(4
)
15

3

—

14

8

9

4

—

21

Total

$
(15
)
$
10

$
3

$
—

$
(2
)

$
6

$
14

$
4

$
—

$
24

PSI

Prices actively quoted

$
(1
)
$
(9
)
$
—

$
—

$
(10
)

$
(9
)
$
1

$
—

$
—

$
(8
)

Prices based on models and other valuation methods

2

3

3

—

8

2

3

1

—

6

Total

$
1

$
(6
)
$
3

$
—

$
(2
)

$
(7
)
$
4

$
1

$
—

$
(2
)

(1)         ~~Active~~While liquidity varies by trading regions, active quotes are ~~considered to be~~generally available for two years for standard electricity transactions and three years for standard gas transactions. Non-standard transactions are classified based on the extent, if any, of modeling used in determining fair value. Long-term transactions can have portions in both categories depending on the tenor.
(2)The results of Cinergy also include amounts related to non-registrants.

Energy Trading Credit Risk
Cinergy’s extension of credit for energy marketing and trading is governed by a Corporate Credit Policy. Written guidelines document the management approval levels for credit limits, evaluation of creditworthiness, and credit risk mitigation procedures. Exposures to credit risks are measured and monitored daily by ~~the~~our Corporate Credit Risk ~~function.~~function, which is independent of all trading operations. As of ~~March 31,~~September 30, 2003, approximately 9899 percent of the credit exposure related to energy trading and marketing activity was with counterparties rated Investment Grade or the counterparties’ obligations were guaranteed or secured by ~~a parent company or other entity rated~~an Investment ~~Grade.~~Grade entity. No single non-investment grade counterparty accounts for more than one percent of our total credit exposure.
83

Energy commodity prices can be extremely volatile and the market can, at times, lack liquidity. Because of these issues, credit risk for energy commodities is generally greater than with other commodity trading.
104

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

ACCOUNTING MATTERS
Critical Accounting Policies
Preparation of financial statements and related disclosures in compliance with generally accepted accounting principles (GAAP) requires the use of assumptions and estimates. In certain instances, the application of GAAP requires judgments regarding future events, including the likelihood of success of particular initiatives, legal and regulatory challenges, and anticipated recovery of costs. Therefore, the possibility exists for materially different reported amounts under different conditions or assumptions.

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

•                  Fair Value Accounting for Energy Marketing and Trading;
•                  Retail Customer Revenue Recognition;
•                  Regulatory Accounting;
•                  Pension and Other Postretirement Benefits; and
•                  Impairment of Long-lived Assets.

Accounting Changes
Energy Trading
In October 2002, the EITF reached consensus in EITF 02-3, to (a) rescind EITF 98-10, (b) generally preclude the recognition of gains at the inception of ~~new~~ derivatives, and (c) require all realized and unrealized gains and losses on energy trading derivatives to be presented net in the Statements of Income, whether or not settled physically. The consensus to rescind EITF 98-10 required most energy trading contracts that do not qualify as derivatives to be accounted for on an accrual basis, rather than at fair value. The consensus was immediately effective for all new contracts executed after October 25, 2002, and required a cumulative effect adjustment to income, net of tax, on January 1, 2003, for all contracts executed on or prior to October 25, 2002. The cumulative effect adjustment, on a net of tax basis, was a loss of $13 million for Cinergy and $8 million for CG&E, which includes primarily the impact of certain coal contracts, gas inventory, and certain gas contracts, which were all accounted for at fair value. We expect ~~the ongoing impact of~~ this rescission to have the largest ongoing impact on our gas trading business, which uses financial contracts, physical contracts, and gas inventory to take advantage of various arbitrage opportunities. Prior to the rescission of EITF 98-10, all of these activities were accounted for at fair value. Under the revised guidance, only certain items are accounted for at
84

fair value, which could increase inter-period volatility in ~~future~~reported results of operations. As a result, we ~~are reviewing the possible application of~~began applying fair value hedge accounting ~~under Statement 133.~~
~~Business Combinations and Intangible Assets~~
Inin June ~~2001, the FASB issued Statement~~2003 to certain quantities of ~~Financial Accounting Standards No. 141,~~ ~~Business Combinations~~ (Statement 141), and Statement 142. Statement 141 requires all business combinations initiated after June 30, 2001, to be accounted for using the purchase method. With the adoption of Statement 142, goodwill and other intangibles with indefinite lives will no longer be subject to amortization. Statement 142 requires that goodwill be assessed for impairment upon adoption (transition impairment test) and at least annually thereafter by applying a fair-value-based test, as opposed to the undiscounted cash flow test applied under prior accounting standards. This test must be applied at the “reporting unit” level, which is not permitted to be broader than the current business segmentsgas inventory (more fully discussed in Note ~~8. Under Statement 142, an acquired intangible asset should be separately recognized if the benefit~~1(d) of the ~~intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer’s intent~~“Notes to ~~do so.~~Condensed

We began applying Statement 141 in the third quarter of 2001 and Statement 142 in the first quarter of 2002. The discontinuance of amortization of goodwill, which began in the first quarter of 2002, was not material to our financial position or results of operations. We finalized our transition impairment test in the fourth quarter of 2002 and have recognized a non-cash impairment charge of approximately $11 million (net of tax) for goodwill related to certain of our international assets. This amount is reflected in ~~Cinergy’s~~ ~~Statements of Income as a~~ ~~Cumulative effect of a change in accounting principles, net of tax~~. While Statement 142 did not require the initial transition impairment test to be completed until December 31, 2002, it required a transition impairment charge to be reflected as of January 1, 2002. We will continue to perform goodwill impairment tests annually, as required by Statement 142, or when circumstances indicate that the fair value of a reporting unit has declined significantly.
~~Asset Retirement Obligations~~
In July 2001, the FASB issued Statement 143, which requires fair value recognition beginning January 1, 2003, of legal obligations associated with the retirement or removal of long-lived assets, at the time the obligations are incurred. The initial recognition of this liability is accompanied by a corresponding increase in property, plant, and equipment. Subsequent to the initial recognition, the liability is adjusted for any revisions to the expected cash flows of the retirement obligation (with corresponding adjustments to property, plant, and equipment), and for accretion of the liability due to the passage of time (recognized as an operation expense). Additional depreciation expense is recorded prospectively for any property, plant, and equipment increases.
We previously accrued costs of removal on many long-lived assets through depreciation expense if we believed removal of the assets at the end of their useful life was likely. The SEC staff has interpreted Statement 143 to disallow the accrual of estimated cost of removal when no obligation exists under Statement 143, even if removal of the asset is likely. As a result, all accumulated cost of removal for our non-regulated assets, primarily ~~CG&E’s~~ ~~generation assets,~~
85105

~~was reversed upon adoption. However, accrued cost of removal~~Financial Statements” in “Part I. Financial Information”) and are further reviewing additional applications for ~~rate-regulated assets is recoverable through our rates as a component of depreciation. Since Statement of Financial Accounting Standards No. 71,~~ ~~Accounting for the Effects of Certain Types of Regulation~~~~, applies, accruing estimated cost of removal continues to be acceptable. As a result, accumulated cost of removal was not reversed upon adoption of Statement 143 for the rate-regulated assets of~~ ~~PSI~~, ~~CG&E~~~~, and~~ ~~ULH&P~~.hedge accounting.

Derivatives
~~During 1998, the FASB issued Statement 133. This standard was effective for~~
~~Cinergy~~ beginning in 2001, and requires us to record derivative instruments, which are not exempt under certain provisions of Statement 133, as assets or liabilities, measured at fair value (i.e., mark-to-market). Our financial statements reflect the adoption of Statement 133 in the first quarter of 2001. Since many of our derivatives were previously required to use fair value accounting, the effects of implementation were not material.
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (Statement 149). Statement 149 primarily amends Statement 133 to incorporate implementation conclusions previously cleared by the FASB staff, to clarify the definition of a derivative and to require derivative instruments that include up-front cash payments to be classified as a financing activity in the ~~statement~~Statements of ~~cash flows.~~Cash Flows. Implementation issues that ~~have~~had been previously cleared by the FASB staff ~~will continue to be applied in accordance with their respective~~were effective ~~dates~~ at the time that they were cleared and new guidance ~~has varying implementation provisions, none of which will apply until~~was effective in the third quarter of 2003. ~~We have begun~~In connection with our adoption, we reviewed certain power purchase or sale contracts to ~~evaluate~~determine if they met the ~~impacts~~revised normal purchase and normal sale scope exception criteria in Statement 149. If these criteria were not met, the contract was accounted for at fair value. The impact of adopting Statement 149 ~~but are currently unable to determine whether the impacts will be~~was not material to our results of operations or financial position.

~~There has been recent discussion about~~In June 2003, the FASB issued final guidance on the use of broad market indices (e.g., consumer price index) in power purchase and sales ~~contracts and whether such indices disqualify capacity contracts~~contracts. This guidance clarifies that ~~otherwise qualify for the use of~~ the normal purchases and sales scope ~~exception. In April 2003,~~exception is precluded if a contract contains a broad market index that is not clearly and closely related to the ~~FASB staff provided some proposed clarifications on this issue.~~asset being sold or purchased (or a direct factor in the production of the asset sold or purchased). The guidance provides criteria that must be met for the index to be considered clearly and closely related. This guidance, which is ~~currently open for public comment. We expect this guidance to be finalized sometime during~~effective in the ~~summer~~fourth quarter of 2003, ~~with~~is not expected to have a ~~proposed effective date for~~ ~~Cinergy~~ ~~of October 1, 2003. We are unable to determine whether the~~material impact ~~of this recent interpretation would be material to~~on our results of operations or financial position ~~until the FASB staff finalizes its guidance.~~upon adoption.

~~Accounting for Stock-Based Compensation~~
~~We have historically accounted for our stock-based compensation plans under Accounting Principles Board (APB) Opinion No. 25,~~ ~~Accounting for Stock Issued to Employees~~ ~~(APB 25)~~. ~~In July 2002,~~ ~~Cinergy~~ ~~announced that it would adopt Statement of Financial Accounting Standards No. 123,~~ ~~Accounting for Stock-Based Compensation~~ (Statement 123) for all employee awards granted or modified after January 1, 2003, and would begin measuring the compensation cost of stock-based awards under the fair value method. In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, ~~Accounting for Stock-Based Compensation-Transition and Disclosure~~ ~~(Statement 148), which amends Statement 123 and~~
86

~~APB Opinion No. 28,~~ ~~Interim Financial Reporting.~~ Statement 148 provides alternative methods of transition to Statement 123 and more expanded disclosures about the method of accounting for stock-based employee compensation and the effect of the method used on reported results in both annual and interim financial statements. ~~Cinergy~~ adopted Statement 148 on January 1, 2003, and has adopted the transition provisions that require expensing options prospectively beginning in the year of adoption. Awards granted prior to January 1, 2003, will continue to follow the intrinsic value method prescribed by APB 25. The impact of adoption on our financial position and results of operations, assuming award levels and fair values similar to past years, is not material. This change will primarily impact the accounting for stock options and other performance based awards related to the Cinergy Corp. 1996 Long-Term Incentive Compensation Plan, the Cinergy Corp. Employee Stock Purchase and Savings Plan, and the Cinergy Corp. Stock Option Plan.
Consolidation of ~~SPEs~~Variable Interest Entities
(VIE)
~~The~~In January 2003, the FASB issued Interpretation 46, ~~in January 2003. This interpretation will~~which significantly ~~change~~changes the consolidation requirements for ~~SPEs. We~~traditional SPEs and certain other entities subject to its scope. This interpretation defines a VIE as (a) an entity that does not have ~~begun reviewing~~sufficient equity to support its activities without additional financial support or (b) an entity that has equity investors that do not have voting rights or do not absorb losses or receive returns. These entities must be consolidated when certain criteria are met. The interpretation was originally to be effective as of July 1, 2003 for Cinergy; however, the ~~impact~~FASB subsequently permitted deferral of the effective date to December 31, 2003 for either some or all potential VIEs. During this ~~interpretation but have~~deferral period, the FASB plans to clarify and amend several provisions, much of which is intended to assist in the application of Interpretation 46 to operating entities. Clarifications were not ~~yet concluded whether consolidation~~needed for most traditional SPEs and we therefore elected to implement Interpretation 46 for such entities, as discussed below, in accordance with the original implementation date of ~~certain SPEs will be required. There are~~July 1, 2003. Prior period financial statements were not restated for these changes.
Interpretation 46 requires us to consolidate two SPEs ~~for which consolidation may be required. These SPEs~~that have individual power sale agreements to ~~an unrelated third party~~Central Maine Power Company (CMP) for approximately 45 MW of capacity, ending in 2009, and 35 MW of capacity, ending in 2016. In addition, ~~the~~these SPEs have individual power purchase agreements with Capital & Trading to supply the power. Capital & Trading also provides
106

various services, including certain credit support facilities.
~~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 and exposure under~~ Upon the capped credit facilities of approximately $25 million. There is also a non-capped facility, but it can only be called upon in the event the SPE breaches representations, violates covenants, or other unlikely events.
~~If appropriate,~~initial consolidation ~~of all assets and liabilities~~ of these two SPEs, ~~at their carrying values, will be required in the third quarter~~approximately $239 million of ~~2003. Approximately~~notes receivable, $225 million of non-recourse debt, ~~would be~~and miscellaneous other assets and liabilities were included on Cinergy’s Balance Sheets. The debt was incurred by the SPEs to finance the buyout of existing power contracts that CMP held with former suppliers. The cash flows from the notes receivable are designed to repay the debt. Notes 3 and 4 in the “Notes to Condensed Financial Statements” in “Part I. Financial Information” provide additional information regarding the debt and the notes receivable, respectively.
In accordance with Interpretation 46, we are no longer permitted to consolidate a trust that was established by Cinergy Corp. in 2001 toissue approximately $316 million of combined preferred trust securities and stock purchase contracts. These securities are more fully described in the 2002 10-K. In 2001, the trust loaned the proceeds from the issuance of the securities to Cinergy Corp. in exchange for a note payable to the trust that was eliminated in consolidation. As a result of no longer consolidating the trust beginning July 1, 2003, the preferred trust securities (previously recorded as Company obligated, mandatorily redeemable, preferred trust securities of subsidiary, holding solely debt securities of the company) are no longer included in Cinergy’sBalance ~~Sheet upon initial consolidation. However,~~Sheets. In addition, the note payable owed to the trust, which has a current carrying value of approximately $319 million, was included in Long-term debt. The impact onof not consolidating the trust was immaterial to Cinergy’s results of ~~operations would be expected to be immaterial.~~operations.

Cinergy ~~believes~~has concluded that its accounts receivable sale facility, as discussed in the 2002 10-K, ~~would~~will remain unconsolidated since it involves transfers of financial assets to a qualifying SPE, which is exempted from consolidation by Interpretation 46 and Statement of Financial Accounting Standards No. 140, Accounting for Transfers and ~~this interpretation.~~Servicing of Financial Assets and Extinguishments of Liabilities.

87Cinergy is continuing to evaluate the impact of Interpretation 46 on several operating joint ventures, primarily involved in cogeneration and energy efficiency operations, that we currently do not consolidate. If all these entities were consolidated, their total assets of approximately $675 million (the majority of which is non-current) and total liabilities of approximately $225 million (which includes long-term debt of approximately $100 million) would be recognized on our Balance Sheets. Cinergy’s current investment in these entities is approximately $250 million. We also guarantee certain performance obligations of these entities with an estimated maximum potential exposure of approximately $55 million, as disclosed in Note 7(a) of the “Notes to Condensed Financial Statements” in “Part I. Financial Information”. As discussed above, we expect additional interpretative guidance to be issued by the FASB during the fourth quarter of 2003 and Cinergy will adopt those provisions effective December 31, 2003.
Financial Instruments with Characteristics of Both Liabilities and Equity
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (Statement 150). Statement 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement was effective for financial instruments entered into or modified after May 31, 2003, and was effective on July 1, 2003, for financial instruments held prior to issuance of this statement. Statement 150 would have required Cinergy Corp.’s preferred trust securities to be reported as a
107

liability; however, as described more fully above, the trust holding these securities is no longer permitted to be consolidated and the preferred trust securities are no longer reported on ~~ITEM 3.~~ Cinergy’s Balance Sheets. However, Cinergy’s note payable to the trust is recorded on the Balance Sheet as Long-term debt. As a result, the impact of adopting Statement 150 was not material to our results of operations or financial position.
As discussed in the 2002 10-K, Cinergy issued forward stock sale contracts that require purchase by the holder of a certain number of Cinergy shares in February 2005 (stock contracts). The number of shares to be issued is contingent on the market price of Cinergy Corp. stock, but subject to a predetermined ceiling and floor price. In October 2003, the FASB Staff released an interpretation of Statement 150 that requires an evaluation of these stock contracts to determine whether they constitute a liability, with any changes in accounting required in January 2004. We believe that this interpretation will have no impact on our current accounting.
Intangible Assets
In June 2001, the FASB issued Statement 142. With the adoption of Statement 142, goodwill and other intangibles with indefinite lives are no longer subject to amortization. Statement 142 requires that goodwill be assessed for impairment upon adoption (transition impairment test) and at least annually thereafter by applying a fair-value-based test, as opposed to the undiscounted cash flow test applied under prior accounting standards.
We began applying Statement 142 in the first quarter of 2002. We finalized our transition impairment test in the fourth quarter of 2002 and recognized a non-cash impairment charge of approximately $11 million (net of tax) for goodwill related to certain of our international assets. This amount is reflected in Cinergy’s Statements of Income as a cumulative effect adjustment, net of tax. While Statement 142 did not require the initial transition impairment test to be completed until December 31, 2002, it required the cumulative effect adjustment to be reflected as of January 1, 2002.
Asset Retirement Obligations
In July 2001, the FASB issued Statement 143, which requires fair value recognition beginning January 1, 2003, of legal obligations associated with the retirement or removal of long-lived assets, at the time the obligations are incurred. Our accounting policy for such legal obligations is described in Note 1(f) of the “Notes to Condensed Financial Statements” in “Part I. Financial Information”.
Other Matters
Employee Severance Programs
During the second quarter of 2003, Cinergy offered a Voluntary Early Retirement Program (VERP) and other severance benefits (Severance Programs) to certain non-union employees. As a result of the non-union employees electing the Severance Programs, Cinergy recorded expenses of approximately $9 million during the quarter.
108

Cinergy recorded $4 million in the third quarter of 2003 as a result of union employees electing Severance Programs that ended in July 2003 under a separate program than mentioned above.
Additionally, in the third quarter 2003, a VERP was offered to certain non-union employees. Cinergy recorded expenses of approximately $1 million.
Synthetic Fuel Production
In July 2002, Capital & Trading acquired a coal-based synthetic fuel production facility. As of September 30, 2003, Capital & Trading’s net book value in this facility was approximately $60 million. The synthetic fuel produced at this facility qualifies for tax credits in accordance with Section 29 of the Internal Revenue Code. Eligibility for these credits expires after 2007. Cinergy received a private letter ruling from the Internal Revenue Service (IRS) in connection with the acquisition of the facility. To date, Cinergy has produced and sold approximately 3.6 million tons of synthetic fuel at this facility, resulting in approximately $100 million in tax credits, including approximately $60 million in 2003.
In the second quarter of 2003, the IRS announced, as a result of an audit of another taxpayer, that it had reason to question and was reviewing the scientific validity of test procedures and results that were presented as evidence the fuel underwent a significant chemical change. The IRS recently announced that it has finished its review and has determined that test procedures and results used by taxpayers are scientifically valid if the procedures are applied in a consistent and unbiased manner. The IRS also announced that it plans to impose new testing and record-keeping requirements on synthetic fuel producers and plans to issue guidance extending these requirements to taxpayers already holding private letter rulings on the issue of significant chemical change.
Cinergy believes that its testing procedures comply with the standards recently announced by the IRS. We do not anticipate that any new testing or record-keeping requirements imposed by the IRS will have a material effect on our financial position or results of operations.
Energy Market Investigations
In July 2003, Cinergy received a subpoena from the Commodity Futures Trading Commission (CFTC). As has been previously reported by the press, the CFTC has served subpoenas on numerous other energy companies. The CFTC request sought certain information regarding our trading activities, including price reporting to energy industry publications. The CFTC sought particular information concerning these matters for the period May 2000 through January 2001 as to one of Cinergy’s employees. Based on an initial review of these matters, we placed that employee on administrative leave and have subsequently terminated his employment. Cinergy is continuing an investigation of these matters and has been cooperating fully with the CFTC.
In September 2003, Cinergy, along with 38 other companies, was named as a defendant in civil litigation filed as a purported class action on behalf of all persons who purchased and/or sold New York Mercantile Exchange natural gas futures and options contracts between January 1, 2000, and December 31, 2002. The complaint alleges that improper price reporting caused damages to the class. Responsive pleadings in the case are due on November 17, 2003. We
109

believe this action against us is without merit. At this time, it is not possible to predict the outcome of this matter.
In the second quarter of 2003, Cinergy received initial and follow-up third-party subpoenas from the SEC requesting information related to particular trading activity with one of its counterparties who was the target of an investigation by the SEC. Cinergy has and intends to fully cooperate with the SEC in connection with this matter.
At this time it is not possible to predict the outcome of these investigations and lawsuit or the impact on Cinergy’s financial position or results of operations; although, in the opinion of management, they are not likely to have a material adverse effect on our financial position or results of operations.
110

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This information is provided in, and incorporated by reference from, the “Market Risk Sensitive Instruments and Positions” section in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in “Part 1.I. Financial Information”.

88111

~~ITEM 4.~~ CONTROLS AND PROCEDURES

ITEM 4. CONTROLS AND PROCEDURES
Disclosure controls and procedures are our controls and other procedures that are designed to ~~ensure~~provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 (Exchange Act) is recorded, processed, summarized, and reported, within the time periods specified in the Securities and Exchange Commission’s (SEC) rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ~~ensure~~provide reasonable assurance that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, 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 of our management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of ~~the design and operation of~~ our disclosure controls and procedures ~~within 90 days~~as of ~~the filing date of this quarterly report,~~September 30, 2003, and, based upon this evaluation, our chief executive officer and chief financial officer have concluded that these controls and procedures are ~~adequate to ensure~~effective in providing reasonable assurance that information requiring disclosure is communicated to management in a timely manner and reported within the timeframe specified by the SEC’s rules and forms.

~~There were no significant changes~~Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we have evaluated any change in our internal ~~controls~~control 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 September 30, 2003 and found no change that has materially affected, or ~~in other factors that could significantly~~is reasonably likely to materially affect, our internal ~~controls subsequent to the date of our most recent evaluation.~~control over financial reporting.

89112

PART II. - OTHER INFORMATION
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On August 18, 2003, Cornerstone Propane Partners L.P. filed suit against Cinergy and 38 other companies in the Southern District of New York. The suit is a purported class action on behalf of all persons who purchased and/or sold New York Mercantile Exchange natural gas futures and options contracts between January 1, 2000 and December 31, 2002. The complaint alleges that improper price reporting caused damages to the class. The plaintiffs are seeking unspecified damages. We intend to defend this lawsuit vigorously; however, we cannot predict the outcome of this matter at this time.

We currently, and from time to time, are involved in lawsuits, claims, and complaints incidental to the conduct of our business. In the opinion of management, no such proceeding is likely to have a material adverse effect on us.

See Note 7 of the “Notes to Condensed Financial Statements” in ~~“Item 1.~~“Part I. Financial Information” for further information regarding our commitments and contingencies.

90113

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
~~The annual meeting of shareholders of~~
~~Cinergy~~~~Corp.~~ ~~was held on April 22, 2003, in Covington, Kentucky.~~
~~At the meeting, three Class III directors were elected to the board of~~ ~~Cinergy Corp.~~ ~~to serve for three-year terms ending in 2006, as set forth below:~~
Directors

Votes For

Votes Withheld

Class III

Phillip R. Cox

141,244,619

2,739,531
James E. Rogers

140,128,456

3,855,694
John J. Schiff, Jr.

141,206,249

2,777,901
In lieu of ~~the annual~~a special meeting of shareholders of The Cincinnati Gas & Electric Company (CG&E), a resolution was duly adopted via unanimous written consent of Cinergy Corp., CG&E’ssole shareholder, effective ~~April 21,~~July 23, 2003, ~~electing~~amending the ~~following members~~Regulations to ~~the Board of Directors for one-year terms expiring in 2004:~~effectuate changes with respect to certain officer titles at CG&E.

•                  ~~James E. Rogers~~
•                  ~~R. Foster Duncan~~
•                  ~~James L. Turner~~
~~The annual meeting of shareholders of PSI Energy, Inc. (~~~~PSI~~~~) was held on April 22, 2003, in Covington, Kentucky. Proxies were not solicited for the annual meeting.~~ ~~Cinergy~~~~Corp.~~ ~~owns all of the 53,913,701 outstanding shares, representing a like number of votes, of the common stock of~~ ~~PSI~~~~. By unanimous vote, the following members to the Board of Directors were elected at the annual meeting for one-year terms expiring in 2004:~~
•                  ~~Michael G. Browning~~
•                  ~~James E. Rogers~~
•                  ~~Douglas F. Esamann~~
~~None of the 651,089 outstanding shares, representing 423,431 votes, of the preferred stock of~~ ~~PSI~~~~, were present or voted at the annual meeting.~~
91114

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a)               The documents listed below are being furnished or filed on behalf of Cinergy Corp., The Cincinnati Gas & Electric Company (CG&E), PSI Energy, Inc. (PSI), and The Union Light, Heat and Power Company (ULH&P) ~~and are incorporated herein by reference from the documents indicated and made a part hereof.~~. Exhibits not identified as previously furnished or filed are furnished or filed herewith:

Exhibit
Designation

Registrant

Nature of Exhibit

Previously Filed
as
Exhibit to:
Additional
Exhibits

~~4-xxx~~4.2

PSI

~~Loan Agreement~~Eighth Supplemental Indenture between PSI and ~~the Indiana Development Finance Authority~~Fifth Third Bank, as Trustee, dated as of ~~February~~September 23, 2003 to Indenture dated as of November 15, ~~2003.~~1996.

~~4-yyy~~4.3

PSI

~~6.302% Subordinated Note~~Fifty-fifth Supplemental Indenture dated as of February 15, 2003 between PSI and ~~Cinergy Corp.~~,LaSalle Bank National Association, as Trustee, to Indenture dated ~~February 5, 2003.~~as of September 1, 1939.

~~4-zzz~~31.1

Cinergy Corp.
CG&E
PSI
ULH&P

~~6.403% Subordinated Note between~~ ~~PSI~~ ~~and~~ ~~Cinergy Corp.~~ ~~dated February 5, 2003.~~Certification of James E. Rogers under Section 302 of Sarbanes-Oxley Act.

~~10-tt~~31.2

Cinergy Corp.
CG&E
PSI
ULH&P

~~Asset Purchase Agreement by and among Cinergy Capital & Trading, Inc., CinCap Madison, LLC and~~ ~~PSI~~ ~~dated as~~Certification of ~~February 5, 2003.~~R. Foster Duncan under Section 302 of Sarbanes-Oxley Act.

~~10-uu~~
~~PSI~~
~~Asset Purchase Agreement by and among Cinergy Capital & Trading, Inc., CinCap VII, LLC and~~ ~~PSI~~ ~~dated as of February 5, 2003.~~
~~99.1~~32.1

Cinergy Corp.
CG&E
PSI
ULH&P

Certification of James E. Rogers under Section 906 of Sarbanes-Oxley Act.

~~99.2~~32.2

Cinergy Corp.
CG&E
PSI
ULH&P

Certification of R. Foster Duncan under Section 906 of Sarbanes-Oxley Act.

(b)              The following reports on Form 8-K were furnished or filed during the quarter ended ~~March 31,~~September 30, 2003.

Date of Report

Registrant

Item Furnished or Filed

~~January 31,~~July 22, 2003

~~Cinergy Corp.~~CG&E
ULH&P

Item ~~7. Financial Statements~~5. Other Events and ~~Exhibits~~
~~Item 9.~~ Regulation FD Disclosure

~~February 5,~~July 25, 2003

Cinergy Corp.

Item 12. Results of Operations and Financial Condition
July 25, 2003
Cinergy Corp.
CG&E
Item 5. Other Events and Regulation FD Disclosure

Item 7. Financial Statements and Exhibits
~~February 7, 2003~~
~~PSI~~
~~Item 9. Regulation FD Disclosure~~
92115

SIGNATURES
Pursuant to the requirements ~~of Section 13 or 15(d)~~ of the Securities Exchange Act of 1934, each of the Registrants ~~have~~has duly caused this report to be signed ~~by an officer and the chief accounting officer~~ on ~~their~~its behalf by the undersigned thereunto duly authorized.

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

~~THE UNION LIGHT, HEAT AND POWER COMPANY~~Date: November 13, 2003
/s/
~~Registrants~~
David L. Wozny

~~Date: May 09, 2003~~
~~/s/~~
~~Bernard F. Roberts~~David L. Wozny

~~Bernard F. Roberts~~(duly authorized officer
and
principal accounting officer)

~~Duly Authorized Officer~~
~~and~~
~~Chief Accounting Officer~~

93

I~~, James E. Rogers, certify that:~~
~~1. I have reviewed this quarterly report on Form 10-Q of Cinergy Corp., The Cincinnati Gas & Electric Company, PSI Energy, Inc., and The Union Light, Heat and Power Company;~~
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrants as of, and for, the periods presented in this quarterly report;
4. The registrants’ other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrants and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrants, including their consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
~~b) evaluated the effectiveness of the registrants’ disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and~~
~~c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;~~
5. The registrants’ other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants’ auditors and the audit committee of the registrants’ board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants’ ability to record, process, summarize and report financial data and have identified for the registrants’ auditors any material weaknesses in internal controls; and
~~b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants’ internal controls; and~~
6. The registrants’ other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
~~Date: May 09, 2003~~
~~/s/ James E. Rogers~~
~~James E. Rogers~~
~~Chief Executive Officer~~
94

~~I, R. Foster Duncan, certify that:~~
~~1. I have reviewed this quarterly report on Form 10-Q of Cinergy Corp., The Cincinnati Gas & Electric Company, PSI Energy, Inc., and The Union Light, Heat and Power Company;~~
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrants as of, and for, the periods presented in this quarterly report;
4. The registrants’ other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrants and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrants, including their consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
~~b) evaluated the effectiveness of the registrants’ disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and~~
~~c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;~~
5. The registrants’ other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants’ auditors and the audit committee of the registrants’ board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants’ ability to record, process, summarize and report financial data and have identified for the registrants’ auditors any material weaknesses in internal controls; and
~~b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants’ internal controls; and~~
6. The registrants’ other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
~~Date: May 09, 2003~~
~~/s/ R. Foster Duncan~~
~~R. Foster Duncan~~
~~Chief Financial Officer~~
95116

	2003		2002
	*(in millions)*

Cinergy	$	117	$	124
CG&E and subsidiaries	60		63
PSI	57		61
ULH&P	11		11

		Quarter Ended March 31				Quarter Ended September 30				Year to Date September 30
		(in millions, except per share amounts)				*(in millions, except per share amounts)*
		2003		2002		2003		2002		2003		2002

Net income, as reported	Net income, as reported	$	166	$	85	$	112	$	131	$	363	$	260

Add:	Stock-based employee compensation expense included in reported net income, net of related tax effects.	4		3
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects.						3		5		12		10

Deduct:	Stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects.	5		3
Deduct: Stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects.						4		5		14		11

Pro-forma net income	Pro-forma net income	$	165	$	85	$	111	$	131	$	361	$	259

EPS - as reported	EPS - as reported	$	0.96	$	0.52	$	0.63	$	0.78	$	2.06	$	1.57
EPS - pro-forma	EPS - pro-forma	$	0.95	$	0.52	$	0.63	$	0.78	$	2.05	$	1.56

EPS Assuming Dilution - as reported		$	0.95	$	0.52
EPS Assuming Dilution - pro-forma		$	0.94	$	0.52
EPS assuming dilution - as reported						$	0.62	$	0.77	$	2.04	$	1.55
EPS assuming dilution - pro-forma						$	0.62	$	0.77	$	2.03	$	1.54

	2003		2002
	(in millions)

Cinergy	$	119	$	123
CG&E and subsidiaries	67		68
PSI	52		55
ULH&P	12		11

	Cinergy(1)			CG&E and subsidiaries			PSI
				*(in thousands)*

Quarter Ended September 30, 2002

Electric Operating Revenues as previously reported	$	2,554,687		$	1,747,379		$	776,837

Adjustment for effect of EITF 02-3 implementation	(1,574,214		)	(1,254,762		)	(306,065		)
Other(2)	(15,038		)	—			—

Electric Operating Revenues as adjusted	$	965,435		$	492,617		$	470,772

Gas Operating Revenues as previously reported	$	1,281,411		$	41,452		$	—

Adjustment for effect of EITF 02-3 implementation	(1,171,709		)	—			—
Other(2)	(5,629		)	—			—

Gas Operating Revenues as adjusted	$	104,073		$	41,452		$	—

Fuel and purchased and exchanged power expense as previously reported	$	1,871,365		$	1,391,221		$	474,748

Adjustment for effect of EITF 02-3 implementation	(1,555,263		)	(1,254,762		)	(306,065		)
Other(2)	(13,736		)	—			—

Fuel and purchased and exchanged power expense as adjusted	$	302,366		$	136,459		$	168,683

Gas purchased expense as previously reported	$	1,243,507		$	12,594		$	—

Adjustment for effect of EITF 02-3 implementation	(1,190,659		)	—			—
Other(2)	(3,565		)	—			—

Gas purchased expense as adjusted	$	49,283		$	12,594		$	—

Year to Date September 30, 2002

Electric Operating Revenues as previously reported	$	5,178,481		$	3,249,715		$	1,874,109

Adjustment for effect of EITF 02-3 implementation	(2,578,261		)	(1,948,273		)	(658,318		)
Other(2)	(68,937		)	—			—

Electric Operating Revenues as adjusted	$	2,531,283		$	1,301,442		$	1,215,791

Gas Operating Revenues as previously reported	$	3,301,625		$	277,069		$	—

Adjustment for effect of EITF 02-3 implementation	(2,921,651		)	—			—
Other(2)	(5,629		)	—			—

Gas Operating Revenues as adjusted	$	374,345		$	277,069		$	—

Fuel and purchased and exchanged power expense as previously reported	$	3,357,585		$	2,300,565		$	1,078,596

Adjustment for effect of EITF 02-3 implementation	(2,549,301		)	(1,948,273		)	(658,318		)
Other(2)	(46,426		)	—			—

Fuel and purchased and exchanged power expense as adjusted	$	761,858		$	352,292		$	420,278

Gas purchased expense as previously reported	$	3,142,899		$	145,033		$	—

Adjustment for effect of EITF 02-3 implementation	(2,950,609		)	—			—
Other(2)	(3,565		)	—			—

Gas purchased expense as adjusted	$	188,725		$	145,033		$	—

	Year to Date September 30, 2002
	Net Income			EPS			EPS- Assuming Dilution
	*(in millions, except for EPS)*

Reported results	$	271		$	1.63		$	1.61
Cumulative effect of a change in accounting principle, net of tax	(11		)	(0.06		)	(0.06		)
Revised results	$	260		$	1.57		$	1.55

	Cinergy(1)			CG&E and subsidiaries			PSI
	(in thousands)

Electric Operating Revenues as previously reported	$	1,283,424		$	635,886		$	629,844

Adjustment for effect of EITF 02-3 implementation	(492,921		)	(237,767		)	(263,443		)
Other(2)	(11,127		)	—			—

Electric Operating Revenues as adjusted	779,376			398,119			366,401

Gas Operating Revenues as previously reported	903,261			179,609			—

Adjustment for effect of EITF 02-3 implementation	(713,197		)	—			—

Gas Operating Revenues as adjusted	190,064			179,609			—

Fuel and purchased and exchanged power expense as previously reported	727,547			345,015			386,492

Adjustment for effect of EITF 02-3 implementation	(492,921		)	(237,767		)	(263,443		)
Other(2)	(5,336		)	—			—

Fuel and purchased and exchanged power expense as adjusted	229,290			107,248			123,049

Gas purchased expense as previously reported	823,077			107,968			—

Adjustment for effect of EITF 02-3 implementation	(713,197		)	—			—

Gas purchased expense as adjusted	109,880			107,968			—


~~(1)~~	~~The results of~~ ~~Cinergy~~ ~~also include amounts related to non-registrants and include the elimination of certain intercompany amounts.~~
~~(2)~~	~~Item represents amounts reclassified to~~ ~~Discontinued operations, net of tax~~.

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

	Cinergy
	*(in millions)*

Next 12 months	$	17

13-24 months	19

25-36 months	22

37-48 months	24

49-60 months	27

Thereafter	112

	$	221

Credit Facility	Expiration	Established Lines		Outstanding and Committed		Unused and Available		Expiration	Established Lines		Outstanding and Committed		Unused and Available
		(in millions)									*(in millions)*

364-day senior revolving	April 2003							April 2004
Direct borrowing		$		$	—	$			$		$	—	$
Commercial paper support				193							209

Total 364-day facility		600		193		407			600		209		391

Three-year senior revolving	May 2004							May 2004
Direct borrowing				—							—
Commercial paper support				—							—
Letter of Credit support				11							15

Total three-year facility		400		11		389			400		15		385

Total credit facilities		$	1,000	$	204	$	796		$	1,000	$	224	$	776

	March 31, 2003				December 31, 2002				September 30, 2003				December 31, 2002
	Established Lines		Outstanding		Established Lines		Outstanding		Established Lines		Outstanding		Established Lines		Outstanding
	(in millions)								*(in millions)*
Cinergy
Cinergy Corp.
Revolving lines	$	1,000	$	—	$	1,000	$	25	$	1,000	$	—	$	1,000	$	25
Uncommitted lines (1)	65		—		65		—		65		—		65		—
Commercial paper (2)			193				473				209				473

Operating companies
Uncommitted lines (1)	75		—		75		—		75		—		75		—
Pollution control notes			112				147				112				147

Non-regulated subsidiaries
Revolving lines	8		1		7		1		17		9		7		1
Short-term debt	22		22		22		22				7				22

Cinergy Total			$	328			$	668			$	337			$	668

CG&E and subsidiaries
Uncommitted lines (1)	$	15	$	—	$	15	$	—	$	15	$	—	$	15	$	—
Pollution control notes			112				112				112				112
Money pool			3				9				9				9

CG&E Total			$	115			$	121			$	121			$	121

PSI
Uncommitted lines (1)	$	60	$	—	$	60	$	—	$	60	$	—	$	60	$	—
Pollution control notes			—				35				—				35
Money pool			230				138				165				138

PSI Total			$	230			$	173			$	165			$	173

ULH&P
Money pool			$	5			$	14			$	24			$	14

ULH&P Total			$	5			$	14			$	24			$	14

	Cinergy Business Units																		*Cinergy Business Units*
	Energy Merchant			Regulated Businesses			Power Technology			Total			Reconciling Eliminations(1)			Consolidated			Commercial					Regulated Businesses				Power Technology						Total						Reconciling Eliminations (1)							Consolidated
	(in thousands)																		*(in thousands)*

Quarter ended March 31, 2003

Operating revenues-
External customers	$	447,466	(3)	$	834,315	(4)	$	1		$	1,281,782		$	—		$	1,281,782
Intersegment revenues	39,123			—			—			39,123			(39,123		)	—

Cost of sales -
Fuel and purchased and exchanged power	138,495			140,988			—			279,483			—			279,483
Gas purchased	64,230			171,765			—			235,995			—			235,995

Discontinued operations, net of tax	—			—			—			—			—			—
Cumulative effect of a change in accounting principles, net of tax	26,462			—			—			26,462			—			26,462

Segment profit (loss)(2)	97,105			74,069			(5,089		)	166,085			—			166,085

Quarter ended March 31, 2002
Quarter Ended September 30, 2003

Operating revenues -
External customers	$	271,613		$	714,762		$	2		$	986,377		$	—		$	986,377		$		439,059			$		652,946				$	(28		)			$		1,091,977			$		—			$			1,091,977
Intersegment revenues	36,838			—			—			36,838			(36,838		)	—			44,526					—						—						44,526					(44,526			)			—

Cost of sales -
Fuel and purchased and exchanged power	107,569			121,721			—			229,290			—			229,290
External customers																			188,356					141,641						—						329,997											329,997
Intersegment costs																			—					44,526						—						44,526					(44,526			)			—
Gas purchased																			47,360					32,222						—						79,582											79,582

Segment profit (loss)(2)																			52,204					62,814			(3)			(3,037			)			111,981					—						111,981

Quarter Ended September 30, 2002

Operating revenues -
External customers																			$	449,571			$		669,605				$			62			$		1,119,238				$	—			$			1,119,238
Intersegment revenues																			51,590				—						—						51,590						(51,590			)			—

Cost of sales -
Fuel and purchased and exchanged power
External customers																			174,224				128,142						—						302,366												302,366
Intersegment costs																			—				51,590						—						51,590						(51,590			)			—
Gas purchased	1,912			107,968			—			109,880			—			109,880			36,689				12,594						—						49,283												49,283

Discontinued operations, net of tax	478			—			—			478			—			478			(1,790			)	—						—						(1,790				)		—						(1,790			)
Cumulative effect of a change in accounting principle, net of tax	(10,899		)	—			—			(10,899		)	—			(10,899		)

Segment profit (loss)(2)	16,638			72,797			(4,606		)	84,829			—			84,829			57,534				74,939						(1,905				)		130,568						—						130,568

(1) The Reconciling Eliminations category eliminates the intersegment revenues of Commercial and the intersegment costs of Regulated Businesses. (2) Management utilizes segment profit (loss) to evaluate segment performance. (3) The decrease in 2003 is primarily due to lower megawatt hour (MWh) sales resulting from milder weather and the effects of a continuing sluggish economy.
~~(1)~~	~~The Reconciling Eliminations category eliminates the intersegment revenues of Energy Merchant.~~
~~(2)~~	~~Management utilizes segment profit (loss) to evaluate segment performance.~~
~~(3)~~	~~The increase in 2003 is primarily due to the increase in the average price realized on wholesale commodity non-firm transactions and the sale of synthetic fuel which began in July 2002.~~
~~(4)~~	The increase in 2003 is primarily due to the increase in the average price received per thousand cubic feet (mcf) delivered reflecting a substantial increase in the wholesale gas commodity costs, which is passed directly to the retail customer dollar-for-dollar under the state mandated gas cost recovery mechanism. Also contributing to this increase was higher mcf volumes sold due to colder than normal weather.

	Income			Shares	EPS			Income			Shares	EPS
	(in thousands, except per share amounts)							*(in thousands, except per share amounts)*
Quarter ended March 31, 2003
Quarter Ended September 30, 2003
EPS:
Income before cumulative effect of a change in accounting principles	$	139,623			$	0.81
Cumulative effect of a change in accounting principles, net of tax	26,462				0.15
Net Income								$	111,981		177,751	$	0.63

Effect of dilutive securities:
Common stock options											629
Directors’ compensation plans											148
Contingently issuable common stock											891
Stock purchase contracts											118

EPS - assuming dilution:
Net income plus assumed conversions								$	111,981		179,537	$	0.62

Quarter Ended September 30, 2002
EPS:
Income before discontinued operations								$	132,358			$	0.79
Discontinued operations, net of tax								(1,790		)		(0.01		)
Net Income	$	166,085		173,387	$	0.96		$	130,568		167,967	$	0.78

Effect of dilutive securities:
Common stock options				724							843
Directors’ compensation plans				134							160
Contingently issuable common stock				717							1,118

EPS - assuming dilution:
Net income plus assumed conversions	$	166,085		174,962	$	0.95		$	130,568		170,088	$	0.77

Quarter ended March 31, 2002
EPS:
Income before discontinued operations and cumulative effect of a change in accounting principle	$	95,250			$	0.58
Discontinued operations, net of tax	478				—
Cumulative effect of a change in accounting principle, net of tax	(10,899		)		(0.06		)
Net Income	$	84,829		164,295	$	0.52

Effect of dilutive securities:
Common stock options				976
Employee stock purchase and savings plan				1
Directors’ compensation plans				151
Contingently issuable common stock				542

EPS - assuming dilution:
Net income plus assumed conversions	$	84,829		165,965	$	0.52

	Short-term Regulatory Authority March 31, 2003					Short-term Regulatory Authority September 30, 2003
	(millions)					*(millions)*
	Authority			Outstanding		Authority			Outstanding

Cinergy Corp.	$	5,000	(1)	$	193	$	5,000	(1)	$	209
CG&E and subsidiaries	671			3		671			9
PSI	600			230		600			165
ULH&P	65			5		65			24

	Short-term Borrowings March 31, 2003										Short-term Borrowings September 30, 2003
	Established Lines		Outstanding		Unused		Standby Liquidity(3)		Available Revolving Lines of Credit		Established Lines		Outstanding		Unused		Standby Liquidity(3)		Available Revolving Lines of Credit
	(in millions)										*(in millions)*

Cinergy
Cinergy Corp.
Revolving lines	$	1,000	$	—	$	1,000	$	204	$	796	$	1,000	$	—	$	1,000	$	224	$	776
Uncommitted lines(1)	65		—		65						65		—		65
Commercial paper(2)			193		607								209		591

Operating companies
Uncommitted lines(1)	75		—		75						75		—		75
Pollution control notes			112										112

Non-regulated subsidiaries
Revolving lines	8		1		7				7		17		9		8				8
Short-term debt	22		22		—								7

Cinergy Total			$	328					$	803			$	337					$	784

CG&E and subsidiaries
Uncommitted lines(1)	$	15	$	—	$	15					$	15	$	—	$	15
Pollution control notes			112										112
Money pool			3										9

CG&E Total			$	115									$	121

PSI
Uncommitted lines(1)	$	60	$	—	$	60					$	60	$	—	$	60
Pollution control notes			—
Money pool			230										165

PSI Total			$	230									$	165

ULH&P
Money pool			$	5									$	24

ULH&P Total			$	5									$	24


~~(1)~~	~~Outstanding amounts may be greater than established lines as uncommitted lenders are, at times, willing to loan funds in excess of the established lines.~~
~~(2)~~	~~The commercial paper program is limited to $800 million and is supported by~~ ~~Cinergy Corp.’s~~ ~~revolving lines.~~
~~(3)~~	~~Standby liquidity is reserved against the revolving lines to support the commercial paper program and outstanding letters of credit (currently $193 million and $11~~ (1)Outstanding amounts may be greater than established lines as uncommitted lenders are, at times, willing to loan funds in excess of the established lines. (2)The commercial paper program is limited to $800 million and is supported by Cinergy Corp.’s revolving lines. (3)Standby liquidity is reserved against the revolving lines to support the commercial paper program and outstanding letters of credit (currently $209 million and $15 million, respectively).

	Authorized		Used		Available		Authorized		Used		Available
	(in millions)						*(in millions)*

Cinergy Corp.
PUHCA total capitalization(1)	$	5,000	$	1,521	$	3,479	$	5,000	$	1,601	$	3,399

CG&E and subsidiaries(2)
State Public Utility Commissions	575		—		575		575		400		175

PSI
State Public Utility Commission	500		83		417		500		483		17

ULH&P
State Public Utility Commission	75		—		75		75		—		75

	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’s Ratings Services (S&P)	~~Fitch IBCA (Fitch )~~
~~(2)~~	~~Moody’s Investors Service (Moody’s )~~
~~(3)~~	~~Standard & Poor’s Ratings Services (S&P )~~

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

NOTES TO CONDENSED FINANCIAL STATEMENTS

CAUTIONARY STATEMENTS

CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIALCONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

ORGANIZATION

LIQUIDITY AND CAPITAL RESOURCES

Ambient Air Standards

Global Climate Change

Pensions

Long-term debt due within one year

Other Investing Activities

Guarantees

Collateral Requirements

Capital Resources

Notes Payable and Other Short-term Obligations

Long-term Debt

Off-Balance Sheet Financing

Equity Securities

6779

2003 QUARTERLY RESULTS OF OPERATIONS - HISTORICAL

Summary of Results

Electric Operating Revenues

Gas Operating Revenues

Gas Operating Revenues

Other Revenues

Operating Expenses

Fuel

Purchased and Exchanged Power

Gas Purchased

Gas purchasedStorage and Transportation

Operation and Maintenance

Depreciation

Taxes Other Than Income Taxes

Miscellaneous Income (Expense) - Net

Interest Expense

and PSI’s comparative

Preferred Dividend Requirement of Subsidiary Trust

Income Taxes

2003 YEAR TO DATE RESULTS OF OPERATIONS - HISTORICAL

Summary of Results

Taxes Other Than Income TaxesElectric Operating Revenues

Gas Operating Revenues

Operating Expenses

Fuel

Purchased and Exchanged Power

Gas Purchased

Gas Storage and Transportation

Operation and Maintenance

Depreciation

Taxes Other Than Income Taxes

Equity in Earnings of Unconsolidated Subsidiaries

Miscellaneous Income (Expense) - Net

Interest Expense

Income Taxes

Cumulative Effect of a ChangeChanges in Accounting Principles, Net of Tax

Discontinued Operations

Electric Operating Revenues

Electricity Purchased from Parent Company for Resale

Gas Operating Revenues

Gas Purchased

Operation and Maintenance

Miscellaneous Income (Expense) - netNet

Income Taxes

FUTURE EXPECTATIONS/TRENDS

ELECTRIC INDUSTRY

Wholesale Market Developments

Supply-side Actions

Retail Market Developments

Ohio

Federal Update

Midwest Independent Transmission System Operator, Inc. (Midwest ISO)

Historical

FERC Orders

Significant Rate Developments

PSI Retail Electric Rate Case

PSI Purchased Power Tracker (Tracker)

PSI Fuel Adjustment Charge

PSI Construction Work in Progress (CWIP) Ratemaking Treatment for Nitrogen Oxide (NONOX Equipment

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

PSI Construction Work in Progress (CWIP) Ratemaking Treatment for Nitrogen Oxide (NONO_X Equipment

	Cinergy (1)				CG&E and subsidiaries				PSI
	2003		2002		2003		2002		2003		2002
	*(in thousands)*

Electric gross margin	$	1,672,622	$	1,769,425	$	919,244	$	949,150	$	743,501	$	795,513
Gas gross margin	269,482		185,620		174,912		132,036		—		—
Net income	362,719		260,380		247,018		202,024		94,398		135,440

	Change in Fair Value
	March 31, 2003									March 31, 2002
	Cinergy(1)			CG&E			PSI			Cinergy(1)		CG&E			PSI
	(in millions)

Fair value of contracts outstanding at beginning of period:	$	75		$	42		$	—		$	18	$	28		$	(7	)

Inception value of new contracts when entered(2)	—			—			—			3		1			1

Changes in fair value attributable to changes in valuation techniques and assumptions(3)	1			1			—			—		—			—

Other changes in fair value(4)	73			4			3			1		5			—

Option premiums paid/(received)	(2		)	1			—			28		—			—

Cumulative effect of a change in accounting principle(5)	(20		)	(13		)	(1		)	—		—			—

Contracts settled	(114		)	(37		)	(4		)	18		(4		)	(1		)

Fair value of contracts outstanding at end of period	$	13		$	(2	)	$	(2	)	$	68	$	30		$	(7	)

	Change in Fair Value Year to Date
	September 30, 2003									September 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)	—			—			—			6			5			2

Changes in fair value attributable to changes in valuation techniques and assumptions (3)	1			1			—			14			6			9

Other changes in fair value (4)	120			40			1			72			26			3

Option premiums paid/(received)	(6		)	3			—			24			—			—

Accounting Changes (5)

Cumulative effect of changes in accounting principle	(20		)	(14		)	(1		)	—			—			—

Consolidation of previously unconsolidated entities	7			—			—			—			—			—

Contract reclassification (6)	—			—			—			14			18			5

Contract acquisitions (7)	—			—			—			(16		)	—			—

Contracts settled	(129		)	(48		)	(2		)	(38		)	(28		)	(11		)

Fair value of contracts outstanding at end of period	$	48		$	24		$	(2	)	$	94		$	55		$	1

	Fair Value of Contracts as of March 31, 2003														Fair Value of Contracts as of September 30, 2003
	Maturing														Maturing
Source of Fair Value(1)	Within 12 months			12-36 months			36-60 months		Thereafter			Total Fair Value			Within 12 months					12-36 months			36-60 months		Thereafter			Total Fair Value
	(in millions)														(in millions)

Cinergy(2)
Cinergy(2)
Prices actively quoted	$	(4	)	$	(2	)	$	—	$	—		$	(6	)	$	32				$	(2	)	$	—	$	—		$	30

Prices based on models and other valuation methods	9			15			3		(8		)	19			6					12			5		(5		)	18

Total	$	5		$	13		$	3	$	(8	)	$	13		$	38				$	10		$	5	$	(5	)	$	48

CG&E
Prices actively quoted	$	(11	)	$	(5	)	$	—	$	—		$	(16	)	$		(2		)	$	5		$	—	$	—		$	3

Prices based on models and other valuation methods	(4		)	15			3		—			14			8					9			4		—			21

Total	$	(15	)	$	10		$	3	$	—		$	(2	)	$			6		$	14		$	4	$	—		$	24

PSI
Prices actively quoted	$	(1	)	$	(9	)	$	—	$	—		$	(10	)	$			(9	)	$	1		$	—	$	—		$	(8	)

Prices based on models and other valuation methods	2			3			3		—			8			2					3			1		—			6

Total	$	1		$	(6	)	$	3	$	—		$	(2	)	$			(7	)	$	4		$	1	$	—		$	(2	)

Directors	Votes For	Votes Withheld

Class III
Phillip R. Cox	141,244,619	2,739,531
James E. Rogers	140,128,456	3,855,694
John J. Schiff, Jr.	141,206,249	2,777,901

Exhibit Designation	Registrant	Nature of Exhibit	Previously Filed as Exhibit to:

Additional Exhibits

~~4-xxx~~4.2	PSI	~~Loan Agreement~~Eighth Supplemental Indenture between PSI and ~~the Indiana Development Finance Authority~~Fifth Third Bank, as Trustee, dated as of ~~February~~September 23, 2003 to Indenture dated as of November 15, ~~2003.~~1996.

~~4-yyy~~4.3	PSI	~~6.302% Subordinated Note~~Fifty-fifth Supplemental Indenture dated as of February 15, 2003 between PSI and ~~Cinergy Corp.~~,LaSalle Bank National Association, as Trustee, to Indenture dated ~~February 5, 2003.~~as of September 1, 1939.

~~4-zzz~~31.1	Cinergy Corp. CG&E PSI ULH&P	~~6.403% Subordinated Note between~~ ~~PSI~~ ~~and~~ ~~Cinergy Corp.~~ ~~dated February 5, 2003.~~Certification of James E. Rogers under Section 302 of Sarbanes-Oxley Act.

~~10-tt~~31.2	Cinergy Corp. CG&E PSI ULH&P	~~Asset Purchase Agreement by and among Cinergy Capital & Trading, Inc., CinCap Madison, LLC and~~ ~~PSI~~ ~~dated as~~Certification of ~~February 5, 2003.~~R. Foster Duncan under Section 302 of Sarbanes-Oxley Act.

~~10-uu~~	~~PSI~~	~~Asset Purchase Agreement by and among Cinergy Capital & Trading, Inc., CinCap VII, LLC and~~ ~~PSI~~ ~~dated as of February 5, 2003.~~

~~99.1~~32.1	Cinergy Corp. CG&E PSI ULH&P	Certification of James E. Rogers under Section 906 of Sarbanes-Oxley Act.

~~99.2~~32.2	Cinergy Corp. CG&E PSI ULH&P	Certification of R. Foster Duncan under Section 906 of Sarbanes-Oxley Act.

Date of Report	Registrant	Item Furnished or Filed

~~January 31,~~July 22, 2003	~~Cinergy Corp.~~CG&E ULH&P	Item ~~7. Financial Statements~~5. Other Events and ~~Exhibits~~

		~~Item 9.~~ Regulation FD Disclosure

~~February 5,~~July 25, 2003	Cinergy Corp.	Item 12. Results of Operations and Financial Condition

July 25, 2003	Cinergy Corp. CG&E	Item 5. Other Events and Regulation FD Disclosure

		Item 7. Financial Statements and Exhibits

~~February 7, 2003~~	~~PSI~~	~~Item 9. Regulation FD Disclosure~~

~~CINERGY CORP.~~
~~THE CINCINNATI GAS & ELECTRIC COMPANY~~
~~PSI ENERGY, INC.~~
	~~THE UNION LIGHT, HEAT AND POWER COMPANY~~Date: November 13, 2003	/s/
~~Registrants~~
David L. Wozny

	~~Date: May 09, 2003~~		~~/s/~~	~~Bernard F. Roberts~~David L. Wozny
		~~Bernard F. Roberts~~(duly authorized officer and principal accounting officer)
			~~Duly Authorized Officer~~
			~~and~~
			~~Chief Accounting Officer~~

~~/s/ James E. Rogers~~
	~~James E. Rogers~~
~~Chief Executive Officer~~

~~/s/ R. Foster Duncan~~
	~~R. Foster Duncan~~
~~Chief Financial Officer~~