DUK

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2006, for Duke Energy Corporation. The reporting period is significantly impacted by the consummation of the merger with Cinergy Corp. on April 3, 2006. Consequently, the financial statements reflect the combined operations of the legacy Duke Energy and Cinergy for the second quarter of 2006, while prior year comparisons reflect only legacy Duke Energy operations. The company is also in the process of exiting its Duke Energy North America (DENA) business and has announced a plan to spin off its natural gas business into a separate publicly traded company, targeting a January 1, 2007 effective date.

Key Financial Metrics

Note: Balance sheet figures are as of June 30, 2006. Prior year balance sheet data is not provided in the text for direct comparison in this summary.

Material Changes Versus Prior Period

• Revenue Decline: Consolidated operating revenues decreased by $1,301 million (25%) for the quarter and $3,428 million (32%) for the six months compared to the prior year. This decline is primarily attributed to the deconsolidation of Duke Energy Field Services (DEFS) effective July 1, 2005, which removed significant revenue streams. This decrease was partially offset by the inclusion of Cinergy revenues following the April 2006 merger.
• Net Income Volatility: While Net Income increased for the quarter ($355 million vs. $309 million), it decreased significantly for the six months ($713 million vs. $1,177 million). The prior year six-month period included a one-time pre-tax gain of approximately $1.2 billion from the sale of TEPPCO GP and related interests, which is not present in the current period.
• Discontinued Operations: Loss from discontinued operations increased to $80 million for the quarter and $208 million for the six months, primarily due to exit costs associated with the DENA business and the classification of Cinergy's commercial marketing and trading business as discontinued operations.
• Goodwill: Total goodwill increased to $8,042 million from $3,775 million at year-end 2005, driven by the $4.3 billion in preliminary goodwill recorded from the Cinergy merger.

Guidance, Outlook, and Management Commentary

• Strategic Restructuring: Management is executing a strategy to separate the natural gas and electric businesses. The natural gas segment (including Union Gas and DEFS) is planned to be spun off to shareholders by January 1, 2007. The remaining company will focus on U.S. Franchised Electric and Gas, Commercial Power, International Energy, and Crescent Resources.
• Dividend Increase: The Board of Directors approved a quarterly dividend increase of $0.01 per share, effective in the third quarter of 2006, raising the annual dividend to $1.28 per share.
• Share Repurchases: The company repurchased approximately 17.5 million shares for $500 million during the first six months of 2006. However, the share repurchase program was suspended in June 2006 in connection with the planned spin-off of the natural gas business.
• Segment Performance:
  • U.S. Franchised Electric and Gas: EBIT increased due to the Cinergy merger and favorable weather in the Carolinas, offset by regulatory charges related to profit sharing.
  • Natural Gas Transmission: EBIT increased due to new Canadian assets (Empress System) and a strengthening Canadian dollar.
  • Field Services: EBIT decreased due to the deconsolidation of DEFS, though equity earnings from the 50% interest remained strong due to commodity prices.
  • Commercial Power: EBIT improved due to the addition of Cinergy's non-regulated businesses.
  • Crescent: EBIT increased significantly due to large real estate sales (Potomac Yard and Lake Keowee).
• Risks and Contingencies:
  • Regulatory: The company faces ongoing regulatory reviews regarding rate cases in North Carolina, Ohio, Indiana, and Kentucky. A specific NCUC order resulted in an $18 million charge related to bulk power marketing profit sharing.
  • Environmental: Significant exposure exists regarding Clean Air Act compliance (CAIR, CAMR) and potential costs for emission controls. The company has recorded reserves of approximately $70 million for extended environmental activities.
  • Legal: The company is involved in various litigation matters, including New Source Review (NSR) cases with the EPA, trading-related class actions, and disputes with Sonatrach and Citrus Trading Corporation. Total reserves for legal proceedings are approximately $1.25 billion.

Important Facts for Investor Verification

• Merger Integration: Verify the final allocation of the $4.3 billion in Cinergy-related goodwill and the impact of purchase accounting adjustments on future earnings.
• Spin-off Details: Confirm the timeline and capital structure of the planned natural gas business spin-off, including the transfer of approximately $3 billion in debt to the new entity.
• Discontinued Operations: Monitor the final exit costs and proceeds from the sale of the DENA assets and the Cinergy marketing and trading business to Fortis.
• Regulatory Outcomes: Track the resolution of the NCUC bulk power marketing profit sharing dispute and the outcomes of pending rate cases in Ohio, Indiana, and Kentucky.
• Environmental Compliance Costs: Assess the final estimated costs for compliance with the Clean Air Interstate Rule (CAIR) and Clean Air Mercury Rule (CAMR), which could impact future capital expenditures.
• Legal Reserves: Review the adequacy of the $1.25 billion reserve for legal proceedings, particularly regarding the EPA NSR litigation and trading-related lawsuits.