DUK

Business Context and Reporting Period

This Form 10-Q covers Duke Energy Corporation for the quarterly period ended March 31, 2006. The filing reflects the results of "Old Duke Energy" prior to the consummation of its merger with Cinergy Corp. on April 3, 2006. The company operates as a leading energy provider in the Americas with segments including Franchised Electric, Natural Gas Transmission, Field Services, International Energy, and Crescent Resources. A significant portion of the reporting period was impacted by the deconsolidation of Duke Energy Field Services (DEFS) effective July 1, 2005, and the ongoing exit plan for Duke Energy North America (DENA) assets outside the Midwest.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Operating revenues decreased by $2,127 million (40%) primarily due to the deconsolidation of DEFS, which reduced revenues by $2,658 million. This was partially offset by growth in Natural Gas Transmission ($283 million increase) and International Energy ($63 million increase).
• Net Income Decrease: Net income fell by $510 million. The prior year (Q1 2005) included a one-time pre-tax gain of approximately $1.2 billion from the sale of TEPPCO GP and related interests. Excluding this gain, operating performance remained relatively stable.
• Discontinued Operations: The company reported a loss of $128 million from discontinued operations in Q1 2006, compared to income of $8 million in Q1 2005. This shift was driven by contract termination costs associated with the DENA exit plan.
• Segment Performance:
  • Franchised Electric: EBIT increased to $359 million (from $336 million) due to improved bulk power marketing and customer growth, despite mild weather.
  • Natural Gas Transmission: EBIT rose to $438 million (from $411 million) driven by new Canadian assets and a $24 million gain on a contract settlement.
  • Field Services: EBIT dropped to $144 million (from $919 million) due to the deconsolidation of DEFS and the absence of the TEPPCO sale gain recorded in 2005.

Guidance, Outlook, and Risks

• Merger with Cinergy: The merger was consummated on April 3, 2006. Management expects to incur approximately $55 million in severance costs for the remainder of 2006. Regulatory approvals included rate credits totaling over $200 million to customers in various states (NC, SC, OH, KY, IN).
• DENA Exit Plan: The company is executing a plan to sell substantially all DENA assets outside the Midwest. In May 2006, the sale of generation assets to LS Power closed with expected proceeds of approximately $1.56 billion. Approximately 95% of the derivative portfolio was transferred to Barclays Bank, significantly reducing market and credit risk.
• Regulatory Risks: The North Carolina Utilities Commission (NCUC) requires a general rate review by June 2007. The company faces ongoing litigation regarding Clean Air Act violations (New Source Review) and environmental compliance costs (Clean Water Act, Clean Air Mercury Rule).
• Legal Contingencies: Significant litigation includes disputes with Sonatrach (LNG supply), Citrus Trading, and Exxon Mobil. As of March 31, 2006, the company has recorded reserves of approximately $1.3 billion for legal proceedings, with $1.0 billion in probable insurance recoveries recognized.
• Capital Markets: Credit ratings were upgraded by Moody's in April 2006. The company maintains access to significant credit facilities and shelf registrations for debt issuance.

Investor Verification Checklist

• Merger Integration Costs: Verify the actual realization of the $55 million severance estimate and the impact of regulatory rate credits on future cash flows.
• DENA Asset Sale Proceeds: Confirm the final closing proceeds from the LS Power transaction and any contingent payments dependent on regulatory approvals.
• Environmental Compliance Costs: Monitor the final cost estimates for North Carolina clean air legislation and the impact of the Clean Air Mercury Rule (CAMR) and Clean Air Interstate Rule (CAIR).
• Legal Reserves: Track the resolution of the Sonatrach, Citrus, and Exxon Mobil arbitrations to assess the adequacy of the $1.3 billion legal reserve.
• Deconsolidation Impact: Analyze the long-term financial impact of the DEFS deconsolidation on revenue stability and equity earnings.