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Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.
Introduction

Management's Discussion and Analysis should be read in connection with the Consolidated Financial Statements.

Overview of Business Strategy and Economic Factors

Duke Energy's business strategy is to develop integrated energy businesses in targeted regions where Duke Energy's capabilities in developing energy assets; operating power plants, natural gas liquid (NGL) plants and natural gas pipelines; optimizing commercial operations (including its affiliated real estate operation); and managing risk can provide comprehensive energy solutions for customers and create value for shareholders.

The energy industry and Duke Energy are experiencing a number of challenges, including the substantial imbalance between supply and demand for electricity, the pace of economic recovery, and regulatory and legal uncertainties. In response to these current challenges, Duke Energy is focusing on reducing risks and restructuring its business to be well positioned as the energy marketplace regains its health and vigor. In 2003, Duke Energy established a platform for future growth by selling certain non-strategic assets, cutting expenses and paying down debt, while still funding capital expenditures at the core regulated Franchised Electric and Natural Gas Transmission businesses. Duke Energy also resolved many outstanding legal and regulatory issues; reduced the scope of its international operations by announcing its intention to exit the Australian and European markets; and repositioned Duke Energy North America (DENA) to be a more focused, asset-backed merchant business. The repositioning of DENA included discontinuing proprietary trading and announcing its intentions to exit the merchant generation business in the Southeast region.

Duke Energy's current goals for 2004 include: positive net cash generation; investing in its strongest businesses such as Franchised Electric, Natural Gas Transmission and Crescent Resources, LLC (Crescent); continuing to size its businesses to market realities; addressing merchant energy issues; strengthening relationships with customers; and further reducing regulatory and legal uncertainty. A major focus for 2004 will be to complete the execution of the plans Duke Energy announced for its merchant and international business, including the sale of its assets in the Southeastern U.S and Australia, and its exit from Europe. Duke Energy also plans to preserve its dividend payout of $1.10 per share and to continue to pay down debt in 2004 by $3.5 to $4.0 billion to further strengthen its balance sheet. (Included in the expected 2004 debt reduction amount is approximately $900 million of Australian dollar denominated debt related to International Energy's Australian operations.) Duke Energy believes it is well-positioned to generate cash in 2004 from operations, the settlement of the forward stock purchase component of the outstanding equity units, and from asset sales to meet its goals of reducing debt, paying the dividend and providing for maintenance and modest expansion.

Duke Energy's business model provides diversification between stable, less cyclical businesses like Franchised Electric and Natural Gas Transmission, and the traditionally higher-growth and more cyclical energy businesses like DENA, International Energy and Field Services. Additionally, Crescent's portfolio strategy is diversified between residential, commercial and multi-family development. Although Duke Energy expects to return to profitability in 2004, all of its businesses can be negatively affected by sustained downturns or sluggishness in the economy, including low market price of commodities, all of which are beyond Duke Energy's control, and could impair Duke Energy's ability to meet its goals for 2004.

Declines in demand for electricity as a result of economic downturns would reduce overall electricity sales and lessen Duke Energy's cash flows; especially as industrial customers reduce production and, thus, consumption of electricity. A portion of Franchised Electric's business risk is mitigated by its being subject to regulated allowable rates of return and recovery of fuel costs under fuel adjustment clauses. Natural Gas Transmission is also subject to mandated tariff rates and recovery of certain fuel costs. Lower economic output would also cause the Natural Gas Transmission and Field Services businesses to experience a decline in the volume of natural gas shipped through their pipelines, gathered and processed at their plants, or distributed by their local distribution company, resulting in lower revenue and cash flows. Natural Gas Transmission continues to experience positive renewals of its customer contracts as they expire.

If negative market conditions persist over time and estimated cash flows over the lives of Duke Energy's individual assets do not exceed the carrying value of those individual assets, asset impairments may occur in the future under existing accounting rules and diminish results of operations. Furthermore, a change in management's intent about the use of individual assets (held for use versus held for sale) or a change in fair value of assets held for sale could also result in an impairment. The largest impairments over the past two years have been related to DENA and International Energy and it is estimated that the most significant future risk of impairments also resides within these segments. There is also risk that DENA may not be able to execute its plans to sell its Southeast region merchant plants and that International Energy may not be able to execute its plans to sell the Australian assets, or would obtain lower prices than planned, thus diminishing future cash flow and negatively impacting results of operation.

Duke Energy and its goals for 2004 can also be substantially at risk due to the regulation of its businesses. Duke Energy's businesses in North America are subject to regulations on the federal and state level. The majority of Duke Energy's Canadian natural gas assets is also subject to various degrees of federal or provincial regulation and are subject to the same risks. Regulations, applicable to the electric power industry and gas transmission and storage industry, have a significant impact on the nature of the businesses and the manner in which they operate. Changes to regulations are ongoing and Duke Energy cannot predict the future course of changes in the regulatory environment or the ultimate effect that any future changes will have on its business.

Additionally, Duke Energy's investments and projects located outside of the U.S. expose it to risks related to laws of other countries, taxes, economic conditions, fluctuations in currency rates, political conditions and policies of foreign governments. Changes in these factors are difficult to predict and may impact Duke Energy's future results. Duke Energy's recent restructuring, which focuses its non-U.S. operations on only Latin America and Canada, will help mitigate this exposure.

Duke Energy also relies on access to both short-term money markets and longer-term capital markets as a source of liquidity for capital requirements not satisfied by the cash flow from its operations. If Duke Energy is not able to access capital at competitive rates, its ability to implement its strategy could be adversely affected. Market disruptions or a downgrade of Duke Energy's credit rating may increase its cost of borrowing or adversely affect its ability to access one or more sources of liquidity.