**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM 10-Q**

**x**QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**For the quarterly periodended September 30, 2006**

**Commission file number:  1-2385**

**THE DAYTON POWER ANDLIGHT COMPANY**

 (Exact name ofregistrant as specified in its charter)

| **OHIO**                                  |   | **31-0258470**       |
|-------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of          |   | (I.R.S. Employer     |
| incorporation or  organization)           |   | Identification  No.) |
|                                      |   |                 |
| **1065  Woodman Drive, Dayton, Ohio**     |   | **45432**            |
| (Address of  principal executive offices) |   | (Zip Code)           |

Registrant’s telephone number, including area code: **937-224-6000**

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.
| Yes x |   | No o |   |   |
|-------|--------|------|--------|--------|

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.
| Large  accelerated filer  o |   | Accelerated filer o |   | Non-accelerated filer x |
|----------------------------------|--------|--------------------------|--------|-------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).
| Yes o |   | No x |   |   |
|-------|--------|------|--------|--------|

As of October 30, 2006,there were 41,172,173 shares of common stock outstanding, all of which wereheld by DPL Inc.

 

----

**THEDAYTON POWER AND LIGHT COMPANY**

**INDEX**
|              | ** **                | ** ** | **Page No.**                                                                                |
|--------------|---------------------------|------------|---------------------------------------------------------------------------------------------|
| **Part I.**  | **Financial Information** |       |                                                                                        |
|         |                      |       |                                                                                        |   |   |
|         | Item 1.                   |       | Financial Statements                                                                        |   |   |
|         |                      |       |                                                                                        |   | 3 |
|         |                      |       | Consolidated  Statements of Results of Operations                                           |   |   |
|         |                      |       |                                                                                        |   | 4 |
|         |                      |       | Consolidated  Statements of Cash Flows                                                      |   |   |
|         |                      |       |                                                                                        |   |   |
|         |                      |       | Consolidated Balance  Sheets                                                                |   | 5 |
|         |                      |       |                                                                                        |   |   |
|         |                      |       | Notes to  Consolidated Financial Statements                                                 |   | 7 |
|         |                      |       |                                                                                        |   |   |
|         | Item 2.                   |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |   | 20 |
|         |                      |       |                                                                                        |   |   |
|         |                      |       | Operating Statistics                                                                        |   | 32 |
|         |                      |       |                                                                                        |   |   |
|         | Item 3.                   |       | Quantitative and Qualitative Disclosures about Market  Risk                                 |   | 32 |
|         |                      |       |                                                                                        |   |   |
|         | Item 4.                   |       | Controls and Procedures                                                                     |   | 32 |
|         |                      |       |                                                                                        |   |   |
| **Part II.** | **Other Information**     |       |                                                                                        |
|         |                      |       |                                                                                        |   |   |
|         | Item 1.                   |       | Legal  Proceedings                                                                          |   | 33 |
|         |                      |       |                                                                                        |   |   |
|         | Item 1A.                  |       | Risk Factors                                                                                |   | 34 |
|         |                      |       |                                                                                        |   |   |
|         | Item 6.                   |       | Exhibits                                                                                    |   | 35 |
|         |                      |       |                                                                                        |   |   |
| **Other**    | ** **                |       |                                                                                        |   |   |
| ** **   | ** **                |       |                                                                                        |   |   |
| ** **   | Signatures                |       | 36                                                                                          |
| ** **   | ** **                |       |                                                                                        |   |   |
| ** **   | Certifications            |       |                                                                                        |

 

**AvailableInformation:**

The Dayton Powerand Light Company (DP&L, the Company, we, us, our, or ours unless thecontext indicates otherwise) files current, annual and quarterly reports, andother information required by the Securities Exchange Act of 1934, as amended,with the Securities and Exchange Commission (SEC).  You may read and copy any document we file atthe SEC’s public reference room located at 100 F Street N.E., Washington, D.C.20549, USA.  Please call the SEC at (800)SEC-0330 for further information on the public reference rooms.  Our SEC filings are also available to thepublic from the SEC’s web site at http://www.sec.gov.

Our public Internet siteis http://www.dplinc.com.  We makeavailable, free of charge, through our internet site, our annual reports onForm 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, andamendments to those reports filed or furnished pursuant to the SecuritiesExchange Act of 1934, as amended, as soon as reasonably practicable after weelectronically file such material with, or furnish it to, the SEC.

In addition, our publicInternet site includes other items related to corporate governance matters,including, among other things, our governance guidelines, charters of variouscommittees of the Board of Directors and our code of business conduct andethics applicable to all employees, officers and directors.  You may obtain copies of these documents,free of charge, by sending a request, in writing, to DP&L InvestorRelations, 1065 Woodman Drive, Dayton, Ohio 45432.

2

----

**Part I. Financial Information**

**Item1.  Financial Statements**

**THE DAYTON POWER AND LIGHT COMPANY**

**CONSOLIDATED STATEMENTS OF RESULTS OF OPERATIONS**

 
| ** **                              | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **$ in millions**             | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                    | ** ** | ** **                       |       |                            |       |   |   |   |   |
| **Revenues**                            | ** ** | **$**                            | **390.3**  |                            | $          | 355.5 |   | **$** | **1,036.1** |   | $ | 952.0 |   |
|                                    | ** ** | ** **                       |       |                            |       | ** ** |   |   |   |
| **Cost of revenues:**                   | ** ** | ** **                       |       |                            |       | ** ** |   |   |   |
|  Fuel                              | ** ** | **91.0**                         |       | 87.9                            |       | **251.1** |   | 235.1 |   |
|  Purchased power                   | ** ** | **70.7**                         |       | 48.3                            |       | **134.7** |   | 116.0 |   |
| Total cost of  revenues                 | ** ** | **161.7**                        |       | 136.2                           |       | **385.8** |   | 351.1 |   |
|                                    | ** ** | ** **                       |       |                            |       | ** ** |   |   |   |
| **Gross margin**                        | ** ** | **228.6**                        |       | 219.3                           |       | **650.3** |   | 600.9 |   |
|                                    | ** ** | ** **                       |       |                            |       | ** ** |   |   |   |
| **Operating expenses:**                 | ** ** | ** **                       |       |                            |       | ** ** |   |   |   |
|  Operation and maintenance         | ** ** | **58.9**                         |       | 46.2                            |       | **172.7** |   | 145.6 |   |
|  Depreciation and amortization     | ** ** | **33.0**                         |       | 31.8                            |       | **96.8** |   | 92.9 |   |
|  General taxes                     | ** ** | **27.2**                         |       | 28.6                            |       | **80.3** |   | 81.4 |   |
|  Amortization of regulatory assets | ** ** | **2.4**                          |       | 0.6                             |       | **5.2** |   | 1.5 |   |
| Total operating  expenses               | ** ** | **121.5**                        |       | 107.2                           |       | **355.0** |   | 321.4 |   |
|                                    | ** ** | ** **                       |       |                            |       | ** ** |   |   |   |
| **Operating income**                    | ** ** | **107.1**                        |       | 112.1                           |       | **295.3** |   | 279.5 |   |
|                                    | ** ** | ** **                       |       |                            |       | ** ** |   |   |   |
| Investment income                       | ** ** | **1.6**                          |       | 2.5                             |       | **4.8** |   | 4.6 |   |
| Other income  (deductions)              | ** ** | **(0.2**                         | **)**      | 0.4                             |       | **0.1** |   | 4.5 |   |
| Charge for early  redemption of debt    | ** ** | **—**                       |       | (4.1                            | )          | **—** |   | (4.1 | ) |
| Interest expense                        | ** ** | **(5.5**                         | **)**      | (10.1                           | )          | **(17.5** | **)** | (30.7 | ) |
| ** **                              | ** ** | ** **                       |       |                            |       | ** ** |   |   |   |
| **Income before income taxes**          | ** ** | **103.0**                        |       | 100.8                           |       | **282.7** |   | 253.8 |   |
|                                    | ** ** | ** **                       |       |                            |       |   |   |   |   |
| Income tax expense                      | ** ** | **39.0**                         |       | 37.7                            |       | **107.8** |   | 101.5 |   |
| ** **                              | ** ** | ** **                       |       |                            |       | ** ** |   |   |   |
| **Net income**                          | ** ** | **64.0**                         |       | 63.1                            |       | **174.9** |   | 152.3 |   |
|                                    | ** ** | ** **                       |       |                            |       | ** ** |   |   |   |
| Preferred dividends                     | ** ** | **0.2**                          |       | 0.2                             |       | **0.6** |   | 0.6 |   |
| **Earnings on common stock**            | ** ** | **$**                            | **63.8**   |                            | $          | 62.9 |   | **$** | **174.3** |   | $ | 151.7 |   |

 

SeeNotes to Consolidated Financial Statements.These interim statements are unaudited.

3

----

 

**THE DAYTON POWER AND LIGHT COMPANY**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

 
| ** **                                                                                 | ** ** | **Nine months ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                 | ** ** | **September 30,**          | ** ** |
| **$ in millions**                                                                | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| **Cash  flows from operating activities:**                                                 |       |                            |       |   |   |
| Net income                                                                                 | ** ** | **$**                           | **174.9**  |   | $ | 152.3 |   |
|                                                                                       |       |                            |       |   |   |
| Adjustments:                                                                               |       |                            |       |   |   |
| Depreciation and amortization                                                              | ** ** | **96.8**                        |       | 92.9 |   |
| Amortization of regulatory assets                                                          | ** ** | **5.2**                         |       | 1.5 |   |
| Deferred income taxes                                                                      | ** ** | **(13.0**                       | **)**      | (11.4 | ) |
| Charge for early redemption of debt                                                        | ** ** | **—**                      |       | 4.1 |   |
| Changes in  certain assets and liabilities:                                                |       |                            |       |   |   |
| Accounts receivable                                                                        | ** ** | **(25.7**                       | **)**      | (7.5 | ) |
| Accounts payable                                                                           | ** ** | **41.2**                        |       | (2.8 | ) |
| Net receivable/payable from/to parent                                                      | ** ** | **(2.3**                        | **)**      | (0.9 | ) |
| Accrued taxes payable                                                                      | ** ** | **1.5**                         |       | 37.6 |   |
| Accrued interest payable                                                                   | ** ** | **4.8**                         |       | 3.1 |   |
| Prepayments                                                                                | ** ** | **5.4**                         |       | 3.9 |   |
| Inventories                                                                                | ** ** | **(7.5**                        | **)**      | (9.4 | ) |
| Deferred  compensation assets                                                              | ** ** | **3.4**                         |       | 1.6 |   |
| Deferred  compensation obligations                                                         | ** ** | **(2.5**                        | **)**      | 7.9 |   |
| Other                                                                                      | ** ** | **(11.5**                       | **)**      | 0.6 |   |
| **Net cash provided by operating activities**                                              | ** ** | **270.7**                       |       | 273.5 |   |
|                                                                                       |       |                            |       |   |   |
| **Cash  flows from investing activities:**                                                 |       |                            |       |   |   |
| Capital  expenditures                                                                      | ** ** | **(281.7**                      | **)**      | (137.1 | ) |
| **Net cash (used for) investing activities**                                               | ** ** | **(281.7**                      | **)**      | (137.1 | ) |
|                                                                                       |       |                            |       |   |   |
| **Cash  flows from financing activities:**                                                 |       |                            |       |   |   |
| Issuance of  long-term debt, net                                                           | ** ** | **—**                      |       | 211.2 |   |
| Issuance of  pollution control bonds                                                       | ** ** | **100.0**                       |       | — |   |
| Pollution  control bond proceeds held in trust                                             | ** ** | **(100.0**                      | **)**      | — |   |
| Withdrawal of  restricted funds held in trust                                              | ** ** | **23.1**                        |       | — |   |
| Retirement of  long-term debt                                                              | ** ** | **—**                      |       | (218.9 | ) |
| Dividends paid  on common stock                                                            | ** ** | **—**                      |       | (75.0 | ) |
| Dividends paid  on preferred stock                                                         | ** ** | **(0.6**                        | **)**      | (0.6 | ) |
| **Net cash provided by/(used for) financing  activities**                                  | ** ** | **22.5**                        |       | (83.3 | ) |
|                                                                                       |       |                            |       |   |   |
| **Cash  and cash equivalents:**                                                            |       |                            |       |   |   |
| Net change                                                                                 | ** ** | **11.5**                        |       | 53.1 |   |
| Balance at  beginning of period                                                            | ** ** | **46.2**                        |       | 17.2 |   |
| **Cash and cash equivalents at end of period**                                             | ** ** | **$**                           | **57.7**   |   | $ | 70.3 |   |
|                                                                                       |       |                            |       |   |   |
| **Supplemental  cash flow information:**                                                   |       |                            |       |   |   |
| Interest paid,  net of amounts capitalized                                                 | ** ** | **10.3**                        |       | 25.3 |   |
| Income taxes  paid, net                                                                    | ** ** | **108.3**                       |       | 67.2 |   |
| Non-cash  financing and investing activities:                                              |       |                            |       |   |   |
| Restricted funds held in trust (see Note 6 of Notes  to Consolidated Financial Statements) | ** ** | **75.5**                        |       | — |   |

 

See Notes to ConsolidatedFinancial Statements.

These interim statements areunaudited.

4

----

 

**THE DAYTON POWER AND LIGHT COMPANY**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                            | ** ** | **At**                 | ** **  | **At**                | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                                                                            | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
| **$ in millions**                                                                           | ** ** | **2006**               | ** **  | **2005**              | ** ** |
|                                                                                                  | ** ** | ** **             |        |                  |       |
| **ASSETS**                                                                                            | ** ** | ** **             |        |                  |       |
|                                                                                                  | ** ** | ** **             |        |                  |       |
| **Current  assets:**                                                                                  | ** ** | ** **             |        |                  |       |
|  Cash and cash  equivalents                                                                      | ** ** | **$**                  | **57.7**    |                  | $          | 46.2 |   |
|  Restricted  funds held in trust                                                                 | ** ** | **75.5**               |        | —                |       |
|  Accounts  receivable, less provision for uncollectible accounts of $1.7 and $1.0,  respectively | ** ** | **204.0**              |        | 182.7                 |       |
|  Net  intercompany receivable from parent                                                        | ** ** | **2.4**                |        | —                |       |
|  Inventories,  at average cost                                                                   | ** ** | **85.2**               |        | 77.7                  |       |
|  Taxes  applicable to subsequent years                                                           | ** ** | **11.5**               |        | 45.9                  |       |
|  Other current  assets                                                                           | ** ** | **36.1**               |        | 19.3                  |       |
| Total current assets                                                                                  | ** ** | **472.4**              |        | 371.8                 |       |
|                                                                                                  | ** ** | ** **             |        |                  |       |
| **Property,  plant and equipment:**                                                                   | ** ** | ** **             |        |                  |       |
|  Property,  plant and equipment                                                                  | ** ** | **4,363.1**            |        | 4,118.0               |       |
|  Less:  Accumulated depreciation and amortization                                                | ** ** | **(2,050.2**           | **)**       | (1,973.3              | )          |
| Net property                                                                                          | ** ** | **2,312.9**            |        | 2,144.7               |       |
|                                                                                                  | ** ** | ** **             |        |                  |       |
| **Other  noncurrent assets:**                                                                         | ** ** | ** **             |        |                  |       |
|  Regulatory  assets                                                                              | ** ** | **78.8**               |        | 83.8                  |       |
|  Other  deferred assets                                                                          | ** ** | **136.5**              |        | 138.3                 |       |
| Total other noncurrent assets                                                                         | ** ** | **215.3**              |        | 222.1                 |       |
|                                                                                                  | ** ** | ** **             |        |                  |       |
| **Total Assets**                                                                                      | ** ** | **$**                  | **3,000.6** |                  | $          | 2,738.6 |   |

 

See Notes to ConsolidatedFinancial Statements.

These interim statements areunaudited.

5

----

**THEDAYTON POWER AND LIGHT COMPANYCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                      | ** ** | **At**                 | ** **  | **At**                | ** ** |
|-----------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                                      | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
| **$ in millions**                                     | ** ** | **2006**               | ** **  | **2005**              | ** ** |
|                                                            | ** ** | ** **             | ** **  |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                  | ** ** | ** **             | ** **  |                  |       |
|                                                            |       |                   |        |                  |       |
| **Current  liabilities:**                                       | ** ** | ** **             |        |                  |       |
|  Accounts  payable                                         | ** ** | **$**                  | **137.8**   |                  | $          | 116.2 |   |
|  Accrued taxes                                             | ** ** | **126.1**              |        | 167.7                 |       |
|  Accrued  interest                                         | ** ** | **15.2**               |        | 9.8                   |       |
|  Other current  liabilities                                | ** ** | **32.1**               |        | 28.4                  |       |
| Total current liabilities                                       | ** ** | **311.2**              |        | 322.1                 |       |
|                                                            | ** ** | ** **             |        |                  |       |
| **Noncurrent  liabilities:**                                    | ** ** | ** **             |        |                  |       |
|  Long-term  debt                                           | ** ** | **785.3**              |        | 685.9                 |       |
|  Deferred  taxes                                           | ** ** | **314.7**              |        | 323.2                 |       |
|  Unamortized  investment tax credit                        | ** ** | **44.3**               |        | 46.4                  |       |
|  Other  deferred credits                                   | ** ** | **268.9**              |        | 258.7                 |       |
| Total noncurrent liabilities                                    | ** ** | **1,413.2**            |        | 1,314.2               |       |
|                                                            | ** ** | ** **             |        |                  |       |
| Cumulative  preferred stock not subject to mandatory redemption | ** ** | **22.9**               |        | 22.9                  |       |
|                                                            | ** ** | ** **             |        |                  |       |
| Commitments and  contingencies (Note 7)                         | ** ** | ** **             |        |                  |       |
|                                                            | ** ** | ** **             |        |                  |       |
| **Common  shareholders’ equity:**                          | ** ** | ** **             |        |                  |       |
|  Common stock,  at par value of $0.01 per share            | ** ** | **0.4**                |        | 0.4                   |       |
|  Other paid-in  capital                                    | ** ** | **781.6**              |        | 783.4                 |       |
|  Retained  earnings                                        | ** ** | **464.7**              |        | 290.5                 |       |
|  Accumulated  other comprehensive income                   | ** ** | **6.6**                |        | 5.1                   |       |
| Total common shareholders’ equity                          | ** ** | **1,253.3**            |        | 1,079.4               |       |
|                                                            | ** ** | ** **             |        |                  |       |
| **Total Liabilities and  Shareholders’ Equity**            | ** ** | **$**                  | **3,000.6** |                  | $          | 2,738.6 |   |

 

See Notes toConsolidated Financial Statements.

These interimstatements are unaudited.

6

----

**Notes to Consolidated Financial Statements**

**1.****             ****Basis of Presentation**

***Descriptionof Business***

The Dayton Power andLight Company (DP&L, the Company, we, our, or ours unless the contextindicates otherwise) is a wholly-owned subsidiary of DPL Inc. (DPL).  We are a public utility incorporated in 1911under the laws of Ohio and we conduct our principal business in one businesssegment – Electric Utility.  We sellelectricity to residential, commercial, industrial and governmental customersin a 6,000 square mile area of West Central Ohio.  Electricity for our 24-county service area isprimarily generated at eight coal-fired power plants and is distributed to morethan 500,000 retail customers.  We alsopurchase retail peak load requirements from DPL Energy LLC (DPLE), awholly-owned subsidiary of DPL Inc. Principal industries served include automotive, food processing, paper,plastic manufacturing, and defense.  Oursales reflect the general economic conditions and seasonal weather patterns ofthe area.  We sell any excess energy andcapacity into the wholesale market.

***FinancialStatement Presentation***

We prepare our consolidated financial statements inaccordance with accounting principles generally accepted in the United Statesof America (GAAP).  The consolidatedfinancial statements include the accounts of DP&L and our majority-ownedsubsidiaries.  Investments that are notmajority owned are accounted for using the equity method when our investmentallows us the ability to exert significant influence, as defined by GAAP.  Undivided interests in jointly-ownedgeneration facilities are consolidated on a pro rata basis.  All material intercompany accounts andtransactions are eliminated in consolidation. Interim results for the three and nine months ended September 30, 2006may not be indicative of our results that will be realized for the full yearending December 31, 2006.

Pursuant to the Securities and Exchange Commission(SEC) rules, certain information and footnote disclosures normally included inthe annual financial statements prepared in accordance with GAAP have beenomitted from interim reports. Therefore, these financial statements should beread along with the annual financial statements included in our Annual Reporton Form 10-K for the year ended December 31, 2005 and our quarterly reports onForm 10-Q ended March 31, 2006 and June 30, 2006.  In the opinion of our management, theconsolidated financial statements contain all adjustments (which are all of anormal recurring nature) necessary to fairly state our financial condition asof September 30, 2006, our results of operations for the three and nine monthsended September 30, 2006, and our cash flows for the nine months endedSeptember 30, 2006 in accordance with GAAP.

***Estimates,Judgments and Reclassifications***

The preparation of financial statements in conformitywith GAAP requires us to make estimates and judgments that affect the reportedamounts of assets and liabilities, the disclosure of contingent assets andliabilities at the date of the financial statements, and the revenue andexpenses of the period reported. Different estimates could have a material effect on our financialresults.  Judgments and uncertaintiesaffecting the application of these policies and estimates may result inmaterially different amounts being reported under different conditions orcircumstances.  Significant items subjectto such estimates and judgments include the carrying value of property, plantand equipment; unbilled revenues; the valuation of derivative instruments;valuation allowances for receivables and deferred income taxes; reservesrecorded for income tax exposures; litigation; regulatory proceedings andorders; and assets and liabilities related to employee benefits.  Actual results may differ from thoseestimates.  Certain amounts from priorperiods have been reclassified to conform to the current reportingpresentation.

7

----

***Recently Issued AccountingStandards***

**Stock-Based Compensation**

In December 2004, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standard No. 123 (revised 2004), “Share-Based Payment” (SFAS123R).  SFAS 123R replaces SFAS 123, “Accountingfor Stock-Based Compensation,” and supersedes Accounting Principles Board (APB)Opinion No. 25 (Opinion 25), “Accounting for Stock Issued to Employees.”  SFAS 123R requires a public entity to measurethe cost of employee services received and paid with equity instruments to bebased on the fair-value of such equity on the grant date.  This cost is recognized in results ofoperations over the period in which employees are required to provideservice.  Liabilities initially incurredare based on the fair-value of equity instruments and are to be re-measured ateach subsequent reporting date until the liability is ultimately settled.  The fair-value for employee share options andother similar instruments at the grant date are estimated using option-pricingmodels and any excess tax benefits are recognized as an addition to paid-incapital.  Cash retained from the excesstax benefits is presented in the statement of cash flows as financing cashinflows.  The provisions of thisStatement became effective as of January 1, 2006.  Our September 30, 2006 year-to-date pre-taxresults of operations were increased by approximately $0.6 million as a resultof the adoption of SFAS 123R, which we apply to stock-based transactionsrelated to DPL Inc. common stock.  SeeNote 5 of Notes to Consolidated Financial Statements.

**HowTaxes Collected from Customers and Remitted to Governmental Authorities Should bePresented in the Income Statement**

In June2006, the FASB ratified the consensuses of Emerging Issues Task Force (EITF)Issue No. 06-3, “How Taxes Collected from Customers and Remitted toGovernmental Authorities Should be Presented in the Income Statement (That Is,Gross versus Net Presentation)” (EITF 06-3). EITF 06-3 indicates that theincome statement presentation on either a gross basis or a net basis of thetaxes within the scope of the issue is an accounting policy decision.  The consensus in this issue should be applied to interim and annualreporting periods beginning after December 15, 2006.  We are in theprocess of evaluating EITF 06-3 and have not determined the impact to our overallresults of operations, financial position or cash flows.

**Accounting for Uncertainty inIncome Taxes**

In July 2006, the FASBissued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN48), effective for fiscal years beginning after December 15, 2006.  FIN 48 requires a two-step approach todetermine how to recognize tax benefits in the financial statements whererecognition and measurement of a tax benefit must be evaluated separately.  A tax benefit will be recognized only if itmeets a “more-likely-than-not” recognition threshold.  For tax positions that meet this threshold,the tax benefit recognized is based on the largest amount of tax benefit thatis greater than 50 percent likely of being realized upon ultimate settlementwith the taxing authority.  We arecurrently evaluating the impact of adopting FIN 48, and have not yet determinedthe significance of this new rule to our overall results of operations,financial position or cash flows.

**Accounting for Fair ValueMeasurements**

In September 2006, theFASB issued Statement of Financial Accounting Standards No. 157, “Fair ValueMeasurements,” (SFAS 157) effective for fiscal years beginning after November15, 2007.  The Standard applies wheneverother standards require (or permit) assets or liabilities to be measured atfair value.  The Standard clarifies theprinciple that fair value should be based on the assumptions marketparticipants would use when pricing the asset or liability.  In support of this principle, the Standardestablishes a fair value hierarchy that prioritizes the information used todevelop those standards.  The fair valuehierarchy gives the highest priority to quoted prices in active markets and thelowest priority to unobservable data, for example, the reporting entity’s owndata.  Under the Standard, fair valuemeasurements would be separately disclosed by level within the fair valuehierarchy.  The Standard does not expandthe use of fair value in any new circumstances. We are currently evaluating the impact of adopting SFAS 157, and havenot yet determined the significance of this new rule to our overall results ofoperations, financial position or cash flows.

8

----

**Employers’ Accounting for DefinedBenefit Pension and Other Postretirement Plans — an amendment of FASBStatements No. 87, 88, 106 and 132(R)**

In September 2006, the FASB issued FinancialAccounting Standards No. 158:  “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans, anamendment of FASB Statements No. 87, 88, 106 and 132(R)”**(SFAS158).  This Statement requires an employer that is abusiness entity and sponsors one or more single-employer defined benefit plansto:  a.) recognize the funded status of abenefit plan; b.) recognize as a component of other comprehensive income, netof tax, the gains or losses and prior service costs or credits that ariseduring the period but are not recognized as components of net periodic benefitcost; c.) measure defined benefit plan assets and obligations as of the date ofthe employer’s fiscal year-end statement of financial position; d.) disclose inthe notes to financial statements additional information about certain effectson net periodic benefit cost for the next fiscal year that arise from delayedrecognition of the gains or losses, prior service costs or credits, andtransition asset or obligation. This Statement is effective for fiscal yearsending after December 15, 2006 except for the measuring of plan assets at theemployer’s fiscal year end which is effective for fiscal years ending afterDecember 15, 2008.  We arecurrently evaluating the impact of this Statement and have not yet determinedthe significance of this new rule to our overall results of operations, cashflows or financial position.

**Considering the Effects of PriorYear Misstatements when Quantifying Misstatements in Current Year FinancialStatements**

In September 2006, the SECissued Staff Accounting Bulletin No. 108 (Topic 1N):  “Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements” (SAB108).  The SEC believesthat a registrant should quantify a current year misstatement using both theiron curtain approach and the rollover approach. If the over/understatement of current year expense is material to thecurrent year, after all of the relevant quantitative and qualitative factorsare considered, the prior year financial statements should be corrected.Correcting prior year financial statements for immaterial errors would notrequire previously filed reports to be amended. We are currently evaluating the impact of this Statement and havenot yet determined the significance of this new rule to our overall results ofoperations, cash flows or financial position.

**Accounting for Planned MajorMaintenance Activity**

In September 2006, theFASB posted Financial Statement of Position AUG AIR-1 – “Accounting for PlannedMajor Maintenance Activity” (FSP AUG AIR-1).  Previous guidance for planned major maintenance, such as repairing orreplacing a boiler, allowed four different methods for accruing for these majorrepairs.  These included direct expense,built-in overhaul, deferral and accrue-in-advance.  The FASB has decided that theaccrue-in-advance method is no longer valid because it allows a liability toaccrue for future charges that may or may not happen. We use the direct expensemethod for major planned maintenance which calls for expensing the charges asincurred.  Since we do not use theaccrue-in-advance method, this FSP will have no effect on our overall resultsof operation, statement of financial position or cash flows.

9

----

 

**2.  Supplemental Financial Information**

 
| ** **                                               | ** ** | **At**                 | ** **  | **At**                | ** ** |
|----------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| **Balance Sheet**                                   | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
| **$ in millions**                              | ** ** | **2006**               | ** **  | **2005**              | ** ** |
|                                                     | ** ** | ** **             |        |                  |       |
| **Accounts  receivable, net:**                           | ** ** | ** **             |        |                  |       |
|  Retail  customers                                  | ** ** | **$**                  | **72.6**    |                  | $          | 60.8 |   |
|  Unbilled  revenue                                  | ** ** | **46.0**               |        | 57.5                  |       |
|  Partners in  commonly-owned plants                 | ** ** | **56.6**               |        | 37.7                  |       |
|  Wholesale  customers and subsidiary customers      | ** ** | **8.6**                |        | 2.8                   |       |
|  PJM including  financial transmission rights       | ** ** | **13.6**               |        | 11.0                  |       |
|  Refundable  franchise tax                          | ** ** | **3.1**                |        | 11.8                  |       |
|  Other                                              | ** ** | **5.2**                |        | 2.1                   |       |
|  Provision for  uncollectible accounts              | ** ** | **(1.7**               | **)**       | (1.0                  | )          |
| **Total accounts receivable, net**                       | ** ** | **$**                  | **204.0**   |                  | $          | 182.7 |   |
|                                                     | ** ** | ** **             |        |                  |       |
| **Inventories,  at average cost:**                       | ** ** | ** **             |        |                  |       |
|  Fuel and  emission allowances                      | ** ** | **$**                  | **55.4**    |                  | $          | 48.6 |   |
|  Plant  materials and supplies                      | ** ** | **29.8**               |        | 29.1                  |       |
| **Total inventories, at average cost**                   | ** ** | **$**                  | **85.2**    |                  | $          | 77.7 |   |
|                                                     | ** ** | ** **             |        |                  |       |
| **Other  current assets:**                               | ** ** | ** **             |        |                  |       |
|  Prepayments                                        | ** ** | **$**                  | **8.0**     |                  | $          | 7.6 |   |
|  Deposits and  other advances                       | ** ** | **16.7**               |        | 5.8                   |       |
|  Current  deferred income taxes                     | ** ** | **4.7**                |        | 4.9                   |       |
|  Derivatives                                        | ** ** | **5.0**                |        | —                |       |
|  Other                                              | ** ** | **1.7**                |        | 1.0                   |       |
| **Total other current assets**                           | ** ** | **$**                  | **36.1**    |                  | $          | 19.3 |   |
|                                                     | ** ** | ** **             |        |                  |       |
| **Property,  plant and equipment:**                      | ** ** | ** **             |        |                  |       |
| Construction work in process                             | ** ** | **$**                  | **346.3**   |                  | $          | 165.1 |   |
| Property, plant and equipment                            | ** ** | **4,016.8**            |        | 3,952.9               |       |
| **Total property, plant and equipment**                  | ** ** | **$**                  | **4,363.1** |                  | $          | 4,118.0 |   |
|                                                     | ** ** | ** **             |        |                  |       |
| **Other  deferred assets:**                              | ** ** | ** **             |        |                  |       |
|  Master Trust  assets                               | ** ** | **$**                  | **106.1**   |                  | $          | 107.7 |   |
|  Unamortized  loss on reacquired debt               | ** ** | **20.8**               |        | 22.0                  |       |
|  Unamoritized  debt expense                         | ** ** | **8.5**                |        | 7.4                   |       |
|  Other                                              | ** ** | **1.1**                |        | 1.2                   |       |
| **Total other deferred assets**                          | ** ** | **$**                  | **136.5**   |                  | $          | 138.3 |   |
|                                                     | ** ** | ** **             |        |                  |       |
| **Accounts  payable:**                                   | ** ** | ** **             |        |                  |       |
|  Trade  payables                                    | ** ** | **$**                  | **57.9**    | ** **            | $          | 26.1 |   |
|  Fuel accruals                                      | ** ** | **40.0**               | ** **  | 39.5                  |       |
|  Other                                              | ** ** | **39.9**               | ** **  | 50.6                  |       |
| **Total accounts payable**                               | ** ** | **$**                  | **137.8**   |                  | $          | 116.2 |   |
|                                                     | ** ** | ** **             |        |                  |       |
| **Other  current liabilities:**                          | ** ** | ** **             |        |                  |       |
|  Customer  security deposits                        | ** ** | **$**                  | **19.7**    |                  | $          | 19.2 |   |
|  Deferred  revenue - financial transmission rights  | ** ** | **4.3**                |        | —                |       |
|  Current  portion of long-term debt                 | ** ** | **1.0**                |        | 0.9                   |       |
|  Payroll taxes  payable                             | ** ** | **0.3**                |        | 2.3                   |       |
|  Unearned  revenues                                 | ** ** | **0.1**                |        | 0.4                   |       |
|  Other                                              | ** ** | **6.7**                |        | 5.6                   |       |
| **Total other current liabilities**                      | ** ** | **$**                  | **32.1**    |                  | $          | 28.4 |   |
|                                                     | ** ** | ** **             |        |                  |       |
| **Other  deferred credits:**                             | ** ** | ** **             |        |                  |       |
|  Asset  retirement obligations - regulated property | ** ** | **$**                  | **85.2**    |                  | $          | 81.7 |   |
|  Master Trust  obligations                          | ** ** | **73.8**               |        | 74.5                  |       |
|  Retirees’  health and life benefits           | ** ** | **32.4**               |        | 32.9                  |       |
|  Pension  liability                                 | ** ** | **28.7**               |        | 23.5                  |       |
|  SECA net  revenue subject to refund                | ** ** | **21.5**               |        | 20.5                  |       |
|  Asset  retirement obligations - generation         | ** ** | **13.2**               |        | 13.2                  |       |
|  Litigation  and claims pending                     | ** ** | **3.3**                |        | 3.0                   |       |
|  Environmental  reserves                            | ** ** | **0.1**                |        | 0.1                   |       |
|  Other                                              | ** ** | **10.7**               |        | 9.3                   |       |
| **Total  other deferred credits**                        | ** ** | **$**                  | **268.9**   |                  | $          | 258.7 |   |

 

10

----

**2.  SupplementalFinancial Information (continued)**

 

|                                    | ** ** | **Nine months ended** | ** ** |
|------------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **September 30,**          | ** ** |
| **$ in millions**        | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| ** **                         |       |                            |       |   |   |
| **Cash  flows - other:**           | ** ** | ** **                      |       |   |   |
| Payroll taxes payable              | ** ** | **$**                           | **(2.0**   | **)** | $ | 0.1 |   |
| Deposits and other advances        | ** ** | **(10.5**                       | **)**      | (6.7 | ) |
| Deferred storm costs               | ** ** | **—**                      |       | (5.6 | ) |
| FERC transitional payment deferral | ** ** | **1.0**                         |       | 15.4 |   |
| Other                              | ** ** | **—**                      |       | (2.6 | ) |
| **Total  cash flows - other**      | ** ** | **$**                           | **(11.5**  | **)** | $ | 0.6 |   |

 
| ** **                                                      | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **$ in millions**                                     | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                      |       |                             |       |                            |       |   |   |   |   |
| **Comprehensive  income:**                                      | ** ** | ** **                       |       |                            |       |   |   |   |   |
| Net income                                                      | ** ** | **$**                            | **64.0**   |                            | $          | 63.1 | ** ** | **$** | **174.9** |   | $ | 152.3 |   |
| Net change in unrealized gains on financial instruments         | ** ** | **1.2**                          |       | 1.1                             | ** ** | **1.8** |   | 6.6 |   |
| Net change in deferred gains (losses) on cash flow  hedges      | ** ** | **0.1**                          |       | (2.0                            | )          | **2.9** |   | (4.8 | ) |
| Deferred income taxes related to unrealized gains  and (losses) | ** ** | **(0.8**                         | **)**      | 0.2                             | ** ** | **(3.2** | **)** | (1.0 | ) |
| **Total  comprehensive income**                                 | ** ** | **$**                            | **64.5**   |                            | $          | 62.4 | ** ** | **$** | **176.4** |   | $ | 153.1 |   |

 

**3.   Preferred Stock**

$25 par value,4,000,000 shares authorized, no shares outstanding; and $100 par value,4,000,000 shares authorized, 228,508 shares without mandatory redemptionprovisions outstanding.

 

| Preferred  Stock | ** ** | **Rate**   | ** ** | **Current  Redemption  Price** | ** ** | **Current Shares  Outstanding at  September 30,  2006** | ** ** | **Par Value At  September 30,  2006** | ** ** | **Par Value At  December 31,  2005** | ** ** |
|------------------|------------|------------|------------|--------------------------------|------------|------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **       | ** ** | ** ** | ** ** | ** **                     | ** ** | ** **                                                             | ** ** | **($ in millions)**                        | ** ** | **($ in millions)**                       | ** ** |
| Series A         |       | 3.75%      |       | $                              | 102.50     |                                                                   | 93,280     |                                                 | $          | 9.3                                                 |       | $ | 9.3 |   |
| Series B         |       | 3.75%      |       | $                              | 103.00     |                                                                   | 69,398     |                                                 | 7.0        |                                                | 7.0        |   |
| Series C         |       | 3.90%      |       | $                              | 101.00     |                                                                   | 65,830     |                                                 | 6.6        |                                                | 6.6        |   |
| Total            |       |       |       |                           |       | 228,508                                                                |       | $                                                    | 22.9       |                                                | $          | 22.9 |   |

 

The preferred stock maybe redeemed at our option at the per-share prices indicated, plus cumulativeaccrued dividends.

As long as any preferredstock is outstanding, our Amended Articles of Incorporation contain provisionsrestricting the payment of cash dividends on any of our common stock if, aftergiving effect to such dividend, the aggregate of all such dividends distributedsubsequent to December 31, 1946 exceeds the net income available for dividendson our common stock subsequent to December 31, 1946, plus$1.2 million.  As of September 30,2006, all earnings were available for common stock dividends.  We expect all 2006 earnings to be availablefor common stock dividends, payable to DPL.

**4.****       ****Pension and Postretirement Benefits**

We sponsor a definedbenefit plan for substantially all employees. For collective bargaining employees, the defined benefits are based on aspecific dollar amount per year of service. For all other employees, the defined benefit plan is based primarily oncompensation and years of service.  Wefund pension plan benefits as accrued in accordance with the minimum fundingrequirements of the Employee Retirement Income Security Act of 1974 (ERISA).

Qualifiedemployees who retired prior to 1987 and their dependents are eligible forhealth care and life insurance benefits. We have funded the union-eligible health benefit using a VoluntaryEmployee Beneficiary Association Trust.

11

----

Thenet periodic benefit cost of the pension and postretirement benefit plans forthe three months ended September 30, 2006 and 2005 was:

**Net periodic benefit cost**
| ** **                                    | ** ** | **Pension** | ** ** | **Postretirement** | ** ** |
|-----------------------------------------------|------------|-------------|------------|--------------------|------------|
| **$ in millions**                   | ** ** | **2006**    | ** ** | **2005**           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost                                  | ** ** | **$**       | **1.0**    |               | $          | 0.9 |   | **$** | **—** |   | $ | — |   |
| Interest cost                                 | ** ** | **4.3**     |       | 3.9                |       | **0.5** |   | 0.5 |   |
| Expected return  on assets                    | ** ** | **(5.5**    | **)**      | (5.4               | )          | **(0.2** | **)** | (0.1 | ) |
|                                          |       |        |       |               |       |   |   |   |   |
| Amortization of  unrecognized:                |       |        |       |               |       |   |   |   |   |
| Actuarial (gain) loss                         | ** ** | **0.9**     |       | 1.0                |       | **(0.2** | **)** | (0.1 | ) |
| Prior service cost                            | ** ** | **0.7**     |       | 0.6                |       | **—** |   | — |   |
| Transition obligation                         | ** ** | **—**  |       | —             |       | **0.1** |   | — |   |
| Net periodic  benefit cost before adjustments | ** ** | **1.4**     |       | 1.0                |       | **0.2** |   | 0.3 |   |
| Settlement cost (a)                           | ** ** | **2.6**     |       | —             |       | **—** |   | — |   |
| Curtailment cost  (b)                         | ** ** | **—**  |       | 0.1                |       | **—** |   | — |   |
| Net periodic  benefit cost after adjustments  | ** ** | **$**       | **4.0**    |               | $          | 1.1 |   | **$** | **0.2** |   | $ | 0.3 |   |

 

----

(a)         The settlement cost relates to a former officer (not related to ourongoing litigation with three former executives) who has elected to receive alump sum distribution in 2007 from the Supplemental Executive Retirement Plan.

(b)        The curtailment cost relates to a freeze in benefits for the remainingactive employee participating in the Supplemental Executive Retirement Plan.

The net periodic benefitcost of the pension and postretirement benefit plans for the nine months endedSeptember 30, 2006 and 2005 was:

**Netperiodic benefit cost**
| ** **                                    | ** ** | **Pension** | ** ** | **Postretirement** | ** ** |
|-----------------------------------------------|------------|-------------|------------|--------------------|------------|
| **$ in millions**                   | ** ** | **2006**    | ** ** | **2005**           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost                                  | ** ** | **$**       | **3.2**    |               | $          | 2.9 |   | **$** | **—** |   | $ | — |   |
| Interest cost                                 | ** ** | **12.5**    |       | 11.8               |       | **1.3** |   | 1.4 |   |
| Expected return  on assets                    | ** ** | **(16.3**   | **)**      | (16.1              | )          | **(0.4** | **)** | (0.4 | ) |
|                                          |       |        |       |               |       |   |   |   |   |
| Amortization of  unrecognized:                |       |        |       |               |       |   |   |   |   |
| Actuarial (gain) loss                         | ** ** | **2.9**     |       | 2.9                |       | **(0.6** | **)** | (0.6 | ) |
| Prior service cost                            | ** ** | **1.9**     |       | 1.7                |       | **—** |   | — |   |
| Transition obligation                         | ** ** | **—**  |       | —             |       | **0.2** |   | 0.1 |   |
| Net periodic  benefit cost before adjustments | ** ** | **4.2**     |       | 3.2                |       | **0.5** |   | 0.5 |   |
| Settlement cost  (a)                          | ** ** | **2.6**     |       | —             |       | **—** |   | — |   |
| Special  termination benefit cost (b)         | ** ** | **0.3**     |       | —             |       | **—** |   | **—** | ** ** |
| Curtailment cost  (c)                         | ** ** | **—**  |       | 0.1                |       | **—** |   | **—** | ** ** |
| Net periodic benefit  cost after adjustments  | ** ** | **$**       | **7.1**    |               | $          | 3.3 |   | **$** | **0.5** |   | $ | 0.5 |   |

 

----

(a)         The settlement cost relates to a former officer (not related to ourongoing litigation with three former executives) who has elected to receive alump sum distribution in 2007 from the Supplemental Executive Retirement Plan.

(b)        In 2006, a special termination benefit cost was recognized as a resultof 16 employees who participated in a voluntary early retirement program and wereall retired as of April 1, 2006.

(c)         The curtailment cost relates to a freeze in benefits for the remainingactive employee participating in the Supplemental Executive Retirement Plan.

12

----

 

Thefollowing estimated benefit payments, which reflect future and past service,are expected to be paid as follows:

**EstimatedFuture Benefit Payments**

 
| $ in millions | ** ** | **Pension** | ** ** | **Postretirement** | ** ** |
|-------------------------|------------|-------------|------------|--------------------|------------|
| 2006                    |       | $           | 4.9        |               | $          | 0.8 |   |
| 2007                    |       | $           | 24.6       |               | $          | 3.1 |   |
| 2008                    |       | $           | 19.8       |               | $          | 3.0 |   |
| 2009                    |       | $           | 20.2       |               | $          | 3.0 |   |
| 2010                    |       | $           | 20.7       |               | $          | 2.9 |   |
| 2011                    |       | $           | 20.9       |               | $          | 2.7 |   |
| 2012 – 2016        |       | $           | 111.9      |               | $          | 10.7 |   |

 

**5.****              Stock-BasedCompensation**

We adopted SFAS 123R onJanuary 1, 2006 using the modified prospective approach for stock options andrestricted stock units (RSUs).  As aresult of our adoption of SFAS 123R, we recognized $0.6 million lesscompensation expense for the nine months ended September  30, 2006, as compared to what we would haverecognized under SFAS 123.

In 2000, our Board ofDirectors adopted and DPL shareholders approved The DPL Inc. Stock OptionPlan.  The plan provides that “no singleParticipant shall receive Options with respect to more than 2,500,000shares.”  Options granted in 2000, 2001and 2002 were fully vested as of December 31, 2005 and expire ten years fromthe grant date.  In 2003, 100,000 optionswere granted which vested equitably over five years and expire ten years fromthe grant date.  In 2004, 200,000 optionswere granted that vest over nineteen months and expire approximately 6.5 yearsfrom the grant date; 100,000 of these options vested in May of 2005 and theremaining 100,000 vested in May 2006. Another 20,000 options were granted in 2004 that vested in five monthsand expire ten years from the grant date. In December 2004, 30,000 options were granted that vest equitably overthree years and expire ten years from the grant date.  In 2005, 350,000 options were granted thatvested in June 2006 and expire three years from the grant date.  At September 30, 2006, there were 1,528,500options available for grant.  On April26, 2006, DPL shareholders approved the DPL Inc. 2006 Equity and PerformanceIncentive Plan (EPIP).  With the approvalof EPIP, no further awards will be made under the DPL Inc. Stock Option Plan.

The schedule ofnon-vested option activity for the nine months ended September 30, 2006 was asfollows:

| $ in millions                | ** ** | **Number of Options** | ** ** | **Weighted-Average Grant  Date Fair Value** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|------------------------------------------------------------|------------|
| Non-vested at January  1, 2006         |       |                            | 510,000    |                                                       |       |   | $ | 2.2 |   |   |
| Granted in 1st nine months 2006   |       |                            | —     |                                                       |       |   | — |   |   |
| Vested in 1st nine months 2006    |       |                            | 450,000    |                                                       |       |   | $ | 2.0 |   |   |
| Forfeited in 1st nine months 2006 |       |                            | 40,000     |                                                       |       |   | $ | 0.1 |   |   |
| Non-vested at September 30, 2006       |       |                            | 20,000     |                                                       |       |   | $ | 0.1 |   |   |

 

13

----

 

Summarized stock optionactivity was as follows:

 
|                                              | ** ** | **Nine months  ended  September 30,  2006** | ** ** | **Twelve months  ended  December 31,  2005** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Options:                                     |       |                                                  |       |                                                   |       |
| Outstanding at  beginning of year (a)        | ** ** | **5,486,500**                                         |       | 6,165,500                                              |       |
| Granted                                      | ** ** | **0**                                                 |       | 350,000                                                |       |
| Exercised                                    | ** ** | **(10,000**                                           | **)**      | (1,025,000                                             | )          |
| Forfeited                                    | ** ** | **(40,000**                                           | **)**      | (4,000                                                 | )          |
| Outstanding at end of  period                | ** ** | **5,436,500**                                         |       | 5,486,500                                              |       |
| Exercisable at end of  period                | ** ** | **5,416,000**                                         |       | 4,100,000                                              |       |
|                                         | ** ** | ** **                                            |       |                                                   |       |
| Weighted average  exercise prices per share: | ** ** | ** **                                            |       |                                                   |       |
| Outstanding at  beginning of year            | ** ** | **$**                                                 | **21.86**  |                                                   | $          | 21.39 |   |
| Granted                                      | ** ** | **—**                                            |       | $                                                      | 26.82      |   |
| Exercised                                    | ** ** | **$**                                                 | **21.00**  |                                                   | $          | 21.18 |   |
| Forfeited                                    | ** ** | **$**                                                 | **15.88**  |                                                   | $          | 29.63 |   |
| Outstanding at end of  period                | ** ** | **$**                                                 | **22.02**  |                                                   | $          | 21.86 |   |
| Exercisable at end of period                 | ** ** | **$**                                                 | **20.98**  |                                                   | $          | 20.98 |   |

 

----

(a)*    In dispute with certain former executives,among other things, are approximately 1 million forfeited options not includedabove and 3.6 million outstanding options that are included above (see Note 7of Notes to Consolidated Financial Statements).*

No stock options were granted in the first threequarters of 2006.  The weighted-averagefair value of options granted was $3.80 per share in 2005.  The fair values of the options were estimatedas of the dates of grant using a Black-Scholes option pricing model.

Inthe first quarter of 2006, 10,000 stock options were exercised.  No stock options were exercised in the secondor third quarter of 2006.  The marketvalue of options that were vested at September 30, 2006 was approximately $31million.  Shares issued upon share optionexercise are issued from treasury stock. We have sufficient treasury stock to satisfy outstanding options.

Thefollowing table reflects information about stock options outstanding atSeptember 30, 2006:
| ** **                              | ** ** | ** **      | ** ** | **Options Outstanding**              | ** ** | **Options Exercisable**            | ** ** |
|-----------------------------------------|------------|-----------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| **Range of Exercise  Prices** | ** ** | **Outstanding** | ** ** | **Weighted-  Average  Contractual  Life** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Exercisable** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
|                                    |       |            |       |                                      |       |                                    |       |   |   |   |   |
| $14.95-$21.00                           |       | 4,650,000       |       | 3.7 years                                 |       | $                                       | 20.43      |   | 4,650,000 |   | $ | 20.47 |   |
| $21.01-$29.63                           |       | 786,500         |       | 3.0 years                                 |       | $                                       | 28.01      |   | 766,000 |   | $ | 28.08 |   |

 

As of September 30, 2006,there was $0.1 million of total unrecognized compensation cost related tonon-vested stock options granted under the Plan.  We expect to recognize $0.1million of this cost in 2007.

In addition, RestrictedStock Units (RSUs) were granted to certain key employees prior to 2001.  There were 1.3 million RSUs outstanding as ofSeptember 30, 2006, of which 1.3 million were vested.  Substantially all of the vested RSUs are indispute as part of our ongoing litigation with Peter H. Forster, formerlyDPL’s Chairman; Caroline E. Muhlenkamp, formerly DPL’s Group Vice President andinterim Chief Financial Officer; and Stephen F. Koziar, formerly DPL’sChief Executive Officer and President. The remaining 0.1 million non-vested RSUs will be paid in cash uponvesting and will vest as follows:  20,097in 2007; 14,688 in 2008; 10,205 in 2009; and 5,008 in 2010.

14

----

 

Vested RSUs are marked tomarket each quarter and any adjustment to compensation expense is recognized atthat time.  Non-vested RSUs are valuedquarterly at fair value using the Black-Scholes model to determine the amountof compensation expense to be recognized. Non-vested RSUs do not earn dividends.

The following assumptionswere used in the Black-Scholes model to calculate the fair value of thenon-vested stock options and RSUs:
| Volatility               | **10.3** | **–** | **29.1** | **%**      |
|--------------------------|----------|------------|----------|------------|
| Expected life  (years)   | **0.8**  | **–** | **8.0**  | ** ** |
| Dividend yield  rate     | **3.7**  | **–** | **4.8**  | **%**      |
| Risk-free  interest rate | **3.7**  | **–** | **4.9**  | **%**      |

 

At the 2006 AnnualShareholder’s Meeting, DPL shareholders approved the DPL Inc. 2006 Equity and PerformanceIncentive Plan (EPIP).  Under the EPIP,the Board adopted a Long-Term Incentive Plan (LTIP) under which we will award atargeted number of performance shares of DPL Inc. common stock toexecutives.  Awards under the LTIP willbe awarded based on a Total Shareholder Return Relative to Peersperformance.  No performance shares willbe earned in a performance period if the three-year Total Shareholder ReturnRelative to Peers is below the threshold of the 40th percentile. Further, the LTIP awards will be capped at 200% of the target number ofperformance shares, if the Total Shareholder Return Relative to Peers is at orabove the threshold of the 90th percentile. The Total Shareholder Return Relative to Peers is considered aperformance condition under FAS 123R. The requisite performance period for each tranche of the PerformanceShares is:

| Tranche 1 |   | January 1, 2004 to December 31, 2006 |
|-----------|--------|--------------------------------------|
| Tranche 2 |   | January 1, 2005 to December 31, 2007 |
| Tranche 3 |   | January 1, 2006 to December 31, 2008 |

 

The schedule ofnon-vested performance share activity for the nine months ended September 30,2006 follows:

| $ in millions                | ** ** | ** ** | ** ** | **Number of  Performance Shares** | ** ** | **Weighted-Average Grant  Date Fair Value** | ** **                               |
|----------------------------------------|------------|------------|------------|---------------------------------------------|------------|------------------------------------------------------------|------------------------------------------|
| Non-vested at  January 1, 2006         |       |       | —     |                                        |       |                                                       | —                                   |   |   |
| Granted in 1st nine months 2006   |       |       | 223,289    |                                        |       |                                                       | $     5.9  |   |   |
| Vested in 1st nine months 2006    |       |       | —     |                                        |       |                                                       | —                              |   |   |
| Forfeited in 1st nine months 2006 |       |       | (89,655    | )                                           |       |                                                       | (2.4)                                    |   |   |
| Non-vested at September  30, 2006      |       |       | 133,634    |                                        |       |                                                       | $     3.5  |   |   |

 

Summarized performance shares activity was as follows:

 

|                                   | ** ** | **Nine months**             | ** ** | **Twelve months**          | ** ** |
|-----------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | **ended**                        | ** ** | **ended**                       | ** ** |
| ** **                        | ** ** | **September 30, 2006** | ** ** | **December 31, 2005** | ** ** |
| Performance Shares:               | ** ** | ** **                       |       |                            |       |
| Outstanding at  beginning of year | ** ** | **—**                       |       | —                          |       |
| Granted                           | ** ** | **223,289**                      |       | —                          |       |
| Exercised                         | ** ** | **—**                       |       | —                          |       |
| Forfeited                         | ** ** | **(89,655**                      | **)**      | —                          |       |
| Outstanding at end of  period     | ** ** | **133,634**                      |       | —                          |       |
| Exercisable at end of  period     | ** ** | **—**                       |       | —                          |       |

 

There are no exerciseprices associated with performance shares.

As of September 30, 2006,there was $1.6 million of total unrecognized compensation cost related tonon-vested performance shares granted under the LTIP.  We expect torecognize $0.5 million of this cost over the remainder of 2006 and $1.1 millionin 2007 and 2008.  A forfeiture rate of 20% was estimated in calculatingthe compensation expense.

Sharesissued upon achievement of the required performance condition will be issuedfrom treasury stock.  We have sufficienttreasury stock to satisfy outstanding performance shares.

15

----

 

The following assumptionswere used in a Monte Carlo simulation calculated by an actuarial consultant toestimate the fair value of the performance shares:
| Volatility              | ** ** | **20.3** | **%**      |
|-------------------------|------------|----------|------------|
| Expected life (years)   | ** ** | **3.0**  | ** ** |
| Dividend yield rate     | ** ** | **3.7**  | **%**      |
| Risk-free interest rate | ** ** | **4.7**  | **%**      |

 

For the quarter endedSeptember 30, 2006, total compensation expense was $0.8 million withan associated tax benefit of $0.3 million. Compensation expense for thenine months ended September 30, 2006 was $4.1 million for all share-basedcompensation (stock options, RSUs, and performance shares) and the tax benefitassociated with these expenses was $1.5 million.

For the nine months endedSeptember 30, 2006, operating income was $0.6 million higher under SFAS 123Rthan under SFAS 123, while the impact to net income was $0.4 million due to adecrease in the tax benefit of $0.2 million. There was no impact on basic or diluted earnings per share.

On October 2, 2006, PaulM. Barbas (President and Chief Executive Officer) was granted 19,000 shares ofDPL Inc. Restricted Stock (Restricted Shares), granted under the 2006 Equityand Performance Incentive Plan.  Theseshares were not included in the above calculations as the shares were issuedsubsequent to September 30, 2006.  TheRestricted Shares are to be registered in Mr. Barbas’ name, receive dividendsas declared and paid on all DPL common stock and will vest in twotranches.  A total of 9,000 RestrictedShares shall become nonforfeitable on December 31, 2009 if Mr. Barbas remainsin the continuous employ of the Company until such date.  The remaining 10,000 Restricted Shares willbecome nonforfeitable on December 31, 2011 if Mr. Barbas remains a Companyemployee.

**6.     Long-term Debt**

|                                                                       | ** ** | **At**                 | ** ** | **At**                | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| **$ in millions**                                           | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| First Mortgage  Bonds maturing 2013 - 5.125%                          | ** ** | **$**                  | **470.0**  |                  | $          | 470.0 |   |
| Pollution  Control Series maturing through 2036 - 4.79% and 4.78% (a) | ** ** | **314.4**              |       | 214.4                 |       |
|                                                                  | ** ** | **$**                  | **784.4**  |                  | $          | 684.4 |   |
|                                                                  | ** ** | ** **             |       |                  |       |
| Obligation for  capital leases                                        | ** ** | **2.2**                |       | 3.0                   |       |
| Unamortized debt  discount                                            | ** ** | **(1.3**               | **)**      | (1.5                  | )          |
| Total                                                                 | ** ** | **$**                  | **785.3**  |                  | $          | 685.9 |   |

 

----

(a) Weightedaverage interest rates for 2006 and 2005, respectively.

 

The amounts of maturitiesand mandatory redemptions for first mortgage bonds and capital leases are $0.2million for the remainder of 2006, $0.9 million in 2007, $0.7 million in 2008,$0.7 million in 2009 and $0.7 million in 2010. Substantially all of our property is subject to the mortgage liensecuring the first mortgage bonds and the pollution control series.

We have a $100million unsecured revolving credit agreement that is renewable annually andexpires on May 30, 2010.  This facilitymay be increased up to $150 million.  Thefacility contains one financial covenant: our total debt to total capitalization ratio is not to exceed 0.65 to1.00.  This covenant is currentlymet.  We had no outstanding borrowingsunder this credit facility at September 30, 2006.  Fees associated with this credit facility areapproximately $0.2 million per year. Changes in credit ratings, however, may affect fees and the applicableinterest rate for our revolving credit agreement.

 

16

----

On February 17, 2006, werenewed our $10 million Master Letter of Credit Agreement for one yearwith a financial lending institution. This agreement supports performance assurance needs in the ordinarycourse of business.  We have certaincontractual agreements for the sale and purchase of power, fuel and relatedenergy services that contain credit rating related clauses allowing the counterparties to seek additional surety under certain conditions.  As of September 30, 2006, we had twooutstanding letters of credit for a total of $2.2 million.

Duringthe first quarter of 2006, the Ohio Department of Development (ODOD) awarded usthe ability to issue over the next three years up to $200 million of qualifiedtax-exempt financing from the ODOD's 2005 volume cap carryforward.  The financing is to be used to partially fundthe ongoing flue gas desulfurization (FGD)projects.  The PUCO approved ourapplication for this additional financing on July 26, 2006.

On September 13, 2006,the Ohio Air Quality Development Authority (OAQDA) issued $100 million of 4.80%fixed interest rate OAQDA Revenue Bonds 2006 Series A due September 1, 2036. Inturn, DP&L then borrowed these funds from the OAQDA.  Payment ofprincipal and interest on the Bonds when due is insured by an insurance policyissued by Financial Guaranty Insurance Company. We are using the proceeds fromthese borrowings to assist in financing our portion of the costs of acquiring,constructing and installing certain solid waste disposal facilities comprisingair quality facilities at Miami Fort, Killen and Stuart GeneratingStations.  These facilities are currentlyunder construction and the proceeds from the borrowings have been placed inescrow with the trustee (the Bank of New York) and are being drawn upon only asfacilities are built and qualified costs incurred.  In the event any ofthe proceeds are not drawn, we would eventually be required to return theunused proceeds to bondholders.  We expect to draw down all of theproceeds from the borrowing over the next year.

Weexpect to use the remaining $100 million of volume cap carry forward prior tothe end of 2008. We are planning to issue in conjunction with the OAQDA another$100 million of tax-exempt bonds to finance the remaining solid waste disposalfacilities at Miami Fort, Killen, Stuart and Conesville Generating Stations.

There are nointer-company debt collateralizations or debt guarantees between us and ourparent.  None of our debt obligations areguaranteed or secured by affiliates and no cross-collateralization existsbetween any subsidiaries.

**7.     Commitments and Contingencies**

**Contingencies**

In the normalcourse of business, we are subject to various lawsuits, actions, proceedings,claims and other matters asserted under laws and regulations.  We believe the amounts provided in our ConsolidatedFinancial Statements, as prescribed by GAAP, are adequate in light of theprobable and estimable contingencies. (See Note 1 of Notes to Consolidated Financial Statements.)  However, there can be no assurances that theactual amounts required to satisfy alleged liabilities from various legalproceedings, regulatory proceedings and orders, claims, tax examinations andother matters discussed below, and to comply with applicable laws and regulations,will not exceed the amounts reflected in our Consolidated Financial Statements.

**EnvironmentalMatters**

Our facilities andoperations are subject to a wide range of environmental regulations andlaw.  In the normal course of business,we have investigatory and remedial activities underway at these facilities tocomply, or to determine compliance, with such regulations.  We have been identified, either by agovernment agency or by a private party seeking contribution to site clean-upcosts, as a potentially responsible party (PRP) at two sites pursuant to stateand federal laws. Our units are subject to the acid rain provisions of theClean Air Act and the NOx and Ozone Transport rule. All of the SO2 and NOx emissions datasubmitted to the EPA pursuant to these provisions for 2005 and the firstquarter 2006 were recorded and reported in compliance with EPA regulations. Subsequentlywe detected a malfunction with its emission monitoring system at one of itsgeneration stations and ultimately determined its SO2 and NOx emissions datawas under reported. We have petitioned the EPA to accept an alternativemethodology for calculating actual emissions for 2005 and the first quarter2006. The Company has sufficient allowances in its general account to cover theunderstatement and is working with the EPA to resolve the matter. Managementdoes not believe the ultimate resolution of this matter will have a materialimpact on operating results or financial position. We record liabilities forprobable estimated loss in accordance with Statement of Financial AccountingStandards No. 5 (SFAS 5), “Accounting for Contingencies.” To the extent aprobable loss can only be estimated by reference to a range of equally probableoutcomes, and no amount within the range appears to be a better estimate thanany other amount, we accrue for the low end of the range. Because ofuncertainties related to these matters, accruals are based on the best informationavailable at the time. We evaluate the potential liability related to probablelosses quarterly and may revise our estimates. Such revisions in the estimatesof potential liabilities could have a material effect on our results ofoperations and financial position.

**LegalMatters**

In the normal course ofbusiness, we have been named a defendant in various legal actions, includingarbitrations, class actions and other litigation. Certain of the legal actionsinclude claims for substantial compensatory and/or punitive damages or claimsfor indeterminate amounts of damages. We are also involved in other reviews, 

17

----

investigations andproceedings by governmental and self-regulatory organizations regarding ourbusiness. Certain of the foregoing could result in adverse judgments,settlements, fines, penalties or other relief.

Because litigation isinherently unpredictable, particularly in cases where claimants seeksubstantial or indeterminate damages or where investigations and proceedingsare in the early stages, we cannot predict with certainty the loss or range ofloss related to such matters, how such matters will be resolved, when they willbe ultimately resolved, or what the eventual settlement, fine, penalty or otherrelief might be. Consequently, we cannot estimate losses or ranges of lossesfor matters where there is only a reasonable possibility that a loss may havebeen incurred. Although the ultimate outcome of these matters cannot beascertained at this time, it is the opinion of management, that the resolutionof the foregoing matters will not have a material adverse effect on ourfinancial condition, taken as a whole; such resolution may, however, have amaterial effect on the operating results in any future period, depending on thelevel of income for such period.

We have provided reservesfor such matters in accordance with SFAS 5, “Accounting for Contingencies.” Theultimate resolution may differ from the amounts reserved.

Certain legal proceedingsin which we are involved are discussed in Note 11 to the Consolidated FinancialStatements and, Part I, Item 3, of our Annual Report on Form 10-K for thefiscal year ended December 31, 2005; and Note 7 to the Consolidated Financial Statementsand Part II, Item 1, included in our Form 10-Q for the quarterly periods endedMarch 31, 2006 and June 30, 2006. The following discussion is limited to recentdevelopments concerning our legal proceedings and should be read in conjunctionwith those earlier reports.

On January 13, 2006, wefiled a claim against one of our insurers, Associated Electric & GasInsurance Services Limited (AEGIS), under a fiduciary liability policy torecoup legal fees associated with our litigation against three formerexecutives.  An arbitration of thismatter was held on August 4, 2006.  Thearbitration panel ruled on or about September 12, 2006 that the AEGIS policydoes not require an advance of defense expenses to us.  Rather, the arbitration panel stated that weare required to file a written undertaking as a condition precedent to repayexpenses finally established not to be insured. We have filed a written undertaking with AEGIS and will continue topursue resolution of the claim through mediation and arbitration in 2007.

On February 13, 2006, wereceived correspondence from the Ohio Department of Taxation (ODT) notifying usthat ODT has completed their examination and review of our Ohio CorporationFranchise Tax Returns for tax years 2002 through 2004 and that the finalproposed audit adjustments result in a balance due of $90.8 million beforeinterest and penalties.  We have reviewedthe proposed audit adjustments and are vigorously contesting the ODT findingsand notice of assessment through all administrative and judicial meansavailable. On March 29, 2006, we filed petitions for reassessment with the ODTto protest each assessment as well as request corrected assessments for eachtax year.  On October 12, 2006, we signeda Memorandum of Understanding with the ODT that stated if the ODT’s positionsare ultimately sustained in judicial proceedings, the total additional taxliability that we would be subject to for tax years 2002 through 2004 would beno more than $50.7 million before interest as opposed to the $90.8 millionstated in the ODT’s correspondence of February 13, 2006.  We believe we have recorded adequate tax reservesrelated to the proposed adjustments; however, we cannot predict the outcome,which could be material to our results of operations and cash flows.

We are also under auditreview by various state agencies for tax years 2002 through 2004.  We have also filed an appeal to the OhioBoard of Tax Appeals for tax years 1998 through 2001.  Depending upon the outcome of these auditsand the appeal, we may be required to increase our tax provision if actualamounts ultimately determined exceed recorded reserves.  We believe we have adequate reserves in eachtax jurisdiction but cannot predict the outcome of these audits.

In September 2006, webecame aware of unasserted claims under the Fair Labor Standards Act concerningthe calculation of overtime rates for our unionized workforce.  We will vigorously oppose these claims, if assertedagainst us.  However, if we do notprevail, the cost to us would be in the range of $0-$3.5 million.

18

----

**Contractual Obligations andCommercial Commitments**

We enter into variouscontractual and other long-term obligations that may affect the liquidity ofour operations.  At September 30, 2006,these include:

**Contractual Obligations**
| ** **                           | ** ** | ** ** | ** ** | **Payment Year**           | ** ** |
|--------------------------------------|------------|------------|------------|---------------------------------|------------|
| **$ in millions**          | ** ** | **Total**  | ** ** | **Less than 1  Year** | ** ** | **2 - 3 Years** | ** ** | **4 - 5 Years** | ** ** | **More than 5  Years** | ** ** |
|                                 |       |       |       |                            |       |   |   |   |   |   |   |
| Long-term debt                       |       | $          | 783.1      |                            | $          | — |   | $ | — |   | $ | — |   | $ | 783.1 |   |
| Interest  payments                   |       | 581.7      |       | 39.1                            |       | 78.3 |   | 78.3 |   | 386.0 |   |
| Pension and  postretirement payments |       | 249.2      |       | 33.4                            |       | 46.0 |   | 47.2 |   | 122.6 |   |
| Capital leases                       |       | 3.2        |       | 1.1                             |       | 1.4 |   | 0.7 |   | — |   |
| Operating leases                     |       | 0.5        |       | 0.3                             |       | 0.2 |   | — |   | — |   |
| Fuel and  limestone contracts (a)    |       | 586.8      |       | 86.7                            |       | 315.5 |   | 97.5 |   | 87.1 |   |
| Other long-term  obligations         |       | 27.5       |       | 14.6                            |       | 9.8 |   | 3.1 |   | — |   |
| Total contractual  obligations       |       | $          | 2,232.0    |                            | $          | 175.2 |   | $ | 451.2 |   | $ | 226.8 |   | $ | 1,378.8 |   |

 

----

(a)  DP&L operated units.

Long-term debt:

Long-term debt as of September 30, 2006, consists ofour first mortgage bonds and tax-exempt pollution control bonds and includes anunamortized debt discount.  (See Note 6of Notes to Consolidated Financial Statements.)

Interest payments:

Interest payments associated with the long-term debtdescribed above.

Pension and postretirementpayments:

As of September 30, 2006, we had estimated futurebenefit payments as outlined in Note 4 of Notes to Consolidated FinancialStatements.  These estimated futurebenefit payments are projected through 2016.

Capital leases:

As of September 30, 2006,we had two capital leases that expire in November 2007 and September 2010.

Operating leases:

As of September 30, 2006,we had several operating leases with various terms and expiration dates.  Not included in this total is approximately$88 thousand per year related to right-of-way agreements that are assumed tohave no definite expiration dates.

Fuel and limestonecontracts:

We have entered intovarious long-term coal contracts to supply portions of our coal requirementsfor our generating plants and a long-term contract to supply limestone for theoperation of our flue gas desulfurization (FGD) units.  Coal contract prices are subject to periodicadjustment, and have features that limit price escalation in any given year.

A new long-term bargeagreement was executed for five years beginning September 2006.

Other long-termobligations:

As of September 30, 2006,we had various other contractual obligations including non-cancelable contractsto purchase goods and services with various terms and expiration dates.

19

----

We enter into variouscommercial commitments, which may affect the liquidity of our operations.  At September 30, 2006, these include:

Credit facilities:

We have a $100 million, 364-day unsecured creditfacility that is renewable annually and expires on May 30, 2010.  At September 30, 2006, there were noborrowings outstanding under this credit agreement.  The new facility may be increased up to $150million.

Guarantee:

We own a 4.9% equity ownership interest in an electricgeneration company.  As of September 30,2006, we could be responsible for the repayment of 4.9%, or $21.8 million, of a$445 million debt obligation that matures in 2026.

**8.****              Peaking GeneratingFacilities**

Through DPL Energy, DPL owns peaking facilities towhich DP&L has rights to the capacity, energy and ancillary serviceoutput.  DPL has received and isevaluating purchase offers for three of its peaking generation sites. The sitesrepresent a combined capacity of 872 megawatts and a net book value ofapproximately $300 million.  A decisionabout whether to sell these assets has not been made or approved. The Companybelieves that if terms could be reached with potential buyers a transactioncould be taken to its Board for approval during the fourth quarter of 2006. Ifapproved, a transaction is not expected to close until the first half of 2007.

**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations  **

Certainstatements contained in this discussion are “forward-looking statements” withinthe meaning of the Private Securities Litigation Reform Act of 1995.  Matters discussed in this report that relateto events or developments that are expected to occur in the future, includingmanagement’s expectations, strategic objectives, business prospects,anticipated economic performance and financial condition and other similarmatters constitute forward-looking statements. Forward-looking statements are based on management’s beliefs,assumptions and expectations of our future economic performance, taking intoaccount the information currently available to management.  These statements are not statements ofhistorical fact.  Such forward-lookingstatements are subject to risks and uncertainties and investors are cautionedthat outcomes and results may vary materially from those projected due tovarious factors beyond our control, including but not limited to:  abnormal or severe weather; unusualmaintenance or repair requirements; changes in fuel costs and purchased power,coal, environmental emissions, gas and other commodity prices; increasedcompetition; regulatory changes and decisions; changes in accounting rules;financial market conditions; and general economic conditions.

Forward-lookingstatements speak only as of the date of the document in which they aremade.  These forward-looking statementsare identified by terms and phrases such as “anticipate”, “believe”, “intend”, “estimate”,“expect”, “continue”, “should”, “could”, “may”, “plan”, “project”, “predict”, “will”,and similar expressions.  We disclaim anyobligation or undertaking to provide any updates or revisions to anyforward-looking statement to reflect any change in our expectations or anychange in events, conditions or circumstances on which the forward-lookingstatement is based.

20

----

**UPDATES/OTHER MATTERS**

**Peaking Generating Facilities**

Through DPL Energy, DPL owns peaking facilities towhich DP&L has rights to the capacity, energy and ancillary serviceoutput.  DPL has received and isevaluating purchase offers for three of its peaking generation sites. The sitesrepresent a combined capacity of 872 megawatts and a net book value ofapproximately $300 million.  A decisionabout whether to sell these assets has not been made or approved. The Companybelieves that if terms could be reached with potential buyers a transactioncould be taken to its Board for approval during the fourth quarter of 2006. Ifapproved, a transaction is not expected to close until the first half of 2007.

**Updates on Competition and Regulation**

On April 4, 2005, wefiled a request at the Public Utilities Commission of Ohio (PUCO) to implementa new rate stabilization surcharge effective January 1, 2006 to recovercost increases associated with environmental capital and related operations andmaintenance costs, and fuel expenses.  OnNovember 3, 2005, we entered into a settlement agreement that extended our ratestabilization period through December 31, 2010. During this time, we will continue to provide retail electric service atfixed rates with the ability to recover increased fuel and environmental coststhrough surcharges and riders. Specifically, the agreement provides for:

·                  A ratestabilization surcharge equal to 11% of generation rates beginning January 1,2006 and continuing through December 2010. Based on 2004 sales, this rider is expected to result in approximately$65 million in net revenues per year.

·                  A new environmentalinvestment rider to begin January 1, 2007 equal to 5.4% of generation rates,with incremental increases equal to 5.4% each year through 2010.  Based on 2004 sales, this rider is expectedto result in approximately $35 million in annual net revenues beginning January2007, growing to approximately $140 million in annual new revenues by 2010.

·                  An increase tothe residential generation discount from January 1, 2006 through December 31,2008 which is expected to result in a revenue decrease of approximately $7million per year for three years, based on 2004 sales.  The residential discount is accounted for inthe $65 million net revenue stated above, and will expire on December 31, 2008.

On December 28, 2005, thePUCO adopted the settlement with certain modifications (RSS Stipulation).  The PUCO ruled that the environmental riderwill be bypassable by all customers who take service from alternate generationsuppliers.  Future additional revenuesare dependent upon actual sales and levels of customer switching.  Applications for rehearing were denied andthe case was appealed to the Ohio Supreme Court by the Ohio Consumers’ Counsel(OCC) on April 21, 2006.  On September 1,2006, DP&L made a tariff filing to implement the environmental investmentrider beginning January 1, 2007.

We agreed to implement aVoluntary Enrollment Process that would provide residential customers with anoption to choose a competitive supplier to provide their retail generationservice should switching not reach 20% in each customer class.  During2005, approximately 51 thousand residential customers that volunteered for theprogram were bid out to Competitive Retail Electric Service (CRES) providerswho were registered in our service territory; however, no bids were receivedand the 2005 program ended.  As part of the RSS Stipulation, we agreed toimplement the Voluntary Enrollment Program again in 2006 and 2007. Approximately 25 thousand residential customers have volunteered for the 2006program.  As of October 16, 2006, all four rounds of bids were complete,which resulted in no bids being received.  The magnitude of any customerswitching and the financial impact of this program in 2007 cannot be determinedat this time.

As of September 30, 2006,four unaffiliated marketers were registered as CRES providers in our serviceterritory; to date, there has been little activity from these suppliers. DPL Energy Resources, Inc. (DPLER), one of our parent’s significantsubsidiaries, is also a registered CRES provider and accounted forsubstantially all of the load served by CRES providers within our serviceterritory in 2006.  In addition, several communities in our service areahave passed ordinances allowing the communities to become governmentaggregators for the purpose of offering alternative electric generationsupplies to their citizens.  To date,none of these communities have aggregated their generation load.

In early 2004, there wasa complaint filed at the PUCO concerning the pricing of our billingservices.  The parties reached asettlement on the price we charge CRES providers for performing billingservices.  The PUCO issued an Orderapproving the settlement with minor modifications.  This Order gave us the authority to defercosts of approximately $16 million plus carrying charges, and later requestPUCO approval for recovery of those costs from all customers.  The PUCO denied applications for rehearing,and the deferral case was appealed to the Ohio Supreme Court.  On September 27, 2006, the Supreme Courtissued a decision affirming the PUCO’s order in this case.  On June 17, 2005, we filed a subsequent case,requesting PUCO approval for recovery of the deferred billing 

21

----

costs plus carryingcharges.  On March 1, 2006, the PUCOapproved our recovery of this cost with one minor modification.  This new rider is expected to result inapproximately $7 million in additional annual revenue beginning March 2006through 2010.  On March 30, 2006, the OCCfiled an appeal of this new rider to the Ohio Supreme Court.  Within that appeal, the OCC filed a motion tostay our recovery of this new rider.  Themotion for stay was subsequently denied by the Court.  On October 19, 2006, the OCC filed to dismisstheir appeal, but an appeal related to this matter filed by the Ohio Partnersfor Affordable Energy is still pending.

On September 1, 2005, we filed an applicationrequesting the PUCO grant us authority to recover distribution costs associatedwith storm restoration efforts for ice storms that took place in December 2004and January 2005.  In February 2006, wefiled updated schedules in support of our application.  On July 12, 2006, the PUCO approved ourfiling, allowing the Company to recover approximately $8.6 million inadditional revenues over a two-year period. The OCC filed an application for rehearing in this case that wassubsequently denied by the PUCO.

OnAugust 28, 2006, the Staff of the PUCO issued a report relating to compliancewith the Federal Energy Policy Act of 2005. In that report the Staff makes recommendations to the Commission toimplement new rules and procedures relating to net metering, customer generatorinterconnection, stand by power, time-of-use rates, and renewable energyportfolio standards.  We, among others,filed comments on September 18, 2006, and reply comments on October 6, 2006.  If adopted by the Commission, theserecommendations may result in new regulatory requirements for Ohio investor-ownedutilities related to renewable energy standards, fuel sources, automated meterinfrastructure, and time differentiated rate options for customers.  The financial implications of this mattercannot be determined at this time.

OnJuly 23, 2003, the Federal Energy Regulatory Commission (FERC) issued an Orderthat the rates for transmission service of seven companies, including us, maybe unjust, unreasonable, or unduly discriminatory or preferential.  A number of orders have since been issued onthe subject of how best to modify rates. As a result, the FERC ordered utilities to eliminate certain charges andto implement transitional charges, known as Seams Elimination Charge Adjustment(SECA), effective December 1, 2004 through March 31, 2006, subject to refund.Through this proceeding, we are obligated to pay SECA charges to otherutilities, but we receive a net benefit from these transitional payments.  Beginning May 2005, we began receiving SECApayments and have received over $24.8 million, net of SECA charges, throughSeptember 2006.  Several parties havesought rehearing of the FERC orders which are still pending.  The hearing was held in May 2006 and aninitial decision was issued on August 10, 2006 that, if upheld by the FERC,would reduce the amount of SECA charges we and other parties are permitted torecover.  We, among others, have takenexception to the initial decision.  Afinal FERC order on this issue is expected later this year.  We have entered into a significant number ofbi-lateral settlement agreements with certain parties to resolve the matter,which by design will be unaffected by the FERC’s decision to affirm, modify, orreject the initial decision.  We believewe have recorded adequate reserves related to the proposed adjustments;however, we cannot predict the outcome.

OnMay 31, 2005, the FERC instituted a proceeding under Federal Power Act Section206 concerning the justness and reasonableness of PJM’s transmission ratedesign.  This proceeding sets the ratesfor hearing and requests that all of PJM members, which include us, address thejustness and reasonableness of the current rate design.  On November 22, 2005, we, along with tenother transmission owners, filed in support of PJM’s existing rate design.  A hearing was held in April 2006 and aninitial decision was issued on July 13, 2006 recommending a rate designdifferent than PJM’s existing rate design. We expect a final FERC order on this issue later this year.  Due to the comment and appeal process, thepotential for adjustments to the initial decision and the complexity of theissues, we cannot determine what effect the final outcome of this proceedingmay have on our future recovery of transmission revenues.

PJMhas a proposal before FERC that may affect the value of our generation capacity. The proposal introduces a new Reliability Pricing Model (RPM) that would changethe way generation capacity is priced and planned for by PJM.  OnSeptember 29, 2006, a settlement agreement executed by us along with most ofthe parties to the case was filed that generally retains the RPM concept asproposed by PJM, with certain modifications.  If approved by theFERC, the economic effects of the settlement will vary depending on futuremarket conditions.

**Updates on Environmental Considerations**

***Air and Water Quality***

OnDecember 17, 2003, the United States Environmental Protection Agency(USEPA) proposed the Interstate Air Quality Rule (IAQR) designed to reduce andpermanently cap sulfur dioxide (SO2)and nitrogen oxide (NOx) emissions from electric utilities.  The proposed IAQR focused on states,including Ohio, whose power plant emissions are believed to be significantlycontributing to fine particle and ozone pollution in other downwind states in 

22

----

the eastern UnitedStates.  On June 10, 2004, the USEPAissued a supplemental proposal to the IAQR, now renamed as the Clean AirInterstate Rule (CAIR).  The final ruleswere signed on March 10, 2005 and were published on May 12, 2005.  On August 24, 2005, the USEPA proposedadditional revisions to the CAIR and initiated reconsideration on oneissue.  On March 15, 2006, the USEPAannounced it had completed its review of the requests for reconsideration anddetermined that it would propose no changes to CAIR and denied the requests forstay.  We have determined that CAIRrequirements will have a material effect on our operations, requiring theinstallation of flue gas desulfurization (FGD) equipment and continualoperation of the currently installed Selective Catalytic Reduction (SCR)equipment.  As a result, we areproceeding with the installation and have begun the construction of FGDequipment at various generating units.

OnJanuary 30, 2004, the USEPA published its proposal to restrict mercury andother air toxins from coal-fired and oil-fired utility plants.  The final Clean Air Mercury Rule (CAM-R) wassigned March 15, 2005 and was published on May 18, 2005. The final rules willhave a material effect on our operations. We anticipate that the FGDs being installed to meet the requirements ofCAIR may be adequate to meet the Phase I requirements of CAM-R.  We expect that additional controls will beneeded to meet the Phase II requirements of CAM-R that go into effect January1, 2018.  On March 29, 2005, nine statesfiled lawsuits against USEPA, opposing the regulatory approach taken byUSEPA.  On March 31, 2005, various groupsrequested that USEPA stay implementation of CAM-R.  On August 4, 2005, the United States Court ofAppeals for the District of Columbia denied the motion for stay.  On October 21, 2005, USEPA initiatedreconsideration proceedings on a number of issues.  On May 31, 2006, USEPA took final action onCAM-R essentially reaffirming its original rulemaking.

Under the CAIR andCAM-R cap and trade programs for SO2, NOx and mercury, we estimate we will spend more than $465 million from2006 through 2008 to install the necessary pollution controls.  If CAM-R litigation results in plant specificmercury controls, our costs may be higher. Due to the ongoing uncertainties associated with the litigation of theCAM-R, we cannot project the final costs at this time.

**RISKFACTORS**

A comprehensive listingof risk factors that we consider to be the most significant to your decision toinvest in us is provided in our most recent Form 10-K and is incorporatedherein by reference.  The Form 10-K maybe obtained as discussed on page 2, ‘Available Information.’  Any updates are provided in Part II, Item 1A “RiskFactors” of this quarterly report and the quarterly reports for March 31, 2006and June 30, 2006.  If any of theseevents occur, our business results of operations, financial position or cashflow could be materially affected.

**RESULTSOF OPERATIONS**

**Income Statement Highlights**
|                                          | ** **      | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|------------------------------------------|-----------------|----------------------------------|------------|---------------------------------|------------|
| ** **                               | ** **      | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **$ in millions**              | ** **      | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                     |            |                             |       |                            |       |   |   |   |   |
| Revenues                                 | ** **      | **$**                            | **390.3**  |                            | $          | 355.5 | ** ** | **$** | **1,036.1** |   | $ | 952.0 |   |
| Less:                                    | Fuel            | ** **                       | **91.0**   |                            | 87.9       | ** ** | **251.1** |   | 235.1 |   |
|                                     | Purchased power | ** **                       | **70.7**   |                            | 48.3       | ** ** | **134.7** |   | 116.0 |   |
| Gross margin                             | ** **      | **$**                            | **228.6**  |                            | $          | 219.3 | ** ** | **$** | **650.3** |   | $ | 600.9 |   |
|                                     |            |                             |       |                            |       |   |   |   |   |
| Gross margin as a percentage of revenues | ** **      | **58.6**                         | **%**      | 61.7                            | %          | **62.8** | **%** | 63.1 | % |
|                                     |            |                             |       |                            |       |   |   |   |   |
| Operating income                         | ** **      | **$**                            | **107.1**  |                            | $          | 112.1 | ** ** | **$** | **295.3** |   | $ | 279.5 |   |

 

23

----

**Revenues**

Revenues increased 10% to $390.3 million in the third quarter of 2006compared to $355.5 million in the third quarter of 2005 reflecting higheraverage rates for retail sales and greater wholesale sales volume.  These increases were partially offset bylower retail sales volume, lower average rates for wholesale sales anddecreased ancillary revenues associated with participation in a RTO.

Retail revenues increased $13.5 million in the thirdquarter of 2006 compared to 2005, primarily resulting from $21.0 million inhigher average rates and $0.5 million of higher miscellaneous revenues,partially offset by decreased sales volume of $8.0 million relating to milderweather experienced in 2006 compared to 2005. The higher average rates were primarily the result of the ratestabilization plan surcharge and regulated asset recovery riders, most of whichwere implemented early in 2006. Wholesale revenues increased $22.9 million, primarily resulting from a$44.6 million increase in sales volume, partially offset by a $21.7 milliondecrease in average market rates.  Duringthe third quarter of 2006, RTO ancillary revenues decreased $1.6 million to$20.6 million from $22.2 million in the third quarter of 2005.  Cooling degree-days were down 17% to 639 forthe third quarter of 2006 compared to 772 for the same period in 2005.  Heating degree-days increased to 105 for thethird quarter of 2006 compared to 23 for the same period in 2005.

Revenues increased 9% to $1,036.1 million in the first nine months of2006 compared to $952.0 million in the first nine months of 2005, primarilyreflecting higher average rates for retail sales and greater wholesale salesvolume.  These increases were partiallyoffset by lower retail sales volume relating to the milder weather in 2006 ascompared to 2005 and lower wholesale average market rates.

Retail revenues increased $38.2 million in the first nine months of2006 compared to the first nine months of 2005, primarily resulting from a $56.3million increase relating to higher average rates and increased miscellaneousrevenues of $0.9 million, partially offset by decreased sales volume of $19.0million resulting from milder weather experienced in 2006 compared to 2005.  The higher average rates were primarily theresult of the rate stabilization plan surcharge, and regulated asset recoveryriders implemented throughout 2006. Wholesale revenues increased $45.4 million, primarily related to a $71.5million increase in sales volume, partially offset by a $26.1 million decreasein average market rates.  During thefirst nine months of 2006, RTO ancillary revenues increased $0.5 million to$55.7 million from $55.2 million in the first nine months of 2005.  Heating degree-days were down 10% to 3,173for the nine months ended September 30, 2006 compared to 3,538 for the sameperiod in 2005.   In addition, coolingdegree-days were down 20% to 845 for the first nine months of 2006 compared to1,050 for the same period in 2005.

**Gross Margin, Fuel and Purchased Power**

Gross margin in the third quarter of 2006 increased$9.3 million to $228.6 million from $219.3 million in the third quarter of2005.   As a percentage of totalrevenues, however, gross margin decreased 3.1 percentage points to 58.6% from61.7%.  Fuel costs increased by $3.1million or 4% in the three months ended September 30, 2006, as compared to thesame period in 2005, primarily resulting from higher market prices.   Purchased power costs increased $22.4million or 46%, primarily resulting from higher volumes of power purchased dueto less generation being available relating to scheduled maintenance and forcedoutages, partially offset by lower market prices.

Gross margin in the first nine months of 2006increased $49.4 million to $650.3 million from $600.9 million in the first ninemonths of 2005.   As a percentage oftotal revenues, however, gross margin decreased by 0.3 percentage points to62.8% from 63.1%.  Fuel costs increasedby $16.0 million or 7% in the nine months ended September 30, 2006, as a resultof higher market prices and higher generation output as compared to 2005.  Purchased power costs increased by $18.7million or 16% in the first nine months of 2006 compared to the same period in2005 primarily resulting from higher volumes of power purchased.

**Operation and Maintenance Expense**

Operation and maintenance expense increased $12.7 million or 27% in thethird quarter of 2006 compared to the same period in 2005 primarily resultingfrom a $3.8 million increase in employee compensation and benefit expenses, themajority of which was pension related; increased service operations costs of$2.8 million, most of which was related to greater line clearance activity andelectric system overhead and substation costs; a $2.6 million increase in powerproduction costs of which $1.5 million was due to credits received in 2005that were not received in 2006 and increased operating expenses; $1.4 millionin PJM administrative fees; and increased low-income assistance program costsof $1.3 million.

Operation and maintenance expense increased $27.1million or 19% in the first nine months of 2006 compared to the same period inthe prior year primarily resulting from a $7.9 million increase in employeecompensation and benefit expenses, most of which was related to pension expenseand incentive accruals; increased service operations costs of $4.8 million, themajority of which was related to greater line clearance activity; a $4.6million increase in power production costs relating to $3.0 million ofcredits received in 2005 that were not received in 2006 and increased operatingexpenses; $4.2 million in PJM administrative fees, including $2.5 milliondeferred in 2005 by PUCO authority until rate relief was granted in 

24

----

February 2006; increased low-income assistance programcosts of $2.9 million; and a $1.8 million increase in reserves for injuries anddamages.  These increases were partiallyoffset by a $1.1 million decrease in Directors’ and Officers’ liabilityinsurance premiums.

**Depreciation and Amortization**

Depreciation and amortization increased $1.2 millionand $3.9 million in the third quarter and in the first nine months of 2006,respectively, compared to the same periods in 2005 primarily reflecting ahigher plant base.

**General Taxes**

General taxes decreased $1.4 million in the third quarter of 2006compared to the third quarter of 2005 primarily due to a decrease in the OhiokWh tax related to lower retail customer sales resulting from the milderweather experienced in 2006 compared to 2005 and a 2006 adjustment to payrolltaxes.

General taxes decreased $1.1 million in the first nine months of 2006as compared to the same period in 2005 primarily due to an Ohio kWh taxdecrease related to lower retail customer sales resulting from the milderweather experienced in 2006 compared to 2005 and a payroll tax adjustment in2006.  These decreases were partially offset by higher taxes from the newState of Ohio Commercial Activities Tax that began in July 2005.

**Amortization of Regulatory Assets**

For the quarter ended September 30, 2006, amortizationof regulatory assets was $1.8 million higher than the same period in 2005primarily reflecting $0.9 million for the amortization of costs incurred tomodify the customer billing system for unbundled rates and electric choicebills; $0.4 million for the amortization of PJM administrative fees deferredfor the period October 2004 through January 2006; and $0.4 million for theamortization of incremental costs incurred in 2004 and 2005 for severe storms.

Amortization of regulatory assets increased $3.7million for the nine months ended September 30, 2006 compared to the sameperiod in the prior year primarily reflecting $1.8 million for the amortizationof costs incurred to modify the customer billing system to accommodateunbundled rates and electric choice bills; $1.0 million for the amortization ofdeferred PJM administrative fees; $0.4 million for the amortization of deferredsevere storm costs incurred in 2004 and 2005; and $0.3 million for theamortization of costs incurred to integrate us into the PJM system.  We received orders from the PUCO in the firstquarter of 2006 approving the recovery of the customer billing costs and PJMadministrative fees through rate riders beginning March 2006 and February 2006,respectively.  In July 2006, we receiveda PUCO order approving the recovery of the incremental storm costs through arate rider beginning in August 2006.  Thecustomer billing costs rate rider is expected to be in place for five years,the PJM administrative fee rate rider is expected to collect deferred costsover a three-year period, and the storm costs rate rider is expected to be inplace for two years.

**Investment Income**

Investment income decreased $0.9 million during thethird quarter of 2006 compared to the third quarter of 2005 primarily due tolower interest income earned from cash on deposit.

Investment income remained stable for the nine monthsended September 30, 2006 compared to the nine months ended September 30, 2005,increasing only $0.2 million or 4%.

## **OtherIncome (Deductions)**

Other income (deductions) remained relatively stable in the thirdquarter of 2006 compared to the third quarter of 2005, decreasing only $0.6million that was comprised of various minor items.

Other income (deductions) for the nine months endedSeptember 30, 2006 decreased $4.4 million compared to the same period in2005.  This decrease is primarilyattributable to $12.3 million in gains recognized on the sale of pollutioncontrol emission allowances during 2005, partially offset by $7.0 million inreduced investment management fees.

**Charge for Early Redemption of Debt**

For the three months and nine months ended September30, 2005, we recorded a $4.1 million charge resulting from premiums paid forthe early redemption of debt, including the write-off of unamortized debtexpense associated with the refinancing of our pollution control debt atreduced interest rates.  There was no suchactivity in 2006.

25

----

**Interest Expense**

Interest expense decreased $4.6 million or 46% for thethree months ended September 30, 2006 compared to the same period in 2005,primarily relating to $3.6 million of greater capitalized interest resultingfrom increased capital expenditures for pollution control equipment at thegenerating plants and $1.7 million of lower interest expense reflecting the2005 refinancing of pollution control bonds at reduced interest rates and lower debt service charges associated with DPLInc.’s early retirement of ESOP debt.

Interest expense decreased $13.2 million or 43% in thefirst nine months of 2006 compared to the first nine months of 2005, primarilyrelating to $8.0 million of increased capitalized interest resulting from higherpollution control capital expenditures at the generating plants and $5.3million of lower interest expense reflecting the refinancing of pollutioncontrol bonds at reduced interest rates in 2005, lower debt service charges associated with DPL Inc.’s early retirement ofESOP debt, and the elimination of the interest penalty resulting fromthe delayed exchange offer of the $470 million 5.125% series First MortgageBonds.  See Note 6 of Notes toConsolidated Financial Statements.

## **Income TaxExpense**

Income taxes increased $1.3 million for the thirdquarter of 2006 compared to the same period in 2005 reflecting higher bookincome offset by a decrease in the effective tax rate related to the phase-outof the Ohio Franchise Tax.

Income taxes increased $6.3million for the first nine months of 2006 compared to the first nine months of2005 reflecting higher book income offset in part by a decrease in theeffective tax rate related to the phase-out of the Ohio Franchise Tax and adecrease in the tax reserve.

26

----

**FINANCIAL CONDITION, LIQUIDITY AND CAPITALRESOURCES**

Our cash and cashequivalents totaled $57.7 million at September 30, 2006, compared to $46.2million at December 31, 2005, an increase of $11.5 million. This increase wasattributed to $270.7 million in cash generated from operating activities and $23.1million of pollution control restricted funds, partially offset by $281.7million in capital expenditures and $0.6 million in dividends paid on preferredstock.

We generated net cashfrom operating activities of $270.7 million and $273.5 million for the firstnine months of 2006 and 2005, respectively. The net cash provided by operatingactivities in both years was primarily the result of operating profitability;and by cash provided by certain assets and liabilities.  The tariff-based revenue from our businesscontinues to be the principal source of cash from operating activities.  Management believes that the diversified retailcustomer mix of residential, commercial, and industrial classes provides uswith a reasonably predictable cash flow from utility operations.

Net cash flows used forinvesting activities were $281.7 million and $137.1 million in the nine monthsended September 30, 2006 and 2005, respectively, to provide funding for capitalexpenditures.

Net cash flows providedby financing activities were $22.5 million in the first nine months of 2006compared to cash used for financing activities of $83.3 million in the firstnine months of 2005.  Net cash flows providedby financing activities for the nine months ended September 30, 2006 wereprimarily the result of $23.1 million of draws from funds held by the trusteeto finance our solid waste pollution control capital expenditures, partiallyoffset by $0.6 million of dividends on preferred stock.  Net cash flows used for financing activitiesfor the nine months ended September 30, 2005 were used to retire long-term debtand pay dividends on common and preferred stock.  These uses of cash were partially offset bythe issuance of long-term debt.

Wehave obligations to make future payments for capital expenditures, debtagreements, lease agreements and other long-term purchase obligations, and havecertain other contingent commitments.  Webelieve our cash flows from operations, the credit facilities (existing orfuture arrangements), and other short- and long-term debt financing, will besufficient to satisfy our future working capital, capital expenditures andother financing requirements for the foreseeable future.  Our ability to generate positive cash flowsfrom operations is dependent on general economic conditions, competitivepressures, and other business and risk factors. If we are unable to generate sufficient cash flows from operations, orotherwise comply with the terms of our credit facilities and long-term debt, wemay be required to refinance all or a portion of our existing debt or seekadditional financing alternatives.  Adiscussion of each of our critical liquidity commitments is outlined below.

**Capital Requirements**

Capital expenditures were $281.7 million and $137.1 million for thefirst nine months of 2006 and 2005, respectively, and are expected toapproximate an aggregate amount of $360 million in 2006.  Planned construction additions for 2006primarily relate to our environmental compliance program, power plantequipment, and our transmission and distribution system.

Capital projects aresubject to continuing review and are revised in light of changes in financialand economic conditions, load forecasts, legislative and regulatorydevelopments and changing environmental standards, among other factors.  For the period 2006 through 2008, we areprojecting to spend an estimated $820 million in capital projects (previously$810 million), approximately 57% of which is to meet changing environmentalstandards.  Our ability to complete ourcapital projects and the reliability of future service will be affected by ourfinancial condition, the availability of internal and external funds atreasonable cost, and adequate and timely return on these capitalinvestments.  We expect to finance ourconstruction additions in 2006 with a combination of cash on hand, tax-exemptdebt and internally-generated funds.

**Debt and Debt Covenants**

At September 30, 2006, our scheduledmaturities of capital lease obligations, over the next five years are $0.2million for the remainder of 2006, $0.9 million in 2007, $0.7 million in 2008,$0.7 million in 2009 and $0.7 million in 2010.  Substantially all of our property is subjectto the mortgage lien securing the first mortgage bonds.  Debt maturities in 2006 are expected to befinanced with internal funds.  Certaindebt agreements contain reporting and financial covenants for which we are incompliance as of September 30, 2006 and expect to be in compliance during thenear term.

Issuanceof additional amounts of first mortgage bonds is limited by the provisions ofour mortgage; however, management believes that we continue to have sufficientcapacity to issue first mortgage bonds to satisfy our requirements inconnection with our construction programs. The amounts and timing of future financings will

27

----

dependupon market and other conditions, interest rate increases, levels of electricsales and construction plans.

We have a $100million unsecured revolving credit agreement that is renewable annually andexpires on May 30, 2010.  This facilitymay be increased up to $150 million.  Thefacility contains one financial covenant: our total debt to total capitalization ratio is not to exceed 0.65 to1.00.  This covenant is currentlymet.  We had no outstanding borrowingsunder this credit facility at September 30, 2006.  Fees associated with this credit facility areapproximately $0.2 million per year. Changes in credit ratings, however, may affect fees and the applicableinterest rate for our revolving credit agreement.

Duringthe first quarter of 2006, the Ohio Department of Development (ODOD) awarded usthe ability to issue over the next three years up to $200 million of qualifiedtax-exempt financing from the ODOD’s 2005 volume cap carryforward.  The financing is to be used to partially fundthe ongoing FGD projects.  The PUCOapproved our application for this additional financing on July 26, 2006.

On September 13, 2006, the Ohio Air QualityDevelopment Authority (OAQDA) issued $100 million of 4.80% fixed interest rate OAQDARevenue Bonds 2006 Series A due September 1, 2036. In turn, DP&L thenborrowed these funds from the OAQDA. Payment of principal and interest on theBonds when due is insured by an insurance policy issued by Financial GuarantyInsurance Company. We are using the proceeds from these borrowings to assist infinancing our portion of the costs of acquiring, constructing and installingcertain solid waste disposal facilities comprising air quality facilities atMiami Fort, Killen and Stuart Generating Stations.  These facilities are currently underconstruction and the proceeds from the borrowings have been placed in escrowwith the trustee (the Bank of New York) and are being drawn upon only asfacilities are built and qualified costs incurred.  In the event any ofthe proceeds are not drawn, we would eventually be required to return theunused proceeds to bondholders.  We expect to draw down all of theproceeds from this borrowing over the next year.

Weexpect to use the remaining $100 million volume cap carryforward prior tothe end of 2008. We are planning to issue in conjunction with the OAQDA another$100 million of tax-exempt bonds to finance the remaining solid waste disposalfacilities at Miami Fort, Killen, Stuart and Conesville Generating Stations.

On February 17, 2006, werenewed our $10 million Master Letter of Credit Agreement for one yearwith a financial lending institution. This agreement supports performance assurance needs in the ordinarycourse of business.  We have certaincontractual agreements for the sale and purchase of power, fuel and relatedenergy services that contain credit rating related clauses allowing the counterparties to seek additional surety under certain conditions.  As of September 30, 2006, we had twooutstanding letters of credit for a total of $2.2 million.

There are nointer-company debt collateralizations or debt guarantees between us and ourparent.  None of our debt obligations areguaranteed or secured by affiliates and no cross-collateralization existsbetween any subsidiaries.

**Credit Ratings**

Currently, our senior secured debt credit ratings areas follows:
|                                        | ** ** | **Rating** | ** ** | **Outlook** | ** ** | **Effective** |
|----------------------------------------|------------|------------|------------|-------------|------------|---------------|
|                                   |       |       |       |        |       |          |
| Fitch Ratings                          |       | A          |       | Stable      |       | April 2006    |
|                                   |       |       |       |        |       |          |
|  Moody’s Investors Service   |       | A3         |       | Positive    |       | June 2006     |
|                                   |       |       |       |        |       |          |
|  Standard & Poor’s Corp. |       | BBB        |       | Positive    |       | August 2006   |

 

**Off-Balance Sheet Arrangements**

Wedo not have any off-balance sheet arrangements that have or are reasonablylikely to have a current or future effect on our financial condition, revenuesor expenses, results of operations, liquidity, capital expenditures or capitalresources that are material to investors.

28

----

**ContractualObligations and Commercial Commitments**

We enter into variouscontractual and other long-term obligations that may affect the liquidity ofour operations.  At September 30, 2006,these include:

**Contractual Obligations**

 
| ** **                           | ** ** | ** ** | ** ** | **Payment Year**           | ** ** |
|--------------------------------------|------------|------------|------------|---------------------------------|------------|
| **$ in millions**          | ** ** | **Total**  | ** ** | **Less than 1  Year** | ** ** | **2 - 3 Years** | ** ** | **4 - 5 Years** | ** ** | **More than  5 Years** | ** ** |
|                                 |       |       |       |                            |       |   |   |   |   |   |   |
| Long-term debt                       |       | $          | 783.1      |                            | $          | — |   | $ | — |   | $ | — |   | $ | 783.1 |   |
| Interest  payments                   |       | 581.7      |       | 39.1                            |       | 78.3 |   | 78.3 |   | 386.0 |   |
| Pension and  postretirement payments |       | 249.2      |       | 33.4                            |       | 46.0 |   | 47.2 |   | 122.6 |   |
| Capital leases                       |       | 3.2        |       | 1.1                             |       | 1.4 |   | 0.7 |   | — |   |
| Operating leases                     |       | 0.5        |       | 0.3                             |       | 0.2 |   | — |   | — |   |
| Fuel and  limestone contracts (a)    |       | 586.8      |       | 86.7                            |       | 315.5 |   | 97.5 |   | 87.1 |   |
| Other long-term  obligations         |       | 27.5       |       | 14.6                            |       | 9.8 |   | 3.1 |   | — |   |
| Total  contractual obligations       |       | $          | 2,232.0    |                            | $          | 175.2 |   | $ | 451.2 |   | $ | 226.8 |   | $ | 1,378.8 |   |

 

----

(a) DP&Loperated units.

 

Long-term debt:

Long-term debt as of September 30, 2006, consists ofour first mortgage bonds and tax-exempt pollution control bonds and includes anunamortized debt discount.  (See Note 6of Notes to Consolidated Financial Statements.)

Interest payments:

Interest payments associated with the long-term debtdescribed above.

Pension andpostretirement payments:  

As of September 30, 2006, we had estimated futurebenefit payments as outlined in Note 4 of Notes to Consolidated FinancialStatements.  These estimated futurebenefit payments are projected through 2016.

Capital leases:

As of September 30, 2006,we had two capital leases that expire in November 2007 and September 2010.

Operating leases:

As of September 30, 2006,we had several operating leases with various terms and expiration dates.  Not included in this total is approximately$88 thousand per year related to right-of-way agreements that are assumed tohave no definite expiration dates.

Fuel and limestonecontracts:

We have entered intovarious long-term coal contracts to supply portions of our coal requirementsfor our generating plants and a long-term contract to supply limestone for theoperation of our flue gas desulfurization (FGD) units.  Coal contract prices are subject to periodicadjustment, and have features that limit price escalation in any given year.

A new long-term bargeagreement was executed for five years beginning September 2006.

Other long-termobligations:

As of September 30, 2006,we had various other contractual obligations including non-cancelable contractsto purchase goods and services with various terms and expiration dates.

29

----

We enter into variouscommercial commitments, which may affect the liquidity of our operations.  At September 30, 2006, these include:

Credit facilities:

We have a $100 million, 364-day unsecured creditfacility that is renewable annually and expires on May 30, 2010.  At September 30, 2006, there were noborrowings outstanding under this credit agreement.  The facility may be increased up to $150million.

Guarantee:

We own a 4.9% equityownership interest in an electric generation company.  As of September 30, 2006, we could beresponsible for the repayment of 4.9%, or $21.8 million, of a $445 million debtobligation that matures in 2026.

**MARKETRISK**

Asa result of our operating, investing and financing activities, we are subjectto certain market risks, including fluctuations in interest rates and changesin commodity prices for electricity, coal, environmental emissions andgas.  Commodity pricing exposure includesthe impacts of weather, market demand, potential coal supplier contractbreaches or defaults, increased competition and other economic conditions.  For purposes of potential risk analysis, weuse sensitivity analyses to quantify potential impacts of market rate changeson the results of operations.  Thesensitivity analyses represent hypothetical changes in market values that mayor may not occur in the future.

**CommodityPricing Risk**

 

Approximately 22% of ourfirst nine months 2006 revenues were from sales of excess energy and capacityin the wholesale market.  Energy andcapacity in excess of the needs of existing retail customers are sold in thewholesale market when we can identify opportunities with positive margins.  As of September 30, 2006, a hypotheticalincrease or decrease of 10% in annual wholesale revenues could result inapproximately a $19 million increase or decrease to net income, assuming noincreases or decreases in fuel and purchased power costs.

We have approximately100% and 83% of the total expected coal volume needed for 2006 and 2007,respectively, under contract.  Themajority of our contracted coal is purchased at fixed prices.  Some contracts provide for periodicadjustment and some are priced based on market indices.  Substantially all contracts have featuresthat limit price escalations in any given year. Our 2006 emission allowance (SO2   andNOx) consumptionis expected to be similar to 2005.  Our holdings of SO2 and NOx allowances are approximately equal to our expectedneeds from 2006 through 2010.  There may be exchanges of allowancesbetween future years to balance our 2006-2010 position.  We do not expectto purchase allowances outright for 2006. The exact consumption of SO2 and NOx allowances willdepend on market prices for power and availability of our generating units.  The utilization of SO2 allowances will depend upon actualsulfur content of the coal burned.  Fuelcosts are impacted by changes in volume and price and are driven by a number ofvariables including weather, reliability of coal deliveries, scheduled outagesand generation plant mix.  Fuel costs are forecasted to increaseapproximately 7% in 2006 compared to 2005 and are forecasted to increaseapproximately 5% in 2007 compared to 2006. This forecast assumes coal prices will increase approximately 10% in2006 as compared to 2005 and increase approximately 5% in 2007 as compared to2006.

Purchased power costsdepend, in part, upon the timing and extent of planned and unplanned outages ofour generating capacity.  We willpurchase power on a discretionary basis when wholesale market conditionsprovide opportunities to obtain power at a cost below our internal productioncosts. As of September 30, 2006, a hypothetical increase or decrease of 10% inannual fuel and purchased power costs, excluding Regional TransmissionOrganization (RTO) services, could result in approximately a $29 millionincrease or decrease to net income.

30

----

**InterestRate Risk**

 

As a result of our normal borrowing and leasingactivities, our results are exposed to fluctuations in interest rates, which wemanage through our regular financing activities.  We maintain both cash on deposit and investmentsin cash equivalents that may be affected by interest rate fluctuations.  Our long-term debt represents publicly-heldsecured notes with fixed interest rates. At September 30, 2006, we had no short-term borrowings.

The carrying value of ourdebt was $786.3 million at September 30, 2006, consisting of our first mortgagebonds, our tax-exempt pollution control bonds and our capital leases.  The fair value of this debt was $789.5million, based on current market prices or discounted cash flows using currentrates for similar issues with similar terms and remaining maturities.  The principal cash repayments and relatedweighted average interest rates by maturity date for long-term, fixed-rate debtat September 30, 2006 are as follows:
|                            | ** ** | **Long-term Debt**       | ** ** |
|----------------------------|------------|-------------------------------|------------|
| **Expected Maturity** | ** ** | **Amount**                    | ** ** | ** ** | ** ** |
| **Date**                   | ** ** | **($ in millions)** | ** ** | **Average Rate** | ** ** |
|                       |       |                          |       |   |   |
| 2006                       |       | ** **                    | **$**      | **0.2** |   | 6.0 | % |
| 2007                       |       | ** **                    | **0.9**    |   | 6.1 | % |
| 2008                       |       | ** **                    | **0.7**    |   | 6.9 | % |
| 2009                       |       | ** **                    | **0.7**    |   | 6.9 | % |
| 2010                       |       | ** **                    | **0.7**    |   | 6.9 | % |
| Thereafter                 |       | ** **                    | **783.1**  |   | 5.0 | % |
| Total                      |       | ** **                    | **$**      | **786.3** |   | 5.0 | % |
|                       |       |                          |       |   |   |   |
| Fair Value                 |       | ** **                    | **$**      | **789.5** | ** ** | ** ** | ** ** |

 

Debt maturities in 2006are expected to be financed with internal funds.

**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

We prepare ourconsolidated financial statements in accordance with accounting principlesgenerally accepted in the United States of America (GAAP).

Thepreparation of financial statements in conformity with GAAP requires us to makeestimates and judgments that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements, and the revenue and expenses of the periodreported.  Different estimates could havea material effect on our financial results. Judgments and uncertainties affecting the application of these policiesand estimates may result in materially different amounts being reported underdifferent conditions or circumstances. Significant items subject to such estimates and judgments include thecarrying value of property, plant and equipment; unbilled revenues; thevaluation of derivative instruments; valuation allowances for receivables anddeferred income taxes; reserves recorded for income tax exposures; litigation;regulatory proceedings and orders; and assets and liabilities related to employeebenefits.  Actual results may differ fromthose estimates.  Refer to our 2005Annual Report filed on Form 10-K for a complete listing of our criticalaccounting policies and estimates.

31

----

**THE DAYTONPOWER AND LIGHT COMPANY**

**OPERATING STATISTICS**

 
| ** **                           | ** ** | **Three months ended** | ** **  | **Nine months ended** | ** ** |
|--------------------------------------|------------|----------------------------------|-------------|---------------------------------|------------|
| ** **                           | ** ** | **September 30,**           | ** **  | **September 30,**          | ** ** |
| ** **                           | ** ** | **2006**                         | ** **  | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                 |       |                             |        |                            |       |   |   |   |   |
| Sales (millions  of kWh)             |       |                             |        |                            |       |   |   |   |   |
|                                 |       |                             |        |                            |       |   |   |   |   |
| Residential                          | ** ** | **1,432**                        |        | 1,546                           | ** ** | **3,939** |   | 4,182 |   |
| Commercial                           | ** ** | **1,075**                        |        | 1,086                           | ** ** | **2,906** |   | 2,937 |   |
| Industrial                           | ** ** | **1,169**                        |        | 1,174                           | ** ** | **3,254** |   | 3,281 |   |
| Other retail                         | ** ** | **380**                          |        | 380                             | ** ** | **1,069** |   | 1,077 |   |
| Other  miscellaneous revenues        | ** ** | **—**                       |        | —                          | ** ** | **—** |   | — |   |
| Total retail                         | ** ** | **4,056**                        |        | 4,186                           | ** ** | **11,168** |   | 11,477 |   |
|                                 |       |                             |        |                            |       |   |   |   |   |
| Wholesale                            | ** ** | **1,149**                        |        | 719                             | ** ** | **2,649** |   | 1,913 |   |
|                                 |       |                             |        |                            |       |   |   |   |   |
| Total sales                          | ** ** | **5,205**                        |        | 4,905                           | ** ** | **13,817** |   | 13,390 |   |
|                                 |       |                             |        |                            |       |   |   |   |   |
| Revenues ($ in  thousands)      |       |                             |        |                            |       |   |   |   |   |
|                                 |       |                             |        |                            |       |   |   |   |   |
| Residential                          | ** ** | **$**                            | **137,317** |                            | $          | 136,337 | ** ** | **$** | **369,412** |   | $ | 362,294 |   |
| Commercial                           | ** ** | **73,672**                       |        | 64,875                          | ** ** | **207,192** |   | 184,372 |   |
| Industrial                           | ** ** | **35,214**                       |        | 33,887                          | ** ** | **98,586** |   | 95,602 |   |
| Other retail                         | ** ** | **22,779**                       |        | 20,844                          | ** ** | **65,074** |   | 60,707 |   |
| Other miscellaneous  revenues        | ** ** | **3,289**                        |        | 2,771                           | ** ** | **8,700** |   | 7,836 |   |
| Total retail                         | ** ** | **272,271**                      |        | 258,714                         | ** ** | **748,964** |   | 710,811 |   |
|                                 |       |                             |        |                            |       |   |   |   |   |
| Wholesale                            | ** ** | **97,438**                       |        | 74,567                          | ** ** | **231,469** |   | 186,029 |   |
|                                 |       |                             |        |                            |       |   |   |   |   |
| RTO ancillary  revenues              | ** ** | **20,653**                       |        | 22,239                          | ** ** | **55,696** |   | 55,191 |   |
|                                 |       |                             |        |                            |       |   |   |   |   |
| Total revenues                       | ** ** | **$**                            | **390,362** |                            | $          | 355,520 | ** ** | **$** | **1,036,129** |   | $ | 952,031 |   |
|                                 |       |                             |        |                            |       |   |   |   |   |
| Electric customers at  end of period | ** ** | **513,469**                      |        | 511,948                         | ** ** | **513,469** |   | 511,948 |   |

 

# **Item 3.  Quantitative and Qualitative Disclosuresabout Market Risk**

See the “Market Risk”section of Item 2.

**Item 4.  Controls and Procedures**

OurChief Executive Officer (CEO) and Chief Financial Officer (CFO) are responsiblefor establishing and maintaining our disclosure controls and procedures.  These controls and procedures were designedto ensure that material information relating to us and our subsidiaries iscommunicated to the CEO and CFO.  Weevaluated these disclosure controls and procedures as of the end of the periodcovered by this report with the participation of our CEO and CFO.  Based on this evaluation, our CEO and CFOconcluded that our disclosure controls and procedures are effective (i) toensure that information required to be disclosed by us in the reports that wefile or submit under the Exchange Act is recorded, processed, summarized andreported, within the time periods specified in the SEC’s rules and forms and(ii) to ensure that information required to be disclosed by us in the reportsthat we submit under the Exchange Act is accumulated and communicated to ourmanagement, including our principal executive and principal financial officers,or persons performing similar functions, as appropriate, to allow timelydecisions regarding required disclosure.

32

----

**Part II.  Other Information**

**Item 1.  LegalProceedings**

 

In the normal course ofbusiness, we have has been named a defendant in various legal actions,including arbitrations, class actions and other litigation. Certain of thelegal actions include claims for substantial compensatory and/or punitivedamages or claims for indeterminate amounts of damages. We are is also involvedin other reviews, investigations and proceedings by governmental andself-regulatory organizations regarding our business. Certain of the foregoingcould result in adverse judgments, settlements, fines, penalties or otherrelief.

Because litigation isinherently unpredictable, particularly in cases where claimants seeksubstantial or indeterminate damages or where investigations and proceedingsare in the early stages, we cannot predict with certainty the loss or range ofloss related to such matters, how such matters will be resolved, when they willbe ultimately resolved, or what the eventual settlement, fine, penalty or otherrelief might be. Consequently, we cannot estimate losses or ranges of lossesfor matters where there is only a reasonable possibility that a loss may havebeen incurred. Although the ultimate outcome of these matters cannot beascertained at this time, it is the opinion of management, that the resolutionof the foregoing matters will not have a material adverse effect on ourfinancial condition, taken as a whole; such resolution may, however, have amaterial effect on the operating results in any future period, depending on thelevel of income for such period.

We have provided reservesfor such matters in accordance with SFAS 5, “Accounting for Contingencies.” Theultimate resolution may differ from the amounts reserved.

Certain legal proceedingsin which we are involved are discussed in Note 11 to the Consolidated FinancialStatements and, Part I, Item 3, of our Annual Report on Form 10-K for thefiscal year ended December 31, 2005; and Note 7 to the Consolidated Financial Statementsand Part II, Item 1, included in our Form 10-Q for the quarterly period endedMarch 31, 2006 and June 30, 2006. The following discussion is limited to recentdevelopments concerning our legal proceedings and should be read in conjunctionwith those earlier reports.

On January 13, 2006, wefiled a claim against one of our insurers, Associated Electric & GasInsurance Services (AEGIS), under a fiduciary liability policy to recoup legalfees associated with our litigation against three former executives.  An arbitration of this matter was held onAugust 4, 2006.  The arbitration panelruled on or about September 12, 2006 that the AEGIS policy does not require anadvance of defense expenses to us. Rather, the arbitration panel stated that we are required to file awritten undertaking as a condition precedent to repay expenses finallyestablished not to be insured.  We havefiled a written undertaking with AEGIS and will continue to pursue resolutionof the claim through mediation and arbitration in 2007.

On February 13, 2006, wereceived correspondence from the Ohio Department of Taxation (ODT) notifying usthat ODT has completed their examination and review of our Ohio CorporationFranchise Tax Returns for tax years 2002 through 2004 and that the finalproposed audit adjustments result in a balance due of $90.8 million beforeinterest and penalties.  We have reviewedthe proposed audit adjustments and are vigorously contesting the ODT findingsand notice of assessment through all administrative and judicial meansavailable. On March 29, 2006, we filed petitions for reassessment with the ODTto protest each assessment as well as request corrected assessments for eachtax year.  On October 12, 2006, we signeda Memorandum of Understanding with the ODT that stated if the ODT’s positionsare ultimately sustained in judicial proceedings, the total additional taxliability that we would be subject to for tax years 2002 through 2004 would beno more than $50.7 million before interest as opposed to the $90.8 millionstated in the ODT’s correspondence of February 13, 2006.  We believe we have recorded adequate taxreserves related to the proposed adjustments; however, we cannot predict theoutcome, which could be material to our results of operations and cash flows.

We are also under auditreview by various state agencies for tax years 2002 through 2004.  We have also filed an appeal to the OhioBoard of Tax Appeals for tax years 1998 through 2001.  Depending upon the outcome of these auditsand the appeal, we may be required to increase our tax provision if actualamounts ultimately determined exceed recorded reserves.  We believe we have adequate reserves in eachtax jurisdiction but cannot predict the outcome of these audits.

33

----

In September 2006, webecame aware of unasserted claims under the Fair Labor Standards Act concerningthe calculation of overtime rates for our unionized workforce.  We will vigorously oppose this claim, if assertedagainst us.  However, if we do notprevail, the cost to us would be in the range of $0-$3.5 million.

OnSeptember 21, 2004, the Sierra Club filed a lawsuit against us and the otherowners of the Stuart Generating Station in the United States District Court forthe Southern District of Ohio for alleged violations of the Clean Air Act (CAA).On October 13, 2006, and pursuant to an approved procedural schedule, theSierra Club filed an amended complaint setting forth additional actions takenby us that the Sierra Club alleges were also in violation of the CAA. We arecurrently reviewing that amended complaint and will vigorously defend ouraction. The case is currently in discovery; a trial date has not been set.

** **

**Item1A. Risk Factors**

 

A comprehensive listingof risk factors that we consider to be the most significant to your decision toinvest in us is provided in our most recent Annual Report on Form 10-K and isincorporated herein by reference.  The Form10-K may be obtained as discussed on page 2, ‘Available Information.’  If any of these events occur, our business,financial position or results of operation could be materially affected.  The following risk factors are additions toour 2005 Annual Report on Form 10-K discussion on risk factors.

Greenhouse gas (GHG)emissions, consisting primarily of carbon dioxide emissions, are presentlyunregulated.  Numerous bills have beenintroduced in Congress to regulate GHG emissions, but to date none havepassed.  Future regulation of GHGemissions is uncertain.  However, suchregulation would be expected to impose costs on our operations.  Such costs could include measures as advancedby various constituencies, including a carbon tax; investments in energyefficiency; installation of CO2 emissions control technology, to the extentsuch technology exists; purchase of emission allowances, should a tradingmechanism be developed; or the use of higher-cost, lower CO2 emitting fuels.  We will continue to make prudent investmentsin energy efficiency that reduces our GHG emissions intensity.

Wright Patterson AirForce Base (WPAFB) represents approximately 1% of our annual revenues.  WPAFB has the right to select anothercompetitive retail electric supplier to meet its generationg needs. EffectiveAugust 2006, WPAFB secures its generation under our standard offer rate untilsuch time as they choose to contract with an alternative supplier. If thisoccurs, this could impact our results of operations.

We are currentlyconstructing flue gas desulfurization (FGD) facilities at five units located atour J. M. Stuart and Killen Electric Generating Stations.  Construction of the FGD facilities at eachunit is scheduled to be completed in phases commencing mid-year 2007 through2008.  We are also co-owners of electricgenerating stations operated by other investor-owned utilities, who are invarious stages of constructing FGD facilities at these stations.  Significant construction delays couldadversely affect our ability to operate or may substantially increase our coststo operate these electric generating stations under federal environmental lawsand regulations that become effective in 2010. For those electric generating stations where we are co-owners but do notoperate, significant construction delays may substantially increase our prorata share of the cost to operate those facilities beginning in 2010.

Annually, PJM, theregional transmission organization that provides transmission services for alarge portion of the midwest United States, performs a review of the capitaladditions required to provide reliable electric transmission servicesthroughout its territory.  PJM allocatesthe costs of constructing these facilities to the applicable entity that willbenefit from the new construction.  FERCis authorized to provide rate recovery to utilities for the costs they incur toconstruct these transmission facilities. To date, we have not been required to construct any new facilities norhave we been assigned any costs as a result of PJM’s annual review, but thereis no guarantee that we will not be assigned some costs or be required toconstruct facilities in the future.

34

----

** **

**Item 6.  Exhibits**
| 4.1    |   | Loan Agreement, dated as of September 1, 2006, by  and between Ohio Air Quality Development Authority and The Dayton Power and  Light Company (Filed as Exhibit 4.1 to the Company’s Current Report on Form  8-K filed on September 19, 2006, File #1-2385)                                                  |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                              |
| 4.2    |   | 44th Supplemental Indenture to the First and  Refunding Mortgage, dated as of September 1, 2006, by and between the Bank of  New York, as trustee and The Dayton Power and Light Company (Filed as Exhibit  4.2 to the Company’s Current Report on Form 8-K filed on September 19, 2006,  File #1-2385) |
|   |   |                                                                                                                                                                                                                                                                                                              |
| 10.1   |   | Non-Employee Director Compensation Summary dated as  of September 19, 2006 (Filed as Exhibit 10.1 to the Company’s Current Report  on Form 8-K filed on September 25, 2006, File #1-2385)                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                              |
| 31.1   |   | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                              |
| 31.2   |   | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                              |
| 32     |   | Certification pursuant to Section 906 of  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                              |

 

35

----

**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|        | ** **            | **THE DAYTON POWER AND LIGHT COMPANY**            | ** **             |
|--------|-----------------------|---------------------------------------------------|------------------------|
|   |                  | (Registrant)                                      |                   |
|   |                  |                                              |                   |
|   |                  |                                              |                   |
|   |                  |                                              |                   |
| Date:  | October 31, 2006 |                                              | /s/ Paul M. Barbas     |   |
|   |                  | Paul M. Barbas                                    |                   |
|   |                  | President and Chief Executive Officer             |                   |
|   |                  | (principal executive officer)                     |                   |
|   |                  |                                              |                   |
|   |                  |                                              |                   |
|   | October 31, 2006 |                                              | /s/ John J. Gillen     |   |
|   |                  | John J. Gillen                                    |                   |
|   |                  | Senior Vice President and Chief Financial Officer |                   |
|   |                  | (principal financial officer)                     |                   |
|   |                  |                                              |                   |
|   |                  |                                              |                   |
|   | October 31, 2006 |                                              | /s/ Frederick J. Boyle |   |
|   |                  | Frederick J. Boyle                                |                   |
|   |                  | Controller and Chief Accounting Officer           |                   |
|   |                  | (principal accounting officer)                    |                   |

 

36

----